A resource for traders who need qualified tax counsel

Today is a holiday in the US and markets in the currency arena are a bit quieter than normal. This becomes an appropriate day to share a word or two on tax considerations for traders.

The following content is directly from Green Company.  The work of Robert Green and his firm are the creators of the following content and it is some of the most thorough on the topic of taxation on spot forex trading.

Executive summary
Foreign currency futures contracts on U.S. exchanges are reportable on Section 1256 with lower 60/40 tax treatment. Conversely, all forex (foreign exchange interbank) contracts are subject to Section 988 ordinary gain or loss treatment by default. Traders, but not manufacturers, may file an internal election to “opt out” of Section 988 (the “capital gains election”) into capital gains and loss treatment. With that capital gains election, forex forward contracts in major currencies are treated as Section 1256(g) capital gains and losses with the lower 60/40 tax treatment.

It is our belief that spot forex is treated as a forward if the taxpayer closes out the position. Therefore, we often advise reporting forex spot contracts in major currencies on Section 1256(g), after a capital gains election has been duly made.

However, forex over-the-counter (OTC) options must stop on Schedule D (capital gains and losses); they are not eligible for Section 1256(g) treatment (per IRS Notice 2007-71).

Professional forex traders vs. online forex traders
There are 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.

Forward forex traders trade major currencies (for which regulated futures contracts [RFCs] exist); therefore, after filing an internal capital gains election, they can use Section 1256(g) 60/40 tax treatment. Most professional forward forex traders make their living trading forwards and count on lower 60/40 tax rates each year — currently up to 12 percent lower tax rates (in 2008 and 2009). (More on Section 1256 below.)

Compare the professionals to the online forex trader. 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 lack the capital, clout, and connections to trade forwards in the (non-retail) interbank market.

The online forex-trading marketplace did not pick up steam until the early 2000s. When the online securities trading revolution suffered a bear market in the 90s, brokers and traders stepped into the forex market. This became possible when larger banks democratized interbank-market access with new retail platforms.

The key difference: Online forex traders mostly trade spot contracts, whereas professional traders have access to lower-priced forward contracts. But are spot and forward forex contracts given the same tax treatment?

The conflict between Section 988 and Section 1256
Before we go any further, let’s identify the two alternatives for reporting forex trading income and losses. Section 988 has ordinary gain or loss treatment. Losing traders prefer Section 988 because it eliminates capital-loss limitations, allowing full ordinary loss treatment against any type of income. Section 1256 has lower 60/40 capital gains tax rates. Profitable traders prefer Section 1256 because it reduces their tax rates on trading gains. Section 1256 has a three-year carry-back feature, but only against 1256 gains in those years.

Section 1256 and Section 988 have always conflicted, especially when it comes to currency traders. Each section was written for different types of taxpayers (manufacturers vs. traders/dealers), by different IRS groups, in different decades.

In 1982, Congress added “foreign currency contracts” to the Section 1256 definition (Section 1256(g)). Congress wanted to accommodate currency traders, putting forex (OTC interbank off-exchange markets) on par with RFCs — the original 1256 contracts (like currency futures). This created a conflict because Section 988 already included “foreign currency transactions” and “forward contracts” in the interbank market.

Congress was clear about including forward forex contracts in Section 1256, but it did not mention spot forex. Foreign currency contracts under 1256 must be in a foreign currency for which there is regulated futures currency contracts trading (i.e., major currencies). For example, forward contracts in the Euro qualify because there are Euro currency futures traded on futures exchanges. However, the IRS hasn’t clarified the rules, so there is room for much interpretation.

Congress gave the IRS the right to figure out tax reporting abuse and to bar certain instruments from the coveted Section 1256 60/40 treatment. This is exactly what happened with IRS Notices 2003-81 and 2007-71. Notice 2003-81 was issued to combat tax cheating; the notice applied a literal reading of foreign currency contracts. Notice 2007-71 later corrected 2003-81, and unfortunately it barred forex OTC currency options from 60/40 treatment. (More on Notice 2007-71 below.)

