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Do you buy and sell a fair number of stocks?

Consider whether you’re a trader or investor …

Because there are some major tax differences. We will discuss the basic rules so you can apply them to your own situation when filling out your 2020 return.

Key factors separate traders and investors:

Traders engage in frequent buying and selling, usually owning securities briefly … for just a few days or even only a few minutes for some busy day traders.

Their trading activities are continuous, over the full year and not just for a couple of months.

And they look to make money on short-term swings in market prices.

Investors earn profits mainly on long-term appreciation and dividends. They hold securities for longer periods of time and sell much less often than traders.

The capital gains break is the main tax benefit for investors. Gains from the sale of securities held for more than one year are taxed favorably at 0%, 15% or 20%, compared with the top 37% tax rate on ordinary income. These long-term capital gains rates are based on income thresholds adjusted each year for inflation. For 2020, the 0% rate applies to taxable income of up to $40,000 on single returns, $53,600 for head-of-household filers and $80,000 for joint filers. The 20% rate begins at $441,451 for singles, $469,051 for heads of household and $496,601 for couples filing jointly. The 15% rate is for filers with taxable incomes between the 0% and 20% break points. The 3.8% surtax on net investment income kicks in for single people with modified AGIs over $200,000 … $250,000 for joint filers.

But losses are capped. They can offset only capital gains plus up to $3,000 of other income, with any excess capital losses carried forward to future years.

And investors generally can’t claim any deductions … even on Schedule A.

Traders, unlike investors, can deduct their expenses on Schedule C. More good news is that net profits from trading aren’t subject to self-employment tax.

But traders’ gains are mainly short-term and taxed at ordinary income rates.

Although their losses are generally treated as short-term capital losses …

There is a way to fully deduct lossesBy making a Section 475(f) election. Traders who so elect must recognize gains and losses as if they’d sold their holdings for fair market value on the last day of the tax year. While the election is in effect, the deemed gains and losses are treated for tax purposes as ordinary income and loss.

The election can only be made prospectively. An election for the current year is required to be done by the due date of the tax return for the preceding year. Once made, the election continues for each year unless revoked under special rules.

The deadline to make an election for the 2021 tax year is April 15, 2021. If you want to elect and haven’t done so previously, you must attach a statement to your 2020 Form 1040, or with your timely request for a filing extension. For details on making the mark-to-market election, see the instructions to Schedule D and IRS Publication 550. Note that IRS does not like to approve late elections.

Tax Tips

Here’s a reminder if you help care for an elderly parent or grandparent.

You may be able to claim the $500 credit for other dependents on your 1040 if you meet certain tests. Your parent or grandparent needn’t live with you to qualify. But your relative’s income from taxable sources for 2020 must be less than $4,300, and you must show that you provided more than half of the person’s total support.

The rules to qualify for the dependent care credit are more stringent. The $4,300 income test doesn’t apply, but your relative needs to have lived with you for six months during the year and be unable to care for him- or herself. Other rules for the credit need also be met. For example, expenses for the care must be incurred so you can work, and you must report the provider’s tax ID number on Form 2441.

There’s a limited credit for putting energy-efficient windows in your home. The popular break for energy-saving home improvements now goes through 2021. The credit remains at 10%, with a $500 maximum. Any credits taken in prior years count against the $500. And many items are capped. For example, no more than $150 can be claimed for water heaters and furnaces, and $200 for windows and skylights.

Also availableA juicier 26% credit for the cost of residential solar panels or other alternative energy systems. The 26% credit can be taken through 2022. It falls to 22% in 2023 and then disappears entirely, unless extended by lawmakers.

Form 5695 is used by taxpayers to claim both of these tax breaks.

Did you get subsidies for buying insurance through an exchange last year?

