What You Need to Know about Taxes if You Day Trade Stocks - dummies

What You Need to Know about Taxes if You Day Trade Stocks

Day traders aren’t investing; they’re looking to take advantage of short-term price movements, not to take a stake in a business for the long term. Unless, of course, you’re asking the IRS about it. The IRS defines trading much differently than people in financial circles do. To the taxmen, you are a trader only if all of the following apply to you:

  • You seek to profit from daily market movements in the prices of securities, not from dividends, interest, or capital appreciation.

  • Your activity is substantial; the IRS code does not spell out what substantial means, but it probably means you’re making at least 3,000 trades per year.

  • You carry on the activity with continuity and regularity. In other words, day trading is more or less your full-time job, you’ve stuck with it for at least six months already, and you plan to keep trading into the next year.

If you trade part-time, have other employment, or are new to the day trading game, the IRS probably won’t let you define yourself as a trader. Don’t care what an IRS agent calls you, as long she doesn’t call you for an audit? Well, understanding the difference between trader and investor in IRS lingo is important to avoid that audit.

Those who qualify as traders enjoy deductions that regular investors don’t. You may quality as a trader for some of your activities and as an investor for others. If you think this scenario applies to you, you need to keep detailed records to separate your trades, and you should use different brokerage accounts to make the difference clear from the day you open the position.

In political economics, taxation serves two purposes. The first is to raise money for the government. The second is to encourage people to do things that the elected officials who amend the tax code want them to do.

Much of the investing tax code is intended to promote the formation and growth of businesses. Short-term day trading doesn’t do that, so the tax law doesn’t offer short-term investors the same benefits that it gives to long-term investors and business owners.