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126 T.C. No. 15
UNITED STATES TAX COURT
L.S. VINES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12763-04. Filed: May 11, 2006.
P, a lawyer for over 34 years, settled a class action law suit during
1999 and received compensation for his legal services. P received
approximately half of the compensation in taxable year 1999 and half
in taxable year 2000 and reported it as ordinary income for the
respective taxable years. P decided to leave the practice of law and
begin a business of trading
securities. After P failed to cover a margin call, P's brokerage
accounts were liquidated on Apr. 14, 2000, resulting in a short-term
capital loss. Throughout his career, P relied on accountants for tax
advice. When P filed for an extension of time to file his 1999 tax
return on Apr. 17, 2000, P did not elect the mark-to-market method of
accounting pursuant to sec. 475(f), I.R.C.,
because P's accountant was not aware of the mark-to-market election
for securities traders or any related revenue procedure. In June 2000,
P learned of the mark-to-market election for securities traders from a
friend, obtained the citation of sec. 475(f), I.R.C., and learned that
Rev. Proc. 99-17, 1999-1 C.B. 503, required the election to be filed no
later than the due date for the previous year's tax return; i.e., Apr.
17, 2000. P then employed a law firm to file the election and a
request for relief pursuant to sec. 301.9100-3(c), Proced. & Admin.
Regs. On July 21, 2000, the law firm submitted the election on P's
behalf. P did not trade any securities, realize any further gains, or
suffer any further losses between Apr. 17 and July 21, 2000. P's
losses were exactly the same on July 21, 2000, as they were on Apr.
17, 2000. In a Private Letter Ruling, dated Dec. 5, 2001, R denied P's
request for an extension of time to file the election pursuant to sec.
301.9100-3(c), Proced. & Admin. Regs. Subsequently, R determined deficiencies
in tax for P's taxable years 1999 and 2000.
Held: P is entitled to an
extension of time to file his sec. 475(f), I.R.C., election pursuant
to sec. 301.9100-3, Proced. & Admin. Regs. P is entitled to relief
because he acted reasonably and in good faith and the interests of the
Government will not be prejudiced. Accordingly, P is entitled to the
benefits of sec. 475(f), I.R.C., for the taxable year 2000 as if he
had timely filed the election.
David D. Aughtry, Roy J. Crawford, and
Hale E. Sheppard, for petitioner.
Monica D. Armstrong, for respondent.
WELLS, Judge: Respondent determined
deficiencies in tax for petitioner's 1999 and 2000 taxable years of
$6,312,641 and $6,835,942, respectively. 1
The issue we decide is whether,
pursuant to section 301.9100-3, Proced. & Admin. Regs.,
petitioner should be granted an extension of time to file a section 475(f) election for his
taxable year 2000. Unless otherwise indicated, all section references
are to the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts and certain exhibits
have been stipulated. The parties' stipulations of fact are
incorporated in this Opinion by reference and are found as facts in
the instant case.2
At the time of filing
the petition, petitioner resided in Birmingham, Alabama. Petitioner is
an attorney who practiced personal injury law in Birmingham, Alabama,
for approximately 34 years. During January 1994, petitioner began
representing certain plaintiffs in a national class action lawsuit
that settled with the defendants during
1999. Petitioner received approximately one-half of his compensation
for settling the class action suit during the taxable year 1999 and
the other half during the taxable year 2000. Petitioner reported net
profits of $18,520,775 and $16,966,055 from his law practice on line
29 of Schedule C, Profit or Loss From Business, of his Forms 1040,
U.S. Individual Income Tax Return, for taxable years 1999 and 2000,
respectively.
During August 1999, petitioner
established brokerage accounts with DLJ Direct and Ameritrade for the
purpose of investing a portion of his compensation from settling the
class action suit. Petitioner deposited $5 million in each of those
accounts. Petitioner later established a brokerage account with Terra
Nova during December 1999.
During the fall of 1999, petitioner decided
to wind down his law practice and begin a new career as a securities
trader. Previously, petitioner had traded in the stock market
only irregularly. Between December 1999 and January 2000, petitioner
concluded the class action suit, transferred his remaining cases to
other attorneys, paid off the balance of the lease of his
downtown-Birmingham law office, and terminated the lease. By late
January 2000, petitioner had spent a substantial amount of money
equipping and organizing one floor of his home as a securities trading
office. Based on the volume and frequency of petitioner's trading, the
parties have stipulated that petitioner became engaged in the trade or
business of trading securities on January 28, 2000.
Petitioner used margin borrowing as
part of his securities trading strategy. On April 14, 2000, DLJ Direct
forced the liquidation of petitioner's entire account and terminated
petitioner's trading on account of petitioner's failure to cover a
margin call after technology stocks declined sharply during early
April, 2000. As of April 14, 2000, petitioner's net trading losses
totaled $25,196,151.54. After his account was liquidated on April 14,
2000, petitioner held no securities in his DLJ Direct, Ameritrade, or
Terra Nova accounts.
