1. Trader Tax Management OptionsAnimal Las Vegas Student Summit September 26, 2009

2. Disclaimer Options Any strategies used as examples and discussed, using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation or solicitation to buy or sell securities. Taxation Any US tax advice contained in this presentation is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or (ii) providing, marketing or recommending to another party any transaction or matter addressed herein. The information presented provides only a general discussion of the tax law affecting the taxation of options and is not intended to be applicable to any individual investment and/or tax situation. You are strongly advised to contact your own tax professional in considering the tax consequences of your own specific set of facts and circumstances.

3. Before We Begin! What are we going to do? Talk about some of the tax aspects of options trading You will understand more about tax return preparation You should be able to talk more intelligently with your CPA or tax preparer What we are not going to do? Teach you to prepare your own tax return Cover intricacies of options taxation exhaustively Answer your specific personal tax questions

4. Agenda Tax Tips for DIYers Review – Trader vs Investor Mark-to-Market Accounting Trading in an Entity Types Benefits & Burdens Now What?Reporting Investor tax return Trader tax return MTM/Trader tax return

5. Do-It-Yourselfers Tax Tips

6. Tax Tips for DIYers When do you report the sale of a Short Put that gets assigned? Never Adjusts the basis of the stock assigned Example: You short in Oct a Jan 10 65 put on RIMM for $4.60 At Jan expiration RIMM dips to $64.94 and you are assigned the stock Your basis in RIMM is $60.40 (65 – 4.60) The Short Put sale is NOT reported in 2009 If you trade often this is difficult to identify!! … as a separate transaction

7. Tax Tips for DIYers When are Dec option sales reported? Calls – when there is a closing transaction Puts – either: When there is a closing transaction, or When the assigned stock is sold (lowered basis) Commodity ETFs – Gold, Silver, Platinum If held one year or less ST capital gain/loss If held more than one year LT, BUT at the 28% collectible rate

8. Tax Tips for DIYers ACAT fee reimbursement on retirement funds Considered a contribution to IRA, therefore not reimbursed, ie, like commission reimbursement Q: Is ACAT fee charged a distribution? 1099-R? Opinion: Must consider retirement account in the hands of the holder not the individual broker Gross proceeds from 1099-B agreement to sum of line 3 plus line 10 on Sch D Guaranteed letter from IRS if Sch D < 1099-B Form examples:

9. Tax Tips for DIYers

13. Let’s do some math! Gross proceeds from Form 1099-B$12,480 Option sales (not reported to IRS)6,325 Subtotal18,805 Less: Short put assigned153 Dec short call77 Total – Sch D, line 3$18,575

14. Tax Tips for DIYers Index funds qualify as Sec 1256 contracts SPX, OEX, COMP, DJX, RUT 60/40 LTCG treatment Individual securities/options are taxed, NOT trading strategies The “Put Calendar” is not taxed as a whole The opening & closing transactions of each leg are taxed as of the closing transaction (FIFO) Example:

15. Tax Tips for DIYers Initiate a Put Calendar on SPY in Aug 09 BTO Dec 09 100 FYSXV STO Sep 09 100 SWGUV BTC/Expire Sep 09 100 SWGUV STO Oct 09 100 SWGVV BTC/Expire Oct 09 100 SWGVV STO Nov 09 100 SWGWV BTC/Expire Nov 09 100 SWGWV STC Dec 09 100 FYSXV* Taxable Transaction #1 Taxable Transaction #2 Taxable Transaction #3 *Taxable Transaction #4

16. Tax Tips for DIYers Initiate a Covered Call/Collar on Amedisys: Buy AMED in early Jun 2009 STO Jun 09 35 Call CQWFG BTC/Expired Jun 09 35 Call CQWFG STO Jul 09 35 Call CQWGG BTO Aug 09 30 Put CQWRH BTC/Expired Jul 09 35 Call CQWGG STO Aug 09 35 Call CQWGH STC Aug 09 30 Put CQWRH Expired Aug 09 35 Call CQWGH AMED* called at Aug expiration Taxable Transaction # 1 Taxable Transaction # 2 Taxable Transaction # 3 Taxable Transaction # 4 *Taxable Transaction # 5

