Paying Taxes when Forex Trading
It might have taken you months or years to make your first profits trading the foreign exchange markets or FOREX. Hopefully you have records of all your loses as you will need them to now offset the profits you have made trading. That is it, Uncle Sam and the IRS will tax your FOREX winnings as soon as you begin to profit. FOREX traders in the United States have two options to claim their profits from foreign exchange trading, either using IRC Section 1256 dealing with contracts or IRC Section 988 for foreign currency transactions.
With the first IRC section code, 1256, you can file your profits on form 6781 and split them 60/40. 60% of the profits will be taxed as capital gains which is a nice 15% at this time and the other 40% are taxed as ordinary income. The ordinary income tax rate depends on your income level and tax situation. With code section 988 your earnings are taxed as interest income which is the same as ordinary income for the most part. Keep a record that you want to opt-out of section 988 before you start trading to avoid this difficult tax classification.
At the end of the tax year you should receive a 1099 from your FOREX broker. This form is also filed with the IRS which makes it impossible to avoid paying tax on the profits from your trading account. So keep track of all your loses and all your expenses and look into the rules for running a home-based business if you do all your trading from home. There are many deductions you can take as a home-based business that will help cushion the tax bill. Also try to pay estimated taxes throughout the year if you know you will owe when you file your return next April. You can avoid penalties this way and not have to scramble to find the funds to pay the IRS when it is time to report.