Tax time has arrived and now more than ever we want to reduce our tax liability so we can have more free disposable income and build our wealth. Here are the top seven tax deductions for active traders:
- Home Office – Many people whose small businesses qualify them for a home office deduction are afraid to take it because they’ve heard it will trigger an audit. But if you deserve it, take advantage of it. You must use a portion of your home exclusively and regularly for your trading business. The office is generally in a separate room or group of rooms, but it can be a section of a room if the division is clear and you can show that personal activities are excluded from the business section. To figure out how much you can deduct you can use the business percentage method. Assuming you uses 15% of your home for trading, multiply that by all your indirect costs (rent, mortgage interest, property tax, insurance, utilities, etc). So, if your monthly cost of maintaining your home is $3,000 per month you just earned a $5,400 tax deduction for the year.
- Section 179 Depreciation – When purchasing equipment such as computers, office furniture and other fixtures, you can use section 179 depreciation. This IRS code section allows you to claim 100% of the depreciation expense in the first year of the use of the asset, rather than claiming depreciation over 5 or 7 years. Accelerating your depreciation period can save you thousands of dollars in tax liability. For 2016 & 2017 the limit is $500,000 on new and used equipment including off-the-shelf computer software.
- Education, Seminars, and Training – These expenses can be deducted if you are qualified for trader in securities status. Investing in your professional development could help you become a better trader and could also save you thousands of dollars in tax payments. Education business expenses paid after the start of your business are allowed for maintaining and improving your business. However, learning a new business before starting that business is not allowed as a business expense. If you are learning about investing while carrying on an investment activity, that education expense is not allowed as a Section 212 investment expense by Section 274(h)(7). Our tip to you: If you pay for trading education services before qualifying for Trader in Securities Status, consider using Section 195 start-up expenditures treatment.
- Section 195 Startup Expenses – You can probably claim reasonable startup costs on your return under section 195 of the IRS code. Section 195 allows an expense allowance in the first year up to $5,000. Even if you started late in the year you could still deduct the full $5,000 expense allowance. The remainder of the costs could be amortized over 180 months.
- Health insurance premiums – One of the many perks of being self-employed is that you can deduct what you spend on health insurance premiums as an “above the line” deduction on the first page of your individual tax return. Deduct health insurance premiums from individual AGI if you have an S-Corp trading company paying you W-2 wages which include your premiums. The plan must be in association with your small business and not a third-party employer plan for you or your spouse.
- Retirement Plans – Most traders that qualify for Traders in Securities Status should consider a Solo 401(k) retirement plan. Consistently high-income traders with TSS should consider a defined benefit plan if they are close to age 50. Traders need an entity like an S-Corp trading company to arrange retirement plan deductions since sole proprietor traders don’t have earned income required for employee benefit plan deductions. You can contribute up to $59,000 per year to your Solo 401K or up to $215,000 to your defined benefit plan.
- Tangible Property Expensing – Expense new tangible property items up to $2,500 per item. Up until 2015, the IRS threshold for capitalization with depreciation vs. full expensing was $500; now that threshold is $2,500. This means that purchases which may have taken years to claim in the past can be claimed in full in the year of purchase. For example, if you purchase a new trading computer system it’s best to arrange separate invoices for each item not exceeding $2,500, this way you increase your tax deductions and reduce your tax liability.
These top seven deductions could save active traders thousands of dollars in unnecessary tax payments. Make sure to consult your Tax Advisor for the full details or ask OTA Tax Pros for a free tax consult.