In my experience, day traders generally fall into one of two categories: a small minority achieving considerable success, or the majority, rapidly diminishing their previously amassed fortunes once they venture into day trading.

Day trading entails executing a vast number of security sales on a daily basis. An unsuccessful day trader quickly learns that, by default, they are restricted to a net deduction of only $3,000 in losses per year due to the annual limitation on individual capital loss deductions stipulated in Internal Revenue Code (IRC) §1211(b)(1). When the trader’s net losses extend into the six-figure realm, this $3,000 annual limitation can be significantly distressing.

A potential remedy for this issue is located within the Internal Revenue Code at IRC §475(f)(1). The relevant passage reads as follows:

(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 process to make this election is outlined by Revenue Procedure 99-17,[1] which stipulates a relatively early cut-off date for making the decision to elect:

(1) General procedure. Except as provided in section 5.03(2) of this revenue procedure, for a taxpayer to make a section 475(e) or (f) election that is effective for a taxable year beginning on or after January 1, 1999, the taxpayer must file a statement that satisfies the requirements in section 5.04 of this revenue procedure. 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]

A calendar year individual taxpayer looking to make this election beginning in 2023 must have filed the election by April 15, 2023 (not 2024, when the 2023 return is due).

In Private Letter Ruling 202325003[3], a taxpayer unaware of this due date sought relief from the IRS under Reg. §301.9100-1 and 3.  While the regulations provide the IRS has the discretion to grant such relief, in this case (and virtually every case looking for relief for a late election under IRC §475(f)(1)), the IRS declined to provide that relief, finding the taxpayer failed to act in good faith and granting the relief would prejudice the interests of the government.

Facts of the Case

The PLR outlines the following facts presented by the taxpayer seeking relief:

Taxpayer is an individual and has engaged in securities trading. Taxpayer states that Taxpayer was not familiar with tax aspects of securities trading and was not aware that Taxpayer's trading activity during Year 2 might have enabled Taxpayer to claim that Taxpayer was a trader eligible to make a §475(f)(1) election.

To make a timely §475(f)(1) election for Year 2, Taxpayer had to make the §475(f)(1) election by Date 2, the unextended due date of Taxpayer's federal income tax return for Year 1. Taxpayer continued to engage in securities trading after Date 2 and asserts that Taxpayer learned about the existence of a §475(f)(1) election during Year 3 by seeing news about the CARES Act and net operating loss (NOL) extensions. At that time Taxpayer realized that it would have been beneficial for Taxpayer to have made a §475(f)(1) election with a Year 2 effective date. However, Taxpayer did not file the request for an extension of time under §301.9100-3 to make a late §475(f)(1) election for Year 2 until Date 3.[4]

Requirements to Obtain Relief Under Reg. §301.9100-3

The PLR first outlines the general rules to obtain relief to make a regulatory election after its due date:

Section 301.9100-1(c) provides, in part, that the Commissioner has discretion to grant a reasonable extension of time to make a regulatory election (defined in §301.9100-1(b) as an election whose due date is prescribed by regulations published in the Federal Register, or by a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin). Section 301.9100-1(b) defines the term election to include a request to change an accounting method.

Section 301.9100-3 sets forth rules that the Commissioner must use to determine whether the Commissioner will grant an extension of time for regulatory elections that do not meet the requirements of §301.9100-2 for an automatic extension. Generally, a taxpayer must provide sufficient evidence to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and that the grant of relief will not prejudice the interests of the Government.[5]

The ruling summarizes the requirements a taxpayer must meet to show he/she acted reasonably and in good faith, the first requirement that must be met to be granted relief:

Section 301.9100-3(c) provides that the Commissioner will grant a reasonable extension of time to make a regulatory election only when the interests of the Government will not be prejudiced by the granting of relief. Section 301.9100-3(c)(1)(i) provides that the interests of the Government are prejudiced if granting relief would result in a taxpayer having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made (taking into account the time value of money).[6]

The ruling also gives details on how the taxpayer must demonstrate that the interests of the government would not be prejudiced by a grant of relief, the second requirement to obtain relief:

Section 301.9100-3(c)(2) provides special rules for accounting method regulatory elections. Section 301.9100-3(c)(2)(ii) provides that the interests of the Government are deemed to be prejudiced except in unusual and compelling circumstances if the accounting method regulatory election for which relief is requested requires an adjustment under §481(a) (or would require an adjustment under §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).[7]

In this ruling, the IRS would find that neither requirement had been met.

