Features of the Mark-to-Market elections
(see Non Mark-to-Market Trader for different features)
Some features of Mark-to-Market are:
- Filing with the §475(f) mark-to-market method of accounting requires that your Trader Status is valid and will be upheld by the IRS or the tax court.
- Effective for years 2011 and thereafter, the complicated reconciliation of IRS Form 8949 and the broker issued form 1099-B is mostly avoided.
- If the M2M election was filed previously, the year’s net trading losses are “ordinary losses” and are therefore not limited to the annual $3,000 “capital loss” limitation. They are generally fully deductible and they reduce your taxable income from all other sources. The year’s net trading losses do not get added to any existing balance of your prior years’ capital loss carryforwards.
- The year’s net trading gains are “ordinary gains” and are therefore not available to offset against any current year net “capital losses” nor any old prior years’ capital loss carryforwards.
- The year’s net trading gains, while taxed as “ordinary,” are nonetheless not subject to Self-Employment tax pursuant to IR Code §475(f)(1)(D) (but they are of course subject to your regular federal income tax rates).
- Since net trading gains are not subject to Self-Employment tax no deduction for an IRA or other Retirement plan or Health Insurance plan may be directly based on them. (but by forming a separately filing trading entity self-employment income can be created)
- The year’s net trading gains are usually taxed at your regular ordinary rates. The capital gains tax rates are not applied to your trading gains. Although securities separately held for investment may be subject to the capital gains tax rates, upon sale.
- The year’s net trading gains in §1256 contracts (futures) are usually taxed at your regular ordinary rates. The special 60/40 capital gains tax rates are not applied to your trading gains. Although §1256 contracts separately held may be subject to the preferential 60/40 capital gains tax rates. (note: the §475(f)(2) election for futures is separate and apart from the §475(f)(1) election for securities).
- The year’s trading gains and losses in each specific §988 transaction (FOREX) are usually taxed at the regular ordinary income rates as interest income or deducted as interest expense.
- The year’s trading gains and losses in each specific §988 transaction (FOREX) are usually taxed as a regular §1256 contract if you elected under §988(a)(1)(B) by the end of the day that the position was opened, pursuant to §988(c)(1)(B)(iii).
- Stocks that are so identified are subject to mark-to-market while other stocks specifically identified as being held solely for capital gain treatment and/or for investment purposes are not subject to the mark-to-market accounting and tax treatment.
- The Wash Sales rule is ignored for these securities.
- The activity is not treated as a passive activity, even if held passively through a trader entity.
- The income is not treated as portfolio income.
- A wife may elect Mark-to-Market, while her husband might not.
- Securities held overnight on December 31st are accounted for “as sold” and the paper gains or losses are shown on the current year’s tax return. For the first year that a trader elects to change to the mark-to-market method some of the current year’s net gains (or in limited circumstances, losses) may be limited to being recognized approximately at the rate of 25% per year over four years. This four-year rule holds true even if in the following year the taxpayer realizes significant net losses (or gains).
- ○ Example: If you properly elect mark-to-market between January 1, 2016 and April 15, 2016 this will convert any capital losses on trading securities held at December 31, 2015 into deductible ordinary losses in 2016. This might also convert disallowed wash-sale capital losses from December 2015 into fully deductible ordinary losses in 2016. These ordinary losses would be fully deductible either as straight losses in 2016, subject to a two year NOL carryback and/or deductible over one or four years pursuant to IR Code §481.
- ○ Example: If you properly request to revoke mark-to-market between January 1, 2016 and April 15, 2016 this will mark to FMV the tax basis of any trading securities held at December 31, 2015. These is no IR Code §481 adjustment.
- Sole proprietors report expenses (which generally includes margin interest) on Schedule C and trading activity (which generally includes the commissions thereon) on Form 4797.
- Sole proprietor M2M traders may report each individual trade on IRS Form 4797. At times the IRS may prohibit the old “details provided upon request.”
- Partners, LLC members and S-Corp shareholders report passthru amounts on Schedule E and other tax forms.
- Partners, LLC members and S-Corp shareholders deduction for margin interest may be limited if they are not active managers.
- Partners’, LLC members’ and S-Corp shareholders’ gains and losses reported on Schedule K-1 Form 1065, box 11F and Form 1120S, box 10E are generally ordinary gains or losses (unless for example, a segregated account held non-M2M positions or an upper tier passthru entity did not elect M2M)
- Partners, LLC members, S-Corp shareholders and C-Corp shareholders may be subject to Self-Employment tax and therefore may be able to have a deduction for a Retirement plan or Health Insurance plan.
- In general, capital gain vs. ordinary income may be recharacterized under §§475(f), 988, 1258 or 1296.