Partnership Files Response Regarding Mark-to-Mark Election

GWA, LLC, George A. Weiss, Tax Matters Partner,
Petitioner
v.
Commissioner of Internal Revenue
Respondent

UNITED STATES TAX COURT

Judge Albert G. Lauber

REPLY TO RESPONDENT'S RESPONSE TO PETITIONER'S MOTION FOR PARTIAL SUMMARY JUDGMENT

I. INTRODUCTION

On May 21, 2021, petitioner filed a Motion for Partial Summary Judgment (the “Motion”) pursuant to Rule 121¹ asking this Court to determine whether a section 475(f)(1) mark-to-market election made by OGI Associates LLC (“OGI”), a disregarded entity wholly owned by GWA, LLC (“GWA”), a partnership, applied only to securities directly held by OGI in its securities trading business and did not apply to any other securities. On July 9, 2021, respondent filed his Response to Petitioner's Motion for Partial Summary Judgment (the “Response”) asking this Court to answer a different question — whether OGI was “the relevant person with respect to the section 475(f) mark-to-market election.” Response at 1. Petitioner files this reply in accordance with the Court's July 21, 2021 order.

Section 475(f)(1) can apply only to (1) “a person” (2) “who is engaged in a trade or business as a trader in securities,” and (3) “who elects to have [section 475(f)(1)] apply to such trade or business.” Sec. 475(f)(1)(A) (emphasis added). As the Motion explained, OGI satisfied each of section 475(f)(1)'s requirements in 1998. At that time, OGI was a person, as defined by section 7701(a)(1), who engaged in a trade or business as a trader in securities, and who made an election to apply section 475(f) to such trade or business for the 1998 taxable year.

The Response does not argue that OGI was not a section 7701(a)(1) person. Nor does the Response argue that, as a matter of fact, OGI did not engage in a securities trading business in 1998. Instead, the Response argues that OGI was not the relevant person for purposes of section 475(f) because (1) respecting OGI as the relevant person would be manifestly incompatible with the intent of section 475(f), and (2) the activities clause of Treas. Reg. § 301.7701-2(a) attributes OGI's securities trading business to GWA and causes GWA to be the relevant person. As explained below, respondent is wrong on both counts. In any event, if GWA were the relevant person in 1998 for section 475(f) purposes, it was not engaged in the trade or business of trading securities in 1998 and made no valid section 475(f)(1) election. Therefore, because section 475(f) is elective, respondent cannot require GWA to apply section 475(f) to securities that OGI did not own.

II. ARGUMENT

A. No Legally Relevant Fact Is in Dispute

The Motion is ripe for summary judgment. Respondent, however, argues that a number of facts are in dispute and that the issue presented by the Motion should not be resolved at this time. But the facts that respondent identifies are not material facts.² Primarily, respondent argues:

Here, the issue is whether GWA was “a person . . . engaged in a trade or business as a trader in securities.” I.R.C. § 475(f)(1)(A). Whether, in substance, GWA should be treated as owning the Basket Securities and engaged in a trade or business of trading securities depends on material facts that relate to the primary dispute in this case.

Response at 4.

But respondent's point is irrelevant for two reasons: First, the “Basket Securities” whose ownership respondent wants to impute to GWA did not exist in 1998, the year to which OGI's section 475(f) election statement applied.³ The validity of an election is determined at the time it is made. Second, the section 475(f)(1) election at issue here applied only to securities held by OGI in its securities trading business. OGI's election cannot apply to securities that OGI did not own. Therefore, GWA's activities in 1998 or thereafter are irrelevant to the issue that is the subject of the Motion.

In short, respondent has challenged no material fact relevant to petitioner's position. Specifically, he has not challenged that:

• In 1998, OGI was a juridical person, a Connecticut limited liability company, with the legal power to contract, own property and sue or be sued under Connecticut law. Motion at 8, ¶¶ 8, 9.

• In 1998, in its capacity as an unincorporated juridical person under Connecticut law, OGI engaged in a trade or business of trading securities that were settled to and held in prime brokerage accounts that it owned. Motion at 9-10, ¶¶ 15, 16.

• The following statement (the “1998 Election Statement”) was included with GWA's 1998 Form 1065:

  ELECTION UNDER INTERNAL REVENUE CODE SECTION 475(f)
  FOR OGI, LLC (A WHOLLY OWNED LIMITED LIABILITY COMPANY OF GWA, LLC.)

