Forex for a trader
Forex taxes in us

Forex taxes in usHow To File Taxes As A Forex Trader. Most new traders never have concern themselves with finding out the specifics of taxes in relation to forex trading. All of a new trader's focus is simply on learning to trade profitably! However, at some point, traders must learn how to account for their trading activity and how to file taxes-hopefully filing taxes is to account for forex gains, but even if there are losses on the year, a trader should file them with the proper national governmental authority. Filing taxes on forex profits and losses can be a bit confusing for new traders. In the United States there are a few options for Forex Trader . First of all, the explosion of the retail forex market has caused the IRS to fall behind the curve in many ways, so the current rules that are in place concerning forex tax reporting could change any time. Regulations are continually being instituted in the forex market, so always make sure you confer with a tax professional before taking any steps in filing your taxes. There are essentially two sections defined by the IRS that apply to forex traders - section 988 and section 1256. Section 1256 is the standard 6040 capital gains tax treatment. This is the most common way that forex traders file forex profits. Under this tax treatment, 60% of total capital gains are taxed at 15% and the remaining 40% of total capital gains are taxed at your current income tax bracket, which could currently be as high as 35%. Profitable traders prefer to report forex trading profits under section 1256 because it offers a greater tax break than section 988. Losing trader tend to prefer section 988 because there is no capital-loss limitation, which allows for full standard loss treatment against any income. This will help a trader take full advantage of trading losses in order to decrease taxable income. In order to take advantage of section 1256, a trader must opt-out of section 988, but currently the IRS does not require a trader to file anything to report that he is opting out. Also, if your forex account is huge and you lose more than $2 million in any single tax year, you may qualify to file a Form 886. If your broker is based in the United States, you will receive a 1099 at the end of the year reporting your total gainslosses. This number should be used to file taxes under either section 1256 or section 988. Forex trading tax laws in the U. K. are much more trader-friendly than the United States.

Currently, spread betting profits are not taxed in the U. K., and many U. K. brokers offer retail forex demo and regular accounts in a spread betting structure. This means a trader can trade the forex market and be free from paying taxes; thus, forex trading is tax-free! This is incredibly positive for profitable forex traders in the U. K. The drawback to spread betting is that a trader cannot claim trading losses against his other personal income. Also, if a trader is managing funds or trading for an institution there are many other tax laws that one may have to abide by. However, if a trader stays with spread betting, no taxes need to be paid on profits. There are different pieces of legislation in process that could change forex tax laws very soon. One should make sure that one confers with a tax professional to ensure he is abiding by all proper laws. Another option that carries a higher degree of risk is creating an offshore business that engages in forex trading in a country with little to no forex taxation; then, pay yourself a small salary to live on each year, which would be taxed in the country where you are a citizen. There are many types of forex software that can help you learn to trade the forex market. This type of business formation is very risky because you must make sure you are abiding 100% by tax laws and not slipping into illegal activities. This type of operation should be carried out only with the help of a tax professional, and it may be best to confirm with at least 2 tax professionals to make sure you are making the right decisions. Trading Taxes in the US. Day trading taxes in the US can leave you scratching your head.

Yet, if you’re marking hundreds or even thousands of intraday trades each year, it’s in your interest to understand how Uncle Sam will view your habit. Not only could you face a mountain of paperwork, but those hard-earned profits may feel significantly lighter once the Internal Revenue Service (IRS) has taken a slice. This page will break down tax laws, rules, and implications. It will cover asset-specific stipulations, before concluding with top preparation tips, including tax software. So, how does day trading work with taxes? Intraday income tax will depend on which category you fall into, ‘trader’ or ‘investor’. Unfortunately, as an IRS spokesman pointed out, “The question is clear; the answer isn’t.” So, you’ll need to follow the guidelines set out in the 70,000 page long tax code and take into account decisions in relevant case law. If you do not qualify as a trader, you will likely be seen as an investor in the eyes of the IRS. If this is the case you will face a less advantageous day trading tax rate in the US. You will have to account for your gains and losses on form 8949 and Schedule D. Your expenses will fall under the category of “miscellaneous itemized deductions.” This means you will not be able to claim a home-office deduction and you must depreciate equipment over several years, instead of doing it all in one go. Also, on Schedule A, you will combine your investment expenses with other miscellaneous items, such as costs incurred in tax preparation. You can also only write off the amount that exceeds 2% of your adjusted gross income. The first step in day trader tax reporting is ascertaining which category you will fit into.

Investors, like traders, purchase and sell securities. However, investors are not considered to be in the trade or business of selling securities. Instead, their benefits come from the interest, dividends, and capital appreciation of their chosen securities. The crucial difference between whether you are entitled to page 1 deductions, as opposed to Schedule A deductions against income, rests on whether you’re in the ‘trade’ or ‘business’ of selling securities. The bad news is that nowhere in the lengthy tax code is ‘trade’ or ‘business’ clearly defined. Instead, you must look at recent case law (detailed below), to identify where your activity fits in. Do you spend your days buying and selling assets? If so, you are probably going to fall under the ‘trader’ umbrella. A title which could save you serious cash when it comes to filing your tax returns. Day trading tax laws and recent cases tell us you’re a ‘trader’ if you meet the requirements tested in Endicott vs Commissioner, TC Memo 2013-199. The two considerations were as follows: 1. The individual’s trading was substantial. 2. The individual aimed to catch and profit from the price fluctuations in the daily market movements, rather than profiting from longer-term investments. In this case, the taxpayer’s primary strategy was to purchase shares of stocks and then sell call options on the underlying stocks.

