Day Trading Options and Taxes

In most cases, professional day trading qualifies as a business for tax purposes. If you fall under the IRS guidelines for professional trading, you receive a tax status that can result in favorable tax treatment of capital gains and losses sustained when trading and writing stock options. Vigilant adherence to tax regulations is required to make certain you qualify for special tax treatment.

Trader Status

Active trading of stock options does not automatically qualify you as a professional trader for tax purposes. The IRS considers professional traders to be individuals who engage in short-term trading for the purpose of earning a living. While there are no set guidelines, it is generally accepted that you must engage in trading activities for at least 20 hours a week to qualify as a part-time trader, and 40 or more to qualify as a full-time trader. In addition, you must have a high volume of trades over the course of one year -- typically at least 1,000 short-term trades that are intended to take advantage of market fluctuation. If you qualify as a day trader and also want to trade options as a mid-to-long term investment strategy, keep separate accounts. The IRS wraps your longer-term investments into your personal income, rather than that of the business.

General Options Tax Rules

Basic put and call options have fairly simple tax rules for day traders: when you purchase a put or call, the costs of the purchase are business expenses. Any loss you acquire when you sell an option or let it expire is also a business expense. Gains from selling options and from the sale of stock purchased through options are business income. If you write an option, the holder pays you a premium that is business income. You do not realize this income until the option is exercised or until it expires. Recognizing losses as a business expense allows you to offset a larger portion of your income than you can if you are filing taxes solely as an individual.

Margin Accounts and Other Expenses

The Financial Industries Regulation Authority requires all pattern day traders to trade in margin accounts, even if they are trading options. Costs associated with maintaining a margin account are business expenses on your taxes. You may deduct the cost of computer and home office equipment directly related to your trading business, along with classes, subscriptions and other educational information you use to become a better options trader.

IRS Reporting

Professional option traders report taxable business income on Schedules C and D of Form 1040, and should also pay estimated income tax each quarter. It is important to remember that gains and losses from trade activity are not directly related to the self-employment tax, so review tax form instructions thoroughly as you determine what you owe. Complex options trading practices, including saddling and section 1256 contracts have different tax rules, and there are certain accounting methods that may be beneficial to you if you are trading high volumes of options and futures. Consult an accountant who specializes in day trading to ensure that you are getting the maximum benefit from your professional trader status.

References

• "Fairmark.com"; IRS Guidance on Trader Taxation; Kaye A. Thomas
• "The Wall Street Journal"; Think You're a Trader? The IRS May Disagree; Tom Herman; September 2008
• FINRA: Day Trading Margin Requirements: Know the Rules
• Financial Web: Trading Stock Options? Tax Advice
• IRS.gov: Sales and Trades of Investment Property

Resources

• OIC Education: Home
• IRS.gov: Publication 334 (2009), Tax Guide for Small Business
• The Options Industry Council: Taxes & Investing: A Guide for the Individual Investor