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TAX 1020 | Special Tax Rules - Robert Green, CPA
 Forex Terms & Concepts
In a currency pair the base currency refers to the currency listed on the left hand
side of the pair. The base currency’s value is always equal to 1. The currency listed
on the right, the cross currency, establishes at what rate or price the cross currency
will equal or purchase 1 unit of the base currency.
The term bearish refers to a market in which prices are moving down continually.
The term can also be used to describe the price dirction of a single candle or bar
within a chart. If the stock market has been trending downwards, traders will refer
to it as a 'bearish market'. If a single price candle closes at a lower price than
it opened, it can be referred to as a 'bearish candle'. Professional traders also
often refer to 'the bulls' or the 'the bears' of a market, in this case 'the bears'
would represent the sellers in the market.
The term bullish refers to a market in which prices are moving up continually. The
term can also be used to describe the price dirction of a single candle or bar within
a chart. If the stock market has been trending upwards, traders will refer to it
as a 'bullish market'. If a single price candle closes at a higher price than it
opened, it can be referred to as a 'bullish candle'. Professional traders also often
refer to 'the bulls' or the 'the bears' of a market, in this case 'the bulls' would
represent the buyers in the market.
Candlestick charting is a method of charting very common in the Forex market. A
candlestick is composed of a body and an upper and lower wick. The candlestick gives
traders a quick visual look at the open, high, low and closing price of a currency
in a given time period. Traders monitoring a 4 hour candlestick chart are being
shown the open, high, low and closing price of a currency 4 hours at a time; in
other words, each candlestick represents 4 hours of price data (other time frames
are also used and range from 1 minute charts to monthly charts).
Most modern nations have central banks that perform similar functions. Usually a
branch of government, a central bank is responsible for setting interest rates,
stabilizing the economy and reporting to the general public on economic conditions.
Typically, central banks will loan funds to commercial banks at a certain set interest
rate. Commercial banks then base their lending rates accordingly. Key central banks
to the global economy include: The Federal Reserve (USA), The Bank of Japan, the
Bank of Canada, The European Central Bank, The Bank of England, etc. etc.
Price data plotted onto charts often forms unique and distinct patterns; patterns
that often precede very specific bullish or bearish price moves. Also referred to
as ‘chart patterns' or 'price patterns'; these formations can be very helpful to
technical traders when analyzing the market.
Charting describes the process of plotting price data for the purpose of creating
a visual history of a market’s (specific currency, commodity or stock) price movement.
Modern charting is of course not done by hand, but rather is done with the aid of
computers. Traders monitor price action across different charting time frames in
order to understand a market’s history, and in turn its likelihood for a bullish
or bearish future.
Price consolidation refers to the narrowing of price highs and lows in a given time
frame. This is usually a result of buyers and sellers that are unsure of market
direction. Often, consolidation occurs as a means to test the strength of a trend.
Lower highs and higher lows demonstrate a lack of domination from either the buyers
or sellers, and as if being squeezed through a narrow passage, prices eventually
break free and typically do so in favor of a strong move up or down.
In a currency pair the cross currency refers to the currency listed on the right
hand side of the pair. The cross currency’s value is always set in comparison to
1 unit of the base currency. The cross currency, establishes at what rate or price
the currency will equal or purchase 1 unit of the base currency.
EMA (exponential moving average) refers to the type of moving average that more
heavily weighs recent price data when calculating average levels. Simple moving
averages (SMA) sometimes react too slowly to price changes because they give equal
weight to even the oldest prices in the equation. EMAs attempt to resolve this problem,
and as such are a common choice of today's Forex traders.
When examining currency pairs one must understand what is meant by ‘exchange rate’.
Obviously, the exchange rate refers to the rate, or price at which one currency
can be exchanged for another. However, many traders look at a currency pair, EUR/USD
for example, without understanding a very basic concept: A price quote of 1.4760
is to say that 1.4760 US Dollars (currency on the right) will purchase 1 Euro (currency
on the left).
