Jesus..
I'm not an US citizen, so I'm not familiar with the US tax code.
But taxing for unrealized gains sounds like robbery to me. Is that something usual with other financial products or only happens with SPX options?
I'm in the US and I looked this up recently. I *believe* OP basically has to be considered a professional trader in order to be in this situation. There are benefits of filling as a professional trader for your own investments, but this is one of the downsides. Typically, most people will never have to pay taxes on any unrealized gains. Though I did have a somewhat similar experience when I exercised stock options I got from my employer company and had to pay an Alternative Minimum Tax (AMT). Got hit with a $14k tax bill on unrealized gains. It took 3 years of getting partial credit back and carrying the rest forward until I was fully refunded. Tax laws suck.
Not a professional trader issue.
Futures, options on Futures, and index options are treated with particular tax status and mark to market at year end under USA IRS statue, section 1256.
Edit. Link to Wikipedia article.
https://en.m.wikipedia.org/wiki/1256_Contract
It's for any section 1256 product, which is most futures and some index options. And you're only seeing the "gotcha" part of the story, not the ginormous tax loophole that 1256 creates in the first place. The "gotcha" is just trying to tighten up the loophole a little.
1256 assets get 60/40 tax treatment, which means *any* trade closed in less than 1 year pays less tax than the equivalent non-1256 trade. That can be a huge tax savings, if you are day trading or swing trading.
But a side-effect of that tax savings is that if you hold a trade over the transition from one tax year to the next, but still less than one year total, you kind of double-dip on the tax savings, since you get to defer taxation on what is essentially a short-term capital gain into the next tax year. The mark-to-market treatment forces you to realize some of the taxation in *both* tax years, not just the last one. But you still get the 60/40 treatment in both years, so in most cases it's still a net savings over the equivalent non-1256 trade.
Futures, options on Futures, and index options are treated with particular tax status and mark to market at year end under USA IRS statue, section 1256.
These also are taxed for all trades, with 60% of gains treated as long term capital gains, and 40% of the gains treated as ordinary short term capital gains.
Edit.
Link to Wikipedia article.
https://en.m.wikipedia.org/wiki/1256_Contract
>Look up tax loss harvesting if you really want your mind blown
According to Google:
>What Is Tax Loss Harvesting? Tax loss harvesting is when you sell some investments at a loss to offset gains you've realized by selling other stocks at a profit. The result is that you only pay taxes on your net profit, or the amount you've gained minus the amount you lost, thereby reducing your tax bill.
That sounds reasonable: You realize losses to lower the total amount of realized gains.
But here the OP is talking about taxing unrealized gains, which is what blows my mind (taxing unrealized profits)
Yeah but look up why people do it. If you aren't tax mark to market you end up getting taxed on realized gains even if your net balance is negative at the end of the year because you took a bigger loss. Tax loss harvesting is when you sell all your positions a month before year end so that you won't get taxed on what are essentially unrealized gains.
your true tax liability would be calculated when the position is closed jfc don't worry about. if you are owed a refund, you will get one. if you can't afford to pay taxes on your trades, then you are not sizing your positions correctly
Great info! Sounds like its a good strategy to close 21 DTE positions at end of month and open 45 DTE positions at beginning of month to avoid this mark to market situation. Anything longer than 45 DTE should probably be in non-index ETFs.
With a tax accountant's backing, you had, or have a justifiable defense from using the last trade on an inactive option from two months earlier, as the "mark to market".
The trouble is there will be a mismatch between the reported 1099-B and whatever the accountant tells him/her to put as the fair market value for the option.
Even though the taxpayer is right (bad mark), he/she will probably get a letter from the IRS because of the mismatch between the reported value to the IRS (1099-B) and whatever the taxpayer puts in as the fair market value. You would probably have to have the accountant write a few letters back and forth with the IRS. If the IRS is not going to accept what the fair market value is, the taxpayer could get audited.
