Mark-to-Market & Trader Taxes

January 4, 2024 Advanced
Learn the unique tax considerations that impact full-time traders' bottom lines, including qualifying under special IRS rules.

You've finally taken the leap into the world of full-time trading, and like all good traders, you want to take advantage of any edge that might help increase your profitability. So, let's talk about trader taxes.

Uncle Sam needs to get a slice, but your strategy can help determine the size of that piece. That's right: There are unique tax considerations for those who trade for a living that can greatly affect your bottom line.

First, let's make sure you don't run afoul of the Internal Revenue Service (IRS). In fact, the IRS has very strict rules to determine whether you qualify—by its standards—as a full-time trader and are entitled to use what is informally referred to as the "trader's election."

From the IRS: Special rules apply if you are a trader in securities in the business of buying and selling securities for your own account. To be engaged in business as a trader in securities, you must meet all the following conditions:

  • You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
  • Your activity must be substantial.
  • You must carry on the activity with continuity and regularity.

The following facts and circumstances should be considered in determining if your activity is a securities trading business:

  • The typical holding periods for securities bought and sold.
  • The frequency and dollar amount of your trades during the year.
  • The extent to which you pursue the activity to produce income for a livelihood.
  • The amount of time you devote to the activity.

If your trading activities do not meet the above definition of a business, you're considered an investor and not a trader. It doesn't matter whether you call yourself a trader or a "day trader."

Mark-to-market

If you feel you meet the above criteria, you could choose to take the "mark-to-market election," which must be claimed for the current year when you file your taxes from the previous year. Mark-to-market means you treat a trading position as closed at year-end and account for any gains or losses based on the marked value. When the position is later sold or covered, the cost is adjusted to the marked value.

To make the mark-to-market election, traders are required to file Form 3115 (Application for Change in Accounting Method). IRS Publication 550 describes the procedures in making this election with the IRS. 

As far as the IRS is concerned, for tax reporting purposes, full-time traders have no open positions come December 31. The mark-to-market price is used against your cost basis to determine if you have a profit or loss on those positions. You'll also want to consult IRS Topic 429 and your tax advisor to better understand "wash sale" rule implications for full-time traders.

Now, the benefits

When trading for a living, you can deduct any expenses related to your trading business, including the cost of software, subscriptions, data feeds, educational tools, and even your computer if you use it more than 50% of the time for your trading.

But the biggest benefit is you're allowed to write off an unlimited amount of losses against your profits—your de facto earned income. This is a huge advantage. Compare that to an ordinary investor with $50,000 in earned income (taxable wages, for instance) and $20,000 in trading or investing losses; the investor can only deduct $3,000 of those losses, which leaves $47,000 in taxable income. As a full-time trader with the mark-to-market election in place, if you have $50,000 in profits, you can write off all $20,000 of your losses, leaving you with only $30,000 in taxable income.

Keep in mind, the $30,000 left over is treated as ordinary income (which could bump a filer to a higher tax bracket). There is also the potential to incur self-employment tax on the business's net income.

What about reversing status?

If you want to revoke your trading-as-a-business status, IRS permission is needed by filing Form 3115 to request the dissolution of trader status. The IRS is not likely to grant permission if the request is made solely to achieve tax bill benefits. Grants are more likely to be issued if the taxpayer is no longer trading as a career.

And traders, who also invest using longer-term strategies, may want to have a separate account in which they hold positions for capital appreciation or dividend income. A trader would not file Form 8949 for the elected account; instead, Form 4797 should be filed. Traders who have both types of accounts (investor and trader) would file an 8949 and a 4797.

As with all tax issues and planning, you should always seek the advice of a professional before you do anything. They can help you better understand the unique tax considerations and potential advantages or disadvantages for full-time traders as well as file any needed documentation with the IRS.

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The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. 

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. 

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Supporting documentation for any claims or statistical information is available upon request.

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