Disclaimer from Hartmann & Company Inc.

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1 Disclaimer from Hartmann & Company Inc. The following seminar is being provided for educational and informational purposes only. Information delivered by Hartmann & Company Inc. does not constitute specific tax advice. You are solely responsible for your tax reporting decisions, and you should carefully evaluate all information delivered to you by Hartmann & Company Inc. Please consult your tax consultant to discuss your specific situation.

2 Disclaimer from our Host Traders Library (TL) assumes no responsibility for errors, inaccuracies or omissions i in these materials. il They do not warrant the accuracy or completeness of the information, text, graphics, links or other items contained within these materials. OTA shall not be liable for any special, indirect, incidental, orconsequential damages, including andwithout limitation to losses, lost revenues or lost profits that may result from these materials. TL does not provide tax advice and no portion of this presentation should be so construed. Our host has no obligation nor liability relating to or derived dfrom any tax, penalty or related dinterest charge assessed against a taxpayer or any return preparer.

3 Speaker Bio: Harold (Buddy) Hartmann Harold (Buddy) Hartmann is the CEO and founder of Hartmann & Company Inc. His firm specializes in trader and investor taxation. Mr. Hartmann is a frequent lecturer on trader taxation and has been working in the trader tax arena since 1997 and has extensive experience in the areas of trader planning, entity formation, and IRS & state exams at all levels, as well as preparation of thousands of traders tax returns. His firm has trader clients in most states across the US.

4 Why use a trader tax CPA? What is tradertaxtax status? What are wash sales? Do they apply to me? What h is Mark to Market k method of accounting? How are Futures treated? How are Forex treated?

5 Trader Taxology Overview: The basis for understanding trader taxation; Step 1 Trader status = tax saving$ Step 2 Types of trader s and their taxation Step 3 Method s of accounting for your trading business Step 4 Entity evaluation Keep it simple? Step 5 Retirement planning. Step6 2011Trader developments

6 Trader s Tax Coach Session: The basis for understanding trader taxation; #1 Trader status #4 Entities #2 Trader disciplines #5 Fringe benefits #3 Methods of accounting #6 Retirement planning

7 #1 - Trader Tax Status Trader Status Trader Investor

8 Step #1 Trader tax status: Benefits of qualifying for trader tax status (business status vs. normal investor status)? Rising to a business status provides a trader the ability to write off and deduct all of your ordinary & necessary business deductions associated with your trading business including; trader specific home office education start up expenses & organizational expenses (entities) margin interest and much more

9 Step #1 Trader tax status: continued Fixed assets Current year and prior years contributed to the business Leasing equipment Communications telephone direct, cell phone partial, fax lines, etc. Cable TV business % DSL, T 1, Dial up back up, etc. mixed use only a % Office supplies Rent or home office % Legal and professional fees your national trader tax guy! Advertising Consultingfor computer programmers, mentors, research specialists, etc. (do not forget your 1099 Misc. over $600). Employees we ll discuss later Software Website set up, maintenance, etc. Many more!!

10 Step #1 Trader tax status: - continued This is compared to the treatment an investor incurs. Investment expenses are; extremely limited in nature only allowed in excess of 2% of your Adjusted Gross Income (AGI) are an add back when computing AMTI meaning they are not deductible at all against the Alternative Minimum Tax (AMT). Investment interest deductible on Schedule A limited. Annual $3,000 capital loss deduction limit and wash sales apply.

11 Investor status Trader status No deductions? Tax savings!!!

12 Trader Tax Status Trader Trader Status Investor IRS Code Guidance Precedents

13 IRS Guidance

14 Trader Tax Status Trader Trader Status Investor IRS Code Guidance Precedents Qualifications Characteristics Trades

15 Qualifying for Trader Tax Status Step #1: The Federal Tax Courts have used the following factors to determine trader status. In order to rise to trader status a business trader should meet all if not most of the following qualifications; Taxpayers investment intent. Nature of income derived from the trading activity. Frequency, extent, and regularity of the trader s security transactions. The Tax courts have stated that in order to be a trader you must meet these 2 vital characteristics before taking into account all other characteristics; The trader s activity must be substantial & the trader seeks to profit form short term swings in the market rather than LT appreciation of holding securities. So what qualifies?