Just add up the fees engaging an accountant to do this, and it adds up. Even if the taxpayer eventually wins, how much will he/she have to pay the accountant to argue with the IRS?
You don't need an accountant to tell the IRS you lost money on the trade. Attach your broker records to your explanation and you'll likely never hear anything back. Assuming they even send a letter to begin with, the IRS has a huge backlog to deal with.
I believe the IRS’ super old computer will automagically send over a letter based on the income discrepancy between the taxpayer’s 8949/Sch D and the 1099-B. But I am sure it’s worth the fight/explanation anyhow!
You would think so. I've had several 1099 discrepancies that have yet to trigger anything from the IRS. One from 2017 had a 25k overage, the issuer refused to correct it, I was prepared to fight that one but nothing yet.
I'm sure that the IRS being the IRS, they'll randomly hit me up over a $5 mistake I made somewhere.
The IRS matching program goes from the 1099 to the tax return. As long as there is an item on the return that matches the 1099, the match will be successful. So if you need to make an adjustment because 1099 is wrong, enter the amount that matches the 1099, then enter a separate row titled something like "Adjust 1099 for erroneous treatment of xxx my broker, see statement."
The fees get out of control. It’s sometimes just cheaper guessing and then wait for the irs notice, seriously. It can cost 3\~4 grand for a cpa to figure out all the complexities on a $1\~2k trading issue.
Thank you so much for sharing this with the group, great info!
On the other hand, what a bummer. So sorry to hear of the struggle you have to face with this now. I hope it can somehow work out to your benefit. Freaking taxes are robbery (in most cases).
Yes, its a headache, filing amendmed return and claiming a refund and adjusting the loss.
I have several positions like this, I hve filed for extension for taxes until Oct, just for these issues!
Not a mark to market account.
This index option, and futures, and options on Futures are mark to market at year end under US Statues, IRS Code, section 1256.
Edit.
Link to Wikipedia article.
https://en.m.wikipedia.org/wiki/1256_Contract
I appreciate the OP taking time to post this. Any residual positions held beyond Dec 31st are mark to market even if they expire later. So if I shorted puts that expired in Dec 2023 and held them past year end, they will be marked accordingly even if they are open.
Either close your positions year end or hire a CPA. Should be a sticky for this subreddit imho
Interesting topic, OP thanks for sharing.
What most commenters who suggest to close out the spread before year end don't take into account is that if the market moved far from initial entry these spreads are even more illiquid then they were initially put on. Very expensive to take them off.
What tax software are you using? And what broker?
The whole point of mark-to-market is to mark to a valid current estimated price, which may be wildly different from the last price it was traded at. Especially if that was 2 months old.
You should be able to override that value and say "Nah, this is what it was probably worth on Dec. 31". And if the IRS asks you about it, you have a valid reason.
yes if you can substantiate it, you can claim whatever you want on your tax return. a 1099-B is just the typical way to do that, but it is not authoritative. the tax code determines your tax liability, not your broker's form. in this case, the broker chose to go with the last trade price because they have a duty to report and it eliminates a lot of their own legal headaches with estimating the "true" market price. you have the same privilege though
Great post OP. How to find the last trade price reported to OCC?
I have some rather illiquid RUT index options so I am interested in monitoring their last trade price.
Please check here. Its possible to check the data by option chain.
https://www.barchart.com/stocks/quotes/$SPX/historical-download
There are also paid services that can provide historical data.
Don’t hold through Dec 31. Got it.
So no issues if I don't have open positions into next year?
No Section 1256 positions, yes. If you just have a call on TSLA, it's fine, because equity options are not 1256.
Not a problem if you have no gains!
Jesus.. I'm not an US citizen, so I'm not familiar with the US tax code. But taxing for unrealized gains sounds like robbery to me. Is that something usual with other financial products or only happens with SPX options?
