Trader Tax Management

1. Trader Tax Management OptionsAnimal Las Vegas Student Summit September 26, 2009

2. Disclaimer Options Any strategies used as examples and discussed, using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Taxation Any US tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) providing, marketing or recommending to another party any transaction or matter addressed herein. The information presented provides only a general discussion of the tax law affecting the taxation of options and is not intended to be applicable to anyindividual investment and/or tax situation. You are strongly advised to contact your own tax professional in considering the tax consequences of your own specific set of facts and circumstances.

3. Before We Begin! • What are we going to do? • Talk about some of the tax aspects of options trading • You will understand more about tax return preparation • You should be able to talk more intelligently with your CPA or tax preparer • What we are not going to do? • Teach you to prepare your own tax return • Cover intricacies of options taxation exhaustively • Answer your specificpersonal tax questions

4. Agenda • Tax Tips for DIYers • Review – Trader vs Investor • Mark-to-Market Accounting • Trading in an Entity • Types • Benefits & Burdens • Now What? Reporting • Investor tax return • Trader tax return • MTM/Trader tax return

5. Do-It-Yourselfers Tax Tips

6. Tax Tips for DIYers • When do you report the sale of a Short Put that gets assigned? • Never • Adjusts the basis of the stock assigned • Example: • You short in Oct a Jan 10 65 put on RIMM for $4.60 • At Jan expiration RIMM dips to $64.94 and you are assigned the stock • Your basis in RIMM is $60.40 (65 – 4.60) • The Short Put sale is NOT reported in 2009 • If you trade often this is difficult to identify!! … as a separate transaction

7. Tax Tips for DIYers • When are Dec option sales reported? • Calls – when there is a closing transaction • Puts – either: • When there is a closing transaction, or • When the assigned stock is sold (lowered basis) • Commodity ETFs – Gold, Silver, Platinum • If held one year or less ST capital gain/loss • If held more than one year LT, BUT at the 28% collectible rate

8. Tax Tips for DIYers • ACAT fee reimbursement on retirement funds • Considered a contribution to IRA, therefore not reimbursed, ie, like commission reimbursement • Q: Is ACAT fee charged a distribution? 1099-R? • Opinion: Must consider retirement account in the hands of the holder not the individual broker • Gross proceeds from 1099-B agreement to sum of line 3 plus line 10 on Sch D • Guaranteed letter from IRS if Sch D < 1099-B • Form examples:

9. Tax Tips for DIYers

10. Tax Tips for DIYers

11. Tax Tips for DIYers

12. Tax Tips for DIYers

13. Tax Tips for DIYers Let’s do some math!

14. Tax Tips for DIYers • Index funds qualify as Sec 1256 contracts • SPX, OEX, COMP, DJX, RUT • 60/40 LTCG treatment • Individual securities/options are taxed, NOT trading strategies • The “Put Calendar” is not taxed as a whole • The opening & closing transactions of each leg are taxed as of the closing transaction (FIFO) • Example:

15. Tax Tips for DIYers • Initiate a Put Calendar on SPY in Aug 09 • BTO Dec 09 100 FYSXV • STO Sep 09 100 SWGUV • BTC/Expire Sep 09 100 SWGUV • STO Oct 09 100 SWGVV • BTC/Expire Oct 09 100 SWGVV • STO Nov 09 100 SWGWV • BTC/Expire Nov 09 100 SWGWV • STC Dec 09 100 FYSXV* Taxable Transaction #1 Taxable Transaction #2 Taxable Transaction #3 *Taxable Transaction #4

16. Tax Tips for DIYers • Initiate a Covered Call/Collar on Amedisys: • Buy AMED in early Jun 2009 • STO Jun 09 35 Call CQWFG • BTC/Expired Jun 09 35 Call CQWFG • STO Jul 09 35 Call CQWGG • BTO Aug 09 30 PutCQWRH • BTC/Expired Jul 09 35 Call CQWGG • STO Aug 09 35 Call CQWGH • STC Aug 09 30 Put CQWRH • Expired Aug 09 35 Call CQWGH • AMED* called at Aug expiration Taxable Transaction # 1 Taxable Transaction # 2 Taxable Transaction # 3 Taxable Transaction # 4 *Taxable Transaction # 5

17. Tax Tips for DIYers • Last but not least: • DO NOT BLINDLY RELY ON ONLINE OR BROKERAGE-PROVIDED TAX SOFTWARE!! • There are toomany exceptions and nuances • At a minimum • Download your transactions into Excel • Sort and Sum by Ticker and Activity (Open then Close) • Agree 1099-B to stock sales • Provide spreadsheet & brokerage statement to CPA