17. Tax Tips for DIYers Last but not least: DO NOT BLINDLY RELY ON ONLINE OR BROKERAGE-PROVIDED TAX SOFTWARE!! There are too many exceptions and nuances At a minimum  Download your transactions into Excel  Sort and Sum by Ticker and Activity (Open then Close) Agree 1099-B to stock sales Provide spreadsheet & brokerage statement to CPA

18. Investor vs Trader Review of Rules

19. Investor vs Trader Why? – Subject to different tax rules Definitions: Investor – Stock purchase for capital appreciation/dividends Little regard for short-term fluctuations; buy and hold Trader – Regularly and continuously trade stock/securities Trade in own account Profit from short-term fluctuations Can be BOTH trader and investor IRS presumption Investor

20. Investor vs Trader Taxation of Investors Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D / D-1 Subject to $3000 net capital loss limit Subject to IRC Sec 1091 wash sale rules Investment expenses (except interest) Schedule A miscellaneous itemized deductions Subject to 2% AGI threshold Not deductible for AMT purposes Interest – deductible up to net investment income (Form 4952) Net investment income does not include  Long-term capital gains  Qualified dividends

21. Investor vs Trader Taxation of Traders Stocks/securities considered capital assets Gains and losses considered capital Reported on Schedule D / D-1 Subject to $3000 net capital loss limit Subject to IRC Sec 1091 wash sale rules Investment expenses Schedule C/E* deductions Interest deductible (for material participation) Home office deduction eligibility Gains NOT subject to self-employment tax Mark-to-Market (MTM) election eligibility _____________________________________________________________________________________________________ * Flow-through entity, such as partnership, LLC, S-Corp

22. Investor vs Trader – Expenses Deductible – BOTH Investor and Trader Investment counsel/advice Subscription services  OptionsAnimal  OptionsPlanet  OptionsMonster OptionsAnimal Mentor? – Possibly (see below) OptionsAnimal TUITION? – Possibly (we’ll explore later) Office expenses – administrative, supplies Pro-rata portion of computer/software used to determine/manage investments – must be able to substantiate How do you substantiate? Reg 1.212-1(g) – expenses paid or incurred by the taxpayer … for the management, conservation, or maintenance of investments held by the taxpayer for the production of income Keep a dated log … trade journal

23. Investor vs Trader – Expenses Investor expenses – Summary All expenses for the production of income (Sec 212) Deducted on Sch A as Miscellaneous Deductions Subject to 2% AGI threshold Interest expense deductible to the extent of net investment income – does not include LTCG / Div No Sec 179 expensing election No home office deduction

24. Investor vs Trader – Expenses Trader expenses - Summary All ordinary and necessary expenses (Sec 162) Interest expense on margin accounts – if material participation, otherwise, for a limited partner, to extent of net investment income Sec 179 expensing of computers/software available* Eligible for home office deduction Travel Automobile expenses from principal place of business (home) deductible – if for business purpose * Sec 179 election cannot create a loss

25. Investor vs Trader – Case Summary Favorable Cases In Holsinger, Tax Court remarked in its opinion that trading activity of over 1,100 trades or the value of securities traded over $9 million was deemed substantial Levin – most of working days; substantial time Summary Regular and continuous Short holding periods Substantial number of trades

26. Investor vs Trader – Expenses Is OptionsAnimal tuition deductible? What are deductible educational expenses? Required to keep present job or salary, or Maintains or improves required skills in present job What are non-deductible educational expenses? Required to meet minimum standards, OR Qualifies one for new trade or business Quotes from the OptionsAnimal website: “OptionsAnimal connects you to fellow students as well as seasoned instructors…” “If you have not spoken with one of our Education Specialists …”

27. Investor vs Trader – Expenses Conclusion: Deductible as education expenses?: If you are already considered a “trader” or trading inside a trading entity where you are an employee, then deductible If new to trading stocks and options, then non- deductible UNLESS … (next slide) Qualify for Lifetime Learning or Hope credits? Must be defined by Sec 481 of Higher Education Act of 1965 as qualified post-secondary institution

