IRS OUTLINES RULES FOR COMPLYING WITH NEW MARK-TO-MARKET PROVISIONS.

Rev. Rul. 93-76

PURPOSE

This revenue ruling provides guidance under section 475 of the Internal Revenue Code to enable taxpayers to comply with the mark-to- market requirement for section 475.

LAW

Section 475 of the Code was enacted on August 10, 1993, in the Revenue Reconciliation Act of 1993 (the "Act"), Pub. L. No. 103-66, section 13223, 107 Stat. 481. It requires mark-to-market accounting treatment for certain securities held by a "dealer in securities" as defined in section 475(c)(1). Section 475 is effective for all taxable years ending on or after December 31, 1993.

Section 475(a) of the Code sets forth two mark-to-market rules. First, any security that is inventory in the hands of a dealer must be included in inventory at its fair market value. Second, any security that is not inventory in the hands of a dealer and that is held at the close of any taxable year is treated as sold by the dealer for its fair market value on the last business day of that taxable year, and any gain or loss is required to be taken into account for that taxable year.

Section 475(b)(1) of the Code provides that the mark-to-market rules do not apply to: (1) any security held for investment; (2) any evidence of indebtedness that is acquired (including originated), or any obligation to acquire an evidence of indebtedness that is entered into, by a dealer in the ordinary course of its trade or business, but only if the evidence of indebtedness or obligation to acquire an evidence of indebtedness is not held for sale; (3) any security that is a hedge with respect to a security that is not subject to the mark-to-market rules; and (4) any security that is a hedge of a position, right to income, or liability that is not a security in the hands of the taxpayer. Under section 475(b)(2), a security must be clearly identified in the dealer's records as being covered by one of the exceptions described in section 475(b)(1) before the close of the day on which the security was acquired, originated, or entered into.

In addition to the identification requirements in section 475(b), section 475(c)(2)(F)(iii) of the Code requires a dealer in securities to identify a position that is not a security described in sections 475(c)(2)(A)-(E), but that is treated as a security because it is a hedge with respect to such a security.

Notice 93-45, 1993-29 I.R.B. 73, extended to October 31, 1993, the date by which a dealer in securities must identify certain securities for purposes of section 475(b) of the Code.

ISSUES AND HOLDINGS

ISSUE 1: If a taxpayer believes that it is not a dealer in securities within the meaning of section 475(c)(1) of the Code but nevertheless timely identifies all of its securities as being covered by one of the exceptions in section 475(b)(1), does that "protective identification" cause the taxpayer to be treated as a dealer?

HOLDING 1: No. A taxpayer that is not a dealer in securities within the meaning of section 475(c)(1) of the Code does not become a dealer in securities, or create an inference that it is a dealer in securities, by making a protective identification of its securities.

ISSUE 2: Is a bank or an insurance company excepted from the mark-to-market rules on the grounds that it is, per se, not a dealer in securities within the meaning of section 475(c)(1) of the Code?

HOLDING 2: No. A bank or an insurance company is subject to the mark-to-market rules if its activities bring it within the definition of a dealer in securities in section 475(c)(1) of the Code. For example, many banks are dealers because they regularly originate and sell loans. As another example, an insurance company that regularly makes and sells policyholder loans is a dealer for purposes of section 475.

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 section 475(c) of the Code?

HOLDING 3: No. A taxpayer whose sole business consists of trading in securities is not a dealer in securities within the meaning of section 475(c) of the Code because that taxpayer does not purchase from, sell to, or enter into transactions with, customers in the ordinary course of a trade or business.

ISSUE 4: Does the classification of a security under financial accounting principles, including FASB Statement No. 115 (Accounting for Certain Investments in Debt and Equity Securities) determine whether the security qualifies for one of the exceptions to the mark- to-market rules under section 475(b)(1) of the Code?

