Tuesday, February 2, 2010

Re: [TheOptionClub.com] Some clarification on 1256 tax treatment

 

Hi,

Thanks for the info.  Does this apply to all tax filers, or only those under trader status?

Does anyone have thoughts on switching to trader status, by the way (pros/cons)?  I'd guess that mark-to-market reduces hassle of record-keeping, and one also gets to write-off expenses, correct?  But are there drawbacks?

I'm wondering how to establish trader status -- whether there are certain trade activity minimums, and whether it requires an accountant or lawyer initially, and how much that would cost.

Thanks!

On Mon, Feb 1, 2010 at 7:06 PM, nahorowitz <nhorowitz@axeus.com> wrote:
 

Some clarification on 1256 tax treatment. There are some grey areas in the law regarding 1256 treatment. For those of you who don't know about 1256, it is IRS rule that gives 60% long term/40% short term tax treatment to broad-based index options, so this is a big tax-saver for folks who collect premium and would otherwise be taxed 100% short term rate.

All broad-based cash settled index options for sure get 1256 tax treatment. So this includes all index options, as well as any other obscure cash settled options. They must meet the definition of "Broad-based" which basically means 10 or more constituents. Narrow-based indexes (9 constituents or less) do not qualify.

Now the grey area in the law has to do with options on ETFs that mirror broad-based indexes. So does SPY qualify for 1256 treatment? Several of the CPAs who are expert in trader taxation (e.g., Robert Green of GreenTraderTax.com) take the position that options on broad-based index ETFs DO qualify for 1256 treatment. But there is no law or IRS ruling or case law directly on this point, but there are some strong arguments in favor of this position.

One of the tax matching software programs called GainsKeeper keeps an up-to-date list of ETFs that they believe qualify for 1256 treatment of their options. I know that SPY and UNG are on their list. The product manager told me that the IRS uses Gainskeeper on their side, so if your ETF symbol is on Gainskeeper's list you may be quite safe since the IRS will be checking that same list on their side.

Now that ThinkOrSwim has merged with Ameritrade and Ameritrade was a Gainskeep client, TOS now offers Gainskeeper Gain/Loss reports on the TOS website. Several other brokers also offer Gainskeeper reports for free. If the GainsKeeper reports says "Mixed" in the holding period column, then those are the symbols that they say qualify for 1256 treatment. I know SPY and UNG, which are both broad based index ETFs, have my options trades showing "mixed" on my Gainskeeper report.


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