Are Covered Call Premiums Taxed as Ordinary Income or Capital Gains?

The Short Answer: Premiums Are Not Taxed When You Collect Them

When you sell a covered call, the premium you collect is not taxed right away. The IRS does not treat that cash as income the moment it hits your account. Instead, the tax event happens later — when the option expires, gets closed, or results in your shares being called away. In almost every common scenario, the premium ends up taxed as a short-term capital gain, not ordinary income. That distinction matters because short-term capital gains are taxed at your regular income tax rate, which can be as high as 37% for federal purposes in 2024.

How the IRS Actually Taxes Covered Call Premiums

The IRS lays out the core rules for options taxation in Publication 550 (Investment Income and Expenses). Here is how the three most common outcomes are treated:

**Option expires worthless.** This is the best-case scenario for a covered call seller. When the option expires with no value, you recognize a short-term capital gain equal to the full premium you collected — regardless of how long you held the option open. The gain is reported in the tax year the option expires.

**You buy the option back to close the position.** If you close the trade before expiration by buying the same option back, your gain or loss equals the premium you collected minus what you paid to close. That net amount is a short-term capital gain or loss. Again, holding period of the option does not matter here — options you write (sell to open) always produce short-term results when closed or expired.

**Your shares get called away (assignment).** This is where it gets more complicated. When the buyer exercises the call and your shares are sold at the strike price, the premium you collected gets added to your sale proceeds. The gain or loss on the stock itself depends on how long you held those shares — and that holding period can be affected by the covered call you wrote. More on that in the next section.

The Holding Period Trap: How Covered Calls Can Turn Long-Term Gains Short-Term

This is the most overlooked tax risk in covered call writing. The IRS has rules — sometimes called the "qualified covered call" rules under IRC Section 1092 — that can suspend or eliminate the long-term holding period on your underlying shares while a covered call is open.

If you sell a call that is "in the money" or does not meet the IRS definition of a qualified covered call, the clock on your stock's holding period stops ticking. If your shares had not yet reached the 12-month threshold for long-term capital gains treatment, that pause could cost you. You might sell shares you thought would qualify for the 15% or 20% long-term rate, only to find out they are taxed at your ordinary income rate instead.

A qualified covered call generally must be written on stock you already own, have a strike price that is not too deep in the money relative to the stock's price, and have more than 30 days until expiration. The IRS Publication 550 and the Options Industry Council (OIC) both provide detailed criteria. If you are close to the 12-month mark on a stock position, talk to a tax professional before writing any call that is at or in the money.

Canadian investors face a parallel issue. The Canada Revenue Agency (CRA) treats covered call premiums as capital gains in most cases, but the CRA can reclassify that income as business income if it determines you are trading options as a business rather than as an investor. Frequency, intent, and the size of your positions all factor into that determination.

Worked Example: AAPL Covered Call, Three Outcomes

Let's make this concrete. Suppose you own 100 shares of Apple (AAPL) that you bought 8 months ago at $170 per share. AAPL is now trading at $195. You sell one covered call with a $200 strike expiring in 45 days and collect a $3.50 premium, or $350 total.

**Outcome 1 — Option expires worthless.** AAPL closes at $198 on expiration day. The $200 call expires with no value. You keep your 100 shares and recognize a $350 short-term capital gain in the current tax year. Your shares' holding period was not affected because the $200 strike was out of the money and the call met the qualified covered call definition.

**Outcome 2 — You close early.** Two weeks later AAPL drops to $185 and the call is now worth $0.80. You buy it back for $80. Your short-term capital gain is $350 minus $80, or $270.

**Outcome 3 — Assignment.** AAPL rallies to $205 and the buyer exercises. Your 100 shares are sold at $200. Your total proceeds are $20,000 (strike) plus $350 (premium) = $20,350. Your cost basis was $17,000 (100 shares × $170). Your gain is $3,350. Because you held the shares for only 8 months at the time of sale and the holding period was not suspended, this is still a short-term capital gain — you had not yet crossed the 12-month threshold. Had you held those shares for 13 months before the call was assigned, the stock gain would have been long-term and taxed at the preferential rate, with only the premium portion treated as short-term.

The numbers shift meaningfully depending on your tax bracket. At a 32% federal rate, a $3,350 short-term gain costs roughly $1,072 in federal tax. At the 15% long-term rate, the same gain would cost $503. That $569 difference is real money — and it is why holding period management matters.

Risks You Need to Know Before You Write Your Next Call

Tax risk is not the only thing that can go wrong. Here are the main risks covered call writers face, stated plainly:

**Capped upside.** If AAPL jumps from $195 to $220 and you sold the $200 call, your shares get called away at $200. You miss $20 per share of upside. The $3.50 premium does not come close to covering that gap.

**Stock can still fall.** The premium provides a small cushion — in the AAPL example, $3.50 per share — but if AAPL drops to $160, you still lose $35 per share on the stock. Covered calls reduce risk slightly; they do not eliminate it.

**Early assignment.** American-style options (which most US equity options are) can be exercised at any time before expiration. If the call goes deep in the money, you could be assigned before you planned, triggering a taxable sale of your shares earlier than expected.

**Wash sale interaction.** If you close a covered call at a loss and then write a substantially identical call within 30 days, the wash sale rule under IRS guidelines may disallow that loss. FINRA and the IRS both flag options in wash sale analysis. This is a gray area — consult a tax advisor.

**Complexity at tax time.** Each option trade generates its own 1099-B entry. If you are writing calls on multiple positions throughout the year, your tax return gets complicated fast. Good record-keeping from day one saves headaches in April.

What This Means for Your Strategy Going Forward

Most covered call writers are selling short-dated, out-of-the-money calls on stocks they plan to hold long-term. If that describes you, the tax picture is fairly straightforward: premiums from expired or closed calls are short-term capital gains, and you report them in the year they are realized.

The place to be careful is when you are approaching the 12-month mark on a stock you want to hold for long-term gains treatment. In that window, writing an in-the-money or deep-in-the-money call can freeze your holding period and cost you the preferential rate. The OIC recommends that investors review the qualified covered call rules before writing any call on a position that is close to the long-term threshold.

For Canadian investors, the CRA's position is that premiums are generally capital gains, but the agency looks at the full picture of your trading activity. If you are writing calls on dozens of positions every month, the CRA may decide you are running a business, which means the income is fully taxable at your marginal rate with no capital gains inclusion rate benefit.

The bottom line: covered call premiums are almost always short-term capital gains, not ordinary income. But the tax impact on your underlying shares — and whether you preserve long-term gains treatment — depends on which calls you write and when. When in doubt, run the scenario by a tax professional before you place the trade, not after.

Are covered call premiums considered ordinary income by the IRS?

No. The IRS does not classify covered call premiums as ordinary income in most cases. When an option expires worthless or you close it by buying it back, the gain is treated as a short-term capital gain, which is taxed at your ordinary income rate — but it is still reported as a capital gain on Schedule D, not as wages or business income. IRS Publication 550 covers the details.

When do I actually owe tax on a covered call premium?

You owe tax in the year the option position is closed — either by expiration, by buying it back, or by assignment of your shares. The premium you collect when you open the trade is not a taxable event on its own. The IRS defers the tax until the position is resolved.

Can selling covered calls ruin my long-term capital gains on a stock?

Yes, it can. Under IRC Section 1092, writing a call that does not qualify as a "qualified covered call" can suspend your stock's holding period. If your shares have not yet hit the 12-month mark for long-term treatment, that suspension could mean your eventual stock sale is taxed at short-term rates instead of the lower long-term rate. The Options Industry Council (OIC) has detailed guidance on qualified covered call criteria.

How are covered call premiums taxed in Canada?

The Canada Revenue Agency (CRA) generally treats covered call premiums as capital gains, meaning only 50% of the gain is included in taxable income under current inclusion rules. However, the CRA can reclassify the income as fully taxable business income if it determines you are trading options as a business based on frequency and intent. Canadian investors who write calls regularly should consult a tax advisor familiar with CRA options guidance.

What happens tax-wise if my covered call gets assigned?

When your shares are called away, the premium you collected is added to your sale proceeds from the stock. The total gain or loss on the stock is then short-term or long-term depending on how long you held the shares — and whether the covered call suspended your holding period. The option premium itself does not get a separate long-term treatment even if the stock gain qualifies.

Do covered calls trigger the wash sale rule?

They can. If you close a covered call at a loss and write a substantially identical call within 30 days before or after, the IRS wash sale rule may disallow that loss. FINRA and the IRS both include options in wash sale analysis, though the rules around "substantially identical" options are not always clear-cut. Keep detailed records and consult a tax professional if you are closing losing option positions and re-entering similar trades.