Investors enjoy several tax advantages not available for other sources of income. Capital gains rates, tax-free income, like-kind exchanges, and the ability to donate appreciated stock are just a few of the possible benefits available to investors. But investor capital loss rules, on the other hand, can be a significant irritant.
Losses on Schedule D are limited to $3,000 per year. I have one client that lost over $300,000 on an investment. Unless the client has capital gain income to offset the loss, she can claim a $3,000 loss for the next 100 years of her life.
When big losses occur, some taxpayers might consider changing their position from being an investor to being a trader. Instead of reporting capital gains and losses on Schedule D, traders report their activity on Schedule C. Losses on Schedule C are deducted in full in the year of sale, making this a tempting proposition compared to the $3,000 per year alternative. Other investment expenses could also be deducted in full on Schedule C, instead of being limited to the 2% threshold for itemized expenses on Schedule A. In a year of big losses, these could be a huge boon to a taxpayer.
It should be noted that traders selling stocks for a gain held over a year would lose by being taxed at regular income tax rates instead of the beneficial long-term capital gains rates available when reporting on Schedule D. However, since true traders hold stocks typically for only very short periods of time, this is not an issue to them. It would, however, cause additional tax to an investor claiming to be a trader.
The IRS knows that taxpayers may try to claim their activity belongs on Schedule C when they are, in reality, typical investors. The IRS will check the facts and circumstances of a taxpayer’s situation to determine if they are a trader or an investor. If someone has claimed to be a trader, but the IRS determines they qualify as an investor, the income and expenses are reclassified, and penalties will likely be applied.
If you are trying to decide if you qualify as a trader, consider the following.
While this is not an all-inclusive list, it may help you determine whether you can justify calling yourself a trader. If you qualify as a trader there is nothing wrong with reporting your activity as such. Just make sure you have the documentation to support your position, and be prepared to share that with the IRS if they ask you to prove you aren’t an investor.
Hopefully we are past the media craze about a guest on the Dr. Phil Show. Today we need to talk about what it means to have a cash-based business.
There is nothing wrong with having a business that has a high percentage of payments coming from cash. Beauty salons and food establishments are just a couple of places where paying with cash is common. Even paying expenses in cash is fine. It's all about the documentation.
The IRS knows that it can be tricky (and, admit it, tempting) to not report all cash receipts in your business. They have collected data from thousands of businesses through the decades and they know roughly what to expect when reviewing your tax return. They also collect data about card payments. If card payments are higher than expected then the IRS will send a notice asking you to explain why cash receipts are lower than expected. Unfortunately in this "guilty until proven innocent" scenario you will need to explain why something didn't happen, and proving a negative can be very difficult.
Cash payments means no "automatic" documentation. You won't get a report at the end of the month/year telling you what your cash receipts were. Make sure you record transactions to document everything. Depending on the type of business you run, keep records regularly. If you have a barber shop, log the number of customers and track your daily receipts. If you host parties in a home log sales after every event. Make sure your records add up and match your bank statements.
These details can make the difference between proving your income and having the IRS presume you are underreporting.
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