Transcription
In today's episode, I'm going to share with you the tax strategies the top 1% of traders are using to legally pay, in some cases, zero income tax on their trading profits. This is a big deal. In fact, being a more profitable trader isn't always about making more money. In some cases, it's simply about being more tax-efficient than the next trader out there.
And before you say, "Ross, it's going to be very easy for me to pay zero income tax on my trading profits because guess what? I'm not making any money." Well, hold on just one second. These strategies also apply to traders who take losses. They allow you to harvest those losses to offset other income either now, or you can carry forward that loss to offset income in the future. These are strategies that most beginner traders don't know about.
My name is Ross Cameron. I'm a full-time trader and I'm probably best known for turning an account with less than $600 into more than $20 million of gross profit. That's a lot of money. And as you would imagine, that comes with a really big tax bill. So, I hired the best accountants that I could find. So, I have these New York City accountants who are very good. It's not that my trading profits are incredibly complicated. The taxes are fairly straightforward, but I wanted to make sure I was doing them the right way. And once I got that first tax bill for the first year, I wanted to make sure that if there were any available deductions that I was using them. And so some of the things that I'm going to share with you, I learned either the hard way by overpaying in taxes during the first years they made really good money, or by paying a really high-powered CPA to give me this advice.
So I should note at the beginning of this episode that I'm a trader. I'm not a CPA. So, I'm going to share with you some of the tips and tricks that I've picked up along the way, but I always want to encourage you to consult a CPA before you file your own tax return.
So, let's begin high level with a little bit of a case study and an example of my taxes. So, last year I made a little over $6 million. So, I'm going to round down to 6 million. Now, I happen to live in the United States and so I am subject to federal income tax, which at $6 million is 37%. Now, I'm in the top bracket. Now, the way the taxes work is I don't pay 30% on the total six million. I pay the lower brackets all the way up until I get to six million. So, basically the first couple hundred,000 is at a lower bracket. The next few hundred,000 is a slightly higher bracket. And then eventually we get up to 6 million, which happens pretty quickly. And anything over, uh, I think $800,000 is at this top bracket. So, the majority of the, uh, $6 million is taxed at 37%.
Now, I also live in the state of Massachusetts. So, you've got state income tax. We have a 6% flat tax in Massachusetts. Makes things really simple. But Massachusetts decided to add a 4% millionaire tax, which a lot of states are doing. So, on top of the 6% tax, anything you make in excess of a million dollars is subject to an additional 4% tax. Well, wait a second. So, that means now it's not 6% for me. It's 10%. Wait a second. So now we're looking at 47%. Again, roughly, I, if you're making $50 million, yeah, the first million is not going to be 47%, but then the rest is going to be more or less 47%. So, holy smokes. So, you're saying on $6 million I'm going to owe at least $2.8 million in tax? That's right. But do you want to know how much I actually paid in tax last year on this six million? The answer is zero. And it's because of the strategies that you're about to learn here today.
So here's the first strategy. When my CPA down in New York first did my filings, he said, "Boy, Ross, you're going to owe a lot of taxes last year." And I did. I paid a ton of tax on that first really big year. And he said, "Ross, how do you feel about Puerto Rico?" And I said, "Puerto Rico? What do you mean? It's an island in the Caribbean. I feel great about it." He said, "I know, but how do you feel about moving there?" I said, "Moving there? I don't know about that." He said, "Well, Puerto Rico has this special thing, which today is called Act 60. And what it allows is for any US resident to move to Puerto Rico, and when you move there, you no longer have any federal income tax, and you are exempt from all tax on all capital gains."
Wait a second. So, I said, "If I move to Puerto Rico, this tax bill goes from $2.8 million to zero." And he said, "That's exactly right. It goes to zero." And I said, "Well, geez, I better go check it out." So, I flew down to Puerto Rico and I checked it out and I thought, "This is a beautiful place. There's no question about it." But for me, it's not a good time to make the move. I've got two young kids. They're already settled in school and I felt like I couldn't do it. But I will tell you that if you are younger and you have the freedom to move to Puerto Rico and you're making some decent money, it is a compelling proposition. It really is. Think about being in Massachusetts, being in New York City, being in California. If you're in Puerto Rico, you spend 6 months and a day there and you have no closer connections anywhere else in the United States. All of a sudden, you've got no federal income tax and no state income tax. That's a meaningful difference when you're younger and you're earning that money and you're trying to save as much as you can because when you're in your 20s, and if I had known about this when I was in my 20s, I absolutely would have done it. It gives you the chance to get a big jump start on saving. And all that money that you're saving can be reinvested. And now thanks to compound interest, it can grow so much faster. And this is a thing where I hate to say it, but the states that have really high income taxes, I feel like they're holding you back. They're keeping you down. And I don't think that's a good thing.
