The Van Tharp Institute

August 30, 2006 — Issue #286

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In this Issue:

Workshops

Day Trading Workshop, $500 Discount Expires Today
Two Core Workshops in Sydney, Australia, $700 Discounts Expire Next Week 

Feature Article

Mark-to-Market Makes a Magical Difference for Most Traders, By Jim Crimmins

Trading Tip

What Are You Willing to do to Succeed? by Van K. Tharp

New Reports

Market Mastery Reports - Now Downloadable 

Listening In...

System Developers' Remarks

View this newsletter on-line, or read back issues

 

Workshops:

 


Day Trading Workshop

$500 Discount Expires TODAY

September 16-18, 2006 - Raleigh, NC

Presented by: D.R. Barton and Brad Martin

Learn More About the Course...


Peak Performance 101 Workshop Australia

Presented by Van Tharp

September 23-24-25

Learn More  --  Register Now

Combo Pricing Available!


Systems Workshop 
Australia

Presented by Van Tharp

September 27-28-29

Learn More  --  Register Now

Combo Pricing Available!


$700 Discounts for Australian Workshops expire next week.

 

Feature

Mark-to-Market Makes a Magical Difference for Most Traders

By Jim Crimmins, President, Traders Accounting

Whenever we consider the benefits of trader tax status, the one item that tops the list is the ability to elect a special accounting method known as mark-to-market, or MTM for short. While mark-to-market won’t automatically turn your losing positions into winners, it can have an almost magical effect on your after-tax earnings and day-to-day record keeping.

Sound too good to be true? Actually, for most traders, MTM is indeed the magic bullet that enables them to fully deduct their business-related expenses, avoid the time-consuming wash sale rule and remain exempt from self-employment tax.

But there is a catch or two to this otherwise generous gesture from the Internal Revenue Service that could cost you dearly. We’ll soon see why it’s a good idea to contact a tax professional before you make this one-time, irrevocable election.
Let’s take a closer look at the all-important mark-to-market accounting method election and the trapdoors you need to avoid to make it work for you.

The Mark-to-Market Method

Since 1997, mark-to-market accounting has enabled traders to change the tax status of their earnings from capital gains/losses to ordinary income/losses. This occurs on the last day of the year, at which time you tally all of your open holdings as if you were selling them at the market price that day; in other words, they are “marked to market.” On January 1st, you re-tally your holdings as if you were repurchasing them at the current price. The basis of each holding is then adjusted to reflect these hypothetical gains and losses for tax purposes.

Advantages of Mark-to-Market

The advantages of mark-to-market accounting include:

• No wash sales: MTM traders are exempt from the wash sale rule; because holdings are tallied at year’s end, there is no need to account for gains or losses that might occur within the 30-day wash sale restrictions. Many traders elect MTM specifically to avoid cumbersome wash sale accounting. 

• Losses are fully deductible: Because your income/losses are treated as ordinary income and not capital gains/losses, you are not bound by the $3,000 capital loss limitation. This means you can deduct all losses in the year they occur, providing tax relief when you need it most. Here’s how a $40,000 loss would impact Janet Trader (with trader status and MTM) versus Johnny Investor (without both). Note that Janet Trader was able to offset her regular $100,000 income with her $40,000 loss, while Johnny Investor was limited to the $3,000 capital loss deduction: 

Total household income: $140,000
Trading loss: <$40,000>
Trading expenses: $24,230

Janet Trader’s tax savings: $19,269
Johnny Investor’s tax savings: $984
Benefit of trader tax status & MTM: $18,285 

• No change to self-employment exemption: Even though MTM income is not considered capital gain, traders who elect MTM remain exempt from self-employment tax, the same as investors and non-MTM traders. 
Disadvantages of Mark-to-Market 

There are three potential disadvantages to electing mark-to-market:

• No capital loss carryover: Capital losses can only be offset by capital gains. If you are carrying forward a substantial capital loss, beware: by selecting MTM, your gains would be considered ordinary income moving forward, hence only $3,000 per year could be used to offset your capital loss. 

• Loss of long-term capital gains: Forex/futures traders who deal mainly with 1256 contracts typically avoid MTM in order to retain the advantageous long-term capital gains tax rate on 60% of their earnings. 

• Election is permanent: As an individual trader, once you’ve made the MTM election, you’re stuck with it. You can petition the IRS, but don’t expect leniency, especially if there is a tax advantage to you. Below, we’ll see how a Traders Accounting tax professional can help you around this obstacle. 

