Tax Implications of Online Trading

by Dennis Hartman

Internet brokers are among the major options for individuals who want to invest in the stock market, either as a supplementary investment or in an aggressive, serious manner. While trading online is similar to trading through a broker in person, it also has some important differences. State tax agencies and the Internal Revenue Service (IRS) maintain tax codes that spell out the tax implications of buying and selling stock online.

General Tax Liability

Trading stock online has many of the same general tax implications as trading by submitting purchase and sale orders over the phone, in writing or in person. This means that, at the end of the tax year, you must add up all of your investment income, including profits and dividends from online and non-Internet trading, and report it on your individual income tax return. You can also claim a deduction for your investment expenses, including money spent to manage online and traditional stock transactions. Failing to report income from online trading carries the same penalties and fines as failure to report other income.

Market-to-Market Trading

In some cases, individuals who participate in online trading use the convenience and speed of trading stocks over the Internet to qualify as market-to-market traders, rather than regular investors, based on the number of transactions they complete. If you perform multiple stock transactions every day and regard your online trading as a major source of your income, you may qualify as a market-to-market trader. The IRS allows market-to-market traders to compute and claim their gains and losses at the end of each tax year without actually selling the stocks that create those profits and losses. This distributes the tax liability of gains for frequent traders. It also simplifies the accounting required for reporting gains and losses on stocks that you sell and repurchase before filing a tax return.

Investment Expenses

Even if you're not a market-to market trader, your online trading can still create tax deductible investment expenses that help save you money. Eligible investment expenses include the money you spend to purchase investment software, along with expenses for investment advice from an online consultant and automatic charges to reinvest dividends or manage your accounts online. As an investor, you can write off up to $3,000 in investment expenses to offset your gains from online trading. Your deduction must exceed 2 percent of your adjusted gross income for the year. If you're a market-to-market trader, these limits don't apply, but you can claim the same items as investment expenses.

Record Keeping

Online trading uses servers that your broker maintains, along with your personal computer, to track your transactions and keep records of the money you make and spend. This can greatly simplify the process of filing your income taxes. Online investment services will send you electronic documentation that outlines your taxable investment income for the year, along with information about taxes withheld. If you need to submit proof of your deduction claims or earnings to the IRS, you can print out statements from your online account, which is a more thorough and accurate source of records than any manual investment accounting system.

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