Top 10 mistakes traders make when filing their taxes

Active investors and traders have special challenges when it comes to filing taxes. If you want to stay on good terms with the IRS, watch out for these common mistakes. The list is brought to you by Trader Tax Advisors, our affiliate which specializes in tax preparation and taxation advice for traders . Find out more about how you can avoid audits, reduce taxes legally and keep more of your profits at Trader Tax Advisors.

Here are the Top 10 Mistakes Traders make when filing their Taxes 

The US Tax code is a complex maze.  It is almost  75,000 pages long and includes more than 1,999 different publications and tax forms. 

The results of trading can have a large impact on your taxes, so   you need to have the proper knowledge and expertise to reduce your tax liability and stay in compliance. 

1. Not Filing a Tax Return Due to Trading Losses or Minimal Trading – Were you under the impression that you only need to file a tax return if you had trading profits?  Careful. Failure to report your trading activity - even if you only had losses or minimal gains – may lead to IRS notices or serious penalties.  The issue is usually resolved by doing one simple action – filing a tax return. 
2. Reporting Gains and Losses on Schedule C Instead of Schedule D – Some traders experience major losses and attempt to write them off in full, claiming that they are business traders and therefore allowed to report their losses on Schedule C. The IRS code clearly state that all capital transactions must be reported on Schedule D and limits traders to claiming on $3,000 of losses in the year they occurred. 
3. Paying Self-Employment (SE) Taxes on Trading – Many traders elect to trade via a business entity such as a corporation, partnership, or LLC.  They report their trading income as ordinary income and so subject any trading profits to self-employment tax.  Interestingly enough, trading income is not considered to be earned income, and therefore is not subject to the self-employment tax.  If you are paying SE taxes on your gains, you’re overpaying the IRS. 
4. Mixing up the Tax Treatment Between Securities, 1256 Contracts, Forex and Options – Stocks, bonds and mutual funds belong to the securities group and are taxed at long-term capital gain rate if held more than a year. Futures contracts are part of Section 1256 contracts which are entitled to a special tax treatment known as the 60/40 split.  Forex can be taxed either as ordinary income or as section 1256(g).  Traders need to make sure they are reporting their trades correctly and not missing out on any available tax breaks. 
5. Using TurboTax to Prepare Your Taxes – In recent years, TurboTax and others have become increasingly popular as a way of preparing a tax return.  While it might be a good solution for a simple straightforward financial situation, traders need to prepare a more complex return that requires unique tax knowledge.  There is no tax code that defines who can qualify as a trader in securities.  Traders should use an experienced firm that specializes in these unique circumstances to reduce the risk of an IRS examination. 
6. Representing Yourself in Front of the IRS – If you are contacted by the IRS for an examination, you should always seek professional representation – especially if you are trying to claim trader in securities status or trying to write off losses in excess of $3,000.  Advocating takes experience.  A trader should only go to an IRS audit with a qualified representative who knows exactly which area of your tax return can generate a refund or reduce the impact of lost deductions. 
7. Not Forming a Business Entity – or Forming the Wrong Kind – Trading through a business entity line an LLC or corporation provides many tax benefits, but in order to qualify for trader in securities status, you need to do more than just set up a business.  Risks and benefits vary by state.  Some traders make the mistake of not forming an entity at all, causing them to miss out on tax benefits like writing off their medical premiums, retirement contributions and start-up costs. 
8. Not Filing MTM Accounting Method – Failure to make the section 475MTM election on securities will get you stuck with writing off only $3,000 of your losses, as the capital gain rules limit losses that can be claimed in one year to a maximum of $3,000.  The biggest pitfall for traders is not deducting trading losses when they otherwise could.  There are many nuances to electing MTM and strategies to consider.  The election is not automatic to all and the decision must be made only after consulting with a trader tax specialist. 
9. Not Claiming Trader Tax Status or Claiming it Improperly – Business traders can save upwards of $5,000 using business expense treatment. Business expenses allow traders to claim home-office deductions, education expenses, and startup costs, whereas Investment expenses do not.   Missing out on trader status can cost you thousands of dollars in unnecessary taxes. 
10. Failing to Have a Clear Tax Strategy – Traders who need advice on financial matters should seek out an expert.  With a clear tax strategy, you can reduce your tax liability, save money, and ultimately build wealth faster by paying few taxes and staying out of trouble with the IRS.  Seek expert advice and execute on it. 
    

This content is strictly intended to provide enrichment information only and should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions.