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July 8 — The IRS put a controversial strategy involving the use of “basket options” to avoid millions of dollars in capital gains taxes under the microscope it reserves for abusive corporate tax shelters, winning praise from Capitol Hill.
In Notice 2015-47, the Internal Revenue Service labeled the basket options strategy of converting short-term capital gains and ordinary income into lighter-taxed long-term gains as a “listed transaction.” Individuals using the maneuver now have to declare it on their tax returns or face penalties.
IRS declared a similar transaction “of interest” in Notice 2015-48.
The action drew immediate praise from Senate Finance Committee ranking member Ron Wyden (D-Ore.), who lauded the IRS and the Treasury Department for “heeding my call to take action and bring the hammer down on these basket options once and for all.”
In June, Wyden wrote a letter to the administration capping months of efforts to get the basket options strategy shut down, including a March report asserting the options are an abusive shelter.
The tax strategy was once used by the hedge fund Renaissance Technologies, whose use of basket options was the subject of a Senate hearing in 2014. According to a report by that panel, Renaissance probably avoided more than $6 billion in U.S. income taxes over 14 years through transactions with Barclays Plc and Deutsche Bank AG.
Steve Rosenthal, a senior fellow at the Tax Policy Center in Washington who testified about the transactions, said a listed transaction “is, in effect, flagged as a tax shelter by the IRS. They're really sort of the worst of the worst that the IRS trips over.”
In Notice 2015-47, the IRS said it would treat as a listed transaction a deal in which a taxpayer attempts to defer and treat ordinary income and short-term capital gain as long-term capital gain via the use of an option contract that references a basket of actively traded personal property, such as securities.
In Notice 2015-48, the government said it would designate as a “transaction of interest” a similar deal, but one which may reference assets that aren't actively traded. The transaction could be an option, a notional principal contract or forward contract. According to the guidance, if a transaction is identified by both notices, it will be treated as a listed transaction.
Matthew Stevens, a principal with EY LLP's International Tax Services Capital Markets Group, told Bloomberg BNA on July 8 that the IRS's action in cracking down on the basket options strategy is “perfectly understandable,” given the pressure from Congress. “They're being responsive to the Hill,” he said.
In Notice 2015-47, the IRS is employing “a well-defined set of rules” to shape its position on the guidance, Stevens said.
However, he said, there is concern that under Notice 2015-48, the IRS may be drawing transactions under the microscope where taxpayers weren't trying to turn short-term capital gain into long-term gain to escape taxes.
With assistance from Richard Rubin in Washington.
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Texts of Notice 2015-47 and Notice 2015-48 are in TaxCore.
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