His aim was to profit from the premiums received from selling call options against the correlating quantity of underlying stock that he held. He usually sold call options that held an expiry term of between one to five months. Endicott hoped the options would expire, allowing for the total amount of the premium received to be profit. He was not trading options on a daily basis, as a result of the high commission costs that come with selling and purchasing call options. Endicott then deducted his trading related expenses on Schedule C. This reduced his adjusted gross income. However, the IRS disagreed with the deductions and instead moved them to Schedule A. They insisted Endicott was an investor, not a trader. One of the first things the tax court looked at when considering the criteria outlined above, was how many trades the taxpayer executed a year. They also looked at the total amount of money involved in those trades, as well as the number of days in the year that trades were executed. Endicott had made 204 trades in 2006 and 303 in 2007. Then in 2008, he made 1,543 trades. The court decided that the number of trades was not substantial in 2006 and 2007, but that it was in 2008. In 2006 Endicott made purchases and sales that totaled around $7 million. In 2007, the total was close to $15 million, and in 2008 it was approximately $16 million.

The court agreed these amounts were considerable. However, they also stated, “managing a large amount of money is not conclusive as to whether a petitioner’s trading activity amounted to a trade or business.” From this case and other recent tax rulings in the US, a clearer picture of what is needed to satisfy the definition of ‘trader’ is appearing. The most essential of which are as follows: You spend a substantial amount of time trading. Ideally, this will be your full-time occupation. If you’re a part-time trader, you need to be buying and selling several assets pretty much every day. You can demonstrate a regular pattern of making a high number of trades, ideally almost every day the market is open. Your aim is to profit from short-term price fluctuations, rather than long-term gains. The US day trading tax rate looks favorably on the ‘trader’. So, meeting their obscure classification requirements is well worth it if you can. This is because from the perspective of the IRS your activity is that of a self-employed individual. This allows you to deduct all your trade-related expenses on Schedule C. This includes any home and office equipment. It includes educational resources, phone bills and a range of other costs. However, it’s important you keep receipts for any items, as the IRS may request evidence to prove they are used solely for trade purposes.

On the flip side, if you are classed as a trader, you can write-off just the amount that exceeds 2% of your adjusted gross income. Not to mention that Schedule C write-offs will adjust your gross income, increasing the chances you can fully deduct all of your personal exemptions, plus take advantage of other tax breaks that are phased out for higher adjusted gross income levels. Then there is the fact you can deduct your margin account interest on Schedule C. Throw in that you don’t have to pay self-employment tax on your net profit from trading, and you realize, it’s a pretty sweet deal. Mark-To-Market Traders. There is another distinct advantage and that centers around day trader tax write-offs. Normally, if you sell an asset at a loss, you get to write off that amount. However, if you, a spouse, or company you control buys the same stock within 30 days, the IRS deem this a ‘wash sale’ (further details below). This brings with it a considerable tax headache. Fortunately, you can jump this hurdle if you become a ‘mark-to-market’ trader. This will see you automatically exempt from the wash-sale rule. This is what you do: On the last trading day of the year, you’d pretend to sell any and all holdings. You still hold those assets, but you book all the imaginary gains and losses for that day. You’d then enter the new year with zero unrealized gains or losses.

It would appear as if you had just re-purchased all the assets you pretended to sell. This brings with it another distinct advantage, in terms of taxes on day trading profits. Usually, investors can deduct just $3,000 or $1,500 in net capital losses each year. Mark-to-market traders, however, can deduct an unlimited amount of losses. If you’ve had a poor trading year, this could save you considerable sums. If you do qualify as a mark-to-market trader you should report your gains and losses on part II of IRS form 4797. For further clarification, see IRS Revenue Procedure 99-17 in Internal Revenue Bulletin 99-7. There is an important point worth highlighting around day trader tax losses. In particular, the ‘wash-sale’ rule. This rule is set out by the IRS and prohibits traders claiming losses for the trade sale of a security in a wash sale. A wash sale takes place when you trade a security at a loss, and then within thirty days either side of the sale, you, a partner, or a spouse purchase a ‘substantially identical’ instrument.

If the IRS refuses the loss as a result of the rule, you will have to add the loss to the cost of the new security. This would then become the cost basis for the new security. For further guidance on this rule and other important US trading regulations and stipulations, see our rules page. So, how to report taxes on day trading? If you’re a trader, you will report your gains and losses on form 8949 and Schedule D. You can deduct only $3,000 in net capital losses each year. However, if you’re married and use separate filing status then it’s $1,500. Schedule C should then have just expenses and zero income, whilst your trading profits are reflected on Schedule D. To prevent any confusion, it’s a useful tax tip to include a statement detailing your situation. You can’t join the nation’s most successful traders, such as Bruce Kovner and George Soros if you fall at the tax hurdle. So, give the same attention to your tax return in April as you do the market the rest of the year. Whilst it isn’t crystal clear, below are typical scenarios to help you see where your activity may fit in. Example 1 – Let’s say you spend 8-10 hours trading a week and you average around 250 sales a year, all within a few days of your purchase. The IRS is likely to say you don’t spend enough time trading to satisfy the ‘trader’ criteria. Example 2 – Let’s say you spend around 20 hours a week trading and you average around 1,250 short-term trades in a single year. The IRS shouldn’t put up a fight if you declare your takings as a day ‘trader’ on your tax return. It’s also worth bearing in mind you can be both a ‘trader’ and ‘investor’.

