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Taxation and Forex

  • #1
  • First Post: Dec 28, 2009 10:46am Dec 28, 2009 10:46am
Hello everyone o/
Ok so I have been trading for about three months now (since I turned 18). How is taxation worked out for forex profits? Is it capital gains tax or something? Also if I was to form a LLC corporation or something similar would that benefit me tax wise? Sorry I have no idea what to do here!

Thanks!
David.
  • #2
  • Dec 29, 2009 2:50pm Dec 29, 2009 2:50pm
The first thing to do is talk to a tax accountant - only he or she would be qualified to advise you in your specific situation.

My (very general) understanding is that FX trading is considered short term capital gains, but there are specific rules for handling it that I don't quite remember.

This link should start your head spinning on the issue

http://www.greencompany.com/Educatio...Currency.shtml
  • #3
  • Dec 29, 2009 4:01pm Dec 29, 2009 4:01pm
Here is what I would suggest....

Go out and buy a economy size jar of Vaseline.. . Apply it to the appropriate orifice... Then bend over and grab your ankles....

Taxes will be on an upward trajectory over the next few years big time to pay for the moronic b.s. that has taken place over the past year......

Enjoy the change bro.....


p.s.
You are doing the right thing asking the questions and yes you would want to find a good accountant that is well Experienced in handling incomes derived from trading.. Find one that suits your own level of aggressiveness while of course staying within the boundaries of the law.
If you are very conservative in your trading you would not want an accountant that has you worried you might end up in jail and likewise if you are aggressive you would not be happy, more than likely, if your accountant was not protecting your assets as aggressively as you think he/she should. They are human too, some more aggressive than others....
It is a specialty, you wouldn't want your wifes gynecologist to operate on your brain, would you....humm, and,
Aunt Nancy that works for H&R Block seasonally don't count either....

plus,
taking the time to talk with the right accountant BEFORE you get too far along can head off making many mistakes (perhaps costly) before they happen...
  • #4
  • Dec 29, 2009 4:14pm Dec 29, 2009 4:14pm
You in the US?

First, state by state it varies. You may have to pay taxes, you may not, and the rate may vary.

Federally, in general, forex is treated either 1 of 2 ways, as ordinary income, or capital gains. You can choose which, due to a loophole that currently exists, but once you choose it's very difficult to go back. Losses are usually best treated as income, since there's a limit to capital losses you can declare per year, but if you're making money and in anything other than the lowest of brackets you'd probably be best off going the capital gains route. 1256 capital gains is treated as a blend, part long term, part short term. It's quite favorable.

Read:
http://www.forexfactory.com/showthread.php?t=164471

That's about the 1256 method.

As for an LLC, a straight LLC won't save you anything. Some of the more complex schemes might, but they're far outside of the scope of this post. You might be able to LLC in a state that has no state income tax, and then setup some complex compensation scheme to avoid most state taxes, but that's also way outside of this post.

Generally, the way to learn this stuff is to sit down with your federal returns and the booklet and fill out a mock return. Then go thru the state form and do the same. Once you've gone thru the process and have a clue about how it all fits together, then you can go talk to an accountant. It's tempting to do it the other way, to let the accountant do all the work, but most have no clue about how all of this stuff fits together and odds are you won't end up with the best advice. At the end of the day, knowledge is the best form of protection you can have. Then you'll be well qualified to judge how qualified the accountant is.
  • #5
  • Dec 29, 2009 5:11pm Dec 29, 2009 5:11pm
Quoting Rabid
You in the US?

First, state by state it varies. You may have to pay taxes, you may not, and the rate may vary.

Federally, in general, forex is treated either 1 of 2 ways, as ordinary income, or capital gains. You can choose which, due to a loophole that currently exists, but once you choose it's very difficult to go back. Losses are usually best treated as income, since there's a limit to capital losses you can declare per year, but if you're making money and in anything other than the lowest of brackets you'd probably be best off going the capital...
Good info above. Most tax professionals know squat other than 1040 EZ. Due your due diligence and save yourself some serious dinero.
  • #6
  • Dec 29, 2009 8:09pm Dec 29, 2009 8:09pm
Ok great info guys! I had no idea even where to start looking, havent even ever filed a tax return / statement before.
I live in Florida - was just told no income tax here which is I guess a good thing for me!
  • #7
  • Dec 29, 2009 8:24pm Dec 29, 2009 8:24pm
Here is what I understand about tax reporting concerning forex. I trade the spot currency market or “cash forex” in the interbank market (not on regulated futures exchanges) and the trades transact as IRS section 1256 contracts. I trade full time as of 11.10.2009.
I have two scenarios that I am examining in order to set up this “business” for 2010.
Scenario #1 is pretty simple. I just report my income as an “Investor”. I would report section 1256 contracts as capital gains and losses on Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles). This would allow me to split the gains and losses 60/40 on Schedule D: 60 percent long-term, 40 percent short-term. This 60/40 split works as follows: 60% is taxed at the lower long term capital gains rates (up to 15%) and 40% is taxed at the higher short-term capital gains rates (or “ordinary rate” up to 35%). The current maximum blended 60/40 rate is 23%. That’s it and I could likely handle this reporting myself. I would have to keep some records in accordance with IRS rules but that’s not a big deal.
Scenario #2 is a bit more complex but much like what we did with my other business. I could establish a legal entity, such as an LLC, S or C corporation. After completing the IRS SS-4 form, I would be issued an Employer Identification Number. Then I would transfer my brokerage account, out of my personal social security number, and into the new EIN. At this point, my business can begin and all "ordinary and necessary" business expenses incurred in my business of money management are 100% deductible. I use the term money management because I have not completely ruled out trading some money for others under certain very strict conditions. This would be at least 5 years into the future. I know that an LLC is a popular choice for traders. I’m not sure why yet. I have read that if I get into a high tax bracket, I would want to lower the income reported on my personal income tax return. I might be able to accomplish this by taking “shareholder distributions” fom my corp. I understand that I will have to report some personal income and pay self-employment tax as well as some corporate tax if a C or S corp is elected and so forth but there may be a formula here that keeps the tax liability low and allows me to pursue other business interests related to day trading such as teaching, writing and radio. (again waaaay in the future) I just don't want to limit my options at this early stage. I also have substantial itemized deductions that I could take advantage of. I know that having a corporation own a portion of an LLC could be advantageous in some ways. I am still trying to figure out the best way to set up my business entity. I can post more after I speak with my accountant later this week.