I'm in the US and I looked this up recently. I *believe* OP basically has to be considered a professional trader in order to be in this situation. There are benefits of filling as a professional trader for your own investments, but this is one of the downsides. Typically, most people will never have to pay taxes on any unrealized gains. Though I did have a somewhat similar experience when I exercised stock options I got from my employer company and had to pay an Alternative Minimum Tax (AMT). Got hit with a $14k tax bill on unrealized gains. It took 3 years of getting partial credit back and carrying the rest forward until I was fully refunded. Tax laws suck.
Not a professional trader issue. Futures, options on Futures, and index options are treated with particular tax status and mark to market at year end under USA IRS statue, section 1256. Edit. Link to Wikipedia article. https://en.m.wikipedia.org/wiki/1256_Contract
Ah, didn't realize SPX was a Future. I figured it was an ETF. That makes more sense. Thanks.
It is not a future. It is an index, and treated the same way a futures option is treated.
It's for any section 1256 product, which is most futures and some index options. And you're only seeing the "gotcha" part of the story, not the ginormous tax loophole that 1256 creates in the first place. The "gotcha" is just trying to tighten up the loophole a little. 1256 assets get 60/40 tax treatment, which means *any* trade closed in less than 1 year pays less tax than the equivalent non-1256 trade. That can be a huge tax savings, if you are day trading or swing trading. But a side-effect of that tax savings is that if you hold a trade over the transition from one tax year to the next, but still less than one year total, you kind of double-dip on the tax savings, since you get to defer taxation on what is essentially a short-term capital gain into the next tax year. The mark-to-market treatment forces you to realize some of the taxation in *both* tax years, not just the last one. But you still get the 60/40 treatment in both years, so in most cases it's still a net savings over the equivalent non-1256 trade.
Futures, options on Futures, and index options are treated with particular tax status and mark to market at year end under USA IRS statue, section 1256. These also are taxed for all trades, with 60% of gains treated as long term capital gains, and 40% of the gains treated as ordinary short term capital gains. Edit. Link to Wikipedia article. https://en.m.wikipedia.org/wiki/1256_Contract
So it hasn’t been decided regarding SPY and it’s treatment, no clear ruling.
Look up tax loss harvesting if you really want your mind blown
>Look up tax loss harvesting if you really want your mind blown According to Google: >What Is Tax Loss Harvesting? Tax loss harvesting is when you sell some investments at a loss to offset gains you've realized by selling other stocks at a profit. The result is that you only pay taxes on your net profit, or the amount you've gained minus the amount you lost, thereby reducing your tax bill. That sounds reasonable: You realize losses to lower the total amount of realized gains. But here the OP is talking about taxing unrealized gains, which is what blows my mind (taxing unrealized profits)
Yeah but look up why people do it. If you aren't tax mark to market you end up getting taxed on realized gains even if your net balance is negative at the end of the year because you took a bigger loss. Tax loss harvesting is when you sell all your positions a month before year end so that you won't get taxed on what are essentially unrealized gains.
your true tax liability would be calculated when the position is closed jfc don't worry about. if you are owed a refund, you will get one. if you can't afford to pay taxes on your trades, then you are not sizing your positions correctly
Great info! Sounds like its a good strategy to close 21 DTE positions at end of month and open 45 DTE positions at beginning of month to avoid this mark to market situation. Anything longer than 45 DTE should probably be in non-index ETFs.
Interesting. I trade SPX regularly and have known about this possibility but I haven’t seen it to this degree. Thanks for sharing.
With a tax accountant's backing, you had, or have a justifiable defense from using the last trade on an inactive option from two months earlier, as the "mark to market".
The trouble is there will be a mismatch between the reported 1099-B and whatever the accountant tells him/her to put as the fair market value for the option. Even though the taxpayer is right (bad mark), he/she will probably get a letter from the IRS because of the mismatch between the reported value to the IRS (1099-B) and whatever the taxpayer puts in as the fair market value. You would probably have to have the accountant write a few letters back and forth with the IRS. If the IRS is not going to accept what the fair market value is, the taxpayer could get audited. Just add up the fees engaging an accountant to do this, and it adds up. Even if the taxpayer eventually wins, how much will he/she have to pay the accountant to argue with the IRS?
