Accounting differences

Not only do currency futures traders enjoy beneficial tax treatment, they also have it easier when it comes to filing their tax return. Futures brokers send traders (and the IRS) a Form 1099, which provides one total for your gains or losses.

The “mark-to-market accounting” rules of Section 1256 make accounting a snap. Brokerages simply adjust realized gains and losses with beginning- and end-of-year unrealized gains and losses.

The gains or losses listed on the Form 1099 are be reported on Form 6781, then transferred to a Schedule D.

However, forex traders do not have their profits or losses reported on a Form 1099, so they are on their own. Some brokerages offer online reporting, but these are often incomplete and are unreliable when it comes time to fill out a tax return.

So if you trade in anything other than Section 1256 contracts, you will probably need your own accounting solutions or software programs. Unfortunately, most good accounting programs are geared toward stock traders. There is a solution for forex traders, though: the “Performance Record Approach” (PRA) The IRS accepts results from the PRA, and the formula is as follows:

NP=ENA – BNA – C + W

NTA=NP – II + IE+OE
where

NP = net performance

ENA = ending net assets (at market value)

BNA = beginning net assets (at market value)

C = cash deposited

W = cash withdrawn

NTGL = net trading gain/loss

II = investment income

IE = interest expense

OE = other expenses

If you have not switched out of Section 988, the net trading gain/loss should be reported on Line 21 of Form 1040. If you do elect out, the net trading amount should be added to Form 6781 as “cash forex elected out of IRC 988.”

Cash traders using their monthly statement to account for gains or losses can easily get confused. Some traders get different statements for different currencies traded, and trying to figure out profit or loss can be a nightmare. The performance record approach is the answer.