T2W Trading Community

Our lovable Beethoven-size tax break benefits commodities and forex traders in three ways:

1. The split: Instead of having all of your trading gains subject to the short-term capital gains tax rate of up to 35%, Section 1256 contracts allow 60% of your gain to be taxed at the lower long-term rate of 15%. This results in a combined tax rate of 23%, a 12% savings over the short-term capital gains rate.
2. The carry-back: Section 1256 losses can be carried back three years, rather than merely forward to the following year, as long as you obey the rules. For instance, you can only carry your loss back to years in which you had 1256 gains, and only 1256 gains can offset them. The loss is first carried back to the most recent qualifying year; after that, any remaining loss may be absorbed by the next two most recent years. As a result, you can amend previous years’ returns to include this year’s loss and possibly even receive a refund.
3. The tax preparation: Section 1256 affords forex futures traders a significant accounting advantage over forex currency traders, beginning with the Form 1099s you receive from your broker at year’s end (currency traders don’t get 1099s). On your 1099s, you just plug the aggregate profits or losses found on Line 9 into Part 1, Line 2 of IRS Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles) and the form does the 60/40 split for you: the 60% total to be taxed at the lower long-term rate winds up on Line 9, the 40% total to be taxed at the higher short-term rate can be found on Line 8. The two totals will eventually end up on Schedule D (Capital Gains and Losses): the 60% total on Part 2, Line 11, the 40% portion on Part 1, Line 4.

Currency Traders Can Cash In, Too
It’s little wonder that currency traders choose to opt out of their default Section 988, which taxes their gains or losses as interest income or expenses at the current tax rate of 35%. The catch is, they must opt out on a “contemporaneous basis,” meaning before making the trades, by noting their intention “internally” in their records.

Because there is no requirement to notify the IRS of your decision, some traders bend the rules and make their choice a more opportune time, such as the end of the year. However, should the IRS decide to crack down on abusers who “cherry-pick” their tax bracket, a shady track record could prove costly down the road.

Unfortunately, forex traders sometimes slip into bad tax habits. Some lump their currency activity in with their 1256 commodity trading at tax time, while others fail to opt out of their default Section 988 status and end up paying the highest tax rate on their trades. A Traders Accounting tax professional can help you set the optimum course for tax savings.

Our lovable tax break may be trader’s best friend, but in some instances it may be advantageous for currency traders to avoid the cuddly beast. As a general rule, if you have currency losses, you will typically improve your tax position by not opting out and instead remaining in Section 988. In this scenario, your ordinary losses could then be offset by any form of income rather than only Section 1256 income, and would not be subject to the $3,000 capital loss limitation and restricted to 1256 offsets.

Nothing about forex taxation is ever as simple as it may appear; each trader’s individual circumstances dictate a unique set of options to choose and courses to follow to arrive at their optimal tax position.

Trader’s Accounting’s tax professionals know the intricacies of the unique tax landscape that comes with your trader tax status. It’s not a place you want to navigate alone. Give us a call today at 800-938-9513 and let us help you discover the hidden tax savings you’ve been missing.