Tax implication of Trading Forex

I hope Andrei doesn’t mind that I post his comment on the front page.  I think it provides some good insight on the tax implications of trading currencies:

"On the issue of taxes… I recently discussed this with my tax advisor. One book I read recommened incorporating, as then you don’t take your profits on Sched. D as a capital gain, but rather pay yourself a salary for your trading time. If you ever want to leave an inheritance for someone, you issue them non-voting "shares" in the company instead. Sounded great in principle, but my advisor said a client of her’s just got snagged with a surprise $70,000 bill from the IRS using this method."

She says Sched. D actually ends up being cheaper for individual investors like us in just about every case. Many people are put off by the 35% short-term capital gains tax (which Forex most certainly would be - I can’t imagine holding a pair for over a year just to qualify for the short-term rate of 15%). However, she said that most people forget to realize that this percentage - like eveyrthing else - depends on your income bracket. 35/15% is just the top, and you have to be trading at a fairly significant level to even get close to that. Most people end up paying somewhere closer to 15-20% for the short-term gains, and a proportionately smaller % on the long-term ones. 15% is certainly better than the rates most people are taxed at for income, or even self-employment tax.

The other size is deductions. With a business you get Sched. C, without you itemize on Sched. A. You are guarenteed $5000 minimum deduction even if you don’t itemize (on Sched. A - Sched. C comes with no guarentees), plus Sched. D allows for an adidtional $3000 of losses. That’s a pretty decent offset, and it can get higher if you itemize. And keep in mind if you’re deducting only around $5000, you’re likely no where even near the 35% gain tax bracket.

She very highly recommened taking the capital gains route over incorporating, with the caviat that you should have someone familiar with this area of tax law look over your returns, or use a software such as Gains Keeper. There are certainly easy ways to over-pay if you don’t know what you’re doing. She’s prepared my taxes for 5 years now, and each time she’s gotten much more out for me that I did by myself (and I thought I was anal with itemizing), or even what Quicken/TurboTax found. So I’m going to trust her in this as well.

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