Should You Trade As A Business?
You may not be in the business of trading but that doesn’t mean you shouldn’t start a company to make all your trades under.
Even as a hobby, there can be a lot of benefits to starting your own company. There are a few cons, however, against starting your own company and it could cost you more in the long run.
Why You Should Start A Company
Typically, a trader will start an LLC to make their trades. Limited liability companies can be formed by one person or several, have low startup fees, and can still benefit from pass-through taxation. Every state has different rules for forming an LLC, but most require light paperwork and a one-time fee.
Without a company a person can file as a “trader” with the IRS. This is beneficial come tax time because it allows you to deduct all trading-related expenses. Unfortunately, the IRS sets the requirements for the “trader” status so high that very few people can reach it.
To obtain the “trader” status the IRS expects you to trade full-time. It will want you to make multiple trades a day, every day. You will also have to trade enough money that it appears to be your full-time job.
The IRS also feels that as soon as you start a company, you are automatically considered a professional. Being a professional is the same as having the “trader” status. It allows you to deduct all trading-related expenses for your company, deductions such as computer, book shelves, printers, and a home office. Having these deductions can save you a lot of money when the tax man comes knocking at your door.
Without the “trader” status or a company, you can deduct very little from your taxes. Because trading is not considered a business activity, it is passive, all the expenses necessary to trade are excluded as deductions.
Another big benefit to having your own company is to trade with partners. If you want to pool your money with family, friends, or an investment club you will need to do so under a company. Pooling money together without a company is not a good idea because there are no rules or contracts in place to make sure everything is accounted for. You will also lack the ability to split the money out for taxes.
Why You Shouldn’t Start A Company
There are a few setbacks to starting your own company. Not only does the IRS now see you as a professional but so does everyone else. Anytime you form a company to make your trades, you will always be a professional.
All those free and cheap perks you’ve been enjoying are now gone. Look through your option brokerage paperwork and you will see that they charge you extra to be a professional trader. The free real-time data you used to receive now comes at a price.
The analytics tools you use, such as charting programs or screeners, probably have a different and higher price for professionals.
Not only will you pay more for services but the headache at tax time will be bigger. Accounting for a company’s taxes is more complicated than personal taxes. You will now have to record and keep all the paperwork used for your deductions. It is best to consult with a tax professional on these matters.
It may seem like a cool idea to start a company strictly for trading, but there are only a few situations in which it makes sense to start a company. If trading is your full-time job, you’ve been profitable for a long period, and you are trading a large enough size to offset the extra cost then you should probably start a company.
It also makes sense if you plan on trading with multiple people. Whenever you are pooling money or resources together it is best to have clear documentation in place to set the boundaries.
Keep in mind that starting a company will cost you more money up front. You must pay to start the company and then you will be slapped with extra fees from all your service providers. It is a good idea to price out the increases beforehand, that way you have a good idea of what to expect.
When making decisions that will affect your taxes it is best to consult a tax professional. They will be able to help you work through the details of your own situation and discover what is best for you.