Tag Archives: 988

Green’s 2023 Trader Tax Guide

June 18, 2020 | By: jparasole

Purchase the online PDF version in our Green & Company, Inc. store. Amazon offers a paperback version.

Our online guide PDF is 113 pages, 8 x 11, single-spaced, and easy to read. You get access immediately after purchase and see the Download PDF link in your email receipt. We might update this online guide during 2023 for tax changes that impact traders, and you will have access to the updated versions. 

Use Green’s 2023 Trader Tax Guide to receive every trader tax break you’re entitled to on your 2022 tax returns. Learn intelligent moves to make in 2023. Whether you self-prepare your tax returns or engage a CPA firm, this guide can help you optimize your tax savings. Even though it may be too late for some tax breaks on 2022 tax returns, you can still use this guide to execute these tax strategies and elections for tax-year 2023.

The 18 chapters cover trader tax status, Section 475 MTM, tax treatment (equities, 1256 contracts, options, ETFs, ETNs, forex, precious metals, cryptocurrencies, etc.), accounting for trading gains and losses, trading business expenses, tips for preparing tax returns, tax planning, entity solutions, retirement plan strategies, IRS and state tax controversy, traders in tax court, proprietary trading, investment management, international tax, ACA Net Investment Income Tax, short selling, Tax Cuts and Jobs Act, CARES Act, and recent tax law changes.

Green’s Trader Tax Guide has been published yearly since 1997 and remains the gold standard in trader tax.

About the Author
Robert A. Green is a CPA and CEO of Green & Company, Inc. (GreenTraderTax.com). Mr. Green is a leading authority on trader tax and a Forbes contributor. He is also the author of The Tax Guide for Traders (McGraw-Hill, 2004) and Green’s annual Trader Tax Guide. Mr. Green is frequently interviewed and has appeared in the New York Times, Wall Street Journal, Forbes, and Barron’s. He is the Traders Expo’s chief tax speaker and presents tax Webinars for Interactive Brokers, TradeStation, Lightspeed, and other trading industry participants.

 

 

Forex Tax Treatment & Planning

September 7, 2014 | By: Robert A. Green, CPA

When it comes to taxes, forex traders can have the best of both worlds: ordinary loss treatment and lower 60/40 tax rates on gains.

Presented by Robert A. Green, CPA

Green explains forex tax and regulatory treatment, plus planning opportunities.
Read forex tax treatment in our Trader Tax Center.

Tax Compliance

September 4, 2014 | By: Robert A. Green, CPA

Tax compliance includes tax planning and annual tax return preparation, including investor K-1s at year-end. After year-end, general partners of hedge funds need to provide investors with annual income tax reports. Schedule K-1s pass through all items of income, loss and expense, retaining their underlying character of income or loss. Underlying character includes lower 60/40 tax rates on Section 1256 contracts (futures), short-term or long-term capital gains or losses on securities or ordinary income or loss from Section 988 forex.

Carried-interest tax break
The carried-interest tax break can be used in hedge funds, but it cannot be used in separately managed accounts (SMAs). If carried interest provisions are included in the fund’s operating agreement and PPM, the general partner investor is allocated a partnership K-1 share of each item of income — let’s say 20% — in lieu of the fund paying an outside advisor an incentive fee. Generally, the general partner and investors receive tax breaks in connection with carried interest. The advisor receives a share of lower tax rates on 60/40 or long-term capital gains, and the investor avoids investment expense treatment, which often is disallowed for AMT or doesn’t exceed the 2% of AGI limitation for miscellaneous itemized deductions.

Carried interest remains high on the list of “tax loopholes” facing repeal in discussions for tax reform, but we have written many blogs and articles defending it. Carried interest can be arranged in offshore funds with a mini-feeder structure. There are other nuances in connection with self-employment tax and the ObamaCare 3.8% Medicare tax on unearned income (investment income). We cover all these issues on our blog and in Green’s Trader Tax Guide.

Tax treatment elections
There are different types of tax treatment elections that can be made and it’s important to make the right decisions on time. In some cases, these tax elections should be contemplated in the development process and included in the private placement memorandum. For example, investors with large capital loss carryovers may be searching for hedge funds that will generate capital gains rather than Section 475 MTM ordinary income on securities or Section 988 ordinary income on forex. You can have capital gains treatment on both securities and forex.

