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BOSS Business ServicesTrader Status Special ReportTax, Asset Protection and Estate Planning Ramifications of Trader Status...
Why would someone want to be a trader?
Are there alternatives?
Does trader status do anything for my estate planning?
Does trader status protect my assets?</li></ul>AN ANALYSIS OF TRADER STATUS<br />Is it wise to trade in one’s own name and...
Not subject to $3000 cap for capital loss deduction;
Deduct interest and operating expenses as ordinary expenses.</li></ul>However, once you claim the trader status, these ben...
Trader status special_report.28thjuly
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Trader status special_report.28thjuly


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Trader status special_report.28thjuly

  1. 1. BOSS Business ServicesTrader Status Special ReportTax, Asset Protection and Estate Planning Ramifications of Trader Status<br />All rights reserved. No part of this publication may be reproduced or transmitted by any means whatsoever without the written permission of the publisher.This publication is intended to be informative and to aid in the education of its intended audience. As laws are constantly changing, it is recommended you engage the services of a competent professional if legal or expert assistance is required. It is the desire of the publisher to make the information provided both informative and entertaining to promote retention and understanding of the materials<br />If you have questions about the content of these materials please contact: <br /> <br /> BOSS Business Services 888-969-BOSS (2677)<br />Copyright © 2010 by BOSS Business Services<br />Printed in The United States of America<br />This Special Report was written to assist those individuals who are actively trading their own accounts in the stock market and who are contemplating the best way to structure their affairs for maximum tax, estate planning and asset protection benefits. As with all things in the law and in taxation, facts and circumstances have a material impact on all planning, so make sure you consult with a professional before choosing a particular course of action. <br />Scenario:<br />Bob and Mary have been happily married for many years and have recently discovered the stock market. The volatility of the stock market kept them away from actually trading until recently, when they took a few courses on profiting on market swings. Everything was great until they spoke to an accountant. The accountant began using terms like “mark-to-market” elections, “trader status” and “writing off losses” and pretty much scared the pants off Bob and Mary. <br />The accountant was focused on making sure Bob and Mary could deduct their trading losses against their other income. Bob and Mary wondered why the accountant was so focused on losses. What about making money?<br />The accountant liked to use the word “trader” and mentioned how it was a special status that changed the way Bob and Mary would be taxed. <br />Bob and Mary then met with their attorney, who essentially said the accountant was crazy for even mentioning trader status because it was nearly impossible to obtain. The attorney went on to talk about placing arbitrary rules on oneself like mark-to-market elections and asked about how Bob and Mary would protect their profits and, more importantly, how they planning on passing the account on to loved ones should anything happen to Bob and Mary. <br />Bob and Mary were confused. The accountant was worried about losses. The attorney was worried about gains, asset protection and estate planning. Both professionals were giving Bob and Mary a headache. <br />Solution:<br />Read this Special Report. It will explain why the accountant was interested in trader status, how it works, and when it might be appropriate. By the end of this report, you should have a good idea of the following:<br /><ul><li>What is trader status?
  2. 2. Why would someone want to be a trader?
  3. 3. Are there alternatives?
  4. 4. Does trader status do anything for my estate planning?
