What Is an Entity Trading Account?

An entity trading account is a dedicated account type belonging to a legal entity such as a corporation or limited partnership. There are certain advantages to entity trading accounts over individual trading accounts, such as tax deductions and certainty in tax law.

Understanding the Entity Trading Account

An entity trading account needs one or more persons with authority to trade in the account. Such persons should be competent and honest traders in order to avoid losses in the account arising from poor trading decisions or unscrupulous behavior.

Institutional investors set up formal business entities to conduct their operations. For select individuals, particularly day traders or other active traders who wish to make a living from trading securities, it makes economic sense to establish a separate entity, rather than using individual investment accounts. Avoiding taxes is a principal motivation.

The proliferation of online and discount brokerages have played a significant role in elevating some investors into pseudo-professional investors. As such, the demand for business and tax planning around the migration from individual brokerage accounts to the incorporation of business entities for investment purposes has grown as well.

Key Takeaways

  • An entity trading account is controlled by a legal entity such as a corporation, which has one or more people authorized to trade on the entity's behalf.
  • Entity trading accounts may be suitable for individual investors who actively trade or day trade and want to set up a legal trading business in order to take advantage of certain tax deductions.
  • Entity trading accounts offer the same functionality and markets as traditional individual accounts.

Benefits of Trading Through Business Entities

While technical in nature, the benefits of trading through a business entity extend beyond tax advantages. Several benefits include paying salaries in connection with retirement plan contributions, greater flexibility in accessing certain asset classes, and establishing a performance record. The latter benefit is significant for individuals who wish to capitalize on their investment prowess or methodology by creating an investment fund which other investors can contribute to. Example of this would include establishing a hedge fund or separately managed fund under a registered investment advisor.

Moving individual investment accounts to a business account also has the advantage of allowing for the tax deduction of expenses related to trading activities, such as Bloomberg subscriptions or specialized equipment, for example.

By conducting investment activities through an entity, individuals may gain access to certain other investment providers and potential counterparties. For instance, a hedge fund may not consider doing business with an individual through their vanilla brokerage account but may consider engaging in transactions with a serious individual investor who manages their assets with an entity linked trading account. Also, because an entity account is established, it may be transferable, allowing for the sale of a business or the monetization of an individual's investment abilities and track record.

A person or group of persons that starts a legal trading business and opens an entity trading account may also change their accounting methods or legal structure by dissolving and re-forming the business. As long as an individual trader stays an individual trader, they don't have this flexibility.

To further benefit the trader, although more complicated, multiple entities and entity accounts may be set up. This allows each entity to maximize the tax efficiency of itself as well as all the entities as a whole. Such structures should be discussed with a qualified accountant.

Entity trading accounts typically come with all the functions of an individual trading account and often have no initial deposit requirements (may vary by broker). Entity trading accounts can trade in cash, on margin, and access markets like futures, options, forex, and all other markets which are accessible through the broker.

Example of Setting Up an Entity Trading Account

Sara has been successfully day trading for more than a year, pulling in regular monthly income.

Sara talks with an accountant and decides that she could be more efficient with her taxes and costs by setting up a corporation and then trading within that legal structure.

She sets up Sara Trading Inc., and then opens an entity trading account for that corporation, with herself as the only authorized trader on the account.

She trades as she did before, but now all the transactions—and profits and losses—are occurring within the entity trading account and corporation instead of her individual accounts. The corporation has more discretion and leeway on deductions and how to allocate pre-tax dollars in order to minimize taxes. With the help of her accountant, Sara is able to reduce the taxes she pays on her trading profits.