Trader Tax Status (TTS) and the Section 475 mark-to-market election can provide significant tax advantages for active traders. However, qualifying is not automatic and comes with important considerations. This guide explains who qualifies, the benefits, and how to make the election properly.
Disclaimer
This is general information, not tax advice. Trader Tax Status is complex with significant implications. Consult a qualified tax professional experienced with trader taxation before making any elections.
What Is Trader Tax Status?
Trader Tax Status is an IRS designation that recognizes trading as a business rather than investment activity. The distinction matters because:
- Investors: Trade for long-term capital appreciation, have limited expense deductions, and face capital loss limitations
- Traders (TTS): Trade as a business seeking to profit from short-term market movements, can deduct business expenses, and may elect mark-to-market treatment
TTS does not require forming a business entity. Individual traders can qualify if they meet the IRS criteria.
Qualifying for Trader Tax Status
The IRS uses a facts and circumstances test based on several factors. No single factor is determinative, but collectively they establish your trading business:
Trading Activity
- Frequency: Trade on most trading days (200+ trades per year is a common benchmark)
- Regularity: Trade consistently throughout the year, not just occasionally
- Time devoted: Spend substantial time trading, researching, and managing positions
Seeking Short-Term Profits
- Primarily seek to profit from daily market movements
- Hold positions for short periods (days to weeks typically)
- Not primarily focused on long-term capital appreciation or dividends
Continuity and Regularity
- Trading activity is continuous and regular throughout the year
- Trading is not sporadic or occasional
- Consistent pattern of activity from year to year
Key insight: There is no bright-line test for TTS. The IRS and tax courts look at the totality of circumstances. Traders with 500+ trades per year who trade most days are generally safer than those with minimal activity.
Benefits of Trader Tax Status
Business Expense Deductions
TTS traders can deduct trading-related business expenses on Schedule C:
- Market data subscriptions and news services
- Trading software and platforms
- Computer equipment and monitors
- Education courses and books
- Home office expenses
- Internet and phone (business portion)
- Professional fees (accountant, tax advisor)
No Capital Loss Limitations (with MTM)
With the Section 475 mark-to-market election, trading losses are treated as ordinary losses rather than capital losses. This means:
- No $3,000 annual limitation on deducting losses
- Losses fully deduct against ordinary income
- No need to carry forward large losses for years
Wash Sale Exemption (with MTM)
The Section 475 election exempts traders from wash sale rules. You can sell at a loss and immediately repurchase without losing the loss deduction.
Section 475 Mark-to-Market Election
The mark-to-market (MTM) election under Section 475(f) is a powerful but irrevocable choice that fundamentally changes how trading gains and losses are taxed.
How MTM Works
- All positions are marked to market at year-end
- Unrealized gains and losses become realized for tax purposes
- All gains and losses are treated as ordinary income/loss
- No distinction between short-term and long-term
Benefits of MTM
- Unlimited loss deductions: No $3,000 cap on losses against ordinary income
- No wash sales: Exempt from wash sale rule complexities
- Loss carryback: Ordinary losses may be carried back to previous years
- Simplification: No need to track holding periods
Drawbacks of MTM
- Loss of long-term rates: No preferential 0%/15%/20% rates on any gains
- Phantom income: Pay taxes on unrealized gains at year-end
- Irrevocable: Cannot revoke without IRS permission (rarely granted)
- Year-end cash management: May owe taxes on paper profits
Important Consideration
The MTM election is generally beneficial for traders with losses or those who trade frequently with mostly short-term positions. It may not be beneficial if you hold positions long-term or have significant long-term gains that would otherwise qualify for lower rates.
How to Make the Section 475 Election
The election must be made by the due date of the tax return for the year prior to the year it takes effect. This means you must plan ahead.
For Existing Traders
- Make the election by April 15 (or the due date of your prior year return)
- File a statement with your tax return or as a separate statement
- The election takes effect for the current year
For New Traders
New traders have a special rule. You can make the election within 2 months of starting your trading business if you are a new taxpayer or newly qualify for TTS.
Election Statement Requirements
The election statement must include:
- Your name and identification number
- A statement that you are making an election under Section 475(f)
- The first tax year for which the election is effective
- The trade or business for which you are making the election
Separating Investment and Trading Accounts
You can maintain both trader and investor accounts. The MTM election applies only to your trading business. Keep them clearly separated:
- Use different brokerage accounts for trading vs. investing
- Document which account is for trading business
- Investor account maintains capital gains treatment
- Trading account uses MTM treatment
Key insight: Segregating accounts allows you to get the best of both worlds - ordinary loss treatment on trading while maintaining long-term capital gains rates on investments held over a year.
Entity Structure for Traders
Some traders form business entities for additional benefits:
S Corporation
- Can provide payroll tax savings on trading income
- More complex and costly to maintain
- Must pay reasonable salary
LLC
- Limited liability protection
- Pass-through taxation (no double taxation)
- Can elect S Corp status for payroll tax benefits
Partnership
- Multiple members can pool capital
- Complex tax reporting requirements
- Flexibility in allocating income and losses
Track Your Trading Activity
Pro Trader Dashboard helps you document your trading frequency and activity, which is essential for supporting Trader Tax Status qualification.
Documentation and Record Keeping
TTS traders must maintain excellent records to support their status:
- Daily trading logs with time spent
- Trade confirmations and statements
- Records of research and analysis activities
- Business expense receipts
- Written trading plan and strategies
- Evidence of continuous trading throughout the year
Common Mistakes to Avoid
- Claiming TTS without qualifying: The IRS audits TTS claims; be sure you meet the criteria
- Missing the election deadline: The April 15 deadline for MTM is firm
- Not segregating accounts: Mixing trading and investment creates complications
- Poor documentation: Cannot prove TTS without records
- Forgetting estimated taxes: MTM can create large tax bills; plan for quarterly payments
Summary
Trader Tax Status with the Section 475 mark-to-market election can provide significant benefits for active traders, including unlimited loss deductions, wash sale exemption, and business expense deductions. However, it requires meeting IRS qualification criteria, making timely elections, and maintaining proper documentation.
The MTM election is particularly valuable for traders who have significant losses or trade frequently with short holding periods. Those who hold positions long-term or have substantial long-term gains may want to maintain separate investment accounts to preserve preferential capital gains rates.
Given the complexity and irrevocable nature of these elections, work with a tax professional experienced in trader taxation before making any decisions.
Learn more: setting up a trading business and quarterly estimated taxes.