Trader Tax Issues
OptionsAnimal
Dallas Student Summit
April 2, 2011
Disclaimer
Options
Any strategies used as examples and discussed, using actual securities and
price data, are strictly for illustrative and educational purposes only and are not
to be construed as an endorsement, recommendation or solicitation to buy or
sell securities.
Taxation
Any US tax advice contained in this presentation is not intended to be used,
and cannot be used, for the purpose of (i) avoiding penalties that may be
imposed under the Internal Revenue Code or applicable state or local tax law
provisions, or (ii) providing, marketing or recommending to another party any
transaction or matter addressed herein.
The information presented provides only a general discussion of the tax law
affecting the taxation of options and is not intended to be applicable to any
individual investment and tax situation. You are strongly advised to contact
your own tax consultant in considering the tax consequences of your own
specific set of facts and circumstances.
Agenda
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Securities & options taxation in general
A Primer on OSI
New basis reporting
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aka “Pin the tail on the correct basis”
The Roadmap – www.optionstaxguy.com
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Trader vs Investor
Mark to Market
Entity selection
Reporting
Goal
Understand how to get from the
Trade
to the
Tax Return
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
What Triggers Tax?

Completed transaction

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Open followed by Close
Stock
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Sale
Cover
Options

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Purchase
Short Sale
BTO
STO
STC/Expiration
BTC/Expiration
Which transaction establishes basis for gain/(loss)?

The debit/non-credit side of the transaction
What is Taxed?


Gains and losses
Determined on a:

First In – First Out (FIFO) basis


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First shares purchased are the first shares sold
Used when cannot or does not identify which shares
sold [Reg 1.1012-1(c)(1)]
IRS presumption
Specific Lot Identification basis

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Shares must be identified to broker
Broker must confirm in writing [Reg 1.1012-1(c)(3)]
How is it Taxed?

Stocks/securities are generally capital assets

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Holding periods

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Closing transaction generates gain/loss – generally
Mark to market deems sale/repurchase but character
is still capital – generally
Short-term – one year or shorter
Long-term – longer than one year
Generally begins on day after acquisition
Generally ends on day of disposition
Pass-through entities – retain character
Amount of the Tax?

Short-term capital gains


Ordinary income rates – 10% to 35%
Long-term capital gains

Marginal rate bracket up to 15%

Marginal rate bracket 25%+
0%
15%
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
How are Strategies Taxed?
They’re NOT!!
Individual Trades ARE
How are Strategies Taxed?

Initiate a Put Calendar on SPY in Jan 2011

BTO May 11 130

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STO Jan 11 130
BTC/Expire Jan 11 130
STO Feb 11 130
BTC/Expire Feb 11 130
STO Mar 11 130
BTC/Expire Mar 11 130
STC May 11 130*
Four lines on Sch D/D-1
Taxable Transaction #1
Taxable Transaction #2
Taxable Transaction #3
*Taxable Transaction #4
How are Strategies Taxed?
How are Strategies Taxed?

Initiate a Covered Call/Collar on Apple:

Buy AAPL on 7/20/2010

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STO Sep 10 280 Call
BTC/Expired Sep 10 280 Call
STO Oct 10 320 Call
BTO Nov 10 290 Put
BTC/Expired Oct 10 320 Call
STO Nov 10 300 Call
STC Nov 10 290 Put
Expired Nov 10 300 Call
Taxable Transaction # 1
Taxable Transaction # 2
Taxable Transaction # 3
Taxable Transaction # 4
AAPL* called at Nov 10 expiration
*Taxable Transaction # 5
How to keep it straight ...