HOLDING 4: No. The classification of a security under financial accounting principles is not dispositive of the treatment of the security for federal income tax purposes. For example, for purposes of section 475 of the Code, a security may in certain cases qualify for the held-for-investment exception to the mark-to-market rules even though, under applicable financial accounting principles, the security is classified as available for sale.

ISSUE 5: Does an identification of a security as "held for investment" under section 1236 of the Code serve to identify that security as "held for investment" (within the meaning of section 475(b)(1)(A)) or as "not held for sale" (within the meaning of section 475(b)(1)(B))?

HOLDING 5: No. Some securities that may be properly identified as held for investment under section 1236 do not qualify as exceptions under section 475(b). Therefore, a dealer in securities (within the meaning of section 475(c)(1)) that intends to identify a security for purposes of section 475(b) must identify that security with specific reference to section 475, even if a section 1236 identification has been made. (But see Holding 9 with respect to securities held at the close of the taxable year preceding the first taxable year that ends on or after December 31, 1993.)

ISSUE 6: Is a dealer in securities required to use a special procedure to comply with the identification requirements under section 475 of the Code, including identification of a security as being excepted from mark-to-market accounting?

HOLDING 6: No. Until further guidance is published, a dealer may comply with the identification requirements under section 475 of the Code using any reasonable method (see, for example, guidance concerning identification requirements under sections 988(a)(1)(B), 1221, 1236(a)(1), and 1256(e)(2)(C) of the Code). The identification, however, must be made on, and retained as part of, the dealer's books and records. The dealer's records must clearly indicate the specific security or hedge being identified, and the identification must clearly indicate that it is being made for purposes of section 475. Alternatively, the dealer may identify specific accounts as containing only securities or hedges that are covered by a particular exception, so that placing a security or hedge in the account identifies the security or hedge as being covered by that exception. In addition, rather than identifying specific securities or accounts as being covered by an exception described in section 475(b)(1), a dealer may comply with the identification requirement under section 475(b) by clearly indicating the specific securities or accounts that are not covered by an exception and identifying all other securities or accounts as being excepted.

ISSUE 7: If a taxpayer held securities (within the meaning of section 475(c)(2) of the Code) on August 10, 1993, or acquires, originates, or enters into securities between August 10, 1993 and October 31, 1993, is an otherwise proper identification timely for purposes of section 475(b)(2) or section 475(c)(2)(F)(iii) if made on or before October 31, 1993?

HOLDING 7: Yes. In the case of securities (within the meaning of section 475(c)(2) of the Code) that are held on August 10, 1993, an identification is timely for purposes of section 475(b)(2) or section 475(c)(2)(F)(iii) if it is made on or before October 31, 1993.

In the case of securities acquired, originated, or entered into between August 10, 1993, and October 31, 1993, an identification is timely for these purposes if it is made on or before October 31, 1993, or (for certain securities described in section 475(c)(2)(C)) such later time as provided in Holding 8.

ISSUE 8: If a dealer in securities originates or acquires an evidence of indebtedness in the ordinary course of a trade or business, are there any exceptions to the requirement that the dealer make an identification under section 475(b)(2) of the Code before the close of the day on which it originates or acquires the security?

HOLDING 8: Yes. Pending further guidance, if a financial institution (as defined in section 265(b)(5) of the Code) originates or acquires an evidence of indebtedness in the ordinary course of a trade or business, an identification of the evidence of indebtedness is timely if it is made in accordance with the dealer's accounting practice, but no later than 30 calendar days after the date of origination or acquisition. The preceding sentence applies to any dealer in securities for evidences of indebtedness that are mortgage loans.

Also, pending further guidance, a dealer in securities that enters into commitments to acquire mortgage loans may identify those commitments as being held for investment if the dealer acquires the mortgage loans and holds the mortgages as investments. This identification of commitments to acquire mortgage loans must be made in accordance with the dealer's accounting practice, but no later than 30 calendar days after the date of origination or acquisition of the mortgage loans.

