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Senate Committee on Finance: Use of Collars, Forwards, Swaps and Other Derivatives Decrease Taxpayer Equity
March 05, 2015
Miscellaneous
The Senate Committee on Finance came out with a report a few days ago titled “How Tax Pros Make the Code Less Fair and Efficient: Several New Strategies and Solutions.” In the report, the Committee outlines various uses of derivatives that according to the Committee make the Code unfair to the average Joe. The report takes the form of a comparison of the taxes that a middle class American family earning $100k would pay and the taxes a sophisticated party with a derivative market counterparty connection would pay. You would guess what the drift of the report is.  Average Joe ends up paying a higher overall tax rate than sophisticated party because Joe has no access to tax planners and derivative market counterparties (hint: contrary to most hedge funds).

The report goes on to outline the perceived problems and proposes the following recommendations, which if adopted would generate 10s of billions of revenue and restore equity:
  • Collars: Treasury to write regulations under Sec. 1259 defining collars as constructive sales.
  • Wash Sales: Congress to amend Section 1091 so that the wash sale rules apply to forward contracts, swaps and derivatives involving commodities and currencies.
  • Derivatives in General: Marks-to-market all derivative instruments, and tax the resulting gains or losses as ordinary income, regardless of whether the contract is held to maturity or disposed of early.
  • Constructive Ownership: Add a one-sided put or call option to the Sec 1260 definition of constructive ownership transaction.
  • Basket Options: The IRS should not merely rely on GLAM 2010-005 but should issue stronger guidance such as a tax shelter notice.
  • Deferred Comp: Adopt Camp’s proposal that all compensation deferred under deferred compensation plans would be included in gross income for the taxable year of vesting. Right now under a properly structured Sec. 409A plan compensation could be deferred even if vested. Alternatively, impose a $1M cap on deferred compensation.
  • We can’t guess whether any of these would turn to fruition but it is good to keep track of the direction political winds are blowing. There has been a recurrent theme in the political landscape drumming up the fact that the wealthy rip benefits the rest do not.   On a somewhat of a sociological and philosophical note, we do not see this as a world-shattering revelation. This has been the case since the first civilized person started roaming the lands of Mesopotamia. On a practical note, the question is how strong these voices need to be before the investment fund industry takes another blow to its bottom line?  Some people would say that it is getting tougher and tougher to defend investment funds on the Hill. The report could be found here.
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Tags: collars, derivatives, forwards, senate finace committee, swaps