Day Traders: When is Income Tax applied?

[Ruishi]

Hi all,

I hope there's some day traders here who can provide some insight because Ive been scratching my head over this one... When exactly is the income tax rate applied to "income" from day trading (for someone with trader tax status)? What I mean is, is it applied to the profit from the end of each day after losses have been accounted for? ...or will I be taxed on EACH individual profitable trade, even if some of that money is lost 5 minutes later on a losing trade? Or (wishful thinking?) is it applied to my net profit at the end of the year, after all losses have been taken out?

Ex.
On Sept 8th: At 10:00am, I trade AMD for a profit of $500. Then at 11:30, I close a losing trade on INO at a loss of $400. At 3:00pm, I trade BOXL and make a profit of $100.

Total Profit: $600
Total Loss: $400
Net Gain: $200

Am I charged income tax on the $600, even though I didn't keep it all?
Or am I charged income tax on the $200 because that was the profit by the end of the day?
Or does it look at net gain in the above manner over the period of the whole year?

I know there's the wash sale rule and exemption, which I'm also learning about and I'm sure it relates to this issue, but right now I'm just trying to understand the basics of basics on how income tax is applied to day trading before those rules/exemptions apply.

In this scenario, lets assume the person has trader tax status, not investor.

Thanks in advance for your insight on this.

 

[youbet]

What is "trader tax status?"

 

[Car-Guy]

I day trade but I do it in my IRA so I don't report anything. I had to look up "traders tax status"...

 

[Ruishi]

Well I'm still learning but what I think I understand is this:

Trader Tax Status is a tax designation that applies a different set of income tax rules to day traders who day-trade for a living (ex. someone who trades for at least 4 hours per day, every day, making at least several trades a day). This is opposed to "Investor" status, which has its own set of rules (which are less conducive to a day trader as someone trading several trades a day, closing positions before the end of the day).




Here's some better explanations if you're interested:




https://www.investopedia.com/terms/t/trader.asp


https://www.dummies.com/personal-fi...ax-information-for-irs-qualified-day-traders/

 

[pb4uski]

You should probably be making estimated payments for taxes based on your year-to-date taxable income.

Typically, estimated payments for income:

• from Jan 1 - Mar 31 is due on Apr 15;
• from Jan 1 to May 31... less previous payments is due on Jun 15;
• from Jan 1 to Aug 31... less previous payments is due Sept 15;
• from Jan 1 to Dec 31... less previous payments is due Jan 15

COVID has disrupted that typical pattern... IIRC the payments that would have typically been due on Apr 15 and Jun 15 were deferred to Jul 15.

You estimate your year-to-date taxable income and tax through the end of March, May, August or Dec, calculate the tax and then reduce the year-to-date tax by previous estimated payments and withholdings.

 

[Fermion]

Just pay estimated taxes quarterly. It is highly unlikely you qualify for mark to market trader status if you don't understand taxes on trades.

An example. I made a $60,000 profit on Stemline earlier this year, $20,000 on some puts I bought in March (should have been $2,000,000 but that is another story), and I lost about $5,000 on Merck. I sent the IRS $15,000 based on the realized gains (minus realized losses) of $75,000. Before September, I will probably send them more, as I have made another $30,000 trading ITCI and SGMO.

It sucks until you realize you are making money.

 

[Ruishi]

Thanks for the replies, although I'm still confused. Fermion and pb4uski, you both are suggesting I pay estimated taxes quarterly, but the issue I'm having is how do I figure out what my estimated taxes are in the first place? Ie. for a day trader (with TTS status), when does profit become taxable "income"?

Fermion, you said its unlikely that I would qualify if I dont understand taxes. Why is that? Isnt qualifying for TTS mostly a matter of how much time you are spending trading, how many trades in a year, and whether you are doing it with the intention of making a living?

I've been day trading in simulator full time for a while now and plan to keep similar patterns when I go live. I analyze premarket, watch for the right set ups and trade for at least 5 hours per day, plenty of trades per day, every market day. From everything I've read, it seems that I would qualify for Trader Tax Status as soon as I can file it that way. Part of my preparation before I go live is to figure out taxes so that there aren't nasty surprises down the road. Which brings us back to the initial question.



Thanks for any insights or resources in advance!

 

[Go-NoGo]

Isnt qualifying for TTS mostly a matter of how much time you are spending trading, how many trades in a year, and whether you are doing it with the intention of making a living?

Thanks for any insights or resources in advance!

Here's something I read earlier in the WSJ that might help:

The Benefits of Calling Yourself a ‘Trader’ for Tax Purposes:
https://www.wsj.com/articles/the-benefits-of-calling-yourself-a-trader-for-tax-purposes-11593947083

"..All filers, unless they tell the Internal Revenue Service otherwise, are considered regular investors, a status that brings with it restrictions on deductions related to investment expenses and a limit of $3,000 a year on deductions for capital losses against ordinary income.

To qualify for trader tax status, investors generally should be trading throughout the day, or almost daily, and substantially in non-retirement accounts. Trading also should be the investor’s primary source of income."

And also check out the IRS publication for day trader status:

Topic No. 429 Traders in Securities (Information for Form 1040 or 1040-SR Filers)
https://www.irs.gov/taxtopics/tc429

 

[pb4uski]

Thanks for the replies, although I'm still confused. Fermion and pb4uski, you both are suggesting I pay estimated taxes quarterly, but the issue I'm having is how do I figure out what my estimated taxes are in the first place? Ie. for a day trader (with TTS status), when does profit become taxable "income"?....