18. Investor vs Trader Review of Rules

19. Investor vs Trader • Why? – Subject to differenttaxrules • Definitions: • Investor – • Stock purchase for capital appreciation/dividends • Little regard for short-term fluctuations; buy and hold • Trader – • Regularly and continuously trade stock/securities • Trade in own account • Profit from short-term fluctuations • Can be BOTH trader and investor • IRS presumption Investor

20. Investor vs Trader • Taxation of Investors • Stocks/securities considered capital assets • Gains and losses considered capital • Reported on Schedule D / D-1 • Subject to $3000 net capital loss limit • Subject to IRC Sec 1091 wash sale rules • Investment expenses (except interest) • Schedule A miscellaneous itemized deductions • Subject to 2% AGI threshold • Not deductible for AMT purposes • Interest – deductible up to net investment income (Form 4952) • Net investment income does not include • Long-term capital gains • Qualified dividends

21. Investor vs Trader • Taxation of Traders • Stocks/securities considered capital assets • Gains and losses considered capital • Reported on Schedule D / D-1 • Subject to $3000 net capital loss limit • Subject to IRC Sec 1091 wash sale rules • Investment expenses • Schedule C/E* deductions • Interest deductible (for material participation) • Home office deduction eligibility • Gains NOT subject to self-employment tax • Mark-to-Market (MTM) election eligibility _____________________________________________________________________________________________________ * Flow-through entity, such as partnership, LLC, S-Corp

22. Investor vs Trader – Expenses • Deductible – BOTH Investor and Trader • Investment counsel/advice • Subscription services • OptionsAnimal • OptionsPlanet • OptionsMonster • OptionsAnimal Mentor? – Possibly (see below) • OptionsAnimal TUITION? – Possibly (we’ll explore later) • Office expenses – administrative, supplies • Pro-rata portion of computer/software used to determine/manage investments – must be able to substantiate • How do you substantiate? • Reg 1.212-1(g) – expenses paid or incurred by the taxpayer … for the management, conservation, or maintenance of investments held by the taxpayer for the production of income Keep a dated log … trade journal

23. Investor vs Trader – Expenses • Investor expenses – Summary • All expenses for the production of income (Sec 212) • Deducted on Sch A as Miscellaneous Deductions • Subject to 2% AGI threshold • Interest expense deductible to the extent of net investment income – does not include LTCG / Div • No Sec 179 expensing election • No home office deduction

24. Investor vs Trader – Expenses • Trader expenses - Summary • All ordinary and necessary expenses (Sec 162) • Interest expense on margin accounts – if material participation, otherwise, for a limited partner, to extent of net investment income • Sec 179 expensing of computers/software available* • Eligible for home office deduction • Travel • Automobile expenses from principal place of business (home) deductible – if for business purpose * Sec 179 election cannot create a loss

25. Investor vs Trader – Case Summary • Favorable Cases • In Holsinger, Tax Court remarked in its opinion that trading activity of over 1,100 trades or the value of securities traded over $9 million was deemed substantial • Levin – most of working days; substantial time • Summary • Regular and continuous • Short holding periods • Substantial number of trades

26. Investor vs Trader – Expenses • Is OptionsAnimal tuition deductible? • What are deductible educational expenses? • Required to keep present job or salary, or • Maintains or improves required skills in present job • What are non-deductible educational expenses? • Required to meet minimum standards, OR • Qualifies one for new trade or business • Quotes from the OptionsAnimal website: • “OptionsAnimal connects you to fellow students as well as seasoned instructors…” • “If you have not spoken with one of our Education Specialists …”

27. Investor vs Trader – Expenses • Conclusion: • Deductible as education expenses?: • If you are already considered a “trader” or trading inside a trading entity where you are an employee, then deductible • If new to trading stocks and options, then non-deductible UNLESS … (next slide) • Qualify for Lifetime Learning or Hope credits? • Must be defined by Sec 481 of Higher Education Act of 1965 as qualified post-secondary institution

28. Investor vs Trader – Expenses • Start-up expenses? • Expenses that would be deductible if incurred in an active trade or business (Sec 162) but also applies to investment expenses (Sec 212) • Investigatory – incurred prior to decision to acquire or create • Pre-opening – incurred after decision but before opening for business • “wages being paid to employees who are being trained and to [their] instructors” [H Rep No 96-1278, 96th Cong, 2nd Sess] • Up to $5000 (IRC Sec 195) • Amounts over $5000 – capitalized and amortized over 180 months

29. Investor vs Trader – Expenses • Strategy: • Potentially start-up expenses • Specifically, pre-opening, and • Especially if operating inside an entity • Must elect and election is irrevocable • Secondarily, educational expenses since: • No minimum standards to “trade” • No qualification standards for trading as a business • Uphill battle since burden of proof on taxpayer

