4 Ways Futures Accounts Get Taxed

The reason we dislike paying taxes each year may go beyond the natural annoyance at handing over some of your hard earned money, and have just as much to do with how complicated it can be. In one calendar year, tax codes can change up to +500 times a year and with the IRS having 20% of the their budget cut over the last 5 years, that can create a lot of headaches – and delays. Which might be why John Oliver of HBO’s ‘Last Week Tonight’ reported some tax paying citizens send their checks stained with mustard, or why sitting governors make some not so nice WW2 comparisons to the IRS.

But those of us who trade futures have a little different take on tax season, where we feel a little more celebratory. You see, futures markets don’t just give you exposure to world markets and the ability to go both long and short – there’s some real tax advantages as well. It all starts with exchange traded futures and options on futures being labeled as ‘Section 1256 Contracts’ by the IRS.

1256 Contract

Unlike stocks, futures based investments are based on their marked to market value at the end of the year, so any open trade profits or losses in the account are treated as realized profits or losses as of the last day of the year. This is generally good news for investors, as futures gains or losses are treated as 60% long term capital gains and 40% short term capital gains, NO MATTER the holding period. For example, an investor who holds a futures position for just a few minutes, or hours, can book 60% of the profits on that trade as long term gains (and pay the lower long term capital gains rate) – even though the trade was anything but long term.

In addition, futures based investments do not require the accounting of individual trades. This is a godsend for any of you who have spent hours searching through old brokerage statements from 4 years prior trying to find the cost basis for a certain stock. There is also no trade by trade accounting in futures, no wash sale rules, and losses can be carried back three years on futures based investments. Not too shabby.

But what if you’re not really a futures ‘trader’? What if you’re more of a futures investor, accessing the futures markets through a professional manager utilizing either separately managed accounts, private funds, or (as is becoming more and more normal) mutual funds and ETFs.

 

Separately Managed Accounts:

An investor having their futures account managed for them by a professional commodity trading advisor (CTA) gets all of the same futures market based tax treatment outlined above, as the manager trades the same exchange traded futures. That’s the good news, but there’s a catch – the CTA’s management and incentive fees are not part of the section 1256 gains and losses, meaning the 1099-B reports the marked to market profit or loss before these fees.  All hope is not lost, however, as investors can offset some of those fees by doing itemized deductions and taking investment-related deductions. Problem is, such miscellaneous itemized deductions are only deductible to the extent they exceed 2% of your adjusted gross income. So, an accredited investor making $300,000 per year can only deduct expenses over $6,000 (2% of $300k).  Investors utilizing separately managed accounts receive a 1099-B from the Futures Commission Merchant holding the account, with the total amount of fees paid to the CTAs available via your broker or the CTA you’re invested in (there’s no required government report outlining the total fees).

 

Privately offered Funds

Which brings us to investors who access the futures markets through privately offered funds, or as their also known – commodity pools. Fund investors haven’t really ‘traded’ futures markets themselves or had futures traded in accounts in their name. They’ve invested in a partnership (for tax purposes) which does the futures trading, and the partnership reports what portion of the futures trading profit or loss is taxable to each investor every year. The good part of that is the tricky 2% of adjusted gross income barrier goes away, with the fund able to offset all the expenses to the fund (including management and incentive fees paid to the trading advisor) against profits. The (semi) bad part… the investor receives a K1, which in our experience never gets into your hands as quickly as you would like, potentially delaying your tax filing. Many people find a single K1 much easier come tax time, however, than multiple 1099-Bs outlining futures profit and loss.  Finally, there is no taxable event upon redeeming your investment in a private fund, meaning you don’t pay capital gains on the difference between the sales price and purchase price (you’ve already paid tax via the K1 numbers each year).

 

Liquid Alternatives – Mutual Funds & ETFs

Which brings us to the fast growing world of alternative investment mutual funds and ETFs. The biggest difference in mutual fund taxation is that there is a profit or loss from the buying and selling of the mutual fund (not just from what’s happening inside of the fund like in the private fund/K1 scenario). Buying a mutual fund for $5,000 and selling it later on for $7,000 will result in $2,000 for taxable capital gains. Further, it’s not abundantly clear what happens to the blended 60/40 tax treatment of futures markets within a mutual fund utilizing such contracts. From what we can tell, it doesn’t survive the mutual fund wrapper (if we’re wrong on that, please comment on this post), with investors getting a 1099 listing the annual capital gain and dividend income from the mutual fund and that being treated as normal capital gains income, going into either the long term or short term buckets, not both. But ignorance is bliss for many in this regard, as they willingly sacrifice whatever tax savings may be present from a K1 structure in order to receive a 1099 1 to 2 months earlier.

Happy Tax Season!

If you have any questions about different tax codes or exposures when it comes to futures trading, please feel free to give us a call or email us.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.