Taxation of Investors Versus Traders & Dealers

Many individuals (and businesses) buy stock and securities with the hopes and intent of the securities appreciating and perhaps paying interest or dividends.  What determines when an individual is treated as an investor, dealer or trader?  Furthermore, what is the tax treatment and proper way to report income and expenses when one is classified as an investor, dealer or trader?  The article below has been prepared by a tax attorney to provide information related to the above issues and questions.  Please remember to always discuss your specific facts and circumstances with your tax attorney and tax advisors, as this article is for informational purposes only.

The Internal Revenue Service applies different definitions and meanings to the terms investors, dealers and traders.  Thus, we will begin with an explanation as to these terms.  An investor would typically buy and sell securities in anticipation of the securities appreciating, as well as producing other returns such as interest or dividends.  In short, the investor would buy a security and hold the security for personal investment as opposed to conducting these activities in a trade or business.  Generally, the investor would hold the securities for themselves and for a substantial period of time.  When an investor sells or disposes of the securities, the transactions are reported as capital gain or capital loss on the investors 1040 via a Schedule D.  As an investor, capital loss limitations under IRC Section 1211(b) would apply as well as wash sale rules under IRC 1091.  Investors may be able to deduct expenses associated with creating the taxable income on their Schedule A itemized deductions.  Further, interest paid for money to buy investment property that generated taxable income may be deducted.  The cost of commissions and other related fees to dispose of the stock are not deductible but should be accounted for in calculating the gain or loss from the sale or disposition of the securities.

A dealer will differ from an investor in that a dealer will purchase and hold securities for their customers and conduct these activities in the ordinary course of the dealer’s business.  The dealer may hold an inventory of securities.  The dealer will make their money and income by marketing securities to their clients.  A dealer will report gains and losses from the disposition of securities by applying and using market-to-market rules.

Apart from being designated as an investor or dealer, special rules can apply when you are determined to be a trader in securities.  In short, a trader would be considered to be in the business of buying and selling securities for your own account.  Under certain circumstances you could be considered to be a business even if you do not hold an inventory and maintain customers.  The IRS could consider you to be in business as a trader in securities if you meet the following conditions:

 

  • The activity is substantial;
  • You are attempting to profit from daily market movements if the pricing of securities and not so much from appreciation, interest or dividends; and,
  • The activity is practiced with continuity and regularity.

If you are a trader in securities you can report your income and expenses on a Schedule C with your 1040 and thus Schedule A limitations would not apply, and further, the gains and losses from selling securities are not subject to self-employment tax.

The article above has been prepared by John McGuire of The McGuire Law FirmJohn is a tax attorney and business attorney with the firm and can be reached at John@jmtaxlaw.com

 

Is a Lawsuit Settlement Taxable?

Is the money I receive in a lawsuit settlement taxable?  If you have received money via a lawsuit settlement, you may be asking yourself this exact question.  Perhaps you were injured in a car accident, or filed suit against a prior employer for wrongful termination and are now receiving a monetary settlement.  The settlement may or may not be taxable depending upon all of the facts and circumstances surrounding your case.  The article below has been prepared by a tax attorney to provide additional information relating to whether or not proceeds from a lawsuit settlement need to be included in gross income on your individual income tax return.  Please remember, this article is for informational purposes only, and should consult your tax attorney or tax advisor regarding your specific facts and circumstances.

If your lawsuit settlement was the result of personal injuries and/or personal sickness you do not need to include the settlement amount, or that portion in your gross income as long as you did not take an itemized deduction of the medical expenses.  If you did previously take an itemized deduction of the medical expenses in prior years (this would likely be taken on a Schedule A) you must include the portion that was deducted and provided a benefit in prior years in your income.

Ok, so what about settlement awards and amounts for emotional distress and/or mental anguish?  If the award or settlement was for emotional distress or mental anguish that originated from personal injury or personal sickness, the proceeds from the settlement would not be taxable and thus not need to be included in your gross income.  However, if you receive a settlement amount for emotional distress or mental anguish that did not originate from personal injury or personal sickness, that portion or amount of the settlement is taxable, and thus would be included in your gross income.  If a portion of your settlement is taxable as emotional distress or mental anguish, the amount can be reduced by the amount that you paid for other medical expenses that are attributed to the emotional distress or mental anguish and that have not been previously deducted and medical expenses you previously deducted for the emotional distress and mental anguish that did not provide an actual tax benefit

What about non-personal injury type settlements?  What about a settlement for lost wages or lost profits?  If you receive money via a settlement for last wages, not only is the amount taxable and included in gross income, but the settlement amount is also subject to self-employment tax.  For example, if you sued a prior employer for discrimination or involuntary termination and requested lost wages, and won a settlement, the portion received for lost wages should be included in income and subject to self-employment tax.  If you filed a suit against a third party for lost profits and received a settlement for lost profits, the proceeds would be taxable, and would included in your business income.  It may depend upon the business structure, plaintiffs in the suit and other related issues as to the further taxation of those settlement proceeds for lost business profits.

