March 2014

Protect yourself from market losses with Section 475 MTM

March 27, 2014 | By: Robert A. Green, CPA

As the dot-com bust and tech wreck unfolded in 2000, we preached the importance of Section 475 MTM elections to business traders for “tax-loss” insurance. We knew when the markets inevitably turned bearish, many traders would incur huge trading losses. This election means losses are considered business ordinary losses; without it, the losses are capital losses limited to $3,000 against ordinary income per year.

Business ordinary losses can be monetized into tax refunds quickly, whereas capital loss carryforwards often take a long time to monetize — sometimes a decade or more. Traders want immediate tax refunds to replenish their trading capital. Otherwise, they may have little capital left to generate capital gains.

Based on 30 years of experience working closely with traders, we know there are huge swings in bull and bear markets. We’ve seen clients make a lot of money in a few years and lose a lot in a subsequent year. Traders need to be able to carry back losses and that can’t be done on securities unless Section 475 is used. Futures traders can carry back Section 1256 contract losses three years but only against Section 1256 contract gains.

A worst-case scenario in the 2000 tech wreck: Several securities traders made $500,000 in 1999 and lost it all in Q1 2000. They lost their 1999 taxes due in Q1 2000 and they missed the Section 475 MTM election by April 15, 2000. They couldn’t pay the IRS for 1999 gains and they got stuck with a capital loss carryover for 2000, which they couldn’t monetize since they had no capital left to trade. With a simple 2000 Section 475 election, they could have filed a net operating loss (NOL) carryback wiping out their 1999 tax debt. They would have been square with the IRS.

Why talk about 1999/2000? Because it feels like similar market conditions are developing now. 2013 was a big income year for traders and Q1 2014 started off rocky. Consider the rush of tech/mobile/gaming IPOs; CNBC’s Jim Cramer says its Deja vu with the dot-com and tech wreck of 1999/2000. There could be a big correction or bear market later this year.

This past week I consulted with a client on a potential worst-case scenario for 2013/2014. He broke even for 2013 but said TradeLog shows over $1 million of wash sales deferred to 2014. That presents a huge 2013 tax liability on phantom income and he already lost all that tax money and more in Q1 2014.

Luckily, he came to us in time — he will file a Section 475 election by April 15, 2014. The required Section 481a adjustment turns deferred wash sales on year-end 2013 business positions into business ordinary losses on Jan. 1, 2014. The important challenge for him is to maintain his trader tax status in 2014 so he can use Section 475. We suggested filing a 2013 Form 9465 Installment Agreement Request including a note that taxpayer expects to file an NOL carryback wiping out his 2013 tax debt.

Section 475 is free to elect, which is why we call it free tax-loss insurance. While it costs money to switch back to the cash method, traders rarely do that — they just exit their trading activity, thereby suspending Section 475. We recommend section 475 on securities only; you want to retain the lower 60/40 tax rates on 1256 contracts.

Be careful to segregate your investments so 475 won’t apply on those investments and you can hold them for lower long-term capital gains rates. Section 475 marks to market open business positions at year-end, but not investment positions.

Only business traders qualifying for trader tax status may use Section 475. The main requirement is 1,000 trade volume per year (annualized) and frequency over 75% of available trading days with trade executions.

Existing taxpayer individuals and partnerships file Section 475 elections by April 15, 2014. Attach the election statement to your 2013 tax return or extension. The second step is to perfect the election with a 2014 Form 3115 (change of accounting method) filed with your 2014 tax return. New taxpayers/new entities may adopt 475 within 75 days of inception by filing an internal resolution.

It’s important to run Tradelog software to determine your trading gains and losses for 2013 and 2014 year to date. Turn on the Section 475 MTM election within Tradelog software for 2014, and the program will calculate the Section 481a adjustment for Jan. 1, 2014.

If you have a large trading loss for Q1 2014, and also a large capital loss carryover, it’s probably wise to make the Section 475 MTM election to lock in the 2014 loss as ordinary. Resume trading in a new entity with capital gains treatment so you can use up the capital loss carryovers.

If the music stops in the markets, don’t be caught without a chair to sit on — Section 475 may be just the chair for you.

