Day trading is very much like a business where you have income and losses, and at the end of the year, you get one gigantic tax headache. Luckily, day trading taxes can be simple to calculate, as it just takes some understanding of the modern tax code.
Before we can break into the tax code and your day trading tax rate, we first have to understand what the government defines as day trading. First, you have to spend a number of hours per week trading. This can be either full or part-time, though a large number of trades will be necessary to confirm you are actually day trading.
Next, you should have a history of frequent trading patterns and transactions that indicate trades are being made and completed quickly, and you must demonstrate that your desired outcome is profit derived solely from short-term positions. These are the very basic guidelines.
Your stockbroker should know whether or not your account has enough activity to be considered a day trading operation. Having no other full or part-time job is the quickest and most accepted way to reach day trading status. Since trades of less than one year in length are taxed at a day trading tax rate equal to your bracket as normal income, day traders usually pay significantly more in taxes than other professions and part time, long term investors.
Just like any other business, day trading does generate some possibilities for write-offs. Office space, internet connections, day trading computers, electronics, and portions of your home electricity and utility bills can all be written off against your income. Trading losses, however, are not so easily written off. Only $3,000 may be written off in one calendar year, and usually limited losses increase your day trading taxes, as well as your overall day trading tax rate, unless you incorporate under sub-chapter S.
As day trading has grown in popularity, so has the S-corp. Many traders are now incorporating their business within their state as a way to increase their tax advantages and decrease the amount of money they pay to Uncle Sam.
Under an S-corporation, an unlimited amount of losses can be written off annually with the help of mark to market accounting. Under mark-to-market accounting, assets of your business (your current open holdings) are priced at their current market price and depreciated as a loss against your profits. Or, in poor years, mark-to-market allows for losses of greater than the $3,000 maximum as an individual filer. It is very much possible to reduce your overall day trading tax rate with a simple S-corp, though be prepared for more paperwork and documentation than is necessary for personal income tax filing.
Day trading is a high risk, high reward profession, and while the tax laws have yet to give a break to day traders and speculators, there is still plenty more money to be made than there is to be taxed. If you’re currently day trading and worried about day trading taxes, consult an accountant who is familiar with your state and local laws. Any price you have to pay for personalized tax planning will likely prove to be the best investment you’ve ever made and pay for itself year after year in a lower tax burden.