Forex Trading Taxes
If you trade forex in the US, you probably know that making profits is only half the story. The other half is taxes — and they can be confusing, especially if you’re also working with a prop trading firm. The way the IRS looks at your money depends on whether you’re trading your own account or getting payouts from a prop firm. Understanding the rules early can save you headaches and even money.
Trading Your Own Money: Section 988 and 1256
When I first put real money into my forex account, I didn’t realize how the IRS would look at my trades. I quickly learned that Section 988 treats profits and losses like regular income — basically, the same as a paycheck. At first, that stressed me out, especially during my first big losing streak. It felt like everything was going wrong. But knowing that I could deduct those losses against gains made the following tax season much less painful.
Some traders choose Section 1256 treatment, where 60 percent of gains are taxed at the long-term capital gains rate and 40 percent at the ordinary rate. I tried this when I noticed consistent profits over several months. It slightly lowered my tax bill, but the catch is that you have to elect it ahead of time and not every broker supports it. Talking to a tax professional helped me avoid mistakes here.
Prop Firm Payouts: Treated as Income
Prop firm payouts are a different thing. You’re not trading your own money but now you’re trading the firm’s capital and getting a share of those profits. The IRS treats this as income for services, not trading gains. When I started working with a US-based prop firm, I received a Form 1099-NEC at the end of the year. That money is considered ordinary income, and I also had to account for self-employment tax.
Even when working with an overseas firm, you still report the income to the IRS as if it were domestic. Extra forms like the FBAR may come into play if you hold funds in foreign accounts. I made the mistake of ignoring this for one account early on and ended up paying penalties — a costly lesson.
Deducting Expenses Can Help
One thing I found helpful when I started getting prop firm payouts is that a lot of my expenses could actually lower my taxes. Stuff like trading software, data subscriptions, and even my home office setup all counted. I remember the evaluation fee I paid before getting funded — it ended up reducing my taxable income, which was a nice surprise. Some traders who qualify for Trader Tax Status can get even more deductions, though figuring all that out can get a little tricky.
What it all means
Looking back, the main thing I learned is that profits from my own forex account fall under Section 988, or 1256 if you’ve elected it, while money from prop firms is treated as ordinary income, often with self-employment tax. It makes a real difference because it changes how much you pay and what expenses you can write off. I’ve also realized that prop firms have created a whole new type of trader — one who’s technically an independent contractor in the IRS’s eyes.
Keeping track of everything has been a lifesaver. I use a simple spreadsheet to log every payout and expense, and it has saved me countless headaches during tax season. Talking to a tax advisor who understands trader taxation is another move I wouldn’t skip — it can prevent mistakes that end up costing a lot.
At the end of the day, whether you’re trading your own account or working with a prop firm, the IRS wants its share. Knowing the rules ahead of time has helped me plan better, avoid surprises, and keep more of the money I actually worked for.