FOREX TAX & REGULATORY TREATMENT
Forex. Start on this page first.
See our Updated Trader
Tax Center pages.
Traders need to stay abreast of the many new forex developments. We briefly
mention these developments below and cover them in detail on our blog's
Tax & Regulation section.
In the best of circumstances, forex traders can enjoy unlimited ordinary-loss
treatment, and, with a proper election, achieve lower 60/40 tax
rates (Section 1256g) on their gains in some cases. But favorable 60/40
tax treatment is not assured with the IRS on spot forex and traders need
to be aware of what’s involved.
There are new regulatory developments on the forex front too. In 2010,
the CFTC reined in U.S. and foreign forex brokers doing business with
Americans, reducing leverage for retail forex traders to 50:1 from well
over 100:1. The CFTC also requires FIFO accounting, which many traders
find to be a problem on pair trades. American traders had previously been
trading in the UK which allows spread betting (not FIFO). Many traders
seek to skirt these tougher CFTC rules with foreign institutions, but
only foreign banks have a reprieve on registration until July 16, 2011.
In the past, forex was the odd man out of regulation, but now the CFTC
has brought it under NFA regulatory oversight, and required RFED (Registered
Foreign Exchange Dealer) or FCM NFA registrations. The NFA is now auditing
the RFED brokers and it’s issued several troubling enforcement actions,
asserting “price slippage” in favor of the broker and other
All these developments are intertwined. The CFTC’s call for regulation
over forex was based on assertions that spot forex trading is futures-like.
That may help our tax arguments for lower 60/40 tax rates, after making
the proper elections. NFA audits of forex brokers will bring to light
details on their trading platforms, which may only reference prices in
the Interbank market, may weaken our tax arguments. Forex is a highly
nuanced area of tax and regulatory law and you can count on GreenTraderTax
to stay on top of these changes.
To learn more about forex tax and regulatory matters, please read our
blog and take
our forex Webinars.
Green has recorded several short videos
for MoneyShow.com on forex too.
See our Jan. 29, 2011 Spot
Nov. 12, 2010 Forex Tax Update
We’ve been working on a major update to our forex tax treatment research
and content recapped here.
Don't get alarmed, our new conclusions confirm prior challenges on spot
forex tax treatment and support our prior conclusions. We continue to
believe retail spot forex contracts in major currencies may qualify for
lower 60/40 tax rates in Section 1256g (foreign currency contracts), riding
the coattails of interbank forward contracts — after making a valid
opt-out election from Section 988 (foreign currency transactions). The
new CFTC forex trading rules (covered on our blog) may help our case since
the CFTC Chairman's "Gensler letter" implies the term "spot
forex" is a misnomer since it's "futures-like."
We plan to offer forex traders revised "substantial authority"
tax opinion letters to support their forex tax treatment. Several large
forex traders asked for these opinion letters because they and their tax
preparers want peace of mind on their tax filings and protection from
potential tax penalties. Current rules require "substantial authority"
which doesn’t mean it's a guarantee to win.
As pointed out on prior calls and blogs, some forex traders are considering
currency futures since after the new CFTC forex rules the leverage is
similar to retail spot forex, plus the lower 60/40 tax rates clearly apply
to futures. Is U.S. forex trading safe? pointed out that the NFA recently
fined some retail forex brokers for abusive practices on their software
trading platforms. Why take a risk on spot forex tax treatment if you
can trade currency futures instead? It's not that simple, of course, and
there are many other factors to consider.
As we have indicated, spot forex isn't specifically mentioned by the
IRS and court cases as being specifically allowed in Section 1256g; only
forwards are mentioned, hence the risk in tax treatment. Recent court
cases and Notice 2007-71 barred forex options from Section 1256g because
they don't require settlement with the currency; the option holder could
decide not to exercise. Forward forex contracts require settlement in
physical currency and we argue that spot forex does too.
There's a lot at stake tax-wise. Remember, with lower Section 1256 60/40
tax rates, the maximum blended tax rate is 23 percent, a whopping 12 percent
less than the current maximum ordinary tax rate of 35 percent. Forex traders
are counting on GreenTraderTax to defend their 60/40 tax treatment on
Foreign currency futures contracts on U.S. exchanges are reportable as
Section 1256 contracts with lower 60/40 tax rates (60 percent are long
term capital gains) and mark-to-market (MTM). Conversely, all forex (foreign
exchange interbank) contracts are subject to Section 988 (foreign currency
contracts) ordinary gain or loss treatment by default. Traders, but not
manufacturers, may file an internal election on a contemporaneous basis
to “opt out” of Section 988 into capital gains and loss treatment.
This is called the “capital gains election.” With this election,
forex forward contracts in major currencies are treated as Section 1256g
capital gains and losses with the lower 60/40 tax treatment.
It’s important to note that Section 1256g only specifically mentions
forex interbank forward contracts, for which regulated futures contracts
exist too. In other words, it applies only for the major currencies, and
excludes the minor currencies for which futures contracts don’t
exist. The IRS considers Section 1256 an exclusive club and it doesn’t
want to allow other types of financial products in, so it doesn’t
open flood gates to 60/40 tax rates.
A case in point is forex options. Some forex traders tried to squeeze
forex options into the definition of Section 1256g (foreign currency contracts).
At first, the IRS accepted that in Notice 2003-81, but the IRS and Tax
Court reversed that ruling in Notice 2007-71 and Summitt v. Comr. , 134
T.C. No. 12 (2010), barring forex options from Section 1256g.
