As a successful prop trader, you’ll quickly encounter the issue of prop trading taxes when it comes to your first payout.
But what does this mean exactly?
In this guide, I’ll explore the topic of taxes in prop trading in more detail, particularly explaining how you need to declare your profits from prop trading, what taxes are involved, and whether there are any special considerations to keep in mind.
In addition to the US, I’ll also take a look at Australia, New Zealand, Canada and the United Kingdom.
Note: This article reflects my view from the perspective of a prop trader and is neither to be construed as tax advice nor does it replace professional advice.
Table of Contents
Key Takeaways
- Prop traders in the USA usually operate as self-employed individuals. Now, traders don’t need a specific prop trading license as they are trading with the firm’s capital. You can also choose to form a business entity, such as a Limited Liability Company (LLC) or an S-Corporation
- Profits from prop trading are subject to federal and state tax. Prop traders in the USA are self-employed. So, as a prop trader, you must pay self-employment tax. You have to report your income (and losses) on Schedule C of your tax return. You’re also responsible for making quarterly estimated tax payments
- In my guide, I’ll delve into prop trading tax, tax exemptions, and the legal foundations in more detail. At the same time, I’ll briefly touch upon prop trading tax in Australia, New Zealand, Canada, and the United Kingdom
What Taxes apply to Prop Trading in the US?
Trader’s income from proprietary trading is taxable in the USA.
As a prop trader, you have to pay self-employment tax (15.3%) to cover Social Security and Medicare. If your state requires it, then you will need to pay state tax as well.
Some states like Florida, Texas, and Nevada don’t have any income tax at all. While some states have flat income tax rates for everyone, others have a graduated income tax system with several tax brackets.
If you trade as an individual, then you are conducting business as a Sole Proprietor. If you want, you can open a business entity to manage your funded trading, though it’s not mandatory.
LLC members generally don’t face this tax. However, they also miss out on retirement plan contributions and self-employed health insurance deductions.
Many prop firms like Apex Trader Funding issue Form 1099-MISC to traders. The prop firm distributes your share of the trading gains as payouts, which are reported to you and the IRS on a 1099 form, typically a 1099-NEC (for non-employee compensation).
You calculate your self-employment tax on Schedule SE (Form 1040) based on your net earnings from self-employment. If you are working as a sole proprietor or a single member LLC, your income is reported on Schedule C (Form 1040) That reflects your business profits or losses.
You will likely need to make quarterly estimated tax payments to cover income and self-employment taxes. If you fail to do so, it can lead to penalties.
You can deduct various trading-related expenses (platform fees, data, etc.) which can appear in prop trading to reduce your tax burden. LLC members claim unreimbursed partnership expenses (including potential home office deductions) on Schedule E. Sole proprietors use a Schedule C to report revenue and deduct expenses.
Prop Trading is a Commercial Activity
In order to be a funded trader, you don’t need to register as a business. There’s no specific license required to become a prop trader. Your main focus is tax law compliance, not licensing.
You’ll need a Series 57 License if you trade equities with a prop firm. It’s administered by FINRA and required by firms that trade in listed securities.
If you want, you can also do prop trading as a business. However, you don’t need to register immediately after signing up with a prop trading firm. During the evaluation phase, you are not yet generating profits. Only when you receive a contract from the company as a funded trader, you should register the business.
Business License and Registration with The Tax Office
You’ll need to choose a business structure (LLC and S-Corp are popular with traders). Then, I’d recommend that you consult a lawyer/tax advisor to select the best option for your situation.
Next, you have to pick a unique and available business name. The state’s Secretary of State website usually has a search tool to check name availability.
Then, you need to file the appropriate paperwork with your state, typically with their Secretary of State office. This involves Articles of Organization (for LLCs) or Articles of Incorporation (for corporations).
After your business is approved by the state, you’ll need to obtain an EIN (Employer Identification Number) from the IRS.
This acts like a Social Security number for your business. Then, check with your local city or county for any additional licensing or registration requirements. Finally, you can register as a business with your preferred prop trading firm.
Caution: False Self-Employment
If you only work for one prop trading company, false self-employment can arise. Companies sometimes can misclassify employees as independent contractors intentionally to save money. This is illegal and will hurt you.
As an independent contractor, you’ll pay more taxes, lose benefits like health insurance, and could face legal problems if the IRS disagrees with your status.
So, to make sure you’re truly self-employed, set your own hours, choose how you trade, and ideally work with other prop firms, too. You can also form a business (like an LLC) for additional support.
Also, make sure to track every business expense carefully with receipts and invoices. If you’re unsure, talk to a tax advisor or an experienced accountant.
Your Prop Trading Tax Liability
Below, I’ve provided an example for calculating prop trading taxes in the USA.
Let’s assume after expenses, you have $2,000 in net profit each month. Your self-employment tax would then be $2,000 x 15.3% = $306 per month.
