Dear new Forex trader,
I am challenged to write this article to tell you something no one wants
you to know about: FOREX Taxes.
As you know taxes are something you cannot escape. Yes, after having fun
with currency trading, you have to pay taxes for the pleasure of profiting and
most probably, loosing money, while chasing your Forex dreams.
If you have been involved in a Forex training and you heard nothing about
taxes, then you may consider your self a scam victim. Not a good state to be in,
I know. Sorry about that, but this is the reality, as you will learn from your
experience sooner or later.
Please, don’t spent your hard earned money to pay for any Currency
educational program, ebook, seminar, forex signals or whatever fancy product on
that matter you may find before to put them on a simple test. Just ask them: “Do
you offer education on Forex taxes?" I bet they don’t.
You want to apply the same test to your broker, feel free to do
it.
Why no one wants to tell you anything about the taxes you have to pay? If
you are smart enough to be involved into this business, you are getting that
chill on the spinal cord, while reading these lines, already.
Yes, your intuition is correct. The taxes you have to pay at the end of the
year may exceed all of the hard earned profits. Your losses, in some and most of
the cases, cannot be write out to their full extend and have to be rolled over
to the next year or years.
Let us take, for example, the tax code in the USA. There are two completely
different and contradictory rules dealing with taxes on currencies. The first
special rule is in Section 988 and the other one is in Section 1256 of the
Internal Revenue Code.
Section 1256 gives you considerable tax break, but it governs commodities.
As a currency trader you fall under the special rules of Section 988. However,
under certain conditions you are allowed to opt out of Section 988 and move into
Section 1256. The trap here is that you have to do this before and not after the
fact, simply to improve your tax position.
But moving into Section 1256, is not be the best case scenario if you
accumulate losses at the end of the year. Section 988 is the best choice for you
now.
You feel confused, please don’t, it is just the beginning of the tax maze.
Do you know that if you elected the mark-to-market accounting method, you won’t
be able to opt out of Section 988? You never heard about mark-to-market
accounting method? Ooops!
This is something you have to declare to Internal Revenue Service when you
are submitting you tax forms for the previous year on or before April 15. I
assume that you already submitted your tax forms and did not claim
mark-to-market accounting method, because you just read about it for the first
time.
Don’t worry, because you may not automatically get mark-to-market treatment
when you file as a trader. And you can't elect this treatment if you aren't a
trader.
The main advantage of the mark-to market method is that it eliminates the
Wash Sales Rule and discards loss limitations.
Under the Wash Sale Rule, if you sell security for a loss and buy it back
within the 30-day period before or after the loss-sale date, the loss cannot be
immediately claimed for tax purposes.
This rule is designed to prevent
you from selling security to claim the loss, then buying it back within a short
period of time to regain the ownership. Pay attention here, the rule applies to
a 30-day period before or after the sale date. It prevents from "buying the
security back" before it's even sold.
Without mark-to-market election you can deduct only $3,000 of net capital
loss, with the excess loss carrying forward only, not back to earlier,
profitable years. The election makes your trading loss free of this limitation,
and you can carry it back as well as forward. Do you see the difference and how
this can affect your trading results?
However, the election cannot be changed without the consent of the Internal
Revenue Service. You must use this method for all your future trading
years.
As stated earlier, you can make mark-to-market election, but not necessary
the mark-to-market treatment from IRS. You have to prove to IRS that you deserve
the traders’ status first.
Do you know what qualifies you as a trader? The shocking truth is that IRS
has no clear answer on this clear question. The only way to define your status
is to follow the guidelines developed through recent court cases addressing the
matter.
IRS treats you by default as an investor. Here you will find just one court
statement sounding clearer then the others:
“Even though a trader may have many transactions (500 or more), they still
may be an investor if the holding period is a matter of months rather than days
or weeks."
The tax codes are very different in different countries. The purpose of
this article is not to scare you but to give you a clear message that: You must
invest some time and money into serious currency tax code research and
consultation before to get involved into the currency trading at
all.
If you select to use a professional tax preparation service, you still need
to be fully aware about the tax rule on currency trading in your country and
take proper decisions on that matter when necessary.
For you trading success,
Teo Gee
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