How Are Options Premiums Taxed: Buyers, Writers, and the 60/40 Rule

Options premiums are not taxed at the moment money changes hands. When you pay a premium to buy a contract, it sits in your account as a capital expenditure. When you collect a premium for writing one, the IRS treats it as a deferred item, not income. The tax event comes later, when the option expires, gets sold or closed, or is exercised, and the character of the gain or loss depends on which of those three things happens and whether you were the buyer or the writer.¹

Options qualify as capital assets under the general definition in the tax code, which is why gains and losses on them follow capital gains rules rather than ordinary income rules.² From there, buyers and writers diverge.

How the Premium Is Taxed When You Buy an Option

For a buyer, federal law says the gain or loss on the option takes its character from the underlying property.³ Since most listed options relate to stock, that means capital gain or loss treatment, with the holding period determining short-term versus long-term.

If the Option Expires Worthless

The full premium you paid is a capital loss. The IRS treats the option as if it were sold on the expiration date, and your holding period runs from the purchase date through expiration.¹ Since most listed contracts expire in under a year, the loss is usually short-term.

If You Sell the Option Before Expiration

The difference between what you paid and what you received is your capital gain or loss, and the holding period decides whether it’s short-term or long-term, exactly as it would with stock.¹

If You Exercise the Option

Exercise is not itself a taxable event for the option. The premium folds into the stock transaction. For a call, the premium you paid is added to the strike price to form your cost basis in the acquired shares. For a put, the premium reduces the amount realized from selling the underlying stock.¹

One point people miss: when you exercise a call and take delivery of stock, the holding period on that stock starts the day after exercise. It does not relate back to when you bought the option. Long-term treatment on the shares requires holding them more than a year from that exercise date.

Commissions and transaction fees ride along in the obvious direction. Fees on the buy side increase your basis; fees on the sell side reduce your proceeds; on an exercise, they roll into the stock’s basis or reduce the amount realized.

How the Premium Is Taxed When You Write an Option

Writers get a different rule, and it’s a strict one. Under Section 1234(b), a writer’s gain or loss from a closing transaction, and any gain from an option that lapses, is always short-term capital gain or loss regardless of how long the position was open.³ A buyer who holds long enough can reach long-term rates on the option itself. A writer cannot.

If the Written Option Expires Unexercised

The full premium you received becomes a short-term capital gain, recognized on the expiration date.¹

If You Close the Position Early

Buying back an equivalent contract closes the position. The difference between the premium originally received and the cost of that closing purchase is a short-term capital gain or loss.¹

If You Are Assigned

Assignment doesn’t create a separate taxable event on the premium. If a call you wrote is assigned, the premium received is added to the amount realized on the sale of the underlying stock. If a put you wrote is assigned, the premium reduces your cost basis in the shares you’re now obligated to buy, and the holding period on those shares begins on the purchase date.¹ Assignment is the one path where a writer can end up with long-term treatment, but only on the stock portion and only if the stock was held long enough. The option premium itself just merges into that stock calculation.

Short-Term Versus Long-Term Rates

The short-term versus long-term distinction is where the tax dollars actually get decided. Short-term gains, from assets held one year or less, are taxed at ordinary income rates. Long-term gains, from assets held more than one year, get preferential rates of 0%, 15%, or 20% depending on income and filing status.⁴

High-income traders also owe a 3.8% net investment income tax on capital gains once modified adjusted gross income passes $200,000 for single filers or $250,000 for married couples filing jointly.⁵ Those thresholds are not indexed for inflation. Stacked with the 20% long-term rate, the effective federal ceiling on long-term gains reaches 23.8%. Short-term gains run to 37% plus the 3.8% surtax.

Because most listed options expire within months and because writer gains are short-term by statute, the majority of options premium outcomes land in the short-term bucket. The main exceptions are LEAPS held over a year on the buyer side, and Section 1256 contracts, which have their own rules.

