Oh, the deductible expenses you'll know as a trader!

Repeat after me these three magic words, "Ordinary, necessary and reasonable."

These are the generously inclusive terms the Internal Revenue Service uses to determine whether the business expenses you claim on your income tax are appropriate deductions.

As a self-employed trader, in business, nearly everything you purchase that has a legitimate business purpose can be deducted from your gross income on your federal income taxes, including training, medical expenses (with the appropriate business), utilities, research materials, equipment, services, supplies and all business-related travel.

There is a catch, of course. You must qualify for trader status. Otherwise, you will be treated as an investor, lose most of your potential tax write-offs to the 2 percent threshold for deductible investment expenses and face the $3,000 ceiling on capital loss deduction. You face this capital loss ceiling if you did not elect the mark-to-market accounting method by the April 15 deadline.

It can help significantly to trade as a business entity: C Corporation, Limited Partnership or an LLC are popular ways to avoid being considered a mere investor and the loss of most of those valuable deductions. To avoid the cookie-cutter approach to tax-efficient trading, you should contact a trader's tax accounting professional to help you determine which business entity is right for you.

Trader Tax Deductions

Because it's not at all uncommon to accumulate $15,000 to $25,000 in deductible expenses annually, here’s a look at some of the major deductible expenses:

Home Office Deduction: One of the most tantalizing features of working from home is the home office deduction, which is based on the percentage of your home that you use exclusively for your trading business.

If you own your home, your indirect expenses include real estate taxes, mortgage interest, home insurance, utility bills, repairs and maintenance, condominium association dues and the like. Depreciation is calculated on the purchase price of the house (but not the land) at the same percentage your home is used exclusively for trading. If you rent, your rent payment may be your major indirect expense.

Margin Interest: All margin interest is fully deductible for traders using mark-to-market.

Legal and Professional Fees: The fees you pay your accountant, lawyer, investment advisor and other business consultants are deductible in the year in which they are paid. If you have an entity that is on an accrual method (or hybrid accrual / mark-to-market), you can deduct the expense when it occurred. Business books and related materials, dues in professional organizations, subscriptions to investment newsletters and professional journals and business licensing fees also are deductible.

Travel and Entertainment: If you travel for business, it's fully deductible: Airfare, lodging, rental car, taxis, meals, phone bills and tips. But, be sure to document everything with receipts. If you entertain a client and pick up the tab, you may deduct 50 percent of the bill as long as business was discussed immediately before, during or after the event.

New Equipment: You may write off the purchase of equipment in one of two ways: By taking the full deduction in the year of purchase or by "capitalizing" (amortizing) the cost over several years. A trader's tax professional can help you determine which method is best for you.

Business Expenses: The many and sundry costs of doing business, from advertising to thank you gifts, stamps and postage to ink cartridges and paper clips, are all deductible.

Services: You may deduct the cost of your datafeed, Internet service provider for your website, high-speed Internet, second business telephone line and cable TV service if they are used strictly for business purposes.

Education Expenses: You may deduct the cost of education, including seminars, class tuition, books and other expenses, as long as the purpose of the class is to maintain or improve skills related to your current work.

This is just a partial list of your deductible expenses as a trader. Contact a trader's tax accounting professional to help you make the most of the business deductions available to you.

*Reprinted (and modified) with permission from Online Trading Academy (www.onlinetradingacademy.com). Jim Forrester is Tax Director of Traders Accounting (www.tradersaccounting.com)