Investment Fees Are Not Deductible But Borrow Fees Are

July 12, 2018 | By: Robert A. Green, CPA | Read it on

The Tax Cuts and Jobs Act suspended “certain miscellaneous itemized deductions subject to the two-percent floor,” which includes “investment fees and expenses.” However, the new law retained “other miscellaneous deductions” not subject to the two-percent floor, including short-selling expenses like stock borrow fees.

While individual taxpayers may no longer deduct investment fees and expenses on Schedule A starting in 2018, they are still entitled to deduct investment interest expenses, up to net investment income, as calculated on Form 4952.

The new law (page 95) has a complete list of suspended miscellaneous itemized deductions including “expenses for the production or collection of income.” That list does not include short-selling expenses. Section 67(b) excludes certain deductions from the “2-percent floor on miscellaneous itemized deductions;” including (8) “any deduction allowable in connection with personal property used in a short sale.”

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This blog post was their Top Story on July 16

Carrying charges vs. itemized deductions
Because investment fees and expenses are no longer deductible, some accountants might consider a Section 266 election to capitalize investment management fees as “carrying charges” to deduct them from capital gains and losses. But that won’t work: The IRS said taxpayers could not capitalize investment management fees under Section 266 because they are managerial rather than transactional.

Short-sellers probably could capitalize borrow fees under Section 266 because they are transactional. However, it’s safer to deduct these short-sale costs as “Other Miscellaneous Deductions” on Schedule A (Itemized Deductions) line 28. The new tax law suspended the Pease itemized deduction limitation, so the deduction has full effect on lowering taxable income. One concern: The IRS lists all Section 67(b) exclusion items in the instructions for Schedule A line 28, but it left out (8) for short-sale expenses. The code has substantial authority, and it’s reasonable to conclude that Schedule A instructions for other miscellaneous deductions on line 28 are not an exhaustive list.

Stock borrow fees
Short selling is not free; a trader needs the broker to arrange a loan of stock.

Brokers charge short sellers “stock borrow fees” or “loan premiums.” Tax research indicates these payments are “fees for the temporary use of property.” Watch out: Some brokers refer to stock borrow fees as “interest expense,” which confuses short sellers.

For tax purposes, stock borrow fees are “other miscellaneous deductions” on Schedule A line 28 for investors. Borrow fees are business expenses for traders qualifying for trader tax status (TTS). Borrow fees are not interest expense, so investors should not include them in investment interest expense deductions on Schedule A line 14.

It’s a significant distinction that has a profound impact on tax returns because investment expenses face greater limitations in 2017, and suspension in 2018 vs. investment interest expenses which are deductible up to investment income. Other miscellaneous deductions, including borrow fees, reported on Schedule A line 28 remain fully deductible for regular and alternative minimum tax (AMT).

Investment management fees cannot be capitalized
In a 2007 IRC Chief Counsel Memorandum, the IRS denied investors from capitalizing investment management fees paid to a broker as carrying charges under Section 266. Investors wanted to avoid alternative minimum tax (AMT) and other limitations on miscellaneous itemized deductions, the rules in effect before 2018. The problem is worse in 2018 with investment expenses entirely suspended.

The memo stated:

  • “Consulting and advisory fees are not carrying charges because they are not incurred independent of a taxpayer’s acquiring property and because they are not a necessary expense of holding property.
  • Stated differently, consulting and advisory fees are not strictly analogous to common carrying costs, such as insurance, storage, and transportation.”

Borrow fees might be able to be capitalized
Borrow fees seem to meet the requirements raised in the 2007 IRS Chief Counsel Memorandum for capitalization as carrying charges under Section 266. (It’s safer to deduct them as “other misc. deductions” on Schedule A line 28.)

Treasury Regulations under 1.266-1(b)(1) highlight several types of expenses that qualify as carrying charges, including taxes on various types of property, loan interest for financing property, costs to construct or improve the property, and expenses to store personal property.

A short seller cannot execute a short sale without borrowing securities and incurring borrow fees; they are a “necessary expense of holding” the position open, and “not independent” of the short-sale transaction. Borrow fees are not for the “management of property,” they are for the “acquisition, financing, and holding” of property.

Investment fees vs. brokerage commissions
Investors engage outside investment advisors and pay them advisory fees including management fees and/or incentive fees. Other investors may pay a broker a flat or fixed fee. These costs are managerial and not transactional, based on how many trades the manager makes. They cannot be capitalized under Section 266 according to the above IRS memorandum.

Brokerage commissions are transaction costs deducted from sales proceeds and added to cost basis on brokers’ trade confirmations and Form 1099-Bs. This tax reporting for brokerage commissions resembles a carrying charge.

Short-seller payments in lieu of dividends
When traders borrow shares to sell short, they receive dividends that belong to the lender — the rightful owner of the shares. After the short seller gets these dividends, the broker uses collateral in the short seller’s account to remit a “payment in lieu of dividend” to the rightful owner to make the lender square in an economic sense.

Section 263(h) “Payments in lieu of dividends in connection with short sales” require the mandatory capitalization of these payments if a short seller holds the short position open for 45 days or less (one year in the case of an extraordinary dividend).

If a short seller holds the short sale open for more than 45 days, payments in lieu of dividends are deductible as investment interest expense.

Investment interest expenses
Section 163(d)(3)(c) states, “For purposes of this paragraph, the term ‘interest’ includes any amount allowable as a deduction in connection with personal property used in a short sale.” A broad reading of “any amount” could be construed as opening the door to borrow fees, but I doubt that. “Any amount” refers to dividends in lieu of dividends held more than 45 days.

Under certain conditions, Section 266 allows capitalization of interest to finance a property.  Short sellers and others might want to consider the possibility of a Section 266 election on investment interest expense, too — especially if they plan a standard deduction or don’t have sufficient investment income. Excess interest is a carryover to subsequent tax years.

Transactional vs. managerial expenses
The following investment expenses seem transactional, and therefore eligible for capitalization in Section 266: Storage of precious metals or cryptocurrency, borrow fees on short sales, excess risk fees on short sales, and margin interest expenses.

The following investment expenses seem to be managerial rather than transactional, and therefore cannot be treated as carrying charges under Section 266: Investment management fees, fixed or flat fees paid to brokers, computers, equipment, software, charting, education, mentors, coaching, monthly data feed fees, market information, subscriptions, travel, meals, supplies, chatrooms, office rent, staff salaries and employee benefits, accounting, tax and legal services, and most other trading-related expenses.

Section 266 election statement and tax reporting

Consider filing a Section 266 election statement with your tax return, including on an extension.

  • “For tax-year 2018, taxpayer herewith elects under Code Section 266 and IRS Regulations 1.266-1 to capitalize short-selling expenses as carrying costs applied to capital gains and losses.”

Explain the election and tax treatment in a tax return footnote.

Report short-selling expenses for realized (closed) short sales as “expenses of sale or exchange” on Form 8949 (Sales and Other Dispositions of Capital Assets) in column (g) “adjustment to gain or loss.” Defer borrow fees paid on unrealized (open) short sales until realized (closed) in the subsequent year.

Consult a trader tax expert on using this potential alternative solution. If you get full deductibility on Schedule A, it’s safer to skip Section 266 capitalization, which the IRS might scrutinize.

Trader tax status
If a short-seller qualifies for trader tax status, then stock borrow fees and other short-selling expenses are deductible as business expenses from gross income.

