How Taxes Can Impact Forex Traders
The only thing more certain than our eventual death is that we must pay our taxes to the IRS. Taxation makes the world go around; it’s the foundation of a capitalist economy. So, even though we may begrudge sending some of our hard-earned income to the IRS, we don’t have a lot of choice in the matter.
Paying Taxes as a Freelancer
Everyone earning more than the current minimum income rate is subject to income tax. The more you earn, the more tax you pay. Luckily, there are ways to minimize your tax liability, to ensure you don’t pay more than you need to. This is what accountants call ‘tax planning’. Paying taxes as a freelancer is more problematic, as you may have different income streams to consider, but you do still need to file your taxes, even if you make a loss.
Taxes and Forex
Forex traders probably don’t pay much attention to thoughts of taxation when they first dip a toe in the forex markets. They probably assume (rightly as it happens), that their profits will be meager if they actually make any money at all. However, if you persevere and become a successful forex trader, it is worth paying attention to the subject of tax.
There are two ways to look at tax in relation to forex trading. One is important if you are successful enough to make a profit on your trading endeavors. The other applies if you make a loss on your training account.
Profits and Losses
On your IRS tax return, you will see a section called 1256. This is an IRS sanctioned Section 1256 contract, which is where you include details of your income from forex trading. Income from forex trading – and other types of trading – is taxed as a capital gain rather than standard income from employment or self-employment. The first 60% of your gains from forex trading is taxed at 15%, which is the rate paid on long-term gains. The other 40% of your profits are taxed at your current income tax rate, which could be as high as 35%.
The other IRS sanctioned contract we need to mention is a Section 988 contract. This is applicable to traders who make losses. Section 988 lets you apply a loss from forex trading against any other income, which minimizes your tax liability.
Filing Your Taxes at Year-End
When you file your taxes at the end of the year, report your profits or losses in the appropriate section. If you are not sure which section best applies to you, it is a good idea to speak to a tax professional, who can advise you on the best way to minimize your tax exposure, legally, of course.
Watch Out for Form 1099
Most forex traders use a broker to conduct their trades, often via a trading platform. US-based forex brokers will send out form 1099 at the end of the tax year, so use this as a reminder to get your accounts in order.
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