Tax compliance is complex for traders with lots of different tax forms.
The IRS uses multiple tax forms for trading businesses eligible for trader tax status (TTS). It can be confusing to taxpayers, accountants, and the IRS. Traders enter gains and losses, portfolio income, and business expenses in various tax forms. Which tax form or schedule should a forex trader use? It depends on their circ*mstances. Which form is correct for securities traders using the Section 475 MTM method? Can trading gains be reported directly on Schedule C? The different reporting strategies for the various types of traders make tax time not so cut and dry.
SOLE PROPRIETOR TRADING BUSINESS
Most sole proprietorship businesses report revenue, cost of goods sold, and expenses on Schedule C. However, business traders qualifying for TTS report only trading business expenses on Schedule C. Trading gains and losses are reported in other tax forms, depending on the situation. They can consolidate trading gains, losses, and business expenses on an entity tax return — a partnership Form 1065 or S-Corp Form 1120-S.
Sales of securities for each trade (no summary reporting) are reported on Form 8949, which feeds into Schedule D (cash method) with capital losses limited to $3,000 per year against ordinary income (the rest is a capital loss carryover). Capital losses are unlimited against capital gains. (We cover Form 8949 in Chapter 4.)
TTS traders who elect and use Section 475 MTM on securities report each securities trade on Form 4797 Part II. MTM means open securities trades are marked-to-market at year-end prices. Traders still report sales of segregated investments in securities (without MTM) on Form 8949 and Schedule D. Form 4797 Part II receives ordinary gain or loss treatment, avoiding the capital loss limitation and wash-sale loss rules. Net operating loss (NOL) calculations include Form 4797 losses that cause negative taxable income. The 20% qualified business income (QBI) deduction includes Section 475 gains and excludes capital gains and portfolio income.
Section 1256 contract traders (i.e., futures) should use Form 6781 (but if they elected Section 475 for commodities/futures, they should report them on Form 4797). Section 1256 traders don’t use Form 8949 — they rely on a one-page Form 1099-B showing their net trading gain or loss (“aggregate profit or loss on contracts”). The futures gain loss amount is shown in summary format on Form 6781 Part I.
If the trader has a significant Section 1256 loss, they should consider carrying back the loss three tax years but only apply it against Section 1256 gains in those years. To make this election, check box D labeled “Net section 1256 contracts loss election” on the top of Form 6781 filed on a timely basis.
Spot forex traders with Section 988 ordinary gains or losses who don’t qualify for TTS should use line 8(z) (other income or loss) on 2023 Schedule 1 (Form 1040). TTS traders should use Form 4797, Part II, ordinary gain or loss. What’s the difference? Form 4797 Part II losses contribute to NOL carryforwards against any income, whereas Form 1040’s “other losses” do not. With a capital gains election to opt out of Section 988, use Form 8949 for minor currencies and Form 6781 for major currency pairs (under Section 1256(g). Forex uses summary reporting. (We cover forex tax treatment in Chapter 3 and forex accounting treatment in Chapter 4.)
For sales of cryptocurrencies, use Form 8949, but not wash sales or Section 475 MTM.
For more information, see Green’s Trader Tax Guide. See Chapter 6 onTrader Tax Return Reporting Strategies.
