*This article is not financial advice and shouldn't be taken as such. It is just my opinion based on the research I have done.
In different regions worldwide, tax rules and regulations for earnings from binary options trading can vary significantly.
In some cases, you may have to pay taxes for earning a few dollars from binary options trading; in other cases, you may be able to keep your earnings exempt from tax entirely. In some regions, the tax is a percentage of your profits (much like income tax), while there are fixed tax payments in other areas.
In any case, knowing what you owe (if you owe anything at all) and how you should pay taxes will help you streamline your operations. You can modify your trading strategy with the right tax information, so pay as little tax as possible. You may be able to earn rebates and discounts or benefit from tax deduction schemes.
On that note, here is everything you need to know about taxation for your earnings from binary options trading.
Table of Contents
Taxation in the USA
The US market is one of the biggest and most popular options for binary options trading. Traders worldwide choose to work in the US market due to the flexibility, the large number of options, and the high market value.
However, while there is a lot of earning potential in the US market, it can be quite expensive in terms of taxation. You may be eligible for capital gains tax or a straightforward income tax if you are trading in the US or trading options remotely and earning profits in the US through an offshore broker.
Taxes for Binary Options Trading
In the US, earning from capital gains trading can be classified as extra earning, income tax, or capital gains. In many countries, including the US, Australia, and Canada, the earnings from binary options trading are typically subject to a capital gains tax.
Which category your earnings will fall under depends on the value of the earnings. However, you also need to keep in mind that taxes in the US vary from state to state, and there are Federal taxes to account for.
Capital Gains vs. General Income Tax
The two main routes you can take are either reporting your earnings under general income tax or as capital gains income.
If you are a job-goer or business-person who trades binary options casually and it's a secondary income for you, then it would make sense to file your earnings under capital gains tax. This will cover earnings from asset trade or income generated from asset sales. This applies to both short-term gains and long-term gains where short-term is less than one financial year.
If you have earnings from binary options trading that have taken more than a year to mature, or you are filing for a previous year that you missed out on, you would file this under the long-term capital gains tax. If you get the 1040 D Form, you will see both options listed there under the capital gains section, and you can file your taxes accordingly.
Filing this income under the general income tab will be the best option for people making a full-time income from binary options trading. This is the recommended route by the IRS for people residing in the US or filing taxes in the US as non-resident tax payers.
Furthermore, filing your trading income as normal income tax gives you some tax benefits as you may be eligible for tax deductions and discounts.
However, the amount of tax that can be waived off through the general income route depends on how much you have earned and whether that was a long-term or short-term earning. Keep in mind that when filing under the general income tax, you will need to provide some additional details, including specific sources of income, your broker, and the rest of your income map.
Some binary options brokers file taxes on behalf of their clients. This is the easiest solution for clients, but it usually costs a bit more money. Brokers are not required by law to file taxes, so you will have to check with your broker to know if you need to file taxes at the end of the year. This is also the time to discuss the specific binary options tax rules with your broker.
If your broker is in a different state and you are filing income taxes in another state, you'll need to know exactly which regulations to follow to avoid problems in the future.
Binary options trading profits can be liable to deductions, but this varies from state to state, your portfolio, and how much you are earning. Binary options traders that are doing this as a registered business, even if it is a single-employee organization, can benefit from tax deductions.
As a business, it's still not possible to make trading binary options tax-free, but you can get a significant kickback when the losses are subtracted from your overall earnings. In some states, there is a maximum deduction limit of $3000, whereas, in other states, you can deduct a lot more.
Keeping track of your losses, earnings, profits, and expenses will be very helpful when it comes to earning deductions at the end of the year. If you aren't sure how this will work out in your overall earnings, get in touch with a professional tax advisor to make the most of this feature.
In the US, traders can choose between three forms to file their binary options taxes depending on how much they earn from trading and whether it is short-term or long-term earnings.
The most common form is the 1040D which is used for small earnings over a short period of time. If you have earnings of less than $10,000 and have been generated within a single year, this is the form to go for.