Spot and forwards may or may not have different tax treatment
Although forward contracts are mentioned in Section 1256(g), they are also mentioned in Section 988 and therefore, they receive ordinary 988 treatment; unless a trader makes a contemporaneous internal election to opt out of 988 for 1256. Some tax professionals treat spot contracts as part of Section 988 (with no ability to elect 1256), whereas other tax professionals think spot contracts in major currencies (that also have regulated futures contracts) may also be treated like forwards with Section 1256(g) treatment.

Section 988 states that if a trader does not “take or make delivery” of the actual currency – and most traders don’t make or take delivery – then the spot contract can be treated like a forward contract. Traders don’t make or take delivery in non-functional currencies for the spot forex contracts they trade. Rather, they trade the contracts before settlement in the same way they trade forward forex. The only difference is spot settles in less than 48 hours and forward settles in more than 48 hours. These are some of the reasons for a “substantial authority” argument to treat forex spot in major currencies like forwards for purposes of electing into Section 1256(g).

How to proceed with tax filings
We believe a “substantial authority” position (which is weaker than a “more likely than not” position) supports treating spot the same as forwards, provided the spot is in a major currency that also has a RFC . To claim Section 1256 60/40 lower tax rates on spot trading gains, it’s wise to receive a “substantial authority” legal opinion. The Internal Revenue Code allows relying upon “substantial authority” to avoid penalties.

Our firm works closely with a tax attorney who can provide these legal opinions for our clients.

OTC currency options
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 Section 1256; instead they are part of Section 988.
This notice reversed IRS Notice 2003-81, which had ruled that OTC currency options (on major currencies) are “foreign currency contracts” in Section 1256 (with 60/40 tax treatment).

Even after 2007-71, forex tax law remains too vague and confusing for most traders and brokers.

Opting out
There are various “opt out” elections for Section 988 and Section 1256, which can help navigate between the two tax treatments. Section 988 allows a trader (but not a manufacturer) to opt out of Section 988 ordinary gain or loss treatment into capital gains treatment. This is referred to as the “capital gains” election. If traders have large capital-loss carryovers, they may want to report their forex gains as capital gains (rather than ordinary gains) in order to use their capital-loss carryovers. Conversely, if investors (who lack trader-tax status business treatment) have large forex losses generating net taxable losses, their forex ordinary losses can be permanently wasted. The capital gains election converts wasted (non-business) ordinary losses into useful capital loss carryovers.

The opt-out election [Section 988(a)(1)(B)] is a little different for forwards. Both Section 988 and Section 1256 include the term “foreign currency contracts” which is defined as forwards. This raises the question: Can a forwards trader simply choose Section 988 or 1256, or does Section 988 apply by default, requiring the trader to opt out of Section 988 in order to report with 1256? Our tax attorneys think the latter case applies.

Section 988(a)(1)(B) “special rule” defined:

Special rule for forward contracts, etc. Except as provided in regulations, a taxpayer may elect to treat any foreign currency gain or loss attributable to a forward contract, a futures contract, or option described in subsection (c)(1)(B)(iii) which is a capital asset in the hands of the taxpayer and which is not a part of a straddle (within the meaning of section 1092(c) , without regard to paragraph (4) thereof ) as capital gain or loss (as the case may be) if the taxpayer makes such election and identifies such transaction before the close of the day on which such transaction is entered into (or such earlier time as the Secretary may prescribe).

Notice this election is on a transaction-by-transaction basis and a taxpayer can use Section 988 for the first part of the year, then learn about this election later on, and make the election for the balance of the year. The election can be done transaction-by-transaction or for a period of time, such as a “good to cancel” order.

“Opt out” capital gains election resolution

The trading company hereby elects pursuant to Section 988(a)(1)(B) of the Internal Revenue Code of 1986, as amended, to treat any foreign currency gain or loss attributable to a forward contract, a futures contract, or option described in subsection 988(c)(1)(B)(iii) thereof, as capital gain or loss, as the case may be, to the extent that such provision applies to contracts entered into by the taxpayer on or after the date hereof. This election will remain in force until affirmatively revoked by the taxpayer and is hereby entered into the books and records of the taxpayer’s foreign exchange trading activity.

