Mark-to-Market Tax Election For Securities (Not Commodities) One benefit of being a trader in securities is the ability to elect the Mark-to-Market (MTM) method of accounting. The tax election is available to an active trader and not to an investor in securities. The election is available for individuals and entities that file U.S. tax returns. Note that a person or entity trading mainly in 1256 contracts typically would not want to make the MTM election because that person would lose the 60% long-term capital gain treatment available for futures trading subject to the 1256/commodities tax rules. Contact Us
What is the Mark-to-Market Election?
The tax election is available to an active trader and not to an investor in securities. The election is available for individuals and entities that file U.S. tax returns. Contact Us Note that a person or entity trading mainly in 1256 contracts typically would not want to make the MTM election because that person would lose the 60% long-term capital gain treatment available for futures trading subject to the 1256/commodities tax rules.
Before Electing Mark-to-Market Tax Treatment Remember, you can establish an investment securities account or an entity whose trading positions are outside the scope of the mark to market election. Trades in these other accounts generate capital gain or loss. Need Assistance? Contact Us
Trading Futures and Commodities? Futures contracts (such as most index options) in mark-to-market accounts are still entitled to special tax treatment and should be excluded from the scope of the mark to market election. Mark to market is not a preferred accounting method for profitable commodities and futures traders. The reason is that the default tax rules allow for 60% long term and 40% short term capital gain. As a result, the maximum blended tax rate on commodities and futures is 23% versus 35% on securities. Electing mark to market accounting converts commodities and futures trading capital gains and losses (60/40 treatment) to ordinary gain and loss treatment (a 12% tax rate increase). However, if you have large commodity trading losses before April 15 of the current year, electing mark to market accounting will allow the trading losses to be treated as ordinary.
Strategies for Making the Mark to Market Election As the election is specific to the active trader, it is best made by an entity, rather than an individual taxpayer. An S corporation is easier to liquidate than an individual. The individual unhappy with his or her election needs to cease trading activities and become inactive (trading in the interim should be conducted through an entity) so that trading status lapses. Make sure you (or your entity) are an active securities trader. There is no bright line test for trader versus investor status based on what little legal precedent exist. Make sure you have significant portfolio turnover on an annualized basis. Other factors (use of a margin account, options, futures, and short selling) can support active trader status.
Identification of Securities Not Subject to the Election While a trader generally holds securities to capture short term market swings, a trader may nevertheless hold some securities for long term appreciation as an investment. In that circumstance, there is an exception to the market to market election if the taxpayer has clearly identified the investment securities in the trader’s records before the close of the day on which the investment security was acquired or the date the mark to market election was made. You have to be able to demonstrate by clear and convincing evidence that the securities have no connection with his or her trading business. If the electing trader holds an investment security and is also trading in the same or substantially similar security, the identification is not effective unless the investment securities are held in a separate non trading account maintained with a third party. There are two ways to make the exemption identification. The first is to establish a separate brokerage account for investment securities. The second way is to indicate on your own records which securities are not part of your trading business.
Miss the Mark to Market Election? If a taxpayer blows the timing requirement, then the mark to market election is not available for that desired election year. One way around the timing problem is to form a legal entity from which to trade, such as a LLC. For a new trading entity, you must elect within 75 days of the start of trading activities, and then include the election in the entity's first tax return. If your mix of positions includes both active trading and buying some positions (or taking some shorts), for the longer term you should establish an investment securities account. This account can be at the same brokerage where your active trading account is maintained.
Should I Consider a MTM Election? Only someone who qualifies as an active securities trader can elect MTM treatment. If you elect MTM tax treatment, it results in a "deemed" sale of your open securities positions on the last business day of the taxable year. The term "mark-to-market" refers to when all open positions are marked to fair market value at year end. In effect a sale of all open positions (long and short) is triggered for tax purposes at year end using the year end market prices. On the first day of the following year those positions are bought back for the same market value. If you make the election and have a security that has gone down in value, you will recognize a loss on that security. If you have a security that has gone up in value, you will recognize a gain on that security. Your tax basis/cost in that security is adjusted up or down to reflect the gain or loss that you recognize on your tax return. This tax treatment flushes out all realized and unrealized gains and losses for U.S. tax reporting purposes. The mark to market tax election applies only to trading gains and losses and not to business expenses. An active trader may elect MTM for trading gains and losses and use the accrual or cash method of accounting for business expenses.
