Section 988

The principal intention of Section 988 is to tax foreign currency transactions that occur in the normal course of global business.

For example, if a manufacturer uses foreign currency to buy something in another country, the fluctuation in exchange rates needs to be taken into account. Section 988 states these fluctuations are treated as ordinary income or loss and reported as interest income or income expense. As a result, they are subject to the ordinary tax rates.

Forex traders are subject to foreign exchange rate fluctuations and as such are taxed under Section 988 rules.

However, currency traders can treat their forex positions as “capital assets” and, thus, elect out of Section 988. Traders who do this will have their currency positions treated as Section 1256 contracts.