Transcript The Taxation of Options

Trader Tax
Management
OptionsAnimal
Las Vegas Student Summit
September 26, 2009
Disclaimer
Options
Any strategies used as examples and discussed, using actual securities and
price data, are strictly for illustrative and educational purposes only and are not
to be construed as an endorsement, recommendation or solicitation to buy or
sell securities.
Taxation
Any US tax advice contained in this presentation is not intended to be used,
and cannot be used, for the purpose of (i) avoiding penalties that may be
imposed under the Internal Revenue Code or applicable state or local tax law
provisions, or (ii) providing, marketing or recommending to another party any
transaction or matter addressed herein.
The information presented provides only a general discussion of the tax law
affecting the taxation of options and is not intended to be applicable to any
individual investment and/or tax situation. You are strongly advised to contact
your own tax professional in considering the tax consequences of your own
specific set of facts and circumstances.
Before We Begin!
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What are we going to do?
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Talk about some of the tax aspects of options trading
You will understand more about tax return preparation
You should be able to talk more intelligently with your
CPA or tax preparer
What we are not going to do?
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Teach you to prepare your own tax return
Cover intricacies of options taxation exhaustively
Answer your specific personal tax questions
Agenda
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Tax Tips for DIYers
Review – Trader vs Investor
Mark-to-Market Accounting
Trading in an Entity
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Types
Benefits & Burdens
Now What?
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Reporting
Investor tax return
Trader tax return
MTM/Trader tax return
Do-It-Yourselfers
Tax Tips
Tax Tips for DIYers
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When do you report the sale of a Short Put
that gets assigned?
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Never … as a separate transaction
Adjusts the basis of the stock assigned
Example:
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You short in Oct a Jan 10 65 put on RIMM for $4.60
At Jan expiration RIMM dips to $64.94 and you are
assigned the stock
Your basis in RIMM is $60.40 (65 – 4.60)
The Short Put sale is NOT reported in 2009
If you trade often this is difficult to identify!!
Tax Tips for DIYers
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When are Dec option sales reported?
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Calls – when there is a closing transaction
Puts – either:
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When there is a closing transaction, or
When the assigned stock is sold (lowered basis)
Commodity ETFs – Gold, Silver, Platinum
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If held one year or less
ST capital gain/loss
If held more than one year
LT, BUT at the
28% collectible rate
Tax Tips for DIYers
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ACAT fee reimbursement on retirement funds
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Considered a contribution to IRA, therefore not
reimbursed, ie, like commission reimbursement
Q: Is ACAT fee charged a distribution? 1099-R?
Opinion: Must consider retirement account in the
hands of the holder not the individual broker
Gross proceeds from 1099-B agreement to
sum of line 3 plus line 10 on Sch D
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Guaranteed letter from IRS if Sch D < 1099-B
Form examples:
Tax Tips for DIYers
Tax Tips for DIYers
Tax Tips for DIYers
Tax Tips for DIYers
Tax Tips for DIYers
Let’s do some math!
Gross proceeds from Form 1099-B
Option sales (not reported to IRS)
Subtotal
$12,480
6,325
18,805
Less:
Short put assigned
Dec short call
Total – Sch D, line 3
153
77
$18,575
Tax Tips for DIYers
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Index funds qualify as Sec 1256 contracts
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SPX, OEX, COMP, DJX, RUT
60/40 LTCG treatment
Individual securities/options are taxed, NOT
trading strategies
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The “Put Calendar” is not taxed as a whole
The opening & closing transactions of each leg
are taxed as of the closing transaction (FIFO)
Example:
Tax Tips for DIYers
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Initiate a Put Calendar on SPY in Aug 09
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BTO Dec 09 100 FYSXV
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STO Sep 09 100 SWGUV
BTC/Expire Sep 09 100 SWGUV
STO Oct 09 100 SWGVV
BTC/Expire Oct 09 100 SWGVV
STO Nov 09 100 SWGWV
BTC/Expire Nov 09 100 SWGWV
STC Dec 09 100 FYSXV*
Taxable Transaction #1
Taxable Transaction #2
Taxable Transaction #3
*Taxable Transaction #4
Tax Tips for DIYers
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Initiate a Covered Call/Collar on Amedisys:
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Buy AMED in early Jun 2009
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STO Jun 09 35 Call CQWFG
BTC/Expired Jun 09 35 Call CQWFG
STO Jul 09 35 Call CQWGG
BTO Aug 09 30 Put CQWRH
BTC/Expired Jul 09 35 Call CQWGG
STO Aug 09 35 Call CQWGH
STC Aug 09 30 Put CQWRH
Expired Aug 09 35 Call CQWGH
AMED* called at Aug expiration
Taxable Transaction # 1
Taxable Transaction # 2
Taxable Transaction # 3
Taxable Transaction # 4
*Taxable Transaction # 5
Tax Tips for DIYers
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Last but not least:
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DO NOT BLINDLY RELY ON ONLINE OR
BROKERAGE-PROVIDED TAX SOFTWARE!!
