Oct 21, 2023
Written by:
Al Hill
Taxes are the elephant in the room when it comes to day trading. Everybody wants to tout large PNL gains made over a short amount of time, but nobody wants to admit that a large portion of those gains are lost to taxes. Whether you are an active, full-time day trader or someone who just makes a few trades per year, taxes can have a direct impact on your gains.
Unless you are trading from a non-taxable account like a ROTH IRA, you will have to report all of your capital gains and losses to the IRS once tax season comes around. Unsure of how your trading activities are taxes? It’s time to learn exactly how day trading is taxed and how it could affect the way you trade.
Day trading in its traditional definition is not tax-free. Unless you are doing your day trading from a non-taxable account, then any day trading you do is subject to capital gains taxes, just like any other form of trading. It doesn't matter if you are day trading stocks, ETFs, or even options contracts, any capital gains you record need to be reported and you can fully expect to be taxed on those gains.
It sure does! Simply by the nature of day trading itself, traders will find themselves subject to the higher tax rates from short-term capital gains. Of course, day trading provides ample opportunities to potentially make more gains during each and every trading session. The sheer volume of trades that a day trader makes compared to a long-term investor allows for the opportunity to make a far larger profit in a shorter amount of time. Just be prepared to pay the tax man when the time comes!
Yes, day traders are taxed differently from long-term investors. However, day traders do not have a specific tax bracket. Any trader that buys and sells the same asset within one calendar year will be taxed as short-term capital gains. You can be a day trader, a swing trader, or a scalp trader. As long as you sell that asset within a year from when you bought it, you will be subject to what is called short-term capital gains taxes.
Short-term capital gains are taxed at a higher rate than long-term capital gains. Why do you have to hold an investment for a year to get the lower tax rate? It’s probably a way for the government to promote long-term investing. Short-term capital gains are generally treated like income whereas long-term capital gains are seen as asset appreciation. Here is a chart to show the basic differences in a short-term or long-term capital gains investment.
|
Gross Annual Income |
Long-Term Tax Rate |
Short-term/Regular Tax Rate |
|
Up to $9,325 |
0% |
10% |
|
$9,326 to $37,950 |
0% |
15% |
|
$37,951 to $91,900 |
15% |
25% |
|
$91,901 to $191,650 |
15% |
28% |
|
$191,651 to $416,700 |
15% |
33% |
|
$416,701 to $418,400 |
15% |
35% |
|
$418,401 or more |
20% |
39.6% |
Source: https://www.benzinga.com/money/day-trading-taxes
You can see how differently investments are taxed when they are held for less than a year. When it gets to the highest brackets, the tax rate is nearly double that of the long-term tax rate. If you are a successful day trader, you still might need to think about whether or not it is worth it for you to pay all of those taxes each year.
For day traders taxes are simple: since you are likely not holding these stocks for more than a year, you will undoubtedly be subject to short-term capital gains tax rates. No matter how successful you are at day trading, you should always take into account the taxes that will be taken off of your total gains.
Your tax rate as a day trader depends on how much money you make from trading in a given year. Since it is taxed by the short-term capital gains rate, day trading profits are treated the same as income from employment. Here is a quick table to show you the short-term capital gains tax rates for 2022 for "Single" filers:
|
Tax rate |
Taxable income bracket |
Tax owed |
|---|---|---|
|
10% |
$0 to $10,275 |
10% of taxable income |
|
12% |
$10,276 to $41,775 |
$1,027.50 plus 12% of the amount over $10,275 |
|
22% |
$41,776 to $89,075 |
$4,807.50 plus 22% of the amount over $41,775 |
|
24% |
$89,076 to $170,050 |
$15,213.50 plus 24% of the amount over $89,075 |
|
32% |
$170,051 to $215,950 |
$34,647.50 plus 32% of the amount over $170,050 |
|
35% |
$215,951 to $539,900 |
$49,335.50 plus 35% of the amount over $215,950 |
|
37% |
$539,901 or more |
$162,718 plus 37% of the amount over $539,900 |
Source: https://www.nerdwallet.com/article/taxes/federal-income-tax-brackets
The general rule of thumb is that day trading is taxed at the same rate as employment income. This means that you will pay a certain percentage of taxes on short-term capital gains depending on your income level. This will vary depending on how you file: single, married - filing jointly, married filing separately, or head of household.
When it comes to your day trading taxes, you are able to reduce your short-term capital losses from your short-term capital gains. This means that you can deduct capital losses from taxes every year. The downside is that you can only deduct a total of $3,000 per year. The exception to this is if you are married and filing separately in which case you are only able to deduct $1,500 each.
If you have losses that exceed $3,000 they cannot be claimed and will simply be rolled forward to your taxes as just normal losses. There are exceptions to this rule if you qualify as marked-to-market or have Trader Tax Status.
The mark-to-market rule is an interesting exception to the short-term capital gains taxes. Traders that invoke this rule are seeking to claim more than the allotted $3,000 in capital losses on their income tax. On April 15th of the previous tax year, traders must make an election to the IRS. This election, if granted by the IRS, permits you to count the total of your capital gains or losses as business property. This allows you to report more losses as business costs rather than living costs.
You might often hear of this as mark-to-market accounting. This is a method of accounting that adjusts the value of an investment to its current market price. In terms of taxes or accounting, this means that the fair value of the asset or investment is its market price at the end of the year.
