Posted by forex at 4:55 AM
Read our previous post
1. Review tax law for forex. Forex is essentially a derivative market; that is, trades are set up as spot or futures option trades. As such, the IRS treats forex like options and allows traders to use two rules for reporting income: IRC (internal revenue code) 1256 and IRC 988.
2. Use IRC 1256. Under IRC 1256 the IRS allows traders to use a 60/40 tax consideration. This means that 60 percent of the gains/losses from trades are counted as long-term capital gains/losses; the other 40 percent are treated as short term.
3. Define short term and long term. In the investment world, short term refers to stocks traded or held less than one year (spot). Long term refers to investments held over one year (futures).
4. Calculate the tax rate for forex income. The short-term tax rate for investments is 35 percent for stocks. Due to the 60/40 rule under IRC 1256, this equates to a 23 percent rate for forex.
5. Use IRC 988 tax code benefits for spot trades (over the counter). These are defined as contracts which settle within two days.
6. Review IRC 988 benefits. Tax rate for IRC 988 is 35 percent; however, if you have a loss you can count all losses as 'ordinary' (not just the first $3,000 which is allowed for regular trade losses under 1256).
7. Comparing IRC 988 and 1256. 1256 contracts are generally more complex (longer duration) but can offer additional savings through the 60/40 consideration and lower tax rate. However, tax rates for IRC 988 stay the same for both gains and losses, which makes the process less complex. .
8. Decide on the best option for you. Choose a contract to trade and report income under. In general, 988 contracts are for spot traders (settle in two days) and 1256 contracts are for futures traders (longer term and more complex contracts). You must make a decision by January 1 of the trading year.
9. Review the performance record formula for reporting income. Calculate income as follows:
Ending trade value - Beginning trade value = Net trade value
Net trade value - cash deposits + withdrawals - income from interest + interest paid + trading expenses = Net income to report under either IRC 1256 or 988.