How to Pay Taxes on Gains Made from Forex Trading?

Taxes on Forex trading is different in every country. Some governments avoid taxing small traders, while others use capital gains tax or CFD taxes. It's worth mentioning that there are many countries that do not have any taxes on trading and are highly attractive for investors.
One of the main goals of Forex traders should be reducing expenditure on taxes and trading. Understanding how taxation works in your country and around the world can help you better plan your trading journey.
In many countries, income from Forex trading is taxed using an income tax. The total amount traders are required to pay depends on their earnings and personal income tax rate. In the United Kingdom, if traders trade Forex on spread betting accounts, they do not have to pay any capital gains tax. In the UK, spread betting is taxed differently than traditional investing. What's more, small traders that earn up to 1000 GBPs per year are free from taxation.

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Forex Taxes Explained

Traders have to pay tax on capital gains when they sell a given security at a higher price than the original cost of purchase. It goes without saying that traders do not have to pay any tax for those trades, where they have earned no payouts. To achieve profits, traders need to have an understanding of financial markets and after becoming successful they have to be compliant with local regulations. The exact methodology and rate of capital gains tax depends on the specific country. Here is the maximum capital gains tax rate for individuals in some countries:
  • United States - 37%
  • China - 20%
  • Germany - 25%
  • Greece - 15%
  • Japan - 20.315%
  • Russia - 13%
  • United Kingdom - 20%
  • Switzerland - 0%
  • Sweden - 30%
  • Spain - 23% 
There are several things to keep in mind. Firstly, many countries, including Russia, do not have a separate tax rate for capital gains earnings. Instead, those gains are taxed at the same rate as the personal income tax. One more important thing that needs to be mentioned here is the fact that those rates, which are shown above represent the maximum capital gains tax rates. In many countries, the effective tax rate on those types of earnings can be much lower, depending on the total annual income of an individual, as well as on other circumstances. 

Some countries differentiate Forex from other investments and treat them differently. For instance, countries that take Forex and CFD trading as a form of spread betting, have generally less taxes. Capital gains tax is generally used for taxing short term and long term investors that trade physical assets such as physical stocks and physical precious metals such as: Gold, Silver and Bronze.

Basics of Capital Gains Tax

How can one calculate the amount of capital gains tax Forex traders need to pay to their governments? Well, the accurate calculation of the payable capital gains tax amount consists of two stages. The first thing traders need to do is to calculate the so-called ‘taxable income’. In the case of the Forex trading, it will be the payout earned after closing each winning trade. For the purpose of a better illustration, let us take a look at this 1-hour EUR/USD chart:

Paying tax on Forex trading
The opening and closing prices are shown by white arrows. As we can see from this chart, by the beginning of the second half of June, the EUR/USD pair was trading near $1.1240 level. Once the pair rose to $1.1335, an individual decided to open a long EUR/USD position, investing $10,000, at 1:10 leverage.
During the subsequent weeks of trading, the Euro has appreciated steadily, rising all the way up to $1.1742 level by the end of July, at which point the trader decided to lock-in gains and close the position. As the chart above demonstrates, the Euro made some additional gains, reaching a $1.19 level. However, this was followed by correction and recently the single currency traded near $1.1760 level.
In our example, the trader has gained 502 pips. Now, investing $10,000 at 1:10 leverage means that the size of the position will be $100,000, the equivalent of 1 standard lot. At the time of the closing trade, that position would be worth approximately $103,590. In this case, the brokerage company will get its $90,000 loan back and the trader is left with the remaining $13,590.
Since the market participants have invested the $10,000 into this trade, the size of the payout for this transaction is $3,590. Traders are not taxed when trading, as the profits and losses are often changing the trading balance. Traders are taxed when they decide to move their earnings to their local bank account for everyday use. 
Finally, it is worth noting that traders do not have to make some complex tax calculations after closing every single winning trade. Instead, by the end of the tax year, the brokerage company issues the document, which shows the total amount of gains or losses for the year. Consequently, the market participants can use this number for the purpose of filing their tax returns.

Filing Taxes on Forex Profits Under Section 988

Let us now move on to the question of how to file taxes as a Forex trader in the United States. As mentioned before, in this situation, traders have two options. The first possibility is for traders to file their trading earnings under section 988.
This means that those capital gains will be taxed as ordinary income. Here it is important to understand that the US tax code makes a distinction between the short term and long term capital gains. The tax on the long term capital gains can range from 0% to 20%, depending on the amount of annual earnings.
On the other hand, with section 988, the amounts earned from Forex trading are treated as an ordinary taxable income. So the actual amount the Forex traders will pay for their payouts, does depend on their tax brackets. Consequently, if the trader files his or her earnings under this section, the effective tax rate can range from 0% to 37%. To illustrate this better, let us take a look at this chart, which shows 2020 tax brackets in the US:
How to pay Forex taxes
Firstly, before starting any calculations, it is important to remember that the numbers displayed above only include taxable income. The fact of the matter is that every US citizen and resident can choose between standard or itemized deductions. The standard deduction for single or married individuals filing separately is $12,400. For married individuals filing jointly, this deduction stands at $24,800.
So for example, if two married people who have $150,000 in combined annual income decide to file taxes jointly and use the standard deduction, then their taxable income will be $100,000 - $24,800, which is $125,200. As we can see from the above chart, they fall into the 22% tax bracket.
However, here it is important to mention that this does not mean that they have to pay 22% on their entire taxable income. Instead, they will pay 10% for $19,750, 12% for $60,500 and 22% for the remaining $44,950. Therefore, the total tax liability here will be $1,975 + $7,260 + $9,889, which equals $19,124.
We can conclude from this example, that if the trader files his or her trading earnings under section 988, then the effective capital gains tax rate would range from 0% to 37%. On the one hand, if a trader's only source of income is Forex trading and his or her annual earnings are at $12,400 or lower, then the market participant does not have to pay income tax.
On the other hand, for those traders whose other sources of income exceed $518,400, the effective capital gains tax will be 37%. It goes without saying that the majority of Forex traders will fall somewhere between these two extremes.

Reducing Taxable Income with Forex Losses

One major benefit for traders to file their trading earnings under section 988 is the fact that they can use the total amount of their net losses to reduce their taxable income.  To understand this better, let us take a look at this 1-hour USD/JPY chart:
Tax tips for Forex traders
Let us suppose that the trader opens a long USD/JPY position at 107.14 level, by investing $10,000 at 1:10 leverage just like in our previous example. As we can see from the above diagram, the pair mostly move sideways, before dropping significantly by the end of July 2020.
Now, let us further suppose that faced with this downward trend, the market participant decides to cut his or her losses and liquidate the position at 105.12 level. This means that at the time of its closing, the market value of this trade was $98,114. As in the previous case, the brokerage company will take back its $90,000 loan and the trader is left with the remaining $8,114. Considering the fact that the market participant originally invested $10,000, the loss for this trade will amount to $1,886.
Now, let us return to our example of the couple with a $150,000 annual income. If they suffer this loss in trading, they can file their trading returns under section 988 and reduce their taxable income by $1,886. This means that instead of $125,200, their taxable income will be $123,314. Since they are in the 22% tax bracket, this will save them $414.92.

Forex Trading Tax Laws with Section 1256

Any proper Forex tax manual would mention that traders do have an alternative to file their earnings under section 988. In fact, they can decide to file their annual amount of gains or losses under section 1256.
In this case, 60% of traders’ annual earnings will be taxed at a fixed rate of 15%, while the other 40% will be taxed at the rate of the taxpayer's tax bracket, which can range from 10% to 37%. This can be an attractive option for those traders with a 22% tax bracket or higher.
To illustrate this better, let us return to our earlier example, of the couple with $150,000 annual income. Let us suppose here that $30,000 out of $150,000 came in from the Forex trading. Therefore, if the couple decides to file those earnings under section 988, then the effective capital gains tax will be 22%. Therefore, the total amount which should be paid in taxes will be $30,000 x 0.22, which is $6,600.
On the other hand, if they decide to file their trading earnings under section 1256, in this case, 60% of the amount, which is $18,000 out of $30,000, will be taxed at 15% and the remaining $12,000 will be taxed at 22%. Therefore, the total amount of tax will be $2,700 + $2,640, which is $5,340. So in this case the couple will be able to save $1,260.
As we can see from this example, many traders can save a considerable amount of money on tax by filing their trading earnings under section 1256. However, it does have one important downside. The total amount of losses that can be claimed under this section is capped at $3,000 per year. This means that if a trader suffers a net loss of $10,000 per year, then an individual will only be able to reduce his or her taxable income by $3,000.
Consequently, the choice between section 988 and 1256 will depend on the traders’ average earnings, as well as their tax brackets. For those market participants who often end up with net losses or are in the 10% or 12% brackets, filing under section 988 might be a better option.
On the other hand, for those traders who earn payouts consistently and are in the 22% tax bracket or higher, filing under section 1256 might be a worthy choice. So this choice entirely depends on one’s individual circumstances.

