Am I a Dealer?

A Dealer or Market Maker is someone who acquires securities from sources not usually available to the general public and then sells them at a markup to his customers. Dealers who are acting as brokers must be registered with the Securities and Exchange Commission . To qualify as a dealer in securities, a taxpayer must engage in transactions with customers.

Dealers who are brokers may also be specialists in one or more stocks. As a broker, a dealer is authorized to acquire and sell securities for customers’ accounts for a commission. A Broker/Dealer can transact business as a Principal (for his own dealer account) or as Agency (as a broker representing the customer to another dealer).

The IRS rules relating to the characterization of annual gain or loss as being classified as “capital or ordinary” or further being classified as “long-term or short-term” generally do not apply – to the transactions carried out by dealers in the course of their trade or business of buying and selling securities at a markup to customers. Dealers report results of their operations using the mark-to-market method of accounting.

From a recent case, Marrin v Comr (1998): “…reliance on our decision in Commissioner v. Stevens (1935) …In Stevens, we found that a broker could be regarded as a customer of a securities dealer under certain circumstances; we based our holding, however, on the fact that the taxpayer had an established place of business, held himself out to the general public as a securities dealer, and dealt primarily in the securities trade for his livelihood. Generally, where a taxpayer trades on his own account and sells securities to persons he does not know, the purchasers are ‘not his customers, but customers of the brokers who bought of him.’ Seeley v. Helvering (1935).”

From Rev. Rul 97-39 Issue #3 “If a taxpayer’s sole business consists of trading in securities (that is the taxpayer does not purchase from, sell to, or otherwise enter into transactions with customers), is the taxpayer a dealer in securities within the meaning of §475(c)?”
Holding #3 “No. A taxpayer whose sole business consists of trading in securities is not a dealer in securities within the meaning of §475(c) because that taxpayer does not purchase from, sell to, or enter into transactions with, customers in the ordinary course of a trade or business.

Click here for more on qualifying under Dealer Status.

Definition of Dealer in Securities

The SEC Exchange Act defines a dealer as someone who is engaged in the business of buying and selling securities for his own account §3(a)(5), 15 U.S.C. 78c(a)(5) and that would require their registration as a dealer under §15(b), 15 U.S.C. 78o(b).

Definition of Dealer in Securities

In general, a dealer in securities is required to use a mark-to-market method of accounting for securities. A dealer in securities is a taxpayer who regularly purchases securities from or sells securities to customers in the ordinary course of a trade or business, or who regularly offers to enter into, assume, offset, assign, or otherwise terminate positions in certain types of securities with customers in the ordinary course of a trade or business. A security includes an evidence of indebtedness.

Congress enacted the mark-to-market rules of section 475 to provide a more accurate reflection of the income of securities dealers. The Congress did not believe that the mark-to-market rules were intended to be used by taxpayers whose principal activity was the selling of goods and services to obtain a deduction earlier than would otherwise be permitted.

Definition of Dealer in Securities

IRS Regulations §1.1402(a)-5(d) A dealer in stocks or securities is a merchant of stocks or securities with an established place of business, regularly engaged in the business of purchasing stocks or securities and reselling them to customers; that is, he is one who as a merchant buys stocks or securities and sells them to customers with a view to the gains and profits that may be derived therefrom.

Persons who buy and sell or hold stocks or securities for investment or speculation, irrespective of whether such buying or selling constitutes the carrying on of a trade or business, are not dealers in stocks or securities.

Definition of Dealer in Securities

IRS Regulations §1.471-5(c) …a dealer in securities is a merchant of securities, whether an individual, partnership, or corporation, with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived therefrom. If such business is simply a branch of the activities carried on by such person, the securities inventoried as provided in this section may include only those held for purposes of resale and not for investment.

Taxpayers who buy and sell or hold securities for investment or speculation, irrespective of whether such buying or selling constitutes the carrying on of a trade or business, and officers of corporations and members of partnerships who in their individual capacities buy and sell securities, are not dealers in securities.

