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It is no wonder that the taxation of foreign currency trading is so confusing. After all, understanding the fundamentals of the currency markets are confusing alone without the right trading education. Add a little dash of “modern day” taxman bureaucracy and voila, you have two very different tax code sections. Knowing the specifics about what you trade will better help you determine how your Forex trades are taxed.

Spot Forex Tax

Spot Forex is where one trades the actual currency for immediate delivery and the transaction is settled "on the spot". This type of trading, by default, falls under IRC Section 988 and is not subject to short-term or long-term capital gains tax, but instead is reported as “other income” and is subject to your ordinary income tax rate. Since IRC Section 988 gain or loss is taxed as ordinary income, you are able to overcome the $3,000 dollar a year capital loss limitation.

Any person, regardless of trader status, has the option to opt out of Section 988 tax treatment and into IRC Section 1256 tax treatment. This election must be documented on a proactive basis and may not be a universal election made at the end of the year. Opting out of Section 988 could be a good decision in the event that you are in a profit position. If you generate a loss, you will still be bound by the $3,000 a year capital loss limitation.

Futures on Forex Tax

Those who buy Forex futures contracts are subject to IRC Section 1256 tax treatment. These transactions receive a split tax treatment of 60/40, where 60 percent of the gains are taxed as long-term gains and 40 percent of the gains are taxed as short-term gains, regardless of the holding period. This is reported on Schedule D and is subject to the $3,000 a year loss limitation. The benefit of IRC Section 1256 contracts is the long-term capital gains tax treatment on 60% of your profit. Currently, this tax rate for individuals is anywhere from 0% to 15% tax.

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With a large government deficit, stay clear of the IRS cross hairs this tax season. Now more than ever it’s extremely important to get proper tax advice; although, most CPAs won’t admit they are not always equipped to help traders or investors. Our tax professionals have studied the IRS code and trader tax court rulings for years and are determined to slash your tax bill!

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