Written by a TurboTax Expert • Reviewed by a TurboTax CPAUpdated for Tax Year 2023 • October 19, 2023 8:10 AM
OVERVIEW
How does trading stocks affect your taxes? Over-trading can have a serious impact on finances. Learn how to be aware of day trading taxes and reduce your tax liability.
Taxes on day trading
Many new investors view day trading as an efficient way to earn money quickly. The idea behind the concept is to make trades over short periods to take advantage of short-term price changes while profiting at the same time.
The results of day trading may surprise you, though, as it can result in losses or substandard returns for the vast majority of traders. It can have large impacts on your taxes, too.
Factors that drive day trading behavior
A few key factors have popularized day trading. Looking at historical data makes day trading look easy, while technology makes day trading easier to access and cheaper than ever before.
You may also hear news shows with investment segments quoting successful experts in sound bites — but they typically don't highlight the resources experts have available or their decades of experience, which can mislead viewers. Finally, many investors seem to only speak about their successes and not their failures.
Day trading taxes: How the costs could exceed the gains
Successful day traders need access to several tools to outperform the markets. They typically pay for an investment trading platform and purchase tools that offer research, charting, and other functions necessary to trade profitably.
While brokerage fees are mostly disappearing, some firms still charge fees on certain transactions. Any brokerage fees that must be paid, quickly add up when you buy and sell investments many times per day. Regulatory fees, although small, add another cost.
Some day traders use margin, or debt, to leverage their trades. This creates the potential for higher gains while exposing traders to the risk of larger losses. Investors have to pay interest and may have to pay other fees to use margin, too.
How day trading impacts your taxes
A profitable trader must pay taxes on their earnings, further reducing any potential profit. Additionally, day trading doesn't qualify for favorable tax treatment compared with long-term buy-and-hold investing.
If your day trading is operated as a business and you meet certain IRS requirements to be considered a "trader in securities," some tax impacts can be reduced while at the same time potentially making any net profits subject to self-employment tax. For everyday investors who don’t qualify as a business, the following rules may apply:
- You're required to pay taxes on investment gains in the year you sell.
- You can offset capital gains against capital losses, but the gains you offset can’t total more than your losses.
- You can use up to $3,000 in excess losses per year to offset your ordinary income such as wages, interest, or self-employment income on your tax return and carry any remaining excess loss to the following year.
- If investments are held for a year or less, ordinary income taxes apply to any gains.
- Holding an investment for more than a year usually allows traders to take advantage of lower long-term capital gains tax rates.
- Capital gains distributions and dividend distributions require investors to pay taxes in the year these distributions are paid out.
- Investors may avoid or defer these taxes by holding their investments in a tax-advantaged account, such as a 401(k) or Roth IRA.
Investing long term could help to solve day trading issues
Experts often consider long-term investing a better investment strategy than day trading. Long-term investors can take advantage of long-term capital gains tax rates, which can help them save money on taxes. If you hold your investments within a tax-advantaged account, you may receive even more tax benefits.
Long-term investors usually invest in diversified portfolios rather than concentrated positions. Diversified portfolios that aren't touched have often performed better than traders who miss the top ten performing days during the year.
By investing for the long term, you could help to grow your money faster without the heightened risks, costs, stress, and extra headaches associated with day trading. That said, the future is uncertain, and investing is inherently risky. Ultimately, you must come up with the best investment plan for your situation.
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FAQs
Day-trading tax rates
Day trading taxes can vary depending on your trading patterns and your overall income, but they generally range between 10% and 37% of your profits. Income from trading is subject to capital gains taxes.
Who does the IRS consider a day trader? ›
You must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation; Your activity must be substantial; and. You must carry on the activity with continuity and regularity.
How many trades do you need to be a day trader for taxes? ›
We recommend an average of four transactions per day, four days per week, 16 trades per week, 60 a month, and 720 per year on an annualized basis. Count each open and closing transaction separately, not round-trip. Scaling in and out counts, too.
How do day traders show proof of income? ›
How to Provide Proof of Income
- Annual Tax Return (Form 1040)
- 1099 Forms.
- Bank Statements.
- Profit/Loss Statements.
- Self-Employed Pay Stubs.
The first way day traders avoid taxes is by using the mark-to-market method. This method takes advantage of the ability of day traders to offset capital gains with capital losses. Investors can get a tax deduction for any investments they lost money on and use that to avoid or reduce capital gains tax.
How much money do day traders with $10000 accounts make per day on average? ›
With a $10,000 account, a good day might bring in a five percent gain, which is $500. However, day traders also need to consider fixed costs such as commissions charged by brokers. These commissions can eat into profits, and day traders need to earn enough to overcome these fees [2].
What is the difference between an investor and a trader? ›
Trading involves buying and selling assets (such as stocks) for short-term gains. Traders primarily focus on share prices as they make their decisions. Investors, on the other hand, focus on long-term gains when they buy and sell investment vehicles.
Are day traders considered unemployed? ›
The law considers a trader in securi es to be self-employed, even though a trader doesn't maintain an inventory and doesn't have customers. Traders report their business expenses on Schedule C , Profit or Loss From Business .
Is day trading considered earned income? ›
Earned income includes wages, salaries, bonuses, and tips. It's money that you make on the job. But even if day trading is your only occupation, your earnings are not considered to be earned income.
Do day traders pay Social Security tax? ›
Your income from short term capital gains isn't subject to Social Security tax. It is “unearned income”. The income is still subject to income tax. You'll need to make estimated tax payments for federal tax purposes on April 15, June 15, September 15, and January 15.
If you buy an asset and sell it within a year of buying it and your profit, you're taxed at the short-term rate. Essentially, the profit is added to your yearly income and taxed at the same rate as your income. Depending on your tax bracket, short-term capital gains are taxed at 10% – 37%.
Should I set up an LLC for day trading? ›
Should You Start an LLC as a Day Trader? A day trader would choose to start an LLC for legal protection and to protect against personal losses. An LLC takes only a few minutes to create and costs less than $200, even if you use an online service to set it up for you.
Do day traders have to report every transaction? ›
As a trader (including day traders), you report all of your transactions on Form 8949 Sales and Other Dispositions of Capital Assets.
Can you write off day trading losses? ›
You can use up to $3,000 in excess losses per year to offset your ordinary income, such as wages, interest, or self-employment income on your tax return and carry over any remaining excess loss to following years. If investments are held for a year or less, ordinary income taxes apply to any gains.
Is trader tax status worth it? ›
Tax Advantages of Trader Status
Potential upsides of qualifying for trader status for tax purposes include: Traders can deduct expenses on Schedule C and benefit from SE tax exemption. They're considered to be in the business of buying and selling stocks (and other securities, if applicable) for a profit.
How do day traders pay themselves? ›
A day trader can have dry spells or experience volatility in their earnings. As a result, many trading firms offer instead a draw in lieu of a salary. This is often a modest amount of money meant to cover everyday living expenses and is drawn monthly. Then, any excess earnings are paid out in the form of bonuses.
What are the trading rules for day traders? ›
The so-called first rule of day trading is never to hold onto a position when the market closes for the day. Win or lose, sell out. Most day traders make it a rule never to hold a losing position overnight in the hope that part or all of the losses can be recouped.
