Last month, I explained how active traders can qualify for “trader tax status” to deduct unlimited business expenses, saving around $8,000 per year. In this article, we’ll cover the key differences in the tax treatment for securities, futures, forex, indexes, options, ETFs, and precious metals. You have to make the appropriate elections on time to get the best tax treatment for your situation.
Securities traders: Consider Section 475 before April 15
Trader tax status is a requirement for electing Section 475 MTM (marked-to-market) accounting, to convert subsequent trading losses into unlimited ordinary losses, which can offset income of any kind. It’s the best way for securities traders to avoid capital-loss limitations and wash-sale loss deferrals.
To elect Section 475 MTM for 2012, file an external election with the IRS by April 15, 2012 by attaching an election statement to your 2011 tax return or extension (S-Corps must file the election by March 15). New taxpayers (new entities) may elect Section 475 internally in their own books and records within 75 days of inception. There are many nuances to (and myths about) Section 475, which are beyond the scope of this article. See “2012 tax primer, part 1” (Active Trader, February 2012) and Green’s 2012 Trader Tax Guide for more on this topic.
Tax treatment depends on the instrument
There are a bevy of products to trade and you should learn how they are taxed before classifying them incorrectly on your tax return.
Futures. One of the biggest tax treatment differences is with futures, where the tax rates are up to 12 percent less, generally referred to as “60/40” tax rates. Whether it’s a day trade, or the position is held for more than a year, 60 percent is a long-term capital gain taxed up to 15 percent, and 40 percent is a short-term capital gain taxed at ordinary rates up to 35 percent. (Get it while it’s hot: Some Democratic politicians claim the lower futures tax rates are a “tax loophole” worthy of closure.)
Business traders and investors should always seek out opportunities to pay the lower futures tax rates associated with Section 1256 contracts, which are “regulated futures contracts” (RFCs) on U.S. futures exchanges. Most people are familiar with RFCs on commodities such as agricultural products, energies, interest rates, currencies, and stock indexes, but Section 1256 contracts also include non-equity options, broad-based indexes, options on indexes, foreign currency contracts (see the forex section below), and more. Broad-based indexes are defined as 10 or more underlying securities, which includes most E-Mini stock index futures.
For the complete article, see the March 2012 issue of Active Trader magazine. Click here to subscribe.
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