Consequences of the MTM Election There are many other important things to know about the mark to market tax election.
Change in Tax Character of Gain or Loss. The MTM election changes the character of a trader’s gains or losses from capital gain or loss to ordinary income or loss. For a trader who makes the election, the $3,000 capital loss limitation no longer applies.
Wash Sale Rule No Longer Applies. Once the mark to market election is made, the wash sale rule no longer applies. That could be a huge benefit for a trader with a large number of repetitive trades in the same securities.
The Election is Permanent. The MTM election is a permanent choice. Once it is made, it cannot be withdrawn without IRS consent.
No Self Employment Tax Impact. Mark to market election does not trigger self-employment taxes on the trader’s income.
Pre-Election Trading Concerns. Once elected, you will no longer have capital gains or losses as all the gains or losses will be characterized as ordinary. If you have a large capital loss carry forward you would not want to elect mark to market accounting as ordinary income cannot be used to offset the capital loss carry forward.
Mechanics of the Mark to Market Election The mechanics of taking the election involve both the timing and certain required paperwork. The election needs to be made by the due date (without regard to extensions) of the original federal tax return for the taxable year immediately preceding the year in which the election is to be effective (the “election year”). Hence if a taxpayer wants the MTM to be effective for tax year 2013 (the election year), then the election needs to be made by the due date of the 2013 tax return—April 15, 2013. The election must either be attached to that return or to a timely-filed request for an extension of time to file that return.
Paperwork for the Mark to Market Election Attach a written statement to the tax return that provides the following information: the election being made, the first taxable year for which the election is effective, and the trade or business for which the election is made. An existing taxpayer must file a Form 3115, Application for Change in Accounting Method. This Form 3115 must be attached to the taxpayer’s timely filing (including extensions) return for the year of change.
Reporting Trading Income Under Mark to Market Election Prior to the mark to market election, gains and losses would have gone on Schedule D, Capital Gains and Losses. Now such gains and losses are not capital but they are are ordinary and reported on Form 4797, Sales of Business Property. Each trade is listed under Part II, Ordinary Gains and Losses. Expenses are reported on Schedule C, Profit or Loss From Business.
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MEET ATTORNEY HANNAH M TERHUNE Hannah Terhune, a hedge fund and international tax attorney, contributes her expertise, experience and thoughts to many digital content media and magazine repositories. Hannah Terhune's articles are widely circulated on the Internet and recommended by TheStreet.com and other respected media. Hannah Terhune's articles will advance your knowledge and understanding of the industry. They are embraced worldwide as a definitive and reliable source of critical information. Contact Us for Articles & Reprint Rights
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Advising Clients on Internet Server Co-Location Agreements, Practical International Tax Strategies (March 15, 2004)
Structuring and Financing International Operations Using Hybrid Entities and Tax-Efficient Financing. Practical International Tax Strategies (Jan. 15, 2004)
Tax-Free Asset Acquisitions – More Strategies for S-Corporations: Sourcing Income to Preserve the Use of Credits and Carryovers: Practical International Tax Strategies (April 15, 2003)
Reducing Operational and Exit Taxes On Closely-Held Businesses. Practical U.S./Domestic Tax Strategies (August 2003)
Coming Ashore – Establishing U.S. Operations: Practical International Tax Strategies (July 31, 2003)
