Tax ramifications - securities vs. futures trading

[CarlErikson]

My trading experience consists of trading securities and options on securities. I have never traded futures, but have become interested in the e-mini ES and/or NQ trading.

I have a question about the tax ramifications of switching to futures trading.

Currently my occupation is a "securities trader." I.e., I have trader status in terms of the tax law. Therefore, I do not pay any self-employment tax. I have also made the mark-to-market election, but only for securities trading. I am a retail trader and trade my own account.

Here are a few paragraphs from:

http://www.unclefed.com/Tax-Help/HTML/p53302.html

Dealer in Securities

If you are a dealer in options or commodities, your gains and losses from dealing or trading in section 1256 contracts (regulated futures contracts, foreign currency contracts, nonequity options, and dealer equity options) or property related to those contracts (such as stock used to hedge options) are subject to SE tax. For more information, see sections 1256 and 1402(i) of the Internal Revenue Code.


Trader in Securities

You are a trader in securities if you are engaged in the business of buying and selling securities for your own account. As a trader in securities, your gain or loss from the disposition of securities is not subject to SE tax. However, see Dealer in Securities, earlier, for an exception that applies to section 1256 contracts. For more information about traders in securities, see Publication 550, Investment Income and Expenses.

My question is, I know that if I trade futures, that 60% of my gains (if any) will be considered long-term capital gains and 40% is considered short-term capital gains regardless of the holding period.

Suppose currently I only trade QQQs and SPYs and make a certain amount of profit. All of these capital gains are considered ordinary gains because of my mark-to-market election. However, I do not pay any self-employment tax.

If I trade NQ and ES futures, and make a certain amount of profit, 60% of the gains will be considered long-term capital gains and the rest will be short-term capital gains. But according to the above quote, it implies I would have to pay self-employment tax which is an extra 15% tax.

Suppose I could make the same amount of profit by trading securities or by trading futures. Which option would you choose to be more tax efficient? Or am I not understanding something in the above scenario properly?

Thanks,
Carl

 

[CarlErikson]

I think I have answered my own question after searching around on the web.

From IRS publication 550:

For dealers:

"Gains and losses derived in the ordinary course of a commodity or option dealer's trading in section 1256 contracts and property related to these contracts are included in net earnings from self-employment. In addition, the rules relating to contributions to self-employment retirement plans apply."

For traders:

"Gains and losses from selling securities as part of a trading business are not subject to self-employment tax. This is true whether the [MTM] election is made or not."

I am interpreting this as saying that only dealers (not traders) have to pay self-employment tax. Of course, dealers are able to contribute to retirement plans while traders are not.

But it is still a little unclear. Couldn't "gains and losses from selling securities" refer to securities traders as opposed to commodities traders?

If my understanding is correct (and because I am a short-term trader, not a dealer), then in terms of tax efficiency it is clearly better to trade futures contracts (NQ, ES) rather than securities such as QQQ and SPY.

Please correct me if I am wrong.

Thanks,
Carl