16 Qualifying for Trader Tax Status Continued: Grey area IRS provides only characteristics of a trader. In order to rise to trader status a business trader should meet all if not most of the following qualifications: Trades full time or part time on most available trading days. Requisite time of hours per week, this includes trading, administrative, research, and accounting. Continuous & Regular Sporadic trading is a no no allowable days? A long lapse in trading? Substantial The IRS does not provide a defining # of trades. Continued..

17 Qualifying for Trader Tax Status continued Trading style? Investments segregated? More in Step #6! Other typical characteristics Intent to profit (hobby), separate books, tools and capital infusion. Atlik Act like a business trading business plans go along way! Trader journal. The IRS pattern of trading review Be aware of this pattern. 75% of trading days available. Trader status tt is applied if you meet these characteristics, ti if your trading is less than this without good reason you may jeopardize trader status. Not an election! You can apply after the fact even amend. Consult with trader tax expert if unsure.

18 Trader tax status default reporting Sole proprietor Form 1040 Schedule C reporting. Cash basis accounting capital gain and loss. Wash sale rules apply. No earned income. No asset protection. Medical Sch A limited to 7.5% of your AGI. Limited i start up expenses. Higher IRS scrutiny.

19 #3 Trader s Disciplines Equities Trader s Disciplines Futures Forex

20 Trader Taxation - Disciplines Capital Odi Ordinary Trader Taxation

21 Trader Taxation Capital Ordinary Equities Commodities Forex

22 Step #2 Types of Trader s and their taxation Trader taxation depends on the discipline your are trading; Capital gain taxed at ordinary rates and loss subject to 3K limits. Ordinary taxed at ordinary rate and no limitations i i on business losses. Equities and Forex traders Ordinary is preferred in most cases we will discuss further. Equities & Options 2 types Cash basis (default is capital gain) and Mark To Market (ordinary). Commodities (futures) 2 types Cash basis (default is capital gain lower blended rate) and Mark To Market (ordinary) (under certain planning opportunities only). Forex (currencies) 2 types default is Ordinary and Capital gain lower blended rate (election under section 988)

23 Forex treatment t Capital vs. Ordinary r Step #2: Currency trading 3 types of tax treatment Forex (OTC) options Capital gain treatment. Foreign Currency Futures contracts Sec treatment. Forex (foreign exchange interbank) contracts Sec. 988 treatment

24 Trader s Disciplines & Taxation Equities Capital MTM Trader s Disciplines Futures Sec Ordinary Forex Ordinary Sec. 1256

25 #3 Trader s s Methods of Accounting Equities Capital MTM Methods of Accounting Futures Sec MTM Forex Ordinary Sec. 1256

26 Step #3 Types of trader s and their method of accounting Discipline Equities Futures Forex Default status: Capital gain/loss ST ordinary rate Capital gain/loss 60/40 split Ordinary ST ordinary rate Election: Proactive/Internal Proactive/Internal Internal only! IRC Code section: Elected status: Ordinary Ordinary Capital gain/loss 60/40 split When to pull the trigger: A must unless Tax planning Depends

27 IRC 475 Mark-to-market accounting is tax loss insurance Step #3: What is it? We want to clarify it is a method of accounting you can apply only if you do qualify for trader status STEP#1. MTM is a must for equities traders unless?? MTM Short term gains are treated the same as any other cash basis trader or investor taxed as a short term trading gain at your prevailing income tax rate no difference sowhybother? Futures traders definitely not a must? Tax planning opportunities.

28 The only reason you would not elect it! step #3 continued Status: Capital Capital Elected MTM Trading gain: $ 30,000 $ 30,000 Capital loss: $ 33 33,000 $ 30 30, Taxation??? $ 3,000 None! All of it Remember Capital loss only offsets Capital gain! MTM election turns your Income into Ordinary income.