If a TTS trader engages an outside investment manager, then investment advisory fees remain investment expenses.

Darren L. Neuschwander, CPA and Roger Lorence, JD contributed to this blog post.

Webinar July 19, 2018: Investment Fees Are Not Deductible But Borrow Fees Are. Recording available afterward. Click here.

Related blog posts: Short Selling: How To Deduct Stock Borrow Fees and Short Selling: IRS Tax Rules Are Unique.

 


How To Avoid IRS Challenge On Your Family Office

June 28, 2018 | By: Robert A. Green, CPA | Read it on

Investors may no longer deduct investment expenses, including those passed through from an investment partnership. Restructuring these expenses into a management company might achieve business expense treatment providing it’s a genuine family office with substantial staff rendering financial services to extended family members and outside clients.

The IRS might assert the family office is managing “one’s own investments,” not for outside clients, so the management company is also an investment company with non-deductible investment expenses. Before you go in that direction, it’s wise to learn the lessons of the Lender Management court case from December 2017, which is one of the first on family offices.

Size matters
A single-family office serves one ultra-wealthy extended family, whereas, a multi-family office handles more than one family. Well-established single- and multi-family offices offer a wide variety of financial services, including wealth management, financial planning, accounting, tax, and personal finance. They have substantial staff and salaries, offices, equipment, and operations — the markings of an independent financial services company.

Family office requirements
A family office management company with underlying investment partnerships can use business expense treatment when it has the following characteristics, borne out of the Lender Management tax court case and earlier case law:

- It’s a functional financial services company with significant staff and salaries, an office, equipment and bona fide operations.
- It operates in a continuous and business-like manner.
- Its staff has expertise that is valuable to its clients.
- A profit-allocation of capital gains is considered advisory fee compensation for services rendered. It gets paid more than just its share of profits based on capital.
- It should be profitable.
- It caters to many extended family members with diverging financial needs. It does not operate with a single mindset but provides customized services to each family member.
- Family members and their investment partnerships are not obligated to use the family office.
- There should not be a majority of common ownership between the management company and investment partnerships (this factor is critical).
- It’s safer to have third-party clients who are not family members (a suggestion, not a requirement).

Small family offices have trouble
If two spouses own an investment partnership and management company, then the family office has 100% common ownership, which fails the requirements. The micro family office renders services exclusively to the spousal-owned investment partnership. The management company does not function as an independent financial services company, with outside staff or an outside office. It does not stand alone as a financial service provider. In the eyes of the IRS, it oversees its own investments. This management company should not use business expense treatment. (Some trader accounting and law firms sold this scheme to traders who do not qualify for trader tax status. I’ve always said it did not work and the Lender court confirms it doesn’t work.)

Management fees and carried interest
Consider this typical example: An investment partnership pays a 0.5% management fee on funds under management of $1M ($5,000 per year). The investment partnership also pays a 20% profit allocation (carried interest) based on performance (say, $50,000 for the year). The investment partnership passes through an investment expense of $5,000 for the management fee, which the investor cannot deduct on their tax return. The profit allocation avoids the investment expense deduction problem because it carves out a share of capital gains on each investor’s Schedule K-1.

The management company reports $5,000 of revenue for the management fee, which gives the impression of being a trade or business. However, that’s not enough revenue to cover expenses, so it lacks presumption of business purpose. The management company also reports capital gains income of $50,000 from the profit allocation of investment income. Total income is $55,000 minus business expenses of $52,000 equals a net income of $3,000. The capital gains help satisfy the presumption of business purpose test. The owner sacrificed the $5,000 deduction in the investment partnership to arrange $52,000 of deductions in the management company. However, the IRS might disallow the entire $52,000 deduction, asserting the management company is also an investment company with non-deductible investment expenses because it did not satisfy the requirements for a family office under the Lender court.

Hedge funds
Assume a hedge fund manager owns the management company, which deducts business expenses. The hedge fund partnership does not qualify for trader tax status, so it’s an investment partnership. Most hedge funds meet this scenario. The management company is genuine, and there is little common ownership because the hedge fund is predominately owned by outside investors. That satisfies the Lender court requirements for a management company.

It might be different for a startup hedge fund before outside investors become limited partners in the limited partnership. Until and unless that happens, the manager is managing his own investments, and it fails Lender. The limited partnership is probably not paying the management company advisory fees including profit allocation in connection with the managers capital.

Lender Management tax court case
In Lender Management v. Comm. (Dec. 16, 2017), the tax court overruled the IRS by awarding business expense treatment to Lender Management. It was a well-established single-family office servicing many family-owned investment partnerships. Lender provided customized investment and management services throughout the year to many different family members, with varying needs, across an extensive family tree. Lender Management and the investment partnerships did not have too much common ownership according to IRS and tax court calculations. Only a few of Lender’s dozens of family members owned the management company.

The IRS was unable to cite attribution rules that should apply to Lender. The Lender case also dealt with how to handle revocable vs. irrevocable trusts in the overlap test for common ownership. The Lender court did not define how much overlap ownership is permitted.

Other tax court cases
In Higgins v. Comm. (1941), the tax court said, “No matter how large the estate or how continuous or extended the work may be, overseeing the management of one’s own investments is generally regarded the work of an investor.”

In Dagres v. Comm. (2011), “Selling one’s investment expertise to others is as much an expertise as selling legal expertise, or medical expertise.”

Trade or business partnerships
In Higgins, replace the words “business” for “investment” and the outcome is favorable: “Overseeing the management of one’s own businesses is generally regarded as the work of a business.” If there is a trading partnership with trader tax status, or a rental real estate partnership with ordinary income, then the management company can look through to the business treatment.

A C-Corp management company
Some families and tax advisors are considering a C-Corp management company to take advantage of the new tax law’s 21% flat rate.

Be sure the management company meets the Lender court requirements for a family office. Otherwise, the IRS does not permit a C-Corp investment company to deduct investment expenses. Section 212 (investment expenses) applies to non-corporate taxpayers, not corporations. A C-Corp with a trade or business is entitled to deduct business expenses in connection with making ancillary investments, like investing treasury capital.

When taking into account the Tax Cuts and Jobs Act, don’t focus solely on the federal 21% flat tax rate on the C-Corp level. There are plenty of other taxes, including capital gains taxes on qualified dividends, corporate taxes in 44 states, and IRS 20% accumulated earnings tax assessed on excess retained earnings, which is any amount above zero for an investment company. (See How To Decide If A C-Corp Is Right For Your Trading Business.)

Apportionment between investment and business partnerships
Family offices might want to consider having more of their underlying investment partnerships achieve business treatment, like trader tax status or rental real estate income. If a family office does not satisfy the requirements, and it services investment partnerships and business partnerships, it might consider using hybrid reporting to apportion business expenses vs. investment expenses.

Wealthy families diversify their interests and invest in family-owned investment partnerships in securities and commodities, outside hedge funds, private equity funds, venture capital funds, and real estate partnerships and REITs. Consult a tax advisor to learn more about which underlying investment partnerships have investment expense treatment vs. trade or business activities.

Darren Neuschwander, CPA, and Roger Lorence, Esq., contributed to this post.


Hope For Active Crypto Traders With Massive Losses

June 16, 2018 | By: Robert A. Green, CPA | Read it on

The AICPA recently asked the IRS to permit cryptocurrency traders, eligible for trader tax status (TTS), to use a Section 475 MTM election on securities and commodities providing for ordinary gain or loss treatment.

