FOREX TRADING TAX: ALL THE INFORMATION YOU NEED ON PAYING TAXES While FOREX TRADING

• The main objective for traders on the foreign currency, or forex, markets is to execute profitable trades and see their forex balance increase
• Many people only care about making money in the short run in a market where gains and losses can be realized in the space of a single blink of an eye.
• But before making that initial trade, it normally makes sense to think about the tax ramifications of buying and selling forex.

The Fundamentals of Forex Taxes

Cash forex is exchanged on the unregulated interbank market, which is governed by IRC Section 988, and currency futures are traded on the regulated exchange markets, which are governed by IRC Section 1256.

Depending on your losses and gains as well as your specific tax bracket, filing tax on forex trading under the first or the second option has advantages and disadvantages. Before delving into more depth, it is important to note that foreign exchange taxes are subject to the 60/40 tax rule, which states that 60% of losses and gains are recognized as long-term capital losses or gains and 40% as short-term capital losses or gains.

As Per Contracts under Section 1256

• Your taxes come under section 1256 if you trade futures currencies, in this scenario, investors are subject to a set 15% tax rate on 60% of long-term capital gains or losses.
• For investors who fall into one of the higher income tax categories (22% or higher), this form of forex tax treatment is typically advantageous.
• Short-term gains are always taxed at the same rate as the trader’s ordinary income when the proceeds of equities sold within a year of their purchase. These account for the final 40% and have taxes ranging from 10% to 37%.

As Per Contracts under Section 998

• If an investor reports their profits under this provision, they will be taxed at a rate ranging from 0% to 37% and will be considered as regular income. Depending on their individual bracket, a forex trader will pay a different amount. It’s crucial to remember that if a trader’s annual revenue is less than $12,400 and their sole source of income is forex trading, they are not required to pay tax on this sum.
• If you incur net losses during the course of the year, deciding to submit your spot forex trading taxes under this section can be quite advantageous because all losses, unlike in the 1256 contract, will be treated as ordinary losses.

Which Contract Should Trader Use?

1. Selecting which tax form is best for your circumstances, The investor has the choice to trade as either 1256 or 988, even though options, futures, and OTC are separated into separate groups,The choice of which to utilize must be made by the start of the calendar year.
2. Contracts under IRC 988 are less complex than those under IRC 1256, It is preferable when the trader reports losses because the tax rate is constant for both gains and losses. Notably, 1256 contracts offer 12% higher savings for a trader with net gains despite being more complicated.
3. The majority of accounting organizations use 1256 contracts for trading in futures and 988 contracts for spot dealers. Therefore, it’s crucial to consult your accountant before making an investment. You cannot change from one to the other once you start trading.
4. Usually traders decide to move from 988 status to 1256 status because they often expect net gains. Making an internal record in your books and filing the adjustment with your accountant are both necessary steps to withdraw from a 988 status. The difficulty of choosing between 988 and 1256 contracts can increase if you trade equities in addition to currencies because equity transactions are taxed differently.

Monitoring Your Performance:

Any practice requires you to keep track of your progress, and tax and forex trading are no exception

Your performance record might give you a more in-depth breakdown of your wins and losses even though your brokerage statement will give you a general overview of your trading activities.

The IRS-approved record-keeping formula is as follows:

• Step1: Subtract the opening assets from the closing assets.
• Step2: Subtract cash deposits from withdrawals and add deposits.
• Step3: Subtract your interest income from your paid interest.
• Step4: Include additional business-related expenses.

The performance record formula will provide you with a more accurate representation of your profit-to-loss ratio and make year-end filing simpler for you and your accountant.

IMPORTANT POINTS TO KEEP IN MIND

Remember the deadline:

• In most circumstances, you must select a tax situation type before January You can make this decision at any point before your first trade if you are a novice trader.

Keep accurate records:

• It will help you save time during tax season, this will allow you to spend more time trading and less time preparing your taxes.

Pay your taxes:

• Some traders try to game the system by not paying taxes on their forex trades.
• Some believe they may get away with it since over-the-counter trading is not regulated with the Commodity Futures Trading Commission (CFTC).
• You should be aware that the IRS will eventually catch up with you, and the tax evasion fees will be more than the taxes you owing.

“Today, it takes more brains and effort to make out the income-tax form than it does to make the income.”

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