These are a just a few examples out of a myriad of questions the IRS and tax court will look at to determine a trader’s tax status. Unfortunately, the IRS does not seem interested in offering any help to traders trying to understand these requirements. Instead, they seem more than happy to leave it up to the tax courts to determine how these guidelines apply in the real world. While tax court justices excel at interpreting tax law, it can be difficult to use their decisions to develop black and white rules. Each individual’s circumstances are unique and may be interpreted differently.
Because of the uniqueness of each individual, there is no single sure-fire strategy to make an active trader immune to the effects of murky trading tax law. We generally recommend that active traders conduct their active trading business in a legal entity (usually an LLC).
When you set up a legal trading entity, the mere act of setting up the entity tells the IRS that you are going into the active trading business. With that being said, if you are a trader, you still must be an active short-term trader in an entity. You must treat your trading as a business; learning to document your trading time, your expenses, and a few other matters. Trader’s Accounting can help you navigate these tasks to maximize your trading dollars.
In some cases, we recommend that you establish two legal trading entities. Generally, the combination structure is composed of a C Corporation and an LLC. The combination structure is used in very limited circumstances to utilize the advantages of each type of business.