Ultimate Guide To Understand Taxation Levied On Day Traders

By Ashutosh Jha → Last Updated on Sunday, May 10, 2020
Taxation levied on day traders can be tedious to track, and managing them, a minefield. Rules vary as per your trading activity and other criteria that affect your net taxes.

Day trading taxes in the U.S. can often be trickier than your anticipations. You would have to deal with a ton of paperwork, and those profits would feel diminished when the Internal Revenue Service (IRS) takes a share of your capital gains income.
Ultimate Guide To Understand Taxation Levied On Day Traders

Asset Holding Time

The tax levied on a capital gain depends on the duration for which you held the asset before selling it. Capital gains are classified as either long-term or short-term and taxed differently.

1. Long-Term Capital Gains

Long-term capital gains from assets that are often held for more than a year before being sold off.

Long-term capital gains are taxed as per the graduated thresholds for taxable income at 0%, 15%, 20%, or greater than 20% in some exceptions.

The tax on a long-term capital gain is lesser compared to that asset being sold within a year.

Long-term capital gains are taxed more reasonably compared to short-term capital gains. Thus, it is sometimes advisable to hold onto your assets for at least a year before selling them off.

2. Short-Term Capital Gains

Short-term capital gains happen when you hold your stocks for more than a day, but less than a year. In that case, you are eligible to pay a 15% tax.

Your delivery of shares must go into your Demat account. Exchanges typically take up about T+2 working days as settlement time. So, if you purchase a stock on Monday, you would observe it in your account on Wednesday.

Short-term capital gains tax is subject to taxation just as ordinary income and does not possess any special tax rates.

Considering short-term gains taxes as regular taxable income, they are subject to one of seven tax rates corresponding to the seven federal tax brackets in the U.S., where rates range from 10% to 37%.

Number of Trades

The tax court firstly looks at the number of trades the taxpayer executed in a year. They also observe the total net amount of money involved in those trades, and the number of days in the year of the execution of trades.

This data gives insights regarding various factors, including the category in which you would fall in, whether short-term or long-term capital gains tax.

Sum of Money Used

The total amount of money used in the trade would also distinguish you as it would categorize whether you are a trader or a businessman. Tax laws would then be different for both scenarios.

It also tells them the net tax to be deducted considering the frequency of trades, and a more considerable amount of the money involved in those trades was also high.

Alpaca provides its users with a free brokerage account to gain deeper insights about trading and help them with a jump start.

Trader's Tax Deductions

Being a trader can be a very favourable option for you as from the perspective of the IRS, you are more of a self-employed individual. This enables you to deduct all your trade-concerning expenses on Schedule C.

Schedule C includes any home and office equipment, educational resources, phone bills as-well-as other miscellaneous costs.

You must keep receipts for any such items, as the IRS can request evidence to justify that they are used primarily for trading alone.

You are entitled to write-off just the amount exceeding over 2% of your adjusted gross income.

Schedule C write-offs offer to adjust your gross income, implying that you can fully deduct all your exemptions, claim advantage of other tax breaks that have been phased out for higher adjusted gross income levels.

You are also entitled to deduct your margin account interest on Schedule C. Make a claim that you don't need to pay self-employment tax on your net profit from trading.

Mark-To-Market Traders

If you sell an asset at a loss, you can write-off that sum. However, if you, your spouse, or a company controlled by you re-purchases the same stock within 30 days, the IRS calls it a 'wash sale.'

Falling under the wash sale can often be a conundrum when it comes to paying taxes. However, If you become a 'mark-to-market' trader, you can surmount this barrier. This way, you can have yourself exempted from the wash sale rule.

To save yourself from a wash sale, on the last trading day of the year, pretend to sell all holdings. You still hold on to those assets, but book all the imaginary gains and losses for that last day.

When the year would end, you would own zero unrealized gains or losses. It would give off the impression that you re-purchased all the assets you pretended to sell.

A day trader can be benefited again from the 'Mark-to-market' trader rule. When it comes to investors, they can only deduct about $3,000 or $1,500 in net capital losses per year.

Mark-to-market traders are eligible to deduct an unlimited amount of losses. You can save a decent sum of money if your trading year has been weak.

If you happen to qualify as a mark-to-market trader, you must report your gains and losses on part II of IRS form 4797.

Alpaca can provide you with a paper trading account to practice before trading in real money. This can help you devise strategies to use in real-time against the competition and market volatility.

Reporting Taxes

If you're a trader, you must report your gains as-well-as losses on form 8949 and Schedule D.

You are eligible to deduct only $3,000 in net capital losses every year. However, if you have a spouse and use separate filing status, then the amount becomes $1,500.

Schedule C should then control expenses and zero income, while your capital gains are reflected on Schedule D. You should include a statement detailing your situation to avoid any confusion.

Final Words

Taxes on your day trading income varies depending on various factors, as mentioned above.

You must know all how the IRS can deduct your capital gains in the form of taxes. There also exist some workarounds like 'mark-to-market' trader to avoid wash sales.

You must maintain everything on a legal basis and ensure that you are following the right protocols while filing in your tax returns.

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Ashutosh Jha

Ashutosh Jha is a professional blogger, Blog and IT Consultant. He writes about Blogging, SEO, Making Money, Internet Marketing and Web Design.
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