Section 1256 Contracts

Section 1256 contracts include:

• U.S. regulated futures contracts (RFCs) and options on U.S. RFCs
• U.S. broad-based indexes made up of 10 or more underlying securities – also known as stock index futures
• options on U.S. broad-based indexes
• foreign futures if granted Section 1256 treatment in an IRS revenue ruling (lists are online at https://greentradertax.com/tax-treatment-for-foreign-futures/)
• non-equity options (a catchall)
• CBOE-listed options on commodity ETF widely-held publicly traded partnerships (PTP)
• CBOE-listed options on precious metals ETF publicly traded trusts (PTT)
• CBOE-listed options on volatility ETN prepaid forward contracts
• forward forex contracts with the opt-out election into Section 1256(g) on the major pairs for which futures trade (we make a case for spot forex, too)
• forex OTC options (Wright court)

Section 1256 contracts have lower 60/40 capital gains tax rates: 60% (including day trades) subject to lower long-term capital gains rates and 40% taxed as short-term capital gains using the ordinary rate. At the maximum tax bracket for 2022 and 2023, the blended 60/40 rate is 26.8% — 10.2%, lower than the highest regular bracket of 37%.

 There are significant tax savings throughout the income brackets. The LTCG rate in the lowest two ordinary brackets is 0%. (See our table below.) Regular state tax rates apply because they do not include a long-term rate.

Section 1256 contracts are marked-to-market (MTM) daily. For tax purposes, MTM reports both realized activity throughout the year and unrealized gains and losses on open trading positions at year-end.

With MTM and summary reporting, brokers issue simple one-page 1099-Bs reporting “aggregate profit or loss on contracts” by reporting both realized and unrealized gains and losses. Report that amount on Form 6781 Part I, which breaks the net 1256 gain loss down by the 60/40 split and then moves the amounts to Schedule D capital gains/losses.

There is a Section 1256 loss carryback election. Rather than use the 1256 loss in the current year, taxpayers may deduct 1256 losses on amended tax return filings, applied against Section 1256 gains only. (Using Form 1045 is better than 1040X; the IRS issues the refund faster, and the process is less complicated.) It’s a three-year carryback; unused amounts carry forward, and it’s the only remaining carryback opportunity for traders. (For details on executing this 1256 loss carryback election, see Chapter 6.)