However, if you were to go down this route, you’d have to separate your long-term holdings and keep detailed records to distinguish between both sets of activities. You can’t get to grips with trading tax in the USA without understanding the essential tax jargon. A few terms that will frequently crop up are as follows: This represents the amount you initially paid for a security, plus commissions. It acts as a baseline figure from where taxes on day trading profits and losses are calculated. If you close out your position above or below your cost basis, you will create either a capital gain or loss. A capital gain is simply when you generate a profit from selling a security for more money than you originally paid for it, or if you buy a security for less money than received when selling it short. Both traders and investors can pay tax on capital gains. Normally, if you hold your position for less than one year it will be considered a short-term capital gain, and you’ll be taxed at the usual rate. However, hold the position for over a year and you can benefit from a lower tax percentage rate, often around 15%, but depending on your income, could also drop to just 5%. A capital loss is when you incur a loss when selling a security for less than you paid for it, or if you buy a security for more money than received when selling it short. You’ll often find for the purposes of taxes for day trading, you can write off (deduct) capital losses, up to the number of capital gains you’ve earned this year. If you suffer more losses than gains in a year, you could write-off an additional $3,000 on top of your offsetting gains. If your losses exceed the additional $3,000, you then have the option to carry those losses forward to the next tax year where you’ll have another $3,000 deduction allowance. Asset Specific Taxes. With vast differences between instruments, many rightly question whether there are different tax stipulations you need to be aware of if you’re trading in a variety of instruments. However, on the whole, the IRS is more concerned with why and how you’re trading, than what it is you’re trading.

Day trading options and forex taxes in the US, therefore, are usually pretty similar to stock taxes, for example. Having said that, there remain some asset specific rules to take note of. Gains and losses under futures taxes follow the ’6040’ rule. The rate that you will pay on your gains will depend on your income. 60% of the gain is treated as a long-term capital gain at a rate of 0% if you fall in the 10-15% tax bracket. If you fall into the 25-35% tax bracket, it will be 15%, and it will be 20% if you fall into the 36.9% tax bracket. The 40% of the gains are considered to be short-term and will be taxed at your usual income tax rate. So, on the whole, forex trading tax implications in the US will be the same as share trading taxes, and most other instruments. Whilst futures options can come with some interesting stipulations, the primary concern for all instruments is around ‘trader’ vs ‘investor’ status. Many traders get to mid-April and suddenly realize the IRS doesn’t just want to know your profit and loss on each sale, but they also want a detailed description. If you want a straightforward day trading taxes rate, you’ll need to keep a record of the following: Instrument Price Purchase & sale date Size Entry & exit point. Having this information to hand will make taxes on trading US stocks a stress-free procedure. Day Trader Tax Software. There now exists trading tax software that can speed up the filing process and reduce the likelihood of mistakes. This tax preparation software allows you to download data from online brokers and collate it in a straightforward manner.

Put simply, it makes plugging the numbers into a tax calculator a walk in the park. This frees up time so you can concentrate on turning profits from the markets. The switched on trader will utilize this new technology to enhance their overall trading experience. Day trading and taxes are inescapably linked in the US. Taxes on income will vary depending on whether you’re classed as a ‘trader’ or ‘investor’ in the eyes of the IRS. Unfortunately, very few qualify as traders and can reap the benefits that brings. For those who are tempted to tweak their records in pursuit of the ‘trader’ classification, be warned the consequences of failing to pay the correct amount, or late payments, can result in severe ramifications. These can range from financially crippling fines and even jail time. Note this page is not attempting to offer tax advice. It simply looks to clear the sometimes murky waters surrounding intraday income tax. If you remain unsure or have any other queries about day trading with taxes, you should seek professional advice from either an accountant or the IRS. Forex Taxes - Do you have to pay? Below article on forex tax rules applies to U. S. traders only. Foreign investors that are not residents or citizens of the United States of America do not have to pay any taxes on foreign exchange profits. Please, seek advice from a trader tax expert if you have any doubts on forex taxes. Below article is written By Robert A. Green, CPA. Currency traders face complexities and nuances come tax time. Currency futures are treated like other types of futures; your accounting is a snap and you enjoy lower 6040 blended tax rates. However, cash forex can be an accounting nightmare and you face higher ordinary tax rates, unless you “elect out” of IRC 988 for 6040 treatment. When it comes to forex trading, special tax rules apply.

