Trader Tax Management

Trader Tax Management

OptionsAnimal

Las Vegas Student Summit

September 26, 2009

Disclaimer

OptionsAny strategies used as examples and discussed, using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities.

TaxationAny US tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) providing, marketing or recommending to another party any transaction or matter addressed herein.

The information presented provides only a general discussion of the tax law affecting the taxation of options and is not intended to be applicable to any individual investment and/or tax situation. You are strongly advised to contact your own tax professional in considering the tax consequences of your own specific set of facts and circumstances.

Before We Begin!

What are we going to do? Talk about some of the tax aspects of options trading You will understand more about tax return preparation You should be able to talk more intelligently with your

CPA or tax preparer

What we are not going to do? Teach you to prepare your own tax return Cover intricacies of options taxation exhaustively Answer your specific personal tax questions

Agenda

Tax Tips for DIYers Review – Trader vs Investor Mark-to-Market Accounting Trading in an Entity

Types Benefits & Burdens

Now What? Reporting Investor tax return Trader tax return MTM/Trader tax return

Do-It-Yourselfers

Tax Tips

Tax Tips for DIYers When do you report the sale of a Short Put that

gets assigned? Never Adjusts the basis of the stock assigned Example:

You short in Oct a Jan 10 65 put on RIMM for $4.60 At Jan expiration RIMM dips to $64.94 and you are

assigned the stock Your basis in RIMM is $60.40 (65 – 4.60) The Short Put sale is NOT reported in 2009

If you trade often this is difficult to identify!!

… as a separate transaction

Tax Tips for DIYers

When are Dec option sales reported? Calls – when there is a closing transaction Puts – either:

When there is a closing transaction, or When the assigned stock is sold (lowered basis)

Commodity ETFs – Gold, Silver, Platinum If held one year or less ST capital gain/loss If held more than one year LT, BUT at the

28% collectible rate

Tax Tips for DIYers

ACAT fee reimbursement on retirement funds Considered a contribution to IRA, therefore not

reimbursed, ie, like commission reimbursement Q: Is ACAT fee charged a distribution? 1099-R? Opinion: Must consider retirement account in the

hands of the holder not the individual broker

Gross proceeds from 1099-B agreement to sum of line 3 plus line 10 on Sch D Guaranteed letter from IRS if Sch D < 1099-B Form examples:

Tax Tips for DIYers

Tax Tips for DIYers

Tax Tips for DIYers

Tax Tips for DIYers

Tax Tips for DIYers

Let’s do some math!

Gross proceeds from Form 1099-B $12,480

Option sales (not reported to IRS) 6,325

Subtotal 18,805

Less:

Short put assigned 153

Dec short call 77

Total – Sch D, line 3 $18,575

Tax Tips for DIYers

Index funds qualify as Sec 1256 contracts SPX, OEX, COMP, DJX, RUT 60/40 LTCG treatment

Individual securities/options are taxed, NOT trading strategies The “Put Calendar” is not taxed as a whole The opening & closing transactions of each leg

are taxed as of the closing transaction (FIFO) Example:

Tax Tips for DIYers

Initiate a Put Calendar on SPY in Aug 09 BTO Dec 09 100 FYSXV

STO Sep 09 100 SWGUV BTC/Expire Sep 09 100 SWGUV STO Oct 09 100 SWGVV BTC/Expire Oct 09 100 SWGVV STO Nov 09 100 SWGWV BTC/Expire Nov 09 100 SWGWV

STC Dec 09 100 FYSXV*

Taxable Transaction #1



*Taxable Transaction #4

Tax Tips for DIYers

Initiate a Covered Call/Collar on Amedisys: Buy AMED in early Jun 2009

STO Jun 09 35 Call CQWFG BTC/Expired Jun 09 35 Call CQWFG STO Jul 09 35 Call CQWGG BTO Aug 09 30 Put CQWRH BTC/Expired Jul 09 35 Call CQWGG STO Aug 09 35 Call CQWGH STC Aug 09 30 Put CQWRH Expired Aug 09 35 Call CQWGH

