As long as you are full-time Forex traders, you will enjoy some impressive tax advantages that ordinary market participants won't get. However, this qualification might be challenging. It is a good idea to try and qualify for the trader status to bring down your federal income taxes.
The qualification will make you enjoy various deductions. As long as trading is your full-time job, not a hobby, there are multiple deductions available on Schedule C. Besides; Uncle Sam specifies that all your trading expenses qualify as business expenses. All other filers will use schedule A. this difference comes with a series of tax savings that you can enjoy.
The Schedule C Advantage
The ideal for individual investors is to deduct all expenses incurred in trading on Schedule A of their tax return. Uncle Sam classifies this as miscellaneous itemized deductions, making them subjected to 3% of the AGI (Adjusted Gross Income) threshold before they can be deducted. The implication of this is that a trader with annual income amounting to $200,000 with $10,000 trading expense can only deduct $6,000.
Consider another trader in the same situation that merits the trader tax status and has his trading expenses listed on schedule C: loss or profit from the business. Expenses on schedule C are not bound by the 2% rule, which binds the itemized expense (miscellaneous), which qualifies the trader to deduct the entire $10,000.
This also applies to interest expense, if there is any. It is pretty essential for commodity and forex traders that are highly leveraged and have substantial interest expenses. Such traders can deduct the entire interest on schedule C, whereas individual investors need to list such expenses as an itemized deduction (miscellaneous) using schedule A.
How to Qualify for Trader Status
Qualification for trader status is not a straightforward process, even though it comes with significant tax advantages. Uncle Sam specifies that:
Your profit should come from daily market movements of security price actions. It should not be centered on dividends, capital appreciation, or interests.
Your trading activity should be massive, and
It would help if you were consistent (regularity and continuity) with it.
Interestingly, the law never gave a particular definition on some terms like “substantial, regularity and continuity.”
What to do to Qualify for trader status?
Here are some laid down rules provided for people that need to qualify for trader status for tax purposes:
You should trade every day, whether full or part-time.
On average, you should trade (or doing other things related to the trading business) for a minimum of four hours per day.
Your trade should be all year long, just like you will do with a full-time job.
Every trading day, you should trade 75% or more.
Every year, there should be a thousand trades or more.
A high percentage of your trade should either be swing or day trades.
Your desire should be to make a living trading.
There are heavy investments in tools. Software, educations, etc., related to trading
You use dedicated office space or a home office for trading.
You have a huge trading account relative to your entire asset.
One needs to bear in mind that algorithmic trade might not apply. You must be in charge of the trading activity. Besides, your profit model should revolve around constant buying and selling at a profit. If you center on long-term holding, dividend income, and interests, the capital gains you try to treat as a capital gains tax rule will make your status as a trader raise eyebrows.
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