IRS Files Sur-Reply in Tax Court Regarding Mark-to-Market Election

GWA, LLC, George A. Weiss, Tax Matters Partner,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

Judge Albert G. Lauber

Filed Electronically

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

In accordance with the Court's order dated July 21, 2021, respondent submits this Sur-Reply to Petitioner's Reply to Respondent's Response to Petitioner's Motion for Partial Summary Judgment.

I. Material facts remain in dispute.

Section 475(f) permits a mark-to-market election in the case of a (1) person, (2) who is engaged in a trade or business as a trader in securities, and (3) who elects to have section 475(f) apply to such trade or business. I.R.C. § 475(f)(1)(A). Petitioner has placed in issue whether respondent erred in determining that GWA, LLC (“GWA”) was subject to a section 475(f) election. Petition ¶ 5.h. The Court must determine whether at the time GWA filed its section 475(f) election, it was a person who was engaged in a trade or business as a trader in securities and elected to have section 475(f) apply to such trade or business. Petitioner claims that even if GWA is the relevant person under section 475(f), it made no valid section 475(f) election because it was not engaged in the trade or business of trading securities at the time of its election. Pet. Reply, p. 2. The resolution of this issue could take two paths. First, the Court could determine as a matter of law that for section 475(f) purposes GWA and its disregarded limited liability company (“LLC”), OGI Associates LLC (“OGI”), are a single taxpayer and that OGI's activities are attributable to GWA. In that case, this Court would not need to decide, as a factual matter, whether GWA was engaged in a trade or business of trading securities when it made the election. Should the Court agree with petitioner that OGI's activities are not attributable to GWA, a question of fact remains — whether GWA was engaged in a trade or business as a trader in securities at the time it filed its election.

Petitioner claims that during 1998 through 2010, GWA held some securities and other property for long-term investment and did not directly conduct or engage in any trade or business. Gendreau Decl. ¶ 8. But GWA said that it did engage in a trader activity through a wholly owned LLC on an attachment to the Form 3115 (Application for Change in Accounting Method) included with its 1998 federal income tax return.¹ GWA filed a Form 3115 to change from the cash to the accrual method of accounting. Goldberg Decl. ¶ 4. Question 11 on Form 3115 mandates that the applicant [GWA] “attach a description of the applicant's trade or business, including the goods or services it provides and any other types of activities it engaged in that generate gross income.” Goldberg Decl. ¶ 4. In response to Question 11, GWA stated: “[t]he taxpayer's primary business activity is as an investment company. The taxpayer also engages in a trader activity operated through a wholly-owned limited liability company.” Goldberg Decl. ¶ 4.

Even if GWA were not eligible to make the section 475(f) election by virtue of the trader activity it conducted through OGI, facts discovered thus far indicate that GWA might have been a trader in securities, in substance, during 1998. Respondent is aware that GWA entered into barrier options and swaps with Royal Bank of Canada (“RBC Transactions”) between 1998 and 2003. Goldberg Decl. ¶ 5. GWA has not produced its books and records from 1998, but GWA's balance sheet for March 31, 2003 (prior to GWA entering into the first Barrier Transaction with Deutsche Bank) reports marketable securities of $114,269,508 attributable to the RBC Transactions. Goldberg Decl. ¶¶ 5, 6. Moreover, in GWA's accounting records for the month ending March 31, 2003, there is a “Royal Bank” “Trial Balance” that reports long inventory securities of $466,844,184 and short inventory securities of $461,568,120. Goldberg Decl. ¶ 7.

When the first Barrier Transaction was entered into with Deutsche Bank on April 15, 2003, some or all of the inventory of securities reported on the Royal Bank Trial Balance for the month ending March 31, 2003 were transferred into the Basket (reference property) for the Deutsche Bank Barrier Transaction entered into on April 15, 2003 — one of the transactions that is at issue in this case. Goldberg Decl. ¶¶ 8, 9. GWA's activities in 1998 and thereafter are not only relevant, but, as illustrated above, interconnected with the Barrier Transactions at issue before the Court. It appears that the same trading activity that gave rise to respondent's determinations in the 2009 and 2010 FPAAs was occurring in GWA in 2003 and perhaps as early as 1998 when GWA's section 475(f) election was made. Contrary to petitioner's claim, GWA's activities in 1998 and thereafter are relevant.

Furthermore, factual issues may still be in dispute if the Court determines that GWA made a section 475(f) election. If the Court finds that GWA made a valid section 475(f) election, then GWA was required to mark to market all of its securities unless the exception under section 475(f)(1)(B) applies. See I.R.C. § 475(f)(1)(A). Section 475(f)(1)(B) provides that GWA is not required to mark to market any security “(i) which is established to the satisfaction of the Secretary as having no connection to the activities of such person as a trader, and (ii) which is clearly identified in such person's records as being described in clause (i) before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).” If petitioner argues that the Barrier Transactions meet this exception, petitioner would have to introduce facts to prove that the Barrier Transactions had no connection to GWA's activities as a trader, and that the Barrier Transactions were clearly identified in its records as having no connection with its activities as a trader in accordance with section 475(f)(1)(B).