Throughout his career, petitioner used
certified public accountants to advise him on Federal tax matters and
to prepare his Federal tax returns. J. Wray Pearce (Mr. Pearce), a
certified public accountant with over 30 years of experience, had
served as petitioner's business and personal accountant for over 13
years. Mr. Pearce had visited petitioner's home several times and was
very familiar with petitioner's securities trading business. He had
seen all of petitioner's trading-related computers and equipment,
helped hire some of the employees in petitioner's securities trading
business, and reviewed daily calculations of petitioner's securities
trading.
On April 13, 2000, Mr. Pearce met with
petitioner to obtain his signature on Form 4868, Application for
Automatic Extension of Time to File U.S. Individual Income Tax Return,
for the taxable year 1999. On April 17, 2000, petitioner timely filed
Form 4868, requesting an extension until August 15, 2000, to file his
return for taxable year 1999. A section 475(f) election was not
enclosed with the Form 4868. Because Mr. Pearce did not know about the
applicability of section 475(f) or any related Internal Revenue
Service (IRS) revenue procedure to securities traders, Mr. Pearce did not advise petitioner of
the availability of a section 475(f) election.
On or about June 4, 2000, Dr. James G.
Sullivan (Dr. Sullivan), a friend of petitioner, visited petitioner at
his home. Dr. Sullivan had helped petitioner set up the computers that
petitioner used to conduct his securities trading business. During Dr. Sullivan's June visit,
petitioner told Dr. Sullivan that he had suffered significant losses
during the first quarter of the 2000 taxable year and that,
consequently, his DLJ Direct account had been liquidated on April 14,
2000. Dr. Sullivan knew several professional "day traders" and
informed petitioner that he might be able to deduct his security
losses as ordinary losses. Before Dr. Sullivan's June visit,
petitioner had no indication that petitioner might be able to claim
ordinary losses for his securities trading business.
On the next day, June 5, 2000,
petitioner attempted to contact another accountant, Charles E. Sellers
(Mr. Sellers), regarding the possibility of deducting his losses as a
securities trader. On June 6, 2000, petitioner spoke with Mr. Sellers
by telephone and told him that Dr. Sullivan had suggested that
petitioner might be able to deduct his losses as a securities trader
as ordinary losses. At the time of petitioner's telephone conversation
with Mr. Sellers, Mr. Sellers was unaware of section 475(f) and the
mark-to-market election available to securities
traders. Petitioner then spoke with Dr. Sullivan by telephone and
asked Dr. Sullivan for a citation of the exact provision that would
allow securities traders to deduct their losses as ordinary losses.
Dr. Sullivan checked with his daytrader contacts, who gave him a
citation of section 475(f). Dr. Sullivan relayed the citation to
petitioner, who in turn relayed it to Mr. Sellers.
Mr. Sellers
informed petitioner that, according to Rev. Proc. 99-17, 1999-1 C.B.
503, in order for a section 475(f) election to be effective for the
2000 taxable year, petitioner had to file the election by April 17,
2000, the due date for his 1999 tax return. Mr. Sellers then informed
petitioner that he should qualify for an extension of time within
which to make the section 475(f) election under section 301.9100-3, Proced. & Admin. Regs. (section 9100 relief).3
Mr. Sellers
recommended that petitioner hire other tax counsel to make the section
475(f) election and to request section 9100 relief. Petitioner hired
the Washington, D.C., law firm of Caplin & Drysdale to prepare and
file the section 475(f) election and request for section 9100 relief. On July 21, 2000, Caplin & Drysdale, on behalf of
petitioner, submitted to respondent a "Taxpayer Election of Mark to
Market Accounting Under Section 475(f)" (section 475(f) election),
along with a six-page letter outlining the reasons petitioner should
qualify for section 9100 relief to make the section 475(f) election
for the taxable year 2000. The letter also stated that petitioner
would file a formal private letter ruling request. Also enclosed with
the section 475(f) election and the six-page letter was a "protective"
Form 3115, Application for Change in Accounting Method.
The Form 3115 stated that petitioner
intended to adopt an accounting method for his new securities-trading
business, not change an accounting method for an existing business. An
attachment to the Form 3115 stated in pertinent part:
The taxpayer
desires to adopt a new method of accounting for securities which are
held in connection with his trade or business as a trader in
securities to the mark to market method of recognizing gains and
losses as described in Section 475(f).
* * * * * * *
The taxpayer is not requesting any
change in the accounting methods used in his trade or business as an
attorney and since the year 2000 is his first year in the trade or
business of trading securities he is adopting a mark to market
accounting method with regard to his trade or business of trading
securities.
* * * * * * *
The taxpayer does not have to make any
section 481(a) adjustment because he was not engaged in the trade or
business of being a trader in securities prior to the year 2000. He is
adopting a mark to market method of accounting for his trade or
business as a securities trader which did not begin until 2000.
* * * * * * *
Based on the limited number of
securities transactions in 1999 as set forth above and since
[petitioner] was still engaged in the full time practice of law for
all of 1999, it seems clear that he did not qualify as a trader in
securities in 1999 and therefore has not adopted a method of accounting for his
trade or business as a securities trader in any year prior to 2000.