  OGI, LLC is engaged in a trade or business as a trader in securities and elects to have Internal Revenue Code Section 475(f)(1) apply to such trade or business.

  OGI, LLC shall recognize gain or loss on any security held in connection with such trade or business at the close of any taxable year as if such security were sold for its fair market value on the last business day of such taxable year, and any gain or loss shall be taken into account for such taxable year.

Motion at 10, ¶ 18.

B. Section 475(f) Applies to a “Person,” as Defined by Section 7701(a)(1), Including a Limited Liability Company That Elects to Be Disregarded as an Entity under the Check-the-Box Regulations

OGI, a limited liability company classified as a disregarded entity under the Check-the-Box Regulations,⁴ is a “person” within the meaning of section 7701(a)(1). Motion at 16-22. Treas. Reg. § 301.7701-6(a) (the “Person Regulation”) and caselaw⁵ confirm OGI's status as a section 7701(a)(1) person. Motion at 16-22. Moreover, the Check-the-Box Regulations have no impact on section 7701(a)(1)'s person definition or OGI's status as a section 7701(a)(1) person that is separate from its owner, GWA. Motion at 25-30.

For all the reasons explained in the Motion, OGI was a section 7701(a)(1) person. Notably, respondent never asserts that OGI was not a “person” as defined in section 7701(a)(1) and the Person Regulation.⁶ At most, respondent argues that the question is unresolved.⁷ Respondent does argue that “[w]hether section 7701(a)(1) defines a disregarded entity as a 'person' is ambiguous,” Response at 3, but he never argues that any such ambiguity should be resolved against treating OGI as a section 7701(a)(1) person. Instead, as explained below, he argues that section 7701(a)(1) does not apply here because the term “person” as used in section 475(f) is manifestly incompatible with section 475(f) or because the term “person” as used in section 475(f)(1) really means “taxpayer” as defined by section 7701(a)(14).

Respondent also offers no rebuttal to petitioner's explanation that the Check-the-Box Regulations did not modify section 7701(a)(1) or the Person Regulation to exclude from the person definition limited liability companies that are also disregarded entities. He does not argue that a limited liability company that is a disregarded entity is not an “other unincorporated organization,” which the Person Regulation defines as a person.⁸ Instead, he acknowledges that McNamee v. Department of the Treasury, 488 F.3d 100 (2d Cir. 2007), which he argues is controlling,⁹ “did not decide whether a disregarded entity was a section 7701(a)(1) person because it was not necessary for its decision.” Response at 9. He also acknowledges that the court in McNamee observed that a single-owner limited liability company comes “closest” to an “'other unincorporated organization' — an organization that might or might not be an entity separate from its owner” Response at 10 (emphasis added). Thus, McNamee, a case that respondent argues is controlling here, acknowledges that an “other unincorporated organization,” which the Person Regulation defines as a person, may have a tax identity separate from its owner — a point that bolsters, not undercuts, petitioner's position.

The most respondent does is to argue that the Seaview Trading line of cases¹⁰ do not resolve whether a limited liability company that is a disregarded entity is a section 7701(a)(1) person. Response at 13-15. In the Motion, petitioner explained that the Seaview Trading line of cases confirm that a limited liability company is respected as a person regardless of whether it is classified as a disregarded entity. Motion at 18-22. Respondent attempts to distinguish those cases on the grounds that there was a perceived administrability concern that justified regarding disregarded entities as persons under the uniform partnership audit regime (“TEFRA”), which he argues is not present for section 475(f). Response at 14. Presumably, what respondent means is that administrability considerations support a determination that the section 7701(a)(1) person definition must be used for TEFRA purposes because it is not manifestly incompatible with the TEFRA rules.¹¹ Here, as explained below, the section 7701(a)(1) person definition must apply for section 475(f) purposes because, for other reasons, it is not manifestly incompatible with section 475(f).¹²

In short, respondent never argues that OGI was not a section 7701(a)(1) person and raises no argument that counters petitioner's position that OGI is a section 7701(a)(1) person.