The crucial point to understand is there are no cases or current IRS
rulings stating whether “spot” forex is eligible for Section
1256g. While some tax professionals are taking a conservative position,
our belief is that spot forex qualifies for Section 1256g if the taxpayer
closes out the position. We are willing to provide a “substantial
authority” tax opinion to traders, so if they are audited by the
IRS, they will avoid paying penalties if a court decides against them.
Professional forex traders vs. online forex traders
There are key differences between professional forex traders and this
newer breed of online forex traders. Professional forex traders often
trade “forward contracts” (rather than spot forex) because
forwards have more transparency and better pricing than spot.
Forward forex traders trade major currencies for which regulated futures
contracts (RFCs) exist; therefore, after filing an internal capital gains
election, they can use Section 1256g 60/40 tax treatment. Most professional
forward forex traders make their living trading forwards and count on
lower 60/40 tax rates each year — currently up to 12 percent lower
tax rates (2010 rates). (More on Section 1256 below.)
Compare the professionals to the online forex trader. Most online forex
traders are new to forex; some moved from the online securities or futures
trading space. Many have very low account sizes ($2,500 to $25,000) and
lack the capital, clout and connections to trade forwards in the (non-retail)
Forwards settle in more than 48 hours and spot settles in less than 48
hours, usually overnight. Only larger professional traders can arrange
the credit and clout to trade forwards, generally with high leverage.
Smaller traders only have access to spot forex since it settles overnight
and if they continue the trade they must roll it over. Margin is settled
daily in this regard.
The online forex-trading marketplace didn’t pick up steam until
the early 2000s. When the online securities trading revolution suffered
a bear market in the 90s, brokers and traders stepped into the forex market.
This became possible when larger banks democratized interbank market access
with new retail software trading platforms. It was also a beneficiary
of the Commodity Futures Modernization Act of 2000, where regulators agreed
The key difference: Online forex traders mostly trade spot contracts,
whereas professional traders have access to lower-priced forward contracts.
But are spot and forward forex contracts given the same tax treatment?
The Section 988 and Section 1256 conflict
Before we go any further, let’s identify the two alternatives for
reporting forex trading income and losses. Section 988 has ordinary gain
or loss treatment. Losing traders prefer Section 988 because it eliminates
capital-loss limitations, allowing full ordinary loss treatment against
any type of income. Section 1256 has lower 60/40 capital gains tax rates.
Profitable traders prefer Section 1256 because it reduces their tax rates
on trading gains. Section 1256 has a three-year carry-back feature, but
only against 1256 gains in those years. Section 988 ordinary loss treatment
can be a problem if the trader doesn’t have trader tax status (business
treatment) and has negative tax income. In that case, the excess forex
ordinary losses are wasted and can’t be included in capital loss
or business net operating loss carry backs or forwards.
In 1982, Congress added “foreign currency contracts” to the
Section 1256 definition (Section 1256g). Congress wanted to accommodate
currency traders, putting forex (OTC interbank off-exchange markets) on
par with RFCs — the original 1256 contracts (like currency futures).
Although forward contracts are mentioned in Section 1256g, they’re
also mentioned in Section 988 and, therefore, they receive ordinary 988
treatment unless a trader makes a contemporaneous internal election to
opt out of 988 for 1256.
Spot and forwards tax treatment
Some tax professionals treat spot contracts as part of Section 988 (with
no ability to elect 1256), whereas other tax professionals — like
Green & Company CPAs, LLC – think spot contracts in major currencies
that also have regulated futures contracts may be treated like forwards
with Section 1256g treatment.
Section 988 regulations state that if a trader doesn’t take or
make delivery of the actual currency – and most traders don’t
make or take delivery – then the spot contract can be treated like
a forward contract. Traders don’t make or take delivery in non-functional
currencies for the spot forex contracts they trade. Rather, they trade
the contracts before settlement in the same way they trade forward forex.
The only difference is spot settles in less than 48 hours and forward
settles in more than 48 hours. These are some of the reasons for a “substantial
authority” argument to treat forex spot in major currencies like
forwards to elect into Section 1256g.
However, the IRS and the courts have not given any guidance as to whether
spot contracts qualify for Section 1256g. In fact, the recent case of
Summitt v. Comr. along with IRS Notice 2007-71 have caused some
tax professionals to question whether spot contracts can so qualify. Summitt
and Notice 2007-71 both held that OTC foreign currency call options
do not qualify for Section 1256g because Section 1256g was aimed at forward
contracts, not OTC options. Some tax professionals have the sense that
the IRS is seeking to be stingy in expanding 1256g treatment to financial
instruments which were not clearly mentioned in the Congressional Reports
published at the time that Section 1256 was enacted.
A close reading of the Summitt case leads us to believe that
Section 1256g does apply to spot contracts. The Summitt Court
gave the following reason for its decision: As enacted in 1982, Section
1256g clearly referred to a contract which required delivery of the foreign
currency, not to a contract in which delivery was left to the discretion
of the holder (which is the case for an option, which is a unilateral
contract that does not require delivery or settlement unless and until
the option is exercised by the holder). It is also clear that the 1984
amendment to Section 1256g (“or the settlement of which depends
on the value of”) was inserted to allow a cash-settled forward contract
to come within the term “foreign currency contract”, but not
to allow a new class of financial instruments (i.e., OTC options) into
1256g. Foreign currency contracts can be physically settled or cash settled,
but they still must require, by their terms at inception, settlement at
It would seem that spot contracts qualify for Section 1256g under both
the 1982 and 1984 definitions, as they aren’t unilateral contracts
and do require delivery of the foreign currency or settlement at expiration.
