Question on FOREX profits and US TAx treatment

RMSTrader

Private
Messages
25
Hello. I am new to trading FOREX...have been successfully DEMO trading for 3 months now and I'm planning on 'going live' within the next 6 weeks.

One of the ongoing questions I've been researching is how to declare Forex profits on my US tax return.

It seems that there are 2 IRS rules under which FX profits can fall: Section 1256 and Section 988.

It is my understanding that 1256 allows you to declare 60% of your profits as long term capital gains (taxed at a max of 15%) and 40% of your profits as short term capital gains (taxed at a max of 35%)....leaving us with a combined tax rate of 23%. The so-called 60/40 benefit.

It is my further understanding that, even if you are a day-trader like myself (close all positions at end of each day), you can STILL use the section 1256 60/40 benefit as long as you 'opt out' of using section 988..which is more generous for losses, but taxes ALL profits as short term capital gains at the draconian rate of 35%.

To all you Jedi master traders out there....Does this sound like I'm piecing this together sensibly? How do YOU guys (US based traders) claim your profits?

Thanks in advance for your thoughtful responses!

Ric
 

Agent86

Sergeant
Messages
194
Forex Futures or Cash Forex ?

Hi

I wanted to know what people thought of this also:

I googled various topics and read this article also:
Tax Strategies for Forex Traders - Traders Log

How does one know if they are trading futures or cash forex ?

It would appear this section creates confusion for me as I prepare for my first year of live trading:
If you trade exclusively in forex futures, it’s smooth sailing come tax time; your trades fall under Section 1256 and automatically receive the 60/40 split.

But things get a little more complicated tax-wise if you dabble in cash forex, which is subject to Section 988 (Treatment of Certain Foreign Currency Transactions).
I'm not sure if this unbrella statement is true or not, or how to interpret this article or specific text.
Does this mean trading style or the company your trading with which determines if your either future or cash ?
I'll have to ask my broker maybe they can tell me.

Please advise

P.S
I'm US trader
 

cowmadagan

Sergeant
Messages
393
My advice is to make the profits first, worry about it later.

Spend your reading time learning. I can also say that I also went live after three months of demo. I wish I did 6 months.

I guess the best question is who else just gets an accountant to do it? (I'm not a US trader)
 

Agent86

Sergeant
Messages
194
lol thanks

hey thanks

but I'm already making profit, i've been trading demo for 3 years.

I'm planning / anticipating profits but it's true the accountant could tell me

The broker just indicated that it's up to the trader how to file it.
The broker or company your trading with does not determine this.

I was confused by the terms used such as forex futures vs forex cash.
Apparently this is not a forex term but only IRS specific.

So at least I've sorted that out a bit.

Thanks, I'll check with the accountant.

However, the other problem with this is that your suppose to declare it internally in the beginning of the year and not at the end.

It sounds like to me if your expecting gain then the favorable fileing would be Section 1256.

As suggested by another article here:
Forex Taxes - Do I have to Pay?

I'll have to let my accountant look at these to be sure but thats where it sounds like I'm headed to take advantage of lower capital gains on profits.


Well I may have answered my own question, but I do appreciate the response a lot.

Thanks
Happy trading
 

Forexwatchman

Sergeant
Messages
198
The short answer is this: Get an accountant. You'll need a professional to do all the filing and coach you on record keeping and filing practices because if you mess up on your own, it could be a huge catastrophe, but if the accountant messes up, it's on him.

Basically, make sure if you are making a profit to keep quarterly estimated tax payments to avoid owing money at the end of the year. Keep accurate records of your trading activity and your gains/losses generated. There are two methods to reporting gain/loss from buying and selling the actual currencies themselves. The first method is the default rule as defined by section 988 of the Internal Revenue Code. This code section states that the trading of the currencies themselves is taxed as ordinary income which is similar to interest income. It's not the best tax break in most circumstances. The second method of reporting gains/losses is treating the gains/losses as 1256 contracts. This method is only available to those who properly opt out of the regular section 988 treatment as defined by the code. Also, for those traders who elect to opt out of section 988 treatment they will need to keep the proper election records as defined by the code. The number one issue is to not report the gain/loss on the wrong part of the income tax return. There is a significant difference between reporting the gain/loss as other ordinary income and as 1256 contracts. If you have not properly elected to opt out of section 988, files on Form 6781 as 1256 contracts and you are later audited you could possibly face significant interest and penalties for additional tax due. Likewise if the trader has properly elected to opt out of section 988 and files as other ordinary income they could be losing a significant tax benefit. So just hire an account, let them worry about this mess!
 

Agent86

Sergeant
Messages
194
Thanks

Thanks,

So then I guess I would just print my forex account statement, and get a 1099 from the forex company and give that mess to the accountant should be all I need to do ?
Thats what I was sort of hoping, but knowing the actual % of tax would give an idea of how much to set aside for tax which is what I was trying to determine on my own prior to tax time.

Thanks for the response, and the accountant should be able to tell me based on the amount of estimated profits etc.
 

RMSTrader

Private
Messages
25
Thanks for the responses....so the consensus is 'get an accountant'. :)

I agree but I still like to know what they are doing...being the DIY kinda guy that I am.
 

Agent86

Sergeant
Messages
194
Taxes Yuck

Thanks for the responses....so the consensus is 'get an accountant'. :)

I agree but I still like to know what they are doing...being the DIY kinda guy that I am.
I agree, how does anyone know if their being ripped off or not if all they do is to lets say get an accountant.

In otherwords lets say I don't know how to count so I get an accountant who says.- Oh sure I'll count it for you and let you know how much you have.
lol

See what I mean. And ultimately it's still the responsibility of the filer not the accountant when it comes down to it.

If you didn't pay enough or filed it wrong it shows due diligence to have an accountant, however it's still a subject of ignorance of the law being no excuse in violating the law in which case it will not end up being the accountants responsibility it will still be mine.

I was just trying to get an understanding of which method I should file and which would apply. So that I could understand if it was even a real decision or not as far as legality goes. If I simply have to file one way only then I want to learn and know about it in case some accountant attempt to do otherwise causing me to be non compliant.

By the way accountants can also be very wrong too.

But like you I am also DIY and want to know for my own confidence and not just take the word of an accountant.

I guess I'll have to dig into some IRS codes and read these sections.

Happy trading.
 

cowmadagan

Sergeant
Messages
393
Well, accountants have a vested interest in spending more time on your account, and keeping your business. Also, they are on the hook if they screw up.
There's nothing stopping you from 'getting a second opinion' like from a doctor.

Also, I'd be concerned about lulling yourself into a false sense of security that you 'know the tax regulations' when you aren't notified of each pedantic nuance in the anti-biz (like anti-Christ) called governance.

...ok...maybe it sounds like I feel that government jobs depend on commerce.
 

Tyce Shelburn

Recruit
Messages
5
Simple answer: FOREX profits are treated as "regular" income. Meaning that if you're a part-time trader or full-time trader, your profits are added to your total gross income and ultimately affect your tax bracket (after deductions).

Complex answer: If your a Part-time trader vice a Full-time trader, your deductions are greater as a Full-time trader.

Example 1- Fulltime traders can deduct the utilities and physical office space in their home. Part time traders can't.

Example 2 - Both FT and PT traders can deduct office supplies, computer, Internet Service Provider charges, subscriptions applicable to the profession, and so on.

Simply put, Profits and Losses are simple, deductions are complex.
 
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