29 Step #3 - IRC 475 MTM election procedures: MTM governed by IRC Sec 475 (f) has three steps involved in the election, if you miss any of these steps there is very good chance MTM will not be granted by the IRS. 1st step File election 2nd step Application in current year. 3rd step File form 3115 Application for Change in Accounting Method with an IRC Sec. 481 [a] adjustment, if applicable. MTM also exempts traders from wash sales and can ease the burden of year end reporting. New taxpayer equals tax planning.

30 Step 3 Forex IRC 988 Ordinary 1 st! Internal Revenue Code Section 988 governs Forex trading. Sec. 988 provides Ordinary income treatment from day 1. Traders have the availability to elect out of Sec. 988 for a equivalent treatment of a Sec future contract blended preferable rate. The election is internal and must be Contemporaneous.

31 Net operating losses (NOL): If a trader has negative business income i.e. trading losses & trading expenses creating negative taxable income they have 2 choices; Easiest & Safest Carry forward and apply. Instant gratification Carryback. Remember cash basis traders no carry back 3K and then only offset against future capital gains. Commodities traders Carryback (IRC Sec 1256). Non business (non trader status) Forex traders need to be aware if they ( ) y have large losses!

32 #4 Trading Entities General Partnership C Corporation Entities LLC S Corporation Keep it simple Unless!

33 Trader income earned vs. unearned: Earned income is subject to Self employment taxes (SE tax). SE tax is made up of Fica 5.2% and Medicare 2.45% which totals The Employer pays 7.65 and the employee pays 7.65%. Trading income is not subject to SE tax, therefore on trading gains up to $106,800 you do not pay 15.3% in SE tax on this amount. Fica is capped at the $106,800 (2011 and will rise in future years) and Medicare is uncapped. This is a savings of over $16,000. That is a fantastic benefit that Congress has provided but now you want to deduct your SE Medical premiums and you want to contribute to a retirement plan you cannot do it as a sole proprietor. Only earned income subject to SE tax will qualify for your medical and retirement. How do we create earned income in order to unlock additional trader benefits?

34 Earned Income Comparison Consultant Trader Self employment tax Not subjected to S/E tax Additional tax $15,300 Additional Tax $0

35 Keep it simple, Unless: How do I structure my trading business so I can optimize my tax savings? By default you will be a sole proprietor so Entity or no entity? Major benefits of a trading entity Retirement planning and Medical expenses. Other benefits we will discuss in a moment. Sole proprietor Versus Entity formation The need for earned income? Trading entities We prefer flow through entities, i.e. LLC, H/W Partnership, S corp. The exact trading entity depends on your facts and circumstances, it also depends on the state you live in. ONE size does not fit all.

36 Entities Other benefits Spouse Children Creating earned income IRS Exams New Taxpayer MTM Limited Liability

37 Keep it simple, Unless (continued) : My preferred entity a Limited Liability Company (LLC). Key advantages of an LLC: a. Limited liability. b. Flexibility of special allocations (must have substantial economic effect). c.compensation of Member s Vital to providing the needed earned income for retirement and SE medical insurance premiums. Key disadvantage Non taxable fringe benefits not available to member s or rephrase available but ttaxable to member. i.e. coverage under accident and health plan, group term life insurance, disability insurance, cafeteria plans, etc. a. These non taxable fringes are afforded via a C corporation. b. Why I do not use C corps' in most of my tax planning for beginning gand intermediate trader s. Keep it simple! Unless

38 #5 Sec. 105 MERP Employee Business Entity Benefit Plan How to Qualify Proprietorship Hire Spouse Partnership S Corporation C Corporation Hire Spouse (if <5% owner) >2% Shareholders ineligible Hire Self

39 Non discrimination rules Nondiscrimination: Must cover all eligible employees However, you can exclude: Under age25 less than 35 hours/week less than 9 months/year less than 3 years service Controlled group rules Affiliated service groups