Most investors benefit from trader tax status (TTS), so if your fund qualifies, it’s generally a good idea to claim that status. With TTS, the advisor and investors get business expense treatment without passive loss activity limitations. (One exception: non-active owners report investment interest expense as itemized deductions.) That means investors get the full benefit of advisory fees paid “above the line” (from gross income) rather than face many restrictions as itemized deductions below the line. With TTS, the fund is entitled to elect Section 475 mark-to-market (MTM) (on securities only), which exempts the fund from dreaded wash sales at year-end, plus Section 475 receives business ordinary loss treatment, avoiding capital loss limitations. Some managers skip a Section 475 election because they don’t want to be burdened with contemporaneous segregation rules for investments vs. business positions and they don’t want MTM to apply at year-end, so they can defer capital gains to the next tax year(s). Otherwise, they would pass MTM income to investors who might want redemptions to pay taxes and the manager has not yet sold those underlying shares. TTS and Section 475 issues are highly nuanced and often misunderstood, so advisors should discuss them with us in advance. Some hedge funds have TTS and Section 475 MTM on one portfolio, and they properly segregate an investment portfolio without TTS, where they generate long-term capital gains. (Read our blog IRS warns Section 475 traders for more about segregation of investments.)

Our tax compliance service includes everything  you need
Our CPAs plan and prepare tax compliance for hedge funds, management companies and the individuals owning the management company. We help managers plan their tax matters in a way that suits their needs and their investors’ needs. While some tax breaks help both the manager and investors, others may help only one of them, while still others may help one at the expense of the other. For example, if the fund doesn’t qualify for trader tax status, carried interest helps both the manager and the investors. But in a futures fund with lower 60/40 tax rates, carried interest may only help the manager.

Green, Neuschwander & Manning, LLC knows every state very well. Use our professionals to conceive and structure the best tax plans for your fund and get them incorporated into the fund documents; then, use our CPAs to execute those plans and tax elections on a timely basis.

Tax edge: Count on us to handle all the tax matters correctly, including carried-interest tax breaks, the S-corp self-employment tax loophole, the new 3.8% Medicare tax on unearned income, trader tax status/Section 475 MTM accounting, lower 60/40 Section 1256(g) forex tax treatment breaks, forex tax treatment, ETF and ETF option tax treatment, international tax planning including PFIC and QEF elections, mini-master feeders, tax changes and more.

One big tax change started on Jan. 1, 2013: the Medicare 3.8% tax on unearned income, principally investment income. (Read about that in our Trader Tax Center page for Net Investment Tax.)

For more information on our tax strategies for investment managers, see Green’s Trader Tax Guide, our blog and Webinars.

Ready For Help?

Tax compliance, planning and annual tax return preparation services:
Green, Neuschwander will prepare the federal and all required state tax returns for your hedge funds and other investment vehicles. We also can prepare the tax returns for your management companies and your individual return. Click Tax Compliance (Preparation and Planning) and choose Investment Management.

If you have any questions or would like a quote, please email us at info@gnmtradertax.com or call us.

We look forward to working with you soon.

Sincerely,
Robert A. Green, CPA & Darren L. Neuschwander, CPA
Managing Members of Green, Neuschwander & Manning, LLC (GNMTraderTax)

 

Forex

August 29, 2014 | By: Robert A. Green, CPA

Forex refers to the foreign exchange market (also known as the “Interbank” market), where participants trade currencies, including spot, forwards, or over-the-counter (OTC) option contracts. Forex differs from trading currency-regulated futures contracts (RFCs). Currency RFCs are Section 1256 contracts reported on Form 6781 with lower 60/40 capital gains tax treatment.

Forex tax treatment. By default, forex transactions start off receiving ordinary gain or loss treatment, as dictated by Section 988 (foreign currency transactions). The excellent news is that Section 988 ordinary losses offset ordinary income in full and are not subject to the $3,000 capital loss limitation — that’s a welcome relief for many new forex traders who have initial losses and offset the losses against wage and other income.

Section 988 allows investors and business traders — but not manufacturers — to internally file a contemporaneous “capital gains election” to opt out of Section 988 into capital gain or loss treatment. Generate capital gains to use up capital loss carryovers, which otherwise may go wasted for years.

The capital gains election on forex forwards allows the trader to use Section 1256(g) treatment with lower 60/40 capital gains rates on major currency pairs if the trader doesn’t take or make delivery of the underlying currency. A major currency pair is a forex pair that also trades as a regulated futures contract on U.S. futures exchanges. There are lists of currency pairs that trade on U.S. futures exchanges available on the Internet (search FX products on CME).

Spot vs. forwards. Most online trading platforms and brokers only offer forex spot contracts. Because guidance from the IRS isn’t clear, most retail off-exchange forex traders are unsure how to handle spot forex. Our extensive work in this area has led us to believe that, in many cases, spot forex can be treated like forex forwards, qualifying for lower 60/40 tax rates in Section 1256(g) on major currency pairs only with the capital gains election. These tax rates may be desirable if you have significant trading gains on spot forex contracts. We lay out a case for Section 1256(g) treatment on spot forex transactions, with certain conditions and restrictions. It’s essential to use proper tax return footnote disclosure. (See blog post referenced below.)

