Unfortunately, the IRS offers no clear definition of what classifies someone as a trader or an investor for tax purposes. Most of the guidance we have comes from the court cases over the years. Knowing the rulings on the past cases can help you understand what does and does not qualify for trader tax status in the eyes of the IRS.
The following are some of the more important cases dealing with trader tax status. I have included the important take aways from each case.
Moeller vs. United States (1983)
Joseph and Dorothy Moeller were retired and relied almost entirely on the income derived from their investments for income. Here are the facts of their case:
Needless to say, the Moellers lost their case. They were not looking to profit from short term price movements in the market (average holding periods and focus on income producing investments) so trader status was denied.
Stephen A. Paoli (1991)
In 1982, Stephen had 326 transactions: Here are the other facts the courts looked at in this case:
Stephen lost his case because his trading was not continuous through out the year. He maintained that he spent 4 to 5 hours every day to trading and studying the market even though he didn't trade. The court did not believe him because he could not provide documentation (this is why we recommend keeping a trading log or journal every day).
Fredrick Mayer (1994)
Fredrick Mayer sold an oil drilling company in June 1980 for $134 million. He formed a corporation called "Captiva" to manage his money. "Captiva" was to be a manager of managers. The years in question were 1986-1988. Here are the facts of his case:
Mr. Mayer lost his trader status due to hiring outside money managers to manage his portfolio. The average holding periods also showed that he was interested in long term growth. The tax courts ruled in favor of the IRS and Mayer was taxed as an investor.
Rudolph Steffler (1995)
The tax court questioned whether or not the pattern of trading was frequent, regular, and continuous enough to constitute a business. Here are the facts of the Steffler case:
Trading 27 times over a 3 year period was not enough activity in the courts eyes to grant trader status. Steffler was taxed as an investor.
So What Does The IRS Look For?
According to IRS Tax Topic 429 (Traders In Securities):
The IRS focuses on four areas when granting trader status:
Miss one of those four and you will be denied trader tax status and will be taxed as an investor.