Tag Archives: options

Tax Treatment For Trading Options (Recording)

March 7, 2017 | By: Robert A. Green, CPA

Join trader tax expert Robert A. Green, CPA as he explains:
  • How options traders may qualify for trader tax status benefits, and the challenges they face from the IRS.
  • Tax treatment for options is diverse, including simple and complex trades on securities vs. Section 1256 contracts.
  • Outright option trades: trade option (closing transaction), the option expires (lapses), and exercise the option.
  • Complex option trades: straddle loss deferral rules.
  • Brokers don’t report wash sale losses between different option exercise dates, but taxpayers should.
  • A timely Section 475 election exempts options traders from wash sale losses, straddle loss deferral rules, and capital loss limitations.

Tax Treatment For Trading Options

May 27, 2015 | By: Robert A. Green, CPA

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Options trading is proliferating with the advent and innovation of retail option trading platforms, brokerage firms and trading schools. A trader can open an options trading account with just a few thousand dollars vs. $25,000 required for “pattern day trading” equities (Reg T margin rules).

Options trading provides the opportunity to make big profits on little capital using “risk it all” strategies. Options are a “tradable” financial instrument and a way to reduce risk with hedging strategies. When it comes to option taxation, complex trades with offsetting positions raise complex tax treatment issues like wash sale and straddle loss deferral rules.

Investors also trade options to manage risk in their investment portfolios. For example, if an investor owns significant equity in Apple and Exxon, he or she may want to trade options to manage risk or enhance income on long equity positions. He or she can collect premium by selling or “writing” an options contract or buy a “married put” for portfolio insurance. Traders also use ETFs and indexes for portfolio-wide insurance. (Investopedia has explanations for different option trading strategies.)

Simple vs. complex option trades
There are simple option trading strategies like buying and selling call and put options known as “outrights.” And there are complex option trades known as “option spreads”which include multi-legged offsetting positions like iron condorsbutterfly spreads; vertical, horizontal and diagonal spreads; and debit and credit spreads.

Tax treatment for outright option trades is fairly straightforward and covered below. Tax treatment for complex trades triggers a bevy of complex IRS rules geared toward preventing taxpayers from tax avoidance schemes: deducting losses and expenses from the losing side of a complex trade in the current tax year while deferring income on the offsetting winning position until a subsequent tax year.

Look to the underlying financial instrument tax treatment
Options are “derivatives” of underlying financial instruments including equities, ETFs, futures, indexes, forex, and more. The first key to determining an option’s tax treatment is to look at the tax treatment for its underlying financial instrument. The option is to buy or sell that financial instrument and it’s tied at the hip.

For example, an equity option looks to the tax treatment of equities, which are considered “securities.” Conversely, options on Section 1256 contracts are deemed “non-equity options.”

ETFs are taxed as securities, so options on securities ETFs are taxed as securities. Options on commodity ETFs (structured as publicly traded partnerships) are non-equity options taxed as Section 1256 contracts. Options on futures are taxed as futures, which are Section 1256 contracts.

Capital gains and losses for securities are reported when realized (sold or closed). Conversely, Section 1256 contracts are marked-to-market (MTM) at year-end and they benefit from lower 60/40 capital gains tax rates: 60% long-term and 40% short-term. MTM imputes sales on open positions at market prices so there is no chance to defer an offsetting position at year-end. Generally, that means wash sale and straddle loss deferral rules don’t apply to Section 1256 options.

There are three things that can happen with outright option trades:

  • Trade option (closing transaction)
    Trading call and put equity options held as a capital asset are taxed the same as trading underlying equities. Report proceeds, cost basis, net capital gain or loss and holding period (short-term vs. long-term held over 12 months) from realized transactions only on Form 8949 (Capital Gains & Losses).
  • Option expires (lapses)
    There’s a minor twist on the above scenario. Rather than realizing a dollar amount on the closing out of the option trade, the closeout price is zero since the option expires worthless.Use zero for the realized proceeds or cost basis, depending on whether you’re the “writer”or “holder” of the option and if it’s a call or put. Use common sense — collecting premium on the option trade is proceeds and therefore the corresponding worthless exercise represents zero cost basis in this realized transaction. For guidance on entering option transactions as “expired”on Form 8949, read IRS Pub. 550 – Capital Gains And Losses: Options.
  • Exercise the option
    This is where tax treatment gets more complicated. Exercising an option is not a realized gain or loss transaction; it’s a stepping-stone to a subsequent realized gain or loss transaction on the underlying financial instrument acquired. The original option transaction amount is absorbed (adjusted) into the subsequent financial instrument cost basis or net proceed amount.Per IRS Pub. 550 Capital Gains & Losses: Options: “If you exercise a call, add its cost to the basis of the stock you bought. If you exercise a put, reduce your amount realized on the sale of the underlying stock by the cost of the put when figuring your gain or loss. Any gain or loss on the sale of the underlying stock is long term or short term depending on your holding period for the underlying stock…If a put you write is exercised and you buy the underlying stock, decrease your basis in the stock by the amount you received for the put…If a call you write is exercised and you sell the underlying stock, increase your amount realized on the sale of the stock by the amount you received for the call when figuring your gain or loss.” Some brokers interpret IRS rules differently, which can lead to confusion in attempting to reconcile broker-issued Form 1099Bs to trade accounting software. A few brokers may reduce proceeds when they should add the amount to cost basis. Equity options are reportable for the first time on 2014 Form 1099Bs.Exercising an option gets to the basics of what an option is all about: it’s the right, but not the obligation, to purchase or sell a financial instrument at a fixed “strike price” by an expiration date. Exercise may happen at any time until the option lapses. An investor can have an in the money option before expiration date and choose not to execute it, but rather hold or sell it before expiration.
  • Holding period for long-term capital gains
    When an equity option is exercised, the option holding period becomes irrelevant and the holding period for the equity begins anew. The holding period of the option doesn’t help achieve a long-term capital gain 12-month holding period on the subsequent sale of the equity. When an option is closed or lapsed, the option holding period does dictate short- or long-term capital gains treatment on the capital gain or loss.With exceptions recapped in IRS Pub. 550: “Put option as short sale.  Buying a put option is generally treated as a short sale, and the exercise, sale, or expiration of the put is a closing of the short sale. If you have held the underlying stock for one year or less at the time you buy the put, any gain on the exercise, sale, or expiration of the put is a short-term capital gain. The same is true if you buy the underlying stock after you buy the put but before its exercise, sale, or expiration.”

