February 2017

A Case For Retail Forex Traders Using Section 1256(g) Lower 60/40 Tax Rates

February 25, 2017 | By: Robert A. Green, CPA

Trading leveraged forex contracts off-exchange has different tax treatment from trading currency futures on-exchange. Currency futures automatically have lower “60/40 tax rates” in Section 1256, with 60% benefiting from lower long-term capital gains rates, even on day trading. It’s harder to achieve lower 60/40 tax rates on leveraged forex trading, but worth the effort since 60/40 rates are significantly lower. (See Several Ways To Trade Currencies, Some With Lower Tax Rates.)

Forex trading
Most American retail forex traders open accounts with a CFTC-registered Retail Foreign Exchange Dealer (RFED) or an FCM Forex Dealer Member. By default, off-exchange leveraged spot and forward forex contracts are Section 988 ordinary gain or loss tax treatment. A forex trader may elect capital gains treatment, which on short-term capital gains is the ordinary tax rate. If a forex trader doesn’t “take or make delivery” in cash, there is a case for using Section 1256(g) (foreign currency contracts) on “major” currencies if the trader meets the requirements of Section 1256(g)(2). The same tax treatment applies to Eligible Contract Participants (ECP). Tax treatment is uncertain for spot forex contracts traded with RFED and FCM Forex Dealer Members.

Section 988 foreign currency transactions
By default, spot and forward forex transactions in the interbank market start off in Section 988 “foreign currency transactions,” and they are subject to ordinary gain or loss tax treatment. A forex trader is entitled to file an internal, contemporaneous Section 988 opt-out election, otherwise called a capital gains election, for short-term capital gains and loss treatment. This election can be filed or retracted, on a “good to cancel basis” during the tax year.

Section 988(a)(1)(B) opt-out election: “A taxpayer may elect to treat any foreign currency gain or loss attributable to a forward contract, which is a capital asset in the hands of the taxpayer and which is not a part of a straddle, as capital gain or loss…” The election mentions forwards, not spot. That’s okay since Reg. 1. 988 equates spot forex trades with forwards. Reg. 1. 988-1(b) defines a spot forex contract, and 1.988-2(d)(i)(ii) provides that a spot contract that does not result in taking or making delivery of the nonfunctional currency is analogous to a forward “or similar contract.” The election excludes straddles, which are offsetting positions with substantially reduced economic risk. Straddles include arbitrage trades in forward contracts.

Section 1256(g)(2) foreign currency contracts
After filing a capital gains election, if the forex trader met three IRS requirements for Section 1256(g)(2) listed below, they may use Section 1256 for major currency pairs only. Minor currency pairs remain short-term capital gains. The IRS considers a forex currency pair to be “major” if the same pair trades as a regulated futures contract (RFC) on U.S. futures exchanges.

Section 1256(g)(2) requirements:

(i) “Which requires delivery of, or the settlement of which depends on the value of, a foreign currency which is a currency in which positions are also traded through regulated futures contracts;
(ii) which is traded in the interbank market;
(iii) which is entered into at arm’s length at a price determined by reference to the price in the interbank market.”

Are retail forex dealers in the interbank market?
It’s uncertain where the IRS draws the line on interpreting (ii) “traded in the interbank market.” When the IRS wrote Section 1256(g) in the mid-1980′s, only banks participated in the interbank market. Advances in trading platforms like ECNs and new regulations established in the “Commodity Futures Modernization Act” (CFMA) of 2000 added new participants to the interbank market, including CFTC-registered Retail Foreign Exchange Dealers (RFED) and Futures Commission Merchant (FCM) Forex Dealer NFA-Members.

Some RFED and FCM forex dealers offer “no dealing desk” execution with immediate client trades made in the interbank market. Others are “dealing desks” offsetting client positions, and netting risk in the interbank market. (See Learn Why The NFA Barred FXCM And What It Means For Forex Traders.)