Fibonacci is not only the name of a famous mathematician; it is also the name of
a very common technical indicator. Essentially, Leonard Fibonacci's number sequence
is used as a means to gauge potential market retracements. The math behind the indicator
is subject matter for an entire course, as is much of the related philosophy and
strategy. However, the short explanation is that Fibonacci levels offer traders
a look at where prices might retrace or extend to in the form of a series of numbers
(price levels) that are represented as lines plotted on a chart. Fib levels are
most commonly used after a major move up or down, in an effort to predict a possible
price retracement.
When describing market analysis most professionals segregate the topic into two
separate categories: Technical Analysis & Fundamental Analysis. While technical
analysis focuses on the study of historical price data and price patterns, fundamental
analysis focuses on global economics. A fundamental analyst is abreast of fundamental
indicators released from governments, indications such as a nation’s Gross Domestic
Product, Unemployment Rates, Interest Rates and so on. Fundamental factors generally
tend to impact currency prices less quickly than do technical factors; though the
opposite is often true in the minutes immediately following the release of any major
fundamental indicator.
Fundamental and technical indicators are comprised of statistical or mathematical
data. Technical indicators are generally used to track the patterns of historical
price data. The calculations and methods behind technical indicators vary depending
on the purpose - be it to track price averages, price ranges, or repeated price
cycles. Common technical indicators include moving averages, MACD, Oscillators and
so on. Fundamental indicators are more often referring to statistical economic data
published relating to the money flow and health of a given economy. Common fundamental
indicators include GDP, Nonfarm Payroll, Producer Price Index and so on.
Essentially, there are two types of traders; Intra-day traders and Inter-day traders.
An intra-day trader prefers to open and close positions within the same trading
day. These type of traders are generally trading shorter time frame charts, and
tend to stay in positions for hours at a time, as opposed to days at a time. Inter-day
traders (or swing traders) on the other hand describes those traders who prefer
to hold positions overnight, and possible for days or weeks at a time.nge market
place. The NYSE (New York Stock Exchange) and CME (Chicago Mercantile Exchange)
are examples of physical exchanges. The Forex market is essentially a network of
banks and brokerages all of which are connected globally to one another, but not
through any one physical exchange.
A lagging indicator refers to a technical indicator that gives traders an indication
that a trend has already begun, in other words the notification is a bit after the
fact, hence the term 'lagging'. Though lagging indicators can be a bit behind, they
still help traders catch onto trends that otherwise might have gone overlooked.
Moving averages are considered lagging indicators. The opposite of lagging indicators
would be 'leading indicators', indicators that work to warn traders ahead of time
that something is developing. The best technique is not to use only one indicator
type or the other, but a combination of both.
Leverage describes the set level at which a trader is essentially borrowing money
from their broker or bank. Leverage set at 100 – 1 is to say that a trader can control
a position or contract in the market that is 100 times the size of the margin they
have posted in order to place the trade. For example, a standard $100,000 contract
(1 lot) in the Forex market would require a margin post of $1,000 if a trader were
at 100 – 1 leverage.
In financial markets the term liquid and its various forms take on a few different
meanings; in this instance if a broker’s trading agreement refers to the possibility
that a trade will be liquidated, that is to say that the trade will be close, and
unrealized profit or loss will become realized profit or loss.
A liquid market refers to a market that is cash heavy, and liquidity refers to substantial
level of capital or funds existing within a market or bank. Markets with high trading
volume and substantial money flow are considered liquid markets. Banks and brokerages
that clear trades are considered liquidity providers, as they are providing the
funds necessary to support the execution of trades.
The Term 'long' refers to the buying side of the market and is most often used by
traders as a verb, i.e 'I went long the Euro', thus meaning that I bought the Euro.
Traders might also say that they are 'long 20 lots on the Pound', meaning of course
that they have bought 20 lots of the Great British Pound.
In the off-exchange retail Forex market contracts are most often referred to as
lots. 1 lot would be the same as saying 1 contract. In a standard account a full
lot is equal to $100,000. Thus, a trader placing a 4 lot trade, for example, would
be controlling $400,000. In a mini account a full lot is equal to $10,000. Thus,
a trader placing a 4 mini lot trade would be controlling $40,000.
