988 transaction

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A 988 transaction is a transaction described in section 988(c)(1) of the Internal Revenue Code [1] in the United States of America. This transaction occurs when a taxpayer enters into or acquires any debt instrument, forward contract, futures contract, option, or similar financial instrument held in a non-functional currency. [1] The rules for 988 transactions do not apply to any regulated futures contract or non-equity options which would be marked to market under 26 USCA § 1256 [2] (1256 contract) if held on the last day of the taxable year. [1]

The Internal Revenue Code (IRC), formally the Internal Revenue Code of 1986, is the domestic portion of federal statutory tax law in the United States, published in various volumes of the United States Statutes at Large, and separately as Title 26 of the United States Code (USC). It is organized topically, into subtitles and sections, covering income tax, payroll taxes, estate taxes, gift taxes, and excise taxes; as well as procedure and administration. Its implementing agency is the Internal Revenue Service.

Forward contract non-standardized contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today

In finance, a forward contract or simply a forward is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today, making it a type of derivative instrument. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position. The price agreed upon is called the delivery price, which is equal to the forward price at the time the contract is entered into.

Futures contract standardized legal agreement to buy or sell something (usually a commodity or financial instrument) at a predetermined price (“forward price”) at a specified time (“delivery date”) in the future

In finance, a futures contract is a standardized forward contract, a legal agreement to buy or sell something at a predetermined price at a specified time in the future, between parties not known to each other. The asset transacted is usually a commodity or financial instrument. The predetermined price the parties agree to buy and sell the asset for is known as the forward price. The specified time in the future—which is when delivery and payment occur—is known as the delivery date. Because it is a function of an underlying asset, a futures contract is a derivative product.

Contents

History

The provisions covering 988 transactions were enacted as part of the Tax Reform Act of 1986. [3] [4]

Tax Reform Act of 1986

The U.S. Congress passed the Tax Reform Act of 1986 (TRA) to simplify the income tax code, broaden the tax base and eliminate many tax shelters. Referred to as the second of the two "Reagan tax cuts", the bill was also officially sponsored by Democrats, Richard Gephardt of Missouri in the House of Representatives and Bill Bradley of New Jersey in the Senate.

Application

The foreign currency gain or loss on a 988 transaction is treated as ordinary income or loss unless an election is made to treat it as a capital gain or loss. [1]

Under the United States Internal Revenue Code, the type of income is defined by its character. Ordinary income is usually characterized as income other than long-term capital gains. Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a sole proprietorship, partnership or LLC. Rents and royalties, after certain deductions, depreciation or depletion allowances, and gambling winnings are also treated as ordinary income. A "short term capital gain", or gain on the sale of an asset held for less than one year of the capital gains holding period, is taxed as ordinary income.

See also

Related Research Articles

A Tobin tax, suggested by James Tobin, an economist who won the Nobel Memorial Prize in Economic Sciences, was originally defined as a tax on all spot conversions of one currency into another. Tobin's tax was originally intended to penalize short-term financial round-trip excursions into another currency. By the late 1990s, however, the term Tobin tax was being incorrectly used to apply to all forms of short term transaction taxation, whether across currencies or not – another term for these broader tax schemes is Robin Hood tax, due to tax revenues from the speculator funding general revenue. More exact terms, however, apply to different scopes of tax.

Speculation is the purchase of an asset with the hope that it will become more valuable in the near future. In finance, speculation is also the practice of engaging in risky financial transactions in an attempt to profit from short term fluctuations in the market value of a tradable financial instrument—rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, dividends, or interest.

Bank Secrecy Act 1970 act of the United States Congress

The Bank Secrecy Act of 1970 (BSA), also known as the Currency and Foreign Transactions Reporting Act, is a U.S. law requiring financial institutions in the United States to assist U.S. government agencies in detecting and preventing money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, file reports if the daily aggregate exceeds $10,000, and report suspicious activity that may signify money laundering, tax evasion, or other criminal activities.

Hedge (finance)

A hedge is an investment position intended to offset potential losses or gains that may be incurred by a companion investment. In simple language, a hedge is a risk management technique used to reduce any substantial losses or gains suffered by an individual or an organization.

A capital gains tax (CGT) is a tax on capital gains, the profit realized on the sale of a non-inventory asset that was greater than the amount realized on the sale. The most common capital gains are realized from the sale of stocks, bonds, precious metals, and property. Not all countries implement a capital gains tax and most have different rates of taxation for individuals and corporations.

The foreign exchange market is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines the foreign exchange rate. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the Credit market.