Nevertheless, the issue isn’t free from doubt. The 1982 version
of Section 1256g didn’t apply to spot contracts because it didn’t
allow for cash settlement of a foreign currency contract. It could be
argued that the 1984 amendment didn’t admit a new class of financial
instruments — spot contracts — into Section 1256g, just as
it didn’t admit OTC options.
A senior IRS official involved in the Summitt case has told us he believes
spot contracts do qualify for 1256g, but he was not speaking on behalf
of the IRS as an organization.
Suggestions for how to proceed
Traders should consult a forex tax expert. GreenTraderTax (Green &
Company CPAs, LLC) provides consultation and tax preparation services.
Our tax attorneys provide tax opinions when needed. Our Web site (www.greentradertax.com)
is for educational purposes only. We are not responsible for any positions
you extrapolate and take on your own.
We have not seen the IRS disallow forex tax treatment based on our positions
to date; however, it’s difficult to know how the IRS will react
in the future. Its possible one IRS agent will deny ordinary loss treatment
for forex trading losses whereas another will deny lower 60/40 tax rates
on forex trading gains.
We believe a “substantial authority” position (which is weaker
than a “more likely than not” position) supports treating
spot the same as forwards, provided the spot is in a major currency that
also has a RFC. It’s wise to receive a substantial authority tax
opinion to claim Section 1256 60/40 lower tax rates on spot trading gains.
The Internal Revenue Code allows relying upon substantial authority to
We have several other arguments supporting our case beyond the scope
of this content.
CFTC calls “spot” forex a misnomer
Recent developments from the CFTC and NFA for the retail forex marketplace
— calling for less leverage among other things — shed some
light on these open tax questions. We believe the CFTC’s recent
findings may help our case for treating spot forex like forwards forex
for purposes of fitting into Section 1256g after a duly filed opt-out
election from Section 988.
Financial market regulators and their rules are different from the IRS
and their tax rules. The IRS may not respect these additional arguments,
since regulations don’t necessarily set precedent for tax purposes.
In forging their new 2010 rules for the forex marketplace, the CFTC and
NFA studied the retail “spot” forex marketplace, and they
came up with some findings that shed light on the question of what truly
is spot forex, and how it differs from forwards.
In his well-known “Gensler-Letter” in 2009, CFTC Chairman
Gary Gensler asked Congress for more authority to regulate the retail
spot forex marketplace. Chairman Gensler argued that retail spot forex
trading platforms were successfully evading CFTC regulation by mislabeling
their trading platforms as “spot forex” transactions; he thought
they were more appropriately “futures-like” and therefore
under the CFTC umbrella of regulation. To that point in 2009, futures
were clearly regulated by the CFTC and NFA. For further info on forex
regulations and the history, see our blog articles on this subject.
Think about how a trader speculates for profit in the retail spot forex
trading marketplace. Most don’t have the capital, credit and connections
to open a forward trading account for trades that can be open for 48 hours
or longer — the longer the period, the more the risk and the more
credit comes into question. The retail spot forex trading platforms were
created in 2000 just as traders searched for ways to play the forex market
and retail brokers looked for ways to offer forex opportunities to their
Traders buy the Euro on a given day and that spot contract settles in
less than 48 hours. What does this mean? It means the trader pays for
the Euros with a market (software platform) price on a given second and
they need to trade the contract away before it settles the next day, as
most traders are unable and unqualified to take delivery. The trader puts
up $1 out of 100 to buy the Euro (100:1 leverage). After the new CFTC
forex rules, this changes to $1 in 50 (50:1 leverage on major currencies).
These traders don’t have enough money for the rest of the leverage,
so they can’t pay up for delivery. If the trader wants to continue
the trade, they roll it over, meaning they execute another similar trade
the next day.
The important point is that spot forex traders are doing the same speculative
forward-looking trading as forward forex traders or currency futures traders.
Since they can’t buy forex forwards, they buy spot forex and roll
the positions over daily, simulating forwards trading.
If the trader bought and took delivery on the currency spot, they would
hold physical currency and then they could not opt out of Section 988.
There’s a risk the IRS could say spot forex simulates holding the
physical currency itself and therefore no opt out is allowed at all, as
is the case with physical currency. But that can’t happen because
the IRS specifically wrote in Section 988 traders could opt-out of Section
988 on spot forex when they don’t take or make delivery —
which is the case for spot forex traders. Therefore, if the capital gains
election is allowed, spot should be allowed in Section 1256g too.
Here’s another confusing point about spot and trade vs. settlement
dates. Trades in forex or securities trade on one day and may settle for
delivery on a later day. Spot traders are sort of taking advantage of
the time frame before trade and settlement date.
This type of retail spot forex trading didn’t exist until after
2000, well after Section 1256g was created and amended by the IRS in 1982
and 1984, respectively. The fact that this type of spot trading wasn’t
listed specifically for inclusion in Section 1256g doesn’t mean
it was purposely omitted. Rather, it was left out because it didn’t
exist at the time.
The IRS may act very technically on all this and say spot is left out
of Section 1256g. Our substantial authority opinion should help in a given
Tax Court case and protect against tax penalties. We aren’t saying
these positions will be won in the end. We think theory and reality is
on our side and we should prevail on these positions. Plus, the IRS people
we spoke with seem to agree. But, until it’s in writing formally
from the IRS, it’s a risk.
If you don’t want any part of this uncertainty, trade currency
Prior content and many other useful links, so
scroll down this page for more help.
Taxation of forex is confusing and uncertain in the tax code and that
makes tax filings difficult for forex traders. The tax problem is that
some types of forex are treated as IRC 1256 contracts with lower 60/40
tax treatment and other types of forex are treated as IRC 988 foreign
currency transactions with ordinary gain or loss treatment. Plus, IRC
1256 and IRC 988 are conflicting tax-code sections.