The idea of market expectations should seem simple enough; essentially, the point
is this: Forex traders must be educated! The mass of well educated traders generally
have simialar expectations in terms of where prices will head. For example, given
a poor showing in Nonfarm payroll, the mass of traders are going to expect the Dollar
to weaken on the first friday of the month. A trader focused on nothing but moving
averages and who is ignorant to obvious market expectations will have very limited
success. Do your homework, read the commentary of market analysts, prep your daily
trading; in short - know what the market is expecting!
Market sentiment refers to the general feeling of the majority of traders in a given
market. If because of a weak Nonfarm Payroll report the majority of currency traders
feel that the US Dollar will weaken; market sentiment surrounding the Dollar is
thus negative. Often, a negative market sentiment surrounding a particular currency
or economy can become reality. If many traders feel that the dollar should be weak
and subsequently start selling the Dollar, the initial market sentiment may become
a market reality as a mass of traders all selling the Dollar would in theory weaken
it's global standing.
Margin describes the amount of funds a trader must post in order to control a leveraged
contract in the market. Often, accounts that are traded with leverage are also referred
to as margined accounts. At 100 – 1 leverage a standard FX contract of $100,000
will require $1,000 of margin. If a trader’s account has less than a $1,000 in equity
they would not be allowed to open a position of this size.
Traditionally, a margin call occurs when a brokerage actually contacts a trader
and informs them that their trade has moved against them enough to require a deposit
of more margin (if they wish to keep the position open). In the FX market the term
is more often used to describe a situation in which a brokerage firm actually closes
the trader’s position, usually without warning. Most brokerages have set margin
call levels that traders are informed of when opening their account, it is generally
safe to assume that if your position reaches this level, your broker will automatically
close the trade.
In the off-exchange retail Forex market, a mini account refers to an account in
which the full value of one single mini lot or contract is equal to $10,000 (10%
the value of a standard account). Traders can of course set trades that are multiple
mini lots, or even fractional mini lots, but a single mini contract will always
be equal to $10,000. Many retail FX brokers offer 200-1 leverage on mini accounts;
though traders can have their leverage set to a lower level.
The term off-exchange is often used to describe the Forex Market place.
Because the Forex market has no central exchange, or physical location wherein trading
is facilitated, it is considered an off-exchange market place. The NYSE (New York
Stock Exchange) and CME (Chicago Mercantile Exchange) are examples of physical exchanges.
The Forex market is essentially a network of banks and brokerages all of which are
connected globally to one another, but not through any one physical exchange.
To oscillate is to volley between two key levels or values within a specified technical
indicator. Most often, oscillating indicators are attempting to plot short-term
overbought and oversold levels, thus offering traders a visual look at where prices
might be too high or two low when an obvious trend is otherwise unidentifiable.
Oscillating indicators are very popular, and include: Stochastic Oscillator, RSI,
and many others.
The term PIP stands for Percentage In Point. Essentially, Forex traders are after
profit in terms of pips; not Dollars or Yen or Euros, but pips. The reason for this
is because the pip is the last digit represented in a currency’s price quote; it
is the smallest increment that a currency’s value can rise or decline. Traders look
at currency price moves in terms of how many pips, and then translate that into
a value that makes sense in their base currency. In a standard account, for example,
the average pip value is around $10 USD.
Price movement or price volatility occurs in the Forex market as a result of varying
factors that include, but are not limited to the following: political and geopolitical
events, the flow of money in and out of the world’s investment markets, economic
stability or the lack there of within specific countries, action taken by the Federal
Reserve or the equivalent government bodies of other nations to raise or lower interest
rates, and the overall market sentiment derived from the study of technical analysis.
For more on price movement suggested IBFXU sections include both Technical Analysis
and Fundamental Analysis.
Price data plotted onto charts often forms unique and distinct patterns; patterns
that often precede very specific bullish or bearish price moves. Also referred to
as ‘chart patterns’; these formations can be very helpful to technical traders when
analyzing the market.