Definition of Dealer in Securities

For purposes of the mark-to-market rules, a dealer in securities is a taxpayer who in the ordinary course of the taxpayer’s trade or business regularly holds itself out as being willing and able to purchase securities from or sell securities to (or regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with) customers. A taxpayer who sells nonfinancial goods or provides nonfinancial services, such as a consumer products retailer or an accountant, does not become a dealer in securities by the act of extending credit for the purchase of goods or services. Nor does a taxpayer who purchases securities, but does not sell more than a negligible portion of the securities.

Definition of Dealer in Securities

For purposes of the mark-to-market rules, effective for tax years ending after December 30, 1993, a dealer in securities is a taxpayer who in the ordinary course of the taxpayer’s trade or business regularly holds itself out as being willing and able to purchase securities from or sell securities to (or regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with) customers. 233

/Footnote/ 233 §475(c)(1); Regs. §1.475(c)-1(a)(2).

For purposes of the inventory rules for tax years ending before December 31, 1993, a dealer is defined as a merchant in securities (whether an individual, partnership, or corporation) with an established place of business who regularly engages in the purchase and resale of securities to customers. 234 Taxpayers who buy and sell securities for investment or speculation, irrespective of whether such buying and selling constitutes a trade or business, are not considered dealers. 235 Other taxpayers that are not considered dealers include brokers, 236 investors, 237 floor traders, 238 underwriters, 239 and officers of corporations and members of partnerships who in their individual capacities buy and sell securities. 240

/Footnote/ 234 Regs. §1.471-5.

/Footnote/ 235 Id.

/Footnote/ 236 Seely v. Helvering, 77 F.2d 323, 324 (2d Cir. 1935); Factor v. Comr., 281 F.2d 100 (9th Cir. 1960); Hammit v. Comr., 79 F.2d 494 (3d Cir. 1935).

/Footnote/ 237 See, e.g., Schafer v. Helvering, 299 U.S. 171 (1936); Serris v. Comr. T.C. Memo 1978-500; Stephens, Inc. v. Comr., 464 F.2d 53 (8th Cir. 1972); Gruver v. Comr., 142 F.2d 363 (4th Cir. 1944); U.S. v. Ross, 251 F.Supp. 175, 182 (S.D.N.Y. 1966).

/Footnote/ 238 Seely v. Helvering, 77 F.2d 323, 324 (2d Cir. 1935).

/Footnote/ 239 Mirro-Dynamics Corp. v. U.S., 247 F.Supp. 214 (D. Cal. 1965), aff’d, 374 F.2d 14 (9th Cir. 1967), cert. denied, 389 U.S. 896 (1967).

/Footnote/ 240 Regs. §1.471-5.

Definition of Dealer in Securities

(official guidance as used by Examiners during tax audits pursuant to the Internal Revenue Manual, Part 4, Charter 37, issued after TraderStatus.com brought the dealer-status issue to a head)

4.37.1.5.6 (07-31-2002)
IRC section 475 Mark to Market Accounting for Dealers in Securities

IRC section 475 is a far-reaching Code Section that requires dealers in securities to mark their securities to market. The section is far-reaching because of the definition of a dealer in securities. The definition goes beyond what one would think of as a traditional dealer in securities.

The general rule of Section 475 is two pronged.

  1. IRC section 475(a)(1) provides that all securities, which are inventory in the hands of a dealer in securities, will be included in inventory at the fair market value of the securities.
  2. IRC section 475(a)(2) provides that all other securities held by a dealer in securities at the end of a tax year will be marked to market for tax purposes.
  3. An adjustment will be made for any gains or losses subsequently realized.

4.37.1.5.6.1 (07-31-2002)
IRC section 475(c)(1) Mark to Market Dealer Definition

  1. A dealer in securities for purposes of IRC section 475 is a taxpayer who, in the ordinary course of a trade or business, regularly:
    1. Sells securities to or purchases securities from customers or
    2. Offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers.

