Whether you are already trading or planning to trade, you should know from the start that you’ll have to deal with trading taxes. We will give you the run down on tax treatment for day traders.
Taxes are a nightmare for anyone, right? If they are horrible when you’re earning money, imagine if your trading year went bad? Or if you forget reporting your income?
If you ever did tax reporting, you know that it’s as hard as going back to college and answering a challenging exam on the first day. That’s why I’m committed to helping you learn some tax terminologies, and, especially, what are the tax treatment regional differences depending on where you are.
Tax treatment terminology for day traders
Every area has its own vocabulary.
Ask a guy what is baking, for example. His answer will never be “applying the translucent powder onto the hollows of your face, which will allow the foundation and concealer to set into the skin”.
This is because he never had to wear makeup before. There is no point in him learning what baking is.
However, YOU are learning to trade. So, you must know a few tax terminologies and, especially, tax treatment for day traders.
As the name implies, the earned income is the money you earn and make from your job – salaries, wages, bonuses, and tip.
However, in some places, day trading earnings aren’t considered to be earned incomes, which means you won’t have to pay the self-employment tax, but you also won’t contribute to social security.
If you want to become a full-time day trader and day trading isn’t considered a “job” in your country, you should start investing for retirement purposes because you’ll probably won’t be eligible for retirement benefits.
It’s the total income from investment property before any deductions.
The investment income usually doesn’t include net capital gains, which means that the majority of day traders won’t have a significant investment income for the taxes on day trading.
Besides the total income from the investment property, it also includes annuities, interest, dividends, and royalties.
The amount initially paid for a security, plus commissions.
As the name suggests, it’s the basis from which gains and losses are calculated.
If your value rises above the cost basis, you have generated a capital gain. If the position falls below the cost basis, there is a capital loss.
When you trade, you can sell a security and earn money from it. The value of this money is capital gain. Usually, you’ll pay taxes on the profits, especially if you held a position for less than a year. It will depend on your country and on the security you’ve bought.
Independent on if you’re trading long or short, you can have capital losses.
In many places, you’re able to deduct the capital losses from the capital gains you’ve earned the same year, which means your tax price will also be altered.
Another tax advantage is that you’re often able to write-off an additional amount, in the case of suffering more losses and gains in one year.
This is a probability for US traders – they are likely to run into the wash-sale rule at some point.
The wash sale happens when someone buys or sells a security at a loss, and within thirty days before or after the sale, she buys another “identical” security.
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Regional differences of tax treatment for traders
United Kingdom tax treatment for traders
The instrument is a significant factor for day trading tax treatment in the UK, but it isn’t the major one.
Spread betting and CFD trading, for example, are very similar margined products, but they are charged differently in the UK. Spread betting is a form of financial derivatives trading which the profits are typically exempted from capital gains tax and stamp duty – unlike CFD trading.
Several things will affect your taxes if you live in the UK, such as how you approach your trading activities, if you’re classed as a day trader or as an investor, and what are the variables that surround your transactions.
Your trading activity is considered when you’re taxed. The case law and regulations in the UK divide traders into:
- Speculative: Traders who trade through speculation – similar to gambling. In this category, the trader is free from business tax, income tax, and capital gains tax.
- Self-employed – If you consider trading as your job, you’re most likely to be taxed as a regular independent individual in the UK. You’ll have to pay business tax and/or the other obligations of those who fall under the third tax bracket.
- Private investor – In this category, the private investor’s gains and losses are taxed under the capital gains tax regime.
Day Trader x Investor
Trading and investing are two different things, and if you don’t know why, give a quick read in the How trading is different from investing in 5 minutes article.
Some criteria and factors that classify you into an investor or day trader are motivation and transactions. Her Majesty’s Revenue and Customs (HMRC) is the organ that makes this classification.
The motivation factor considers if the trades were mostly one-off or if there have been many trades of the same nature also carried out by ordinary traders (investing x trading).
HMRC also checks if trading is the person’s sole occupation or if they also have other employment (trading x investing), and also if the person reinvests their profits into more trading activities (trading).
The transaction factor considers how the person has acquired the shares (through purchasing or inheritance), the length of time between the purchase and sale, if the person sold the stock in an emergency, if there is evidence of a trading behaviour pattern, and more.
And in every country tax treatment for day traders is different – so here are the leading markets for you.
The United States of America trading tax treatment
Tax treatment can be very different depending on the country you reside on, with different variables that influence the taxes prices and ways to charge. However, all the countries have their ways to differentiate between trading and investing when the trading treatment is different.
In the US, for example, the Internal Revenue Service (IRS) also classifies day traders for taxation purposes.
The day trader for the IRS
The IRS classifies you as a day trader if you profit from the daily price movements of the securities you buy and sell, if your activity is substantial (at least four trades/day, 15/week or 60/month), and if you engage on the trading activity in a continuous basis.