Can also be referred to as price movement; price volatility describes continued
and rapid price movement either bullish or bearish, or sometimes both. A market
whose prices are fairly stagnant and not moving might be referred to as a sideways
market, thus leaving little opportunity for traders to capture profit. A volatile
market on the other hand refers to prices that are moving and adjusting rapidly,
thus allowing good trading opportunities.
Currencies tend to trade within certain price ranges. Traders need to understand
trading ranges in conjunction with average daily pip movements before they can make
a logical trading plan, or before they prepare a profit target level. If trading
the Euro, for example, a trader had better be aware that the Euro price range over
the last week has been somewhere in between 4100 and 4400. That information considered,
very few currencies move more than 80 to 90 pips in a single day, and the Euro is
not an exception. If a trader intends to place a short term trade (3 - 4 days or
less), they must first consider price range, and then the likelihood of a movement
to their desired price level. Can 80 pips be made inside of 2 days? Not likely,
set your sights a bit lower and always consider price range and average daily pip
movements.
The Term 'short' refers to the selling side of the market and is most often used
by traders as a verb, i.e 'I went short the Euro', thus meaning that I sold the
Euro. Traders might also say that they are 'short 20 lots on the Pound', meaning
of course that they have sold 20 lots of the Great British Pound.
Simply stated, traders need volatility in order to be successful, that is to say,
prices need to move. Sideways markets typically suggest low volatility and a trading
period in which, prices are neither trending up or down. Certain trading strategies
can work well in sideways markets; if traders are after smaller gains pip wise.
However, most traders are looking to avoid sideways prices, unless of course prices
are consolidating or narrowing, which of course would indicate a potential price
breakout.
The term PIP stands for Percentage In Point. Essentially, Forex traders are after
profit in terms of pips; not Dollars or Yen or Euros, but pips. The reason for this
is because the pip is the last digit represented in a currency’s price quote; it
is the smallest increment that a currency’s value can rise or decline. Traders look
at currency price moves in terms of how many pips, and then translate that into
a value that makes sense in their base currency. In a standard account, for example,
the average pip value is around $10 USD.
A stop loss is designed to protect traders from excessive losses in the event that
a market's price dramatically changes in one direction or another. As a general
rule of thumb, even professional traders with years of experience should utilize
stop losses. Traders should establish a threshold of pain before entering into a
trade and set a stop loss at said level. When and if the price moves to the stop
loss the trade will be closed. Stop losses do not guarantee that the trader will
be protected from loss. In certain market conditions the stop loss will be filled
at the next available price which may be at a different price than the trader has
specified.
Support and resistance levels are used by traders to gauge points at which prices
are not able to either rise higher (resistance) or decline lower (support). when
prices range within these levels a 'channel' is formed. Traders generally attempt
to time entry points based on a push past one of these two levels, or a push away
from one of these two levels, thus indication that either the market is going to
set a new high or low, or that it is going to continue to trade within the established
levels.
The study of historical price patterns and data; usually used in an effort to predict
future price movement patterns.Price patterns are plotted on charts that can vary
in time frame and charting style. Most commonly seen in the Forex market are bar
or candlestick charts.
In any given market, prices can essentially trend in one of three directions: up,
down, or sideways. A trend is formed when prices maintain one of these three directions
for a specified period of time, whether it is an hour or a week. Most traders attempt
to trade with the trend when it can be easily identified, thus good trading opportunities
often come when traders are able to time entries in conjuction with market trends.
Professional traders know that spotting a true reversal in the current direction
of a trend can be paramount to the success of their analysis. Trend reversals occur
typically after price consolidation (see next Course Term), and if spotted early
can provide excellent entry points into the market. By defition, any dramatic change
in the direction of a trend can be considered a reversal, but shorter term directional
trends should be viewed only as retracements; directional changes lasting the duration
of mulitple candles, or hours and days on the other hand can be considered actual
reversals.
In any market, trading volume refers to the amount of trades in and out of the market
in correlation with their contract size. A market with high trading volume (high
amount of transactions and high level of money exchanging hands) will substantially
impact the overall economy of a nation. Trading markets with high volume will also
impact the individual trader, as increased trade volume ensures that traders can
easily enter and exit trades as there is an adequate supply of buyers and sellers.
