Trader Tax Issues

Trader Tax Issues

OptionsAnimal

Dallas Student Summit

April 2, 2011

Disclaimer

OptionsAny strategies used as examples and discussed, using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities.

TaxationAny US tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) providing, marketing or recommending to another party any transaction or matter addressed herein.

The information presented provides only a general discussion of the tax law affecting the taxation of options and is not intended to be applicable to any individual investment and tax situation. You are strongly advised to contact your own tax consultant in considering the tax consequences of your own specific set of facts and circumstances.

Agenda Securities & options taxation in general A Primer on OSI New basis reporting

aka “Pin the tail on the correct basis”

The Roadmap – www.optionstaxguy.com Trader vs Investor Mark to Market Entity selection Reporting

Goal

Understand how to get from the

Tradeto the

Tax Return

Securities Taxation

General Concepts

Taxation of Strategies

Options Symbology Initiative

New Broker Reporting Requirements

What Triggers Tax? Completed transaction

Open followed by Close Stock

Purchase Sale Short Sale Cover

Options BTO STC/Expiration STO BTC/Expiration

Which transaction establishes basis for gain/(loss)? The debit/non-credit side of the transaction

What is Taxed?

Gains and losses Determined on a:

First In – First Out (FIFO) basis First shares purchased are the first shares sold Used when cannot or does not identify which shares

sold [Reg 1.1012-1(c)(1)] IRS presumption

Specific Lot Identification basis Shares must be identified to broker Broker must confirm in writing [Reg 1.1012-1(c)(3)]

How is it Taxed?

Stocks/securities are generally capital assets Closing transaction generates gain/loss – generally Mark to market deems sale/repurchase but character

is still capital – generally Holding periods

Short-term – one year or shorter Long-term – longer than one year Generally begins on day after acquisition Generally ends on day of disposition

Pass-through entities – retain character

Amount of the Tax?

Short-term capital gains Ordinary income rates – 10% to 35%

Long-term capital gains Marginal rate bracket up to 15% 0%

Marginal rate bracket 25%+ 15%

Securities Taxation

General Concepts




How are Strategies Taxed?

They’re NOT!!

Individual Trades ARE

What did he

say?


Initiate a Put Calendar on SPY in Jan 2011 BTO May 11 130

STO Jan 11 130 BTC/Expire Jan 11 130 STO Feb 11 130 BTC/Expire Feb 11 130 STO Mar 11 130 BTC/Expire Mar 11 130

STC May 11 130* Four lines on Sch D/D-1

Taxable Transaction #1



*Taxable Transaction #4



Initiate a Covered Call/Collar on Apple: Buy AAPL on 7/20/2010

STO Sep 10 280 Call BTC/Expired Sep 10 280 Call STO Oct 10 320 Call BTO Nov 10 290 Put BTC/Expired Oct 10 320 Call STO Nov 10 300 Call STC Nov 10 290 Put Expired Nov 10 300 Call

AAPL* called at Nov 10 expiration

Taxable Transaction # 1




*Taxable Transaction # 5

How to keep it straight ...

That was a lot of trades!!! The OCC – and others – helped us out here

with the ...


The ‘Do-It-Yourselfers’ best friend No more OPRA symbols

OPRA: Apple Dec 2009 210 Call – AAQLB OSI: AAPL091219C00210000 (what it would have been)


Excel function to build OSI Symbol osisymbol(open,ticker,expiry,weekly,type,strike)

open – 0=closed, 1=open ticker – stock symbol, ie, AAPL, SPY expiry – expiration date in ‘mmm yyyy’ format weekly – weekly expiration day (numeric) type – Put (P) or Call (C) strike – strike price

Good for sorting option symbols

Securities Taxation

General Concepts




New Basis Reporting

Brokers now required to report cost basis and holding period

Both will be reported to IRS Implementation timeframe

Stock purchases – January 1, 2011 Mutual funds – January 1, 2012 Options & debt instruments – January 1, 2013

Why? Close tax gap $6.7B over 10 years

Basis Reporting Problems

Community property laws Inheritance

Stepped-up basis All long-term

Wash sale rules Loss add back Holding period adjustment

Assigned puts Decrease basis of assigned shares

Broker transfers

Basis Reporting ... so far so

Good

Purchased and sold/same broker – sometimes

Bad

Purchased and sold/different broker

Cost basis – Wrong

Cost basis – “UNKNOWN”

Examples from 2010 tax year

Basis Reporting Examples



What is the Point?

Keep track of:

COST BASIS

YOURSELF!

