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.
