Day Trading Taxes

Dec 1, 2021 01:52 PM ET
Day Trading Taxes

In the process of declaring earnings and losses, day traders must jump through a number of legal hurdles, which may be difficult. Regardless of whether you're a full-time trader or just attempting to save money for the future, there are a number of tax considerations.

Taxes and trading are two areas that can help you improve your approach and avoid paying unnecessary fines to the government.

The rationale for taxing traders

When you generate profits from your trading activities, you are liable to pay taxes. This can eat up a significant portion of your earnings, depending on the nature of your trades. Compared to long-term investments, day trading does not qualify for favorable tax treatment.

Special day trader tax treatment may be available in rare situations to devoted day traders, which may mitigate some tax consequences while also possibly subjecting any net earnings to self-employment taxes.

As a securities trader, you're subject to a set of rules that differ from other traders. A trader who doesn't have an inventory or have clients is nonetheless considered to be in business under the law. 

All of the following requirements must be met before you may trade in securities:

  • To make money, you must focus on the daily swings in the price of assets, not dividends, interest, or capital gain.

  • You must have a large amount of trading;

  • The action must be performed regularly and consistently.

In assessing if your operation is a securities trading business, the following facts and conditions should be considered:

  • How long do you intend to hang on to the assets?

  • How often and how much money do you trade in a given year?

  • What do you do for a living, and how much time and effort do you put into it?

  • The length of time you dedicate to the trading activity.

If the substance of your trading operations does not qualify as a business, you are referred to as an investor rather than a trader in the financial industry. Whether you name yourself a day trader or a trader, you are still an investor. If you are a trader, you may also be a stockholder for investing purposes. 

Investment securities are exempt from the specific requirements that apply to those traded. If you are a trader, you need to keep meticulous records to distinguish between the assets you are holding for investment and those you are trading. Once the day the trader obtains the securities for investment, they must be designated as such in the trader's records.

Remember that trading fees and other costs associated with purchasing or selling shares are not deductible in calculating the gain or loss when they are sold. Self-employment tax does not apply to the profits and losses incurred by a trader in the sale of securities.

Types of taxes applicable to traders

Capital gains

Taxes are levied when you earn from the sale or acquisition of a financial asset. If you've been on the job for less than a year, you'll probably have to pay capital gains tax on your profits. Your capital gains taxes will be calculated according to standard short-term investment income rates.

Earned income

This is the amount of money you make as a result of your employment. The profits you make from day trading may not be classified as earned income by some tax systems, even if you do it full-time. There is no social security contribution, despite the fact that you will not have to pay self-employment taxes. That implies that in such circumstances, you may not be able to get full retirement benefits.

Investment income

This type of income is the revenue from one’s various holdings of securities before considering any relevant deductions. In computing the investment income, one does not include net capital gains, except when they want such earnings to appear in financial statements. In most cases, many intraday traders will not have a significant amount of investment income to report for day trading taxes.

Cost basis

Cost basis is the amount spent on acquiring security, including applicable trading commissions or fees. It serves as a starting point from which gains and losses may be calculated. When you end your trade, if the value of your position is more than your cost basis, you've made a profit. You'll suffer a loss on your investment if it drops below your cost basis.

Capital-related losses

Losses are subject to taxation in the event you lose money on the purchase or sale of securities. If in a particular year you end up with losses exceeding your capital gains, such losses are deductible. In addition, if you've had greater losses or profits in a year, you may be able to deduct more money from your taxes under some systems.

The United States offers one such tax example. Tax rules enable you to write off an additional $3,000 every year, which you can carry over to the next year's returns.

Wash-sale rule

When day trading in the US, you're bound to encounter the wash-sale regulation. It states that if you sell or exchange securities in a wash-sale, you cannot claim a loss. A wash-sale occurs when a person makes a loss on the purchase or sale of a security and subsequently proceeds to invest in a security that is considered by the IRS as being of a similar class within thirty days of the initial transaction.

If you want to claim a tax return for shares you sold 30 days ago, you can't hold onto them because of the wash sale rule.

In summary

Even if you have no intention of building a profession out of forex trading, filing your taxes correctly may save you hundreds, if not thousands, in taxes over the long term. It's an essential element of the trading process, and it's worth the effort.


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