AMED* called at Aug expiration

Taxable Transaction # 1




*Taxable Transaction # 5

Tax Tips for DIYers

Last but not least: DO NOT BLINDLY RELY ON ONLINE OR

BROKERAGE-PROVIDED TAX SOFTWARE!! There are too many exceptions and nuances

At a minimum Download your transactions into Excel Sort and Sum by Ticker and Activity (Open then Close)

Agree 1099-B to stock sales Provide spreadsheet & brokerage statement to CPA

Investor vs Trader

Review of Rules

Investor vs Trader Why? – Subject to different tax rules Definitions:

Investor – Stock purchase for capital appreciation/dividends Little regard for short-term fluctuations; buy and hold

Trader – Regularly and continuously trade stock/securities Trade in own account Profit from short-term fluctuations

Can be BOTH trader and investor IRS presumption Investor

Investor vs Trader Taxation of Investors

Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D / D-1 Subject to $3000 net capital loss limit Subject to IRC Sec 1091 wash sale rules Investment expenses (except interest)

Schedule A miscellaneous itemized deductions Subject to 2% AGI threshold Not deductible for AMT purposes

Interest – deductible up to net investment income (Form 4952) Net investment income does not include

Long-term capital gains Qualified dividends

Investor vs Trader Taxation of Traders

Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D / D-1 Subject to $3000 net capital loss limit Subject to IRC Sec 1091 wash sale rules Investment expenses

Schedule C/E* deductions Interest deductible (for material participation) Home office deduction eligibility

Gains NOT subject to self-employment tax Mark-to-Market (MTM) election eligibility_____________________________________________________________________________________________________

* Flow-through entity, such as partnership, LLC, S-Corp

Investor vs Trader – Expenses Deductible – BOTH Investor and Trader

Investment counsel/advice Subscription services

OptionsAnimal OptionsPlanet OptionsMonster

OptionsAnimal Mentor? – Possibly (see below) OptionsAnimal TUITION? – Possibly (we’ll explore later)

Office expenses – administrative, supplies Pro-rata portion of computer/software used to determine/manage

investments – must be able to substantiate How do you substantiate?

Reg 1.212-1(g) – expenses paid or incurred by the taxpayer … for the management, conservation, or maintenance of investments held by the taxpayer for the production of income

Keep a dated log … trade journal

Investor vs Trader – Expenses

Investor expenses – Summary All expenses for the production of income (Sec 212) Deducted on Sch A as Miscellaneous Deductions Subject to 2% AGI threshold Interest expense deductible to the extent of net

investment income – does not include LTCG / Div No Sec 179 expensing election No home office deduction

Investor vs Trader – Expenses Trader expenses - Summary

All ordinary and necessary expenses (Sec 162) Interest expense on margin accounts – if material

participation, otherwise, for a limited partner, to extent of net investment income

Sec 179 expensing of computers/software available* Eligible for home office deduction Travel Automobile expenses from principal place of

business (home) deductible – if for business purpose

* Sec 179 election cannot create a loss

Investor vs Trader – Case Summary

Favorable Cases In Holsinger, Tax Court remarked in its opinion that

trading activity of over 1,100 trades or the value of securities traded over $9 million was deemed substantial

Levin – most of working days; substantial time

Summary Regular and continuous Short holding periods Substantial number of trades

Investor vs Trader – Expenses Is OptionsAnimal tuition deductible?

What are deductible educational expenses? Required to keep present job or salary, or Maintains or improves required skills in present job

What are non-deductible educational expenses? Required to meet minimum standards, OR Qualifies one for new trade or business

Quotes from the OptionsAnimal website:• “OptionsAnimal connects you to fellow students as well as seasoned instructors…”• “If you have not spoken with one of our Education Specialists …”


Conclusion: Deductible as education expenses?:

If you are already considered a “trader” or trading inside a trading entity where you are an employee, then deductible

If new to trading stocks and options, then non-deductible UNLESS … (next slide)

Qualify for Lifetime Learning or Hope credits? Must be defined by Sec 481 of Higher Education

