How Are Options Taxed in the US? The Facts You Need to Know

Figuring out how options are taxed in the US can get tricky. Taxes on options trading depend on factors like your strategy and whether you hold a long or short position. Are options taxed as capital gains? How are option premiums taxed? We’ll untangle these rules and more so you’re prepared.

Key takeaways

• US taxation of options involves different rules for long and short positions, including complications like wash sales and special rules for premiums.
• Taxes on options trading vary depending on strategy; complex setups like straddles require careful adherence to IRS rules.

How Are Options Taxed?

When it comes to taxes on options trading, the rules can seem overwhelming.

First, a quick note—this is informational only. You’ll want to consult a tax professional for advice tailored to your financial situation.

Now, let’s break down how options are taxed, starting with the basics and moving into specific scenarios. Here’s a simple table that summarizes the tax treatment of options:

The Basics of How Options Are Taxed: Long vs. Short Options Taxation

The IRS treats taxes on options trading differently depending on whether you’re holding a long or short position. The distinction lies in how long you hold the position and the type of gain or loss you realize:

• Long Positions (Buyer): If you buy an option (either a call or a put), the resulting gain or loss depends on how long you held the option—less than a year makes it a short-term capital gain, taxed as ordinary income. More than a year makes it a long-term capital gain, which may qualify for lower tax rates. 
• Short Positions (Seller/Writer): These are always considered short-term gains or losses, no matter how long the option is held. The IRS considers the income from selling the option to be ordinary.

How Put and Call Options Are Taxed

Taxes associated with put and call options capital gains tax depend significantly on how the trade ends—whether the option is exercised, expired, or simply closed. Understanding options trading taxes is key to navigating these situations. Here’s a breakdown:

• If the Option is Exercised (Call Case): If the Option is Exercised: For call options, if you exercise the right to buy, the premium paid is added to your purchase price. For example, if you purchased an option (perhaps through our screener for the options market) for a $3 premium and exercised it to buy stock at $50/share, your total cost basis is $53/share. Any gains when selling the stock will be taxed based on this adjusted basis and the holding period of the stock. A common question is, “Are options taxed as capital gains?” In this case, the answer depends on the holding period of the underlying stock and the adjusted cost basis. 
• If the Option is Exercised (Put Case): For put options, the premium reduces the amount realized from selling the stock. For instance, if you wrote a put option and it was exercised, lowering your sale proceeds, the taxable gain or loss would account for this reduction. Knowing how option premiums are taxed helps clarify these scenarios.
• If the Option Expires: When an option expires worthless, the premium you paid (for buyers) is a loss. This loss is treated as either short-term or long-term, depending on how long the position was held.
• If the Option is Closed Before Expiry: Whether you bought or sold the option, closing it before expiration results in short- or long-term gains/losses depending on the holding period.

How Are Option Premiums Taxed?

The treatment of premiums—the price you pay or receive for an option—plays a key role in determining your taxable income or losses. Here’s a closer look:

• If you’re the buyer, premiums paid contribute to your cost basis. What’s taxable depends on what happens to the option (whether exercised, expired, or sold). Many traders wonder, “Are options taxed as capital gains?” If the option is exercised, the tax treatment of the gain depends on whether the resulting stock trade qualifies as a short-term or long-term gain. These factors are integral to understanding options trading taxes and knowing how option premiums are taxed.
• If you’re the seller (or writer), the premium is counted as income when received. However, whether this income remains taxable depends on how the option is resolved. For example, if the buyer exercises the option, your final taxable gain or loss will include the premium. This reinforces the importance of considering put and call options capital gains tax implications.

IRS Terminology and Investor Categories

Here’s where things get tricky with options trading taxes. The IRS doesn’t always classify traders the way the financial industry does. For example:

• Even if day-to-day trading is your primary activity, the IRS may still categorize you as an ‘investor’ rather than a ‘trader in securities,’ depending on specific criteria.
• Being officially recognized as a trader by the IRS has stricter requirements, and it’s best to consult IRS resources or a tax professional if you think this applies to you.

Beyond terminology, options themselves fit into different categories that dictate how they’re taxed:

• Employee Stock Options: These include non-qualified stock options (NSOs) and incentive stock options (ISOs). Gains from NSOs are treated as ordinary income, while ISOs can receive capital gains treatment if holding requirements are met.
• Equity Options: Standard put and call options on stocks or ETFs have their own tax treatments depending on whether you exercised, sold, or held them to expiration.

Taxes on options trading can turn on whether the option buyer or seller exercised it, left it to expire, or closed the position. Whether you’re wondering how option premiums are taxed or curious if gains fall under the put and call options capital gains tax rules, your overall strategy determines what’s taxable. It’s vital to stay on top of your trades and consult a tax expert to ensure accurate reporting.

Should You Worry About the “Wash Rule”?

If you’re a stock trader, you’re likely familiar with the “Wash Rule.” It applies to both stocks and options, preventing you from claiming a loss if you buy the same or a “substantially identical” security within 30 days of selling it at a loss. The IRS enforces this to stop traders from taking advantage of losses while reacquiring the same position quickly.

For options, the Wash Rule can create challenges, especially for frequent traders. For example, selling a losing call option and then reacquiring the same call with a near-identical strike price within 30 days can trigger the rule. The same applies to put and call options capital gains tax situations where similar positions are quickly reestablished.

The disallowed loss doesn’t vanish, though—it’s added to the cost basis of the new position. This may defer the tax benefit but complicates tracking for consistent record-keeping. For serious options traders, the Wash Rule can sneak up on you if trades aren’t documented carefully.

Consult a tax advisor to align your trading strategy with the rules on how options are taxed and avoid costly errors.

How Are Options Taxed in the Case of Complex Strategies?

If, like us, you often go for something more complex than a single-leg strategy, the “how are options taxed?” question gets a bit harder to answer. Complex options strategies—like spreads, straddles, and butterflies—can be powerful but come with unique tax implications. These strategies often play a role in options trading taxes, particularly for active traders. 

The IRS pays particular attention to “straddles,” a situation where related positions offset each other to reduce risk. When this happens, the IRS might defer losses to prevent deductions until the offsetting position is closed. Understanding how options are taxed, especially for strategies involving put and call options capital gains tax, ensures traders can navigate these complexities effectively.

For instance, if you hold stock and buy a protective put option, the two create a straddle. Here’s the catch—the loss from one leg of the trade won’t be deductible until the other leg is resolved. This deferral ensures gains and losses are taxed together.

However, not all strategies are bound to the same rules. Section 1256 contracts, such as options on broad-based indexes, offer more favorable treatment. Gains and losses on these contracts follow a “60/40” split—60% taxed at long-term capital gains rates and 40% at short-term rates, regardless of holding period. Plus, Section 1256 trades aren’t subject to wash sale rules.

Once again, this information is meant for general understanding and not as professional tax advice—be sure to consult a tax professional for guidance on how options are taxed in your specific situation.