Mark-to-market for securities dealers.

New proposed regulations (REG-100420-03) describe a potential framework for a safe harbor that would meet the Sec. 475 mark-to-market requirements that apply to securities dealers. The IRS invites comments on the safe harbor and other alternative valuation methods.

Dealers in securities must mark their securities to market, under Sec. 475(a). If a security is inventory, it must be included in inventory at its fair market value (FMV). If it is not inventory and is held at the end of the tax year, the security must be treated as if it were sold at FMV on the last business day of the tax year. Mark-to-market treatment is available on an elective basis to commodities dealers (Sec. 475(e)) and waders in securities or commodities (Sec. 475(f)).

The IRS notes that it is difficult to determine FMV in certain situations. To reduce administrative burdens, it is considering whether to publish proposed rules that, by allowing values used on a financial statement to be used on the return, would provide an elective safe harbor for satisfying the statutory requirement to value securities and commodities. Three broad principles would guide eligibility for the safe harbor:

1. Any mark-to-market method used on a financial statement submitted for financial reporting purposes would have to be sufficiently consistent with the method used under Sec. 475.

2. The financial statement would have to be one for which the taxpayer has a strong incentive to report values fairly.

3. If requested, the taxpayer would have to timely provide to the IRS the information and documents needed to verify the relationship between the values reported on the financial statement and those used for Sec. 475.

The safe harbor is being considered for securities dealers. Whether it would be extended to securities traders and commodities dealers and traders would depend on whether the extension would comport with the principles described above.

The IRS notes that Sec. 475 applies to a wide variety of securities and commodities and that it is relatively easy to determine the FMV of positions for which pricing information is readily available, such as most actively traded personal property. The need for a safe harbor is most pressing for positions for which pricing information is not readily available, including more complex notional principal contracts, derivative instruments and various hedges.