Should I start a corporation for my trading portfolio?

tl;dr: Only set up an LLC for trading if you are 100% sure you will not need to make withdrawals until you are 59 1/2, or if you use expensive equipment like a Bloomberg Terminal to trade. Otherwise, continue trading in a personal account and find another activity to fund your retirement accounts beyond your IRA.

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So, you made money trading stocks, but then you realized how much of a bite capital gains tax is. 

You're wondering if you can reduce your taxable income by starting a corporation and conducting your trading activities under that umbrella. Maybe a Delaware corporation?

Short answer: No, you should not form a corporation to hold your trading portfolio. 

Long answer: Starting a corporation can still help you dodge taxes in other ways. Let's look at some of the ways having company accounts can reduce your taxes, then talk about the corporate structures you should use (hint: it will be either a sole proprietorship or an LLC taxed as an S-corp).

Reasons not to incorporate your trading account:

People typically think of corporations as a means of avoiding taxes on their capital gains. It crosses all of our minds at some point. But here are the problems with doing that:

Complexity: You can't just make a shell corporation and then ACATS your account over to the company. You'd be performing a "transfer of securities" which has tax implications and adjusts your basis on holdings.

Taxes: When you perform a transfer of securities, you have to pay capital gains tax on any appreciation (just as if you had sold the securities and transferred cash). Your new business account will also have bases adjusted for whatever price the stock was when you transferred. Some states will also tax you additionally for performing a transfer. Remember, you are not transferring your portfolio to another one of your accounts. You're transferring your portfolio to an account that is explicitly not your own and belongs to a company. You are therefore liquidating your portfolio and will be taxed accordingly.

Liability: Since your business now owns the assets in your portfolio, you now need to protect them from liability. The chance of getting sued may be negligible if you are just using the business for trading. But if you do any other business, that portfolio is now on the hook for liability and you'd need enough insurance to cover legal issues.

Few tax advantages: You LLC will still have to pay tax on your capital gains, so you won't be avoiding taxes. However, it is possible to reduce your capital gains tax using a business account IF your trading income is low enough that your corporate tax rate would be lower than your personal tax rate. For example, if you make $30,000 trading but are a high-earner on your W2, you can pay only 15% capital gains tax trading in an LLC but would pay 30% in a personal account.

The problem, however, is that to access the funds for personal use, you'd be taxed on the distribution from your corporate account to your personal account. Unless you want your funds tucked away in LLCs, you won't personally benefit.

Exceptions: If you use expensive software for your trading, like a Bloomberg Terminal, you might be better off using a corporate account to trade because it would make it easier to write off that expense. 

If you are a successful trader but do not need the income for expenses, you can stuff your trading income into retirement accounts which will reduce your taxes. This is only advantageous if you do not expect to use the income until you are of retirement age (59 1/2 years old).

Benefits of incorporating

Although transferring your trading account might not be the right move, there are other advantages for opening a business. You should consider opening a business just for these.

Remember, you can only use your company's profit into these. You cannot make $100,000 at your W-2 job and invest it all into business retirement accounts. 

Additional retirement accounts: This is the big advantage. If you are self-employed, you can open up i401(k)s and SEP accounts which can help you defer almost all of your taxable income unless you make more than $88,000/year on your business. You can use life insurance policies to further avoid taxes.

Deductible expenses: Self-employed people can deduct expenses that fuel your business. If you upgrade your computer and use it for work, you can deduct it. Improvements to your home office are also deductible. Even a proportion of your rent or mortgage can be deducted from your income, if you work from home.

Pay your family: It is an open secret that if your kids help you in your business, you can pay them up to the standard deduction ($12,950) without them having to pay taxes on it. You deduct that money from your business income (because you're paying that money as a salary or wage), and your kids can invest it into their own retirement accounts for tax-free growth.

Corporation types for your diabolical plan

If you want to create a corporation to avoid taxes, you'll almost certainly want to be a single-member LLC as an S-corp, or a sole proprietorship.

C-Corp (what not to do): A C-Corp is the corporation most people think of, with a board and executive members. For your own business, this structure is problematic because the corporation must pay taxes on its profit, and then you as the owner must pay taxes on your distributions. You get double-taxed.

Sole Proprietorship: This is the default corporate structure. If you sell something on Etsy, you are a sole proprietor. There are no legal protections for you as the owner, but you can still set up retirement accounts and pay your family. For bookkeeping, you are a business owner. For liability reasons, the business is just an extension of your own personal activity, and therefore your assets are not protected.

I used this structure from 2019-2022 with no issues as a YouTuber. But if you are landscaper with employees, you'll want an LLC for the liability protection.

LLC as an S-Corp: A standalone single-member LLC is just a sole proprietorship with liability protection. But when the LLC elects to be taxed as an S-Corp, you get the advantage of paying yourself a set salary, and you can avoid some taxes on additional distributions (bonuses).

As a sole proprietorship, you must pay income tax and self-employment tax on all of your income. As an S-Corp, you only pay both taxes on the salary you set for yourself. If your business has additional profit, you can pay yourself that money as a bonus, which is subject to income tax but not self-employment tax.

More information:https://howtostartanllc.com/start-an-s-corp

Final thoughts: Find a business that works for you, such as home improvement. Make a YouTube channel for it, and write off the equipment and expenses for home improvement. This will help you avoid taxes on income that you spend funding your projects. And who knows- you might even make money on your channel which you can then use to fund retirement accounts. Or set your kids up for life.