C. OGI Was the Relevant Person for Purposes of Section 475(f)(1)

Respondent asserts that, even if OGI was a section 7701(a)(1) person, it was not the relevant person for purposes of section 475(f)(1). Respondent's relevant person arguments are overlapping, but petitioner infers two primary strands to the arguments. First, respondent argues that the section 7701(a)(1) person definition should not apply for purposes of section 475(f)(1) because it is manifestly incompatible with the intent of section 475(f). In support of that argument, he argues that treating a disregarded entity as a section 475(f)(1) person would somehow enable “selectivity” — i.e., the ability of a person and its owner to selectively choose which securities to mark to market — beyond what Congress intended. He also argues that, even though section 475(f)(1) expressly applies to a person, when Congress used the term “person,” it really meant to use “taxpayer,” as defined by section 7701(a)(14). Second, he argues that the activities clause of Treas. Reg. § 301.7701-2(a) mandates that the activities of a section 7701(a)(1) person must be treated as engaged in by its owner. That is, he argues that, even if OGI and GWA are separate section 7701(a)(1) persons, and even though OGI, not GWA, engaged in a securities trading business and made the section 475(f) election, GWA must be treated as engaging in OGI's trading business and as making the election. The unifying theme to respondent's two arguments is that OGI must be completely ignored as a person for purposes of section 475(f)(1). Neither of these arguments withstand scrutiny.

1. Applying the Section 7701(a)(1) Person Definition to Section 475(f)(1) Is Not Manifestly Incompatible with Section 475(f)

As GWA explained in the Motion, section 7701(a) definitions are mandatory “[w]hen used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof.” Sec. 7701(a); see also Motion at 22. As respondent acknowledges, neither section 475, in general, nor section 475(f), in particular, distinctly expresses a bespoke person definition.¹³ See Response at 17. Therefore, the section 7701(a)(1) definition of person must apply unless it is manifestly incompatible with the intent of section 475(f). It is not enough for there to be some dissonance between a section 7701(a) definition and the overall policy or intent of the Code provision in which it is used. The incompatibility must unequivocally contravene the intent of the provision in which it is used.¹⁴

a. Any Congressional Concerns About Selectivity Do Not Render the Section 7701(a)(1) Person Definition Manifestly Incompatible with Section 475(f)

In enacting section 475(f), Congress did express some general concern about selectivity, but it adopted an overall statutory scheme that nevertheless enables a considerable amount of selectivity through the use of related parties. And Congress left it to respondent to police selectivity involving coordination of securities investments between related parties. Section 475(g) provides:

The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this section, including rules — (1) to prevent the use of . . . related parties . . . to avoid the provisions of this section. . . .

In the 28 years since being granted this authority, respondent has prescribed no such regulations, with the result that related parties are free to selectively decide whether a particular security should be owned by a party that has a section 475(f) election in effect or a related party who does not. And respondent cannot write regulations through litigation. Nevertheless, respondent offers the following example of objectionable selectivity:

If the single owner and disregarded entity both own securities, but the section 475(f) election applies only to the disregarded entity, the single owner can transfer securities that it wants to mark into his disregarded entity, while holding the securities it does not mark. That could result in timing differences for recognition or gains and losses and change in character issues for the gains and losses.

Response at 18-19. Respondent argues that this example of “selectivity” is “on full display here.”¹⁵ Id. at 19. What respondent fails to address is that his perceived “selectivity” is not due to the transfer of securities between a disregarded entity and its owner. Instead, it is due to the fact that the transfers are between related parties. Thus, this “selectivity” is not unique to disregarded entities. This same “selectivity” could occur between any related parties. A non-trader can cause a security that is not subject to a section 475(f) election to become subject to an election by transferring it tax-free to a related-party trader — such as a controlled partnership or corporation — that has made a section 475(f) election. In the context of a controlled partnership or corporation, respondent would not be able to make the argument that he makes here and challenge the validity of the controlled partnership’s or corporation’s section 475(f) election, illustrating that his selectivity argument rings hollow.

Thus, the type of selectivity that respondent identifies is not manifestly incompatible with the intent of section 475(f) because selectivity among related parties generally is not proscribed or regulated. Congress gave respondent full regulatory authority to address any selectivity that he deemed problematic, which he has not done.

On the other hand, it is entirely consistent with the intent of section 475(f) to allow a person (i.e., a trader) who is not a taxpayer to elect to apply section 475(f) in its securities trading business. The term taxpayer is a subset of the term person. Motion at 23. And accounting method provisions apply to numerous persons who are not taxpayers. For example, a foreign corporation, which may not be “subject to tax” by the United States, must adopt accounting methods in a number of situations. See Treas. Reg. § 1.964-(1)(c)(6). A foreign corporation that is engaged in a securities trading business may not be directly subject to tax, but it may nevertheless be required to adopt an accounting method to compute its earnings and profits. Because a trader must affirmatively elect to apply section 475(f), applying section 475(f) to section 7701(a)(1) persons (rather than just those persons who are taxpayers) is logical and compatible with the purposes of section475(f).¹⁶ Indeed, as explained below, in administering the rules that govern the adoption and change of accounting methods, respondent mandates that the term taxpayer must be interpreted to mean person, as defined by section 475(f).