Forex tax reporting. Brokers provide details and summary reporting for forex trades, and most offer helpful online tax reports. Spot forex brokers aren’t supposed to issue Form 1099-Bs at tax time. Section 988 is realized gain or loss, whereas, with a capital gains election on major pairs into Section 1256(g), MTM treatment should be used.

Section 988 transactions for investors are reported in summary form on line 8(z), “other income or loss” of 2022 Schedule 1 (Form 1040). Watch out for negative taxable income caused by forex losses without TTS; you might waste some losses. (TTS forex traders use Form 4797 Part II instead, and the negative income may generate an NOL carryover depending on the taxpayer’s income from other sources.) Section 1256(g) treatment uses Form 6781, just like other Section 1256 contracts.

The Section 988 opt-out election. Make the Section 988 opt-out election by filing it internally (meaning you don’t have to file an election statement with the IRS) on a contemporaneous basis (meaning the IRS does not allow hindsight — the election is effective from the date made going forward). Section 988 talks about the election on every trade, but you can also make a “good to cancel” election, which is more practical. You can make the election and withdraw it throughout the year.

A word of caution: Forex trading losses can become wasted for non-TTS traders who don’t elect out of Section 988 and have negative taxable income. Forex losses become a part of NOL for those who qualify for TTS, but investors don’t have NOL treatment. Investors with no other source of income may be better off electing out of Section 988, so their forex losses can be classified as capital-loss carryovers and not wasted forever. Remember, the effective date of the election is as of the date made and going forward.

For more information, see Green’s Trader Tax Guide. 

Why do forex forward dealers issue 1099s, yet spot forex brokers do not?

August 16, 2012 | By: Robert A. Green, CPA

Did you receive a Form 1099 from your forex broker or bank this year? If you traded forex spot, you most likely did not. Conversely, if you traded forex forwards, you probably did receive a 1099, the kind used for Section 1256 contracts, like futures. But, how does this affect your tax filings?

1099 rules
The rules state that a 1099 should be issued for forex forwards, treating them like Section 1256(g) foreign currency contracts. Those same rules state 1099 should not be issued for forex spot trading. Some taxpayers mistakenly think if they don’t receive a 1099, they don’t have to report anything. That is very wrong — you need to report your trading gains and losses and other income, whether you receive a 1099 or not. That includes income from foreign brokers, too. If the 1099 is wrong, you must report the correct amount. It’s best to ask your broker or bank to correct the 1099 when you identify an error.

Spot vs. forwards
Most online forex traders have accounts with retail off-exchange forex brokers, most of whom only offer trading in the forex spot market. Spot settles in one to two days, whereas forwards settle in over two days. Brokers use the terminology T+1 for trade date plus one for a one-day settlement.

Retail forex brokers are not direct participants in the Interbank foreign exchange market. Rather, they are customers of Interbank forex dealers, and they make a derivative market for retail spot traders. Some of these retail forex brokers square their books on customer trades, and net the difference in the Interbank market, while others simply behave like a “house,” acting as market makers for their clients.

Professional and institutional forex traders like larger hedge funds have access to trading directly with forex dealers in the Interbank market. These forex dealers offer well-heeled clients access to forex forwards and options in addition to spot trading. Because forwards settle in over two days, they require more credit from traders, as they are high-leverage activities.

Rolling spot contracts
A leading forex dealer offers a “rolling spot” trading program. Instruments traded in this program are treated like forwards for purposes of 1099 issuance. CFTC Chairman Gary Gensler called these contracts futures-like. We understand that other forex dealers offer similar trading products, too.

These “rolling spot” forex contracts don’t have a fixed settlement date, as they are open ended contracts. While technically they could settle during a spot term of one to two days, they primarily settle during a forward term over two days. This dealer says these contracts act more like a forward contract than a spot contract, and therefore they issued a 1099 for forwards. That called for using a 1099 for Section 1256g (foreign currency contracts), which requires reporting of realized and unrealized gains and losses. This forex dealer marked open positions to market at year-end, too. But, forex by default has Section 988 ordinary gain or loss treatment.

1099s don’t dictate tax treatment
It’s very important to note that Form 1099s don’t dictate tax treatment. 1099 issuance rules call for 1099s based on a default standard — investor status. One of our clients received a 1099 from this dealer showing a $100,000+ loss treated as Section 1256g. But this client never filed an opt-out election from Section 988 into Section 1256g. Does the issuance of this 1099 dictate the taxpayer’s tax treatment, or do his own facts, circumstances and elections dictate tax treatment? Good news, it’s the latter. See the example footnote below that we plan to include with this client’s 2011 income tax return. In this case, the client prefers Section 988 ordinary loss treatment, rather than Section 1256 capital loss treatment subject to the $3,000 loss limitation against ordinary income. Taxpayers don’t want broker-issued 1099s to force them into worse tax treatment.