What about settlement proceeds for lost property?  Typically, if the proceeds received for lost property do not exceed your adjusted basis in the property, then the proceeds would not be taxable, but rather would reduce your basis in the property.   However, if the amount received was in excess of your adjusted basis, the amount in excess is income.

What if you are paid interest on the settlement amount?  Generally, the interest would be taxable, and would included like normal interest from a savings account.

The above article has been prepared by John McGuire of the McGuire Law Firm.  John is a tax attorney and business attorney in Denver, Colorado.  Please feel free to contact John directly with any questions, comments and concerns.

How and When Does the IRS Begin a Criminal Investigation?

How and when do criminal tax investigations begin?  Many people have heard of persons being criminally indicted or charged with tax-based claims for failing to pay tax or failing to file tax returns, but how does the government begin or initiate the criminal tax process?  The article below has been prepared by a tax attorney to provide additional information regarding these questions and issues.  Please remember this article is for informational purposes and you should consult your tax attorney or a criminal attorney with your specific questions.

The Internal Revenue Service has a Criminal Investigation Division that conducts criminal investigations relating to alleged violations of not only the Internal Revenue Code, but also the Bank Secrecy Act (BSA) and certain money laundering statutes.  The investigators will then provide their findings to the Department of Justice for recommended prosecution.

The information that will lead to a criminal investigation can be obtained by the Internal Revenue Service in many ways.  Perhaps an individual owed tax to the IRS or was being audited by the IRS and the IRS revenue officer or revenue agent noticed issues that appeared illegal, fraudulent or felt the matter needed further review.  The revenue officer or revenue officer could refer the case or issues to the Criminal Investigation Division.  Oftentimes, information could be received by the public such a disgruntled employee, ex-spouse or other whistleblower.  Furthermore, the IRS may obtain information from other law enforcement agencies whether federal, state or local that could inevitably lead to the initial criminal investigation.

Once the criminal investigation has begun, Special Agents will analyze the information to determine if criminal tax fraud or some other financial crime may have occurred.  The preliminary investigation is often referred to as the “Primary Investigation.”  A supervisor of the Special Agents will review the initial information and make a determination as to approve the case for further review and development.  If the supervisor approves, approval can be obtained from the head office and the Special Agent in charge will initiate a Subject Criminal Investigation.  At this point, the investigation would be considered open and ongoing as the Special Agent will work to further obtain facts and evidence needed to establish the necessary elements for criminal activity.  The information, facts and evidence can be obtained in various ways from various sources such as third-party interviews, search warrants, surveillance, subpoenaing bank records, related financial records & tax returns and reviewing any other financial or asset related documentation.  Generally, the Special Agent will work with a criminal tax attorney within the IRS Chief Counsel in an attempt to ensure certain legalities are maintained during the course of the investigation.

At what point is there a charge or prosecution?  Once all evidence has been gathered and analyzed, the Special Agent and their supervisor will make a determination that the evidence does or does not equate to criminal activity.  If the evidence does not substantiate criminal activity and charges, the investigation is discontinued.  If the determination is that the evidence would substantiate a criminal charge and thus prosecution recommended, the Special Agent would move forward with preparing a special agent report.  The special agent report would thereafter be reviewed by multiple parties such as supervisors, review teams etc.

Upon this “final review” if the Criminal Investigation Division determines a criminal prosecution is warranted, the division will recommend prosecution to the Department of Justice (Tax Division) or United States Attorney.  Generally, the Tax Division of the Department of Justice will prosecute the matter if it is a tax investigation, and the United States Attorney would prosecute for other investigations.

If you have been contacted by an IRS Criminal Investigator or know of an ongoing investigation of which you are a witness or target, it is highly recommended you contact a tax attorney or criminal tax attorney.