That was a lot of trades!!!
The OCC – and others – helped us out here
with the ...
Options Symbology Initiative


The ‘Do-It-Yourselfers’ best friend
No more OPRA symbols


OPRA: Apple Dec 2009 210 Call – AAQLB
OSI: AAPL091219C00210000 (what it would have been)
Options Symbology Initiative
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Excel function to build OSI Symbol
osisymbol(open,ticker,expiry,weekly,type,strike)

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open – 0=closed, 1=open
ticker – stock symbol, ie, AAPL, SPY
expiry – expiration date in ‘mmm yyyy’ format
weekly – weekly expiration day (numeric)
type – Put (P) or Call (C)
strike – strike price
Good for sorting option symbols
Securities Taxation
General Concepts
Taxation of Strategies
Options Symbology Initiative
New Broker Reporting Requirements
New Basis Reporting


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Brokers now required to report cost basis and
holding period
Both will be reported to IRS
Implementation timeframe

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Stock purchases – January 1, 2011
Mutual funds – January 1, 2012
Options & debt instruments – January 1, 2013
Why?

Close tax gap
$6.7B over 10 years
Basis Reporting Problems
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Community property laws
Inheritance
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Wash sale rules
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Loss add back
Holding period adjustment
Assigned puts

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Stepped-up basis
All long-term
Decrease basis of assigned shares
Broker transfers
Basis Reporting ... so far so

Good

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Purchased and sold/same broker – sometimes
Bad

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Purchased and sold/different broker

Cost basis – Wrong

Cost basis – “UNKNOWN”
Examples from 2010 tax year
Basis Reporting Examples
Basis Reporting Examples
Basis Reporting Examples
What is the Point?
Keep track of:
COST BASIS
YOURSELF!
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
Entity Selection
Complete Roadmap with associated links at: www.optionstaxguy.com/roadmap
Investor vs Trader
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Why? – Subject to different tax rules
Definitions:

Investor –
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Trader –
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Stock purchase for capital appreciation/dividends
Little regard for short-term fluctuations; Buy and hold
Regularly and continuously trade stock/securities
Trade in own account
Profit from short-term fluctuations
Can be BOTH trader and investor
IRS presumption
Investor
Investor vs Trader
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Taxation of Investors
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Stocks/securities considered capital assets
Gains and losses considered capital
Reported on Schedule D
Subject to IRC Sec 1091 wash sale rules
Subject to $3000 loss limit
Investment expenses (except interest)


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Schedule A deductions
Subject to 2% AGI threshold
Not deductible for AMT purposes
Interest – deductible up to net investment income
Investor vs Trader
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Taxation of Traders
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Stocks/securities considered capital assets
Gains and losses considered capital
Reported on Schedule D
Subject to IRC Sec 1091 wash sale rules
Subject to $3000 loss limit
Gains NOT subject to self-employment tax
Investment expenses
 Schedule C/E* deductions
 Interest deductible for material participation
 Home office deduction eligibility
Mark-to-Market (MTM) election eligibility
_____________________________________________________________________________________________________
*
Flow-through entity, such as partnership, LLC, S-Corp
Investor vs Trader
– MTM Election

What is Mark-to-Market (MTM)?

