- If the IRS considers you a "trader" -- that is, you consider trading your part- or full-time job and meet certain requirements, your reporting requirements are very different from the ordinary investor. If you execute at least 1,000 short-term trades per year (options or otherwise) and spend at least 20 hours per week on trading activities, you are a self-employed trader and your income is seen as business income. Traders use IRS Schedules C and D with IRS Form 1040 to report their business income as well as any profit or loss from trading activity. Individual investors report capital gains or losses with other investment activity directly on the 1040 form.
- If you are classified as a trader, you must make estimated quarterly tax payments. Use IRS Form 1040ES to calculate the tax payments, and remit them via check or electronic withdrawal. Tax payments are due on April 15, July 15, Oct. 15 and Jan. 15 each year. If you do not trade enough to be considered a trader, your gains from options trading may still result in a greater tax obligation. You may increase your paycheck withholding or make estimated payments in the same way as a trader. IRS Publication 505 outlines your options and can help you determine which action to take.
- If you are a trader, your gains and losses will be reported as part of your business income and taxed at ordinary income rates, regardless of how they arise. Individual investors are taxed at capital gains rates, and the reporting depends on the activity. Expired options are capital losses. If you sell an option, you realize a gain if you make money or a loss if you lose money. For gains, tax rates are short-term gain rates if you held the option for less than a year and long term gain rates if you held it for longer. You may use any losses to offset your gains for the year and lower your taxable income. Exercised options are wrapped in to the purchase or sale of the related stock: The cost of the option becomes part of the cost basis of the stock. You are only taxed on the gain (or able to deduct the loss) when the stock is sold.
- Tax rules become more complicated as you delve deeper into options trading. "Straddling" -- the practice of purchasing offsetting positions to reduce risk -- operates under a different set of tax rules. If you plan to trade heavily, it is important to consult with an accountant or tax preparer about the tax consequences of various situations. This will allow you to plan your trades to maximize profit and minimize the risk of tax penalties.
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