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Ways and Means Releases Discussion Draft of Financial Product Tax Reform

Posted in Financial Products, General, Legislative, Tax reform


On January 24 the chair of the House Ways & Means Committee released proposals to reform the taxation of financial products.  The reforms include:

  • Mark-to-market taxation for speculative financial investments.  Specifically the draft would require taxpayers engaged in speculative financial activity—but not business hedging against common risks—to mark certain financial derivative products to fair market value at the end of each tax year, thus triggering the recognition of gain or loss for tax purposes.  The proposal would apply to property acquired and positions established after December 31, 2013.
  • Eliminate the requirement for many common business transactions to separately “identify” hedges for tax purposes.  For taxpayers that are engaged in hedging business risks, the draft would allow transactions that are properly treated as hedges for financial accounting purposes to be treated as hedges for tax purposes.  This taxpayer-favorable proposal would minimize inadvertent failures to identify a transaction as a hedge for tax purposes, even though the transaction satisfies all of the substantive requirements for hedging transaction tax treatment.  The proposal would be effective for hedging transactions entered into after December 31, 2013.
  • Eliminate phantom income on non-write-down debt restructurings.  The draft would reform the tax rules that apply to debt restructurings that do not involve a forgiveness of principal. This change would reduce the prevalence of “phantom” cancellation-of-indebtedness income when debt is restructured—a common practice during economic downturns—thereby creating a more taxpayer-favorable rule.  The discussion draft would eliminate the phantom taxable income problem associated with many debt restructurings by generally providing that the issue price of the modified debt instrument cannot be less than the issue price of the debt instrument prior to modification.  The proposal would be effective for debt modifications that occur after December 31, 2013.
  • Harmonize the Tax Treatment of Bonds Traded at a Discount or Premium on the Secondary Market. The draft would require the holder of the bond to recognize taxable income on the discount over the remaining life of the bond.  Further the amount of discount to be recognized for tax purposes would be limited to the discount that typically reflects an increase in interest rates that has occurred since the date the bond was originally issued—as opposed to steeper discounts that often reflect deterioration in the creditworthiness of the borrower.  The proposal would be effective for bonds acquired after December 31, 2013.
  • Require average cost basis for securities.  The draft would require the cost basis of the security to be based on the average cost basis of all other shares or units of the identical security held by the taxpayer.  The proposal would be effective for sales of securities occurring after December 31, 2013.
  • Tighten “wash sale” rules.  The draft would reform the wash sale rule (i.e., sell to recognize tax loss but buy back the security) so that it applies to transactions involving closely related parties.  Specifically the draft would expand the scope of the wash sale rules to include acquisitions of replacement securities by certain closely related parties, including spouses, dependents, controlled or controlling entities (such as corporations, partnerships, trusts or estates), and certain qualified compensation, retirement, health and education plans or accounts.  The proposal would be effective for sales of securities occurring after December 31, 2013.

The release includes (1) an overview of the proposals, (2) a summary description of the specific legislative proposals, (3) proposed legislative text, and (4) a 27-page detailed technical explanation of the proposals. Many of these proposals are also found in a 2011 ABA report recommending tax reform in this area.