LLC For Stock Trading: How To (Legally) Save $20k In Taxes
You're about to read an advanced step-by-step guide to “LLC for stock trading”.
So, if you want to know:
- What it's like day-trading as an LLC?
- How does the IRS treat self-employed day-traders?
- What is the best tax saving solution for day-traders?
- How to start an LLC for trading?
- What are the benefits of trading via an LLC?
- What does it mean to qualify as a legal day-trader?
- How does the IRS qualify day-traders?
- A whole lot more...
Then you must read this.
Let’s dive right in!
Day Trading Through A Limited Liability Company
Yes. A limited liability company (LLC) can buy stocks.
There are a variety of reasons why you should insist on trading stocks using an LLC.
An LLC is a legal business entity which combines the simplicity of a sole proprietorship but still maintains your safety from legal exposure.
When you incorporate your business as an LLC, you protect your personal assets from any form of liability.
Whether you are just starting to trade stocks or you have been trading stocks your entire life, there are HUGE tax benefits that come along with incorporating your stock trading business as an LLC.
However, if you choose to trade stocks as a sole proprietor, you will not be able to take advantage of both your asset protection and tax saving strategies.
Choosing to work as an independent trader is a popular way to earn extra money on the side.
But then there was my friend Walter, a Texas stock trader.
Walter chose to go all-in when it came to trading stocks, to do it full time.
The first 5 years, Walter suffered from immense capital losses.
However, as he progressed, he slowly started to find his groove, to find the strategy that would enable him to profit consistently.
To make a long story short, Walter utilized his strategy to reach a milestone of consistently profiting $500 thousand annually.
But like any other business venture, Walter’s income generated from trading was taxable.
Walter was a successful trader.
However, he was a self employed trader.
Being a self employed trader was terrible in terms of taxes. Walter suffered.
For this reason, Walter decided to seek a strategy that would enable him to save as much as he can from paying taxes.
What is the standard tax treatment for traders?
How would this impact Walter?
We’ll cover that next.
Self Employed Trader Taxes
In terms of the standard tax treatment for traders, the Internal Revenue Service (IRS) does not consider trading a business activity.
The IRS presumes that when individuals invest, they trade for the purpose of long-term capital accumulation (as opposed to paying off current liabilities).
For this reason, all income earned from trading is considered unearned or passive income.
Additionally, you cannot reduce your income by contributing to an individual retirement account (IRA) or a pension fund.
To make an already cringy situation worse, you cannot deduct any normal business expenses, despite the fact that the costs of operating a successful stock-trading business are significant.
For you, it may be the costs of trading platforms, software, internet access, computers, education - the costs start addiing up.
Regardless of what the expenses are, the IRS does not consider trading a business activity and you are thereby not eligible for tax deductions.
Pretty much, the only advantage you have is that your stock trading income is not subject to self-employment taxes.
The biggest issue traders suffer from the most is that you cannot freely deduct income as a result of losses. Your deductions are limited.
If you trade, you can legally deduct only $3,000 against your ordinary income.
Meaning, if you suffer losses, which exceed $3,000, you can carry the remaining losses forward to subsequent years - $3,000 per year.
The question to answer was - “How can a trader save on taxes?”
We answer this question next.
Keep on going!
LLC For Investing In Stocks
The best thing we did for Walter was incorporating his trading business.
In his home state of Texas, we filed an LLC for him.
This qualified his trading business as a LEGAL trading business.
This means, once we filed an LLC, the IRS viewed his business as a legitimate legal business.
Under normal circumstances, the IRS does not stick their noses into an LLC involved in trading stocks.
The IRS believes that no one will go through the hassle of forming a company unless they are committed to trading as a business venture.
This reduces audit exposure.
Filing an LLC for Walter was a game changer.
The LLC allowed Walter to finally deduct business expenses, up to $5,000.
The IRS says that single-member LLCs may deduct business expenses up to $5,000 in a single year.
