Mark-to-Market Accounting for Dealers in Commodities and Traders in Securities or Commodities

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-104924-98]

RIN 1545-AW06

Mark-to-Market Accounting for Dealers in Commodities and Traders

in Securities or Commodities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations for dealers in

commodities and traders in securities or commodities regarding the

election to use the mark-to-market method of accounting for their

businesses. Section 1001(b) of the Taxpayer Relief Act of 1997 amended

the applicable tax law for these taxpayers. This document also contains

proposed regulations providing guidance on statutory changes to section

475 contained in the Internal Revenue Service Restructuring and Reform

Act of 1998 (IRS Restructuring Act). This guidance is necessary because

section 7003 of the IRS Restructuring Act generally prohibited the

application of mark-to-market accounting to nonfinancial customer

paper. Among other things, the proposed regulations provide guidance to

taxpayers who are using mark-to-market accounting for nonfinancial

customer paper. This document also provides notice of a public hearing

on these proposed regulations.

DATES: Written comments and outlines of topics to be discussed at the

public hearing scheduled for June 3, 1999, at 10 a.m. must be received

by May 13, 1999.

r. Among other things, the proposed regulations provide guidance to

taxpayers who are using mark-to-market accounting for nonfinancial

customer paper. This document also provides notice of a public hearing

on these proposed regulations.

DATES: Written comments and outlines of topics to be discussed at the

public hearing scheduled for June 3, 1999, at 10 a.m. must be received

by May 13, 1999.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-104924-98), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered Monday through

Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-

104924-98), Courier's Desk, Internal Revenue Service, 1111 Constitution

Avenue, NW., Washington, DC. Alternatively, taxpayers may submit

comments electronically via the Internet by selecting the ``Tax Regs''

option on the IRS Home Page, or by submitting comments directly to the

IRS Internet site at http://www.irs.ustreas.gov/prod/tax_regs/

comments.html. The public hearing will be held in room 2615, Internal

Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations about

elections by commodities dealers and securities and commodities

traders, Jo Lynn Ricks, 202-622-3920; concerning the regulations about

nonfinancial customer paper, Pamela Lew, 202-622-3950; concerning

submissions and the hearing, Michael L. Slaughter, Jr., 202-622-7190

(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

ATION CONTACT: Concerning the regulations about

elections by commodities dealers and securities and commodities

traders, Jo Lynn Ricks, 202-622-3920; concerning the regulations about

nonfinancial customer paper, Pamela Lew, 202-622-3950; concerning

submissions and the hearing, Michael L. Slaughter, Jr., 202-622-7190

(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed

rulemaking has been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507(d)). Comments on the collection of information should be

sent to the Office of Management and Budget, Attn: Desk Officer for the

Department of Treasury, Office of Information and Regulatory Affairs,

Washington, DC, 20503, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.

Comments concerning the collection of information must be received by

March 29, 1999.

The first collection of information in this proposed regulation is

described in the Explanation of Provisions section of this document

(rather than being included in the text of the proposed regulations).

That description indicates that the elections under section 475(e)(1)

and (f)(1) and (2) may be required to be made on a form to be

developed by the IRS. This burden will be reflected on that new form.

The second collection of information in this proposed regulation is

in Secs. 1.475(e)-1 and 1.475(f)-2. The information required to be

recorded under Secs. 1.475(e)-1 and 1.475(f)-2 is required by the IRS

to determine whether an exemption from mark-to-market accounting is

properly claimed. This information will be used to make that

determination upon audit of taxpayers' books and records. The likely

recordkeepers are businesses or other for-profit institutions.

Estimated total annual recordkeeping burden: 1,000 hours

to be

recorded under Secs. 1.475(e)-1 and 1.475(f)-2 is required by the IRS

to determine whether an exemption from mark-to-market accounting is

properly claimed. This information will be used to make that

determination upon audit of taxpayers' books and records. The likely

recordkeepers are businesses or other for-profit institutions.