Complex trades lead to complex tax treatment issues
In general, if an investor has an offsetting position he or she should look into more complex tax treatment issues.

Offsetting Positions
IRS Pub. 550: Capital Gains & Losses: Straddles defines an “offsetting position” as “a position that substantially reduces any risk of loss you may have from holding another position.”

In the old days, shrewd professional options traders would enter offsetting positions and close out the losing side before year-end for a significant tax loss and let the winning side remain open until the subsequent year. They used this strategy to avoid paying taxes. The IRS goes through (and causes) great pains to prevent this type of tax avoidance. Offsetting position rules included “related persons” including a spouse and your flow-through entities.

“Loss Deferral Rules”in IRS Pub. 550 state “Generally, you can deduct a loss on the disposition of one or more positions only to the extent the loss is more than any unrecognized gain you have on offsetting positions. Unused losses are treated as sustained in the next tax year.”

IRS enforcement of offsetting position rules
Frankly, the offsetting position rules are complex, nuanced and inconsistently applied. There are insufficient tools and programs for complying with straddle loss deferral rules. Brokers don’t comply with taxpayer wash sale rules or straddle loss deferral rules on Form 1099Bs or profit and loss reports. Few local tax preparers and CPAs understand these rules, let alone know how to spot them on client trading records.

The IRS probably enforces wash sale and straddle loss deferral rules during audits of large taxpayers who are obviously avoiding taxes with offsetting positions. They make a lot of money, but it’s always deferred to the next tax year. The IRS doesn’t seem to be questioning wash sales and straddles during exams for the average Joe Trader.

I expect the IRS will launch a tax exam initiative for measuring taxpayer compliance with new cost-basis reporting law and regulations. I see a big problem brewing with unreconciled differences between taxpayer and broker rules on wash sales.

Wash sales
As we stress in our extensive content on wash sale loss deferral rules, Section 1091 rules for taxpayers require wash sale loss treatment on substantially identical positions across all accounts including IRAs. Substantially identical positions include Apple equity, Apply options and Apple options at different expiration dates on both puts and calls.

If a taxpayer re-enters a substantially identical position within 30 days before or after existing a position, the IRS defers the tax loss by adding it to the cost basis of the replacement position. When a taxable account has a wash sale caused by a replacement position purchased in an IRA, the wash sale loss is permanently lost.

Cost-basis regulations phased-in options as “covered securities” starting with 2014 Form 1099Bs. Brokers report wash sales based on identical positions, not substantially identical positions. Investors who trade equities and equity options cannot solely rely on Form 1099Bs and they should use their own trade accounting software to generate Form 8949. Learn more about wash sales in our Trader Tax Center.

Straddle loss deferral rules
Options traders use option spreads containing offsetting positions to limit risk and provide a reasonable opportunity to make a net profit on the trade. That’s very different from an unscrupulous trader entering a complex trade with offsetting positions set up for no overall risk (the rule is substantially reduced risk) or reward. Why would an options trader do that? For tax avoidance reasons only.

The IRS straddle loss deferral rules are set up to catch this trader and prevent this type of tax avoidance. The straddle loss deferral rule defers a loss to the subsequent tax year when the winning side of the position is closed, thereby reversing what the unscrupulous trader was trying to achieve. The IRS also suspends holding period so it’s impossible to qualify for long-term capital gains rates in the following year, too. Transaction-related expenses (carrying costs) and margin interest (certain interest) are also deferred by adding them to the cost-basis of the offsetting winning position.

Learn more about straddle loss deferral rules in connection with options in IRS Pub. 550: Capital Gains & Losses: Straddles. “A straddle is any set of offsetting positions on personal property. For example, a straddle may consist of a purchased option to buy and a purchased option to sell on the same number of shares of the security, with the same exercise price and period. Personal property. This is any actively traded property. It includes stock options and contracts to buy stock but generally does not include stock. Straddle rules for stock. Although stock is generally excluded from the definition of personal property when applying the straddle rules, it is included in the following two situations. 1) The stock is of a type which is actively traded, and at least one of the offsetting positions is a position on that stock or substantially similar or related property. 2) The stock is in a corporation formed or availed of to take positions in personal property that offset positions taken by any shareholder.”

Straddle loss rules are complex and beyond the scope of this blog post. Consult a tax adviser who understands the rules well.

Caution to unsuspecting option traders
Active traders in equities and equity options entering complex trades with multi-legged offsetting positions may unwittingly trigger straddle loss deferral rules if they calculate risk and reward wrong and there is substantially no risk.

Section 475 MTM
Traders who qualify for trader tax status may elect Section 475(f) MTM accounting, provided they do so by the deadline. MTM means the trader reports unrealized gains and losses on trading positions at year-end by imputing sales at year-end prices. Segregated investment positions are excluded from MTM. The character of the income changes from capital gain and loss to ordinary gain or loss. Section 475 trades are exempt from Section 1091 wash sale rules and straddle loss deferral rules since no open positions are deferred at year-end.

Employee stock options
Don’t confuse tradable options with employee stock options. When an employee acquires non-qualified options on his employer’s stock (equity), the later exercise of those options triggers ordinary income reported on the employee W-2 because the appreciated value is considered a form of wage compensation.

Other resources
Ernst & Young prepared a useful guide with a good section on options taxation. It was requested by The Options Industry Council and is available on the CBOE website at https://www.cboe.com/LearnCenter/pdf/TaxesandInvesting.pdf.

The Tax Court Was Right To Deny Endicott Trader Tax Status (Recording)

October 7, 2014 | By: Robert A. Green, CPA

Join CPAs Robert A. Green and Darren Neuschwander, Managing Members of Green NFH, LLC

Click here to read the related blog dated Aug. 30, 2013.

Description: In this Webinar, we review a Word file containing the actual tax court case. We read important sentences highlighted in yellow, and discuss several comments added by Green. All options traders and other traders who manage their investments and want to claim trader tax status need to watch this recording. We added this Word file as a PDF to Green’s Trader Tax Guide.

Options

August 28, 2014 | By: Robert A. Green, CPA

Options cover the gamut of tax treatment. They are a derivative of their underlying instrument and sometimes have the same tax treatment. For example, equity options are a derivative of the underlying equity, and both are taxed as securities.

