Day trading can be an adrenaline-fueled side hustle or, with skill and the right tools, a lucrative full-time career. You must pay capital gains taxes on day trading income. How much you pay and whether the day trading income is taxed as short-term or long-term capital gains can significantly impact how much you pay in taxes. Read on to understand the IRS's treatment of day-trading taxes and how you could save more.
What is Day Trading?
Day trading is the short-term trading of securities. It is a form of high-risk speculation in which a day trader buys and sells financial instruments on the same day. As the name implies, all trading positions are closed before the market closes at the end of the day.
At one time, only large financial institutions, brokerages or trading houses could engage in day trading in the stock market. But now, any average investor can day trade.
Day traders buy and sell stocks or other assets during the trading day to profit from rapid price fluctuations. Skilled day traders use various strategies or analysis techniques to predict price movements. Many day traders use technical analysis of price movements. To be successful at day trading, you'll need a high degree of self-discipline and objectivity. Learn more about how to day trade, day-trading strategy and day-trading rules.
Understanding Taxes on Day Trading
Any profit earned from day trading is earned income, which you must pay tax on. To understand the tax obligations, consider long-term versus short-term capital gains.
What is the Capital Gains Tax?
Capital gains tax is the tax you pay on capital gains, as opposed to income tax. According to the IRS, capital assets include most assets from your home or personal-use items to investments in stocks or bonds. Gains on the value or revenue from the assets are considered capital gains. Capital gains may be taxed at rates different from income.
Any profit you earn as a day trader could be subject to capital gains tax. If you buy a stock for $15 and sell it for $25, you have $10 in capital gains that you must add to your taxable income.
Capital gains tax rates vary by how long you hold the investment and whether the IRS classifies it as short-term or long-term capital gains.
Short-Term vs. Long-Term Capital Gains?
The difference between short-term and long-term gains affects how the IRS treats your capital gains. If you buy and hold an asset for at least a year, it is taxed as long-term capital gains. Long-term capital gains are the profits collected after selling an investment held for over a year. Capital gains are taxed at a lower rate than standard income, usually at the rate of 0% to 20%, based on income.
In day trading, if you buy an asset and sell it within a year for profit, you'll need to pay short-term capital gains tax. In that case, the profit is added to your yearly income and taxed at the same rate as your income. Depending on your tax bracket, short-term capital gains are taxed at 10% to 37%.
Capital Gains Tax Rates
Capital gains tax rates vary based on your income, filing status and whether they are considered long-term or short-term capital gains. Day trading taxes also vary by income and trading patterns. Day trading taxes usually range between 10% and 37% of profits. Here is an overview of rates based on income and filing status.
Short-Term Tax Rates
Here is an overview of short-term capital gains rates in 2024:
|Married couples filing jointly
|Head of household
|Up to $11,600
|Up to $23,200
|Up to $16,550
|$11,600 – $47,150
|$23,200 – $94,300
|$16,550 – $63,100
|$47,150 – $100,525
|$94,300 – $201,050
|$63,100 – $100,500
|$100,525 – $191,950
|$201,050 – $383,900
|$100,500 – $191,950
|$191,950 – $243,725
|$383,900 – $487,450
|$191,950 – $243,700
|$243,725 – $609,350
|$487,450 – $731,200
|$243,700 – $609,350
Long-Term Tax Rates
Here is an overview of long-term capital gains rates in 2024:
|Married filing jointly
|Married filing separately
|Head of household
|Up to $47,025
|Up to $94,050
|Up to $47,025
|Up to $63,000
|$47,026 – $518,900
|$94,051 – $583,750
|$47,026 – $291,850
|$63,001 – $551,350
How to Qualify for Trader Tax Status
Qualifying as a day trader according to IRS criteria can lead to additional tax savings. According to the IRS, to qualify for the tax trader status, you must meet three specific criteria:
- Seek profits in daily market movements from securities, not from dividends, interest or standard capital appreciation.
- Engage in substantial trading activity.
- Carry out the activity regularly.
By IRS criteria, if you follow a buy-and-hold investment strategy, it doesn't qualify as day trading. Likewise, to be considered active as a day trader, you must make multiple trades a day and only hold securities for a short period. You must both make trades and have substantial funds for trading.
If you don't qualify as a day trader, you have standard investor status. Even large hedge funds may have investor tax status and not qualify for trader tax status.
