The 2007 notice refers to the legislative history of sections 1256 and 988 and concludes that an FX option is not an FX contract under section 1256(g)(2)
What are taxpayers left with? The character advantage, which allowed mark-to-market to pass through the eye of the needle in 1981, has undergone several significant changes since the enactment of section 1256. FX transactions are governed by section 988 and generally get ordinary treatment. The rate differential between ordinary income and capital gain has shrunk and then widened again.
During the same period, mark-to-market taxation lost its reputation as being ‘‘a very bad scheme’’ and became increasingly accepted as the correct method to tax financial contracts.
But the taxation of FX options, swaps, and similar contracts remains uncertain. Should these contracts be marked to market under the plain language of the statute, or should they be taxed under the realization
principle? How do the character rules of sections 988 and 1256 interact for these contracts? And how can any policymaker justify a differing treatment of FX forwards from other OTC currency derivatives based on the history of a statute when the statute itself is so clear?
I counsel those whose slumber is disturbed by such uncertainty that they should not worry: With uncertainty, there is always opportunity.