Day trading is the purchasing and selling or the selling and purchasing of the same security on the same day according to the Financial Industry Regulatory Authority (FINRA). The Internal Revenue Service (IRS) sets guidelines to determine how traders in securities must report income and expenses on their income taxes. The IRS also sets special rules to determine if an individual qualifies as a securities trading business or as an investor for tax purposes.
Trading Versus Investing
IRS securities trading guidelines exist to differentiate day trading from investing. Investors expect to receive income and profits in the form of dividends, interest and capital gains. Investors typically deduct expenses such as accounting fees and legal advice from taxable investment income. Traders, on the other hand, do not seek dividend or interest income for profits. Traders rely on daily fluctuations in the prices of securities to receive a profit or loss. The IRS treats these trading practices differently. Securities investors file taxes as individuals whereas day trading activities are treated as a business for tax purposes.
Day Trading Conditions
According to the IRS, to be a trader in securities "you must seek to profit from daily market movements in the prices of securities." Day traders must buy and sell securities from their own account. Further, trading activities must be substantial and individual traders must carry on activities continually and regularly according to the IRS. Each of these conditions must be met for an individual to be considered in business as a trader in securities.
Record Keeping and Forms
An individual may be considered a trader in some securities and an investor in others. As a result, the IRS requires taxpayers to keep thorough records of all securities to differentiate between investment securities and trading securities. Because buying and selling of securities result in capital gains and/or losses, the trader must report gains and losses to the IRS on the Profit and Loss Form 1040, Schedule D. Traders must report trading business expenses on Schedule C.
Individuals should consider certain circumstances that relate to trading activities to determine if such activities result in a securities trading business according to the IRS. For example, individuals must consider the holding periods of securities bought and sold. Also, individuals must consider the frequency of trades conducted throughout the year. If daily trading activities are carried out for the income necessary to maintain a certain lifestyle and livelihood, and the amount of time devoted to trading activities are excessive, the IRS utilizes these facts to determine if the individual is in the securities trading business.
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