Futures contracts are taxed at different rates than stocks, bonds, ETFs and mutual funds. In some cases, trading e-mini stock index futures may result in more favorable tax treatment than other trading instruments. Like other futures contracts, the e-mini stock index futures contracts (including ES, NQ, YM and TF) generally fall under Section 1256 of the U.S. tax code, and gains and losses are marked-to-market at the end of each tax year. Marked-to-market means that all realized and un-realized gains and losses are reported. Futures contracts fall under the 60/40 rule, where 60% of gains are treated as long-term capital gains and 40% are treated as short-term capital gains (ordinary income) - regardless of the actual length of the holding period. For active traders, this can result in tax savings.
Currently, the maximum long-term capital gains tax rate is 15% and the maximum short-term capital gains tax rate is 35%. With the 60/40 rules, futures traders can achieve a net maximum blended tax rate of 23%. Depending on the tax payer's tax bracket, this figure can be lower. For example, assume a trader makes $50,000 in one year trading the ES. $30,000 will be taxed at the lower, long-term capital gains rate, and $20,000 will be taxed at the higher, short-term capital gains rate:
$30,000 X 15% = $4,500 (60% at long-term capital gains rate)
$20,000 X 35% = $7,000 (40% at short-term capital gains rate)
$4,500 + $7,000 = $11,500 (23% of $50,000)
If, on the other hand, the $50,000 the trader made in one year was made trading stocks, the entire amount would be taxed at the higher, short-term capital gains tax rate:
$50,000 X 35% = $17,500
The difference between the short-term capital gains and the Section 1256 contracts (in this example, the ES) is $6,000, a substantial tax savings.
When trading stocks, by comparison, 100% of gains are taxed at the short-term gains tax rate if the positions are held for less than one year. The favorable tax treatment for futures traders is one reason why active traders enter the futures market rather than the stock market.
Another advantage with trading futures is the ease of year-end filing. At the end of each year, futures brokers send each futures client a 1099-B form. This tax form shows the net result of all trading - not each individual trade. This number is entered on the tax return (compared with stock trades where each individual trade must be entered). Even though most futures trading is exempt from detailed transaction reporting, it is prudent to keep well-maintained and accurate records of all trading activity in case of an audit.
Taxes are complicated and the rules change frequently. It is important to consult with a qualified tax attorney or accountant for up-to-date information and advice that is applicable to each trader's situation.
The Bottom Line
The e-minis are the small but mighty cousins of their larger, full-sized contracts. Popular among individual and institutional traders alike, the e-minis offer substantial volume and volatility, both of which help set the stage for profitable trading opportunities. Most futures brokers offer competitive pricing structures and robust trading platforms with which to perform market analysis and enter trades. The e-minis are traded using margin, giving traders the ability to enter positions they would otherwise be able to with cash account. In addition, since the e-minis are futures contracts, they are subject to favorable tax treatment.