40 Trader Benefit s Reimburse medical expenses incurred for: self spouse dependents Not subject to 7.5% floor Avoid self employment l ttax Supplement spouse s coverage

41 Eligible Expenses Major medical, LTC, Medicare, Medigap Co pays, py, deductibles, prescriptions p Dental, vision, and chiropractic Braces, LASIK, fertility, special schools Nonprescription medications (by prescription)

42 The required steps Written plan document Benefits are reasonable compensation Verify bona fide employment Document payments py Certification

43 Health Savings Account 1. High deductible health plan $1,200+ Min deductible (individual coverage) $2,400+ Min deductible (family coverage) Plus 2. Tax deductible Health Savings Account Contribute/deduct up to $3,050/$6,150 (2011) per year Account grows tax free Tax free withdrawals for qualified expenses

44 HSA Expenses Major medical, LTC, Medicare, Medigap Co pays, deductibles, prescriptions Dental, vision, and chiropractic Braces, fertility treatments, special schools

45 #6 - Retirement Planning: Again one size does not fit all but this one is close. Depending factor is age. 50 and above we can look at 2 different plans to see what will yield the best tax benefit Solo 401(K) plan vs. Solo defined benefit plan. There are many more retirement plan s. The best all around retirement plan for most traders will be a Mini/Solo 401(K) plan with an attached profitsharingplan plan for maximizingtax deductions versus earned income why? Elective deferral 2009 limit is $16,500 under age 50, over 50 years of age add on $5,500 in 401(K) plans for The reason the Mini 401(K) is more powerful than the SEP or Simple? $ for $ example. Planning twist Roth elective deferral s very powerful tool and why I use it with my traders?

46 Defined contribution plan comparison Mini 401K SEP Elective deferral 16.5K $ for $ Profit sharing.20/$.20/$ on all earned income Catch up on elective deferral No catch up provision

47 S.E.P. 401K 1 Net profit form Self employment 53,803 10, /2 of the self employment tax (3,801) (760) 3 Subtract line 1 form 2 50,002 10,000 4 Self employed rate as a decimal 20.00% 20.00% 5 Multiply line 3 by line 4 10,000 2,000 6 Multiply $245,000 by your plan contribution rate 61,250 61,250 7 Enter the smaller of line 5 or line 6 10,000 2,000 8 Contribution dollar limit 49,000 49,000 9 Allowable elelctive deferrals - 10, Subtract line 9 form 8-39, Subtract line 9 form 3-12 Enter 1/2 of line Enter the smallest of line 7,10, or Subtract line 13 form 3 10, Enter the esmaller of line e9o or line 14 10,000 SEP - maximum $ 10,000 Add lines 13 and 15 Elective deferral only! $ 10,000 Total SE tax impact $ 7,602 $ 1,520 Tax 35% $ 3,500 $ 3,500 Do not forget the regular tax rate bite - higher income with the SEP!

48 Ultimate retirement plan Cash Balance plan Mini/Solo 401K is awesome but supercharge it! For the right trader s only. Hybrid plan Defined contribution (401K and Profit sharing)plus a defined benefit component. $16,500 ($5,500 catch up), $49,000 profit sharing, $195, Years old $80K+, 50 Years old $131K+, 60 Years old $218K+

49 New Cost basis regulations A must know for my traders! The Emergency Economic Stabilization Act of 2008 contains new requirements for brokerage firms and mutual fund companies regarding customer statements and Internal Revenue Service reporting. What is the required reporting? How does this effect my traders? Future disciplines effected? Read it at my blog page.

50 Services: Hartmann & Company Inc Trader tax planning trader status, MTM, etc. Trader entity structuring & formation Trader tax accounting Trader tax preparation Trader tax retirement planning & formation Trader tax IRS & state exam consulting And much more..

51 Hartmann & Company Inc. We are a brick and mortar accounting firm located in beautiful Madison, CT All trader tax returns are completed on premises and overseen directly by your Trader s Tax Coach Harold (Buddy) Hartmann

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53 Questions