Section 1256 Contracts

Section 1256 contract traders enjoy lower 60/40 tax rates, summary reporting and no need for accounting.

Section 1256 contracts include:
  • 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
    (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 taxed at the lower long-term capital gains rate and 40% are taxed at the short-term rate, which is the ordinary tax rate. At the maximum tax brackets for 2015 and 2016, the top Section 1256 contract 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% ordinary tax 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 year-end.

For more in-depth information on Section 1256 contract tax treatment, read Green’s 2016 Trader Tax Guide.