Who is a “Dealer” per the SEC?
http://www.sec.gov/divisions/marketreg/bdguide.htm#II

Unlike a broker, who acts as agent, a dealer acts as principal. Section 3(a)(5)(A) of the Act generally defines a “dealer” as:

any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise.

The definition of “dealer” does not include a “trader,” that is, a person who buys and sells securities for his or her own account, either individually or in a fiduciary capacity, but not as part of a regular business. Individuals who buy and sell securities for themselves generally are considered traders and not dealers.

Sometimes you can easily tell if someone is a dealer. For example, a firm that advertises publicly that it makes a market in securities is obviously a dealer. Other situations can be less clear. For instance, each of the following individuals and businesses may need to register as a dealer, depending on a number of factors:

a person who holds himself out as being willing to buy and sell a particular security on a continuous basis;

a person who runs a matched book of repurchase agreements; or

a person who issues or originates securities that he also buys and sells.

Here are some of the questions you should ask to determine whether you are acting as a dealer:

  • Do you advertise or otherwise let others know that you are in the business of buying and selling securities?
  • Do you do business with the public (either retail or institutional)?
  • Do you make a market in, or quote prices for both purchases and sales of, one or more securities?
  • Do you participate in a “selling group” or otherwise underwrite securities?
  • Do you provide services to investors, such as handling money and securities, extending credit, or giving investment advice?
  • Do you write derivatives contracts that are securities?

A “yes” answer to any of these questions indicates that you may be a dealer.

With regard to the above “with customers” requirement, what is the difference between selling “to” a Market Maker and selling “through” an ECN?

Selling “to” a Market Maker simply implies that if an order is displayed on the bid/ask of an issue you have the ability to “hit” that order. Selling “through” an ECN (Electronic Communications Network) actually allows you access to “the book” (to post your bid or offer to the world). This increase in visibility affords you a much higher probability to execute your trade.

It is well established that a Broker/Dealer can transact business as a Principal (for his own dealer account) or as Agency (as a broker representing the customer to another dealer). Whether transactions executed through an ECN are similar enough to a Broker/Dealer who is acting as Principal has not been challenged in the courts as of yet. It is therefore arguable that using ECNs such as ISLAND/INET or ARCA ATTN BRUT BTRD REDI STRK & TRAC and selling directly to Customers (as opposed to selling to a Market Maker, who in turn sells to his customers) meets the “to customers” test qualifying you to file as a Dealer in Securities.

Dealers or market makers typically have access to NASDAQ Level III where they not only have all the real-time quotes available to see (such as with Level II) but they also may enter their own quotes and execute orders. On the surface, this is not unlike how an ECN operates with the user. So is this taxpayer a “trader?” or is this taxpayer a “dealer?”

It’s also been said that to qualify as a dealer the taxpayer should be providing some level of merchandising functions or other services that the taxpayer should to be compensated for providing. Entering one or two orders a day might not be “merchandising” very much. But trading with enough volume that you are providing continual liquidity to the market is a horse of a different colour.

[update: for more education of what to do and what not to do see references to 2007 court cases below, discussing Court opinions on taxpayer positions of trader vs. dealer – where pro se taxpayers presented good faith but faulty arguments based partially on and similar to the concepts discussed above]

IRS document regarding Mark to Market for Dealers in Securities; Equity Interests in Related Parties and the Dealer-Customer Relationship

This document contains proposed regulations that make mark-to-market accounting inapplicable to most equity interests in related entities. The regulations also relate to the definition of a dealer in securities for certain federal income tax purposes. To qualify as a dealer in securities, a taxpayer must engage in transactions with customers. The proposed regulations concern the existence of dealer-customer relationships. The Revenue Reconciliation Act of 1993 amended the applicable tax law. These regulations provide guidance for taxpayers that engage in securities transactions. View or Download full text from IRS sites (when they are operational)

The IRS issued Rev. Proc. 2002-11 regarding Dealer Status.

