by Dustin Griffiths and John Briggs
Stock Trades and the IRS
At a quick glance, buying and selling stocks is pretty straight forward. If you dabble in options, it can be a little more complicated but still fairly straight forward. When it comes to tax implications however, it can be fairly complicated with the IRS. We will address three issues.
- Are reporting on the correct form?
- Are you paying the correct amount of tax?
- What is a “Trader in Securities” and why should you care?
Reporting Stock Trades or Option Trades
The IRS requires that you report all income associated with stock or option transactions. (Notice they are only interested in the income portion. However, you are allowed to deduct your cost to own the stock or option.) There are two forms that could potentially be used to report these transactions; Form 8949 and Schedule D.
Some technical info: In 2011, IRS required that brokerages report basis (your cost) on your brokerage statements (1099-B) . Before 2011, it wasn’t required. Which means, IRS didn’t have any record of what you paid. In this scenario, form 8949 is used because your cost (basis) wasn’t reported to them. If the basis of your stock has been reported you report those transactions on Schedule D. Those transactions reported on form 8949 will consolidate and flow through to Schedule D.
Schedule D basically summarizes your stock and option activity for the year and lets you and the IRS know if you have a capital gain or a capital loss.
On either of these forms the information you will be required to report are the names of stocks, dates purchased, dates sold, sales price, basis, and potential wash sales. These consolidate into totals for short term gains or losses (stocks or options held less than a year) and long term gains or losses (stock or options held for one year or more).
Now that you have reported your transactions on the correct form, how are those transactions taxed? Short term gains are taxed as ordinary income rates (aka just like your w-2 income would be). Long term gains are taxed at capital gains rates. Capital gains rates vary from year to year and are based on your tax bracket. It can be 0%, 15% or 20%.
Losses, whether short term or long term, are limited each year. You can use any losses to offset gains but out of the amount remaining only $3,000 can be realized each year. Any excess is carried forward indefinitely, with only up to $3,000 in loss being realized each year. So if I had a $300,000 capital loss. I would get to take $3,000 of that each year. By the time I turn 133 years old, I would have used up that one year of capital losses. Or, if I had a $300,000 capital loss last year, and then had a $200,000 capital gain the following year, I wouldn’t pay any tax on that gain because my $300,000 loss would eat that profit. I would then have $100,000 capital loss going forward. (Technically $94,000).
Trader in Securities Consideration
Depending on your scenario, you might benefit from being considered a Trader in Securities. According to the IRS “special rules apply if you are a trader in securities, in the business of buying and selling securities for your own account. This is considered a business, even though you do not maintain an inventory and do not have customers. To be engaged in business as a trader in securities, you must meet all of the following conditions:
- You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
- Your activity must be substantial; and
- You must carry on the activity with continuity and regularity.
These conditions are often met by people who are commonly known as “day traders” or “stock ninjas”. (Just kidding about the stock ninjas. I just made that up.) The following facts and circumstances give us some additional things to be considered in determining if your activity is a securities trading business:
- Typical holding periods for securities bought and sold;
- The frequency and dollar amount of your trades during the year;
- The extent to which you pursue the activity to produce income for a livelihood; and
- The amount of time you devote to the activity.”
If you fall into this category the benefits come in the years you record losses. You are considered to be involved in business and income and expenses associated with your activities are reported on Schedule C. The added benefit of reporting on schedule C is that you are not limited to the amount of loss you can recognize each year. Remember from above that the amount of capital loss that can be recognized is maxed out at $3,000 loss each year. By being classified as a trader in securities you could recognize your entire loss in the year it occurred. This helps to reduce tax and can be used to offset any other income received.
If you have questions on whether you qualify or not, please don’t hesitate to reach out to us. We would be more than happy to discuss your situation and how you can maximize your tax savings while keeping and growing your wealth. Reach us at (801) 999-8295.