Option trading guidelines for earned income
It tends to have an inherent value in itself which carries CGT implications. See CG for the formal definition. Binary options present individuals with the opportunity to benefit from fluctuations up or down in, for instance, the price of individual shares or the performance of indices such as stock markets or currency markets. These are derivative products; which means you do not have any ownership in the underlying asset at no point do you own the share in question, for instance.
In fact, there are only two possible outcomes once the option expires: HMRC will almost always regard this as a form of gambling: Cases that have gone before the courts help to shed light on this.
A more recent case Hakki v Secretary of State for Work and Pensions  EWCA Civ concerned a professional poker player who made a living through his winnings and who was facing a child maintenance payment order from the Child Support Agency.
The Court of Appeal once again confirmed the general principle that gambling is not a trade. So even if your only source of income is from binary options profits, it seems unlikely at present that profits would be deemed liable for tax. But do not rule it out completely. The answer, in the majority of cases, is likely to be no as it is not classed as income for tax purposes.
But as ever with tax, it all depends on the context. Use this general guidance and consider your position carefully. An accountant with specific expertise in gambling and financial trading activities should be able to assess your particular circumstances and provide an opinion on potential liabilities.
The professional trader can deduct many more types of expenses than a casual trader, without limitation. So if a casual investor claims the standard deduction , which most do, then even these limited investment expenses cannot be deducted.
There is also an itemized deduction phase-out rule for claiming itemized deductions, reducing the deduction for higher income taxpayers. For instance, professional traders can deduct the full cost of any educational courses, as long as they did not take the courses to actually enter the profession. Since the professional trader status does not require a license, it would be difficult to prove that the course was taken to enter a new profession. Hence, most courses taken after the attainment of professional trader status will probably be deductible if it clearly benefits trading.
On the other hand, a casual investor cannot deduct any such courses at all. Likewise, the casual investor cannot deduct meals and entertainment , transportation mileage , home office expenses , cell phones, and trader chat room fees. However, any investment losses incurred before attaining professional trader status cannot be used to offset professional trader income. Professional traders must also pay quarterly estimated taxes.
Since income can vary widely throughout the year, the quarterly payments may be a lot more or a lot less than what could have been paid given the final income for the tax year.
Overpayments, of course, will be refunded when the trader files his tax returns after the end of the tax year. According to the Taxpayer Relief Act of , traders in securities engage in a trade or business involving active sales or exchanges of securities on the market, not by trading with customers. However, professional trader status is not defined by the tax code — it is defined by IRS guidelines and case law.
Hence, there is some risk in electing the professional trader status, especially since there are no bright lines distinguishing the professional trader from the casual investor in the IRS guidelines, or the court record, for that matter. Factors that the IRS considers when determining whether trading is actually being conducted as a business include the following:.
The trading of securities is only considered a business for those securities that satisfy the trading requirements. Any other securities held by the investor are considered an investment rather than a business, and thus, subject to the investment rules. Records must be kept to distinguish between those securities traded as a business and those that are traded as an investment, since they are subject to different tax rules, which is generally done by keeping them in separate accounts.
If long-term investments are commingled with the short-term investments in the same account, then the owner's professional trading status may be in jeopardy, since the IRS regularly audits professional traders. Trading as a business is reported in the same way that any business reports its income and expenses, by filing Form , Schedule C, Profit or Loss from Business. Other advantages of trading as a business using the mark-to-market method of accounting is that there is no limitation on the deductibility of investment interest expenses.
The gains earned from selling securities are not subject to self-employment tax, since any gains or losses are reported on Part 2 of Form , Sales of Business Property.