Forex trades and Taxes

Discussion in 'Taxes and Accounting' started by Gianem, Aug 17, 2006.

  1. Gianem



    I'm new to these forums and hope I posted this in the correct one.

    I'm considering trading Forex and had a few tax related questions I'm hoping someone can help me with.

    1 - How do you report Forex trades? In Schedule D?

    2 - What tax bracket do they fall under assuming all trades are short term? (Is each Forex trade treated as half long term and half short term irrespective of holding period?)

    3 - I believe on short trades I am liable to pay any interest that may be due on that Forex pair. Is this interest payment part of the trade's cost basis?

    4 - Are there any other tax related issues to be aware of?

  2. I've always had an accountant do all of this. But from what I remember,

    1. Yes.

    2. Short term capital gain. 25%?

    3. Interest is seperate. Interest income, I believe, is calculated seperately that short term capital gain.

    4. The number of trades you make is probably far more than you want to spend time doing. So what I've done is just attached a record of all the trades and sent it to the IRS saying "If you want to check my figures, go right ahead".
  3. Surdo


  4. Here's something I found that's pretty useful. I copy/pasted the contents from the link below for convenience (I didn't write it)


    Futures and Cash Forex
    Forex is traded in two ways: as currency futures on regulated commodities exchanges, which fall under the tax rules of IRC Section 1256 contracts, or as cash forex on the unregulated interbank market, which fall under the special rules of IRC Section 988. Many forex traders are active in both markets.

    Because futures and cash forex are subject to different tax and accounting rules, it is important for forex traders to know which category each of their trades fall into so that each trade can be reported correctly to receive optimum tax advantage.

    Section 1256: The Advantageous Split

    Forex traders receive a significant tax advantage over securities traders under Section 1256: reporting capital gains on IRS Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles) allows you to split your capital gains on Schedule D, with 60% taxed at the lower long-term capital gains rate (currently 15%) and 40% at the ordinary or short-term capital gains rate of up to 35%. That combined rate of 23% amounts to a 12% advantage over the ordinary (or short-term) rate.

    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).

    Section 988: To Opt Out or Not?

    Section 988 was enacted as a way for the IRS to tax companies that earn income from fluctuations in foreign currency exchange rates as part of their normal course of business, such as buying foreign goods. Under this section, such gains or losses are reported and treated as interest income or expense for tax purposes, and do not receive the favorable 60/40 split.

    Because forex futures do not trade in actual currencies, they do not fall under the special rules of Section 988. But as a currency trader, you are exposed daily to currency rate fluctuations, hence your trading activity would fall under the Section 988 provisions.

    But because currency traders consider these fluctuations part of their capital assets in the normal course of business, the IRS enables you to opt out of Section 988, and thereby retain the favorable 60/40 split for these gains under Section 1256.

    The IRS requires that you note "internally" your intention to opt out of Section 988 before making the trades; you are not required to notify the IRS. Obviously, some traders bend this rule based on their year-end outcome, and there seems little inclination on the part of the IRS to crack down, at least so far.

    As a rule of thumb, if you have currency gains, you would benefit (reduce your tax on gains by 12 percent) by opting out of Section 988. If you have losses however, you may prefer to remain under Section 988's ordinary loss treatment rather than the less favorable treatment under Section 1256.

    Tax Time: Tougher for Currency Traders

    Forex futures traders tend to breeze through tax time; their brokerage firm sends them an IRS Form 1099, on which their aggregate profit or loss is listed on Line 9.

    But since currency traders don't receive 1099s, you are left to find your own accounting and software solutions. Don't be tempted to simply lump your currency trades in with your Section 1256 activity, a common temptation; these trades need to be separated into Section 988 reporting, and in cases of loss, you could wind up paying more tax than necessary.

    As a fast-growing market segment, forex trading is almost certain to come under greater IRS scrutiny in the future

    Here is the link

    Also look here: