In PLR 202048009[1] a taxpayer asks the IRS to allow him to make a late election under §475(f)(1), a request the agency turned down.

Mark to Market Election

The mark to market election allows a trader to get around the $3,000 annual limit on net capital losses, treating the transactions as leading to ordinary income and loss.  However, the taxpayer must agree to “mark to market” any securities held at year end, reporting a gain/loss based on their value at the end of the year, resetting their basis to that level at the beginning of the following year.

Since a true trader generally is working with changes in value over extremely short periods of time, traders do not tend to hold any significant number of securities overnight due to the risk of events occurring over times the markets are closed that can’t be reacted to during that time.  Similarly, they aren’t harmed by treating gains as ordinary since a trader won’t be holding the securities for a period anywhere near the one year holding period necessary to get long term capital gain treatment.

IRC §475(f)(1)(A) reads:

(f) Election of mark to market for traders in securities or commodities

(1) Traders in securities

(A) In general

In the case of a person who is engaged in a trade or business as a trader in securities and who elects to have this paragraph apply to such trade or business—

(i) such person shall recognize gain or loss on any security held in connection with such trade or business at the close of any taxable year as if such security were sold for its fair market value on the last business day of such taxable year, and

(ii) any gain or loss shall be taken into account for such taxable year.

Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence. The Secretary may provide by regulations for the application of this subparagraph at times other than the times provided in this subparagraph.

The IRS has provided guidance on making this election in Revenue Procedure 99-17.  Relevant to the letter ruling in question, the procedure has the following deadline to make the election:

The statement must be filed not later than the due date (without regard to extensions) of the original federal income tax return for the taxable year immediately preceding the election year and must be attached either to that return or, if applicable, to a request for an extension of time to file that return.[2]

Taxpayer’s Facts

In this case the taxpayer had been asking about the tax issues of a trader:

During Date 3, Husband communicated with Accountant 1, Taxpayers’ federal income tax return preparer and tax advisor, regarding potentially making a § 475(f) election. In a memorandum to file, Accountant 1 noted that he discussed with Husband in detail the requirements for qualifying as a trader eligible to make a § 475(f)(1) election. Based on Husband’s claim that he was making multiple trades per day, Accountant 1 noted that it appeared that Husband qualified as a trader.[3]

In a footnote it appears the accountant did believe that the election was an option at this time:

In his affidavit, Accountant 1 stated, “I believed at that time [Date 3] that [Husband] appeared to satisfy and meet all the requirements for a valid mark-to-market election.”[4]

As is often the case, the taxpayer was losing money in this trading activity:

Taxpayers reported having a short-term capital loss carryover in the amount of a on their Year 3 federal income tax return. Husband’s stock trading generated significant additional net losses prior to the Date 4 due date for making the § 475(f)(1) election effective for Year 3. Husband continued to trade and incurred substantial additional trading losses after the election due date. Husband’s largest monthly trading losses were incurred in Date 5, after the due date of the election, and approximately b percent of his net trading losses, in the amount of c for Year 3, also arose after the election due date. Further, Husband was unable to generate gains in Year 4 to absorb Taxpayers’ capital losses. In early Year 4, Husband received a Form 1099 reporting that Husband’s trading activities had generated substantial wash sale losses in the amount of d for Year 3.[5]

Now the taxpayer, staring at these large losses, apparently ran into information that told him that it was possible for a trader to deduct these losses on selling the securities in excess of $3,000.  He then asked the accountant about this issue:

On Date 6, e months after the Date 4 election due date, Husband emailed Accountant 1, asking whether it was true that a day trader can deduct more than $3,000 per year in trading losses. Accountant 1 advised Husband that there is some truth to that if Husband qualified as a trader. Accountant 1 did not inform Husband at that time that the deadline to make a § 475(f)(1) election had passed for Year 3, or otherwise inform Husband that making a timely election was required.[6]

This is the first time the facts note that the accountant appears to not have realized when this election was required to be made.  As the facts go on, it’s clear the accountant believed the option to make the election was still available.