There are too many exceptions and nuances
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At a minimum
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Download your transactions into Excel
Sort and Sum by Ticker and Activity (Open then Close)
Agree 1099-B to stock sales
Provide spreadsheet & brokerage statement to CPA
Investor vs Trader
Review of Rules
Investor vs Trader
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Why? – Subject to different tax rules
Definitions:
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Investor –
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Trader –
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Stock purchase for capital appreciation/dividends
Little regard for short-term fluctuations; buy and hold
Regularly and continuously trade stock/securities
Trade in own account
Profit from short-term fluctuations
Can be BOTH trader and investor
IRS presumption
Investor
Investor vs Trader
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Taxation of Investors
 Stocks/securities considered capital assets
 Gains and losses considered capital
 Reported on Schedule D / D-1
 Subject to $3000 net capital loss limit
 Subject to IRC Sec 1091 wash sale rules
 Investment expenses (except interest)
 Schedule A miscellaneous itemized deductions
 Subject to 2% AGI threshold
 Not deductible for AMT purposes
 Interest – deductible up to net investment income (Form 4952)
 Net investment income does not include
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Long-term capital gains
Qualified dividends
Investor vs Trader
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Taxation of Traders
 Stocks/securities considered capital assets
 Gains and losses considered capital
 Reported on Schedule D / D-1
 Subject to $3000 net capital loss limit
 Subject to IRC Sec 1091 wash sale rules
 Investment expenses
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Schedule C/E* deductions
Interest deductible (for material participation)
Home office deduction eligibility
Gains NOT subject to self-employment tax
Mark-to-Market (MTM) election eligibility
_____________________________________________________________________________________________________
*
Flow-through entity, such as partnership, LLC, S-Corp
Investor vs Trader – Expenses
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Deductible – BOTH Investor and Trader
 Investment counsel/advice
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Subscription services
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OptionsAnimal
OptionsPlanet
OptionsMonster
OptionsAnimal Mentor? – Possibly (see below)
OptionsAnimal TUITION? – Possibly (we’ll explore later)
Reg 1.212-1(g) – expenses paid or incurred by the taxpayer
… for the management, conservation, or maintenance of
investments held by the taxpayer for the production of income
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Office expenses – administrative, supplies
Pro-rata portion of computer/software used to determine/manage
investments – must be able to substantiate
How do you substantiate? Keep a dated log … trade journal
Investor vs Trader – Expenses
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Investor expenses – Summary
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All expenses for the production of income (Sec 212)
Deducted on Sch A as Miscellaneous Deductions
Subject to 2% AGI threshold
Interest expense deductible to the extent of net
investment income – does not include LTCG / Div
No Sec 179 expensing election
No home office deduction
Investor vs Trader – Expenses
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Trader expenses - Summary
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All ordinary and necessary expenses (Sec 162)
Interest expense on margin accounts – if material
participation, otherwise, for a limited partner, to
extent of net investment income
Sec 179 expensing of computers/software available*
Eligible for home office deduction
Travel
Automobile expenses from principal place of
business (home) deductible – if for business
purpose
* Sec 179 election cannot create a loss
Investor vs Trader – Case
Summary
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Favorable Cases
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In Holsinger, Tax Court remarked in its opinion that
trading activity of over 1,100 trades or the value of
securities traded over $9 million was deemed
substantial
Levin – most of working days; substantial time
Summary
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Regular and continuous
Short holding periods
Substantial number of trades
Investor vs Trader – Expenses
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Is OptionsAnimal tuition deductible?
Quotes from the OptionsAnimal website:
• “OptionsAnimal connects you to fellow students as well as seasoned instructors…”
• “If you have not spoken with one of our Education Specialists …”
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What are deductible educational expenses?
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Required to keep present job or salary, or
Maintains or improves required skills in present job
What are non-deductible educational expenses?
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Required to meet minimum standards, OR
Qualifies one for new trade or business
Investor vs Trader – Expenses
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Conclusion:
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Deductible as education expenses?:
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If you are already considered a “trader” or trading inside
a trading entity where you are an employee, then
deductible
If new to trading stocks and options, then nondeductible UNLESS … (next slide)
Qualify for Lifetime Learning or Hope credits?
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Must be defined by Sec 481 of Higher Education
Act of 1965 as qualified post-secondary institution
Investor vs Trader – Expenses
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Start-up expenses?