b. Person, as Used in Section 475(f), Cannot Be Interpreted to Mean Taxpayer

Respondent next argues that the term person as used in section 475(f) should nevertheless be interpreted to mean taxpayer, as defined by section 7701(a)(14). The argument proceeds from an assertion that, when Congress wrote section 475, it used the terms person and taxpayer interchangeably¹⁷ and that Congress really meant taxpayer when it carelessly used the term person.¹⁸ Respondent deduces that in section 475 Congress meant to use the term taxpayer whenever it actually used person because, in legislative history and collateral provisions of the statutes that enacted section 475 and section 475(f), it occasionally used the word taxpayer instead of person when it might have used the term person. Respondent does not explain why his perceived interchangeability should be resolved in favor of treating the narrower definition (i.e., taxpayer) as controlling.

The short answer to respondent's interchangeability argument is that Congress used person in section 475(f)(1), instead of taxpayer. See Conn. Nat'l Bank v. Germain, 503 U.S. 249, 253-54 (1992); Motion at 22-23. Section 7701(a) mandates that the term person, as defined by section 7701(a)(1), and the term taxpayer, as defined by section 7701(a)(14), must each apply “[w]hen [i.e., each and every time it is] used in this title, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof.” Thus, even if it were true that Congress carelessly interchanged the terms taxpayer and person in drafting section 475(f), the point would have limited legal significance. Inconsistent use of terms within a Code section might invite consideration of whether a specific use of a term is manifestly incompatible with the intent of that section, but it does not provide the answer. In every case, section 7701(a)(1) requires an analysis of whether the use of a section 7701(a) defined term is manifestly incompatible with the intent of the section in which it is used.¹⁹ If the use is not manifestly incompatible, then the section 7701(a)(1) definition must apply. As explained above, the section 7701(a)(1) person definition is not manifestly incompatible with section 475(f).

Finally, respondent refers the Court to Revenue Procedure (“Rev. Proc.”) 99-17, 1999-1 C.B. 503, and Rev. Proc. 2019-43, sec. 24.01(4), 48 I.R.B. 1107, which he notes explain how a “taxpayer” makes a section 475(f) election. Response at 28. The implication is that respondent interprets the term person, as used in section 475(f)(1), to mean taxpayer. But Rev. Proc. 99-17 requires the electing taxpayer to make the election in accordance with Rev. Proc. 98-60,1998-2 C.B. 761, which expressly provides that “[t]he term 'taxpayer' has the same meaning as the term 'person' defined in § 7701(a)(1) (rather than the meaning of the term 'taxpayer' defined in § 7701(a)(14)).” Rev. Proc. 97-27, sec. 3.01, 1997-1 C.B. 680, and Rev. Proc. 2015-13, sec. 3.17, 2015-5 I.R.B. 419, which provide the general rules for “Changes in Accounting Periods and Methods of Accounting,” similarly define taxpayer to mean person. Thus, even if Congress had actually applied section 475(f) to a taxpayer, rather than a person, who is a securities trader, respondent's own guidance would interpret the term taxpayer for section 475(f) purposes to mean person.

2. The Activities Clause Cannot Cause GWA, Rather than OGI, to Be The Relevant Person for Section 475(f) Purposes

The activities clause is not invalid, but it is not, as respondent suggests, limitless. Respondent cites cases where this Court has applied it. But in every such case, the activities clause did not conflict with the Code section at issue. Conversely, where there is a conflict, this Court has not applied the activities clause when doing so would be manifestly incompatible with the intent of the substantive rules at issue.

Here, there is no conflict between the activities clause and section 475(f)(1). Section 475(f)(1) expressly allows any person who is engaged in a securities trading business to elect to apply section 475(f) to that business. The scope of the activities clause does not extend to circumstances where, as here, the Code provision at issue applies, by its terms, to the activities of a person.²⁰ The Motion explains that the language of Treas. Reg. § 301.7701-2(a) necessarily restricts the scope of the activities clause to its purpose — to classify business entities. Motion at 25-30. The purpose was not to change the definition of person in section 7701(a)(1) or to attribute the activities of one person to another person. Id. Put simply, the activities clause is inapplicable when the Code requires a determination to be made on a person-by-person basis rather than on an entity-by-entity basis.