On Date 7, Husband requested Accountant 1 to do whatever was possible to reduce his federal income tax liability. More specifically, Husband communicated that he would like to deduct all of his stock losses for both Year 1 and Year 2. On Date 8, Accountant 1 emailed Husband information regarding income tax planning considerations associated with potentially making a § 475(f)(1) election. Accountant 1 described additional information that he needed to make the election for Year 2, and provided a description of the requirements for being a trader, including that a taxpayer’s trading activities must be frequent, regular, and continuous. Accountant 1 indicated that he was prepared to make the election for Year 2 on Taxpayers’ Year 2 federal income tax return if Husband (a) believed he met the requirements for being a trader, (b) was willing to bear the risk of making the election, and (c) provided the additional information needed to make the election.[7]

In a footnote, the letter notes that the taxpayer claimed the accountant had committed to making just such an election:

Husband asserts that Accountant 1 made a commitment in the Date 8 email to make a § 475(f)(1) election effective for Year 3 on Taxpayers’ behalf.[8]

However, now another accountant with the same firm comes into the mix (referred to as “Accountant 1” in the ruling) and states that the taxpayer has missed the date to make the election—and also claims the other accountant had told the taxpayer about this date:

Taxpayers’ Year 2 and original Year 3 federal income tax returns were filed by reporting stock gains and losses on a realization basis. In preparation of Taxpayers’ Year 3 tax return, Advisor informed Husband by email on Date 9 that, “Consistent with [Accountant 1]’s earlier analysis, you won’t be able to claim trader status for [Year 3].”3 Following a meeting with Husband and Lawyer, Accountant 2, who was employed at the same accounting firm as Accountant 1 and Advisor, informed Husband by email on Date 10 that a § 475(f)(1) election should have been filed by the unextended due date of the federal income tax return for the year preceding the year for which the election is made. Accountant 2 also alerted Husband of the opportunity to pursue relief under § 301.9100-3 to make a late § 475(f)(1) election for Year 3.[9]

Relief Under Reg. §301.9100-3 for a Late Regulatory Election

The letter ruling is asking for relief under the provision that Accountant 2 referred to—Reg. §301.9100-3.  Under this regulation, a taxpayer may ask the IRS to grant relief to make a late election where the date is set by regulation.[10]  The taxpayer makes that request via a private letter ruling[11] which will require the payment of the appropriate user fee published each year in the initial Revenue Procedure for that year.

For a ruling to be granted under this regulation the taxpayer must meet two criteria:

• The taxpayer acted reasonably and in good faith with regard to the election and

• The grant of relief will not prejudice the interests of the Government.[12]

However, if the requested election involves a change of accounting methods (which the election under §475(f)(1) does) the interests of the Government will be deemed to be prejudiced absent unusual and compelling circumstances if the election for which relief is granted:

• Is subject to the procedure described in Reg §1.446-1(e)(3)(i) (requiring the advance written consent of the Commissioner);

• Requires an adjustment under section 481(a) (or would require an adjustment under section 481(a) if the taxpayer changed to the method of accounting for which relief is requested in a taxable year subsequent to the taxable year the election should have been made);

• Would permit a change from an impermissible method of accounting that is an issue under consideration by examination, an appeals office, or a federal court and the change would provide a more favorable method or more favorable terms and conditions than if the change were made as part of an examination; or

• Provides a more favorable method of accounting or more favorable terms and conditions if the election is made by a certain date or taxable year.[13]

This case presents problems both with regard to the need for a §481(a) adjustment and the fact that the results would be much more favorable for the taxpayer if he had permission to change his accounting method earlier—he now has the full advantage of hindsight. 

As well, Reg. §301.9100-3(b)(3)(iii) also provides a more generic bar on granting a change with the advantage of hindsight, holding a taxpayer is deemed not to have acted reasonably and in good faith if the taxpayer:

Uses hindsight in requesting relief. If specific facts have changed since the due date for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief. In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer’s decision to seek relief did not involve hindsight.

