Yes, you must pay taxes on gains from Forex and other securities in the U.S. Uncle Sam wants his slice of the trading pie. This article lays out the basics of how the IRS taxes Forex trading, including:
- How the IRS treats spot Forex trading versus Futures & Options
- The relevant IRS codes for trading
- The tax rates that apply to U.S. traders
- Tax benefits and exemptions
Let’s get started.
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Tax on Forex Trading in the USA: The Basics
The three most basic things to know from the beginning are:
- Spot Forex gains or losses default to ordinary income for tax purposes under Internal Revenue Code 988.
- Regulated options and futures trading gains or losses fall under short-term and long-term capital gains under Internal Revenue Code 1256.
- Some traders may qualify under IRS rules as “traders in securities for tax purposes,” commonly known as “Trader Tax Status,” which gives them further tax benefits.
Let’s get into the essential details.
IRC 988: Spot Forex
Most retail trading is Spot Forex. If you do not know if your account is Spot Forex versus Futures, the chances are it is Spot Forex, although your broker can confirm this.
The following are the tax rules for Spot Forex, assuming you have not elected the option to be a “trader in securities for tax purposes,” i.e., “trader tax status.”
- Spot Forex gains and losses default to ordinary income for tax purposes. I.e. Spot Forex income is subject to federal income tax brackets.
- Internal Revenue Code (IRC) 988 covers Spot Forex.
The beginning of IRC 988 reads, “… any foreign currency gain or loss attributable to a section 988 transaction shall be computed separately and treated as ordinary income or loss (as the case may be).” Click here for the text of IRC 988 (published by Cornell Law School).
- In IRC 988, the losses you can write off against your income are unlimited. In contrast, capital losses can have a limit of $3,000 per year under certain circumstances.
IRC 1256: Regulated Futures and Options Markets
- Section 1256 contracts, e.g. Futures contracts, get a special tax treatment of 60/40. This means a gain or loss will receive the tax treatment of 60% capital gain or loss and 40% ordinary income.
- Section 1256 contracts use “Mark to Market” accounting. This means any unrealized gains or losses in open positions are counted for tax purposes at the end of the year.
Some of your trading profits being classified as capital gains instead of ordinary income is generally more beneficial. This is because capital gains tax rates are lower than income tax rates. The maximum capital gains tax rate is 20%, whereas the maximum income tax rate is 37%.
IRS Topic 429: Trader in Securities for Tax Purposes, or “Trader Tax Status”
Taxpayers can apply to be a “trader in securities for tax purposes,” also known as “trader tax status.” The IRS outlines this designation in their Topic 429 (here).
The main benefit of trader tax status is the ability to write off business expenses associated with your trading. This ultimately reduces the amount of taxes you will pay. Expenses can include:
- Education fees, such as books, courses, and mentorship
- Subscriptions
- Equipment—computers, monitors
- Data feeds
Qualifying for trading tax status means showing that you trade as a business activity. The IRS lays down some subjective guidance on how a trader can show this:
- Trading activity must be substantial, regular, frequent, and continuous.
- A taxpayer must seek to catch swings in daily market movements and profit from these short-term changes with day trading, rather than profiting from long-term holding of investments.
To show if a trader meets the above conditions, U.S. tax experts have suggested the following:
- An average of four transactions per day, four days per week, 16 trades per week, 60 a month, and 720 annually. Opening and closing a trade counts as two transactions (even though it is one trade). Scaling in and out of a trade also counts as multiple transactions.
- Holding period: The average holding period must be 31 days or less. That’s a bright-line test.
- Hours per day on trading activities: Spend more than four hours daily, almost every market day, working on trading—this can be research and trading. All time counts.
- Operations: The trader has significant business equipment, e.g., computers, monitors, education, business services, and a home office.
- Account size: Securities traders need to have $25,000 on deposit with a reputable, regulated U.S.-based broker to achieve “pattern day trader” (PDT) status.
Do not count the following four types of trading activity for TTS qualification:
- Externally developed automated trading platforms. (If the trader can show they are very involved with creating the trading system, e.g., by writing its rules or code, the IRS may count this as TTS qualification).
- Using a trade copying service.
- Using a money manager.
- Trading retirement funds in non-taxable retirement accounts.
TTS Traders Electing for IRC 475: “Mark to Market” Accounting
Trader Tax Status individuals can elect Section 475, which has several benefits:
- It removes a $3,000 limit on carrying over capital losses. For traders who experience a large losing year, this can save tremendous amounts in future taxes.
- Section 475 also uses the mark-to-market accounting method, with the added benefit of removing “wash sale” requirements. A wash sale happens when you sell a security at a loss and buy the same or “substantially identical” security within 30 days. The wash-sale rule prevents taxpayers from deducting paper losses without changing their market position. Being exempt from the wash sale rule means being able to re-enter previous positions within 30 days that were closed at a loss, and still being able to count the previous loss for tax purposes.