Traders can elect to mark their security holdings to
market value at the end of the tax year
IRC Sec 475(f) –
“… In the case of a person who is engaged in a trade or business
as a trader in securities …”
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Gains and losses treated as ordinary gain/loss
Adjustment to stock basis for unrealized gain/loss
Not subject to self-employment tax
Reported on Form 4797, Part II
Investor vs Trader
– MTM Election Benefits
Two restrictions no longer apply:
$3,000 net capital loss limit
Wash sale rule
However ...
Election is IRREVOCABLE without IRS
consent
Wash Sales
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Wash sale definition:
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Loss transaction
Buy substantially identical stock – OR –
Option to acquire substantially identical stock
Within 30 days before or after loss transaction
Are options subject to wash sale treatment?
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Does AAPL Apr 11 350 SP = AAPL Apr 11 340 SP?
If AAPL at Apr expiration = $330
Yes
If AAPL at Apr expiration = $345
No
Mark to Market Example
Mark to Market Example
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Purchase 100 SPX at 105 on 11/8/2009
Make MTM election on 2/4/2010
SPX closes at 126 on 12/31/2010
Mark-to-Market requirements:
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SPX deemed SOLD on 12/31/2010 at 126
SPX deemed REPURCHASED on 12/31/2010 for
126 – new basis going forward
Gain 21 (126 – 105)
 Long-term 12.6 (60% x 21); 15% max tax rate
 Short-term 8.4 (40% x 21); 35% max tax rate
Mark to Market Example
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SPX declines to 110 by 4/10/2011 and is sold
What is the gain/loss?
How is it taxed?
Deemed repurchase at 126 on 12/31/2010
Sale
110
Less: Basis
126 (from deemed repurchase)
Loss
<16>
LTCL <9.6> (60%)
STCL <6.4> (40%)
 Loss may be carried back three years
Investor vs Trader
– Making the MTM Election
Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com
Investor vs Trader – Living
with the MTM Election
Also available at www.optionstaxguy.com
Investor vs Trader - Summary
Criteria
Investor
Trader MTM Trader
Reporting gain/loss
Sch D
Sch D
Form 4797
Reporting expenses
Sch A
Sch C/E
Sch C/E
Reporting interest
Sch A
Sch C/E
Sch C/E
Invest int exp limits
Yes
No
No
Home office eligible
No
Yes
Yes
Subject to S-E tax
No
No
No
Wash sale rules
Yes
Yes
No
$3000 Cap loss limit
Yes
Yes
No
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
Entity Selection
Entity Selection
Entities – Types

Types of entities for Traders
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Sole proprietor – Sch C/Sch D/Form 4797 (default)
General Partnership – Form 1065
Limited Liability Company (LLC) – Form 1065
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Single member LLC – Sch C/Sch D/Form 4797
Multiple member LLC*
Corporation
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C Corporation – Default; Form 1120
S Corporation – Election; Form 2553
Form 1120S
* LLC with election: Form 8823
Form 2553 (S Corp)
Entities – Setup
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State law prevails – name, articles, etc.
Separate bank account styled identically to
entity name (Patriot Act)
Brokerage account name identical to entity
Business activity code: 523110, 523900
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Source: www.naicscode.com; keyword: securities trader
Employer Identification Number (EIN)
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Setup: www.irs.gov
Walk-through of IRS site at optionstaxguy.com
Entities – Taxation
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Sole proprietorships (SMLLC)
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Flows to page 1 of Form 1040
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Subject to self-employment tax – except traders
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May be subject to state business/franchise tax
Partnership (LLC default for 2+)
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Flows through to Form 1040 via Schedule E page 2
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Flows to Sch B/Sch D/Sch 4797 via K-1
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Subject to self-employment tax – except traders
Entities – Taxation
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C Corporation
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Separate perpetual entity
Subject to double taxation
Benefits more compliant/straightforward
S Corporation
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Separate perpetual entity
Flows through to Form 1040 via Schedule E page 2
Flows to Sch B/Sch D/Form 4797 via K-1
Benefits available same as C but less flexible
Not subject to self-employment
Entities – Benefits
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General benefits
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Employer-reimbursement for education
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Dependent Care Assistance
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Adoption Assistance
Home office
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Principal place of business as a trader
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Regular use – continuing basis
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Exclusive use – no personal, television, exercise
Entities – Benefits
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Employer-provided transportation
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Substantiation for business use
Log
Personal use includible in income (W-2)
100% depreciation for employer
Various valuation methods but limited if owner
Reimbursement at federal rates
Vehicle should be titled in business name
Insurance rates may be higher
May be subject to property tax
Entities – Benefits
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Health & Medical plans
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Entity-dependent treatment
Health reimbursement accounts (Sec 105 plans)
Section 125 plans – cafeteria plans
Retirement plans
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Simplified Employee Pension – super-IRA
SIMPLE
Profit-sharing
Pensions – defined benefit or contribution
Entities – What are we missing?

