The U.S. Tax Court case Cherry v. Commissioner, T.C. Memo 2021-14 (Jan. 21, 2021) is an insightful lesson in the tax consequences of securities trading, and an instructive narrative for any taxpayer involved in heavy trading.
The central question was whether Mr. Cherry was a trader or an investor for tax purposes. This distinction matters for tax purposes because a “trader” can fully deduct expenses related to trading, while an “investor” can only deduct expenses as miscellaneous itemized deductions, which were largely eliminated under the Tax Cuts and Jobs Act.
In 2011, Mr. Cherry made more than 300 trades on days throughout the year, but his average holding period for a given security was over a month. He also maintained other employment during that time.
The IRS initially classified Mr. Cherry as an investor, not a trader. Consequently, he could not deduct expenses related to his securities trading as business expenses.
Mr. Cherry took the matter to the Tax Court, where he argued that he was a trader because he sought profit from short-term market movements rather than long-term appreciation and income.
The Tax Court, however, upheld the IRS’s determination. The court ruled that despite the number of trades, Mr. Cherry was not a trader because he did not execute trades continuously and regularly enough to be considered as carrying on a trade or business.
This case emphasizes the importance of the “trader versus investor” distinction in tax law. To qualify as a trader, one must engage in trading activity with sufficient frequency, extent, and regularity, and must also seek to catch the swings in the daily market movements and profit from these short-term changes rather than profiting from long-term holding, appreciation, or dividends.
For taxpayers involved in securities trading, Cherry v. Commissioner offers a clear message: the frequency and intent of trades matter for tax purposes. This case underscores the need for careful record-keeping and awareness of the tax implications of trading activities.
T&Y CPA 