Options Traders and taxes - John R. Dundon II, Enrolled Agent
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Options Traders and taxes

Options Traders and taxes

The 1099-INT and 1099-DIV reported to the Internal Revenue Service details how much you received in interest and dividends through your account, while form 1099-B reported the total proceeds of your sales of stocks and bonds during the year.

The amounts shown as interest and dividends should have tallied with your own records. But if you sold one or more puts or calls in 2009, you will find your 1099-B, as supplied by your broker, was short. That’s because the tax code does not require brokers to report proceeds from sales of puts or calls. Your personal income-tax return, however, is an entirely different matter.

Nowhere does the law provide an exemption from your obligation to report your options gains.

The brokers’ omission of the proceeds of option trades from form 1099-B often misleads investors, who typically turn over their 1099s to their accountants, providing the purchase date and cost of each item listed as sold in the 1099-B schedule. Your accountant computes the gains and losses, classifies them as long or short term, and produces your Schedule D showing total sales proceeds equal to the corresponding figure on your 1099-B. Too many times, the drill ends there — so the Schedule D that is attached to your tax return reflects only the sales proceeds reported on your 1099-B, with the results of your options transactions omitted.

The consequences of this omission are seldom good. First, and most important, it leaves you exposed to being charged with a felony — willful failure to report taxable income. Second, you may have taken losses on options during the year; neglecting to include any losing options trades in your tax return costs you the tax benefit of those losses.

Changes are in the works. Under 2008 legislation, your broker will be required to furnish you, as well as the IRS, with an expanded 1099-B, showing your adjusted basis for securities you sold during the year. Your broker will have to make the adjustments for stock splits, stock dividends, mergers and other corporate actions involving securities in your account. These changes, reflected in Section 6045 of the tax code, represent a massive shift in record-keeping and computation burdens away from you and onto your broker. In general, the new rules will apply to stock you acquire after the end of 2010. The new rules will also affect options and their effect on reported stock transactions.

Although there is no gain or loss recognized when you exercise an option to buy (a call) or sell (a put) on 100 shares of ABC Co., your cost of that option is added to and becomes part of your cost basis of the stock, or, if a sale, a reduction of the proceeds. If you buy stock pursuant to a put you sold, your cost is reduced by the premium you received. In any case, on a sale of stock so acquired or sold, the gain or loss as reported by your broker will be adjusted to reflect the premium you paid or received.

When an option you own expires unexercised, or lapses, you sustain a capital loss in the amount of the premium you paid; if the lapse is of an option you have written, your gain is the premium paid to you. Your broker will be required to report such gain or loss for the year in which the lapse occurs. The requirement is due to go into effect in 2013; it doesn’t apply to options written, sold or acquired before then.

But this still leaves us where we opened this essay — you buy a call, the stock rises, and you sell the call for a gain. Neither the tax code nor the IRS regulations, as they now stand, requires your broker to report that sale or its proceeds — and no starting date for such a requirement has yet been provided.