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Tax-reporting Changes for Options Trading

Catherine Clay Catherine Clay - Livevol CEO

By Catherine Clay, CEO of Livevol

No one ever said trading options was simple. Unfortunately, the same is true of tax treatment of options gains or losses.

Fortunately (or unfortunately, depending on your point of view), new IRS regulations regarding options trading became effective on January 1, 2014. Starting with options purchased this year, your broker will have to report transactions to the IRS when you close the position, including your cost basis, and your short- or long-term capital gains or losses.

Evidently, the provision was in response to a “tax gap” related to incorrect cost-basis information that the U.S. Government Accountability Office (GAO) estimated at $11 billion during tax year 2001. “Even more astonishing, the GAO estimated that almost 38% of the taxpayers who reported the sale of a security that year had misreported their taxable gain or loss,” reported Jonathan Horn in his article, “The Brave New World of Cost Basis Reporting,” in the Journal of Accountancy.

In theory, the new reporting will simplify things for people accepting the brokers’ cost basis. Anyone wanting to use another system for calculating the cost basis will probably do what they have done in the past─their own calculations.

To complicate things, however, Zacks Finance reports that some options transactions (such as straddles, short sales and wash sales) require special tax treatment and may result in a reportable capital gain before the position is closed. 

Transactions for options purchased or acquired before January 1, 2014, will continue to be reported as they have been in the past, meaning there will be no detailed cost basis reporting to the IRS, only gross proceeds.

I’m no accountant, and taxes are not my favorite thing, but this reminds me that traders need to pay attention not just to the Greeks, but to the IRS.

And (full disclaimer) this blog post is not meant to be tax advice or even a summary of tax law. This news just reminded me that options, like all investments, do not exist in a vacuum. They are affected by taxes and by a host of regulations, all of which successful investors need to consider in their ongoing investment decisions. 
If you’d like to learn more, here are some of the sources for this article:
Naomi Smith, Demand Media, “Is Options Trading Reported to IRS?,” Zacks Finance
Sally P. Schreiber, J.D., “Basis Reporting for Debt Instruments and Options is Phased-in,” Journal of Accountancy,  April 17, 2013.
Jonathan Horn, “The Brave New World of Cost Basis Reporting,” Journal of Accountancy, September 2013.
IRS Cost Basis Reporting Rules, Wells Fargo Advisors.

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