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Trader Tax Status corrections by Green
The tax guide that I prepared from RIA tax research and sent to people who ordered it is entirely correct.
Some postings I previously made on SI's threads are corrected as follows. According to CCH, "the gains and losses from a trader's securities transactions are capital." As opposed to ordinary gain or loss. This contradicts some of the posts we have made on SI. According to RIA, "Any gain or loss recognized by an electing taxpayer is ordinary gain or loss. (Com Rept, see 5111). See the RIA research below.
A trader's "realized" gains and losses are capital, but properly elected year end mark to market gains and losses are "ordinary." Therefore, the $3,000 capital loss limitation remains in effect for a trader's realized losses, but it can be exceeded in an unlimited amount for a trader's year end marked to market ordinary losses.
RIA tax research (CD-ROM) searched "trader" under 1997 Tax Law.
2001. Commodities dealers and traders in securities and commodities can elect the mark-to-market rules
Code Sec. 475(e), as amended by '97 Act 1001(b)
Code Sec. 475(f), as amended by '97 Act 1001(b)
Generally effective: Tax years ending after Aug. 5, '97
Committee Reports, see 5111
Under pre-'97 Act law, the mark-to-market method of accounting that applies to securities dealers did not apply to traders in securities or to dealers in other property. Traders in securities generally are taxpayers who engage in a trade or business involving active sales or exchanges of securities on the market, rather than to customers. ( FTC 2d/FIN I-7650 USTR 4754)
New Law. Congress believes that mark-to-market accounting generally provides a clear reflection of income with respect to assets that are traded in established markets. For market-valued assets, mark-to-market accounting imposes few burdens and offers few opportunities for manipulation. Securities and exchange-traded commodities have determinable market values, and securities traders and commodities traders and dealers regularly calculate year-end values of their assets in determining their income for financial statement purposes. Many commodities dealers also utilize year-end values in adjusting their inventory using the lower-of-cost-or-market method for federal income tax purposes. (Com Rept, see 5111)
The '97 Act allows commodities dealers and securities traders and commodities traders to elect application of the mark-to-market accounting rules, which applied only to securities dealers under pre-'97 Act law. (Com Rept, see 5111)
Dealers in commodities. In the case of a dealer in commodities (defined below) who makes an election, the mark-to-market rules apply to commodities held by that dealer in the same manner as the mark-to-market rules apply to securities held by a dealer in securities. ( Code Sec. 475(e)(1) '97 Act 1001(b)) Any gain or loss recognized by an electing taxpayer is ordinary gain or loss. (Com Rept, see 5111)
475 Mark to market accounting method for dealers in securities.
(1) In general.
In the case of a dealer in commodities who elects the application of this subsection, this section shall apply to commodities held by such dealer in the same manner as this section applies to securities held by a dealer in securities.
observation: This means that exceptions to the mark-to-market rules that apply to securities dealers also apply to dealers in commodities. For example, any commodities held for investment by an electing commodities dealer would not be subject to the mark-to-market rules under Code Sec. 475(b)(1) ( FTC 2d/FIN I-7659; USTR 4754 ) if the commodities dealer complies with the identification requirements of Code Sec. 475(b)(2) ( FTC 2d/FIN I-7660.1; USTR 4754).
Commodity defined. For purposes of the election to be subject to the mark-to-market rules by either a commodities dealer (see above) or a trader in securities or commodities (see below), commodity means ( Code Sec. 475(e)(2))
(1) any commodity which is actively traded (within the meaning of Code Sec. 1092(d)(1) ) (i.e., personal property for which there is an established financial market, see FTC 2d/FIN I-7506.1; USTR 10,924 ); ( Code Sec. 475(e)(2)(A))
(2) any notional principal contract with respect to any commodity described in (1), above; ( Code Sec. 475(e)(2)(B))
(3) any evidence of an interest in, or a derivative instrument in, any commodity (described in (1) or (2) above), including any option, forward contract, futures contract, short position, and any similar instrument in a commodity; and ( Code Sec. 475(e)(2)(C))
(4) any position which: ( Code Sec. 475(e)(2)(D))
. . . is not a commodity described in (1), (2), or (3) above, ( Code Sec. 475(e)(2)(D)(i))
. . . is a hedge with respect to a commodity (described in (1), (2), or (3) above), and ( Code Sec. 475(e)(2)(D)(ii))
. . . is clearly identified in the taxpayer's records as being described in Code Sec. 475(e)(2)(D) (i.e., as a hedge with respect to commodities described in (1), (2), or (3)) before the close of the day on which it was acquired or entered into (or any other time as IRS may by regs prescribe). ( Code Sec. 475(e)(2)(D)(iii))
How to make the election. An election by a dealer in commodities to be subject to the mark-to-market rules may be made without IRS's consent. ( Code Sec. 475(e)(3)) The election is made in the time and manner to be prescribed by IRS. (Com Rept, see 5111) The election, once made, applies to the tax year for which made and all later tax years unless revoked with IRS's consent. ( Code Sec. 475(e)(3))
Traders in securities and traders in commodities.
