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Eight Steps to Successful Trader Tax Filing

By Jim Forrester, CPA

Each New Year brings to a close a trading tax cycle and officially begins the
preparation for our annual reckoning with the Internal Revenue Service. If your
income exceeded your expectations, you can bring that sense of accomplishment to the
daunting job of tax planning; if not, we can often help you recoup some of your
shortfall through prudent tax strategies.

Advance tax planning is a particularly good idea this year, due to changes to the tax
code created by the Working Families Tax Relief Act and the American Jobs Creation
Act of 2004.

Because every trader faces unique circumstances, there can be no cookie-cutter, one-
size-fits-all tax solution across the board. It is important to consult with a
Traders Accounting tax professional before making any decision that could impact your
federal income tax and/or trader tax status.

Here are eight important points to consider in filing a successful tax return:

1. Protect Your Trader Tax Status

Nothing can throw a monkey wrench into your tax plan like being denied trader tax
status by the Internal Revenue Service. Because trader status is constantly evolving
with each tax court decision, it is especially important to position yourself well
within the IRS' working parameters before proceeding.

According to the IRS, to qualify as a trader, you must 1) seek to profit from daily
market movements in the prices of securities and not from dividends, interest or
capital appreciation; 2) your activity must be substantial; and 3) you must carry on
the activity with continuity and regularity. Fail any part of that test and you'll be
treated as an investor, not a trader, for tax purposes.

What's at stake? Investors are subject to the 2% threshold for deductible investment
expenses (and hence cannot write off most of their expenses) and are limited to a $3,
000 capital loss deduction. But as a trader, you can write off 100% of your expenses,
and if you elect the mark-to-market (MTM) accounting option, can offset all of your
losses against income. But remember if your trader status is denied by an IRS audit
you loose your MTM election.

New this year: The Frank Chen case. A curious tax court ruling last summer in the
case of Frank Chen cast a dark cloud over the trader tax status of certain filers. In
the Chen case, the judge agreed with the IRS in denying Chen's trader tax status
based in part on the fact that trading was not Chen's "sole and primary income-
producing activity."

If you make more money at another job, or even have another job in addition to your
trading, be sure to consult a Traders Accounting tax professional before proceeding
with your tax preparations.

2. File a Timely Extension

Because of the complexities of filing a trader tax return, it's often a good idea to
file an extension. If you file an Automatic Extension by the tax deadline of April
15, your tax deadline is automatically moved to Aug. 16. If you need additional time
to complete your taxes, you can file for a second extension by Aug. 16, which would
move your tax deadline to Oct. 15. But this second extension is not automatic; you
must provide a reason for needing extra time and receive the form back marked
"granted" by the IRS.

Bear in mind that an extension only gives you extra time to file; you must still pay
at least 90% of what you owe by the original April 15 deadline, or your Automatic
Extension will be ruled invalid and you'll be slapped with late penalties of 5% per
month up to five months, as well as interest expense on all tax payments after April

3. Report on the Correct Forms

Many traders mistakenly report all trading income on Schedule D (Capital Gains and
Losses). To avoid this common error, if you elected mark-to-market accounting, you
should list your trading activity on Form 4797 (Sales of Business Property), and if
you traded in futures or forex, you should report these trades on Form 6781 (Gains
and Losses from Section 1256 Contracts and Saddles).

4. Don't Depend on IRA Trades for Trader Status

If you are trading in your individual retirement account or 401(k) plan the IRS won't
count those trades toward your trader tax status, even if you meet the other trader

5. Beware Missteps on "Managed Accounts"

If you have "managed accounts" in which you have hired another trader to conduct your
trades, the IRS will not count that activity toward your trader tax status, nor allow
you to take expenses against it. To successfully claim trader tax status, you must
actually be the one "pulling the trigger" on the trades.

6. Prepare Before Proceeding with Mark-to-Market

The rules of mark-to-market election couldn't be clearer: in order to use MTM this
year, you must have notified the IRS of your election by the tax deadline last year.
You would then begin using MTM this year by enclosing IRS Form 3115 along with your
tax return.

But before you make the switch, make sure you separate your investment holdings from
your trading stocks and options. Why? Because unless they are clearly separated, you
will be required to mark them to market at year's end and report any gain as ordinary
income. That could prove disastrous for stocks that have greatly increased in value
over time.

The decision to elect mark-to-market is not to be entered into lightly; it can have a
profound positive or negative impact on your taxes. Once you elect MTM, there is no
going back without IRS approval. Consult a Traders Accounting tax professional to see
if mark-to-market is right for you. Again remember that MTM is an accounting method
only for traders who trade as a business.

7. Include a Complete Trading Log

Traders who elect mark-to-market are often under the misconception that they need
only provide their beginning and ending balance on their tax return and not account
for the trades in between. The IRS has requested that every trader send in a schedule
showing all of his or her trades for the tax year, whether filing as a trader or
investor. The lone exception is for those trading in futures or forex; you need only
submit a net figure (use IRS Form 6781).

8. Thank Your Spouse (Again)

Married traders have another good reason to thank their spouse this year: The Working
Families Tax Relief Act eliminates the so-called "marriage penalty" by increasing the
standard deduction to double the amount given to single taxpayers through 2010.

Trader tax preparation is an often-arduous process that requires a thorough command
of current tax law, recent tax court rulings and IRS interpretation. Before making
any decisions that could affect your trader tax status or return, we recommend that
you consult a trader's tax professional to determine your best course of action.


TRI has invented a special proven diary that eliminates procrastination. This diary
has all the questions needed by the IRS to audit proof your:
-Entertainment and meal expenses
-Recreational activities and sporting events
-Commuting expenses
-Business trips
-And even parking meters & pay phones!

The key is that these tax questions and potential tax deductions in front of you
daily. You are constantly reminded of how to maximize your tax write-offs everyday.
The diary has worked so well that virtually everyone who has used it has noted that
it's very easy to use since all the questions are there, and it has worked miracles
on IRS audits. It has withstood almost every audit it has come up against. Even the
IRS agents were amazed at how good the system has proven to be.

Talk to you soon,

Jim Crimmins
Traders Accounting, Inc.