He was now allowed to deduct the costs of his home office, subscriptions, internet, computers, courses, etc.
Basically, Walter was allowed to deduct anything that was “reasonably” required to operate a trading business, up to $5,000.
That can save you a pretty penny.
In addition, Walter was not limited anymore to deducting losses only up to $3,000 per year.
At this point, because we filed an LLC for Walter, he was able to deduct:
- Part of business expenses
- Full extent of his losses
At this point, if we would have let Walter walk out, all Walter would be doing is day trading as a business.
Day trading as a business is good but not great.
Walter wanted to save more.
We helped Walter save more money, besides for the money we helped him save when setting up an LLC for investing.
How does a trader save more money?
That’s a great question.
S-Corp For Day Trading
By default, the IRS considers income from trading as capital gains and not earned income.
The problem with capital gains is that it lacks benefits, which can be obtained if you elect to be an S Corp.
For this reason, we changed the status of Walter’s LLC from a single-member LLC to an LLC S Corp.
Once we did this, we arranged that Walter should pay himself a base salary.
This accomplished tremendous savings, for Walter.
Paying yourself a base salary unlocks a number of benefits.
The first thing paying yourself a base salary through your S Corp accomplishes is “the solo 401(k) contributions”.
As of 2022, you can contribute up to $61,000 of trading profits in a given tax year to this self-employed retirement plan.
This was great for Walter!
But to make this already great situation even better, Walter can still trade that income tax free, because Walter was a legal business day trader.
This is a double bonus for Walter because he was:
- Not paying taxes on a portion of your earnings.
- Building up stability for retirement
The second thing paying yourself a base salary through your S Corp accomplishes is in regard to the “self employed health insurance contribution”.
Once Walter paid himself a base salary through the S Corp, he was able to deduct his self-employed health insurance premiums from taxes.
Another great benefit that Walter unlocked when electing S Corp status for his LLC, is the fact that he could now deduct business expenses beyond $5,000 for taxes.
A single member LLC can only deduct business expenses up to $5,000.
However, when you elect S Corp status for your LLC, you may deduct up to 20% of your net business income from your taxes.
Before electing S Corp status for his LLC, Walter was only able to deduct $5,000 worth of business expenses from taxes.
Now, he was able to deduct up to 20%!
This strategy saved Walter $20,000 on his taxes!
How can you start an LLC for day trading?
That is next.
How To Start An LLC For Day Trading?
You've probably guessed, the first step to buy stocks using an LLC is to form your limited liability company.
Once you've successfully formed your LLC, it can do so many things as an individual, such as buying stock.
Step #1: Create Your LLC
When you register your LLC, you file LLC articles of organization.
You will typically do this through your Secretary of State’s office.
Your articles of organization form will establish information such as:
- Your name of your LLC.
- Your LLC’s business address.
- All the names and addresses of your LLC’s managers, organizers, and designated registered agent.
- The date you effectively formed your LLC, and the term for which you LLC will operate (if necessary)
When you file your articles of organization, you will need to both pay a filing fee and wait until your application is completely processed.
You want to get an EIN (tax ID number) that is specific to your LLC.
In order to get your EIN, all you need to do is go to the IRS website, it is fast and free.
Step #2: Operating Agreement
Once you have completed the entire articles of organization process, you want to specify who has the authority to purchase stock on behalf of your LLC.
You will specify in your LLC’s operating agreement who has the ability.
You have the option to give authority to only one of your owners / managers or to more than one owner / manager.
Whichever option suits your LLC best, be sure to state your choice clearly in the operating agreement.
Step #3: Open A Brokerage Account
Now that you have clearly stated in your operating agreement who has the authority to purchase stock on behalf of your LLC, you will need to open a brokerage account in your LLC’s name.
Do research as to which stock trading provides an account for LLCs.
Most major brokerage accounts offer you the option to buy stocks on behalf of LLCs.
