How Forex Trades Are Taxed (2024)

The primary goal for foreign exchange (forex) traders is to make successful trades and grow their forex account balance. In a market where profits and losses can be realized in the blink of an eye, many want to make money in the short term without really considering the longer-term ramifications. Nevertheless, it usually makes some sense to consider the tax implications of buying and selling forex before making that first trade.

Key Takeaways

  • Aspiring forex traders might want to consider tax implications before getting started.
  • Forex futures and options are 1256 contracts and taxed using the 60/40 rule, with 60% of gains or losses treated as long-term capital gains and 40% as short-term.
  • Spot forex traders are considered "988 traders" and can deduct all of their losses for the year.
  • Currency traders in the spot forex market can choose to be taxed under the same tax rules as regular commodities 1256 contracts or under the special rules of IRC Section 988 for currencies.

Tax Considerations on Forex and Futures

For tax purposes, forex options and futures contracts are considered IRC Section 1256 contracts, which are subject to a 60/40 tax consideration. In other words, 60% of gains or losses are counted as long-term capital gains or losses, and the remaining 40% is counted as short-term.

A 60/40 tax treatment is often favorable for individuals in higher income tax brackets. For example, the proceeds of stocks sold within one year of their purchase are considered short-term capital gains and are always taxed at the same rate as the investor's ordinary income, which can be as much as 37%. When trading futures or options, investors are effectively taxed at the maximum long-term capital gains rate, or 20% (on 60% of the gains or losses), and the maximum short-term capital gains rate of 37% (on the other 40%).

Section 1256 contracts held through the end of a tax year must be reported at fair market value—called marked to market—as capital gains or losses.

Taxes for Over-the-Counter (OTC) Forex Traders

Most spot traders are taxed according to IRC Section 988 contracts, which are for foreign exchange transactions settled within two days, making them open to treatment as ordinary losses and gains. If you trade spot forex, you will likely be grouped in this category as a "988 trader."

If you experience net losses through your year-end trading, being categorized as a "988 trader" is a substantial benefit. As in the 1256 contract category, you can count all of your losses as "ordinary losses," not just the first $3,000.

Forex Spot Traders Have a Tax Choice

Now comes the tricky part: Deciding how to file taxes for your situation. While options, futures, and OTC are grouped separately, the investor can choose to trade as either 1256 or 988. Individuals must decide which to use by the first day of the calendar year.

IRC 988 contracts are simpler than IRC 1256 contracts. The tax rate remains constant for both gains and losses, which is better when the trader is reporting losses. Notably, 1256 contracts, while more complex, offer 12% more savings for a trader with net gains.

Most accounting firms use 988 contracts for spot traders and 1256 contracts for futures traders. That's why it's important to talk with your accountant before investing. Once you begin trading, you cannot switch from one to the other.

The rules outlined here apply to U.S. traders with accounts at U.S. brokerage firms.

Most traders naturally anticipate net gains and often elect out of 988 status and into 1256 status. To opt out of a 988 status, you need to make an internal note in your books and file the change with your accountant. Complications can intensify if you trade stocks and currencies because equity transactions are taxed differently, making it more difficult to select 988 or 1256 contracts.

Record Keeping for Forex Taxes

You can rely on your brokerage statements, but a more accurate and tax-friendly way of keeping track of profit and loss is through your performance record.

This is a popular formula used in forex record-keeping:

  • Subtract your beginning assets from your end assets (net)
  • Subtract cash deposits (to your accounts) and add withdrawals (from your accounts)
  • Subtract income from interest and add interest paid
  • Add in other trading expenses

The performance record formula will give you a more accurate depiction of your profit/loss ratio and will make year-end filing easier for you and your accountant.

Forex Tax Special Considerations

When it comes to forex taxation, there are a few habits you can adopt that will keep you in good standing with the IRS:

  • Mind the deadline: In most cases, you are required to select a type of tax situation by Jan. 1. If you are a new trader, you can make this decision any time before your first trade.
  • Keep good records: It will save you time when tax season approaches. That will give you more time to trade and less time to prepare your taxes.
  • Pay what you owe: Some traders try to beat the system and don't pay taxes on their forex trades. Since over-the-counter trading is not registered with the Commodities Futures Trading Commission (CFTC), some think they can get away with it. You should know that the IRS will catch up eventually, and the tax avoidance fees will be greater than any taxes you owe.

How Do I Avoid Taxes on Forex?

It's best to keep accurate records of your transactions and file accordingly. It is against the law to attempt to avoid paying the taxes you owe.

How Am I Taxed for Forex Trading?

If you trade 1256 contracts, your trades are taxed at 60% long-term capital gains and 40% short-term capital gains. If you're trading 988 contracts, you treat losses and gains as ordinary (taxed at your income tax bracket level).

Is Forex Tax Free in the US?

In the U.S., Forex trading is considered a business activity that generates income, so you're required to pay taxes.

The Bottom Line

Whether you are planning on making forex a career path or are simply interested in dabbling in it, taking the time to file correctly can save you hundreds, if not thousands, in taxes. It's a part of the process that's well worth the time.