There are two distinct types of currency trading and each has profound differences in tax and accounting rules. First, you can trade in currency futures on regulated commodities exchanges and these futures are treated the same as other commodities and futures – as IRC section 1256 contracts. Or, you can trade “cash forex” in the interbank market (not on regulated futures exchanges) and you are subject to an entire set of special rules – as IRC section 988 contracts. Before you file your tax return, or even better yet before you start trading, find out what you are trading – is it a Section 1256 contract or a Section 988 contract. Many currency traders transact in both. Contracts on regulated commodities exchanges (“regulated futures contracts” (RFC) on currencies) and in the non-regulated "interbank" market (a collection of banks giving third party prices on foreign current contracts (FCC) and other forward contracts) – commonly known as “cash forex.” Learn below how currency traders are taxed similar to commodities traders, except that interbank currency traders must "elect out" of IRC section 988 (the ordinary gain or loss rules for special currency transactions), if they want the tax-beneficial "6040" capital gains rate treatment of IRC section 1256. Currency trading is like commodity trading in general Most currency traders seek to be treated like commodities and futures traders, in that their trading gains and losses are treated as section 1256 contracts. Both business traders and investors report section 1256 contracts as capital gains and losses on Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles). This allows them to split the gains and losses 6040 on Schedule D: 60 percent long-term, 40 percent short-term. This 6040 split gives commodities traders and investors an advantage over securities traders. 60% is taxed at the lower long term capital gains rates (up to 15%) and 40% is taxed at the higher short-term capital gains rates (or “ordinary rate” up to 35%). The current maximum blended 6040 rate is 23%, which is 12% less then the maximum rate of 35% on short term securities (or cash forex trading if you don’t elect out of IRC 988, see below). Certainly, a 12% tax rate reduction is worthwhile to pursue for all currency traders. Cash forex is subject to IRC § 988 (treatment of certain foreign currency transactions) The principal intention of IRC § 988 is taxation on foreign currency transactions in a taxpayer's normal course of transacting global business. For example, if a manufacturer purchases materials in a foreign country in a foreign currency, then the fluctuation in exchange rates gain or loss should be accounting for pursuant to IRC § 988. IRC § 988 provides that these fluctuations in exchange rate gains and losses should be treated as ordinary income or loss and reported as interest income or interest expense.

IRC § 988 considers exchange rate risk in the normal course of business to be like interest. IRC § 988 does not affect currency futures (RFCs) Currency traders who trade currency futures (regulated futures contracts – RFCs) are not affected by IRC § 988, because they are not trading in actual currencies. RFCs based on currencies are just like any other RFC on an organized exchange. Additionally, since RFCs are marked-to-market at the close of each day (and year), in accordance with IRC section 1256, the economic and taxable gain or loss are the same. IRC 988 specifically mentions that RFCs and other mark-to-market instruments are exempt transactions. IRC § 988 does affect Foreign Currency Contracts. When a currency trader uses the interbank market to transact in Foreign Currency Contracts and Other Forward Contracts, they are exposed to foreign exchange rate fluctuations, similar to a manufacturer stated above. However, the currency trader looks upon their currency positions as "capital assets" in the normal course of their trading activity (business or investment). What this means is that a currency trader may elect out of ordinary gain or loss treatment in IRC section 988, thereby falling back to the default section 1256 contract treatment; which is 6040 capital gains and losses. Most currency traders will want to make this election for the tax-beneficial treatment of section 1256 (lower tax rates on gains). Foreign exchange traded currency futures. Many traders ask this question, ‘are currency futures trades done on foreign exchanges also taxed at 6040 for U. S. citizens, or does 6040 only apply to futures listed on US exchanges.’ There is a reasonable basis in fact and law to conclude that futures traded on certain foreign contract markets with either a CFTC Rule 30.10 exemption or No Action Letter are entitled to classification as Section 1256 contracts (e. g., commodities) with the result that “6040” tax treatment is appropriate. For more details see greencompany.

comEducationCenterGTTRecCommodities. shtml#foreignfutures. To “elect out” of IRC 988 or not, that’s the question. If you have cash forex trading gains, you will prefer to elect out of IRC 988, to benefit from up to 12% lower tax rates on Section 1256 contracts. Conversely, if you have cash forex trading losses, you may prefer ordinary loss treatment over Section 1256 capital loss treatment, so you may not want to elect out of IRC 988. Note that IRC 1256 losses may be carried back up to three tax years, but only against IRC 1256 gains in the prior three tax years. Ordinary losses may offset any type of income. But, technically, it’s not a simple choice like this at the end of the year. The rules require that you elect out of IRC 988 on a “contemporaneous basis.” This means that hindsight is not allowed and you must make your decision in advance of the trades’; before you know if you will have gains or losses. Can you bend the rules?

