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This is a good question that just seeks people's experiences, and I hope it gets more attention, but some people feel strongly about this topic, so I just want to drop in with a word of warning. I'd advise taking a lot of caution about the advice you receive here on that topic (at least regarding US law). There was a webinar that covered that on here a while ago, and that webinar included some advice that alarmed me, making me think the presenter was professionally incompetent (along the lines of "being a business for federal purposes won't impact your individual treatment at the state level," which completely ignores that business entities are generally creatures of state law. Tax treatment is a nuanced topic that is ill-suited for such broad statements, even for general purpose webinars.)
There are a number of factors to consider when deciding whether to use a business entity for trading:
Is this a solo venture?
Do you rent property (real or personal, like servers)?
Do you have employees?
Do you, or will you, have customers/clients? (Do you want to trade for others?)
Will forming a business entity improve your liability exposure?
Will your entity be subject to state or federal regulation?
Will an entity help you better separate income and expenses and make it easier to claim certain tax treatment? (Will it encourage you to keep your books more robust in face of an audit?)
Are you considering a SEP or looking to have the entity help with medical insurance premiums?
Also consider the state and local business expenses.
Forming a company might be a great decision in your circumstances, or a waste of time and money (and it might even backfire re fees). Any answer you get on the internet is quite likely to make a number of assumptions, some might be obvious. If you're profitable enough that you believe you could save money or reduce your tax exposure measurably, then it is worth getting professional advice on the topic. A professional will tailor his/her advice around your particular circumstances and needs, and will be responsible for the advice given. You can't say the same of some random internet person, including me.
I have had an S-Chapter since 2009 (For another business), and have decided not to merge my trading under this umbrella for a few reasons.
1. Even under the ridiculously nice tax treatment that has been given to S-Chapters recently, you still get double taxed in some ways, while still enjoying full pass-through in others.
2. Maintaining an S-Chapter will cost you a few thousand dollars a year just to do the paper work / fillings, taxes, legal, etc.
I would say if you are going to form any type of business entity at all, then Sole proprietorship or S-Chapter are the best, because of the tax treatment. But you need to be fairly comfortable with the accounting side of things to be able to take advantage of these. Here is the key gray area if you will. For normal corporations you get double taxed in that, the business pays a business tax, then salaries their employees who then pay personal income tax. With an S-chapter you can take a certain percentage of the companies income and pass it through directly to the shareholders who then only pay the personal income taxes, thus bypassing the double taxation. The grey area in the tax code is that there is an expectation that if you are working as an employee of the company you should salary yourself a reasonable amount and pay double taxes. But there is no line in the sand in the tax code telling you specifically what this is. So, you could salary yourself 25% and pass-through 75% and an auditor might find that ratio a little suspect, if they even look in the first place. By contrast doing a 50% / 50% salary, share holder distribution split seems reasonable to most people I have talked to.
I have friends in the auditing business at the state level and they tell me that they won't audit a company unless they have 100 million in revenue because their staff and backlog are so big they are only targeting the biggest bang for the bucks which makes perfect sense. But this doesn't mean you can't ever get struck by lightning and get audited with a tiny business, it just seems unlikely. In the past I have done a 90% / 10% split, a 75% / 25% split and most recently have been doing 50% / 50% splits for the past 3 years. But there is no language in the tax code that really covers this in any great detail so you are on your own, hoping that whatever you do passes the auditor smell test. (Again the key gray area being what is a reasonable salary.)
In light of these points I am trading 100% under a personal account and will continue to file my taxes using just a normal straddle P&L at the end of the year (I am just one guy running 1 algorythm right now) . For starting out retail traders, unless you have employees, or are planning a bankruptcy and want to shelter income, or have another compelling reason, there is virtually no benefit I can think of by going the company route and being subject to double taxation on any portion of your income. If you are a small prop firm, or a group of quants wanting to go in together and get DMA and use investor funds to do something large scale, then yes.... the business route will be required, but for most retail traders the most common use case of trading will be to use the net loss as a deduction on their personal taxable income. It you are starting out, start with this assumption, and then only if and when you have a compelling reason to scale should you scale.
Just my two cents!
Good luck!
Ian
In the analytical world there is no such thing as art, there is only the science you know and the science you don't know. Characterizing the science you don't know as "art" is a fools game.
Couple of things I would add
- Most FCM's will require individuals trading in an LLC to post personal guarantees for the trading account, making the bankruptcy protection an LLC provides considerably less valuable.
- There are benefits that you can obtain through an LLC or S-Corp that a business trader can not obtain otherwise. (Pensions being the obvious one). Note that doesn't mean you need to trade through that entity to obtain those benefits - it can be a management company. But as @iantg said, maintaining an entity can get expensive so you'll need to make sure the benefit exceeds the cost.
Study it carefully, then have a conversation with your CPA. Most CPAs, even very bright and very good CPAs, are unaware of futures tax treatment, like the Section 1256 contracts 60/40 capital gains split. So work with your CPA and educate them on the stuff from that book.
Between me and my wife we have six LLCs, and in Texas at least its very simple and costs are low. Each one cost maybe $250 in filing fees, I did it online myself and then nothing annually.
For my LLCs and I also enjoy a solo 401k where I can put $54,000 annually (with catch up) into a retirement account. Those funds are of course not taxed at all. (TDA Ameritrade offers a free service to manage such an account BTW - I pay nothing in fees for this.) I also have another IRA account where I trade futures, contact Midland IRA they can help set this up.
Like trading, do your homework, and don't trust answers in a chat for something so important.
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As already stated in this thread, these really are questions for an accountant.
For me, when I had my LLC, I (and my wife) had SEP IRA's that we contributed to at levels @dannyinhouston mentions. I believe that you can not contribute to both an SEP IRA and a 401k. Since I have switched my LLC to an S-Corp I now have a Defined Benefit Pension Plan (again for me and the wife) that allows me to contribute significantly more than an SEP or IRA. In addition since the DBP is a "company" plan, I as an "individual" can also contribute to a 401k! :-)
@dannyinhouston mentioned Green Trader Tax a few posts ago. I'm actually a Green Trader Tax / Green, Neuschwander & Manning client. Not only would I highly recommend them but can make an introduction if anybody is interested.
