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During my past crusade to become a proficient and profitable futures trader, I learned the distressing reality that the term “derivative” meant less to my so-called tax professional than it did to my six-month-old daughter. Unfortunately, I was not able to focus solely on becoming a profitable futures trader. At tax time, I was left to the arduous task of researching the difference in taxation of each futures contract. I was amazed to find that the tax treatment was based on three variables; the underlying asset, if it was exchange regulated, and if I met the classification of a dealer.

With the high profit potential of trading futures and the access to better trading education, the popularity of futures has increased dramatically over the years. Yet still today, some of the larger trader tax firms attempt to erroneously categorize all futures transactions as equals in the eyes of the IRS, or they simply do not have a clear understanding of the variables and terminology. After all, a futures contract is nothing more than a contract to buy an asset at a future date at a price agreed on today… Right?

Securities Futures Contracts (SFC)

Securities futures contracts or the industry term “Single Stock Futures” is a contract of sale for future delivery of a single security or of a narrow-based security index. The tax ramifications from these transactions are generally the same as short-term capital gain, regardless of how long you hold the contract. The gain or loss is reported on Schedule D or IRS Form 4797 in the event you made the Mark-to-Market accounting election.

There is one exception. If you meet the definition of a dealer in securities futures contracts or trade options on those contracts in the regular course of the dealer’s activity and the contract or options are regulated futures contract (traded on a qualified board of exchange), then the activity falls under Section 1256 and is subject to the Mark-to-Market method of accounting.

Commodity Futures Contract (CFC)

Commodity futures are contracts sold today for future delivery of a physical substance, such as food, grains, and metals. If they are regulated futures contracts (traded on a qualified board of exchange or as determined by IRS) they fall under IRC Section 1256 contracts and are subject to the Mark-to-Market method of accounting.

E-mini contracts on the Nasdaq 100, S&P 500, S&P MidCap 400 and Russell 2000 are also subject to Section 1256 contract tax treatment and subject to the Mark-to-Market method of accounting.

Why should I care? I just want to trade futures and make money!

The difference in what classification you fall in could have profound effects on your bottom line and tax bill. If the activity is short-term capital gains, it is normally taxed at your personal income tax rate. If the activity falls under IRC Section 1256 contracts, 60% of your capital gains are treated as long term and the remaining 40% of gains are treated as short term.

Let me give an example using 2009 tax rules (without considering personal exemptions and standard deductions):

Dustin, the “commodities futures” trader, is married filing jointly. He makes $67,000.00 trading gold futures on the CME. This activity falls under section 1256 contracts. His tax liability would be $3,602.50

If Dustin made the same $67,000.00 in profit trading single stock futures or futures on indexes, the entire amount is short-term capital gains and taxed at his personal income tax rate. His tax liability would be $12,937.50

The difference between short-term capital gains and section 1256 contracts is $9335.00 in tax savings!

Still confused or just don’t care because you want to focus on trading?

No other accounting or trader tax firm in the country can match the expertise of our CPAs!

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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