Section 475 MTM traders don’t let 1099s dictate tax treatment, either
For over a decade our Section 475 MTM business securities traders report their trading gains and losses with ordinary gain or loss treatment on Form 4797, Part II. They mark open trading business positions to market at year-end and report them as well. This tax treatment departs significantly from 1099s issued for a default investor using the cash method of accounting. The IRS understands the difference.

Example tax return footnote for a forex client who received a Form 1099
Taxpayer received a Form 1099 treating his forex contracts like forwards (or forward-like). 1099 issuance rules state that a 1099 should be issued for forex forwards, treating them like Section 1256(g) foreign currency contracts. Those same rules say no 1099 should be issued for spot forex.

As agreed by the issuer of this 1099, Form 1099s do not dictate the taxpayer’s tax treatment, as the issuer is generally not aware of the taxpayer’s facts, circumstances and tax-treatment elections.

By default, forex spot and forward contracts have Section 988 ordinary gain or loss treatment. Traders holding these forex contracts as capital assets may file an internal contemporaneous “capital gains election” pursuant to IRC § 988(a)(1)(B) to opt out of section 988 and into capital gains and loss treatment. If such an election is made, then for forex forwards — and forward-like forex contracts, including spot forex in some cases — taxpayers may use Section 1256(g) (foreign currency contract) treatment, providing it’s in major currencies for which regulated futures contracts trade on U.S. futures exchanges, and the taxpayer does not take or make delivery of the underlying currency. See Treas. Reg. § 1.988-3(b).

Section 988 reports realized gains and losses only, whereas Section 1256(g) reports realized, plus mark-to-market unrealized gains and loss treatment at year-end, too. Section 988 is ordinary gain or loss treatment, whereas Section 1256(g) has lower 60/40 tax rates, with 60% a long-term capital gain, and 40% short-term capital gain treatment.

Taxpayer did not file an internal opt-out election from Section 988, and therefore he must report using the default Section 988 ordinary gain or loss treatment for realized gains or losses, only. If the taxpayer is an investor, he reports that ordinary gain or loss on line 21 of Form 1040 (Other Income or Loss). If the taxpayer qualifies for trader tax status (business treatment), he reports the Section 988 ordinary gain or loss on Form 4797, Part II ordinary gain or loss.

In order for the IRS to match the 1099 filed to taxpayer’s return, we report the Form 1099 (for 1256 contracts) on Form 6781 Part I, and next, we zero the same amount out off of Form 6781, so we can transfer the amount to the correct form and line of the tax return. Forex is reported in summary fashion, not line-by-line fashion as done for securities. The amount we transfer to the correct form and line is the realized gain or loss, only. Only Form 6781 includes year-end unrealized gains and losses too on a mark-to-market basis.

Bottom line
1099 issuance rules have always been confusing and misunderstood by taxpayers. When you receive a W-2, you simply report the tax information provided. It’s rare to find errors. Conversely, when you receive a Form 1099 from a broker or bank, you should not just report what’s displayed. You need to consider your own facts, circumstances and tax-treatment elections to report your correct taxable income, loss and expense. This year, securities traders face a barrage of problems with new IRS cost-basis reporting rules for 1099-B issuers. We are finding huge problems on these 1099s. (See our earlier blogs on this.) When it comes to taxes, take the control away from your broker and consult a trader tax expert when needed.

Iraqi Dinar Investing Does Not Trigger IRS Personal-Use Rules

September 20, 2011 | By: Robert A. Green, CPA

Forbes

Iraqi Dinar Investing Does Not Trigger IRS Personal-Use Rules

My recent blog, “Is The Iraqi Dinar Worthless Paper Or Maker Of Millionaires?” generated a firestorm of comments and opposing views. Here are some additional tax answers to questions and comments made. (It’s the most popular blog read on Great Speculations.)

Various IRS publications discuss tax rules for physically-held currency held for personal-use, mentioning capital gains treatment on gains, and no tax-deductible loss (capital or otherwise) on personal-use losses. These are standard tax rules for personal-use property. Taxpayers may only deduct capital losses on investment (Section 212) or trade or business (section 162) property.

Taxpayers who purchase Iraqi dinars generally are buying dinars for investment purposes, not personal-use. An example of personal use would be buying euros to use while traveling in Europe for personal reasons.