So if you're younger, you have the opportunity to make this move. Now, is it the best thing for you? You've got to make that decision. If you're in the middle of life like I am, you've got parents who are older, you've got younger kids. It's not easy. And then you get to the level of being retired and all of a sudden it opens up again. Now, because Puerto Rico is a territory of the United States, it's easy to move there. So, I could move from Massachusetts to Puerto Rico, and it's not really that different than moving from state to state. You get a driver's license, you keep your US passport, you keep your US citizenship, and then if you want to move back, you move back. Some people talk about moving to Dubai or one of these other countries that are tax-free, but those would require you to surrender and give up your US citizenship, which is a big deal, and people don't take that lightly, naturally. So, Puerto Rico is really kind of a a very unique offering being that it's still a US territory, but while you're living there under Act 60, no capital gains tax, no state or federal income tax. Holy smokes, that's a big deal.
Okay, so number one, your first way to pay zero capital gains tax is to move to Puerto Rico and have no closer connection to anywhere else in the US. Okay, if you could do it, awesome. If not, let's move on to number two.
So now you wait, you're already saying, "Wait a second, Ross, you're not in Puerto Rico and you paid zero capital gains on your trading profit. How did you do that?" So the second way to pay zero capital gains on your trading profits is to begin trading in a retirement account. This is a really powerful tool and this is of course not only, uh, sanctioned by the government, it's encouraged by the government. The more you save for your own retirement, the less you have to depend on the government in the future. So in a way, they're giving you a chance to kind of invest in yourself by growing this account.
So here's what I did. I set up what's called a Roth IRA. Now there's two types of individual retirement accounts in the United States, individual retirement account. One is a traditional, the other is a Roth. Now, the Roth IRA has max income restrictions that prevent you from making a direct contribution into the Roth IRA. A traditional IRA has no restrictions. So, here's the way it works. Let's say you made $100,000 this year and you donate $6,000 to a traditional IRA. That $6,000 comes off your $100,000 of taxable income. So your taxable income is now $94,000. You basically saved a little bit in tax. Goes in the traditional IRA over the course of 50 years. It grows. You can take money out of the IRA when you're 59 and a half years old. So it grows and grows and grows. And when you take money out of the traditional IRA at that time, you pay tax on all of the distributions. Well, see, because you got the tax advantage initially, you paid no tax on all the contributions into the traditional IRA. So, you got to pay tax on everything that comes out. The problem is, let's say you contribute $100,000 and then over the course of 30 years, it grows to let's say $500,000. Now, the government's really happy because they get to collect income tax on $500,000. So, they paid, yes, you saved in the beginning, but you pay later.
So with a Roth IRA, you make $100,000 and you do a $6,000 contribution. You still pay income tax on $100,000. So in other words, your contribution comes out after tax. You've already paid tax on the $6,000 that goes in. And since you already paid tax on your contributions, and let's just say they're $100,000 total, this grows to 500 grand, and you have no tax on the withdrawals because you already paid tax initially on it. So the concept here is this is the tree right here and these are all the little apples that are coming off the tree. With a traditional IRA, you're getting taxed on all the apples. With a Roth IRA, you're just paying tax on the initial seed. You tax the seed, not the fruit. Tax the seed, not the tree. That's the idea. That's the expression.
And so naturally, there's a problem as you already have noticed, which is that there's a max contribution. Don't worry, the congressmen in their infinite wisdom who, uh, created the rules around this, decided that there should be a way that you could convert at any time a traditional IRA to a Roth IRA. So, let's say you earn more than the max contribution, than the max amount for a Roth IRA, which I think right now is around $350,000. Double check it. So, if you're earning more than $350,000, which I am, then you contribute to a traditional Roth, a traditional IRA, $6,000, and then you convert it to a Roth IRA. What happens when you convert it? You basically have a 1099 type of tax bill for, uh, $6,000. You do the conversion and then from that point on, it's a Roth IRA. In fact, it's called a backdoor conversion. That's the official name for it. So whether or not you are above or below the max income limit, uh, doesn't really make a difference because at the end of the year, you can always do a traditional to Roth backdoor conversion. And that's exactly what I did. So at this point right now, I am trading in a Roth IRA.
