Our goal as day traders is to make money, not to lose it. However, when we do have losses, and we all will no matter how successful we usually are, there are ways to make those losses less costly. One way is simply to learn from the knowledge we gain from an error or a losing strategy. But there is another, more concrete way to soften the blow from trading losses, and it's something every trader needs to know about come tax time: ?Net Operating Losses.?



In its simplest form, the concept of net operating losses is a part of the tax code that allows you to deduct your businesses expenses, including trading losses, from your income. Specifically, net operating losses are comprised of your ordinary trading losses and trading business expenses, like coaching tuitions, software and data subscriptions, books and magazine subscriptions and many more. You can claim a net operating loss any time you can show that tax-deductible losses exceeded taxable income for a given year. The reasoning behind this part of the tax code is that, if you are taxed during a profitable period without getting any tax relief (e.g. a refund), you might have to pay an unbalanced amount of taxes. Net operating losses allow you to spread that tax burden out.

The most useful part of this concept for most traders is that net operating losses may be carried back two tax years and/or 20 years forward. Furthermore, you can use them to offset any type of income in prior or future years, whether that income is connected to trading or not, and even if you were not trading at the time. In practice, this means, that, for example, if your wife has a job earning a regular income (and you file jointly), you could deduct your net operating losses from your wife's income and possibly save thousands of dollars in taxes. Or, again, if you have a bad year but expect to earn more income in the future because of an expected increase in regular income, you can wait and deduct your losses later, paying more taxes now but saving even more after. The most useful aspect of this concept is its flexibility, as you can see.

Now, none of this is supposed to suggest that we can gain back all that we lose by manipulating the tax code. Net operating losses are not a magic loophole. Instead, they are designed to help spread the burden of losses around, allowing small businesses and independent traders in particular not to suffer from taxes and losses at the same time. I also don't want to suggest that we no longer have to worry about trading losses; they're an inevitable part of what we do. But being a bit more knowledgeable about how to report losses with your taxes can soften the blow of this inevitable part of our business.

Finally, please understand that I am not a tax professional, and you should consult with an accountant or tax specialist to take full advantage of all the wonderful things you might do if you qualify for trader tax status. But the notion of net operating losses should always stay in the back of your mind when reporting your losses.