Although a trader’s security gains and losses are excluded from SE earnings, there is no guidance as to how the trading expenses reported on Schedule C impact SE earnings. Presumably, a trader who has SE earnings from other sources can reduce those earnings by the SE loss generated from the trading expenses.
Trader Tax Returns
Because of the unique tax rules that apply to securities traders, properly reporting trading information on Form 1040 can be a challenge. Practitioners should consider the following reporting issues and recommended solutions:
Stock Trader Schedule C Loss
Traders who do not make a Section 475 election report no income and only expenses on Schedule C, resulting in a loss on that form. This reporting may get the IRS’s attention since Schedule C losses sometimes stem from disallowable hobby losses. To help avoid IRS questions regarding this reporting, a footnote or statement explaining the taxpayer’s trader status and the filing implications should be attached to the return.
Stock Trader Reconciling to Forms 1099-B
Because traders report their security sales on Form 8949, the amounts reported to them on brokers’ Forms 1099-B will normally agree with the reported gross proceeds. However, traders who make the Section 475 election treat their trading gains and losses as ordinary income reported on Form 4797 (Part II). The Form 4797 instructions state that these traders should enter the total gross proceeds from Forms 1099-B on line 1 of Form 4797. To help avoid IRS matching notices for gross proceeds shown on Form 1099-B and ultimately reported on Form 4797, taxpayers should also report the gross proceeds for these transactions on Form 8949 and enter the appropriate code (see the Form 8949 instructions) in column (f) and the appropriate dollar amount in column (g) to reconcile any Forms 1099-B and 8949 differences.
Stock Trader Detailing Trading Activity
In many cases, the taxpayer will have detailed records reporting each trade that can be attached to the return to support the amounts shown on Form 8949. The Form 8949 instructions indicate that, instead of reporting each stock transaction on a separate line, taxpayers can report them on an attached statement containing all the same information as Form 8949 and in a similar format. They can use as many attached statements as they need.
IRS Form 8949
The combined totals from all the attached statements are entered on a Form 8949 with the appropriate box checked. The Form 4797 instructions state that traders who make the Section 475 mark-to-market election should attach a statement to the return detailing each trading transaction and carry the totals to line 10 of Form 4797.