For this reason, there is no adjustment under section 481(a).
Caplin & Drysdale advised petitioner
that he had bound himself to adopt the mark-to-market method of
accounting for his trading business by filing the section 475(f)
election and the protective Form 3115 and requesting section 9100
relief on July 21, 2000. On that basis, Caplin & Drysdale advised
petitioner that he could resume his securities trading activities
without adversely affecting his request for section 9100 relief. Mr.
Sellers gave petitioner the same advice. Based on Caplin &
Drysdale's and Mr. Sellers' advice, petitioner resumed
his trading activities on July 26, 2000.
Between the date that petitioner should
have filed his section 475(f) election, April 17, 2000, and the date
petitioner actually filed his section 475(f) election, July 21, 2000,
petitioner: (1) Did not purchase any publicly-traded stock; (2) did
not sell any publicly traded stock; and (3) had no gain or loss from
the disposition of any publicly traded stock. Thus, petitioner's
losses on July 21, 2000, were exactly the same as they were on April
17, 2000.
On October 27, 2000, Caplin & Drysdale
submitted to respondent on behalf of petitioner a formal private
letter ruling request seeking section 9100 relief for his 2000 section
475(f) election (section 9100 relief request).
Respondent required petitioner to pay a $5,000 fee to file the section
9100 relief request.
When petitioner filed his section 9100 relief
request on October 27, 2000, the 2000 taxable year had not yet closed
and petitioner's tax return for the 2000 taxable year was not yet due.
Respondent had not imposed any accuracy-related penalty under section 6662 with respect to
either the 1999 or 2000 taxable year.
On January 17, 2001, petitioner filed
his Form 1040 for his 2000 taxable year, reporting all items based on
the assumption that his section 9100 relief request would be granted.
Petitioner reported a net loss of $26,768,761 from his securities
trading business on Schedule C of his Form 1040, attached Form 8275,
Disclosure Statement, regarding his section 475(f) election, and also
attached a copy of the section 475(f) election filed on July 21, 2000.4
Following an adverse private letter ruling
request conference on September 25, 2001, respondent's Office of Chief
Counsel (Financial Institutions & Products) issued a conference report
dated October 19, 2001, stating in pertinent part as follows:
For basically administrative reasons,
we were forced to allow 3½
months of hindsight, but if we had the choice, we would not have
allowed one day of hindsight.
* * * * * * *
We did anticipate that taxpayers would
not be able to use 9100 relief to obtain additional time to file the
election.
* * * * * * *
We would have done a regulation project
if we had not believed section 301.9100-3 would prevent taxpayers from
filing late elections.
* * * * * * *
The drafters of Rev. Proc. 99-17 did
not want 9100 relief to be available for 475(f) elections.
On December
4, 2001, respondent's Office of Chief Counsel issued a section
301.9100-3, Proced & Admin. Regs., file memo stating in pertinent part
as follows:
Did the taxpayer apply for relief
before the failure to make the election was discovered by the Service
(see § 301.9100-3(b)(1)(i))? [5] Yes.
* * * * * * *
Is the taxpayer considered to have
acted reasonably and in good faith, taking into account §301.9100-3(b)(3)(i)-(iii)? [6]
* * * * * * *
It is unnecessary to reach conclusions
pertaining to sections 301.9100-3(b)(3)(i)-(iii) due to the taxpayer's
failure to satisfy the requirements under section 301.9100-3(c)(2). [7]
On November 2, 2001, petitioner
filed a Form 1045, Application for Tentative Refund, for his 2000
taxable year, claiming a $4,030,143 decrease in income tax for taxable
year 1999 on account of a claimed net operating loss carryback of
$9,880,708 from his 2000 taxable year.8
On November 2, 2001, petitioner also
filed a Form 1040X, Amended U.S. Individual Income Tax Return, for his
1999 taxable year to reflect the claimed net operating loss carryback
of $9,880,708 from his 2000 taxable year, as well as a net operating
loss carryover of $571,238 from his 1998 taxable year. The amended
return reflected a total tax of $3,049,864.
On December 5, 2001, respondent denied
petitioner's section 9100 relief request in
Priv. Ltr. Rul. 129057-00
(200209053), stating in pertinent part as follows:
Because Taxpayer's
request for relief is denied pursuant to section 301.9100-3(c)(2) for
lack of unusual and compelling circumstance, it is unnecessary for us
to consider Taxpayer's assertion that he acted reasonably and in good
faith under section 301.9100-3(b), without using hindsight in requesting relief.
* * *
OPINION
The issue we decide is whether,
pursuant to section 301.9100-3, Proced. & Admin. Regs., petitioner
should be granted an extension of time to file a section 475(f)
election for his taxable year 2000. Section 475(f) provides as
follows:
SEC. 475(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.
