Tax Day: What Traders Need to Know
Like it or not, we all have to pay taxes.
That alone can be stressful, but day traders have much more to consider than the average person. If you’re a trader, you don’t get to just enter your W-2 into some tax software, sit back, and wait for the results.
There’s way more at play when filing your taxes as a day trader. You probably already know that you have to pay taxes on your trading income, but what are the details? What deductions can you make, if any?
Don’t worry: I’m going to cover all that stuff. Day trading taxes don’t need to be difficult. It’s just like anything else … You have to familiarize yourself with the process. It’s all part of your trading education.
But before we get to the nitty-gritty, my lawyers would have my head if I didn’t say this first: This communication doesn’t establish a professional relationship for accountancy, tax advice, legal or any other professional service.
Any information presented in our communication with you (including, but not limited to, website content, social media content, video content, printed material, audio content, emails, or any other content) regarding any issues should not be construed as advice as it pertains to tax matters, legal matters, or any other matters.
Always consult the advice of a professional licensed in your state or jurisdiction before making decisions on tax or legal matters.
OK, that’s out of the way now, so let’s do this!
There are a few basic terms you need to know off the bat. You’ll probably see these when you’re filing your taxes, so you should understand what they mean.
If you made any money this year from buying and selling securities — which you hopefully have — then those profits are your capital gains.
Capital gains are taxable income and you have to report it as such. Pretty simple.
I think you can probably figure this one out. Capital losses are the opposite of capital gains.
When you lose money from buying or selling a security, that’s a capital loss.
Capital losses are actually deductible. But, depending on your tax status, the amount that you can deduct is limited (more on that in a bit).
Your cost basis is the value used to measure profit and loss. It’s the amount that you pay (including commissions) for a security.
If you close your position at a value higher than your cost basis, it contributes to your capital gains. The opposite is a capital loss.
Earned income does NOT include income from trading. It only counts income made from full-time or part-time jobs, including your salary, hourly wage, tips, bonuses … well, you get the idea.
Since trading income isn’t ‘earned’ income, you don’t have to pay self-employment taxes. Yes, that can save you some money. But if you don’t pay those taxes, you also aren’t contributing to social security. You have to do that to qualify for retirement benefits.
Dividends, interest, royalties, annuities, etc. — any money you make from property held for investments before deductions is investment income.
Capital gains can count toward your investment income, but only if you choose to include it.
The Wash-Sale Rule
The IRS created the wash-sale rule to prohibit traders from claiming a loss on the sale of a security in a wash-sale.
So, what’s a wash-sale? That’s when you trade a security at a loss, and then, within 30 days before or after the sale, you purchase what the IRS calls a “substantially identical” security.
The good news here is that there’s a special exception for this rule, so stay tuned for that.
Tax Day: The Basics
OK! We made it through the tedious stuff. Now let’s talk about filing taxes.
For the most part, it isn’t too complicated. Especially if you aren’t classified as a trader with the IRS.
There are a few things you might not know, including some benefits that you might qualify for. Let’s get to it.
Long-Term vs. Short-Term Investments
Different types of investments are taxed at different rates.
Short-term investments are positions that you held for less than a year. These are taxed at the normal income rate. So, for example, the short-term income tax rate for gross annual income between $37,951 to $91,900 would be 25%.
Long-term investments are any positions that you held for over a year. Using the same income range from above, the long-term tax rate would be 15%.
Keep Separate Accounts
There are plenty of reasons you should separate your long-term investments from your short-term investments.
First of all, it’s just easier. For accounting purposes especially, it can make your life simpler. Beyond that, the IRS requires traders to divide their long-term and short-term investments into different brokerage accounts when trading the same issues.
Lastly, you want to make sure you classify as a trader with the IRS. Combining your investments could disqualify you from getting this designation, and you’d likely miss those tax benefits if you didn’t get them.
And again with the lawyers!
IRS CIRCULAR 230 NOTICE. Nothing in our communications with you (including, but not limited to, website content, social media content, video content, printed material, audio content, emails, or any other content) relating to any federal tax transaction or matter are considered to be “covered opinions” as described in Circular 230.
Pardon yet another legalese interruption. I love my lawyers. I can’t imagine being a lawyer. Just reading the short disclaimer above made me drowsy. I’d probably never get much done if I were a lawyer because I’d be falling asleep all the time.
OK, we’re going to keep moving with the tax stuff.
Yeah, that’s boring too, but we’ve all got to deal with taxes, so grit your teeth when you get tomorrow’s issue and keep going.
The lawyers say they won’t interrupt anymore for the rest of this post, so it’s home-sprint time. Keep an eye out for tomorrow’s issue. Be ready to go!
— Tim Sykes
Editor, Penny Stock Millionaires