The Business of Trading

The Business of Trading


Starting Your Business

Now that you are a trader, you should always be on the lookout for ways to increase your returns. In addition to increasing the actual returns you make on trades, you should also look for ways your trading can make or save you money.

In reality, it doesn’t matter where your income or profit comes from as long as your cash increases at the end of each month. This is what I refer to as the business of trading.

Most people don’t think about trading as a business, but I learned long ago that the best returns frequently can be made by looking at things differently than most people. If you change your thinking and start looking at trading as more than just investing but actually as a business that provides income for you and your family, I think you will be pleasantly surprised at the benefits you will receive.

In the first place, a small business is about the only great tax shelter still available that the Internal Revenue Service (IRS) hasn’t been able to strip away. Not that is hasn’t tried, but Congress has stubbornly realized that it is the entrepreneurial spirit that makes this country what it is, so it has consistently avoided reducing the benefits businesses offer to their owners.

Naturally, it doesn’t hurt that most congresspersons and senators either have small businesses or relatives who have one, but let’s be thankful for the little favors we get, no matter where they come from or what form they take.

The Tax Code

The tax code classifies people in the securities business into three categories: dealers, investors and traders. The deal classification is beyond the scope of this book because it involves people making a market in stocks and other securities for investors. Investors and traders, however, are very important and affect the way we buy and sell currencies or securities and deductions are allowed.

Most people consider themselves investors. They invest and look for a return on their money. Investors, however, do not get any tax benefits other than the potential of capital gain tax treatment on anything they buy and hold for more than a year.

In this market, holding anything for as long as a year may be a financial disaster; the benefit isn’t all that great today. In fact, the jaded side of me wonders of the fact that it isn’t really a benefit is a real reason Congress is thinking about doing away with the tax on capital gains.

If, instead of being an investor, you decide to be a trader, here is a partial list of benefits in the form of tax deductions you get:

- The cost of your trading education
- The cost of your financial software
- The cost of books and audio/video course in investing and trading
- Accounting fees
- Brokerage account fees and commissions
- The cost of office equipment (computers, Internet high speed connection fees, adding machines, phones, phone chargers, etc)
- Interest on your margin accounts and any other investment-related interest expense
- The cost of financial advice and training
- The cost of tax advice
- The cost of legal advice related to your business
- Entertainment and meals expenses during which business is conducted
- The cost of travel to seminars, trade shows, and other business-related trips, anywhere in the world
- The cost of magazine subscriptions related to investing and trading
- The cost of trips to look at corporations in which you are considering investing
- The portion of your home expense that qualifies as a home business and a portion of all expenses paid on maintaining the property
- Automobile expenses

You can tell that the list is rather inclusive and beneficial. Interestingly, as you begin to learn the nuances and combine all the advantages, they add up to a rather tidy sum. For example, if the year you become a trader you purchase a new car to be used in your business, you can take an immediate deduction for the first $25,000 because the car qualifies under Section 29 of the tax code, which allows for asset expensing of the first $25,000 of property brought for use in your business each year.

The rest of the cost of the car can be set up on a depreciation schedule for future years. It isn’t a reason to go out and buy a new car (or is it?), but it isn’t bad.

How to Become a Trader

The IRS code does not define trade or business as it relates to the business of trading. The law that has developed comes from court cases and decisions made in the favor of taxpayers who have made this claim. The key elements in the cases were length of holding period, frequency of trades, and whether the person’s activity was intent on making the money from dividend interest, long term gains, or profits from short-term trading.

If you are a currency trader, it is pretty easy to show your intent because this is all you shoot for. If you also trade stocks, you can still make a claim for trader status even if you hold some of them long term, although it is doubtful you will anyway.


What if I Don’t Make Enough Money to Use Those Deductions

While we all hope our businesses, including our trading business, makes a ton of money. But the reality is it won’t always do so. The good news is that if trading is a business, then your excess expenses can be used to offset income from other sources, just like any other business would allow you to do. It is a win/win situation.

How to Make the Win/Win Better

So far I’ve talked about using trader status as it relates to your personal tax return by creating a small sole proprietorship. In this case you would place your ordinary business expenses on Schedule C, and you would report your income or loss on Schedule D because it is still considered capital. No self-employment income is calculated on the income, and your trading losses are still limited to $3,000 per year but can be carried over indefinitely. You also can use any losses in the stock market to offset gains in the currency market.

Although the benefits of this strategy are good, there is another way – and in many ways, a better way – to operate the business. This is by incorporating the business and creating your own trade corporation.