In general, section 475(f) allows a
taxpayer engaged in a trade or business as a securities
trader to elect the mark-to-market method of accounting. After making
the election, the taxpayer must recognize gain on or loss on any
security held in connection with the securities trading business as if
the security were sold for its fair market value on the last business day of the taxable year. Any gain or
loss must be taken into account in that year. Sec. 475(f)(1)(A)(i).
If
a qualified taxpayer makes a section 475(f) election, the gain or loss
on the sale or disposition of a security is treated as ordinary income
or loss. Sec. 475(d)(3)(A)(i), (f)(1)(D).
Accordingly, if petitioner is entitled
to make the election, he would be able to apply and carry back his
losses from his securities trading business to offset the ordinary
income he received as compensation for settling the class action
lawsuit.
On the other hand, if a taxpayer fails
to make the section 475(f) election, gain or loss from the sale or
disposition of a security is treated as capital gain or loss. See secs.
1221(a) and 1222. Capital losses for individuals are subject to the
capital loss limitations under section 1211(b),
which provides that capital losses are allowed only to the extent of
capital gains, plus $3,000. Petitioner has $35,486,830 in ordinary
income from his law practice and $26,768,761 in short-term capital
losses from his securities trading business.
The parties have stipulated that
petitioner was engaged in a trade or business as a securities trader
by January 28, 2000.
Accordingly, the parties do not dispute
whether petitioner is qualified to make a section 475(f) election;
their primary dispute is whether petitioner should be allowed the
benefit of section 9100 relief to extend the time
to make the section 475(f) election.
Respondent relies on Rev. Proc. 99-17
sec. 5.03, 1999-1 C.B. 503, 504, which states in pertinent part as
follows:
SECTION 5. PROCEDURES FOR MAKING THE
MARK-TO-MARKET ELECTIONS
* * * * * * *
.03 Elections effective for a taxable
year beginning on or after January 1, 1999.
(1) General procedure. * * * for a
taxpayer to make a § 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.
[Emphasis added.]
Accordingly, respondent contends that,
pursuant to Rev. Proc. 99-17 sec. 503, petitioner was required to file
his section 475(f) election by April 17, 2000, the due date for his
1999 tax return.
Petitioner contends that he should be
allowed the benefit of section 9100 relief to extend the time to make
the section 475(f) election because he acted reasonably and in good
faith and the interests of the Government will not be prejudiced.9
Respondent contends that petitioner
should not be allowed section 9100 relief to extend the time to make
the section 475(f) election because an election of the mark-to-market
method of accounting under section 475(f) is an accounting method
regulatory election.10
According to respondent, section 9100
relief is not available
because section 301.9100-3(c)(2), Proced. & Admin. Regs., presumes the
interests of the Government to be prejudiced, absent unusual and
compelling circumstances not present in the instant case. Respondent
contends that, if petitioner is permitted an extension of time to make
the section 475(f) election, it impermissibly will give petitioner the
benefit of "hindsight".
The interpretation of section
301.9100-3(c), Proced. & Admin. Regs., and the parties' arguments
regarding section 9100 relief create issues of first impression in
this Court. We begin our analysis of section 301.9100-3(c),
Proced. & Admin. Regs., keeping in mind the following policies stated
by the Secretary in the preamble to the final regulations:
There are two policies that must be
balanced in formulating the standards for § 301.9100 relief. The first
is the policy of promoting efficient tax administration by providing
limited time periods for taxpayers to choose among alternative tax
treatments and encouraging prompt tax reporting. The second is the policy of permitting taxpayers that
are in reasonable compliance with the tax laws to minimize their tax
liability by collecting from them only the amount of tax they would
have paid if they had been fully informed and well advised. [T.D.
8742, 1998-1 C.B. 388, 389.11]
Section 301.9100-3(a), Proced. & Admin.
Regs., provides in pertinent part as follows:
§ 301.9100-3. Other Extensions–(a) In
general.--
* * * Requests for relief subject to
this section will be granted when the taxpayer provides the 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. [Emphasis
added.]
Accordingly, the Commissioner must
grant relief if the taxpayer provides evidence establishing to the
Commissioner'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 denying petitioner's request for section 9100
relief, respondent, in Priv. Ltr. Rul.
129057-00, stated the following:
Because taxpayer's request for relief
is denied pursuant to section 301.9100-3(c)(2) for lack of unusual and
compelling circumstances, it is unnecessary for us to consider
Taxpayer's assertion that he acted reasonably and in good faith under
section 301.9100-3(b), without using hindsight in
requesting relief. * * * [12]
Respondent's contentions in the instant
case are consistent with respondent's conclusions in Priv. Ltr.
Rul. 129057-00. We disagree with respondent. We conclude
that petitioner acted reasonably and in good faith and that
the interests of the Government are not prejudiced by
allowing petitioner to file a late election.
