Author Topic: Section 1256 Tax Reporting  (Read 11373 times)

Zach

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Section 1256 Tax Reporting
« on: March 01, 2015, 07:10:11 PM »
Since I know we have more than a few experienced investors/traders on the forum, I thought I would put this question out there to see if anyone has any experience in this realm.

In 2014, I traded a significant number of SPY ETF options contracts. From my understanding, I can report the gains earned as 60% long-term gains, 40% short-term gains under IRS Section 1256.

However, my broker, Fidelity, doesn't classify the index options as such. How do I properly report the 1256 gains while still adhering to the short-term gains my broker is reporting in full?

I read this TurboTax thread for some insight - which was helpful, but still doesn't make clear what you do in this situation.

https://ttlc.intuit.com/questions/2314260-options-on-index-fund-etfs-qqq-spy-1256-contract-treatment

Any prior experience would be appreciated  :)

bobeubanks

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Re: Section 1256 Tax Reporting
« Reply #1 on: March 01, 2015, 07:37:49 PM »
If Fidelity isn't calling them out as 1256, you are adding audit risk to file as 1256. You might have an argument that they are 1256 (to my knowledge, whether SPY options are 1256 or not is not yet ruled on by the IRS). I would look at the risk reward here. I.E., is the benefit of filing as 1256 worth the potential IRS nightmare?

Zach

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Re: Section 1256 Tax Reporting
« Reply #2 on: March 01, 2015, 08:53:07 PM »
If Fidelity isn't calling them out as 1256, you are adding audit risk to file as 1256. You might have an argument that they are 1256 (to my knowledge, whether SPY options are 1256 or not is not yet ruled on by the IRS). I would look at the risk reward here. I.E., is the benefit of filing as 1256 worth the potential IRS nightmare?

That is very true...I wonder what my odds are of getting Fidelity to adjust my 1099 to account for the 60/40 rule?  ;)

Fred93

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Re: Section 1256 Tax Reporting
« Reply #3 on: March 01, 2015, 10:04:18 PM »
SPY options are clearly section 1256.  See IRS pub 550 http://www.irs.gov/pub/irs-pdf/p550.pdf

Page 39 clearly lists "nonequity options" as 1256 contracts.  Later, "nonequity option" is defined.

Quote
Nonequity option.
This is any listed option (defined later) that is not an equity option.  Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. 

A broad-based stock index is based on the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).

Could they have chosen a more helpful example?

bobeubanks

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Re: Section 1256 Tax Reporting
« Reply #4 on: March 01, 2015, 10:49:42 PM »
It does seem clear in p550, yet CPAs don't think it is settled (I believe the reasoning is because SPY options are not cash settled). (google spy 1256 and you'll find many hits discussing this). I would think that you could avoid penalties if audited, and might even win, but again the question is whether the gain is worth the potential hassle or not.

Zach

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Re: Section 1256 Tax Reporting
« Reply #5 on: March 01, 2015, 10:55:15 PM »
SPY options are clearly section 1256.  See IRS pub 550 http://www.irs.gov/pub/irs-pdf/p550.pdf

Page 39 clearly lists "nonequity options" as 1256 contracts.  Later, "nonequity option" is defined.

Quote
Nonequity option.
This is any listed option (defined later) that is not an equity option.  Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. 

A broad-based stock index is based on the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).

Could they have chosen a more helpful example?

It is things like this that make it increasingly clear that we need some income tax reform...

There is absolutely no reason that this issue should be so up in the air  ???

Fred

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Re: Section 1256 Tax Reporting
« Reply #6 on: March 01, 2015, 11:29:24 PM »
It is things like this that make it increasingly clear that we need some income tax reform...

There is absolutely no reason that this issue should be so up in the air  ???

In general and in my experience, get your advice from those who make money by giving you the best advice.

Fidelity, E*Trade, Vanguard, Bank of America, ... are not in the tax business.  Their tax statements are "plain vanilla" and conservative IMO.

TurboTax, tax attorneys are more aligned to our interests.  They want our business, and would compete to get our taxes done.  They (should) know tax laws and audit "probabilities" ;-)

I am an investment person but not a tax person.  I won't pay a dime to get investment ideas from those investment advisors; but I'd be more than willing to shell out money to a good tax person/software.

Fred93

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Re: Section 1256 Tax Reporting
« Reply #7 on: March 01, 2015, 11:43:15 PM »
It does seem clear in p550, yet CPAs don't think it is settled (I believe the reasoning is because SPY options are not cash settled). (google spy 1256 and you'll find many hits discussing this).

