Day trading taxes are anything but straightforward, and it’s the last thing you want to deal with after a roller coaster year, that’s hopefully ending in the black. Tax reporting means deciphering the multitude of murky rules and obligations. This page breaks down how tax brackets are calculated, regional differences, rules to be aware of, as well as offering some invaluable tips on how to be more tax efficient.
How Does Day Trading Affect Taxes?
Unfortunately, there is no such thing as tax-free trading. Day trading and taxes go hand in hand. As the saying goes, the only two things you can be sure of in life, are death and taxes. How you’re taxed will vary hugely depending on how much you trade, and which tax system’s remit you fall under.
Tax on trading in the UK is different to that in India, Ireland, Australia and the U.S for example. Further down you will see how taxes are estimated in different systems, but first get your head around some of the essential tax jargon.
In the UK, CFDs, forex and spread betting are classed as ‘speculative’. As no underlying asset is actually owned, these derivatives escape Capital Gains Tax and HMRC view income derived from this speculation as tax-free. Individuals who class themselves as ‘trading for a living’ may need to pay income tax, but in general, profits are not liable for tax.
If trying to decipher what you owe wasn’t already complicated enough, lengthy tax documents also include a whole host of complex vocabulary. Below some of the most important terms have been straightforwardly defined.
This is money you make from your job. However, some tax systems don’t consider day trading earnings to be earned income, even if it’s your full-time occupation. Whilst this may mean no self-employment tax, it also means you won’t be contributing to social security. In some countries, this will mean you’re not eligible for comprehensive retirement benefits.
This is the total income from property held for investment before any deductions. Whilst it will include interest, annuities, dividends, and royalties, it does not include net capital gains, unless you opt to include them. Apart from net capital gains, the majority of intraday traders will have very little investment income for the purpose of taxes on day trading.
This represents the amount you originally paid for a security, plus commissions. It acts as an initial figure from which gains and losses are determined. If your position’s value rises above your cost basis by the time you close your position, you have generated a capital gain. If it falls below your cost basis, you’re left with a capital loss.
This is simply when you earn a profit from buying or selling a security. You’ll usually pay tax on capital gains if you held the position for less than a year. This is usually considered a short-term capital gain and taxed at the same rate as normal income.
Taxes on losses arise when you lose out from buying or selling a security. The good news is, you can often deduct those losses, up to the amount of capital gains you’ve earned this year. On top of that, one of the tax advantages of some systems is that you can actually write-off an additional amount if you’ve suffered more losses and gains in one year.
One such tax example can be found in the U.S. A tax rule allows you to write off an extra $3,000 a year, and anything above that you can actually carry forward to the next tax year.
If you’re day trading in the U.S, you’re likely to run into the wash-sale rule at some point. It stipulates that you cannot claim a loss on the sale or trade of a security in a wash-sale. A wash-sale is when an individual buys or sells a security at a loss, and then within thirty days before or after the sale, buys a ‘substantially identical’ security.
Differences In Financial Instruments
Whilst taxes in day trading can vary, one thing that doesn’t usually make a difference, is what you’re buying and selling. Forex taxes are the same as stock and emini taxes. Similarly, options and futures taxes will also be the same.
Tax systems aren’t concerned about whether you’re buying and selling gold, oil, or Tesco shares, they simply care about the profit and losses you’re making. Instead, it’s the regional differences below that will have an impact.
Some types of investing are considered more speculative than others – spread betting and binary options for example. This can sometimes impact the tax position. In the UK for example, this form of speculation is tax-free. As spread betting is better suited to short term trading it can provide a tax efficient route for high frequency traders.
Every tax system has different laws and loopholes to jump through. Day trading taxes in Canada will be different to those in Australia, Ireland, India, and the UK. This is why estimated tax rates for day trading can vary hugely, even if you’re investing in the same instruments. Having said that, the west is known for charging higher taxes.
People often ask, ‘do day traders pay self employment tax?’ The answer to that is, it depends. Tax on trading profits in the UK falls into three main categories. However, it’s worth remembering the parameters for each status change, so it’s important you check for new developments. The HMRC will either see you as:
- Speculative – This is comparable to gambling activities, and if you fall under this category you’re in effect in a tax haven. You’ll be free from any and all income tax, business tax, and capital gains tax. Some investing vehicles, such as spread betting or binary options, are more likely to be considered ‘speculative’. The note of caution here is that while tax is not payable, it also means losses can not be claimed as they can as a private investor.
- Self-employed trading activity – You’d be taxed the same way any normal self-employed individuals are, so you’ll be liable to pay business tax.
- Private investor – Your gains and losses will be subject to the capital gains tax regime. If you contact HMRC they will help confirm which tax status you fall under.
Tax implications in the UK aren’t so severe it should deter people from dabbling in the market. As long you do your tax accounting regularly, you can stay easily within the parameters of the law.