Section 301.9100-3(b)(1), Proced. &
Admin. Regs., defines reasonableness and good faith as
follows:
(b) Reasonable action and good faith.--
(1) In general.-- Except as provided in paragraphs (b)(3)(i) through
(iii) of this section, a taxpayer is deemed to have acted reasonably
and in good faith if the taxpayer-
(i) Requests relief under this section
before the failure to make the regulatory election is discovered by
the Internal Revenue Service (IRS);
(ii) Failed to make the election
because of intervening events beyond the taxpayer's control;
(iii) Failed to make the election,
because after exercising reasonable diligence (taking into account the
taxpayer's experience and the complexity of the return or issue), the
taxpayer was unaware of the necessity for the election;
(iv) Reasonably relied on the written
advice of the Internal Revenue Service (IRS); or
(v) Reasonably relied on a qualified
tax professional, including a tax professional employed by the
taxpayer, and the tax professional failed to make, or advise the
taxpayer to make, the election. [Emphasis added.]
The benchmarks for reasonableness and
good faith in section 301.9100-3(b)(1), Proced. & Admin. Regs., are
disjunctive; i.e., the taxpayer need satisfy only
subdivision (i), (ii), (iii), (iv), or (v) in order to be deemed to
have acted reasonably and in good faith. In the instant case,
petitioner satisfies at least three of the regulation's benchmarks.
Regarding section 301.9100-3(b)(1)(i),
Proced. & Admin. Regs., there is no question
that petitioner requested relief before respondent discovered the
failure to make the section 475(f) election. Regarding section
301.9100-3(b)(1)(iii), Proced. & Admin. Regs.,
pertaining to the exercise of reasonable diligence, 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.
Regarding section 301.9100-3(b)(1)(v),
Proced. & Admin. Regs., which finds good faith
where the taxpayer acts in reasonable reliance upon counsel,
petitioner was a personal injury lawyer for over 34 years, not a tax
lawyer, and relied on accountants for tax advice throughout his
professional career. In relying on Mr. Pearce, petitioner had no
reason to question Mr. Pearce's qualifications as a
qualified tax professional. 13
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.
Section
301.9100-3(b)(3) provides three exceptions to the general rule stated
in paragraph (b)(1) above. A taxpayer will be deemed not to have acted
reasonably and in good faith if the taxpayer:
(i) Seeks to alter a return position
for which an accuracy-related penalty has been or could be imposed
under section 6662 at the time the taxpayer requests relief (taking
into account any qualified amended return filed within the meaning of
§ 1.6664-2(c)(3) of this chapter) and the new position requires or
permits a regulatory election for which relief is requested;
(ii) Was
informed in all material respects of the required election and related
tax consequences, but chose not to file the election; or
(iii) 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.
The first two exceptions of section
301.9100-3(b)(3), Proced. & Admin. Regs., do not apply. The parties
dispute whether subdivision (iii) applies; i.e.,
whether petitioner had the benefit of hindsight in requesting relief.
Petitioner contends that, had he been
aware of its existence, he would have made the section 475(f) election
on time. Petitioner further contends that, because his total losses on
the day he actually filed the election were exactly the same as they
would have been if he had timely filed, he did not use hindsight in
requesting relief.
Respondent contends that allowing
petitioner an extension of time to make the election impermissibly
gives petitioner the benefit of hindsight. Respondent's brief poses
the following hypothetical:
For the securities trader who has
unrealized losses, the decision to mark-to-market his securities is a
good one. Not only can he recognize his unrealized losses at the end
of the year, but those losses are also ordinary losses which can be
offset against ordinary income. However, for the securities trader who
has unrealized gains at the end of the year, he may regret the
decision of electing the mark-to-market method of accounting because
his unrealized gains are also accelerated and must be recognized at
the end of the year as ordinary income. [14]
We reject respondent's hypothetical, as
well as respondent's contention. Respondent's contention is not
consistent with the plain reading of section
301.9100-3(b)(iii), Proced. & Admin. Regs., which states in pertinent part:
"If specific facts have changed since the due date for making the
election that make the election advantageous to the taxpayer, the IRS
will not ordinarily grant relief." (Emphasis added.) Accordingly, 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 allowance of a late
election is consistent with the preamble to the regulations.
The instant case is distinguishable
from Lehrer v. Commissioner, T.C. Memo. 2005-167. In that case, the
taxpayers sought to make a section 475(f) election for taxable years
1999, 2000, and 2001 in taxable year 2004. The taxpayers reported
$44,000 of capital gains on their 1999 return, $313,715 of short-term
capital losses on their 2000 tax return, and $397,079 of short-term
capital losses on their 2001 return. In 2004, the taxpayers sought to
make a section 475(f) election to escape the $3,000 capital loss limitation. The
taxpayers in Lehrer are the classic example of taxpayers who seek to
use the benefit of hindsight. 15
The taxpayers sought retroactively to convert their
capital losses into ordinary
losses several years later, with continued trading in the interim, in
order to escape a deficiency and a section 6662 accuracy-related
penalty. Lehrer stands in marked contrast to the instant case, where
petitioner filed his election in the tax year it should have been
filed, only a matter of months after the due date under the revenue
procedure, with no trading in the interim, and no accuracy-related
penalty was determined. In sum, we hold that petitioner did not use
hindsight in requesting relief and that he acted reasonably and in
good faith.