For example, TD Ameritrade offers accounts for various business structures, including LLCs.
Here is how you do it...
After you've successfully opened your investment account, you will need to fund it.
And… you are set!!
You have just completed the task of creating an LLC for stock trading.
You can now buy stocks just like you would with your personal account.
What are the benefits of forming an LLC for trading?
The benefits are next.
Keep on going.
Benefits Of LLC For Stock Trading
- No Federal Tax
- Liabilty Protection
- Group Investing Option
- More Capital
- Federal Taxes Apply
- No Liabilty Protection
- No Group Investing Option
- Limited Capital
Advantage #1 Of Setting Up An LLC For Stock Trading: Taxes
When you invest as an individual, you pay taxes on every source of income.
This includes both dividends and capital gains.
When you invest through an LLC (a pass-through entity), you will not pay federal income tax on your gains.
Meaning, when you trade through an LLC, you will save money, which you would otherwise pay as tax.
Advantage #2 Of Setting Up An LLC For Stock Trading: Liability Protection
When you establish your LLC, it is a separate legal entity from you, individually.
All the members in your LLC benefit form asset protection if creditors collect money from your LLC or if your LLC is sued.
For this reason, the members of your LLC risk to lose only what they have put into the company, in the worst case scenario.
This is an extreme advatage because if you would not create an LLC, then all of your LLCs members would risk all of their personal assets.
However, the LLC protects their personal assets such as cars, houses, and personal savings.
Advantage #3 Of Setting Up An LLC For Stock Trading: Group Investing
When you invest or trade stocks through an LLC, you can collaborate with several people to invest, similar to a partnership.
For families, this especially benefits them.
It allows them to build realy advanced savings for the future.
However, even if you're not collaborating with family, if you’re apprehensive about investing, you can still benefit from creating a trading LLC.
When you invest with a group of people, there is a larger pool of knowledge to ease the burden of making tough technical decisions.
As they say, two heads are better than one.
Advantage #4 Of Setting Up An LLC For Stock Trading: More Capital
Aside from the benefits of trading together with family or having partners helping you make tough trading decisions, there is another benefit of investing through an LLC, access to more capital.
Investing through an LLC allows a group of people to combine their finances.
Trading with more capital allows your LLC to both purchase higher value stocks and diversify its portfolio.
Lets say that forming an LLC is not an option for you.
What are your options to save on taxes?
How can you save money on taxes as a trader?
The next topic focuses specifically on that.
Keep on reading.
Trader Status Remedy
Another way to avoid the tax treatment of ordinary traders is to qualify for trader status.
When you qualify for TTS (trader tax status), you'll pay a lot less than you would if you were an ordinary trader.
The benefits of filing taxes with a TTS are tremendous.
What are the benefits of qualifying for trader status?
Benefit #1 Of Trader Tax Status: Mark To Market
One of the great things about qualifying for TTS is that you can claim more than the $3,000 capital loss that normal traders are limited to.
When you file taxes with a TTS, you can claim all of your capital losses against your total income, each year.
However, to do so, you must make a Mark to Mark election in section 475 with the IRS prior to the tax filing deadline for the previous year.
With that being said, if you want to claim all of your capital losses against your total income, be sure to make a Mark to Market election.
The Mark to Market election will ensure that losses are fully tax deductible.
However, be sure to do this before the tax filing deadline.
The reason why you need to elect Mark to Market beforehand is because you cannot elect Mark to Market for previous years.
For this reason you need to elect Mark to Market before your tax filing deadline.
This will activate your Mark to Market for that current year.
However, if you try to elect Mark to Market after the tax filing deadline, you will not be able to elect for the previous year - it just doesn't work like that.
Benefit #2 Of Trader Tax Status: Wash Sale Rule
Another awesome benefit of filing taxes with a TTS is that the Wash Sale Rule does not limit you.
Since you qualify for Mark to Market (which can only be done if you qualify for “trader” status) you have a legal way to surpass the Wash Sale Rule.
