Tax Impact of Investor vs. Trader Status

Tax Impact of Investor vs. Trader Status

If you invest, whether you’re considered an investor or a trader can have a significant impact on your tax bill. Do you know the difference? Investors Most people who trade stocks are classified as investors for tax purposes. This means any net gains are treated as capital gains rather than ordinary income. That’s good if your net gains are long-term (that is, you’ve held the investment more than a year) because you can enjoy the lower long-term capital gains rate. However, any investment-related expenses (such as margin interest, stock tracking software, etc.) are deductible only if you itemize and, in some cases, only if the total of the expenses exceeds 2% of your adjusted gross income. Traders Traders have it better in some situations. Their expenses reduce gross income even if they can’t itemize deductions and not just for regular tax purposes, but also for alternative minimum tax purposes. Plus, in certain circumstances, if traders have a net loss for the year, they can claim it as an ordinary loss (so it can offset other ordinary income) rather than a capital loss. Capital losses are limited to a $3,000 ($1,500 if married filing separately) per year deduction once any capital gains have been offset. Passing the trader test What does it take to successfully meet the test for trader status? The answer is twofold: 1. The trading must be “substantial.” While there’s no bright line test, the courts have tended to view more than a thousand trades a year, spread over most of the available trading days, as substantial. 2. The trading must be designed to try to catch...
All income investments aren’t alike when it comes to taxes

All income investments aren’t alike when it comes to taxes

The tax treatment of investment income varies, and not just based on whether the income is in the form of dividends or interest. Qualified dividends are taxed at the favorable long-term capital gains tax rate (generally 15% or 20%) rather than at the applicable ordinary-income tax rate (which might be as high as 39.6%). Interest income generally is taxed at ordinary-income rates. So stocks that pay qualified dividends may be more attractive tax-wise than other income investments, such as CDs and taxable bonds. But there are exceptions. For example, some dividends aren’t qualified and therefore are subject to ordinary-income rates, such as certain dividends from: Real estate investment trusts (REITs), Regulated investment companies (RICs), Money market mutual funds, and Certain foreign investments. Also, the tax treatment of bond income varies. For example: Interest on U.S. government bonds is taxable on federal returns but exempt on state and local returns. Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also might be excludable on your state return. Corporate bond interest is fully taxable for federal and state purposes. While tax treatment shouldn’t drive investment decisions, it’s one factor to consider — especially when it comes to income investments. For help factoring taxes into your investment strategy, contact us. ©...