The election out of IRC 988 should be filed “internally”, which means you place it in your own books and records, as opposed to filing it with the IRS. Many traders do bend the rules and after year-end if they have cash forex gains, they claim they elected out of IRC 988, to use the beneficial IRC 1256 treatment. In fact, our firm has noticed hundreds of traders who don’t even know the rules and simply report their cash forex gains on Form 6781. Others report them on Form 1040 line 21 as ordinary income and just pay higher taxes, without knowing the difference. We expect the IRS to catch up with all cash forex traders soon, after the explosion of cash forex in the online trading market. Don’t bend the rules and get into trouble, learn about the rules up front and follow them for success. Currencies futures versus cash forex – what’s the accounting difference? Currency futures traders have it easy, on two accounts. Not only do you get the lower-tax 6040 treatment on trading gains, but you also have it much easier come tax time. Your brokerage firm sends you (and the IRS) a simple Form 1099 soon after year-end, reporting one number for your Section 1256 trading gain or loss for the tax year. Line 9 on that Form 1099 is “aggregate profit or loss.” The “mark-to-market accounting” rules in Section 1256 make accounting a snap. Your brokerage firm simply adjusts your realized gains and losses with beginning and end of year unrealized gains and losses for a combined realized and unrealized gain or loss amount. On your tax return, report “aggregate profit or loss” on Form 6781 (the 6040 form).

Those 6040 amounts are then transferred to Schedule D (capital gains and losses) – unless you carry back a Form 6781 loss to prior years. Wow, if only all traders had it so easy on accounting! Section 1256 futures traders don’t need any accounting solutions or programs; unless they want to check their brokerage firms, which may be a prudent idea. Securities and cash forex traders face accounting challenges come tax time. Form 1099s report proceeds on securities transactions and some have “supplemental information” for total sales and purchases of securities options, mutual fund transactions and purchases of securities. Form 1099s do not report cash forex transactions or single stock futures. So these types of traders are on their own. Some brokerage firms offer online reporting, but many have unmatched trades and some say you can not rely on these reports for your tax returns. So if you trade in anything other then Section 1256 contracts, you will probably need your own accounting solutions or software programs. Most good accounting programs are geared towards securities traders. For examples, this writer’s company offers GTT TradeLog, a leading program for active traders to download all transactions and calculate trading gains and losses, with wash sales or IRC 475 mark-to-market adjustments. Here is a good accounting solution for cash forex.

Money managers report cash forex trading gains and losses using a “Performance Record Approach.” These results are sufficient for tax authorities and reporting rates of return to investors. Use the same formula in a worksheet for your tax return. Here’s the formula to use on a worksheet template. Ending net assets (at market value) less beginning net assets (at market value), less additions of cash, plus withdrawals of cash, equals net performance. Then subtract non-trading items like interest income, add interest expense and other expenses and you have net trading gains or losses on cash forex. If you don’t elect out of IRC 988, then you report your ordinary gain or loss from cash forex as “other income” on Form 1040 (line 21). If you elect out of IRC 988, add this amount to Form 6781 as “cash forex elected out of IRC 988.” Your monthly statements may get you lost in the woods. If you try to figure out your cash forex gains and losses from your monthly brokerage statements you may get very confused and lost. We have clients that have different statements for each type of currency (e. g. US dollars, Japanese Yen, Swiss Francs, and Euros) and it can become a nightmare scenario to try and figure it all out. The performance record approach is a salvation and it’s accepted by the IRS. My broker reported my cash forex along with my IRC 1256 contracts, is that ok? A few brokers lump in cash forex in with IRC Section 1256 contracts on 1099 line 9 “aggregate profit or loss.” This is technically incorrect by law, but it may save you taxes and an accounting headache.

Technically, cash forex are IRC 988 transactions and should be segregated from IRC 1256 contracts. Perhaps, these brokers can argue that when you opened your cash forex account, you “contemporaneously” elected out of IRC 988 for IRC 1256 treatment, and that you qualify for such as a trader rather then a manufacturer type business. You should consult with a trader tax expert if this case applies to you. Also consider what happens if you have a large cash forex loss and you prefer ordinary loss treatment instead of Section 1256 treatment – so you don’t get stuck with the capital loss limitation of $3,000? You face difficulty in overriding a broker’s 1099 treatment for 1256 contracts. Consult with a trader tax expert who may be able to help. Cash forex is the “wild west” of trading and IRS reporting. Cash forex is not regulated by the CFTC and it has been called the ‘wild west’ of trading. Cash forex is also the wild west when it comes to taxes and reporting trading gains and losses. There should be no 1099 reporting for cash forex, so you are your own sheriff when it comes to ‘rounding up’ the gain and loss numbers and paying your taxes (with the nuances of IRC 988). A person visited our booth at the Online Trading Expo in NYC and ask if cash forex was taxable at all? She heard that many cash forex traders claimed they don’t pay any taxes on their gains. We told her the IRS sheriff will catch up with them soon and throw the book at them for tax avoidance. Remember, Form 1099 rules are minimum reporting guidelines set forth by the IRS. New products are being created all the time and it takes years for the IRS to set the guidelines for how each product is reported on Form 1099s, if at all. Brokerage firms tussle with the IRS each year on what they must report; as it causes great stress and cost on their accounting systems. Many new and smaller cash forex brokerage firms have ramped up quickly to tap into the explosion of interest in cash forex – especially after the securities markets went into a bear spin a few years ago. Many of these firms are not strong on reporting, systems or tax compliance, so you may be on your own when tax time comes.