The Roadmap

Investor vs Trader

Mark to Market

Entity Selection

Reporting

Entity Selection

Complete Roadmap with associated links at: www.optionstaxguy.com/roadmap

Investor vs Trader Why? – Subject to different tax rules Definitions:

Investor – Stock purchase for capital appreciation/dividends Little regard for short-term fluctuations; Buy and hold

Trader – Regularly and continuously trade stock/securities Trade in own account Profit from short-term fluctuations

Can be BOTH trader and investor IRS presumption Investor

Investor vs Trader

Taxation of Investors Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D Subject to IRC Sec 1091 wash sale rules Subject to $3000 loss limit Investment expenses (except interest)

Schedule A deductions Subject to 2% AGI threshold Not deductible for AMT purposes

Interest – deductible up to net investment income

Investor vs Trader

Taxation of Traders Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D Subject to IRC Sec 1091 wash sale rules Subject to $3000 loss limit Gains NOT subject to self-employment tax Investment expenses

Schedule C/E* deductions Interest deductible for material participation Home office deduction eligibility

Mark-to-Market (MTM) election eligibility_____________________________________________________________________________________________________

* Flow-through entity, such as partnership, LLC, S-Corp

Investor vs Trader – MTM Election

What is Mark-to-Market (MTM)? Traders can elect to mark their security holdings

to market value at the end of the tax yearIRC Sec 475(f) –

“… In the case of a person who is engaged in a trade or business as a trader in securities …”

Gains and losses treated as ordinary gain/loss Adjustment to stock basis for unrealized gain/loss Not subject to self-employment tax Reported on Form 4797, Part II

Investor vs Trader – MTM Election Benefits

Two restrictions no longer apply:

$3,000 net capital loss limit

Wash sale rule

However ...

Election is IRREVOCABLE without IRS consent

Wash Sales

Wash sale definition: Loss transaction Buy substantially identical stock – OR – Option to acquire substantially identical stock Within 30 days before or after loss transaction

Are options subject to wash sale treatment? Does AAPL Apr 11 350 SP = AAPL Apr 11 340 SP? If AAPL at Apr expiration = $330 Yes If AAPL at Apr expiration = $345 No

Mark to Market Example


Purchase 100 SPX at 105 on 11/8/2009 Make MTM election on 2/4/2010 SPX closes at 126 on 12/31/2010 Mark-to-Market requirements:

SPX deemed SOLD on 12/31/2010 at 126 SPX deemed REPURCHASED on 12/31/2010 for

126 – new basis going forward Gain 21 (126 – 105)

Long-term 12.6 (60% x 21); 15% max tax rate Short-term 8.4 (40% x 21); 35% max tax rate


SPX declines to 110 by 4/10/2011 and is sold What is the gain/loss? How is it taxed?

Deemed repurchase at 126 on 12/31/2010

Sale 110

Less: Basis 126 (from deemed repurchase)

Loss <16> LTCL <9.6> (60%)

STCL <6.4> (40%) Loss may be carried back three years

Investor vs Trader – Making the MTM Election

Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com

Investor vs Trader – Living with the MTM Election

Also available at www.optionstaxguy.com

Investor vs Trader - Summary

Criteria Investor Trader MTM Trader

Reporting gain/loss Sch D Sch D Form 4797

Reporting expenses Sch A Sch C/E Sch C/E

Reporting interest Sch A Sch C/E Sch C/E

Invest int exp limits Yes No No

Home office eligible No Yes Yes

Subject to S-E tax No No No

Wash sale rules Yes Yes No

$3000 Cap loss limit Yes Yes No

The Roadmap

Investor vs Trader

Mark to Market

Entity Selection

Reporting

Entity Selection

Entity Selection

Entities – Types

Types of entities for Traders Sole proprietor – Sch C/Sch D/Form 4797 (default) General Partnership – Form 1065 Limited Liability Company (LLC) – Form 1065

Single member LLC – Sch C/Sch D/Form 4797 Multiple member LLC*

Corporation C Corporation – Default; Form 1120 S Corporation – Election; Form 2553 Form 1120S * LLC with election: Form 8823 Form 2553 (S Corp)

Entities – Setup

State law prevails – name, articles, etc. Separate bank account styled identically to

entity name (Patriot Act) Brokerage account name identical to entity Business activity code: 523110, 523900

Source: www.naicscode.com; keyword: securities trader

Employer Identification Number (EIN) Setup: www.irs.gov Walk-through of IRS site at optionstaxguy.com

Entities – Taxation

Sole proprietorships (SMLLC) Flows to page 1 of Form 1040

Subject to self-employment tax – except traders

May be subject to state business/franchise tax

Partnership (LLC default for 2+) Flows through to Form 1040 via Schedule E page 2

Flows to Sch B/Sch D/Sch 4797 via K-1

Subject to self-employment tax – except traders

Entities – Taxation

C Corporation Separate perpetual entity Subject to double taxation Benefits more compliant/straightforward

