Tax News
In FFA 20154703F Chief Counsel blesses the taxpayer’s hedging transactions
December 03, 2015
Administrative Actions
The above referenced field advice was released a few days ago. The advice is heavily redacted but nonetheless, some useful information could be gleaned from it regarding the application of the hedging transactions identification rules and their interplay with the straddle rules. By way of background, various rules can negatively impact futures and forward hedges, such as the Sec. 1092 straddle rules, the Sec. 1256 mark-to-market rules and the capitalization rules of Sec. 263(g). Some of these issues can be avoided by identifying specific positions as hedging transactions under Reg. 1.1221-2(f). The problem for some market participants have been that these identification rules are rather elaborate and many would not go through the administrative burden to properly identify the hedges for tax purposes (identifying for book purposes generally does not suffice). The IRS has said on and off the record that taxpayers should get their ducks in a row and identify properly. Otherwise the IRS would identify straddles and hedges for the taxpayers with negative consequences.

In FFA 20154703F it seems the taxpayer ran into exactly this predicament. The taxpayer had a position in physical oil and engaged in various forward and futures hedges. The IRS apparently audited the taxpayer and claimed that the hedges were not properly identified and that the straddle rules would apply. Thus, losses were to be disallowed (we are assuming here because much of the text was redacted). IRS also claimed that the application of the straddle rules constitutes a change of accounting method under Section 446. Lastly, the IRS seems to have argued that the taxpayer’s accounting of the hedging transactions did not clearly reflect income, that income would be clearly reflected under the straddle rules, and thus, the taxpayer should change accounting methods.

Chief Counsel discussed in length the legislative history of Section 1092 and numerous other primary and secondary authorities. Ultimately it recognized that the IRS needs to exercise restraint in applying the straddle rules. It specifically concluded that the application of the straddle rules was not appropriate under the specific facts. It also discussed that the IRS cannot force the taxpayer from one accounting method that clearly reflects income into another method that the Commissioner thinks more clearly reflects income. All and all, it sided with the taxpayer.

Again, the ruling was heavily edited but what could be gleaned from it is that the IRS is actively looking for hedging transaction issues. Also, it shows that the IRS is fully aware of the litigation hazard when it comes to applying the straddle rules and may be willing to lean a bit towards the taxpayer in instances where routine business hedging transactions are at issue.  The FFA can be found here.
Leave a Reply
You must be logged in to post a comment.
Tags: 1092, straddles, hedges