What Is a Qualified Covered Call for IRS Tax Purposes — and Does Yours Qualify?

The Short Answer: What Makes a Covered Call 'Qualified'?

A qualified covered call (QCC) is a covered call that meets specific IRS rules so it does NOT suspend the holding period on your underlying stock. If your covered call is qualified, you keep counting the days toward long-term capital gains treatment on the shares you already own. If it is not qualified — meaning it falls outside those rules — the IRS treats it as part of a tax straddle under Section 1092 of the Internal Revenue Code, which freezes your holding period clock while the call is open and can turn a long-term gain into a short-term one.

The rules come from IRS Section 1092 and the related Treasury Regulations. The Options Industry Council (OIC) also covers these rules in its tax education materials. This is not a gray area — the IRS has specific numerical tests you can check before you sell the call.

Why the Qualified vs. Non-Qualified Distinction Costs Real Money

Long-term capital gains are taxed at 0%, 15%, or 20% depending on your income. Short-term gains are taxed as ordinary income — up to 37% for high earners in 2024. That gap is enormous.

Here is a simple example. You bought 100 shares of AAPL at $150 and they are now worth $220. You have held them for 10 months. You sell a covered call. If that call is NOT qualified, the IRS suspends your holding period. If you close the position two months later, you still only have 10 months of holding time — not 12 — and your gain is short-term. On a $7,000 gain, the difference between a 15% long-term rate and a 37% short-term rate is $1,540 in extra taxes on that one trade alone.

This is why every covered-call seller needs to know the qualification rules before they pick a strike and expiration.

The Four IRS Tests Your Covered Call Must Pass

The IRS lays out four conditions in Section 1092(c)(4). Your call must meet ALL four to be qualified.

1. You must be the writer (seller) of the call — not the buyer. This is always true for a standard covered call, so you pass this test automatically.

2. The call must be traded on a national securities exchange or other market approved by the IRS. Calls on AAPL, MSFT, NVDA, SPY, and most liquid US stocks listed on CBOE, NYSE Arca Options, or Nasdaq PHLX pass this test. Over-the-counter or exotic options generally do not.

3. The call must not be deep in the money. This is the test most traders fail. The IRS defines 'deep in the money' based on the stock price and the time to expiration. The general rule: the strike price must be no more than one strike below the stock's closing price on the day you sell the call. For stocks priced above $25, the IRS uses a two-strike allowance for longer-dated options (more than 30 days to expiration). The exact bracket rules are in IRS Publication 550 and Treasury Regulation 1.1092(c)-2.

4. The call must have more than 30 days to expiration IF the strike is the first in-the-money strike. Calls with 30 days or fewer to expiration that are in the money at all will generally fail the qualified test.

In plain terms: at-the-money and out-of-the-money calls with more than 30 days to expiration almost always qualify. Deep in-the-money calls and very short-dated in-the-money calls almost never qualify.

Worked Example: Checking a Real Trade on MSFT

Let's say MSFT closes at $415.00 on a Monday. You own 100 shares and want to sell a covered call expiring in 45 days.

Option A — $420 call (out of the money, 45 days out): Strike is above the stock price. This call is NOT in the money at all. It passes all four IRS tests. It is a qualified covered call. Your holding period on your MSFT shares keeps running.

Option B — $410 call (in the money by $5, 45 days out): The strike is $5 below the current price. Is this 'deep in the money'? For a stock priced between $150 and $500, the IRS generally allows the first in-the-money strike without triggering the deep-in-the-money disqualification — but only if the expiration is more than 30 days away. At 45 days, this call likely still qualifies, but you are right at the edge. Check IRS Publication 550, Table 2 for the exact strike-price brackets.

Option C — $390 call (in the money by $25, 45 days out): The strike is two full strikes below the stock price. This is almost certainly deep in the money under IRS rules. This call does NOT qualify. Selling it suspends your MSFT holding period for every day it remains open.

Option D — $412 call (in the money by $3, 22 days out): Expiration is under 30 days AND the call is in the money. This fails the expiration test. Not qualified.

The practical takeaway: stick to at-the-money or out-of-the-money strikes with at least 31 days to expiration and you will almost always be inside the qualified zone.

What Happens to the Premium You Collect?

The premium you receive when you sell a covered call is NOT taxed when you collect it. According to IRS Publication 550, the tax treatment depends on what happens next.