Before you open a cash forex account, ask your brokerage firm what kind of reporting and support they offer you. Bottom line. Currency trading is a hot commodity in the market place, but not all currency contracts are taxed like commodities. Cash forex is subject to IRC section 988 rules and if you’re a trader, you can elect out of IRC 988, to be taxed like commodities – with beneficial 6040 treatment. Before you start trading cash forex, find out if you brokerage firm will help you with trade accounting. If not, you may have a huge accounting headache on your hands come tax time. When it comes to currency trading, it’s wise to learn all the tax rules and consult with a trader tax expert. Forex Trading and Taxes. Seeing profits from forex trading is an exciting feeling both for you and your portfolio. But then, it hits you. What about taxes? The forex tax code can be confusing at first. This is because some forex transactions are categorized under Section 1256 contracts while others are treated under the Section 988 – the Treatment of Certain Currency Transactions. Section 1256 provides a 6040 tax treatment which is lower compared to its counterpart. By default, all forex contracts are subject to the ordinary gain or loss treatment. Traders need to “opt-out” of Section 988 and into capital gain or loss treatment, which is under Section 1256. There is no use in trying to wiggle out of your taxes.

Every trader in the United States is required to pay for their forex capital grains. More Information about Section 1256. Section 1256 is defined by the IRS as any regulated futures contract, foreign currency contract or non-equity option, including debt options, commodity futures options and broad-based stock index options. This section allows you to report capital gains using Form 6781 from the IRS (Gains and Losses from Section 1256 Contracts and Straddles). Take note that you have to separate the capital gains on Schedule D in a 6040 split. It is divided as such: 60% of the total capital gains are taxed at 15% which is the lower rate 40% of the total capital gains can be taxed to as high as 35%. This is the ordinary capital gains tax. More Information about Section 988. In this Section 988, the gains and losses from forex are considered as interest revenue or expense. Because of this, capital gains are also taxed as such. The 6040 split is not used and traders can expect to pay more if they fall under this section. The Section 988 is also complicated because forex traders have to deal with currency value changes on an everyday basis. However, the IRS also made some provisions that will allow daily rate changes to be considered part of the trader’s assets or a part of the business. As a result, you can opt-out of Section 988 and then tax your capital gains using Section 1256. How to Opt Out of Section 988. The IRS does not really require a trader to file anything in order to opt out. But it is important to keep an “internal” record that shows that you have decided to opt out of Section 988. Many forex traders wait for about a year before opting out of this section. Why? They are just observing how much profit they can make from forex trading. Form 8886 and Trading Losses.

If you suffered large losses you may be able file Form 8886 (see below for form). If your transactions resulted in losses of at least $2 million in any single tax year ($50,000 if from certain foreign currency transactions) or $4 million in any combination of tax years you may be able file form 8886. Paying for the Forex Taxes. Filing the tax itself isn’t hard. A US-based forex trader just needs to get a 1099 form from his broker at the end of each year. If the broker is located in another country, the forex trader should acquire the forms and any related documentations from his accounts. Getting professional tax advice is recommended as well. As you can see, there is nothing difficult about paying for forex profits at this point. However, as this trading becomes more popular, the IRS is bound to come up with more measures that will regulate the trade. But if there’s one piece of advice you should take from this, it’s to always pay your taxes. Trader Tax Forums, and Websites* Green Company: Details on currency trading taxes Traders Accounting: They have written a lot of educational resources about trading and taxes Google Answers: Question is a few years old, can still has a lot of information Intuit Community Forum: Post questions and get answers from the people of Intuit. *Online Forex Trading does not promote any of these forums or websites. They are shown purely for educational purposes In other words, please research these sites and use common sense if they ask you for money. How Currency Traders Can Reduce Their Taxes.

The foreign exchange market, or forex, as it is more commonly called, is the biggest market in the world with over $4 trillion changing hands every single day. To put that into perspective, it is 12 times greater than the average daily turnover on the global equity markets and more than 50 times greater than the average daily turnover on the NYSE. Trading in foreign currencies has been around for thousands of years. In fact, some of the first known currency traders were the Middle Eastern moneychangers who exchanged coins to facilitate trade. Given a market this size, it is no surprise that the taxation of forex remains a complexity to most traders and tax professionals. The Tax Reform Act of 1986 instituted the provisions covering Section 988 transactions. Section 988 transactions, the default method of taxation for currency traders, treats the gains or losses from forex transactions as ordinary gains or ordinary losses. If you have forex gains, they are taxed as ordinary income, subject to which ever tax bracket you fall under. Let's look at an example: Joe Trader is married and makes $100,000 salary a year. He has a good year trading FOREX, making $50,000 for the year. Joe falls in the 25% tax bracket, making his tax due on his FOREX gain $12,500 ($50,000 X 25%). BUT WHAT ABOUT FOREX LOSSES? If you lose money trading FOREX, your losses are treated as ordinary losses, and can be used to offset any other income on your tax return.

