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TAX

Scenario 3: A day trader, who qualifies as a trader in discuss both how the client can qualify as a trader
securities, has net realized short-term gains from sales in securities and the differences between the tax
of securities during 2021 of $10,000, has $10,000 of treatment of trading activities with and without a
trading expenses, and holds securities at the close of the Sec. 475(f) election. The election is a two-edged
year on which a net gain of $20,000 would be realized sword, and depending on the client’s circum-
if they were sold for FMV. The trader also receives stances during a year, may increase or decrease his
$95,000 of ordinary income from other sources and or her tax liability. Moreover, the election must be
takes the standard deduction. Notice that by making the made in the year prior to being effective and once
Sec. 475(f) mark-to-market election, both the realized made can only be revoked with the IRS’s consent.
and unrealized gain become part of ordinary income. Therefore, to determine if making a Sec. 475(f)
election will be beneficial, the client must realisti-
ADVISING DAY TRADER CLIENTS cally consider what his or her tax circumstances
When advising a client who day-trades or anticipates are likely to be in both the year the election
doing so in the future, a practitioner should be sure to becomes effective and future years. ■
Quantifying the effects of the election

Scenario 1 Scenario 2 Scenario 3
Day trader not making the Sec. 475(f) election
Ordinary income from other sources $95,000 $95,000 $95,000
Capital gains/losses from trading activities (3,000)* 30,000 10,000
Ordinary income/loss from trading 0 0 0
Schedule C expenses 10,000 10,000 10,000
Adjusted gross income 82,000 115,000 95,000
Standard deduction 12,550 12,550 12,550
Taxable income 69,450 102,450 82,450
Tax 11,028 18,609 13,888
Tax bracket 22% 24% 24%
Day trader making the Sec. 475(f) election
Ordinary income from other sources $95,000 $95,000 $95,000
Capital gains/losses from trading activities 0 0 0
Ordinary income/loss from trading (25,000) 30,000 30,000
Schedule C expenses 10,000 10,000 10,000
Adjusted gross income 60,000 115,000 115,000
Standard deduction 12,550 12,550 12,550
Taxable income 47,450 102,450 102,450
Tax 6,188 18,609 18,609
Tax bracket 22% 24% 24%
Tax difference with Sec. 475(f) election (4,840) 0 4,721
*The day trader’s net capital loss is subject to the $3,000 capital loss limitation.
Source: Joseph Hargadon, Irfan Safdar, Stephanie Wendling, and Eunbin Whang.

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40 | Journal of Accountancy June 2022