Discontinuing the mark-to-market method under sec. 475.

• Author: Manousos, George A.
• Position: IRC section 475

At the end of 1996, the IRS issued final regulations addressing the Sec. 475 mark-to-market rules. These regulations allow a taxpayer to make certain elections resulting in the taxpayer's treatment as a dealer in securities. As a dealer, a taxpayer must mark to market all securities, unless otherwise identified as exempt from Sec. 475, as if the securities had been sold for their fair market value (FMV) on the last business day of the tax year.

Sec. 475(c)(2)(C) defines the term "security" to include any "note, bond, debenture, or other evidence of indebtedness." Regs. Sec. 1.475(c)-1 (b)(2) states that a debt instrument is customer paper if (1) a person's principal activity is selling nonfinancial goods or providing nonfinancial services, (2) a debt instrument was issued by a purchaser of goods or services at the time of purchase to finance the purchase and (3) at all times since the debt instrument was issued, it has been held either by the person selling the goods or by a corporation that is a member of the same consolidated group as that person.

Many taxpayers took the position that their accounts receivable that met this definition of customer paper were securities, and elected dealer treatment under Regs. Sec. 1.475(c)-1(b)(4) and-l(c)(1). Accordingly, an electing taxpayer had to determine the FMV of its nonfinancial customer paper (i.e., trade accounts receivable) on hand at the end of each tax year and recognize gain or loss equal to the resulting increase or decrease in value.

However, the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) modified the definition of security under Sec. 475. Under new Sec. 475(c)(4), for tax years ending after July 22, 1998, "nonfinancial customer paper" is excluded from the definition of security, effectively prohibiting taxpayers from marking to market their trade accounts receivable. In addition, the IRSRRA '98 states that any change resulting from the new law is considered an accounting method change initiated by the taxpayer, and any resulting Sec. 481(a) adjustment must be taken into account over four years beginning with the change year.

Guidelines for Method Change

Rev. Proc. 98-60 (superseding Rev. Proc. 97-37) provides procedures for obtaining automatic consent to change the accounting methods listed in the procedure's appendix. Section 10A of that appendix provides guidelines for discontinuing the mark-to-market method as a result of the IRSRRA '98 modifications to...