  5. 5. Does trader status protect my assets?</li></ul>AN ANALYSIS OF TRADER STATUS<br />Is it wise to trade in one’s own name and claim trader status?<br />If you are a trader in securities, when you file a tax return with the IRS, the IRS treats you as an investor by default. Being an investor, your income from trading is classified as either long term or short term gains or losses by the IRS and is taxed as capital income. While long term capital gains enjoy a lower tax rate, this is not an ideal situation for you if you want to treat your trading as a business and generate substantial income from it.<br />As an investor, you must report all expenses incurred while trading as investment expenses on Schedule A of your tax return. These expenses would then only become deductible if they add up to exceed 2% your adjusted gross income before itemized deduction. You can only deduct the amount exceed the 2% floor and only if you utilize itemized deduction.<br />Additionally, all trading losses incurred can only be deductible against your ordinary income up to $3000. The wash sale rule may also apply to bar you from claiming certain losses (which prevents you from claiming a loss on a sale of stock if you buy replacement stock within the 30 days before or after the sale). Because you are filing as an individual, you do not enjoy any fringe benefits and medical reimbursement or educational costs to better your trading would be pure expenses for you.<br />On the contrary, you may be able to claim trader status and elect mark to market accounting with the IRS. If you qualify for trader status, the IRS regards you as an active trader and all your income and losses from trading becomes active, ordinary income for tax purposes. This avoids the applicability of the $3000 capital loss deduction limit.<br />Because the IRS regards your primary source of income as trading, you are allowed to deduct various business expenses on your Schedule C. Expenses such as accounting fees, automobile expenses, trading software, trading advice, office equipments, and costs of attending seminars, etc. are now tax deductible to you. Further, due to the election of mark to market accounting, the wash sale rule no longer applies as well.<br />By now you are probably thinking, “great! Trader status is exactly what I need.” However, you should probably hold that thought. Why? Here are the reasons why:<br />It is extremely difficult to qualify as a trader<br />If you are just starting out to trade, chances are that you will not qualify for trader status. “Trader” is not defined in the Revenue Code. The IRS has laid out a general guideline in Publication 550 regarding the requirements for trader status. To qualify as a trader, you must at the very least (1) trade substantially, regularly, frequently, and continuously; (2) seek to profit from the short term price swings of the securities. While this may sound simple, it is actually very confusing because this attempted definition is overly vague.<br />From the guideline itself, you may ask “What constitutes the required frequency?” “What fulfills the continuous requirement?” “What qualifies as profiting from short term price swing?” “Will trading 300 times a year qualify?” The answer is that there is no definite answer.<br />The courts have attempted to simplify the determination of trader status over the years. However, these attempts have never successfully clarified exactly what a trader is under the law. There are major inconsistencies. For example, in Commissioner v. Nubar, the court found that 137 transactions a year qualified Mr. Nubar as a trader. That would lead you to conclude that 137 somehow qualifies, but there are cases where traders with over 1000 trades per year did not qualify. For example, in Estate of Yaeger v. Commissioner, the court found that despite over 1000 transactions per year in question, Yaeger did not qualify as a trader. In Holsinger & Mickler v. Commissioner, 372 trades did not qualify.<br />Why? The court considers many factors when deciding. In Nubar, it was the 50’s and electronic such as we have today did not exist. Yaeger was in 1989 and the court used the fact that the taxpayer held on to stocks for a long period of time (over a year) prior to selling to denied the taxpayer trader status. Holsinger was in 2008 and the court held that the actual days where trades occurred (i.e. the taxpayer executed 372 trades on 110 days) was a rationale for excluding the taxpayer from trader status as the trading failed the “frequency, continuity and regularity” test. <br />Who knows what a sufficient amount to qualify as a trader will be in 2010? In fact, based on our research since 2000, there are NO court opinions where trader status was granted. Yikes.<br />Over the years, the courts’ analysis of whether a taxpayer qualifies for the trader status treatment really has become a true case-by-case analysis involving all aspects of a taxpayer’s trading pattern, amount, and volume. There is simply no way to predict for certain whether you will qualify for trader status when the IRS comes knocking on your door.<br />This is not the only reason why you should not trade in your own name and claim trader status. From the legal standpoint in assessing what structure is best for someone to do business in, three aspects should be evaluated: asset protection, estate planning, and tax. By claiming trader status and trading in your own name, you may think you have the tax arena covered, but the truth may be surprising to you. Also, you are taking a big risk with regards to asset protection and estate planning.