IRS Weighs in on Day Traders

I am the technical reviewer for many of the forms and instructions issued by the IRS, including schedules C, D and SE (form 1040) and form 4797. There appear to be many inconsistencies and incorrect statements [ in the January JofA article on page 80 ] regarding traders (including day traders). Please see the instructions for schedule D and form 4797 for the correct treatment and proper reporting by traders. Expenses of traders always go on schedule C. Gain or loss from securities never does. Security transactions are reported on schedule D, unless the mark-to-market election applies, in which case each transaction is reported on form 4797. In neither case is the income subject to self-employment tax, nor can a taxpayer “choose” to pay the tax.

The JofA article stated: “The code then explains that gains and losses from applying the mark-to-market provision, while they may be ordinary income or loss, are not subject to self-employment taxes (IRC section 475(f)(1)(D)). That is, the ability to avoid self-employment taxes from this section does not apply to realized gains or losses; it merely applies to the revaluation of a portfolio of securities from cost to market value occurring at the end of a tax year.”

The excerpt [above] is incorrect because it does not correctly take into account section 475(f)(1)(D), which requires section 475(d) to apply. Section 475(d)(3)(A)(ii) applies subsection (a)(2) to all gain or loss recognized on securities during the year. This affords ordinary gain or loss treatment and exclusion from self-employment tax to all such gains and losses during the year.”

— Curt Freeman, IRS Review Section,
Tax Forms Development Branch,
Tax Forms and Publications Division.