When it comes to taxes for day trading in the US, you’ll either be a ‘trader’ or an ‘investor’. They may be used interchangeably, but your obligations will vary drastically depending on which category you fall under. They are defined as follows:
- Trader – Spends considerable time researching and executing trades (at least 16 hours a week). Also trades nearly every day the market is open and is interested in only short-term positions. Are you actually making money? Whilst bad years are allowed, most real businesses are thought to be profitable three out of the last five years. It also helps if you don’t have another job on the side.
- Investor – You are an investor if you’re not considered to be in the trade or business of buying and selling securities. If you don’t trade regularly and you have a full-time job, you’re probably going to fall into the ‘investor’ category in terms of taxes on intraday trade profits.
A trader can deduct his expenses, whereas, an investor’s deductions are usually extremely limited. Those deductions can add up, especially if you’re in it for the long haul. You should also look at when you have to pay your day trading taxes. Will it be quarterly or annually?
Canada’s taxes for day trading are relatively straightforward. You can either declare your profits as capital gains or as business income to the Canada Revenue Agency (CRA). Each status has very different tax implications.
- Capital gains – If you’re buying and selling securities as an investment, you probably want to use a capital account. Opt for this route and your capital gains will only be 50% taxable. However, it’s less advantageous if you incur losses. Losses can only be claimed against capital gains.
- Business income – If you’re only investing to make a profit, you may want to declare earnings as business income.
Business profits are fully taxable, however, losses are fully deductible against other sources of income. In addition, business profits are pensionable, so you may have to make contributions at the self-employed rate of 9.9%.
The day trading tax rates and rules in India aren’t as complicated as it first appears. Day traders have their own tax category, you simply need to prove you fit within that.
- Speculative activity – As long as you don’t hold any positions overnight, you are considered an intraday trader. Therefore, any trades you make are considered speculative activity and subject to speculative business income tax.
- Speculative business income – All profits will be added or netted to your other incomes. This will then be taxed at your usual total income slab. For example, your salary income is Rs. 5 lacs, and your daily trade profits are 2.4 lacs, then your total income would be 7.4 lacs, which would be taxed as per 20% slab.
Taxes in India are actually relatively straightforward then. However, seek professional advice before you file your return to stay aware of any changes.
For full details, read our guide to Day trading taxes in India.
The tax implications in Australia are significant for day traders. Unlike in other systems, they are exempt from any form of capital gains tax. The Australian Tax Office classifies you as a trader if you carry out ‘business-like activities’ for the purpose of earning income from trading.
Firstly then, do you fall into this category?
- Income – If the primary reason you’ve started investing is to earn an income, then you will probably meet the business requirements. Especially if you set aside specific capital for investing.
- Frequency – If you trade often and according to a plan and strategy then you meet these criteria. If you trade only occasionally then you do not. If you keep a close record of accounts and trades then you’re even more likely to meet the minimum criteria.
Once you meet these requirements you simply pay tax on your income after any expenses, which includes any losses at your personal tax rate. The only rule to be aware of is that any gain from short-term trades are regarded as normal taxable income, whilst losses can be claimed as tax deductions.
Consequences of Not Paying
Paying taxes may seem like a nightmare at the time, but failing to do so accurately can land you in very expensive hot water. The tax consequences for less forthcoming day traders can range from significant fines to even jail time.
In the UK for example, you could start with a 5% penalty on the amount you owe per month. Over time this can reach 47.5%, and if you still fail to pay in some situations you may do a stint at her majesty’s pleasure.
So, think twice before contemplating giving taxes a miss this year. It is not worth the ramifications.
The good news is, there are a number of ways to make paying taxes for day trading a walk in the park. Below several top tax tips have been collated:
Confirm Your Tax Status
To do this head over to your tax systems online guidelines. Follow the on-screen instructions and answer the questions carefully. Then email or write to them, asking for confirmation of your status. Once you have that confirmation, half the battle is already won.
Keep A Record
Some tax systems demand every detail about each trade. You don’t want to be guessing or leaving sections blank on your tax return. So, keep a detailed record throughout the year. Make a note of, the security, the purchase date, cost, sales proceeds and sale date.
Consult Your Tax Advisor
Nobody likes paying for them, but they are a necessary evil. Don’t just consult them once every year, seek advice regularly. You need to stay aware of any developments or changes that could impact your obligations. You never know, it could save you some serious cash.
The end of the tax year is fast approaching. All of a sudden you have hundreds of trades that the tax man wants to see individual accounts of. Not only might they want to know your profit or loss from each sale, but they’ll also demand a description of the security, the purchase date, cost, sales proceeds and sale date. That amount of paperwork is a serious headache.
That’s where tax software and calculators come into play. You can transfer all the required data from your online broker, into your day trader tax preparation software.
If you want to be ready for the end of tax year, then get your hands on some day trader tax software, such as Turbotax. It’s a hassle-free way to keep on top of your tax obligations.
Day trading and paying taxes, you cannot have one without the other. Taxes in trading remain a complex minefield. Unfortunately, they are not avoidable and the consequences of failing to meet your tax responsibilities can be severe. It’s vital therefore you establish your tax status and understand your obligations. Utilising software and seeking professional advice can all help you towards becoming a tax efficient day trader.