It should come as no surprise that the tax authorities are going to be eager to claim their share of your profits generated from selling options which reminds me of a joke: Why didn’t the options trader invite the tax collector to the party? Because they heard he was really good at ‘putting‘ a damper on things!
In this article I will answer the following questions I get asked often:
- What is the required stamp duty for options you purchase?
- What are the capital gains taxes applicable to your options income?
- Is it possible to execute the options wheel strategy within a tax-exempt ISA?
- Can covered calls and cash secured puts be traded within a Self-Invested Personal Pension (SIPP)?
- Which broker would you recommend for investing in options through a SIPP?
Table of Contents
What is Stamp Duty Reserve Tax (SDRT) and how does it affect option trading in the UK?
Stamp Duty Reserve Tax (SDRT) is a tax that is imposed on the purchase of shares in the UK at a rate of 0.5%.
This tax applies to option trading as well. Meaning, traders will have to pay SDRT on their option purchases.
For example, if you were to invest £10,000 in UK shares, you would be required to pay an extra £50 as stamp duty.
|Investment Amount (in £)
|Stamp Duty (in £)
So if you were assigned your shares from selling a cash secured put option, you would need to pay this 0.5% tax.
It’s important to keep this in mind when choosing which options to sell and at what premiums.
From experience, when I sell a cash secured puts on UK stocks I like to look at premiums of 2% or more. This means if I get assigned and have to buy the shares, the 0.5% tax doesn’t eat into my profits that much.
What are the capital gains tax rates for option trading in the UK?
Profits generated from the sale of shares in the UK are subject to capital gains tax (CGT).
The CGT rates for option trading in the UK are 10% or 20%. This all depends on whether you are a basic or higher/additional rate taxpayer.
There is also an annual tax-free allowance of £12,300 in the 2022/23 tax year for CGT. Annoyingly, this will be reduced to £6,000 in 2023/24 and further reduced to £3,000 in 2024/25.
|Annual CGT Allowance (in £)
Understanding the Tax Rates for Earnings (UK)
Income tax is levied at the “basic rate” of 20% on taxable earned income that exceeds both your personal allowance (and blind person’s allowance, if applicable) and falls within the basic rate band.
For the tax year 2023/24, the basic rate band is set at £37,700.
To illustrate, let’s consider an example where an individual has taxable earnings of £40,000.
In this case, they would be liable to pay a 20% tax on the amount that exceeds their personal allowance, which is £27,430.
Consequently, their tax liability would amount to £5,486.
If your taxable earned income surpasses the basic rate limit AND your personal allowance (and blind person’s allowance, if applicable), you will be subject to a higher tax rate of 40% instead of the basic rate.
The threshold at which this higher rate tax begins to apply is known as the “higher rate threshold.” In the tax year 2023/24, the higher rate threshold stands at £50,270. This figure is calculated by adding the £12,570 personal allowance to the £37,700 basic rate band.
Should your taxable earned income exceed the higher rate band limit, you will be liable to pay tax at an additional rate of 45% on the income exceeding the limit.
For the tax year 2023/24, the higher rate band limit, also referred to as the additional rate threshold, is set at £125,140.
|Income Range (in £)
|Up to £12,570
|£12,571 – £50,270
|£50,271 – £125,140
NOTE There is a crucial point to note regarding the ability to offset losses against gains. If you experience a loss from one options trade, you have the opportunity to offset that loss against a gain from another trade.
What are the tax on UK dividend shares?
It’s important to acknowledge that any dividends you receive from your owned shares are also subject to taxation.
In this case, dividends are treated as income and fall under the purview of your personal tax allowance.
The tax-free dividend allowance for the financial year 2023/24 has been reduced by half, from £2,000 in 2022/23 to £1,000.
Individuals who receive dividend income exceeding £1,000 during the 2023/24 financial year will be required to pay dividend tax on the surplus amount at their marginal rate.
|Dividend Allowance (in £)
|Excess Taxed at Marginal Rate
What are the tax implications for receiving dividends from owned US shares?
In the case of receiving dividends from US companies, a withholding tax of 30% is imposed.
This tax can be reduced to 15% by completing a US tax form known as W-8BEN.
|Withholding Tax Rate
|Receiving dividends from US companies
|With W-8BEN form completed
Can you trade options and not pay tax?
Can options be traded in a tax-free ISA?
No, options cannot be traded in a tax-free Individual Savings Account (ISA). There are other tax-free investment options available so you won’t incur tax liabilities.
What is a Self-Invested Personal Pension (SIPP) and how can it be used to tax wrap option trading income?
A Self-Invested Personal Pension (SIPP) is a type of pension wrapper that allows individuals to contribute funds without incurring tax.
SIPPs can be used to tax wrap option trading income. Interactive Brokers allows you to manage your options trading from within a SIPP. This allows traders to generate income without incurring significant tax liabilities.
The process remains the same as conducting these strategies outside of a SIPP, with one key distinction. Within a SIPP, you are required to maintain a cash account since borrowing funds is not permitted.
This limitation poses no issues if you have no intention of utilising leverage when it comes to your long-term savings.
Until the age of 55, you have the option then to reinvest the generated income from options back into my pension. Thus harnessing the power of compounding to grow your retirement savings faster!
Then, when you reach the age of 55, you can start transferring the monies from your SIPP in to your bank account for personal use.
I know several options traders that do this now and it’s a great way to generate monthly cash flow in a tax free way.
Another advantage is the ability to transfer an existing pension to a SIPP and subsequently contribute up to £40,000 annually. This is particularly beneficial for individuals who own their own business, as they can transfer funds tax-free from their business directly into their SIPP.
If you’re interested in delving further into the details of this process, you can find more information on the relevant page of the Interactive Brokers website here.
What is the difference between being classified as a “share trader” versus a “share investor” and how does it affect taxation on option trading profits?
The difference between being classified as a “share trader” versus a “share investor” is that a trader purchases shares with the intention of selling them for profit.
An investor acquires an asset with the goal of generating income such as dividends from owning shares.
The tax implications of being classified as a trader versus an investor can be significant. As profits from trading activities are subject to income tax rather than capital gains tax (CGT).
This means that traders may have to pay higher tax rates on their option trading profits Vs investors.
It is important to be aware of your own tax status. It’s can be more advantageous to be classified as an investor rather than a trader.
But, determining the exact classification can be complex. This is because the tax regulations may not provide a straightforward definition.
I know this subject is a little dull, but it’s good to be familiar with I am sure you would agree.
Oh, and by the way, if you’d like a free PDF version of everything to do with selling options, you can grab a copy of my Options Selling Roadmap here.
As always, happy investing!
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