A calculator spells out the word tax over a piece of paper with a bar graph on it

What to Know About Taxes Before Structuring Your Trading Business

So, you’ve decided to make day trading your full-time career. If you’re truly prepared for the job, there are a lot of potential benefits to the choice you’ve made. You get to work from home, be your own boss and you have the opportunity to make a good deal of money.

But there are also some decisions you’ll have to make before you begin actively trading and some things you’ll have to know about taxes and how they work for day traders. This includes decisions you’ll have to make about how to structure your trading business. Here are some things to know about taxes for traders before you get started:

Trading vs. Investing

It’s important to know up front that just because you consider yourself a day trader does not mean the IRS will see things the same way. There are a few specific things they look at to determine if you’re more of a trader than a long-term investor. There are important tax ramifications to this distinction.

The difference, essentially, is that investors make their money from dividends, interest and capital appreciation while traders make theirs from daily stock movements. In simpler terms, it’s a long-term strategy vs. a short one. If you want to be considered a trader by the IRS, you have to be able to show you make trades regularly and have a substantial number of trades made. Important factors in helping the IRS determine your status will include the frequency and dollar amount of trades, how long you hold your positions, the amount of time devoted to trading and whether it’s the means by which you support yourself.

If you do meet the requirements, you’re going to have to decide how exactly you want to structure your business. There are a few choices available to you.

Sole Proprietorship

If you don’t set up a structure for your trading business, you will be considered a sole proprietorship. There are some tax benefits, but there are drawbacks as well. Essentially, there will be no financial difference between you as an individual and you as a trader. You will file only one tax return for all of your financial activity in a given year. This means that there is no legal separation between you and your business. You will be solely responsible for taxes owed, trading debts and other obligations.

Creating a Business Entity

Creating a business entity is more expensive and time-consuming up-front but can pay off in the long term. One of the biggest advantages to doing so is you’ll file separate tax returns for your business and yourself as an individual, even if you’re the only employee of the business. This allows the IRS a better look at the financials of your trading business, which can help you avoid headaches in the long term.

One type of business structure you can choose is an S corporation. The benefit of choosing this is it allows you to deduct your retirement plan contribution and health insurance from your taxes. Another option is forming a C-corporation. Under this structure, profits tend to come in the form of salary and dividends. The income from trading is taxable to the corporation, not the individual owner. These corporations offer greater flexibility, but also require more work.

Traders may also choose to form a limited liability company or LLC. As the name suggests, this can help shield you from personal liability. Trading businesses which have at least two members have the option to be taxed as an LLC partnership. Under this structure, the LLC files a tax return, but the income or loss from trading goes directly to the members and is reported on their individual tax returns.

If you’re a trader looking to turn your activities into a legal business entity but need help with structuring that business, Traders Accounting is here for you. We have three different business entity packages to choose from based on the needs of your business. Depending on the package, you’ll get such benefits as bookkeeping services, mark-to-market coaching, a home office deduction, free first-year federal and state tax returns and more. Call 800-938-9513 to learn more today.

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