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. If that’s you, listen up.
Let’s set the scene. It’s the middle of February and you’re looking over your 1099. Right there, on your 1099-B, you spot options information! Shocked? The new info 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 option trading reporting easy and straightforward. So, now that the information you need is readily available, let’s dive into some of the reporting demands.
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 tax reporting look like?
Scenario 1: Buy Long, Then Sell
Let’s say you bought an XYZ July 17 2015 @ 92.5 put option contract for $5.30 on September 24, 2014. By the beginning of February, 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 short.
Scenario 2: Sell Short, Then Buy to Cover
Go ahead you traders who can deal with the risk (you know who you are), sell the XYZ contract short 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 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|
|purchase a call||the right to buy||exercised,||cost basis of shares purchased||the strike price plus the premium you paid for the contract (+/- transaction costs).|
|purchase a put||the right to sell||exercised,||proceeds from the sale of shares||the strike price minus the premium you paid for the contract (+/- transaction costs). |
|sell a call||the obligation to sell||assigned,||proceeds from the sale of shares||the strike price plus the premium you received for the contract (+/- transaction costs).|
|sell a put||the obligation to buy||assigned,||cost basis of shares purchased||the strike price minus the premium you received for the contract (+/- transaction costs). |
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? Let’s say you bought an XYZ July 17 2015 @ $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.
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