Securities traders. In the case of a person who is engaged in a trade or business as a trader in securities and who elects to have the mark-to-market rules apply to the trade or business: ( Code Sec. 475(f)(1)(A))
475 Mark to market accounting method for dealers in securities.
(1) Traders in securities.
(A) In general. In the case of a person who is engaged in a trade or business as a trader in securities and who elects to have this paragraph apply to such trade or business --
(i) such person shall recognize gain or loss on any security held in connection with such trade or business at the close of any taxable year as if such security were sold for its fair market value on the last business day of such taxable year, and
(ii) any gain or loss shall be taken into account for such taxable year.
Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence. The Secretary may provide by regulations for the application of this subparagraph at times other than the times provided in this subparagraph.
(B) Exception. Subparagraph (A) shall not apply to any security --
(i) which is established to the satisfaction of the Secretary as having no connection to the activities of such person as a trader, and
(ii) which is clearly identified in such person's records as being described in clause (i) before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).
If a security ceases to be described in clause (i) at any time after it was identified as such under clause (ii), subparagraph (A) shall apply to any changes in value of the security occurring after the cessation.
(C) Coordination with section 1259. -- Any security to which subparagraph (A) applies and which was acquired in the normal course of the taxpayer's activities as a trader in securities shall not be taken into account in applying section 1259 to any position to which subparagraph (A) does not apply.
(D) Other rules to apply. Rules similar to the rules of subsections (b)(4) and (d) shall apply to securities held by a person in any trade or business with respect to which an election under this paragraph is in effect.
. . . the person recognizes gain or loss on any security held in connection with the trade or business at the close of any tax year as if the security were sold for its fair market value on the last business day of the tax year, and ( Code Sec. 475(f)(1)(A)(i))
. . . any gain or loss is taken into account for the tax year. ( Code Sec. 475(f)(1)(A)(ii))
Any gain or loss recognized by an electing taxpayer is ordinary gain or loss. (Com Rept, see 5111)
A security that hedges another security that is held in connection with the taxpayer's trade or business as a trader will be treated as so held. (Com Rept, see 5111)
observation: Thus, an electing taxpayer will recognize gain or loss under the above rules from a security that hedges another security that is held in connection with the taxpayer's trade or business.
Congress does not intend that an electing taxpayer can mark-to-market loans made to customers or receivables or debt instruments acquired from customers that are not received or acquired in connection with a trade or business as a securities trader. (Com Rept, see 5111)
Proper adjustment is made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the above rule (described in Code Sec. 475(f)(1)(A)(i) and Code Sec. 475(f)(1)(A)(ii) ). IRS may provide by regs for the application of the above rules (i.e., the recognition of gain or loss) at times other than the times provided in the above rule (i.e. at times other than the last business day of the tax year). ( Code Sec. 475(f)(1)(A))
Traders in commodities. In the case of a person who is engaged in a trade or business as a trader in commodities (defined above) and who elects to have the mark-to-market rules apply to the trade or business, the rules described in Code Sec. 475(f)(1) (see above) for securities traders who make the mark-to-market election also apply to commodities held by that trader in connection with the trade or business in the same manner as those rules apply to securities held by a trader in securities. ( Code Sec. 475(f)(2))
Exception for certain securities that are not connected to the trader's activities and are clearly identified in the trader's records. The election of the mark-to-market rules by a securities trader does not apply to any security: ( Code Sec. 475(f)(1)(B))
(1) which is established to IRS's satisfaction as having no connection to the activities of the person as a trader, and ( Code Sec. 475(f)(1)(B)(i))
(2) which is clearly identified in the person's records as having no connection to the activities of the person as a trader (see (1) above) before the close of the day on which it was acquired, originated, or entered into (or any other time as IRS may by regs prescribe). ( Code Sec. 475(f)(1)(B)(ii))
Because Congress was concerned with issues of taxpayer selectivity, Congress intends that an electing taxpayer must be able to demonstrate by clear and convincing evidence that a security bears no relation to activities as a trader in order to be identified as not subject to the mark-to-market regime. (Com Rept, see 5111)
If a security ceases to have no connection to the activities of the person as a trader (as described in (1) above) at any time after it was identified as having no connection (under (2) above), the election applies to any changes in value of the security occurring after the cessation. ( Code Sec. 475(f)(1)(B))
Coordination with the constructive sale rules. Any security which is subject to a securities trader's election to have the mark-to-market rules apply and which was acquired in the normal course of the taxpayer's activities as a trader in securities is not taken into account in applying Code Sec. 1259 (constructive sales treatment for certain appreciated financial positions, see 202 ) to any position to which the election does not apply. ( Code Sec. 475(f)(1)(C))
observation: Any securities held by a taxpayer that are subject to the mark-to-market rules are exempt from the constructive sale rules, see 202.
