Tax season catches a lot of options traders off guard. Covered call premiums seem simple — you sold an option, you collected money — but the IRS treats them very differently depending on what happens to that option afterward. Getting this wrong doesn't just mean a messy tax filing. It can mean paying more tax than you owe, or triggering a wash sale you didn't intend.
Here are the four main scenarios you'll encounter and exactly how each one is taxed. (A reminder upfront: this is educational information, not tax advice — your specific situation warrants a conversation with a qualified CPA.)
Scenario 1: Your Covered Call Expires Worthless
The most common and simplest outcome. You sold a $175 covered call on AAPL for $3.00 and it expired worthless on Friday. The $300 premium is treated as a short-term capital gain — regardless of how long you've held the underlying shares. It goes on Schedule D as a closed option transaction. Straightforward.
Scenario 2: You Buy to Close Your Call
You sold the $175 call for $3.00 and bought it back at $1.50 to lock in the gain early. Your $150 profit is a short-term capital gain. Alternatively, if you bought it back at $4.50 to cut a loss, the $1.50 × 100 = $150 is a short-term capital loss. Both get reported on Schedule D as separate opening and closing transactions.
Scenario 3: Your Shares Get Called Away
This one surprises people. When your covered call is exercised and your shares are called away, the IRS says the call premium gets added to your sale proceeds — it's not a separate transaction. Here's how the math works:
- Strike price: $175 → Sale proceeds = $175 + $3.00 call premium = $178 per share effective sale price
- Your gain or loss depends on your cost basis in the shares, not the option
- Whether the gain is short-term or long-term is determined by how long you held the shares — not the option
Scenario 4: You Roll Your Covered Call
Rolling creates two separate taxable events: the buy-to-close is a realized gain or loss immediately, and the sell-to-open is a new open position. Be particularly careful here about wash sale implications — if you close a call at a loss and open a substantially identical position within 30 days, the IRS wash sale rule can disallow that loss. In practice, rolling to a different strike or expiration often avoids this, but it requires careful tracking.
What Are Qualified vs Unqualified Covered Calls?
Most wheel traders never encounter this distinction, but it's worth knowing. A covered call is considered "unqualified" if it's deep in the money — specifically, if the strike is below the first available in-the-money strike. An unqualified covered call can suspend the long-term holding period clock on your underlying shares, potentially converting what would have been a long-term capital gain into a short-term one. If you're selling calls well above your cost basis (which is standard wheel strategy practice), you're almost certainly in the clear.
What Should Your Tracking Records Include for Tax Season?
- Net premium for every trade (after all fees)
- Outcome tag: expired, closed at profit, closed at loss, exercised, or rolled
- Fee amounts listed separately for Schedule D
- Roll pair links for wash sale analysis
- Dividend records if you're wheeling dividend stocks