Some traders and investors may not have a complete understanding of the way their profits or losses will be taxed and how that impacts profit margin, or capital gains taxes, and how these taxes can impact profit margins. However, traders can implement tax planning strategies to help you mitigate capital gains taxes through a deeper understanding of options trading and the applicable taxes.
In this article, we will break down exactly what tax law changes have occurred between 2024 and 2025 that could impact traders and investors in the United States as well as get specific about how options trading is taxed and the difference between being classified as a "trader" versus an "investor" by the IRS.
What Trading-Related Tax Laws Changed Between 2024 and 2025?
Yes, several tax law changes between 2024 and 2025 could impact traders and investors in the United States. Here's a concise summary of the key updates:
1. Inflation-Adjusted Capital Gains Tax Brackets
For 2025, the IRS has adjusted the income thresholds for long-term capital gains tax rates to account for inflation. The tax rates remain at 0%, 15%, and 20%, but the income limits have increased. For example, single filers can now earn up to $48,350 (previously $47,025) and still qualify for the 0% rate. (IRS Updates Capital Gains Tax Rates for 2025: Here’s What You Need to Know - Paws Calais)
2. Proposed Increase in Capital Gains Tax Rates for High Earners
President Biden's FY 2025 budget proposal suggests raising the top marginal rate on long-term capital gains and qualified dividends to 44.6% for individuals earning over $1 million annually. This proposal is still under consideration and has not been enacted into law.
3. Proposed Closure of the Carried Interest Loophole
The Trump administration has expressed intentions to eliminate the "carried interest" tax loophole, which allows private equity and hedge fund managers to pay lower capital gains tax rates on certain earnings. While this move aligns with broader tax reform efforts, it has not yet been implemented.
4. Introduction of the Capital Gains Inflation Relief Act
Senator Ted Cruz introduced the Capital Gains Inflation Relief Act of 2025, aiming to index the cost basis of capital assets to inflation. This measure would adjust the calculation of capital gains to reflect inflation, potentially reducing tax liabilities for investors. The bill is currently pending in Congress.
5. Ongoing Tax Reform Discussions
Congress is actively working on a new tax package intended to extend provisions from the 2017 Tax Cuts and Jobs Act, including lower tax rates and higher deductions. While lawmakers aim to pass the bill by Memorial Day, most experts believe the process may extend into the second half of 2025.
Note: Many of these changes are proposals and have not yet been enacted into law. It's essential to stay informed about legislative developments and consult with a tax professional to understand how these potential changes may affect your individual situation.
Are Options Trading Losses Tax-Deductible?
"Generally, yes, losses incurred from trading options are considered short-term capital losses depending on the length of time that an options trader holders the option. Accordingly, as a capital loss, traders can only use losses to offset capital gains." -- Attorney Josh Lowenthal
"Losses on options for "investors" are typically treated as capital losses which offset capital gains and up to $3k of other income per year. However, certain option traders may qualify for "trader" status which allows for an election to "mark-to-market" at the end of the year. If this "mark-to-market" election is made, the taxpayer is allowed to classify losses as ordinary losses which can offset any type of income with no limits, be exempted from wash sale rules, but must assume any open position on December 31st are closed." -- Eric Bronnenkant, CPA, CFP at Betterment
What is the IRS Wash Sale Rule? According to Fidelity, options traders must also pay attention to the IRS Wash Sale Rule, which "prohibits selling an investment for a loss and replacing it with the same or a "substantially identical" investment 30 days before or after the sale. If you do have a wash sale, the IRS will not allow you to write off the investment loss which could make your taxes for the year higher than you hoped."
Are Options Trading Profits Taxed?"
