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How would you like to put another $6,117 in your pocket this year instead of paying it to Uncle Sam? How about another $18,159? While these are hypothetical figures, I want you to know that as a trader, you have the power to substantially reduce your taxes this year whether you make or lose money.
Tax reduction starts when you understand the Internal Revenue Code, which is actually made up of two tax Codes: a tax Code for businesses and a tax Code for individuals. If you’re running a business, you’re rewarded for your entrepreneurial activities, and encouraged to continue them.
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If you’re an individual with W-2 income, you’re punished with progressively higher taxes and the elimination of deductible items.
What to do? The answer is very simple. Turn your trading activities into a bona fide business, and a world of deductions, fringe benefits and beneficial tax strategies will open up before you. Picture angels…with trumpets blowing…heralding a new day. Not bad, huh?
In a later article, you’ll learn exactly what you need to do to establish your trading business. For now, let’s look at a simple example that will show you the benefit of filing your taxes as a trading business instead of as an individual investor.
You’ll be amazed at what your CPA hasn’t told you!
Common Trader Expenses
Many traders find it is relatively easy to accumulate $15,000 - $25,000 of business expenses each year. Here’s a list of common expenses, with hypothetical (but reasonable) amounts spent for those expenses:
Now, let’s see how those expenses translate into tax savings for two types of people – those who file as an investor, and those who file as a business owner.
$40,000 Gain
How Much Tax Would You Save as an Investor?
Out of the $24,230 in total expenses, you, as an individual without a trading business, could only potentially deduct $6,640 because certain expenses with an asterisk next to them cannot be claimed as expenses by an investor. The remaining $6,640 must then overcome a 2% threshold of your adjusted gross income (AGI) before any amount of it is deductible.
In this example, you have $100,000 in W-2 income with a $40,000 trading gain, for a total AGI of $140,000. 2% of $140,000 is $2,800. Subtract the $2,800 from the $6,640 of deductible expenses, and you’re left with $3,840 in deductions.
Calculated at a 30% tax bracket, and you, as an investor, would see tax savings of $1,152.
How Much Tax Would You Save as a Trader?
On the other hand, suppose you’re a trader who has set up a business entity for your trading, and who has elected the Mark to Market accounting method. Now, all of your $24,230 in business expenses is deductible.
Calculated at a 30% tax bracket, and you, as a trader, would see tax savings of $7,269.
The Bottom-Line Tax Savings for the Trader: $6,117 ($509 per month)
In example A, the main difference is the fact that all of your business expenses were deductible. The net result to you is a monthly cash flow increase of more than $500 by running your trading activities as a business.
$40,000 Loss
How Much Tax Would You Save as an Investor?
In this example, you have the same W-2 income of $100,000, and the same expenses of $24,230. The only difference is that instead of a $40,000 gain, you take a trading loss of $40,000 for the year.
Your limitations on the deductible expenses are restricted as before. Also, since you’ve lost money trading, you can’t deduct your margin expense. So, out of $24,230 in expenses, you can only deduct $2,640.
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With the $40,000 loss, your AGI has dropped from $140,000 to $97,000. With the 2% threshold, your first $1,940 in expenses is not deductible. So you, as an investor, are left with $700 in deductible expenses and a $3,000 capital loss—for total deductions of $3,700.
Calculated at a 30% tax bracket, and you, as an investor, would realize tax savings of $1,110.
As a trader, you’re still able to deduct all $24,230 of your business expenses. Also, as a trader who has previously elected Mark to Market, you’re able to deduct your entire $40,000 loss—giving you a total deduction of $64,230. |
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Calculated at a 30% tax bracket, and you, as a trader, would realize tax savings of $19,269.
Conclusion: It Makes Sense to Trade as a Business
While these numbers are both hypothetical and vastly simplified (for example, we computed taxes at 30% instead of 28% to make the math calculations easy to see), the results bear out consistently for real traders with real trading businesses. In fact, in many ways, we’ve just skimmed the surface of the benefits available to you in your trading business. Read our additional articles to discover other ways to create your financial security through a properly structured trading business.
by Joe Wishcamper, Esq.
Information, charts or examples contained in this lesson are for illustration and educational purposes only. It should not be considered as advice or a recommendation to buy or sell any security or financial instrument. We do not and cannot offer investment advice. For further information please read our .
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