ISSUE 9: If, for the first taxable year ending on or after December 31, 1993 ("the year of change"), a taxpayer is required to change its method of accounting for securities to comply with section 475 and take into account any resulting net section 481(a) adjustment, how does the taxpayer determine which of the securities it held at the close of the taxable year immediately preceding the year of change must be marked to market under the new method of accounting?

HOLDING 9: To compute a net section 481(a) adjustment, a taxpayer needs to determine which of the securities it held at the close of the taxable year immediately preceding the year of change are marked to market as of the beginning of the year of change. Any security not treated as identified as being covered by an exception to the mark-to-market rules must be marked to market as of the beginning of the year of change and thus must be taken into account in computing the amount of the net section 481(a) adjustment. Pursuant to the legislative history, and solely for purposes of determining the securities that are marked to market as of the beginning of the year of change, a dealer in securities that is required to change its method of accounting for securities must apply the standards that follow.

First, any security that, as of the close of the taxable year immediately preceding the year of change, was identified as a security held for investment under section 1236 of the Code is treated as being properly identified as held for investment for purposes of section 475 of the Code. So long as that security continues to qualify as "held for investment" under section 1236(a)(2), it is treated as continuing to be described in section 475(b)(1) of the Code. (But see Holding 5 with respect to securities acquired after the start of the year of change.)

Second, any other security (including a security described in section 475(c)(2)(F)) held by the taxpayer at the close of the taxable year immediately preceding the year of change is treated as having been properly identified under section 475(b) if the information contained in the taxpayer's books and records as of that date supports the identification. If a taxpayer determines that a particular type of information warrants treating a security as having been properly identified, the taxpayer must be consistent with respect to other securities where analogous information exists. Similar consistency is required in determining whether a position is a security described in section 475(c)(2)(F).

ISSUE 10: How is the net section 481(a) adjustment computed for a change to mark-to-market accounting required in the first taxable year that ends on or after December 31, 1993 ("the year of change")?

HOLDING 10: A dealer's net section 481(a) adjustment is determined with reference to the securities described in Holding 9. The amount of the adjustment is the difference between (1) the bases of those securities under the new method of accounting at the beginning of the year of change (that is, the fair market value of those securities as of the close of the taxable year immediately preceding the year of change) and (2) the adjusted bases of those securities under the taxpayer's old method of accounting as of the close of the taxable year immediately preceding the year of change.

ISSUE 11: Over what period is the net section 481(a) adjustment spread?

HOLDING 11: Section 13223(c)(2)(C) of the Act generally requires a dealer to take its net section 481(a) adjustment (whether positive or negative) into account ratably over the 5-taxable-year period beginning with the year of change. In the case of a floor specialist or market maker that used the LIFO method of accounting with respect to certain qualified securities for the 5-taxable-year period ending with its last taxable year ending before December 31, 1993, however, section 13223(c)(3) of the Act provides a special rule. The portion (if any) of the taxpayer's net section 481(a) adjustment that is attributable to the use of the LIFO method of accounting is taken into account ratably over the 15-taxable-year period beginning with the year of change, and the balance of the taxpayer's net section 481(a) adjustment is taken into account ratably over the 5-taxable- year period that applies to all other dealers. The portion of the taxpayer's net section 481(a) adjustment that is attributable to the use of the LIFO method for qualified securities equals the lesser of (a) the taxpayer's net section 481(a) adjustment, or (b) the taxpayer's LIFO recapture amount attributable to qualified securities, computed under section 312(n)(4) without regard to the effective date of that section.

EFFECT ON OTHER DOCUMENTS

Notice 93-45, 1993-29 I.R.B. 73, which extended the time period in which a dealer in securities can timely identify certain securities held on August 10, 1993, and certain securities acquired, originated, or entered into between August 10, 1993, and October 31, 1993, is amplified and superseded.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Robert B. Williams and Jo Lynn Ricks of the Office of the Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling contact Mr. Williams at (202) 622-3960 or Ms. Ricks at (202) 622-3920 (not a toll-free call).