Yes, you are required to pay taxes on gains from Forex and other securities in the U.S.—Uncle Sam expects his share of your trading profits. This article covers the fundamentals of how the IRS taxes Forex trading, including:
- The IRS's treatment of spot Forex trading versus Futures & Options
- Relevant IRS codes for trading
- Applicable tax rates for U.S. traders
- Tax benefits and exemptions
Let’s dive in.
Tax on Forex Trading in the USA
Here are the three key points to understand right from the start:
- Spot Forex gains or losses are treated as ordinary income for tax purposes under Internal Revenue Code 988.
- Gains or losses from regulated options and futures trading are classified as short-term or long-term capital gains under Internal Revenue Code 1256.
- Some traders may qualify as “traders in securities” for tax purposes, known as “Trader Tax Status,” which offers additional tax benefits.
Now, let’s dive into the essential details.
IRC 988: Spot Forex
Most retail trading involves Spot Forex. If you're unsure whether your account is Spot Forex or Futures, it's likely Spot Forex, but your broker can confirm.
Here are the tax rules for Spot Forex, assuming you haven’t elected “trader tax status”:
Spot Forex gains and losses are treated as ordinary income, subject to federal income tax brackets.
Spot Forex is governed by Internal Revenue Code (IRC) 988.
IRC 1256: Regulated Futures and Options Markets
Section 1256 contracts, such as Futures contracts, receive special tax treatment with a 60/40 split—60% of gains or losses are treated as capital gains, and 40% as ordinary income.
These contracts use “Mark to Market” accounting, meaning unrealized gains or losses on open positions are taxed at the end of the year.
Having a portion of your trading profits classified as capital gains is usually advantageous, as capital gains tax rates are lower than income tax rates. The maximum capital gains tax rate is 20%, compared to a maximum income tax rate of 37%.
Tax Rates for Forex Trading Income in the US
Remember, the IRS taxes Spot Forex as Ordinary Income and regulated Futures and Options as 60% Capital Gains and 40% Ordinary Income.
There are four categories for tax filings: single people, married couples filing jointly or separately, and “head of household” who are unmarried with dependents and pay more than half of household expenses.
How Much Trading Income Is Tax-Free in the USA?
Taxpayers must declare all their trading gains or losses on their tax returns. There are no tax-free levels of trading income in the US, whether the trading gains fall under ordinary income or capital gains.
Of course, if your trading income is negative, tax will not be due for that year.
Tax Benefits and Exemptions in the USA
Trader Tax Status (under IRS Topic 429) lets you deduct trading-related expenses like data feeds and equipment.
Tax benefits include deductions, credits, and shelters, with specific IRS requirements.
Tax exemptions, which reduce taxable income, are suspended (set to $0) for 2018-2025, but claiming them might still qualify you for other benefits.
Tips Relating to Forex Trading Taxation in the US
U.S. taxpayers must pay taxes on trading, with specific IRS codes for various instruments. Key considerations include:
- Section 988 vs. Section 1256: Affects how gains and losses are taxed (ordinary income vs. capital gains).
- Trader Tax Status: Provides additional tax benefits for traders.
- Section 475 Elections: Impacts tax treatment and wash-sale rules.
Decisions on tax codes should be made before the tax year starts. Consulting a CPA experienced with traders can help optimize tax savings.
How are forex gains and losses taxed?
Forex gains are taxed, and losses can be offset or carried forward under certain circumstances.
What forex tax expenses can be deducted?
Assuming you have chosen IRS options that allow deductible expenses, items such as equipment, data feeds, and subscriptions are tax deductible.
Do you have to pay taxes on forex trading in the US?
Yes, you must pay taxes on forex trading in the U.S. Trading income is taxed as either ordinary income or capital gains.