Paying Tax on Forex Trading Outside US

It goes without saying that every country’s tax code has its own approach for taxing payouts earned by Forex trading. In the United Kingdom, the tax-free allowance for capital gains stands at £1000. This means that if the total annual amount of capital gains is at £1000 or lower, one does not have to pay any taxes in this category.
For anything above this amount, the tax rate can range from 10% to 20%, depending on the total annual income of the taxpayer. Considering that the first £1000 gained is free from any taxation, the maximum effective capital gains tax for traders will usually be less than 20%.
One thing which makes the United Kingdom an attractive place for traders is the fact that the income earned from spread betting platforms is free of any capital gains tax. Nowadays, many brokerage companies in the UK offer their clients the ability to trade Forex on spread betting platforms. This seems beneficial for traders since they do not have to pay any taxes on those types of earnings.
In Switzerland, there is no capital gains tax. However, the fact of the matter is that those individuals considered to be ‘professional traders’ have to pay the same percentage of taxes as self-employed individuals.
However, traders can avoid this by holding on to each security for 6 months or more, or maintain a low trading volume, with sale proceeds making up less than 500% of the capital. Finally, those traders whose realized capital gains are less than 50% of their annual income can also avoid the ‘professional trader’ status.
In Canada, traders pay the same rate as their income tax on 50% of their total capital gains. However, this tax cut mostly applies to part-time traders. These full-time professional traders whose primary income comes from capital gains, have to pay the income tax rates for the entire annual earnings.

Strategies to Reduce Taxable Income in Forex Trading

It takes some strategic planning to reduce taxable income when trading Forex from countries that have capital gains tax. The first and most basic step is to maintain a detailed record of all your trades, expenses, and losses. Accurate documentation of your trading history can help maximize deductions and minimize the taxable income size. Counting net losses can help reduce taxable income by utilizing Section 988. Reducing taxable income is the primary option to effectively reduce the taxes on FX profits. You can file under Section 1256 where 60% of gains are taxed at a lower rate, however, there is a 3,000 USD annual cap on trading losses. So, calculate carefully if this Section is beneficial depending on your profits. 

Consider tax-efficient trading instruments. Some trading instruments like spread-betting can be tax-free in the UK. This is an effective way to speculate on Forex markets and pay zero taxes on profits. Knowing the taxation laws on FX profits in your jurisdiction is key to getting maximum benefits. Some regions may offer credits for specific trading activities, make sure to investigate if there are any tax credits in your jurisdiction. Consider income-splitting strategies to distribute income among your family members to distribute profits among lower tax brackets. 

Try to find a tax professional or accountant who specializes in capital gains tax to ensure you are taking full advantage of all available tax-saving opportunities in your area while simultaneously staying compliant with local regulations.

Tax free countries for Forex trading

Taxes on Forex trading can be a heavy burden for traders. Especially if we take into an account the fact that traders are charged with various trading fees. Brokers have spread markups, commisions, transaction fees, inactivity fees and swap fees. One of the most important goals in trading is to trade cost effectively. If you are wondering how to avoid tax trading forex, the easiest way is to find the countries where trading is not taxed. There are numerous countries to consider: United Arab Emirates, Ukraine, Georgia, Monaco, Turkey, The British Virgin Islands, Brunei, Bahamas, etc. These countries do not have capital gains tax or personal income tax. Reducing expenditure on fees and taxes is just as important as trading with a regulated broker. 

Forex trading and taxes

Forex taxes are different in every country. Some countries such as the UK, do not tax small Forex traders that earn up to a thousand British Pound Sterlings per year. Traders are taxed based on their income level and status. Traders that are employed by institutions are taxed as regular employees. Retail traders are taxed based on their level of income and whether they are investing in securities or trading CFDs. CFDs stand for Contracts For Difference and are taxed similarly to gambling in many countries. Professional trading is far from gambling, however, trading CFDs on currencies, stocks, indices and other derivatives are a form of spread betting. Since speculator traders do not actually own the underlying asset, they pay taxes when they decide to transfer money to their bank accounts. As we've already mentioned, there's an option to avoid taxes using Forex tax free countries. There are specific Forex trading tax calculators for traders from certain countries. Forex tax calculators help traders calculate how much they will have to give to their government.

How to submit tax returns on FX trading

While regulations may vary depending on the country, the basic premise is similar. A trader needs to keep detailed records of their trading activities to declare both profits and losses. This will help to document both losses and gains and calculate if profits were made. Losses obviously are not taxable, only profits are. It is super critical to know how to stay compliant with authorities when you are trading for a living. Profits are usually taxed when the trader transfers profits from their brokerage account to their bank account. Here is the list:

Keep detailed records of all trading activities

Maintaining accurate and detailed records of all your FX trading activities is important and should include transaction dates, amounts, currency pairs traded, and trading fees. This is not an easy task, meaning, traders have to write down all their trading positions and save it for later use for tax purposes. 

Understand tax treatment

Depending on the country and jurisdiction, taxation on profits or capital gains varies. The percentage and tax bracket policies are different, and knowing in which category your profits fall may mean a difference in how many profits you get at the end of the trading year.

Determine tax status

You should understand whether you are considered an investor or a trader for tax purposes. This classification is super important and can affect your profits and losses that are taxed. Depending on the jurisdiction the percentage and method for each classification will be different. 