30. Investor vs Trader Mark-to-Market Accounting

31. Investor vs Trader – MTM Election • What is Mark-to-Market (MTM)? • Traders can elect to mark their security holdings to market value at the end of the tax year IRC Sec 475(f) – “… In the case of a person who is engaged in a trade or business as a trader in securities …” • Gains and losses treated as ordinary gain/loss • Adjustment to stock basis for unrealized gain/loss • Not subject to self-employment tax • Reported on Form 4797, Part II

32. Investor vs Trader – MTM Election Benefits Two restrictions no longer apply: $3,000 net capital loss limit Wash sale rule

33. Investor vs Trader – MTM Election • Election is effective for the year for which it is made and all subsequent years unless revoked with IRS permission (mandatory) • Must make the election by the unextended due date for the tax return for the year before the year the election is to be effective • Example:

34. Investor vs Trader – MTM Election • Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time. • Does Eric qualify as a trader? Yes Why?

35. Investor vs Trader – MTM Election • Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time. • Does Eric qualify as a trader? • Can he elect MTM for 2009? Yes No

36. Investor vs Trader – MTM Election • Eric would have had to file an election by: • April 15, 2009, or, • Attach the election to his extension (Form 4868) • Eric can make a MTM election for 2010 anytime before April 15, 2010, however, • If this is not his first year as a TRADER (it is not) then Eric will be required to file Form 3115, Application for Change in Accounting Method • A Sec 481(a) adjustment is also required

37. Investor vs Trader – Making the MTM Election Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com

38. Investor vs Trader – Making the MTM Election • Attach the following statement to the timely filed Form 1040 or extension Form 4868 Trader in Securities Election to Mark to Market Taxpayer hereby elects under IRC Sec 475(f) to use the mark-to-market method of accounting for securities. The election will first be effective for the tax year ended [20##]. The election is made for the following trade or business: [trade or business name, EIN] • There is relief for late elections – PLR request • New pass-through entity for late election • New taxpayer – elect by 15th day of third month

39. Investor vs Trader - Summary

40. Section 1256 Contracts A Section 1256 Contract is any: • Regulated futures contract – daily MTM • Foreign currency contract • Dealer equity option – market maker/specialist • Dealer securities futures contract • Non-equity option • Broad-based stock index option (SEC determined) • Cash-settled options • Examples – DJX, SPX, OEX, NDX (not ETFs)

41. Sec 1256 Contracts – Mark-to-Market • At the end of the tax year (last business day) • Treat contract as sold • At FMV on the last business day of year • Gain or loss recognized • Recognized gain/loss taken into consideration upon ultimate disposition of contract – basis adjustment • 60/40 rule – • 60% of recognized gain/loss is long-term • 40% of recognized gain/loss is short-term • No matter what the actual holding period • A net loss can be carried back 3 years • Report on Form 6781 (non-Sec 1256 on Form 4797) • Example:

42. Sec 1256 Contracts – Mark to Market Example

43. Sec 1256 Contracts – Mark to Market Example • Purchase 100 SPX Jun 08 1250 calls bought for 145 on 7/17/06 • SPX Jun 08 1250 call at 252 on last business day of 2006 • Mark-to-Market requirements: • SPX LC deemed SOLD on 12/29/06 at 252 • SPX LC deemed REPURCHASED on 12/29/06 for 252 • Gain 107 (252 – 145) • Long-term 64.20 (60% x 107); 15% max tax rate • Short-term 42.80 (40% x 107); 35% max tax rate

44. Sec 1256 Contracts – Mark to Market Example • SPX Jun 08 1250 LC declines to 228 by 3/12/2007 and is sold • What is the gain/loss? • How is it taxed? Deemed repurchase at 252 on 12/29/06 Sale 228 Less: Basis 252 (from deemed repurchase) Loss <24> LTCL <14.40> - 60% STCL <9.60> - 40% • Loss may be carried back three years

45. Entities Selection & Trading

46. Entities • Types of entities • Sole proprietor – Sch C/Sch D/Form 4797 (default) • General Partnership – Form 1065 • Limited Liability Company (LLC) – Form 1065 • Single member LLC – Sch C/Sch D/Form 4797 • Multiple member LLC* • Corporation • C Corporation – Default; Form 1120 • S Corporation – Election; Form 2553 Form 1120S • * LLC with election: Form 8823 Form 2553 (S Corp)

47. Entities • State law prevails – name, articles, etc. • Separate bank account styled identically to entity name • Brokerage account name identical to entity • Business activity code: 523110, 523900 • Source: www.naicscode.com; keyword: securities trader • Employer Identification Number (EIN) • Setup: www.irs.gov • Quick walk-through of IRS site

48. Entities

49. Entities

50. Entities