There is a sound argument for using Section 1256(g) treatment for RFED and FCM Forex Dealer Members, whether they are no-dealing or dealing desks. I am concerned the IRS may draw the line more narrowly, allowing Section 1256(g) for no-dealing desks, only. In the worst case scenario, the IRS could seek to exclude all RFED and FCM forex dealers arguing they are not participants in the interbank market. They are the “retail” window of the interbank market.

Thomson Reuters CheckPoint tax research on this questions states: “Contracts traded in the interbank market generally include contracts between a commercial bank and another person as well as contracts entered into with a futures commission merchant (FCM) who is a participant in the interbank market. According to the legislative history, a contract that does not have such a bank or FCM, or some other similar participant in the interbank market, is not a foreign currency contract.” The legislative history mentions “FCM, or some other similar participant in the interbank market.” I argue that “some other similar participant” could be a placeholder for RFED, created in 2000, well after Section 1256(g)(2) was written.

Can spot forex contracts be included in Section 1256(g)?
As explained above, Section 988 equated spot with forwards, if the trader does not take or make a delivery. Unfortunately, Section 1256(g) does not recognize spot forex contracts, so I make an argument for inclusion below.

Leveraged spot forex contracts, and forward forex contracts are similar trading products, whereas the IRS only mentioned forwards in the legislative history to Section 1256(g). After Congress had updated the code, it enacted the CFMA of 2000 ushering in leveraged retail off-exchange trading in the spot forex interbank market through CFTC-registered RFED and FCM Forex Dealer Members.

Spot forex contracts have a trade date when initiated, just like forward forex contracts. Spot contracts settle in 1-2 days, and forward contracts settle greater than two days. Forex traders do not “take or make delivery” on leveraged spot forex contracts. For example, with a $2,000 account deposit, a forex trader may buy a spot forex contract priced at $100,000 if using maximum leverage. They are unable to settle the contract in cash with just $2,000 in their account, and they close the trade before it settles, or roll it over. I consider a spot forex contract to be a shorter-term forward contract. Traders use spot forex contracts differently from a manufacturer who executes a “foreign currency transaction” in the spot interbank market for “immediate and fixed delivery.” Rollover fees are evidence of forex contracts for traders.

The Sixth Circuit Court of Appeals Wright decision helps
The Sixth Circuit Court of Appeals reversed the IRS tax court 2014 ruling on Wright vs. Commissioner (6th Cir. 1/7/2016). The case involved forex OTC options where the taxpayer used Section 1256(g) tax treatment. The IRS did not agree, but the appellate court overruled the IRS.

The Sixth Circuit relied on a “literal interpretation” of Section 1256(g)(2): “(i) Which requires delivery of, or the settlement of which depends on the value of, a foreign currency which is a currency in which positions are also traded through regulated futures contracts.” The IRS argued forex OTC options don’t settle in cash due to their “optionality” and therefore do not meet this (i) requirement. The appellate court parsed the exact words and comma placements in Section 1256(g)(2) and decided the forex OTC options, in this case, did meet the (i) requirement.

The appeals ruling concluded if Congress and the IRS wanted to exclude a particular type of “foreign currency contract” from Section 1256(g), it should have updated the code accordingly, rather than rely on legislative history. Section 1256(g) does not exclude forex OTC options, so the Sixth Circuit included them.

Spot forex contracts have a stronger case for meeting Section 1256(g)(2)(i) than forex OTC options. Spot forex contracts settle in cash just like forward forex contracts, and they don’t have optionality. Additionally, Section 1256(g) does not exclude spot forex contracts.

I do not see where the appellate court or IRS reviewed how Wright met the second requirement of Section 1256(g)(2), “which is traded in the interbank market.” The court named the private companies that acted as counterparties to Wright on the forex OTC option transactions. The court did not mention the involvement of any banks, FCM or RFED in these transactions. Section 1256(g) does not exclude RFED and FCM forex dealers from being in the interbank market.

Forex OTC options are different from spot forex contracts. RFED don’t offer forex OTC options. Wright purchased forex OTC options with a private tax shelter promoter, not in the spot interbank market. Traders with foreign currency transactions in the spot forex interbank market start off in Section 988 ordinary gain or loss. The Wright court seemed to confer that Wright’s forex OTC options did not have to start in Section 988. Caution: Forex traders should not skip the required contemporaneous Section 988 opt-out election if they want to use Section 1256(g).