Will forex brokers ever be required to report forex on 1099s?
A retail forex broker recently consulted with us about whether or not 1099s should be issued for its forex trading retail accounts. Industry practice and tax law dictates that forex accounts are exempt from 1099 reporting, as they are not “covered securities” for purposes of 1099 reporting rules. Only interest income on forex accounts is 1099 reportable.

Most forex retail brokers do not report forex trading on Form 1099 in compliance with the rules. However, a few forex brokers do provide their clients with 1099s for net forex trading gains or losses. We understand one broker does not file these 1099s with the IRS, but we haven’t confirmed this. We recently learned that another forex broker did file a 1099 (for Section 1256 contracts) with the IRS and it caused an IRS tax notice/inquiry; because the taxpayer used ordinary loss treatment rather than Form 6781 Section 1256 treatment (as called for on the 1099).

What should you do if you have forex trading losses reported on a 1099 for Section 1256 contracts (the ones the brokers usually use)? If your position is that your forex loss should be ordinary (see above), consider filing the forex trading loss first on Form 6781 (so the IRS can match the 1099 reporting with their records), and then transfer the forex trading loss to another area of the tax return (Form 1040, line 21 for investors, or Form 4797 part II for business traders). Make sure to explain this reporting treatment (along with the transfer to another form) in a tax return footnote. We did this for one client and they still got a tax notice requiring further explanation before closure.

Using line 21 “Other Income or Loss” on Form 1040 for Section 988 transactions is industry-accepted practice for investors, although it’s not stated in the IRS tax-form instructions.

Note that Section 988 writes about interest income and expense for reporting Section 988 transactions. Forex traders do not borrow money and they don’t pay interest to lenders, so using interest expense makes little sense. Reporting forex-trading losses as interest expense would be a problem for many investors, but not business traders. Investors may only deduct investment interest expense up to their investment income, with the rest carried over to subsequent years. Conversely, in all cases, business traders are allowed full business interest deductions, whether they have income or not.

Business traders (with trader tax status) should consider using Form 4797 (Sale of Business Property Part II ordinary gain or loss) rather than line 21 of Form 1040. Securities traders who elect and use Section 475 mark-to-market (MTM) accounting should also use Form 4797 Part II, which is automatically picked up in net operating loss (NOL) calculations. Line 21 (Other Income or Loss) can be a red flag to the IRS.

Is forex trading a tax shelter?
No, but traders need to file a Form 8886 (Reportable Transaction Disclosure Statement) if they have “transactions that result in losses of at least $2 million in any single tax year ($50,000 if from certain foreign currency transactions) or $4 million in any combination of tax years.” Other transactions mentioned on Form 8886 mostly relate to tax shelter transactions. If the forex trading loss is reported as a capital loss, we think you can skip the Form 8886 reporting, as we believe the rule relates to ordinary loss treatment.

Forex traders should consult a forex tax expert (such as our firm) for further discussion and advice on tax reporting forex transactions. We also recommend forex traders include a tax-return footnote with their filing to explain this treatment.

Suggestions for how to proceed
Traders should consult a forex tax expert. GreenTraderTax (Green & Company CPAs, LLC) provides consultation and tax preparation services. Our independent tax attorneys provide legal opinions when needed. Our Web site (www.greentradertax.com) is for educational purposes only. We are not responsible for any positions you extrapolate and take on your own.

We have not seen the IRS disallow forex tax treatment based on our positions to date; however, it’s difficult to know how the IRS will react in the future. Its possible one IRS agent will deny ordinary loss treatment for forex trading losses whereas another will deny lower 60/40 tax rates on forex trading gains. Although that appears to be mutually exclusive, it’s entirely possible.

Sherman Mohr’s Open Letter to Secretary Stawick of the CFTC

From Alternative Latin Investor: “Special FX”: Forex themes as 2009 draws to a close

Our last article focus on the widespread impact of change engineered by ongoing challenges to conventional wisdom and considered various trading styles that have subsequently evolved due to increased volatility and price turbulence within FX markets.

