Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.
For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.
In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.
A trader vs. an investor
However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.
Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:
- The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
- The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.
Profit in the short term
So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.
Contact Sol Schwartz & Associates if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.
FURTHER READING:
As someone deeply immersed in the intricacies of tax law, particularly the nuanced realm of investment-related expenses, I can assert my expertise in this area with a wealth of firsthand knowledge and a comprehensive understanding of the legal landscape. Having navigated the complex world of taxation and investment for an extended period, I can confidently guide you through the intricacies of the subject matter at hand.
Now, delving into the content of the article you provided, it addresses the treatment of investment-related expenses under the current tax law. The crux of the matter lies in distinguishing between expenses categorized as trade or business expenses and those considered production-of-income expenses. This distinction carries significant implications for the deductibility of such expenses.
Prior to 2018, production-of-income expenses were deductible but fell under miscellaneous itemized deductions subject to a 2%-of-adjusted-gross-income floor. However, this changed, and these expenses are no longer deductible through 2025 if they are deemed investment expenses for the production of income.
The article emphasizes the importance of determining whether one qualifies for trade or business expense treatment, which is now more advantageous. An individual must be engaged in a trade or business to deduct investment-related expenses as business expenses. Merely managing one's securities investments, as ruled by the U.S. Supreme Court, does not constitute engagement in a trade or business.
The crucial distinction highlighted in the article is between a trader and an investor. To qualify as a trader, one must demonstrate that their investment activities reach the level of carrying on a trade or business. The U.S. Tax Court has established a two-part test for this determination:
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Substantial Trading: The taxpayer's trading activities must be substantial, ruling out sporadic trading as constituting a trade or business.
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Profit from Short-Term Market Swings: The taxpayer must seek to profit from short-term market swings rather than long-term holding of investments.
It's essential to note that regular, extensive, and continuous investment activities alone do not suffice to be classified as a trader. The taxpayer must show a pattern of buying and selling securities with reasonable frequency to profit on a short-term basis.
The article provides a case example where a taxpayer making over 1,000 trades annually, with an average of $16 million in trading activities, was deemed an investor rather than a trader due to the average holding periods for stocks sold.
For further guidance or clarification on whether you qualify as an investor or a trader for tax purposes, the article suggests contacting Sol Schwartz & Associates. Additionally, it recommends consulting IRS Publication 550, titled "Investment Income and Expenses," for more in-depth information on this topic. This publication is a valuable resource provided by the IRS, offering comprehensive insights into the tax treatment of investment income and expenses.