When it comes to physically-held currency and forex transactions (spot and forward) held for investment or business use, Section 988 (foreign currency transaction) tax rules apply. Section 988 is ordinary gain or loss tax treatment. Good news, the capital loss limitation of $3,000 per year does not apply to Section 988 ordinary losses.

An investor holding forex as a capital asset may file a contemporaneous election to opt-out of Section 988 into capital gains and loss rules, otherwise known as the capital gains election. But if you invest in physically-held currency, Section 988 does not permit you to opt-out of Section 988.

In summary, if you heard from an accountant, the IRS or a friend that capital gains apply by default to physically-held currency, that answer is only correct for personal-use sales of physically-held currency. It’s incorrect for the sale of physically-held currency or forex held for investment or business purposes. And don’t forget, you can’t take a tax loss of any kind (capital or ordinary) on the sale of personal-use physically-held currency either. 

Is U.S. Forex Trading Safe?

October 30, 2010 | By: Robert A. Green, CPA

Forbes

Is U.S. Forex Trading Safe?

Is forex trading safe in the U.S. even with RFED or FCM duly registered brokers with the NFA/CFTC? U.S. forex brokers don’t have “segregation of asset” money protection rules, whereas futures brokers are subject to those rules. The new CFTC forex rules call for higher minimum net capital requirements for RFED forex brokers vs. futures brokers, so that helps cushion the concern about money protection issues. 

For warnings about hidden problems with forex brokers, see Erskine vs. CFTC 06-3896. The CEO of Rockwell Trading brought up this court case and discussed his concerns about forex brokers and their platform markets on our Oct. 27 Webinar. The CEO focused in on this quote in the case: This forex market, which is central to this case, is not a public market, but is instead a “negotiated market,” in which–according to the parties–foreign currency prices (the prices used for the trades in this case) are “constructed” by the FCMs using “software to process and distill currency prices offered by numerous banks and come up with an indicative market price.”

As I said on that Webinar, keep in mind that this court case occurred before the new CFTC forex brokerage rules went into effect on Oct. 18, 2010. The retail forex industry should be run better with the new rules. Later in the call, we circle back on the “segregation of asset” rules; we will try to do more research on it for next week. 

We noticed a troubling NFA news release dated Oct. 28, 2010 “NFA orders $459,000 monetary sanction against New Jersey forex firm Gain Capital Group LLC.” Read the text of the entire Complaint included in the release. 

Here’s another similar NFA fine of $320,000 against New York forex firm IKON Global Markets. Per the NFA release, “The Complaint alleged that IKON engaged in certain price slippage practices on the MetaTrader platform that were favorable to IKON and caused disadvantageous trading conditions for certain customers. The Complaint also charged that IKON failed to supervise the MetaTrader platform used for their forex business, and failed to supervise the firm’s operations.” I wonder if “slippage practices” are what Rockwell Trading CEO is warning us about?

The CFTC and NFA are scrutinizing forex brokers more now after their Oct. 18, 2010 effective date for RFED registrations in accordance with their new CFTC rules for forex transactions, sanctioned by Dodd-Frank Fin Reg too. The NFA website has several good new guides including Forex Transactions: A Regulatory Guide.

American forex traders are being forced to trade with no more than 50:1 leverage on the major currencies (20:1 on minors), FIFO (no hedging rule) and without any form of money protection. Because leverage with currency futures is not far off 50:1 (30:1 on the CME, for example), hedging may be easier with futures, and futures brokers must segregate assets for some protection. We will compare tax treatment between forex and futures next week. More forex traders may want to consider trading currency futures too. 

Offshore Retail Forex Trading Accounts For Americans Are Being Forced Back To The U.S.

September 23, 2010 | By: Robert A. Green, CPA

Forbes

Offshore Forex Trading Is Heading Back To U.S. Shores

New CFTC retail forex rules are going into effect exactly as we thought they would. Although we’re still waiting for more formal guidance from the CFTC and NFA, they both have improved their Web site sections on the subject. 

Foreign accounts transferred back to the U.S.
Most U.S.-based retail forex brokers (not banks) are registering with the NFA as RFEDs. If they don’t register their foreign affiliates as RFEDs too, they’re automatically transferring all U.S. resident retail forex trading accounts back to their U.S. RFED firms, by the CFTC’s Oct. 18 deadline. The trader has no choice in the matter.

Remember, the new retail forex rules do not apply to “eligible contract participants,” which are large non-retail accounts defined in prior blogs and in the rules. We’re noticing that more and more offshore brokers who first thumbed their noses at the new rules are falling into line and respecting the rules. 

Foreign commercial banks unaffiliated with any U.S.-based FCM or RFED may have a 360-day extension from registering as a U.S. financial institution. We heard they may have 360 days from the date Dodd Frank Fin Reg was enacted (July 21). We have not confirmed this yet, though. 