Respondent contends that the interests
of the Government are deemed prejudiced pursuant to section
301.9100-3(c)(2), Proced. & Admin. Regs., which provides in pertinent
part as follows:
(2) Special rules for accounting method
regulatory elections.-- 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–
(i) Is subject to the procedure
described in §1.4461(e)(3)(i) of this chapter (requiring the advance
written consent of the Commissioner);
(ii) 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);
(iii) 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
(iv) 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.
Accordingly, the interests of the
Government are not deemed to be prejudiced in the case of an
accounting method regulatory election if the provisions of section
301.9100-3(c)(2)(i), (ii), (iii), or (iv), Proced. & Admin. Regs., do
not apply or, if they do, unusual and compelling circumstances are
present.
Section 301.9100-3(c)(1), Proced. & Admin. Regs., defines
prejudice as follows:
In general. --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. * * *
(i) Lower tax liability.-- The
interests of the Government are prejudiced if granting relief would
result in the 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 * * *.[ 16]
The interests of the Government are
prejudiced if granting petitioner an extension of time to file
the section 475(f) election would result in petitioner's having a
lower tax liability than if petitioner had timely filed a section
475(f) election. The parties have stipulated that between April 17,
2000, the date petitioner should have filed his section 475(f)
election, and July 21, 2000, the date petitioner actually filed his
section 475(f) election, petitioner did not conduct any trading
activities and incurred no further gains or losses.
Accordingly, pursuant to section
301.9100-3(c)(1)(i), Proced. & Admin. Regs., there is no prejudice in
the instant case because granting petitioner an extension of time to
file his section 475(f) election does not result in petitioner's
having a lower tax liability than he would have had if he had timely
filed the election.
Respondent contends, however, that
prejudice is presumed because of the special rules for accounting
method regulatory elections contained in section
301.9100-3(c)(2), Proced. & Admin Regs. The
parties dispute whether section 301.9100-3(c)(2)(ii), Proced. & Admin. Regs., applies.
Paragraph 3(c)(2)(ii) presumes prejudice, absent unusual and
compelling circumstances, if the election "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)".
Section 481(a) prescribes the rules for
adjustments required by changes in methods of accounting as follows:
SEC. 481(a) General Rule.-- In
computing the taxpayer's taxable income for any taxable year (referred
to in this section as the "year of change")-
(1) if such computation is under a
method of accounting different from the method under which the
taxpayer's taxable income for the preceding taxable year was computed, then
(2)
there shall be taken into account those adjustments which are
determined to be necessary solely by reason of the change in order to
prevent amounts from being duplicated or omitted, except there shall
not be taken into account any adjustment in respect of any taxable
year to which this section does not apply unless the adjustment is
attributable to a change in the method of accounting initiated by the
taxpayer. [Emphasis added. 17]
Accordingly, if a taxpayer changes his
method of accounting and an amount would be duplicated or omitted
because of the change, section 481(a) requires an adjustment to
prevent the distortion. For example, if an accrual method taxpayer
included in income for year 1 an amount which he had the right to
receive, but switched to the cash method of accounting in year 2 when
he actually received the amount, a section 481(a) adjustment would be
necessary to prevent the same item of income from being included in 2
different tax years.
Petitioner contends that, because he
adopted the mark-to-market method of accounting for his securities
trading business in taxable year 2000, the first year that his
securities trading business existed, and did not change from another
method of accounting, no item would be duplicated or omitted, no
section 481(a) adjustment is required, and therefore there is no
prejudice under section 301.9100-3(c)(2)(ii), Proced. & Admin. Regs. 18
Respondent contends that petitioner
ignores the following parenthetical language in paragraph 3(c)(2)(ii):
"(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)". Respondent contends that the parenthetical language
presumes prejudice to the Government because petitioner,
hypothetically, could have adopted the mark-to-market method of
accounting in a year subsequent to the year he should have adopted the
mark-to-market method and a section 481(a) adjustment might possibly
be necessary.
Assuming arguendo that the
parenthetical phrase in paragraph 3(c)(2)(ii) did apply, the interests
of the Government are not deemed to be prejudiced if unusual and
compelling circumstances are present. Section 301.9100-3(c)(2),
Proced. & Admin. Regs., plainly states: "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 [is one to which subdivision (i), (ii),
(iii), or (iv) applies]." (Emphasis added.) In other words, assuming
subdivision (ii) applies, unusual and compelling circumstances defeat
the presumption of prejudice. Respondent contends that the
circumstances surrounding petitioner's failure to timely file a
section 475(f) election were not unusual and compelling and did not
actually cause petitioner to fail to timely file the election.
Respondent points out that the collapse
of the technology stocks, the liquidation of petitioner's trading
accounts, and petitioner's $25 million in losses during the first
quarter of taxable year 2000 did not literally prevent petitioner from
making the section 475(f) election. Respondent further points out that
petitioner failed to timely file the section 475(f) election because
his accountant was unaware of the election and that ignorance of the
law is no excuse.
