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Recent Tax Court Decision Holds That a Writer of Covered Calls Was Not a Trader

Overview

In a recent memorandum decision, Endicott v. Comm'r, T.C. Memo. 2013–199, the United States Tax Court found that an individual selling covered calls for his own account was an investor rather than a trader. Consequently, the court disallowed his treatment of expenses as trade or business expenses, instead treating them as portfolio deductions, subject to various limitations.

Over a three-year period Endicott held core equity positions and would sell call options against his positions, rolling the options or letting them expire every one to five months. His apparent strategy was to profit from the premiums he earned on writing the call options, while holding the underlying stock to protect against his risk on the call options. In two years, he averaged 250 trades a year, which didn't rise to a trader level. In the third year, he had 1,543 trades, which was deemed substantial. Although the stocks were held on average for 35 days, the court found that the average holding period demonstrated no intent to profit from daily swings in the market. In other cases, the Tax Court has similarly applied this two part test in determining trader status: 1) substantial trading and 2) intent to profit from short term market fluctuations.

Although Endicott testified that he devoted every business day to monitoring his portfolio and the stock price in case of any precipitous drop, the court considered a few non-exclusive factors for a taxpayer to be deemed a trader, including: 1) the taxpayer's intent; 2) the nature of the income from the activity; and 3) the frequency, extent and regularity of the taxpayer's transactions. The court rejected Endicott's argument that commission costs prevented him from meeting the frequency requirement as it was not practical to trade options daily.

Overall, this case reiterates certain precedents that funds should consider in their analysis of trader vs.investor status. The case also emphasizes that regular monitoring of the portfolio may not be enough to give rise to trader status without the transactional support.

Contact information

For additional information or questions, please contact:

Ted Dougherty
National Managing Partner, Asset Management Tax
Deloitte Tax LLP
+1 212 436 2165
edwdougherty@deloitte.com
  Shawn McKenna
Partner
Deloitte Tax LLP
+1 213 553 1205
smckenna@deloitte.com

 

This alert contains general information only and Deloitte is not, by means of this alert, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This alert is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this alert.

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