If you have any questions, please contact us.

Darren L. Neuschwander, CPA, Roger D. Lorence, JD and Mark Feldman JD contributed to this blog post. 


Several Ways To Trade Currencies, Some With Lower Tax Rates

| By: Robert A. Green, CPA

Forbes

Several Ways To Trade Currencies, Some With Lower Tax Rates

There are several ways for American retail traders to trade “currencies” and tax treatment varies.

1. U.S. regulated futures contracts
U.S. futures exchanges list the major currency pairs as regulated futures contracts (RFCs). Open a retail account with a CFTC-registered Futures Commission Merchant (FCM).

Currency RFCs automatically have Section 1256 tax treatment with lower 60/40 tax rates. Section 1256 requires mark-to-market (MTM) accounting, which means reporting realized and unrealized capital gains and losses. Because there is no way to generate a long-term capital gain with MTM, Congress agreed that 60% is a long-term capital gain, and 40% is a short-term capital gain, no matter of holding period. (See Section 1256 tax rates vs. ordinary rates below.)

2. Leveraged forex contracts off-exchange 
Most American retail traders open accounts with a CFTC-registered Retail Foreign Exchange Dealer (RFED) or an FCM Forex Dealer Member. (See Learn Why The NFA Barred FXCM And What It Means For Forex Traders.)

By default, foreign currency transactions, including spot and forward forex contracts are Section 988 ordinary gain or loss tax treatment. A forex trader may elect capital gains treatment, which on short-term capital gains is the ordinary tax rate. If a forex trader doesn’t “take or make delivery” in cash, there is a case for using Section 1256(g) (foreign currency contracts) on “major” currencies. (See A Case For Retail Forex Traders Using Section 1256(g).)

3. Currency exchange-traded funds (ETFs)
Structured as Registered Investment Companies (RIC) listed on a securities exchanges, ETF RICs are securities with short-term vs. long-term capital gains and losses treatment, using the realization method. Short-term capital gains are subject to ordinary tax rates, and capital losses are subject to the $3,000 capital loss limitation against other income.

4. Nadex binary options and spreads based on forex
Nadex is a CFTC-registered derivative exchange offering binary options and spreads. Nadex bases one of its binary options products on price movements in forex. It’s not a forex contract. Nadex issues a Form 1099B for Section 1256 contracts, but I have doubts about their qualification for using Section 1256 tax treatment. Nadex binary options and spreads appear to be “swap contracts” with ordinary gain or loss tax treatment. (Read Tax Treatment For Nadex Binary Options.)

Section 1256 tax rates vs. ordinary rates
The difference in the 60/40 blended tax rate vs. short-term capital gains taxed at ordinary rates is significant throughout the graduated tax brackets. The 60/40 rates vs. ordinary rates are:

4% for the 10% bracket,
6% for the 15% bracket,
19% for the 25% bracket,
20% for the 28% bracket,
22% for the 33% bracket,
23% for the 35% bracket, and
28% for the top 39.6% bracket

No matter what tax bracket you are in, there are significant tax savings using Section 1256.

Additionally, there is a Section 1256 loss carryback election, which can be used to amend the prior three years tax returns, offsetting Section 1256 gains only. Section 1256 has summary tax reporting. It’s a breeze tax-wise.


Learn Why The NFA Barred FXCM And What It Means For Forex Traders

February 22, 2017 | By: Robert A. Green, CPA

With the recent news of the National Futures Association (NFA) barring Forex Capital Markets, LLC (FXCM) from membership, many forex traders are scurrying to replace FXCM. It’s imperative that American retail traders understand Commodity Futures Trading Commission (CFTC) regulations for off-exchange forex before making their decision.