A trade corporation is your new legal entity in which to conduct your trading. There are near-term advantages, longer range asset protection, and family financial planning advantages. There will be some extra cost for setup and operation, but as you will quickly see, the advantages far outweigh the cost.

Your first advantage is clarity of purpose. If you form a corporation for the purpose of trading and conduct the trading in that separate entity, there will be no question regarding your trading status, not an issue about your personal tax return and the deductions you take. This is not to suggest that operating things in the sole proprietorship status is in the gray area of the tax code. It isn’t.

Some people like to keep their various businesses separate, protect assets from different creditors and do estate and financial planning as they go. If you fall into this category of individuals, you should consider using a corporation as the entity to operate your trade business.

What Kind of Corporation Should You Use?

There are three types of corporations: a C Corporation, which is considered a regular corporation; a Sub S Corporation, so named because of the tax code section that gives it its benefits; and the Limited-Liability Corporation (LLC), which is a relatively new corporate structure to overcome some of the structural difficulties of the Sub S Corporation. (Interestingly, about the time the states through adopting all this massive legislation to get around the tax code, Congress decided that it didn’t want to be outdone and amended most, but not all, of the difficult portions of the Sub S Code.)

To be fair to both, you know as a reader and me as the author, I must now disclose that I am going to make sweeping generalities about which corporations are best and why. The problem is that everyone’s circumstances are different, and volumes have been written about the “best” structure to use. Nevertheless, I will attempt to weed through the jargon of red tape and see if some meat comes forth.

The C Corporation is used primarily for public companies, multiple shareholders who aren’t interested in disturbing profits and losses but want to build an entity, and individual businesses that want to benefit from a medical reimbursement plan and/or types of retirement programs. For some people, the medical reimbursement can be a great deal because under the current law, individuals and joint filers are limited to medical deductions after a 2 percent limitation of adjusted gross income.

If you make $150,000 per year adjusted gross income, you can only deduct medical expenses abut $3,000. If, on the other hand, you have a C Corporation and you have adopted a medical reimbursement plan, you would be able to get a deduction form the first dollar, plus all of your family’s expenses. It is a nice benefit if you need it.

Excepting the medical situation, you likely will benefit greatest in either a Sub S Corporation or an LLC. The reason is that both have tax flow benefits at the shareholder level. This means that the corporation does not pay a separate tax but that the shareholders (in the Sub S) and the members (in the LLC) pay tax on any gain or take losses personally if there are any. This gives you the benefit of a personal tax shelter in years there is a loss in the company.

Let’s Take a Look at Some Examples

You form an LLC trade corporation. In an LLC, you are allowed to issue multiple types of shares. Because you would like to shift some of your trade income to your children, you issue them a preferred class of stock that has no voting rights no has a preference of income up to a certain level.

This “income shift” strategy allows you to maintain 100 percent control of your company and all the assets but shift dollars to your children, who are in a lower income bracket than you. The children can use the money to pay their bills.

Another twist on this strategy is to pay your children a salary out of the corporation for work they do. The work, depending on the age and ability, would give them earned income and allow them to set up an Individual Retirement Account (IRA) or other retirement program at an early age.

While income shifting takes money out of your pocket and puts it in someone else’s, you get the deduction and if you can control what happens to the money, it is the same as having it. Another benefit to helping your children grow an early retirement program is that you may at least have someone to support you if things don’t always go s you would like.

LLC’s have another advantage; they can be used to protect assets. If you find yourself in a situation where you need to be protected, you can put your assets in an LLC and give, sell, or otherwise structure the share ownership in someone else’s name. You can continue to draw a salary from the company and control the operation of the company through special shares, which can be drafted to give you specific rights to do so.

The assets now belong to someone else and are no longer attachable by creditors, and the income you receive is not attachable because it is salary. (Some states give certain creditors rights to lien a portion of salary, but this can be adjusted to fit the situation.) Please note that in this example, you have actually given up these shares and the assets they represent. This can be a shame. One the other hand, in the scenario I outlined, you would have lost the assets to a creditor not of your choosing.

By using this structure you at least shifted the assets to someone you know, and you get income generated from the company in the form of a salary. I also would like to point out that there are laws governing fraud on creditors. These laws do not prevent you from properly protecting yourself and your family but are intended to stop what are called sham transactions, where there is no truth or substance to your actions. Since we are only talking about proper planning, these and other strategies should all be available to you and used when needed.


This information and other great FOREX information can be found in the book FOREX Made Easy: “6 Ways to Trade the Dollar” by James Dicks.