| Part-time
traders may qualify for trader tax status.
Part-time
traders may qualify for trader tax status. However, if you don't
trade all day, every day, be ready for a fight from the IRS. If
you have another job or business activity besides your trading business,
you should be aware that the IRS might challenge your trader tax
status in a future tax audit.
Recently, the IRS has started to examine more traders (it has increased
the number of audits across the board). The IRS has a new blessing
from Congress to get tough on tax cheats, and Congress needs new
revenue to balance budget deficits.
Based on our experience with the IRS examining tax exams, we have
noticed a new, disturbing trend from the IRS: It is challenging
"part-time traders" and "money-losing traders.
As an example let’s say that in 2001, you had a fulltime job
in California, working 9 to 5, Monday through Friday. You traded
almost every morning before going to work, and you managed your
trading business at nights and on weekends. You elected mark-to-market
accounting for 2001 by April 15, 2001, assuming you would qualify
for trader tax status in 2001.
You incurred significant trading losses in 2001. You filed your
2001 tax returns assuming you qualified for trader tax status -
i.e., you thought you were entitled to report your trading business
expenses on Schedule C (Profit or Loss from Business) and your trading
losses on Form 4797 (Sale of Business Property - Part II Ordinary
Gain or Loss). Your ordinary business losses (Schedule C and Form
4797) contributed to a large net operating loss (NOL). You carried
back your NOL on a Form 1045 tax return and expected a large refund.
Instead of receiving a NOL refund, however, you receive a tax notice
from the IRS asking questions about your trader tax status. The
IRS reviews your Form 1045 NOL refund claim tax return closely (as
is the general rule, since the IRS is sour grapes about paying a
large NOL refund check). The IRS sees you have a job, or another
business, and they figure that since you lost money in trading,
you obviously had to have paid your bills from monies earned in
your job or other activity (or from savings). The IRS then makes
an unreasonable leap in logic, based on the part-time trader and/or
hobby-loss rules: Your trading activity is not a business.
The IRS puts the pressure on you to prove to them that you are entitled
to use business tax treatment for your trading business. You must
prove either that you qualify as a trader and/or the hobby loss
rules don't apply. It is likely that only the very best trader tax
experts can help you at this point.
An edited version of this article appears in the January 2003 issue
of Active Trader magazine.
Robert Green is the leading authority on trader tax. His virtual
tax firm, GreenTraderTax.com has clients across the country. Green
is a monthly contributor to Active Trader, the leading magazine
for traders, and has been featured in Barron's, Fortune, SmartMoney.com
and other publications. He has appeared on CNBC and Bloomberg Television,
and has spoken at trader and investor seminars across the country.
Green is the author of the popular Trader Tax Guides found on the
GreenTraderTax.com Web site. GreenTraderTax.com builds and operates
tax centers for leading direct-access brokers and trading schools.
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