It would be wonderful not to account for some of your financial activities when filing taxes, wouldn’t it? Unfortunately, that won’t happen if you are invested in the currency exchange market. The U.S. is not among the FOREX tax-free countries.
As Benjamin Franklin famously stated, “...nothing is certain except death and taxes.” And the Internal Revenue Service (IRS) has taken the statement to heart.
Not only does the IRS consider your earned income from selling your products and services, but it also taxes many unearned forms of income, such as capital gains distributions and taxable interest. FOREX income, as the best sites to learn FOREX trading will teach you, is taxable. So, you should learn how to report your FOREX income accurately.
Read More: How Does Forex Trading Work?
What Happens If You Don’t Report FOREX Income?
Suppose you don’t include your FOREX income while filing taxes because you assume that it is not taxable. And then, later on, you realize that the IRS requires you to account for it. In that case, you could file taxes later. But there will still be consequences.
Unfortunately, ignorance is not bliss. If you file your taxes late, you would not only owe the tax bill, but may also incur the failure to file and late payment penalties. The former will cost you five percent of your unpaid taxes for every month or part of the month your return is late until it reaches 25 percent of the total tax you owe.
If you file a tax return but don’t pay taxes for the FOREX income you earned, you will likely incur the failure to pay penalty. That will cost you 0.5 percent of your unpaid taxes per month or part of the month you did not pay taxes, up to 25 percent of your pending bill.
In addition, you may be expected to pay an accuracy-related penalty for under-paying taxes on your reported income. Such penalties cost you 20 percent of the underpayment portion that occurred because of your disregard or negligence.
Read More: How to Calculate FOREX Margin
How to Report FOREX Income
Most, if not all trading platforms for FOREX investors enable you to earn income in various currencies. And the best app for forex activities you engage in may be based outside the country. Therefore, you are likely to earn some of your income in foreign currency, thus complicating the tax reporting process since you must still express your earnings in U.S. dollars.
Most times, the FOREX gains and losses you make will be reported in Form 1040 as Other Income on line 8. And you are required to find out that information from line 10 of Schedule 1, so you have to file the latter form too. The IRS considers them simple interest, instead of capital gains or losses.
If you qualify as a trader for taxation purposes, the IRS requires you to report your FOREX trading business expenses on Schedule C (Form 1040).
Understanding IRS Reporting Options
You can report FOREX income on relevant forms under two main IRS rules: IRS Section 1256 or IRS Section 988.
Typically, most FOREX income is taxed under the IRS Section 988 rules, which expects taxpayers to report the income as ordinary gains or losses and pay ordinary tax rates. In such cases, you can deduct your losses without limit, unlike capital losses. That is why you need Form 1040.
But if you opt for the former, your income from FOREX options and futures will be subjected to the 60/40 rule. Based on that rule, 60 percent of your gains or losses shall be treated as long-term gains, while 40 percent of them will be treated as short-term gains. For this reason, you may also need to fill in Form 6781.
Remember, U.S. brokers are supposed to give you a Form 1099 to help you compute your gains or losses. So, feel free to ask for the form if you don’t get one while filing taxes.
Read More: Form 1040: What You Need to Know
- ConstitutionCenter.Org: Benjamin Franklin’s last great quote and the Constitution
- IRS.Gov: Earned Income and Earned Income Tax Credit (EITC) Tables
- IRS.Gov: Your Federal Income Tax For Individuals
- IRS.Gov: Failure to File Penalty
- IRS.Gov: Failure to Pay Penalty
- IRS.Gov: Accuracy-Related Penalty
- IRS.Gov: Foreign Currency and Currency Exchange Rates
- IRS.Gov: Schedule 1Additional Income and Adjustments to Income
- IRS.Gov: Topic No. 429 Traders in Securities (Information for Form 1040 or 1040-SR Filers)
- Cornell.Edu: 26 U.S. Code § 988 - Treatment of certain foreign currency transactions
- Cornell.Edu: 26 U.S. Code § 1256 - Section 1256 contracts marked to market
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.