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Day3 Session 2APaul

This document summarizes the key taxation rules for various options positions: - Gains and losses from long calls, long puts, short calls, and short puts are treated as capital gains and losses upon closing the position or expiration. - Section 1256 contracts like broad-based index options are treated as 60% long-term and 40% short-term capital gains regardless of holding period. - The "tax straddle" rules apply to offsetting positions and can defer losses, impact holding periods, and require capitalization of carrying charges. - New tax rates for 2013 include higher rates for long-term capital gains and qualified dividends as well as a new 3.8% Medicare tax

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Lameune
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Download as PDF, TXT or read online on Scribd
33 views

Day3 Session 2APaul

This document summarizes the key taxation rules for various options positions: - Gains and losses from long calls, long puts, short calls, and short puts are treated as capital gains and losses upon closing the position or expiration. - Section 1256 contracts like broad-based index options are treated as 60% long-term and 40% short-term capital gains regardless of holding period. - The "tax straddle" rules apply to offsetting positions and can defer losses, impact holding periods, and require capitalization of carrying charges. - New tax rates for 2013 include higher rates for long-term capital gains and qualified dividends as well as a new 3.8% Medicare tax

Uploaded by

Lameune
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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CBOE Risk Management Conference

What Everyone Needs to Know


About Listed Options Taxation
William Paul, Covington & Burling LLP
March 5, 2013

Taxation of One-Sided Equity
Options Positions
Long call
Gain/loss on closing transaction is capital gain/loss
Same for loss on expry
Long-term capital gain/loss if hold > 1 year
If exercise, premium added to cost basis of stock
Long put
Same for gain/loss on closing transaction or expry
If exercise, put premium reduces proceeds from sale of stock
Wash Sale Rules apply
Rolls OK
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Taxation of One-Sided Equity
Options Positions
Short call
Gain/loss on closing transactions is capital gain/loss
Same for gain on expry
Always short-term capital gain/loss
If assigned, call premium added to proceeds from sale of stock
Short put
Same for gain/loss on closing transaction or expry
If assigned, premium reduces cost basis of the stock
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Taxation of One-Sided Equity
Options Positions
Exercise and Assignment
If exercise call or assigned on short put, holding
period in stock does not include the period the
option was open
If assigned on short call or exercise put, the
premium adjusts gain/loss on the stock and the
gain/loss will be long-term if stock held >1 year.
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Section 1256 Contracts
Listed options on broad-based indexes, large basket of
stocks, and non-equity underliers
Gain/loss is 60% long-term capital gain, 40% short-term
capital gain/loss regardless of holding period
Open positions are marked to market at end of year
Options on ETFs are generally not 1256 contracts
For options market-makers, listed equity options are
also 1256 contracts
Does not apply to OTC options
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Two-Sided Positions
The tax straddle rules
offsetting positions
options and stock
options and other options
Loss deferral rule
Impact on holding period for long-term gain and
dividends
Capitalization of carrying charges
Qualified Covered Call exception
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Whats New for 2013?
Higher tax rates!
End of Bush tax cuts for upper-income
taxpayers
New 3.8% Medicare tax on net investment
income
7
Whats New for 2013?
2012 Rate 2013 Rate
Long-term Capital Gain 15% 23.8%
Short-term Capital Gain 35% 43.4%
60/40 Gains 23% 31.64%
Interest 35% 43.4%
Dividends 15% 23.8%/43.4%
Maximum Combined Tax Rates for Upper-Income Taxpayers:
Regular Income Tax Plus 3.8% Tax on Net Investment Income
8
Chairman Camps Discussion Draft
Proposals
Tax reform for financial products
All derivatives, including listed options:
marked to market at year-end
ordinary income and ordinary loss
60/40 repealed
Stock that is part of two-sided position with a derivative
treated like a derivative
mark-to-market
ordinary income/loss
Appreciated stock treated as sold if buy put or write call
No Qualified Covered Call exception
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Example 1
Alice has held 1,000 shares of AT&T stock for 30 years. Her basis is $5 a
share and AT&T is currently trading for $35 a share. In a time of
market turmoil like the recent financial crisis, Alice is concerned that
the stock may decline significantly. She does not want to sell the stock
because she likes getting the dividend. So she buys a put with a strike
price of $25 a share.

Current law: Alice has no gain or loss from buying the put.
Draft proposal: Alice is treated as selling her AT&T stock for $35 a
share, with a resulting taxable gain of $20,000. Alice will need to come
up with the cash to pay the tax.
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Example 2
Fred buys 100 shares of Intel stock for $20 a share. After holding the
Intel stock for 3 months and at a time when Intel is trading at $25, Fred
writes a 60-day, $30 call for $2 to generate some additional income.
Assume that the option expires worthless after 60 days and that Intel is
trading for $26 when the option expires.

Current law: Fred has no gain or loss when he writes the covered call. He has a $200
short-term capital gain when the call expires. Freds holding period in the stock
continues to accrue while the written call is outstanding.
Draft proposal: Fred is treated as selling his Intel stock for $25 a share when he
writes the call and he recognizes $500 of short-term capital gain at that time. When
the option expires, Fred recognizes $200 of ordinary income on the option and $100
of ordinary income on the stock (because the stock appreciated from $25 to $26 while
the option was outstanding). Fred is treated as having a basis of $26 a share in the
Intel stock for purposes of computing subsequent gain or loss and has a 3-month
holding period in the stock. (His holding period is suspended during the 60-day
period in which the written call was outstanding.)
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