EDUCATION CENTER
GTT RESOURCES: IRS EXAMS
The IRS is turning up the heat on taxpayers in
general, including traders.
Recently, the IRS has started to examine more traders, as well as other types of taxpayers. The IRS has a new blessing from Congress to get tough on tax cheats, and Congress needs to raise revenue quickly to balance new budget deficits. Better compliance and enforcement are a key part of their strategy.
In our experience working with more than 1,000 traders around the country, we have noticed some new disturbing trends with the IRS turning up the heat on traders. Specifically, the IRS is auditing more trader tax returns and attempting to deny tax loss deductions (expenses and trading losses) for "money losing traders" and some "part-time traders."
Many traders made a fortune in the markets before 2000, and they paid their fair share of taxes on those gains. The IRS was happy to look upon them in those years as "good tax-paying customers." The markets crashed in early 2000 and the majority of traders gave back all their prior years' gains.
Many traders set their "sole proprietor" businesses up properly with trader tax status and mark-to-market accounting, allowing them by law to carry back their 2000 and 2001 net operating losses to prior tax years. These traders filed Form 1045 NOL refund claim tax returns and many are still expecting to receive large refund checks, plus, interest from the IRS.
Now it seems that some traders are receiving tax notices and/or tax exams
instead of tax refund checks. The IRS is unable to attack the tax law
concepts of trader tax status, mark-to-market accounting and net operating
loss tax laws. Instead, the IRS is interested in making sure that a taxpayer
claiming a large NOL refund is fully entitled by law to use "trader
tax status" and "mark-to-market accounting."
For example, the IRS may want to make sure a trader reaches the threshold
of qualifying for trader tax status (being in the trading business) vs.
merely being an active investor. Investors are not entitled to business
deduction treatment and ordinary loss treatment with mark-to-market accounting
(MTM). In order to use mark-to-market accounting, which converts capital
losses into ordinary losses, a trader must first qualify for "trader
tax status." Then, the trader must duly elect MTM on time (by April
15 of the tax year) and also file a timely and proper Form 3115 (Change
of Accounting Method). Some traders elected MTM too late and/or filed
a late or improper Form 3115. All these new trader tax laws were not very
clear – in fact, some were just updated in March of 2002 (see our
Tax Law Changes page).
See specific IRS attacks on Part-time traders and Money losing traders on those respective pages.
Good news!
Check out our new "Advocacy campaign"
to seek relief for all traders in dealing with the IRS. We need your
help to enact this change. Click
here.
An IRS attack on qualification for trader tax status:
One problem is that the IRS itself has generated little useful guidance on the qualification issue. To accommodate the growing questions received from traders, on Nov. 19, 2001, the IRS added a new section to its IRS Publication "Investment Income and Expenses – (Including Capital Gains and Losses) – For Use in Preparing 2001 Returns" titled "Special Rules for Traders in Securities." Unfortunately, this guidance is still lacking and vague; it does not offer concrete objective standards.
Another problem for the IRS is the fact that online trading is basically a virtual business that "sole proprietors" may operate from their home, office or on the road. The IRS seems to be having a hard time understanding the business and respecting it as a real business. The trading business is not a retail store that an IRS agent can visit to see proof of business activity. An active investor may have the same computer and home office set up as someone in the business of trading, and it is hard for the IRS to tell the difference.
Lastly, the IRS seems bent on classifying the buying and selling of securities as an "investment activity" rather than a "business activity." Perhaps, for the IRS, it seems to good to be true that someone can quit their job or have a second job at home, trading for their own account. The IRS figures if you lost money, you don't have a "profit-making intent," which is the key to overcoming the hobby loss rules (see money losing trader page). The fact is that anyone with capital and computer savvy can put themselves in the same position as "professional traders" on Wall Street, which are well-respected by the IRS as being in the business of trading. The IRS is catching up fast on e-commerce, so it's time for their agents to understand new business opportunities on the Internet. Online trading businesses are probably the biggest new Internet trading businesses.
Here’s the bottom line
The IRS has
few guidelines for traders, and those that exist are quite vague.
Moreover, the IRS has a motive to balk on paying refunds, and it seems
bent on not respecting trading as a bona fide business activity. At
every step of the way, we disagree with the IRS in this context. But
the IRS has the power to examine traders, and many agents around the
country are not experienced in trader tax laws and exams. This combination
can lead to trouble for traders being examined.
If you received tax notice about your trading activity, we highly recommend that you contact our firm before you reply to the IRS. The cardinal rule of tax exams is to not offer information, and answer questions briefly and correctly. We invite you to e-mail us at info@greencompany.com or call us. We will keep your tax information strictly confidential per our published privacy policy.
The IRS can make your life difficult, but don't back away from your rights to use trader tax status, mark-to-market accounting and net operating losses. That would be very unfair to you.
If you need help, we suggest you visit
our services page for "IRS Representations." Click
here. We have an excellent track record defending our trader clients
before the IRS. You need us in your corner. Feel free to call
us to discuss your file in strict confidence.
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