Respondent, however, interprets the activities clause to be limitless, thereby setting up a false conflict between the activities clause and section 475(f)(1). Respondent's interpretation of the activities clause would ignore that section 475(f)(1) expressly allows any person who engages in a securities trading business to elect to apply section 475(f) and attribute that person's securities trading business and election to another person — its owner. The conflict between the text of section 475(f)(1) and respondent's overbroad interpretation of the activities clause cannot be ignored. Respondent's interpretation must be rejected as manifestly incompatible with the intent of section 475(f)(1), which is unambiguously expressed by its text.

This would not be the first time that this Court has rejected overbroad interpretations of the activities clause as being manifestly incompatible with the substantive tax rules at issue. As explained in the Motion, Pierre v. Commissioner, 133 T.C. 24 (2009), and RERI Holdings I, LLC v. Commissioner, 143 T.C. 41 (2014), confirm that the activities clause cannot require the activities of a disregarded entity to be treated as engaged in by its owner, if doing so would be manifestly incompatible with the Code. The question in both cases was whether the owner of a limited liability company that was a disregarded entity should be treated as directly owning the assets held by the disregarded entity. This Court held in both cases that treating the owner as directly owning the limited liability company's assets would be manifestly incompatible with the relevant Code provisions.

Despite latching onto McNamee, an employment tax case, and calling it the controlling authority in this case, respondent dismisses Pierre and RERI as having no bearing simply because they are valuation cases.²¹ Response at 36. Respondent argues that “[b]oth of those cases involved the question of how to value property, and the particular activities of the disregarded entity were not relevant to the Court's holding.” Id. To the contrary, the limited liability company's activities were holding property. If it did not matter whether those properties were treated as held by a sole proprietorship, branch, or division (as the activities clause literally requires), instead of by the disregarded limited liability company, there would have been no dispute. In each case, this Court held that applying the activities clause would be manifestly incompatible with the relevant Code sections.²² Specifically, in Pierre, the Court explained that “[i]f the check-the-box regulations are interpreted and applied as respondent contends, they go far beyond classifying the LLC for tax purposes.” Pierre, 133 T.C. at 35. That is petitioner's point here. Treating GWA as engaging in OGI's securities trading business would be manifestly incompatible with the intent of section 475(f)(1) as unambiguously expressed in its text. The reasons for manifest incompatibility differ, but the point is the same. The activities clause does not apply when doing so would be manifestly incompatible with the intent of the substantive Code provisions at issue.

The Seaview Trading line of cases further confirm this point.²³ As explained above, Seaview Trading establishes that a limited liability company that is a disregarded entity is a section 7701(a)(1) person. See Seaview Trading, 858 F.3d at 1287. But it also informs whether a person's activities can be imputed to its owner. Seaview Trading considered whether a limited liability company that is disregarded as an entity is nevertheless a pass-thru partner (i.e., an “other similar person”) for purposes of former section 6231(a)(1)(B). In Seaview Trading, the partnership argued that it was a small partnership because each direct partner was a disregarded entity and, therefore, the disregarded entities' partnership interests were treated as owned directly by its individual owners. Id. at 1284. The Ninth Circuit disagreed and held that the limited liability companies were indeed pass-thru partners because the limited liability companies owned the partnership interests. Id. at 1287. Thus, Seaview Trading confirms that a limited liability company that is a disregarded entity is not disregarded as a person, and it also confirms that the activities clause does not require the activities of a person that is also a disregarded entity to be attributed to its owner. Under respondent's view as articulated in the Response, even though the limited liability companies in Seaview Trading were persons, their activities — holding partnership interests — should have been attributed to their respective owners as the relevant persons, with the result that there would have been no pass-thru partners.²⁴

The Response gives superficial treatment to the authorities, discussed above, that resolve an alleged conflict between the activities clause and the substantive Code provisions at issue by rejecting an interpretation of the activities clause that is manifestly incompatible with the substantive Code provisions in those cases. In contrast, the application and scope of the activities clause were not at issue in the cases on which respondent relies. As a result, the cases respondent cites have no bearing on the question presented in the Motion.