28. Investor vs Trader – Expenses Start-up expenses? Expenses that would be deductible if incurred in an active trade or business (Sec 162) but also applies to investment expenses (Sec 212) Investigatory – incurred prior to decision to acquire or create Pre-opening – incurred after decision but before opening for business  “wages being paid to employees who are being trained and to [their] instructors” [H Rep No 96-1278, 96th Cong, 2nd Sess]  Up to $5000 (IRC Sec 195)  Amounts over $5000 – capitalized and amortized over 180 months

29. Investor vs Trader – Expenses Strategy: Potentially start-up expenses Specifically, pre-opening, and Especially if operating inside an entity Must elect and election is irrevocable Secondarily, educational expenses since: No minimum standards to “trade” No qualification standards for trading as a business Uphill battle since burden of proof on taxpayer

30. Investor vs Trader Mark-to-Market Accounting

31. Investor vs Trader – MTM Election What is Mark-to-Market (MTM)? Traders can elect to mark their security holdings to market value at the end of the tax year IRC Sec 475(f) – “… In the case of a person who is engaged in a trade or business as a trader in securities …” Gains and losses treated as ordinary gain/loss Adjustment to stock basis for unrealized gain/loss Not subject to self-employment tax Reported on Form 4797, Part II

32. Investor vs Trader – MTM Election Benefits Two restrictions no longer apply: $3,000 net capital loss limit Wash sale rule

33. Investor vs Trader – MTM Election Election is effective for the year for which it is made and all subsequent years unless revoked with IRS permission (mandatory) Must make the election by the unextended due date for the tax return for the year before the year the election is to be effective Example:

34. Investor vs Trader – MTM Election Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time. Does Eric qualify as a trader?

35. Investor vs Trader – MTM Election Eric is actively trading stocks and believes he can generate significant income by trading, on a regular and continuous basis, the short-term fluctuations in the stock market. In July 2009 he begins trading full-time. Does Eric qualify as a trader? Can he elect MTM for 2009?

36. Investor vs Trader – MTM Election Eric would have had to file an election by: April 15, 2009, or, Attach the election to his extension (Form 4868) Eric can make a MTM election for 2010 anytime before April 15, 2010, however, If this is not his first year as a TRADER (it is not) then Eric will be required to file Form 3115, Application for Change in Accounting Method A Sec 481(a) adjustment is also required

37. Investor vs Trader – Making the MTM Election Section 481(a) Adjustment spreadsheet – available at www.optionstaxguy.com

38. Investor vs Trader – Making the MTM Election Attach the following statement to the timely filed Form 1040 or extension Form 4868 Trader in Securities Election to Mark to Market Taxpayer hereby elects under IRC Sec 475(f) to use the mark-to-market method of accounting for securities. The election will first be effective for the tax year ended [20##]. The election is made for the following trade or business: [trade or business name, EIN] There is relief for late elections – PLR request New pass-through entity for late election New taxpayer – elect by 15 th day of third month

39. Investor vs Trader - Summary CriteriaInvestorTraderMTM Trader Reporting gain/lossSch D Form 4797 Reporting expensesSch ASch C/E Reporting interestSch ASch C/E Invest int exp limitsYesNo Home office eligibleNoYes Subject to S-E taxNo Wash sale rulesYes No $3000 Cap loss limitYes No

40. Section 1256 Contracts A Section 1256 Contract is any: Regulated futures contract – daily MTM Foreign currency contract Dealer equity option – market maker/specialist Dealer securities futures contract Non-equity option Broad-based stock index option (SEC determined) Cash-settled options Examples – DJX, SPX, OEX, NDX (not ETFs)

41. Sec 1256 Contracts – Mark-to-Market At the end of the tax year (last business day) Treat contract as sold At FMV on the last business day of year Gain or loss recognized Recognized gain/loss taken into consideration upon ultimate disposition of contract – basis adjustment 60/40 rule – 60% of recognized gain/loss is long-term 40% of recognized gain/loss is short-term No matter what the actual holding period A net loss can be carried back 3 years Report on Form 6781 (non-Sec 1256 on Form 4797) Example:

42. Sec 1256 Contracts – Mark to Market Example

43. Purchase 100 SPX Jun 08 1250 calls bought for 145 on 7/17/06 SPX Jun 08 1250 call at 252 on last business day of 2006 Mark-to-Market requirements: SPX LC deemed SOLD on 12/29/06 at 252 SPX LC deemed REPURCHASED on 12/29/06 for 252 Gain 107 (252 – 145) Long-term 64.20 (60% x 107); 15% max tax rate Short-term 42.80 (40% x 107); 35% max tax rate

