Mark to Market - "Trader" Tax Status

Technical topics regarding tax preparation.
#1
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Have a C Corp electing mark to market treatment for 2021 (calendar year taxpayer). They've been in business for a couple years. I've already asked about why they're a C Corp and they've made it clear in no uncertain terms that they aren't looking to revisit at this time.

A small wrinkle is that their is a small disallowed loss (wash sale) of about $2,000 for 2020. On top of that there's a capital loss carryforward from 2020 to 2021 of about $2,500 (so total of $4,500 in losses going to 2021).

So my question is, mechanically, how does this work? Any pitfalls or common mistakes I should be aware of?

Here is the statement I've drafted to attach to the 2020 return (filing in 2021):
Mark to Market Election Pursuant to Internal Revenue Code Section 475(f)(1) and IRS Rev. Proc. 99-17.
1) [Company Name] (“Taxpayer”) is making a mark to market election under IRC Sect. 475(f)(1).
2) The election shall be effective for the 2021 tax year (January 1, 2021 – December 31, 2021) and all subsequent tax years, unless revoked with the consent of the Secretary.
3) The election is effective for Taxpayer, a trader in securities, except to the extent of any exceptions pursuant to IRC Sect. 475(f)(1)(B).

In connection with this election, Taxpayer is requesting a Change in Accounting Method and will include IRS Form 3115 with its 2021 tax return in accordance with IRC Sect. 475 and the regulations thereunder.


Then, my understanding is that I'd file Form 3115 with the 2021 tax return (filing in 2022). And I'd take the full amount of the wash sale disallowed loss as a 481(a) adjustment (showing as a negative) for tax year 2021, and marking the $50k de minimis election box to take it all in 2021.

Last question is what happens to the capital loss carryover? Is that also treated as a 481(a) adjustment? Or does it retain its character going forward? If the election was in place for 2020, it would have been an ordinary loss. No NOL complications.
 

#2
Doug M  
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From Rev Proc 99-17

.03 Elections effective for a taxable year beginning on or after January 1, 1999.
(1) General procedure. Except as provided in section 5.03(2) of this revenue 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.
 

#3
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Thanks, yes, the statement appears that it follows 5.04 of the rev proc. Just wanted to make sure I'm not missing anything here.
 

#4
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My version of the statement would look like:

1. Taxpayer hereby elects under the automatic consent procedure outline in Rev Proc 99-17, to mark taxpayers security holdings to market at the end of each year tax year(475(f)). Form 3115 will be attached to the timely filed return, including any 481(a) adjustments.
2. Election being made: Election to use the mark to market method of accounting under Coder section 475(f).
3. First taxable year for which the election is effective: January,1,2021
4. Trade or business for which the elction is being made: Day Trader Corp; Form 1120

And I'd take the full amount of the wash sale disallowed loss as a 481(a) adjustment (showing as a negative) for tax year 2021


Understand the c/o 2020 capital loss as a 481 adjustment but not the 2020 wash sale since the 475 election is effective 1-1-21. Would not the 2020 wash sale loss just increase the basis of the repurchased securities?
 

#5
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Help me think this through. My brain is fried. I'm making up figures.

I am pretending to look at a broker's statement for a trader, not a dealer, who made the 475(f) election. The statement shows net proceeds, cost basis, and wash sales adjustments for each transaction with totals at end. All stock purchased and sold in same year.

Totals: Net proceeds: 2540601 Cost basis of stock 2569211 Wash sales loss disallowed 29449 Gain/Loss (28610)

For ordinary trader, Sch D gain would be $839, would it not?

For 475(f) trader, which allows trader to take wash sale losses (or does it?), does the basis provided by the brokerage not already add the disallowed wash sale loss to the basis of the new stock that was purchased within the 30 days? If so, would the gain for the 475(f) trader not now be:

2540601 Less (2569211-29449) = $839 gain

So if I'm going to add the wash sale losses to the computation, I would need to subtract the $29449 already added in by the broker to come out with basically an $839 gain and not a ($28610) loss. Correct?
 

#6
iDred  
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I'll say this as I have elected to use mark to market for my taxes.

You have to be careful with what it says on the broker statement and the wash sale amount.

I knew exactly what my gains and losses were for the year based on how my cash changed and also having no transactions at the end of the year that would be considered a wash sale.

When I tried to add back or subtract that wash sale on the broker statement my gain / loss was not correct.

I could not figure out at the time how they got the wash sale number and decided to go by how much my account value changed.

What I'm saying is you have to be careful here and do not trust those broker statements as they are incorrect many times.

Try and find out what your client thinks his account values actually changed during the year. He should have an idea about how much he made so you can at least have something to compare against.

This trader stuff gets complicated, especially when dealing with options and futures. I know because I am a trader and a cpa.