Financing U.S. Business Operations Using Cross-Border Income Trust: Practical International Tax Strategies (July 15, 2003)
Methods of Compensating the Executive – An Overview of Various Tax Features: Practical U.S./Domestic Tax Strategies (May 2003)
Update on Spanish Holding Companies. Practical European Tax Strategies (Aug. 2003)
Outbounding Income from Intellectual Property, Practical International Tax Strategies (March 15, 2003)
Taxable Stock Purchases: More Planning Strategies for S-Corporations, Practical U.S./Domestic Tax Strategies (Feb. 2003)
Business Globalization: Selecting the Proper Offshore Entity, Practical International Tax Strategies (Feb. 15, 2003)
Taxable Acquisitions: Financing Asset Acquisitions When an S-Corporation is Involved. Practical U.S./Domestic Tax Strategies (January 2003)
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Acquisition Techniques Using Partnerships or LLCs – Planning Strategies to Defer Taxable Gain. Practical U.S./Domestic Tax Strategies (Oct. 15, 2002)
Domestic and International Tax Planning for Multiple Corporations. Practical International Tax Strategies (Sept. 15, 2002)
Tax Benefits of Spanish Holding Companies: A Planning Opportunity for U.S. Companies. Practical International Tax Strategies (Aug. 31, 2002)
Key Tax Aspects of International M&A – Planning Scenarios Involving Tax Acquisitions. Practical International Tax Strategies (Sept. 15, 2003)
Corporate-Level Penalty Taxes on S-Corporations – Transaction Costs in Mergers, Acquisitions and Buy-Outs. Practical U.S./Domestic Tax Strategies (December 2002)
Taxation of Foreign Partnership Income: Issues to Consider in Reviewing Foreign Operating Structures. Practical International Tax Strategies (Dec. 31, 2002)
The Future of European-Based Business Operations: A Look at the Tax Aspects of the Societas Europaea. Practical European Tax Strategies (November 2002)
Shifting Intangible Income to an Offshore Company Part II: Sale or License? Practical International Tax Strategies (Sept. 15, 2001)
Shifting Intangible Income to an Offshore Company "Round Tripping" and the Risk of Bringing §956 into Play. Practical International Tax Strategies (Aug. 15, 2001)
Update on Filing Requirements for Transfers of Property Offshore. Practical International Tax Strategies (July 15, 2001)
Want a Multinational Corporation In Your Backyard? Strategic Tax Planning for Countries Without a Clue. Practical International Tax Strategies (June 15, 2001)
Planning Notes for U.S. Businesses Operating Overseas: U.S. Outbound Tax Issues. Practical International Tax Strategies (May 31, 2001)
U.S. Strategic Tax Planning and Other Modern Day X Files An FSA to Remember. Practical International Tax Strategies (May 15, 2001)
More on International Tax Planning for Highly Compensated Individuals Combining Individual Leasing Programs, Deferred Compensation and Rabbi Trusts. Practical U.S./International Tax Strategies (April 30, 2001)
International Tax Planning for Highly Compensated Individuals Taking Advantage of Special Treatment for "Rabbi Trusts." Practical U.S./International Tax Strategies (April 15, 2001)
More on Dealing with Passive Foreign Investment Companies Using Inter-Company Loans, Handling Start-Up Costs and Other Matters. Practical U.S./International Tax Strategies (March 31, 2001)
Dealing with Passive Foreign Investment Companies How the System Works and Strategies to Avoid PFIC Status. Practical U.S./International Tax Strategies (March 15, 2001)
Swiss Corporate Ventures, Inc. – Advantages of Establishing a Holding Company in Switzerland. Practical U.S./International Tax Strategies (Feb. 28, 2001)
Cost-Sharing Rules under IRS Attack, Part IV. Practical U.S./International Tax Strategies (Feb. 15, 2001)
International Tax 101. Practical U.S./International Tax Strategies (Jan. 31, 2001)
International Tax 101: More Cliff Notes to Cross-Border Business. Practical U.S./International Tax Strategies (Jan. 15, 2001)