Estimated total annual recordkeeping burden: 1,000 hours. The estimated

annual burden per recordkeeper varies from 15 minutes to 3 hours,

depending on individual circumstances, with an estimated average of 1

hour. Estimated number of recordkeepers: 1,000.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless it displays a valid

control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Background

Section 475 provides that dealers in securities generally must use

mark-to-market accounting for all securities. Exceptions from the mark-

to-market requirement are generally provided for securities not held

for sale to customers and certain securities held as a hedge, provided

that the securities are identified as exempt in a proper and timely

manner.

For purposes of section 475, a security includes any note, bond,

debenture, or other evidence of indebtedness. Revenue Ruling 97-37

(1997-39 I.R.B. 4), clarified that ``other evidence of indebtedness''

includes customer paper, commonly referred to as trade accounts

receivable. The IRS provided procedures for a taxpayer to change its

method of accounting for customer paper in Revenue Procedure 97-43

(1997-39 I.R.B. 12).

The IRS Restructuring Act modified the definition of security for

purposes of section 475 to exclude nonfinancial customer paper

fied that ``other evidence of indebtedness''

includes customer paper, commonly referred to as trade accounts

receivable. The IRS provided procedures for a taxpayer to change its

method of accounting for customer paper in Revenue Procedure 97-43

(1997-39 I.R.B. 12).

The IRS Restructuring Act modified the definition of security for

purposes of section 475 to exclude nonfinancial customer paper. For

this purpose, nonfinancial customer paper is any receivable arising out

of the sale of nonfinancial goods or services by a person the principal

activity of which is the selling or providing of nonfinancial goods or

services if the receivable is held by that person (or a related person)

at all times since its issuance. Section 475(c)(4), added by the IRS

Restructuring Act, precludes a taxpayer from using mark-to-market

accounting under section 475 for nonfinancial customer paper. In

addition, the legislative history of the IRS Restructuring Act

indicates that taxpayers may not account for nonfinancial customer

paper using a mark-to-market or lower-of-cost-or-market method of

accounting under other sections of the Code. See H.R. Conf. Rep. No.

599, 105th Cong., 2d Sess. 353-54 (1998). Congress, however, authorized

the Secretary to issue regulations describing situations where

taxpayers must use mark-to-market accounting for nonfinancial customer

paper in order to prevent taxpayers from using the exclusion in section

475(c)(4) to avoid marking to market receivables that are inventory in

the hands of the taxpayer or a related person.

Section 475(e) and (f), added by section 1001(b) of the Taxpayer

Relief Act of 1997, allows securities traders and commodities traders

and dealers to elect mark-to-market accounting similar to that

currently required for securities dealers. These provisions are

effective for all taxable years ending after August 5, 1997, the date

of enactment of the Taxpayer Relief Act

r or a related person.

Section 475(e) and (f), added by section 1001(b) of the Taxpayer

Relief Act of 1997, allows securities traders and commodities traders

and dealers to elect mark-to-market accounting similar to that

currently required for securities dealers. These provisions are

effective for all taxable years ending after August 5, 1997, the date

of enactment of the Taxpayer Relief Act. The proposed regulations

clarify several issues relating to these elections, including the

identification of securities and commodities as exempt from mark-to-

market accounting, the character of marked securities and commodities,

and the time and manner for making the elections.

Explanation of Provisions

Nonfinancial Customer Paper

Sections 1.446-1(c)(2)(iii), 1.471-12, and 1.475(c)-2(d) of the

proposed regulations provide that taxpayers may not use mark-to-market

or lower-of-cost-or-market accounting for any nonfinancial customer

paper unless a regulation affirmatively provides that the nonfinancial

customer paper is to be marked to market as inventory.

The remaining proposed regulations pertaining to section 475(c)(4)

are cross references or minor technical changes required by the

addition of Sec. 1.475(c)-2(d).

Dealers in Commodities

The proposed regulations generally provide that, except as provided

in guidance prescribed by the Commissioner, the rules for mark-to-

market accounting for securities dealers apply to commodities dealers

that make an election under section 475(e)(1) (electing commodities

dealers). Comments are requested whether there are circumstances where

the specific rules applicable to securities dealers should not be

applied to electing commodities dealers.