Act of 1965 as qualified post-secondary institution


Start-up expenses? Expenses that would be deductible if incurred in an active

trade or business (Sec 162) but also applies to investment expenses (Sec 212) Investigatory – incurred prior to decision to acquire or

create Pre-opening – incurred after decision but before opening for

business “wages being paid to employees who are being trained and to

[their] instructors” [H Rep No 96-1278, 96th Cong, 2nd Sess] Up to $5000 (IRC Sec 195) Amounts over $5000 – capitalized and amortized over 180 months


Strategy: Potentially start-up expenses

Specifically, pre-opening, and Especially if operating inside an entity Must elect and election is irrevocable

Secondarily, educational expenses since: No minimum standards to “trade” No qualification standards for trading as a business

Uphill battle since burden of proof on taxpayer

Investor vs Trader

Mark-to-Market Accounting

Investor vs Trader – MTM Election

What is Mark-to-Market (MTM)? Traders can elect to mark their security holdings

to market value at the end of the tax yearIRC Sec 475(f) –

“… In the case of a person who is engaged in a trade or business as a trader in securities …”

Gains and losses treated as ordinary gain/loss Adjustment to stock basis for unrealized gain/loss Not subject to self-employment tax Reported on Form 4797, Part II

Investor vs Trader – MTM Election Benefits

Two restrictions no longer apply:

$3,000 net capital loss limit

Wash sale rule


Election is effective for the year for which it is made and all subsequent years unless revoked with IRS permission (mandatory)

Must make the election by the unextended due date for the tax return for the year before the year the election is to be effective

Example:


Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time.

Does Eric qualify as a trader?


Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time.

Does Eric qualify as a trader? Can he elect MTM for 2009?


Eric would have had to file an election by: April 15, 2009, or, Attach the election to his extension (Form 4868)

Eric can make a MTM election for 2010 anytime before April 15, 2010, however, If this is not his first year as a TRADER (it is not)

then Eric will be required to file Form 3115, Application for Change in Accounting Method

A Sec 481(a) adjustment is also required

Investor vs Trader – Making the MTM Election

Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com

Investor vs Trader – Making the MTM Election

Attach the following statement to the timely filed Form 1040 or extension Form 4868

Trader in Securities Election to Mark to Market

Taxpayer hereby elects under IRC Sec 475(f) to use the mark-to-market method of accounting for securities. The election will first be effective for the tax year ended [20##]. The election is made for the following trade or business: [trade or business name, EIN]

There is relief for late elections – PLR request New pass-through entity for late election New taxpayer – elect by 15th day of third month

Investor vs Trader - Summary

Criteria Investor Trader MTM Trader

Reporting gain/loss Sch D Sch D Form 4797

Reporting expenses Sch A Sch C/E Sch C/E

Reporting interest Sch A Sch C/E Sch C/E

Invest int exp limits Yes No No

Home office eligible No Yes Yes

Subject to S-E tax No No No

Wash sale rules Yes Yes No

$3000 Cap loss limit Yes Yes No

Section 1256 Contracts

A Section 1256 Contract is any: Regulated futures contract – daily MTM Foreign currency contract Dealer equity option – market maker/specialist Dealer securities futures contract Non-equity option

Broad-based stock index option (SEC determined) Cash-settled options Examples – DJX, SPX, OEX, NDX (not ETFs)

Sec 1256 Contracts – Mark-to-Market At the end of the tax year (last business day)

Treat contract as sold At FMV on the last business day of year Gain or loss recognized Recognized gain/loss taken into consideration upon

ultimate disposition of contract – basis adjustment 60/40 rule –

60% of recognized gain/loss is long-term 40% of recognized gain/loss is short-term No matter what the actual holding period

A net loss can be carried back 3 years Report on Form 6781 (non-Sec 1256 on Form 4797) Example:

Sec 1256 Contracts – Mark to Market Example


Purchase 100 SPX Jun 08 1250 calls bought for 145 on 7/17/06

SPX Jun 08 1250 call at 252 on last business day of 2006

Mark-to-Market requirements: SPX LC deemed SOLD on 12/29/06 at 252 SPX LC deemed REPURCHASED on 12/29/06

for 252 Gain 107 (252 – 145)

Long-term 64.20 (60% x 107); 15% max tax rate Short-term 42.80 (40% x 107); 35% max tax rate


SPX Jun 08 1250 LC declines to 228 by 3/12/2007 and is sold

What is the gain/loss? How is it taxed?