An article by Robert A. Green, CPA of GreenTraderTax CPAs written
in February, 2008.
See several earlier articles by Mr. Green on forex tax below as well.
Retail spot forex traders are different from professional forward
The forex Interbank market has been around for many decades. Robert A.
Green founded Green & Company CPAs in 1983 to handle the special tax
and accounting needs of several leading professional forex traders and
Interbank brokers (they used phones only before the Internet).
It's important to understand some key differences between professional
forex traders and this newer breed of online forex traders.
Professional forex traders often trade "forward contracts" (rather
than spot forex) because forwards have more transparency and better pricing
than spot. Most professional traders in forward forex understand they
are trading major currencies (for which regulated futures contracts [RFCs]
exist); therefore they can claim IRC 1256 60/40 tax treatment.
Most professional forward forex traders make a good living trading forwards
and they count on lower 60/40 tax rates each year (up to 12-percent lower
tax rates). Remember, IRC 1256 losses may be carried back three tax years,
but only applied against IRC 1256 gains in those years.
Contrast professionals with the newer breed of online forex trader. Most
online forex traders are new to forex; some moved from the online securities
or futures trading space. Many have very low account sizes ($2,000 to
$25,000) and they lack the capital, clout and connections to trade forwards
in the (non-retail) Interbank market.
The retail online forex trading marketplace did not pick up steam until
the early 2000s. When the 1990s online trading revolution in securities
suffered a bear market, brokers and traded morphed into the forex market.
This became possible when larger banks democratized Interbank market access
with new retail platforms.
The key difference is that online forex traders mostly trade spot contracts,
whereas professional traders have access to lower-priced forward contracts.
But are spot and forward forex contracts treated the same?
Spot and forwards may or may not have different tax treatment.
Although forward contracts are mentioned in IRC 1256, they receive ordinary
988 treatment unless a trader makes a contemporaneous internal election
to opt out of 988 for 1256.
Some tax professionals treat spot contracts as part of IRC 988 (with
no ability to elect to choose 1256), whereas other tax professionals think
that spot contracts in major currencies (with RFCs) may also be treated
like forwards above.
IRC 988 appears to state that if a trader does not "take or make
delivery" of the actual currency – and most traders don't make
or take delivery – then the spot contract can be treated like a
The key issue for forward contracts to be included in IRC 1256 is that
the forward contracts must be in major currencies (not minor currencies),
for which RFCs (regulated futures contracts) also are traded. For example,
forward contracts in the Euro qualify, since there are euro currency futures
traded on futures exchanges.
How to proceed with tax filings.
We believe that a "reasonable cause" position (which is weaker
than a "more likely than not" position) can currently support
treating spot like forwards, providing the spot is in a major currency
for which RFC futures contracts are also traded.
So if you want to claim IRC 1256 60/40 lower tax rates on spot trading
gains, it's wise to get a "reasonable cause" legal opinion.
Although the IRS requires tax preparers to have "more likely than
not" positions to avoid preparer penalties, they have waived this
higher standard for 2007 tax returns, allowing "reasonable cause"
Our firm works closely with a tax attorney who can provide these legal
opinions for our tax preparation clients.
In all cases, if you trade forex – anything other than currency
futures on US exchanges – it's wise to consult with a forex tax
expert (such as our firm). We are available for consultations and our
firm prepares tax returns for hundreds of forex traders.
The problem is that IRC 988 and IRC 1256 are conflicting sections.
IRC 1256 (60/40 capital gains treatment) and IRC 988 (ordinary gain and
loss treatment) have always been conflicting codes and regulations, especially
when it comes to currency traders.
After all, each code section was written for different types of taxpayers
(manufacturers vs. traders/dealers), by different IRS groups, in different
In 1982, Congress recognized that forex traders acted like futures traders
so they fixed IRC 1256 by adding "foreign currency contracts"
to the IRC 1256 definitions. Congress wanted to accommodate currency traders,
putting forex (OTC interbank off-exchange markets) on par with currencies
traded as "regulated futures contracts" (RFCs), which are (the
original) 1256 contracts.
This started the conflict between IRC 988 and 1256. IRC 988 already included
"foreign currency transactions" and "forward contracts"
in the Interbank market, which Congress said it now intended to be included
in IRC 1256.
Congress was clear about including "forward contracts" in forex
in IRC 1256, but they did not mention spot forex, too. Foreign currency
contracts under 1256 must be in a foreign currency for which there is
regulated futures trading (these are major currencies, all others being
The IRS was supposed to work this all out but they never did in a clear
way, or even at all. So there is room for much interpretation.
Spot forex is the odd man out.
A brewing trouble spot for Congress and the IRS is "spot" forex
(no pun intended). Congress and the IRS have not specifically named "spot
forex" per see as being eligible in IRC 1256 "foreign currency
contracts" and spot is clearly named as eligible in IRC 988.
But spot forex is just like forward forex, and if you apply the same logic
for how Congress justified putting forward forex into IRC 1256, the same
case can be made to include spot forex as well.
Traders don't make or take delivery in non-functional currencies for the
spot forex contracts they trade. Rather, they trade the contracts before
settlement in the same way they trade forward forex. The only difference
is that spot settles in less than 48 hours and forward settles in more
than 48 hours.
What opened the door to IRC 1256 for forward forex was that there were
currency futures contracts in the same currencies for the forward forex
contracts, and the same case applies to spot forex. Keep in mind that
there has been a bevy of new currency futures created since IRC 988 and
1256 rules were modified by Congress.
We currently think there is some room for interpretation on spot forex
(see above), which hasn't yet been barred from IRC 1256 as OTC currency
options were recently in Notice 2007-71 (see below).