Under the proposed regulations, unless the Commissioner otherwise

provides in a revenue ruling, revenue procedure, or letter ruling, the

exemption from mark-to-market accounting for assets held for investment

does not apply to a commodity derivative held by an electing dealer in

commodities

specific rules applicable to securities dealers should not be

applied to electing commodities dealers.

Under the proposed regulations, unless the Commissioner otherwise

provides in a revenue ruling, revenue procedure, or letter ruling, the

exemption from mark-to-market accounting for assets held for investment

does not apply to a commodity derivative held by an electing dealer in

commodities. If the rule described in the preceding sentence applies

(and consequently requires a commodity derivative to be marked to

market), the gain or loss is ordinary. The IRS and the Treasury

Department believe that it would be extremely rare for a commodity

derivative held by a commodities derivative dealer to be acquired other

than in a dealer capacity. See Sec. 1.475(c)-1(a)(2). Moreover, the IRS

and the Treasury Department believe that a dealer in physical

commodities generally engages in derivatives activities that are

virtually indistinguishable from its dealings in physical commodities.

This situation invokes many of the practical concerns that led Congress

to enact section 475(b)(4). The IRS and the Treasury Department welcome

comments on whether, and under what circumstances, it may be

appropriate for a dealer in physical commodities to identify commodity

derivatives as held for investment.

The proposed regulations also provide that, in all cases, if a

dealer in commodities identifies a commodity as exempt from mark-to-

market accounting under section 475(b)(2), the identification is

ineffective unless it is made before the close of the day on which the

commodity was acquired, originated, or entered into. Thus, a rule

similar to the 30-day identification rule for certain securities in

Holding 8 of Rev. Rul. 97-39 (1997-39 I.R.B. 4), does not apply to

commodities dealers.

Traders in Securities or Commodities

market accounting under section 475(b)(2), the identification is

ineffective unless it is made before the close of the day on which the

commodity was acquired, originated, or entered into. Thus, a rule

similar to the 30-day identification rule for certain securities in

Holding 8 of Rev. Rul. 97-39 (1997-39 I.R.B. 4), does not apply to

commodities dealers.

Traders in Securities or Commodities

The proposed regulations provide that the principles underlying the

rules and administrative interpretations applicable to securities

dealers also apply to electing traders, unless the proposed regulations

or the Commissioner provides otherwise. The IRS and the Treasury

Department request comments on whether there are circumstances under

which a specific rule applicable to securities dealers

should not apply to electing securities traders.

The proposed regulations provide rules for the identification of

investment securities as exempt from mark-to-market accounting. The

proposed regulations clarify that a trader in securities who elects

mark-to-market accounting under section 475(f)(1) for its trading

business (an electing trader) must identify, in accordance with section

475(f)(1)(B)(ii), any security held other than in connection with the

trading business.

If the electing trader is also a dealer in securities, the trader

need only identify under section 475(f)(1)(B)(ii) securities that are

not held in connection with the trading business and that are also

described in section 475(b)(1) (without regard to section 475(b)(2)).

That is, the trader need not identify securities that could not

properly be identified as being exempt from section 475(a).

The IRS and the Treasury Department believe that in making the

section 475 election available to securities traders, Congress did not

want taxpayers selectively to mark to market some securities but

selectively to identify other securities as exempt from this treatment

That is, the trader need not identify securities that could not

properly be identified as being exempt from section 475(a).

The IRS and the Treasury Department believe that in making the

section 475 election available to securities traders, Congress did not

want taxpayers selectively to mark to market some securities but

selectively to identify other securities as exempt from this treatment.

Congress addressed this concern by establishing a higher burden of

proof for electing securities traders to identify securities as not

subject to section 475 than is applicable to securities dealers. The

IRS and the Treasury Department share this concern, particularly

because it traditionally has been easier to distinguish investment

securities from dealer securities than to distinguish investment

securities from trading securities. Accordingly, the proposed

regulations provide that in no event is the requirement of section

475(f)(1)(B)(i) satisfied unless the electing trader demonstrates by

clear and convincing evidence that a security has no connection to its

trading activities. The IRS and Treasury Department request comments on

whether any trader of securities could meet this burden and under what

circumstances.

