Day Traders Often Ignore This One Topic At Their Peril Boring things — like taxes — can sometimes be highly profitable.
By Ross Cameron Edited by Micah Zimmerman
Key Takeaways
- It's important to learn how to make a profit by day trading, but a close second is learning how to keep that profit.
- Otherwise, you're doing all this work for the IRS.
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Day traders enjoy talking about lots of things: stocks that are ripping up to new levels, patterns they're seeing, and the big "green days" or profitable trading sessions they've had. That's cool, but the fact is, you can only be proud of what you get to keep after taxes. It's important to learn how to make a profit by day trading, but a close second is learning how to keep that profit. Otherwise, you're doing all this work for the IRS.
I'm not going to give you tax advice because that's not my line of work, and I don't know you. But I can make this article potentially worth millions of dollars by giving you some things to consider when you talk with your tax advisor.
When I did my day trading challenge a few years ago, I wanted to see how far I could go by starting with less than $600. I'll say that my results have been far from typical, with the current profit in my account now being more than $10 million, but I want to focus just on the first year. The beginning balance was $583.15, and the ending balance was more than $335,000.
If I had taken those profits then, I'd have seen killer short-term capital gains. That's when I knew I needed an accountant who knew the Internal Revenue Code like the back of his hand. I did not want shady tax shelters, but I did want every legal tax break I was entitled to. Here are three of the most powerful recommendations he made.
Related: How I Turned $583 into $10 Million by Day Trading
1. "Ross, have you considered moving to Puerto Rico?" I laughed, just as you probably are doing inside right now. "Uh, no, I have a family, and we're not really portable right now." But that was not always true for me, and it may not be true for you. Besides, the benefits can be amazing.
If you live in Puerto Rico for six months and one day over the year, you can be considered a resident. You still retain your US citizenship because Puerto Rico is a US territory. Get this: Residents pay no short-term capital gains tax. Depending on your tax bracket, that could save you 10-37% on your taxes. Imagine finding a day trading strategy that could reliably boost your results by 10-37%. That's Puerto Rico.
2. "Ross, what do you know about the IRA back-door conversion?" I had no idea. This takes a little explaining. You need both a traditional IRA and a Roth IRA. Here's why:
With a traditional IRA, you can deduct a maximum of $7,000 annually. That number changes each year. The problem with the traditional IRA is you need to pay taxes on whatever earnings you withdraw, which you can do without also paying a penalty if you're 59.5 years old or older. It can grow tax-deferred, but you still get whacked at the other end.
Here's where the amazing power of the Roth IRA comes in. The great news is that you get to take out the money tax-free after you're 59.5 years old! The bad news: The Roth currently has a maximum income limit of $161,000 annually. I was way over that in my first year of the trading challenge.
Now for the "back-door conversion." It's not some crazy tax theory but a legal technique. Look it up. You can contribute your tax-deductible $7,000 to a traditional IRA and convert all funds in it to your Roth each year. I'm simplifying the rules, so check with your accountant, OK?
You may think, What's the big whoop about converting $7,000 each year to a Roth so it can grow tax-free? Here's my big whoop: At the time, the maximum contribution was $6,000, and I waited for three years until I had about $18,000 in that account. Then, I started to trade in it. It has grown into more than $6 million, tax-free. Sounds like a lot? Consider this: Peter Thiel, one founder of PayPal, turned $2,000 in a Roth into more than $5 billion.
Related: What Is a Roth IRA and How to Open a Roth IRA Account
3. "Ross, have you traded in a business account?" This can get complicated, so definitely get help, but here's the skinny: If you design it right, you can deduct various trading expenses like computers, software, subscriptions and educational expenses. You'll draw a salary from the business.
But here's where it gets really interesting: You can set up a solo 401(k) similar to the standard type you know about, except you're the only employee. You can defer up to $23,000 of your self-employment income to the 401(k), and it gets better: The company can also contribute up to 25% of your compensation, up to an overall current maximum of $69,000 per year. If you have the trading profits, you can grow your 401(k) by up to $69,000 annually. You can then invest those funds in the stock market, real estate or other assets.
Depending on the people you hang out with, sometimes you can be made to feel bad about not paying a lot in taxes. "Pay your fair share," they will say. I say my fair share is paying every penny I'm legally required to pay. Federal Judge Learned Hand in 1935 wrote: "Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes."
