Press Room: Tax Release
Basket Case? IRS Designates Basket Options as Listed Transactions
Having previously expressed its disapproval of Basket Option Contracts (CCA 201426025), IRS upped the ante in Notice 2015–47 and Notice 2015–48 by designating such options as listed transactions and transactions of interest, respectively. These designations create significant reporting obligations for both holders and writers of the options, including investors participating through pass-through entities, and potentially expose taxpayers to significant penalties and extended statute of limitations for failure to comply.
Reporting for transactions for years 2011 and later may be required by November 5, 2015.
The typical Basket Option Contract involves the taxpayer entering into a contract documented as an option with a counterparty (commonly a financial institution), to receive a return based on the performance of a notional basket of actively traded stocks, hedge funds or other personal property (the referenced Basket). Often the taxpayer is a hedge fund or a high net worth individual.
As described in the Notices, the assets in the referenced Basket typically would generate ordinary income if held directly by the taxpayer, and short-term trading gains and losses if purchases and sales of the assets in the Basket were carried out directly by the taxpayer. Taxpayers, however, have taken the position that short-term gains and interest, and other periodic income (e.g., dividends) is deferred until the contract is terminated and, if the contract is held for more than one year, the entire gain is treated as long-term capital gain (or loss).
IRS arguments against this tax treatment of Basket Option Contracts are all derived from their conclusion that the taxpayer was the beneficial owner of the assets in the referenced Basket during the term of the Option Contract. Taxpayers can anticipate increased IRS scrutiny of these transactions in future audits.