Answer to question regarding the reporting of Option income on your taxes that was raised on the 2/16/10 Tuesday Conference call.

Brian,

Please provide the information in copied response on taxation of options. Also, please provide the group with the IRS reference for review of this issue. If you paste the link to the IRS guide into your browser and print out pages 56-65, or the entire guide, there is information on recording option profits/losses.

Steve

Resolved Question

How are options trading (buy sell put/call) reported in income tax?

I started trading call & put options in 2007 and had no clue how to do the tax on that. TurboTax provided guidelines on reporting the stock sales vs. baseline, but no topics about options. I only receive Schedule D from my broker, which has a note "non governmental document, only FYI". Does this mean I don't need to report my options trading? If I need to, how do I do it? The TurboTax only prompts any income that has 1099, not Schedule D.

Answer

Yes, you need to report gains and losses from options trading.

If you never had offsetting positions, reporting is easy. It is the same as stocks except for options that were exercised/assigned. Table 4-1 on page 57 of IRS Publication 550 gives a simple summary for option positions that were not offsetting

http://www.irs.gov/pub/irs-pdf/p550.pdf

Another good resource for learning about taxes on options is available at

http://www.888options.com/resources/literature/files/taxes_and_investing.pdf

If you did have offsetting positions (a bullish and a bearish position on the same underlying open at the same time, such as a vertical spread) life just got more complicated. The IRS calls such position "straddles" and has special rules for them. See the section of Publication 550 on Straddles beginning on page 57.

Note that some, but not all, covered calls are subject to the straddle rules. Although all covered calls consist of a bullish long stock position and a bearish short call position, some covered calls are "qualified" and exempt for the straddle rules. If you had any qualified covered calls see the discussion on qualified covered calls beginning toward the end of page 58 of Publication 550.

Finally, there is one other special case. If you traded, any Section 1256 option contracts there are special rules associated with them. These are most commonly cash-settled options on a broad-based index, such as SPX or OEX options.