Options include:

Equity options are securities, and they include:

  • stock options
  • options on narrow-based indexes
  • options on securities ETFs organized as Registered Investment Companies (RIC)

Non-equity options are Section 1256 contracts, and they include:

  • options on futures
  • options on broad-based indexes
  • options on commodity ETFs organized as publicly traded partnerships (PTP)
  • forex OTC options
  • CBOE-listed options on volatility ETNs and volatility ETFs structured as PTPs are likely included 

Wash-sale loss rules apply between substantially identical positions in securities, which means between equity and equity options, such as Apple stock and Apple stock options at different expiration dates.

Simple vs. complex option trades

There are simple option trading strategies like buying and selling call and put options known as “outrights.” And there are complex option trades known as “option spreads” which include multi-legged offsetting positions like iron condors; butterfly spreads; vertical, horizontal and diagonal spreads; and debit and credit spreads.

Tax treatment for outright option trades is relatively straightforward. Tax treatment for complex trades triggers a bevy of sophisticated IRS rules geared toward preventing taxpayers from tax avoidance schemes: deducting losses and expenses from the losing side of a complex trade in the current tax year while deferring income on the offsetting winning position until a subsequent tax year.

There are three things that can happen with outright option trades:

  1. Trade option (closing transaction).
  2. Option expires (lapses).
  3. Exercise the option.

There are special rules for the holding period for long-term capital gains.

For more in-depth information on options tax treatment, including simple vs. complex trades, read Green’s 2018 Trader Tax Guide.

Tax Treatment For Nadex Binary Options

June 20, 2014 | By: Robert A. Green, CPA

There’s a bevy of financial instruments to trade on securities and futures exchanges around the world, and derivatives and swaps exchanges offering binary options and swap contracts are increasingly becoming part of the mix. How are these unique instruments treated come tax-time? Can they be considered Section 1256? Let’s delve into binary options and swaps in more detail. (For more background on Section 1256 and its qualified board or exchange requirement, see Tax treatment for foreign futures.”)

Dodd-Frank changed the law
A principal focus of the Dodd-Frank Wall Street Reform and Consumer Protection Act law enacted in July 2010 is better regulation and control of the several-hundred-trillion-dollar derivatives and swaps marketplace. Dodd-Frank requires many privately negotiated derivatives and swaps contracts to clear on derivatives and swaps exchanges to insure collection of margin and to prevent another financial crisis. Remember, AGI wrote too many derivatives and swaps contracts, which it did not have sufficient capital or margin to pay out when markets melted down and counterparties demanded payment in 2008.

Dodd-Frank synchronized regulation and tax law, requiring the IRS to exclude swap contracts from Section 1256. Although Congress required private derivative contracts to clear on Section 1256 exchanges, it didn’t want to reward derivatives contracts with Section 1256 tax advantages.

Before Dodd-Frank, the CFTC had more leeway in designating instruments as “options.” According to a CFTC lawsuit, the CFTC used a limited definition of what constituted an option; e.g. it trades like an option (more on this lawsuit later). According to a CFTC official, “After Dodd-Frank, unless the option expires into a futures contract, the CFTC categorizes it as a swap contract. If the contract expires into cash, it’s a swap contract.”

Regulators don’t drive tax treatment
The Securities and Exchange Commission (SEC) regulates securities and the IRS treats sales of securities with short-term and long-term capital gain/loss tax treatment based on realized gains subject to wash sale loss deferral rules. The Commodity Futures Trading Commission (CFTC) regulates commodities, futures, forex and derivatives and the IRS has varying tax treatment for these different types of financial instruments.

Regulated futures contracts and nonequity options are Section 1256 contracts afforded lower 60/40 capital gains tax rates with MTM accounting reporting realized and unrealized gains and losses at year-end (reported on Form 6781).

If an investor sells physical commodities, capital gain/loss treatment applies and there is no MTM. Conversely, if a farmer sells physical commodities, ordinary treatment applies, but again, there is no MTM.

Forex (interbank spot and forward contracts) falls under Section 988 ordinary gain and loss on realized transactions. Traders may file a contemporaneous “capital gains election” to opt out of Section 988, whereas manufacturers may not.

Notional principal contracts defined as two or more periodic payments — commonly called swaps — receive ordinary gain or loss treatment and MTM accounting applies.

IRS proposed regulations on swaps 
In connection with Dodd-Frank, the IRS issued proposed regulations “Notice of Proposed Rulemaking and Notice of Public Hearing Swap Exclusion for Section 1256 Contracts” (REG-111283-11) on Oct. 17, 2011. Excerpts are provided below, with our notes in italics:

• Summary: .. describe swaps and similar agreements that fall within the meaning of section 1256(b)(2)(B). This document also contains proposed regulations that revise the definition of a notional principal contract under §1.446-3 (Note that swaps generally fall within the definition of “Notional Principal Contracts”.)

• Dodd-Frank Act added section 1256(b)(2)(B), which excludes swaps and similar agreements from the definition of a section 1256 contract. Section 1256(b)(2)(B) provides that the term “section 1256 contract” shall not include— any interest rate swap, currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement. (All swaps are effectively excluded.)

• Congress enacted section 1256(b)(2)(B) to resolve uncertainty under section 1256 for swap contracts that are traded on regulated exchanges. .. increased exchange-trading of derivatives contracts by clarifying that section 1256 of the Internal Revenue Code does not apply to certain derivatives contracts transacted on exchanges. (Nadex binary options trade on a regulated exchange.)

• Option on a notional principal contract
Section 1256(b)(2)(B) raises questions as to whether an option on a notional principal contract that is traded on a qualified board or exchange would constitute a “similar agreement” or would instead be treated as a nonequity option under section 1256(g)(3). Since an option on a notional principal contract is closely connected with the underlying contract, the Treasury Department and the IRS believe that such an option should be treated as a similar agreement within the meaning of section 1256(b)(2)(B). (If a Nadex binary option were deemed an option on a NPC, it would be excluded as a NPC per this rule.)

• Ordering rule
The proposed regulations provide an ordering rule for a contract that trades as a futures contract regulated by the Commodity Futures Trading Commission (CFTC), but that also meets the definition of a notional principal contract. The Treasury Department and the IRS believe that such a contract is not a commodity futures contract of the kind envisioned by Congress when it enacted section 1256. (We don’t think the IRS will view Nadex binary options as a futures contract; therefore, will view it as a NPC.)

