Tax Notes consistently and promptly publishes all relevant developments regarding hedge fund taxation. Hedges are when a taxpayer enters into financial instruments to control a risk related to its business. Taxpayers are generally required to identify hedges on the day they enter into them for tax purposes. Hedges are used to control risk related to price fluctuations, interest rate changes, currency exchange rates, and changes in market conditions. The hedges must hedge against risks related to an ordinary asset or obligation.

Because hedges and the risks associated with them may come from different financial instruments with different tax treatment, the tax code allows taxpayers to identify hedges and achieve the same tax character on each leg of the hedge. Taxpayers may use a variety of financial products, such as forward contracts, future contracts, options, and notional principal contracts. Recent legislative proposals have suggested that taxpayers should be able to use generally accepted accounting principles (GAAP) identification for tax purposes.

Section 1221 generally provides the rules for business hedges. If a taxpayer controls risk for an asset or obligation that isn’t ordinary in character and not related to a business risk, then it is governed by the straddle rules under section 1092. The straddle regime began as an anti-abuse statute to keep taxpayers from entering into offsetting positions which will allow the taxpayer to lock into gain but extend the holding period.

Tax Analysts consistently and promptly publishes all relevant developments regarding hedge fund taxation, including accounting and avoidance. To stay up to date on all tax-related topics, subscribe to Tax Notes Today Federal.