In addition, the IRS and the Treasury Department seek comments on

the manner in which securities are identified as not held in connection

with trading activities and, in particular, comments that focus on the

administrability of rules in this area.

Because of the fungible nature of certain securities, the proposed

regulations provide a special rule for identifying securities held

other than in connection with the electing trader's trading business

when the electing trader also trades other of the same or substantially

similar securities. In this circumstance, the electing trader does not

satisfy section 475(f)(1)(B)(i) unless the security is held in a

separate, nontrading account maintained with a third party

ions provide a special rule for identifying securities held

other than in connection with the electing trader's trading business

when the electing trader also trades other of the same or substantially

similar securities. In this circumstance, the electing trader does not

satisfy section 475(f)(1)(B)(i) unless the security is held in a

separate, nontrading account maintained with a third party. The IRS and

the Treasury Department are considering extending this special

identification rule to all securities, rather than solely to those that

are fungible, and request comments on the advisability of doing so.

Under the proposed regulations, all identifications under section

475(f)(1)(B)(ii) must be made on the same day the electing trader

acquires, originates, or enters into the security. Thus, a rule similar

to the 30-day identification rule for certain securities in Holding 8

of Rev. Rul. 97-39 does not apply to electing traders.

Because the principles of the rules and administrative

interpretations applicable to securities dealers apply to electing

traders, if an electing trader improperly identifies as exempt a

security that is actually held in connection with that business, the

gain or loss with respect to the security is ordinary, and the

consequences described in section 475(d)(2) apply to the security

(i.e., the security is marked to market and any losses realized with

respect to the security prior to its disposition are recognized only to

the extent of gain previously recognized with respect to the security).

Similarly, under the proposed regulations, if an electing trader fails

to identify a security that is not held in connection with its trading

business, the consequences of section 475(d)(2) apply to the security,

and the gain or loss with respect to the security is ordinary.

Moreover, in the event of this failure, the Commissioner may

nevertheless treat the security as if the requirements for exemption

from mark-to-market accounting were satisfied

ions clarify that if a dealer in securities

also has a securities or commodities trading business or a commodities

dealing business, the dealer may make an election for that business.

The proposed regulations also provide that the mark-to-market

elections for dealers in commodities and for traders in securities or

commodities must be made in the time and manner prescribed by the

Commissioner. The IRS and the Treasury Department anticipate requiring

taxpayers to make the election by filing a form, to be developed by the

IRS, not later than 2\1/2\ months after the beginning of the taxable

year for which the election is made. (See the Paperwork Reduction Act

section of this preamble, which requests comments on the burden that

may be imposed by this requirement.) Interim procedures are being

provided in a revenue procedure.

Proposed Effective Dates

The proposed regulations in Sec. 1.475(c)-2(d)(1) apply to every

taxpayer who is required by section 475(c)(4) to cease using mark-to-

market accounting for nonfinancial customer paper. These regulations

are applicable for all taxable years ending after July 22, 1998.

Proposed Secs. 1.446-1(c)(2)(iii), 1.471-12, and 1.475(c)-2(d)(2) are

applicable for all taxable years ending on or after January 28, 1999.

The proposed regulations in Secs. 1.475(e)-1 and 1.475(f)-2

generally apply to securities or commodities acquired on or after March

1, 1999. The rules concerning the time and manner for making the mark-

to-market elections for commodities dealers and securities and

commodities traders are generally applicable for taxable years ending

on or after January 28, 1999.

Special Analyses

y 28, 1999.

The proposed regulations in Secs. 1.475(e)-1 and 1.475(f)-2

generally apply to securities or commodities acquired on or after March

1, 1999. The rules concerning the time and manner for making the mark-

to-market elections for commodities dealers and securities and

commodities traders are generally applicable for taxable years ending

on or after January 28, 1999.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory impact analysis is not required. It is hereby certified

that the collection of information in these regulations will not have a

significant economic impact on a substantial number of small entities.

