Before starting to trade in the Forex market, new traders should be familiar with the taxation of the Forex market and the tax benefits of a Forex career path.

While Forex trading is a confusing and complicated market, filing US taxes for your loss/profit ration can be even more complicated and even somewhat frustrating.

Taxes for Forex and Futures Investors​

All regulated futures contracts such as non-equity option, dealer equity options, foreign currency contracts or dealer securities futures contract investments are defined by the Internal Revenue Code (IRC) as 1256 contracts. The IRS is responsible for enforcing the IRC. These IRS contracts are subject to the 60/40 rule which means that 40% of the gains/losses are counted as short term capital gain/loss and 60% are counted as long term.

There are two types of benefits of this tax treatment:

1. Time

Most Forex traders make several transactions on a daily basis. 60% of these trades can be counted as long term gains/losses.

2. Tax Rates

Stock investors are taxed at the 35% short term rate if they own the stock for less than a year, while Futures and Options investors are subject to taxes at a 23% rate.

 Taxes for Over the Counter Investors

​Most spot traders are subjected to IRC 988 contract taxes. IRC 988 contract are applied for Forex transactions which are made within two days, which make these contract open to ordinary gains and losses reported to the IRS. Forex traders are usually automatically grouped in under IRC 988 contracts.

The biggest advantage of this tax treatment is loss protection. If you don’t see through your year-end trading, being categorized as an IRC 988 contract enables you to count all your losses as ordinary losses instead of just the first 3,000$.

IRC 988 vs. IRC 1256 Contracts

IRC 988 contracts’ tax rates remain constant for gains and losses which is ideal in case you

experience losses. IRC 1256 contracts are more complicated. However they include tax savings opportunities for traders with net income 12% or more.

As an investor you can choose either a 1256 or 988 contract, and you have to make the decision before January 1st. The different types of Forex contracts conflict, however at most accounting companies you will be subjected to 988 contracts if you are a spot trader and if you are a Futures trader you will be subjected to 1256 contracts. A key factor to deciding which contract to choose is consulting with your accountant before trading. Once you decide on a contract and start trading you won’t be able to change your contract.

Since traders expect net gains they will want to elect out of a 988 contract into 1256 contract. To opt out of a 988 contract you will have to make in advance an internal note in your books at your accountant. If you choose to trade stocks as well as Forex this complication increases. You might not be able to switch your contract status since stock transactions are taxed differently.

Keeping track of your performance record is a tax friendly way of recording your profits and losses. Following is an IRS approved formula of performance tracking:

1. Subtract your net beginning assets from your net end assets.

2. Subtract cash deposits and add account withdrawals.

3. Subtract income from interest

4. Add paid interest

5. Add trading expenses.

In conclusion, there are a few more things you should remember when it comes to Forex taxation:

Tax filing deadlines:  by January 1st you are required to choose a tax contract. You can change the contact in the middle of the year only with IRS approval.

By keeping your detailed records you will save time when the tax season will arrive.