The universe of futures presents highly leveraged opportunities. However, if you are a trader considering futures trading, you should have a fundamental understanding of the way that futures are taxed. In this blog, we will be covering exactly that.
Compared to equity traders, future traders benefit from a more favorable treatment of taxes. According to section 1256 of the IRC (Internal Revenue Code), ‘any futures contract traded on a U.S exchange, foreign currency contract, dealer equities option, dealer securities futures contract, or non-equity options contract are taxed at 60% of the long-term capital gains rates and short-term capital gains rates at 40% - regardless of how long the trade was held.’ Since the highest capital gains rate for the long-term is 20%, while the maximum short-term rate stands at 20%, the average maximum combined tax rate would be 26.8%.
Also, every contract under section 1256 will be ‘marked to market’ at the conclusion of every year. Traders are allowed to report all unrealized or realized gains or losses, and shall be exempt from all wash-sale regulations.
For instance, let us suppose that John bought a $30,000 contract in February 2021 and rolled over at each contract expiration. Now, on the final day of the tax year, that is, December 31st, 2021, the contract’s FMV (Fair Market Value) stands at $36,000. John will now be recognizing a $6,000 ($36,000-$30,000) capital gain on his 2021 tax return. This gain of $6,000 will be taxable in the 60-40 ratio.
Now, if John sells the contract in 2022 for $34,000, he will have to enter a $2,000 ($36,000-$34,000) loss on his tax return for the year. This loss will also taxable in a 60-40 proportion.
If any future trader wants to carry back the losses, Section 1256 allows this for a maximum period of three years, provided that the carried back losses are not more than the gains accumulated during the previous year and are not increasing the operating losses for the current year. The loss will initially have to be carried back to the earliest year, and any remaining loss amount can then be carried to the two subsequent years. Once again, the 60-40 rule will be applicable. If there are any losses that remain unabsorbed even after carrying back, they can be carried forward.
Thankfully, the taxation process surrounding futures trading is pretty simple. However, if you still need any further knowledge or understanding on the topic, please feel free to reach out to us.
CFTC RULE 4.41 HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
Trading contains substantial risk and is not for every investor. An investor could potentially lose all or more than the initial investment. Risk capital is money that can be lost without jeopardizing one's financial security or life style. Only risk capital should be used for trading and only those with sufficient risk capital should consider trading. Past performance is not necessarily indicative of future results. All Software provided or purchased is strictly for educational purposes only. Any presentation (live or recorded) is for educational purposes only and the opinions expressed are those of the presenter only. Testimonials may not be representative of the experience of other clients or customers and is not a guarantee of future performance or success.
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