Forex Tax Tips: Reporting Trading Gains and Losses to the IRS
Posted by Riverman
As I fired up TurboTax and prepared to do my taxes this year, I found myself mystified about how to report forex gains and losses from the spot currency markets where I do my trading. My currency broker had sent me an IRS 1099-B form reporting my overall gains for the year, but didn’t provide any detail on their cost basis, dates, or anything else beyond the cumulative total gain of all my trades. I didn’t know if there was any other information I’d need to report to the IRS, or where in my tax forms to report it. I assumed Schedule D, along with the rest of my investment earnings, but wasn’t sure.
So I went poking around online for free advice on how to handle my forex taxation conundrum (or FTC, for short). In short order, Google delivered me to an excellent article by Robert Green, CPA. It’s a pretty comprehensive overview of tax treatment of different types of investments, and it has a subsection on forex that I found very helpful. In particular, this sentence cleared a few things up nice and quickly: “Traders in forex, both forward and spot contracts, are by default subject to ordinary gain or loss treatment under IRC 988 (foreign currency transaction rules).”
Green goes on to discuss ways that forex futures traders can file their gains under Section 1256 of the IRS code to avoid paying at ordinary tax rates. To do so, they would divide their gains and losses between 60% long-term gains (and thus taxed at a lower rate) and 40% short-term gains (taxed at the higher ordinary rate), substantially lowering the overall tax rate on their trades. Green notes that these rules could arguably be applied to the spot forex markets as well…which is where things get complicated.
Some further reading in an essay by Jim Forrester of Traders Accounting only succeeded in confirming that the simplest, least controversial way for a spot (or cash) forex trader to file their trades is as ordinary, short-term gains or losses. But Forrester also makes the point, alluded to in Green’s article, that “the IRS enables you to opt out of Section 988 [ordinary gains], and thereby retain the favorable 60/40 split for these gains under Section 1256.” How you do this is a somewhat complicated process, but if it’s worth it to you to save those percentage points on your taxes, Forrester’s accounting firm will be happy to help you out.
As for me, I didn’t have huge forex gains to report, and I didn’t feel like breaking any new ground in IRS policy, and I didn’t feel like paying someone to clarify the difference between Section 988 and Section 1256, and I definitely didn’t want the IRS calling me up and asking me to explain why I’d opted to account for my spot forex trades with forex futures rules. So I decided to keep it simple and safe and go with ordinary tax rates all the way.
But just to be sure, I went right to the source and called up the IRS. I was pleasantly surprised at how quickly I got a live person on the line, and after bouncing between a few people and clarifying some other tax issues (no, I couldn’t double-count mortgage interest as both an itemized personal deduction and a home office business deduction), I got to the IRS employee with all the investment answers. I described my forex trading activity and the 1099-B form I’d received, and his answer was unambiguous: report the gains on Schedule D. Report them as short-term gains. Pay taxes at the short-term gain rate. Describe them as gains from currency investments. End of story.
(If you’re ever befuddled about how to report an item on your taxes, I highly recommend calling up the IRS and describing your dilemma in excruciating detail. They won’t mind – in fact they’ll probably ask for even more excruciating detail; they’re required by law to answer your question (provided it’s about taxes); and afterwards you’ll feel reassured that you got the official line on the matter. Which is definitely one of the first things you’d want to mention to an IRS auditor if they ever show up at your door.)
Anyway, I hope this rambling taxation narrative was helpful – or at least that those links I provided to real tax advice are. Just keep in mind that this is merely a personal account of my own research into forex tax issues, and for God’s sake don’t take it as the final word on the subject. And now, please read the friendly disclaimer below. And then re-read it.
**DISCLAIMER: This post is simply an informational article intended for educational purposes and does not constitute tax advice from a licensed tax preparer. Be sure to consult an accountant or tax professional specializing in forex trading with any tax questions before reporting your trading gains or losses to the IRS.**
***This article was posted 3/1/2007, tax laws may have changed.***