Do you have other sources of income?

Do you prepare your own income taxes? If so, do you use software like Turbo Tax?

To estimate your taxes you'll need to do a broad-brush tax return for the year at the end of March, May, August and December... probably in Excel or Turbo Tax. Or I like this calculator:https://www.dinkytown.net/java/1040-tax-calculator.html
.
Profit is taxable income when it is realized... when you sell at a gain or loss... however, it isn't payable until the estimated tax dates above. So for example, if you close out January with a gain the taxes on that gain wouldn't need to be paid until Apr 15.

See page 4 of this link: https://www.irs.gov/pub/irs-pdf/f2210.pdf

I would do it based on YTD trading results assuming that the rest of year trading results are nil.... so if you have a $50k pension and YTD trading gains of $20k then calculate the tax based on $70k of income for the year less deductions for the year.

So for example..... if you were single and used the standard deduction of $12,400 then taxable income is $57,600 and tax of $8,468... then at the end of March your YTD income is $32,500 so your estimated payment would be $3,931 ($8,468/$70k*$32,500).

Let's say that you have no other trading gains the rest of the year, your remaining estimated payments would be $1,512 for 3 quarters ($12.5k/$70k*$8,468)... for a total of $8,467.

 

[youbet]

Thanks to everyone who posted links to info regarding my question "what is trader tax status"! Interesting stuff. I like to trade a bit but I'll never reach that level. Still, enlightening to read about.

 

[Montecfo]

Hi all,

I hope there's some day traders here who can provide some insight because Ive been scratching my head over this one... When exactly is the income tax rate applied to "income" from day trading (for someone with trader tax status)? What I mean is, is it applied to the profit from the end of each day after losses have been accounted for? ...or will I be taxed on EACH individual profitable trade, even if some of that money is lost 5 minutes later on a losing trade? Or (wishful thinking?) is it applied to my net profit at the end of the year, after all losses have been taken out?

Ex.
On Sept 8th: At 10:00am, I trade AMD for a profit of $500. Then at 11:30, I close a losing trade on INO at a loss of $400. At 3:00pm, I trade BOXL and make a profit of $100.

Total Profit: $600
Total Loss: $400
Net Gain: $200

Am I charged income tax on the $600, even though I didn't keep it all?
Or am I charged income tax on the $200 because that was the profit by the end of the day?
Or does it look at net gain in the above manner over the period of the whole year?

I know there's the wash sale rule and exemption, which I'm also learning about and I'm sure it relates to this issue, but right now I'm just trying to understand the basics of basics on how income tax is applied to day trading before those rules/exemptions apply.

In this scenario, lets assume the person has trader tax status, not investor.

Thanks in advance for your insight on this.

Some highlights:
Assuming you elect mark to market, your net income/loss is taxable at ordinary rates with no wash sales. Loss deductions are not limited as they are with investors.
Business expenses deductible.

 

[cathy63]

IRS Pub 550 Page 68 has useful info for Traders. https://www.irs.gov/pub/irs-pdf/p550.pdf

Per this pub:

Transactions from trading activities result in capital gains and losses (unless a section 475(f) election has been made) and must be reported on Form 8949 and Schedule D (Form 1040 or 1040-SR), as appropriate. Losses from these transactions are subject to the limit on capital losses explained earlier in this chapter.

and

To make the mark-to-market election for 2020, you must have filed an election statement no later than the due date for your 2019 return (without regard to extensions). The statement must be attached to that return or with a properly filed request for extension...

So, I believe the question you need to answer is: did you file such a statement with your 2019 return or request for extension? (If you were not required to file a 2019 return, then you have more leeway. Read Pub 550 for details.)

If you did not make the mark-to-market election for 2020, then you will be reporting your trades on Schedule D just like everyone else. To answer your original questions, the tax is on your net gains for the entire year, with short-term and long-term gains figured separately; but as others have pointed out, you will need to estimate it and pay it in four installments.

 

[clobber]

I mean, the overall answer to the question is that you will file a tax return on April 15 of the following year, just like any other taxpayer. If that results in a refund or slight underpayment, then fine. If it results in a penalty, then you probably should have been making estimated payments.

In other words, making profits on trading is not that much different that getting a big bonus at work, or taking a withdrawal from a tIRA. If you don't have taxes withheld on it, then you will probably owe come 15 April and there could be penalties.

 

[11522914]

I day trade but I do it in my IRA so I don't report anything. I had to look up "traders tax status"...

+1

Day trade primarily in my Roth IRA.

 

[Ruishi]

Thanks all for your thoughts on this. I'm tracking my day trading while in the simulator to practice and reach some benchmarks for consistent profit before going live. I'm taking into account all related fees as well as income tax to see what the net profit is to determine whether I'm making enough money consistently to be ready to go live or if I need to stay in the simulator to refine techniques more. The simulator doesnt calculate any fees or anything for me, so I've got an excel sheet set up for tracking this. I'm just trying to figure out the best way to apply income tax it as well.


I'm aware that I wont qualify for Trader Tax Status for the first year, but this planning for the long term set up. Given that I will likely be starting sometime now in the latter half of this year, I plan for 2021 to be a full year of trading, and thus, TTS. That way I will be able to file for mark-to-market for 2021 in when I file taxes for 2020.



Is anyone here under Trader Tax Status? I have other questions for you, if anyone is.

 

[pb4uski]

.... Is anyone here under Trader Tax Status?...

Nope. I'm retired and no longer work.