Mark to Market (475(f)) Election
For people classified as securities traders, the mark-to-market election exists to potentially provide income tax relief depending on the taxpayer's particular facts and circumstances. The section 475(f) election can only be taken if a taxpayer meets very specific criteria that has been largely defined by case law. Below, I will highlight some of the general facts about this election.
To make a mark-to-market election, a taxpayer must qualify as a trader. Based on case history, the characteristics of a trader include the following:
- The taxpayer cannot be considered an investor or a dealer in securities/commodities;
- The trading activities of a taxpayer must be conducted as a trade or business;
a) The trading activities of a taxpayer must not reflect an investment intent (traders seek to take advantage of short-term swings in the market);
b) The nature of the income derived from the trading activity must be primarily attributed to the short-term trading of securities; and
c) The taxpayer must be engaged in substantial trading activity.
The IRS has also set forth a series of criteria for determining whether a taxpayer qualifies for the election:
- The taxpayer must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
- The activity must be substantial; and
- The activity must be carried on with continuity and regularity.
The IRS examines the following areas to arrive at a determination:
- Typical holding periods for securities bought and sold;
- The frequency and dollar amount of trades during the year;
- The extent to which the taxpayer pursues the activity to produce income for his or her livelihood; and
- The amount of time devoted to the activity.
How to Elect
A taxpayer may make the mark-to-market election using the procedures of Rev. Proc. 99-17. The election must be made by the original due date of the applicable return and may only be revoked with permission from the IRS. Making the election involves attaching a statement to the return. The statement must include the following information:
- That the taxpayer is making the election under 475(f);
- The fist tax year for which the election is effective; and
- The trade or business for which the taxpayer is making the election.
Note that Section 9100 provides relief for taxpayers who fail to make a timely mark-to-market election. To receive relief, a taxpayer must have acted reasonably/in good faith, and granting the relief will not prejudice the government's interests.
What's the Benefit?
The benefits of a mark-to-market election include:
- The ability to deduct losses beyond the $3,000 per year capital loss limit; and
- The ability to deduct expenses associated with the trading business (including computers and the home office deduction).
Drawbacks for making the election include:
- Losing preferential tax rates for long-term capital gains and qualified dividends for securities used in the business;
- The difficulty in revoking the election (change in accounting - form 3115 would be required); and
- Recognition of the fair market value of securities on hand at the end of year regardless of whether the securities were sold.
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.