Tax Implications of Options Trading

The bottom line: The IRS treats options differently than stocks, and if you don’t understand these rules, you’re going to pay way more than you should. Worse, you could accidentally fuck up your taxes and face penalties. This isn’t optional knowledge. This is “protect your money from the government” knowledge.

Options taxes aren’t intuitive. You can be right about direction, make money on your trades, and still get destroyed at tax time if you don’t understand how equity options vs index options are taxed, what the wash sale rule does to your losses, and how multi-leg strategies complicate everything.

This guide breaks down exactly how the IRS taxes your options trades, what mistakes cost traders thousands every year, and how to structure your trading to keep more of what you earn.

Let’s make sure the tax man doesn’t take more than his fair share.

Why Options Taxes Are Different (And More Complicated)

If you’re coming from stock trading, forget what you know. Options tax rules are their own beast.

Here’s why options taxes are more complex than stock taxes:

1. Not all options are taxed the same way

The IRS splits options into two categories: equity options (options on stocks and equity ETFs) and non-equity options (options on indexes, commodities, and futures). These are taxed completely differently.

With equity options, you’re taxed based on how long you held the position (short-term vs long-term capital gains). With non-equity options (called Section 1256 contracts), the IRS uses a 60/40 split regardless of holding period.

2. Your holding period resets in weird ways

When you exercise an option, the premium you paid gets added to your cost basis in the stock. When you sell an option, the premium you received might change how your stock sale is taxed. The holding period rules are not straightforward.

3. Multi-leg strategies have special rules

Iron condors, spreads, straddles, butterflies – the IRS groups most of these as “straddles” and applies loss deferral rules. You can’t always claim losses on one leg while the other leg is still open.

4. The wash sale rule destroys your losses

Sell an option at a loss and buy back the same (or “substantially identical”) option within 30 days? Loss disallowed. And brokers often fuck up wash sale reporting on options, so you can’t just trust your 1099.

5. Expiration creates tax events

When an option expires worthless, that’s a taxable event. When you hold certain options past December 31, the IRS makes you “mark to market” and report unrealized gains or losses. These rules don’t exist with stocks.

The government wants its cut of your profits. And if you don’t report correctly, they want penalties on top.

The Two Types of Options: Equity vs Non-Equity

The first thing you need to understand: The IRS doesn’t care about calls vs puts. It cares about what the option is ON.

Equity Options (Stock Options and Equity ETFs)

What they are:

  • Options on individual stocks (AAPL, TSLA, MSFT calls/puts)
  • Options on ETFs that hold stocks (SPY, QQQ, IWM)

How they’re taxed:

Your gains and losses are taxed based on how long you held the position:

Short-term capital gains (held 1 year or less):

  • Taxed as ordinary income at your regular tax bracket
  • Could be as high as 37% federal + state taxes
  • Most options traders fall into this category because options expire quickly

Long-term capital gains (held more than 1 year):

  • Taxed at preferential rates: 0%, 15%, or 20% depending on income
  • Rare in options trading unless you’re trading LEAPS and holding over a year

The reality: 99% of equity options trades are short-term because most options expire in weeks or months, not years. So you’re paying ordinary income rates on your gains.

Example:

You buy an AAPL $150 call for $5.00 and sell it three weeks later for $8.00. You made $300 profit ($3 x 100 shares).

  • Holding period: Less than a year
  • Tax treatment: Short-term capital gain
  • Tax rate: Your ordinary income tax rate (let’s say 24%)
  • Taxes owed: $72 (24% of $300)

Non-Equity Options (Section 1256 Contracts)

What they are:

  • Options on broad-based indexes (SPX, NDX, RUT)
  • Options on futures (ES, NQ, CL)
  • Options on commodities
  • Options on foreign currencies

How they’re taxed:

The IRS uses what’s called the 60/40 rule:

  • 60% of your gain or loss is taxed at long-term capital gains rates
  • 40% of your gain or loss is taxed at short-term capital gains rates

This applies NO MATTER HOW LONG YOU HOLD THE POSITION.