Cost-Sharing Strategies Under Attack, Part III IRS Challenges to Cost-Sharing Arrangements. Practical U.S./International Tax Strategies (Dec. 15, 2000)
Cost-Sharing Strategies Under Attack, Part II, Transfer Pricing Rules and Cost-Sharing Arrangements. Practical U.S./International Tax Strategies (Nov. 30, 2000)
Cost-Sharing Strategies Under Attack How Transfer Pricing Rules Affect Cost-Sharing Arrangements. Practical U.S./International Tax Strategies (Nov. 15, 2000)
Dutch Tax Treats Use Them or Lose Them. Practical U.S./International Tax Strategies (Oct. 15, 2000)
Going Global? Go Home – Unless You're Prepared for the U.S. Tax Consequences. Practical U.S./International Tax Strategies (Sept. 30, 2000)
Commissionaire Use in Austria: Focus on a Commissionaire-Friendly Jurisdiction. Practical U.S./International Tax Strategies (Sept. 15, 2000)
Using Stripped Subsidiaries for Foreign Country Sales Another Alternative to the Traditional Buy-Sell Model. Practical U.S./International Tax Strategies (July 31, 2000)
Handling the IRS Corporate Tax Audit: In Defense of the U.S. Tax Director. Practical U.S./International Tax Strategies (June 30, 2000)
Avoiding Taxable Income by Managing CFC Guarantees of U.S. Parent Company Debt. Practical U.S./International Tax Strategies (June 15, 2000)
Tax Measures to Hedge Against the U.S. Equity Devolution. Practical U.S./International Tax Strategies (May 31, 2000)
Bringing Home the Bacon: Planning Strategies for Offshore Income, Part III. Practical U.S./International Tax Strategies (April 30, 2000)
Commissionaire Use in France: Vetting the VAT. Practical U.S./International Tax Strategies (April 15, 2000)
Bringing Home the Bacon: Planning Strategies for Offshore Income, Part II. Practical U.S./International Tax Strategies (March 31, 2000)
Bringing Home the Bacon: Planning Strategies for Offshore Income, Part I. Practical U.S./International Tax Strategies (March 15, 2000)
Commissionaire Use in Spain. Practical U.S./International Tax Strategies (Feb. 28, 2000)
Commissionaire Use in Belgium. Practical U.S./International Tax Strategies (Feb. 15, 2000)
Crafting the Cross-Border Contract: Foreign Taxes and the U.S. Foreign Tax Credit. Practical U.S./International Tax Strategies (Jan. 31, 2000)
Crafting the Cross-Border Contract: Structuring a Services Agreement. Practical U.S./International Tax Strategies (Jan. 15, 2000)
Crafting the Cross-Border Contract: Drafting to Obtain Sales or Business Profits Treatment. Practical U.S./International Tax Strategies (Dec. 15, 1999)
Crafting the Cross-Border Contract: Unbundling Show-How from Know-How. Practical U.S./International Tax Strategies (Nov. 30, 1999)
Managing the Cross-Border Payroll, Part II: Withholding and Reporting Obligations. Practical U.S./International Tax Strategies (Nov. 15, 1999)
Managing the Cross-Border Payroll, Part I: Overview of U.S. Payroll Taxes. Practical U.S./International Tax Strategies (Oct. 31, 1999)
Cutting Foreign Tax Costs Using Well Known, Multi-Jurisdictional Tax Planning Strategies. Practical U.S./International Tax Strategies (Oct. 15, 1999)
Structuring an International Joint Venture: Transferring Intangible Property and Other Assets. Practical U.S./International Tax Strategies (Sept. 30, 1999)
Integrating The Foreign Sales Corporation Into Commissionaire Distribution Operations. Practical U.S./International Tax Strategies (Sept. 15, 1999)
Using A Foreign Sales Corporation To Fund An Individual Retirement Account: Some Practical Examples. Practical U.S./International Tax Strategies (Sept. 15, 1999)
Integrating The Foreign Sales Corporation Into commissionaire Distribution Operations. Practical U.S./International Tax Strategies (Aug. 15, 1999)
Commissionaire Modeling for European Union Customer Sales. Practical U.S./International Tax Strategies (July 31, 1999)
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Taking Charge of Foreign Profits Through Commissionaire Operations. Practical U.S./International Tax Strategies (June 15, 1999)
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