• Definition of Regulated Futures Contract (RFC)
Section 1256(g)(1) defines a regulated futures contract as “a contract (A) with respect to which the amount required to be deposited and the amount which may be withdrawn depends on a system of marking to market, and (B) which is traded on or subject to the rules of a qualified board or exchange.” The apparent breadth of section 1256(g)(1) has raised questions in the past as to whether a contract other than a futures contract can be a regulated futures contract. (The IRS is trying to clean up some loose definitions in the past.)

Trading binary options on Nadex
The derivatives exchange based in the U.S. is the North American Derivatives Exchange (Nadex) which offers retail traders an online trading platform for limited-risk “binary options and spread contracts” based on stock indices, commodities, forex and financial events. Make a speculation and hold it through expiration for an “all or nothing” pay off, which some pundits say is akin to making a bet. Or trade the contract before expiration to cash it in at the current market price fluctuating on Nadex. Most Nadex contracts settle in one hour or one day, and the rest settle in a week or longer.

There is active trading on the Nadex platform/exchange similar to trading platforms on securities and futures exchanges. A trader may not notice much difference, but there are important differences in regulation and tax treatment.

Nadex issued 1099Bs using Section 1256 treatment
For tax years 2004 through 2013, Nadex issued direct members a Form 1099-B reporting Section 1256 tax treatment.

As pointed out in our first blog in this series, Nadex is a domestic board of trade — a category 2 qualified board or exchange (QBE) since it’s a CFTC-regulated “Designated Contract Market”. But that alone is not enough; Nadex binary options still must meet the definition of Section 1256 contracts. In February 2014, Nadex emailed us the following statement: “Nadex has recently been advised by staff of the Commodity Futures Trading Commission that its instruments are considered ‘commodity options’ categorized as ‘swaps.’”

We feel that Nadex binary options probably don’t qualify for Section 1256 
Nadex binary options don’t seem to meet the definition of inclusion in Section 1256 as either a regulated futures contract or a nonequity option, and they seem to meet the definition of exclusion from Section 1256 as a swap contract.

Nadex binary options don’t meet the definition of Section 1256 for “regulated futures contract” (RFC). A Nadex binary option requires full payment in advance — it’s not collateral — and there is no withdrawals based on MTM. Nadex binary options are prepaid bets. There seems to be consensus on this point.

Nadex binary options probably do not meet the definition of Section 1256 for “nonequity options” as they don’t seem to meet the definition of “options” in the tax code (Section 1234a) (see further discussion below). We haven’t seen a private letter ruling, tax opinion letter or tax research supporting a nonequity option argument for Nadex binary options.

Nadex binary options probably are excluded from Section 1256 as swap contracts. The CFTC said they are “commodity options” categorized as swaps. Dodd Frank law enacted Section 1256(b)(2)(B) into law effective July 2011. Section 1256(b)(2)(B) excludes swap contracts from Section 1256 tax breaks. Proposed regs for Section 1256(b)(2)(B) are not yet effective and they define swaps based on the IRS definition of “notional principal contracts” (NPC). NPC normally require two payments whereas Nadex binary options have one payment. The difference between one versus two payments does not seem material to us.

The IRS proposed regulation excludes all notional principal contracts (swaps) from Section 1256. But, the IRS received many comments arguing that exchange-traded swap contracts, as opposed to off-exchange OTC swaps, should not be excluded since the commenters believed they had Section 1256 tax treatment before Dodd-Frank. Until the final regulation 1256(b)(2)(B) is issued, we won’t know the final outcome. Nadex binary options are exchange-traded swaps, not OTC. Even if in final IRS regulations Nadex binary options are not excluded as exchange-traded swaps, they still must qualify as a non-equity option and we don’t think they do.

We suggested to Nadex that they file for a private letter ruling to support using Section 1256 on 1099Bs for Nadex binary option transactions.

CFTC definition of “option”
The Nadex email says the CFTC referred to their binary options as “commodity options.” They are bets that rise or fall based on an underlying market or financial event, they are based on option pricing models and they trade like options. Before Dodd-Frank, the CFTC could use this narrow definition. The issue of whether binary options are “options” in accordance with CFTC regulation came up in court in 2013. As reported on Goodwingaming, “The binary option trading platform Banc de Binary currently faces a civil lawsuit in the District of Nevada brought by the CFTC for allegedly violating ‘the Commission’s ban on trading options off-exchange.’ The regulatory authority of the CFTC covers ‘options’ which are adroitly defined as ‘transaction(s) .. . held out to be of the character of, or . . commonly known to the trade as option(s).’” The defendant argued their binary options are not options per the CFTC’s full regulatory definition. The CFTC argued that only the first part of the definition counts: “What makes an option an option is the first of these three components — price speculation.” This sounds similar to Nadex’s options pricing.

“In a parallel lawsuit brought by the Securities and Exchange Commission, Judge Robert Jones (District of Nevada) agreed, explaining: With a binary option, . . . the purchaser receives neither the stock itself nor the right to purchase the stock in the future. Binary options are in substance pure gambling bets. . . . Binary option givers and buyers do not purport to trade interests in securities any more than tellers and gamblers at a racetrack purport to trade interests in horses. . . . The Court simply cannot agree that a contract under which the purchaser has no putative right to obtain the security is an ‘option.’”

IRS definitions of “option” is different
The tax code definition of an option sounds like the SEC argument rather than the CFTC argument in the above court cases. The main problem with saying that a Nadex binary option is a nonequity option for Section 1256 is that there is no right to receive property, or alternatively to receive cash equal to the right to receive property (in the case of a cash settled option).

Tax court cases and very limited IRS guidance
Industry professionals equate binary options with “digital options” and “paired options.” These terms came up in just a few tax court cases, which are about tax avoidance, not options. We don’t see any statements in these cases that indicate the court viewed binary options as true options. Section 1256 tax treatment is not used on binary options in any of these tax court cases. These cases do not connect the dots for supporting a Section 1256 position.

In The Markell Company, Inc. v. Commissioner, TC Memo 2014-86, “taxpayer/partner wasn’t entitled to multimillion dollar loss on complicated basis-inflating paired options/Son of BOSS (tax shelter) transaction using newly formed LLC/partnership.”..”Paired Options. The paired options in this case consisted of short and long European digital call options. These cash-or-nothing options can be valued by multiplying the present value of the cash payoff amount by the probability calculated from the Black-Scholes-Merton (BSM) model that the digital option will be in the money at the expiration date.” While Markell used paired options, the case is about tax avoidance transactions based on purposely mispricing paired options. (This case does provide tax guidance for treating binary options based on currencies as Section 988 ordinary gain or loss. There is a connection between the binary option and the underlying instrument it’s meant to mimic in price.)