Income tax remains harder to figure out as there are lots of considerations, like yearly income and exactly how much you’ll be able to deduct.
However, for this example, let’s assume your taxable income puts you in the 12% tax bracket. You’d then have to pay approximately $240 per month in income tax ($2,000 x 12%).
To cover both your self-employment and income taxes, you’d ideally make quarterly estimated payments. A revised estimate could be:
Quarterly Payment: ($306 + $240) x 3 months = $1,638
It’s a very simplified example. Your actual income tax liability could be higher or lower depending on your overall tax situation (deductions, filing status, other income, etc.). That’s why consulting with a tax advisor is very important.
Seek Advice from a Tax Advisor on Prop Trading Taxes
My advice is that you connect with a tax advisor early on when starting your self-employment as a prop trader. Utilize their expertise. They will not only inform you about prop trading taxes but also show you potential savings or provide advice on the right company structure.
Prop Traders are Subject to Income Tax and the Self-Employed Tax
The final tax return is, of course, individual for each prop trader. The submission depends on various factors, such as marital status, tax class, and the number of children.
There are various tax-free allowances in the USA that you can also claim as a prop trader. It should be noted that as a self-employed individual, you have to pay income tax, and also the self-employment tax.
Different Countries, different Taxes
Each country has its own tax laws.
I’ll briefly discuss prop trading taxes in Australia, New Zealand, Canada, and the United Kingdom:
Prop Trading Tax in Australia
Profits from prop trading might be subject to Capital Gains Tax (CGT) if the investments are held for more than 12 months. The profits can be taxed as regular income if they are held for a short time.
Goods and Services Tax (GST) won’t apply to traded financial products, but fees (like brokerage) may incur GST. You can also deduct business expenses (brokerage, data subscriptions, etc.) to lower taxable income.
However, you must maintain detailed records of your trades for accurate tax calculations and deduction claims.
Prop Trading Tax in Canada
Your profits are treated as income, not capital gains, so they’ll be taxed at your normal tax rate. Your profit will be subject to federal and state income tax. The rates differ between provinces.
Your earned income is taxed in chunks called tax brackets. Each bracket has its own rate. The prop-trading firm won’t give you tax statements like a regular employer might.
Therefore, it’s essential for Canadian residents to report their prop trading income to the Canada Revenue Agency (CRA) and fulfill their tax obligations accordingly. Consult a tax professional for more guidance on this.
Prop Trading Tax in New Zealand
If you’re a sole prop trader, your trading profits are added to your personal income. If you set up a company, the business income is taxed at the company tax rate.
Each structure impacts deductions and reporting. Profits from frequent, short-term trades are typically considered business income. Longer-term holdings may qualify for capital gains tax, but the distinction can be complex. Discuss this with a tax advisor for personalized guidance.
Prop Trading Tax in the UK
Capital Gains Tax (CGT) applies to profits from the sale of assets. CGT rates currently stand at 10% for basic rate taxpayers and 20% for higher/additional rate taxpayers, with an annual tax-free allowance.
If HMRC views prop trading as a business, income tax at varying rates (up to 45%) may apply.
For prop traders operating as a limited company, corporation tax applies, with rates subject to change. Personal trading as a sole proprietor or through a limited company can impact your tax situation.
Traders must report gains and income to HMRC and can deduct certain Forex trading-related expenses. Due to the complex tax rules, I strongly suggest that you consult a tax professional regarding this.
Conclusion
In conclusion, you must pay taxes on your income from prop trading. You are subject to taxation. However, you can claim expenses to reduce your profit and thus the tax burden.
In principle, it doesn’t matter whether you register with the prop trading provider as an individual (self-employed) or as a company. You are always subject to taxation. Since tax laws in the USA are complex, it’s advisable to always seek the help of qualified tax advisors.
Frequently Asked Questions
In the FAQ section, I have compiled the most relevant information on prop trading taxes for you.
What legal status does Prop Traders have?
Proprietary traders are not employed by the prop trading firm. They operate as sole proprietors. For more information, see the section “Prop Trading is a Commercial Activity“.
What taxes does Prop Traders pay?
A prop trader pays income tax and self-employment tax. Read more about this under “Prop Traders are Subject to Income Tax and the Self-Employed Tax“.
Do I need a business license for Prop Trading?
No. You can trade professionally without a business registration. For more information, read the section “Prop Trading is a Commercial Activity“.
Who can assist me with Prop Trading Tax Registration?
You should never file your tax return alone. Always seek out a qualified tax advisor who also understands the prop trading business. Read my recommendation under “Seek Advice from a Tax Advisor on Prop Trading Taxes“.
Having more than eight years of trading experience, I know how hard it is to find a good and reliable Prop Trading Firm and not to choose the wrong one. With PropTradingScam.com I want to help you to pick the right one, stay safe, and share your experience.
