Section 1256 Contracts
Section 1256 contract traders enjoy lower 60/40 tax rates, summary reporting and no need for accounting.
- U.S. futures (regulated futures contracts) and options on futures
- foreign futures with CFTC and IRS approval
- broad-based indexes and options on broad-based indexes
(a broad-based index is one that is made up of 10 or more securities)
- forward forex with the opt-out election into Section 1256g on the main currencies, for which futures trade (we make a case for spot forex too)
- options on commodities/futures ETFs taxed as publicly traded partnerships
- other non-equity options
Section 1256 contracts bring meaningful tax savings. These contracts have lower 60/40 tax rates, meaning 60% (including day trades) are long-term capital gains, and 40% are short-term capital gains taxed at ordinary tax rates. At the maximum tax brackets for 2015 and 2016, the 60/40 tax rate is 28% — 12% lower than the top ordinary rate of 39.6%.
With zero long-term rates in the 10% and 15% ordinary brackets, there is meaningful tax rate reduction throughout the brackets. In the 15% bracket, the blended 60/40 rate is 6%. (Here’s the math: 60% LT x 0% LT rate = 0%. Plus, 40% ST x 15% ST rate = 6%.) In the 10% ordinary tax bracket, the blended 60/40 rate is 4%. States don’t apply a long-term rate, so regular state tax rates apply.
Section 1256 contracts are marked-to-market (MTM) on a daily basis. MTM means you report both realized and unrealized gains and losses at year-end. Many traders have small or no open positions on Section 1256 contracts at the end of the year.
Form 1099-B reporting for Section 1256 contracts is concise and reliable for tax reporting purposes. With MTM reporting, there are no wash sale losses to consider. See 1099-B line 11 “aggregate profit and loss on contracts” and enter that summary amount on Form 6781 Part I.
Taxpayers can elect to carry back a Section 1256 loss. Check that box on top of Form 6781 to report current year net losses on Form 1040X amended tax returns for the prior three tax years, in order of oldest year first. The loss can only offset Form 6781 gains, not other income.
For more in-depth information on Section 1256 contract tax treatment, read Green’s 2016 Trader Tax Guide.