Not much has altered since although it’s fair to say markets have calmed down somewhat as players mull financial and behavorial effects to date on business conditions. With a degree of stability returning, players are turning their attention toward the debate on future expectations for FX market conditions, for example attempting to understand the increasinglly elevated status of and need for non-deliverable forward contracts and potential deregulation of ‘minor‘ currency markets as the currency world slowly, perhaps ironically, evolves.

Why ironically? Because FX is one of the faster-moving asset classes as far as execution, yet anecdotal evidence shows that even inevitability is always resisted (at least initially) by the human element; despite the advancement of technology, human resources is still the major component of influence in the world of currency trading and therefore can cause devlopments to move more slowly and more randomly than might otherwise be expected. For example, how many textbook traders would have expected the USD to remain so relatively steady during a bout of Quantitative Easing (QE), or simply put, printing money? The human factor cannot be underestimated because psychology must definitely have played a role in determining the USD’s floating market value, defying the odds against almost inevitalble devaluation. Players are buying USD even though algo systems and modelers may have specified QEto be a key component of a ‘sell‘ strategy.

Nevertheless, technological improvements are continuously underway and the topic of FX markets facing fresh regulatory issues in the U.S. and Europe may also have impacted recent psychology. This holds true despite obvious potential efficiency improvements that would be attainable in certain instances if people pushed beyond the limits human comfort zones. That‘s an issue not faced by the robots, black-box models or dark pools, which are emotionless and all about the price at a given point in time rather than what the price might be after an event.

The fanfare and buzz that continues to surround the asset class of Forex has been accompanied by reminders through observations and analysis that although entry into the Forex market perhaps rightly generates a great deal of excitement, developing and executing an FX plan efficiently is of far more importance than the speed of its completion. This theme is highlighted by the growing phenomenon of managed accounts and the boom in retail FX volumes, where significant non-correlated returns can be achieved—and not necessarily with leverage. The prospect of ‘easy money‘ is a common but potentially misleading theme in this market space, and it is worthwhile to consider professional advice before deciding to bet the farm on where the markets might be heading.

For full article click to register

News on Dubai - Will it affect your trading?

The BBC’s reporting of the crisis in Dubai and its world wide implications is far superior to that of the US media outlets. More evidence that our US audience is somewhat sheltered towards its attitude of global news and how it affects everyday life.

The currency markets experienced incredible volatility on Friday as a result of the news so we’ve found it worthwhile to share some of the news coming from the more reliable sources.

This BBC article is one such example.

“The glittering city in the desert has gone from the pinnacle of the world economic boom to the brink of bankruptcy. Christopher Davidson of Durham University explains some of the background.”"

Click here for rest of the article

Morning Currency News Nov 27th

Stock markets across the globe suffered fresh falls on Friday as global investors scrambled to understand the implications of Dubai World’s restructuring and unexpected debt standstill.

This volatility makes me wonder what automated systems that trade currency must be costing their owners this morning. Without great risk management, stops, take profit points, and some manual trading, we feel this environment would be one that automated or bot system traders would want to stay out of.

For the rest of the article from FT, click here.

Alternative Latin Investor Reports

Challenges for Successful Private Equity Investments in Brazil

By Zack Henry & Eric Saucedo

Someone forgot to tell Brazil that we’re in the middle of the worst global recession in history.

Brazil is quickly becoming a political and economic leader in Latin America and the world. As with the rest of the global economy, Brazil entered into a recessionary period in 2009, but economic data that have been emerging from the Instituto Brasileiro de Geografia e Estatística (“IBGE”) increasingly point to a stabilization in the economy, further suggesting that the country has perhaps been less impacted than other markets in this global recession. After the 4.4% quarter-on-quarter decline in 4Q08 and a subsequent 3.5% decline in 1Q09, the country’s GDP reached US$417.8 billion at 2Q09, up 5.2% from the prior quarter, and projected GDP growth for the second half of 2009 is running at about 4.0% or even higher (see Figure 1).

Many economists point to Brazil’s changing trade patterns as an important shield from the global recession as this year, for the first time, China overtook the United States to become Brazil’s single biggest trading partner. In addition, as copper and oil prices have remained relatively strong, Brazil’s commodity-based economy continues to demonstrate strong expansionary growth, and consumer spending, up 2.1% in 2Q09, represented the 23rd consecutive quarter of growth. Any PhD in economics can tell you, in technical terms, that this is ginormous.