View Guest Author Profile
Robert Green, CPA
Robert A. Green, CPA is CEO and founder of Green & Company CPAs, LLC (GreenTraderTax.com),
a virtual tax and accounting firm catering to traders and investment management
businesses; Green & Company Inc., a publishing company; and GTT Alliance for Traders,
an advocacy alliance for traders. Mr. Green writes the monthly "Business of Trading"
section for Active Trader magazine, and the main trader tax content for SFO magazine.
He is also the author of The Tax Guide for Traders (McGraw-Hill 2004) and the annual
GreenTrader tax return examples guides.
When it Comes to Trading in Currencies, Special Tax Rules Apply
Currency traders face complexities and nuances come tax time. Currency futures are
treated like other types of futures; your accounting is a snap and you enjoy lower
60/40 blended tax rates. However, cash forex can be an accounting nightmare and
you face higher ordinary tax rates, unless you "elect out" of IRC 988 for 60/40
treatment.
There are two distinct types of currency trading, and each has profound differences
in tax and accounting rules.
First, you can trade in currency futures on regulated commodities exchanges. These
futures are treated the same as other commodities and futures – as IRC section 1256
contracts.
Or, you can trade "cash forex" in the off-exchange retail foreign currency market
(forex)(not on regulated futures exchanges), subjecting you to an entire set of
special rules concerning IRC section 988 contracts.
Before you file your tax return, or even better yet before you start trading, find
out what you are trading – is it a Section 1256 contract or a Section 988 contract?
Many currency traders transact in both: contracts on regulated commodities exchanges
("regulated futures contracts" [RFC] on currencies) and in the non-regulated forex
market (a collection of banks giving third party prices on foreign current contracts
[FCC] and other forward contracts) – commonly known as "cash forex."
Learn below how currency traders are taxed similar to commodities traders, except
that interbank currency traders must "elect out" of IRC section 988 (the ordinary
gain or loss rules for special currency transactions) if they want the tax-beneficial
60/40 capital gains rate treatment of IRC section 1256.
Currency Trading is Like Commodity Trading in General
Most currency traders seek to be treated like commodities and futures traders in
that their trading gains and losses are treated as section 1256 contracts.
Both business traders and investors report section 1256 contracts as capital gains
and losses on Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles).
This allows them to split the gains and losses 60/40 on Schedule D: 60-percent long-term,
40-percent short-term. This 60/40 split gives commodities traders and investors
an advantage over securities traders. 60 percent is taxed at the lower long-term
capital gains rates (up to 15 percent) and 40 percent is taxed at the higher short-term
capital gains rates (or "ordinary rate" up to 35 percent).
The current maximum blended 60/40 rate is 23 percent, which is 12 percent less than
the maximum rate of 35 percent on short-term securities (or cash forex trading if
you don't elect out of IRC 988, see below).
Certainly, a 12-percent tax rate reduction is worthwhile to pursue for all currency
traders.
Cash forex is subject to IRC section 988 (treatment of certain foreign currency
transactions)
The principal intention of IRC section 988 is taxation on foreign currency transactions
in a taxpayer's normal course of transacting global business.
For example, if a manufacturer purchases materials in a foreign country in a foreign
currency, the fluctuation in exchange rates should be accounted for pursuant to
IRC section 988. IRC section 988 provides these fluctuations in exchange rate should
be treated as ordinary income or loss and reported as interest income or interest
expense. IRC section 988 considers exchange rate risk in the normal course of business
to be like interest.
IRC section 988 does not affect currency futures (RFCs)
Currency traders who trade currency futures (regulated futures contracts – RFCs)
are not affected by IRC section 988 because they are not trading in actual currencies.
RFCs based on currencies are just like any other RFC on an organized exchange. Additionally,
since RFCs are marked-to-market at the close of each day (and year) in accordance
with IRC section 1256, the economic and taxable gain or loss are the same. IRC section
988 specifically mentions that RFCs and other mark-to-market instruments are exempt
transactions.
