Tax Treatment On Financial Products

Which financial products you trade and where you trade them can make a huge difference in tax savings.

Tax treatment of financial products affects investors, traders, and hedge funds. But sadly, many taxpayers overlook essential differences in tax treatment for these groups, resulting in overpayments. Education is key. This section contains valuable information about how to treat the various instruments come tax time. We cover U.S. and international equities, U.S. futures, and other Section 1256 contracts, options, ETFs, ETNs, forex, precious metals, foreign futures, cryptocurrencies, and swap contracts.

It’s important to distinguish between securities vs. Section 1256 contracts with lower 60/40 capital gains rates vs. other financial products such as forex or swaps with ordinary income or loss treatment. Various elections are available to change tax treatment.

DON’T RELY SOLELY ON 1099-Bs

One might expect that broker-issued 1099-Bs would handle all these issues, but for some tax treatments, they do not. For example, some brokers categorize CBOE-listed options on volatility ETNs (i.e., VXX) as securities. Still, there is substantial authority to treat these CBOE-listed options like VXX as “non-equity options” included in Section 1256, which might be more tax advantageous.

Broker compliance rules differ from those taxpayers should follow on wash-sale loss adjustments on securities. How you report the activity on your tax return depends on your facts, circumstances, and elections. There is no way for every broker to police all their clients’ elections, qualification for trader tax status (TTS), and whether they have filed an election for Section 475 MTM on time. Brokers should issue 1099-Bs for the “everyman,” not based on each taxpayer’s facts, circumstances, and elections filed. Therefore, it is imperative that taxpayers review the 1099-Bs entirely and only use the information if it agrees with their situation.

Some financial products like spot forex are not “covered securities” for 1099-B issuance. Some U.S. cryptocurrency exchanges issue a Form 1099-K (Payment Card and Third-Party Network Transactions) to investors who reach a certain threshold of transactions. For 2022, some U.S. cryptocurrency exchanges are issuing a 1099-MISC or 1099-B.

Brokers issue Form 1099-Bs for securities and Section 1256 contracts to investors and traders. Recent tax legislation beefs up tax compliance and reporting for cryptocurrencies.

CAPITAL GAINS VS. ORDINARY INCOME

Most financial instruments — including equities, futures, options, ETFs, ETNs, precious metals, and cryptocurrencies held as capital assets — are subject to capital gains treatment. But some of these financial products, such as U.S. futures, qualify as Section 1256 contracts with lower 60/40 capital gains rates. The distinction between typical capital gains and 60/40 capital gains treatment makes a big difference. The capital-loss limitation is a problem for traders and investors who may have trouble using up large capital-loss carryovers in subsequent tax years. By default, forex contracts and swap contracts are subject to ordinary gain or loss treatment. Traders with TTS and a Section 475 MTM election have ordinary-loss treatment, which is more likely to generate tax savings or refunds sooner. Some financial products don’t qualify for a Section 475 election, including forex, cryptocurrencies, and ETNs structured as prepaid forward contracts. ETNs structured as debt instruments are securities eligible for Section 475 treatment.

Click “Explore Tax Treatment On Financial Products” on a mobile device” above. On a computer, see it on the upper-right. 

For more information, see Green’s Trader Tax Guide Chapter 3 Tax Treatment of Financial Products