The preferred tax rate. Securities are usually taxed at short-term capital
gains rates for future traders because they normally hold positions
for less than a year. Most securities traders pay higher income tax
rates than futures traders. It is important to know that the time
traders hold the futures contract is not relevant to the preferential
treatment of the 60/40 split. The 60/40 split is automatic to any
regulated futures trade. Take a look at an example using 2011 tax
rules. the "commodities futures" trader, is married filing jointly.
He makes $75,000.00 trading gold futures on the CME. This activity
falls under section 1256 contracts. The traders tax liability would be
$1,103. If they made the same $75,000.00 in profit trading single
stock futures or futures on indexes, the entire amount is short-term
capital gains and taxed at their personal income tax rate. Their tax
liability would be $7,754. The difference between short-term capital
gains and section 1256 contracts is $6,651.00 in tax savings.
Traders market treatment with this type of trading. Futures traders
also benefit from a built-in mark-to-market accounting. Section 1256
contracts are marked to market at the end of each tax year. No
election needs to be made. Consequently, all traders and investors
report realized and un-realized gains and losses. This also means that
if you are trading futures, you will not need to worry about wash sale
rules as they do not apply to futures. Do not confuse section 1256
mark-to-market accounting with IRC 475 (f) election to use MTM. MTM
(IRC 475) is generally not the preferred method for profitable
commodities and futures business traders as it will increase their
taxes on gains and only marginally improve their ability to carry back
Ease of filing. Another great benefit is that year-end tax
reporting generally does not require a detailed listing of each trade,
as is required for securities traders. This can save you time when
filling out your tax return and cost when using a professional
accountant. Regardless of the fact that most futures trading is exempt
from detailed transaction reporting, traders must keep the detailed
records in their files as any well-run business would maintain its
records. If the trader is audited, these details will be used to
substantiate the volume of your daily activity in support of claiming
"trader status" on their tax return.
Three year carry back of losses from section 1256 contracts.
An trader or partnership having a net section 1256 contracts loss can
elect under §1212(c) to carry this loss back 3 years, instead of
carrying it over to the next year. The loss carried back to any year
under this election cannot be more than the net section 1256 contracts
gain in that year. In addition, the amount of loss carried back to an
earlier tax year cannot increase or produce a net operating loss for
that year. The loss is carried to the earliest carry back year first,
and any unabsorbed loss amount can then be carried to each of the next
2 tax years. If only a portion of the net section 1256 contracts loss
is absorbed by carrying the loss back, the unabsorbed portion can be
carried forward, under the capital loss carryover rules, to the year
following the loss. If you experienced losses in futures trading in
2011 and have futures gain in prior years, you need to contact one of
our professional accountants as you will need to file Form 1040X or
Form 1045, Application for Tentative Refund, for the year to which you
are carrying the loss. This could mean a savings of thousands of
dollars to you.
Trading futures offers many advantages such as leverage, 24 hour
trading opportunities, favorable 60/40 split on your tax liability,
ease of tax filing and the ability to carry back your losses.
Commodity Futures markets were created. With the volatility in prices
around the world, you can see how difficult it would be for a
commercial interest to know what they were going to pay get paid when
they needed a Commodity sometime in the future. Commodity Futures
contracts were created to help commercial interest lock in fixed
prices on products that are to be delivered or delivery taken at a
future date. Commodity Futures exchanges, where the products trade,
act as intermediaries and guarantors of the Futures contracts. They
also create the contract specifications for each Commodity Futures
contract so every participant knows exactly what they are buying or
selling. Wheat Farmer is looking to lock in higher prices to protect
the crop he will own. To do this, he is looking to sell the Wheat
contract around the $9.20 to $9.80 price zone. He is placing an offer
to sell at these prices.
Below that we see that General Mills will need Wheat to make
products for some future delivery time. They are posting bids in the
$5.75 to $6.40 zone. These become the market bid prices. If there were
no other participants but these two entities, then the current bid
would be $6.40 and the current offer would be $9.20. For the market to
make a trade, a buyer and seller would have to agree on a price. As
this example stands, there is no way they could make a trade with a
bid/ask spread that far apart. Neither entity could afford to trade
with the other participant and stay profitable.
This is where speculators come into the trading markets.
Speculators act as the power to get prices from one price point to
another so that commercial interest can hedge their price risk. This
hedge is rarely done with other commercial interest, but instead they
take the other side of the speculators trade in many cases. Notice
that as price leaves the $6.40 level that an uptrend starts to form.
This is what most speculators are looking for is a trend to
participate in. Once they see this trend, the buying will keep coming
into the market until a larger force producer absorbs all the current
demand in the market. Once this demand is absorbed by the producer,
the price will eventually start to fall because there are no more
buyers left. This causes the trend to turn down and the speculators
are now looking to sell in this trend until eventually, the
speculators push the prices down to where General Mills Processor is
waiting for lower prices to start buying Futures contracts to hedge
with. Eventually, they absorb all the supply in the market and prices
will begin another uptrend. At that point, the speculators will jump
on board that trend too.
This cycle is repeated over and over in the
Commodity markets and yet many are not aware of why prices turn at certain levels and
times of the year. It all comes down to the commercial interest that
are hedging their positions. Figure 1 shows a perfect cycle of prices
rising and falling into these levels. We all know the markets are not
perfect as this is just an example of what happens on a regular basis.
Traders use their analysis skills to enter the best trades at supply
and demand zones, but keep in mind the trend that you are trading in.
This will minimize potential losses and more importantly, increase
your chances for making money in the markets.