No two trading enterprises are the same, which means no two trader tax strategies should be exactly the same either. That’s why Trader’s Accounting does not use a cookie cutter or automated approach for your trading tax savings.
Our recommendation for your operation is based on the information you provide as the individual trader. Active trader business incorporation services are tailored to meet your unique needs for tax efficiency. Let our accountants help you determine the most advantageous entity for your trading work and make it a reality!
Incorporating your trading business and optimizing your tax return
Trading tax law can be confusing. Without the help of a specialist, you may not be able to determine whether you meet the definition of a trader in securities per IRS and tax court guidelines. The vague guidelines that are given to help you make this determination will likely leave you with many questions, such as:
- How long can I hold onto my positions?
- How often do I have to trade?
- How many trades does it take to be considered substantial activity?
- If the market is not conducive to my trading strategy, how long can I stay out of the market without bringing my continuity and regularity of trading into question?
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These are a just a few examples out of a myriad of questions the IRS and tax court will look at to determine a trader’s tax status. Unfortunately, the IRS does not seem interested in offering any help to traders trying to understand these requirements. Instead, they seem more than happy to leave it up to the tax courts to determine how these guidelines apply in the real world. While tax court justices excel at interpreting tax law, it can be difficult to use their decisions to develop black and white rules. Each individual’s circ*mstances are unique and may be interpreted differently.
Because of the uniqueness of each individual, there is no single sure-fire strategy to make an active trader immune to the effects of murky trading tax law. We generally recommend that active traders conduct their active trading business in a legal entity (usually an LLC).
When you set up a legal trading entity, the mere act of setting up the entity tells the IRS that you are going into the active trading business. With that being said, if you are a trader, you still must be an active short-term trader in an entity. You must treat your trading as a business; learning to document your trading time, your expenses, and a few other matters. Trader’s Accounting can help you navigate these tasks to maximize your trading dollars.
A note on sole proprietorships for traders:
Trading out of a sole proprietorship is a popular option for many active traders. However, since it is essentially a business with no entity, you are not legally separated from your business. What does this mean? That in terms of taxes and liability, it is no different than trading out of your personal name and account, leaving you personally responsible for any trading debts, taxes owed, or other obligations.
Because there are some tax benefits to be had from trading as a sole proprietorship, many traders consider this type of business before another separate business entity. To determine whether an individual is in the business of trading as a Sole Proprietor, the IRS looks at three main factors:
- You must seek to profit from daily market movements in the prices of securities
- Your trading activity must be substantial
- You must carry on the activity with continuity and regularity
In order to determine if the active trader is following these conditions the IRS looks at the following facts and circ*mstances:
- Typical holding periods for securities
- The frequency and dollar amount of trades
- The extent to which you pursue the trading activity to produce income for a livelihood
- The amount of time devoted to the trading activity
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Benefits of Incorporating Your Trading Enterprise
While trading in a legal entity does not automatically guarantee that the IRS or tax court will consider your trading activity to be in the active trading business, it does offer some other benefits. Generally, a legal entity files a separate income tax return from the individual. Filing a separate income tax return allows you to provide the IRS with a clearer picture of your trading business because the business activity is not co-mingled with individual activity on one return. The more clearly your information is presented to the IRS upfront, the fewer problems you will have in the future.
Additionally, forming a trading business entity can separate the business assets from your personal assets which may provide some asset protection depending on state law. Also, legal entities can allow traders to establish benefits that are traditionally associated with businesses such as 401(k) plans. These are just a few benefits that legal entities can provide.
Common Trading Legal Entities
Limited Liability Company (LLC) for Trading Stocks
An LLC is a business entity created under state law that may shield you from personal liability. LLCs taxed as partnerships are becoming the most popular choice for active traders due to their ease and flexibility. To be taxed as a partnership, your entity must have at least two members, and it is then considered to be a pass-through entity. This means that while the LLC files its own return, the income or loss from trading flows to the members and is reported on the members’ individual income tax returns. Members are allowed to take distributions of capital from the LLC, which provides a method of taking out money without having to pay payroll taxes. In addition, the trading income from an LLC is not subject to self-employment tax.
Don’t be confused by Single Member LLCs (SMLLC). When you trade through an SMLLC, the IRS considers your SMLLC a disregarded entity for tax purposes. This causes you to file a Schedule C on your individual income tax return, thus you are effectively trading as a sole proprietor.
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C Corporation
The C Corporation is frequently used by traders for its ability to offer benefits, such as Medical Reimbursem*nt Plans, which do not work well in pass-through entities like LLCs. The C-corp is a standalone entity, meaning the income from trading is taxable to the C Corporation and does not flow through to the individual owners. Profits are generally removed from this type of entity through salary or dividends. C-corps have greater tax planning flexibility and can shield shareholders from direct tax liability, but require more work, such as holding annual meetings, etc.
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Combination Structure
In some cases, we recommend that you establish two legal trading entities. Generally, the combination structure is composed of a C Corporation and an LLC. The combination structure is used in very limited circ*mstances to utilize the advantages of each type of business.
Trader’s Accounting can help you turn your trading activities into a legal trading business entity to better build and preserve your wealth.
As people pursue a trading business to augment their income, they are looking for work-from-home jobs that offer flexibility and financial independence. Men and women who have children at home or full-time jobs can trade—it is just a matter of obtaining the right opportunity. The idea of trading for a living at home is appealing to many people who have considered trading as a business. If you want to become a full-time trader from home, it’s important that you take the time to plan and research your trading business.
Setting up a trading entity at home correctly is an important step if you plan to work as a full-time trader. Business entity packages from Trader’s Accounting will allow you to take advantage of many benefits that the typical investor does not have access to. From our two packages, you will receive some of the following benefits:
- Home office deduction
- Trading entity operating documents
- Trading entity consultation services
- Bookkeeping services
- Bookkeeping coaching for traders
- Free first year federal and state tax returns
- Mark-to-market coaching
- Obtain a federal tax ID (EIN)
After deciding to take their operation to the next level by incorporating, many home-based active traders will need expert advice to begin and complete the process. Save yourself the frustration with your taxes by consulting directly with the recognized leading CPAs and other trading specialists at Trader’s Accounting.
Get expert advice (and save thousands of dollars) with our free 30-minute consultation. Take the first step toward creating your business entity and maximizing your trading profit by signing up or calling us to get started today!
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