While there are numerous benefits in futures trading on stocks or ETFs, one of the key drivers driving many traders towards futures trading is fiscal efficiency.
Due to IRS classifications in markets such as futures under section 1256, capital gains and losses are estimated at 60% long-term and 40% short-term.
This means that a futures trader can get 60% of his profit at the most favorable long-term tax rate, even if the contract was held for less than a year. This is different from stocks or ETFs, where they are taxed 100% on their normal income bracket.
Learn more about the tax benefits of futures trading in this 3-minute video.
Long-term capital gains
The rate of long-term capital gains tax is 0%, 15% or 20% depending on your taxable income and your status as a presenter. For most individual merchants, 15% will be the rate used.
This means that 60% of your income from futures trading will be taxed at 15% instead of your typical tranche rate.
If a futures trader is in a 30% income tax bracket and reports a $ 10,000 profit on year-over-year transactions, $ 6,000 of that profit would be taxed at 15%, while only $ 4,000 they would be taxed at their usual tax rate.
$ 10,000 profit x 60% long-term capital gains rate = $ 6,000
Profit of $ 10,000 x 40% short-term capital gain rate = $ 4,000
Tax rate of $ 6,000 x 15% = $ 900
$ 4,000 x 30% tax = $ 1,200
$ 900 + $ 1,200 = $ 2,100 total income taxes
To understand this benefit compared to equity trading, if a trader reported the same $ 10,000 earnings from equity trading in a year and was in the same tax bracket as the previous futures trader, 100% of this profit would be reported as short-term capital gains and taxed the full amount of income tax.
$ 10,000 x 30% = $ 3,000 total income taxes
In this example, the futures trader who benefited from section 1256 of the IRS experienced a 9% tax efficiency over its counterparty as a equity trader, resulting in a net difference of $ 900 in the its total tax burden of the negotiation during the year.
You can easily see the tax advantage of futures trading just by looking at these hypothetical examples. While entirely hypothetical, if the previous trader were in a higher than 30% income tax bracket used in this example, the 60/40 tax rule would result in even more favorable tax efficiency.
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