How to Pay Tax On Forex Trading?

There are not many things that we hate more than paying taxes. Nowadays, it seems like we have to pay taxes on almost everything and at the end of the day, we are left with a fraction of the money we made.

Forex traders are charged in various ways. Brokers have trading and non-trading fees such as spread markups, commissions, inactivity fees, and deposit and withdrawal fees. And on top of that, there are naturally occurring market spreads that increase in low liquidity. What’s more, some governments tax Forex traders in various ways. These taxes are usually split into two different categories, income tax and capital gains tax.

Taxation laws are different for every country, and we’ll discuss how US and European FX traders are taxed in detail.

Difference Between Income and Capital Gain Taxes

Depending on the country they reside, Forex traders are eligible for income and capital gains taxes. That is why understanding forex trading taxes is so important. Before we go any further, let’s discuss the differences between income tax and capital gain tax.

Income Tax

This is a really easy-to-understand system that does not require many calculations. Simply put, income tax is the tax you pay on your yearly income, and it’s calculated based on the percentage of the income tax in your area.

There are quite a few income sources that can be subjected to income tax. Salary, wages, winnings, trading profits, and many more, all can be classified as income and become subject to taxation. In the US in particular, there are many things that are taxed with income tax.

Income tax is the percentage of your income throughout a year. Most of these percentages are fixed and those that change, change according to how much money a person makes. Taxation based on income level is also widely known as wealth tax.

Capital Gain Tax

A more common tax format for tax on forex income is capital gain tax. This tax comes into play whenever a trader sells an asset that he/she purchased for cheap and now is selling for a profit.

To calculate the capital gain taxes, traders need to look at two important price points. The price at which they purchased an asset and the price at which they sold this asset. The difference between these two is called capital gain.

Let’s take a look at an example of capital gains to better understand what it means. For example, a trader has opened a market position for the EUR/USD currency pair, the trade went in the predicted direction and he made capital gains of $3000, and if the capital gain tax is %10, he has to pay $300 in taxes according to the law.

And you might be wondering what happens if the trader makes losses. In that case, it will be classified as capital loss and will be calculated in the same way. From now on, it depends on your local laws to determine how capital loss is treated in your area. Some countries let traders deduct some amount of capital losses from gains when calculating their taxes.

Paying Forex Taxes Around the World

Now that we know what are the differences between income taxes and capital gain taxes, we can take a look at the tax systems in some places of the world and find out how they work.

USA

It is not a surprise to anyone that the US taxation system is complex. Taxes on capital gains from Forex are not any different in this regard.

Traders in the USA need to take into account that there are taxes on short-term and long-term capital gains. Short-term capital gains are gains that were made by selling an asset that a trader owned for less than a year. If a trader purchased an asset and sold it at least a year later for profits, it will be subject to long-term capital gains. When it comes to paying taxes, short-term gains are taxed more than long-term ones.

Another important decision that traders need to make is deciding which section to follow when filing taxes. The IRS (Internal Revenue Service of the USA) requires traders to declare themselves as one of the two section followers at the start of a year and then pay taxes according to that section’s rules. These sections are 1256 and 988.

Section 1256

If Forex traders decide to trade futures and options, they will be taxed under section 1256. This section splits taxes as 60/40 and traders will be paying tax on their forex incomes based on this split.

So what do we mean by that? When a trader is following this section, 60% of the gains he makes will be classified as long-term gains, while the remaining 40% will be calculated as short-term gains.

This section is primarily used by traders who are certain of their profitability. They receive many different benefits and better tax breaks as a result.

The section 1256 also comes with certain disadvantages. This section is primarily used by profitable traders. And losses that can be claimed under this section are $3000. What this means is that if a trader has lost $10,000 or $70,000 in both cases he will only be able to deduct $3000 taxable income.

Section 988

Section 988 is a simpler section in terms of how taxes are charged. The section is primarily used by spot market traders. This section is primarily used by traders that have high losses as there are some advantages that they can use.