If a forex dealer wants to do business with American retail traders on leveraged forex contracts off-exchange, the CFTC requires the forex dealer register with the CFTC, SEC or bank regulator. There is CFTC-registered Retail Foreign Exchange Dealers (RFED), and CFTC-registered Futures Commission Merchant (FCM) Forex Dealer Members. For a listing of these “Forex Firms,” see Directory of CFTC Registrants and NFA Members. There are also SEC-registered broker-dealers, banks, and other regulated financial institutions, as explained in Forex Transactions, A Regulatory Guide (see counterparties on page 2).

In his well-known “Gensler-Letter” in 2009, CFTC Chairman Gary Gensler asked Congress for more authority to regulate the “retail” spot forex marketplace. Chairman Gensler argued that retail spot forex trading platforms were successfully evading CFTC regulation by mislabeling their products as “spot forex” transactions; he thought they were more appropriately “futures-like” and therefore under the CFTC umbrella of control. Here is a press release by the CFTC describing new regulations subsequently promulgated, effective October 2010. At that time, the CFTC created a new class of membership, RFED.

FXCM bombshell news
On Feb. 6, 2017, the NFA barred FXCM from membership due to “numerous deceptive and abusive execution activities that were designed to benefit FXCM, to the detriment of its customers.” The NFA Directory of members listed FXCM as an RFED, FCM, Forex Dealer Member and Forex Firm.

A MarketWatch article, FXCM names interim CEO, changes name to Global Brokerage wrote “The CFTC said FXCM was “engaging in fraudulent activities” with respect to FXCM’s retail customers, by telling them they used a “No Dealing Desk” order execution model, meaning orders would be executed directly in the market without using a liquidity provider, or market maker. But in fact, FXCM used a “Dealing Desk” model, by routing orders through market maker Effex Capital LLC that was actually supported and controlled by FXCM, allegedly in exchange for kickbacks to FXCM on profitable trades.”

There are two remaining CFTC-registered RFED: Gain Capital Group LLC based in the U.S., and Oanda Corporation from Canada. Oanda and Gain Capital are also CFTC-registered FCM Forex Dealer Members. Retail forex traders have other options for CFTC-registered counterparties: There are several CFTC-registered FCM Forex Dealer Members, although they may set higher minimum account sizes vs. RFED.

Dealing desk vs. no-dealing desk execution
A “dealing desk” acts as a counterparty to its forex traders; it offsets some client trades against other client trades, some against the house, and it lays off net risk with participants in the interbank market. Gain Capital and Oanda state they are dealing desks.

A “no-dealing desk” acts as a counterparty for customers, too. It mostly acts as an “agent,” immediately executing client trades with other participants in the interbank market.

Trading offshore
As stated above, the CFTC does not permit foreign or domestic forex brokers or banks to act as a counterparty to American retail off-exchange forex traders unless the forex dealer registers with the CFTC, SEC or U.S. bank regulator. It’s the law from the Commodity Futures Modernization Act (CFMA) of 2000. Some unregistered foreign forex dealers accept American retail clients, and they may become a target of CFTC enforcement.

I recently asked an NFA media relations person about this issue and she replied that “CFTC regulations and NFA rules generally are applicable to the firms engaging in over-the-counter retail forex. These rules and regulations do not apply to individual customers/investors.” (I asked the CFTC if they condone American retail forex traders going offshore with unregistered forex firms. Stay tuned for an update.)

The lesson of FXCM is that even working with a CFTC-registered forex dealer can be risky. Using an unregistered offshore forex dealer may be dangerous if you are trading with significant leverage, don’t have money-protection coverage, the firm is a bucket shop or the CFTC takes enforcement action against the firm.

Other CFTC and NFA rules for off-exchange leveraged forex trading

CFTC caps on leverage: RFED working with American retail traders must cap leverage on the major currency pairs at 50:1, and on the minor currency pairs at 20:1. (See my post: New CFTC Forex Trading Rules Call For 50:1 Leverage.)

Hedging rule: The NFA Rule 2-43b Forex Orders states “Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis.”

ECPs who meet certain high net worth requirements are “institutional” and exempt from CFTC regulations for American retail off-exchange forex traders. Eligible Commercial Entities (ECE) are free from these rules, too. (For a definition of ECP, click here and for ECE, click here.)