In short, yes, unless a Mark-to-Market election is made, options are considered Capital in nature rather than ordinary. As such, any gains in excess of capital losses are going to be taxed at capital gains rates." -- Attorney Josh Lowenthal
"Net profits from options trading are typically subject to capital gains taxes for taxpayer's treated as investors. Most gains are treated as short-term capital gains unless a long options position is held for over 1 year (which would qualify for long-term gains treatment). Short options positions which are short covered or expire worthless have a short-term holding period regardless of how long the contract was open. If the taxpayer qualifies for "trader" status, net trading profits are taxed as ordinary income (after business expenses but exempt from self-employment tax)." -- Eric Bronnenkant, CPA, CFP at Betterment
What are capital gains? Capital gains are generally defined as the profits received from selling a capital asset – or an investment – such as stock market assets or property. The capital gains tax is a form of double taxation, which means after the profits from selling the asset are taxed once; a double tax is imposed on those same profits.
What is a Mark-to-Market election? According to the Tax Advisor, "Under the mark-to-market rules, dealers and eligible traders are treated as having sold all their securities on the last day of the tax year at their fair market value (FMV), causing gain or loss to be taken into account for the year."
How can I be classified as a Trader by the IRS instead of an Investor?
According to Mr. Bronnenkant, "If an investor is trying to evaluate whether they meet the requirements for "trader" status and the "mark-to-market" election, they should seek out a tax advisor who has significant experience with active trading clients. The IRS does not have a bright line test but the more factors in the taxpayer's favor, the more likely it is that they can qualify. Making these elections always comes with the risk that the IRS may disagree with their position and reclassify the taxpayer back to "investor" status (losing ordinary loss treatment , losing deduction for trading expenses, and bringing back the wash sale rules). The IRS states that the "following facts and circumstances should be considered in determining if your activity is a securities trading business:
1. Typical holding periods for securities bought and sold;
2. The frequency and dollar amount of your trades during the year;
3. The extent to which you pursue the activity to produce income for a livelihood; and
4. The amount of time you devote to the activity."
Still confused? An expert can pull it all together for us!
Let's start with Ryan Flanders CFA, Chief Investment Officer of The Flanders Group. Ryan says, "Trading options are considered
the same as trading any other security and fall under the same IRC tax
code. For this analysis, we will assume options are being bought and sold
as a trading mechanism, rather than with the intention of allowing them to be
exercised (as they are designed).
As with any other security, a
trader may use short term-losses to offset short-term gains and long-term
losses to offset long-term gains. After that step, you will then
reconcile short-term gain/loss with long-term gain/loss to determine whether
you benefit from capital gain tax treatment (long-term) or if its taxed as
ordinary income (short-term). Keep in mind options gains and losses are
combined with all other capital assets, so you must account for all securities
together to determine your gains and losses (including stocks, bonds,
crypto, etc.).
Most of the time options are considered to be
short-term rather than long-term as you must hold the contract for longer than
365 days for it to be considered a long-term gain/loss. Another item that
often trips up option traders is the IRS wash sale rule, which disallows a loss
if you sell and then repurchase a "substantially-identical"
investments 30 days before or after the sale. Often traders will try to
"scalp" the same expiry and strike throughout the day, which can trip
up the wash-sale rule and disallow any potential losses that had accumulated
from that position."
We spoke with Stuart Weichsel, a partner at Gallet Dreyer & Berkey. According to Weichsel, "Cash settled equity options are subject to simple rules, with many complex exceptions. When options are exercised through the purchase or sale of the underlying security (instead of closed out), the option transaction and the underlying purchase or sale are integrated. Some options are subject to the special Sec. 1256 mark-to-market rules.
All options are subject to the Sec. 1292 straddle rules--preventing a taxpayer from entering into offsetting option transactions and recognizing only the “loss leg” of the positions in the first tax year to maximize tax losses while leaving unrealized gains. (There is an exception to the Sec. 1292 rules for a taxpayer issuing a “covered call.” The close out of the call at a loss is not suspended despite the offsetting gain on the covered stock).
Finally, the Sec. 1259 Constructive Sale rules may apply if the equity options are used to limit risk in an appreciated position, engaging in a “constructive sale.” Using options to enter into a constructive sale may cause the realization (and taxation) of the otherwise unrealized gain on the appreciated position."