How to Elect Mark-to-Market

To elect mark-to-market as your accounting method, you must enclose a statement of intent with your tax return or extension request and file by the appropriate tax deadline (March 15 or April 15) the year prior to beginning MTM accounting. For example, to use MTM for your 2006 return, you would have had to elect mark-to-market by April 15, 2006. The one exception: if you’re filing as a new business entity (i.e., general or limited partnership, limited liability company or C Corporation), you have 75 days from opening to note your accounting preference in your meeting minutes.

Your first year using MTM, you will fill out IRS Form 3115 (Application for Change in Accounting Methods) and submit it with your tax return. This form contains an adjustment, Section 481(a), which captures duplications and omissions resulting from the change in accounting methods. If the adjustment is $25,000 or less, you may deduct the full amount on your return; if it exceeds $25,000, you may deduct 25% each year for the next four years.

Exempt Your Investments Before You Elect MTM

Before you elect mark-to-market, be sure to separate your investment holdings from your trading stocks and options. Why? Because unless they are clearly separated, you will be required to mark them to market at year’s end and report any gain as ordinary income. That could prove disastrous for stocks that have greatly increased in value over the years.

The IRS lets you exempt your personal investments from your trading business, but only if you identify those investments up front. Like the MTM election itself, this designation is irrevocable; you cannot decide later to fold your investment losers into your trading stock for ordinary losses or cherry-pick your trading winners for capital gains treatment.

Under the IRS guidelines, you must clearly identify your investment stock as such in your records by the close of the day on which you acquired it or when the MTM election was made. There are two ways to do this: you may establish a separate account for your investment stocks (the wisest course of action for MTM traders), or simply note in your records which securities are not part of your trading business.

Be prepared to convince the IRS that your investments have no connection whatsoever to your trading business; otherwise, you’ll be required to mark them to market at year’s end and report any gains as ordinary income.

What If You Miss the Election Deadline?

Did you miss the mark-to-market election deadline? You can file for an extension of up to six months to make your mark-to-market election via the private letter ruling procedure under IRS Section 301.9100-1 (Extensions of Time to Make Elections). The IRS may charge a fee for this. In practice, however, most traders who miss the MTM deadline don’t realize it until the following year, and hence miss the election extension deadline as well.

The tricky business of meeting the MTM election deadline is one reason we at Traders Accounting encourage individuals to trade under the umbrella of a business entity. One of the best ways in general to secure and protect your trader tax status is to trade as a business entity, but it comes in particularly handy where the mark-to-market deadline is concerned. As I mentioned previously, the IRS allows newly formed business entities (including general and limited partnerships, LLCs and C Corporations) 75 days from formation to note their accounting preference in their meeting minutes. 

Down the road, should the MTM election prove undesirable (say you shift to trading predominately forex/futures, for example), you may simply dissolve the business entity and form a new one, thereby avoiding the one-time-only election rule. 

Get Advice Before You Elect MTM

Is the mark-to-market method right for you? Because every trader faces different circumstances, there is no cookie-cutter approach when it comes to this all-important decision. For some, MTM is the obvious solution to the time-consuming task of tracking wash sales. For others, the ability to fully deduct their losses in the year they occur can make a big difference starting out.

If you find yourself carrying forward a capital loss or have other questions relating to mark-to-market accounting, be sure to consult a tax professional (preferably one who specializes in trading) about your situation before you decide.

About Jim Crimmins: Jim Crimmins is the founder and President of Traders Accounting. Jim worked with one of the largest and well-known educational organizations of the stock market where he became a master on entity structuring and developed a network of experts in the trading arena. 

Jim has become a nationally known speaker on tax strategies, entity structuring, and lifestyle change. He delivers over 30 talks a year throughout America as well as speaking in several chat rooms each month.  You can learn more at TradersAccounting.com.

 

Trading Tip 

What Are You Willing to do to Succeed?

By

Van K. Tharp

Dear Dr. Van Tharp:   

"What's a reasonable goal for me as a trader? Can I make a living trading? Can I make millions trading? Is that reasonable for a former professional?”

“I’m aged 46, and I’d like to move into full time trading. I’ve accumulated about $200,000 in cash. What is possible for me given my age and goal to become a full time trader?”

Sincerely, E.R. 

Dear E.R.,

Your trading goal is up to you. You can certainly become a full time trader.  That is probably possible within a year to 18 months.   You can certainly take a million dollars out of the market and you could reach the stage where you take a million dollars out of the market each year.  It depends upon what you are willing to do.