Index Options and the 60/40 Rule

Section 1256 carves out special treatment for regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, and dealer securities futures contracts. For an ordinary investor, the piece that matters is “nonequity options,” which covers options on broad-based stock indexes such as the S&P 500 or Nasdaq-100. Options on individual stocks and on narrow-based indexes are not Section 1256 contracts.⁶

Two rules govern these contracts. First, mark-to-market: any open Section 1256 position on the last business day of the year is treated as if you sold it at fair market value on that day, and the resulting gain or loss counts for the current tax year even though the position is still open. Second, the 60/40 split: regardless of holding period, 60% of the gain or loss is treated as long-term and 40% as short-term.⁶ Even a position held one day gets the blended rate.

Section 1256 also allows a loss carryback election that ordinary equity options do not. A net Section 1256 loss can be carried back up to three years against Section 1256 gains reported in those prior years. Corporations, estates, and trusts cannot make the election. The carryback is limited to prior-year Section 1256 gains and cannot create or increase a net operating loss.⁷

Covered Calls Can Change the Tax on Your Stock

Selling covered calls against stock you already own can quietly reshape the tax treatment of the stock itself. The pivot is whether the call qualifies as a “qualified covered call.” A qualified covered call generally must have more than 30 days to expiration and a strike price that is not deep in the money, with the regulations setting the lowest permissible strike at no less than 85% of the stock’s applicable price.⁸

Writing a qualified covered call at or out of the money lets the stock’s holding period keep running normally. Writing a qualified covered call in the money suspends the stock’s holding period while the option is open; it pauses rather than resets.

Non-qualified covered calls are harsher. Sell one against stock held for less than a year and the stock’s holding period is terminated entirely. Close both together and the whole net result is short-term. Close the call first and a new holding period on the stock starts only on the day you close the call. That mechanism can convert what would have been a long-term stock gain into a short-term one purely because of how the call was structured.

Wash Sale Rules Apply to Options

The wash sale rule disallows a capital loss when you acquire substantially identical stock or securities within 30 days before or after the sale that produced the loss. The statute defines “stock or securities” to include contracts or options to acquire or sell stock or securities.⁹ Three common patterns trip the rule:

Selling stock at a loss and buying a call option on the same stock within 30 days.
Selling an option at a loss and buying a substantially identical option within 30 days.
Letting an option expire at a loss and buying another option on the same underlying within 30 days.

The disallowed loss doesn’t vanish. It’s added to the basis of the replacement position, to be recovered when that position is closed. Traders who roll options frequently on the same underlying are the ones most likely to hit this without noticing, because closing one contract and opening a similar one on the same stock within the window is exactly the pattern the rule targets.

Where to Report It

Standard equity options that are sold, closed, or expire go on Form 8949, with dates, proceeds, cost basis, and gain or loss. Those totals flow onto Schedule D.¹⁰ Section 1256 contracts go on Form 6781, which handles the mark-to-market calculation and the 60/40 split, and is also where the loss carryback election is made.¹¹

When an option is exercised or assigned, the option itself is generally not a separate line on your broker’s 1099-B. The premium is built into the basis or proceeds of the underlying stock, and it shows up when that stock is eventually sold. If the reported basis doesn’t line up with your records, particularly when commissions and premium adjustments are in play, correct the figures on Form 8949 using the appropriate adjustment code.

1
Internal Revenue Service. Publication 550 – Investment Income and Expenses
2
Office of the Law Revision Counsel. 26 US Code 1221 – Capital Asset Defined
3
Office of the Law Revision Counsel. 26 US Code 1234 – Options to Buy or Sell
4
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
5
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
6
Office of the Law Revision Counsel. 26 US Code 1256 – Section 1256 Contracts Marked to Market
7
Internal Revenue Service. Form 6781 – Gains and Losses From Section 1256 Contracts and Straddles
8
eCFR. 26 CFR 1.1092(c)-1 – Qualified Covered Calls
9
Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
10
Internal Revenue Service. Instructions for Form 8949
11
Internal Revenue Service. About Form 6781, Gains and Losses From Section 1256 Contracts and Straddles