S Corporation Separate perpetual entity Flows through to Form 1040 via Schedule E page 2 Flows to Sch B/Sch D/Form 4797 via K-1 Benefits available same as C but less flexible Not subject to self-employment

Entities – Benefits

General benefits Employer-reimbursement for education

Dependent Care Assistance

Adoption Assistance

Home office Principal place of business as a trader

Regular use – continuing basis

Exclusive use – no personal, television, exercise


Employer-provided transportation Substantiation for business use Log Personal use includible in income (W-2) 100% depreciation for employer Various valuation methods but limited if owner Reimbursement at federal rates Vehicle should be titled in business name Insurance rates may be higher May be subject to property tax


Health & Medical plans Entity-dependent treatment Health reimbursement accounts (Sec 105 plans) Section 125 plans – cafeteria plans

Retirement plans Simplified Employee Pension – super-IRA SIMPLE Profit-sharing Pensions – defined benefit or contribution

Entities – What are we missing?

Most benefits based on compensation

You need to be an employee Wages Forms 941, 940, W-2, W-3, State

Form 5500 possibly

Form 1120/1120S/1065

Entities – Warning!

Simply setting up an entity does NOT elevate

one’s trading to that of a TRADER

The most simple entity is usually the best

entity flow-throughs

Setup entity in your domicile state – NEXUS

Avoid “package deals” of entity setup and

compliance

The Roadmap

Investor vs Trader

Mark to Market

Entity Selection

Reporting


Initiate a Covered Call/Collar on Apple: Buy AAPL on 7/20/2010

STO Sep 10 280 Call BTC/Expired Sep 10 280 Call STO Oct 10 320 Call BTO Nov 10 290 Put BTC/Expired Oct 10 320 Call STO Nov 10 300 Call STC Nov 10 290 Put Expired Nov 10 300 Call

AAPL* called at Nov 10 expiration





*Taxable Transaction # 5

Reporting

Reporting

Mark to Market example from above SPX deemed SOLD on 12/31/2010 at 126

SPX deemed REPURCHASED on 12/31/2010 for

126

Gain 21 (126 – 105)

Long-term 12.6 (60% x 21); 15% max tax rate

Short-term 8.4 (40% x 21); 35% max tax rate

Reporting

Reporting Form 4797

Used for MTM Traders Reported in Part II, Ordinary Gains and Losses Favorable capital gain rates do not apply Wash sale rules do not apply $3000 net capital loss limit does not apply

Reporting

Jeff’s OTB Bull Puts Joseph A Banks (JOSB) – Jul 2011 30/35

Opened 1/25/2011 – $0.80 credit Closed 3/2/2011 – $0.40 debit

Green Mtn Coffee Rsters (GMCR) – Sep 2011 30/32 Opened 2/7/2011 – $0.49 credit Closed 3/10/2011 – $0.17 debit

Noble Energy (NE) – Jun 2011 30/32 Opened 1/27/2011 – $0.35 credit Closed 2/22/2011 – $0.13 debit

$0.40 profit

$0.32 profit

$0.22 profit

Reporting

Joseph A Banks (JOSB) – Jul 2011 30/35

STO JOS110716P00035000 on 1/25/2011 for $1.50

BTO JOS110716P00030000 on 1/25/2011 for $0.70

BTC JOS110716P00035000 on 3/2/2011 for $0.75

STC JOS110716P00030000 on 3/2/2011 for $0.35

Reporting

Green Mtn Coffee (GMCR) – Sep 2011 30/32

STO GMCR110917P00032000 on 2/7/2011 for $2.34

BTO GMCR110917P00030000 on 2/7/2011 for $1.85

BTC GMCR110917P00032000 on 3/10/2011 for $0.70

STC GMCR110917P00030000 on 3/10/2011 for $0.53

Reporting

Noble Energy (NE) – Jun 2011 30/32

STO NE110618P00032000 on 1/27/2011 for $1.01

BTO NE110618P00030000 on 1/27/2011 for $0.66

BTC NE110618P00032000 on 2/22/2011 for $0.41

STC NE110618P00030000 on 2/22/2011 for $0.28

Reporting

Reporting Tips

Schedule D/Schedule D-1 Used by both investor and trader Name, dates, sale, cost, gain/loss If applicable, use “VARIOUS” to designate dates

of block purchases or sales; still separate short-term and long-term

Identify wash sales under the affected transaction by designating “WASH SALE” and adding the loss amount as a positive in col (f)

Reporting Tips

Expired options Long options

Name, expiration date in col (c), “EXPIRED” in col (d)

Short options Name, expiration date in col (b), “EXPIRED” in col (e)

Tie stock sales to 1099B gross proceeds

Thank You!

Trader Tax Issues

OA Dallas Student Summit

April 2, 2011

Documents

Trader Tax Issues