We disagree with respondent's
contention that unusual and compelling circumstances are not present
in the instant case. The Commissioner has not defined, by regulation
or otherwise, unusual or compelling circumstances. We note that the
preamble to the regulations states: "What are
unusual and compelling circumstances must be decided on a case-by-case
basis in light of all applicable facts and circumstances." T.D. 8742,
1998-1 C.B. at 390. We briefly recount the facts of the instant case.
Petitioner suffered a $25 million loss
when his trading accounts were liquidated on April 14, 2000, 3 days
before the date prescribed in Rev. Proc. 99-17, supra, for timely
filing a section 475(f) election. Mr. Pearce, petitioner's tax adviser
who had full knowledge of petitioner's trading activities and losses
and over 30 years of experience as an accountant, was unaware of the
section 475(f) election for securities traders. Mr. Sellers, another
accountant, was also unaware of the availability of the section 475(f)
election. As soon as petitioner learned of the existence of the
section 475(f) election, he promptly employed Caplin & Drysdale to
make the section 475(f) election and file a request for section 9100
relief. Petitioner conducted no further trading activities between the
date he should have filed the election and the date he actually filed
the election. We find the combination of circumstances in the instant
case both unusual and compelling and conclude that the interests of the
Government should not be presumed to be prejudiced even if the
parenthetical phrase of section 301.9100-3(c)(2)(ii), Proced. & Admin.
Regs., did apply.
In conclusion, under section
301.9100-3(c)(1)(i), Proced. & Admin. Regs., there is no prejudice to
the Government in the instant case. Petitioner did not realize any
gains or suffer any further losses between the time he should have
filed his section 475(f) election and the date he actually filed the
election. Petitioner will be entitled to no more
than he would have been entitled to had he filed his section 475(f)
election by the date prescribed in Rev. Proc. 99-17, supra, which is
precisely the purpose of section 9100 relief: to "permit []taxpayers
that are in reasonable compliance with the tax laws to minimize their
tax liability by collecting from them only the amount of tax they
would have paid if they had been fully informed and well advised." T.D.
8742, 1998-1 C.B. at 389. 19
We conclude that
petitioner is entitled to an extension of time to file his section
475(f) election pursuant to section 301.9100-3, Proced. & Admin. Regs.
Petitioner is entitled to relief because he acted reasonably and in
good faith and the interests of the Government will not be prejudiced.
Accordingly, we hold that petitioner is entitled to the benefits of a
section 475(f) election for the taxable year 2000 as if he had timely
filed the election.
To reflect the foregoing,
Decision will be entered under
Rule 155.
1
Respondent contends that petitioner in not entitled
to certain deductions for meals and
entertainment for taxable year 1999, gifts to employees for taxable
year 1999, and alimony payments for taxable year 2000 all of which
petitioner concedes.
2
The instant case was
tried in the Court's Electronic (North) Courtroom where evidence was presented
electronically and certain testimony was taken by video conference. In
addition to the usual paper format, the parties filed briefs on CD
Rom.
3
Sec. 9100 relief is discussed in detail infra.
4
Respondent's technical case history indicates that respondent told
petitioner's representative during a telephone conference on Mar. 26,
2001, that "the Form 3115 and statement are not binding on us and that
he should tell the taxpayer to file a protective election for 2001."
The technical case history also indicates that, during a separate
telephone conference on Apr. 6, 2001, respondent told petitioner's
representative: "If * * * [petitioner] is not granted section 9100
relief, he has to make the election and follow the procedures for
making the election for year 2001 - So [petitioner] should think about
a protective election."
At the time respondent advised petitioner's representative to file a
protective election for taxable year 2001, petitioner had already
filed his tax return for his 2000 taxable year on Jan. 17, 2001. On
Apr. 11, 2001, petitioner filed a document captioned "Taxpayer
Protective Election for Mark to Market Accounting under Section
475(f)" for taxable year 2001. On Oct. 17, 2001, petitioner filed a
Form 1040X, Amended U.S. Individual Income Tax Return. The Form 1040X
made no changes to petitioner's income or deductions but had attached
to it a Form 3115, Application for Change of Accounting Method, which
petitioner had not attached to the tax return he filed on Jan. 17,
2001, or the protective sec. 475(f) election he filed on Apr. 11,
2001.
The parties also dispute whether petitioner properly made a valid sec.
475(f) election for his 2001 taxable year. We do not reach that issue
because, for reasons stated below, we hold that petitioner is entitled
to a sec. 475(f) election for his 2000 taxable year.
5
Sec. 301.9100-3(b)(1)(i)-(v), Proced. & Admin. Regs., discussed more
fully below, lists five criteria, under any one of which the taxpayer is
deemed to have acted reasonably and in good faith.
6
Sec. 301.9100-3(b)(3)(i)-(iii), Proced. & Admin. Regs., discussed more
fully below, lists five criteria, under any one of which the taxpayer is
deemed not to have acted reasonably and in good faith.