Dover Corp, v. Commissioner, 122 T.C. 324 (2004), the first activities clause case respondent cites, describes the tax consequences that result when a wholly owned limited liability company that has elected to be a corporation checks the box to cease being taxed as a corporation and becomes a disregarded entity. The taxpayer and respondent agreed in that case that such an election should be taxed as a section 332 liquidation, and as a result, the Court found that respondent conceded that the activities of the disregarded entity were treated as the activities of its owner.²⁵ See id. at 347-48. In addition, the Check-the-Box Regulations and the activities clause were directly applicable because a wholly owned limited liability company that was taxed as a corporation elected to become disregarded as an entity (i.e., disregarded as a corporation under the Check-the-Box Regulations) and, under the activities clause, the limited liability company's activities as an entity were treated as a branch or division of its owner. The fact that the limited liability company remained a section 7701(a)(1) person was irrelevant because the Code sections at issue — the provisions of Subchapter C — apply only to determine the tax consequences of transactions involving corporations.²⁶

Respondent next argues that Whirlpool Financial Corp, v. Commissioner, 154 T.C. 142 (2020), supports his argument that the activities clause makes GWA the relevant person for section 475(f) purposes. Whirlpool is correct in its general observations about disregarded entities, id. at 146 and 162-163, but those observations are irrelevant here. The Code section at issue in Whirlpool was section 954(d), which defines foreign base company sales income. Under section 954(d), foreign base company sales income is income of a controlled foreign corporation that results from sales involving the CFC and a “related person.” However, the section 7701(a)(1) person definition does not apply for section 954(d) purposes; instead, section 954(d)(3) provides a bespoke definition of person, under which the term includes only an “individual, corporation, trust or estate.” A disregarded entity is none of those. Thus, Whirlpool's description of the effect of the activities clause for section 954(d) purposes is both correct and irrelevant where, as here, section 7701(a)(1) defines person for purposes of the relevant Code section. Indeed, the fact that section 954(d) includes a specialized definition of person shows that, when Congress intends for the section 7701(a)(1) person definition not to apply for purposes of a particular Code section, it says so in the statute.

Respondent also cites a footnote in each of Hussey v. Commissioner, 156 T.C. No. 12, at *1 n.3 (2021), and Brown v. Commissioner, T.C. Memo. 2013-275, at *12 n. 16, for the proposition that the activities clause requires OGI's activities as a securities trader to be treated as engaged in by GWA. Response at 29. The Code sections at issue in Hussey provided for the tax consequences of the discharge of the debt of a “taxpayer.” A limited liability company that is disregarded as an entity is not a taxpayer, and application of the activities clause created no conflict with the relevant Code sections. Moreover, because the application and scope of the activities clause were not at issue in Hussey, it is precedentially irrelevant.

In Brown, the Court considered whether a private jet was placed in service the year that the taxpayer claimed. The footnote on which respondent relies went to another point — whether a lease between a disregarded entity and its owner constituted qualified business use for purposes of section 280F, which generally includes “any use in a trade or business of the taxpayer.” Brown, T.C. Memo. 2013-275, at *24 n.16. Although the Court noted that the lease between the disregarded entity and its owner had to be ignored, the relevant Code section focused on a “taxpayer.” As in Hussey, the application and scope of the activities clause were not at issue, and, like Hussey, Brown has no bearing here.

In totality, the relevant case law establishes that the activities clause has boundaries. It cannot apply when its application would be manifestly incompatible with the relevant Code section. Here, because section 475(f)(1) allows any person who is engaged in a securities trading business and who makes the election to mark its securities to market, the activities clause cannot cause OGI's activities as a person to be treated as GWA's activities because doing so would be manifestly incompatible with the text of the relevant Code provision.

In sum, the best interpretation of the interplay between the activities clause and section 475(f)(1) is that there is no conflict because the activities clause does not apply where the Code provision at issue applies to the activities of a person in its capacity as a person. To the extent that the Court interprets a conflict, the activities clause must yield to the plain text of section 475(f)(1), which allows any person who is engaged in a securities trading business to elect to apply section 475(f) to securities held by such person in such business.

D. McNamee Is Not Controlling and Does Not Address the Specific Questions in the Motion

Respondent asserts that the Second Circuit's decision in McNamee v. Department of the Treasury, 488 F.3d 100 (2d Cir. 2007), controls this case. Not only is McNamee not controlling, it is irrelevant.

