Introduction
Taxes are where many traders discover that the year they thought they made money, they actually made money for the IRS and owe themselves tuition. This guide is the operational overview: what income is taxed, at what rate, what the traps are, and how to budget for it.
Short-Term vs Long-Term Gains
- Short-term capital gains
- Position held 1 year or less. Taxed as ordinary income - your marginal rate (up to 37% federal, plus state).
- Long-term capital gains
- Position held more than 1 year. Taxed at 0% / 15% / 20% federal depending on income. Plus 3.8% NIIT for high earners.
Why it matters
A trader making $100K of short-term gains in a high-tax state might pay 45%+. The same $100K as long-term gains might pay 18%. The difference is holding period - and for day/swing traders, nearly everything is short-term.
The Wash Sale Rule
If you sell a security at a loss and buy a “substantially identical” security within 30 days before or after, the loss is disallowed for tax purposes. The loss is added to the cost basis of the replacement position instead.
What it means in practice
- You sell AAPL at a $1,000 loss. You re-buy AAPL 5 days later. The $1,000 loss is not deductible this year; it adds to the basis of the new position.
- The “substantially identical” test catches: same ticker, options on the same ticker, contracts/shares of the same ETF.
- It does NOT typically catch: similar sector ETFs, different tickers, totally unrelated positions.
- The window is 30 days before and after the loss sale. Total ~60 days of exposure.
Section 1256 (Futures Advantage)
Certain regulated futures, broad-based index options, and some foreign-currency contracts get a special tax treatment: 60% long-term / 40% short-term, regardless of holding period. No wash sale rule applies. Marked-to-market at year end.
What qualifies
- Regulated futures: ES, NQ, YM, CL, GC, ZN, 6E, etc.
- Broad-based index options: SPX, NDX, RUT, VIX options.
- Some foreign-currency contracts (not retail FX).
What doesn’t
- Equity options (AAPL calls, etc.) - those are regular capital gains.
- Narrow-based index options.
- Retail spot FX via a broker - not Section 1256.
Reported on IRS Form 6781.
Options Tax Quirks
- Long call/put, closed for profit/loss
- Regular short-term or long-term capital gain/loss based on holding period.
- Expired options
- The option is treated as sold for $0 on the expiration date.
- Exercised call (long)
- Premium paid is added to the cost basis of the underlying shares.
- Exercised put (long)
- Premium paid reduces the proceeds of the sold shares.
- Assigned call (short)
- Premium received is added to the proceeds of the sold shares.
- Assigned put (short)
- Premium received reduces the cost basis of the purchased shares.
- Broad-based index options (SPX, NDX)
- Section 1256 treatment: 60/40 long/short. Big advantage for active index-option traders.
Crypto Tax
- Every sale is a taxable event - including crypto-to-crypto swaps. Trading ETH for SOL is a sale of ETH and a purchase of SOL.
- Short vs long: same 1-year rule as equities.
- Staking / lending income: ordinary income at fair market value when received. Then capital gains when sold based on the basis set at receipt.
- Airdrops: ordinary income at FMV on receipt.
- DeFi complexity: LPs, wrapped tokens, bridges - each can be a taxable event. Use a tool (Koinly, CoinTracker).
- Wash sale rule technically doesn’t apply to crypto in the US (as of 2026 - this has been proposed for legislation multiple times; may change).
- Mining income: ordinary income at FMV when mined.
Dividends & Interest
- Qualified dividends
- Dividends from US corporations (and some foreign) held longer than 60 days. Taxed at long-term capital gains rates.
- Ordinary dividends
- Dividends from REITs, MLPs, or short-held positions. Taxed as ordinary income.
- Interest income
- From bonds, Treasuries, cash-equivalent yields. Taxed as ordinary income (with state exemption for Treasuries in most states).
- Return of capital
- Not a taxable distribution; reduces cost basis instead. Common with MLPs.
Trader Tax Status (TTS)
The IRS distinguishes investors from traders. TTS is a designation with specific requirements that, if you qualify, unlocks real tax advantages.