In my March 2018 blog post Cryptocurrencies: Trader Tax Status Benefits And Section 475 Issues, I suggested crypto TTS traders consider filing a protective 2018 Section 475 election on securities and commodities, due by April 17, 2018, in case the IRS allowed it. Many crypto traders had significant losses in early 2018 with the market correction, and with a 475 election, they might avoid the $3,000 capital loss limitation using ordinary loss treatment. I said it hinged on whether the IRS changed its designation of crypto from intangible property to a security or a commodity.

The AICPA letter* implied that the IRS could keep its current classification of crypto as intangible property, yet still permit the use of Section 475.  However, it does raise other questions: The AICPA letter did not distinguish between securities and commodities, whereas, Section 475 does. TTS traders may elect Section 475 on securities only, commodities only, or both, and that has other tax implications.

If the IRS considers crypto a security, then Section 1091 wash-sale loss rules for securities would apply. Wash-sale loss adjustments are a headache and can be costly. (If you buy back a losing trade 30 days before or after, you must defer the wash-sale loss to the replacement position’s cost basis.) As intangible property, crypto is not currently subject to wash-sale losses. A Section 475 election on securities exempts TTS traders from making wash-sale loss adjustments.

If the IRS considers crypto a commodity, then a TTS trader should be able to elect Section 475 on commodities. However, that election has other tax consequences: If you trade Section 1256 contracts, including futures, you will surrender the lower 60/40 capital gains rates on 1256 contracts. For that reason, most traders elect Section 475 on securities only.

AICPA letter excerpt
8. Traders and Dealers of Virtual Currency

“Overview: Taxpayers considered dealers and traders who engage in buying and selling securities in the ordinary course of business to customers may make a ‘mark-to-market’ election under section 475. This election recognizes ordinary gains or losses on the deemed sales involved in the mark-to-market process. The securities holdings on the last day of the year are deemed as sold for their fair market value resulting in both ordinary income and ordinary expenses the same as for any other trade or business. Taxpayers who trade virtual currencies perform this activity on virtual currency exchanges that contain all the robust trading features available on trading platforms for securities and commodities, including the same level of liquidity. In this context, virtual currencies are akin to securities and commodities. This particular issue is also under consideration by the Commodity Futures Trading Commission.

Suggested FAQ
Q-22: May taxpayers who trade virtual currency elect the mark-to-market rules under section 475 if they otherwise qualify as a dealer or trader?

A-22: Yes. The nature of virtual currency trading is akin to dealers and traders of securities and commodities and a taxpayer may elect mark-to-market treatment. The taxpayer must otherwise qualify as a dealer or trader in order to make the election.

* The IRS has made no indication that they intend to adopt all, or any, of the many excellent recommendations from the AICPA.

SEC update
On June 14, CNBC reported, “The SEC’s point man on cryptocurrencies and initial coin offerings (ICOs) says that bitcoin and ether are not securities but that many, but not all, ICOs are securities and will come under the regulatory control of the SEC and relevant securities laws.”

The official explained what constitutes a security in the eyes of the SEC. An initial coin offering is likely a security because a third-party company, which is not decentralized ownership, sells an investment product to the public. The sponsor uses the money raised for its internal use. The buyer/investor expects a profit — a return on the investment. Conversely, bitcoin and ether are likely not securities because there was no ICO, ownership is decentralized, and they were not sold as investments.



Spending Crypto For Personal Use Can Be A Tax Mistake

June 4, 2018 | By: Robert A. Green, CPA | Read it on

If a taxpayer purchases virtual currency (cryptocurrency) and spends it on personal use, the IRS requires him to calculate a capital gain or loss on each transaction. Capital gains on personal-use property are reportable and subject to tax, whereas, the IRS disallows capital losses.

The AICPA recently asked the IRS for some equitable relief by adopting a “de minimus election,” which provides a $200 threshold for excluding capital gains income on personal transactions. (See the AICPA letter and an excerpt of the de minimus rule proposal below.)

If a taxpayer acquires virtual currency as an investment, though, then all capital gains and capital losses are reportable, and the de minims rule should not apply.

The AICPA suggests the IRS apply a similar de minimus rule used for foreign currency transactions in Section 988(e)(2) (see below). The code section refers to personal purchases, not Section 162 business or Section 212 investment property. For example, if a taxpayer acquired Euros for a European vacation, the de minimus rule applies, and the taxpayer can exclude capital gains on the Euros spent if the capital gain is under $200 per transaction.

The IRS does not permit taxpayers to deduct capital losses on personal-use property, including foreign currency or virtual currency held for personal use. Taxpayers may not deduct capital losses on the sale of a private auto or a primary residence.

Examples of using crypto for personal use vs. investment property

1.    Joe purchased one Bitcoin in early 2017 for personal-use spending, and his Bitcoin rose in price substantially during the year. Joe planned on many vendors adopting Bitcoin as a means of payment. Joe’s original intention was for personal use, so a de minimus exemption should apply to him if the IRS approves that AICPA recommendation*. If Joe bought Bitcoin in 2018, he might have a capital loss, which would be non-deductible on personal-use property.

2.    Nancy invested in 10 Bitcoins in early 2017, and her intention was capital appreciation and diversification into a new asset class. She spent Bitcoin frequently during the year on personal transactions, buying goods and services wherever Bitcoin was accepted. She hoped it would be tax-free, but it’s not.

The intention of the taxpayer is critical in determining tax treatment. If the aim is for personal use, then the de minimus rule should apply to capital gains under $200, and capital losses are not deductible. If the intention is for investment, then it’s capital gains and losses. If the purpose is for business, ordinary gain or loss treatment applies.

With tax treatment hinging on category (personal use, investment, and business), it’s wise to segregate cryptocurrency into these buckets carefully. If the IRS agrees with the AICPA proposal on the de minimus exemption, declare a crypto wallet for personal use, and the rest as an investment to protect capital loss treatment on the bulk of your crypto that you don’t plan to spend.

Excerpt from the AICPA letter
4. Need for a De Minimis Election

“Overview: Some taxpayers may only have a minimal amount of virtual currency that is designated for making small purchases (such as buying coffee). Tracking the basis and FMV of the virtual currency for each of these small purchases is time consuming, burdensome, and will yield a de minimis amount of gain or loss. A binding election applicable for a specified amount of virtual currency is beneficial to taxpayers.

Currently, section 988(e)(2) allows for an exclusion of up to $200 per transaction for foreign currency exchange rate gain, if derived from personal purchase. The same exclusion should apply to virtual currencies even though they are considered property rather than foreign currency.

Suggested FAQ

Q-9: May individuals use a de minimis rule for virtual currency similar to the section 988(e)(2) exclusion of up to $200 per transaction for foreign currency exchange rate gain?

A-9: Yes. Individuals may use a de minimis rule, similar to section the 988(e)(2) exclusion, for virtual currency transactions to alleviate the burden or recordkeeping for individuals who use virtual currency as a medium of exchange. This de minimis rule allows taxpayers to exclude transactions resulting in $200 or less of gain.”

Section 988(e)(2) Exclusion for certain personal transactions
“If—

(A) nonfunctional currency is disposed of by an individual in any transaction, and

(B) such transaction is a personal transaction,

no gain shall be recognized for purposes of this subtitle by reason of changes in exchange rates after such currency was acquired by such individual and before such disposition. The preceding sentence shall not apply if the gain which would otherwise be recognized on the transaction exceeds $200.