So the question becomes—do these facts represent unusual and compelling circumstances along with strong proof the decision to seek relief did not involve hindsight?

Failure to Act Reasonably or in Good Faith

The PLR finds that the facts demonstrate rather clearly that the taxpayer had the benefit of hindsight in seeking to make the late election:

To make a timely § 475(f)(1) election for Year 3, Taxpayers had to make the § 475(f)(1) election by Date 4, the unextended due date of Taxpayers’ federal income tax return for Year 2. Taxpayers did not file their first request for relief under § 301.9100-3 until Date 11. Taxpayers’ request for a late filing of the § 475(f)(1) election was made with the benefit of nearly f months of hindsight. Husband continued to trade during Year 3 and Year 4. Husband realized his largest monthly trading loss during Date 5, after the due date for filing a § 475(f)(1) election for Year 3. Further, Husband suffered approximately b percent of his trading losses for Year 3 after the election due date. Additionally, Husband received a Form 1099 in early Year 4 reporting wash sale losses in the amount of d from his trading activities in Year 3, and knew the outcome of his trading activities in Year 4 before filing a request for relief under § 301.9100-3 to make a late § 475(f)(1) election. Taxpayers gained a benefit from hindsight because they were able to determine the effect of a § 475(f)(1) election with the benefit of knowledge that Husband’s ongoing trading activities (a) produced a significant increase in realized trading losses and wash sale losses, and (b) did not produce meaningful gains to absorb Taxpayers’ capital losses. Thus, Taxpayers’ specific facts materially changed after the due date for making the § 475(f)(1) election, and those specific fact changes made that election advantageous to Taxpayer. Moreover, Taxpayers did not provide strong proof showing that their decision to seek relief to make a late election did not involve hindsight. Accordingly, under § 301.9100-3(b)(3), Taxpayers are deemed to have not acted reasonably and in good faith.[14]

The IRS also did not find the taxpayer’s assertion that he had instructed Accountant 1 to timely make the election persuasive, noting in a footnote:

Husband’s assertion that he instructed Accountant 1 to timely make a § 475(f) election is not supported by the facts provided. Rather, it is evident that Husband and Accountant 1 did not even begin to revisit the prospect of making a § 475 election until at least e months after the election due date had passed.[15]

The footnote suggests there might be a possible finding of reasonable cause in a case where an adviser failed to make an election after having been timely informed by the taxpayer to prepare such an election.  But since that wasn’t the case here, we can’t say for sure that such a situation would lead to relief being granted.

Granting Relief Would Prejudice the Interests of the Government

The IRS was also not impressed with the taxpayers’ claims that granting relief would not prejudice the interests of the government:

Taxpayers have not presented unusual and compelling circumstances. After suffering large trading losses during Date 5, Husband revisited the prospect of making the election with Accountant 1 on Date 6, more than e months after the due date for making the § 475(f)(1) election. Accountant 1 advised Husband of the possibility of deducting his trading losses if Husband qualified as a trader, but Accountant 1 failed to point out the need to have timely made an election (the due date for which had already passed). Those circumstances are neither unusual nor compelling.[16]

[1] PLR 202048009, November 25, 2020, https://www.irs.gov/pub/irs-wd/202048009.pdf (retrieved November 27, 2020)

[2] Revenue Procedure 99-17, Section 5.03(1)

[3] PLR 202048009

[4] PLR 202048009

[5] PLR 202048009

[6] PLR 202048009

[7] PLR 202048009

[8] PLR 202048009

[9] PLR 202048009

[10] Reg. §301.9100-2(a)

[11] Reg. §301.9100-2(e)(5)

[12] Reg. §301.9100-2(a)

[13] Reg. §301.9100-2(c)(2)

[14] PLR 202048009

[15] PLR 202048009

[16] PLR 202048009