In Douglas R. Griffin, (TC Memo 2011-61), “HydroTemp timely filed a return for the tax year ending June 30, 2003, reporting a $7,524,153 long-term capital gain from the asset sale to Pentair and a $7 million short-term capital loss from the sale of binary options (i.e., options in which the payoff is structured to be either a fixed amount of compensation if the option expires in the money or nothing at all if the option expires out of the money). .. IRS’s position. IRS disallowed HydroTemp’s losses from its claimed binary options sale.” In this case, the court accepted the binary option transactions as legitimate and the taxpayer won the case. (This case may provide tax guidance for treating the sale of binary options before they expire as being capital gain or loss on realized transactions; however, the IRS attorneys did not seem to have focused on the tax treatment of the options, but simply questioned the legitimacy of the transaction . When terminating a binary option short of expiration, perhaps capital gains and loss treatment is applicable, as discussed below.)

In an IRS Coordinated Issue Paper explaining IRS Notice 2003-81 (Tax Shelters), ,the IRS discusses “option premium” on binary options. “Gain and loss on options is accounted for on an open transaction basis. As explained in Notice 2003-81, the justification for open transaction treatment is that the gain or loss on an option cannot be finally accounted for until such time as the option is terminated. Thus, premium income is not recognized until an option is sold or terminated. Rev. Rul. 58-234.… explains that this is the treatment for the option writer because the option writer assumes a burdensome and continuing obligation, and the transaction therefore stays open without any ascertainable income or gain until the writer’s obligation is finally terminated. When the option writer’s obligation terminates, the transaction closes, and the option writer must recognize any income or gain attributable to the prior receipt of the option premium.” This should be the rule for the receipt of option premium whether the instrument is truly an option or not. This IRS guidance seems weak for building a case that a binary option is treated as a true option and therefore a nonequity option in Section 1256. (In Notice 2003-81, the binary options discussed were based on foreign currency transactions and Section 988 ordinary gain or loss on realized transactions applied by default on the binary options, not Section 1256.)

Tax compliance and planning
In general, we think binary options start off with ordinary gain or loss treatment. In Highwood Partners v. Commissioner (133 TC 1, 2009), digital options based on currency transactions were Section 988 ordinary gain or loss treatment. If you have a Nadex 1099B reporting Section 1256 treatment from binary options based on currencies, you should use Section 988 ordinary gain or loss treatment and not Section 1256, thereby overriding the 1099B.

Swap tax treatment calls for ordinary gain or loss tax treatment, too. Ordinary losses can generate large tax refunds since traders are not subject to the $3,000 capital loss limitation. Caution, large ordinary losses without qualification for trader tax status (business treatment) can lead to some wasted losses and wasted itemized deductions; as those ordinary losses are not a capital loss carryover or a net operating loss carryback or forward.

When a trader sells a Nadex binary option (not based on currency) before expiration, the IRS may view the proceeds as a “termination payment” on the sale of a capital asset, rather than a “period payment” on a swap contract. Normally, termination payments on capital assets are capital gains.

Tax attorneys Mark Feldman and Roger Lorence, and Darren Neuschwander, CPA contributed to this blog. 

Another trader tax court loss

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

The IRS is piling up victories in tax court against individual traders who inappropriately use Section 475 MTM business ordinary loss treatment for deducting large trading losses. Fariborz Assaderaghi & Miao-Fen Lin v. Commissioner is yet another IRS win that can be added to the list. According to Tax Analysts, “The Tax Court held that a husband’s trading activity in securities didn’t constitute a trade or business and, thus, he wasn’t eligible for a mark-to-market accounting method election under section 475(f) and the couple was limited to a $3,000 deduction of losses from the purchase and sale of securities under section 1211(b) for each year at issue.”

Only traders who qualify for trader tax status (Schedule C business expenses) may elect and use Section 475. Lots is at stake since without trader tax status or a timely Section 475 MTM election, traders are forced to use a puny $3,000 capital loss limitation against other income.

We agree with the IRS that Assaderaghi did not qualify for trader tax status in any of the years examined. Assaderaghi had many day trades, and he used professional trading equipment and charts. But he had a demanding full-time career as an engineer/executive and the IRS is more skeptical toward part-time traders claiming trader tax status. Assaderaghi was unable to prove his hours spent in trading and his evidence lacked credibility in the eyes of the IRS and tax court.

Most importantly, Assaderaghi came up short on meeting our golden rules for 2008, the one year he had a chance to qualify for trader tax status. He had 535 trades and our golden rules call for 1,000 total trades. He traded just over 60% of available trading days and our golden rules call for trade executions on 75% of available trading days. In the other years examined, he came up far short of trader tax status and when you view the years together it’s especially weak.

Perhaps Assaderaghi could have fought harder to win trader tax status in 2008, and concede the other years, but that is generally not the main issue. A bigger issue is filing a timely Section 475 MTM election and Assaderaghi and his accountant did not do that. It’s significant since Assaderaghi’s CPA deducted $374,000 in trading losses for his 2008 Schedule C, but the IRS forced them to use a puny $3,000 capital loss limitation instead. Once again, a trader and professional go to tax court with a clear losing case on technical grounds, missing or botching a Section 475 MTM election, and there is nothing that can be done about it. They wasted their money and effort in tax court.

Assaderaghi made some tragic rookie tax mistakes which sealed his fate as a loser with the IRS. He made the common mistake of asking his local CPA tax preparer to elect trader tax status and Section 475 MTM, but after not getting an answer from his CPA, he didn’t do anything about it. His accountant was clueless about trader tax benefits and rules — which is sadly still often the case. When it comes to timely Section 475 elections, there is no excuse allowed for relying on an accountant, and there is no IRS relief. The IRS is lenient on many things, but not Section 475.

His accountant grasped the idea of trading as a business — filing a Schedule C — but he jumped to the tragic conclusion that he could simply report trading gains and losses on schedule C like other types of businesses. He should have filed a timely election for Section 475 and reported trading gains and losses on Form 4797 Part II with ordinary gain and loss treatment. It’s clear the accountant did not know that Section 475 MTM had to be elected by April 15, 2008 for 2008 or perfected with a 2008 Form 3115 change of accounting filed in 2009 with the 2008 tax returns. Had Assaderaghi known the golden rules, perhaps he would have traded more to meet them.

