Other Financial Products

Volatility ETNs, swaps, foreign futures, and precious metals.

Volatility ETNs. There are many volatility-based financial products to trade, and tax treatment varies. For example, CBOE Volatility Index (VIX) futures are Section 1256 contracts with lower 60/40 MTM tax rates. The NYSE-traded SVXY is an ETF taxed as a security.

Volatility exchange-traded notes (ETN) are structured as “prepaid forward contracts” or as “debt instruments.” Our tax counsel says that an ETN prepaid forward contract is not a security in the eyes of the IRS, whereas ETN debt instruments are.

Sales of ETN prepaid forward contracts use the realization method on sales. Long-term capital gains rates apply if held for 12 months or longer. Because it’s not a security, ETN prepaid forward contracts (i.e., VXX) are not subject to wash-sale loss adjustments or Section 475 (if elected). ETN debt instruments (i.e., UGAZ) are securities subject to wash-sale losses and Section 475 (if elected). Check the tax section of the ETN prospectus.

There is substantial authority to treat CBOE-listed options on volatility ETNs and on volatility ETFs structured as publicly traded partnerships as “non-equity options” with Section 1256 treatment. See our blogs: How To Apply Lower Tax Rates To Volatility Options (https://tinyurl.com/volatility-option), and ETNs Have Different Structures With Varying Tax Treatment (https://tinyurl.com/gtt-etns).

In preparing Form 1099-Bs, many brokers use the tax classification determined by exchanges for labeling securities vs. 1256 contracts. Some brokers treat both ETNs as securities on 1099-Bs with wash-sale loss adjustments, even though prepaid forward contracts do not fall in that category. Some brokers treat CBOE-listed options on volatility ETNs and ETF PTPs as securities on Form 1099-Bs, even though they are eligible for Section 1256 treatment. Taxpayers should consider departing from 1099-Bs based on substantial authority positions and explain why in a tax return footnote.

Swap contracts. The Dodd-Frank financial regulation law promised to clear private swap transactions on exchanges to protect the markets from another swap-induced financial meltdown — remember those credit default swaps with insufficient margins? When Congress enacted Dodd-Frank in 2010, traders hoped that clearing on futures exchanges would allow Section 1256 tax treatment. They were wrong: Congress and the IRS immediately communicated that Section 1256 would not apply to swap transactions, and they confirmed ordinary gain or loss treatment. Please read our blog post: Tax Treatment for Swaps Options, https://tinyurl.com/gtt-swaps.

Foreign futures. By default, futures contracts listed on international exchanges are not Section 1256. If the international exchange wants Section 1256 tax treatment, it must obtain an IRS Revenue Ruling. Only a handful of international futures exchanges have Section 1256 treatment: Eurex, LIFFE, ICE Futures Europe, and ICE Futures Canada. Foreign futures are otherwise ST or LT capital gains. (Read our blog Tax Treatment for Foreign Futures https://tinyurl.com/ttfutures to see the list of exchanges with this IRS approval and Updated 2021 US IRC Section 1256 qualified board or exchange list.) Remember, Section 1256 tax treatment uses MTM accounting at year-end. Foreign futures without Section 1256 are reported like securities using the realization method for short- vs. long-term capital gains.

Precious metals. Physical precious metals are a particular class of capital assets called collectibles. If you hold collectibles over 12 months before the sale, you must use the collectibles capital gains tax rate — capped at 28%. That rate is higher than the top long-term capital gains rate of 20% (2022 and 2023). The short-term capital gains rate applies if you hold collectibles for 12 months or less. Precious metals are not securities, so wash-sale loss adjustments and Section 475 do not apply. Please read our blog post: Tax Treatment for Precious Metals, https://tinyurl.com/gtt-precious.

For more information, see Green’sTrader Tax Guide Chapter 3 Tax Treatment of Financial Products.