Foreign Exchange or Forex Trading is a trading methodology where currencies are bought or sold in order to make profits. Along with Canada, there are a lot of other countries where Forex Trading is taxed and regulated, but unfortunately many forex traders, especially the new ones, do not understand the taxation system. This negligence often leads to illegal activity and big disadvantages.
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What is Forex Trading Tax?
While we understood what Forex trading is, it would be worth looking into the taxation in Forex Trading in the Canadian context:
Understanding Tax in this Context
We all understand that tax is an amount paid to the government for anything we buy or our income that has been officially taxed. This money is used to run the country and benefit us, in return. Similarly, Tax in Forex Trading is done based on the income generated by Forex Traders annually. They have to pay the tax to the government based on their earnings, both gains or losses.
Why are Forex Traders Taxed?
Foreign Exchange involves almost all the currencies around the world, and due to that reason, governments believe they need to be involved with it and tax it. Moreover, the profits made in Foreign Exchange are often very huge, and it is seen as a good opportunity by the governments to generate massive revenue that can be further used for the development of the country with an improved economy.
How Much Tax is Applied in General?
The tax is not generally applied for the first $200 in gains and losses. After that, the gains in your forex trading are taxed at 50% of your marginal rate. That means you will be taxed at about 43% (which is the marginal tax rate) of your capital gain into 50%. That will be your total capital gain tax.
To simplify, the formula could be understood as:
Capital Gain×50%43%=Capital Gain Tax
However, your marginal tax rate may vary according to various circumstances.
Tax Strategies for Traders
For people who are new to Forex trading, here are some tax strategies that could prove helpful to them:
Understand the ways of Forex Trading
You should understand the Canadian laws surrounding Forex trading, so you can devise the most appropriate strategy for yourself. Initially, you will have to work for others, learn new skills before you can find yourself in a good position. Then, collaborate with others and lead the game.
Choose to opt out of Section 988 in case of Gains
This is a small tip that may help you: if you are expected to make gains in your forex trading, choose to opt out of section 988 and choose 1256 instead since you will be able to increase your savings by about 12% using that paradigm. However, if you are going in loss, section 988 will be a significantly better option for you, since in 1256 you will lose even more wealth via the taxes.
Seek Guidance from Accounting Tax Professional
Every once in a while, pay a visit to a Forex Accounting Tax professional for technical guidance regarding foreign exchange. They will charge you a sum, but in return, they may provide you with helpful advice that will enable you to generate more revenue by the end of your fiscal year.
Don’t Invest too much right from the get-go
Naturally, this should go without saying, but we will discuss it nevertheless. When you start forex trading, you must start with a little investment to see the scope of your expertise and skills here. Chances of loss are pretty high at the start, so you will be better off starting small. When you begin to see much success, go bigger, slowly and steadily.
How to Pay Tax as a Forex Trader?
As a new Forex trader, here are some things you need to understand on how the taxpaying process works:
Understand the IRC Contracts
We have discussed a little about Section 988 and 1256. These are basically 2 distinct IRC contracts, that the Forex traders have to choose from. Both have their advantages and disadvantages. For better understanding, read as follows:
- In IRC 988, the tax rate remains the same in both losses and gains.
- In IRC 1256, the 60/40 rule is used, where 60% of gains and losses are termed and long-term capital gains and the remaining 40% are termed as short-term gains.
Choose your Preferred IRC Contract
Once you have chosen the IRC contract you prefer, you should trade in under a paradigm that will give you the most benefit in that contract. This isn’t an easy thing to determine, but nevertheless, it is important. After all, you have to file your taxes accordingly.
It is recommended that you use the IRC 988 if you are a new trader because it is simple and will facilitate you more in case of losses, however as you get experienced in foreign exchange, and start earning big, you should go for 1256 for greater savings.
Keep a record or Brokerage Statements
IRS has a full-fledged formula for keeping a record of your forex trading. It is a comprehensive plan that allows you to record every single thing that will be reviewed by the end of the year. This is a performance record formula and it will give you a better picture of your trading-year, which will ultimately help you when you are filing your taxes.
File your Taxes at the end of the year
This is the final stage of taxing. Once you have filed all your taxes and submitted them, you are cleared after review and approval. Now, you need not worry about your taxes and look forward to the coming year, as you will have even greater challenges, that will hold even greater profits for you.
Regardless of how strict the implementation of the law is, taxation on foreign exchange trading should be taken seriously. It will lead to cleaner and fairer trading, and will protect you from any kind of trouble.
For more about Canadian currency tax reporting, see this resource.