Trader Tax Management Spread Trade Systems Chicago Student Summit March 28, 2009.
Trader Tax Issues
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Transcript of Trader Tax Issues
Trader Tax Issues
OptionsAnimal
Dallas Student Summit
April 2, 2011
Disclaimer
OptionsAny strategies used as examples and discussed, using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities.
TaxationAny US tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) providing, marketing or recommending to another party any transaction or matter addressed herein.
The information presented provides only a general discussion of the tax law affecting the taxation of options and is not intended to be applicable to any individual investment and tax situation. You are strongly advised to contact your own tax consultant in considering the tax consequences of your own specific set of facts and circumstances.
Agenda Securities & options taxation in general A Primer on OSI New basis reporting
aka “Pin the tail on the correct basis”
The Roadmap – www.optionstaxguy.com Trader vs Investor Mark to Market Entity selection Reporting
Goal
Understand how to get from the
Tradeto the
Tax Return
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
What Triggers Tax? Completed transaction
Open followed by Close Stock
Purchase Sale Short Sale Cover
Options BTO STC/Expiration STO BTC/Expiration
Which transaction establishes basis for gain/(loss)? The debit/non-credit side of the transaction
What is Taxed?
Gains and losses Determined on a:
First In – First Out (FIFO) basis First shares purchased are the first shares sold Used when cannot or does not identify which shares
sold [Reg 1.1012-1(c)(1)] IRS presumption
Specific Lot Identification basis Shares must be identified to broker Broker must confirm in writing [Reg 1.1012-1(c)(3)]
How is it Taxed?
Stocks/securities are generally capital assets Closing transaction generates gain/loss – generally Mark to market deems sale/repurchase but character
is still capital – generally Holding periods
Short-term – one year or shorter Long-term – longer than one year Generally begins on day after acquisition Generally ends on day of disposition
Pass-through entities – retain character
Amount of the Tax?
Short-term capital gains Ordinary income rates – 10% to 35%
Long-term capital gains Marginal rate bracket up to 15% 0%
Marginal rate bracket 25%+ 15%
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
How are Strategies Taxed?
They’re NOT!!
Individual Trades ARE
What did he
say?
How are Strategies Taxed?
Initiate a Put Calendar on SPY in Jan 2011 BTO May 11 130
STO Jan 11 130 BTC/Expire Jan 11 130 STO Feb 11 130 BTC/Expire Feb 11 130 STO Mar 11 130 BTC/Expire Mar 11 130
STC May 11 130* Four lines on Sch D/D-1
Taxable Transaction #1
Taxable Transaction #2
Taxable Transaction #3
*Taxable Transaction #4
How are Strategies Taxed?
How are Strategies Taxed?
Initiate a Covered Call/Collar on Apple: Buy AAPL on 7/20/2010
STO Sep 10 280 Call BTC/Expired Sep 10 280 Call STO Oct 10 320 Call BTO Nov 10 290 Put BTC/Expired Oct 10 320 Call STO Nov 10 300 Call STC Nov 10 290 Put Expired Nov 10 300 Call
AAPL* called at Nov 10 expiration
Taxable Transaction # 1
Taxable Transaction # 2
Taxable Transaction # 3
Taxable Transaction # 4
*Taxable Transaction # 5
How to keep it straight ...
That was a lot of trades!!! The OCC – and others – helped us out here
with the ...
Options Symbology Initiative
The ‘Do-It-Yourselfers’ best friend No more OPRA symbols
OPRA: Apple Dec 2009 210 Call – AAQLB OSI: AAPL091219C00210000 (what it would have been)
Options Symbology Initiative
Excel function to build OSI Symbol osisymbol(open,ticker,expiry,weekly,type,strike)
open – 0=closed, 1=open ticker – stock symbol, ie, AAPL, SPY expiry – expiration date in ‘mmm yyyy’ format weekly – weekly expiration day (numeric) type – Put (P) or Call (C) strike – strike price
Good for sorting option symbols
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
New Basis Reporting
Brokers now required to report cost basis and holding period
Both will be reported to IRS Implementation timeframe
Stock purchases – January 1, 2011 Mutual funds – January 1, 2012 Options & debt instruments – January 1, 2013
Why? Close tax gap $6.7B over 10 years
Basis Reporting Problems
Community property laws Inheritance
Stepped-up basis All long-term
Wash sale rules Loss add back Holding period adjustment
Assigned puts Decrease basis of assigned shares
Broker transfers
Basis Reporting ... so far so
Good
Purchased and sold/same broker – sometimes
Bad
Purchased and sold/different broker
Cost basis – Wrong
Cost basis – “UNKNOWN”
Examples from 2010 tax year
Basis Reporting Examples
Basis Reporting Examples
Basis Reporting Examples
What is the Point?
Keep track of:
COST BASIS
YOURSELF!