(3) Personal transactions. For purposes of this subsection, the term “personal transaction” means any transaction entered into by an individual, except that such term shall not include any transaction to the extent that expenses properly allocable to such transaction meet the requirements of—

(A) section 162 (other than traveling expenses described in subsection (a)(2) thereof), or

(B) section 212 (other than that part of section 212 dealing with expenses incurred in connection with taxes).”

(Note: Section 162 is for business, and Section 212 is for investments.)

* The IRS has made no indication that they intend to adopt all, or any, of the many excellent recommendations from the AICPA. 


ETNs Have Different Structures With Varying Tax Treatment

May 17, 2018 | By: Robert A. Green, CPA | Read it on

Exchange-traded notes (ETNs) are structured either as debt securities or prepaid executory contracts, and that makes a critical difference in tax treatment.

“The tax treatment of ETNs is often complicated to determine,” said New York City tax attorney Roger D. Lorence. “You have to review the tax section of each prospectus. In many cases, the offering is an undivided interest in the underlying positions, such as futures, so that the ETN is not an interest in an entity nor itself a security. However, other ETNs are structured as a debt instrument, usually with leverage concerning some index (such as natural gas futures).

ETNs structured as debt securities are taxed similarly to other securities with the realization method for capital gain or loss. (Realization is when you sell the security.) They are subject to Section 1091 wash-sale loss adjustments, which can raise tax liabilities. (Scroll to the end of the blog for more on wash-sale loss adjustments.) Section 475 ordinary gain or loss treatment should apply to these debt securities, too, if the trader qualifies for trader tax status (TTS) and makes the election on time.

ETNs organized as prepaid executory contracts (also referred to as prepaid forward contracts) are not securities. They calculate a rate of return or interest rate based on the movement of an underlying financial instrument, futures index, or equities index. The ETN holder does not own the underlying instrument or index. This can have a significant impact on tax liabilities, as it likely means that Sections 1091 wash sales and 475 MTM should not apply to them. ETN prospectuses say they don’t address Sections 1091 and 475.

Report the sale or exchange of ETNs organized as prepaid executory contracts when realized as short-term and long-term capital gains and losses, except currency ETNs which are ordinary gain or loss treatment.

The problem
Here’s the problem when it comes time to preparing tax returns: Most brokers categorize all types of ETNs as securities on 1099-Bs and make wash-sale loss adjustments. Those adjustments might defer tax losses to the subsequent year, thereby raising tax liabilities. When it comes to ETN prepaid executory contracts, consider deviating from the 1099-B to reverse out wash-sale loss adjustments on these ETNs. Explain why in a tax return footnote. If this presents a significant change in tax liability, consider obtaining a “substantial authority” letter from a tax attorney to support the tax filing. The broker carries over these wash sale loss adjustments as an increase in cost basis in the subsequent year, so don’t forget to reverse that, too. Deviating from 1099-Bs raises complications, so consult a tax advisor.

Options on ETNs: There is a similar problem with CBOE-listed options on volatility ETNs and ETFs. Many broker 1099-Bs classify these options as securities, but there is substantial authority to treat them as non-equity options, which are Section 1256 contracts. As Section 1256 contracts, they are not subject to wash-sale loss adjustments and qualify for lower 60/40 capital gains tax rates. (See How To Apply Lower Tax Rates To Volatility Options, Tax Treatment For Exchange Traded Notes.)

ETN debt securities prospectus
See the Credit Suisse Velocity Shares prospectus applicable to ETN symbol XIV and five related volatility ETNs. Here are excerpts from pages 75-76:

“Debt Securities U.S. Holder Payments or Accruals of Interest Payments or accruals of ‘qualified stated interest’ (as defined below) on a debt security will be taxable to you as ordinary interest income at the time that you receive or accrue such amounts (in accordance with your regular method of tax accounting).

Purchase, Sale and Retirement of Debt Securities: When you sell or exchange a debt security, or if a debt security that you hold is retired, you generally will recognize gain or loss equal to the difference between the amount you realize on the transaction (less any accrued qualified stated interest, which will be subject to tax in the manner described above under Payments or Accruals of Interest) and your tax basis in the debt security.”

ETN prepaid executory contracts prospectus
Among the most-popular traded ETN symbols are VXX, VXZ, XVZ, all prepaid executory contracts issued by iPath. According to IPathETN.com U.S. Federal Income Tax Considerations, “For U.S. federal income tax purposes, Barclays Bank PLC and investors agree to treat all iPath ETNs, except certain currency ETNs, as prepaid executory contracts with respect to the relevant index. If such iPath ETNs are so treated, investors should recognize gain or loss upon the sale, redemption or maturity of their iPath ETNs in an amount equal to the difference between the amount they receive at such time and their tax basis in the securities. Investors generally agree to treat such gain or loss as capital gain or loss, except with respect to those iPath ETNs for which investors agree to treat such gain or loss as ordinary, as detailed in the chart below.”

The UBS Velocity Shares prospectus applicable to EVIX and EXIV states: “In the opinion of our counsel, Sullivan & Cromwell LLP, the Securities should be treated as a pre-paid forward contract…”

Volatility ETN products
In order of volume http://etfdb.com/etfdb-category/volatility/

- iPath S&P 500 VIX ST Futures ETN (VXX) – Prepaid*
- iPath Series B S&P 500 VIX Short-Term Futures ETN (VXXB) – Prepaid
- iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) – Prepaid
- iPath S&P 500 Dynamic VIX ETN (XVZ) – Prepaid
- iPath Series B S&P 500® VIX Mid-Term Futures ETN (VXZB) – Prepaid
- Credit Suisse VelocityShares Daily Long VIX Short-Term ETN (VIIX) – Debt**
- UBS VelocityShares VIX Short Volatility Hedged ETN (XIVH) – Debt
- UBS VelocityShares 1X Daily Inverse VSTOXX Futures ETN (EXIV) – Prepaid
- UBS VelocityShares VIX Variable Long/Short ETN (LSVX) – Debt
- UBS VelocityShares VIX Tail Risk ETN (BSWN) – Debt
- UBS VelocityShares 1X Long VSTOXX Futures ETN (EVIX) – Prepaid
Listed on securities exchanges: NYSE, Nasdaq, or Bats.

*Prepaid: The iPath volatility ETNs are prepaid executory contracts
**Debt: a debt security

Tax attorney weighs in
Lorence takes a look at the prospectus for the UGAZ ETN by Credit Suisse, which states that the offerings are short-term debt obligations, longer-term debt obligations, and warrants.

“The debt obligations are clearly described by tax counsel as producing interest income and similar interest-type income (e.g., market discount),” Lorence said. “Debt obligations are classified as securities for Section 1091; although there are issues about whether some commodities offerings, such as futures, are also securities, the UGAZ debt obligations would be securities for Section 1091. Wash sale rules for debt securities limit the substantially identicality of debt obligations by requiring that they be essentially the same bond for market value purposes (e.g., same issuer, same or virtually the same coupon and maturity). In all cases dealing with ETNs and ETFs, I have found these just to be marketing labels, and the tax consequences have to be found in the tax disclosure in the prospectus.”