7 Sec. 301.9100-3(c)(2),
Proced. & Admin. Regs., provides special rules for accounting method
regulatory elections, which presume prejudice to the interests of the
Government absent unusual and compelling circumstances. The application
of sec. 301.9100-3(c)(2), Proced. & Admin. Regs., is a central issue
in the instant case and is discussed in greater detail below.
8
Respondent later denied petitioner's refund request.
9
Petitioner also contends that Rev. Proc. 99-17, 1999-1 C.B. 503, is
invalid and unlawful because the plain language of sec.
475(g) compels the Commissioner to issue regulations outlining the
procedures for making the sec. 475(f) election, which the
Commissioner did not do, and cites Zinniel v. Commissioner,
89 T.C. 357 (1987), affd. 883 F.2d 1350 (7th Cir. 1989), in support
of his position.
Because we hold, for reasons stated below, that petitioner is
entitled to sec. 9100 relief, we do not need to decide questions
relating to the validity of the limitations set forth in Rev. Proc.
99-17, supra.
10
See sec. 301.9100-1(b), Proced. & Admin. Regs., ("Regulatory
election means an election whose due date is prescribed by a
regulation published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin".).
11
The Secretary also expressed this view in the preamble to
temporary/proposed sec. 301.9100 regulations, T.D. 8680, 1996-2 C.B.
194, which states: "The regulations provide a means by which taxpayers
can be in the same position they would have been in had they made their
elections in a timely manner."
This view was also endorsed by Annette Smith, Tax Legislative Counsel,
in the hearing on temporary/proposed sec. 301.9100 regulations, T.D.
8680, 1996-2 C.B. 194, where she stated:
I would agree that the 9100 policy should be to try to put a
taxpayer back in the same position they would have been had they
made a timely election, and I think that policy's based on the
fact that there can be significant consequences to a taxpayer
who's qualified to make an election and fails to make it timely.
[Reprinted in Tax Notes Today, 96 TNT 216-16 (Oct. 30, 1996).]
12
Respondent's Chief Counsel 9100 File Memo. also states: "It is
unnecessary to reach conclusions pertaining to sections
301.9100-3(b)(3)(i)-(iii) [whether petitioner acted reasonably and in
good faith] due to the taxpayer's failure to satisfy the requirements
under sec. 301.9100-3(c)(2)."
13
We note that, although whether petitioner's reliance was reasonable
is not an issue, sec. 301.9100-3(b)(2), Proced. & Admin. Regs.,
places a limit on reasonable reliance on a qualified tax
professional. A taxpayer will not be considered to have reasonably
relied on a qualified tax professional if the taxpayer knew or
should have known that the professional was not (i) competent to
render advice on the election, or (ii) aware of all relevant facts.
14
An implicit contention in respondent's hypothetical is that a
taxpayer with unrealized gains will not make the mark-to-market
election because it will result in ordinary income treatment and
will instead wait for the required time to pass to get the benefit
of capital gains.
15
The taxpayers in Lehrer v. Commissioner, T.C. Memo. 2005-167, did
not raise the issue of sec. 9100 relief. We held that the taxpayers
failed to file within the time prescribed by Rev. Proc. 99-17,
supra
16
The interests of the Government are also prejudiced if the taxable
year in which the regulatory election should have been made, or any
taxable years that would have been affected by the election had it
been timely made, are closed by the period of limitations on
assessment under sec. 6501 before the taxpayer is granted 9100
relief. Sec. 301.9100-3(c)(1)(ii), Proced. & Admin. Regs. That
provision is not a prohibition in the instant case, as the
limitations periods for all taxable years affected by the election
remain open.
17
Sec. 1.481-1(a)(1), Income Tax Regs., contains almost identical
language regarding the purpose of the adjustment under sec. 481(a).
Rev. Proc. 99-17, sec. 204, 1999-1 C.B. at 504 itself corroborates
this purpose:
In computing taxable income, § 481(a) requires a taxpayer to take
into account those adjustments necessary to prevent amounts from
being duplicated or omitted when the taxpayer's taxable income is
computed under a method of accounting different from the method used
to compute taxable income for the preceding taxable year.
18
Cf. sec. 301.9100-3(f), Example (4), Proced. & Admin. Regs., which
provides as follows:
Election not requiring adjustment under section 481(a).
Taxpayer D prepares D's 1997 income tax return. D is unaware that a
particular accounting method regulatory election is available. D
files D's 1997 return without making the election and uses another
permissible method of accounting. The applicable regulation provides
that the election is made on a cut-off basis (without an adjustment
under sec. 481(a)). In 1998, D requests relief under this section to
make the election under the regulation. If D were granted an
extension of time to make the election, D would pay no less tax than
if the election had been timely made. Assume that paragraphs (c)(2)(i),
(iii), and (iv) of this sec. do not apply. Under paragraph
(c)(2)(ii) of this section, the interests of the Government are not
deemed to be prejudiced because the election does not require an
adjustment under section 481(a).
19
See supra note 11, and accompanying text. |