Assaderaghi’s tax return screamed for an IRS beat down. The IRS computers see trades on Schedule C and issue a tax notice because trades don’t belong on Schedule C. The IRS tries to match broker 1099-Bs to Schedule D (in 2008 and Form 8949 after 2010), Form 4797 Part II (section 475 MTM) and Form 6781 (Section 1256). The IRS agent asked the CPA preparer about his filing of a Section 475 MTM election and the CPA did not even know what the agent was talking about. Case closed — it’s a loser! You can never file a Section 475 MTM election late (or with hindsight).

Lessons learned: Learn trader tax benefits and rules with our content and hire a proven trader tax CPA like our firm Green NFH, LLC to assist you with the election, Form 3115, Form 4797 and tax return footnotes.

It’s important to note that 2014 Section 475 MTM elections are due by April 15, 2014 for individuals and existing partnerships, and March 15, 2014 for existing S-Corps. “New taxpayers” (new entities) file a Section 475 MTM election in their own books and records (internally) within 75 days of inception of the new entity formation. We recommend Section 475 MTM on securities only, so you retain lower 60/40 capital gains rates on Section 1256 contracts like futures. Section 475 MTM does not apply to segregated investment positions. If you have capital loss carryovers, you may want to wait until you generate more capital gains to use them up first.

Make sure you meet our golden rules for trader tax status based on tax court cases. The Assaderaghi case does not change our golden rules. The Assaderaghi court reinforced the notion that business traders must be consistent in trading volume and frequency and avoid sporadic lapses in active trading. The tax law requires “regular, frequent and continuous trading based on daily market movements and not long-term appreciation.”

It’s wise to stop trading as an individual and form an entity that qualifies for trader tax status and files an entity business tax return that resembles many active trading hedge funds. As pointed out in Green’s 2014 Trader Tax Guide, a high ranking IRS person in the trader tax status and Section 475 area recently warned at a tax conference that the IRS is going after individual traders inappropriately using trader tax status and Section 475 MTM ordinary loss treatment. Get the help you need to be a winner.

See the Tax Analysts PDF file on this case with our yellow highlights.

Another non-business trader busted in tax court

November 15, 2013 | By: Robert A. Green, CPA

Chalk up another win for the IRS on denying trader tax status. But it’s not a result of IRS excellence. Rather, it’s another case of a taxpayer filing a huge red-flag tax return with crazy unsupportable positions.

See the latest tax court case decision denying trader tax status: Nelson, TC Memo 2013-259. Here is an RIA summary with my highlights in yellow.

First off, the taxpayer seems to have been a tax cheat and that never bodes well in an exam. What trader in his or her right mind files a Schedule C for trader tax status deducting $800,000 of trading business expenses over two years? Nelson did, and when pressed, she conceded most of these expenses early on (see footnote 8 in the case). Most of those Schedule C expenses were probably unsubstantiated even as investment expenses on Schedule A. The IRS did not allow a Schedule C, since Nelson did not qualify for trader tax status.

Our firm has always pointed out that a sole proprietor trading business Schedule C is a red flag as it only shows expenses. We prefer a pass-through entity tax return for reporting a trading business. Traders generally have business expenses of $5,000 to $25,000. If the trader has trading gains, we use our income-transfer strategy to zero out Schedule C.

In another recent IRS tax court win denying trader tax status, Endicott reported $300,000 of margin interest on his trading business Schedule C and that triggered his tax exam. The IRS was correct; it should have been reported as investment interest expense on Schedule A.

As with Endicott, we agree with the Tax Court and IRS that Nelson did not qualify for trader tax status in 2005 and 2006. First, it sounds like Nelson’s live-in boyfriend, perhaps a trader himself, made many of the trades on her trading account. Nelson seemed focused on her active and successful mortgage business. We’ve always pointed out that trades made by an outside manager do not qualify for trader tax status. This can be a problem even with married couples, when one spouse trades the other spouse’s individual account. This is why we recommend a general partnership or LLC filing a partnership tax return for married couples — or significant others — so the trader/partner can bring trader tax status to the entity level for the benefit of all partners, even passive owners.

The tax court is right to point out that even if Nelson was credited with making all the trades — which clearly she did not — the activity did not rise to the level of trader tax status. The account failed our golden rules for trader tax status. Our rules call for 1,000 total trades and the Nelson account had half that in one year and one-quarter of that in the other year. Even considering a partial year, it was too few trades. Our golden rules call for executions on 75% of available trading days, and the Nelson account had executions of less than 50% one year and less than 30% the other year. The IRS was not clear about the average holding periods; they may have been under 31 days, which could be okay. But there were far too many sporadic lapses in trading, which is against the tax law requiring “regular, frequent and continuous” trading.

“I appreciate the break down of trading within this case,” says Green NFH co-managing member Darren Neuschwander, CPA. “This will be good to show clients how the IRS is clearly reviewing trader tax status.”

Notice Nelson couldn’t get relief from significant accuracy-related penalties. According to the RIA summary, “Nelson’s claim that she spoke with a friend who is an accountant was insufficient to show what advice the accountant provided and whether her reliance on same was reasonable.”

Bottom line
Get educated on trader tax status before you claim it. Conservatively assess it at year-end before deploying it on your annual tax returns. Consider an entity going forward. If you’re examined by the IRS, consult with a trader tax status expert and consider their representation. Don’t bring a losing case to tax court and argue it on your own.

Tax court was right to deny Endicott TTS

August 30, 2013 | By: Robert A. Green, CPA

We agree with the IRS and tax court on denying trader tax status (TTS) — otherwise known as business treatment — to Endicott (TC Memo 2013-199, Aug. 28, 2013) for 2006 and 2007 since he clearly was a long-term stock investor managing risk in his long portfolio with call options held on average one to five months and a number of stock positions held for over a year, with some over four years.

Many investors use options in this manner. They hold significant long positions in stock and are exposed to bearish headlines, so during “risk off” periods they may sell calls or buy puts on their underlying stock. When they expect little movement they may “write premium” to enhance their income.

Management of an investment portfolio is a far cry from being a business trader with an entity, day and swing trading weekly and monthly options full-time with executions almost every day of the week, average holding periods of less than seven days, and no connection to management of risk in an investment portfolio.

