LLC for Investing in Stocks: Everything You Need to Know
You might create an LLC for investing in stocks to help protect your personal assets from lawsuits or company debt.3 min read
2. Tax Issues for Traders
3. Becoming a Qualified Trader
Updated September 7, 2021:
You might create an LLC for investing in stocks to help protect your personal assets from lawsuits or company debt. Limited liability companies (LLCs) are popular business structures because they have the simplicity of a sole proprietorship without the legal exposure. Becoming an LLC also helps a trader qualify as a business, without going through the steps required of a sole proprietor.
The Internal Revenue Service (IRS) typically doesn't scrutinize an LLC involved in regular stock trading because it assumes no one would go to the hassle of forming a company if they were not committed to the business venture of trading.
How to Buy Stocks on Behalf of an LLC
An LLC might buy stocks for many reasons. After you've formed your LLC and organized it under state law, the company can buy stocks, just like an individual can. But before you can do this, you must:
- File documents to form your LLC with your state, and pay the filing fee.
- Obtain your EIN (tax ID number) from the Internal Revenue Service. You might be able to do this online.
- Establish an operating agreement that defines the LLC's operations. Make sure it includes the ability to buy and sell stocks.
- Choose the person who is authorized to buy stocks if the company has more than one owner. Include the procedure for making these purchases.
- Research investments by completing an internet search on potential purchases to make sure they meet the LLC's investment strategy.
- Open a brokerage account in the LLC's name. Many major brokerages, such as Ameritrade, offer business accounts.
- Once the account is open and you have put funds in it, you are ready to buy stocks.
Tax Issues for Traders
Because the IRS does not consider trading to be a business, all income earned is considered unearned or passive income. The income from trading can't be reduced by contributing to an IRA, but it also isn't subject to self-employment taxes. You can't deduct normal business expenses, even though the costs incurred to become a successful trader can be significant.
The biggest issue for most traders is that deductions for losses are limited to the gains. Traders can only deduct $3,000 against ordinary income. If they incur larger losses, they can carry them forward to subsequent years, at $3,000 per year. The only way around these limitations is to become a qualified trader.
Becoming a Qualified Trader
Becoming a qualified trader allows the investor to deduct common business expenses on a Schedule C, including taking Section 179 deductions and writing off equipment used in trading activities. The IRS defines a qualified trader as one who trades often and continuously to profit from the short-term fluctuations in market prices. To become a qualified trader, you must trade on a full-time basis. Trading must be the majority of your income. Traders make multiple trades per day and research, document, and educate themselves on the art of trading.
Qualified traders are allowed to elect a Section 475(f), also called the mark-to-market election (MTM). This lets the trader take ordinary income and losses rather than capital gains and losses. At the end of the year, all positions are assumed to be sold, and a gain or loss is calculated.
This amount is added to the actual gain or loss at year's end for tax purposes, eliminates the $3,000 limit for net capital losses, and helps traders avoid the 30-day wash rule. The rule disqualifies deductions for losses on stocks considered “substantially identical” if bought within 30 days before or after the sale of similar stock.
Discount and online brokerages have made it increasingly easy for people to trade in the stock market. But, individuals don't have access to some of the tax advantages or asset protection that LLCs and corporations do.
Single member LLCs, in which one person is the full owner of the company, have no federal tax filing requirements. You should check, however, to see if there are state requirements. Sometimes, two individuals might form an LLC, with one having the money to invest and the other offering the sweat equity part of the business. This person will likely be given a profit percentage that is higher than his or her capital or financial contribution.
If you need help with LLCs for investing in stocks, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.