This article is intended for option traders. Please excuse the option jargon! But even the savviest option traders can need a little help at tax time, particularly with cost basis reporting. If that’s you, listen up.
Suppose you traded some options last year, for the first time in a few years. If so, you might see something new on your 1099-B ... options information. This information you’re seeing is courtesy of a rule change that was kicked around for years before finally landing in front of taxpayers beginning with the 2014 tax year. It’s actually a good thing—the IRS is looking to make the reporting of taxes on options trading easy and straightforward. So, now that the information you need is readily available, let’s dive into some of the 1099 reporting requirements.
The thing about options is there are options, right? You can sell a contract short or buy it long. You can get assigned or you can exercise. With so many choices, what does the reporting look like regarding taxation on options trading?
Scenario 1: Buy Long, Then Sell
Let’s say you bought an XYZ July 15, 2017, at 92.5 put option contract for $5.30 on September 24, 2016. By the beginning of February 2017, it was continuing to decline and you needed to jump ship, selling it for $1.16. This transaction is simple and straightforward. Your cost is $5.30, plus transaction costs, and your proceeds are $1.16, minus transaction costs, which your 1099-B will reflect. Seems too easy, perhaps? Let’s see what happens if you switch it around and sell it to open the position.
Scenario 2: Sell to Open, Then Buy to Close
Go ahead, you traders who can deal with the risk (you know who you are), sell the XYZ put option contract to open at $5.30 then close with a $1.16 purchase. The IRS decided to make this transaction just a wee bit tricky, but don’t worry. We’ll explain. Your 1099-B is going to show a proceeds amount of $4.14 (modified by transaction costs) and a basis of $0. Confused? You’re not the only one. The IRS mandates that a trader with a cash-settled, written contract report only the gain or loss as proceeds. Your tax document will not reflect the $5.30 or $1.16 amounts, just your profit of $4.14 less transaction costs.
See, that wasn’t too bad. If this was a loss, your proceeds amount would be negative. Just for clarification, GainsKeeper® is still going to show the original sale and purchase amounts so that you can understand how your 1099 calculates a profit or loss.
Option expirations are simple to report at tax time. When the contract expires, the premium and transaction costs paid (for option buyers) will be a loss. Option writers will realize a gain equal to the amount of the cash received (the premium less transaction costs) for selling the contract.
Now, Some Choices
I used to read “Choose Your Own Adventure” books in elementary school. Tax reporting on assignments and exercises is similar. The options are limited (in my chart, not the market!), and there are only four paths you can take when an exercise or assignment takes place. Follow along:
|If you _____||you have _______ the underlying at the strike price.||When _____||your _____||equals the strike price _____ the premium you paid for the contract (+/- transaction costs).|
|purchase a call,||the right to buy||exercised,||cost basis of shares purchased||PLUS|
|purchase a put,||the right to sell||exercised,||proceeds from the sale of shares||MINUS|
|sell a call,||the obligation to sell||assigned,||proceeds from the sale of shares||PLUS|
|sell a put,||the obligation to buy||assigned,||cost basis of shares purchased||MINUS|
Essentially, the contract in and of itself will not be a reportable line item on your 1099 if the contract was exercised/assigned. It’s built into either your cost or proceeds, depending on which path you took.
Want another example on the taxation of stock option contracts? Let’s say you bought an XYZ July 15, 2017, at $100 call for $5, which was exercised. The contract is “done.” However, it isn’t taxable until you sell the shares of XYZ. Whenever you do decide to sell XYZ, your basis is $100 + $5 (strike price plus the premium and plus transaction costs). And keep in mind that could be the next day or 10 years later.
One final note: options on broad-based indices such as the S&P 500 (SPX) are treated a bit differently. Broad-based index options (as well as futures contracts and options on futures) fall under Section 1256 of the IRS tax code, and are required to be treated with mark-to-market status. This means that even if you didn’t liquidate a position by the last trading day of the year, the IRS treats it as if you did, and uses the closing price of that final trading day to figure your unrealized gain or loss. The closing price is “marked” and used as the cost basis going forward. For more on this and other "special" tax rules for traders, please refer to this primer.
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