You have three options for your tax strategy as a day trader. One solution is to keep filing your Form 1040 (U.S. Individual Tax Return) year after year. That is the most expensive and least viable tax deductable solution and unfortunately, that is what most people do.

Next, you could try to file as a "day trader" and deduct your business expenses from your taxes on Schedule C of your Form 1040. This is risky and does not offer you any income tax deduction strategies, so we advise day traders to stay away from this solution.

The third day trading tax strategy is to place your trading capital in a legal entity. There are various entities that may be appropriate, depending on your situation. Your main choices are the c-corporation, the flow-thru entities such as the limited liability company (LLC) and the limited partnership, and a combination of a c-corporation and a flow-thru entity.

The following is an explanation of the corporation - LLC tax strategy for active day traders. This tax solution can allow day traders to legally tax deduct computers, home office equipment, all educational expenses, and a large percentage of meals, entertainment and travel. You will learn how to run your day trading activities as a qualified business, and how you can grant yourself all the legal perks, benefits, tax breaks, and tax deductions afforded to large companies.

The Day Trader Deduction Limitations of the 1040 Tax Return

As you probably know, when you file your Form 1040 tax return, your ability to tax deduct expenses related to your day trading activities is extremely limited. Certain expenses are tax deductible, but these itemized deductions are subject to the 2% of adjusted gross income limitation. Additionally, tax deductions for day trading strategy seminars and home offices are categorically disallowed.

Another limitation affecting more and more day traders is the Wash Sale rule. This rule prevents you from realizing losses on securities sales if you are in basically the same financial position in a 61-day window of time. The goal of the IRS is to prevent day traders from selling a position simply to record the loss, and then immediately buying back the stock at a lower basis price. Unfortunately, with active day trading being more the norm, individuals often find themselves moving in and out of the same stock within the same 61-day window.

One benefit of day traders filing a Form 1040 tax return is the capital gain treatment of your long-term stock positions. If you hold your securities for 12 months or longer you can lower your capital gains tax bracket to as low as 10% or 20%.

In conclusion, if you work at a full-time job and are realizing capital gains in the stock market, you do not have any powerful strategies for deducting your tax liabilities. In fact, all of the day trading expenses incurred in learning solutions of how to grow and manage your capital are almost entirely non-tax deductible. But what if there was a solution that made your day trading activities into a business? What if you became a qualified money manager in your part-time? Do you think that you might receive preferential tax deductions by the IRS? Let's see:

Filing as a "Day Trader" on your Form 1040 Tax Return … tax deductions but very risky

This tax strategy boils down to this: You convert your investment activities into a day trading business. Once your day trading is recognized as a business, you are able to tax deduct any ordinary and necessary business expenses. What does it take to form a day trading business? The Internal Revenue Code is conspicuously quiet about how to qualify as a day trading business. So, the burden has been placed on brave individuals who filed their 1040 tax returns and attempted to establish themselves as "day traders" in order to tax deduct their business expenses.

Most of these day traders were slaughtered in the tax courts. In case after case, the individuals were rebuked by the courts. The net effect of the rulings is that it is nearly impossible to qualify as a day trader. To qualify, you would most likely have to be trading full-time, hold your positions for less than a day, and trade a large amount almost every business day throughout the year. In essence, the court has said, "If you are not on the floor of the exchange, or holed up in a trading room, you do not qualify."

Some CPAs have been very active in promoting "day trader status" filings. If you look at the actual text from the court cases, you will agree that attempting to establish your day trading business as an individual trader on your personal Form 1040 tax return is a risky strategy and can lead to sleepless nights worrying about a possible audit. The bottom line is that while a very small portion of active day traders can realize substantial tax deductions by filing as a "day trader", a majority of investors do not qualify for this solution and need an alternative strategy.

The Day Trader’s Tax Solution: Placing Your Day Trading Capital in an Entity Structure

Instead of attempting the herculean task of qualifying as a "day trader" on your personal return, there is a strategy that is automatic, trouble-free, and positively overflowing with powerful tax deductions. This tax strategy is what business greats like Warren Buffet, Michael Dell, and Michael Bloomberg, along with tens of thousands of others, have chosen for their investment capital.

Advantages of Using a Corporation

One of the most exciting things about using a corporation as a day trader is the sheer amount of tax deductions and perks that are available to corporate owners and company employees. Congress has created tax solutions and special exemptions for corporations. It is the lobbyists of the major corporations that have solved the day traders’ tax deduction dilemma. Now, you can own your own corporation and be able to tax deduct all "ordinary and necessary" business expenses, fully deduct the costs of attending board meetings that are held in vacation areas, deduct all medical expenses with no limitations, contribute up to $40,000 to your own pension plan, and much much more.

For day traders that are generating a large amount of excess revenue, the corporation strategy allows you to start-up additional businesses with the expenses of the new business offsetting the income from the day trading business. Another great benefit of the corporate tax strategy is that it is a perpetual entity. Many individuals choose to retain the controlling interest in the corporation, and gift the non-controlling stock to their beneficiaries early in the growth of the business. That way, all future growth occurs in the estate of the beneficiaries, so that when you pass away, your beneficiaries do not need to sell off your business simply to pay the taxes. All they would be receiving is the small amount of controlling stock.

Taking Action

If you are a part-time day trader, you have created a solution where you can take advantage of major tax strategies usually reserved for day traders with full-time businesses. It is simply a matter of getting started. We are the experts in this arena. We can look at your situation and show you how the entity structure strategy would work in your situation.