I recently had a Day Trading for Dummies reader ask me about the tax effects of an equity options strategy that he was using. His broker was not giving him a clear answer, and that’s not a surprise – derivatives are taxed differently than stocks and bonds, which is part of their appeal for day traders. However, this means that you can be in the dark until the day you get an unpleasant letter from the IRS.
The IRS has a publication on investment taxes and expenses, and it’s definitive. It’s so definitive that it can be hard to find anything, which makes it hard to use.
And so, I sent the reader to a tax guide for investors put out by the Chicago Board Options Exchange, which explains the IRS regulations in a way that makes sense to options traders. I highly recommend it if this is you.
Day traders can easily be undone by tax issues. The federal government’s tax policy is designed to maximize revenue (natch) but also to promote economic growth. The speculation that traders do helps make for healthy, liquid financial markets, but it doesn’t really support the kind of sustainable growth that leads to job creation and other economic benefits. Because of that, the tax code has some loopholes that can penalize day traders.
If you are going to day trade, do some research on the tax effects of your desired strategies, making sure to pay attention to the wash-sale rules and limits on deductions of short-term capital losses. You want to be smart about it.
