Posted by Tradovate on April 16, 2024 at 10:20 AM
When trading equities or ETFs, you’re taxed 100% at your normal income bracket. But when trading futures, you can take 60% of your profit at the more favorable long-term tax rate, regardless of the time you’ve held the contract(s).
How it’s different
Trading futures comes with unique tax advantages over trading equities and ETFs.
Under Section 1256 of the U.S. Internal Revenue Code, when trading markets such as futures, capital gains and losses are calculated at 60% long-term and 40% short-term.
The power of long-term capital gains
When trading futures, your long-term capital gains tax rate will not be the same as your standard tax bracket rate; instead, it will be 0%, 15%, or 20%. It all depends on your taxable income and filing status, but if you’re like most futures traders, your long-term capital gains tax rate will be 15%—meaning that 60% of your futures trading income will be taxed at just 15%.
Let’s explore some of the tax advantages of trading futures with a few examples
If a futures trader in a 30% income tax bracket reports a $20,000 profit on trades for the year, $12,000 of that profit would be taxed at 15%, while only $8,000 would be taxed at their regular tax rate.
$20,000 profit x 60% long-term capital gains rate = $12,000
$20,000 profit x 40% short-term capital gains rate = $8,000
$12,000 x 15% tax rate = $1,800
$8,000 x 30% tax rate = $2,400
$1,800 + $2,400 = $4,200 total taxes on profit
Now let’s contrast trading futures with trading equities. If an equities trader reports the same profit of $20,000 and is in the same 30% tax bracket as the futures trader above, 100% of that profit would be reported as short-term capital gains and be taxed the full income tax amount.
$20,000 x 30% = $6,000 total taxes on profit
As we can see, the futures trader above benefits from IRS Section 1256, receiving a 9% tax efficiency and resulting in a $1,800 net difference in their total tax burden for that year. If the futures trader above was in a higher income tax bracket than 30%, the 60/40 tax rule would provide them with even more favorable tax efficiency.
This is not meant as tax advice, please consult a tax professional.
FAQs
Trading futures comes with unique tax advantages over trading equities and ETFs. Under Section 1256 of the U.S. Internal Revenue Code, when trading markets such as futures, capital gains and losses are calculated at 60% long-term and 40% short-term.
What are the tax advantages of trading futures? ›
Capital Gains Advantages. While short-term capital gains from stocks or ETFs are taxed at your ordinary income tax rate, futures are taxed using the 60/40 rule: 60% are taxed at the long-term capital gains tax rate of 15%, while only 40% of your short-term capital gains are taxed at your ordinary income tax rate.
What is the 60 40 tax rule for futures? ›
Futures, forex, and options
Section 1256 contracts get special tax treatment of 60/40. This means that positions held for any amount of time will receive 60% long-term capital gains treatment and 40% short-term capital gains treatment.
What benefit did they receive from having a futures market? ›
One of the reasons futures markets exist is to help facilitate the management of portfolio risk. Thus, some traders may use them to hedge their equity portfolio. One way they might do this is by taking a futures position opposite to their positions in the actual commodity or financial instrument.
Which of the following is a benefit of trading futures? ›
Low Execution Cost
To own a futures contract, an investor only has to put up a small fraction of the value of the contract (usually around 10%) as margin. The margin required to hold a futures contract is therefore small and if he has predicted the market movement correctly, he receives huge profits.
How much tax do you pay on futures income? ›
Futures and options traders run the risk of making a profit or a loss. The profit or loss from Futures and Options trading must be considered "non-speculative" business income under the Income Tax Act of 1961. Traders are required to disclose both profits and losses on their income tax returns (ITR).
How do taxes work for day trading futures? ›
Day-trading tax rates
Day trading taxes can vary depending on your trading patterns and your overall income, but they generally range between 10% and 37% of your profits. Income from trading is subject to capital gains taxes.
What is the 80% rule in futures trading? ›
–If the market opens up inside of value and then trades out of value, the rule applies the same way. If the market can trade back inside value for two consecutive 30 minute periods, then it has an 80% chance of rotating to the other side of value.
Do you need 25k to trade futures? ›
To apply for futures trading approval, your account must have: Margin approval (check your margin approval) An account minimum of $1,500 (required for margin accounts.) A minimum net liquidation value (NLV) of $25,000 to trade futures in an IRA.
How do you calculate tax on futures trading? ›
It all depends on your taxable income and filing status, but if you're like most futures traders, your long-term capital gains tax rate will be 15%—meaning that 60% of your futures trading income will be taxed at just 15%.
The futures markets provide direct access to trade a variety of products and contracts, both financial and commodities, which are not available through stock option trading. This means that futures can offer greater diversification which can help offset the risk of having all your eggs in one directional basket.
Is it better to trade futures or stocks? ›
While futures can pose unique risks for investors, there are several benefits to futures over trading straight stocks. These advantages include greater leverage, lower trading costs, and longer trading hours.
What are the pros and cons of futures trading? ›
The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.
What are the tax advantages of futures trading? ›
As of tax year 2023, long term capital gains rates are 0%, 15%, or 20%, also based on your income and filing status and are typically lower than your ordinary tax rate. This means that 60% of profit from futures trading may be taxed at a lower rate than your ordinary tax rate.
What is the main benefit of using futures for day trading? ›
As a futures trader, you can express your opinion long or short multiple times a day or week and you do not have to worry about day trading restrictions applicable to equities or the ability to take a short position in the market. So why miss out on another opportunity because of restrictions? Make a move into futures.
What is the primary benefit of a futures exchange? ›
One of the key benefits of futures trading is leverage. In other words, one of the major advantages of trading futures is that you can pay a margin and get the same benefit of buying the entire quantity of stock. The other advantages of trading futures include speculation, arbitrage, hedging, etc.
What is the disadvantage of trading futures? ›
Future contracts have numerous advantages and disadvantages. The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.
Is it worth it to trade futures? ›
While futures can pose unique risks for investors, there are several benefits to futures over trading straight stocks. These advantages include greater leverage, lower trading costs, and longer trading hours.
What is the advantage of using futures? ›
Futures have several advantages over options in the sense that they are often easier to understand and value, have greater margin use, and are often more liquid. Still, futures are themselves more complex than the underlying assets that they track. Be sure to understand all risks involved before trading futures.
What are the tax advantages of trader status? ›
Trader tax status comes with a number of benefits, including the ability to deduct interest as an expense. Traders can deduct educational expenses, like stock trading seminars and educational materials, provided that these expenses are itemized and exceed two percent of their adjusted gross income.
