Trader with Mark to Market election

MTM Trader is a trader who has officially elected with IRS to employ the Mark to Market method of
accounting for his positions at the end of the year. The election is declared in a letter to the IRS filed with
a "timely filed" tax return for that year.

Mark to market election must be filed with the IRS by April 15 of the year in which the trader wishes to
switch to Mark to market accounting method. This means, that if you have not filed this election this past
April, you will not be permitted to apply Mark to Market method to your 2001 tax return. You will able
to file this election with your 2001 return, and use MTM for the year 2002.

IRS Form 3115, Application for Change in Accounting Method. is a form used for the Section 481
adjustment that may be required the first year a trader files under MTM accounting method.

Case law examples that determined Trader vs Investor Status.

There are several important questions to ask yourself before electing MTM, that we will get to in a
moment. First, let's discuss the implications of an MTM election.

First of all, an MTM trader is truly in the business of trading! This means, that his trades generate no
capital gains or losses - rather, all his transactions are reported on Form 4797, then transferred to Schedule
C as ordinary income or loss (A memo to IRS must be included, explaining the procedure). To him,
winning trades are simply income, losing trades are a loss to be deducted from his income. He need not
worry about the $3000 net loss limitation that applies to investors and traders.

At the same time, the MTM election means loss of the tax shelter on existing
positions - the MTM trader reports not only his completed trades' income and losses,
but also the unrealized income or losses on any positions open at the end of the
year. This is where the common name of the election come from - the trader marks
to market value his open positions at the end of the year and reports the
unrelialized profits and losses in his Schedule C for that year.

Because his activities result in ordinary income or loss, an MTM trader with a loss for
the year is able to deduct his loss fully against his other income, or against his
spouse's income (in a joint filing). In addition, a net operating loss from his trading
business can be carried back two years by re-filing for those years, and/or carried
forward 20 years.

Because of the different tax rates on ordinary income and capital gains (especially
long term), the MTM trader needs to ensure that his investments (if any) are
segregated in a separate brokerage account from his daily trading, to ensure proper
accounting. That way, the MTM trader can continue to take advantage on the long
term capital gains tax rates on his investments.
Wash sale rules have no impact on the trader who has elected Mark to Market
accounting.

One important thing you need to remember before electing MTM

accounting: if you have accumulated net capital losses to carry forward from
previous year(s), these are only deductible against capital gains.

Once you switch to MTM accounting, all your future profits will be ordinary income -
therefore you would not able to utilize your carry forward losses, unless you have
other sources of capital gains.

MTM election can only be revoked under rare special circumstances, so it not a step
to be taken lightly. Please make sure this is appropriate for your situation.

In order to have MTM election in place for year 2001, you must file the election in
writing before April 16, 2001. There is not specific form, rather a letter that must
include: description of the election, specific business the election covers (such as
Schedule C), and the first year that you used Mark to Market election in the past, or
will use now.

You send this letter in to the IRS office at the same address where your tax return
goes. It is a good idea to use certified mail with return receipt!

What about the Self Employment Tax?

Trader in Securities
You are a trader in securities if you are engaged in the business of buying and
selling securities for your own account. As a trader in securities, your gain or loss
from the disposition of securities is not taken into account when you figure net
earnings from self-employment. However, see Dealer in Securities, earlier, for an
exception that applies to section 1256 contracts. For more information about
traders in securities, see Publication 550.
Quoted directly from the IRS, Publication 533, Who Must Pay Self-Employment Tax?, , emphasis added

Investment Interest and Expenses

The limitation on investment interest expense that applies to investors (who must
itemize deductions) does not apply to interest paid or incurred in a trading
business. A trader reports interest and other expenses (except for commissions and
other costs of acquiring or disposing of securities, which are used to figure the gain
or loss) from a trading business on Schedule C (instead of Schedule A).
 Deductions
List of some common deductions, some can be used on Schedule A ( Investor), most
can be used on Schedule C (Trader, MTM Trader) *)

Can I claim a Home office deduction?

Chat room subscription costs for traders

Subscriptions, including: Level II, data feeds, stock newsletters, newspapers, and others
associated with trading/investments

trading books and trader publications, related magazines

Club dues and memberships, if linked to trading/investing

ISP fees

Telephone costs (usually dial up costs, long distance charges). Must have separate line
to claim 100%

Seminars attended, including transportation and lodging costs (trading seminars,

conferences, courses)

Rent, if leasing office space

Interest paid, on schedule A for investor, C for trader. On schedule C all can be written
off, on A tied to investment income. Additionally, credit card interest used for purchasing
stocks, if properly segregated can be used. Any interest charges for equipment can also
be used as deduction

Computer, and office supplies

TV Cable fees, i.e. you use for CNN or FNN.