Hold an SPX call for one day? 60/40 split.
Hold an SPX call for six months? 60/40 split.
Doesn’t matter.

Why this is usually better:

Since 60% is taxed at long-term rates (max 20%) instead of ordinary income rates (up to 37%), you pay less tax on the same gain.

Example:

You trade SPX options and make $10,000 in profit over the year.

With 60/40 treatment:

  • $6,000 taxed at 20% (long-term rate) = $1,200
  • $4,000 taxed at 37% (short-term/ordinary rate) = $1,480
  • Total tax: $2,680

If it was equity options (all short-term):

  • $10,000 taxed at 37% = $3,700
  • Total tax: $3,700

Tax savings with Section 1256: $1,020 on the same $10,000 gain.

This is why a lot of active traders prefer trading SPX options over SPY options. Same exposure to the S&P 500, but better tax treatment.

The Confusing Part: Index ETFs

Here’s where it gets messy. SPX (the index itself) is a Section 1256 contract. But SPY (the ETF that tracks the S&P 500) is NOT.

Section 1256 (60/40 tax treatment):

  • SPX, NDX, RUT (actual indexes)
  • ES, NQ (futures)

NOT Section 1256 (normal equity option treatment):

  • SPY, QQQ, IWM (ETFs)
  • Individual stocks

The IRS hasn’t provided crystal clear guidance on every single index-based ETF, so consult a tax pro if you’re trading exotic stuff.

How Different Option Transactions Are Taxed

Let’s break down the specific tax treatment for each type of options transaction.

Buying Options (Long Calls/Puts)

What happens when you BUY an option:

You pay a premium. That’s your cost basis.

Three possible outcomes:

1. You sell the option for a profit

  • Gain = Sale price – Purchase price
  • Taxed as short-term or long-term capital gain depending on holding period (or 60/40 if Section 1256)

2. You sell the option for a loss

  • Loss = Purchase price – Sale price
  • Capital loss that can offset gains (subject to wash sale rule)

3. The option expires worthless

  • Loss = Full premium paid
  • Capital loss, deductible on Schedule D
  • Loss is recognized on the expiration date

Example 1 – Profitable trade:

You buy a $50 call for $2.00 premium ($200 total). You sell it later for $4.00 ($400 total).

  • Gain: $200
  • Tax treatment: Short-term capital gain (if held under a year)
  • Reported on: Schedule D, Form 8949

Example 2 – Worthless expiration:

You buy a $100 put for $3.00 premium ($300 total). It expires worthless.

  • Loss: $300
  • Tax treatment: Short-term capital loss
  • Deductible: Yes (up to $3,000 per year against ordinary income if you have more losses than gains)

Selling Options (Short Calls/Puts)

What happens when you SELL an option:

You receive a premium. That’s initially treated as a “short sale” – you have an open obligation.

Three possible outcomes:

1. The option expires worthless (you keep the premium)

  • Gain = Full premium received
  • Taxed as short-term capital gain
  • Recognized on expiration date

2. You buy back the option to close

  • Gain/Loss = Premium received – Buyback cost
  • Always treated as short-term (even if open more than a year)

3. The option is exercised/assigned

  • Premium is added to your stock basis (calls) or reduces proceeds (puts)
  • Not a separate taxable event – gets factored into stock transaction

Example 1 – Option expires worthless:

You sell a $45 put for $1.50 premium ($150 received). It expires worthless.

  • Gain: $150
  • Tax treatment: Short-term capital gain
  • Date recognized: Expiration date

Example 2 – Buying back to close:

You sell a $60 call for $3.00 premium ($300 received). You buy it back later for $1.00 ($100 paid).

  • Gain: $200 ($300 – $100)
  • Tax treatment: Short-term capital gain
  • Reported on: Schedule D

Important rule: When you sell options and buy them back to close, it’s ALWAYS short-term, even if you held the position open for more than a year. The IRS doesn’t care how long it was open when you close by buying it back.

