The Supreme Court in it's land mark decision in 1987, Groeztinger v Commissioner, ruled that a person who gambled for their own account, with continuity and regularity and the primary purpose of engaging in the activity must be for income or profit, was in the business of gambling and therefore entitled to report these activities on a Schedule C, "Profit or Loss from a Business", and to claim any necessary and ordinary expenses incurred while conducting the business. Thus the professional gambler was recognized by the IRS. The court found support for its decision in a series of cases which had established trading securities for one's own account can constitute a trade or business if the trading is sufficiently frequent and substantial. The Court stated "We are unable to discern any meaningful distinction between the so-called "active trader" of securities and the full-time gambler. The essential nature of these activities is identical, to state it simple, one gambles on stocks, the other on dogs. Both bet or trade solely for their own account and do not enter into with specific individuals; rather their profits and losses depend solely upon their ability to predict the outcome s in an impersonal and (presumably) non-manipulatable marker or pari-mutuel event."

There have been traders and investor ever since stock markets were devised. Other than the NASDAC where a computer does the trading, stock exchanges have a "pit" where each trader specializes in a handful of stocks. Once you issue a buy, a representative of the brokerage goes to the trader of that stock and buys the number of shares you specified, The same thing occurs when you sell a stock through a broker. Until recently there was only a small number of people could be qualified to be an "active trader", most of which worked in the "pits" of the exchanges" and had no long term holdings. With the arrival of the Internet, a number of companies began offering online trading which enables many more people to choose to day trade and many of these now qualify to report their winnings, losses and expenses on a Schedule C.

Investor or Trader?

If a taxpayer can classify themselves as a trader, in the trade or business of trading, a whole different reporting world is open. To review, investors report gains an losses on Schedule D. Gains on stocks held for more than one year are treated to the specially reduced capital gains tax rates. Losses are limited to $3,000 per year with a lifetime carryover. Investment expenses including investment publications, services and equipment used such as computers and printers must be deducted and depreciated on Schedule A, "Itemized Deductions". These investment expenses are subject to the 2 percent and 3 percent rules and the AMT limitations. Home office expenses are not allowed to an investor.

Traders on the other hand, report ordinary and necessary business expense , including margin interest and Section 179 deductions, on Schedule C. Traders may be eligible for the home office deduction. Traders are NOT required to pay self-employment taxes on trading gains nor may they offset other self-employment income with trading losses. Traders are not allowed the more favorable long-term capital gain tax rates, But then again , the probably not traders if they hold securities for more than one year.

Courts have described the distinction between "investing" and "trading" as follows. In investing, securities are purchased to be held for capital appreciation and dividend income, usually without regard to short-term developments which influence the price on daily basis. In a trading account, securities are bought and sold with reasonable frequency in an endeavor to catch the swings in the daily market movements and profit thereby on a short term basis.

In summary the courts tend to allow trader status if:
· The taxpayer spends a lot of time trading. Preferably without a regular full-time job.
· The taxpayer has established a regular and continuous pattern of making many trades (at least several almost everyday the markets are open).
· The taxpayers' goals are to profit solely from short-term swings rather than from long-term gains or dividends.

This is the way the material was presented to me, but I have a hard time believing that the IRS will not go after day traders for the Social Security Tax on their earnings. But if you qualify any ordinary and necessary business expense will be allowed such as interest on money used to trade, travel to and from the location where you choose to do your trades, meals and lodging if trading away from home, the cost of computers, Internet access, investing programs, books, seminars and newsletters. A home office deduction can be very helpful in lowering your tax if you qualify. You can write off your losses against any other type of income depending on the amount. If you cannot write off all your losses in the current tax year, you can carry the forward the balance year after year until it is fully written off. Note that the investor is limited to declare losses of only $3000 per year and can carry the balance forward but can only claim $3000 in any one year.

This has yet to be published in the pubs by the IRS as they tend to lag behind in publishing unfavorable rulings by the courts.