Mark to Market (475(f)) Election

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Discussion
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.

Who Qualifies?
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:

1. The taxpayer cannot be considered an investor or a dealer in securities/commodities;
2. 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:

1. The taxpayer must seek to profit from daily market movements in the prices of securities and not from dividends, interest, or capital appreciation;
2. The activity must be substantial; and
3. The activity must be carried on with continuity and regularity.

The IRS examines the following areas to arrive at a determination:

1. Typical holding periods for securities bought and sold;
2. The frequency and dollar amount of trades during the year;
3. The extent to which the taxpayer pursues the activity to produce income for his or her livelihood; and
4. 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:

1. That the taxpayer is making the election under 475(f);
2. The fist tax year for which the election is effective; and
3. 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:

1. The ability to deduct losses beyond the $3,000 per year capital loss limit; and
2. The ability to deduct expenses associated with the trading business (including computers and the home office deduction).

Drawbacks for making the election include:

1. Losing preferential tax rates for long-term capital gains and qualified dividends for securities used in the business;
2. The difficulty in revoking the election (change in accounting - form 3115 would be required); and
3. Recognition of the fair market value of securities on hand at the end of year regardless of whether the securities were sold.

References
https://www.thetaxadviser.com/issues/2010/feb/sec475mark-to-marketelection.html
https://www.irs.gov/taxtopics/tc429

Disclosure
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.