Exercising Options

When you exercise an option (or get assigned), the option premium affects the cost basis of the stock, but it’s NOT a separate taxable event at that moment.

If you exercise a CALL (you’re buying stock):

  • Cost basis = Strike price + Premium paid
  • Holding period for the stock starts on the day you exercise (NOT when you bought the call)

Example:

You buy a $100 call for $5.00 premium. You exercise it and receive 100 shares.

  • Stock cost basis: $105 per share ($100 strike + $5 premium)
  • When you sell the stock: That’s when you report the gain/loss
  • Stock holding period: Starts the day you exercised

If you exercise a PUT (you’re selling stock):

  • Proceeds from stock sale = Strike price – Premium paid
  • This reduces your gain or increases your loss on the stock

Example:

You own 100 shares with a cost basis of $90. You buy a $95 put for $2.00 and exercise it.

  • Stock sale proceeds: $93 per share ($95 strike – $2 premium)
  • Gain per share: $3 ($93 proceeds – $90 basis)
  • Total gain: $300 (taxed based on how long you held the STOCK)

If you’re ASSIGNED on a short call:

  • Stock sale proceeds = Strike price + Premium received

If you’re ASSIGNED on a short put:

  • Stock cost basis = Strike price – Premium received

The key: Premiums get folded into stock basis, and the tax event happens when you sell the stock, not when the option is exercised.

The Wash Sale Rule: Your Worst Tax Enemy

This is where traders get absolutely destroyed.

The wash sale rule says: If you sell a security (including options) at a loss, and you buy back the “same or substantially identical” security within 30 days before or after the sale, you cannot deduct the loss.

The loss isn’t gone forever – it gets added to the cost basis of the new position. But you can’t use it to offset gains in the current tax year.

Why this matters in options: Most options traders are actively trading the same underlyings repeatedly. If you’re not careful, you’re creating wash sales constantly without realizing it.

What Triggers a Wash Sale with Options

The 61-day window: 30 days before + the sale date + 30 days after = 61-day period where you can’t repurchase.

What counts as “substantially identical”:

The IRS hasn’t provided perfect clarity, but here’s what we know:

Definitely a wash sale:

  • Sell a $100 call (June expiry) at a loss
  • Buy a $100 call (June expiry) within 30 days
  • Same strike, same expiration = wash sale

Probably NOT a wash sale:

  • Sell a $100 call at a loss
  • Buy a $105 call (different strike)
  • Different strike price = likely NOT substantially identical

Gray area:

  • Sell a $100 call (June) at a loss
  • Buy a $100 call (July) within 30 days
  • Same strike, different expiration = IRS hasn’t given clear guidance

Definitely a wash sale:

  • Sell a call option on XYZ at a loss
  • Buy XYZ stock within 30 days
  • Option and underlying stock ARE substantially identical

NOT a wash sale:

  • Sell a call option at a loss
  • Buy a put option (even same strike/expiration)
  • Calls and puts move opposite directions, so NOT identical

Real-World Wash Sale Scenarios

Scenario 1: The serial options trader

Monday: You buy a TSLA $250 call, sell it Friday at a loss ($500 loss).
Next Monday: You buy another TSLA $250 call.

Result: Wash sale. Your $500 loss is disallowed. It gets added to the cost basis of your new call.

How to avoid: Wait 31 days before buying the same TSLA $250 call. Or buy a different strike ($255 call) if you must stay in the position.

Scenario 2: The “I’ll just switch strikes” mistake

You sell a $100 call at a $400 loss. You immediately buy a $105 call.

Result: Probably safe. Different strikes are generally not considered “substantially identical.” But there’s some IRS gray area here if the strikes are very close.

Safer bet: Make sure strikes are at least $5 apart, or wait the 30 days.