If the call expires worthless, the premium becomes a short-term capital gain in the tax year it expires — regardless of whether the call was qualified or not. Holding period of the call itself does not matter here.

If the call is exercised and your shares are called away, the premium is added to the sale proceeds of the stock. The gain or loss on the stock is then long-term or short-term based on how long you held the shares — which is exactly why the qualified vs. non-qualified distinction matters so much.

If you buy the call back to close the position, you have a capital gain or loss on the option itself. Short-term in almost all retail cases, since most covered calls are held less than a year.

Canadian investors: the CRA treats option premiums differently. Under CRA guidance, premiums received on covered calls are generally treated as capital gains at the time of expiry or close, not ordinary income. Consult a Canadian tax professional and review CRA Interpretation Bulletin IT-479R for details.

The Risks You Need to Know Before You Sell

Tax straddle risk is real and not obvious. Many retail traders sell a slightly in-the-money call to collect more premium without realizing they have just frozen their holding period. If the stock then drops and they sell the shares at a loss, that loss may be deferred under the straddle rules — meaning they cannot claim it in the current tax year.

Wash-sale rules can also interact with covered calls in unexpected ways. FINRA and the SEC have both issued investor education materials warning that options strategies can trigger wash-sale complications when combined with stock purchases or sales in the same account.

Record-keeping is your responsibility. Your broker's 1099-B will show proceeds from option sales, but it will NOT tell you whether your call was qualified or not. You need to track that yourself — specifically the stock's closing price on the day you sold the call, the strike you chose, and the days to expiration.

Always consult a qualified tax professional or CPA before making decisions based on these rules. Tax law changes, and the IRS can update the strike-price brackets in Publication 550 annually. The information here is educational, not tax advice.

A Quick Checklist Before You Sell Your Next Covered Call

Run through these four questions before you enter the trade:

1. Is the call listed on a recognized exchange like CBOE or NYSE Arca Options? If yes, check.

2. Is the strike at the money or out of the money? If yes, you are almost certainly in qualified territory.

3. If the strike is in the money, is it only the first in-the-money strike (not deep in the money)? If yes, move to question 4.

4. Does the call have more than 30 days to expiration? If yes, you likely qualify.

If you answer no to question 3 or 4, treat the call as non-qualified and assume your holding period on the underlying stock will be suspended while the call is open. Adjust your strategy or your strike accordingly.

The OIC offers free educational resources on options taxation that can help you build this habit into your trade-entry process. Pairing that with IRS Publication 550 gives you the two primary sources you need.

Does selling a covered call reset my long-term holding period on the stock?

Only if the call is non-qualified under IRS Section 1092. A qualified covered call — generally at the money or out of the money with more than 30 days to expiration — does not suspend your holding period. A deep-in-the-money or very short-dated in-the-money call will freeze the clock for every day it is open.

Where exactly does the IRS define what a qualified covered call is?

The primary source is Internal Revenue Code Section 1092(c)(4) and Treasury Regulation 1.1092(c)-2. IRS Publication 550 (Investment Income and Expenses) also contains a plain-English summary and the specific strike-price bracket tables you need to check your trades.

Is the premium I collect from a covered call taxed as ordinary income?

No. Under IRS Publication 550, option premiums are not taxed when received. If the call expires worthless, the premium is a short-term capital gain in that tax year. If the call is exercised, the premium is added to your stock sale proceeds and the gain is long-term or short-term based on your stock holding period.

Can I sell an in-the-money covered call and still have it be qualified?

Yes, but only under narrow conditions. The call must be the first in-the-money strike — not deep in the money — and it must have more than 30 days to expiration. Check the specific price brackets in IRS Publication 550, Table 2, because the allowable in-the-money amount varies by stock price range.

How do I know if my covered call is deep in the money by IRS standards?

The IRS uses price brackets tied to the stock's closing price on the day you sell the call. For stocks priced above $25, the allowable in-the-money amount is generally one or two strikes depending on expiration length. The exact brackets are published in IRS Publication 550 and updated periodically, so check the current year's version before trading.

Do these IRS qualified covered call rules apply to Canadian investors too?

No. Canadian investors are governed by the Canada Revenue Agency (CRA), not the IRS. The CRA has its own rules for covered call taxation, outlined in CRA Interpretation Bulletin IT-479R, and generally treats premiums as capital gains rather than income. Canadian investors should consult a tax professional familiar with CRA options guidance.