Taxes For Options Traders - 103

 If I were to ask you, what your largest expense is? What would you say? You know, what is the thing? The one thing that costs you the most money? Is it your mortgage? student loan payments, car payments, credit card? health insurance? What is it? Well, if you saw the title of this episode, you probably guessed that I'm talking about taxes. And, I mean, you can name them right with all the different types of taxes that we pay. It adds up, we got income taxes for federal and for state, we got payroll taxes, we got property taxes, we got estate taxes, we've got gift taxes, we've got sales taxes, on and on, there's a lot more that I can't even think of. I mean, it is estimated that most Americans pay somewhere close to 50% of their earnings on taxes. Now, I'm guessing that if you're the one that pays the bills, that's not shocking to you. I mean, maybe the 50% is kind of like eye opening, like really? Is it that much? Yeah, unfortunately, it really is.

But in this episode, I wanted to talk about taxes and options, and one simple change that you can make to lower the taxes on your trading games. Now, let me start off with a disclaimer, I am not an accountant, I'm not a CPA, not a professional on taxes, nor do I want to be. So make sure that you talk to your tax person about anything that you hear. Right. Now, when it comes to federal income taxes, there are two types that deal with options trading. Now, here we're talking about, you know, your gains on your trading. So if you're making gains, there's two types of taxes that you could pay. The first is regular income taxes. And the second is capital gains taxes. So capital gains is normally the tax that you pay, when you have held an asset for a year or more. And then you sell it for a profit, you would pay capital gains tax on any profit. So if you have a stock, and you own it for over a year, when you sell it, that's the tax that you would pay capital gains. Compare that to if you held the asset for less than one year, then you would be taxed at your regular income tax rate, whatever that is. Now, capital gains is usually much lower as a percentage. Okay, I don't want to go into the actual percentages here, because they keep changing depending on who's in the White House and all that other politics. But for our purposes, capital gains is lower, and is preferred, because of course, it's less.

So, of course, the best way to deal with taxes is to not have them at all, to not have to pay them at all. And those of you who are trading in your Roth accounts, will never have to pay taxes on the gains. So if you can, that would be preferable to trade your options in your IRA so that any taxes that you have will not be taxed, you don't ever have to pay taxes on those. So that's really cool deal. Now, if you have a regular IRA, you will have to pay taxes when you eventually withdraw the money, but you don't have to pay it now. And if you're trading in a in a regular trading account, then yes, you will have to pay the taxes depending on your tax situation, quarterly or year. Okay. Now, there is a piece of the tax code that most traders don't know about. That actually helps options traders pay less taxes. It's called section 1256 of the IRS code. Now securities regarded as 1256 investments include non equity options, foreign currency contracts, regulated futures contracts, dealer equity options, and dealer securities futures contracts. Okay, so now what's the difference between section 1256 and non section prophetesses? Well, every section 1256 security, if you have a gain or loss, it is treated as being 60% long term, and 40% short term, no matter how long you own it. Now long term means that your cap is your capital gains tax rate. Okay. And the 40% short term means your personal income tax rate.

So, for example, if we have a Joe Schmo trader, he makes $1,000 on an options trade, okay, and if this was a section 1256 security option, then his capital gains tax is 15%, let's just guess. And his personal tax rate is 22%. Okay, for this example, now, he made $1,000 on his trade, right, so 60% of that would be long term 40% of that will be short term. So long term, he would be paying $90 for taxes, and short term, you would be paying $88 for taxes. So for a total gain, or total tax of $178, on his $1,000 game, okay, so he's paying about 17.8% total, on $1,000. But if this was a non 1256 Options trade, and he still made the same $1,000, he would be paying 22% in taxes, which is his personal return rate, and he would be paying $220. So he would have saved $42, which doesn't sound like a lot, but that's just one trade, you got to add it up. But if you look at it percentage, it's 4.2%. So he actually kept 4.2% more money in his pocket, because he's trading 1256 options, instead of not 1256 options.

So just by simply switching, you can save or you can keep about 4%, more than you already do. This is money that you've already made. But you didn't have to pay the government. Right. So if you trade for a whole year, let's say, and you make 10% for the year, well, a big chunk of that goes to taxes. This way, you're actually saving 4% of that of the total that you would pay. So instead of paying maybe, you know, 22%, you're paying 17%, or it could be less depending on your personal situation. Or it could be more, though most of the larger traders that we have in our in our movement, in our coaching programs and whatnot, they're usually trading with a lot more money. And so the percentage might be the same. Or it might be more because their income tax rates are different, are probably higher, right? So their tax rates will vary, that amount will be more, but the dollar amount increases significantly when it's non 1256. So now that you know what that is, now that you know what the benefit is, how do you make the switch? Right? How do you go from non 1256 to 1256? And how do you know which options are which?

