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jgordosea
jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3031
Experience:  I've prepared all types of taxes since 1987.
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Are commissions paid for foreign exchange transactions deductible

Resolved Question:

Are commissions paid for foreign exchange transactions deductible as ordinary income/loss on line 21 of your form 1040 (claiming the income/loss under section 988/1256) or do those commisions have to be separately reported on a schedule D (capital gains/losses)?
Submitted: 1 year ago.
Category: Tax
Expert:  Megan C replied 1 year ago.
Thanks for asking your question! I'm sorry to hear about your tax issue and I'm going to try my best to help you understand or resolve it.

Thank you for your question. Commissions are not deductible as other income on your tax return. Instead, they are added to your cost basis, which will decrease the amount you have to pay in capital gains tax. Add these to your cost basis when you fill out schedule D and you have properly accounted for them.

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Customer: replied 1 year ago.

Thanks for your response, however I think you misinterpreted my question. Your response on commissions pertains to adjusting the cost basis on actual "securities," creating a capital gain or loss that ends up on Schedule D.


 


However, since foreign exchange is NOT considered a "security" in the eyes of IRS (IRC 988, 1256) and thus cannot create capital gains/losses on transactions. Gains/losses on foreign exchange are reported as ordinary income/losses and go on line 21 of form 1040. I am trying to figure out if any costs related to the gains/losses in trading foreign exchange (interest paid or received, commissions, etc...).


 


It's possible too that these foreign exchange commissions are added to my cost basis when transacting; and since I'm adjusting my cost basis on foreign exchange, that would flow into an adjusted gain/loss on line 21 of form 1040 (in effect answering my question)


 


I'm just looking for the citation in the IRC, or a court case precedent or a JKLasser citation, etc... that addresses this specific question of tax treatment of commissions on foreign exchange transactions.


 


Thanks for your time. If this is too specific for you, no worries - please pass on it and I'll try for someone with more expertise in this niche situation.


-D

Expert:  Megan C replied 1 year ago.
I'm opting out to let someone else take a look at this for you. My gut feeling is that this is a line 21 expense, but I cannot find a citation for you so I cannot say with certainty. Someone else will assist you shortly. Thanks.
Customer: replied 1 year ago.

No worries at all; I really appreciate your trying. I'm going to try to end this discussion/transaction without your losing points or hurting your ratings (first time I'm on this site).


 


Thanks again.


-D

Expert:  jgordosea replied 1 year ago.
Greetings,

Another expert here.

Since you are intending to claim ordinary income treatment for the foreign exchange transactions Schedule D (and section 1256 that can allow capital gain treatment when election out of section 988 is made) do not apply.

Also, it was correctly stated that an adjustment to cost basis, as is common with security transactions, does not apply.

Presuming that the foreign exchange transactions are by an individual investor, and not a business, the expenses for production of income is a miscellaneous itemized deduction subject to the 2% of adjusted gross income floor.

Section 212 of Title 26 does this allow the deduction for individuals.
See http://www.law.cornell.edu/uscode/text/26/212
Also see regulation 26CFR1.212-1, for example at http://www.timbertax.org/research/regulations/26cfr1.212-1/

Note that the regulation does specify that section 212 does not apply to expense eligible for deduction under section 162,Trade or business expenses.

For line 21 income, whether hobby income or gambling income or foreign transactions under section 988, the individual's deduction is only allowed as an itemized deduction.

Sorry if that is not the answer you would prefer but inclusion as ordinary income by an individual results in deduction by the individual under section 212.

Please ask if you need clarification.
Thank you.
Customer: replied 1 year ago.

Hi JG - thanks for your response.


 


This is interesting, I hadn't looked at section 212 like this before. Thanks for the specific citation.


 


Let me just give you a little more clarity - but I think we are close to a resolution.


 


This is for myself, an individual. I have a high income for the 2012 tax year and have been taxed at federal, state and local levels and pay AMT where my marginal tax rate is in excess of 40%. I have FX spot losses to report, and intend on reporting those losses on Line 21 of form 1040, and citing IRC 988 as my taxing reference so it can be deducted as an ordinary loss against my existing income, so I can get the benefit of a lower AGI and thus a tax refund come next year.


 


My understanding of your interpretation is that FX commissions are treated differently (as itemized deduction subject to 2% AGI floor under sec 212) than commissions on say stocks (as baked into the cost basis of the capital gains/losses, and input on Schedule D, and limited to a maximum of $3k of capital losses for adjustment to AGI.


 


Your statement here is presented "factually":


 


"For line 21 income, whether hobby income or gambling income or foreign transactions under section 988, the individual's deduction is only allowed as an itemized deduction."


 


Is that quote your own, or from one of your 2 referenced sources? I couldn't find it in there, sorry. With my more specific info, do you still suggest that this is an itemized deduction subj to 2% floor? Seems like that would have AMT implications...


 


Thanks for your response, this has been helpful. Will give you a good mark at the conclusion/your response to my above question.

