Resident tax expert Lee Hadnum answers readers’ most pressing trading tax questions.
Q: I’m US resident and am looking at investing in both forex and stocks. I’ve been told that the forex investments have some substantial advantages for US tax purposes. Can you please clarify if this is the case, and, if so, exactly what are the advantages?
A: Yes, forex investments can have tax advantages. Forex traders involved in the forex spot market can choose to be taxed under the same tax rules as regular commodities (IRC Section 1256 contracts) or under the special rules of IRC Section 988 (Treatment of Certain Foreign Currency Transactions). IRC 988 applies to spot forex unless you elect to opt out. Note that forex futures are always taxed as Section 1256 contracts.
By using the Section 1256 route, 60 per cent of the capital gains are taxed at the long-term capital gains rate (currently 15 per cent) and the remaining 40 per cent at the standard capital gains rate, which depends on the tax bracket the trader falls under (and can be as high as 35 per cent). This results in an average rate of 23 per cent, which is 12 per cent less than the standard rate. Therefore, forex investors can have distinct tax advantages over stock traders.
Excerpted from an article originally published in the May/Jun 2010 issue of YourTradingEdge magazine. All rights reserved. © Copyright 2010, MarketSource International Pty Ltd.
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