How Forex Taxes are to be Calculated?
Investors from United States of America must pay taxes on the earnings they make from forex trading. Tax rules involving forex earning applies to U.S. traders only.
But foreign investors, who are not residents or citizens of the US, do not have to pay taxes on forex profits. For professional tax calculations you should consult with an advisor or tax consultant.
If you are involved in trading forex spot or cash market the tax rules applied will be same as the tax rules as regular commodities, which is IRC or Internal Revenue Code/ Section 1256 contracts. Or it may come under the special rules IRC Section 988 that involves “Treatment of Certain Foreign Currency Transactions”. It is also applied for cash/spot forex unless the trader chooses to opt out.
Rules under the Section 1256 offers some additional advantages for the currency traders. Under this section of guidelines forex traders enjoy significant advantage over stock traders. If a forex trader reports capital gains on IRS Form 6781 that is gains/losses from Section 1256 Contracts and Straddles, he or she can divide their capital gains on Schedule D using 60/40 split.
Accordingly, 60% of the capital gains will be taxed at the lower end, long-term capital gains rate which is currently 15%. Remaining 40% will be taxed at ordinary or short-term capital gains rate and this can be around 35%. This however depends on the tax bracket the trader falls under. This makes the total average rate to 23% and it is 12% less than regular, short-term rate.
Although cash forex is subject to Section 988 rules, a trader can elect the more advantageous Section 1256 split. Section 988 generally applies for the companies that generate income from the fluctuation in foreign exchange rates as a normal business practice. In this case the profit or the loss they make from foreign exchange by buying and/or selling of foreign goods are considered as interest income or expense and get taxed consequently. Therefore, they cannot avail the beneficial 60/40 split.
Ideally, all forex traders come under Section 988 as they are exposed to daily exchange rate fluctuations. But, thankfully, IRS considers these daily fluctuations as part of the currency trader’s assets in normal course of business and gives the trader the option of rejecting or opting out of Section 988 and in electing the favorable 60/40 split under Section 1256 for calculating the tax.
Tags: forex taxes, forex trading, Section 1256, Section 988