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
Entity Selection
Complete Roadmap with associated links at: www.optionstaxguy.com/roadmap
Investor vs Trader Why? – Subject to different tax rules Definitions:
Investor – Stock purchase for capital appreciation/dividends Little regard for short-term fluctuations; Buy and hold
Trader – Regularly and continuously trade stock/securities Trade in own account Profit from short-term fluctuations
Can be BOTH trader and investor IRS presumption Investor
Investor vs Trader
Taxation of Investors Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D Subject to IRC Sec 1091 wash sale rules Subject to $3000 loss limit Investment expenses (except interest)
Schedule A deductions Subject to 2% AGI threshold Not deductible for AMT purposes
Interest – deductible up to net investment income
Investor vs Trader
Taxation of Traders Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D Subject to IRC Sec 1091 wash sale rules Subject to $3000 loss limit Gains NOT subject to self-employment tax Investment expenses
Schedule C/E* deductions Interest deductible for material participation Home office deduction eligibility
Mark-to-Market (MTM) election eligibility_____________________________________________________________________________________________________
* Flow-through entity, such as partnership, LLC, S-Corp
Investor vs Trader – MTM Election
What is Mark-to-Market (MTM)? Traders can elect to mark their security holdings
to market value at the end of the tax yearIRC Sec 475(f) –
“… In the case of a person who is engaged in a trade or business as a trader in securities …”
Gains and losses treated as ordinary gain/loss Adjustment to stock basis for unrealized gain/loss Not subject to self-employment tax Reported on Form 4797, Part II
Investor vs Trader – MTM Election Benefits
Two restrictions no longer apply:
$3,000 net capital loss limit
Wash sale rule
However ...
Election is IRREVOCABLE without IRS consent
Wash Sales
Wash sale definition: Loss transaction Buy substantially identical stock – OR – Option to acquire substantially identical stock Within 30 days before or after loss transaction
Are options subject to wash sale treatment? Does AAPL Apr 11 350 SP = AAPL Apr 11 340 SP? If AAPL at Apr expiration = $330 Yes If AAPL at Apr expiration = $345 No
Mark to Market Example
Mark to Market Example
Purchase 100 SPX at 105 on 11/8/2009 Make MTM election on 2/4/2010 SPX closes at 126 on 12/31/2010 Mark-to-Market requirements:
SPX deemed SOLD on 12/31/2010 at 126 SPX deemed REPURCHASED on 12/31/2010 for
126 – new basis going forward Gain 21 (126 – 105)
Long-term 12.6 (60% x 21); 15% max tax rate Short-term 8.4 (40% x 21); 35% max tax rate
Mark to Market Example
SPX declines to 110 by 4/10/2011 and is sold What is the gain/loss? How is it taxed?
Deemed repurchase at 126 on 12/31/2010
Sale 110
Less: Basis 126 (from deemed repurchase)
Loss <16> LTCL <9.6> (60%)
STCL <6.4> (40%) Loss may be carried back three years
Investor vs Trader – Making the MTM Election
Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com
Investor vs Trader – Living with the MTM Election
Also available at www.optionstaxguy.com
Investor vs Trader - Summary
Criteria Investor Trader MTM Trader
Reporting gain/loss Sch D Sch D Form 4797
Reporting expenses Sch A Sch C/E Sch C/E
Reporting interest Sch A Sch C/E Sch C/E
Invest int exp limits Yes No No
Home office eligible No Yes Yes
Subject to S-E tax No No No
Wash sale rules Yes Yes No
$3000 Cap loss limit Yes Yes No
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
Entity Selection
Entity Selection
Entities – Types
Types of entities for Traders Sole proprietor – Sch C/Sch D/Form 4797 (default) General Partnership – Form 1065 Limited Liability Company (LLC) – Form 1065
Single member LLC – Sch C/Sch D/Form 4797 Multiple member LLC*
Corporation C Corporation – Default; Form 1120 S Corporation – Election; Form 2553 Form 1120S * LLC with election: Form 8823 Form 2553 (S Corp)
Entities – Setup
State law prevails – name, articles, etc. Separate bank account styled identically to
entity name (Patriot Act) Brokerage account name identical to entity Business activity code: 523110, 523900
Source: www.naicscode.com; keyword: securities trader
Employer Identification Number (EIN) Setup: www.irs.gov Walk-through of IRS site at optionstaxguy.com
Entities – Taxation
Sole proprietorships (SMLLC) Flows to page 1 of Form 1040
Subject to self-employment tax – except traders
May be subject to state business/franchise tax
Partnership (LLC default for 2+) Flows through to Form 1040 via Schedule E page 2
Flows to Sch B/Sch D/Sch 4797 via K-1
Subject to self-employment tax – except traders
Entities – Taxation
C Corporation Separate perpetual entity Subject to double taxation Benefits more compliant/straightforward
S Corporation Separate perpetual entity Flows through to Form 1040 via Schedule E page 2 Flows to Sch B/Sch D/Form 4797 via K-1 Benefits available same as C but less flexible Not subject to self-employment
Entities – Benefits
General benefits Employer-reimbursement for education
Dependent Care Assistance
Adoption Assistance
Home office Principal place of business as a trader
Regular use – continuing basis
Exclusive use – no personal, television, exercise
Entities – Benefits
Employer-provided transportation Substantiation for business use Log Personal use includible in income (W-2) 100% depreciation for employer Various valuation methods but limited if owner Reimbursement at federal rates Vehicle should be titled in business name Insurance rates may be higher May be subject to property tax
Entities – Benefits
Health & Medical plans Entity-dependent treatment Health reimbursement accounts (Sec 105 plans) Section 125 plans – cafeteria plans
Retirement plans Simplified Employee Pension – super-IRA SIMPLE Profit-sharing Pensions – defined benefit or contribution
Entities – What are we missing?