Expert:  jgordosea replied 1 year ago.
Hello again,

That statement is my own to relate the treatment of other income reported on line 21 of Form 1040 and the related expenses to the foreign exchange transactions. There is not an exception from section 212 and the regulations that allows any other treatment.

Since this is not a capital asset, but other ordinary income, the treatment of the related expenses is the same as the established pattern for other such income. Adjustment to basis is generally for capital assets.

Indeed, there are negative implications to the statutory treatment of individual expenses for the production of income. So, if this is an ongoing item consideration may wish to be given now to using a business entity rather than trading individually for 2013.
For an article and links to more discussion see http://www.greencompany.com/blog/index.php?sectionid=31

As always, please ask if you need more information.
Thank you.



Customer: replied 1 year ago.

I want to thank you again for your time. However I've found the answer to my question in a few Tax Court precedents, that state commissions are in fact to be included as part of the cost-basis:



i'll point you to 2 documents:



IRS memo XXXXXXXXX - page 7 (not IRC law, just opinion from Chief of Branch 5:


"Preliminarily, commissions on the purchase and sale of the currency products are not deductible regardless of whether Taxpayer was a trader in the currency products. Rather, the purchase commissions increase the basis of the contracts; unless Taxpayer was a dealer in the currency products, sales commissions reduce the selling price of the contracts. See Covington v. Commissioner, 120 F.2d 768 (5th Cir. 1941), cert. denied, 315 U.S. 822 (1942); cf. § 1.263(a)-2(e) (commissions on


the purchase and sale of securities)."



COMMISSIONER OF INTERNAL REVENUE v. COVINGTON


120 F.2d 768 (1941)


The regulations of the Treasury Department have consistently provided, that deductions for commissions paid in the purchase and sale of securities by one who is not a dealer, are not deductible as business expenses, that commissions paid on purchases shall constitute a part of the cost of the securities, and commissions paid on sales shall be deducted from the selling price. The courts have applied a similar rule to commissions paid on purchases and sales of property other than securities. It is true that in Article 282, of Treasury Regulation 77, there was inserted the words hereinafter set out in italics: "Commissions paid in selling securities, [ 120 F.2d 771 ]



when such commissions are not an ordinary and necessary business expense, are an offset against the selling price.* * *"



But it is also true that it has been uniformly held that this exception applies only to dealers in securities and that this provision was made and applied where the details of accounting in the dealer's business made it impractical for him to match his selling commissions against each individual sale.



In conclusion:


1. Commissioner vs Covington ruled commissions should be included as a part of cost-basis for buying and selling securities (since they don't qualify as a business expense [since i'm not a business or in business]).


2. These commissions would be included in my cost-basis.


3. Since IRS has allowed FX gains/losses to be reported on line 21 of form 1040 as ordinary income/losses under IRC 988, commissions would be included on any line 21 calculations.


Expert:  jgordosea replied 1 year ago.

Hello again,


Certainly you are the ultimate decision maker of how to report your income and expenses on your individual return.


As to the case Commissioner vs Covington cited, the court gave this reasoning for the decision:"We think, however, that in the ruling allowing the deduction of commissions attributed to sales, the Board was wrong. Neuberger v. Commissioner, 2 Cir.,104 F.2d 649, on which it based this ruling, does indeed so hold. But we are unable to see the distinction as to deductibility which it and the Board following it, draw between commissions on sales and those on purchases. Helvering v. Winmill, 305 U.S. 79, 59 S.Ct. 45, 83 L.Ed. 52, reversing Winmill v. Commissioner, 2 Cir., 93 F.2d 494, holds flatly that commissions on purchases are not deductible as expenses, but must be added to cost. The court in the Neuberger case in holding that its Winmill decision was disapproved in the Supreme Court, only as it related to commissions on purchases and in reaffirming its decision in that case as to commissions on sales, draws, we think, a distinction without a difference."


Both the Commissioner vs Covington case and the case of Helvering v. Winmill, 305 U.S. 79, 59 S.Ct. (which was a basis for the Covington decision) are speaking of sales of securities. We have already discussed the treatment that is still common today of costs of sales and of purchases being part of cost basis on Schedule D sales.


Because these are decisions regarding sales of securities, that makes them distinguishable, to me, from the current reporting allowed by section 988 as other income on line 21. As the current law is written, the language of section 212 of Title 26 remains the authority for investment expenses (not for sales of securities) despite the court decisions cited in favor of deducting costs on the sale of securities.


I hope and trust that my efforts and our discussions have been useful as you decide how to report the income and expenses.

Thank you for the opportunity to be of service.

jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3031
Experience: I've prepared all types of taxes since 1987.
jgordosea and 6 other Tax Specialists are ready to help you
Customer: replied 1 year ago.

As a follow-up to this, I want you to know that I've spoken directly with a CPA at with the firm Green Trader Tax, who specialize in this matter. For my situation, I've been informed that FX losses, when no opted-out of section 988, are deductible against any other income. This includes, commissions paid to enter into those transactions and also any and all interest paid as a result of using leverage. Your suggestion that these commissions are to be deducted on Schedule A, subject to 2% rule appear to be incorrect.

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