I know for holding stocks on the long term, more than a year, there is a lower tax rate. How do day traders profit with tax rates around 30% or higher? Are the profits still worth it with such high rates? Or do they work around the taxes somehow?
I would say it's all relative. Take the following two scenarios:
- I'm a daytrader and I can make $1,000,000 a year with my aggressive trading, but I have to pay a 35% tax rate. My remaining profit is $650,000.
- I'm a long-term trader and I can make $500,000 a year with less frequent trading. My tax rate is 20%. My remaining profit is $400,000.
If you were facing these options, would you chose #2 just because you pay a lower tax rate, even though you make less money?
These numbers are of course fictional, but the point I'm trying to make is that everyone will seek the method that allows them to make the most money. If they have to pay a higher tax rate, so be it.
One other thought: daytraders will have higher expenses, which are deductible.
Long-term capital gains, as you note, get special tax treatment. They are lower than regular income tax rates. Short-term capital gains aren't penalized, they are just treated as regular income under the regular rates. So, from a tax perspective, the day-trader gets by the same way as the rest of us because they are paying the same rates on the same progressive income tax scale.
The advantage that a day trader really wants is an opportunity that allows them to buy at the Bid and sell at the Ask. Without that advantage there is really only a 50% probability of profit.
Now someone who holds a position for a day is not a day trader. A day trader only hold positions for a few minutes and is a market-maker.
But someone who makes a lot of short term trades can get 60% of the trades as long-term capital-gain treatment by trading futures.
Or a day trader that makes hundreds of trades per day can choose trader-status with the IRS. Trader-status sets profit at the income tax rate, which does not get the long-term capital-gain rate, but allows any amount of trading loss to be deducted. So the larger loss deduction can flow-through to the overall personal tax liability. Also, expenses can be easily deducted with trader-status, just file a Schedule C.
Otherwise, someone wanting to make their investment activities as a corporation, they would have to form an investment company with the SEC and that is not as easy. A corporation of some purpose other than investment, can have investment activities of 60% Treasures or bank deposits and 40% other investments and do that without forming an investment company.