If you have reached $10,000 in earnings at any time during the year or have exceeded this amount, then there are two forms you need to prepare. These include the FinCEN form 114 and the 8938 form. If your earnings did not cross a total of $10,000 during the entire year, the FinCEN form 114 would be enough. However, if you exceeded this amount, then attaching the 8938 form will also be required.
For very small traders who have a maximum earning of $1500 in a financial year, a marginal rate of tax will be applied. For traders who have earned between $1500 and $10000, a flat rate of 20% will be applied.
State and Federal Taxes
In some states, the income tax can be as low as 6%, while in others, it can be as high as 44%. When filing taxes, you will need to prepare both state and federal tax returns. In most cases, federal taxes will be slightly lower than state taxes.
In both cases, you will need to prepare a complete summary of how much you earned, the exact breakdown according to the assets traded, the sources of income, and any expenses you incurred during the process. Adding in broker details and fees and commissions that you paid to the broker will also be helpful.
If you have a broker that provides you with earning statements or facilitates you in your tax returns, then that will certainly make your life easier. However, law does not require binary options brokers to provide you with earning statements or assist in filing taxes for your binary options.
It is your job to keep a complete history of your trading binary options earnings and to file taxes for these earnings at the end of the year. If you trade binary options, then you will also be using a credit card or a debit card to debit/credit money from your brokerage account.
The IRS has the right to, and often does, randomly audit bank accounts and credit/debit cards to see what the individual is doing, what they are earning, and what the source of funds are. The last thing you want is for your account to come up in a random audit and for you to not have the right documentation to back up all the financial activity taking place in your accounts.
It would be a good idea to hire a tax consultant who can give you professional tax advice and help you with filing taxes and maintaining a good record of your earnings from binary options. However, it is also recommended that you have at least a basic understanding of binary options trading taxes and the various processes related to maintaining good financial documentation.
If you want to make paying taxes easier for yourself and you don't mind paying your broker a small premium for this service, you can use a tax declaration form. You can get this form from authorized brokers in the US. Usually, these brokers provide a tax declaration service anyway.
All the taxes you are liable for will be filed by the broker and shared with the IRS. Rather than paying out of pocket, the tax amount will be deducted from your binary options earnings. If you have an account with the same broker, they will simply be deducted from your broker account, and then you can withdraw the remainder to your personal account.
With this approach, you don't have to do all the tax work yourself, but more importantly, all the tax is not deducted in one big transaction. Rather, your taxes are deducted with each transaction throughout the year.
This is particularly useful for people that make small transactions and don't want to have to pay a large amount at the end of the year. If you pay taxes periodically, you can better protect yourself from tax debt.
If you want your broker to handle the taxes directly with the IRS and not have to pay tax as you go, this is also an option. You can still choose to pay taxes at the end of the year on all your binary options profits.
If you pay taxes through a broker, you must consider the fees. Especially if you are paying taxes per trade, the processing fees, which the broker charges, can get quite pricey.
Depending on how much tax you are paying and how frequently you are trading, it could make more sense to compile your taxes through an external tax consultant and then pay it all at once at the end of the year.
Whether it is classified as capital gains or charged as a regular income tax, it will play a role in how you should pay your taxes. Again, working out these details with a tax consultant will help you save the most money and manage a tax payment routine that is easy to maintain.
Some traders, especially beginners, often underestimate the importance of paying taxes properly. Many will not show their true earnings, while others will hide their entire earnings. Both of these practices are not recommended at all.
If you make an honest mistake when filing taxes, the IRS will understand that, but if you deliberately change your income statements and earnings just to avoid taxes, you're asking for trouble.
The IRS does audit the accounts of both individuals and businesses. Sooner or later, it will come up in their system. In most cases, the finances of a person, usually the discrepancy of their earnings and expenditures, is what catches the eye of the IRS. At that point, not only will you be scrutinized and penalized, but it will put your trading career in a tough spot as well.
Completing your tax obligations, filing taxes, and maintaining a good record of all your earnings and losses during your trading career can be challenging. If you don't know how to do this, start off on the right foot and get a professional to help you out. This way you will understand what you need to do – and in the future, you can do this yourself.
Early on it is imperative that you learn about the process the right way. As your trading volume grows, the process will only get more complicated. Lastly, make sure you are following the right regulations to ensure you are paying what you really owe.