As previously noted, in those instances where a small entity elects to

apply the rules in these regulations, the burden of the collection of

information is not

significant. Accordingly, a Regulatory Flexibility Analysis is not

required. Pursuant to section 7805(f), this notice of proposed

rulemaking will be submitted to the Chief Counsel for Advocacy of the

Small Business Administration for comment on its impact on small

business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. The IRS and

the Treasury Department specifically request comments on the clarity of

the proposed regulations and how they can be made easier to understand.

All comments will be available for public inspection and copying.

A public hearing has been scheduled for June 3, 1999, beginning at

10 a.m. in room 2615 of the Internal Revenue Building, 1111

Constitution Avenue, NW., Washington, DC. Due to building security

procedures, visitors must enter at the 10th Street entrance, located

between Constitution and Pennsylvania Avenues, NW

to understand.

All comments will be available for public inspection and copying.

A public hearing has been scheduled for June 3, 1999, beginning at

10 a.m. in room 2615 of the Internal Revenue Building, 1111

Constitution Avenue, NW., Washington, DC. Due to building security

procedures, visitors must enter at the 10th Street entrance, located

between Constitution and Pennsylvania Avenues, NW. In addition, all

visitors must present photo identification to enter the building.

Because of access restrictions, visitors will not be admitted beyond

the immediate entrance area more than 15 minutes before the hearing

starts. For information about having your name placed on the building

access list to attend the hearing, see the FOR FURTHER INFORMATION

CONTACT section of this preamble.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who

wish to present oral comments at the hearing must submit written

comments and an outline of the topics to be discussed and the time to

be devoted to each topic (signed original and eight (8) copies) by May

13, 1999. A period of 10 minutes will be allotted to each person for

making comments. An agenda showing the scheduling of the speakers will

be prepared after the deadline for receiving outlines has passed.

Copies of the agenda will be available free of charge at the hearing.

Drafting information. The principal authors of these regulations

are Jo Lynn Ricks and Pamela Lew of the Office of Assistant Chief

Counsel (Financial Institutions & Products). However, other personnel

from the IRS and the Treasury Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

the Office of Assistant Chief

Counsel (Financial Institutions & Products). However, other personnel

from the IRS and the Treasury Department participated in their

development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by

removing the entries for Secs. 1.475(a)-3 through 1.475(e)-1 and adding

the following entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.475(a)-3 also issued under 26 U.S.C. 475(g).

Section 1.475(b)-1 also issued under 26 U.S.C. 475(b)(4) and 26

U.S.C. 475(g).

Section 1.475(b)-2 also issued under 26 U.S.C. 475(b)(2) and 26

U.S.C. 475(g).

Section 1.475(b)-4 also issued under 26 U.S.C. 475(b)(2), 26

U.S.C. 475(g), and 26 U.S.C. 6001.

Section 1.475(c)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(c)-2 also issued under 26 U.S.C. 475(g) and 26

U.S.C. 860G(e).

Section 1.475(d)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(e)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(f)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(f)-2 also issued under 26 U.S.C. 475(g).* * *

Par. 2. In Sec. 1.446-1, paragraph (c)(2)(iii) is added to read as

follows:

Sec. 1.446-1 General rule for methods of accounting.

* * * * *

(g) and 26

U.S.C. 860G(e).

Section 1.475(d)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(e)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(f)-1 also issued under 26 U.S.C. 475(g).

Section 1.475(f)-2 also issued under 26 U.S.C. 475(g).* * *

Par. 2. In Sec. 1.446-1, paragraph (c)(2)(iii) is added to read as

follows:

Sec. 1.446-1 General rule for methods of accounting.

