If I were to ask you, what your largest expense is? What would you say? You know, what is the thing? The one thing that costs you the most money? Is it your mortgage? student loan payments, car payments, credit card? health insurance? What is it? Well, if you saw the title of this episode, you probably guessed that I'm talking about taxes. And, I mean, you can name them right with all the different types of taxes that we pay. It adds up, we got income taxes for federal and for state, we got payroll taxes, we got property taxes, we got estate taxes, we've got gift taxes, we've got sales taxes, on and on, there's a lot more that I can't even think of. I mean, it is estimated that most Americans pay somewhere close to 50% of their earnings on taxes. Now, I'm guessing that if you're the one that pays the bills, that's not shocking to you. I mean, maybe the 50% is kind of like eye opening, like really? Is it that much? Yeah, unfortunately, it really is.
But in this episode, I wanted to talk about taxes and options, and one simple change that you can make to lower the taxes on your trading games. Now, let me start off with a disclaimer, I am not an accountant, I'm not a CPA, not a professional on taxes, nor do I want to be. So make sure that you talk to your tax person about anything that you hear. Right. Now, when it comes to federal income taxes, there are two types that deal with options trading. Now, here we're talking about, you know, your gains on your trading. So if you're making gains, there's two types of taxes that you could pay. The first is regular income taxes. And the second is capital gains taxes. So capital gains is normally the tax that you pay, when you have held an asset for a year or more. And then you sell it for a profit, you would pay capital gains tax on any profit. So if you have a stock, and you own it for over a year, when you sell it, that's the tax that you would pay capital gains. Compare that to if you held the asset for less than one year, then you would be taxed at your regular income tax rate, whatever that is. Now, capital gains is usually much lower as a percentage. Okay, I don't want to go into the actual percentages here, because they keep changing depending on who's in the White House and all that other politics. But for our purposes, capital gains is lower, and is preferred, because of course, it's less.
So, of course, the best way to deal with taxes is to not have them at all, to not have to pay them at all. And those of you who are trading in your Roth accounts, will never have to pay taxes on the gains. So if you can, that would be preferable to trade your options in your IRA so that any taxes that you have will not be taxed, you don't ever have to pay taxes on those. So that's really cool deal. Now, if you have a regular IRA, you will have to pay taxes when you eventually withdraw the money, but you don't have to pay it now. And if you're trading in a in a regular trading account, then yes, you will have to pay the taxes depending on your tax situation, quarterly or year. Okay. Now, there is a piece of the tax code that most traders don't know about. That actually helps options traders pay less taxes. It's called section 1256 of the IRS code. Now securities regarded as 1256 investments include non equity options, foreign currency contracts, regulated futures contracts, dealer equity options, and dealer securities futures contracts. Okay, so now what's the difference between section 1256 and non section prophetesses? Well, every section 1256 security, if you have a gain or loss, it is treated as being 60% long term, and 40% short term, no matter how long you own it. Now long term means that your cap is your capital gains tax rate. Okay. And the 40% short term means your personal income tax rate.
So, for example, if we have a Joe Schmo trader, he makes $1,000 on an options trade, okay, and if this was a section 1256 security option, then his capital gains tax is 15%, let's just guess