Notice 2007-71 (established Aug. 27, 2007)
IRS Notice 2007-71 narrowly (yet definitively) addresses the tax treatment
for "over-the-counter currency options," stating they may no
longer be treated as "foreign currency contracts" in IRC 1256
(with lower 60/40 tax rates); instead they are part of IRC 988 (ordinary
gain or loss).
Notice 2007-71 entirely reverses IRS Notice 2003-81, which had ruled that
OTC currency options (on major currencies) are "foreign currency
contracts" in IRC 1256 (with 60/40 tax treatment). Relief was provided
for this change.
Even after 2007-71, forex tax law remains too vague and confusing for
most traders and brokers.
A summary view of forex tax after Notice 2007-71
Look at it this way.
Spot forex in uncertain. See details above.
Forward forex in uncertain. See details above.
Currency futures are "regulated futures contracts" in IRC 1256
OTC currency options are IRC 988 and they are barred from IRC 1256 (Notice
There are also elections to "opt-out"
There are various elections to "opt out" of IRC 988 and IRC
1256, which can serve to navigate again between the two tax treatments.
IRC 988 allows a trader (but not a manufacturer) to "opt out"
of IRC 988 ordinary gain or loss treatment into capital gains treatment.
This is referred to as the "capital gains" election. If a trader
has large capital-loss carryovers, they may want their forex gains to
be capital gains (rather than ordinary gains) in order to use up their
capital-loss carryovers. Conversely, if an investor (lacking trader tax
status) has large forex losses generating net taxable losses, their forex
ordinary losses can be permanently wasted. With the capital gains election,
they can covert wasted ordinary losses (not allowed for NOL since they
are not business traders) into useful capital loss carryovers.
As explained above, the opt-out election - IRC 988(a)(1)(B) - works a
little differently for forwards. Both IRC 988 and IRC 1256 include the
term "foreign currency contracts"; which are defined as forwards.
This raises a good question, can a trader simply choose IRC 988 or 1256,
or does IRC 988 apply by default and allow a trader to opt out of IRC
988 into 1256? Our tax attorneys think the later case applies.
Have your cake and eat it too.
We continue to think it's possible for most forex traders to get the best
of both (tax) worlds: ordinary loss treatment on spot and forward forex
trading losses (rather than capital-loss limitations), and IRC 1256 lower
60/40 tax rates on forward forex contracts (and maybe spot forex, too,
with more aggressive interpretations of the law – see above).
IRC 988 vs. IRS 1256 tax treatment.
IRC 988, by default, has ordinary gain or loss treatment. Losing traders
prefer IRC 988, since it does away with capital-loss limitations, allowing
full ordinary loss treatment against any type of income.
IRC 1256, by default, has lower 60/40 capital gains tax rates. Profitable
traders prefer IRC 1256, since it reduces their tax rates on trading gains.
IRC 1256 has a three-year carryback feature, but only against 1256 gains
in those years.
More about the intentions of Congress and the IRS.
In lay terms, Congress realized that trading in the forex market resembled
trading in the currency futures markets and that currency traders often
traded both forex and futures in one coordinated trading program.
It would be wrong, confusing and open the door to tax cheating, to only
allow ordinary gain or loss treatment on forex and 60/40 tax treatment
on futures. This is the reason Congress added "foreign currency contracts"
to IRC 1256 – to allow for navigation between IRC 988 and IRC 1256.
Hedging forex with futures and vice versa can also tie IRC 988 and 1256
IRC 988 must remain intact as well, as it mostly applies to manufacturers,
global corporations, and hedgers of those businesses. Hence, the continued
conflicts remain in IRC 988 and 1256.
Congress gave the IRS the right to figure out tax reporting abuse and
to bar certain instruments from coveted IRC 1256 60/40 treatment. This
is exactly what happened with the IRS Notices 2003-81 and 2007-71. Notice
2003-81 was issued to combat tax cheating and the Service applied a literal
reading of foreign currency contracts. 2007-71 later corrected 2003-81
and unfortunately it barred OTC currency options from 60/40 treatment.
History of IRC 1256 on "foreign currency contracts"
The definition of Section 1256 contracts includes certain forward contracts
for the future delivery of foreign currency:
"A forward contract is similar to a futures contract in that it
contemplates delivery of a specified quantity of goods, at a specified
price, at some specified date in the future. Forward contracts differ,
however, because they are private contracts in which the parties remain
entitled to performance from each other. No organized market or established
mechanism is available for terminating a taxpayer's position prior to
the delivery date, as in the case of futures. In addition, the terms of
a forward contract are usually not standardized, and forward contracts,
unlike futures, do not typically involve mark-to-market procedures or
margin requirements (although contract parties may agree on such measures
Informally, the IRS has indicated that it refers to “the OTC market
maintained by banks to purchase and sell foreign currency and financial
products,” and noted that “Congress intended to include within
the definition of a foreign currency contract bank forward contracts in
currencies that are [also] traded through RFCs because bank forward contracts
are economically comparable to and used interchangeably with RFCs.”
FSA 200025020 (June 23, 2000).
"Before ERTA (older tax law) was enacted, the tax consequences of
trading in forward and futures contracts were basically the same. The
ERTA regime, however, created disparity in the tax treatment of the instruments
given that Section 1256 only applied initially to RFCs (regulated futures
contracts), not to forward contracts. Congress subsequently came to view
forward contracts as being economically comparable to, and traded interchangeably
with, RFCs despite the differences noted above. The volume of trading
through forward contracts in foreign currency was substantially greater
than foreign currency trading on futures exchanges, and forward currency
prices were readily available. Accordingly, in order to eliminate the
disparity created by ERTA, the scope of Section 1256 was expanded in 1982
to encompass the foreign currency contracts described below."