Any wages paid to family members for assistance (e.q. spouse doing data entry of trade
confirmations, reconciliations)

Home Office expenses, however, need to review this on individual basis

follow this link for an interesting article

Tax Preparation and advice, any fees associated with trading paid to a tax professional
Auto expense when used in trading (i.e. mileage to seminars, tax prep, P.O. box)

Office supplies (printer ink cartridges, paper...)

Depreciation on all fixed assets used in trading

* This is not an exhaustive list.

Publication 550 (2008), Investment Income and Expenses

(Including Capital Gains and Losses)

Special Rules for Traders in Securities

Special rules apply if you are a trader in securities in the business of buying and
selling securities for your own account. To be engaged in business as a trader in
securities, you must meet all the following conditions.

• You must seek to profit from daily market movements in the prices of
securities and not from dividends, interest, or capital appreciation.

• Your activity must be substantial.

• You 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.

• Typical holding periods for securities bought and sold.

• The frequency and dollar amount of your trades during the year.

• The extent to which you pursue the activity to produce income for a
livelihood.

• The amount of time you devote to the activity.

If your trading activities are not a business, you are considered an investor, and not
a trader. It does not matter whether you call yourself a trader or a “day trader.”
Note.
You may be a trader in some securities and have other securities you hold for
investment. The special rules discussed here do not apply to the securities held for
investment. You must keep detailed records to distinguish the securities. The
securities held for investment must be identified as such in your records on the day
you got them (for example, by holding them in a separate brokerage account).

How To Report
Transactions from trading activities result in capital gains and losses and must be
reported on Schedule D (Form 1040). Losses from these transactions are subject to
the limit on capital losses explained earlier in this chapter.

Mark-to-market election made. If you made the mark-to-market election, you

should report all gains and losses from trading as ordinary gains and losses in Part II
of Form 4797, instead of as capital gains and losses on Schedule D. In that case,
securities held at the end of the year in your business as a trader are marked to
market by treating them as if they were sold (and reacquired) for fair market value
on the last business day of the year. But do not mark to market any securities you
held for investment. Report sales from those securities on Schedule D, not Form
4797.

Expenses. Interest expense and other investment expenses that an investor

would deduct on Schedule A (Form 1040) are deducted by a trader on Schedule C
(Form 1040), Profit or Loss From Business, if the expenses are from the trading
business. Commissions and other costs of acquiring or disposing of securities are
not deductible but must be used to figure gain or loss. The limit on investment
interest expense, which applies to investors, does not apply to interest paid or
incurred in a trading business.

Self-employment tax. Gains and losses from selling securities as part of a

trading business are not subject to self-employment tax. This is true whether the
election is made or not.

How To Make the Mark-to-Market Election

To make the mark-to-market election for 2009, you must file a statement by April
15, 2009. This statement should be attached to either your 2008 individual income
tax return or a request for an extension of time to file that return. The statement
must include the following information.

• That you are making an election under section 475(f) of the Internal Revenue
Code.

• The first tax year for which the election is effective.

• The trade or business for which you are making the election.
If you are not required to file a 2008 income tax return, you make the election by
placing the above statement in your books and records no later than March 15,
2009. Attach a copy of the statement to your 2009 return.

If your method of accounting for 2008 is inconsistent with the mark-to-market

election, you must change your method of accounting for securities under Revenue
Procedure 2008-52 (or its successor) available at www.irs.gov/irb/2008-
36_IRB/ar09.html. Revenue Procedure 2008-52 requires you to file Form 3115,
Application for Change in Accounting Method. Follow its instructions. Enter “64” on
line 1a of the Form 3115.

Once you make the election, it will apply to 2009 and all later tax years, unless you
get permission from IRS to revoke it. The effect of making the election is described
under Mark-to-market election made, earlier.

For more information on this election, see Revenue Procedure 99-17, on page 52 of
Internal Revenue Bulletin 1999-7 at
www.irs.gov/pub/irs-irbs/irb99-07.pdf.

Revoking the MTM Election

The revocation process is exactly the opposite of the election process, except you do not have to
express your desire to revoke with a timely filed election.

However, you must request permission from the IRS to revoke the election. If granted, another
Form 3115 must be filed and another 481(a) adjustment made.

Once the MTM election is made on a timely filed tax return or timely filed extension, you are
proverbially stuck with it. You cannot simply not file Form 3115 or use other non-compliance
techniques to essentially cry “Kings X.” You may be charged penalties for willful failure to
comply.

In limited situations the §475(f) election may be revoked with the consent of the
Secretary under §475(f)(3).
If a separately filing entity has made the election - in lieu of revocation the owners
may simply stop using the entity, liquidate it or dissolve it.

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