If You Traded Bitcoin, You Should Report Capital Gains To The IRS

February 16, 2017 | By: Robert A. Green, CPA

Forbes

If You Traded Bitcoin, You Should Report Capital Gains To The IRS

The IRS considers cryptocurrencies, including Bitcoin, to be “intangible property.” Investors and traders holding cryptocurrency as a capital asset should use capital gain or loss tax treatment on sales and exchanges, with the realization method. For example, if you buy Bitcoins with U.S. dollars and later sell them for U.S. dollars, a capital gain or loss needs to be reported on that transaction. An exchange of one cryptocurrency for another cryptocurrency is a taxable sale transaction, even though U.S. dollars are not involved in the transaction.

Americans also trade Bitcoin or leveraged Bitcoin contracts on Bitcoin exchanges, and they should report realized capital gains and losses on each trade, even if the trader doesn’t convert underlying Bitcoin back into U.S. dollars.

It’s similar to having a foreign-based brokerage account, denominated in a foreign currency (i.e., Euros), where a trader buys and sells European equities held in Euros, and does not convert Euros back to U.S. dollars during the year. Two potential choices for tax reporting: Convert Bitcoin to U.S. dollars on each purchase and sale transaction using the Bitcoin market price that day denominated in U.S. dollars, or perhaps the IRS will allow using Bitcoin as a functional currency, using an average Bitcoin vs. U.S. dollar conversion rate for the tax year.

The CFTC does not permit American retail customers to trade leveraged Bitcoin contracts on unregistered Bitcoin exchanges. (Read my related blog post: If You Want To Trade Bitcoins, First Learn CFTC Rules.)

Whether it’s legal or not under CFTC regulations, the IRS requires American resident taxpayers to report Bitcoin trading income and losses worldwide on U.S. resident tax returns. It doesn’t matter whether you repatriate funds back to the U.S., or not.

IRS guidance on cryptocurrency
In March 2014, the IRS issued long-awaited guidance (IRS Notice 2014-21) labeling cryptocurrency, including Bitcoin, “intangible property.” Investors and traders hold Bitcoin as a capital asset, so it receives capital gain and loss treatment. The AICPA and others have requested further guidance on virtual currency from the IRS. For investors and traders, I have a few unresolved questions below.

Intangible property is not a security, yet it seems logical that several tax rules for investors and traders are similar, whereas a few others are not.

Cryptocurrency is like securities in these cases

  • Use the realization method for sales of cryptocurrency held as a capital asset, which means you defer reporting of the capital gain or loss until closing the position.
  • Don’t use mark-to-market accounting at year-end, which means you don’t report unrealized gains and losses.
  • Use holding period rules to distinguish between short-term vs. long-term (12 months or longer) capital gains and losses. The long-term capital gains rates are lower than short-term rates, taxed as ordinary income.
  • The $3,000 capital loss limitation against other income applies.
  • Report each trade separately on Form 8949 (Sales and Other Dispositions of Capital Assets); we assume the IRS does not permit summary reporting. It’s OK to attach a report from your broker listing an accounting for each cryptocurrency trade.

Cryptocurrency is unlike securities in these cases

  • I don’t think you’ll have to make wash sale loss adjustments since Section 1091 wash sale rules only mention securities, not intangible property. Hopefully, the IRS will clarify this issue.
  • Traders qualifying for trader tax status may not elect Section 475 ordinary gain or loss treatment on cryptocurrency. Section 475 covers securities and commodities, not intangible property.
  • Cryptocurrency is not sovereign currency or forex with Section 988 ordinary gain or loss treatment, or Section 1256(g) foreign currency contract treatment. The IRS and CFTC call cryptocurrency “currency,” but not “foreign currency.”

Onshore and offshore cryptocurrency exchanges do not issue American investors or traders a Form 1099B.

Read my prior blog post: IRS Guidance On Bitcoin Transactions.