To consider whether you meet IRS trader status criteria, look at:
- How many daily trades are you making?
- Are you trading at least four days per week?
- Is trading your primary business?
- Do you have another primary source of income?
- Is your average holding period less than 31 days?
- Do you work at least four hours daily on trading business-related activity, including setting up trades, research or analysis?
- Do you have the necessary equipment, software and research tools for professional day trading?
How to Save on Day Trading Taxes
If you qualify as a day trader, you can use various strategies for saving more on taxes popular with day traders. Here is an overview of what you can consider.
Use the Mark-to-Market Method
Day traders use the mark-to-market method to offset capital gains with capital losses. Investors can get a tax deduction for lost money and reduce capital gains tax. You can usually deduct up to $3,000 for losses, but day traders can deduct more with the mark-to-market method.
If you qualify as a trader by IRS criteria, you can file an election to mark-to-market your securities or commodities. This process allows you to mark the value of the security to the new market value at the start of every year, effectively resetting any gains or losses to $0.
While you won’t be able to carry over losses into the next year, for most day traders, the advantages outweigh the downside.
Use the Wash-Sale Exemption
With the wash-sale exemption, investors sell off losing assets to offset gains. Because of this widespread habit, according to IRS rules, you cannot sell an investment at a loss and buy it again within 30 days. However, this strategy comes with significant risk
With the wash-sale exemption, you can offset gains by selling off assets. Day traders often use this exemption to save more on taxes. For example, you could speculate that a company’s stock may dip after its quarterly earnings call in a few days. Then, you could buy the stock and sell it when it drops. Finally, assuming the stock does drop, you could count the loss as a tax write-off.
Finally, if you’re already using mark-to-market, you’re exempt from this rule.
Deduct Qualified Business Expenses
The simplest way to offset day trading taxes is to deduct all qualified business expenses to reduce your taxable income. You may deduct ordinary and necessary expenses for a day trading business, including computers, software, trading service subscriptions, trading apps, internet, cell phones and more. You may also deduct the expenses of a designated home office and continuing education or training directly related to your day trading business.
You can work with a financial adviser experienced in helping businesses optimize tax savings and correctly document all deductions.
Take Advantage of Tax-Exempt Accounts
If you need to reduce your taxable income to stay within a lower tax bracket, consider tax-exempt or tax-advantaged accounts. For example, in 2024, you could contribute up to $23,000 to a 401(k) account or up to $7,000 to an IRA.
Tips on How to File Day Trading Taxes
When preparing to file day trading taxes, be sure to keep accurate records of all trades and total income. Using trusted tax preparation software or working with a certified public accountant (CPA) or tax professional can make filing easier. To get started, find the best free tax software or learn how to file your taxes for free.
As a day trader, you have the opportunity to earn significant returns. Like anyone else, you must pay taxes on all income at relevant rates.
If you qualify as a day trader according to IRS qualifications, you may be eligible for additional tax savings with the mark-to-market method or the wash-sale exemption to reduce your tax burden. You can also deduct qualified business expenses and consider tax-advantaged retirement accounts. With careful records and receipts for your business, you could save more on your earnings this year.
Frequently Asked Questions
What is the most tax-efficient way to day trade?
The most tax-efficient way to day trade is to use the mark-to-market method or consider other tax-advantaged opportunities like tax-deferred retirement accounts.
How can I save tax on trading income?
To save on tax while day trading, you’ll need to track business expenses, save more in tax-deferred retirement accounts and check whether you qualify as a day trader by IRS qualifications.
How much tax do I pay as a day trader?
How much tax you pay as a day trader will depend on your income and trading strategy, as well as whether you qualify as a trader according to IRS qualifications.
Are taxes hard for day traders?
Taxes require careful recordkeeping and receipts; however, with tax preparation software or the help of a tax professional, it should not be too challenging for day traders.
As a day trader, do you pay taxes at the end of the year?
Yes, as a day trader, you must pay taxes each year. If you are self-employed or a freelance day trader, you will also need to pay estimated taxes quarterly.
About Alison Plaut
Alison Kimberly is a freelance content writer with a Sustainable MBA, uniquely qualified to help individuals and businesses achieve the triple bottom line of environmental, social, and financial profitability. She has been writing for various non-profit organizations for 15+ years. When not writing, you will find her promoting education and meditation in the developing world, or hiking and enjoying nature.