In McNamee, the issue was whether a limited liability company classified as a disregarded entity or the individual owner of the disregarded entity was liable for unpaid employment taxes with respect to employees of the limited liability company. The pro se owner of the disregarded limited liability company argued that he was not liable for employment taxes on the limited liability company's employees, in part, because the Check-the-Box Regulations were invalid. The court disagreed and held that the regulations are valid because they provided guidance as to how various types of entities, including single-owner businesses, are classified for tax purposes. In so doing, the court emphasized that a single-owner limited liability company could choose whether to be treated as a corporation or disregarded as an entity and explained:

If such an LLC elects to be treated as a corporation, its owner avoids the liabilities that would fall upon him if the LLC were disregarded; but he is subject to double taxation—once at the corporate level and once at the individual shareholder level. If the LLC chooses not to be treated as a corporation, either by affirmative election or by default, its owner will be liable for debts incurred by the LLC, but there will be no double taxation. The IRS check-the-box regulations, allowing the single-owner LLC to make the choice, are therefore eminently reasonable.

McNamee, 488 F.3d at 109.

The court also considered the taxpayer's argument that his limited liability company was the “employer” for U.S. federal tax purposes and therefore was liable for the unpaid employment taxes. In doing so, the court noted that although the payroll tax sections of the Code define “employer,” the Code does not mention limited liability companies. The court went on to state that “nothing in the Code provides that an LLC is always to be regarded, for purposes of federal taxation, as the employer” and held that if a limited liability company does not elect to be classified as a corporation, it is disregarded as a separate entity and cannot be regarded as the employer. McNamee, 488 F.3d at 111.

The McNamee court did not address whether a limited liability company, even though a disregarded entity, was a section 7701(a)(1) person. It also overlooked the Code provisions that define employer to mean the person for whom services are performed, the person who pays wages, and the person who employs an individual.²⁷ Had it addressed the section 7701(a)(1) person question, the court necessarily would have considered whether the section 7701(a)(1) person definition was manifestly incompatible with the intent of the employment and withholding tax Code provisions at issue. But because the court did not address the person question, it did not address the manifestly incompatible question. That is to say, McNamee does not answer the question presented to this Court in the Motion, much less control its outcome.²⁸

The McNamee court was concerned with who was liable for the employment tax — i.e., who was the taxpayer for employment tax purposes. The court did not want to allow the taxpayer to “escape personal liability for the taxes owed by his sole proprietorship and to have the proprietorship escape taxation as a separate entity.” McNamee, 488 F.3d at 111. Here, there is no dispute as to who is responsible for the tax on OGI's income. GWA must report OGI's securities trading gains and losses on its returns (i.e., GWA was the taxpayer for reporting purposes), and its partners must pay tax on their shares of OGI's trading gains.

McNamee addresses none of the issues that this Court must resolve to decide whether GWA is the relevant person in this case. It does not explicate the section 7701(a)(1) person definition. It does not consider the proper scope of the activities clause. And it does not test respondent's interpretation of the activities clause under the manifestly incompatible standard to decide whether the section 7701(a)(1) person definition is incompatible with the employment tax Code provisions. Instead, McNamee simply holds that the individual owner of a limited liability company that was a disregarded entity was liable for employment taxes. See McNamee, 488 F.3d at 111.

Ultimately, the McNamee court determined that the individual owner was liable for employment taxes on his limited liability company's employees because the regulations gave him an “eminently reasonable” choice to either be liable for his limited liability company's taxes or avoid personal liability by causing the limited liability to elect to be a corporation and thereby subject the limited liability company's income to double tax. 488 F.3d at 109. That choice is not at issue here. GWA does not dispute that it is liable for taxes on OGI's income.

E. If GWA Is the Relevant Person, the Section 475(f) Election Was Invalid

Respondent argues that, for section 475(f)(1) purposes, GWA was the relevant person with respect to OGI's 1998 securities trading business. Respondent, however, overlooks the implications of his argument on whether the 1998 Election Statement constitutes a valid section 475(f)(1) election with respect to any security not held by OGI.

Rev. Proc. 99-17 provides the exclusive procedures for traders in securities to make an election to use the mark-to-market method of accounting under section 475(f). A taxpayer²⁹ seeking to make an election for taxable years beginning before January 1, 1999, and for which the original U.S. federal income tax return is filed on or after March 18, 1999, must make the election by attaching a statement that satisfies the requirements of section 5.04 of Rev. Proc. 99-17, to an original income tax return for the election year that is timely filed (including extensions). See Rev. Proc. 99-17, secs. 5.02 and 5.04. The statement must “describe the election being made,” identify the first taxable year for which the election is effective, and, in the case of an election under section 475(f), it must also describe “the trade or business for which the election is made.” Rev. Proc. 99-17, sec. 5.04.