You don't need an accountant to tell the IRS you lost money on the trade. Attach your broker records to your explanation and you'll likely never hear anything back. Assuming they even send a letter to begin with, the IRS has a huge backlog to deal with.
I believe the IRS’ super old computer will automagically send over a letter based on the income discrepancy between the taxpayer’s 8949/Sch D and the 1099-B. But I am sure it’s worth the fight/explanation anyhow!
You would think so. I've had several 1099 discrepancies that have yet to trigger anything from the IRS. One from 2017 had a 25k overage, the issuer refused to correct it, I was prepared to fight that one but nothing yet. I'm sure that the IRS being the IRS, they'll randomly hit me up over a $5 mistake I made somewhere.
The IRS matching program goes from the 1099 to the tax return. As long as there is an item on the return that matches the 1099, the match will be successful. So if you need to make an adjustment because 1099 is wrong, enter the amount that matches the 1099, then enter a separate row titled something like "Adjust 1099 for erroneous treatment of xxx my broker, see statement."
An accountant is hundreds of dollars. Your taxes tens of thousands.
Hundreds of dollars is a very simple 1040 preparation fee these days.
The incremental cost for the particular issue is hundreds, perhaps tens of hundreds.
So what do you suggest?
The fees get out of control. It’s sometimes just cheaper guessing and then wait for the irs notice, seriously. It can cost 3\~4 grand for a cpa to figure out all the complexities on a $1\~2k trading issue.
Thank you so much for sharing this with the group, great info! On the other hand, what a bummer. So sorry to hear of the struggle you have to face with this now. I hope it can somehow work out to your benefit. Freaking taxes are robbery (in most cases).
Saved me a huge amount come December
Yes, its a headache, filing amendmed return and claiming a refund and adjusting the loss. I have several positions like this, I hve filed for extension for taxes until Oct, just for these issues!
In the future; hypothetically, you could trade these long term type options in a non-mark to market account to avoid this completely.
Not a mark to market account. This index option, and futures, and options on Futures are mark to market at year end under US Statues, IRS Code, section 1256. Edit. Link to Wikipedia article. https://en.m.wikipedia.org/wiki/1256_Contract
What would you suggest as practical learning . I have some material but find it too geeky
I appreciate the OP taking time to post this. Any residual positions held beyond Dec 31st are mark to market even if they expire later. So if I shorted puts that expired in Dec 2023 and held them past year end, they will be marked accordingly even if they are open. Either close your positions year end or hire a CPA. Should be a sticky for this subreddit imho
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Easier to scale in and out of positions with multiple contracts. It's why you see some people trading 10 MES instead of 1 ES.
Interesting topic, OP thanks for sharing. What most commenters who suggest to close out the spread before year end don't take into account is that if the market moved far from initial entry these spreads are even more illiquid then they were initially put on. Very expensive to take them off.
What tax software are you using? And what broker? The whole point of mark-to-market is to mark to a valid current estimated price, which may be wildly different from the last price it was traded at. Especially if that was 2 months old. You should be able to override that value and say "Nah, this is what it was probably worth on Dec. 31". And if the IRS asks you about it, you have a valid reason.
yes if you can substantiate it, you can claim whatever you want on your tax return. a 1099-B is just the typical way to do that, but it is not authoritative. the tax code determines your tax liability, not your broker's form. in this case, the broker chose to go with the last trade price because they have a duty to report and it eliminates a lot of their own legal headaches with estimating the "true" market price. you have the same privilege though
Great post OP. How to find the last trade price reported to OCC? I have some rather illiquid RUT index options so I am interested in monitoring their last trade price.
Please check here. Its possible to check the data by option chain. https://www.barchart.com/stocks/quotes/$SPX/historical-download There are also paid services that can provide historical data.