Forex trading is a lucrative business that has attracted many traders globally. With the emergence of online trading platforms, forex trading has become more accessible to anyone with an internet connection. However, traders must understand that forex trading is subject to taxes. This article aims to explain what taxes on forex in the US are.
Taxes on forex refer to the taxes that traders must pay on the profits they make from forex trading. In the US, forex trading is considered a speculative activity, and the Internal Revenue Service (IRS) taxes it based on the gains or losses made from trading.
The IRS categorizes forex trading as a section 988 transaction. This means that forex traders are subject to ordinary income tax rates, which are higher than the capital gains tax rates that apply to stocks and other investments. The IRS requires forex traders to report their gains or losses on Form 1040, Schedule D.
Forex traders can either be classified as traders or investors. Traders are individuals who engage in frequent buying and selling of currencies with the aim of making profits. On the other hand, investors hold currencies for the long-term, hoping to profit from the appreciation of the currency.
Traders are subject to different tax rules compared to investors. Traders can deduct their trading expenses, such as the cost of software, internet connection fees, and other expenses incurred while trading. Traders can also elect to mark-to-market their accounts, meaning that they report any gains or losses at the end of each trading day, and pay taxes on that amount.
Investors, on the other hand, are not allowed to deduct their trading expenses. They are subject to the same tax rules as investors in other securities. They pay taxes on their gains or losses when they sell the currency.
Traders who elect to mark-to-market their accounts can claim losses greater than $3,000 as ordinary losses, which can be used to offset other types of income, such as salaries or business income. However, traders must meet certain criteria to qualify for mark-to-market accounting.
Traders who do not elect to mark-to-market their accounts are subject to a 60/40 rule. This means that 60% of their gains or losses are taxed at the long-term capital gains tax rate, while the remaining 40% are taxed at the short-term capital gains tax rate. The long-term capital gains tax rate is lower than the short-term capital gains tax rate.
Forex traders must keep detailed records of their trading activities, including the date of the trade, the currency pair traded, the amount traded, the price at which the trade was made, and the gains or losses made from the trade. This information is necessary when filing taxes.
In conclusion, taxes on forex in the US are complex and require traders to understand the tax rules that apply to them. Forex traders can be classified as investors or traders, each subject to different tax rules. Traders can elect to mark-to-market their accounts, which allows them to deduct their trading expenses and claim losses as ordinary losses. However, traders must meet certain criteria to qualify for mark-to-market accounting. Forex traders must keep detailed records of their trading activities to ensure accurate reporting of gains or losses when filing taxes.