However, there are a number of questions that you will need to ask yourself because each scenario has a different answer.

How much do you love trading?   How committed are you to being a full time trader making millions?  Are you willing to work 12-16 hours a day, 6 days per week, for the next five years?   Are you willing to work at least four to six of those hours a day on starting your own trading business? Are you willing to spend another hour or two a day developing probably the most valuable skill you could ever have, self-knowledge?

Are you willing to give up most of your free time -- at least until your trading business is off and running soundly?  And are you willing to think about trading when your family is still enjoying the things that you used to do together?

Will you do whatever it takes to be the best -- including discipline and full responsibility for your results? You would need to start by spending at least the first six months really working on yourself, looking at all of your psychological patterns and developing ways to overcome any personal obstacles.

In addition, you will need another four to six months to develop a business plan that will be the basis of your trading business.  Most people don't  treat trading like a business.  And most businesses fail because they don't plan.

Are you willing to learn a new way of thinking about the markets? This means thinking in terms of risk to reward, understanding that risk is what you lose when you lose in a trade and understanding that position sizing is the core of how you’ll work to meet your profit targets. Probably most of what you have learned about the markets needs to be turned upside down, examined, and then probably thrown out as garbage. Could you handle it?

Would you be able to develop at least three systems that fit the big picture?   And are you willing to work on these systems enough so that they become great systems?  

I mention all this because all of these things are required if you are really serious about being a top trader that earns a lot of money in this field. I have made the studying of top traders my vocation and have written books on all of these subjects for years.

It's all up to you. Are you willing to do the necessary work or is the goal too lofty?

My Peak Performance Home Study Course will get you started and guide you through a lot of the work that you will need to do. I recommend that you devote a full two hours each day to working on it until you’re completed.

All the best
Your Coach
Van Tharp

About Van Tharp: Trading coach, and author Dr. Van K Tharp, is widely recognized for his best-selling book Trade Your Way to Financial Fre-edom and his outstanding Peak Performance Home Study program - a highly regarded classic that is suitable for all levels of traders and investors. You can learn more about Van Tharp at www.iitm.com.

Special Reports By Van Tharp

Market Mastery Reports - Downloadable 


$39.95 each 
[Regularly $59.95]

BUY ALL 4 Reports for $129.00!

Click on any title below to read an excerpt

1. Doing a Spring Cleaning on Yourself as a Trader
2. Understanding Expectancy and the Golden Rule of Trading
3. Are You Doomed to Failure? Yes, but Only if You Avoid Working on Yourself!
4. How Academia Leads Wall Street Astray

More Info...

Listening in...  

We just completed another successful How to Develop a Winning Trading System Workshop. 

We asked attendees to list the five strongest benefits they got from the course. 

Here are some of their answers:

"Has shown me the holes in my system."

"It has increased my expectations of future trading."

"Made me believe I really can do this."

"Value of stops and exits."

"Able to bounce ideas off Chuck and D.R. to get real time feedback on what you are thinking."

"Valuable to be introduced to other types of traders and how they think about their trading."

"Exposure to real world profitable methods and systems."

"Solidify my position sizing strategy."

"Learned four new indicators that will enhance my system. Learned system improvements from Chuck and D.R."

"Different points of view."

"In a positive expectancy system, position sizing is everything."

"On-the-job training with the marble game and group exercises."

"In depth exploration of system development steps."

 

Visit Van Tharp's New Blog: www.smarttraderblog.com

Participate on our Trading Forum,  a place for traders and investors to share ideas and learn from each other. 

 

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The Van Tharp Institute
102-A Commonwealth Court, Cary, NC 27511 USA
800-385-4486 * 919-466-0043 *  Fax 919-466-0408

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Copyright 2006 the International Institute of Trading Mastery, Inc.

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Quote:

"The important thing is this: To be able at any moment to sacrifice that which we are for what we could become." ~Charles DuBois

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Free Trading Simulation Game

A computerized version of Van's famous "marble game." 

It is designed to teach you the important principles of proper position sizing. 

Download the 1st three levels of the game for free. Register now. 

 

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Workshop Schedule

Sept 16-18 Day Trading
Sept 23-25 Peak Performance 101
SYDNEY, AUSTRALIA
Sept 27-29 Systems Development
SYDNEY, AUSTRALIA
Oct 23-25 17 Steps
Oct 27-29 Mutual Funds & ETFs
Nov 3-5 Peak 101
Nov 7-9 Peak 202

 More Info...

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