A career as an active trader is fast-paced and filled with huge potential rewards, and whilst this is the reason why many people enter the trading world in the first place, you must also be aware of all the rules with which you must comply. Taxes are a complicated matter that none of us enjoy dealing with, and although tax advice offered to traders by the IRS will definitely help you to manage the work, there can still be a mountain of paperwork at tax return time if not handled properly.
Therefore, it is essential, as an active trader, that you set yourself upright and manage your taxes efficiently to avoid throwing away your hard-earned profits.
Here are how traders should manage their taxes in this day and age.
1. Be Smart with your Trading Points
Participating in the business of buying and selling securities means that you are now self-employed in the eyes of the IRS, and that comes with many expense deductions that can work in your favor. All costs incurred from trading will be deducted as in the case of any other self-employed person, and the fact that this can reduce your adjusted gross income means that it is likely that you will be able to make the most out of numerous tax breaks that are often phased out at higher levels.
Your margin account interest can also be deducted (usually for more than 50%) for any necessary equipment that you use in your trading activities – from a computer to a bookshelf and even a fax machine. If you have an office at home that is regularly and exclusively used for trading, there is a further deduction. Perhaps the best tax break, however, is that you don’t have to pay self-employment tax on the net profit that you get from trading.
2. Pay Close Attention to your 1099 Tax Forms
Being prepared is so important when filing your taxes, and for traders and investors like yourself, this task can be relatively simple as there are only a few IRS tax forms to focus on. The most important of these is the 1099 tax form that will typically be sent out to you in the mail somewhere in February. Especially if you are a relative beginner at trading, you may be asking yourself, “What is a 1099 form?” Essentially, 1099 is a document of proof that shows the profits which you have made on your investments and keeps you honest in reporting those profits when you file your taxes. From there, both you and the IRS will be able to figure out your total income during the year and the source of it – and based on this information, you need to report that amount in different places on your tax return.
3. Take Advantage of the Mark-To-Market Rules
Being a trader comes with many benefits and the benefits that the IRS offer can work in your favor if you know how to use them correctly. Instead of being an ordinary investor and having to deal with a tax accounting nightmare from being involved in a regular wash-sale, you can be exempt from this rule by becoming a mark-to-market trader.
Basically, mark-to-market accounting only takes into consideration the total profits and losses of a tax year – and you can “sell” all your holdings at the current market price on that year’s final trading day. Once the new year starts and trading resumes, you begin with a clean slate – with no unrealized gains or losses, as if you have just purchased the shares that you “sold” at the end of the last year. Remember to book all the gains and losses to provide a total accounting of the business assets for tax purposes.
Moreover, mark-to-market traders can deduct losses beyond the $3,000 limit, which is allowed for ordinary investors each year – but you have to make an election on April 15 of the previous tax year to be able to report your gains and losses on Part II of IRS Form 4797.
4. Utilize Financial Software
If you are an active, full-time trader, it is almost impossible to manually keep track of the thousands of individual trades that will be there on your tax return. Remember that the IRS wants to know every bit of information that they can get from you – from the profit or loss of each sale to detailed descriptions of each specific security. In addition, they also want more data about purchase dates, cost, sales proceeds, and sales dates. This is a challenge that every trader has to face each year around the middle of April – and trying to make up or hide details, or being unorganized with your total long and short term gains, will only make the situation with the IRS worse.
So how do you stay on top of all this and keep up with the record of your trades? Fortunately, with modern technology, financial software is a readily available solution that is recommended by many expert traders. Financial software comes with features that allow you to extract trading data from online brokers, and with this valuable information, all you have to do is to transfer it into a separate tax preparation software program of your choice to keep everything organized. That way, you will be able to handle a huge amount of information in a time-efficient manner without breaking a sweat.
Taxes are far from straightforward, and while this guide has provided you with the information you need to make managing your taxes easier, there is still a lot more to know in order to become a trading tax master. As a trader, it is wise to assess your current tax situation and keep on educating yourself to prepare for the future. With that being said, having a tax professional who can assist you in preparing and filing your returns to ensure that you are doing everything by the boom, whilst at the same time making the most out of all the benefits allowed, is definitely beneficial – and is one of the best investments that a trader can make.