Honestly you should not be touching this stuff if you are unsure because you will wind up messing his return up if you are not an experienced financial trader.

I cringe when I think about how my fellow traders are losing lots of money by not knowing how to prepare taxes and not going to a specialist in trader taxes. I'm not talking about a trader who trades just stock but futures and options. The other issue is many tax preparers will take an approach to protect themselves and because of not knowing the rules will make the trader pay a lot more in taxes to make sure the preparer is protected.
 

#7
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But if the brokerage statement is incorrect for someone who made the 475(f) day trader election, it is incorrect for the trader who did not make the 475(f) election, and the TP would have to make corrections either way.

For few transactions, this might not be hard to do, but for the day trader who might have 200 transactions of the same stock in a short period of time, it would be very hard to spotcheck ATF (as in four months later) the transaction where the disallowed wash sale losses on the brokerage statement would be added to the basis of the stock sold in another sale by the TP. As you say, the trader would have to know what his cost of the initial purchase was, and if buying and selling the same stock with no additional money input, what he actually ended up with in the end to determine the actual gain or loss. Presumably, the broker is keeping up with this if they are indeed tracking cost basis, and the trader would need very good records to challenge what the broker provides, i.e., to use in an audit or even preparing the return.

But while it might be hard, it can be done as the brokerage usually provides a very detailed record of purchases and sales.

I know there are articles out there in internet land that tell the day trader he can use his wash sale losses, but most are written before brokerages started tracking basis in covered securities. Although the rules were the same then as they are now, I think it is important to point out that if the brokerage is reporting the cost basis as being covered, the trader, whether day or otherwise, has to take into consideration that the brokerage has adjusted the cost basis of at least one of these transactions for the disallowed wash sales. Especially if the brokerage infers on its website that the "cost basis of the security you bought is increased by the amount of the disallowed loss." Note here, it is referring to covered securities.

What I am saying is if the brokerage has already adjusted the basis of the (re)purchased stock by the amount of the disallowed wash sale loss, then the TP will be overstating his losses if he does takes the disallowed wash sale loss as a loss, but does not adjust the broker's reported covered basis by the amount that was added into the basis of the repurchased stock. He would essentially be taking the same deduction twice.
 

#8
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I take back my previous statement. I just took the very comprehensive brokerage statement I am pretending to look at and spotchecked the recorded purchase cost of the shares in the details of investment activity against what the brokerage reported as the cost basis - the disallowed wash sale losses in the reported covered short-term gains or losses section of the 1099B and am coming up with the same figures. So actual cost versus brokerage reported cost less disallowed wash sale loss equals the same thing.

And the point being if the daytrader takes the wash sale losses without adjusting the reported covered basis on the 1099B, he/she has deducted the same losses twice.
Last edited by Yellowdog on 16-Apr-2021 8:31am, edited 2 times in total.
 

#9
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There is software your client can purchase (that's what mine did). My client really likes Tradelog. I only have 1 client who is a trader so I never considered it, but if you have many, maybe they offer a version for tax professionals that you may want to consider.
 

#10
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The brokerage provides the purchase/sale detail in a .csv file which can be viewed, sorted and saved as an Excel file.

If you know the nuances of Excel, you can easily manipulate the information.
 

#11
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Yellowdog wrote:The brokerage provides the purchase/sale detail in a .csv file which can be viewed, sorted and saved as an Excel file.

If you know the nuances of Excel, you can easily manipulate the information.


I'm pretty solid at excel, but there are a lot of complexities in the rules that I think you may miss/not be able to calculate especially when you have losses being carried both backward and forward and the same ticker being traded daily for a month and a half, with derivative transactions on that same underlying. I tried to manually calculate wash sales just so I could see how things work, and that's when I told my client - you have to get the calculations done by someone else or take the whole return to someone else.
 

#12
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The reason I posted in the first place is that I had someone ask about making the 475(f) election and was asking about "taking" those wash sale losses. I pointed out in our pretend scenario that the wash sale losses were added to the basis of subsequently purchased stock, so in essence, there were no losses. He actually had gains. And if I do what I just did here, take the actual cost of the pretend purchases and subtract that from his pretend sales proceeds, we were coming up with the same gain that I get by taking the pretend 1099B sales proceeds less reported cost basis adjusted by the wash sale losses.

Granted, the 475(f) election has to be made by the due date of the tax return for the previous year for which you are making the election. I don't do returns for those who make the 475(f) election and generally do not advise them on making the election. For someone with the amount of transactions that would warrant a 475(f) election, I tell them they need to consult with someone who has more knowledge than I do about all the peculiarities of this election.
 

#13
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Also a day trader with the election who does have stock in the portfolio at year-end, (note in my scenario, the TP did not), must treat that stock as if it was sold at FMV on 12/31. This could be a loss or a gain. So whatever the FMV is on 12/31 becomes the new basis. Many articles refer to taking the loss, but you would also have to report the gain.