* * * * *

(c) * * *

(2) * * *

(iii) Section 475 is the exclusive authority on which a taxpayer

may rely to use the mark-to-market method of accounting for

nonfinancial customer paper, as defined in section 475(c)(4)(B). Thus,

except to the extent provided in Sec. 1.475(c)-2(d), the mark-to-market

method of accounting is not a permissible method of accounting for

nonfinancial customer paper. In addition, the lower-of-cost-or-market

method of accounting is not a permissible method of accounting for

these assets. See Sec. 1.471-12. This paragraph (c)(2)(iii) applies to

all tax years ending on or after January 28, 1999.

* * * * *

Par. 3. Section 1.471-12 is added as follows:

Sec. 1.471-12 Nonfinancial customer paper.

Nonfinancial customer paper, as defined in section 475(c)(4)(B),

may not be treated as inventory except as provided in Sec. 1.475(c)-

2(d). This section applies to taxable years ending on or after January

28, 1999.

Par. 4. In Sec. 1.475(c)-1, paragraphs (b)(3)(i) and (b)(4)(ii) are

revised to read as follows:

Sec. 1.475(c)-1 Definitions--dealer in securities.

* * * * *

(b) * * *

(3) * * *

Nonfinancial customer paper, as defined in section 475(c)(4)(B),

may not be treated as inventory except as provided in Sec. 1.475(c)-

2(d). This section applies to taxable years ending on or after January

28, 1999.

Par. 4. In Sec. 1.475(c)-1, paragraphs (b)(3)(i) and (b)(4)(ii) are

revised to read as follows:

Sec. 1.475(c)-1 Definitions--dealer in securities.

* * * * *

(b) * * *

(3) * * *

(i) For purposes of section 471, the taxpayer accounts for any

security (as defined in section 475(c)) as inventory;

* * * * *

(4) * * *

(ii) Continued applicability of an election.--(A) In general.

Except as provided in paragraph (b)(4)(ii)(B) of this section, an

election under this paragraph (b)(4) continues in effect for subsequent

taxable years until revoked. The election may be revoked only with the

consent of the Commissioner.

(B) Taxable years ending after July 22, 1998. An election under

this paragraph (b)(4) is ineffective for taxable years ending after

July 22, 1998.

* * * * *

Par. 5. In Sec. 1.475(c)-2, paragraph (d) is added to read as

follows:

Sec. 1.475(c)-2 Definitions--security.

* * * * *

(d) Inventory--(1) Nonfinancial customer paper is generally not

marked to market under section 475. Except as provided in paragraph

(d)(3) of this section, nonfinancial customer paper (as defined in

section 475(c)(4)(B)) is not a security even if it is inventory.

(2) Treatment of nonfinancial customer paper under other sections

of the Internal Revenue Code. For nonfinancial customer paper that is

not a security, the mark-to-market method of accounting and the lower-

of-cost-or-market method of accounting are not permissible methods of

accounting. See Secs. 1.446-1(c)(2)(iii) and 1.471-12.

section 475(c)(4)(B)) is not a security even if it is inventory.

(2) Treatment of nonfinancial customer paper under other sections

of the Internal Revenue Code. For nonfinancial customer paper that is

not a security, the mark-to-market method of accounting and the lower-

of-cost-or-market method of accounting are not permissible methods of

accounting. See Secs. 1.446-1(c)(2)(iii) and 1.471-12.

(3) Nonfinancial customer paper treated as inventory. [Reserved]

Sec. 1.475(e)-1 [Redesignated as Sec. 1.475(g)-1]

Par. 6. Section 1.475(e)-1 is redesignated as Sec. 1.475(g)-1.

Par. 7. New Sec. 1.475(e)-1 and Secs. 1.475(f)-1 and 1.475(f)-2 are

added to read as follows:

Sec. 1.475(e)-1 Election of mark-to-market accounting for dealers in

commodities.

(a) Time and manner of making election. An election under section

475(e)(1) must be made in the time and manner prescribed by the

Commissioner.

(b) Application of securities dealer rules to electing commodities

dealers. Except as otherwise provided in this

section or in other guidance prescribed by the Commissioner, the rules

and administrative interpretations under section 475 for dealers in

securities apply to dealers in commodities that make an election under

section 475(e)(1).