There are also many google links discussing kitty cat videos, how many angels fit on the head of a pin, and other obscurata.   Let them argue among themselves.


Quote
I would think that you could avoid penalties if audited, and might even win, but again the question is whether the gain is worth the potential hassle or not.

Most auditors want to get in and get out and not have a big hassle, review by their superiors, etc.  Therefore it is very unlikely that they're gonna go after some little guy in a situation where the the regs are unclear.  If somebody at IRS cares about this, it would be so much easier to simply issue a revised regulation that makes it more explicit.

They aren't going to put you in jail over some situation where the IRS pubs clearly say that S&P 500 index options are 1256 and you did what any ordinary human would believe was correct. 

And even in the extremely unlikely case that some strange guy at IRS decides to audit you to make an example of you over this obscure point, that would be the kind of focused audit where only the brokerage statements are involved, ie not the kind of audit where you have to produce tons of paperwork.   You could always bail at that time by accepting his view and paying a bit more tax.

It is always possible to get a letter from the IRS after you do something that doesn't match a 1099.  However, those are rather mechanical, and can be answered with a letter explaining the situation.  I get one of these letters EVERY YEAR.  Usually has about 10 points where the IRS computer thinks I did something wrong.  My accountant answers each point with one sentence, and the answers are accepted.  She's good, and knows exactly what to say.  For normal folks (your or me) we might need two sentences.

Seems to me a no-brainer.

bobeubanks

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Re: Section 1256 Tax Reporting
« Reply #8 on: March 02, 2015, 12:11:02 AM »
There are also many google links discussing kitty cat videos, how many angels fit on the head of a pin, and other obscurata.   Let them argue among themselves.

Sure, but the people questioning whether SPY options qualify as 1256 have more qualifications than I do. I'd trust well known CPAs and national brokerages before a random guy on a message board.

Quote

Most auditors want to get in and get out and not have a big hassle, review by their superiors, etc.  Therefore it is very unlikely that they're gonna go after some little guy in a situation where the the regs are unclear.  If somebody at IRS cares about this, it would be so much easier to simply issue a revised regulation that makes it more explicit.

They aren't going to put you in jail over some situation where the IRS pubs clearly say that S&P 500 index options are 1256 and you did what any ordinary human would believe was correct. 

Yes, that is essentially what I said.

I don't know how much the OP stands to gain from going 1256 route. I don't know how sensitive he is to dealing with the IRS. If he only stands to gain a couple of bucks, I can't imagine that even a remote risk of any involvement with the IRS would be worth it. So it is by no means a no-brainer to advise OP to go 1256.

Zach

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Re: Section 1256 Tax Reporting
« Reply #9 on: March 02, 2015, 03:54:31 PM »
There are also many google links discussing kitty cat videos, how many angels fit on the head of a pin, and other obscurata.   Let them argue among themselves.

Sure, but the people questioning whether SPY options qualify as 1256 have more qualifications than I do. I'd trust well known CPAs and national brokerages before a random guy on a message board.

Quote

Most auditors want to get in and get out and not have a big hassle, review by their superiors, etc.  Therefore it is very unlikely that they're gonna go after some little guy in a situation where the the regs are unclear.  If somebody at IRS cares about this, it would be so much easier to simply issue a revised regulation that makes it more explicit.

They aren't going to put you in jail over some situation where the IRS pubs clearly say that S&P 500 index options are 1256 and you did what any ordinary human would believe was correct. 

Yes, that is essentially what I said.

I don't know how much the OP stands to gain from going 1256 route. I don't know how sensitive he is to dealing with the IRS. If he only stands to gain a couple of bucks, I can't imagine that even a remote risk of any involvement with the IRS would be worth it. So it is by no means a no-brainer to advise OP to go 1256.

We're talking about ~$1,500 in tax, so I'm probably going to report it under 1256 and be willing to answer to the IRS should there be an issue.

Zach

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Re: Section 1256 Tax Reporting
« Reply #10 on: March 02, 2015, 04:12:27 PM »
Fidelity is going to have their legal team review this situation. The IRS publication 550 provides a list of securities that qualify under the 1256 guidelines, but does not specify that a qualifying security has to meet more than one requirement. While the contracts are not settled in cash, they qualify under the non-equity options section as Fred93 pointed out.

Hopefully some good news soon :)

kadjai

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Re: Section 1256 Tax Reporting
« Reply #11 on: November 29, 2016, 09:45:48 PM »
Was there ever a resolution to this?  It's helpful information so far...