Taxation of Options
This chapter summarizes some basic rules governing the federal income taxation of certain option transactions by individuals. It will not address most of the tax issues of relating to investments, including state and local taxation; instead, it will focus on the unique nature of options for federal income tax purposes and tax issues that are important to maximize your after-tax returns. Remember that it is not what you make that matters; it is what you keep.
There are special tax rules for option transactions, including rules on uncovered long options, uncovered short options, exercise and assignment, and other transactions. There are rules for gains and losses considered short term (less than 12 months) and long term (12 months or more). What makes option taxation unique are special rules for what are called section 1256 contracts, which include options on broad-based indexes (e.g., the S&P 500 index, or SPX) and futures options (e.g., S&P 500 futures options).
Outside an IRA, in general, a gain or loss from an option is not taxed until the option is offset or it expires. Thus, buying an option is not a taxable event but, instead, a tax is triggered at the time of sale or expiration of the option. A premium received for writing a call or put is not included in income at the time of receipt but is taxed at the time the option is offset or at expiration of the option. An exercise or assignment of an option can extend the timing of ...