Nor am I an accountant, attorney, or tax expert. However, I am a person who spent $150 for an informative consultation with a tax expert this week, a session that showed me that, according to the IRS, I'm probably not a trader.
I thought you might be interested to know what I learned. According to that expert, I probably don't qualify for trader tax status. Trader tax status allows traders some distinct benefits, including applying business expenses against taxable income, the possibility of carrying losses back two years or forward, and others.
I probably don't qualify, despite the fact that I trade fulltime, sitting at my desk probably more hours than most office workers sit at theirs, consider it my business and trade what I consider significant numbers of contracts with significant amounts held in margin for those trades. If I don't qualify, perhaps some of you who consider yourselves eligible for trader tax status might seek further clarification from your tax professionals if your situations are like mine.
What's the problem for me? It's twofold. The major difficulty is that I trade income-style strategies. My goal is to avoid trading every day. I want to earn a living. When I'm trading often, it's because my trades have required multiple adjustments, and adjustments mean something's gone wrong. I usually need to lower my profit expectations after I've adjusted.
That's why I don't want to make too many adjustments. Therefore, in my largest account, I placed trades 109 of the approximate 252 trading days of the year. That sounds like a lot to me, especially for an income-style trader. That's 43 percent of the days. However, the professional I consulted mentioned a landmark case in which the trader traded 45 percent of the days the market was open. The IRS prevailed against that trader who had thought himself eligible for trader tax status.
Another concern, in which I was skating toward the edge of acceptability, was in the number of trades. This expert wants his clients to have at least 400 round-trip (open and either closed or expired) trades each year. Although I trade lots of contracts each month, my trades are usually placed in big lots. My main brokerage's activity page breaks those trades for 2009 into 740 trades, since some were filled as numbers of 2-lots and 5-lots, etc., and a second, smaller account shows 109 actual options trades. I can't even count the trades in the IRA account I trade. Still, that means I may have barely skated into the number of round-lot trades that are needed.
However, since I clearly didn't exceed the criteria established in that landmark case for the number of days I traded, I wasn't going to push the envelope on this. If I had met both these criteria, I would have had another test to fulfill. The average length of time I was in a trade would have had to have been under 30 days. I think I would have met that one.
This is by no means an exhaustive discussion of the pros and cons of trader status and the qualifications needed. However, it was only because I knew something of these onerous qualifications that I wasn't totally floored to be told I might not qualify for trader status. Of course I think I should. I'm far more professional in my trading and devote more time to it now than I did when I was a newbie trader with a small account day trading every day in those long-ago times before pattern day traders needed a $25,000 minimum account. Yet back then I probably would have qualified more readily.
Maybe I should open a single-contract QQQQ option trade each day and close it a few minutes later, to complete enough round-trip trades on enough trading days to qualify? Nah. Most of my contracts are 1256 contracts, contracts on broad-based indices such as the RUT, SPX and OEX. I don't have to worry about wash sale rules on those 1256 contracts, and I'd have to do so if I were routinely trading the Q's or IWM or even a stock such as IBM or INTC. In my early days, I filled out a few Schedule D's with all those complicated wash-sale calculations, and I don't want to do that again.
Besides, I gave up directional trading for a reason, because it didn't fit my lifestyle or trading goals. I wanted a serious trading business, and I have it. The IRS's rules may seem wrong-headed to me and probably to a lot of you reading this, but until those rules are changed, whatcha going to do?
Anyway, I thought some of you might want to check out whether you qualify for trader tax status. Check with your broker for recommendations for an accountant who is knowledgeable about these issues. Be careful of your hometown accountant unless that hometown accountant has undergone extensive research into trading-related issues. I've heard from traders whose accountants didn't know about wash-sale rules or account for them in the forms, didn't understand the difference in 1256 trades on futures and broad-based, cash-settled indices and other types of options trades, and who blithely assured clients like me that, sure, they qualified for trader tax status.