Scenario 3: The cross-account disaster

You sell options at a loss in your Robinhood account. You buy the same options in your TastyTrade account within 30 days.

Result: WASH SALE. The wash sale rule applies across ALL your accounts – taxable accounts, IRAs, your spouse’s accounts, everything.

Most brokers don’t catch this. They only track wash sales within the same brokerage account. It’s on YOU to track wash sales across accounts.

Scenario 4: The stock/option trap

You sell AAPL stock at a $1,000 loss. Within 30 days, you buy AAPL call options.

Result: Wash sale. Stock and options on the same underlying are considered substantially identical.

How Brokers Report Wash Sales (And Why You Can’t Trust Them)

Your broker will report wash sales on your 1099-B. They’re required to track wash sales on identical securities within the same account.

The problem:

  1. They don’t track wash sales across your other brokerage accounts
  2. They don’t track wash sales between your accounts and your spouse’s accounts
  3. They don’t track wash sales between taxable and IRA accounts
  4. They often fuck up the “substantially identical” determination on options

Multiple traders report brokers incorrectly flagging options with different strikes or expirations as wash sales. Others report brokers missing obvious wash sales.

Your responsibility: Review every wash sale on your 1099. If your broker flagged something incorrectly, you need to correct it on your tax return (and document why). If your broker missed a wash sale, you’re required to report it.

How to Avoid Wash Sales

Strategy 1: The 31-day wait

Simplest approach: After taking a loss, wait 31 calendar days before repurchasing the same security.

Mark your calendar. Set a reminder. Don’t trade that ticker for 31 days.

Strategy 2: Change strikes significantly

If you must stay in the position, change strike prices by at least $5-10 (depends on stock price). A $100 call and a $110 call are probably different enough.

Strategy 3: Change expirations

Sell June calls at a loss, buy September calls instead. Different expiration dates add another layer of distinction.

Strategy 4: Switch to puts (opposite direction)

Sell calls at a loss? Buy puts instead. They’re inverse positions, so not substantially identical.

Not the same directional thesis, but it’s a legal workaround if you think the stock could move either way.

Strategy 5: Trade correlated but different tickers

Instead of rebuying SPY calls after a loss, buy QQQ calls. Both are market exposure, but different securities = no wash sale.

Strategy 6: Mark-to-market election (advanced)

Professional traders can elect “mark-to-market” accounting (IRS Form 3115), which exempts them from wash sale rules. But this has big implications – talk to a tax pro before considering this.

Multi-Leg Strategies: Straddle Rules and Loss Deferrals

If you trade spreads, iron condors, straddles, or any multi-leg strategy, congratulations: You’ve entered advanced tax hell.

The IRS groups most multi-leg strategies together and calls them “straddles.”

A straddle (for tax purposes) occurs when: You hold positions that offset or substantially reduce risk to each other.

Examples:

  • Long call + Long put (actual straddle)
  • Bull call spread
  • Iron condor
  • Any strategy with multiple legs that hedge each other

The tax impact: Loss deferral rule

You cannot deduct losses on one leg of a straddle if you have unrealized gains on the other leg.

Here’s how it works:

You have a bull call spread:

  • Long $100 call: Down $1,000 (closed at a loss)
  • Short $105 call: Up $800 (still open)

At year-end, you closed the long call at a $1,000 loss. But you still have an $800 unrealized gain on the short call.

Normal treatment: You’d deduct the $1,000 loss.

Straddle treatment: You can only deduct $200 of the loss this year ($1,000 loss minus $800 unrealized gain). The remaining $800 loss is deferred until you close the other leg.

Why this rule exists: The IRS doesn’t want you cherry-picking losses to deduct while holding offsetting gains to defer into next year.

Qualified Covered Calls: The Exception

Covered calls have special treatment if they meet certain requirements:

To be a “Qualified Covered Call”:

  • Expiration must be more than 30 days out
  • Strike price can’t be “deep in the money”
  • Must be on stock you already own

If qualified: The covered call is NOT treated as a straddle. You can deduct losses normally.

