Academic journal article Journal of Accountancy

Paying the Piper: Some Tax Rules for Day Traders

Academic journal article Journal of Accountancy

Paying the Piper: Some Tax Rules for Day Traders

Article excerpt

One of the new vocations of the Internet age is day trading; it is characterized by traders' rapidly buying and selling securities to take advantage of small movements in their value and liquidating the portfolios by the end of the trading day. Coverage in the news media has generally focused on the lack of regulations governing the industry, the large losses that have prompted some day traders to act irrationally and the few successful traders who have earned large profits. But the news media has barely discussed the tax rules covering these trading transactions.

The Taxpayer Relief Act of 1997 contained several provisions that both help and hurt day traders in their computation of income taxes. First, the act permits the day trader to use mark to market accounting for his or her security portfolio. This allows him or her to recognize gains or losses in the value of a security portfolio before a gain is realized by the sale of a security. Since day trading is characterized by rapid turnover of securities and the day trader does not want to hold securities overnight, the effects of this provision are hard to determine.

Second, a day trader can classify his or her activities as a business to be reported under schedule C of form 1040. This is significantly better for the trader than the provisions that applied before the act went into effect. Previously, a day trader was limited to annual capital losses of $3,000, regardless of whether he or she had short- or long-term losses. But if he or she files as a business, there is no limitation to the total losses that can be taken. Since many day traders have experienced large losses, this is a significant tax benefit.

Third, the trader has greater latitude in deducting costs. As an individual, the day trader would have to deduct business costs on schedule A of form 1040 where 2% of adjusted gross income is first subtracted from the deduction. But if that trader classifies his or her activities as a business, such expenses--which include computer equipment, software, communication expenses, margin interest and related items--are fully deductible, and the 2% rule does not apply.

However, there are several negative tax rules associated with day trading. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.