"As added to the Code in 1982, Section 1256(b)(2) provides that
a foreign currency contract constitutes a Section 1256 contract. Under
Section 1256(g)(2)(A), a foreign currency contract is any contract that
meets three requirements. First, the contract must require delivery of
a foreign currency in which positions are also traded through RFCs (or
alternatively, the contract must contemplate a settlement that depends
on the value of such a traded currency). Currently (this old statement
is no longer true), only a handful of currencies are traded through
RFCs, including the Canadian dollar, British pound, Japanese yen, Swiss
franc, and German mark (pre-Euro). Other actively exchanged currencies
are not so traded, and as a result, forward contracts involving those
currencies are not subject to Section 1256 (e.g., Italian lire)."
Our comment: This list of currencies is dated and it has greatly expanded
to all the major currencies over the years, so a case can be made that
most spot forex has RFCs traded in those same currencies.
"In IRS Field Service Advice Memorandum 200025020, the Service,
after noting the lack of a definition of the 'interbank market' in the
statute, offered the following guidance:
"The interbank market refers to the OTC market maintained by banks
to purchase and sell foreign currency and financial products. The interbank
market is not a formal market, but rather a group of banks holding themselves
out to the general public as being willing to purchase, sell or otherwise
enter into certain transactions. The Service broadly interprets the interbank
market to include all banks and investment banks (as the terms are generally
used in the marketplace).
"Assuming that the first test is met, the second requirement is
that the contract must be traded in the interbank market. The legislative
history describes the interbank market as an informal market through which
certain foreign currency contracts are negotiated among any one of a number
of commercial banks. Contracts traded in the interbank market generally
include contracts between a commercial bank and another person as well
as contracts entered into with a futures commission merchant (FCM) who
is a participant in the interbank market. According to the legislative
history, a contract that does not have such a bank or FCM, or some other
similar participant in the interbank market, is not a foreign currency
Will forex brokers ever be required to report forex on 1099s?
A retail forex broker recently consulted with us about whether or not
1099s should be issued for their forex trading accounts. Industry practice
and forex tax law dictates that forex accounts are exempt from 1099 reporting.
Only interest income on forex accounts is 1099 reportable.
The above forex broker told us that their big-four accounting firm initially
wanted them to issue 1099s for forex accounts in the same way a futures
broker issues 1099s for IRC 1256 contracts. The big-four firm explained
that forex was now considered a futures-related product. We later learned
that the big-four firm changed their mind and decided to continue the industry
policy of no Form 1099 reporting for forex trading gains and losses.
Each year, our tax preparers notice that two forex brokers (not naming
names here) issue futures-type 1099s for their forex trading accounts.
We recently heard that one of these forex brokers only sends the 1099
to their clients and not also to the IRS. That's odd, as 1099s are intended
to be filed with the IRS.
Tax reporting for forex.
What should you do if you have forex trading losses reported
on a 1099 for IRC 1256 contracts?
If your position is that your forex loss should be ordinary (see above),
consider filing the forex trading loss first on Form 6781 (so the IRS
can match the 1099 reporting with their computers), and then transfer
the forex trading loss to another area of the tax return (line 21 of Form
1040 for investors or Form 4797 Part II for business traders).
Using line 21 Other Income or Loss on Form 1040 for IRC 988 transactions
is industry-accepted practice, although it's not stated in any IRS tax forms or
Note that IRC 988 writes about interest income and expense for reporting
IRC 988 transactions. Consider that forex traders do not borrow money
per-se and they don't pay interest to lenders, so using interest expense
makes little sense.
If traders had to report forex trading losses as interest expense, it
would be a problem for many investors, but not business traders. That's
because investors may only deduct investment interest expense up to
their investment income, with the rest carried over to subsequent years.
Conversely, in all cases, business traders are allowed full business interest
deductions, whether they have income or not.
Business traders (with trader tax status) should consider using Form 4797
(Sale of Business Property Part II ordinary gain or loss) rather than
line 21 of Form 1040. Securities traders who elect and use IRC 475 mark-to-market
accounting also use Form 4797 Part II; which is automatically picked up
in NOL (net operating loss) calculations. Line 21 is more of a red flag
to the IRS.
Traders need to file a Form 8886 (Reportable Transaction Disclosure Statement)
if they have "transactions that result in losses of at least $2 million
in any single tax year ($50,000 if from certain foreign currency transactions)
or $4 million in any combination of tax years..." Other transactions
mentioned on Form 8886 mostly relate to tax shelter transactions.
Forex traders should consult a forex tax expert (such as our firm) for further
discussion and decisions to make for tax reporting of their forex transactions.
We also recommend that forex traders include a tax return footnote with
their filing to explain this treatment.
Warning label and suggestions for how to proceed.
Traders should consult a forex tax expert on a one-by-one consultation
basis. Our Web site content above and throughout is for educational purposes
only. We are not responsible for any positions you extrapolate and take
on your own.
GreenTraderTax does provide consultation
preparation services. Our independent tax attorneys provide legal
opinions when needed (see above).
At tax time, it's important to provide your accountant
with your forex trade accounting, by spot, forwards, OTC currency options,
futures or otherwise.
We have not seen the IRS disallow forex tax treatment based on our prior
content. But it's too uncertain to tell how the IRS may react in the future.
It's possible that one IRS agent or office can seek to deny ordinary
loss treatment for forex trading losses where another IRS agent or office
can seek to deny lower 60/40 tax rates on forex trading gains. Although,
that appears to be mutually exclusive, it's entirely possible in the real
If you get an IRS notice or action in that regard, we strongly suggest
that you contact our firm for help.
