Section 1256 Contracts

Section 1256 contracts enjoy lower 60/40 capital gains tax rates, summary tax reporting, and easier mark-to-market (MTM) accounting.

Section 1256 contracts include:

  • The U.S. regulated futures contracts (RFCs)
    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
  • non-equity options (a catchall)
  • CBOE-listed options on commodity ETF publicly traded partnerships
  • CBOE-listed options on precious metals ETF publicly traded trusts
  • CBOE-listed options on volatility ETN prepaid forward contracts and ETN debt instruments
  • 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 2019 and 2020, the blended 60/40 tax rate is 26.8% — 10.2% lower than the highest ordinary 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 from throughout the year and unrealized gains and losses on open trading positions at year-end.

With MTM and summary reporting, brokers can issue simple one-page 1099-Bs reporting “aggregate profit or loss on contracts” after taking into account realized and unrealized gains and losses.

There is also a Section 1256 loss carryback election.

Section 1256 tax rates vs. ordinary rates (2019 & 2020 rates)

Ordinary
Rates
Long-Term
Capital Gains
Rates
40%
Short-Term
Rates
60%
Long-Term
Rates
Blended
60/40
Rates
Savings
In
Rates
10% 0% 4.0% 0% 4.0% 6.0%
12% 0% 4.8% 0% 4.8% 7.2%
22% 15% 8.8% 9% 17.8% 4.2%
24% 15% 9.6% 9% 18.6% 5.4%
32% 15% 12.8% 9% 21.8% 10.2%
35% 15% 14.0% 9% 23.0% 12.0%
37% 20% 14.8% 12% 26.8% 10.2%

For more information, see Green’s Trader Tax Guide

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