How a Taxpayer Can Establish a Business as an Active Cryptocurrency Trader Under Current Law
Crypto trading can qualify as a Section 162 trade or business even though there is no cryptocurrency specific guidance from the IRS or the courts. The federal tax rules that define whether an activity rises to the level of a business apply to any asset class, including digital assets. A taxpayer must demonstrate that crypto trading activity is regular, continuous, substantial, and directed toward short term profit. This framework is drawn from existing trader status case law, which has developed entirely in the context of securities, but its principles provide meaningful guidance for evaluating a crypto trading business.
How Federal Law Distinguishes a Trading Business from an Investment Activity
The Internal Revenue Code draws a clear distinction between a trade or business under Section 162 and an investment activity under Section 212. A business may deduct ordinary and necessary expenses in full. These may include:
- Data service subscriptions
- Trading platforms and software
- Home office expenses
- Trading related education
Investors, by contrast, are generally limited to nondeductible Section 212 expenses because miscellaneous investment expense deductions have been suspended.
Several other provisions also shape the tax consequences of a trading business:
- Section 1402: Trading gains are not subject to self employment tax.
- Section 163(d): Interest expense allocable to investments may be limited.
- Section 163(j): Corporate level business interest deductions may be restricted.
- Section 199A: A trading business may qualify, but capital gains are generally excluded unless Section 475(f) applies.
- Reg. §1.469-1T(e)(6): Trading in personal property for one’s own account is treated as a non passive activity.
The Trader Versus Investor Standard Developed in Case Law
Courts have consistently held that the distinction between a trader and an investor depends on the nature of the activity, not its size. A unified test has emerged from cases such as Higgins, Moller, Liang, King, Endicott, Nelson, Assaderaghi, Holsinger, and Kay.
The courts focus on three core factors:
- Substantial trading activity, often measured by the number of trades and number of trading days.
- Frequent, regular, and continuous market engagement, rather than sporadic or opportunistic activity.
- A primary objective of short term profit from market movements rather than long term appreciation.
In addition, courts have clarified that:
- Trading for clients is not required for trader status.
- Trading for one’s own account may qualify as a business.
- Dealers, traders, and investors are distinct categories for tax purposes.
How the IRS Interprets Trader Activity
IRS Topic No. 429 mirrors the judicial standard. It explains that a trader must:
- Seek to profit from daily market movements
- Conduct substantial trading activity
- Maintain continuity and regularity of trades
The IRS evaluates factors such as holding periods, number and dollar amount of trades, time devoted to trading, and whether the activity resembles a source of livelihood.
Applying These Principles to Cryptocurrency Trading
There is no IRS ruling, regulation, or court case addressing whether crypto trading qualifies for trader status. Existing authority relates only to securities. Crypto trading differs from securities in several ways:
- It trades continuously across global markets
- It exhibits different volatility and liquidity characteristics
- It is not subject to wash sale rules
- It is property for tax purposes, not a security
Because Section 475(f) applies only to securities and commodities, crypto traders cannot elect mark to market treatment. These distinctions place crypto traders in a regulatory and judicial void. With no crypto specific trader guidance, taxpayers must rely on general Section 162 principles.
What Taxpayers Can Rely On Under Current Law
Several established authorities provide a basis for evaluating crypto trading businesses:
- Groetzinger standard: A trade or business exists when activity is regular, continuous, and profit motivated.
- Reg. §1.469-1T(e)(6): Trading personal property is treated as a non passive business activity.
- Notice 2014-21: Crypto is property, meaning Section 162 may apply if activity resembles a business.
Building a Defensible Crypto Trading Business
A taxpayer seeking business treatment for crypto trading should demonstrate the same characteristics required in securities trader cases. These include:
- High trading volume
- Frequent activity throughout the year
- Short holding periods
- Significant time devoted to trading
- Business like operations, including recordkeeping and separate accounts
Interest expense may be treated as business interest or investment interest depending on the taxpayer’s level of participation. Entity structure does not determine trader status, but it may affect reporting.
The Role of Entity Structure
A trading LLC does not automatically create a business. A single member LLC is disregarded, and the IRS focuses on the owner’s trading activity. A multi member LLC is a partnership unless it elects corporate treatment. The title of a brokerage account does not determine whether the trading activity rises to the level of a business.
Final Takeaway
Crypto traders may qualify as a Section 162 business, but the burden of proof is high. No crypto specific guidance exists, so taxpayers must rely on general business principles, trader case law, and well supported documentation. A consistent pattern of high frequency trading, short holding periods, and business like operations strengthens the case that the activity rises to the level of a trade or business.
See current federal rates on the Economic Dashboard.
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