Definition of Securities Dealer vrs. Definition of a Securities Trader

The critical issue in distinguishing between securities dealers and securities traders is whether the taxpayer has “customers.” Wood, 943 F.2d at 1050-53. The United States Tax Court has taken the position that a “dealer” is a person who purchases securities or commodities with the expectation of realizing a profit, not because of a rise in value during the interval of time between purchase and resale, but merely because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost.
This excess or mark-up represents remuneration for their labors as a middle man bringing together buyer and seller, and performing the usual services of retailer or wholesaler of goods.

Definition of a Commodities Dealer

§1258(d)(5)(B) Definitions. —
For purposes of this paragraph —
1258(d)(5)(B)(i) Options Dealer. —
The term ‘options dealer’ has the meaning given such term by section 1256(g)(8).

1258(d)(5)(B)(ii) Commodities Trader. —
The term ‘commodities trader’ means any person who is a member (or, except as otherwise provided in regulations, is entitled to trade as a member) of a domestic board of trade which is designated as a contract market by the Commodity Futures Trading Commission.

1256(g)(8) Options Dealer
1256(g)(8)(A) In General
The term “options dealer” means any person registered with an appropriate national securities exchange as a market maker or specialist in listed options.

1256(g)(8)(B) Persons Trading In Other Markets
In any case in which the Secretary makes a determination under subparagraph (C) of paragraph (7), the term “options dealer” also includes any person whom the Secretary determines performs functions similar to the persons described in subparagraph (A). Such determinations shall be made to the extent appropriate to carry out the purposes of this section.

Commodities Dealer information

The commission income of commodities and options dealers is ordinary income. Futures contracts and options traded by commodity and options dealers are generally called ” §1256 contracts” for tax purposes. Gains and losses of a commodity and options dealers from trading §1256 contracts are treated as capital gains and losses, and net capital gains are treated as self-employment income for FICA purposes. 26 An options dealer’s gains and losses from transactions carried out in the course of the trade or business of an options dealer (market maker or specialist, depending on the exchange) are subject to a complex set of rules. An options dealer who is also a dealer in securities, however, is generally subject to the same treatment as a securities dealer with respect to transactions carried out as a securities dealer.

/Footnote/ 26 §1402(i). See e.g., Rudman v. Comr., 118 T.C. No. 21 (4/29/02). As mentioned above, the 1984 Bluebook, p. 313, notes that no inference is intended as to whether options and commodity dealers are viewed as engaged in a trade or business in connection with their transactions in §1256 contracts as the result of the application of self-employment taxes to such persons.

Definition of Dealer in Securities Futures contracts:

Rev. Rul. 2004-94 – Dealers in securities futures contracts. This ruling holds that Tier 1, Tier 2, and Tier 3 NQLX LLC Market Makers that satisfy the market maker requirements described in the ruling perform functions similar to the functions performed by options dealers (as defined in section 1256(g)(8)(A) of the Code) and that these NQLX LLC Market Makers are therefore dealers in securities futures contracts within the meaning of section 1256(g)(9)(B).

An NQLX Market Maker must meet all of the following requirements:

  1. Be a member of NQLX;
  2. Be registered as a floor trader or floor broker with the CFTC or as a dealer with the Securities Exchange Commission (SEC);
  3. Maintain records sufficient to prove compliance with the NQLX Market Maker requirements, including, but not limited to, documents concerning personnel effecting relevant orders, relevant trade and cash blotters, relevant stock records, and documents concerning applicable internal system capacity and performance; and
  4. Hold itself out as willing to buy and sell SFCs for its own account on a regular or continuous basis.For an NQLX Market Maker to fulfill the regular or continuous requirement in paragraph (4) above, it must satisfy the following criteria for each of its assigned SFC products:
    1. (i) Provide continuous two-sided quotations for the first two delivery months of each assigned SFC product throughout the trading day, except during unusual market conditions as determined by NQLX (such as a fast market in either the SFC product or the security underlying the SFC product) at which times the Market Maker must use its best efforts to quote continuously and competitively;
    2. (ii) Quote for the first two delivery months, with (A) a Maximum Bid/Ask Spread of no more than the greater of $0.10 or 150% of the bid/ask spread in the primary market for the security underlying the SFC product and (B) a Minimum Number of Contacts of no less than the lesser of 10 contracts or the corresponding contract size equivalent of the best bid and best offer for the security underlying the SFC product; and
    3. (iii) Respond to requests for quotation in each assigned SFC product within 5 seconds for all delivery months other than the first two delivery months with a two-sided quotation that has (A) a Maximum Bid/Ask Spread of no more than the greater of $0.20 or 150% of the bid/ask spread in the primary market for the security underlying the SFC product and (B) a Minimum Number of Contracts of no less than the lesser of 5 contracts or the corresponding contract size equivalent of the best bid and best offer for the security underlying the SFC product.Any NQLX Market Maker that fails to comply with the NQLX rules, CFTC rules, or SEC rules, as applicable, is subject to disciplinary action in accordance with NQLX rules.