IRC section 988 does affect Foreign Currency Contracts
When a currency trader uses the forex market to transact in Foreign Currency Contracts
and other Forward Contracts, they are exposed to forex rate fluctuations.
However, currency traders look upon their currency positions as "capital assets"
in the normal course of their trading activity (business or investment).
What this means is that a currency trader may elect out of ordinary gain or loss
treatment in IRC section 988, thereby falling back to the default section 1256 contract
treatment; which is 60/40 capital gains and losses. Most currency traders will want
to make this election for the tax-beneficial treatment of section 1256 (lower tax
rates on gains).
Forex traded currency futures
Many traders ask this question: ‘Are currency futures trades done on foreign exchanges
also taxed at 60/40 for U.S. citizens, or does 60/40 only apply to futures listed
on US exchanges?' There is a reasonable basis in fact and law to conclude that futures
traded on certain foreign contract markets with either a CFTC Rule 30.10 exemption
or No Action Letter are entitled to classification as Section 1256 contracts (e.g.,
commodities) with the result that "60/40" tax treatment is appropriate.
To "elect out" of IRC section 988 or not, that's the question
If you have cash forex trading gains, you will prefer to elect out of IRC section
988 to benefit from up to 12-percent lower tax rates on Section 1256 contracts.
Conversely, if you have cash forex trading losses, you may prefer ordinary loss
treatment over Section 1256 capital loss treatment. As a result, you may not want
to elect out of IRC section 988. Note that IRC section 1256 losses may be carried
back up to three tax years, but only against IRC section 1256 gains in the prior
three tax years. Ordinary losses may offset any type of income. But, technically,
it's not a simple choice like this at the end of the year.
The rules require that you elect out of IRC section 988 on a "contemporaneous basis."
This means that hindsight is not allowed and you must make your decision in advance
of the trades, before you know if you will have gains or losses.
Can you bend the rules?
The election out of IRC section 988 should be filed "internally," which means you
place it in your own books and records as opposed to filing it with the IRS.
Many traders do bend the rules and, after year-end, if they have cash forex gains,
they claim they elected out of IRC 988 to use the beneficial IRC 1256 treatment.
In fact, our firm has noticed hundreds of traders who don't even know the rules
and simply report their cash forex gains on Form 6781. Others report them on Form
1040 line 21 as ordinary income and just pay higher taxes, without knowing the difference.
We expect the IRS to catch up with all cash forex traders soon, after the explosion
of cash forex in the online trading market.
Don't bend the rules and get into trouble; learn about the rules up front and follow
them for success.
Currencies futures vs. cash forex – what's the accounting difference?
Currency futures traders have it easy on two accounts. Not only do they get the
lower-tax 60/40 treatment on trading gains, but they also have it much easier come
tax time.
Your brokerage firm sends you (and the IRS) a simple Form 1099 soon after year-end,
reporting one number for your Section 1256 trading gain or loss for the tax year.
Line 9 on that Form 1099 is "aggregate profit or loss."
The "mark-to-market accounting" rules in Section 1256 make accounting a snap. Your
brokerage firm simply adjusts your realized gains and losses with beginning and
end of year unrealized gains and losses for a combined realized and unrealized gain
or loss amount.
On your tax return, report "aggregate profit or loss" on Form 6781 (the 60/40 form).
Those 60/40 amounts are then transferred to Schedule D (capital gains and losses)
– unless you carry back a Form 6781 loss to prior years.
Wow, if only all traders had it so easy on accounting!
Section 1256 futures traders don't need any accounting solutions or programs unless
they want to check their brokerage firms, which may be a prudent idea.
Securities and cash forex traders face accounting challenges come tax time.
Form 1099s report proceeds on securities transactions, and some have "supplemental
information" for total sales and purchases of securities options, mutual fund transactions
and purchases of securities. Form 1099s do not report cash forex transactions or
single-stock futures.
Traders who fill out Form 1099s are on their own. Some brokerage firms offer online
reporting, but many have unmatched trades and some say you can not rely on these
reports for your tax returns.