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Expenses that would be deductible if incurred in an active
trade or business (Sec 162) but also applies to investment
expenses (Sec 212)
 Investigatory – incurred prior to decision to acquire or
create
 Pre-opening – incurred after decision but before opening for
business
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“wages being paid to employees who are being trained and to
[their] instructors” [H Rep No 96-1278, 96th Cong, 2nd Sess]
Up to $5000 (IRC Sec 195)
Amounts over $5000 – capitalized and amortized over 180 months
Investor vs Trader – Expenses
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Strategy:
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Potentially start-up expenses
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Secondarily, educational expenses since:
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Specifically, pre-opening, and
Especially if operating inside an entity
Must elect and election is irrevocable
No minimum standards to “trade”
No qualification standards for trading as a business
Uphill battle since burden of proof on taxpayer
Investor vs Trader
Mark-to-Market
Accounting
Investor vs Trader
– MTM Election
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What is Mark-to-Market (MTM)?
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Traders can elect to mark their security holdings to
market value at the end of the tax year
IRC Sec 475(f) –
“… In the case of a person who is engaged in a trade or business
as a trader in securities …”
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Gains and losses treated as ordinary gain/loss
Adjustment to stock basis for unrealized gain/loss
Not subject to self-employment tax
Reported on Form 4797, Part II
Investor vs Trader
– MTM Election Benefits
Two restrictions no longer apply:
$3,000 net capital loss limit
Wash sale rule
Investor vs Trader
– MTM Election
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Election is effective for the year for which it is
made and all subsequent years unless revoked
with IRS permission (mandatory)
Must make the election by the unextended due
date for the tax return for the year before the
year the election is to be effective
Example:
Investor vs Trader
– MTM Election
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Eric is actively trading stocks and believes he
can generate significant income by trading, on a
regular and continuous basis, the short-term
fluctuations in the stock market. In July 2009 he
begins trading full-time.
Does Eric qualify as a trader?
Investor vs Trader
– MTM Election
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Eric is actively trading stocks and believes he
can generate significant income by trading, on a
regular and continuous basis, the short-term
fluctuations in the stock market. In July 2009 he
begins trading full-time.
Does Eric qualify as a trader?
Can he elect MTM for 2009?
Investor vs Trader
– MTM Election
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Eric would have had to file an election by:
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April 15, 2009, or,
Attach the election to his extension (Form 4868)
Eric can make a MTM election for 2010
anytime before April 15, 2010, however,
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If this is not his first year as a TRADER (it is not)
then Eric will be required to file Form 3115,
Application for Change in Accounting Method
A Sec 481(a) adjustment is also required
Investor vs Trader
– Making the MTM Election
Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com
Investor vs Trader
– Making the MTM Election
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Attach the following statement to the timely
filed Form 1040 or extension Form 4868
Trader in Securities Election to Mark to Market
Taxpayer hereby elects under IRC Sec 475(f) to use the mark-to-market
method of accounting for securities. The election will first be effective for the
tax year ended [20##]. The election is made for the following trade or
business: [trade or business name, EIN]
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There is relief for late elections – PLR request
New pass-through entity for late election
New taxpayer – elect by 15th day of third month
Investor vs Trader - Summary
Criteria
Investor
Trader
MTM Trader
Reporting gain/loss
Sch D
Sch D
Form 4797
Reporting expenses
Sch A
Sch C/E
Sch C/E
Reporting interest
Sch A
Sch C/E
Sch C/E
Invest int exp limits
Yes
No
No
Home office eligible
No
Yes
Yes
Subject to S-E tax
No
No
No
Wash sale rules
Yes
Yes
No
$3000 Cap loss limit
Yes
Yes
No
Section 1256 Contracts
A Section 1256 Contract is any:
 Regulated futures contract – daily MTM
 Foreign currency contract
 Dealer equity option – market maker/specialist
 Dealer securities futures contract
 Non-equity option
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Broad-based stock index option (SEC determined)
Cash-settled options
Examples – DJX, SPX, OEX, NDX (not ETFs)
Sec 1256 Contracts
– Mark-to-Market
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At the end of the tax year (last business day)
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Treat contract as sold
At FMV on the last business day of year
Gain or loss recognized
Recognized gain/loss taken into consideration upon
ultimate disposition of contract – basis adjustment
60/40 rule –
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60% of recognized gain/loss is long-term
 40% of recognized gain/loss is short-term
 No matter what the actual holding period
A net loss can be carried back 3 years
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Report on Form 6781 (non-Sec 1256 on Form 4797)
Example:
Sec 1256 Contracts
– Mark to Market Example
Sec 1256 Contracts
– Mark to Market Example
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Purchase 100 SPX Jun 08 1250 calls bought
for 145 on 7/17/06
SPX Jun 08 1250 call at 252 on last business
day of 2006
Mark-to-Market requirements:
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SPX LC deemed SOLD on 12/29/06 at 252
SPX LC deemed REPURCHASED on 12/29/06
for 252
Gain 107 (252 – 145)
 Long-term 64.20 (60% x 107); 15% max tax rate
 Short-term 42.80 (40% x 107); 35% max tax rate
Sec 1256 Contracts
– Mark to Market Example
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SPX Jun 08 1250 LC declines to 228 by 3/12/2007
and is sold
What is the gain/loss?