Nadex offered Bitcoin binary contracts in 2016
The North American Derivatives Exchange, Inc. (Nadex), a U.S.-based CFTC-regulated derivatives exchange, offered Bitcoin binary contracts for part of 2016. On Dec. 16, 2016, Nadex filed a Self-Certification to Delist Bitcoin.

Over the past several years, Nadex issued Americans a Form 1099B for Section 1256 contracts. That’s an advantageous tax treatment with lower 60/40 tax rates, and I doubt whether it’s correct to use Section 1256 tax treatment for Bitcoin binary contracts. (Read Tax Treatment For Nadex Binary Options.)

Bitcoin and foreign bank account reporting
U.S. residents with a foreign bank, brokerage, investment and another type of account (including retirement and insurance in some cases) who meet reporting requirements must e-file FinCEN Form 114, Report of Foreign Bank and Financial Account. If your foreign bank and financial institution accounts combined are under $10,000 for the entire tax year, you fall under the threshold for filing FinCEN Form 114.

The IRS allowed taxpayers to exclude Bitcoin from 2013 foreign bank account filings. It’s not clear if the IRS continues to allow an exclusion of Bitcoin, or Bitcoin derivative contracts, on current year FinCEN 114 filings. Suppose you have Bitcoin or Bitcoin derivative contracts held at a foreign Bitcoin exchange. When in doubt, and considering significant penalties for non-compliance, it’s probably wise to include these Bitcoin accounts on FinCEN 114. (Read Bitcoin Is Not Reported On 2013 FBARs.)

For another update on cryptocurrency tax treatment, read Taxation of Virtual Currency, Jan. 16, 2017, Bloomberg, by Elizabeth R. Carter.


If You Want To Trade Bitcoins, First Learn CFTC Rules

| By: Robert A. Green, CPA

The CFTC requires counterparties, including brokers and exchanges, doing business with American retail customers to register if they offer “leveraged” or “financed” financial products, including derivatives. The CFTC brought an enforcement action against unregistered Bitfinex of Hong Kong because they offered leveraged cryptocurrency contracts to American retail customers. Several other unregistered offshore exchanges offer leveraged cryptocurrency contracts to American retail customers. Many Americans trade cryptocurrency on exchanges that do not provide leveraged contracts, and that seems okay.

Bitcoin is the most famous cryptocurrency, and there’s been significant price volatility the past few years. That’s attracted American retail traders to Bitcoin exchanges offering leveraged trading and derivative products based on Bitcoin price movements.

In this post, I discuss CFTC regulation for Bitcoin counterparties (exchanges and brokers), and in my related post, I cover tax treatment for trading Bitcoin. (See If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

Is Bitcoin trading legal for American retail customers?
Some American retail customers trade leveraged or financed cryptocurrency contracts with counterparties that are not registered with the Commodity Futures Trading Commission (CFTC) or another U.S. regulator to allow cryptocurrency trading by American retail customers. I asked the CFTC and National Futures Association (NFA) if that is legal, and both said CFTC regulations for American retail customers apply to counterparties, not American retail customers. Does that imply that leveraged Bitcoin and cryptocurrency trading may be legal for American retail customers, and illegal for counterparties? Perhaps, yes, but I am not sure. It’s risky for American retail customers to trade leveraged Bitcoin contracts or another leveraged cryptocurrency because the CFTC may take enforcement action against their counterparties as it did against Bitfinex (see below). Maintain control of Bitcoin wallets to avoid some counterparty risk with regulators.

CFTC regulations
The Commodity Futures Trading Commission (CFTC) requires counterparties, including brokers and exchanges, to register with the CFTC if they offer leveraged or margined financial products to American retail traders. That includes some Bitcoin exchanges and Bitcoin derivative products.

If a forex dealer wants to do business with American retail traders on leveraged forex contracts off-exchange, the CFTC requires the forex dealer register with the CFTC, SEC or bank regulator. There is CFTC-registered Retail Foreign Exchange Dealers (RFED), and CFTC-registered Futures Commission Merchant (FCM) Forex Dealer Members.