Wash sale loss adjustments
Congress doesn’t want taxpayers to realize “tax losses” that are not “economic losses.” If you close a securities transaction and re-open it right away, you haven’t closed your financial position in that security. At year-end, many taxpayers do “tax loss selling” of securities in December, and the IRS wash sale rules defer the loss if the taxpayer re-purchases a substantially identical position within 30 days before or after, which means into January of the subsequent year. Thirty days is an eternity for day and swing traders. (Learn more about wash sales.)

See my earlier blog posts: How To Apply Lower Tax Rates To Volatility OptionsTax Treatment For Exchange Traded Notes and Tax Treatment For Volatility Products Including ETNs.

Darren Neuschwander CPA contributed to this blog post.

 

 

 

 

 


Accounting Method Impacts Crypto Income Taxes

April 10, 2018 | By: Robert A. Green, CPA | Read it on

Many crypto traders face massive tax bills for 2017. Which accounting method they apply could change their tax bills by tens of thousands of dollars.

Specific identification vs. FIFO
The IRS wants the “specific identification” (SI) accounting method used on property transactions, which applies to crypto. SI requires “adequate identification” of units sold, but most crypto traders cannot comply with these formal IRS regulations.

Many crypto traders and accountants use the alternative “first in first out” (FIFO) accounting method. FIFO is reliable and practical. A side benefit of FIFO is longer holding periods with potential qualification for long-term capital gains tax at 0%, 15%, and 20% graduated rates.

But FIFO likely raised tax bills for many crypto traders in 2017, because coin prices rose dramatically during the year. Selling coins purchased at lower prices (cost basis), increased 2017 capital gains. Many traders held significant amounts of crypto at year-end, embedded with higher cost-basis. If these traders complied with SI adequate identification rules, they might have reduced capital gains income by choosing higher-cost lots for sale.

Special IRS rule for securities
Thomson Reuters tax publishers explains the FIFO rule as follows:

“Except for stock for which the average basis method is available (i.e., mutual fund shares), if a taxpayer sells or transfers corporate stock that the taxpayer purchased or acquired on different dates or at different prices, and the taxpayer doesn’t adequately identify the lot from which the stock is sold or transferred, the stock sold or transferred is charged against the earliest lot purchased or acquired to determine the basis and holding period of the stock.

“An adequate identification is made if the taxpayer, ‘at the time of the sale or transfer,’ specifies what particular shares are to be sold or transferred and, within a reasonable time after that, the broker or other agent confirms the specification in a written document. In this event, the taxpayer’s instruction prevails even though delivery was actually made from a different lot. Stock identified under this rule is considered to be the stock sold or transferred by the taxpayer, even if stock certificates from a different lot are actually delivered to the taxpayer’s transferee. For this purpose, an adequate identification of stock is made at the time of sale, transfer, delivery or distribution if the identification is made no later than the earlier of the settlement date or the time for settlement required by Rule 15c6-1 under the Securities Exchange Act of 1934. A standing order or instruction for the specific identification of stock is treated as an adequate identification made at the time of sale, transfer, delivery or distribution.”

The tax court and IRS relaxed SI rules in some cases, but more stringent IRS regulations remain the law. In Concord Instruments Corp, (1994) TC Memo 1994-248, per Thomson Reuters,

“Taxpayer had maintained cost records of each lot of stock that was purchased, the date of purchase, and the price per share. T’s accountant used these records to prepare T’s income tax returns. To compute the gain from T’s stock sales, the specific identification method was used and the highest cost shares were treated as sold first. The court concluded that Taxpayer had sufficiently identified the stock sold to avoid the FIFO method of reporting the gains.”

The tax court allowed oral communication by the trader to the broker and the court relaxed the broker rules for providing contemporaneously written confirmation.

With high-speed trading on coin exchanges, it seems nearly impossible to comply with adequate identification rules for the SI accounting method. Crypto traders don’t use brokers; they trade online over coin exchanges without any communication between trader and exchange. Would the IRS consider this situation to be compliant with SI adequate identification rules? Maybe not.

New York tax attorney Roger D. Lorence says: “Given how longstanding this regulation is, I would describe it as having in effect the force of law.  The legal effect is to create a rebuttable presumption of its correctness; the presumption is overcome only upon the showing of strong proof.  Unless the cryptocurrency trader has contemporaneous records showing specific identification, if they are in the US Tax Court, they would be held to FIFO.”

AICPA weighs in
In June 2016, the AICPA asked the IRS if crypto traders could use FIFO as an alternative accounting method. (See Comments on Notice 2014-21: Virtual Currency Guidance.)

“Allow an alternative treatment under section 1012 (e.g., first in first out (FIFO)). The treatment of convertible virtual currency as noncash property means that any time virtual currency is used to acquire goods or services, a barter transaction takes place, and the parties need to know the fair market value (FMV) of the currency on that day. The party exchanging the virtual currency for the goods or services will need to also track the basis of all of his or her currency to determine if a gain or loss has occurred and whether it is a short-term or long-term transaction. This determination involves a significant amount of recordkeeping, even if the transaction is valued at under $10.

“Currently, there are no alternative tracking methods provided for such transactions (other than for securities under Treas. Reg. § 1.1012-1(c)). Therefore, taxpayers are required to specifically identify which virtual currency lot was used for each transaction in order to properly determine the gain or loss for that particular transaction. In many cases, it is impossible for a taxpayer to track which specific virtual currency was used for a particular transaction.”

Example of specific identification
A crypto trader bought 20 Bitcoins before 2017 at low prices. He bought 30 more Bitcoins between January and June 2017 at materially higher rates. In July 2017, he transferred the 30 Bitcoins purchased in 2017 to a coin exchange. He kept the original 20 in his wallet off-exchange. He adequately identified the 30 newer units for the trading. He used and complied with SI, and it saved him thousands of dollars in capital gains taxes compared to using FIFO.

Cherry picking
Choosing an option in a trade accounting program to cherry pick the highest cost basis for lowering capital gains after the fact is likely not acceptable to the IRS. “Last in first out” (LIFO) is also expected not acceptable.

File an extension
I suggest crypto traders file extensions for 2017 by April 17, 2018, to avoid late-filing penalties of 5% per month (up to a maximum of 25%). Hopefully, the IRS will issue new guidance addressing permissible accounting methods and their application in the real world of crypto trading.

Consult with a cryptocurrency trade accounting expert.

Darren Neuschwander CPA contributed to this blog post.

 


Cryptocurrencies: Trader Tax Status Benefits And Section 475 Issues

March 14, 2018 | By: Robert A. Green, CPA | Read it on

Active cryptocurrency (coin) traders can qualify for trader tax status (TTS) to deduct trading business expenses and home-office deductions. TTS is essential in 2018: The Tax Cuts and Jobs Act suspended investment expenses, and the IRS does not permit employee benefit plan deductions on investment income. A TTS trader can write off health insurance premiums and retirement plan contributions by trading in an S-Corp with officer compensation.

The benefits of Section 475
There’s an additional critical tax benefit with TTS: Electing Section 475 mark-to-market accounting (MTM) on securities and/or commodities. Section 475 turns capital gains and losses into ordinary gains and losses thereby avoiding the $3,000 capital-loss limitation and wash-sale loss adjustments on securities (this is what I like to call “tax-loss insurance”). Many coin traders incurred substantial trading losses in Q1 2018, and they would prefer ordinary loss treatment to offset wage and other income. Unfortunately, most coin traders will be stuck with significant capital-loss carryforwards and higher tax liabilities.