II. GWA, LLC and its disregarded entity OGI were a single taxpayer and person for purposes of section 475(f).

Treas. Reg. § 301.7701-1(a)(4) provides that “under §§ 301.7701-2 and 301.7701-3, certain organizations that have a single owner can choose to be recognized or disregarded as entities separate from their owners.” Treas. Reg. § 301.7701-2(a) states that, “if [an] entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.” Petitioner's argument that OGI is a person separate from GWA that is eligible to make its own separate section 475(f) election fails because under the section 7701 regulations and the caselaw interpreting them, GWA is the only section 475(f) taxpayer and person for federal tax purposes. For federal tax purposes, OGI does not exist as an entity separate from GWA, with limited exceptions based on specific provisions of the check-the-box regulations.² See Treas. Reg. § 301.7701-2(c)(2)(iii)-(vi).

In the context of employment taxes related to wages paid before January 1, 2009, this Court found with respect to a disregarded entity that “the sole member of a limited liability company and the limited liability company itself are a single taxpayer or person. . . .” Costello v. Comm'r, T.C. Memo. 2016-184, at *12 (citing Med. Practice Solutions, LLC v. Comm'r, 132 T.C. 125, 127 (2009), aff'd without published opinion sub nom. Britton v. Shulman, No. 09-1994, 2010 WL 3565790 (1st Cir. August 24, 2010), cert. denied, 563 U.S. 1034 (2011)). This Court has also consistently found that a disregarded LLC and its single member are a “single taxpayer or person” in cases challenging collection actions where a notice of lien or levy was issued to the disregarded LLC instead of its single member, or vice versa. See Med. Practice Solutions, 132 T.C. at 127; Bergdale v. Comm'r, T.C. Memo. 2014-152, at *6 (“As in Med. Practice Solutions, we conclude that for purposes of the instant proceeding, DC LLC and petitioner are a single taxpayer or person to whom notice is given”); Scott Labor, LLC v Comm'r, T.C. Memo. 2015194, at *18.³ Under the check-the-box regulations, a disregarded LLC is treated for federal tax purposes as a “tax nothing” unless it elects to be taxed as a corporation. 6611, Ltd. v. Comm'r, T.C. Memo. 2013-49, at *47.

The Second Circuit Court of Appeals in McNamee v. Dept, of the Treasury, 488 F.3d 100 (2d Cir. 2007), rejected the same argument that petitioner now raises — that a disregarded LLC is an entity separate from its owner. In that case, the court stated that “the single-member LLC is the employer if it elects to be treated as a corporation; but if it does not elect that treatment, it is [d]isregarded' as a 'separate' entity, [Treas. Reg.] § 301.7701-3(b)(1)(ii), and hence cannot be regarded as the employer.” McNamee, 488 F.3d at 111 (emphasis in original).

Section 7701(a) provides that its definitions apply when used in the Code, where not otherwise distinctly expressed or manifestly incompatible with the intent thereof. Under section 3306(a)(1) and the regulations in effect at the time, the statute and regulations at issue in McNamee, the “employer” was defined as any “person” who employed individuals and paid wages for state-law purposes. Section 3401(d) provides that the term “employer” means the “person” for whom an individual performs or performed any service. Neither section 3306(a) nor section 3401(d) provided a bespoke definition of “person.” The Second Circuit Court of Appeals did not, as petitioner suggests, blithely ignore that the employment tax Code sections refer to a “person” and section 7701(a)'s rule that the “person” definition therein applied throughout the Code unless manifestly incompatible with Congressional intent. See Pet. Reply, pp. 27-28 (arguing that the McNamee court “overlooked the Code provisions that define employer to mean the person for whom services are performed. . . .”) (emphasis in original). The Second Circuit could not, as petitioner claims, “simply hold[ ] that the individual owner of a limited liability company that was a disregarded entity was liable for employment taxes,” Pet. Reply at 29, unless the disregarded LLC's single owner was the section 7701(a) person and the LLC itself had no separate existence for purposes of section 3306(a) and 3401(d). Similarly, the Sixth Court of Appeals in Littriello v. U.S., 484 F.3d 372 (6th Cir. 2007) and this Court in Med. Practice Solutions, 132 T.C. at 130, could not have reached the conclusion that the disregarded LLC's single member was the “employer” for employment tax purposes if, as petitioner argues, the disregarded LLC was per se a separate section 7701(a) “person.”