Securities held by the taxpayer must be held “primarily for sale to customers in the ordinary course of his trade or business.” The courts have attempted to define this through the application of a series of factors. Typical examples of these factors are those set forth by the Fifth Circuit in Winthrop, 417 F.2d 905 (5th Cir. 1969), as follows:

  • Nature and purpose of the acquisition of the securities and the duration of the ownership;
    Extent and nature of the taxpayer’s efforts to sell the securities;
    Number, extent, continuity, and substantiality of the sales;
    Extent of subdividing, developing, and advertising to increase sales;
    Use of a business office for the sale of the property;
    Character and degree of supervision or control exercised by the taxpayer over any representatives selling the securities; and
    Time and effort the taxpayer habitually devoted to the sales.

A later decision of the Fifth Circuit, Biedenharn Realty Co., 526 F.2d 409 (5th Cir., 1976), attempted to weigh the above factors in relative importance. It was believed that frequent and continuous sales are the most important indicator of dealer status. This was followed by the extent of improvement activity, the extent of solicitation and advertising activities, and the extent of other brokerage activities.

Other cases have asked these questions, looking for answers in the affirmative:

  • Does the dealer advertise?;
    Does the dealer have inventory?;
    Does the dealer have a business license?;
    Does the dealer have a high volume of business?;
    Does the dealer have a public presence as a dealer?;
    Does the dealer have a customer base?

When the answers to these questions is yes, the taxpayer could be considered to be a dealer. Whereas, taxpayers who buy and sell securities as individuals and do not trade directly with customers are often considered to be investors or traders.

Recent Tax Case Suggests Subtle Changes in Definitions:

A taxpayer (Thomas v Comr 2003 11th Cir GA), apparently trying to follow the logic above, tried to argue retroactively that he was entitled to ordinary loss treatment on his securities trading of between 226 to 322 sales per year and averaging $60,000 per sale.

While we believe the court erred in several places, the point in bringing this up now is that the IRS is currently using this tax case against taxpayers under audit. But this case, while lost by this taxpayer on appeal, actually loosens the definition of a dealer stating: “Under Section 1221(a)(1) of the Code, even a taxpayer who buys and sells securities as part of a business must report his gains and losses as capital rather than ordinary, unless he trades on behalf of a customer (sic).” Note that this court only requires one arms-length customer (for example, your spouse, your corporation, or your brother) to qualify yourself for securities dealer status (assuming of course you have otherwise achieved the status a securities trade or business to begin with).

Further, in denying the taxpayers’ arguments, this court further stated: “Taxpayer was not trading securities on behalf (sic) of any customers. He received no commissions for his trades and stipulated that his profits depended on market fluctuations.” and again “The tax code’s distinction between ordinary and capital losses is elementary. Sales of securities for personal gain may result in ordinary losses only when a taxpayer conducts the sales on behalf of customers in the ordinary course of a business activity.” Note that this court considers trading on behalf of customer(s) to qualify for ordinary loss treatment, rather than the accepted definition of buying from and selling to customers.