Deemed repurchase at 252 on 12/29/06

Sale 228

Less: Basis 252 (from deemed repurchase)

Loss <24> LTCL <14.40> - 60%

STCL <9.60> - 40% Loss may be carried back three years

Entities

Selection & Trading

Entities

Types of entities Sole proprietor – Sch C/Sch D/Form 4797 (default) General Partnership – Form 1065 Limited Liability Company (LLC) – Form 1065

Single member LLC – Sch C/Sch D/Form 4797 Multiple member LLC*

Corporation C Corporation – Default; Form 1120 S Corporation – Election; Form 2553 Form 1120S * LLC with election: Form 8823 Form 2553 (S Corp)

Entities

State law prevails – name, articles, etc. Separate bank account styled identically to

entity name Brokerage account name identical to entity Business activity code: 523110, 523900

Source: www.naicscode.com; keyword: securities trader

Employer Identification Number (EIN) Setup: www.irs.gov Quick walk-through of IRS site

Entities

Entities

Entities

Entities

Entities Benefits

Retirement plans Fringe benefits

Medical reimbursement plans (IRC Sec 105) Educational assistance plans – $5250/year (IRC Sec 127)

New entity elections – MTM

Burdens Compliance

Entity tax return Payroll complications

Accounting – personal vs business expenses

Reporting

Investor

Trader

MTM Trader

Reporting - Example Jeff made the following trades during 2008:

300 shs AAPL Nov 08 90 SC; STO $12.80; Expired Dec 08 90 SC; STO $4.90; Expired Jan 09 90 SC; STO $5.50; Expired

500 shs WMT Nov 08 55 SC; STO $2.24; Expired Dec 08 55 SC; STO $1.95; Exercised

500 shs RIMM Nov 08 45 SC; STO $5.40; Expired Dec 08 45 SC; STO $5.70; Expired Dec 08 40 SP; BTO $3.75; STC $2.96 Jan 09 45 SC; STO $4.75; Expired

Reporting - Example Jeff’s 2008 trades – continued:

500 shs MCD Jan 09 90 SC; STO $2.20; Expired

Jeff’s 2008 trading expenses: OptionsAnimal subscription – $600 Computer – $1500 (exclusive use); MACRS 5 year Monitors – $900 (three); MACRS 5 year Furniture – $750 desk, chair, monitor stand; MACRS 7 year Software – $250 Microsoft Office (Excel); SL 36 months Fiber optic cable line – $480 Travel – $1500 (Chicago & Las Vegas Summits)

Airfare & Hotel – $1300 Meals – $200

TOTAL EXPENSES – $5980

Reporting - Example

Jeff’s other information: Jeff’s spouse has W-2 wages of $60,000 Jeff has two children that are his dependents Jeff has itemized deductions of:

Real estate tax – $5,000 Mortgage interest – $10,000 Charitable contributions – $2,500 (cash)

Reporting – Investor




Form 1040

Reporting – Trader

Reporting – Trader

Form 1040

Reporting – MTM Trader

Sec 481(a) adjustment – taxed in current year

If not a new entity, Form 3115 required



Form 1040

Reporting – Summary

Tax liability comparison Investor $4,374 Trader $4,149 MTM/Trader $4,606

Stock basis increase by the amount of 481(a) adjustment

Stock basis adjustment decreases future gains/increases future losses

Contact Information Gregory L Buhrow, CPA, PC

2355 Gus Thomasson RoadDallas, TX 75228-3004

Telephone: (214) 327-0700 Facsimile: (214) 327-0740 (7am-6pm CT) Websites: www.buhrow.com

www.gregbuhrowcpa.com www.optionstaxguy.com

Emails: [email protected]@[email protected]

Thank You!

OptionsAnimal

Las Vegas Student Summit

September 26, 2009

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