Below is an abstract of an article written for the ABA’s Tax Lawyer, titled The Amount of Trade that Makes a Trade or Business in Cameron v. Commissioner.
The author, Robert J. Wille, calls for revision of the IRS rules to determine when an online stock trader is to be treated for tax purposes as a proprietor of a trade or business or merely as an investor:
In Cameron v. Commissioner, the Tax Court found that a taxpayer’s online trading activities did not rise to the level of a “trade or business.” The court stated that, as a threshold matter, an individual who manages his own investment securities is just an investor, “regardless of the extent and scope of such activity,” and is not engaged in the “trade or business” of being a trader in securities for purposes of section 162.
However, the court also explained, it is possible that a person who manages his own investments can be engaged in the “trade or business” of being a trader in securities. “A taxpayer’s activities constitute a trade or business where both of the following requirements are met: (1) the taxpayer’s trading is substantial, and (2) the taxpayer seeks to catch the swings in the daily market movements and to profit from these short-term changes rather than to profit from the long-term holding of investments.”
Although the Commissioner conceded that Cameron satisfied the second requirement, the court concluded that Cameron’s trading activity was not substantial. Thus, Cameron was not entitled to a deduction for expenses related to carrying on a “trade or business.”
The rise of online trading presents new challenges to the criteria courts use in determining whether someone is engaged in a “trade or business.”
Courts have not sufficiently updated an outdated body of case law to deal with the novel issue of online traders. This case offers an opportunity to explore the existing case law and regulation with respect to the nature and level of trading activity that qualifies as a “trade or business.”
Why does it matter?
Listen to Richard Chapo of Business Tax Recovery:
As strange as it may sound, the IRS has looked to business to distinguish between day traders and long term stock investors. Simply put, the IRS views day traders as a small business, while those that buy or sell stock less frequently are simply stuck with Schedule D stock reporting. The difference may sound minute, but it matters from a tax point of view.
Day traders and investors are both stuck with paying taxes on their gains and dividends. Given the nature of the game, however, day traders rarely have dividend income because they do not hold on to the stock long enough. The real advantage for day traders, however, comes in the additional expense department.
Since day traders are viewed as small businesses by the IRS, they can deduct whatever any small business can. This includes expenses such as those related to home offices, internet access, stock research costs, utilities and so on. An investor cannot deduct these expenses in relation to their investment activity. In simple terms, the day trader gets to claim expenses on Schedule C, while the investor does not.
See also IRS Publication 550 (PDF)
Related Posts:
Tax Court Update – December 2008 – Mark to Market Election and 9100 Relief
Tax Court Update – March 2009 – When is Gambling Considered a Trade or Business?
(Kudos once again to Professor Paul Caron for flagging this article.)
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