Do You Pay Taxes on Forex: Sections 988, 1256, and Filing

Yes, you pay taxes on forex trading profits in the United States, and the rate depends mostly on what you trade. Retail spot forex gains are taxed as ordinary income at rates up to 37%, while regulated forex futures and options qualify for a blended maximum rate of roughly 27% under the 60/40 rule. Losses can be even more valuable than gains are costly, but only if you understand which section of the tax code applies to each contract and which elections you qualify to make.

Spot Forex Falls Under Section 988

The default rule for most retail forex traders is Section 988 of the Internal Revenue Code, which covers transactions in nonfunctional currencies. That includes the spot forex contracts that make up the bulk of retail trading. Gains and losses from a Section 988 transaction are ordinary.¹

Ordinary treatment means your forex profits stack on top of wages, freelance income, and everything else, then get taxed at your marginal rate. For 2026, the top marginal rate is 37% for single filers earning above $640,600.² No favorable capital gains rates apply.

The upside sits on the loss side. Because Section 988 losses are ordinary, they offset your other ordinary income dollar for dollar with no annual cap. Capital losses, by contrast, can only offset $3,000 of ordinary income per year after exhausting capital gains. A bad forex year under Section 988 can meaningfully reduce the tax you owe on your salary or business income.

Regulated Futures and Options Fall Under Section 1256

Forex contracts traded on a regulated exchange, including regulated futures contracts and certain foreign currency options, fall under Section 1256. These contracts are marked to market at year-end, so the IRS treats any open position as if you sold it on December 31 at fair market value.³

The resulting gain or loss is split under the 60/40 rule: 60% is long-term capital and 40% is short-term, regardless of how long you actually held the position.⁴ Long-term capital gains max out at 20%; short-term gains follow ordinary rates up to 37%. For a top-bracket trader, the blended maximum works out to roughly 26.8%. That’s a meaningful discount compared to full ordinary treatment. The trade-off: Section 1256 losses also follow the 60/40 split, so you lose the unlimited ordinary loss offset that Section 988 provides.

Three-Year Loss Carryback

Section 1256 offers a benefit that no other part of the individual tax code still provides: a three-year loss carryback. A net loss on Section 1256 contracts in the current year can be carried back to any of the three preceding tax years and applied against Section 1256 gains from those years.⁵ The carryback can only offset prior Section 1256 gains, not other income, and it cannot create or increase a net operating loss for any carryback year. You make the election on Form 6781 and claim the refund on Form 1045.

Can You Elect Out of Section 988?

Traders expecting net gains sometimes want spot forex profits taxed as capital gains instead of ordinary income. Section 988 allows an election to treat gains and losses as capital, but only for specific transaction types: forward contracts, futures contracts, and certain options that are capital assets and not part of a straddle.¹ The election has to be identified before the close of the day you enter the transaction.

Whether the opt-out extends to spot forex contracts on retail platforms is genuinely unclear. The IRS has not issued definitive guidance. Some tax practitioners take the position that the election can apply to spot forex; others disagree. If you plan to elect out of Section 988, working with a tax professional who specializes in trader taxation is worth the cost. The wrong call can lead to penalties on audit.

The 3.8% Net Investment Income Tax

Higher-earning forex traders face an additional layer that the basic Section 988 versus 1256 analysis misses. Section 1411 imposes a 3.8% surtax on net investment income for individuals whose modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers.⁶

The statute defines net investment income to include gains from a trade or business of trading in financial instruments or commodities. Forex trading lands squarely in that definition, so both Section 988 ordinary gains and Section 1256 capital gains can trigger the surtax. For a top-bracket trader subject to NIIT, the effective maximum rate on Section 1256 gains climbs from 26.8% to about 30.6%, and Section 988 gains can reach 40.8%. Those thresholds are not indexed for inflation.

Investor or Business Trader?

Separate from which code section governs your contracts, the IRS also cares whether you trade as a casual investor or as someone running a trading business. That distinction controls which expenses you can deduct, not how your gains are taxed.

Investor Status

If you trade forex on the side while holding a regular job, the IRS treats you as an investor. The Tax Cuts and Jobs Act suspended miscellaneous itemized deductions for investment expenses, and the One Big Beautiful Bill Act made that suspension permanent starting in 2026.² Software costs, charting platforms, educational courses, and similar expenses are nondeductible for investors going forward. Capital losses are also capped: after offsetting capital gains, only $3,000 of remaining capital losses can reduce ordinary income each year, with the excess carried forward.

Business Trader Status

Traders whose activity is frequent and continuous enough to qualify as a business get substantially better treatment. Business traders report expenses on Schedule C and deduct ordinary and necessary business costs directly: trading platforms, data feeds, professional development, and a dedicated home office.⁷

The IRS looks at several factors: substantial volume and frequency of trades, intent to profit from short-term price movements rather than long-term appreciation, and treating the activity as a primary occupation with continuity and regularity. A few trades a month won’t qualify. The IRS wants to see something that looks like a full-time job.

