Forex

The forex Interbank market has been around for many decades. Robert A. Green founded Green & Company CPAs in 1983 to handle the special tax and accounting needs of several leading professional forex traders and Interbank brokers (they used phones only before the Internet).

It's important to understand some key differences between professional forex traders and this newer breed of online forex traders.

Professional forex traders often trade "forward contracts" (rather than spot forex) because forwards have more transparency and better pricing than spot. Most professional traders in forward forex understand they are trading major currencies(for which regulated futures contracts [RFCs] exist); therefore they can claim IRC 1256 60/40 tax treatment.

Most professional forward forex traders make a good living trading forwards and they count on lower 60/40 tax rates each year (up to 12-percent lower tax rates). Remember, IRC 1256 losses may be carried back three tax years, but only applied against IRC 1256 gains in those years.

Contrast professionals with the newer breed of online forex trader. Most online forex traders are new to forex; some moved from the online securities or futures trading space. Many have very low account sizes ($2,000 to $25,000) and they lack the capital, clout and connections to trade forwards in the (non-retail) Interbank market.

The retail online forex trading marketplace did not pick up steam until the early 2000s. When the 1990s online trading revolution in securities suffered a bear market, brokers and traded morphed into the forex market. This became possible when larger banks democratized Interbank market access with new retail platforms.

The key difference is that online forex traders mostly trade spot contracts, whereas professional traders have access to lower-priced forward contracts. But are spot and forward forex contracts treated the same?

Spot and forwards may or may not have different tax treatment.
Although forward contracts are mentioned in IRC 1256, they receive ordinary 988 treatment unless a trader makes a contemporaneous internal election to opt out of 988 for 1256.

Some tax professionals treat spot contracts as part of IRC 988 (with no ability to elect to choose 1256), whereas other tax professionals think that spot contracts in major currencies (with RFCs) may also be treated like forwards above.

IRC 988 appears to state that if a trader does not "take or make delivery" of the actual currency – and most traders don't make or take delivery – then the spot contract can be treated like a forward contract.

The key issue for forward contracts to be included in IRC 1256 is that the forward contracts must be in major currencies (not minor currencies), for which RFCs (regulated futures contracts) also are traded. For example, forward contracts in the Euro qualify, since there are euro currency futures traded on futures exchanges.

How to proceed with tax filings.
We believe that a "reasonable cause" position (which is weaker than a "more likely than not" position) can currently support treating spot like forwards, providing the spot is in a major currency for which RFC futures contracts are also traded.

So if you want to claim IRC 1256 60/40 lower tax rates on spot trading gains, it's wise to get a "reasonable cause" legal opinion. Although the IRS requires tax preparers to have "more likely than not" positions to avoid preparer penalties, they have waived this higher standard for 2007 tax returns, allowing "reasonable cause" positions.

Our firm works closely with a tax attorney who can provide these legal opinions for our tax preparation clients.

In all cases, if you trade forex – anything other than currency futures on US exchanges – it's wise to consult with a forex tax expert (such as our firm). We are available for consultations and our firm prepares tax returns for hundreds of forex traders.