Tax Treatments for Stock Market Securities
By Tammy Nguyen
June 25th, 2021
During covid-19 pandemic, more taxpayers turned to the stock market to buy and sell securities. Within a short period, stock trading activities became more popular than ever before. The tax treatments on these activities are different, depending on whether you are classified as investors or traders. The primary focus of this article is to explain the tax impact of these activities.
Taxation for Investors
In general, you are considered as an investor when you buy and sell securities and hold them over a period of time for investment, with expected income from dividends, interests, or capital appreciation. Therefore, the gains and losses on the sale of these securities are treated as capital gains and losses and reported on schedule D. If you hold the positions for more than one year, the gains and losses are considered as long-term investment (taxed at a maximum 20% rate). If you hold it one year or less, the gains and losses are treated as short-term investment (taxed at a maximum 37% rate).
However, certain restrictions for investor tax status:
- Wash sales rules do apply- All investor expenses such as management fees, investment advice, education expenses, courses on investing, conference, investment seminars, software, equipment, supplies and related business activities are treated as investment expenses and subject to the 2% of adjusted gross income limitation.
- Cannot set up qualified retirement plan
- Cannot deduct health insurance premiums
Taxation for Traders
When you seek profits from daily market activities in the business of buying and selling securities and carry on a trade or business, you are considered as day trader. The special rules for traders do apply. Apparently, you can be a trader in some securities and can be an investor for other securities. However, you need to keep a detailed record in a separate brokerage account to distinguish between them.
Interestingly, traders have option to choose the mark-to-market election under section 475 (f). The tax treatments for traders are different, depending on whether the mark-to market rule is elected or not.
Traders with no mark-to-market election
Traders still treat the gains and losses from sales of these assets as capital gains and losses on schedule D. The limitations on capital losses up to $3,000 to ordinary income, wash sales rules and 20% deduction on QBI continue to apply. However, all business and home office expenses listed above are deductible on schedule C. Any dividends and interest are reported on schedule C as well.
Traders with mark-to market election
Under this rule, the gains and losses on sales of the securities during the year are treated as ordinary gains and losses (except for securities for investment purposes). And all the securities on the brokerage accounts by end of the year will be treated as having sold with fair market value (FMV). Therefore, traders must recognize all gains and losses on these deemed sales and the actual sales as ordinary gains and losses that are reported on form 4797, Sales of Business property. Similarly, dividends and interests are reported on schedule C. Because of trader tax status with the mark-to-market election, you will take the advantages for your tax purposes:
- Capital losses limits, wash sales rules do not apply- Investment Interests are not limited to investment income
- All business expenses are deductible on schedule C including the items:
· Management fees, investment advice, education expenses, courses on investing, conference, investment seminars, software, equipment, supplies, Travel, consultants, etc.
· Home office expenses for business use of the home.
· Amortization of organization costs/start-up costs.
· Section 179 depreciation on fixed assets
- 20% deduction on qualified business income (QBI) on gains- Set up qualified retirement plan
- Get health insurance premiums deduction.
Conclusion
Covid-19 pandemic has caused an irrational exuberance which led to a rapid drop in value for the stock market. It led to many people working from home, laid-off, or furloughed. Thus, an increased number of people engage in security trading. The tax treatments of these trading activities can vary vastly, depending on their tax status. Therefore, taxpayers should consult with tax practitioners (EAs or CPAs) to see what tax status would get more benefits for tax purposes and whether their stock trading activities qualify as a trader under mark-to-market rules.
For more information or need a consultation, please contact T&M Tax Consulting at (360) 489-1596 or admin@tmtaxconsulting.com
Reference: