There are several good reasons to select futures as a trading venue for active traders. Included in those reasons are the possibility of lower effective income tax rates and simplified reporting on your tax return. A full time futures trader may have additional tax benefits with trader tax status from the IRS.
Choosing Filing Status
An active trader may elect to report trading profits and losses through one of two types of reporting. Trading results can be accounted for using mark to market accounting or listed on the trader's tax return as capital gains and losses. Each choice has its advantages. In addition, a full time trader can qualify for trader tax status with the IRS. Trader tax status allow the trader to account for his trading as a business and reduce his trading profits with the typical business related deductions, such as home office expenses.
Capital Gains and Losses
Choosing capital gains and losses reporting with futures trading has a significant income tax rate advantage. Capital gains and losses from futures trading are automatically split into 60 percent long term gains and 40 percent short term gains. Long term capital gains are taxed at a maximum rate of 15 percent. For a trader in the top 35 percent tax bracket, this long term / short term gain split results in a blended tax rate of 23 percent.
Reporting Futures Gains and Losses
Capital gains and losses from futures trading are reported on a different tax form than the Schedule D used to report gains and losses from other security types, such as stocks and options. Futures gains and losses are reported on IRS Form 6781: Gains and Losses from Section 1256 Contracts and Straddles. The trader does not have to provide a trading log to the IRS for futures trading. The traders broker will provide a 1099 with the gains and losses properly split for transfer to the appropriate sections of the Form 6781.
Mark to Market
Choosing mark to market accounting for futures trading changes all trading profits and losses to ordinary income and losses for trading purposes. Income tax rate using mark to market will be like regular wage income with tax rates up to 35 percent. The advantage of mark to market is the ability to take large net trading losses in the year they occur. Capital gains losses used against other income is limited to $3,000 per year. A trader with large futures trading losses and a large amount of other income could select mark to market to use the future trading losses to offset the other income in the same year.
- TradersLog; Futures: What You Trade Determines How You’re Taxed; Jim Forrester, CPA
- Day Trading Coach; Eight Steps to Successful Trader Tax Filing; Jim Forrester, CPA
- Trade Log Software: Futures Trading
- Trade Log Software: The Pros and Cons of Mark to Market
- Internal Revenue Service. "Form 6781: Gains and Losses From Section 1256 Contracts and Straddles," Page 2. Accessed Jan. 25, 2020.
- U.S. House of Representatives, Office of the Law Revision Counsel. "26 USC 1092: Straddles." Accessed Jan. 25, 2020.
- Internal Revenue Service. "Form 6781: Gains and Losses From Section 1256 Contracts and Straddles," Pages 1-2. Accessed Jan. 25, 2020.
- U.S. House of Representatives, Office of the Law Revision Counsel. "26 USC 1256: Section 1256 contracts marked to market." Accessed Jan. 25, 2020.
- Internal Revenue Service. "Form 6781: Gains and Losses From Section 1256 Contracts and Straddles," Pages 3-4. Accessed Jan. 25, 2020.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.