Ordinarily (not fully discussed here) we’d ignore this minor tax case as one argued ineffectively by the taxpayer and decided by the court with its share of errors in the opinion. But since, in 2005, the IRS has taken the initiative and is now using this tax case to argue against securities traders/dealers, we feel that fair’s fair.

While we generally do not propose taking such a dealer status position per se, if you are under audit don’t go it alone or go with a representative who does not do trader status tax planning as a primary portion of his or her practice. There are simply too many tricks and traps for the unwary as this Thomas case shows.




Rev. Proc. 2002-11, 2002-7 I.R.B. 526 (2/19/2002)
26 CFR 601.201: Rulings and determination letters
(Also Part I, Section 1256(g)(9) )

Rev. Proc. 2002-11
SECTION 1. PURPOSE
This Revenue Procedure contains procedures that an exchange may follow to enable the Internal Revenue Service to determine whether certain persons trading on that exchange qualify as “dealers” under section 1256(g)(9) of the Internal Revenue Code (the “Code”). It is expected that, after the issuance of a letter ruling to a specific exchange determining whether a specific category of persons trading securities futures contracts (and options on such contracts) on that exchange qualifies for dealer status under section 1256(g)(9), the Service will publish the same conclusion in a revenue ruling.

SECTION 2. BACKGROUND
The Commodity Futures Modernization Act of 2000, enacted as part of the Consolidated Appropriations Act, 2001 (Public Law 106-554, 114 Stat. 2763), authorizes the trading of securities futures contracts, a new type of derivative financial product. In general, gain or loss is recognized on securities futures contracts upon disposition, and the character of that gain or loss is determined by newly enacted section 1234B of the Code.

The timing and character of gains and losses on dealer securities futures contracts (and options on such contracts), however, is determined under section 1256 . Dealer securities futures contracts are subject to mark-to-market treatment, and gains or losses are treated as 60 percent long-term capital gain or loss and 40 percent short-term capital gain or loss. Section 1256(a). For purposes of the application of section 1256 to dealer securities futures contracts (and options on such contracts), a person is a dealer if the Secretary of the Treasury determines that the person performs functions with respect to such options or contracts similar to the functions performed with respect to stock options by persons registered with a national securities exchange as a market maker or specialist in listed options.

In Notice 2001-27, 2001-13 I.R.B. 942, the Service and the Treasury Department requested comments and suggestions regarding both the substance of the required determinations and the manner in which they should be made. Numerous comments have been received regarding criteria that could be used to identify dealers in securities futures contracts (and options on such contracts). In addition, staff of the Service and Treasury initiated numerous conversations with both regulators and various exchanges. These ongoing conversations are expected to continue unabated.

The exchanges on which securities futures contracts and options may be traded, however, are still developing rules that will govern trading. In addition, certain of the regulatory requirements that will be imposed by the Securities and Exchange Commission and the Commodity Futures Trading Commission have not yet been issued in final form, and the rules promulgated by some exchanges may differ in important respects from those governing the trading of any other products.

During the current period, when trading rules are being developed, it is important for the Service and Treasury to provide certainty for taxpayers while at the same time not constraining the development of trading structures for the new markets. Given the likely diversity of trading platforms and the potential for new trading models, the Service and Treasury have determined that encouraging exchanges to apply for case-by-case determinations while they are developing their trading rules is preferable to either writing general rules before the trading structures are known or waiting until the structures are finally established and then making the exchanges wait for a general rule to be crafted.

The issuance at this time of general guidance for determining dealer status would risk constraining the development of the structures for the new markets. On the other hand, if general guidance is not issued now, the absence of an interim process for securing dealer determinations could impair the ability of the exchanges to adapt their proposed trading systems to the requirements for achieving dealer status for market participants. As a result of the flexibility inherent in the process of obtaining a letter ruling, an exchange will have an opportunity, if it so desires, to make adjustments in its proposed trading practices should those be needed to secure dealer status for particular groups of traders.