Now, one of the things that I teach our members at Warrior Trading is about this software that I've used over the years. It's very interesting. It allows you to take the exact same trade both in a taxable account and in a tax-free account at the same time. So, essentially, you're mirror trading yourself. You're not allowed to do it with other people because you have to be a registered financial advisor to trade on behalf of other people. I am not, and you likely are not either, but you can trade your own money basically in two accounts. So, you've got your main account and then you've got your Roth IRA. And so, this is how I set it up. I trade in the main and the Roth IRA grows. Now, because the Roth IRA initially has a smaller balance, it's growing a little bit more slowly. But as that account starts to get bigger and bigger and bigger because you can't take money out to pay bills, you get to a point where you've got enough buying power in that account to really grow it.
Now, I'm fortunate over the past decade, I've diversified my income. This is another thing that I encourage all of our members to focus on diversifying your income. So, I've gotten to a point where I realized I don't need to produce profit in my taxable account anymore. I've got income coming in from, hey, copies of this bestseller right here, how to day trade the stock market. So, now that I've got the income coming in from royalties here, I've got some income coming in from our software company over at warriortrading.com. I don't need to be producing extra taxable gain each year. So, I'm now very fortunate that I can trade just in the Roth IRA. You might not be there yet, but it is something to strive for because that is the second way to be 100% tax-free on your trading profits.
Now, let's talk about the third technique. So, the third technique is a little bit different. So, in this third technique, we're not using a Roth IRA because in this third technique, we're assuming that you actually need the income to pay your bills, which means you're trading as a business. And when you trade as a business, you set up either an LLC or a corporation. And these unlock some powerful tools that make a huge difference when you're filing your taxes.
So number one is trader tax status. Trader tax status says that if you are trading as your source of income, you're trading to make a living off of actively buying and selling in the financial markets. That is your business. Therefore, just as if you are a plumber or an electrician, you can deduct all necessary and reasonable business expenses against your income. So, now look around here. We've got monitors. We've got a desk. We've got a dedicated area in this space which is heated and cooled solely for the purpose of trading. This room right here is my home office. Okay. So now you start itemizing all of these expenses. You've got your equipment, right? You've got your dues and subscriptions. So let's say this is, um, market data that you're paying for. You've got continued education. Now whether you're an attorney or you're a realtor, these are all expenses that you would likely incur. Now, as a trader, will you have a business car? No, probably not. So, you probably won't be able to get yourself a business expense, uh, deduction for a car because you're trading from home. You're not a plumber, so you can't get a plumber van. Um, but you will be able to pay for the equipment, obviously. Um, you know, furniture and then office, uh, expenses. So, uh, rental, if you're renting an office or if you've got a home office, then you speak with your CPA about the percentage in square footage that the office represents. Now, your office cannot be 90% of your dwelling because it's not, uh, considered to be allowed. There is a max of what it can be, but just check with your CPA to see what that is. And then you can either be taking a percentage of all the expenses related to your home or your current rental as an office deduction. So that would be a percentage of, um, all the utilities, the tax bills, etc., etc. Or what some people will do is they'll do, um, like a, a type of rental agreement, which is a little bit more complicated. In any case, you do one of the two because you've got legitimate business expenses that are necessary and reasonable in order to create your office. And so now you add all of these up with trader tax status and you're allowed to deduct them against your income.
So let's say you made, um, in this case, we'll just say we'll use $100,000 to keep the number simple. Let's say you made $100,000 of total net profit trading. And your continuing education, let's say, was $3,000. So this is three grand. Your dues and subscriptions, let's say that's $1,800. Let's say it's $2,000. We'll just round up. Your equipment and furniture, let's say that's $2,000 also. So, it'd be higher in the first year, but maybe less in the future. And let's just say this is like $500 a month, internet, everything else. Said $6,000. So, now we've got $13,000 in expenses. So, now your income comes down to $87,000. Right now, this is just trader tax status. Other things that you can deduct as an LLC or a corporation, you've now got $87,000 of, of still income in the business. Let's say you needed $50,000 of that to cover your cost of living. So minus $50 grand that went out the door to cover cost of living. So you got $37,000 left. And that's what you're essentially figuring is, okay, how much of this do I have to use to cover my taxes?
So now you look at other deductions you can take. And one of the ones that a lot of people will use will be health insurance. So health insurance, I'll put this as, um, as two, number two. And then number three, um, is a solo 401k. So distributing the profits of the LLC or the corporation into a solo 401k for the owner of that corporation. And so all of this helps chip away at your total taxable number. So it goes from 87. You drop it down more and more and more and more. And that helps you obviously reduce your ultimate tax liability.