Dummy offshore corporations: Not a good idea
Even if you hear from some that the CFTC may focus its enforcement efforts against foreign unregistered intermediaries rather than on individual traders, it’s important to understand the CFTC considers evasion a “prohibited transaction.” Forming a dummy offshore corporation to open a retail off-exchange forex trading account with an unregistered offshore bank or broker is considered evasion, according to the CFTC. Attorneys, CPAs and financial advisors who suggest using dummy corporations to evade these CFTC rules may face challenges by their professional license boards and bars on infractions to their ethical codes of conduct. 

If you are foolish enough to use a dummy offshore corporation in this regard, you still need to disclose your American ownership of the corporation to your foreign broker, who may deny the account treating it as an American-owned account. If you don’t make that “know the client” disclosure, the broker may have grounds to take action against you. 

RFED U.S.-based forex accounts lack protection
Commercial banks like Citi FX Pro offer FDIC insurance protection and segregation protection in bankruptcy. Securities brokers offer SIPIC protection. Futures brokers don’t have any quasi-governmental insurance protection, but at least they have a “segregation” of assets regime in a bankruptcy filing, which is a lesser form of protection. 

The problem for RFED forex brokers in the U.S. is they don’t have a quasi-governmental insurance program and they can’t even offer futures segregation protection in a bankruptcy filing either. For this reason, some U.S. forex brokers previously suggested that their clients use their affiliates offshore. We heard that the UK offered some money protection on forex brokerage accounts. 

In a bankruptcy filing in the U.S. (think Refco), segregated futures accounts have seniority over other creditors and equity holders, so futures account holders get paid first. The problem for forex accounts with RFEDs is that futures segregation regimes aren’t respected on forex accounts in bankruptcy filings because the rules refer to futures traded on exchanges and forex is traded off exchange. This is an oversight from Congress. This is not the case for commercial banks; only brokers. 

A CFTC official told me he feels forex is still safer under their new rules with registration of RFEDs, minimum capital requirements, better disclosure and lower leverage. There may be some money protection issues in the UK, but working with an unregistered broker or bank and using unlimited leverage might make it more unsafe overall. Traders may have trouble and higher costs seeking remedies in foreign jurisdictions too. If a retail trader enters a prohibited transaction working with an unregistered RFED offshore, he may not have rights to use U.S. courts either. Some forex brokers in the UK and other jurisdictions may register with the NFA as RFEDs and then continue to offer money protection in the UK, although they will still need to adhere to the new CFTC rules on leverage and more.

Bottom line
If you trade retail forex off exchange, make sure your broker or bank is duly registered in the appropriate manner with the CFTC, as either an RFED with the NFA or a commercial bank (U.S. or foreign) with U.S. bank regulators. Both RFEDs and commercial banks may offer leverage up to 50:1 on the major currencies. Only the commercial bank may offer protection on your money. Skip the idea of setting up a dummy offshore corporation to work with a non-registered foreign broker or bank. 

Can American Off-exchange Retail Forex Traders Evade Strict New CFTC Rules By Trading On Offshore Platforms?

September 1, 2010 | By: Robert A. Green, CPA

Forbes

Questions Linger Regarding New Forex Rules

Congress and regulators have thrown the forex trading industry a huge curve ball and we are all scurrying to get answers to important questions.

Many questions remain regarding trading offshore to evade leverage and other constraints posed by the new CFTC rules. Today we try to answer a few more questions along these lines. The answers are still unclear, and we await new NFA guidance, which was promised to one forex dealer executive. A forex dealer executive told me the NFA may actually be waiting on the CFTC regarding the overseas issue, and he expects it will take more than a few days. The overseas firestorm is probably underway. 

According to one leading forex broker executive, the CFTC author of these new retail forex trading rules said the Dodd-Frank (DF) change classifying financial institutions (FI) as “U.S. only” (see CFTC Q&A “who can offer..” section) won’t be made for 360 days from DF enactment (7/21/10). This gives EU banks offering forex trading to U.S. customers time to register in the U.S. But I think FI refers to banks and not CFTC-registered FCMs, which probably include the FDMs (forex-dealer merchants, the prior designation) too. The DF list has FI, SEC-registered and CFTC-registered companies, plus insurance companies and more. FI and FCM seem to be different categories.

So if this forex broker says its U.S. retail forex traders using offshore platforms from its affiliates have more time to close accounts, that may not be true in my view. If the foreign account is deemed a foreign affiliate of an existing CFTC-registered FDM, then using the 360-day extension seems inappropriate to me for financial institutions. If it’s a foreign institution such as an EU bank with no U.S. CFTC-registered FCM or FDM registrations, then maybe it’s okay to use the 360-day extension. 