IRS Guidance On Bitcoin Transactions

March 25, 2014 | By: Robert A. Green, CPA

The IRS just issued bitcoin guidance stating that it is considered property, not a currency.

That’s good news for taxpayers with huge gains on using, investing or trading bitcoin, since it receives capital gains treatment and if they held it over one year, the lower long-term capital gains tax rate applies.

Conversely, it’s bad news for those with large losses, with the recent price of bitcoin dropping significantly. According to the IRS guidance, bitcoin does not receive Section 988 ordinary loss treatment, which is unlimited; instead, it’s capital-loss treatment is limited to $3,000 per year.

The IRS guidance stresses a point — widely overlooked by many taxpayers — that using bitcoin to purchase an item or service triggers capital gain or loss recognition reflecting appreciation or depreciation of bitcoin. Compare the market price on the date bitcoin is used to make a purchase vs. the market price on the date you acquired that bitcoin, and the difference is a capital gain or loss on property. Few people or companies have filed Form 1099s on these transactions, as may be required, and taxpayers will have to scurry around to figure their cost basis and sales proceeds on each purchase where they used bitcoin as a digital currency. See the example of buying a cup of coffee with bitcoin in the Bloomberg article Bitcoin Is Property Not Currency in Tax System, IRS Says. The WSJ articles IRS Says Bitcoin Is Property, Not Currency and Q&A: The New IRS Rules on Bitcoin are good too.

Having to report a capital gain or loss on each purchase using bitcoin will have a chilling effect on bitcoin reaching its goal to be a widely used digital currency. Who wants to spend 30 minutes or more figuring out their capital gain or loss for a simple $3 cup of coffee? And who wants to risk getting audited by the IRS over bitcoin tax reporting to boot?

See the IRS Notice 201421 which includes many good FAQs that may strike a cord with taxpayers.

SEC large trader reporting rule

March 24, 2014 | By: Robert A. Green, CPA

Some high-frequency-trader (HFT) clients are receiving email notices from their brokerage firms advising them to file SEC Registration Form 13H to obtain a SEC Large Trader ID number (LTID). The broker needs that LTID in order to comply with the SEC Large Trader Reporting Rule, a rule that has been in place since 2011. (Broker-dealers were required to comply with the rules by April 30, 2012.)

In my view, regulators are keen on tackling — but not necessarily blocking — HFT. They need a better handle on HFT for their own reporting and accountability to Congress. Regulators are still concerned about the flash crash from May 2010, which, along with Congress, they blame on HFT. The first step in regulation is often registration light. It’s not public so your friends won’t see what you are up to. But, it will give the SEC a means to analyze what you are doing in the markets and it may react accordingly. Perhaps the SEC can request a broker to analyze all activity for a given LTID. Bottom line, this is more government oversight for HFT, but it’s not a burden of compliance or cost. (I don’t see any fee required with Form 13H.) It would be worse to have financial-transaction taxes – something we continue to fight against – and HFT trading restrictions. (New York’s Attorney General just blocked a data provider from giving an edge to HFT customers.)

Interactive Brokers includes a helpful summary of these SEC rules. The summary describes what the SEC is after:

“Large Trader” is defined as a person or entity who, directly or indirectly, through the exercise of “Investment Discretion,” effects transactions in exchange-listed equities and options that equal or exceed 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million over the course of any calendar month … Calculating Options Traded. The Rule requires the calculation of shares and dollars of options traded as follows: Shares traded = option contracts traded * option multiplier (typically 100)… (similar option multiplier for ETFs and index options)…

… Initial Filing: A person must “promptly” file an initial Form 13H after its transactions reach the identifying activity level. The SEC states that under normal circumstances, “promptly” means 10 days.

The filing threshold is high and the filing requirement seems simple enough to do on your own. Of course, it’s always wise to consult a securities attorney with any questions. We recommend Brent Gillett JD of

Take a look at a manual SEC Form 13H with instructions, but note you must file it electronically with the SEC EDGAR system. It asks for basic information and not much else.

If you or your broker determines you should file SEC Form 13H, don’t miss the very short 10-day deadline. Not acting can cause you a bunch of trouble. I wonder if all brokers are set up properly to make this filing analysis.