<br />Asset Protection<br />Conducting trades in your own name and claiming trader status provide no asset protection at all. All of your assets including cash, securities, and potentially real estate and equipment are sitting under your name up for grabs for any creditors. In this litigious society, there are too many ways you could be the subject of a lawsuit. We have seen everything from car accidents involving kids, quad runner accidents, injured guests at parties, defamation suits, pseudo partnerships gone bad as well as plenty of other matters turn people’s lives upside-down. Should you unfortunately come out on the wrong side of a lawsuit and are pursued by creditors; it would simply be too late to set up any sort of asset protection structure. In fact, any structure established at such time may be pierced by the court because the sole purpose would appear to be siphoning assets away from your creditors.<br />Estate Planning<br />Trading in your own name with trader status also provides no benefit in terms of estate planning. Again, all your assets are simply exposed and disorganized under your name. This only makes the settlement of your estate more complicated and costly for loved ones. <br />Tax<br />As previously described, claiming trader status and mark to market election gives you the ability to reap certain tax benefits:<br /><ul><li>Mark to market election is not subject to the wash sale rule;
  6. 6. Not subject to $3000 cap for capital loss deduction;
  7. 7. Deduct interest and operating expenses as ordinary expenses.</li></ul>However, once you claim the trader status, these benefits may not turn out to be as wonderful as they seem. <br />Electing mark to market accounting has to be done prior to the year you wish to utilize such method. This adds uncertainty because you do not know whether you will benefit from such accounting method at the time you elect it. Further, the election is irrevocable. Once you make the election – you are stuck. <br />You will need a written permission from the IRS in order to elect out of mark to market. This is very inconvenient and ironic especially considering that trading is the kind of activity where lots of flexibility and anticipation are needed.<br />Mark to market accounting gives you the benefit of avoiding the wash sale rule. The wash sale rule is avoided because mark to market requires you to report gains and losses on all securities held at the end of the year, even if you have not sold them. This is actually a major downfall for this accounting method because you could end up paying excessive taxes before you realize any gains on securities. For example, if a security peaks its price at the end of the year, you will have to pay taxes at that peak as if you have realized a gain even though you have not. When you finally sell such security and the price has fallen off, you essentially have paid a higher tax than you would have had to. Do you remember Qualcomm’s end of year run-ups in the late 90’s and early 2000’s. Can you imagine having to pay 20%+ in gains on stock you never sold that is now worth less than the taxes you owe? Why would you willingly put yourself in that situation?<br />The unlimited ordinary loss deduction available to traders is plainly a counter-intuitive idea for claiming trader status. The whole purpose of claiming such status is because you seek to trade securities and conduct such activity as a business, in order to make a profit. It makes no sense for you to claim the status in order to write off the losses. If you know you are going to lose money trading, you might as well not trade in the first place.<br />Further, this benefit can actually never be realized for a single taxpayer who claims trader status. The reason is because the IRS and the courts would not allow someone who has other employment to qualify as a trader. In other words, you would not have any other ordinary income other than the income from trading. However, to claim the loss deduction you would have lost money from trading. Because you have no ordinary income from trading and you are not permitted to have other ordinary income from activities outside of trading, you would not be able to write off the trading losses against anything.<br />Your alternative<br />Considering all three aspects, for a trader, there is a much better solution than claiming trader status with the IRS and trade in your own name. Since you are serious about trading, the best solution is to operate like a business. Operating a business with proper business structures ensures that you are treated as a business by the IRS and receive the maximum tax benefits that a legitimate business should receive. <br />At BOSS, we have done diligent research and carefully devised a structure that best serves this purpose for people trading in the stock market. The purpose of the structure is to maximize asset protection, estate planning and tax benefits in a comprehensive structure. <br />This structure consists of setting up a limited liability entity (such as a limited partnership or LLC) as your trading vehicle. The limited liability entity holds your trading brokerage account. We generally recommend a limited partnership for traders, but it really depends on your individual circumstances. <br />A corporation is then established as a small percentage owner and manager of the limited partnership (or LLC). If you utilize this trading structure, you can be sure that your trading business receives the maximum benefits from all three aspects previous mentioned: asset protection, estate planning, and tax. In addition, you are freed from the worries of qualifying as a trader in the IRS’s eyes.