Tax News
Henricus v. Comm’r.: a Trader v. Investor Déjà vu
September 30, 2011
It seems like as of late the Tax Court is set on slamming every person that comes through its doors claiming a trader status.  It feels like it was yesterday when I talked about the Richard Kay case on this blog. There I alluded that a taxpayer who seemed to fall within the category of what most people in the trading community would call a swing trader ended up being treated as an investor.  On top of that the taxpayer was hammered with a Section 6662 penalty. Well, roll forward a few months and we have the same story all over again. The Tax Court just decided the following case Henricus C. van der Lee et ux. v. Comm’r., T.C. Memo. 2011-234 (September 29, 2011).  In Henricus we have a former Merrill Lynch trader who at some point branched out on his own. He left Merrill and started trading stocks, options and futures from his home. Throughout the year at issue the taxpayer executed a total of 189 trades.

As in Richard Kay the Tax Court applied the 3 prong trader v. investor facts and circumstances test, namely, it weighed the: (1) the taxpayer’s intent, (2) the nature of the income to be derived from the activity, and (3) the frequency, extent, and regularity of the taxpayer’s securities transactions. As with Richard Kay, the Tax Court thought that the holding period and the frequency of the trading did not rise to trader status. In this case the Court took an issue with the fact that Henricus never sold stock on the day of its acquisition and that his trading activity was, in the court’s view, sporadic. As a result, just as in Richard Kay, the taxpayer was slapped with a penalty.

 On this trader v. investor issue, I firmly believe that there is somewhat of a disconnect between the law and the reality. A swing trader could look at charts, market patterns, financial data, liquidity data, message boards and other analytics for days before it initiates a trade. It is still a trade and not an investment. A swing trader would not day trade by definition and would execute trades “sporadically” within the Tax Court's understanding. Yet a swing trader does not rely on dividends, interest, stock splits or company earnings appreciation. It merely relies on short term market pricing inefficiencies. Moreover, trading in naked regulated options and future contracts which are short term contracts by their very nature, ought to suggest that the taxpayer is engaged in a trading business and not mere investing.  Regrettably for taxpayers the Tax Court does not see this issue as I do. I suggested in my Richard Kay post that the moral of the story here is that taxpayers who take a trader position should carefully consider the accuracy related penalty of Section 6662 and should seek an opinion of counsel. Maybe one day there will be a bright-line trader v. investor rule that would not keep taxpayers guessing.
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Tags: Henricus v. Commissioner, trader v. investor