Most benefits based on compensation
You need to be an employee Wages Forms 941, 940, W-2, W-3, State
Form 5500 possibly
Form 1120/1120S/1065
Entities – Warning!
Simply setting up an entity does NOT elevate
one’s trading to that of a TRADER
The most simple entity is usually the best
entity flow-throughs
Setup entity in your domicile state – NEXUS
Avoid “package deals” of entity setup and
compliance
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
How are Strategies Taxed?
Initiate a Covered Call/Collar on Apple: Buy AAPL on 7/20/2010
STO Sep 10 280 Call BTC/Expired Sep 10 280 Call STO Oct 10 320 Call BTO Nov 10 290 Put BTC/Expired Oct 10 320 Call STO Nov 10 300 Call STC Nov 10 290 Put Expired Nov 10 300 Call
AAPL* called at Nov 10 expiration
Taxable Transaction # 1
Taxable Transaction # 2
Taxable Transaction # 3
Taxable Transaction # 4
*Taxable Transaction # 5
Reporting
Reporting
Mark to Market example from above SPX deemed SOLD on 12/31/2010 at 126
SPX deemed REPURCHASED on 12/31/2010 for
126
Gain 21 (126 – 105)
Long-term 12.6 (60% x 21); 15% max tax rate
Short-term 8.4 (40% x 21); 35% max tax rate
Reporting
Reporting Form 4797
Used for MTM Traders Reported in Part II, Ordinary Gains and Losses Favorable capital gain rates do not apply Wash sale rules do not apply $3000 net capital loss limit does not apply
Reporting
Jeff’s OTB Bull Puts Joseph A Banks (JOSB) – Jul 2011 30/35
Opened 1/25/2011 – $0.80 credit Closed 3/2/2011 – $0.40 debit
Green Mtn Coffee Rsters (GMCR) – Sep 2011 30/32 Opened 2/7/2011 – $0.49 credit Closed 3/10/2011 – $0.17 debit
Noble Energy (NE) – Jun 2011 30/32 Opened 1/27/2011 – $0.35 credit Closed 2/22/2011 – $0.13 debit
$0.40 profit
$0.32 profit
$0.22 profit
Reporting
Joseph A Banks (JOSB) – Jul 2011 30/35
STO JOS110716P00035000 on 1/25/2011 for $1.50
BTO JOS110716P00030000 on 1/25/2011 for $0.70
BTC JOS110716P00035000 on 3/2/2011 for $0.75
STC JOS110716P00030000 on 3/2/2011 for $0.35
Reporting
Green Mtn Coffee (GMCR) – Sep 2011 30/32
STO GMCR110917P00032000 on 2/7/2011 for $2.34
BTO GMCR110917P00030000 on 2/7/2011 for $1.85
BTC GMCR110917P00032000 on 3/10/2011 for $0.70
STC GMCR110917P00030000 on 3/10/2011 for $0.53
Reporting
Noble Energy (NE) – Jun 2011 30/32
STO NE110618P00032000 on 1/27/2011 for $1.01
BTO NE110618P00030000 on 1/27/2011 for $0.66
BTC NE110618P00032000 on 2/22/2011 for $0.41
STC NE110618P00030000 on 2/22/2011 for $0.28
Reporting
Reporting Tips
Schedule D/Schedule D-1 Used by both investor and trader Name, dates, sale, cost, gain/loss If applicable, use “VARIOUS” to designate dates
of block purchases or sales; still separate short-term and long-term
Identify wash sales under the affected transaction by designating “WASH SALE” and adding the loss amount as a positive in col (f)
Reporting Tips
Expired options Long options
Name, expiration date in col (c), “EXPIRED” in col (d)
Short options Name, expiration date in col (b), “EXPIRED” in col (e)
Tie stock sales to 1099B gross proceeds
Thank You!
Trader Tax Issues
OA Dallas Student Summit
April 2, 2011