Under the procedures set forth below, if an exchange is one on which securities futures contracts (or options thereon) are, or are expected to be, traded, the exchange may request a letter ruling that, based on its specific rules and facts and circumstances, certain persons trading such contracts (or options thereon) on the exchange will be treated as “dealers” under section 1256(g)(9).

The Service expects that, once it has reached a decision regarding the request for ruling, the same conclusion will be published in a revenue ruling, which will serve as general guidance. The Service and Treasury are committed to expedited processing for both the letter ruling and the revenue ruling.

SECTION 3. PROCEDURES
.01 Procedures for submitting a ruling request. An exchange desiring a letter ruling concerning whether certain persons trading on that exchange will qualify as dealers with respect to specific contracts traded on that exchange is required to submit a letter ruling request under the procedures provided in Rev. Proc. 2002-1, 2002-1 I.R.B. 1 (or successor procedure).

.02 Time for submitting a ruling request. Ruling requests may be submitted prior to the date on which the exchange anticipates that trading in the securities futures contracts at issue will begin, provided the exchange has developed a substantially definite framework and set of rules within which these contracts are expected to trade and has undertaken significant actions to obtain necessary regulatory approvals and to establish requisite contractual arrangements and trading systems. The Service will not rule on requests involving alternative plans of proposed transactions or hypothetical situations. See section 7.02 of Rev. Proc. 2002-1, 2002-1 I.R.B. 1, 20.

.03 Information that should be included in each ruling request. In addition to the information required by Rev. Proc. 2002-1, the exchange must submit any relevant information that will help the Service to determine whether or not persons trading in securities futures contracts on that exchange qualify as dealers under section 1256(g)(9). References to securities futures contracts include options on such contracts. References to rules applicable to trading in securities futures contracts include rules that are not yet adopted in final form but that are expected to be applicable. The current status of such rules should be described. The ruling request should also include the following:

Copies of information filed with non-tax regulatory agencies regarding trading on that exchange in the securities futures contracts at issue.

Information regarding whether persons trading in such contracts on that exchange are required to register with the Securities and Exchange Commission or the Commodity Futures Trading Commission and the nature of any required registration.

A description of any books and records requirements under federal securities laws or commodities laws to which persons trading on that exchange are subject.
Information regarding whether persons trading in such contracts on that exchange will be required to be members of the exchange and, if such persons are not required to be members of the exchange, whether such persons are required to be lessees or delegates of other persons entitled to trade at member rates on the exchange.

References to the exchange’s rules, if any, to which such persons will be subject when trading in such contracts.

A description of any books and records requirements the exchange will impose on such persons and any rules granting the exchange the right to monitor and/or examine a person’s trading activities and financial stability.

Information regarding whether the exchange, the Securities and Exchange Commission, or the Commodity Futures Trading Commission imposes any licensing requirements on such persons, including a description of any such requirements.

Information regarding whether the exchange imposes net capital requirements on such persons, or imposes such requirements on a clearing member firm that clears a person’s trades; whether clearing firms impose any capital requirements on persons clearing trades through those firms; and, in either case, a description of any net capital requirements.

Information regarding whether the exchange requires such persons to regularly and continuously hold themselves out as willing to buy and sell securities futures contracts, regardless of market conditions; and, if the exchange imposes no such affirmative obligation, whether those persons will in fact make a two-sided market because of other factors or obligations, including a description of any such other factors or obligations.

Information regarding whether the exchange anticipates that those persons expect to profit by entering into either side of a position to capture a portion of the bid-ask spread, or whether the exchange anticipates that those persons expect that most of their gross income from trading in these securities futures contracts will be attributable to profits from market price movements.
Information regarding whether the exchange anticipates that such persons will enter into transactions to hedge their risks with respect to the securities futures contracts traded on the exchanges and the nature of such hedges.

An estimate of the average gross trading volume that the exchange anticipates such persons will generate with regard to these contracts.

Information regarding whether the exchange anticipates that trading in these securities futures contracts will be a substantial part of the principal business activity of such persons. Such information might include, for example, an estimate of the average percentage of gross income that the exchange anticipates such persons will generate from trading in these securities futures contracts.
Information regarding whether the exchange will impose a substantial presence requirement or a trading activity requirement on such persons, including a description of any such requirements.
An estimate of the volume of proprietary trading, compared to the volume of trading for customers, that such persons are expected to generate on the exchange.

