Forex Tax Basics

Understanding Forex tax basics is important if you plan on being a trader. The tax code involving this market can be confusing. Before you start making too much money, you need to think about how you will keep track of your profits and losses and pay taxes on them.

Two Taxation Options

When you live in the United States, taxes can be confusing. One of the most confusing things about paying taxes on your profits from the Forex market is that you can choose between two different methods to be taxed under. The IRS lets you choose whether you want to have your Forex trades taxed under Section 1256 of the IRS code as if they were commodities. The other option is to have them tax under the special rules of IRC Section 988. After reading that, I'm sure you know exactly which one you want to choose when it's tax time and you should not be confused at all...right? Oh you're still confused? Me too. Let's keep going.

Using 1256

If you decide to use Section 1256, you may be able to realize some significant tax advantages. With this, you get to split up your profits and pay taxes on them at two different rates.

60% of your profits will be taxed at the long-term capital gains tax rate, while the other 40 percent are taxed at the higher short-term capital gains tax rate. This has the potential to save you as much as 23% on your Forex trades. Not bad, huh?

Opting Out

According to the IRS companies that engage in international business are taxed on any profits that they generate from fluctuations in the exchange rates of currencies. THis puts them into Section 988 of the code and does not enable them to the same 60/40 split. If you do nothing, you will also fall into this category on your tax return. To get the favorable split, you have to opt out of Section 988.

How exactly do you opt out? You do so internally, which means you create some kind of document at the beginning of the year that shows you opted out. Naturally, some people cheat and wait until the end of the year to do this.

Section 988

If you lose money trading on the year, leaving your taxes under Section 988 makes more sense. This way, you get to deduct a bigger capital loss.

Considerations

Depending on your Forex broker, you may get a document at the end of the year showing how much you earned or lost. You can also print out your pfofit and loss statement from your trading platform as well. Just make sure that you pay taxes or you could end up in trouble with Big Brother.

Traders in many other countries do not have to pay Forex tax. For example, traders in the Forex UK market don't have to pay taxes on earnings. If you fall into one of these regions, lucky you. You probably shouldn't be reading this page and you should be making tax-free profit in the market.


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