If NOT qualified (unqualified covered call): It’s treated as a straddle, and loss deferral rules apply.

Example of qualified covered call:

You own 100 shares of XYZ stock (bought at $95). You sell a $100 call with 60 days to expiration.

  • Strike is above purchase price (not deep ITM)
  • More than 30 days to expiration
  • Result: Qualified covered call, normal tax treatment

Example of unqualified covered call:

You own 100 shares of XYZ stock trading at $100. You sell a $95 call (deep in the money) with 20 days to expiration.

  • Strike is below current price (deep ITM)
  • Less than 30 days to expiration
  • Result: Unqualified, subject to straddle rules

Why you care: If your covered call is unqualified and you take a loss on the stock, that loss might be deferred due to unrealized gains on the short call.

Section 1256 Straddles

Good news: If your straddle consists entirely of Section 1256 options (like SPX options), the loss deferral rule does NOT apply.

You can trade iron condors on SPX all day and not worry about straddle tax rules. This is another reason professional traders often prefer index options.

Mark-to-Market Rule for Section 1256 Contracts

If you hold Section 1256 options (SPX, NDX, futures options) through December 31, the IRS requires you to “mark to market.”

What this means:

On December 31, you’re treated as if you sold all Section 1256 positions at their fair market value, even though you didn’t actually sell.

You report unrealized gains or losses for the current tax year. Then your cost basis resets for the new year.

Example:

You buy an SPX call in November for $5,000. On December 31, it’s worth $7,000. You’re still holding it.

  • For 2025 taxes: You report a $2,000 gain (60/40 treatment)
  • New basis for 2026: $7,000

If the call drops to $6,000 in January 2026 and you sell, you report a $1,000 loss for 2026.

Why this matters: You might owe taxes on unrealized gains. If you’re holding big winners into the new year on Section 1256 contracts, you’re creating a tax liability even if you haven’t sold.

Planning tip: If you have big unrealized gains on SPX or other Section 1256 contracts near year-end, consider closing before December 31 and reopening in January if you want to avoid reporting unrealized gains.

Capital Loss Limitations

This applies to all capital gains/losses, not just options, but it’s critical to understand.

If you have more capital losses than gains:

You can deduct up to $3,000 per year of net capital losses against your ordinary income (salary, business income, etc.).

Any losses beyond $3,000 carry forward to future years.

Example:

You made $20,000 on some trades and lost $28,000 on others. Net loss: $8,000.

  • This year: Deduct $3,000 against ordinary income
  • Carry forward: $5,000 to next year

Why this matters: If you blow up your account with a $50,000 loss, you can only deduct $3,000 per year. It’ll take you 17 years to fully deduct that loss.

This is why risk management isn’t just about protecting your capital – it’s about protecting your tax benefits too. A massive loss in one year might not be fully deductible for decades.

Trader Tax Status (TTS): The Pro Designation

If options trading is your actual business (not a side hobby), you might qualify for Trader Tax Status.

Benefits of TTS:

  1. Deduct business expenses: Office space, computers, data subscriptions, education
  2. Avoid capital loss limitations: Losses treated as ordinary business losses (no $3,000 cap)
  3. Mark-to-market election: Avoid wash sale rules entirely

Requirements (according to IRS):

  • Substantial trading activity: Hundreds or thousands of trades per year
  • Trading is your primary activity: Not a side gig; you’re trying to profit from short-term price movements
  • Regularity and continuity: Trading almost every market day
  • Time commitment: Spending several hours per day trading

What doesn’t count:

  • Occasional trading while working a full-time job
  • Long-term buy-and-hold investors
  • People who trade a few times per month

The reality: Qualifying for TTS is hard, and the IRS scrutinizes it. You need documentation proving trading is your main business activity.

If you think you qualify, consult a CPA who specializes in trader taxes. Green Trader Tax and Trader Tax CPA are firms that focus on this.

