IRS Grants Late §475(f) Election-But In a Very Unique Situation

The election to “mark to market” securities under §475(f) is an election that has very strict time limits imposed, pursuant to Revenue Procedure 99-17.

Many taxpayers have discovered to their dismay that this election is required to be made early in the year in which the method is to apply, and that the IRS will not waive allow a late election—generally because such an election clearly would be made with the benefit of hindsight. The Tax Court has numerous times backed the IRS up on this position for much the same reason—the position outlined in Revenue Procedure 99-17 is justified due to the obvious benefit a late electing taxpayer has from having better information than those that followed the rules.

The election can be quite beneficial to taxpayers who qualify as traders if, as often turns out, they aren’t very good at being traders. The mark to market election allows the losses to be treated as other than capital losses, avoiding the $3,000 a year limitation. But taxpayers often do not seek advice early enough in a year to timely file the election, and many tax advisers aren’t aware of the existence of this option if they have not previously worked with day traders.

So Private Letter Ruling 200927005 initially grabs our attention due to tax reporting service headlines that state that the IRS allowed a late §475(f) election—which it did. But in looking at the details, it turns out that there are unusual facts at work that do not grant any real relief to those taxpayers who find out too late about the option to use a §475(f) election.

In this particular case, a foreign entity eligible under the check the box regulations to be treated as a partnership, had inadvertently failed to file Form 8832 within two and a half months of the date of the first year it wished to be treated as a partnership. The ruling doesn’t state if this was the first year of the entity, but note that foreign entities are subject to slightly different default status rules under Reg. §301.7701-3(b)(2) that make the default treatment a corporation unless at least one member has unlimited liability. However, such an entity can still elect to be treated as a partnership, but must file the Form 8832. It seems likely that the taxpayer in this case simply failed to note that special requirement for foreign entities—but, again, the ruling doesn’t explicitly tell us this.

The entity had made a §475(f) election and had filed returns and accounted for results consistent with that treatment and with the status as a partnership. The entity, having discovered the error, apparently qualified for automatic relief from the late entity election. But since this “new” entity could not have made the election for mark to market in a timely fashion (it didn’t exist), what happens to the §475(f) election?

In this limited fact pattern, the IRS found it could grant the taxpayer the late election under §475(f) pursuant to Reg. §301.9100-3. Unlike the case of taxpayers truly trying to make a late election because they weren’t aware of the option, this taxpayer could show that it had acted reasonably and in good faith and that the granting of the election would not prejudice the interests of the government. In more traditional cases, the simple fact that the taxpayer now has access to more complete information on the cost/benefits of making the election are deemed to violate the requirements at Reg. §301.9100-3(c)(2)(iv).