Revenooer Rants | Day traders: beware
November 18, 2013
In times past, stock market activity like we have witnessed of late seems to have attracted lots of folks' attention — thinking that anybody can make money when the market starts zooming.
And so, many set up shop as so-called "day traders," and start trading away, eventually to convince themselves that they are conducting a trading business.
An attractive conclusion, given that the Internal Revenue Code allows one to deduct all "ordinary and necessary" expenses paid or incurred in the course of carrying on a "trade or business," which is not an option for the typical "investor," who just occasionally buys and sells for their own account.
But for one's activities to rise to the level of a "trader," the trading must be substantial (considering the number of trades executed, amount of money moving around, and the number of days spent in the activity.)
So here comes Sharon Nelson, a mortgage broker, who started "trading" in 2005 and 2006 through Ameritrade. She had no outside clients, it seems; her trades were only for her own profit-seeking.
So, during 2005, there were a total of 250 available trading days. Ms. Nelson executed 535 trades over the course of 121 days. During the year, there were eight periods of at least seven days during which no purchases or sales occurred.
The good news, however, is that her 2005 trades generated more than $470,000 of short term gains.
And during 2006, there also were a total of 250 available trading days — 235 trades were executed in the course of 66 days, though again, there were seven periods of at least seven days during which no purchases or sales occurred. The trading generated about $37,000 of gains in 2006.
In filing her 2005 and 2006 income tax returns, however, Ms. Nelson included Schedule C each year (where one reports the profit or loss from an unincorporated trade or business), deducting a whopping $808,000 of business expenses over the biennium. (Lots of professional fees, rent and utilities, among others.)
Needless to say, the Revenooers took note of the situation and after due consideration, disallowed all of the expenses, concluding that her trading activities were not "substantial" in the circumstances.
And by the way, noted the Revenooers on the way out — add the 20 percent accuracy-related penalty to the unpaid tax tab, in consideration of the negligence displayed by the taxpayer, or just downright disregard of the rules, notwithstanding that Ms. Nelson consulted with an accountant friend.
And the Tax Court agreed, in a recently issued decision.
What was that saying about pigs getting fat, while hogs just get downright slaughtered?
CONSULT YOUR TAX ADVISER — This article contains general information about various tax matters. You should consult your CPA regarding the implications to your own particular situation. Jeff Quinn is a shareholder in Ashley Quinn, CPAs and Consultants, Ltd., with offices in Incline Village and Reno. He can be reached at 831-7288, welcomes comments at firstname.lastname@example.org, and invites readers to consider his other commentary at http://blog.nolo.com/taxes.