Day Tripper – Tax Planning Considerations for Day Traders

Overview

One of the things that I like to do at social gatherings is to start a discussion over which musical group was musically more gifted – The Beatles or Bee Gees. I did not say which group made more money or was more famous. I say the Bee Gee “hands down”.

Hear me out! The Beatles had the benefit of social timing and marketing. If you listen to the early Beatles, they needed music lessons. Yes, they were good song writers. Nevertheless, when you consider the Bee Gees, the harmonization between the Brothers Gibb and more importantly their ability to reinvent themselves in the disco era with some of the most memorable tunes of the era, you will see it my way (or not!). All of this for the title of the blog post.

The IRS makes important distinctions between traders and investors and dealers. the distinction is important in a couple of area. Dealers and traders are viewed as being in business. A trader must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation.
The treading activity must be substantial, and must carry on the activity with continuity and regularity.
The following facts and circumstances should be considered in determining if your activity is a securities trading business:

(1) Typical holding periods for securities bought and sold.
(2) The frequency and dollar amount of trades during the year.
(3) The extent to which the trader pursues the activity to produce income for a livelihood, and
(4) The amount of time you devote to the activity.

Many traders had to get a day job after the 2008 market correction. Nevertheless, many day traders continue to make a profitable living with market returns that many professional money managers would envy. The problem is what do to do about taxation for the frequent trading – short term capital gain income taxed at ordinary rates.

What to Do This Year

1. Create a Qualified Retirement Plan – Run your business through an investment LLC. Pay yourself a management fee. You will pay some self employment taxes but who cares! A combination of plans – defined contribution and defined benefit – such as a 401(k), profit sharing and cash balance defined benefit plan. The combination of these plans will create a deduction much larger than your management fee at virtually any age. From that point, your investment earnings within the plans will grow on a tax deferred basis.

What to Do Next Year

1. Become Puerto Rican

The PR has passed a series of tremendous tax incentives that favor the Day Trader. Essentially all of your treading income will be income tax free for federal and PR tax purposes after you become Puerto Rican. You need to live in the PR for six months per year so that if you live in Dubuque, it should not be that hard to move to San Juan in the cold months.

2. Private Placement Insurance Products

Your parents may still be complaining about how much they spent on your education and why can’t you get a regular job. Make their complaining useful. Use them to structure and purchase a private placement life insurance or a private placement variable deferred annuity. PPLI will provide tax-free treatment on the investment income and provide you with the ability to take distributions from the policy on a tax-free basis. The investment gains will also pass tax-free at the death of the insured. The deal can be structured to avoid the dreaded investor control rule. You will be surprised how fast your investment capital will grow with tax deferral.

Summary

I will do a longer article on this topic after Year End. I wanted to outline a few ideas for any day traders staring year end in the face. These ideas will help you come out on top.

About gerrynowotny

I am a tax and estate planning attorney with a JD and LL.M in estate planning from the Univesity of Miami School of Law. I have worked in the life insurance industry for twenty three years and the last eleven in private placement life insurance.
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