No matter if you are trading for a living or just to supplement your earnings you have to think about the tax implication of your endeavors. As soon as you are profitable, in some weird cases even when you are in a loss, you will have to pay taxes or at least report your trading activity if you want to follow the rules.
And you should follow them—your focus should be on being successful in trading first and optimizing your taxes later.
When you trade currencies by a broker based in any country you still have to pay taxes by the rules of your own nation. There is a huge variety in rules around the world with extreme examples, like a previous rule of paying taxes in some Eastern European countries on all of your gains without the ability to deduct losses from them. Those rules understandably lead to high levels of tax evasion and were abolished but still there are great discrepancies internationally.
Most of the countries tax their residents’ forex gains when they remove their profits from their trading accounts. Some countries like the USA require their residents to report their profits yearly even when not removing them from their account.
- Know and follow the deadlines!
This way there will be no surprises for you—fines could be very high if you miss reporting your gains and expenses.
- Know the rules and optimize your payments!
Optimizing your taxes is not evasion; it is the rational thing to do. If you know your rights and possible exemptions you may save hundreds or thousands of dollars a year. Think about the time you spend with it as a long-term investment.
- Don’t try to evade taxes!
If you run a successful forex business you don’t need to anyway. The risk of getting caught is an uncertainty that will mean unnecessary stress and that’s not good for your performance.
- Keep your own records don’t just rely on your broker’s statements!
- The opening balance of the year
- The closing balance of the year
- Deposits and Withdrawals
- Interest incomes and paid interests
- Other costs, like fees and commissions
If you have these, even if you have more than one account, you will be able to fill most of the documents in the case your broker(s) have technical issues. It is always handy to have your own sensitive data redundantly stored.
Now let’s see some examples of forex taxation from around the world!
In the states, forex gains are taxed very strictly. You have to pay attention to a lot of rules and deadlines if you want to optimize your payments.
Basically, your gains can fall under two different rulings the Section 988 and the Section 1256.
If the trader doesn’t opt out of it his/her trading will fall under this ruling. But be careful if you are profitable, staying under this Section is unfavorable as all of your gains will be taxed as short-term capital gains (a 35% rate). When you have losses Section 988 is favorable as you can deduct your losses from other taxable incomes.
Section 1256, Long and Short-Term Capital Gains (60-40 rule)
If you are a profitable trader you should elect to be treated under this section. It provides you with a much more favorable tax rate where 60 percent of your gains are treated as Long Term Capital Gains and only 40% percent as short-term gains. This way, your effective tax rate will be only 23%.
Note that you can only opt for the latter in the case of trading with exchange rates that have a futures equivalent on a regulated exchange (most of the major pairs).
Rules in the UK are much more favorable for trading. If you live in the UK you probably know that there is the widely used spread-betting structure that is tax-free (!!) and a lot of brokers offer forex trading under that legislation. If you choose an account like that your gains will be exempt from income taxes, otherwise usual capital gains taxing rules apply.
As a general advice, I encourage you to consult with a tax expert knowledgeable in your country’s rules—if you want to run a serious forex business you will have to do it sooner or later anyway.
But before you do that concentrate on the more important task at hand—being a successful trader!