A Note on Taxes and the Pricing of Treasury Bill Futures Contracts

Abstract

FUTURES CONTRACTS IN GENERAL, and Treasury bill futures in particular, are taxed in a manner that provides individual investors with an apparent opportunity.' The IRS currently considers all futures contracts to be capital assets. Unlike other capital assets, however, the holding period for long-term gains is six months for futures contracts, but only long positions qualify. All gains and losses on short positions are short term regardless of the holding period. The asymmetrical tax treatment of short and long positions gives individual investors the opportunity to profit at the expense of the government. The investor takes a long position in a futures contract with over six months to maturity and holds the position for six months. If at that time he has a loss, he sells the position, recording a short term loss. If he has a gain he holds the position another day, and records a long term gain. By this strategy all gains are taxed as long term gains, and all losses are short term. The opportunity is even greater in the Treasury bill futures market. Cash Treasury bills are not treated as capital assets, so that all gains and losses are ordinary. To take advantage of this fact the investor takes a long position in a futures contract with over six months to maturity. If he has a gain on the last trading day, he liquidates his futures contract and records a long term gain. If he has a loss, he waits until the contract matures and takes delivery of the bills.