IRS Makes It Easier for Hedge Fund Traders to Revoke Section 475(f) Election

Tucked away in the annual update to the automatic change in accounting methods revenue procedure, Rev. Proc. 2015-14, was a revision that was somewhat buried in the recurring Internal Revenue Code section 475 election for securities traders. Within a subsection of the mark-to-market accounting method section, was the new revocation method for the 475(f) mark-to-market election.

This change, which makes it easier for hedge fund traders to revoke a section 475(f) election, was an unexpected – albeit welcomed – surprise from the IRS Associate Chief Counsel Office. Hedge fund traders looking to revoke an election for tax year 2015 may still have time to do so, but they need to act fast because the April 15^th deadline is rapidly approaching.

Securities and commodities traders who have an IRC section 475(f) election in place, whether individually or at an investment partnership level, now have the ability to make an automatic revocation of this election for calendar years 2015 and beyond. If you are thinking about making this election, contact your accounting professional as soon as possible to discuss your options.

No more jumping through hoops

Prior to this new automatic method, taxpayers were required to seek consent from the IRS via an “advance consent” application requesting permission to revoke the 475(f) election as mandated under statute IRC section 475(f)(3). For hedge funds, this required submitting a formal application on Form 3115 to the IRS along with a fee of $7,000 (which increased to $8,600 as of February 2, 2015).

The application required a description of the current and proposed method of accounting for securities, as well as a business reason for the election revocation. The consent took several months for approval or denial, which limited the tax planning opportunity for portfolio managers.

How to revoke a 475(f) election

The new automatic change puts the revocation procedures in line with the old 475(f) election procedures under Rev. Proc. 99-17, as modified.

The partnership requesting revocation will need to file a “notification statement” by the original due date of the preceding year return, without extensions. The statement can be filed with an extension of time to file the return or with the tax return for the tax year preceding the year of change. This provides an opportunity window of 3.5 months in the beginning of the tax year to decide whether to revoke the election, mirroring that of the timing to make the 475(f) election.

April 15, 2015, is the deadline to file the notification statement for revocations effective for the 2015 calendar year.

The notification statement must include all of the following:

• Name of taxpayer with 475(f) election in place
• Statement requesting the accounting method change to a realization method
• Beginning and ending dates for year of change
• Types of instruments subject to the method change
• Statement revoking the taxpayer’s 475(f) election in place.

The partnership must then file Form 3115 with its 2015 tax return under standard automatic method change procedures described in Rev. Proc. 2015-13, effective for forms filed on or after January 16, 2015.

Implications of a 475(f) election

Individuals as well as investment partnerships who qualify as a trader in securities (as opposed to an investor in securities) are eligible to make an IRC section 475(f) election.

This election allows the partnership to avoid wash sales, straddles and certain other securities transaction tax rules; this is because the election requires the partnership to mark-to-market all of its trading securities at year-end as if the securities were sold, thereby, recognizing all unrealized gains and losses on such securities for the year. In addition, all securities included in the 475(f) trading account will be subject to the highest income tax rates.

All losses within the 475(f) account are fully deductible against other types of income. Conversely, capital losses without the election are limited to a $3,000 deduction against other income for individual taxpayers.

Making a 475(f) election

Qualifying investment partnerships who wish to make the election need to do so by the original due date of the preceding year return, without extensions. The election can be filed with an extension of time to file the return or with the tax return for the year prior to the election year, which is generally April 15 of the election year. If you file an extension, you should consider sending a hard copy of the election via certified mail with a return receipt card.

For a newly formed partnership, the election must be placed in its books and records within 2.5 months of the election effective date, and it needs to be attached to its initial filed tax return.

Investment partnerships using fund administrators should notify their administrator of their intent on making the election and provide their administrator with a copy of such election to keep on file. This provides third-party verification of the election, in case the IRS questions the validity of the election under audit. Likewise, if you intend to revoke your 475(f) election, you should inform your fund administrator.

Once the election has been made, it is applicable for all prospective years until either the investment partnership ceases operations or the election is revoked by the IRS.

If you are thinking about making a 475(f) election or revoking an existing election, contact me or another member of Kaufman Rossin’s hedge fund and private equity tax team immediately to discuss your options.