(c) Commodity derivatives deemed not held for investment--(1) In

general. Except as otherwise determined by the Commissioner in a

revenue ruling, revenue procedure, or letter ruling, if a dealer in

commodities that made an election under section 475(e)(1) holds a

commodity described in section 475(e)(2)(B) or (C) (describing certain

notional principal contracts and commodity derivatives), section

475(b)(1)(A) (exempting from mark-to-market accounting certain

positions that are held for investment) does not apply to that

commodity.

ng, revenue procedure, or letter ruling, if a dealer in

commodities that made an election under section 475(e)(1) holds a

commodity described in section 475(e)(2)(B) or (C) (describing certain

notional principal contracts and commodity derivatives), section

475(b)(1)(A) (exempting from mark-to-market accounting certain

positions that are held for investment) does not apply to that

commodity.

(2) Character of commodity derivatives required to be marked to

market. If a commodity is required to be marked to market because of

the application of paragraph (c)(1) of this section, the gain or loss

with respect to that commodity is ordinary.

(d) Same day identification. An identification of a commodity as

exempt from mark-to-market accounting under section 475(b)(2) is not

effective unless it is made before the close of the day on which the

commodity was acquired, originated, or entered into.

Sec. 1.475(f)-1 Procedures for electing mark-to-market accounting for

traders.

(a) Time and manner of making election. An election under section

475(f)(1) or (2) must be made in the time and manner prescribed by the

Commissioner.

(b) Coordination with section 475(a). If a dealer in securities

also has a securities or commodities trading business or a commodities

dealing business, the dealer may make an election under section

475(e)(1), (f)(1), or (f)(2) for that business.

Sec. 1.475(f)-2 Election of mark-to-market accounting for traders in

securities or commodities.

he time and manner prescribed by the

Commissioner.

(b) Coordination with section 475(a). If a dealer in securities

also has a securities or commodities trading business or a commodities

dealing business, the dealer may make an election under section

475(e)(1), (f)(1), or (f)(2) for that business.

Sec. 1.475(f)-2 Election of mark-to-market accounting for traders in

securities or commodities.

(a) Securities not held in connection with trading activities--(1)

Taxpayer identification of investment securities. If a trader in

securities makes an election under section 475(f)(1)(A) (electing

trader) and holds a security other than in connection with that trading

business, the electing trader must identify that security in accordance

with section 475(f)(1)(B)(ii). If the electing trader is also a dealer

in securities, however, the preceding sentence applies only to

securities described in section 475(b)(1) (without regard to section

475(b)(2)).

(2) Satisfaction of Commissioner. In no event is the requirement of

section 475(f)(1)(B)(i) satisfied unless the electing trader

demonstrates by clear and convincing evidence that a security has no

connection to its trading activities.

(3) Substantially similar securities held for trading and

investment. An electing trader that holds a security other than in

connection with its trading business and also trades the same or

substantially similar securities in no event satisfies the requirement

of section 475(f)(1)(B)(i) unless the security is held in a separate,

nontrading account maintained with a third party.

(4) Consequences of failure to identify investment securities. If

an electing trader holds a security that is not held in connection with

its trading business and fails to identify the security in a manner

that satisfies the requirements of section 475(f)(1)(B)(ii)--

rement

of section 475(f)(1)(B)(i) unless the security is held in a separate,

nontrading account maintained with a third party.

(4) Consequences of failure to identify investment securities. If

an electing trader holds a security that is not held in connection with

its trading business and fails to identify the security in a manner

that satisfies the requirements of section 475(f)(1)(B)(ii)--

(i) The consequences described in section 475(d)(2) apply to the

security; and

(ii) The character of the gain or loss with respect to the security

is ordinary.

(5) Commissioner identification of investment securities.

Notwithstanding paragraph (a)(4) of this section, the Commissioner may

treat a security described in that paragraph as meeting the

requirements of section 475(f)(1)(B)(i) and (ii).

(b) Character of securities marked to market. The gain or loss with

respect to a security that is marked to market under section

475(f)(1)(A) is ordinary.