Common Tax Mistakes (And How They Cost You)

Mistake 1: Not Tracking Wash Sales Across Accounts

Your broker only tracks wash sales within one account. If you trade at multiple brokers, or if your spouse trades, you must manually identify wash sales.

The cost: You deduct losses you’re not entitled to, then get audited and owe back taxes + penalties.

The fix: Use tracking software (TradeLog, GainsKeeper) or maintain a detailed spreadsheet of all trades across all accounts.

Mistake 2: Trusting Your 1099 Blindly

Brokers make mistakes on wash sales, especially with options. They might flag trades that aren’t wash sales, or miss trades that are.

The cost: Overpaying taxes or underpaying and facing penalties.

The fix: Review every wash sale flag on your 1099. If incorrect, file Form 8949 with an adjustment and keep documentation.

Mistake 3: Not Reporting Expired Options

When an option expires worthless, that’s a taxable event. Some traders forget to report it.

The cost: IRS might catch the missing transaction and assess penalties.

The fix: Make sure every expired option appears on Schedule D as a sale with proceeds of $0.

Mistake 4: Claiming Long-Term Gains on Short Option Buybacks

You sell a call option and hold it open for 13 months. You buy it back to close. You think it’s long-term.

Wrong. Closing by buying back is ALWAYS short-term, no matter how long it was open.

The cost: Reporting incorrect tax treatment and potentially getting audged.

The fix: Any option you close by repurchase is short-term. Period.

Mistake 5: Missing Section 1256 Benefits

You trade SPY options all year and pay ordinary income rates. You could have traded SPX options and paid 60/40 rates on the same trades.

The cost: Thousands of dollars in unnecessary taxes.

The fix: If you’re an active trader, consider switching to Section 1256 contracts for tax efficiency.

Mistake 6: Violating Wash Sales Without Realizing

You sell AAPL options at a loss, then buy AAPL stock 10 days later. Wash sale. You sell AAPL in your Robinhood account at a loss, buy AAPL in your IRA 15 days later. Wash sale.

The cost: Disallowed losses you thought you could deduct.

The fix: Track every purchase within 30 days of every loss, across all accounts.

How to Actually Report Options on Your Tax Return

Let’s get practical. Here’s what you need to file.

Forms You’ll Receive

Form 1099-B (Proceeds from Broker Transactions)

Your broker sends this by mid-February. It lists every options trade you made:

  • Date acquired
  • Date sold
  • Proceeds (sale price)
  • Cost basis (purchase price)
  • Short-term or long-term
  • Wash sale adjustments (if any)

Form 1099-MISC (Miscellaneous Income)

If you received any bonus payments or promotions from your broker, this reports it.

Forms You’ll File

Schedule D (Capital Gains and Losses)

This is the summary form that shows your total capital gains/losses from all sources.

Form 8949 (Sales and Other Dispositions of Capital Assets)

This is where you list every single transaction. Your 1099-B data goes here.

  • Part I: Short-term transactions
  • Part II: Long-term transactions

You can check a box indicating “Reported on 1099-B” so you don’t have to manually type every trade if your broker reported it correctly.

If you have wash sales to correct or other adjustments:

  • List the transaction
  • Show the amount from 1099-B
  • Show your adjustment in column (g)
  • Explain with a code (like “W” for wash sale adjustment)

Section 1256 Contracts Reporting

If you traded SPX, futures options, or other Section 1256 contracts, you also file:

Form 6781 (Gains and Losses from Section 1256 Contracts and Straddles)

  • Part I: Section 1256 contracts (your SPX trades)
  • This form calculates the 60/40 split automatically
  • The result flows to Schedule D

Record Keeping Requirements

What you need to keep:

  • Brokerage statements for every trade
  • Documentation of exercise/assignment
  • Wash sale tracking spreadsheet (if trading across multiple accounts)
  • Records showing your basis adjustments
  • Any correspondence with your broker about incorrect 1099s

How long to keep records: At least 7 years from the date you file your return. The IRS can audit you for 3 years normally, or 7 years if they suspect fraud or substantial underreporting.