The CFTC considers Bitcoin a “currency,” but not a “foreign currency.” The CFTC says Bitcoin is not forex, so it doesn’t fall under the forex regulations. The CFTC also refers to Bitcoin as a “commodity.”

The North American Derivatives Exchange, Inc. (Nadex), a U.S.-based CFTC-regulated exchange, offered leveraged Bitcoin binary contracts until it discontinued that product at the end of 2016. On Dec. 16, 2016, Nadex filed a Self-Certification to Delist Bitcoin.

Bitcoin exchanges offering leverage try to escape CFTC jurisdiction
Bitcoin exchanges have sought exemption from CFTC jurisdiction in claiming traders are “making and taking delivery” of each trade on their “exchange,” by transferring the title into Bitcoin wallets. The CFTC does not regulate private transactions in commodities, or forward contracts when made for delivery within 28 days. For example, a farmer may sell wheat to a cereal manufacturer for immediate delivery, or with a forward contract. A warehouse receipt is evidence of delivery.

CFTC jurisdiction applies to counterparties offering futures, options, derivatives, and financed (or leveraged) retail transactions for future delivery. In the CFTC enforcement case cited below, the CFTC explained how leveraged trades in the spot Bitcoin market with an American retail customer fell under CFTC jurisdiction as a financed retail transaction. The CFTC also disagreed that Bitfinex made full delivery of Bitcoin to traders.

Two CFTC enforcement cases against Bitcoin exchanges
Bitfinex in June 2016, and Coinflip in September 2015. Read CFTC vs. BFXNA INC. d/b/a BITFINEX and CFTC Bitfinex Enforcement Action, an analysis by law firm Clifford Chance. Here are some excerpts from the Clifford Chance client briefing:

  • “The Order expands the CFTC’s regulation of bitcoin and other cryptocurrencies into spot markets under certain conditions.”
  • “The result is that spot trades qualifying as financed retail transactions will be regulated as if they were futures trades.”
  • “The Exception does not apply since the bitcoins were not actually delivered. In finding lack of actual delivery, the CFTC looked to the fact that at all times Bitfinex held the private keys needed to access the wallet where bitcoins were held.”

On-exchange vs. off-exchange
On-exchange means a CFTC-registered U.S. futures, options or derivatives exchange like the CME, CBOE, ICE, NYMEX and NADEX.

On-exchange also includes foreign futures and options exchanges, providing the CFTC issued a “Part 30 Letter” granting the foreign exchange permission to solicit accounts with American retail customers. The exchange must demonstrate similar rules as in the U.S. including posting prices, setting margin requirements, meeting capital adequacy, and more. (See a list of CFTC Part 30 Letters on the CFTC website.)

The CFTC’s mission is to protect American retail customers
The CFTC prefers leveraged trading transactions for American retail traders conducted on-exchange, so the exchange may act as the counterparty to both buyer and seller, who otherwise do not know each other. With off-exchange forex, the CFTC-registered RFED and Forex Firms are the counterparties.

Consider the infamous failure of the largest (at the time) Bitcoin exchange, Mt. Gox, which filed for bankruptcy protection in Japan in 2014. The CFTC is trying to protect American retail customers from these types of losses.

Exemptions for ECP and ECE
Eligible Contract Participants (ECP) who meet certain high net worth requirements are “institutional” and exempt from CFTC regulations for American retail customers. ECP can trade off-exchange leveraged financial products, including Bitcoin derivatives. Eligible Commercial Entities (ECE) are exempt, too. (For a definition of ECP, click here and for ECE, click here.)

Republicans are interested in scaling back Dodd-Frank regulations
President Trump, his administration officials, and the GOP leaders in Congress have indicated they want to scale back elements of the Dodd-Frank Act. It’s conceivable they could reduce some of the CFTC limitations on American retail customers trading leveraged financial products off-exchange.

Tax reporting
Whether it’s legal or not under CFTC regulations, the IRS requires American resident taxpayers to report Bitcoin trading income and losses worldwide on U.S. resident tax returns. It doesn’t matter whether or not you repatriate funds back to the U.S. (See my blog post: If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)


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