Late Section 475(f) Election and Section 9100 Relief

Those who are traders in securities or commodities can make a mark-to-market election. This election can allow the trader to immediately deduct losses each year and avoid the wash sale rules.

But many traders do not know about this election and only learn of it after it is too late to benefit from it. Even experienced CPAs often fail to know of or advise their clients on this election.

The Vines v. Commissioner, 126 T.C. 279 (2006) is an example. It provides an example of how and when taxpayers may be able to make this election late.

Facts & Procedural History

Vines is a personal injury attorney. He stopped practicing law in 1999 in order to become a securities day trader. He received legal fees in 1999 and 2000 from work he performed that resulted in a settlement award.

Vines placed $5 million on account with two different brokerage companies to carry out this day-trading activity. Unfortunately, he margined his investment accounts and one of his brokerage accounts was liquidated when he could not cover the margin call.

His investment earnings were $35 million in 1999 and 2000, but he lost $25 million in April 2000.

Vines’ CPA failed to advise him of the availability of Section 475(f) for certain day traders. Later, Vines’ friend (who was a doctor) told Vines that he may be able to deduct his securities trading losses as ordinary losses pursuant to Section 475(f). After researching the issue, Vines’ CPA advised him that he should still be able to file for a Section 475(f) election.

By this time, Vines had filed his extension for his 1999 return in April of 2000 and had failed to make the Section 475(f) election with the extension.

Vines hired a tax law firm to help him to submit a private letter ruling request to make the late election. The PLR was submitted in July of 2000–just three months after the due date for the extension to make the election for the 2000 tax year on the 1999 return or extension filing.

About the Mark-to-Market Election

Section 475(f) allows traders in securities or commodities to elect the mark-to-market method of accounting.

With this method, at the end of each taxable year, the taxpayer must recognize any gain or loss on securities held in connection with their trading business as if they were sold for their fair market value on the last business day of the year. The gain or loss is treated as ordinary income or loss, rather than capital gain or loss.

If a taxpayer makes the Section 475(f) election, they can apply and carry back losses from their securities trading business to offset ordinary income. However, if they fail to make the election, any gain or loss on securities trading will be treated as capital gain or loss, subject to capital loss limitations. And more importantly, absent a mark-to-market election, the wash sale rules can be problematic.

The Wash Sale Rules

The wash sale rules apply to taxpayers who sell securities at a loss and then acquire substantially identical securities within a specified period before or after the sale. If the wash sale rules apply, the loss on the sale is disallowed and added to the basis of the newly acquired securities.

For traders who have made a Section 475(f) election, the wash sale rules do not apply to securities held in connection with their trading business. This means that traders can realize losses on the sale of securities, and immediately repurchase substantially identical securities without triggering the wash sale rules. This can be beneficial for traders who want to recognize losses without disrupting their trading strategy.

For taxpayers who have not made the Section 475(f) election, the wash sale rules do apply to securities held as capital assets. This means that if they sell securities at a loss and then acquire substantially identical securities within the specified period, the loss will be disallowed and added to the basis of the newly acquired securities. This can limit the ability of taxpayers to recognize losses and offset gains.

Section 9100 Relief

Rev. Proc. 99-17, Section 5.03 provides procedures for making the mark-to-market election. It states that a taxpayer must file a statement that satisfies the requirements in section 5.04 of the revenue procedure, 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.

Section 9100 relief allows taxpayers to obtain an extension of time to make a regulatory election if they can establish that they acted reasonably and in good faith and the interests of the government will not be prejudiced. Thus, the IRS should grant relief if the taxpayer provides evidence establishing to the IRS’s satisfaction that two conditions are satisfied: (1) the taxpayer acted reasonably and in good faith, and (2) the interests of the government will not be prejudiced by granting relief.

In this case, the IRS argued that the election of the mark-to-market method of accounting under Section 475(f) is an accounting method regulatory election and that Section 301.9100-3(c)(2), presumes the interests of the government to be prejudiced, absent unusual and compelling circumstances. The IRS argued that the taxpayer was required to file his Section 475(f) election by April 17, 2000, the due date for his 1999 tax return, and therefore, Section 9100 relief is not available.

The taxpayer argued just the opposite. He argued that he acted reasonably and in good faith and that the interests of the government will not be prejudiced.

The Court’s Analysis

The U.S. tax court did not agree with the IRS. It concluded that the taxpayer acted reasonably and in good faith and that the interests of the government are not prejudiced by allowing the taxpayer to file a late election. The court made the following observations:

There is no question that petitioner requested relief before respondent discovered the failure to make the section 475(f) election. …. we note that while petitioner had practiced law for over 30 years, he had only been in business as a securities trader for approximately 3 months at the time respondent contends he should have made his section 475(f) election; i.e., April 17, 2000. Within a day of learning of the section 475(f) election from Dr. Sullivan, petitioner contacted a new accountant, Mr. Sellers. Mr. Sellers was also unaware of section 475(f), but petitioner retrieved the citation of section 475(f) from Dr. Sullivan and provided it to Mr. Sellers. Petitioner also immediately hired Caplin & Drysdale to file the section 475(f) election and request section 9100 relief. In relying on Mr. Pearce, petitioner had no reason to question Mr. Pearce’s qualifications as a qualified tax professional. Mr. Pearce has over 30 years of experience in tax and accounting, has held numerous leadership positions within his field and had extensive knowledge of petitioner’s trading activities and losses from those activities.

The court also considered whether the taxpayer benefitted from hindsight:

the relevant inquiry is whether allowing a late election gives the taxpayer some advantage that was not available on the due date. In the instant case, the only fact that changed after the due date for making the election was the discovery of the availability of the election itself. Petitioner conducted no trading activities and incurred no further losses between the time he should have filed the section 475(f) election and the date he actually filed the election. If a late election is allowed, petitioner will not be entitled to anything more than that to which he would have been entitled had he timely made the election.

The court also distinguished these facts from a prior case in which a taxpayer sought a Section 475(f) election to escape the $3,000 capital loss limitation.

The Takeaway

The IRS routinely denies requests for relief to make late Section 475(f) elections. This case shows that the courts may not be as strict. To qualify even with the court, the taxpayer would need to have not traded, to have filed the request for the late election soon after the due date for the return that would include the election, and not get an immediate benefit from making the election.