Let's use Joe as an example again: Instead of making $50,000, Joe loses $50,000 trading forex. The $50,000 loss can be taken against his W-2 income, making his taxable income $50,000 ($100,000 - $50,000). If his forex loss were a capital loss instead of an ordinary loss, Joe would only be able to take $3,000 off of his taxes, making his taxable income $97,000. The remaining $47,000 loss would have to be carried forward and used up in future years. So what type of FOREX trader benefits from Section 988 tax treatment? In my opinion, if a trader is not consistently profitable and has other earned income on their tax return, they should stay under the Section 988 taxation to be able to fully utilize any losses that come from FOREX trading. If you are not consistently profitable in your FOREX trading AND you have no other earned income, you should consider doing what profitable FOREX traders should do: opt out of Section 988 tax treatment. I'll explain why at the end of the article. IRC section 988(a) (1) (B) provides FOREX traders with a way to opt out of the ordinary gainloss tax treatment: "Except as provided in regulations, a taxpayer may elect to treat any foreign currency gain or loss. as a capital gain or loss (as the case may be) if the taxpayer makes such election and identifies such transaction before the close of the day on which such transaction is entered into". This exception gives forex traders the option to opt out of ordinary gainloss treatment; making your forex trades taxed the same as section 1256 contracts. Section 1256 contracts are taxed at a more beneficial rate of 6040, 60% taxed at long term capital gains rates and 40% taxed at short term capital gains rates. The maximum tax rate on ordinary income currently is 39.6%. The maximum tax rate on Section 1256 contracts by comparison is 28%, almost a 30% reduction in taxation on the gains! Using our example above, if Joe had opted out of the Section 988 tax treatment, his tax rate on his $50,000 FOREX gain at a 6040 rate would drop 24% (19% vs. 25%), saving him $3,000 in taxes that year! Here is a comparison of ordinary tax rates vs. the 6040 tax rate using 2013 tax brackets: The IRS requires a trader to make the election to opt out of Section 988 tax treatment internally, meaning you make the opt out election in your own corporate books or records. You do not have to notify the IRS in advance, as you do if you were making the mark to market election. I'd personally suggest having your opt out election notarized, which would help solidify your claim of a timely election if you got audited.

Opting out of Section 988 tax treatment for forex traders is a no-brainer decision for profitable traders due to the tax savings. However, it also makes sense for traders who are not consistently profitable yet but also don't have any earned income on their tax returns. If a trader has an ordinary loss and no earned income to offset it against, the ordinary loss ends up being wasted as it cannot be carried forward to future tax years. If you opt out and elect Section 1256 tax treatment, the loss can be carried forward and used against future capital gains. If you are still uncertain as to whether to opt out or not, please seek out the advice of a knowledgeable trader tax specialists to assist you with this decision. Forex Taxation Basics. For beginner forex traders, the goal is simply to make successful trades. In a market where profits – and losses – can be realized in the blink of an eye, many investors just want to "try their hand" before thinking long-term. While forex can be a confusing field to master, filing taxes in the U. S. for your profitloss ratio can be reminiscent of the Wild West.

Here is a breakdown of what you should know – even before your first trade. For Options and Futures Investors. Forex options andor futures are grouped in what are known as IRC Section 1256 contracts. These IRS-sanctioned contracts mean traders get a lower 6040 tax consideration. This means that 60% of gains or losses are counted as long-term capital gainslosses and the remaining 40% as short term. The two main benefits of this tax treatment are: Time Many forex futuresoptions traders make several transactions per day. Of these trades, up to 60% can be counted as long-term capital gainslosses. Tax Rate When trading stocks held less than one year, investors are taxed at the same rate as their ordinary income. When trading futures or options, investors are taxed at a 23% rate (calculated as 60% long-term x 15% max rate + 40% short-term rate x max income tax rate). For Over-the-Counter (OTC) Investors. Most spot traders are taxed according to IRC Section 988 contracts. These contracts are for foreign exchange transactions settled within two days, making them open to ordinary losses and gains as reported to the IRS. If you trade spot forex you will likely automatically be grouped in this category.

The main benefit of this tax treatment is loss protection. If you experience net losses through your year-end trading, being categorized as a "988 trader" serves as a large benefit. As in the 1,256 contract, you can count all of your losses as "ordinary losses" instead of just the first $3,000. Which Contract to Choose. Now comes the tricky part: deciding how to file taxes for your situation. What makes foreign-exchange filing confusing is that while optionsfutures and OTC are grouped separately, you as the investor can pick either a 1256 or 988 contract. You have to decide before January 1 of the trading year. IRC 988 contracts are simpler than IRC 1256 contracts in that the tax rate remains constant for both gains and losses – an ideal situation for losses. Notably, 1256 contracts, while more complex, offer more savings for a trader with net gains – 12% more. The most significant difference between the two is that of anticipated gains and losses. At most accounting firms you will be subject to 988 contracts if you are a spot trader and 1256 contracts if you are a futures trader. The key factor is talking with your accountant before investing. Once you begin trading you cannot switch from 988 to 1256 or vice versa.