Now there's a fourth thing here. So I'll erase this. We'll just clean this up a little bit. Number four is mark-to-market accounting. So mark-to-market accounting is a pretty big deal, especially for traders who have lost money. With mark-to-market accounting, you can write off unlimited losses against your income. That's not true if you don't apply for mark-to-market accounting. So at the end of the year from your broker, you will get a 1099. And the 1099 has a couple of things. One is it will exempt wash sales. And so what that is, a wash sale is when you sell something for a loss and then you buy back a substantially similar position within 30 days. This wash sale rule was created because in December, what a lot of investors used to do is any position they were holding for a loss, they would sell it. So they would have a loss on their 1099 and then in January they would buy back the position. So, they would basically just take the loss, harvest the loss, and then get back into the same stock. And the IRS said, "No, no, no, no. If you're going to sell it and buy it back within 30 days, you can't write off that initial loss."
Well, wait a second. What about for a day trader? What if you're day trading and you take a loss and then you trade the stock the next day? The IRS would say, "Well, that's a wash sale." So, all of a sudden, this becomes a problem for day traders. I've known traders who have had a million dollars of, um, of wash sales that were exempt. So even though they might have only made $200,000 on the year in net profit, it showed that they actually had $1.2 million in profit because of the wash sales that were exempt. Now that doesn't make sense. Of course, you can't pay $600,000 in tax if you literally only made $200,000 of profit. But you know, when these wash sale rules were created, they never thought people would be trading as actively as they are. So then in that case, you've got to hire a CPA to figure it out and explain it to the IRS, which is just a pain and is expensive.
So the alternative is filing for mark-to-market accounting. When you have mark-to-market accounting, you're exempt from wash sales. And that does two things. Number one, you don't have the wash sales. But the second thing mark-to-market accounting does is it removes the $3,000 restriction that you can only write off $3,000 of a capital loss against income. So now let's say that things didn't go very well and you actually lost $100,000 day trading in, in your first year here in your LLC, in your corp. And then you still had an extra $13,000 in deductions. So you're actually down $113,000. But let's say on the good side, you've got a W2 job, um, and you made, um, $150 grand. All right, that's awesome. So, at least life is good over here. Now, if you did not already set this up as a business, you wouldn't be writing off any of the $13,000 and you'd only be able to write off $3,000 of this $100,000 loss. Only $3,000. And so you would still pay income tax on, well, $147,000. There you go. Which would be pretty terrible considering in total you only made about $37,000 this entire year when all this is said and done.
If you file for mark-to-market accounting, trader tax status, you have your LLC, you're trading as a business, then all of a sudden this $113,000 is a loss that offsets this income here. And now you're paying tax on $37,000 instead of $147,000. So now your tax on this is like, you know, $10,000, maybe less, versus the tax on $147,000. That makes a huge difference.
Now again, I want to remind you as always, as you know, I'm not a CPA. I'm just sharing with you the things that I have learned over the years. So tax rules are complicated. Every individual circumstance is different depending on what state you're in, depending on how old you are, depending on how much you make and your different sources of income. There's a million variables. So, you should always consult a CPA before you file your return. However, what I have learned over the years is that most traders are not taking advantage of either trading in a corporation, trader tax status, or mark-to-market accounting. Most traders are not using a Roth IRA, even if you're only using it as the second account.
So, number one, we talked about Puerto Rico. Number two, we talked about IRA. And number three, we talked about businesses. So, if you're trading in a business, this is the one where you still will have capital gains tax. You will, but it will be lower as long as you're using the trader tax status and mark-to-market accounting. It'll be lower than it would have been otherwise. So, these are your three potential steps.
And what I see traders doing who are earning seven figures a year consistently is they're voting with their money. They're often moving to states that have lower tax liabilities. So states like Florida, New Hampshire, Texas are obviously a lot more popular than New York City, California, and even Massachusetts. I mean, Massachusetts is a high-income state thanks to this new millionaire tax. But a lot of states are doing it. They're wanting to fund all of these services, and they're making the wealthy people pay for it. And you know, look, you can have your opinion as you'd like it, but there's a huge difference between the people in the top income bracket who are making $2 million a year and the people who are making $200 million and $2 billion, but we're all in the same bracket. So, I'm the poorest rich person that there is according to the IRS because I fit in the top bracket, but I'm in the very bottom of the top bracket. And this is where you have to be really thoughtful about what you're going to do to minimize the unnecessary taxes that you have.
So yes, you have to pay tax if you're taking profit out, but you don't need to overpay. So it's your right to make sure you're taking advantage of the deductions that are available. They are taking advantage of a Roth IRA so you can start saving for retirement. And if you'd like, you can always consider moving to Puerto Rico.
Now, I hope you guys have really enjoyed this episode. If you found it helpful at all, I hope you hit that thumbs up. I hope you are subscribed to the channel. I'll remind you as always that trading is risky and my results aren't typical. So, please take it slow and I'll see you for the next upload real soon.