The 1256 Contract Strategy: How Futures & Options Get a 60/40 Tax Break
The 1256 Contract Strategy: How Futures & Options Get a 60/40 Tax Break
CORE INSIGHTS
- The 60/40 Rule: Profits from Section 1256 contracts (SPX, Futures) are taxed as 60% Long-Term and 40% Short-Term, regardless of holding period. This lowers the max rate from 37% to ~26.8%.
- SPX vs. SPY: Trading Index Options (SPX) qualifies for this break. ETF Options (SPY) do not. Switching tickers is an instant 10% tax cut.
- No Wash Sales: Section 1256 contracts are exempt from the Wash-Sale Rule. You can harvest losses and re-enter immediately without penalty.
For short-term traders, taxes are the biggest enemy. The IRS carved out a special loophole for “regulated futures.” By trading Index Options instead of ETFs, you can slash your tax bill without changing your strategy.
Regular Trade (SPY): $100k Profit x 37% = $37,000 Tax
1256 Trade (SPX): ($60k x 20%) + ($40k x 37%) = $26,800 Tax
*Result: $10,200 saved instantly.
What-If Scenario: The Day Trader ($200k Profit)
| Instrument | Tax Rate | After-Tax Profit |
|---|---|---|
| SPY Options | 35% (Ordinary) | $130,000 |
| SPX Options | 26% (Blended) | $148,000 |
Visualizing the Tax Savings
*Figure 1: Liability Gap. The Green Bar (1256) keeps more money in your pocket.*
Strategic Action Steps
Stop trading SPY/QQQ for short-term plays. Switch to SPX/NDX (or XSP/MNX for smaller accounts).
On Dec 31, all open 1256 positions are treated as “sold.” You cannot defer gains to next year. Plan cash flow for taxes.
Net losses in 1256 contracts can be carried back 3 years to offset past gains. Standard losses cannot do this.
The Bottom Line: Who Should Choose What?
- Choose SPX/NDX: Active traders and high earners seeking tax efficiency.
- Choose SPY/QQQ: Buy-and-hold investors or small accounts where contract size is an issue.
Frequently Asked Questions
What qualifies as a Section 1256 Contract?
Regulated futures (e.g., /ES) and non-equity options (Index Options like SPX, NDX). ETF options (SPY) do NOT qualify.
How does the 60/40 Rule work?
Regardless of holding period, 60% of gains are taxed as Long-Term (20%) and 40% as Short-Term (37%). This blends to a max rate of ~26.8%.
What is Mark-to-Market?
All open 1256 positions are treated as ‘sold’ on Dec 31st for tax purposes. You cannot defer gains, but Wash Sale rules do not apply.