Most traders will anticipate net gains (why else trade?) so they will want to elect out of their 988 status and in to 1256 status. To opt out of a 988 status you need to make an internal note in your books as well as file with your accountant. This complication intensifies if you trade stocks as well as currencies. Equity transactions are taxed differently and you may not be able to elect 988 or 1256 contracts, depending on your status. Keeping Track: Your Performance Record. Rather than rely on your brokerage statements, a more accurate and tax-friendly way of keeping track of profitloss is through your performance record. This is an IRS-approved formula for record keeping: Subtract your beginning assets from your end assets (net) Subtract cashdeposits (to your accounts) and add withdrawals (from your accounts) Subtract income from interest and add interest paid Add other trading expenses. The performance record formula will give you a more accurate depiction of your profitloss ratio and will make year-end filing easier for you and your accountant. When it comes to forex taxation there are a few things you will want to keep in mind, including: Deadlines for filing : In most cases, you are required to elect a type of tax situation by January 1. If you are a new trader, you can make this decision before your first trade – whether this is in January 1 or December 31. It is also worth noting that you can change your status mid-year, but only with IRS approval.

Detailed record keeping : Keeping good records (and backups) can save you time when tax season approaches. This will give you more time to trade and less time to prepare taxes. Importance of paying : Some traders try to "beat the system" and earn a full or part-time income trading forex without paying taxes. Since over-the-counter trading is not registered with the Commodities Futures Trading Commission (CFTC) some traders think they can get away with it. Not only is this unethical, but the IRS will catch up eventually and tax avoidancefees will trump any taxes you owed. Trading forex is all about capitalizing on opportunities and increasing profit margins, so a wise trader will do the same when it comes to taxes. Whether you are planning on making forex a career path or are interested in simply seeing how your strategy pans out, taking the time to file correctly can save you hundreds if not thousands in taxes, making it a transaction that's well worth the time. Explore Tax Treatment On Financial Products. Get the best of both worlds with forex taxes: Ordinary losses in Section 988 or elect capital gains for a chance to use lower 6040 rates in Section 1256(g) “Forex” refers to the foreign exchange market where participants trade currencies, including spot, forwards or over-the-counter option contracts. In the forex industry and IRS content, it’s called the “Interbank” market. Forex differs from trading currency RFCs (regulated futures contracts) on futures exchanges. Like other RFCs, currency RFCs are Section 1256 contracts reported on Form 6781 with lower 6040 capital gains tax treatment.

By default, forex transactions start off receiving an ordinary gain or loss treatment, as dictated by Section 988 (foreign currency transactions). The good news is Section 988 ordinary losses offset ordinary income in full and are not subject to the dreaded $3,000 capital loss limitation — that’s a welcome relief for many new forex traders who have initial losses. Section 988 allows investors and business traders — but not manufacturers — to internally file a contemporaneous “capital gains election” to opt-out of Section 988 into a capital gain or loss treatment. One reason to do so is if you need capital gains to use up capital loss carryovers, which otherwise may go wasted for years. The capital gains election on forex forwards allows the trader to use Section 1256(g) treatment with lower 6040 capital gains rates on major currencies if the trader doesn’t take or make delivery of the underlying currency. “Major currencies” means currencies for which currency RFCs trade on U. S. futures exchanges. There are lists of currency contracts including pairs that trade on U. S. futures exchanges available on the Internet. Section 1256(g) does not mention the inclusion of spot forex, so we make a case for including spot forex in Section 1256(g) in our blog post, A Case For Retail Forex Traders Using Section 1256(g) Lower 6040 Tax Rates. The “Tax Cut & Jobs Act” (Act) The Act created a new 20% deduction on qualified business income (QBI) in pass-through entities. A forex trading company with trader tax status (TTS) is eligible for the QBI deduction as Section 988 ordinary income is includible in QBI for TTS traders.

QBI excludes capital gains or investment-related Section 988 ordinary income. Trading is a specified service activity, so the 20% deduction is phased out above the taxable income threshold of $415,000 (married) and $207,500 (other taxpayers). A forex TTS trading company should weigh the opportunity for this deduction vs. the capital gains election and use of Section 1256(g) lower 6040 tax rates. Consult with us about it. Forex accounting and tax reporting. Summary reporting is used for forex trades, and most brokers offer good online tax reports. Spot forex brokers aren’t supposed to issue Form 1099Bs at tax time. Section 988 is realized gain or loss, whereas, with a capital gains election into Section 1256(g), mark-to-market (MTM) treatment should be used. Section 988 transactions for investors are reported in summary form from gross income. Watch out for negative taxable income caused by forex losses without TTS; some of those losses may be wasted. (If you qualify for TTS, the negative income will likely generate a NOL.) There are several nuances and complexities in forex tax treatment, accounting and tax compliance that you should know about. For example, forex brokers handle rollover interest and trades differently. Most online trading platforms and brokers only offer forex spot contracts. These contracts clear within two days, whereas forex forward contracts clear in over two days.

If a trader wants to stay in a spot trade longer than two days, the broker offers a “rollover trade” which technically is a realized sale and purchase of a new position (but not all brokers treat it that way). Forex spot traders don’t take delivery of the foreign exchange. The Section 988 opt-out election. The election to opt out of Section 988 must be filed internally (meaning you don’t have to file an election statement with the IRS) on a contemporaneous basis (meaning the IRS does not allow hindsight). Section 988 talks about the election on every trade, but you can also make a “good to cancel” election which is more practical. The election can be made and withdrawn throughout the year. For extensive content on forex tax treatment, accounting and reporting, read Green’s 2018 Trader Tax Guide. Explore Tax Treatment On Financial Products.


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