Be sure to file a 2020 return and properly report the health premium credit. The credit is estimated when individuals purchase insurance through the exchange, and applicants can choose to have it paid directly to the health insurance company to lower their monthly premiums. For those who get a credit, filing a tax return is mandatory. Attach Form 8962 to figure the credit, list any advance payments made to the insurer and reconcile the two figures. IRS is on the prowl for people who get subsidies and either don’t file returns or file but erroneously report the credit.

Donations

Voluntarily pay down the federal debt and get an income tax deduction. If you’re feeling charitable and want to help reduce the spiraling federal debt, Uncle Sam will say thank you. These payments qualify as charitable contributions. Deduct contributions on Schedule A if you itemize. Nonitemizers can take up to $300 of total cash donations made to qualified charities … $600 on a joint return for 2021 … as an above-the-line deduction on Form 1040. You can give online at www.pay.gov.

Penalties

Failing to timely file correct information returns can lead to large penalties. The basic fine for returns that were due this year is $280 per 1099, W-2 and the like. Lesser penalties are imposed when the forms are corrected by Aug. 1.

There is a safe harbor for de minimis, inadvertent errors on filed returns. If the mistake is $100 or less … $25 or less in the case of tax withheld … then the issuer will escape penalties and needn’t file a corrected form, unless the payee elects otherwise.

Tax Treaties

IRS can help foreign tax authorities gather information. At the behest of Indian tax officials, IRS sent a third-party summons to Citibank asking for records on accounts owned by an Indian citizen, who Indian authorities suspect hasn’t complied with the foreign account reporting rules under Indian law. The individual opposed the summons, but to no avail. A federal court allowed it because it was properly issued at the request of a U.S. treaty partner (Puri, D.C., Calif.).

Working Abroad

Americans working overseas get a bit more relief on housing costs in 2021. The standard ceiling on the foreign housing exclusion increases to $15,218, up $154 from last year. But workers in many high-cost locations around the world qualify for a significantly higher exclusion. Notice 2021-18 has the complete details.

Business Taxes

The federal tax consequences of forgiven PPP loans are pretty clear:

The debt forgiveness is not taxable … and businesses can deduct expenses paid for with forgiven loan amounts. As a general rule, cancellation of debt income is taxable, but Congress provided an exception for businesses that take out a loan through the Small Business Admin.’s Paycheck Protection Program and get it forgiven.

State taxation is not as clear-cut. Many states follow the federal law, but others tax the forgiven debt or deny firms a tax deduction for their expenses. So be sure to check the law in the state in which your business files tax returns.

New SBA rules let self-employed individuals qualify for larger PPP loans. Prior SBA rules required sole proprietors with no employees to use a formula starting with net profit on line 31 of Schedule C to figure the maximum PPP loan they can borrow. SBA has now eased this requirement by allowing self-employeds to calculate the loan formula by starting with either net profit on line 31 or gross income on line 7 of Schedule C. Calculating the maximum PPP loan amount using a gross-income formula will help sole proprietors whose Schedule C shows little profit, or even a net loss, after taking into account deductible expenses.

Amended returns claiming domestic production deductions are eyed by IRS. Tax reform axed this write-off for 9% of income derived from U.S. production activities for post-2018 years. According to IRS, in the wake of the repeal, the agency has received a wave of questionable amended returns and refund claims for this tax break in the billions of dollars. Examiners are auditing these claims and are getting help from engineering specialists and lawyers within the Service.

More payees would get Form 1099-K from PayPal, Airbnb, etc., if Democrats have their way. Presently, these third-party networks send 1099-Ks to payees who have over 200 transactions and were paid more than $20,000. The latest congressional stimulus bill would lower the $20,000 payment threshold to $600 and remove the 200-transaction threshold, effective for 2022 and later.

Payroll Taxes

Businesses get formal IRS guidance on the employee retention tax credit … the payroll tax credit for firms financially hurt by the coronavirus pandemic that keep paying their workers. The published guidance describes the general rules, defines terms, and provides a set of questions and answers on a wide range of subjects.