K.I.S.S.
  • #8
  • Edited 2:42pm Jan 11, 2010 1:06pm | Edited 2:42pm
KissFan, what did you find out from your CPA?

I've called 6 and only 1 called me back so far

I guess one of the main questions I have:

If you are a sole proprieter trader that qualifies for "trader tax status," and you are making money throughout the year, can you just take money out of your account whenever you feel like it and not have to pay taxes on it besides the capital gains due on your net profit?

(Made up numbers alert!) Imagine I am a single trader who does not own a home, and I have no other sources of income. I net $50,000 from my trading in 2010, but along the way I took out $20,000 in small increments to live off of, so the difference in my trading account is +$30,000. Is it correct to say that I would pay taxes on the $50,000, but not EXTRA taxes on the $20,000, or what?
Hindsight is 20/20
  • #9
  • Jan 11, 2010 3:20pm Jan 11, 2010 3:20pm
Quoting cosgrove
KissFan, what did you find out from your CPA?

I've called 6 and only 1 called me back so far

I guess one of the main questions I have:

If you are a sole proprieter trader that qualifies for "trader tax status," and you are making money throughout the year, can you just take money out of your account whenever you feel like it and not have to pay taxes on it besides the capital gains due on your net profit?

(Made up numbers alert!) Imagine I am a single trader who does not own a home, and I have no other sources of income. I net $50,000...
I did talk to him and it is my best understanding that I will pay tax on all profits whether I pull them out of my account or not. Profits are realized at the end of the year. I say "it is my best understanding" because I am repeating what I understood. I hope that this helps you. I can give you his information if you will PM me.

K.I.S.S.
  • #10
  • Jan 11, 2010 3:43pm Jan 11, 2010 3:43pm
If you form a Corporation (S-Corp is best) then you can take any income from trading performed under the S-Corp as a dividend and avoid paying the self-employment tax on it. Of course, a loss incurred on the year (and any reasonable business expenses) may be deducted outright from your personal tax liability via the "Profit & Loss from Business" form...

I have formed several S-Corps over the years. First one I paid an attorney about $500, not including the filing fees. Later ones I did myself based on modifications to the original I paid for.

An LLC or sole proprietor setup gets you nothing in the way of tax advantage other than representing that you have a business & can therefore deduct business expenses or losses - income reported via these forms would be subject to the self-employment tax.
"If The Fool persists in his Folly he will become wise." - William Blake
  • #11
  • Jan 11, 2010 3:47pm Jan 11, 2010 3:47pm
Quoting The Fool
An LLC or sole proprietor setup gets you nothing in the way of tax advantage other than representing that you have a business & can therefore deduct business expenses or losses - income reported via these forms would be subject to the self-employment tax.
I believe this page from Green and Company refutes your statement: http://www.greencompany.com/Educatio...mployTax.shtml

Unless I misunderstood...
Hindsight is 20/20
  • #12
  • Jan 11, 2010 3:53pm Jan 11, 2010 3:53pm
Quote
If you are a sole proprieter trader that qualifies for "trader tax status," and you are making money throughout the year, can you just take money out of your account whenever you feel like it and not have to pay taxes on it besides the capital gains due on your net profit?
In the US, "full time trader" tax status isn't necessary for 1256 contracts. Forex trades aren't subject to the wash sale rule.

You can take money out of the account whenever you want, but you will pay tax on your gains regardless.

Quote
(Made up numbers alert!) Imagine I am a single trader who does not own a home, and I have no other sources of income. I net $50,000 from my trading in 2010, but along the way I took out $20,000 in small increments to live off of, so the difference in my trading account is +$30,000. Is it correct to say that I would pay taxes on the $50,000, but not EXTRA taxes on the $20,000, or what?
Provided the account is in your own name, yes. There is no withdrawl tax.