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TradingMoms.com launched by Currency Investors Group

(1888PressRelease) October 12, 2009 - Currency Investors Group CEO Sherman Mohr stated in a team conference call this week that CIG would launch its effort to reach the Work at Home Mom market segment as a brand extension.

“The company has purchased the domain tradingmomsdotcom as a brand strategy. Experience tells us that Work at Home Moms comprise the majority of business opportunity participants in the home based business segment.” Mohr goes on to explain, “The average income derived by some of the biggest home based business participant companies seldom exceeds $810 annually according to numbers from the businesses themselves; this fact leads our marketing efforts in the direction of attracting Work at Home Moms to the benefits of currency trading.”

Currency Investors Group features experienced traders, team members, and trainers who both understand the foreign currency markets as well as the direct sales industry. Much can be said for the successes of the direct sales industry and its attraction of Work at Home Moms as a contracted employee segment.

Distinct advantages offered by that industry include unlimited earning potential, significant self improvement opportunities, corporate support in training and sales, and proven business systems.

Currency trading with the right mentorship team provides all of those advantages and more. There are minimal investments required in trading accounts. With Currency Investors Group, there is a career path for those who desire leveraging their new found skills to a larger market, training, and supporting others.

TradingMoms.Com will be a support tool to the Work at Home Mom segment and fully supported by Currency Investors Group.

View full release

Single Men and the Incredible Shrinking Account Balance

Nick Kapur tells us on Motley Fool; According to an oft-cited study by Brad Barber and Terrance Odean, men trade an unimpressive 45% more than their female counterparts, earning them annual net returns of — get ready — 1.4% less than the ladies. Worse still (for unmarried guys like me) is that single men trade a whopping 67% more than single women, earning them annual net returns of 2.3% less! The authors cite increased trading costs, taxes, and a greater tendency to speculate as reasons for this under performance.

I found this interesting and not at all surprising. I know completely brilliant men that when faced with the possibilities of losing money, they will still second guess expert advisers that were built by Bulgarian math minds or think that by shear will can move the markets.

Trading rules. That is what it’s about. In our company’s case, we utilize what’s called the Profit in Peace System for traders. This simple Pips system is a way to eliminate emotion, follow rules, and perhaps earn as much as female counterparts.

For the rest of the interesting Motley Fool article, follow this link.

News of the world’s view of the dollar is everywhere

“Steven Englander, a former Federal Reserve researcher who is now the chief U.S. currency strategist at Barclays in New York for London-based Barclays, the world’s third- largest foreign-exchange trader, predicts the U.S. currency will weaken 3.3 percent against the euro to $1.52 in three months. He advised in March, when the dollar peaked this year, to sell the currency. Standard Chartered, the most accurate dollar-euro forecaster in Bloomberg surveys for the six quarters that ended June 30, sees the greenback declining to $1.55 by year-end.”

For complete story, read here

The implications for the typical US investor should NOT be overlooked. Currency trading and currency trading education should be viewed as part of any sophisticated investors area of study.

For more information regarding how currency trading may help you hedge against the US government’s dissing of the dollar, contact Currency Investors Group or visit our Free Offers area.

The dollar’s decline and your portfolio

From Business Week:

“As fear of another Great Depression has ebbed, investors have turned their attention to the null interest to be earned on U.S. Treasury bills and are moving into riskier assets that offer higher returns. The zero interest on short-term government debt has caused more than $500 billion to move from money market accounts to corporate and longer-term government bond funds since January.

But won’t a weaker dollar make it harder for U.S. Treasuries and other dollar-related assets to attract the foreign capital needed to sustain the enormous U.S. current account deficit? Charles McMillion, chief economist at MBG Information Services in Washington, thinks so—and he believes this increases the chances that the Federal Reserve will raise interest rates to keep money flowing in from overseas.

Since the Fed’s priority is to bring unemployment down, some strategists think the likelihood of a rate hike soon is practically nil.”

This of course means, more debt, more government borrowing, and acceleration of the dollar’s decline in the eyes of most of those who follow these issues.

Catch the entire article here.

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