IRC SECTION 475 ELECTION
IRC SECTION 475 ELECTION FOR MARK-TO-MARKET (MTM) ACCOUNTINGQUALIFIED TRADERS MUST MAKE A PROPERLY FILED ELECTION BY 4/15/2022 TO OBTAIN THE BENEFITS OF IRC SECTION 475 FOR TAX YEAR 202
Elections under Section 475 have potentially enormous upside advantages to virtually all qualified traders and almost no disadvantages. Every trader should carefully consider electing MTM accounting as there are benefits for all traders, although unique situations applicable to certain tax situations can limit some of these advantages.
Taxpayers who wish to reap all the benefits of a Section 475 election may still do so by forming a new trading entity which can make the election by placing a statement with the required wording in its books and records within 2 months and 15 days of its inception.
Existing entities must make the election by the due date of their tax return, for the year preceding the Section 475 election year. For a calendar year S Corporation, the election for tax year 2022 must be made by 3/15/22, the due date for the 2022 calendar year tax return.
The election will have the effect of transforming capital gains and losses into ordinary income and loss and require you to report trading gains and losses on Form 4797 Ordinary Gains and Losses. The tax rates on short term capital gains and losses and ordinary income and loss are exactly the same, so this reporting requirement has neither a positive nor negative effect.
Taxpayers who trade Section 1256 contracts (commodities, index options, etc.) or who have significant capital loss carry forwards or who have a unique tax situation should consult a qualified tax professional about whether a Section 475 election is appropriate and whether a new trading entity should be created to take advantage of Section 475.
ADVANTAGES OF A SECTION 475 ELECTION
- The $3000 limitation on deductible capital losses does not apply
- Net operating losses created by ordinary trading losses can be carried forward to offset future income
- Deferred losses on wash sales are fully deductible against gains and cumbersome record keeping requirements related to wash sales are eliminated
- Easier to segregate and report investment profits (potential long term capital gains) from trading profits
WHO CAN BENEFIT FROM A SECTION 475 ELECTION
- Traders with current year-to-date losses
- New traders without a proven track record
- Traders who have had both very profitable and unprofitable years due to market volatility
- Position traders with significant 12/31/21 unrealized gains or losses
- Trading entities such as partnerships, LLC’s, family limited partnerships and C and S Corps.
- Almost all traders can benefit from this election as a hedge or insurance policy against a bad year or a difficult market environment
A qualified professional with extensive experience in both tax laws pertaining to traders and tax preparation for traders should be consulted prior to making this election due to the complexity and rigid IRS procedures for making a timely and proper election. This professional should have knowledge of the business of trading and the markets. Profit or loss for the current year to date, unrealized profit or loss from the prior year end, the type of securities traded, any capital loss carry forwards and all specific and unique aspects of your particular tax situation must be taken into account.
Securities can be identified as investment positions and need not be marked-to-market at year end and subject to the tax on unrealized gains. This can be used as an effective planning tool in some cases to allow a trader to utilize unused carry forward losses and still allow a trader to claim the benefits of Section 475 Mark-to-Market accounting. A trader would still have available the ability to have long term capital gains taxable at the lowest capital gains rates available.
New traders without a proven track record and new entities recently set up for trading should strongly consider making this election. In the current difficult trading and market environment, the election can act as a hedge or insurance policy to allow you to benefit from a potentially unprofitable year and allow you to apply losses backward or forward against income from a profitable year.
Some ways to have both mark-to-market accounting benefits and capital gains rate advantages are:
- Elect MTM accounting in a new entity set up for trading activities and retain non-MTM securities identified as investment positions. This can be used as an effective planning tool in some cases to allow a taxpayer to utilize unused carry forward losses and have available the ability to have long term capital gains taxable at the preferential lowest capital gains rates
- Elect MTM accounting for your personal trading and set up an entity to trade assets that will utilize the advantages of favorable long term capital gains tax rates
- Elect MTM accounting for your trading account and segregate and identify other securities in a separate brokerage account which can have capital gains tax rate apply
- One spouse can be set up as a MTM trader while the other spouse with clearly segregated assets can be considered an investor