Hopefully the NFA and/or CFTC will clarify this important issue soon. There are plenty of people asking these important questions, as thousands of Americans have offshore retail forex trading accounts.

It makes sense to me that DF gives 360 days to foreign institutions to form U.S. affiliates if desired. To spring a prohibition on foreign financial institutions offering forex trading to U.S. customers as of Oct. 18, 2010 (the effective date of the new CFTC rules) would be extremely undiplomatic on a global country-by-country dealing basis. There may be lawsuits and diplomatic requests made and this takes plenty of time to deal with properly.

This type of financial transaction/trading protectionism is rearing its ugly head on several international stages already. The U.S. is upset about EU rules and proposed rules requiring U.S.-based investment advisers to register in the EU for a required “passport” to raise money from EU investors. This is a huge problem for the U.S.-based investment-management industry. EU banks are upset about new U.S. “FATCA” tax rules requiring EU banks to report to the IRS U.S. customers in their ranks. FATCA ties in with this FI U.S.-only forex trading rule too, as it can help enforce it. 

According to the forex dealer executive I spoke with, the NFA plans to issue a notice to members perhaps today or in a few days to clarify DF and the new CFTC retail forex trading rules, mostly for implementation issues. This expected notice may not speak to the foreign trading issues, although hopefully it will. 

One big implementation issue is how currently CFTC-registered FDMs (under CRA) go about converting their registrations to the new DF-category of RFED. Will this be automatic? How can FDMs make many changes in their registration by Oct. 18, the implementation date for the new CFTC rules? 

This executive said many U.S. forex dealers currently use offshore platforms and affiliates for segregation of funds in the UK for asset protection purposes. He said if a person files for bankruptcy in the U.S., their UK forex trading account capital and rights are protected from U.S. bankruptcy courts. Leverage is unlimited in the UK, but usually 100:1. U.S. customers avoid the NFA’s controversial hedging rule when trading in the UK. He said capital isn’t a big issue because many U.S. forex dealers can absorb more U.S. customers to repatriate from the UK and other international affiliates. I presume leading forex dealers can move UK capital back to U.S. too as needed. This executive says non-residents (international business) may want to stay in the UK since the U.S. leverage is lowered to 50:1. He said U.S. platforms can handle things. The biggest concern is upsetting some U.S. clients who already set up foreign-based accounts and now may have to redo all the paper work back into the U.S. 

U.S. FDMs in the forex dealer coalition are fine on these new rules per this executive. Most are already registered as FDMs and compliant with the NFA, and 50:1 leverage is reasonable in their view. They expect the RFED change to be fairly easy to accomplish. 

I see a big problem for foreign forex dealers operating from tax havens. Most don’t have U.S. operations or branches and they won’t want to register in the U.S. Registration for foreign companies probably requires a U.S. operation, subsidiary or branch office designation. Branch office taxes can lead to trouble on Section 482 transfer pricing tax issues (where the profits are booked). If the IRS finds trouble with tax haven cheating, it can pounce on these institutions. Therefore, I presume many tax-haven forex dealers may lose forex trading business to CFTC-registered RFEDs who will be happy to win back this business. 

Forex IB (Introducing Broker) CFTC-registration changes are important too. The final rules are better than expected from the proposed rules. With final rules, a forex IB can simply register with the NFA on its own in the same manner as futures IBs do now. They don’t need that troublesome (proposed rule) guarantee from an FDM, although they have that choice too. Few FDMs want to take that kind of risk or tie up their capital by guaranteeing a forex IB.

There are many characters in the forex industry that inappropriately blur the lines between education, investment advice, money management and other related services. Many of these forex players may be drawn into registration in some capacity with the NFA and CFTC, perhaps as an IB, and many will want to avoid that registration for many different reasons. Some may have trouble passing NFA back ground checks. Others don’t want the NFA oversight over their perhaps fraudulent or inappropriate business models. Many don’t want to be burdened with other rules like disclosure and reporting. Many will surely have trouble with the conflicts of interest rules too.

The attorney and author of this article said to me via email: I spoke with an attorney at the CFTC Monday who is dealing with these rules. His interpretation was that because of the change to the CEA by Dodd-Frank from “financial institution” to “U.S. financial institution”, overseas forex intermediaries that are not registered as FCMs or RFEDs will not be able to serve as counterparty to U.S.-based retail investors with respect to OTC forex transactions. This would apply to futures and options and futures “look alike” contracts. I say that the enforcement issues are unresolved in our article both because of the practical realities involved in enforcing this rule and because this was just an opinion of one regulator, not of the Agency.

