Tax Tips for Forex Traders (Part 1)
02/19/2008 12:00 am EST
As we head into tax preparation time,
we thought it would be a good idea to ask Robert Green of GreenTraderTax.com to
provide us with an update on one of the more confusing tax preparations, the
IRS Notice 2007-71 (established Aug. 27, 2007) reverses IRS Notice 2003-81. IRS Notice 2007-71 narrowly (yet definitively) addresses the tax treatment for "over-the-counter currency options," stating they may no longer be treated as "foreign currency contracts" in IRC 1256 (with lower 60/40 tax rates); instead they are part of IRC 988 (ordinary gain or loss).
Notice 2007-71 entirely reverses IRS Notice 2003-81, which had ruled that OTC currency options (on major currencies) are "foreign currency contracts" in IRC 1256 (with 60/40 tax treatment). Relief was provided for this change.
Although both of these IRS Notices appear narrow in scope-addressing OTC currency options, which are just one of many types of currency vehicles to trade-both notices have much greater implications on the current state of forex tax law.
Even after 2007-71, forex tax law remains too vague and confusing for most traders and brokers.
Retail spot forex traders are different from professional forward forex traders.
The forex interbank market has been around for many decades. Robert A. Green founded Green & Company CPAs in 1983 to handle the special tax and accounting needs of several leading professional forex traders and interbank brokers (they used phones only before the Internet).
It's important to understand some key differences between professional forex traders and this newer breed of online forex traders.
Professional forex traders often trade "forward contracts" (rather than spot forex) because forwards have more transparency and better pricing than spot. Most professional traders in forward forex understand they are trading major currencies (for which regulated futures contracts [RFCs] exist); therefore they can claim IRC 1256 60/40 tax treatment.
Most professional forward forex traders make a good living trading forwards and they count on lower 60/40 tax rates each year (up to 12-percent lower tax rates). Remember, IRC 1256 losses may be carried back three tax years, but only applied against IRC 1256 gains in those years.
Contrast professionals with the newer breed of online forex traders. Most online forex traders are new to forex; some moved from the online securities or futures trading space. Many have very low account sizes ($2,000 to $25,000) and they lack the capital, clout, and connections to trade forwards in the (non-retail) interbank market.
The retail online forex trading marketplace did not pick up steam until the early 2000's. When the 1990's online trading revolution in securities suffered a bear market, brokers and traders morphed into the forex market. This became possible when larger banks democratized interbank market access with new retail platforms.
The key difference is that online forex traders mostly trade spot contracts, whereas professional traders have access to lower-priced forward contracts. But are spot and forward forex contracts treated the same?
|More tomorrow in Part 2.||Part 2 | Part 3 | Part 4|