Favorable Tax Treatment

Favorable Tax Treatment for "Regulated Futures Contracts" (RFC)

"Regulated futures contracts" (RFC) are traded on commodities exchanges and are regulated by the exchange and the CFTC.

• Exchange traded commodities, including "currency RFCs" are covered under IRC section 1256 contracts. Investors report RFC section 1256 contracts as capital gains and losses on Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles)
• Investors are allowed to split the gains and losses 60/40 on Schedule D: 60% long-term, 40% short-term. Unlike traditional securities, there are no "holding periods" for futures contracts. Open trade profits or losses are treated as realized capital gains or losses as of the last day of the year and the 60/40 rule is applied to the gross profit or loss achieved during the year.
• With the maximum tax bracket of 35% on short-term capital gains and 15% on long-term capital gains, the current maximum blended rate of 60/40 tax treatment is 23%.
• The wash sale rules that generally apply to losses from the sale of stock, or securities do not apply to any loss arising from a section 1256 contract (which is marked to market at the end of the tax year).

Favorable Tax Treatment for Currency Trading

Investors who participate in the Forex market will notice the advantageous tax treatment for capital gains earned. Forex interbank investors can elect out of IRC section 988 for the more beneficial IRC section 1256, which allows investors to split their capital gains between 60% long term and 40% short term* , regardless of investment holding period.

There are two distinct types of currency trading, each subject to different tax treatments:

Cash Forex – Spot Market (Currency Pairs)

Cash Forex is subject to IRC section 988 (treatment of certain foreign currency transaction). The principal intention of IRC section 988 is to tax foreign currency transactions that take place in day-to-day international business operations, such as manufacturing and exporting. Fluctuations in exchange rates should be treated as ordinary income or loss and reported as interest income or interest expense. In the Forex interbank market investors are exposed to foreign exchange rate fluctuation and view their currency holdings as "capital assets". On this premise, currency investors may elect out of the ordinary gain or loss treatment in IRC section 988, thereby falling back to the default section 1256 contract treatment, or 60/40 capital gains and losses (i.e., 60% is taxed at long-term capital gains rates and 40% are taxed at short-term capital gains rates). When electing out of IRC section 988 the rules require the investor to elect out on a "contemporaneous basis". This means hindsight is not allowed and you must make your decision in advance of the trades. The election out of IRC section 988 should be filed "internally", which means the investor will keep their election decision in their own records as opposed to filing it with the IRS. With the top Federal Income Tax Bracket of 35% on regular income and 15% on capital gains, the current maximum blended rate of 60/40 tax treatment is 23%.

Currency Futures Traded on a Regulated Exchange

Currency futures traded on a regulated exchange are treated the same as other commodities and futures, that is they fall under IRC section 1256 contracts. Capital gains and losses are reported on form 6781 (Gains and Losses from Section 1256 contracts and Straddles). This allows business traders and investors to split the gains and losses 60/40 on Schedule D (60% is taxed at long-term capital gains rates and 40% are taxed at short-term capital gains rates). With the top Federal Income Tax Bracket of 35% on regular income and 15% on capital gains the current maximum blended rate of 60/40 for currency futures is 23%.

This information is for educational purposes only and should not be construed as tax or investment advice of any kind. Please consult with your tax professional for further clarification.

* This applies to US investors only. Foreign investors that are not residents or citizens of the United States have no tax ramifications on foreign exchange profits.

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