The revenue procedures are not suggestions, and this Court has repeatedly held that a trader who has failed to follow the election requirements under Rev. Proc. 99-17 has not made a valid election under section 475(f). See Kantor v. Commissioner, T.C. Memo. 2008-297, 96 T.C.M. (CCH) 500 (2008) (holding that the trader failed to make an election where the trader did not follow the election requirements of Rev. Proc. 99-17); Knish v. Commissioner, T.C. Memo. 2006-268, 92 T.C.M. (CCH) 498 (2006) (holding that no election was made where the required statement was not attached to the required tax return). This Court has similarly applied this rigid election standard in other cases. See, e.g„ Plumb v. Commissioner, 97 T.C. 632 (1991) (holding that a taxpayer seeking to make an election not available to him will be treated as having made no election); Weschenfelder v. Commissioner, T.C. Memo. 2019-133 (holding that a failure to include the statement on the return, in the location and manner required by regulation, invalidated the foreign earned income exclusion election); New Gaming Sys., Inc, v. Commissioner, T.C. Memo. 2001-277, 82 T.C.M. (CCH) 794 (2001) (holding that a valid election out of the modified accelerated cost recovery depreciation method was not made because the required information was not included as required by regulations).

By its terms, the 1998 Election Statement was made by OGI with respect to the securities trading business in which OGI engaged in 1998. In the statement, OGI elects to apply section 475(f)(1) “to such trade or business,” and agrees to recognize gain or loss on any security that it holds in such trade or business at the close of any taxable year. OGI does not elect to apply section 475(f) to securities held by GWA.

If, as respondent argues, GWA were the relevant person in 1998 for section 475(f)(1) purposes, then the 1998 Election Statement was not a valid section 475(f)(1) election with respect to any security held by OGI, GWA, or any other person. First, only the relevant person for section 475(f)(1) purposes can file a valid section 475(f)(1) election. By its terms, the 1998 Election Statement was filed by and on behalf of a person, OGI, who according to respondent was not the relevant person and who cannot, as a disregarded entity, make its own election.³⁰ Response at 15. The statement attached to the return is clearly labeled to be an election “FOR OGI.” No section 475(f)(1) election statement was filed for GWA, who is the person respondent asserts is the relevant person.

Second, even if the 1998 Election Statement were treated as being filed by GWA, it would still not constitute a valid election because it expressly limits the scope of the election to securities that were held by OGI, whereas a valid section 475(f)(1) election for GWA must apply to all securities that it holds in its securities trading business.

For example, suppose a person who is a securities trader files a section 475(f)(1) election statement that purports to limit the election to a subset of securities held in connection with the trading business. The election to mark-to-market some, but not all, securities that the person holds in its securities trading business is invalid. If the person nevertheless marks to market only the securities covered by the invalid election, it would be using an impermissible accounting method. Respondent could require the person to discontinue using the impermissible method. But, the section 475(f) method is an elective method. Respondent cannot require the person to change from an impermissible mark-to-market method to an elective method that the person did not elect to use. He can only require that the person change to a permissible, non-elective method.

Here, the bottom line is that, if GWA was the relevant person to make a section 475(f)(1) election in 1998, it did not make a valid section 475(f)(1) election. And, the election that was made (regardless of who is deemed to have made it) cannot be expanded to include securities that were not held by OGI. In the absence of a valid election, respondent cannot require GWA to apply section 475(f) to any security that GWA directly held.

* * * *

III. CONCLUSION

As no genuine questions of material fact exist, petitioner prays that this Court grant petitioner's Motion for Partial Summary Judgment and grant such other and further relief as this Court deems just and proper.

Respectfully submitted,

Sheri A. Dillon
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-739-5749
Tax Court Bar No.: DS0248
sheri.dillon@morganlewis.com

Jennifer E. Breen
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-739-5577
Tax Court Bar No.: BJ1937
jennifer.breen@morganlewis.com

James G. Steele, III
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-739-5390
Tax Court Bar No.: SJ2284
james.steele@morganlewis. com

William F. Nelson
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-373-6782
Tax Court Bar No.: NW0106
william.nelson@morganlewis.com

Drew A. Cummings
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-739-5122
Tax Court Bar No.: CD0643
drew.cummings@morganlewis.com

Eric J. Albers-Fiedler
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue, NW
Washington, D.C. 20004
Telephone No.: 202-739-5169
Tax Court Bar No.: AE0177
eric.albers-fiedler@morganlewis.com

Dated: August 11, 2021