What defines a Trader? |
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A trader must be primarily in the business of trading, to the point where trading is on a "level or carrying on a trade or business".
Keep in mind that there are no official guidelines by the IRS for the definition of a trader. Rather, case law must be relied upon.
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A trader can have income from other sources, but he must be able to clearly establish that the other activities do not contradict his claimed trader status. For example, a person with a full time day job (during market hours) would likely not be able to convince the IRS to allow trader status. |
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A trader is defined as "one who buys and sells securities for his/her personal account, not on behalf of clients" (source: investorwords). Therefore, a person who trades with someone else's money would have a harder time making a case for trader status, as his time to devote to trading his own account would be limited. See some case law examples here.
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A trader who is also a longer term investor must take care to segregate his investments in a separate brokerage account from his trading activities. This impacts two areas - the different tax rates applicable to trading income and long term capital gains, as well as his Trader status with the IRS.
The number of trades that qualifies an individual to claim trader status as opposed to an investor is conspicuously absent from the guidelines and regulations. Rather, it is left up to the individual's discretion to make such a claim, and the burden of proof is upon the taxpayer in the case of a subsequent audit to prove his trading activities.
There are two types of traders. Traders who elect the Mark to Market (MTM) accounting method and those who do not. Please see this page for discussion of MTM Traders, we will continue discussion of traders who do not elect MTM here.
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Is there any publication that explains the proper way to file a Schedule C as a day trader?
Publication 550, Investment Income and Expenses, which is specific to traders, includes a section titled Special Rules for Traders in Securities.
Internal Revenue Code section 475(f) and Revenue Procedure 99-17 apply only to traders who elect mark-to-market.
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What about the Self Employment Tax?
Trader in Securities
You are a trader in securities if you are engaged in the business of buying and selling securities for your own account. As a trader in securities, your gain or loss from the disposition of securities is not taken into account when you figure net earnings from self-employment. However, see Dealer in Securities, earlier, for an exception that applies to section 1256 contracts. For more information about traders in securities, see Publication 550. Please note that this is relevant to the Mark to Market Trader, the "basic trader" still has capital gains, rather than "income".
Quoted directly from the IRS, Publication 533, "Who Must Pay Self-Employment Tax?", (emphasis added)
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A trader who does not elect MTM uses Schedule D for all his trade reporting. All his trades result in capital gains and loses, and same rules as for investors apply, including the $3,000 net capital loss limitation. The main difference between an investor and a trader is that since the trader is in the business of trading, he can claim his trading related expenses on Schedule C - Profit or Loss from a Business. Therefore, a trader is not subject to the 2% of his adjusted gross income threshhold that an investor is, and all his trading related expenses are deductible. The IRS has recently come out with Daytrader FAQ.
It may be advantageous in some cases for a trader to consider incorporating. Because of the upfront costs (your time as well as your money), as well as annual costs and record keeping considerations, these are generally best utilized by traders who show consistent large annual profits.
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