So, if you trade in anything other than Section 1256 contracts, you will probably
need your own accounting solutions or software programs.
Most good accounting programs are geared towards securities traders.
Here is a good accounting solution for cash forex
Money managers report cash forex trading gains and losses using a "Performance Record
Approach."
These results are sufficient for tax authorities and reporting rates of return to
investors. Use the same formula in a worksheet for your tax return. Here's the formula
to use on a worksheet template.
Ending net assets (at market value) less beginning net assets (at market value),
less additions of cash, plus withdrawals of cash, equals net performance. Subtract
non-trading items such as interest income, add interest expense and other expenses,
and you have net trading gains or losses on cash forex.
If you don't elect out of IRC 988, you report your ordinary gain or loss from cash
forex as "other income" on Form 1040 (line 21).
If you elect out of IRC 988, add this amount to Form 6781 as "cash forex elected
out of IRC 988."
Your monthly statements may get you lost in the woods. If you try to figure out
your cash forex gains and losses from your monthly brokerage statements, you may
get very confused and lost. We have clients that have different statements for each
type of currency (e.g., U.S. dollars, Japanese yen, Swiss francs and Euros) and
it can become a nightmare scenario to try and figure it all out. The performance
record approach is a salvation and it's accepted by the IRS.
My broker reported my cash forex along with my IRC 1256 contracts. Is that OK?
A few brokers lump in cash forex in with IRC Section 1256 contracts on 1099 line
9 "aggregate profit or loss."
This is technically incorrect by law, but it may save you taxes and an accounting
headache. Technically, cash forex are IRC 988 transactions and should be segregated
from IRC 1256 contracts.
Perhaps these brokers can argue that when you opened your cash forex account, you
"contemporaneously" elected out of IRC 988 for IRC 1256 treatment, and that you
qualify for such as a trader rather than a manufacturer-type business.
You should consult with a trader tax expert if this applies to you.
Also, consider what happens if you have a large cash forex loss and you prefer ordinary
loss treatment instead of Section 1256 treatment – so you don't get stuck with the
capital loss limitation of $3,000.
You face difficulty in overriding a broker's 1099 treatment for 1256 contracts.
Consult with a trader tax expert who may be able to help.
Cash forex is the "wild west" of trading and IRS reporting
Cash forex is not registered with the CFTC and it has been called the ‘wild west'
of trading.
Cash forex is also the wild west when it comes to taxes and reporting trading gains
and losses.
There should be no 1099 reporting for cash forex, so you are your own sheriff when
it comes to ‘rounding up' the gain and loss numbers and paying your taxes (with
the nuances of IRC 988).
A person visited our booth at the Online Trading Expo in NYC and asked if cash forex
was taxable at all? She heard that many cash forex traders claimed they don't pay
any taxes on their gains. We told her the IRS sheriff will catch up with them soon
and throw the book at them for tax avoidance.
Remember, Form 1099 rules are minimum reporting guidelines set forth by the IRS.
New products are being created all the time and it takes years for the IRS to set
the guidelines for how each product is reported on Form 1099s, if at all. Brokerage
firms tussle with the IRS each year on what they must report; as it causes great
stress and cost on their accounting systems.
Many new and smaller cash forex brokerage firms have ramped up quickly to tap into
the explosion of interest in cash forex – especially after the securities markets
went into a tailspin a few years ago.
Many of these firms are not strong on reporting, systems or tax compliance, so you
may be on your own when tax time comes.
Before you open a cash forex account, ask your brokerage firm what kind of reporting
and support they offer you.
Bottom line
Currency trading is a hot commodity in the market place, but not all currency contracts
are taxed like commodities. Cash forex is subject to IRC section 988 rules, and
if you're a trader you can elect out of IRC 988. This will allow your gains to be
taxed like commodities – with beneficial 60/40 treatment. Before you start trading
cash forex, find out if your brokerage firm will help you with trade accounting.
If not, you may have a huge accounting headache on your hands come tax time. When
it comes to currency trading, it's wise to learn all the tax rules and consult with
a trader tax expert.
If you have any questions, e-mail us at
info@greencompany.com
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