Well, most stock options are non 1256. And by most I mean the options in any company that you trade, or any ETF that you trade. So if you're trading Apple options, IBM options, Microsoft, whoever whatever company option that you're trading is going to be non 1256. ETFs are also non 1256. So if you go into the GLD, the USO, the IBB, any of those ETFs are non 56. And you'll know by looking at the name of it when you're going to try and trade it if it says ETF, it's non 1256. Okay, the main ones that get the 1256 treatment are indexes, and futures options. This is one of the reasons that I have moved a large portion of my trading funds over to my futures options trading account. Because when you trade in size, you know the savings are enormous. So I've been moving more and more money over to my futures options trading account so that I can pay less on taxes even if I'm making the same amount of money. So I do have a special announcement on that. If you are interested futures options and the way I trade them and what I do, we're having a one day live event called futures options live this month, on July 30. So one day events going to be live, it's going to be a lot of fun. You can get your tickets today at www.futuresoptionslive.com. And if you're listening to this episode close to when we publish it, there should still be tickets left. If not, maybe you can, if you're new, we're still interested, maybe you can email us. And if we have the recordings, for sale, or available, we'll let you know.

At the live event, I'm going to be going over exactly how futures options work, how they're different from stock options, you know, taxes are just one of the many benefits that they have, and how you can get started with them. Okay, so hopefully, I'll see you there. Now, the other kinds of 1256 options that I mentioned, the ones that I trade are also they're called Index Options. So these are cash settled options on the actual indexes, like the S&P 500, the Russell 2000, the NASDAQ 100, and others. These also get the 60-40 tax treatment. Okay, so if you're a member of our Options Genius advisory, you'll notice that we trade SPX, and we trade rut every month, those are indexes. Those are SPX is for the S&P 500. And the RUT, the rut is for the Russell 2000. You can trade those with ETFs. But the indexes have much greater benefits, taxes being one of them. And so you'll notice that any hedge fund that is doing say iron condors on the s&p 500, or they're probably trading the Russell or the NASDAQ or whatever, if they're trading options, if they're a large trader, you know, they're a hedge fund. If they're a money management fund, if they're Warren Buffett, they all trade the indexes. tax treatment is one of the benefits. Okay, the other benefit I mentioned, there's that they're cash settled, meaning there's no early assignment, that can be a big one, depending on how much you're trading or what you want with your strategy. There are also many other benefits that we are going to cover in a future episode. So stay tuned for that. So let's say right now, if you are trading SPY, if you're trading IWM, for trading QQQ, if you're already trading these, these are ETFs, they don't give you the 1256 tax treatment.

So you can do the same trade in an index. And immediately start saving on your taxes. Okay, now, the index options, the S&P or the SPX, the RUT, those are obviously much larger than the ETFs. And so it helps if you have a little bit larger account. But most traders can make the switch today, you do have to get approved by your broker. So you do have to have a higher level, the highest level that they allow. But if you have a track record, that shouldn't be a big problem, you know, you can let them know that, hey, I'm becoming more sophisticated, I want to try these indexes, I want to get the tax treatment, I look at my trading history, I know I can do this. And they'll they should allow you to trade indexes just not much of a big difference. Okay, now again, there are many other benefits to indexes or ETFs. We'll cover those in a future episode. But as you saw in our simple example, with Joe Schmo trader right trader example, just by switching to 1256 options instantly helped the guy make 4% greater returns. And I said, like I said, the larger you trade, the more you're going to save. And this is like free money. I mean, it's just it's, if you don't know about it, you're gonna pay it. Right. If you don't know about 1256, you're just gonna be paying the money in taxes, and you're never even gonna think about it never even notice that oh, my God, I'm paying too much. Unfortunately, most CPAs don't know about this, they have no clue what 1256 is, because most of their clients are not options traders. So you might have to go to your accountant, your CPA, and educate them. And you might have to tell them, hey, these options are 1256 options, and they're not regular options. So they need to be taxed differently. Now, it does mean more work for your accountant, so they're not going to be very happy about that.

Truth be told, they might try to take some shortcuts and group them all together. So you have to be very on top of it. And that's why I'm doing this episode so you can realize that there is a difference. And, you know, if you're trading futures options, then it's a little bit easier because you will get a separate tax paper for any futures that you trade and futures contracts themselves or 1256, as well as futures options. Okay, now, mostly all the time, I'm only trading the futures options, not the futures themselves, because there's, there's differences. But if you trade futures or futures options, you will get a separate tax paper at the end of the year, that pretty much lets you know it says it out. These are futures, these are 1256. So that's easier for your broker. But if you are mixing SPX and SPY trades in your regular trading account, you're going to have to separate those and make sure you tell your broker or your CPA, what the differences and how it's going, Okay, because they might not always catch it, they might not know about it. So you have to let them know. I hope that it saves you some money. And I hope to see you at futures options live, the live event that we're having on the 30th. All right, have a great day trade with the odds in your favor. And I'll see you next time!

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