Failure to Act Reasonably and in Good Faith

A significant obstacle taxpayers face in demonstrating they acted reasonably and in good faith is the undeniable advantage they receive by having a more comprehensive understanding of their net gain/loss from trading for the year when they are permitted to make the election after the date required by Revenue Procedure 99-17. This late election essentially allows them to make a more informed decision, which can skew the balance of fairness.

As the ruling explains:

To make a timely §475(f)(1) election for the taxable year that ended Date 1, Taxpayer would have had to make the election by Date 2, the unextended due date of Taxpayer’s Year 1 federal income tax return. Taxpayer’s request for a late filing of the §475(f)(1) election was not made until Date 3. This late filing provided Taxpayer the benefit of over a months of hindsight to review and consider the results of Taxpayer’s securities trading transactions and to determine whether Taxpayer would have benefited by making the election. Accordingly, if Taxpayer had made a timely §475(f) election, Taxpayer would not have had the benefit of knowing the results of Taxpayer’s securities transactions after the election’s due date, and Taxpayer would not have had this time to act on that knowledge.

As a result, Taxpayer gained a benefit from hindsight because Taxpayer was able to determine the effect of making a §475(f)(1) election beginning with Year 2, armed with the benefit of knowing the results of Taxpayer’s securities trading activities for over a months following the due date for making the election. Moreover, Taxpayer did not provide strong proof showing that Taxpayer’s decision to seek relief to make a late election did not involve hindsight.[8]

In a footnote, the PLR indicates the taxpayer recognized this challenge and attempted, unsuccessfully, to provide information to persuade the IRS that the taxpayer had not benefitted from hindsight:

Taxpayer submitted some federal income tax return information and other documents depicting Taxpayer’s trading activity both before and after the due date for the election, but Taxpayer did not offer clear factual proof showing that Taxpayer’s decision to seek relief to make a late election did not involve hindsight. Nevertheless, Taxpayer asserts that Taxpayer would have timely made the election even without knowledge of the factual developments that made the election advantageous.

The main issue is that the taxpayer was aware of their financial outcomes that took place since the date the election was due. Consequently, it is virtually impossible to prove that if there had been significantly different results during the period from the due date of the election until the date relief was requested, the taxpayer would not have factored in this information in their decision-making process regarding the election.

Grant of Relief Would Prejudice the Interests of the Government

The ruling also points out that according to the regulations, a presumption exists that government interests would be compromised if an IRC §481(a) adjustment is necessitated due to a request for a belated accounting method adjustment.

Under §301.9100-3(c)(2)(ii), the interests of the Government are deemed to be prejudiced, except in unusual and compelling circumstances, if the accounting method regulatory election for which relief is requested requires an adjustment under §481(a) (or would require an adjustment under §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).[9]

The ruling concludes that the taxpayer had not presented such unusual and compelling circumstances in this case.

Taxpayer has not presented unusual and compelling circumstances for its failure to timely make a §475(f)(1) election.

Since a §475(f)(1) election is an accounting method regulatory election that requires a §481(a) adjustment, the interests of the Government are deemed to be prejudiced because Taxpayer has failed to present unusual and compelling circumstances to justify granting the requested relief.[10]

[1] Revenue Procedure 99-17, February 8, 1999, https://www.taxnotes.com/research/federal/irs-guidance/revenue-procedures/irs-outlines-procedures-for-electing-mark-to-market-accounting-method/dldc?highlight=99-17

[2] Revenue Procedure 99-17, February 8, 1999

[3] Private Letter Ruling 202325003, June 23, 2023, https://www.taxnotes.com/research/federal/irs-private-rulings/letter-rulings-%26-technical-advice/irs-denies-securities-trader-late-mark-to-market-election/7gx04

[4] Private Letter Ruling 202325003, June 23, 2023

[5] Private Letter Ruling 202325003, June 23, 2023

[6] Private Letter Ruling 202325003, June 23, 2023

[7] Private Letter Ruling 202325003, June 23, 2023

[8] Private Letter Ruling 202325003, June 23, 2023

[9] Private Letter Ruling 202325003, June 23, 2023

[10] Private Letter Ruling 202325003, June 23, 2023