by Bob Williams
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The term do-it-yourself is being applied to all sorts of areas these days: home renovation, classic car restoration, even computer repairs. So it’s not all that surprising that, now that the financial markets seem to be feeling better, more individual investors are doing their own stock trading as well.
These hardy individuals cut out the middle man, do their own research into stocks and market trends, and buy and sell their stocks directly online. And if you’ve just joined the DIY trend in investing, we may have some information for you that can save some time and frustration when it comes to doing your first tax return as a budding entry into the world of finance.
A Matter of Definition
First of all, you need to know just how the IRS sees your activity. You can be classified as an “investor,” or as a “trader.” The IRS views you as a trader in securities if you are engaged in the business of buying and selling securities for your own account. That means all the following statements have to be true in your case:
- You have to seek to profit from daily market movements, rather than from dividends, interest or capital appreciation.
- Your activity must be substantial.
- Your activity has to be continuous and regular.
Note that how much profit you made – or didn’t make – does not factor into this particular equation, only the amount of activity.
Keep in mind also that the IRS looks at a few related circumstances in determining if your trading activity is a business or not.
- Typical holding periods for securities bought and sold
- The frequency – and dollar amounts – of your trades during the year
- The extent to which you pursue the activity to produce income for your livelihood
- The amount of time you devote to your trading activity
Simply put, if your main income is from buying and selling stocks in order to make money on the sale rather than dividends, chances are you’re a stock trader to the IRS.
If your situation doesn’t meet the definition of a trader, then you’re an investor. What’s the difference? Well, for one thing, if you’re a trader, you’re a business, and the IRS will expect your tax return to reflect the fact that you’re self-employed. That means self-employment taxes and other factors. There also are certain reporting differences, which can be best explained in the Instructions for Schedule D, Capital Gains and Losses.
Tell It Like It Is
No matter whether an investor or a trader, you’ll become very familiar with the IRS Form 8949, Sales and Other Dispositions of Capital Assets; Form 1099-B, Proceeds from Broker and Barter Exchange Transactions; and Schedule D, Capital Gains and Losses.
Traders of years gone by would have had a somewhat easier time with the paperwork than now. There was a time when you would have reported your cumulative purchases and sales figures on Schedule D. Now, however, you’ll need to furnish the IRS with a Form 1099-B (furnished by your online trading service) for each transaction. Since for some day traders, that could mean a mountain of documentation, the IRS does give you an out.
Instead of filing a pile of 1099-Bs, the IRS also allows you to send them a spreadsheet with each trade on them (you may even be able to get a completed spreadsheet directly from your online trading provider). Make sure, though, to include columns for the information the IRS would get on the 1099-B. Also remember you’ll need the actual dates the stock was bought and sold. You can no longer write “Various” for “Date of Acquisition.”
When filing your income tax return on 1040.com, you would simply use Form 1099-B to sum up your stock transactions, then e-file the completed return. Then, mail your completed spreadsheet of trades along with a printed copy of your e-filed return to the IRS (the address should appear on the PDF of the return). The IRS tax gnomes will then incorporate your spreadsheet data into the actual return.
Of course, good record-keeping is the key to a relatively painless income tax filing season. The better your records, the quicker you’ll get everything completed, with all I’s dotted and T’s crossed.
Then you can keep your eyes on the market – instead of the tax man.
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