Section 988 enables traders to count all of their losses and deduct them from taxes, compared to section 1256, where only $3000 can be deducted. Which is the reason why most traders who suffer losses use this section, as they are protected from paying huge taxes, on top of making significant losses.

One thing that we need to mention is that traders choose these sections at the start of the year. What this means is that, once you choose one section, you can’t change it until the next year arrives, and you have to pay taxes based on the section you chose, even if the second option is better for you at that moment. So before making a decision as to which section to choose, always make an analysis of your upcoming year, what are your potential profits, losses, and only after coming up with a good plan, make a choice.

Europe

Now moving east, let’s take a look at understanding forex trading taxes in European countries. While you might think that things are somewhat similar here, considering that the EU tries to operate as one whole unit with similar laws and rules, Forex taxes are different from country to country.

The first thing that differentiates Europe from the US is the lack of capital gain taxes. Not many European countries have capital gains and those that do usually have really small percentages. In the end, everything comes down to the country in question. For example, most European countries look at each trader individually, how much they make, are they professional traders, and more. While France has just a flat 30% tax on any forex income and an additional 4% if the individual has a high income.

In the UK things are a bit more complicated. The country’s government divides its taxes into three types, income, capital gain, and corporation taxes. If you are a trader, who trades professionally and treats it as a profession, you are either taxed as income taxes or capital gain tax. But, if you are a speculative trader, who treats forex trading as gambling, you are not subject to any taxes, and this income is classified as a secondary income.

So the UK does not have a set tax rate, but the average tax for Forex trading here is around %20, which is relatively low compared to some other world-leading countries.

Tax-Free Countries

On the bright side, there are countries where you don’t have to pay tax on forex profits. As a result, professional traders flock to these countries.

The Bahamas is one of the most famous in this. regard. Traders don’t have to pay any taxes on most of their financial activities, as the Bahamas has a strong income source from tourism and other dealings.

On the European side, Switzerland is a country with no forex taxes. This is a tax haven in Europe where a huge number of traders move in to avoid paying huge taxes.

Reporting Taxes

Well knowing how much taxes you need to pay, and other nuances are necessary, it is also important to know how to file these taxes. One small mistake can cause you to have problems with the IRS. And therefore, we will discuss what to do when paying taxes on forex trading gains.

Before we reach this reporting phase, it’s always important to implement a few things to make this final process much easier. One of the most important things that traders need to do before taxation is to keep track of their trades. At the end of the year, brokers will send you a file with details of all of your trading activities, it’s still a good thing to keep track of them yourself. By checking your tax report, you will know approximately what awaits you and how much you will need to pay when the time comes to pay tax on forex trades.

Filing your taxes depends on the country you reside in, as every country will have different rules for filing taxes. But in general, things will be somewhat similar, you will receive a form that you will need to fill in. It can be a physical document or an online form. There you will be asked to enter all sorts of information regarding your trading year. These can be trades you made, profits and losses from each trade, how long you were holding on the assets, and other similar information.

Another great tool that traders use before filing taxes is the Forex trading tax calculator. This is a special software that helps traders calculate the taxes they have to pay. Here you just simply enter the information of the trades you made, and the forex trading tax calculator does the rest for you. This is a great tool to double-check if everything is correct, before sending your tax files to the IRS.

FAQs on paying taxes in Forex

How do you pay tax on Forex?

When paying tax on forex income your experience will depend on the country you live in. But in general, you will be receiving a tax form that you need to fill out with necessary information regarding your trading activities and profits and losses you have made. In addition, traders often use forex trading tax calculators to make this process easier.

How to report Forex losses on Tax report

When reporting your forex losses on a tax report, first you need to check which section you are using. If you are using section 988, you will simply need to indicate losses in the designated sections of the file. But if you are using section 1256 you can only report losses up to $3000, and you can do that similarly to section 988.