Endicott failed all our golden rules for TTS qualification in 2006 and 2007. Our rules call for 500 round trip trades and Endicott had 204 trades in 2006 on 75 days and 303 trades on 99 days in 2007. Our rules call for executions on 75% of available trading days and Endicott had well under 40%. Additionally, there were seven months in 2006 in which he executed less than three trades in a given month.

Endicott was even less frequent than Holsinger, another landmark trader tax court case we covered on our blog dated 9/3/08. Holsinger executed 372 options trades on 45% of trading days. Holsinger was at least trading and not managing his investments like Endicott.

We have some questions about Endicott’s 2008 trading activity since his numbers —1,543 trades on 112 days, including investments — exceeded our 500 round trip requirement. But, he still was stuck at 45% of day executions, well below our 75% requirement. He started trading ETFs instead of options in 2008, perhaps in connection with his portfolio of investments, although we don’t know for sure. The court clearly focused on the big picture over three years (2006 to 2008) and couldn’t get past the fact that Endicott was a significant investor managing his portfolio and was not running a separate and distinct trading business.

Endicott begged for a beat down from the IRS. He deducted $300,000 on a trading business Schedule C, including huge margin interest on his long stock investment portfolio. Investors deduct investment interest expense on Schedule A (itemized deductions) and it’s limited to investment income.

There are some interesting precedents that come out of the Endicott court.

We’ve written about presenting the “hotel analogy” for options traders to the IRS and this ruling seems to deny one pillar of that argument. Although we would have presented the argument better, Endicott did not deserve to make this case. It’s only for a very close call on TTS.

Endicott argued his number of trading days should include days his option investments were actually open — not just the execution days for buys and sells. He said he did not trade options on a daily basis because commissions made it unprofitable. That’s bogus. Option traders can trade enough to surpass our golden rules if they are running a business. The court agreed and said counting days that investments are open doesn’t hold muster for counting trading days. We don’t consider this a denial of our hotel analogy, but it’s certainly a shot across the bow on that argument.

There are some interesting technicalities in the Endicott ruling. The court broke down qualification for TTS into two sub-part tests, although we think they are basically one test. The first test was “substantial” for size and number of trades. The court erred in viewing Endicott’s significant stock portfolio as part of the TTS test, as although it was large, it doesn’t count in a TTS analysis.

The second test was for “frequency” and it focused on trading execution days as a percentage of available trading days. Endicott knew he came up far short and he tried to claim days for options being open.

We agree with the tax court that Endicott was not attempting to catch the swings in the daily market because his overall holding period of the call options. Holding periods of one to five months are definitely not, as the tax court implies, “indicative” for a trader seeking such swings in the daily market.

(Note: Upon our complete reading of the Endicott case, we found a footnote by the tax court of what is deemed as an “executed trade.” The tax court appears to take the position that the expiration of an option in itself does not count within a trader’s number of “executed trade” for TTS qualification due to lack of any required action of the trader himself. The following example was given: If a taxpayer “purchased stock, sold a call option that expired unexercised, and subsequently sold the stock,” only three trades were deemed executed. This is contrary to our position that the expiration of an option is a trade itself.)

The lesson in the Endicott court case is it’s very important to ring fence investments vs. business trading. If you have material investments, it’s wise to use a trading business entity for that separation. When trader tax status is analyzed, don’t let investments infect your analysis. Don’t count investments in the numerator or denominator for the percentage of days traded, number of trades or average holding period.

Had Endicott had a consultation with our firm in the years in question, we would have certainly told him he did not qualify for TTS. As we have said for several years, it’s more challenging for an options trader to qualify for TTS. Especially when they have a full-time job and trade monthly options on the side a few days per week, bunching trades around explorations.

There is plenty of good news in the Endicott court ruling, too. It affirms TTS and reinforces what does qualify.

What should options traders do to qualify for TTS? 
We advise setting up a separate trading business entity that disconnects trading from an individual’s investment portfolio. Don’t manage your investments with options and other “risk on and risk off” instruments like ETFs and indexes. Rather, day and swing trade options, ETFs and indexes on a stand-alone business-trading-program basis. Make sure you meet our golden rules.

Side note: The Edicott Court raised a concern about Endicott’s other Schedule C for consulting income. Endicott retired in 2002 and received income on a yearly basis as part of a non-compete agreement as the president of his former company. He reported this income on a separate “Consulting” Schedule C for each respective tax year. There appears to be no actual daily work requirement for Endicott in association with the receipt of this income and therefore it had no interference on his attempt to trade. The tax court pointed out that a taxpayer that qualifies for TTS “generally” should have the business of trading as his/her “sole or primary source of income.” The key term is “generally.” Just because a taxpayer has another source of income and net trading losses in a given tax year does not in itself deny a taxpayer from qualifying as TTS. In Endicott’s case, this other income was for past services and it should not have been a contributing reason for denial of TTS. 

Watch our Sept. 10, 2013 Webinar recording on this subject.

Holsinger case: IRS denies trader tax status and MTM

September 3, 2008 | By: Robert A. Green, CPA

A trend is not your friend. The IRS won a few tax court cases over the past few years; disallowing trader tax status and IRC Section 475(f) mark-to-market accounting (MTM, ordinary loss treatment) for “close call” traders. 

Unfortunately for all business traders, a few of these tax court cases had weak factors for qualification for trader tax status, plus botched MTM elections. Plus, the cases were argued poorly in court; often by the traders without a trader tax expert’s help, or by an expert who was not sufficiently strong enough on trader tax law. 

A very recent IRS tax court case victory (denying trader tax status and MTM) has caused a stir in the media and among traders. It’s Holsinger vs. IRS. This case was written up in today’s Wall Street Journal by Tom Herman, an excellent WSJ columnist on tax matters. 

See the below links for that article and the links in that article:
Think You’re A Trader? IRS May Disagree
United States Tax Court: WILLIAM G. HOLSINGER AND JOANN MICKLER, v. COMMISSIONER OF INTERNAL REVENUE
http://www.irs.gov/taxtopics/tc429.html 

Note that one expert’s quote in the article is wrong. A trader can segregate investment positions and still benefit from lower long-term capital gains tax rates, while benefiting from IRC 475 MTM ordinary loss (or gain) treatment on business positions. Otherwise, it’s an excellent article. 

As another example, in Chen vs. IRS, a part-time trader lost both trader tax status and MTM ordinary trading loss treatment; where he should have only lost MTM on technical grounds (and he represented himself poorly on all fronts).