Among the myriad of topics addressed: What constitutes qualified wages, full or partial suspension of operations, and significant decline in gross receipts. How to claim the ERTC, reduce payroll deposits, and request advances of the credit. Interaction between the ERTC and PPP loans. Employers that use third-party payers. Substantiation requirements. And more. See IRS Notice 2021-20 for the full details.

The guidance covers the ERTC rules applicable only for 2020, not 2021. IRS says it will soon release information on changes made by Congress for 2021.

Cash Rewards

Cash rewards earned for credit card purchases are generally not taxable. That’s because the rewards don’t result in the receipt of gross income. Instead, they are treated as a reduction in the property purchased by the customer.

This proposition was recently tested in Tax Court, in a unique case in which an individual manipulated American Express’s credit card rewards program. He bought VISA gift cards with his credit card, earned cash rewards for the purchases, and used the gift cards to buy money orders that he deposited into his bank account. He also bought reloadable debit cards and money orders directly with his credit cards. Over a two-year period, he spent $6 million on these purchases and earned $300,000 in rewards. According to the Court, the rewards earned through the purchase of the VISA gift cards are tax-free. But rewards earned on the direct purchase of money orders and reloadable debit cards are taxable (Anikeev, TC Memo. 2021-23).

Filing Season

Victims of Okla. and Texas storms have until June 15 to file federal returns and pay federal taxes. This includes the 2020 Forms 1040 and 1120 normally due on April 15, the 2020 Forms 1065 and 1120S due on March 15, estimated payments for the first quarter of 2021, and quarterly payroll tax returns. Individuals in the affected area have until June 15 to make IRA contributions for 2020.

Affected taxpayers can claim storm losses on their 2020 Form 1040 or their return for 2021. The law lets taxpayers in federally declared disaster areas, who suffered losses not reimbursed by insurance, claim those losses on the return for the year in which the loss occurred or the return for the prior year.

A filing deadline is nearing for calendar-year partnerships and S corporations.

Their 2020 federal returns are due by March 15. Those needing more time can file Form 7004 with the Service to request an automatic six-month extension.

Calendar-year regular corporations (C corps) have until April 15 to file 2020 returns. These firms can request an automatic six-month extension with the Service by that date and pay enough to cover any tax that may be due.

All 1040 and 1040-SR filers must answer a question on virtual currency. Last year, individuals who filed Schedule 1 with their 2019 returns had to answer whether they had received, sold, sent, exchanged or acquired any financial interest in virtual currency. That question has been moved to the front page of the 1040 for 2020 returns. IRS also clarified that you needn’t answer “yes” if all you did in 2020 was buy virtual currency, such as bitcoin, with real currency.

Do you believe you qualify for stimulus checks but didn’t receive them?

File a 2020 federal tax return to claim the recovery rebate credit … even if your income is below the threshold for filing. The credit is fully refundable, meaning that you will get the funds even though you might not have any tax liability. Most people who were eligible for the first two rounds of stimulus checks in 2020 and early 2021 should have received the payments. But those who didn’t or got less than expected can claim a credit on line 30 of the Form 1040 or 1040-SR. Use the Recovery Rebate Credit Worksheet in the 1040 instructions for this purpose.

With filing season upon us, IRS is emphasizing its taxpayer bill of rights, which showcases the protections that taxpayers have when dealing with the agency. Among the provisions: The right to challenge the Service’s position. Confidentiality. Privacy. The right to pay no more than the correct amount of tax. Plus quality service. This is all well and good, but it won’t help people who call IRS’s toll-free phone lines and are unable to reach a live person to get their tax questions answered.

Enforcement

The bulk of IRS audits are correspondence exams that are done by mail and that focus on narrow issues. In 2019, 80% of audits of individuals were correspondence audits. These audits are not assigned to a single examiner. IRS’s National Taxpayer Advocate recommends that the Service provide taxpayers responding to correspondence audits with the name, phone number and e-mail of a single person whom the taxpayer can contact throughout the audit process.