If you have any questions or need help on forex tax,
please e-mail us at email@example.com
or call us.
We suggest a 30-minute
consultation with Robert Green or our tax attorneys.
GreenTraderTax provides forex tax content to many others:
Use the links below to access the following articles, interviews, and
other content from GreenTraderTax. See why the media (and also the leading
forex brokerage) look to GreenTraderTax for clarity in the confusing world
of forex taxation.
Robert Green gave the workshop
on forex taxation at the Forex Trading Expo in Las Vegas, Nevada in
September 2006 & 2007. Those presentations, including power points,
were based on pre-IRS Notice 2007-71 state of the law.
Robert Green hosted a FXStreet.com Live Web Event titled "Forex
taxation: IRC 988 versus 1256 60/40 treatment, trader tax status, forex
funds and more!" on Oct. 3, 2006.
Matthew Swibel, “Betting
Against the Dollar,” Forbes Magazine, International Investing
Guide (July 24, 2006), quotes me on the taxation of gains on currency
Robert Green, "In-Depth
Tax Information for Traders Including Forex," on the Robin Dayne
Show, VoiceAmerica Radio (July 5, 2006).
Robert Green, Workshop
on "FX Trading & Taxes," Currency Trading Expo. (June
Radio show with Robert Green on Forex
Trading Taxes, TraderInterviews.com (April 3, 2006).
Robert Green, "Trading
Across Borders: The Tax Issues," SFO Magazine (February 2006).
Robert Green hosts the Forex
Tax Forum on DailyFX.com. Use the link on the right to visit the DailyFX
Tax Forum. Several other leading forex sites soon will be distributing
GreenTraderTax's Forex Tax and Forex Fund content as well.
articles on forex tax by Robert A. Green:
Taxation of forex is confusing and uncertain in the tax code and that
makes tax filings difficult for forex traders. The tax problem is that
some types of forex are treated as IRC 1256 contracts with lower 60/40
tax treatment and other types of forex are treated as IRC 988 foreign
currency transactions with ordinary gain or loss treatment. Plus, IRC
1256 and IRC 988 are conflicting tax-code sections.
By Robert A. Green, CPA of GreenTraderTax CPAs.
Start with Robert Green's introduction article below and then read the
more in-depth articles on forex taxation
Traders prefer the best of all tax worlds with ordinary tax treatment
for losses, so they are exempt from capital loss limitations. And capital
gains (60/40) tax treatment for gains, so they save up to 12 percent in
tax rates (23 percent vs. 35 percent at current tax rates). Traders should
learn the complex rules for forex taxation before they start trading forex
so they can make the necessary elections in advance to ensure the best
overall tax treatment. Can forex traders have their (tax) cake and eat
Here is how the different types of forex are taxed:
Currency futures and options listed on U.S. commodities and futures exchanges
are by default treated as 1256 contracts. There is no confusion in the
tax code about it and traders or investors get lower 60/40 tax-treatment
But for these U.S.-listed forex futures and options, few traders know
they may also elect out of IRC 1256 for IRC 988 (foreign currency transaction)
ordinary gain or loss treatment. But this is not a big problem in the
real world since very few individual traders would want to exchange lower
60/40 tax-treatment for higher ordinary gain tax-treatment. This election
is very strict and it must be made on Jan. 1 or the start of trading later
in the year, and once made can only be revoked with IRS consent.
You can't cherry pick the election after-the-fact when you know you
have losses. This election is mostly used by corporations and hedgers
to avoid capital-loss treatment. Don’t panic about forex futures
losses; IRC 1256 losses may be carried back three tax years, but only
applied against IRC 1256 gains in those years.
Currency futures and options listed on foreign (not U.S.) exchanges are
treated differently by default, but possibly in the same manner after
doing some legwork. IRC 1256 contracts include not only contracts listed
on U.S. exchanges but certain non-exchange traded contracts, also. Two
things can help you get foreign currency futures treated as IRC 1256 contracts:
First, we have argued recently that foreign futures are similar to U.S.
futures and should be afforded IRC 1256 treatment. Otherwise, the U.S.
may be in contravention of tax treaties with many other countries.
Second, on spot forex taxation, we argue that a trader or investor may
elect out of IRC 988 for IRC 1256 on foreign currency futures listed on
foreign exchanges. Therefore, we believe that like spot forex discussed
below, you may claim IRC 1256 treatment on foreign currency futures listed
on foreign exchanges, providing you also timely elect out of IRC 988.
Over-the-counter currency options are a huge marketplace. They are not
futures or options contracts listed on U.S. or foreign exchanges, nor
are they interbank-traded spot or forward currency contracts. OTC currency
options are a breed apart and traded often by sophisticated traders. Even
though the IRS never cleared up dueling and conflicting older tax law
code sections IRC 1256 and IRC 988 in connection with spot forex taxation,
the IRS did make the tax rules clear for OTC forex options in their 2003
tax notice (2003-81). In the notice, the IRS clearly states that OTC forex
options are IRC 1256 contracts, but if you want 60/40 treatment, you still
have to elect it.
Notice a trend developing here. IRC 1256 recognizes some foreign currency
contracts as being 1256, while dueling IRC 988 also recognizes those same
contracts as being IRC 988. Which tax code section wins and applies?
It’s reasonable to conclude that the trend shows you can claim
1256 treatment, but you should also elect out of IRC 988. Join the 60/40
lower tax club, but also get permission first to leave the higher-taxing
IRC 988 club.
