What Are the Taxes for Day Traders?
W hile taxes are complicated no matter your career, knowing how they pertain to your field can help make the filing process more stress-free. As an active trader, you need to understand the various tax laws as they relate to day traders. Having this knowledge ensures you file correctly and don’t overpay come tax season. Use this guide to better understand the day trade tax, how day traders file taxes, and what you can deduct.
- The day trading tax rate you get depends on whether you classify as an investor or a trader. As a trader, you face a more favorable day trader tax rate.
- What you ultimately pay in taxes depends on your income and how you file.
- The U.S. day trading tax rate is more beneficial for traders than investors because the IRS views you as a self-employed individual.
What Are Day Trader Taxes?
Day trader taxes refer to the financial charges that active traders must pay the government during tax season. The intraday income tax depends on whether you classify as a trader or an investor. As a trader, you can expect a better day trader tax rate.
How Much Do Day Traders Pay in Taxes?
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What you can expect to pay in taxes depends on your income and how you choose to file. For example, you can file as single, head of household, married filing separately, or married filing jointly. Your income within these filings gets you a different tax bracket or tax rate. To better understand these rates, you need to know how capital gains work.
When you sell an asset for a profit, you likely get a capital gain. Keep in mind that both profits and gains are taxable figures. The amount of tax you pay on a capital gain depends on how long you had the asset before you sold it. There are two types of capital gains: short-term and long-term. While long-term gains refer to gains on assets you held for more than a year, short-term gains are gains on assets you held for less than a year. Here’s a look at the tax rates for both types of capital gains:
- Long-term gains: 0%, 15%, or 20%.
- Short-term gains: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
Based on this, you can see that the tax on long-term capital gains is often lower than if you sold the asset in less than a year (short-term). To take advantage of long-term gain tax rates, hold your assets for at least a year.
Other capital gains you may encounter include the following:
- Gains on collectibles: If you have collectibles such as a stamp collection or various artwork, these are taxed at 28%.
- Net investment income tax: Some taxpayers may also have to pay the net investment income tax that adds another 3.8% tax on your investment income. This occurs when your modified adjusted gross income surpasses $250,000 if you filed as married filing jointly or if you’re a surviving spouse, $200,000 if you filed as single or head of household, or $125,000 if you filed as married filing separately.
- Principal residence sale capital gains: If you lived in a home for at least two years, the first $250,000 you make on its sale is excluded from your income during the year you sold it. If you file as a married couple jointly, the exclusion rises to $500,000.
It’s also worth noting that gains don’t come with special tax rates. In addition, your ordinary income follows a different tax rate commensurate with your income.
How Do Day Traders File Taxes?
To understand how to file as a day trader, consider whether you fall under the ‘investor’ or ‘trader’ category. Understanding how taxes work in this regard can help you avoid getting flagged by the Internal Revenue Service (IRS). Here’s the difference between investors and traders and how the filing process differs for each denotation:
While investors buy and sell securities like traders, they typically do it for long-term gains. They gain benefits from the interests, dividends, and capital appreciation that comes from their securities and assets. If you’re in the ‘business’ of selling securities, you’re considered an investor.
Filing as an Investor
When you fall under the investor category, you need to record your gains on tax form 8949 and Schedule D. Your expenses need to be counted as ‘miscellaneous itemized deductions.’ Rather than doing it all at once, you need to depreciate your office equipment over several years. You also need to include your investment expenses with your other miscellaneous items such as tax preparation costs on Schedule A. You do, however, get to write off the amount that goes beyond your adjusted gross income by 2%. Other forms worth noting are the Schedule C form, which includes expenses and zero income, and the Schedule D form that includes your trading profits.
Traders buy and sell stocks for a short-term profit. Typically, having this classification can get you a good amount of money during tax season. To qualify as a trader, you should do a substantial amount of trading, and you need to have aimed for a profit from the price movements in the daily market as opposed to profiting from longer-term investments. If you’re in the ‘trade’ as opposed to the ‘business’ of selling securities, you classify as a trader. Tax courts look at the number of trades you executed within a given year, the amount of money involved in each of those trades, and how many days you executed trades in that year.
Filing as a Trader
Since the IRS views you as a self-employed individual, you can deduct all trade-related expenses via the Schedule C form. Schedule C write-offs adjust your gross income, which increases your chances of getting various tax breaks. You can also deduct your margin account interest via the Schedule C form, and you don’t have to pay self-employment tax on your trading net profit.
As a trader, you still need to report gains and losses on both Form 8949 and Schedule D, though. While you can only deduct $3,000 in net capital losses every year, this drops to $1,500 if you file separately as a married couple.
When you sell a stock at a loss, you typically get to write off that amount. However, when you buy the same stock within 30 days, the IRS counts this as a ‘wash sale,’ which makes the taxing process more complex. If you’re a mark-to-market trader, you can avoid the wash-sale rule altogether. To go this route, pretend to sell all of your holdings at the current market price on the last trading day of the year. Then, pretend to buy them again in the new year. This accounting method needs to be done to account for all business assets for a given year.
As a mark-to-market trader, you can count all of your trading gains and losses as business property on IRS form 4797. Essentially, this denotation allows you to treat any stock you have after December 31 as if you sold it at the closing price. For example, let’s say you were down on the stock when the market closed. This means you can report it as a loss without selling it, giving you the ability to reduce your gains and tax bill. The mark-to-market election also allows you to avoid a $3,000 limitation on capital losses. If you decide to follow this accounting method, make sure to specify it in your IRS taxes before the deadline.
While you can classify as both a trader and an investor, aim to separate your long-term holdings and your records for both types of activities to make the filing process easier overall.
Why Does the Tax Rate Favor Traders?
The U.S. day trading tax rate is more favorable for traders than investors because the IRS views traders as self-employed. As a trader, you can deduct every one of your trade-related expenses such as home office equipment and phone bills using the Schedule C form. Just make sure to keep your receipts in case the IRS wants evidence that you used them for trading purposes.
Now that you understand how day traders file taxes, the filing process is infinitely simpler. Make sure to keep records of everything and consider whether you fall under the investor or trader umbrella so that you know how to proceed.