Tax Planning Strategies for Options Traders

Once you understand the rules, you can structure your trading to minimize taxes.

Strategy 1: Harvest Losses Before December 31

If you have losing positions near year-end, close them before December 31 to lock in losses you can use to offset gains.

But watch out: Don’t create wash sales by buying back the same position in January.

Strategy 2: Defer Gains Into Next Year

If you have big winners near year-end and you want to defer the tax, hold them past December 31.

Exception: Section 1256 contracts are marked to market on Dec 31, so this doesn’t work for SPX/futures options.

Strategy 3: Use Section 1256 Options for Active Trading

If you’re trading frequently, consider SPX instead of SPY. Same market exposure, better tax treatment.

The math:

  • If you make $100,000 trading SPY options: Taxed at 37% ordinary income = $37,000 tax
  • If you make $100,000 trading SPX options: 60/40 split ≈ $28,000 tax
  • Tax savings: $9,000

Over years, this compounds significantly.

Strategy 4: Offset Gains with Losses

If you have $50,000 in gains from winning trades, look for losing positions you can close to offset those gains and reduce your tax bill.

Don’t let the tax tail wag the investment dog – don’t close good positions just to save taxes. But if you have dead positions worth closing anyway, do it before year-end.

Strategy 5: Spread Gains Across Years

If you have a monster winner (like a 10-bagger), consider selling half this year and half next year to spread the tax liability across two years instead of one big hit.

Only works if you’re not in a hurry to exit and the position still has value.

Strategy 6: Keep Detailed Records From Day One

Don’t wait until tax time to organize. Track trades weekly using software like:

  • TradeLog
  • GainsKeeper
  • TaxR.ai (for wash sale analysis)
  • Your brokerage’s tax tools

This makes filing easier and catches wash sales/errors before they become audit issues.

Working with a Tax Professional

When you absolutely need a CPA:

  • You trade full-time and want to qualify for Trader Tax Status
  • You have six-figure gains/losses
  • You trade across multiple accounts or with a spouse
  • You trade complicated multi-leg strategies regularly
  • You think your broker made errors on your 1099
  • You’re being audited

How to find a good options trading CPA:

Most tax preparers don’t understand options. You need someone who specializes in trader taxes.

Firms that specialize in trader taxes:

  • Green Trader Tax
  • Trader Tax CPA
  • Compute My Trade (Canada)

Cost: Expect to pay $500-$2,500+ depending on complexity. Worth it if you’re making serious money.

What to ask a potential CPA:

  • “How many options traders do you work with?”
  • “Do you understand Section 1256 contracts and wash sales?”
  • “Can you help me qualify for Trader Tax Status?”

If they look confused, they’re not the right CPA.

Special Situations and Edge Cases

Prop Firm Funded Accounts

If you’re trading through a prop firm (Topstep, Apex, etc.), tax treatment depends on your payout structure.

If you’re classified as an independent contractor:

  • You receive a 1099-NEC (non-employee compensation)
  • Your payouts are treated as self-employment income, not capital gains
  • You pay self-employment tax (15.3%) on top of income tax
  • But you can deduct business expenses

If you receive profit splits:

  • Usually still 1099-NEC
  • Not capital gains treatment

The downside: You’re paying self-employment tax on trading profits, which can be 15%+ higher than capital gains treatment.

The upside: You can deduct your evaluation fees, software, data subscriptions, and home office as business expenses.

Options in IRAs

If you trade options in an IRA (traditional or Roth), different rules apply.