Like the Chen case above, I believe the Holsinger decision is also controversial, in that the IRS easily won denial of MTM ordinary loss treatment on technical grounds, and this taxpayer also conceded trader tax status qualification too easily. 

Both of these cases should serve as precedent for MTM technical issues, yet they will gain ground as settled law for trader tax status and they should not – because they were argued incorrectly and without good enough legal counsel. That’s bad precedent for business traders and it needs to be corrected soon! 

Denial of MTM converts ordinary trading losses into capital loss limitations (which are carryovers instead), which is the biggest type of loss in these cases. However, winning trader tax status – a different but connected point – can keep business ordinary loss treatment for expenses; versus reclassifying them as restricted and limited investment expenses. 

See my full comments on the Holsinger vs. IRS tax court case below. 

These poorly handled cases are becoming an increasing problem for business traders; who are entitled to all trader tax status related benefits (business expenses, MTM treatment and more). 

Judges have made remarks in some of these cases that are not settled tax law and then IRS agents later on cite these court cases as settled law precedent in exams and other proceedings. Traders are hurting themselves by botching trader tax returns, getting examined and then bringing losing cases to tax court; plus often handling those poorly in tax court too boot. 

This tax court case trend coupled with new IRS exam proliferation (see my November 2008 article in Active Trader does not bode well for business traders. 

In the current environment, it’s wise to form a separate trading business entity (for a separate tax filing) and to be more conservative on trader tax status qualification decisions. Plus, do not invite the IRS into your tax return with undue red flags either.

Comments on the Holsinger vs. IRS tax court case: 

Holsinger (H) was a “close call” at best on trader tax status, and GreenTraderTax (GTT) would probably have challenged and maybe not allowed his trader tax status as a tax preparer. 

GTT would not have filed the tax returns this taxpayer filed; which contained important errors. H was not entitled to use his LLC or the LLC’s internal MTM election; because taxpayer conducted most trading in his individual name and therefore did not have trader tax status on the LLC level. No mention was made of an external sole proprietor MTM election by 4/15/01. 

The “agent” argument is a problem in this context (of MTM). I wonder why H didn’t just trade in the name of the LLC, thereby doing himself a disservice in this regard. The case did not mention anything about prior capital loss carryovers either; so we don’t know any other factors that may be important in this context. 

It’s different with a defacto husband and wife general partnership; which can include individual joint trading accounts during the defacto period (in the initial year). Defacto GPs must open GP trading accounts when they are formalized. 

The IRS probably examined (audited) H because he filed a large loss on Schedule C (sole proprietorship before the entity was started) and Schedule E (for the LLC). Expenses were also fairly large by most business trader standards. I doubt H used proper trader tax footnotes and he probably botched his tax reporting too.

H is a retired person and that raises the bar on trader tax status qualification in our view; like for a part-time trader. We have reason to believe that the IRS is prejudiced against retirees, part-time and money losing traders. 

H’s number of round trip trades was well below our published golden rule numbers of 500 round trip trades. Some business traders can have fewer trades, but their other factors need to be strong. See Green’s 2008 Trader Tax Guide for our golden rules. We always say/write that we want to see one or more trades per day; every possible trading day. H had fewer than 160 round trip trades in 2002 and even less in 2001. If all of H’s other factors were very strong, maybe he could have won trader tax status business expense treatment. H’s low number of trades coupled with an average holding period over 31 days was troubling. 

H’s total cost basis on trades was well under 1 million per year and that’s very low for our golden rules as well. We usually see several million for proceeds and cost basis on securities. 

The IRS cited all the normal tax court cases on trader tax status and the range of total trades was very broad. From the denial of trader tax status on less than 50 round trip trades to agreeing to trader tax status on 1,100 total trades (assume 550 round trip trades). H fell in the middle and probably closer to a winning position. 

One of the biggest IRS’s arguments in this H case seems to be that H traded on only 40% of available trading days in 2001 and 45% in 2002. I wonder what’s happened since 2002, as subsequent events add credibility as well. 

Here’s a very important concept to interject into these arguments about number of business days. I don’t see that taxpayer raised the idea that a business trader spends significant amounts of time in their trading business activity; on perhaps all or most available trading days, even if they don’t execute trades on every available day (sometimes for very good market reason). 

There are many examples of other types of valid business activities where a person is devoted to their business activities/duties almost every business day, but they don’t execute transactions every available business day. For example, real estate and other commissioned salesman may work every day but not generate a transaction commission (a sale) every day (and most don’t). 

This is a point that I feel we should get involved with in defending traders with the IRS; before this number of trading day’s argument adds up in tax court cases as hurtful precedent. 

I think the IRS focuses most on number of trades, and actual trading days because these are the most objective factors which the IRS can verify. It’s going to be hard for business traders to prove their time spent in their trading business on a daily basis (unless they have daily trades), since they are not punching a clock controlled by the IRS. 

We have recommended that business traders use all available means to document their time spent on a daily basis; like using business plans, saving login sessions, using calendars, emailing significant memos to themselves on a daily basis and more. 

After all, numbers of trades and trading days alone can not serve as the most important factors. Many traders use automated trading programs now to generate lots of trades on a daily basis and some of them fail qualification for trader tax status for other good reasons – of equal importance in our view. 

Several other factors show business intent and business activity levels as well. For example, H obviously had large business expenses and many business tools and these points were not sufficiently addressed in his favor in the tax court memo. 

H had the typical serious business trader’s set up with multiple monitors, computers, home-office and more and these points were not commented on in the court’s decision; other than as large items for denial as business expenses. It should have been noted that these serious tools and expenses are indicative of a serious trading business activity and not casual investing.

Another big point by the IRS in H is the concept of “daily market movements rather than long-term price appreciation” This brings up the point of average and mean holding periods. 

“Daily market movements” does not mean that day trading only is required; as certainly swing trading is allowed too. H is weak in having an average holding period over one month in stocks. We have seen one month holding periods being okay for trader tax status, usually in connection with stock options (with monthly expirations) only; but usually not for stocks. 

H did himself a disservice by claiming he was often closing positions daily when in fact he rarely did. But, I don’t see any effort in the memo (which is just a snap shot of this case) to segregate out investment positions; which can reduce the average holding period calculation. H first botched MTM with the LLC versus individual accounts and this second misstatement helped him lose credibility with the IRS on the agent level (I presume). 

Hopefully, this case has a lot more analysis and facts behind it, than what is summarized in this brief tax court memorandum.