Excellent comment on our FaceBook page:
Robert: I spoke with both the NFA and the CFTC by phone. The most knowledgeable was a guy in the compliance dept at the CFTC. He says the rules apply to any brokerage, foreign or domestic, that wants to do business with U.S. traders. So, while the regulations are not aimed at traders themselves, they are indeed aimed at any/all brokers that do business with U.S. traders. In other words, if we have accounts at FXCM UK or Dukascopy (Switzerland) or anywhere else in the world, the CFTC will force those brokers to change our leverage to 50:1. The only good news I heard was the definition of what the “major currencies” are. Apparently the NFA has a list of what it considers the major currencies. This is in the Financial Regulations section of the NFA manual. Fortunately this includes (in addition to USD) the EUR, GBP, JPY, CHF, CAD, AUD, NZD and even the Norwegian, Swedish and Danish currencies. In other words, any currency that retail traders are likely to trade will be at 50:1 not 20:1. I can live with that. I’m not happy about the excessive intrusion of our government into our business, but I can live with this.

New CFTC Forex Trading Rules Call For 50:1 Leverage

August 31, 2010 | By: Robert A. Green, CPA

Forbes

New CFTC Forex Trading Rules Call For 50:1 Leverage

The CFTC has published its highly anticipated final rules for trading off-exchange retail forex. As discussed on prior blogs, the recently enacted Dodd-Frank Fin Reg bill forced the hand of the CFTC to act by Oct. 19 because it would otherwise bar non-eligible contract participants from off-exchange retail forex trading. The CFTC acted in the nick of time because these new rules are effective on Oct. 18, 2010 — one day before the Dodd-Frank deadline. 

Some of the changes are crystal clear — like new 50:1 leverage limits on major forex currencies — but the equally important rule about allowing or barring offshore trading is not yet clear per documents published to date. One off-exchange retail forex broker concluded Tuesday that offshore trading won’t be allowed after the effective date, implying that offshore forex brokers will have to register with the CFTC as well and will be subject to these same new rules. 

The CFTC’s new leverage rule calling for a minimum 2 percent deposit on trading major forex currencies off exchange (50:1 leverage) seems on par with what commercial banks like Citi FX Pro offer their retail forex trading customers now. 

It’s a wise move by the CFTC to reduce leverage by two times — 100:1 to 50:1 under the new rules — rather than going way over board with its original proposal of 10:1 leverage. Unlike most off-exchange retail forex dealers in the U.S., Citi FX is not regulated by the CFTC; it is subject to bank regulation. 

It’s important to note the CFTC grants the NFA powers to set leverage rules higher than these new minimum percentages. 

Thankfully, the CFTC responded to the pleas from the off-exchange retail forex trading industry saying the CFTC’s proposed 10:1 leverage rule would put the industry at a huge competitive disadvantage to on-exchange currency futures trading (30:1), commercial bank forex trading (50:1) and offshore off-exchange retail forex trading (200:1). The new deposit rule for non-major currencies is 5 percent (20:1).

Regulators and Congress are often sensitive to chasing business (and fraud) abroad with new rules as well as taking business away from small businesses and handing it over to big banks. The CFTC also wants the U.S. to remain competitive for foreign traders, as foreign traders can continue to trade offshore without concern about registration in the U.S. 

It seems these new rules will put a stop to Americans trading retail forex offshore to evade CFTC rules. That trend picked up the pace in recent years and it may need to be reversed quickly. But we aren’t completely certain of this yet. We will study the new rules and see if offshore trading remains feasible for Americans under extraterritorial provisions of the Dodd-Frank Fin Reg bill. (We discussed how offshore trading might be a problem for American’s using offshore forex platforms on our recent blog and podcast.) 

We base our initial thoughts on the first documents released by the CFTC (links below). In the CFTC’s Q&A document, see the “Who can offer off-exchange forex transactions to retail customers” section. It states that Dodd-Frank Fin Reg changed the definition of allowable financial institutions to “only U.S. financial institutions.” The next section, “What is the scope of the CFTC’s jurisdiction,” implies that unless the entity is regulated by the SEC or bank regulators – again for U.S.-only financial institutions – the default catchall regulator is the CFTC. It makes sense that the CFTC would act in this manner, but again, we aren’t certain of these rules yet. Nothing in these CFTC documents specifically exempts offshore forex platforms or brokers from these new rules, either. Stay tuned for further observations.

For more information: 

CFTC releases final rules regarding retail forex transactions: Click here. 

Final rule regarding retail foreign exchange transactions (summary): Click here.

Federal Register: Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries:Click here.

Questions and answers regarding final retail foreign exchange rule: Click here.

CFTC unveils retail currency-trading rules: Click here.