Good news:

  • No capital gains taxes while trading inside the IRA
  • No wash sale rules inside the IRA

Bad news:

  • Losses inside an IRA don’t offset gains
  • Wash sales can occur BETWEEN your taxable account and IRA (if you sell at a loss in taxable and buy in IRA within 30 days)

Traditional IRA: Gains are taxed as ordinary income when you withdraw in retirement (no capital gains treatment)

Roth IRA: Gains are tax-free if you withdraw after 59.5 and account is 5+ years old

Employee Stock Options (ESOs)

This guide focused on tradable options, but if you have employee stock options (ISOs or NSOs), completely different rules apply.

  • ISOs can trigger Alternative Minimum Tax (AMT)
  • NSOs are taxed as ordinary income on exercise
  • These are complex enough to warrant their own guide – consult a tax pro

Red Flags That Attract IRS Attention

What makes the IRS look closer at your return:

  1. Large capital losses with no gains: If you claim $50,000+ in losses and no gains, they wonder if you’re accurately reporting or just gambling
  2. Trader Tax Status claims: TTS is heavily scrutinized; you need bulletproof documentation
  3. Wash sale corrections: If you adjust your 1099-B significantly, IRS wants to see why
  4. Day trading from an IRA: This can trigger “Unrelated Business Income Tax” in some cases
  5. Pattern day trading income reported incorrectly: If you’re making money day trading, it should look like trading income, not sporadic gains

How to avoid problems:

  • Report everything accurately
  • Keep detailed records
  • Be conservative on gray areas
  • Have a tax pro review if you’re in a complex situation

Tools and Resources for Options Tax Tracking

Trade Tracking Software:

TradeLog – Comprehensive trade tracking, wash sale identification, automatically imports from most brokers. Good for active traders. ($299-$499/year)

GainsKeeper (part of TurboTax) – Integrated tax tracking, handles complex situations, wash sale tracking. ($49-$99)

TaxR.ai – New AI-powered tool specifically for identifying wash sales on options trades. Multiple users report it caught broker errors. Worth trying if you have complex option wash sale issues.

IRS Resources:

Publication 550 (Investment Income and Expenses) – The bible for options taxation. Covers everything in excruciating detail.

Topic 427 (Stock Options) – Basic overview of employee and investor options taxation.

Form 1040 Instructions, Schedule D – How to actually fill out your tax forms.

Professional Help:

Green Trader Tax – Specializes in active trader and professional trader taxes. Experienced with options.

Trader Tax CPA – Another firm focused exclusively on trader taxes.

Your broker’s tax center: Most brokers (Schwab, TastyTrade, E*TRADE) have tax resources and guides specific to their platform.

The Bottom Line: Protect Your Profits

Here’s what every options trader needs to know about taxes:

The essentials:

  1. Know your options type – Equity options (stock/ETFs) vs Section 1256 (indexes/futures) are taxed differently
  2. Understand the 60/40 advantage – SPX and other Section 1256 contracts save you money on taxes vs SPY
  3. Watch the wash sale rule – Don’t sell at a loss and repurchase the same option within 30 days, and track across all accounts
  4. Multi-leg strategies create straddles – Loss deferral rules apply; you can’t always claim losses immediately
  5. Mark-to-market matters – Section 1256 contracts are taxed on unrealized gains at year-end
  6. Capital losses are limited – Only $3,000 per year deductible against ordinary income
  7. Keep detailed records – Track every trade, wash sale, and adjustment across all accounts
  8. Consider Trader Tax Status – If trading is your business, TTS offers major benefits
  9. Use a CPA if complex – Options tax rules are complicated; mistakes cost money
  10. Plan for taxes year-round – Don’t wait until April to think about this

The harsh reality: The IRS gets their cut one way or another. Your job is to structure your trading so they get the legal minimum, not a penny more.

Learn these rules. Follow them. And keep more of what you earn.

Most traders spend hundreds of hours learning strategies and zero hours learning taxes. Then they give away 30-40% of their profits unnecessarily.

Don’t be that trader.

Further Reading

Want to dive deeper into options and trading?

Questions about options taxes? Consult IRS Publication 550 or talk to a CPA who specializes in trader taxes. This guide is educational, not tax advice.