44. Sec 1256 Contracts – Mark to Market Example SPX Jun 08 1250 LC declines to 228 by 3/12/2007 and is sold What is the gain/loss? How is it taxed? Deemed repurchase at 252 on 12/29/06 Sale228 Less: Basis252( from deemed repurchase ) Loss<24>LTCL <14.40> - 60% STCL <9.60> - 40% Loss may be carried back three years

45. Entities Selection & Trading

46. Entities Types of entities Sole proprietor – Sch C/Sch D/Form 4797 (default) General Partnership – Form 1065 Limited Liability Company (LLC) – Form 1065 Single member LLC – Sch C/Sch D/Form 4797 Multiple member LLC* Corporation C Corporation – Default; Form 1120 S Corporation – Election; Form 2553 Form 1120S * LLC with election: Form 8823 Form 2553 (S Corp)

47. Entities State law prevails – name, articles, etc. Separate bank account styled identically to entity name Brokerage account name identical to entity Business activity code:523110, 523900 Source: www.naicscode.com; keyword: securities traderwww.naicscode.com Employer Identification Number (EIN) Setup: www.irs.govwww.irs.gov Quick walk-through of IRS site

48. Entities

52. Benefits Retirement plans Fringe benefits Medical reimbursement plans (IRC Sec 105) Educational assistance plans – $5250/year (IRC Sec 127) New entity elections – MTM Burdens Compliance Entity tax return Payroll complications Accounting – personal vs business expenses

53. Reporting Investor Trader MTM Trader

54. Reporting - Example Jeff made the following trades during 2008: 300 shs AAPL Nov 08 90 SC; STO $12.80; Expired Dec 08 90 SC; STO $4.90; Expired Jan 09 90 SC; STO $5.50; Expired 500 shs WMT Nov 08 55 SC; STO $2.24; Expired Dec 08 55 SC; STO $1.95; Exercised 500 shs RIMM Nov 08 45 SC; STO $5.40; Expired Dec 08 45 SC; STO $5.70; Expired Dec 08 40 SP; BTO $3.75; STC $2.96 Jan 09 45 SC; STO $4.75; Expired

55. Reporting - Example Jeff’s 2008 trades – continued: 500 shs MCD Jan 09 90 SC; STO $2.20; Expired Jeff’s 2008 trading expenses: OptionsAnimal subscription – $600 Computer – $1500 (exclusive use); MACRS 5 year Monitors – $900 (three); MACRS 5 year Furniture – $750 desk, chair, monitor stand; MACRS 7 year Software – $250 Microsoft Office (Excel); SL 36 months Fiber optic cable line – $480 Travel – $1500 (Chicago & Las Vegas Summits) Airfare & Hotel – $1300 Meals – $200 TOTAL EXPENSES – $5980

56. Reporting - Example Jeff’s other information: Jeff’s spouse has W-2 wages of $60,000 Jeff has two children that are his dependents Jeff has itemized deductions of: Real estate tax – $5,000 Mortgage interest – $10,000 Charitable contributions – $2,500 (cash)

57. Reporting – Investor

60. Form 1040

61. Reporting – Trader

63. Form 1040

64. Reporting – MTM Trader Sec 481(a) adjustment – taxed in current year If not a new entity, Form 3115 required

65. Reporting – MTM Trader

66. Form 1040

67. Reporting – Summary Tax liability comparison Investor$4,374 Trader$4,149 MTM/Trader$4,606 Stock basis increase by the amount of 481(a) adjustment Stock basis adjustment decreases future gains/increases future losses

68. Contact Information Gregory L Buhrow, CPA, PC 2355 Gus Thomasson Road Dallas, TX 75228-3004 Telephone: (214) 327-0700 Facsimile: (214) 327-0740 (7am-6pm CT) Websites: www.buhrow.com www.gregbuhrowcpa.com www.optionstaxguy.com Emails:greg@buhrow.com glbcpa@verizon.net glbcpa@gmail.com

69. Thank You! OptionsAnimal Las Vegas Student Summit September 26, 2009