Application of other mark-to-market rules. Rules similar to the rules of Code Sec. 475(b)(4) (rules preventing a securities dealer from treating certain notional principal contracts and other derivative financial instruments as held for investment, see FTC 2d/FIN I-7659.2; USTR 4754), Code Sec. 475(d)(1) (rules coordinating the mark-to-market rules with other tax rules (see FTC 2d/FIN I-7663; USTR 4754 ), Code Sec. 475(d)(2) (rules relating to securities improperly identified as qualifying for an exception to the mark-to-market rules, see FTC 2d/FIN I-7662; USTR 4754 ), and Code Sec. 475(d)(3) (rules relating to the character of gain or loss under the mark-to-market rules, see FTC 2d/FIN I-7654; USTR 4754 ) apply to securities held by a person in any trade or business with respect to which an election by a securities or commodities trader to have the mark-to-market rules apply is in effect. ( Code Sec. 475(f)(1)(D)) In the case of a commodities trader or dealer, Congress anticipates that Code Sec. 475(b)(4) (see above) will apply only to contracts and instruments referenced to commodities. (Com Rept, see 5111)
How to make the election. The elections for traders in securities (see above) and traders in commodities (see above) to be subject to the mark-to-market rules can be made separately for each trade or business and without IRS's consent. ( Code Sec. 475(f)(3)) Thus, a taxpayer that is both a commodities dealer and a securities trader may make the election with respect to one business, but not the other business. (Com Rept, see 5111)
The election is made in the time and manner to be prescribed by IRS. (Com Rept, see 5111) The election, once made, applies to the tax year for which made and all later tax years unless revoked with IRS's consent. ( Code Sec. 475(f)(3))
Four-year spread for Code Sec. 481 adjustments. In the case of a taxpayer who elects to have the mark-to-market rules under Code Sec. 475(e) (election for commodities dealers, see above) or Code Sec. 475(f) (election for securities traders and commodities traders) to change its method of accounting for the tax year which includes Aug. 5, '97, ( '97 Act 1001(d)(4)(B)) the net amount of the adjustments required to be taken into account by the taxpayer under Code Sec. 481 as a result of the change in accounting method is taken into account ratably over the four tax year period beginning with the first tax year. ( '97 Act 1001(d)(4)(B)(ii)) This rule only applies to taxpayers making the election for the tax year which includes Aug. 5, '97. Any elections made after the tax year which includes Aug. 5, '97 will be governed by rules and procedures established by IRS. (Com Rept, see 5111)
[] Effective: Tax years ending after Aug. 5, '97. ( '97 Act 1001(d)(4)(A))
In the case of a taxpayer who elects to have the mark-to-market rules under Code Sec. 475(e) (election for commodities dealers, see above) or Code Sec. 475(f) (election for securities traders and commodities traders) to change its method of accounting for the tax year which includes Aug. 5, '97: ( '97 Act 1001(d)(4)(B)) any identification required under the elections with respect to securities and commodities held on Aug. 5, '97 is treated as timely made if made on or before the 30th day after Aug. 5, '97, ( '97 Act 1001(d)(4)(B)(i))
action alert: Securities and commodities traders and dealers in commodities must identify the securities or commodities, to which the election to be subject to the mark-to-market rules will apply, within 30 days of Aug. 5, '97. |
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