The McNamee court's view of a disregarded LLC and its single member as a single taxpayer and person (i.e., the single member), is consistent with its analysis of section 7701's entity definitions and with Treas. Reg. § 301.7701-6(a) (the “Person Regulation”). As petitioner notes in his Reply, the McNamee court reasoned that the closest fit for an LLC would seem to be “other unincorporated organization” — an organization that might or might not be an entity separate from its owner. Pet. Reply, p. 7. As explained above, for purposes of employment taxes prior to January 1, 2009, a disregarded LLC is an organization that is not an entity separate from its owner because the disregarded LLC and its owner are a single taxpayer and person. Petitioner then argues that, because the Person Regulation's definition of “person” includes “other unincorporated organizations,” a disregarded LLC must fall within that definition. Pet. Reply, p. 7. Petitioner also claims that the check-the-box regulations have no impact on OGI's status as a section 7701(a)(1) person that is separate from its owner, GWA. Pet. Reply, p. 6.

The McNamee court did not find that section 7701(a)(1)'s “person” definition was manifestly incompatible with section 3306(a) or 3401(d), or any employment tax regulation. Therefore, if the disregarded LLC were a separate section 7701(a)(1) “person,” section 7701(a)'s direction that its definitions apply throughout the Code would have required the McNamee court to find that the LLC was also the “employer” under sections 3306(a) and 3401(d). It did not. Instead, it correctly found that the definitions in section 7701(a)(1), (2), and (3) were ambiguous. McNamee, 488 F.3d at 106. Furthermore, the definition of “person” in Treas. Reg. § 301.7701-6(a) copies the definition of partnership found in section 7701(a)(2) when it mentions “unincorporated organizations.” Thus, while a partnership is a person under section 7701(a)(2), it is not clear how a single member LLC is treated. The court found that “in light of the emergence of limited liability companies and their hybrid nature, and the continuing silence of the Code on the proper tax treatment of such companies in the decade since the present regulations became effective,” the check-the-box regulations were “eminently reasonable.” Id. at 109. The check-the-box regulations provide in Treas. Reg. § 301.7701-2(c)(2)(i) that for federal tax purposes, in general, “a business entity that has a single owner and is not a corporation . . . is disregarded as an entity separate from its owner.” The court applied the check-the-box regulations with the result that the disregarded LLC's single member was the single section 7701(a)(1) “person” and the “employer” for employment tax purposes. McNamee is controlling authority that contradicts petitioner's argument that an LLC is per se a section 7701(a) person regardless of whether it is disregarded or not, and petitioner's contention that it is irrelevant is without merit.

If petitioner were correct that a disregarded LLC is per se an entity separate from its single member because it is an “unincorporated organization” under the Person Regulation, there would be no need for the specific regulatory exceptions that describe the limited circumstances where a disregarded LLC is regarded as a separate entity. The exceptions in the check-the-box regulations describe the limited purposes, such as federal employment and excise taxes,⁴ for which a disregarded LLC is regarded as an entity separate from its single member. See Treas. Reg. § 301.7701-2(c)(iii)-(vi). Those exceptions do not apply in this case. To the contrary, McNamee, Costello, and the other cases cited above illustrate that whether the disregarded LLC is treated as a single taxpayer or person with its single member is contextual and depends on which statute incorporates section 7701(a)(1)'s “person” definition.

In the TEFRA cases that petitioner cites, courts determined that disregarded LLCs were pass-thru partners under section 6231(a)(9) by looking to state law to determine the factual circumstances through which the single members in those cases held interests in TEFRA partnerships. See Seaview Trading, LLC v. Comm'r, 858 F.3d 1281 (9th Cir. 2017), aff'g Order of Dismissal for Lack of Jurisdiction, T.C. Dkt. No. 1744-11 (Mar. 11, 2015); Mellow Partners v. Comm'r, 890 F.3d 1070 (D.C. Cir. 2018), aff'g Decision, T.C. Dkt. No. 15498-05 (Nov. 10, 2016). Section 6231(a)(9) defined a pass-thru partner as any “partnership, estate, trust, S corporation, nominee, or other similar person through whom other persons hold an interest in the partnership. . . .” Section 6231(a)(9) requires courts to look to state law to determine the factual circumstances through which the single member held title to the partnership interest. See Seaview Trading, 858 F.3d at 1285-87. The Seaview Trading court, quoting Rev. Rul. 2004-88, explained:

[A]lthough LLC is a disregarded entity for federal tax purposes, LLC is a partner of P[artnership] under the law of the state in which P[artnership] is organized. Similarly, although A, LLC's owner, is a partner of P[artnership] for purposes of the TEFRA partnership provisions under section 6231(a)(2)(B) because A's income tax liability is determined by taking into account indirectly the partnership items of P[artnership], A is not a partner of P[artnership] under state law. Because A holds an interest in P[artnership] through LLC, A is an indirect partner and LLC, the disregarded entity, is a pass-thru partner under the TEFRA partnership provisions. Consequently, the small partnership exception does not apply to P[artnership] because P[artnership] has a partner that is a pass-thru partner.