How is it taxed?
Deemed repurchase at 252 on 12/29/06
Sale
228
Less: Basis
252 (from deemed repurchase)
Loss
<24>
LTCL <14.40> - 60%
STCL <9.60> - 40%
 Loss may be carried back three years
Entities
Selection & Trading
Entities
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Types of entities
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Sole proprietor – Sch C/Sch D/Form 4797 (default)
General Partnership – Form 1065
Limited Liability Company (LLC) – Form 1065
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Single member LLC – Sch C/Sch D/Form 4797
Multiple member LLC*
Corporation
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C Corporation – Default; Form 1120
S Corporation – Election; Form 2553
Form 1120S
* LLC with election: Form 8823
Form 2553 (S Corp)
Entities
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State law prevails – name, articles, etc.
Separate bank account styled identically to
entity name
Brokerage account name identical to entity
Business activity code: 523110, 523900
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Source: www.naicscode.com; keyword: securities trader
Employer Identification Number (EIN)
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Setup: www.irs.gov
Quick walk-through of IRS site
Entities
Entities
Entities
Entities
Entities
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Benefits
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Retirement plans
Fringe benefits
 Medical reimbursement plans (IRC Sec 105)
 Educational assistance plans – $5250/year (IRC Sec 127)
New entity elections – MTM
Burdens
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Compliance
 Entity tax return
 Payroll complications
Accounting – personal vs business expenses
Reporting
Investor
Trader
MTM Trader
Reporting - Example
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Jeff made the following trades during 2008:
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300 shs AAPL
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500 shs WMT
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Nov 08 90 SC; STO $12.80; Expired
Dec 08 90 SC; STO $4.90; Expired
Jan 09 90 SC; STO $5.50; Expired
Nov 08 55 SC; STO $2.24; Expired
Dec 08 55 SC; STO $1.95; Exercised
500 shs RIMM
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Nov 08 45 SC; STO $5.40; Expired
Dec 08 45 SC; STO $5.70; Expired
Dec 08 40 SP; BTO $3.75; STC $2.96
Jan 09 45 SC; STO $4.75; Expired
Reporting - Example
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Jeff’s 2008 trades – continued:
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500 shs MCD
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Jan 09 90 SC; STO $2.20; Expired
Jeff’s 2008 trading expenses:
 OptionsAnimal subscription – $600
 Computer – $1500 (exclusive use); MACRS 5 year
 Monitors – $900 (three); MACRS 5 year
 Furniture – $750 desk, chair, monitor stand; MACRS 7 year
 Software – $250 Microsoft Office (Excel); SL 36 months
 Fiber optic cable line – $480
 Travel – $1500 (Chicago & Las Vegas Summits)
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Airfare & Hotel – $1300
Meals – $200
TOTAL EXPENSES – $5980
Reporting - Example
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Jeff’s other information:
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Jeff’s spouse has W-2 wages of $60,000
Jeff has two children that are his dependents
Jeff has itemized deductions of:
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Real estate tax – $5,000
Mortgage interest – $10,000
Charitable contributions – $2,500 (cash)
Reporting – Investor
Reporting – Investor
Reporting – Investor
Reporting – Investor
Form 1040
Reporting – Trader
Reporting – Trader
Form 1040
Reporting – MTM Trader
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Sec 481(a) adjustment – taxed in current year
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If not a new entity, Form 3115 required
Reporting – MTM Trader
Reporting – MTM Trader
Form 1040
Reporting – Summary
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Tax liability comparison
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Investor
Trader
MTM/Trader
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$4,374
$4,149
$4,606
Stock basis increase by the amount of 481(a)
adjustment
Stock basis adjustment decreases future
gains/increases future losses
Contact Information
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Gregory L Buhrow, CPA, PC
2355 Gus Thomasson Road
Dallas, TX 75228-3004
Telephone: (214) 327-0700
Facsimile: (214) 327-0740 (7am-6pm CT)
Websites: www.buhrow.com
www.gregbuhrowcpa.com
www.optionstaxguy.com
Emails: [email protected]
[email protected]
[email protected]
Thank You!
OptionsAnimal
Las Vegas Student Summit
September 26, 2009