For most people who trade the Forex, most of their research time is spent focusing on trading strategies, currency analysis, and so on, and not usually on topics of accounting. Accounting practice is not usually high on the priority list for these traders. Unfortunately, even for the one who is not concerned about dealing with the IRS, the taxman still cometh.This topic is a very important one to not neglect though. Documentation is not usually presented to governmental tax organizations since the foreign exchange is an unregulated and international market. This places all the responsibility, then, on the trader, not the broker.
At most, the broker provides to the trader with the ability to view a detailed history of his trades. It is up to the trader then to compile these into his own tax report to provide to his accountant.
It should be noted that the quality of the data in the reports will vary from one broker to the next, but this amount of detail can be critical to making a difference between spending an exorbitant amount of time for the accountant to reconcile the data, or simply printing out a simple final report.
Obviously, good, detailed records make a huge difference in your tax reporting. Another tip for forex traders is to be very selective in who your tax preparer will be. This may seem obvious, but one should note that not everyone is intimately familiar with handling Forex gains and losses. It is important that you select one who has experience with accounts who trade the Forex on a regular or even professional basis.
As a Forex trader, you should be just as concerned with tax implications of your trading, and not just learning the latest Forex trading strategy. Know your options when it comes to how you will report your earnings. There are two primary options available to you. For the United States, you can either use IRC Section 1256, dealing with contracts, or IRC Section 988, for foreign currency transactions. With Section 1256, you can split your earnings up into a 60/40 ratio. Sixty percent of your total Forex earnings are taxed at the long-term capital gains rate, which is a nice 15% at this time, while forty percent of it is taxed at the short-term capital gains rate (ordinary income). The ordinary income tax rate is dependent on your specific tax bracket and situation. With Section 988, your earnings are taxed as interest income. If you want to opt out of Section 988 now or in the future (and you probably will prefer this, as it is a difficult tax classification to work with), keep good records to justify your move to Section 1256. By default, all Forex contracts are subject to Section 988.
Spot Forex is considered a forward if the trader closes out the position. Therefore, it is generally recommended that forex spot contracts in major currencies be reported on Section 1256, after a capital gains election has been made. Forex over the counter (OTC) options aren’t eligible for Section 1256 and must stop on Schedule D (capital gains and losses).
Losing traders prefer Section 988, since there are no capital-loss limitations, allowing full ordinary kind treatment against any type of income.
Reporting Forex gains and losses to the IRS can be a little confusing and difficult. Some types of Forex trading are treated as Section 1256, while some are treated as Section 988. To make matters even more cloudy, these two sections are conflicting tax-codes. If you want your taxes done correctly, find yourself a reliable tax advisor that specializes in helping people who trade the Forex.