Here’s the skinny on IRC 988 foreign currency transactions. They
are ordinary gain or losses reported in summary form on line 21 of Form
1040. Conversely, IRC 1256 foreign currency futures are reported on Form
6781; where they are split 60/40 before being moved over to Schedule D
(Capital Gain or Losses).
- Important Note: You need to file a Form 8886 (Reportable
Transaction Disclosure Statement) if you have "transactions that
result in losses of at least $2 million in any single tax year ($50,000
if from certain foreign currency transactions) or $4 million in any
combination of tax years..." Other transactions mentioned on Form
8886 mostly relate to tax shelter transactions. These rules are found
in IRS Reg. § 1.6011-4(b)(5)(iii)(B) and IRS publication 550 and
IRC 988 interbank forex includes spot forex, forward forex and other
types of forex contracts mentioned in the articles below. Spot forex differs
from forward forex contracts in that spot settles in cash in no more than
2 days, and forward contracts settle in more than 2 days.
IRC 988 clearly states that a trader or investor holding a capital asset
(vs. a hedger or regular business) may elect out of IRC 988 for the more
tax-beneficial IRC 1256 on forex forward contracts and foreign forex futures.
IRC 988(a)(1)(B) requires that if you want 60/40 treatment for a forex
future (meaning foreign-exchange listed), options or forward, you have
to elect it (which we recommend using the global good-till-cancelled type
Here is where the big tax uncertainty comes into play. Notice that IRC
988 does not specifically mention that you may elect out of 988 on spot
forex. This glaring omission unfortunately leads many tax professionals
to shortsightedly concur that spot forex may only be treated with ordinary
gain or loss treatment.
We argue that you can dig deeper to find a way to treat spot forex as
IRC 1256, as long as you play it safe and also elect out of IRC 988 on
spot forex too.
Here is how it works and how you can do it.
Although it is not widely known by the forex trading marketplace, IRC
1256 recognizes many types of spot forex contract currencies as 1256 contracts.
Again, the problem is that IRC 988 also specifically recognizes spot
forex contracts as IRC 988 transactions. Again, these two tax code sections
conflict and cause uncertainty and risk for return positions on spot forex.
Does IRC 988 trump 1256 or does IRC 1256 trump 988 or must they co-exit?
The prudent answer seems to be they must co-exist.
If 1256 trumped 988 on spot forex, then spot forex would always be 1256
and you could not even elect out of 1256 for 988 as that is allowed for
U.S. exchange listed currency futures and options only. So you would be
stuck with 60/40 treatment, which is not good if you have large spot forex
trading losses, as you would prefer ordinary loss treatment with IRC 988.
Be careful what you wish for.
So it’s a good thing that our firm and consensus professionals
believe that spot forex is IRC 988 by default (sort of trumping 1256),
so you start with ordinary gain or loss treatment. We explain why we believe
that spot forex is sufficiently similar to forward forex contracts so
you can also elect out of 988 on spot forex, too.
It seems like our logic on spot forex pays good dividends. You can argue
that spot forex is 1256 as long as you elect out of 988 first. Have your
cake and eat it too.
Again, tax law for forex is very confusing and complex and the only thing
that is certain is that there are major conflicts in the tax code with
IRC 1256 and IRC 988.
A note of caution. You can have your cake and eat it too with ordinary
loss treatment and 60/40 gain treatment by using internal elections wisely.
But don't fool around with making these elections. If you wind up with
60/40 treatment on gains and ordinary loss treatment on losses from year-to-year,
that will appear to be “cherry picking” after the fact, even
though the elections must be made in advance of trading.
We expect IRS clarification, but possibly also a requirement for external
elections such as with IRC 475 mark-to-market accounting for business
also very important to read the fine print on this subject. Start with
our excellent articles.
March 18, 2006. We submitted this article on spot forex taxation to Currency
Trader magazine for publishing in their June 2006 issue.
Dec. 20, 2005. Robert A. Green, CPA wrote two articles for SFO magazine
on tax treatment (including some on forex and foreign futures) and global
tax matters (which covers having a foreign forex brokerage account). Click
here to read these articles.
April 2004. 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. Click
here to read this article.
If you have any questions, e-mail us at firstname.lastname@example.org
or call us.
For much more in-depth information about forex taxation, we recommend
that you purchase "The Tax Guide for Traders" by Robert A. Green
and our "2007 GTT Guide: 2006 Tax Return Examples for Commodities,
Futures & Currency Traders (Individual and Entities)." Click
here to visit our guide section.
Ready for a consultation
with Robert Green CPA?
by Robert A. Green, CPA to Futures magazine for the April 2004
March 2006: It's important to read our updated opinions on
forex taxation above. This article is good background information only.
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.
By Robert A. Green, CPA
When it comes to trading in currencies, special tax rules apply.
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 interbank market (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 "interbank" 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
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 interbank market to transact in Foreign
Currency Contracts and other Forward Contracts, they are exposed to foreign
exchange rate fluctuations.
However, currency traders look upon their currency positions as "capital
assets" in the normal course of their trading activity (business
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).
Foreign exchange 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. For more details see www.greencompany.com/EducationCenter/GTTRecCommodities.shtml#foreignfutures.
To “elect out” of IRC section 988 or not, that’s
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
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
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
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
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. For
examples, this writer’s company offers GTT
TradeLog, a leading program for active traders to download all transactions
and calculate trading gains and losses, with wash sales or IRC 475 mark-to-market
adjustments. (GTT TradeLog does not handle forex transactions).
Here is a good accounting solution for cash forex
Money managers report cash forex trading gains and losses using a “Performance
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
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
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
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
Cash forex is not regulated by 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
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.
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 email@example.com
or call us.