There are benefits to 475 income, too. The new tax law ushered in a 20% pass-through deduction on qualified business income (Section 199A), which likely includes Section 475 ordinary income, but excludes capital gains. Trading is a specified service activity, requiring the owner to have taxable income under a threshold of $315,000 (married) or $157,500 (other taxpayers). There is a phase-out range above the limit of $100,000 (married) and $50,000 (other taxpayers).

The IRS says cryptocurrency is intangible property
In March 2014, the IRS issued long-awaited guidance declaring coin “intangible property,” before regulators thoroughly assessed coin. Section 475 is for securities and commodities and does not mention intangible property. An AICPA task force on virtual currency asked the IRS for further guidance (AICPA letter), including if coin traders could use Section 475. The IRS has not yet replied. When an investor holds cryptocurrencies as a capital asset, they should report short-term vs. long-term capital gains and losses on Form 8949. (See Cryptocurrency Traders Owe Massive Taxes For 2017.)

SEC and CFTC weigh in
The U.S. Securities and Exchange Commission (SEC) recently stated Initial Coin Offerings (ICOs) might be securities offerings, which most likely need to register with the SEC. It further said coins or tokens might be securities, even if the ICO calls them something else. According to an SEC statement, “If a platform offers trading of digital assets that are securities and operates as an “exchange,” as defined by the federal securities laws, then the platform must register with the SEC as a national securities exchange or be exempt from registration.” (See SEC ICO information.)

The U.S. Commodity Futures Trading Commission (CFTC) defined cryptocurrencies as commodities in 2015. During a March 7, 2018, CNBC interview, Commissioner Brian Quintenz said the CFTC has enforcement authority, but not oversight authority, over cryptocurrencies traded in the spot market on coin exchanges. The CFTC has enforcement and oversight authority for derivatives traded on commodities exchanges, like Bitcoin futures.

Also on March 7, 2018, a U.S. district judge in New York ruled in favor of the CFTC, stating “virtual currencies can be regulated by CFTC as a commodity.” (See Cryptos Are Commodities, Rules US Judge In CFTC Case.)

Will the IRS change its mind?
There is a long-shot possibility the IRS could change its tune to treat cryptocurrency as a security and or a commodity as a result of recent actions from the SEC and CFTC, including the statements mentioned above. Then coin might fit into the definition of securities and/or commodities in Section 475. Until and unless the IRS updates its guidance, coin is intangible property, which is not listed in Section 475.

If you incurred substantial trading losses in cryptocurrencies in Q1 2018, and you qualify for TTS, you might want to consider making a protective 2018 Section 475 election on securities and commodities by April 17, 2018 (or by March 15 for partnerships and S-Corps). The IRS has a significant workload drafting regulations for the new tax law, and with limited resources, I don’t expect it to update coin guidance shortly.

There is a side effect of making a 475 election on commodities: If you also trade Section 1256 contracts, you surrender the lower 60/40 capital gains rates. Perhaps, you only trade coin and don’t care about Section 1256 contracts. If coin is deemed a commodity for tax purposes, it’s still likely not a Section 1256 contract unless it lists on a CFTC-registered qualified board or exchange (QBE). Coin exchanges or marketplaces are currently not QBE.

Section 475 provides for the proper segregation of investment positions on a contemporaneous basis, which means when you buy the position. If you have a substantial loss in coin that you’ve held onto for months before the sale, the IRS will likely consider it a capital loss on an investment position.

Bitcoin futures
Bitcoin futures trade on the CME and CBOE exchanges. The product appears to be a regulated futures contract (RFC) trading on a U.S. commodities exchange, meeting the tax definition of a Section 1256 contract. That means it also fits the description of a commodity in Section 475.

Section 1256 contracts have lower 60/40 capital gains tax rates, meaning 60% (including day trades) are taxed at the lower long-term capital gains rate, and 40% are taxed at the short-term rate, which is the ordinary tax rate. Section 1256 is mark-to-market accounting, reporting unrealized gains and losses at year-end.

TTS traders usually elect 475 on securities only to retain these lower rates on Section 1256 contracts. A Section 1256 loss carryback election applies the loss against Section 1256 gains in the three prior tax years, and unused amounts are carried forward.

If a TTS trader has a substantial loss in Bitcoin futures, he or she should consider making a 2018 Section 475 election on commodities for ordinary loss treatment. (See Consider 475 Election By Tax Deadline To Save Thousands.)

Cryptocurrency investment trusts
According to Grayscale’s website, the company is “the sponsor of Bitcoin Investment Trust, Bitcoin Cash Investment Trust, Ethereum Investment Trust, Ethereum Classic Investment Trust, Litecoin Investment Trust, XRP Investment Trust and Zcash Investment Trust. The trusts are private investment vehicles, are NOT registered with the Securities and Exchange Commission.” The Grayscale cryptocurrency investment trusts list on OTC markets.

According to its prospectus, Bitcoin Investment Trust is a Grantor Trust, a publicly traded trust (PTT). “Treatment of an interest in a grantor trust holding crypto assets means that you have to look through the trust envelope to the underlying positions,” says New York tax attorney Roger Lorence JD.

It’s similar to other PTTs; like the SPDR Gold Shares (NYSEArca: GLD) with long-term capital gains using the collectibles tax rate applicable to precious metals. With the look-through rule, the cryptocurrency investment trusts are subject to taxation as intangible property.

Excess business losses
The new tax law limits current year business losses to $500,000 (married) and $250,000 (other taxpayers) starting in 2018. The excess business loss carries forward as a net operating loss (NOL). In 2017, there wasn’t a limit, and taxpayers could carryback NOLs two tax years and/or forward 20 years. Section 475 losses often generated immediate tax refunds from NOL carryback returns. At least NOL carryforwards are better than capital loss carryovers.

Several coin traders face a tax trap
They had massive capital gains in 2017 and had not yet paid the IRS and state their 2017 taxes owed. Meanwhile, in Q1 2018, their coin portfolios significantly declined in value, and they incurred substantial trading losses. They now face a significant tax problem: They need to sell cryptocurrencies to raise cash to pay their 2017 tax liabilities due by April 17, 2018. That would leave many of them with little coin left to continue trading. They may choose to file their automatic extensions without tax payment or a small payment and incur a late-payment penalty of 0.5% per month by the extension due date of Oct. 15, 2018. They are banking on coin prices increasing and thereby generating trading gains by Oct. 15. It reminds me of trading on margin; only the bank (in this case, tax authorities) cannot force a sale now. (See Tax Extensions: 12 Tips To Save You Money.)

A Section 475 election is not a savior in this situation: Section 475 turns 2018 capital losses into ordinary losses on TTS positions, but the IRS no longer allows NOL carryback refunds. In prior years, a trader with this problem could hold the IRS at bay, promising to file an NOL carryback refund claim to offset taxes owed for 2017.

Mining inventory vs. capital assets
When a miner receives coin, it’s revenue. The net income after mining expenses is ordinary income and self-employment income. If the miner converts that coin from mining inventory to a capital asset, subsequent sales or exchanges of that coin are capital gains and losses, not ordinary income or loss. Most coin accounting programs assume a conversion to capital asset treatment takes place. However, a miner may not intend to convert coin to a capital asset, and instead leave the coin in inventory. A subsequent sale or exchange would then be an ordinary gain or loss as part of the mining business.

How to qualify for trader tax status
Are you unsure if you are eligible for TTS? Here are the GreenTraderTax golden rules for qualification based on an analysis of trader tax court cases and years of tax compliance experience.

