Investing in money
By Vincenzo Desroches
Forex income reporting rules can work to your clients’ advantage
one of the most popular investment activities that has experienced dramatic growth in the past five years is retail foreign
This activity was once the sole province of
large global banks, central banks, and other
financial institutions due to large lot sizes of
$1 million and average transaction amounts
of $5 million. However, with the creative spirit
of brokers to aggregate accounts, along with
the advent of the Internet and sophisticated
software trading platforms, the ability to
trade foreign currencies is now available to
any consumer on the planet with the will, the
capital, and a PC.
When the end of the year came around,
most forex traders found themselves in a
quandary as to how to prepare and report
gains and losses from their trading activities.
They quickly confronted an “unfriendly” Tax
Code that was extremely vague about treatment, tax rates, and where to enter anything
on Form 1040. A majority of tax professionals were most likely confused as well, since
the language of the Tax Code had not kept up
with the current state of affairs. Attempts to
clarify some sections resulted in ambiguity in
others. Matters have yet to be fully addressed,
but weary traders have had to scan forex news
and tax Web sites to do what is right.
The Tax Code assumes that trading in forex
futures is similar to trading regulated futures
contracts in the over-the-counter market.
RFCs are not like securities where professional traders must treat everything as if it
were ordinary income and expense related
to a business activity. Forex futures contracts
are accorded special treatment under Section
1256, where they receive a “60/40” split.
For example, 60 percent of the net gain for
the year is treated as a long-term capital gain,
and the remaining 40 percent as short-term
capital gain. The rules apply equally to losses.
Long-term capital gains are typically assessed
at a lower rate of tax, such as 15 percent versus 35 percent at the high end of the ordinary
income scale. These rates are scheduled to
change in 2011 and do not include various
state income tax burdens.
A subset of forex traders does trade forex
futures contracts on the OTC exchange. However, most forex traders deal in the spot or
cash forex market. To complicate matters,
many traders transact business in both forex
markets, including futures and spot. The
RFC part of tax reporting is straightforward,
although there was a move early in 2010 to
eliminate the 60/40 split benefit, but it died
in committee. This proposal will likely be
raised again since the Obama administration is searching for new tax revenue.
Brokers in the OTC space do provide 1099s at
year’s end with appropriate tax information.
Spot forex brokers generally do not provide
1099s. By default, these gains fall under Section 988. In this code section, the gains and
losses from forex are treated as interest revenue or expense, the net to be reported on
Line 21 of Form 1040. Consequently, capital gains rules do not apply, the 60/40 split
is not available for use, and unwary traders
can expect to pay more if they do not know
Section 988 is further complicated by requirements to record currency value changes
on a daily basis, but the Internal Revenue Service also permits a trader to opt out of these
provisions. A forex trader may choose Section
1256 treatment for each separate transaction
by opting out of Section 988 before each trade
and maintaining personal records to support
these elections. Most traders wait until year’s
end to make these decisions, but this bending
of the rules will most likely draw IRS attention
at some point.
The present situation is open to obvious
manipulation and abuse. In order to minimize taxes, a taxpayer would only have to
treat all losses as Section 988 to offset other
ordinary income, and then treat all gains as
Section 1256 to benefit from favorable capital
To complicate matters further, the IRS has
provided Notice 2007-71, which states that
“over-the-counter currency options” may no
longer be treated as “foreign currency contracts” in Section 1256; instead, they are now
part of Section 988. Forex binary options have
arrived on the scene in the past two years as if
the IRS anticipated their arrival beforehand.
An opt-out election exists for these, too.
Perhaps the IRS intended to clarify matters, but the 2007 notice and Sections 988 and
1256 remain conflicted and confusing as ever
for most forex traders and brokers.
The one positive point is that none of these
revenue items are subject to self-employment taxes, a relief of sorts. However, forex
traders would be wise to check with their tax
professionals before filing their tax returns,
especially regarding documentation for Line
21 items. AT
AUTOMATIC IRA BILL ON HILL
WASHINGTON, D.C. — Congressman Rich-
ard Neal, D-Mass., has introduced legisla-
tion that would allow companies to set
up automatic payroll deposit individual
retirement accounts, or Auto IRAs, for
workers. “Our bill would require employ-
ers to automatically enroll employees in
an Auto IRA unless the employee opts
out,” said Neal, who chairs the Subcom-
mittee on Select Revenue Measures on
the House Ways and Means Committee.
“These are ‘set it and forget it’ payroll
He noted recent research from Fidelity
that showed only one in 10 workers who
are eligible for automatic enrollment in
employer-provided plans proactively
opted out of the plan. The non-partisan
Retirement Security Project has estimated
that the proposal could raise net national
savings by nearly $8 billion annually.
The bill introduced by Neal is known
as the Automatic IRA Act of 2010. Similar
legislation was introduced in the Senate
in late August by Jeff Bingaman, D-N.M.
In Bingaman’s bill, employers would
receive a $250 tax credit for each of the
first two years that the plan was in operation, even if they contributed nothing.
However, companies that failed to offer
an automatic option to employees would
be subject to an excise tax of $100 for
each uncovered employee.
Vincenzo Desroches is a financial and
forex entrepreneur and a frequent author
on the subject. Reach him at vincenzo.
CFP BOARD TO START PUBLIC
BOSTON — The Certified Financial Planner
Board of Standards has hired a group of
agencies to lead a branding and public
awareness campaign to raise the profile
of the board. Arnold Worldwide’s Washington, D.C., office has been selected as
the agency of record to lead the branding and public awareness campaign,
while Arnold’s sister agency, MPG, will be
responsible for online and offline media
planning duties. Both Arnold and MPG
are part of Havas Worldwide.
Initially, Arnold and MPG will partner
with the CFP Board on research and
strategy to help determine how to best
position the brand and raise consumer
awareness, which may include traditional,
social media and digital components.