One piece of good news for business traders: despite reporting on Schedule C, trading gains are not subject to self-employment tax.⁸ You get the expense deductions of a business without owing the extra 15.3% in Social Security and Medicare tax on your profits.

The Section 475 Mark-to-Market Election

Business traders have another option that can change the character of every gain and loss: the Section 475(f) mark-to-market election. Once made, this election forces all positions held at year-end to be treated as if sold at fair market value on the last business day of the year, and all resulting gains and losses become ordinary.⁹

The main reason traders make this election is the loss side. Ordinary losses under Section 475 are fully deductible against all other income with no annual cap, unlike the $3,000 limit on net capital losses. A $50,000 losing year offsets your other income immediately. The cost: gains also become ordinary, taxed at your full marginal rate rather than the 60/40 blended rate that Section 1256 contracts would otherwise receive.

The deadline catches people every year. To have the election apply for 2026, you needed to attach a statement to your 2025 tax return (or extension request) by the unextended due date of that return, which for most individuals was April 15, 2026.⁸ Once made, the election applies to all future tax years unless the IRS consents to a revocation. Miss the deadline and you’re locked into capital gain and loss treatment for the year.

How to Report Forex on Your Return

Forex tax reporting starts with separating your trades into two buckets: Section 988 transactions and Section 1256 contracts. Your broker may provide a Form 1099-B, but many forex brokers issue incomplete or nonstandard reporting, so you’ll likely need to pull detailed trade logs and calculate your own totals.

Section 1256 Contracts

Your aggregate net gain or loss from all Section 1256 contracts goes on Form 6781. You enter a single number; the form handles the 60/40 split automatically. The 60% long-term portion and the 40% short-term portion both transfer to Schedule D of Form 1040.⁴ If you’re electing the three-year loss carryback, you also make that election on Form 6781.

Section 988 Transactions

Section 988 gains and losses are ordinary, but the IRS does not prescribe a single form for reporting them. Common approaches include Form 4797 (Sales of Business Property) or reporting as other income on Schedule 1 of Form 1040. A net gain flows through as additional ordinary income. A net loss appears as a negative figure that directly reduces your other ordinary income. If you made the Section 475 election, all trading gains and losses regardless of contract type are reported on Form 4797 as ordinary.

Business Trader Expenses

Qualified business traders report deductible expenses on Schedule C. Commissions and transaction costs directly tied to entering or closing a position are not deducted separately; they factor into your cost basis and affect the gain or loss on each trade.⁸ Overhead expenses like platform subscriptions, market data, and office costs are the items that go on Schedule C.

Quarterly Estimated Tax Payments

Forex profits don’t have taxes withheld the way wages do. If you expect to owe $1,000 or more after subtracting withholding and credits, you’re required to make quarterly estimated tax payments. The IRS charges an underpayment penalty if you fall short.¹⁰

You can generally avoid the penalty by paying at least 90% of the current year’s tax liability or 100% of the prior year’s tax (110% if your prior-year AGI exceeded $150,000), whichever is smaller, spread across four roughly equal quarterly payments. For traders with volatile income, the annualized income installment method lets you base each quarter’s payment on income actually earned during that period. It’s reported on Form 2210, Schedule AI.

Records You Need to Keep

Broker-provided forms are a starting point, not a finish line. Keep a complete trade log for every closed position during the year, including the open date, close date, currency pair, position size, and precise gain or loss in U.S. dollars. Many brokers let you export this data, but you’re responsible for verifying it.

Separate your log into Section 988 and Section 1256 trades before you start filling out forms. For Section 1256 contracts, you also need the year-end mark-to-market values of any open positions. Business traders should keep records of all deductible expenses by category, along with documentation of the trading activity itself: hours spent, number of trades, and consistency throughout the year. Those records become essential if the IRS questions your business trader status.

A Note on Wash Sales

The wash sale rule in Section 1091 specifically applies to stock or securities, and currencies are generally not classified as securities. Most practitioners take the position that wash sales do not apply to spot forex transactions, though this area lacks explicit IRS guidance. Section 1256 contracts are marked to market at year-end anyway, which makes traditional wash sale deferrals irrelevant because there’s no unrealized position to defer a loss into. Traders who also hold currency ETFs or currency futures alongside spot positions should be careful, because those related instruments may be securities or Section 1256 contracts with their own rules.

1
Office of the Law Revision Counsel. 26 U.S. Code 988 – Treatment of Certain Foreign Currency Transactions
2
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
3
Office of the Law Revision Counsel. 26 U.S. Code 1256 – Section 1256 Contracts Marked to Market
4
Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles
5
Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
6
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
7
Internal Revenue Service. About Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship)
8
Internal Revenue Service. Topic No. 429, Traders in Securities
9
Office of the Law Revision Counsel. 26 U.S. Code 475 – Mark to Market Accounting Method for Dealers in Securities
10
Internal Revenue Service. Topic No. 306, Penalty for Underpayment of Estimated Tax