Osaka Securities Exchange Securities exchange located in Osaka, Japan

Osaka Securities Exchange Co., Ltd. is the second largest securities exchange in Japan, in terms of amount of business handled.

A 1256 Contract is a term used by the Internal Revenue Service to denote any regulated futures contracts, foreign currency contracts, non-equity options, dealer equity options, dealer security futures contracts, and cash settled options. They are marked to market at the end of the tax year and treated as dispositioned.

Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than that of the base currency of the company. The exchange risk arises when there is a risk of appreciation of the base currency in relation to the denominated currency or depreciation of the denominated currency in relation to the base currency. The risk is that there may be an adverse movement in the exchange rate of the denomination currency in relation to the base currency before the date when the transaction is completed.

The forward exchange rate is the exchange rate at which a bank agrees to exchange one currency for another at a future date when it enters into a forward contract with an investor. Multinational corporations, banks, and other financial institutions enter into forward contracts to take advantage of the forward rate for hedging purposes. The forward exchange rate is determined by a parity relationship among the spot exchange rate and differences in interest rates between two countries, which reflects an economic equilibrium in the foreign exchange market under which arbitrage opportunities are eliminated. When in equilibrium, and when interest rates vary across two countries, the parity condition implies that the forward rate includes a premium or discount reflecting the interest rate differential. Forward exchange rates have important theoretical implications for forecasting future spot exchange rates. Financial economists have put forth a hypothesis that the forward rate accurately predicts the future spot rate, for which empirical evidence is mixed.

Hotchpot

In civil and property law, hotchpot is the blending, combining or offsetting of property to ensure equality of a later division of property.

A foreign exchange hedge is a method used by companies to eliminate or "hedge" their foreign exchange risk resulting from transactions in foreign currencies. This is done using either the cash flow hedge or the fair value method. The accounting rules for this are addressed by both the International Financial Reporting Standards (IFRS) and by the US Generally Accepted Accounting Principles as well as other national accounting standards.

A foreign exchange derivative is a financial derivative whose payoff depends on the foreign exchange rate(s) of two currencies. These instruments are commonly used for currency speculation and arbitrage or for hedging foreign exchange risk.

A financial transaction tax is a levy on a specific type of financial transaction for a particular purpose. The concept has been most commonly associated with the financial sector; it is not usually considered to include consumption taxes paid by consumers.

A currency transaction tax is a tax placed on the use of currency for various types of transactions. The tax is associated with the financial sector and is a type of financial transaction tax, as opposed to a consumption tax paid by consumers, though the tax may be passed on by the financial institution to the customer.

Corn Products Refining Company v. Commissioner, 350 U.S. 46 (1955), is a United States Supreme Court decision that helps taxpayers classify whether or not the disposition of a commodity futures contract by a business of raw materials as part of its hedging of business risk is an ordinary or capital gain or loss for income tax purposes.

Securities Transaction Tax (STT) is a tax payable in India on the value of securities transacted through a recognized stock exchange. As of 2016, it is 0.1% for delivery based equity trading. The tax is not applicable on off-market transactions or on commodity or currency transactions. The original tax rate was set at 0.125% for a delivery-based equity transaction and 0.025% on an intra-day transaction. The rate was set at 0.017% on all Futures and Options transactions. STT was originally introduced in 2004 by the then Finance Minister, P. Chidambaram to stop tax avoidance of capital gains tax. The government reduced this tax in the 2013 budget after a lot of protests for years by the brokers and the trading community. The revised STT for delivery-based equity trading is 0.1% on the turnover. For Futures, the tax has been reduced to 0.01% on the sell-side only. For Equity Options, the STT has been reduced to 0.05% on the sell side of the premium amount. The rest of the tax structure remains as is. Securities transaction tax is a direct tax. Securities Transaction Tax is levied and collected by the union government of India.

Dow Futures are financial futures which allow an investor to hedge with or speculate on the future value of various components of the Dow Jones Industrial Average market index. The futures instruments are derived from the Dow Jones Industrial Average as E-mini Dow Futures.

S&P Futures are financial futures which allow an investor to hedge with or speculate on the future value of various components of the S&P 500 Index market index. The futures instruments are derived from the S&P 500 Index is E-mini S&P Futures. S&P 500 futures contracts were first introduced by the CME in 1982. The CME added the e-mini option in 1997. The bundle of stocks in the S&P 500 is, per the name, composed of stocks of 500 large companies.

References

  1. 1 2 3 4 26 USCA section 988
  2. ↑ 26 USCA § 1256
  3. ↑ NY CPA Journal
  4. ↑ See section 1261(a) of the Tax Reform Act of 1986, Pub. L. No. 99-514 (Oct. 22, 1986).
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