Due to IRS classifications on markets such as Section 1256 Futures, capital gains and losses are calculated as 60% long and 40% short.
This means that a futures trader can earn 60% of their profits at the most favorable long-term tax rate, even if the contract has been held for less than a year. This is different from stocks or ETFs, where you are taxed 100% on your normal income level.
Learn more about the tax advantages of futures trading in this 3rd video
Long-term capital gains
The long-term capital gains tax rate is 0%, 15%, or 20%, depending on your tax base and filing status. For most sole traders, 15% will be the rate used. This means that 60% of your futures trading income will be taxed at 15% instead of your usual tax rate.
If a futures trader is in a tax bracket of 30 and reports $10,000 in trades during the year, $6,000 of that gain would be taxed at 15%, while only $4,000 would be taxed at your usual tax rate.
Profit of $10,000 x long-term capital gains rate of 60% = $6,000
Profit of $10,000 x short-term capital gains rate of 40% = $4,000
$6,000 x 15% tax rate = $900
$4,000 x 30% tax rate = $1,200
$900 + $1,200 = $2,100 total income tax
To understand this advantage over stock trading, if a trader reported the same $10,000 profit on stock trading in a year and was in the same tax bracket as the previous futures trader, 100% of this gain would be declared as short-term capital gains and taxed at the full amount of income tax.
$10,000 x 30% = $3,000 Total income tax
In this example, the futures trader benefiting from IRS Section 1256 experienced a 9% over its trading counterparty, resulting in a total tax charge of 900 for the year.
You can easily see the tax advantage of trading futures simply by looking at these hypothetical examples. Although entirely hypothetical, if the previous trader was in a higher tax bracket than the 30% used in this example, the 60/40 would result in even more favorable tax efficiency.
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