Reportable income

You should report any income generated from FX trading profits. This includes both realized and unrealized gains. Include all sources of income such as interest earned on margin accounts and so on. The majority of countries won’t tax unrealized profits, a.k.a. The open trading positions that are in profits. However, not all jurisdictions are kind to traders, and knowing these details is critical.

Tax forms and filings

The majority of countries require traders to fill in the dedicated tax forms for reporting investment income or capital gains (profits). Familiarize yourself with these forms to fill them correctly and consult tax professionals to ensure you are compliant with the regulations in your country.

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Tax Tips for Forex Traders - Key Takeaways

  • In many countries, Forex traders have to pay the capital gains tax on their net income from trading. Instead of paying for every winning trade individually, traders should report the total annual amount when filling out their tax returns. The brokerage company usually provides this information.
  • In the United States, traders can choose between filing their trading earnings under section 988 or 1258. In the case of section 988, these earnings will be taxed at the same rate as the individual’s tax bracket, ranging from 0% to 37%. With section 1258, 60% of the earnings will be taxed at a fixed rate of 15%, while the remaining 40% will be taxed as ordinary income.
  • Section 988 might be preferable for those traders who frequently end up with losses, or are in the 10% or 12% tax bracket. Traders who are earning consistent payouts and are in 22% tax brackets or higher, section 1258 might be a more appealing option.
  • Generally, CFD trading is not taxed the same way as investing. 

FAQ: Forex Capital Gains Tax Treatment

Why do some countries have no capital gains tax?

There are some countries in the world, including New Zealand, Georgia, and Ukraine, who do not have any capital gains tax for trading stocks, commodities, or currency pairs. One of the most obvious reasons for this policy is to make these countries more attractive for international traders and investors.
The fact of the matter is that there are a significant number of individuals who earn most of their income by investing or trading. Consequently, some of them might consider moving to countries, where there is no capital gains tax and save a massive amount of money in the long term.

What is Form 8866 in the US tax code, and how can traders utilize it?

If a trader loses $2 million or more in a single year or $4 million for any combinations of two years, the trader can qualify to file a Form 8866. The form helps traders to get tax relief after experiencing such losses. At an individual level, such cases are quite rare. In the majority of cases, this form is filled by large corporations that specialize in Forex or Stock trading.

Why is the spread betting exempted from the capital gains tax in the United Kingdom?

The spread betting is essentially the only product which is exempted from both capital gains and stamp duty tax within the framework of Forex trading tax UK, as well as in Ireland. The reason behind this is that spread betting in the UK tax code is essentially treated the same as betting or horse racing, sports, and other similar activities.
The fact of the matter is that traders can maintain their tax-free status as long as they have other sources of income, which will be enough for their living expenses. If, on the other hand, the spread betting is the only source of income for traders, then there is a risk that he or she might be designated as a ‘professional gambler’ by the UK tax authorities. In this case, the trader will be taxed at the same rate as self-employed individuals.

How does the capital gains tax work with other types of investments?

The tax authorities with the majority of countries make no clear distinction between the payouts earned from Forex trading or stock trading. So, do you have to pay taxes on Forex? Yes, but in most cases, the methodology, and tax rates for these two categories tend to be the same.
However, this is not the case with real estate investing. Many countries have separate capital gains tax rates for real estate and for other assets. It is also worth noting that in the United States, as well as some other countries, when selling the home, investors can defer their capital gains tax payment by buying other property from the proceeds of this transaction.
Finally, in many countries, there is no capital gains tax on the sale of a home as one’s primary residence after 2 or some other specified numbers of years have passed since the original purchase

What is the tax rate for forex income called?

Taxes are different in every country. Some countries do not have any taxes on Forex or Stock trading. Income from trading is taxed by Capital Gains Tax. In the USA, traders are taxed under section 1256. Under this section, 60% of the gains are taxed at 15% rate. And 40% of the gains are taxed at current income tax bracket.  However, the IRS doesn't treat Forex traders and stock traders the same. Forex traders pay taxes under Form 1040 or Form 1040NR in the USA.

How to file taxes for forex trading?

In order to file trading taxes, you need to report your capital gains and capital losses. Capital gains are profits made from selling securities. However, Forex trading is considered to be a speculative activity and doesn't get the same treatment as investing in stocks and other securities. If you are trading as an institutional trader, you will be taxed just as any other employee. In case you are a retail Forex trader, you will need to report your profits and losses. Retail Forex traders use a Form 1040 or Form 1040NR in the USA.

How is Forex taxed?

Every country has its own rules when it comes to taxation. In general, Forex income is taxed as capital gains tax. If Forex is your side activity and not a main source of income, you will not be taxed in the UK. In the UK, Forex traders that make up to 1k GBP per year are not required to pay taxes. Forex trading is treated differently than investing. CFD trading or spread betting is taxed similarly as gambling in most countries. 
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