<br />Asset protection<br />One of the benefits of having a proper business structure is that it provides protection for your assets. Rather than owning everything under your name, your trading-related assets are shielded behind the limited partnership or LLC. Should any unfortunate event arise and you are personally sued, you are ensured that your trading activity, which may be your primary source of income, is not jeopardized. <br />Depending on where you file, both limited partnerships and LLCs provide charging order protection. This means that for a creditor to get to the assets inside the entity, said creditor would need to obtain a judgment, get a charging order and then petition the court and seek why that creditor should be allowed to do what no other creditors are allowed to do; namely, pierce the entity and attach the assets. Because the limited partnership or LLC was set up with a legitimate business purposes, this will be next to impossible for the creditor to do. For example, in Nevada, the creditor would have to show fraud or illegal activity to even be considered. <br />Estate Planning<br />Having a proper business structure also is an effective estate planning tool. Owning all of your assets without organization is like holding a mound of sand in your palms. The grains will slip through your fingers if you are not careful, the wind can scatter them, and it is difficult to pass on. Worse yet, it is easy for others to take a scoop from you. This is not an ideal way to handle your assets. <br />Now imagine you take the sand in your palms and pour it into a container and add a lid on top. Now the sand will not scatter in the wind or fall through your fingers. It is much easier to pass on to someone else. It is also much more difficult for others to come and take a scoop because the lid protects the sand. <br />Having a proper business structure is similar to placing the sand in the container. Your assets and businesses are organized and the ownership is consolidated and protected. It is much safer and much more effective tool for your estate planning and can be easily passed on or handed off. <br />Tax<br />The purpose of having the dual entity structure is that each entity serves its purposes and they work harmoniously together as a team. As previously mentioned, the limited partnership or LLC will serve as your trading vehicle and as an effective asset protection tool. The corporation is established to manage your limited partnership or LLC (and others), to engage in any other active business activities, and at the same time, it allows you to utilize the flexible tax deductibility and fringe benefits a corporation enjoys.<br />Under this structure, the limited partnership or LLC will be your primary medium to generate income since it is your trading vehicle. The gains realized from trading can be distributed to the individual partners. That would be you and whoever else you are in business with. The corporation serves as the manager of the limited partnership or LLC and earns a management fee and possibly guaranteed payments (if you so choose). <br />The income from the limited partnership or LLC is taxed only at the individual level, so there is no worry about double taxation treatment for the corporation dividends. There is also no self-employment tax for this income. In addition, since you are no longer concerned with qualifying for the trader status, you may have other sources of income to supplement your livelihood. If you have trading losses from the limited partnership, these losses are passed on to the individual level and can be offset against your other passive income or carried forward.<br />The corporation provides you with the flexibility of various deductions and fringe benefits otherwise not available for an individual taxpayer. One of the biggest is the medical reimbursement, dental and vision plan. These are 100% deductible fringe benefits and it will substantially lower your costs for any medical expenses. In addition, expenses related to your business, such as office equipment, vehicle, software, advice, educational publications, and seminars, etc. are all deductible as business operating expenses for the corporation. These expenses can be carried over the years and offset against the income the corporation receives; namely, the management fees and guaranteed payments. <br />If you find that trading is not for you and you have losses in the corporation when you shut down, so long as a good organization (like BOSS) prepared the documents properly, you will be able to write off the losses against your ordinary income at that time. In other words, you will still ultimately receive the tax benefits of the structure even if it fails. <br />Recommendation<br />While using a structure is not the equivalent of claiming trader status, it is a much more comprehensive and safer structure for an individual who trades. Even though the wash sale rule stays effective with this structure, it can be easily navigated by a careful trader. This structure ensures that you would not have to deal with the burden and uncertainty of complying with the requirements of the trader status. It also avoids the rigidity and risk that accompanies mark to market accounting. <br />The trading structure also provides you with the benefits in asset protection and estate planning, which is otherwise unavailable to individuals merely attempting to claim trader status. <br />In addition, it provides many tax benefits that are not available to individual taxpayers.<br />All in all, this is a much better system for traders in security to run as a business. If you are serious about trading, it is highly recommended that you establish the business structure rather than claiming trader.<br />Would you like to speak to someone about your trading structure? <br />Give BOSS Business Services a call at 888-969-BOSS (2677) and ask for a complimentary review. You may also visit us on the web and request a free consultation with one of our attorneys, tax professionals or planners. <br /> Visit for more information.<br />