(c) Application of securities dealer rules to electing traders.

Except as otherwise provided in this section or in other guidance

prescribed by the Commissioner, the principles of the rules and

administrative interpretations under section 475 for dealers in

securities apply to traders in securities that make an election under

section 475(f)(1).

(d) Same day identification. An identification of a security as

exempt from mark-to-market accounting under section 475(f)(1)(B) is not

effective unless it is made before the close of the day on which the

security was acquired, originated, or entered into.

interpretations under section 475 for dealers in

securities apply to traders in securities that make an election under

section 475(f)(1).

(d) Same day identification. An identification of a security as

exempt from mark-to-market accounting under section 475(f)(1)(B) is not

effective unless it is made before the close of the day on which the

security was acquired, originated, or entered into.

(e) Application to traders in commodities--(1) General rule. If a

trader in commodities makes an election under section 475(f)(2),

paragraphs (a), (b), (c), and (d) of this section apply to the trader

in the same manner that they apply to a trader in securities who makes

an election under section 475(f)(1).

(2) Coordination with section 1256. If a trader in commodities

makes an election under section 475(f)(2) and trades section 1256

contracts that are commodities as defined in section 475(e)(2), then

the rules of section 475(f) and paragraph (e)(1) of this section apply

to those contracts, and not the capital character rules of section

1256.

Par. 8. Newly designated Sec. 1.475(g)-1 is amended by revising

paragraphs (h)(2) and (i) and adding paragraphs (k), (l), and (m) to

read as follows:

Sec. 1.475(g)-1 Effective dates.

* * * * *

(h) * * *

(2) Section 1.475(c)-1(b) (concerning sellers of nonfinancial goods

and services) applies as follows:

(i) Except as otherwise provided in this paragraph (h)(2),

Sec. 1.475(c)-1(b) applies to taxable years ending on or after December

31, 1993.

(ii) Section 1.475(c)-1(b)(4)(ii)(B) applies to taxable years

ending after July 22, 1998.

* * * * *

1.475(g)-1 Effective dates.

* * * * *

(h) * * *

(2) Section 1.475(c)-1(b) (concerning sellers of nonfinancial goods

and services) applies as follows:

(i) Except as otherwise provided in this paragraph (h)(2),

Sec. 1.475(c)-1(b) applies to taxable years ending on or after December

31, 1993.

(ii) Section 1.475(c)-1(b)(4)(ii)(B) applies to taxable years

ending after July 22, 1998.

* * * * *

(i) Section 1.475(c)-2 (concerning the definition of security)

applies as follows:

(1) Section 1.475(c)-2(a), (b), and (c) (concerning the definition

of security) applies to taxable years ending on or after December 31,

1993. By its terms, however, Sec. 1.475(c)-2(a)(3) applies only to

residual interests or to interests or arrangements acquired on or after

January 4, 1995; and the integrated transactions that are referred to

in Sec. 1.475(c)-2(a)(2) and (b) exist only after August 13, 1996 (the

effective date of Sec. 1.1275-6).

(2) Section 1.475(c)-2(d) applies as follows:

(i) Section 1.475(c)-2(d)(1) applies to taxable years ending after

July 22, 1998.

(ii) Section 1.475(c)-2(d)(2) applies to taxable years ending on or

after January 28, 1999.

* * * * *

(k) Section 1.475(e)-1(a) (concerning the time and manner for

making the mark-to-market election for dealers in commodities) applies

to taxable years ending on or after January 28, 1999. Section 1.475(e)-

1(b), (c) and (d) applies to commodities acquired on or after March 1,

1999.

(l) Section 1.475(f)-1 (procedures for electing mark-to-market

accounting for traders in securities or commodities) applies to taxable

years ending on or after January 28, 1999.

(m) Section 1.475(f)-2 (concerning the mark-to-market rules for

traders in securities or commodities) applies to

securities or commodities acquired on or after March 1, 1999.

Robert E. Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 99-1787 Filed 1-27-99; 8:45 am]

Billing Code 4830-01-U