How Forex Trades Are Taxed (2024)

FAQs

How Forex Trades Are Taxed? ›

How Am I Taxed for Forex Trading? If you trade 1256 contracts, your trades are taxed at 60% long-term capital gains and 40% short-term capital gains. If you're trading 988 contracts, you treat losses and gains as ordinary (taxed at your income tax bracket level).

Do you pay taxes on forex trading? ›

Forex Options and Futures Traders

Forex options and futures contracts fall within Internal Revenue Code (IRC) Section 1256. These trades are subject to 60/40 tax consideration where 60% of gains and losses are eligible for long-term capital gains taxes while the remaining 40% is counted as short-term.

What is the tax on forex transactions? ›

What is the TCS taxation rate and which transactions will be affected? A: All forex purchases and remittances (other than for education, medical and business/ commercial purposes) over a threshold limit of Rs 7 lakhs in a financial year executed under the LRS will be liable to be deducted @20%, starting Oct 1, 2023.

Can I claim forex losses on taxes? ›

Forex trading losses are also treated as ordinary losses under Section 988. This means that forex traders are allowed to deduct their losses from their taxable income. For example, if a forex trader loses $10,000 in a tax year, they can deduct that amount from their taxable income.

How much do day traders pay in taxes? ›

Day trading taxes can vary depending on your trading patterns and your overall income, but they generally range between 10% and 37% of your profits. Income from trading is subject to capital gains taxes.

How much can forex traders make a day? ›

On average, a forex trader can make anywhere between $500 to $2,000 per day. However, this figure can vary significantly depending on market conditions, trading strategy, and risk management techniques. Some traders may make more than $2,000 in a single day, while others may make less or even incur losses.

Does Oanda send 1099? ›

OANDA does not report taxes on behalf of our clients, and as such, we do not provide any tax forms relating to profit/loss on your account (e.g. 1099-B form). Your annual account statement may help you with your tax reporting. You can download your annual account statement from the HUB by clicking on Statements .

Do forex traders pay tax in USA? ›

The first thing you should know is that forex trading is considered a business activity in the US, which means that you'll have to pay taxes on your profits. You also need to consider whether you're allowed to take advantage of any tax deductions or credits available to traders.

How do I pay less tax on forex? ›

Counting net losses can help reduce taxable income by utilizing Section 988. Reducing taxable income is the primary option to effectively reduce the taxes on FX profits. You can file under Section 1256 where 60% of gains are taxed at a lower rate, however, there is a 3,000 USD annual cap on trading losses.

How do I report forex losses on Turbotax? ›

Under All Income, locate the Less Common Income section. Click Show more and click Start next to Miscellaneous Income, 1099-A, 1099-C at the bottom. Click Start next to Other Reportable Income. Describe the amount as Section 988 Forex gain or loss (enter a negative number for a loss)

Where do I report forex income? ›

You would enter the information on Schedule 1 (Form 1040) Additional Income and Adjustments to Income, Line 8 as an ordinary gain or (loss).

How do you pay tax on trading? ›

How does a pattern day trader pay their taxes?
  1. Income is taxed automatically through PAYE (at regular Income Tax rates)
  2. Capital Gains Tax can be paid using the Real Time Capital Gains Tax Service.

Where do I put forex on my tax return? ›

Forex trading gains and losses should be reported on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, capital Gains and losses. Forex traders who have a net loss for the year can deduct up to $3,000 of their losses against other sources of income.

How much money do day traders with $10000 accounts make per day on average? ›

With a $10,000 account, a good day might bring in a five percent gain, which is $500. However, day traders also need to consider fixed costs such as commissions charged by brokers. These commissions can eat into profits, and day traders need to earn enough to overcome these fees [2].

Why do day traders get taxed so much? ›

If you buy an asset and sell it within a year of buying it and your profit, you're taxed at the short-term rate. Essentially, the profit is added to your yearly income and taxed at the same rate as your income. Depending on your tax bracket, short-term capital gains are taxed at 10% – 37%.

Do day traders pay taxes on every trade? ›

How day trading impacts your taxes. A profitable trader must pay taxes on their earnings, further reducing any potential profit. Additionally, day trading doesn't qualify for favorable tax treatment compared with long-term buy-and-hold investing.

What is forex income? ›

In the forex market, a profit or loss results from the difference in the price at which the trader bought and sold a currency pair. Currency traders do not deal in cash. Brokers generally roll over their positions at the end of each day.

How does forex trading works? ›

Foreign exchange, or forex, traders speculate on changing exchange rates by converting large sums of money from currency to currency, much like stock traders buy and sell different stocks. Forex traders essentially attempt to buy low and sell high for a profit, but the asset they are trading is currency.

What is the tax rate for capital gains? ›

According to the IRS, the tax rate on most long-term capital gains is no higher than 15% for most people. And for some, it's 0%. For the highest earners in the 37% income tax bracket, waiting to sell until they've held investments at least one year could cut their capital gains tax rate to 20%.

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