So today we're going to be talking about how to legally legally lower your tax liability as a trader. But before I get into this, let me give you a quick disclaimer: I Am NOT a registered tax professional a CPA or anything of that sort And thus this video and anything and everything in it is for entertainment purposes only. But with that being said, let's go ahead and get into it. So the major factor when it comes to paying taxes is how the IRS sees your trading activity.

Does it see it as investing or does it see it as a business and classifying it as a business basically allows you to deduct all of your expenses and most importantly, allows you to surpass the $3,000 capital loss limit for your write-offs. Moreover, you could take this a step further and structure your business in a way that allows you to take advantage of the 21% corporate tax rate instead of paying the high individual tax rate on your personal income tax returns. But anyways, with the IRS watching us all I ask of you in return for this video is that you hit that beautiful and ravishing like button. And also don't forget to subscribe if you see value in the following video.

So to start, one of the biggest mistakes that you can make as a trader is to simply just trade and then at the end of the year, then figure out your tax liability. That's because if you know that you're going to make a consistent profit, if you've already established that you're making consistent profit, or at least a tangible amount of income, you need to take steps to ensure that the IRS properly classifies your business. And again, if you fall into the active trader category or LLC category, the IRS will then deem any activity or revenue that you generate from trading to be business revenue. Whereas if you don't do it, what happens is that they just end up using it as ordinary income if you are classified in the business category.

That means that you can deduct things such as your home office margin fees, education, subscription services, chat room fees, new computers that you purchased for trading, and anything else that is reasonably required for you to earn an income as a trader. And if you structure a trading company to be taxed as an S corp, which LLC's can now designate for tax purposes, you will also be able to deduct your health insurance premium, which is great if trading is your full-time income. Another thing that you can deduct is the full extent of your losses. If you are a regular trader, you can only deduct up to three thousand of your losses, which is really a shame because a lot of traders they lose a lot more than that.

So this deduction can, needless to say, make a huge difference and makes it worth it for a lot of people to simply form an see. Now this is where it gets a little bit more interesting because classifying your trading income as a business activity allows you an exemption from a little regulation that's very pesky Culty Wash Sale rule. This rule makes it so that you can't claim a loss on a stock if you buy it back within 30 of the original days of that sale. And obviously this is meant to curtail investors from kind of churning losses for tax purposes.

Example: If Charlie decides that he's going to sell 2,000 worth of Tesla on Monday and sells it for a $1,000 loss, he gets to claim that $1,000 tax deduction, Then if the sale price is approximately the same the next day, he could then hypothetically just buy back the 2000 and also keep the $1,000 loss that he just accrued. In other words, Charlie still owns the same amount of Tesla shares on Tuesday that he did on Monday but now he also has a $1,000 capital loss. And basically this rule will protect against this. but if you're under business activity then you don't have to worry about it.

Now there is one more step that you could take to further decrease your tax liability. and this one's going to make more sense if you make more money from trading. This one's quite complex. so I Remind you to see a tax professional before you go into any of these things.

But let's say that you start making say several times the average household income in the United States Well, we have a progressive tax system so that means that every marginal dollar will be taxed at a higher rate once you could do a certain point. If you live in a high tax state like California like I do, you could potentially lose half your income in the higher brackets. So instead of working half your year for the United States government, you can take advantage of a little thing called a holding company. And this is 100% legal and this is how a lot of people do it.

So a holding company basically allows you to take advantage of the corporate tax rate of 21 percent. So instead of paying a marginal tax rate around 50 percent, you're now only paying a 21 percent tax rate. And essentially how it works is you set up two different business entities. One is the LLC where you're trading activity occurs, they pass-through entity so that the profits passed through the LLC and then the other is the S corp holding company which then receives your profits.