Quote
I did talk to him and it is my best understanding that I will pay tax on all profits whether I pull them out of my account or not. Profits are realized at the end of the year. I say "it is my best understanding" because I am repeating what I understood. I hope that this helps you. I can give you his information if you will PM me.
If you incorporate, you can get the taxes off your personal tax filing. By itself, however, that won't reduce the taxes your company has to pay, so one way or another the gov't is going to get it's money. I say "by itself" because there may exist deductions that you can take to lower the company tax rate.

However...

If you put it in a company's name, you can't just withdrawl money whenever you want.

Now if you had millions coming in, then there are some complex inter-corporate schemes that can reduce your taxes. However for a small business, the amount of money you'd save is inconsequential when compared to the risk of getting it wrong. There's some grey area there around incorporating in a state that has no state income taxes, however. If you did that, you'd only pay federal taxes, and double tax on the money you specifically pay yourself (thus how profitable it is depends on how much you make).

With all of that said, all you need to really do to reduce your personal taxes is get very good at handling exemptions and deductions. There's an entire art to managing deductions, and there's some very creative things there. For that reason you might find it beneficial to setup an LLC. LLCs are claimed on your own personal taxes, so you'd still get the beneficial 1256 split while being able to take some new deductions.

You might also be able to incorporate the LLC in a state that has no state taxes, but I'm not sure what that would do for your own personal state income tax filing.

On both of those questions (what new deductions you can take and whether an outside LLC would help), you should ask your accountant.

Quote
If you form a Corporation (S-Corp is best) then you can take any income from trading performed under the S-Corp as a dividend and avoid paying the self-employment tax on it. Of course, a loss incurred on the year (and any reasonable business expenses) may be deducted outright from your personal tax liability via the "Profit & Loss from Business" form...
Well, sortof. You can set your ownership up to pay stock, and pay out dividends instead of wages. That would avoid some self-employment tax, but 1256 contracts aren't taxed with SE tax anyway, so there's little difference directly. Now the Bush tax cuts do allow a lower dividend tax rate than wage tax rate, but that provision is set to expire and will probably not be renewed. Furthermore, paying wages out of trading income isn't the best idea, it's only useful if you make far more in trading than you need to live.
  • #13
  • Jan 11, 2010 4:05pm Jan 11, 2010 4:05pm
Quoting cosgrove
I believe this page from Green and Company refutes your statement: http://www.greencompany.com/Educatio...mployTax.shtml

Unless I misunderstood...
Right, but since I operate another business (and pay corporate taxes for it) I can not represent that I trade all day every day & so I don't think I could represent that I should have "trader tax status"...

Now, I formed an S-Corp for the day-trading that I started this year and I plan on filing a tax return for that business soon. Since I had a loss, though, I am not too worried about it, but I do intend to do this year's trading business tax return with an accountant. There are several in the Seattle area who have experience with traders/daytraders - probably true for most larger US cities...
"If The Fool persists in his Folly he will become wise." - William Blake
  • #14
  • Jan 11, 2010 4:29pm Jan 11, 2010 4:29pm
Quoting The Fool
Right, but since I operate another business (and pay corporate taxes for it) I can not represent that I trade all day every day & so I don't think I could represent that I should have "trader tax status"...
Trader tax status is only relevant if you trade stocks. There is no trader tax status for 1256 traders. Trader tax status has to do with the wash sale rule and whether it applies or not, since there is no wash sale rule in 1256 contracts...

Quoting The Fool
Now, I formed an S-Corp for the day-trading that I started this year and I plan on filing a tax return for that business soon. Since I had a loss, though, I am not too worried about it, but I do intend to do this year's trading business tax return with an accountant. There are several in the Seattle area who have experience with traders/daytraders - probably true for most larger US cities...
If you're day trading equities too, things get messy in a hurry.

Linky:
http://www.fairmark.com/capgain/wash/

That's one area of the tax code that needs to be simplified for the modern world.
  • #15
  • Last Post: Jan 13, 2014 9:26pm Jan 13, 2014 9:26pm
If you live in the US you have to report your Forex Gain or Losses on Form 1040.

Whether it still works this way as of 2014 I don't know.

But last I heard, for example, say you fund your Forex account with $5000, and at the end of the year when you do taxes you actually only have $1000 left in the account (and did not take out any withdrawals and have basically lost $4000 to bad trade decisions or to a bad Forex robot)...

Then on Line 21 (Other Income) on your Form 1040 write:

Ordinary gain/loss from IRC 988 cash forex transactions

And then in the column on the far right (21) write:

-4,000

That $4000 loss with be subtracted from your gross income and you won't be taxed for it.

If on the other hand your account went from $5000 to $10,000 (you made $5000 trading), then write "Ordinary gain/loss from IRC 988 cash forex transactions" on line 21, but this time you add: 5,000 to the column on the far right. This will be added to your gross income and it will be taxed.

BUT what I don't know is whether money still in a Forex account is taxed, or only when you actually withdraw it.

Again I am not sure if these tax rules still apply in 2014, but if they do it is sure a simple way.
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