- Volume: three to four trades per day. Don’t count when the coin exchange breaks down an order into multiple executions.
- Frequency: trade executions on 75% of available trading days. If you trade five days per week, you should have trade orders executed on close to four days per week.
- Holding period: The Endicott court required an average holding period of fewer than 31 days.
- Hours: at least four hours per day, including on research and administration.
- Taxable account size: material to net worth, and at least $15,000 during the year.
-Intention to make a primary or supplemental living. You can have another job or business, too.
- Operations: one or more trading computers with multiple monitors and a dedicated home office.
- Automation: You can count the volume and frequency of a self-created automated trading system, algorithms or bots. If you license the automation from another party, it doesn’t count.
- A trade copying service, using outside investment managers and retirement plan accounts don’t count for TTS.

If you qualify for TTS, claim it by using business expense treatment rather than investment expenses. TTS does not require an election, but 475 does.

In 1997, Congress recognized the growth of online trading when it expanded Section 475 from dealers to traders in securities and commodities. It was when I created GreenTraderTax, urging clients and followers in chat rooms to elect 475 for free tax-loss insurance. When the tech bubble burst in 2000, those that followed my advice were happy to get significant tax refunds on their ordinary business losses with NOL carrybacks. I wish Section 475 were openly available to all TTS coin traders now.

Darren Neuschwander CPA contributed to this blog post.

 


Tax Extensions: 12 Tips To Save You Money

March 5, 2018 | By: Robert A. Green, CPA | Read it on

Individual tax returns for 2017 are due April 17, 2018, however, most active traders aren’t ready to file on time. Some brokers issue corrected 1099Bs right up to the deadline, or even beyond. Many partnerships and S-Corps file extensions by March 15, 2018, and don’t issue Schedule K-1s to investors until after April 17. Many securities traders struggle with accounting for wash sale loss adjustments.

The good news is traders don’t have to rush completion of their tax returns by April 17. They should take advantage of a simple one-page automatic extension along with payment of taxes owed to the IRS and state. Most active traders file extensions, and it’s helpful to them on many fronts.

Tip 1: Get a six-month extension of time
Request an automatic six-month extension of time to file individual federal and state income tax returns by Oct. 15, 2018. Form 4868 instructions point out how easy it is to get this automatic extension — no reason is required. It’s an extension of time to file a complete tax return, not an extension of time to pay taxes owed. Estimate and report what you think you owe for 2017 based on your tax information received.

Tip 2: Avoid penalties from the IRS and state for being late
Learn how IRS and state late-filing and late-payment penalties apply so you can avoid or reduce them to your satisfaction. 2017 Form 4868 (Application for Automatic Extension of Time To File U.S. Individual Income Tax Return) page two states:

“Late Payment Penalty. The late payment penalty is usually ½ of 1% of any tax (other than estimated tax) not paid by April 17, 2018. It is charged for each month or part of a month the tax is unpaid. The maximum penalty is 25%. The late payment penalty won’t be charged if you can show reasonable cause for not paying on time. Attach a statement to your return fully explaining the reason. Don’t attach the statement to Form 4868. You’re considered to have reasonable cause for the period covered by this automatic extension if both of the following requirements have been met. 1. At least 90% of the total tax on your 2017 return is paid on or before the regular due date of your return through withholding, estimated tax payments, or payments made with Form 4868. 2. The remaining balance is paid with your return.

Late Filing Penalty. A late filing penalty is usually charged if your return is filed after the due date (including extensions). The penalty is usually 5% of the amount due for each month or part of a month your return is late. The maximum penalty is 25%. If your return is more than 60 days late, the minimum penalty is $210 (adjusted for inflation) or the balance of the tax due on your return, whichever is smaller. You might not owe the penalty if you have a reasonable explanation for filing late. Attach a statement to your return fully explaining your reason for filing late. Don’t attach the statement to Form 4868.”

Tip 3: File an automatic extension even if you cannot pay
Even if you can’t pay what you estimate you owe, make sure to file the automatic extension form on time by April 17, 2018. It should help avoid the late-filing penalty, which is ten times more than the late-payment penalty. So if you can’t pay in full, you should file your tax return or extension and pay as much as you can.

An example of late-payment and late-filing penalties: Assume your 2017 tax liability estimate is $50,000. Suppose you file an extension by April 17, 2018, but cannot pay any of your tax balance due. You file your actual tax return on the extended due date of Oct. 15, 2018, with full payment. A late-payment penalty applies because you did not pay 90% of your tax liability on April 17, 2018. The late-payment penalty is $1,500 (six months late x 0.5% per month x $50,000). Some traders view a late-payment penalty like a 6% margin loan.

By simply filing the extension on time in the above example, you avoided a late-filing penalty of $11,250 (six months late x 5% per month [25% maximum], less late-payment penalty factor of 2.5% = 22.5%; 22.5% x $50,000 = $11,250). Interest is also charged on taxes paid after April 17, 2018.

Tip 4: Add a payment cushion for Q1 2018 estimated taxes due
Traders with 2018 year-to-date trading gains and significant tax liability in the past year should consider making quarterly estimated tax payments this year to avoid underestimated tax penalties.

I recommend the following strategy for traders and business owners: Overpay your 2017 tax extension on April 17, 2018, and plan to apply an overpayment credit toward Q1 2018 estimated taxes. Most traders don’t make estimated tax payments until Q3 and or Q4 when they have more precise trading results. Why pay estimated taxes for Q1 and Q2 if you incur substantial trading losses later in the year?

It’s a better idea to pay an extra amount for the extension to set yourself up for three good choices: A cushion on 2017 if you underestimated your taxes, an overpayment credit toward 2018 taxes, or a tax refund for 2017 if no 2018 estimated taxes are due.

Tip 5: Consider a 2018 Section 475 MTM election
Traders eligible for trader tax status should consider attaching a 2018 Section 475 election statement to their 2017 tax return or extension. These are due by April 17, 2018, for individuals and corporations and March 15 for partnerships and S-Corps. Section 475 turns capital gains and losses into ordinary gains and losses, thereby avoiding the capital-loss limitation and wash-sale loss adjustments on securities (i.e., tax-loss insurance). Furthermore, the 20% pass-through deduction on qualified business income subject to taxable income limitations applies to Section 475 income. (Read Consider 475 Election By Tax Deadline To Save Thousands and How To Become Eligible For Trader Tax Status Benefits.)

Tip 6: File when it’s more convenient for you
Sophisticated and wealthy taxpayers know the “real” tax deadline is Oct. 15, 2018, for individuals and Sept. 17, 2018, for pass-through entities, including partnership and S-Corp tax returns. Pass-through entities file tax extensions by March 15, 2018. (See March 15 Is Tax Deadline For S-Corp And Partnership Extensions And Elections.)

You don’t have to wait until the last few days of the extension period like most wealthy taxpayers. Try to file your tax return in the summer months.

Tip 7: Be conservative with tax payments
I’ve always advised clients to be aggressive but legal with tax-return filings and look conservative with cash (tax money). Impress the IRS with your patience on overpayment credits and demonstrate you’re not hungry and perhaps overly aggressive to generate tax refunds. It’s a wise strategy for traders to apply overpayment credits toward estimated taxes owed on current-year trading income. You want to look like you’re going to be successful in the current tax year.

