The rules for federal income taxation of foreign exchange trading are light years behind the developments in the marketplace. The Internal Revenue Code is stuck in 1984, when foreign exchange trading was a vastly different, and much smaller, world.
Back then, nearly all foreign exchange trading was conducted between banks (or other financial institutions) or through regulated futures contracts. Spot foreign exchange trading at the retail level hardly existed in 1984; today, it is one of the biggest (by dollar value) markets.
The tax treatment of spot forex trades is (surprise) just a mess. The nominees for best tax treatment of a spot forex contract are:
1. All gains or losses are always ordinary and open positions at year-end are marked-to market.
2. All gains or losses are always ordinary and open positions at year-end are not marked-to-market.
3. All gains or losses are ordinary and open positions are marked-to-market, but the taxpayer may make a valid, timely election to treat them as “60/40” transactions (60 percent of gains or losses is long-term and 40 percent is short-term).
While we wait for the awards presenter (Internal Revenue Service Office of Chief Counsel) to open the envelope, you should be aware that because of positions the IRS has taken recently on other types of currency trading, the last nominee may be the most reasonable choice.
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