A description of the exchange’s trading environment (e.g., floor trading or screen trading) and any special features of such environment that differentiate the persons for whom dealer status is sought from other exchange participants.

A discussion of the nature, extent, and frequency of material changes that may occur in any of the above information after the requested ruling is issued. The exchange is encouraged to include suggestions for procedures to be followed by the exchange, its traders, and the Service in the event that material changes in the information occur. See section 12.10 of Rev. Proc. 2002-1, 2002-1 I.R.B. 1, 52; section 7.01 of Rev. Proc. 89-14, 1989-1 C.B. 814, 815.

The foregoing list of information should be provided with any ruling request, along with any additional information that may help the Service to make its determination. After its review of a request for ruling, the Service may require the exchange to submit additional information needed to make its determination. See section 10.06 and 10.07 of Rev. Proc. 2002-1, 2002-1 I.R.B. 1, 43-44.

SECTION 4. EFFECTIVE DATE
This revenue procedure is effective February 4, 2002, the date this revenue procedure was made available to the public.
SECTION 5. DRAFTING INFORMATION
The principal drafter of this notice is Shawn Tetelman of the Office of the Associate Chief Counsel (Financial Institutions and Products). For further information regarding this notice, contact Shawn Tetelman at (202) 622-3930 (not a toll-free call).

Final Regulations Set Forth Safe Harbor for Valuation Under Code Sec. 475; Procedure Issued for Designating Securities, Commodities Considered Eligible Positions (Rev. Proc. 2007-41; T.D. 9328)

To qualify for the safe harbor, a financial accounting method must satisfy certain basic requirements. The method must:

  1. mark eligible positions to market through valuations made as of the last business day of each tax year;
  2. recognize into income on the income statements any gain or loss from marking eligible positions to market;
  3. recognize into income on the income statement any gain or loss on disposition of an eligible position as if a year-end mark occurred immediately before the disposition; and
  4. arrive at fair value in accordance with U.S. GAAP.

Over 80 years ago, the U.S. Supreme Court ruled that a gain or loss from the sale of securities is ordinary income or loss only for security dealers. The High Court said that “Taxpayers who buy and sell or hold securities for investment or speculation… are not dealers in securities within the meaning of this rule” [Schafer, U.S. Sup. Ct. (1936)].

The Professor
Sankarshan Acharya, a professor of finance at an Illinois college, claimed ordinary loss treatment for his stock losses. He argued that, like a securities dealer, he had had suppliers (the people who sold the securities he purchased) and customers (the people who bought the securities he sold). A federal appeals court rejected Acharya’s argument. The court said that securities dealers hold securities as inventory for sale to customers in a retail or wholesale capacity. Acharaya was not a licensed stock broker; and could not hold himself out legally to the public as offering inventory or execution services in financial markets. Indeed, he used a discount broker to trade stocks for his own account. The discount broker would have been entitled to ordinary-income treatment for its own gains and losses from that activity; but Acharya, as an investor, must account for his trades as capital gains and losses [Acharya, U.S. Ct. App. (7th Cir., 2007)].

The Doctor
Shahrooz Jamie was a licensed physician and a “day trader” of securities, buying and selling on his own account the same securities on the same day or within a few days. Jamie engaged in the trading activity for the sole purpose of profiting from short-term fluctuations in the market price of securities. He did not earn dividends or interest from the securities in which he traded. The Tax Court ruled that, even though Jamie was “in the business” of stock trading, he could not claim ordinary loss treatment for his stock losses. Because they deal in securities held primarily for sale to customers in the ordinary course of their trade or business, dealers in securities need not treat securities as capital assets. However, because traders buy and sell securities on their own accounts and have no customers, securities held by traders are capital assets for federal income tax purposes [Jamie, TC Memo 2007-22].