The additional time helps build tax positions like qualification for trader tax status in 2017 and 2018. It may open opportunities for new ideas on tax savings. A rushed return does not. For example, a significant trading gain or loss during the summer of 2018 could affect some decision-making about your 2017 tax return.

Tip 8: Get more time to fund qualified retirement plans
The extension also pushes back the deadline for paying money into qualified retirement plans including a Solo 401(k), SEP IRA and defined benefit plan. The deadline for 2017 IRA contributions is April 17, 2018. If you did a Roth IRA conversion in 2017, the extension adds six months of time to recharacterize (unwind) the conversion. That may come in handy if the stock market drops in Q2 and Q3 2018.

Tip 9: Respect the policies of your accountants
Your accountant can prepare extension forms quickly for a nominal additional cost related to that job. There are no fees from the IRS or state for filing extensions. Be sure to give your accountant tax information received and estimates for missing data.

Your accountant begins your tax compliance (preparation) engagement, and he or she cuts it off when seeing a solid draft to use for extension filing purposes. Your accountant will wait for final tax information to arrive after April 17, 2018. Think of the extension as a half-time break. It’s not procrastination; accountants want tax returns finished.

Please don’t overwhelm your tax preparer the last few weeks and days before April 17 with minor details in a rush to file a complete tax return. Accounting firms with high standards of quality have internal deadlines for receiving tax information for completing tax returns. It’s unwise to pressure your accountant, which could lead to mistakes or oversights in a rush to file a complete return at the last minute. That doesn’t serve anyone well.

Tip 10: Securities traders should focus on trade accounting
It doesn’t matter if your capital loss is $50,000 or $75,000 at extension time: Either way, you’ll be reporting a capital loss limitation of $3,000 against other income. In this case, don’t get bogged down with trade accounting and reconciliation with Form 1099Bs until after April 17. The capital loss carryover impacts your decision to elect Section 475 MTM for 2018 by April 17, 2018, but an estimate is sufficient.

Consider wash-sale loss rules on securities: If you know these adjustments won’t change your $3,000 capital loss limitation, you can proceed with your extension filing. But if you suspect wash-sale loss adjustments could lead to reporting capital gains rather than losses, or if you aren’t sure of your capital gains amount, focus your efforts on trade accounting before April 17. (Consider our trade accounting service.)

Section 1256 contract traders can rely on the one-page 1099B showing aggregate profit or loss. Forex traders can depend on the broker’s online tax reports. Wash sales don’t apply to Section 1256 contracts and forex. Cryptocurrency traders should use coin trade accounting programs to generate Form 8949.

Tip 11: Don’t overlook state extensions and payments
Some states don’t require an automatic extension for overpaid returns; they accept the federal extension. If you owe state taxes, you need to file a state extension with payment. States tend to be less accommodating than the IRS in abating penalties, so it’s usually wise to cover your state taxes first if you’re short on cash. Check the extension rules in your state.

Tip 12: U.S. residents abroad should learn the particular rules
U.S. citizens or aliens residing overseas are allowed an automatic two-month extension until June 15, 2018, to file their tax return and pay any amount due without requesting an extension. (See Form 4868 page 2, and the IRS website.)

Bonus Tip: FinCEN grants permanent automatic extensions for FBARs
Over a year ago, “The Treasury Department’s Financial Crimes Enforcement Network (FinCEN) announced that, to implement the new due date for FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), of April 15 (April 18 for 2017), it will automatically grant all taxpayers filing the form a six-month extension every year to Oct. 15 (which will be Oct. 16, 2017, because Oct. 15 is a Sunday). FinCEN explained that this six-month extension will be automatic each year and that taxpayers do not have to request extensions,” per Journal of Accountancy.

Cryptocurrency (coin) is not currency; the IRS labels it “intangible property.” IRS flow charts for what’s reportable on FBAR and or Form 8938 (Statement of Foreign Financial Assets) indicate that intangible property is not reportable on those forms. Some tax attorneys suggest including cryptocurrency held on foreign coin exchanges on FBAR forms to play it safe. FinCEN officials said they are not expecting to see cryptocurrency (“virtual currency”) reported on FBARs for 2017. If a U.S. resident sells cryptocurrency for currency and holds that currency on a foreign coin exchange, that currency is reportable on FBAR. FinCEN recently raised its significant penalty amounts for failure to file FBAR to keep pace with inflation.

 

 

 


March 15 Is Tax Deadline For S-Corp And Partnership Extensions And Elections

March 3, 2018 | By: Robert A. Green, CPA | Read it on

March 15, 2018, is the deadline for filing 2017 S-Corp and partnership tax returns, or extensions, 2018 S-Corp elections, and 2018 Section 475 elections. Don’t miss any of these tax filings or elections; it could cost you.

2017 S-Corp and partnership tax extensions
Extensions are easy to prepare and e-file for S-Corps and partnerships since they pass through income and loss to the owner, usually an individual. Pass-through entities are tax-filers, but not taxpayers. 2017 individual and calendar-year C-Corp tax returns or extensions with taxes owed are due April 17, 2018.

Some states have S-Corp franchise taxes, excise taxes, or minimum taxes, and payments are usually due with the extensions by March 15.  LLCs filing as a partnership may have minimum taxes or annual reports due with the extension by March 15.

2017 S-Corp and partnership extensions give six additional months to file a tax return, by Sep. 17, 2018.

The IRS late filing penalty regime for S-Corps and partnerships is similar. The IRS assesses $200 per owner, per month, for a maximum of 12 months. Taxpayers may request penalty abatement based on reasonable cause. Ignoring the extension deadline is not reasonable cause. There is also a $260 penalty for failure to furnish a Schedule K-1 to an owner on time, and the penalty is higher if intentionally disregarded. States assess penalties and interest, often based on payments due.

2018 S-Corp elections
Traders qualifying for trader tax status and interested in employee benefit plan deductions, including health insurance and retirement plan deductions, probably need an S-Corp. They should consider a 2018 S-Corp election for an existing trading entity, due by March 15, 2018, or form a new entity and file an S-Corp election within 75 days of inception. Most states accept the federal S-Corp election, but a few states do not; they require a separate S-Corp election filing by March 15. If you overlooked filing a 2017 S-Corp election by March 15, 2017 and intended to elect S-Corp tax treatment as of that date, you may qualify for IRS relief. (See Late Election Relief.)

2018 Section 475 MTM elections for S-Corps and partnerships
Traders, eligible for trader tax status, should consider attaching a 2018 Section 475 election statement to their 2017 tax return or extension due by March 15, 2018, for partnerships and S-Corps, or by April 17, for individuals and corporations. Section 475 turns capital gains and losses into ordinary gains and losses thereby avoiding the capital loss limitation and wash sale loss adjustments (tax loss insurance). There are also benefits to 475 income: The 20% pass-through deduction on qualified business income subject to taxable income limitations. (Read Consider 475 Election By Tax Deadline To Save Thousands.)

If a trader wants to revoke a prior year Section 475 election, a revocation election statement is due by March 15, 2018. (See New IRS Rules Allow Free And Easy Section 475 Revocation.)

Tax compliance services
Green, Neuschwander & Manning LLC offers tax compliance services to traders, which include tax preparation and tax planning. If you haven’t signed up yet for our entity and individual service, do so immediately, so we can prepare your extensions and consider the above elections on time. Alternatively, discuss the above matters with Robert A. Green, CPA in a consultation.

 


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