I bought 1,000 shares of the Nasdaq 100 tracking stock (QQQ) for $95. If I sell a covered call at $90 for $7, how do I report this? What happens if the option is exercised?
-- Russ Geissbuhler
There is no definitive answer to your question, because the
Internal Revenue Service
cannot decide how to treat options on broad-based indices, like the QQQ or the
Standard & Poor's Depositary Receipts
You can make an argument for a few different approaches, says Richard Shapiro, an
Ernst & Young
securities tax partner.
Treat options on the QQQ like regular equity options.
A call is a type of option that gives the purchaser the right, but not the obligation, to buy a security for a specified price at a certain time. It's basically a bet that the stock will go up. If you write a call on a stock you already own, the call is considered to be "covered."
When you sell a covered call, the money you receive for it is called "premium." To figure out your gain or loss, add that premium to the selling price of the shares, says Diane Garnick, equity strategist and exchange-traded fund specialist at
In this case, you spent $95,000 buying QQQ shares and took in $7,000 when you sold the calls. No doubt you were hoping QQQ shares would rise and the calls you sold would expire worthless, allowing you to pocket the premium free and clear. But the shares fell to the point where it became profitable for the buyer of the call to exercise it. You received $90,000 when the option was exercised.
So if you add together the money you took in -- $90,000 plus the $7,000 premium -- and subtract the $95,000 original cost of the shares, you have a $2,000 short-term gain on your hands, says Garnick. She believes this is the appropriate way to treat options on the QQQ or any other exchange-traded fund.
Treat the options as if they are subject to the 60/40 rule.
Options on stock index futures or broad-based stock indices, such as the
S&P 500 index must follow
section 1256 of the tax code. (Regulated futures contracts and foreign currency contracts fall under this section as well.)
Section 1256 says that any gains and losses from the sale of these securities are subject to the 60/40 rule -- 60% of gains and losses are long-term and 40% are short-term, regardless of how long the securities are held.
Under this scenario, you would treat this trade as two separate transactions. You'd have a $5,000 short-term loss from the stock side (you bought at $95,000 and sold at $90,000) and a $7,000 gain from the premium that is subject to the 60/40 rule. You could argue that this is a proper way to report your gain, but Shapiro says this is not typically how options are looked at.
Net your gains and losses.
In this scenario, your $2,000 net gain was the result of taking in that $7,000 in premium. And because that premium came from selling an option that is subject to the 60/40 rule, apply that rule to your gain.
Which is the right way? It's your call (no pun intended).
More Do-or-Die Reminders
Check out the
transcript between Martin Nissenbaum, director of income tax planning at
Ernst & Young
and me for more advice on these issues. Special thanks to those of you who joined us.
Also, here are a few more do-or-die reminders to help you get your 1999 tax return in by midnight Oct. 16.
You can still electronically file your tax return. Most e-filing sites are available until midnight Oct. 16, so check out our
Guide to Online Tax-Filing Sites to determine which one is right for you.
Hint: Be sure your name matches the one on your Social Security card; otherwise you can't electronically transmit your return.
Use your credit card.
You can call 888-2PAY-TAX and charge your 1999 tax payment on
, though you'll pay a "convenience" fee.
The fee averages 3% to 4% of your payment. Check out Official Payments'
Web site for the complete payment scale.
If you file electronically using
TurboTax software programs or Web sites, you can charge your tax bill using your Discover card only.
For more on credit card payments, see
Charging Your '99 Taxes. And check out this earlier
Tax Forum on filing late for some good charging tips.
At this point, you cannot make an IRA or Roth IRA contribution for 1999. The deadline for that was April 17. (April 15 was a Saturday this year.)
But if you opened a Roth IRA account or made a Roth IRA contribution for 1999, make sure you still meet the adjusted gross income limitations. If you now realize you've exceeded those limits, you have until the time you file your tax return to recharacterize that Roth IRA account or contribution. See the
Roth IRA Tax Reporting Guide for tips.
If you still owe money, make your check or money order out to the
, not the IRS.
If you entered a smoking cessation program in 1999, you can deduct the amount you paid for the program, and any prescribed drugs to treat nicotine withdrawal, as a medical expense. However, you cannot include nicotine gum, patches or other treatments that are not prescribed by a doctor.
Remember, you can deduct only the amount of medical and dental expenses that exceed 7.5% of your adjusted gross income. Report these expenses on Schedule A:
, found on the IRS'
Web site. Don't include any medical expenses that were reimbursed by your insurance carrier.
If you entered a smoking cessation program in 1996, 1997 or 1998, you may be able to go back and claim these expenses. Just make sure it's worth your time and effort before you go through the administrative nightmare of amending your tax return.
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