Tax Rates for Forex Trading Income in the US
Remember, the IRS taxes Spot Forex as Ordinary Income and regulated Futures and Options as 60% Capital Gains and 40% Ordinary Income.
There are four categories for tax filings: single people, married couples filing jointly or separately, and “head of household” who are unmarried with dependents and pay more than half of household expenses.
Ordinary Income (e.g., Spot Forex in IRC 988)
Federal income tax has seven tax brackets, from 10% to 37%, at different income levels. The income thresholds change annually to account for inflation. The 2024 ordinary income tax levels (also known as “short-term capital gains tax) rates are:
Single
10% rate: $0 – $11,600
12% rate: $11,600 – $47,150
22% rate: $47,150 – $100,525
24% rate: $100,525 – $191,950
32% rate: $191,950 – $243,725
35% rate: $243,725 – $609,350
37% rate: $609,350+
Married Filing Jointly
10% rate: $0 – $23,200
12% rate: $23,200 – $94,300
22% rate: $94,300 – $201,050
24% rate: $201,050 – $383,900
32% rate: $383,900 – $487,450
35% rate: $487,450 – $731,200
37% rate: $731,200+
Married Filing Separately
10% rate: $0 – $11,600
12% rate: $11,600 – $47,150
22% rate: $47,150 – $100,525
24% rate: $100,525 – $191,950
32% rate: $191,950 – $243,725
35% rate: $243,725 – $365,600
37% rate: $365,600+
Head of Household
10% rate: $0 – $16,550
12% rate: $16,550 – $63,100
22% rate: $63,100 – $100,500
24% rate: $100,500 – $191,950
32% rate: $191,950 – $243,700
35% rate: $243,700 – $609,350
37% rate: $609,350+
Capital Gains Tax Rates
Capital Gains Tax have three bands: 0%, 15% and 20%. Similar to Ordinary Income Tax, the levels change yearly to account for inflation. The Capital Gains Tax (sometimes called “Long-term Capital Gains Tax”) rates for 2024 are:
Single
0% rate: Up to $47,025
15% rate: $47,025 to $518,900
20% rate: over $518,900
Married Filing Jointly
0% rate: Up to $94,050
15% rate: $94,050 to $583,750
20% rate: over $583,750
Married Filing Separately
0% rate: Up to $47,025
15% rate: $47,025 to $291,850
20% rate: Over $291,850
Head of Household
0% rate: Up to $63,000
15% rate: $63,000 to $551,350
20% rate: Over $551,350
How Much Trading Income Is Tax-Free in the USA?
Taxpayers must declare all their trading gains or losses on their tax returns. There are no tax-free levels of trading income in the US, whether the trading gains fall under ordinary income or capital gains.
Of course, if your trading income is negative, tax will not be due for that year.
Tax Benefits and Exemptions in the USA
Specific to trading income, having Trader Tax Status (under IRS Topic 429) means being able to deduct business expenses related to trading, such as data feeds, equipment, subscriptions, etc.
Tax benefits include deductions, credits, exclusions, and shelters for general tax purposes. The IRS has specific requirements to qualify for tax benefits, including income limits, filing status, and dependent status.
A tax exemption is a dollar amount that can be deducted from an individual's total income, reducing taxable income. There are two types of exemptions: personal and dependent. However, for the tax years 2018-2025, the deduction for personal exemptions is suspended (reduced to $0) by the Tax Cuts and Jobs Act. Although the exemption amount is zero, the ability to claim an exemption may make you eligible for other tax benefits.
Tips Relating to Forex Trading Taxation in the US
Here are my top tips:
- Know whether you are trading Section 988 or 1256 contracts and their comparative tax implications. Some traders will only trade Section 1256 contracts because of the tax advantages of capital gains vs. ordinary income tax. For example, instead of trading EURUSD, they will trade the equivalent Euro FX futures (6E) contract.
- Understand three key areas: Tax Trader Status (IRS Topic 429), the ability to write off business expenses under certain conditions, and IRC 475 (mark-to-market and wash sale exemption). This article briefly touches on all three areas, but plenty of reference material exists online to get into the details.
- Work with a Certified Public Accountant (CPA) with trader experience. Some CPAs that have not helped traders file taxes do not know the impact of rules, such as the IRC 475 election. A CPA with trading clients will give tailored advice on the tax codes and give informed recommendations on areas such as whether setting up an LLC or corporation is right for you.
- Many tax options, such as IRC 475 and Trader Tax Status, must be taken before the tax year begins. Know the deadlines that apply to the options you want.
Bottom Line
U.S. taxpayers must pay taxes on their trading, and the IRS has specific codes for different types of trading and instruments. The most important element for traders is understanding the choices between Section 988, 1256, Trader Tax Status, and 475 elections. The options affect whether the IRS treats trading gains and losses as ordinary income or capital gains tax and whether the wash-sale and carry-forward losses rules apply. Taxpayers must make many of the decisions on which tax codes will apply before the start of the tax year, so do the research early. A CPA with experience working with traders is a valuable tool to help save taxes.