Most benefits based on compensation

You need to be an employee

Forms 941, 940, W-2, W-3, State

Form 5500 possibly
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Form 1120/1120S/1065
Wages
Entities – Warning!

Simply setting up an entity does NOT elevate
one’s trading to that of a TRADER

The most simple entity is usually the best
entity
flow-throughs

Setup entity in your domicile state – NEXUS

Avoid “package deals” of entity setup and
compliance
The Roadmap
Investor vs Trader
Mark to Market
Entity Selection
Reporting
How are Strategies Taxed?

Initiate a Covered Call/Collar on Apple:

Buy AAPL on 7/20/2010









STO Sep 10 280 Call
BTC/Expired Sep 10 280 Call
STO Oct 10 320 Call
BTO Nov 10 290 Put
BTC/Expired Oct 10 320 Call
STO Nov 10 300 Call
STC Nov 10 290 Put
Expired Nov 10 300 Call
Taxable Transaction # 1
Taxable Transaction # 2
Taxable Transaction # 3
Taxable Transaction # 4
AAPL* called at Nov 10 expiration
*Taxable Transaction # 5
Reporting
Reporting

Mark to Market example from above

SPX deemed SOLD on 12/31/2010 at 126

SPX deemed REPURCHASED on 12/31/2010 for
126

Gain 21 (126 – 105)

Long-term 12.6 (60% x 21); 15% max tax rate

Short-term 8.4 (40% x 21); 35% max tax rate
Reporting
Reporting

Form 4797





Used for MTM Traders
Reported in Part II, Ordinary Gains and Losses
Favorable capital gain rates do not apply
Wash sale rules do not apply
$3000 net capital loss limit does not apply
Reporting

Jeff’s OTB Bull Puts

Joseph A Banks (JOSB) – Jul 2011 30/35



$0.40 profit
Green Mtn Coffee Rsters (GMCR) – Sep 2011 30/32



Opened 1/25/2011 – $0.80 credit
Closed 3/2/2011 – $0.40 debit
Opened 2/7/2011 – $0.49 credit
Closed 3/10/2011 – $0.17 debit
$0.32 profit
Noble Energy (NE) – Jun 2011 30/32


Opened 1/27/2011 – $0.35 credit
Closed 2/22/2011 – $0.13 debit
$0.22 profit
Reporting

Joseph A Banks (JOSB) – Jul 2011 30/35

STO JOS110716P00035000 on 1/25/2011 for $1.50

BTO JOS110716P00030000 on 1/25/2011 for $0.70

BTC JOS110716P00035000 on 3/2/2011 for $0.75

STC JOS110716P00030000 on 3/2/2011 for $0.35
Reporting

Green Mtn Coffee (GMCR) – Sep 2011 30/32

STO GMCR110917P00032000 on 2/7/2011 for $2.34

BTO GMCR110917P00030000 on 2/7/2011 for $1.85

BTC GMCR110917P00032000 on 3/10/2011 for $0.70

STC GMCR110917P00030000 on 3/10/2011 for $0.53
Reporting

Noble Energy (NE) – Jun 2011 30/32

STO NE110618P00032000 on 1/27/2011 for $1.01

BTO NE110618P00030000 on 1/27/2011 for $0.66

BTC NE110618P00032000 on 2/22/2011 for $0.41

STC NE110618P00030000 on 2/22/2011 for $0.28
Reporting
Reporting Tips

Schedule D/Schedule D-1

Used by both investor and trader

Name, dates, sale, cost, gain/loss

If applicable, use “VARIOUS” to designate dates
of block purchases or sales; still separate shortterm and long-term

Identify wash sales under the affected transaction
by designating “WASH SALE” and adding the loss
amount as a positive in col (f)
Reporting Tips

Expired options

Long options


Short options


Name, expiration date in col (c), “EXPIRED” in col (d)
Name, expiration date in col (b), “EXPIRED” in col (e)
Tie stock sales to 1099B gross proceeds
Thank You!
Trader Tax Issues
OA Dallas Student Summit
April 2, 2011