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The question I have is whether or note this applies to profits from currency if the note is the instrument being held.
IRS Ends Tax Advantage For Currency ETNs
December 11, 2007
The Internal Revenue Service has issued a ruling that ends the tax advantage that currency-based exchange-traded notes (ETNs) have over competing currency products, such as the CurrencyShares exchange-traded funds (ETFs) issued by Rydex Investments.
In fact, the new ruling puts the ETNs at a slight disadvantage for most investors.
This gets complicated if you haven't been following matters, so here is the Cliff's Notes of what happened.
Historically, currency investing has been very tax-inefficient. Investors in a currency-based product like Rydex's Euro Currency Trust ETF (FXE) have two sources of returns, and both receive terrible tax treatment:
- Interest income: FXE literally holds euros in a bank in Europe, where they earn local interest rates. This interest income is paid out to investors quarterly as "ordinary income," subject to tax rates up to 35%.
- Changes in the value of the currency: If the euro gains on the dollar, FXE goes up. When investors sells FXE—no matter how long they hold it—those gains are also taxed as ordinary income, with rates up to 35%. There is no possibility for gains to be taxed at the long-term capital gains tax rate of 15%, because the IRS does not consider currencies an "investment."
Until today, the iPath currency ETNs had a huge advantage on the tax front.
First, rather than having the interest income paid out directly to shareholders, virtual interest income was accumulated into the price of the ETN itself. Investors didn't have to pay taxes on this income until they sold. Moreover, as long as they held the ETN for more than a year, this income would qualify as long-term capital gains, with tax rates of just 15%.
Second, the original iPath prospectus suggested that ETNs could be classified as "pre-paid contracts with respect to their indexes." Under that definition, any long-term gains from currency appreciation were taxed at the 15% long-term capital gains rate.
In other words, all gains could be deferred in the ETN and eventually taxed at 15%. In contrast, interest income in the ETFs was taxed immediately, and all gains of any kind were taxed at 35%.
It was a huge advantage.
The new ruling, however, throws all of that on its head. According to the new ruling, issued December 7, 2007, ETNs—along with any financial instrument linked to a single currency, regardless of whether that instrument is privately offered, publicly offered or traded on an exchange—should be treated as "debt" for federal tax purposes. This means that all gains—interest and otherwise—are taxable as ordinary income, with rates up to 35%. Moreover, shareholders will owe taxes each year on interest income even if that income is incorporated into the value of the note, as it is with ETNs. In other words, shareholders will have to pay taxes each year on interest, even though they won't realize that income until they sell the ETF.
In sum, currency ETNs have gone from having a huge tax advantage—with gains deferred and taxed at the 15% long-term rate—to a slight disadvantage, as investors now have to pay taxes out of pocket on interest they will not receive until they sell the fund.
Does Not Apply To Other ETNs ... Yet
Importantly, this ruling does not apply to other ETNs. In fact, the IRS has issued a request for comment on how taxes should be handled for other "prepaid forward contracts," such as the popular commodity ETNs.
What's interesting about this ruling, however, is that the IRS has taken the step of defining an entire class of investment (currencies) as subject to one type of taxation, rather than allowing different products to dodge or not dodge that tax treatment based on how they are structured.
In a sense, that's a victory for rationality and clarity.
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I've got some choice words saved for the IRS. Can't write them here. lol
I can't speak for all you in the US, but in Canada the CCRA uses an all inclusive statement... "reasonable expectation of profit". Any activity that has a reasonable expectation of profit is considered a business. So unless you can prove that you only bought dinar to lose money and it suddenly ruined your plans by skyrocketing... it will be taxable most likely as a capital gain.
Anyone know of any financial institutions who are actually buying dinar in Canada?
Ever heard of debit cards?
If you need to bring in more than $10,000 cash in to the USA open up a bank account in the country your traveling from and get a debit card. Pull out all the money you can per diem until the bank account is dry.
Just a thought.
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One who does not look ahead remains behind.
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First time posting. Been enjoying all of your insights for a while now. I do not have the link at the moment but will find it today and post.....however, I believe that in Dec. 2007 there was a law passed that changed the taxing on foreign currency from capital gains to ordinary income....it has been a great run at 15% for a while and things like the IQD, etc. are impossible to track re: purchase & initial investment.
Anyone else heard of this?
Thanks Ken K. - You posted the Dec. 2007 article that I was talking about. Which we have talked about before.
Best advice I ever received (I just went through an IRS audit) was to make sure to declare all income, every penny. Thank goodness, I did. Then write off everything possible and imaginable, and then some. If you get audited (only 1% do) and it's not an approved write off, they will just make you correct/deduct it from your write offs. They'll send you to jail for not declaring/hiding income. It's not worth hiding your money (there's always a papertrail) unless your willing to live outside the US. I'm not. We're still the best country to live in and party in, especially after the revalue and the Rays win the World Series!
PS: I thought last Dec 07, as a rider on a bill, currency income profit was going to be taxed as oridinary income 35%), instead of capital gains (15%) effective in 08. I took it as a sign that they knew this was coming. Noone raise any questions when it was put on some unrelated bill because it wasn't important to the masses (or noticed) whom never deal in currency like most Europeans do.
Then there is the alternative minimum tax too.
A cpa told me the same thing last year. Depending on which state you live it. State taxes can hit you big time also.