Taxes are the Achilles heel of active stock traders. Ever have a great year in the market, but end up paying Uncle Sam an exorbitant amount of your profits? A very sad state of affairs, but all too true for the successful trader.
Commissions and taxes are the two things that grind the profits right out of the active successful trader's bank account. The more you make, the more you pay and it seems like a never-ending merry go-round of expenses. Is there anything that can be done to circumvent the dragon claws of taxes and commissions?
Well, commissions are pretty much the cost of doing business. Negotiating with your broker or buying/leasing a seat on the exchange are the only two ways to lower this cost.
But what about taxes?
One of the most common and 100% IRS-approved ways for the active trader to avoid taxes is to trade within an IRA. Please note, I am not a CPA or Tax Advisor. These are simply a few observations from one trader to another (or would-be trader). Consult directly with your tax advisor prior to taking any action in regards to the following. All the same, this should serve as an introduction into how traders can trade tax free within an IRA structure.
Short term gains which are what are produced by active trading are taxed at your regular tax rate. Long term gains on investments held for one year or more are taxed at 20%. However, if you actively trade within your IRA, not only are ALL taxes deferred, you don't have to report any gains or losses. The reason being there is no tax effect on the gains/losses so the IRS doesn't care what happens.
A Roth IRA is an even better vehicle for active traders to trade within. Profits made within the Roth IRA structure are never required by the IRS to be reported. Besides, gains are never taxed if the rules are followed. Basically, you need to hold the Roth for a minimum of 5 years and be over 59 1/2 to withdrawal 100% tax free.
Many traders believe that one can only trade on the long side within an IRA. This isn't true. Short selling is permitted under certain guidelines. In addition your IRA can be traded on margin to magnify the gains.
The IRS may be the trader's nemesis, but knowledge of the beast will mitigate the harm in a completely legal and ethical manner.
Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
