Can my Trade Profit be Taxed?

To outsiders, day trading can seem like more of a hobby than anything else. Traders sit down with their laptops, staring intently at their screens, and occasionally make relatively small profits from one or two of their myriads of investments. To the untrained eye, this can seem like more work than it’s worth. In reality, however, successful traders can compound these profits over time and end up making more money in a few days than most people make in a month. Indeed, for some people, day trading is a full-time job with a healthy salary. But this raises a few questions – Do these profits get taxed? How is it calculated and what does the law say about all this? Can my Trade Profit be Taxed?

First off, yes, your trade profits are taxed but the ways in which they are taxed are dependent on certain factors.

When dealing with trading profits, we have to differentiate between Investments and Operations. Trading Profits from Operations are pretty straightforward as they are essentially just your earnings from operations.

Trading Profits from Investments on the other hand are a bit more tricky as they usually deal with intangible assets such as stocks and bonds which are taxed differently depending on how they are categorised.

Does Trading Count as Income?

Yes, it does. Stocks that are ‘bought for the main purpose of reselling at a profit’ are categorised as trading stock and profits made from their trade are usually seen as a type of income in the form of revenue gains.

This means that any profits you make off of such a trade would be subject to an income tax, however, it also means that any reasonable expenses which assist in the production of this income may be considered as tax-deductible expenses.

Do Day Traders Pay More Taxes?

When compared to those who hold stocks as Capital Assets for many years before selling them, yes, Day Traders pay more in taxes.

When stocks are considered long-term dividend-producing investments, they are normally subject to a Capital Gains Tax (CGT) upon their sale. This CGT is usually taxed at a lower rate than your income tax and thus, day traders (who are subject to an income tax at their marginal tax rate) will generally end up paying more in taxes when they sell their stocks.

Is Trading Profit Before or After Tax?

Usually, when we talk about trading profits, we’re referring to the profits made before tax. To work out your trading profit, you simply need to multiply the price movement of your stocks (the change in their value) by the number of said stocks. This should give you your trading profits for those investments which then need to be taxed accordingly.

Do Day Traders Have to Pay a Capital Gains Tax?

No, they don’t. Capital Gains Tax (CGT) is usually reserved for Capital Assets which are held for a much longer period of time. This occurs primarily because the government wishes to incentivise long-term investments such as stocks which pay out yearly dividends rather than the short-term investments that are synonymous with day trading. As a result, these long-term investments are subject to CGT rather than the more costly Income Tax which plagues day traders.

What Does Buying On Margin mean? – Can my Trade Profit be Taxed?

If you do get involved with day trading, you’ll likely come across the term ‘buying on margin’ quite quickly. This refers to the extremely risky practice of borrowing money (generally from a bank or broker) in order to purchase more assets and (hopefully) increase your revenue. While buying on margin can substantially increase your earnings, it can also exacerbate your losses, and thus, it should not be attempted without first contemplating the potential risks.

What is the Difference Between Day Trading and Swing Trading?

When managing your assets, you don’t necessarily have to choose between selling them after a day or waiting a couple of years. Some traders prefer to let things ride a bit as their investments are given some time to grow. This is called Swing Trading and involves holding on to your assets for a number of days or weeks instead of for a few hours.

The main idea behind Swing Trading is to capitalise on a period of positive price movement as you focus on brief trends within the market. Swing Traders usually make smaller profits than their counterparts, however, consistently making small gains can eventually become a viable means of income.

Of course, there are disadvantages when it comes to swing trading, perhaps the most notable of these is called Gap Risk.

What is Gap Risk? – Can my Trade Profit be Taxed?

Gap Risk refers to an uncommon but terrifying phenomenon in which the stock price of an asset drops radically over a very small amount of time. This drop normally occurs when the market reacts to some piece of important news or some kind of game-changing event in the world. Unfortunately, these fluctuations can happen after the markets have closed or when you’re asleep which means you may wake up one morning to find that your slow-growing stocks are now essentially worthless.

Unlike Day Traders, who tend to close their positions before the end of each day, Swing Traders are more vulnerable to market changes as they hold onto their assets for longer. 

Is Day Trading a Viable Means of Income?

No matter how good you are at playing the stock market, you will have days in which you make bad deals and lose money. But can your Day Trading at least be generally profitable over the long term?

In short, it’s very unlikely. You need to remember that most of the predictably profitable traders are not random individuals sitting at home on their laptops. More often than not, they are experts working for large financial institutes which provide them with every relevant bit of data and technology necessary to make the right calls.

By contrast, studies have been done which show that the vast majority of day traders are losing money on any given day. The exact numbers are disputed, for instance, some people believe that around 10% of Day Traders are predictably profitable while others think the number is closer to 3%. Regardless, the studies seem to agree that, for most people, Day Trading is unlikely to pay off in the long run.

In Conclusion – Can my Trade Profit be Taxed?

Trading Profits are indeed taxed, however, the way in which they are taxed will depend on the nature of the assets. The key distinction is whether or not your assets are being held long-term as Capital Gains or if they are being held short-term for the main purpose of reselling at a profit. When dealing with capital gains, profits are usually subject to a Capital Gains Tax which is normally at a lower rate than your standard income tax.

Profits made by traders, whether they be Day Traders or Swing Traders, are seen as a kind of income and will generally be treated as revenue gains which will then be taxed at your marginal tax rate. Your trading profit is normally determined before tax and is calculated by multiplying the change in the asset’s value with the quantity of said asset. These profits are not normally subject to a Capital Gains Tax.

One of the primary differences in trading is between Day Traders and Swing Traders. Day Traders tend to close all their positions by the end of each day to minimize the Gap Risk which may occur while the markets are closed. By contrast, Swing Traders tend to hold onto their investments for a period of days, weeks or even months in order to capitalise on the growth periods within the market. These gains are usually smaller but over time can be compounded into a viable income strategy. Swing Traders are however, more susceptible to Gap Risk and sudden fluctuations in the market can result in major losses for such investors.

Studies tend to show that Day Trading is not a predictably profitable venture for the majority of investors and that most of the successful traders are professionals who are backed by large organisations. 

Disclaimer LAW101: All of our posts are for research purposes only. Law 101 aims to assist its readers with useful information on the laws of our country that can guide you to make decisions in line with the South African Governmental Laws currently in place. Although our posts cite the constitution in many instances, they are intended to assist readers who are looking to expand their knowledge of the law. Should you require specific legal advice we advise you to get in touch with a qualified legal expert.

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