However, you have to pretend to sell all of your holdings by the last day of the year and buy it back afterwards, for tax purposes.
Benefit #3 Of Trader Tax Status: Expenses
One more, extremely generous, tax break that a TTS designated traders have is the ability to write off a lot of your trading expenses.
You can write off almost anything that is considered necessary for your business.
This includes your computers, chat rooms, internet, etc. from your taxes.
You save a lot of money compared to how much you would pay if you would be an ordinary trader as the write offs for an ordinary trader are extremely limited.
In order to write off your business expenses, you file a Schedule C form.
It sounds pretty good, doesn't it?
How do you qualify as a trader?
What do you have to do to qualify as a trader?
Keep on going.
How Does The IRS Qualify a Day Trader?
If you want to qualify as a trader, you should spend a minimum of 30 hours trading, per week.
Meaning, you should spend a considerable amount of time researching and documenting trades and strategies.
Additionally, you should make 4 - 5 trades per day for most of the tax year.
Meaning, if you are just trading on the side, you likely will not qualify as a trader.
Another easy aspect that will help you qualify as a trader is to average less than 31 days (<31) days for holdings.
Furthermore, you should treat trading as a true profession.
Meaning you should trade using modern softwares and tools.
Even though there is nothing wrong with using basic software material, the IRS will more likely qualify you as a trader if you use more sophisticated operating material.
Lastly, be sure to have a significant amount of money in your account.
This means if you're trading $2,000, the IRS will not qualify you with TTS.
Remember, the goal is to make the IRS think that this is a primary profession, and not simply a hobby.
Qualifying as a trader is never guaranteed, it is complicated.
In fact, just because you qualified last year as a trader, it does not guarantee you will qualify as a trader the next.
Check out IRS Publication 550 and Revenue Procedure 99-17 and 99-49 as the IRS has set forth guidelines for qualifying as a trader.
The IRS defines a qualified trader as someone who trades often and continuously to profit from the short-term fluctuation in market prices.
Frequently Asked Questions
Can I open an LLC for stock trading?
Absolutely! An LLC can indeed buy stocks, just like any individual.
Once the LLC is set up, you can definitely open up a brokerage account in your LLCs name and transfer existing assets.
After that, you’re all set to buy stocks and bonds within the LLC just like you would in a personal brokerage account.
Should I put my stocks in an LLC?
It is not encouraged to put stocks or investments through partnerships and sole proprietorships, they offer zero protection.
Instead, owners should register entities, either as an LLC or as a corporation, before investing or buying stock.
This can be done anytime during the life of a partnership or sole proprietorship.
How do day traders pay tax?
If you are a profitable trader, you must pay taxes on your earnings.
The tax treatment for ordinary day traders is not favorable compared with long term investing.
You are required to pay taxes on investment gains in the year you sell.
You may offset capital gains against capital losses, but the gains you offset cannot total more than your losses.
How do day traders avoid taxes?
When you hold an investment for more than a year allows you to take advantage of lower tax rate, long term capital gains.
Additionally, you can defer these taxes by holding your investments in a tax-advantaged account, such as a 401(k) or a Roth IRA.
Are trading stocks considered a business?
Trading is not considered a business activity by the IRS.
One of the consequences of this is that all of your expenses are not eligible for tax deductions.
How do I start a stock trading business from home?
Step #1: find a stock broker.
Step #2: open a trading account with the stock broker you chose.
Step #3: login to your trading account and add money.
Step #4: view stock details and start trading, responsibly.
How to open an LLC for stock trading?
Step #1: create your LLC for stock trading.
Step #2: authorize who can buy stocks on behalf of your LLC.
Step #3: open an account with a stock brokerage.
Disclaimer: I’m not a lawyer or an accountant, and this is not legal or accounting advice. Before taking any action based on this information, we strongly suggest you consult with a professional accounting advisor about your specific situation.