The Trader Tax Status designation is given to traders who trade for more than 30 hours per week and make an average of 4 to 5 trades per day for most of the tax year. It is essentially claiming that day trading is your business and allows you to qualify for tax efficiency on your capital gains.
But be warned, just because you follow those criteria, it doesn’t mean you are automatically given this status. The IRS has to deem that you are eligible for Trader Tax Status. Some of the tax benefits include claiming your trading income and liabilities as a business expense, as well as writing off costs like computer hardware and other home office expenses.
Believe it or not, each State has different capital gains tax rates. Depending on where you live in the US, you might be paying more or less on your capital gains.
Here are ten of the best states to live in for day traders because they have no income tax or capital gains taxes:
Some states are not as lenient on taxes for day traders. Here are ten states that have high capital gains taxes for day traders:
Source: https://worldpopulationreview.com/state-rankings/capital-gains-tax-by-state
Canada has a similar system to the US. If you are not a day trader, then 50% of your capital gains are taxable at your marginal income tax rate. If you do become a day trader, then your income and losses would be business expenses, just like in the US. However, you'll have to maintain receipts and make typical deductions as you normally would. When you are a professional, 100% of your capital gains are taxable, but so are 100% of your losses. Just as in the US, you can also claim expenses to do with your business of trading.
In Dubai, day trading is an extremely popular way of earning income. Incredibly, the UAE is completely free of personal income taxes, so you may not have to pay any taxes on your capital gains from day trading. You also do not pay any taxes on things like food or other staples you need to live. Dubai is one of the world’s wealthiest cities and is an extremely popular destination for traders.
Another country that is similar to the UAE is Singapore. The wealthy Asian country has no taxes on capital gains or losses. However, the frequency and purpose of your buying and selling may trigger capital gains tax with the Singapore IRAS depending on the nature of business income. You would need to check with a local Singapore accountant to determine your day trading tax status. Other known tax havens for day traders include Switzerland and the Cayman Islands. Puerto Rico is also a popular tax haven for US-based day traders.
FIling your taxes as a day trader can be a real drag. Not only is it time consuming to track all of your trades for the year, but it is easy to make a miscalculation or error. Enter the CPA, a Certified Public Accountant firm that will do your difficult calculations for you! Here are three of the best CPAs for day traders filing their taxes.
Traders Accounting is an online accounting business that specifically helps day traders and active traders manage and file their income taxes. The firm will take care of any income tax requests including personal 1040s, 1099s, 1120s, and much more. Traders Accounting will even help you establish an LLC or C-Corporation if you want to turn your trading into an actual business. Other services include estate planning, bookkeeping, and business expense tracking. Traders Accounting offers a free consultation for interested new users.
Green Trader Tax is a popular site used by day traders for anything related to taxes. Green puts out a book called the Trader’s Tax Guide for each specific tax year. These can be purchased from the site or from other places like Amazon. Green’s will help traders with any form of taxes including foreign exchange, cryptocurrencies, and of course, day trading. The company offers full tax services for traders as well as consulting, accounting services, and IRS and State Tax representation.
Trader Tax CPA provides consulting and compliance services for active day traders. It is a cloud-based CPA firm that offers services such as tax compliance and preparation, trader consulting, accounting, payroll services, and even IRS representation. Trader Tax CPA is one of the more well-known and established online CPAs for day traders in the US.
Do you still want to save some expenses and figure out your day trading taxes yourself? No problem! Here’s one platform that allows you to do everything on your own!
The TradeLog software allows you to keep track of your own day trading activities across all of your brokerage accounts in one platform. It’s a simple spreadsheet format that is easy to learn and use. Even if you find you don’t have the time to do it yourself, TradeLog offers turnkey solutions so you can focus on trading. The cost ranges from $109 to $350 per year for a subscription, which is much cheaper than going through a CPA firm if you're more of a do-it-yourself kind of day trader.
Robinhood users are subject to the same tax rules as any other brokerage in the US. The problem that some new retail traders are facing is getting involved in trading on Robinhood, is the IRS Wash Sale Rule. This is a rule that punishes frequent traders who continue to sell and buy the same stock. If you sell a position at a loss, and then rebuy it within the next 30 days, your capital loss will not count. This is how Robinhood traders who only traded meme stocks reported hundreds, even thousands of wash sales but with minimal real profits.
That being said, the same will affect any day trader on any platform. Day trading taxes are not different on Robinhood. All brokers will be similar. It's up to you to speak with an account or do your own research on your tax liabilities before getting too involved with day trading.
If you think cryptocurrencies are not taxable because they are decentralized, think again. Day trading in cryptos has the same tax implications as equities. The IRS considers cryptos a property, so buying and selling them is a taxable event with capital gains implications. Anything that applies to stock trading, applies to crypto trading when it comes to your trading taxes. The high volatility of the crypto markets makes for some major swings in either direction. So, be aware that you'll have a tax liability on any of your crypto trades.
Day traders in the US are subject to taxes on any capital gains they make. Since a majority of these are going to be short-term capital gains, day traders are often taxed at a higher marginal rate. There are ways around this, like making day trading an actual business, in which case 100% of your gains or losses are taxed as business income. You can also increase your deductions by qualifying for mark-to-market accounting or Trader Tax Status.
Capital gains taxes can be a headache for day traders, and ultimately traders will need to determine if the profits from their day trading activities are worth it given the high tax rates. Be sure to reach out to a knowledgeable trader tax accountant before you get too deep into day trading.
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