Tax News

CCH (cch.taxgroup.com) reports:

  A married couple, who bought and sold stocks through their limited liability company (LLC), were not engaged in a trade or business as traders in securities. As a result, the mark-to-market election (Code Sec. 475(f)) made by the LLC was invalid and losses reported by the taxpayers were capital and not ordinary.

  CCH Comment. A taxpayer is considered engaged in the trade or business of trading stock if (1) the taxpayer's trading is substantial and (2) the taxpayer seeks to profit from short-term swings in daily market movements. In evaluating whether trading activities are substantial, courts generally consider the number of executed trades in a year and the amount of money involved.

  In 2000, the couple began buying and selling stocks and reported approximately $280,000 in capital gains. In April 2001, they formed an LLC and made a mark-to-market election. From April through December, they reported an ordinary loss of approximately $180,000 based on 289 trades of stock with an aggregate basis of $933,000 and a collective sales price of $754,000. In 2002, they executed approximately 372 trades and claimed an ordinary loss of $45,000. They traded on 63 days from April through December 2001 or 40 percent of the possible trading days and on 110 days or 45 percent of the possible trading days in 2002. However, the number of trades and the amount of money involved were not sufficient to qualify the couple as traders.

  CCH Comment. For purposes of comparison, the court cited two decisions in which taxpayers were engaged in substantial trading. In the first case, the taxpayers traded stocks or options worth approximately $9 million ( S.A. Paoli, DC Ill., 92-1 USTC ¶50,102). In the second case, the taxpayer executed over 1,100 sales and purchases in each of the years at issue ( F.R. Mayer, 67 TCM 2949, Dec. 49,838(M), TC Memo. 1994-209). In another case, trading activity was held insubstantial when a taxpayer executed at most 83 purchases and 41 sales in one year and 76 purchases and 30 sales in the second year ( J.A. Moller, CA-FC, 83-2 USTC ¶9698, 721 F2d 810).

  Furthermore, the taxpayers were not attempting to catch swings in daily market movements. Their records showed that they rarely bought and sold on the same day. Many of the their stocks were held for more than 31 days. This trading pattern was more consistent with that of an investor than a trader.

  Since the taxpayers were not engaged in a trade or business, various expenses related to their trading activity were not deductible as business expenses. Deductions of investment interest paid were not allowed to the extent the deductions exceeded the limitation placed on investment income.

W. G. Holsinger, TC Memo. 2008-191, Dec. 57,512(M)

Other References:

 
Code Sec. 162

  CCH Reference - 2008FED ¶8521.1475

 
Code Sec. 163

  CCH Reference - 2008FED ¶9403.45

 
Code Sec. 475

  CCH Reference - 2008FED ¶22,268.55

  Tax Research Consultant

  CCH Reference - TRC INDIV: 48,450

  CCH Reference - TRC SALES: 45,052

  CCH Reference - TRC SALES: 45,350