So the difference between this and many other strategies is that instead of the LLC your LLC passing through the profits to you, it's now passing it in to your holding company. Since the holding company is receiving the profits, the holding company is the one that has to pay the taxes on it. and because for tax purposes it's an S corp, you're able to take advantage of the corporate tax rate instead of the high marginal tax rate. so you only have to pay twenty one percent versus potentially fifty percent or more.

Now, the only catch with this is that in some situations and mostly based on how you structure the company, you will need to pay yourself what the IRS considers a reasonable salary and the normal salary will then pass through to you and will be taxed at the normal rates. But the reasonable salary is sort of a gray area where you have a lot of personal freedom in terms of how you set that. Hypothetically, if you made say, three hundred thousand a year from parading, you could just say, well, you know, I'm only worth fifty thousand a year. So I'm only gonna pay myself a fifty thousand dollar a year salary and then that amount would be the amount that's taxed on your personal income tax return and then everything else gets taxed on the corporate rate of twenty one percent.

But because only that fifty thousand is being taxed on your personal income tax return, That means that you get to save on all the higher marginal rates because fifty thousand doesn't make it to the higher brackets. and then the rest of the two hundred fifty thousand gets taxed at the twenty one percent rate. With that in mind, you might ask yourself, okay, well, why wouldn't I want to set the salary to say zero dollars? Well, that's not considered a reasonable salary for IRS purposes. You do have to set a salary that's reasonable and they will fight you on that if you try to go too low.

So again, see a tax professional because they'll help you figure out what a reasonable salary is. But the key here is that if you paid yourself that fifty thousand under the three hundred that you made, you can then put that two hundred fifty thousand in your holding company and that could be used to make you even more money with later investments, be they at the stock market or real estate or whatever you want to buy. And whatever money that money generates is also taxed at the lower rate instead of being taxed at your high rate. And of course, the holding company can now be used to acquire expensive assets as well as even have a loan borrowed against it.

So to take advantage of these tax breaks and tricks for businesses, you need to start an LLC or qualify as an active trader by IRS disqualification guidelines. So the easier of these two is undoubtedly the LLC route. The LLC is relatively simple to set up, and in most states, it's not very expensive. Unfortunately, in California where I live, it's quite expensive.

It cost $800 but if you live in Maine it's like 20 dollars and you never have to pay anything again. But in California for some reason they make it so that you can $800 which is insane. And then every single year you have to pay another $800 and this is generally pretty easy to file. It's a few documents and then everything's great.

and the other route is to qualify as an active trader. Now, this is also kind of a gray area and it's kind of hard to meet this. That means that you have no less than 720 trades every single year, no lapses in schedule, you have a large account maintenance, and your average holding period is less than 31 days. Now, there are a few other minuscule guidelines with this, but generally these are the big ones that you need to qualify it.

Okay, so let's say that the IRS doesn't classify your trades as business activity. What? What are your options then? Well, there are still two major options available to you. The first one is that you can deduct up to $3,000 worth of capital losses on your next tax returns. That means if you had $5,000 in gains, but you lost 3,000 you only pay taxes on the 2,000.

Of course, the problem is that after 3,000 you can't deduct any more. And the second, and perhaps the best one, is the fact that you don't have to pay self-employment tax. Most self-employed professionals have to pay a certain percentage in self-employment tax, which is basically both portions of Medicare and Social. Security.

When you're when you are a W-2 employee, you basically pay part of it and then your employer pays the other part for you. But when you're self-employed you have to pay both parts and I Think that comes out to a little bit over 14% But as a short term trader that is not applicable to you, the IRS does not choose to put this tax on short-term capital gains. which is shocking because there's very few things the IRS doesn't want to tax anyways. I Hope this video serves as some sort of catalyst to eat you more interested in saving money on your taxes and kind of optimizing your trading strategy and your overall financial situation so that you could pay the least amount of taxes as possible.

There is no reason to pay $1 more than you are legally required to, but of course, make sure to get a professional opinion from someone registered as a CPA or tax professional of whatever sort. But anyways, have a great day folks and I'll see you in the next video.