Forex Taxes & Your Tax Returns
The Forex Market is the Largest in the World
With more forex traders out there than any other type, it is common for forex traders to mis-report their activities on their tax returns. Forex taxes can be confusing to many, however, we are here to make things simple!
FOREX TAXES: HOW FOREX IS REPORTED ON YOUR TAX RETURN
For most of the US, forex traders are what we like to call “retail spot forex traders”. You fund your account, open up your platform (like MT4) and start trading in hopes of turning a profit. This majority of forex traders fall under Internal Revenue Code Section 988. What this means is your gains and losses from trading forex are considered ordinary gains or losses and ARE NOT reported on a schedule D with your 1040 (capital gains and losses).
There are different ways a forex trader can be assessed during tax season and there are typically certain requirements:
-
Section 1256 treatment: When taxed under Section 1256, 60% of your gains or losses will be taxed as long-term capital gains or losses. This means that for a profitable trader, 60% of your gains under Section 1256 will be taxed at a reduced rate. The remaining 40% will be taxed as short-term capital gains. Short-term capital gains are taxed at your ordinary income tax rate.
•This is the standard treatment when trading forex options & futures.
•Spot forex traders who are defaulted under Section 988 have the potential to opt-out of Section 988 treatment. Doing so would allow for your forex trading activity to be treated as Section 1256 activity.
•As opposed to Section 988 losses, which may offset income, Section 1256 losses are subject to a maximum $3000 deduction. Any remaining losses are to be carried over to future years.
•The only trades subject to 1256 treatment when opting out of 988 would be those involving "major" currency pairs. Major currency pairs are defined as those which are traded as regulated futures contracts on U.S. based futures exchanges.
•There are different pros and cons when making the decision to opt-out of 988 based on your specific situation. Consult with a trading tax professional to decide what is best for you.
Important: Forex traders who decide to opt-out of Section 988 treatment, must do so prior to the start of a new tax year in order for your trades to be recognized under Section 1256. Opting out in the middle of the tax year will disallow any trading activity prior, from being treated as 1256 activity.
-
Funded Traders: If you are a funded trader (also known as a "proprietary" or "prop trader"), the trading activity itself is not reported. You are considered a contractor for the funder and you ultimately invoice them for payment. This means you are considered self-employed.
- Important: Be advised that if using cryptocurrency to withdraw from your forex brokerage account, those crypto transactions must be accounted for on your tax return. Many people do not realize this, however, it is extremely important to provide this information to your tax professional.
WHY YOU NEED A FOREX TAX PRO
- •Many Forex Traders also trade or are involved in other markets, making organization a true priority. A trading tax professional can make this much easier for you. Trading tax professionals will be able to not only separate your different types of market activity, they will also be able to teach you how to properly keep record of such activity.
- •Forex traders are not treated the same as crypto or stock traders by default. This means the procedures followed when reporting forex activity on a tax return will differ from other types of activity.
- •The IRS does not care if honest mistakes are made. Lack of understanding is not considered an excuse!
A NOTE FROM THOMAS, YOUR FOREX TAX PRO:
As a long time forex trader, I can tell you that in my experience, having been to a few tax professionals prior to becoming one myself. Many did not truly understand the tax procedures surrounding forex trading activity or the tax implications involved. Most would report my forex trading activity as capital gains or losses. This is INCORRECT and unless you are eligible to opt-out of section 988 treatment, your forex trading activity should be reported as ordinary gains and losses. This means the gains or losses are subject to normal income tax treatment. (For those who have a forex loss for the year, section 988 allows you to offset your income with the losses incurred.)
This is why you need a tax professional who has been in your shoes and understands both what it is like to be a trader and also understands a trader’s tax treatment. Ultimately, you need someone who can accurately file your tax returns.
TRADERS TAX PRO
We make it easy to prepare & file your tax returns
We are here to help you. If you have any questions at all, feel free to contact us and speak directly to a tax professional who has been in your shoes once before. No matter the situation, we will make sense of it all, keeping things simple for you.
Click here to read more about forex trading taxes.
Funded Forex Traders & Taxes
If you are a funded forex trader, the above information only applies to your personal forex trading activities. To learn more about funded forex accounts & taxes, click below.