The qualifying tests
- Volume: typically 4+ trades per day on most trading days.
- Time: substantial time devoted to trading. Part-time with a day job is harder.
- Holding period: most positions closed within days.
- Intent: seeking profit from short-term movements, not long-term appreciation.
What TTS gets you
- Deductibility of trading expenses (data, computers, home office) - limited for investors.
- Ability to elect Mark-to-Market (next chapter).
- Treated as a business; can set up entity structures (LLC, S-corp) with additional benefits.
Mark-to-Market Election
An election available only to traders with TTS (Section 475(f)). If made, your positions are treated as sold on December 31 at fair market value - unrealized gains/losses become realized for tax purposes.
What changes
- No wash sale rule applies to your securities trading.
- Losses are fully deductible as ordinary losses - not capped at $3K/yr like capital losses.
- All gains become ordinary income - you lose long-term rate benefits (rarely an issue for active traders).
- The election is permanent (without IRS approval to revoke). Requires filing by April 15 of the election year.
Capital Losses & Carryforward
If your capital losses exceed your capital gains in a given year:
- Up to $3,000 of net capital loss offsets ordinary income.
- Excess carries forward indefinitely as capital loss. Offsets future capital gains at same character (short-term vs long-term).
- Spouse filing separately: $1,500 deduction instead of $3,000.
- MTM electors don’t hit the $3K cap - losses are ordinary.
Recordkeeping
The IRS wants documentation. If audited, “the broker 1099 says so” is not enough. You need the trade-level record showing date, security, quantity, basis, proceeds, and holding period.
What to keep
- Broker 1099-B (for each broker).
- Broker trade confirmations / monthly statements.
- Your own trade log (this is where TradeSimple’s Journal is invaluable).
- Wash sale adjustments and cost basis reconstructions.
- For crypto: exchange CSV exports, on-chain addresses, tax software reports (Koinly etc.).
- For TTS: records demonstrating volume, time, intent - the qualifying evidence.
Retention
Keep everything for 7 years. The IRS audit window is 3 years for most returns, extended to 6 for substantial understatements, and indefinite for fraud. 7 is the safe floor.
Setting Aside for Taxes
The best habit you can build: every time you realize a gain, move a percentage into a separate savings account labeled “Tax.” Untouched until you file.
Rule of thumb
- Day traders / short-term: set aside 30–35% of realized profits (federal + state).
- High-income traders in high-tax states: 40%+ is not unusual.
- Section 1256 traders: 25% often suffices thanks to 60/40 treatment.
- Long-term buy-and-hold: 20% federal + state is typically enough.
Quarterly estimated payments
If you expect to owe $1,000+ at filing, the IRS expects quarterly estimated payments (Apr, Jun, Sep, Jan). Underpayment penalties apply otherwise. Your CPA will help compute these.
International Traders
This guide is US-focused. Tax treatment of trading varies dramatically by jurisdiction. A non-exhaustive sketch:
- UK: CGT allowance + 10%/20% depending on income. Spread betting is tax-free (but not CFDs).
- EU: varies by country. Germany has a 25% flat + solidarity on capital gains. Netherlands uses a box system based on assets, not realized gains.
- Canada: capital gains taxed at 50% inclusion rate. Active trading may be deemed business income (fully taxable).
- Australia: capital gains with 50% discount if held >12 months; active trading may be business income.
- Singapore: no capital gains tax on most trading.
- Dubai / UAE: no personal income tax; crypto and trading generally tax-free.
Work With a Pro
Tax planning is where a CPA who specializes in traders pays for itself many times over. Find one who:
- Has active trader clients (not just investors).
- Understands TTS, MTM, and Section 1256 deeply.
- Can help with entity structures (LLC, S-corp) if you’re at a volume/income where they make sense.
- Will integrate with your broker 1099s and your own journal data.
Use TradeSimple’s Reports CSV export to hand your CPA clean, date-sequenced trade data - their job gets easier, your fee gets smaller.