So yes, day traders with the 475(f) election have many nuances they must consider and would need to make an adjustment to the 1099B cost basis reporting if they had indeed already reported the sale of that group of stock at year-end. The brokerage would not know this. But that aside, I wrote my scenario specifically so that this provision would not even apply for simplicity sake.
 

#14
iDred  
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yellowdog, glad someone else takes notice to the complications of trader tax status. Not only trader tax status but trader taxes in general. It's not ultra complicated, it's just that you have to know the rules for different securities and the different ways they tax these financial instruments.

The broker statement is really only used as a guide. The broker statement will give you a reasonable idea about your gains and losses, but you have to know how they get taxed.

I trade in futures a lot, and I notice that many other traders don't tax their section 1256 contracts with the benefician 60/40 capital gains treatment. Most traders don't know. The tax preparers they also use also don't really know and don't want to even take the risk of giving them the beneficial tax treatment so they just tax them full short term gains costing them thousands of dollars.

The other thing is you have to really look at the reasons for electing 475. Usually its not a good deal, especially if you trade in futures contracts as you lose your 60/40 capital gains treatment.

I personally electing 475 after having a huge loss that I needed to apply to my earned income for many years into the future, it made a lot of sense to me, even with losing my 60/40 tax treatment. I may switch out of the 475 election once my loss is used up.
 

#15
Doug M  
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Have a C Corp electing mark to market treatment for 2021 (calendar year taxpayer)


As per my #2 post, the notice states:

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.

So, did you attach this information to your 2020 C corp return timely filed return without the extension? Or attached to the extension?

The Notice is not going to allow you to hindsight the transactions for the first 4 months of 2021 and say "Geez, I got all these losses, how can I get around the $3,000 cap loss rule"
 

#16
iDred  
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I like how you guys know about this as I spent a lot of time with this on my own taxes. I had to figure out the whole thing without any help except a couple of internet pages.

One other TIP that I will throw out there. If you have long term stock trades, or trades held for investment, you really should list those on your schedule D, and not on your form 4797. I'm not sure how the C Corp accounts for these as I do it on my personal return.

The reason is that if the IRS looks at your tax trader status, they are going to see if you are actually a day trader. The first thing they will look at is if you are lumping in your long term capital gains on the form 4797. Like if you have Apple long term stock and lumped that in with your day trades. The IRS will probably flag your return and really look at if you are a trader.

The last thing you want to get called in for is proving that you are a day trader and not just a investor like most 99% of the people are.

What I do is I take any stock transactions which I don't trade often, and are pretty obvious they were held for investment, and list those separately on my schedule D. This way if the IRS does look over my return and they see that I'm separating my transactions, they probably don't want to mess with my return and trying to say I'm not a trader. However, if they see lots of lumped in long term sales on the 4797, they will probably call you in and look further at your sales.

But I have mostly options and future contracts, I get K1's for many of these, and they probably don't want to mess with someone trading those things. They will look for the guy claiming he is a trader, who trades mostly amazon, face book, apple type of stocks.

This web page is probably the best help for doing a sec 475 election.
http://www.tradelogsoftware.com/resourc ... form-4797/
 

#17
Doug M  
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If you have long term stock trades, or trades held for investment, you really should list those on your schedule D, and not on your form 4797. I'm not sure how the C Corp accounts for these as I do it on my personal return.


You should have two accounts. One for the trader actvities, the other for long term holdings. The C corp prior cap losses can only be used against gains, and they need be transacted in the long term holding account.

Why a C corp is beyond me.
 

#18
iDred  
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Doug, I also wonder about the C Corp but maybe I know the answer.

I was a very stupid trader at one point, and ran my account into a huge negative number. I almost had to declare bankruptcy if not for having to go back to a normal job and actually settling with my brokerage at 40% of the negative account value.

In that time I was facing bankruptcy, and the possibility of having them come after my possessions in bankruptcy and also my joint accounts, I always wondered if a C-corp would have protected me from this large negative balance I owed and I could have just walked away from it.

That being all said, I never set up a C - corporation but all my trading is done carefully now with loss limitations. I can't go negative anymore, I won't even come close to it so there is no need for a C-corporation for me. However, if you are trading on margin, where you are not limiting your losses with defined risk spreads etc. Then I can see the benefit for a C-corporation here.

I am also not sure if a brokerage is going to let you trade on margin if you are a C-Corp.

What are your thoughts?
 

#19
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I may switch out of the 475 election once my loss is used up.


Requires IRS consent does it not?
 

#20
iDred  
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TAXMASTER wrote:
I may switch out of the 475 election once my loss is used up.


Requires IRS consent does it not?


I believe so, I'm still years away from having to do this so I never looked into the actual details. From what I read about it on the internet it just requires consent, but they will switch you out.
 

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