They also check the period the trader holds the securities (if it’s less than 31 days), the time the trader devotes to the activity (executing at least one trade on at least 75% of available trading days of the year), if the trader lives from trading, and more.
If you are a US citizen or resident and fits in this description, you are probably considered as a day trader in the eyes of the IRS.
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Forex trading tax treatment
Forex market traders with a US brokerage firm, for example, can be charged under two tax regulations: The Internal Revenue Code (IRC), Section 1256, that taxes regular commodities, or the special rules of IRC Section 988 – also known as the Treatment of Certain Foreign Currency Transactions.
These rules only apply to residents and citizens of the US since foreigners don’t have to pay any taxes on foreign exchange profits.
Section 1256 – Regular commodities
This section offers an advantage for US forex traders over stock traders. Their capital gains report can be divided using a 60% / 40% split.
This means that 40% of their capital gains are taxed at the short-term capital gains rate, which depends on the trader‘s tax bracket (as high as 35%), and 60% of their capital gains are taxed at the long-term capital gains rate (currently 15%).
Section 988 – Interest income or expenses
The section 988, or Treatment of Certain Foreign Currency Transactions, is for US companies who profit for their Forex rates as part of their business – their gains and losses are considered as interest income and expenses.
Companies who fall under this section don’t receive the advantage of the 60% / 40% split. It is one nuance on tax treatment for day traders.
Canada taxation for traders
Just like in many countries, the tax treatment in Canada is a complicated thing.
However, it is a fair deal. If you understand where your trading activity falls into, you can quickly pay the taxes on your generated income by the end of the tax year (December 31st).
The tax treatment for trading in Canada is split into two brackets: the capital gains tax regime and the business income tax regime.
In Canada, there are two government-regulated investment options: the Registered Retirement Savings Plan (RRSP) and the Registered Retirement Income Fund (RRIF).
If you invest outside those two, your profits are probably treated as capital gains, which are taxed at just 50% of your marginal tax rate. But we should talk about trading, right?
Taxation of the capital gains is for longer-term and infrequent investments.
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Day traders fall under this category in Canada because they look to close out any positions by the end of the trading day to generate profit.
Since the day trader’s objective is to generate profit, she has to report her earnings as business income, which is fully taxable at the marginal rate.
The benefits of the business income tax regime are two.
The first is that you can deduct 100% your losses from your other sources of income, which reduces your tax liability. The second benefit is that you can claim expenses related to your trading activity – for example, you can present the receipts of a trading course you bought and the monthly internet bill – this also reduces tax liability.
Australia trader tax treatment
Australian trading tax treatment is as confusing as the others (if not more!).
Just like the other countries, taxes are very different between traders and investors.
The Australian Tax Office (ATO) uses the same classification method as the IRS and other taxation institutions to say if the person is a trader or investor.
Similar to Canada, Australia trading losses also can be deducted from any other assessable income and costs can be claimed for reduction of tax liability.
Instruments tax implications
If you’re into cryptocurrencies, you should know that this instrument in Australia is considered as a digital commodity, and not under the same definition as foreign currency.
The ATO recognizes that you don’t have to report this as an income yet, because you’ve simply swapped Australian dollars for a cryptocurrency.
ATO is more concerned in your profits, losses, and expenses rather than on the instrument you used to generate the income. Still, there is no tax-free trading in Australia, nor Forex, nor anything else.
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Singapore taxation for traders
The Inland Revenue Authority of Singapore (IRAS) also divides long-term investing from day trading, but the tax treatment is advantageous compared to other countries.
The day trading taxes are minimal, and in some cases, there are no taxes at all. For long-term investors, there are no taxes on dividend income or capital appreciation gains.
Although the tax treatment is fair, the Singaporean day trading taxes are not always explicit. The fees are based on the gains, but they vary from 0% for those earning up to S$20,000 and end at 22% for earnings above S$320,000.
It will depend on the local tax authority and some factors that will determine if the trading activity should be taxed. The elements are the volume of trades, the organization pattern of the trades, if trading is the person’s sole income, and the amount of money the trader disposes of for trading.
Like the Canadian business income tax regime, in Singapore day traders have the benefit of deducting relevant expenses from their taxes with the proper receipts and evidence at hand.
Conclusion on tax treatment for day traders
Independent on the country you’re in, you should always pay your taxes on time in the right way.
Always keep a record of the trading instruments you trade, the purchase and sale dates, the prices you purchased and sold, the number of shares, and your entry and exit points.
Near the end of the tax year, you’ll then be able to lie down and relax.
No matter where you live, Christmas and New Year celebrations can be used to spend time with your family and/or working to earn some extra cash for trading!
Also, if you still are unsure about what to do by the end of the tax year, I strongly recommend that you contact a tax advisor and the institution responsible for taxation in your country.
Don’t forget how much time and money you’ve jeopardized to earn your profits!