Id. at 1286-87.

In contrast, Treas. Reg. § 301.7701-1(a)(1) expressly provides that “[w]hether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.” That regulation's prohibition on looking to state law to determine an entity's status under section 7701 conflicts with section 6231(a)(9)'s mandate to examine state law to determine the entity's status. The conclusion upon which the Seaview Trading court's decision rested — under state law the disregarded LLC's single member was a person that held a TEFRA partnership interest through another state law person, the LLC — is not relevant to this case. That conclusion is relevant only to whether a disregarded LLC may be a section 6231(a)(9) “pass-thru partner,” not to whether a disregarded LLC may make the section 475(f) election. The Seaview Trading court did not hold that a disregarded entity is a “person” under section 7701. 858 F.3d at 1287. Rather, the court noted that a disregarded entity “could still logically fall within § 7701(a)'s definition of a 'person' insofar as the relevant regulation is concerned with the factual circumstances of partnership-interest ownership.” Id. (emphasis added). Partnership-interest ownership is not at issue in this case. Therefore, the Seaview Trading line of cases are distinguishable.

Here, section 475(f) does not require an examination of state law to determine the relevant “person” eligible to make the election nor does it look to the “factual circumstances of partnership-interest ownership.” Under the correct application of the check-the-box regulations, GWA is the single section 7701(a) person and taxpayer for section 475(f) purposes. Treating GWA as a single taxpayer and person is compatible with section 475(f).

III. GWA was the relevant person for section 475(f) purposes.

A. GWA is the section 475(f) person who made the election with respect to the securities trading business it conducted through its disregarded entity, OGI.

As discussed above in section II, under section 7701, the regulations thereunder, and as interpreted in caselaw, OGI is disregarded as an entity separate from GWA and cannot make a separate section 475(f) election. GWA is the relevant “person” eligible to make the section 475(f) election. GWA in fact made the section 475(f) election “with respect to its securities trading business conducted through its disregarded entity OGI.” Goldberg Decl. ¶ 10. The facts in this case show that GWA, rather than OGI, made the election, are discussed further in section V, infra.

More broadly, disregarded entities cannot generally make their own tax elections, contrary to petitioner's claim. See Pet. Reply, p. 32 n.30. Petitioner emphasizes that the disregarded entity can make the election on Form 8832, Entity Classification Election, when it wants to change its default classification and be treated as a corporation. Pet. Reply, p. 32 n.30. The fact that an LLC with a single owner makes its own election to determine its tax classification going forward (whether as an entity disregarded from its owner or as a corporation) recognizes only that there is a state law entity that exists and, as the McNamee court discussed, the Treasury Department and the IRS issued reasonable regulations that provided a flexible response to the emergence of the LLC and the difficulty of determining its classification for federal tax purposes. The check-the-box regulations allow the entity when it has a single owner to make its choice — to be disregarded as an entity separate from its owner or to be treated as an association taxable as a corporation and thus a separate entity. See McNamee, 488 F.3d at 109. Petitioner also points out that a disregarded LLC may seek an extension of time to make elections under Treas. Reg. § 301.9100-1(b). However, petitioner did not identify any elections that a disregarded LLC can make besides its own entity classification election.

Petitioner claims that it is consistent with the intent of section 475(f) to allow a disregarded entity to elect under section 475(f) and further that the term “taxpayer” is a subset of the term “person.” Pet. Reply, p. 13. Petitioner argues that because a foreign corporation that is not subject to U.S. federal tax must adopt a method of accounting in certain situations, citing to Treas. Reg. § 1.964-1(c)(6),⁵ that it follows that section 475(f) could apply to a “person” that is not a “taxpayer.” Pet. Reply, p. 13. First, Treas. Reg. § 1.964-1(c)(6) does not speak to Congress' intent in drafting section 475(f). Second, petitioner's argument ignores that Treas. Reg. § 1.964-1(a)(1) provides rules for determining the earnings and profits of a foreign corporation for purposes of sections 951 through 964 and provides that the earnings and profits “shall be computed for all Federal income tax purposes substantially as if such corporation were a domestic corporation.” Treas. Reg. § 1.964-1(a)(1) (emphasis added).” In sum, Treas. Reg. § 1.964-1(a)(1) provides that the foreign corporation be treated as a “taxpayer” or a domestic corporation.

As discussed in section III. C., infra, and section III of Respondent's Response, Congress intended that a “taxpayer” make a section 475(f) election. Revenue Procedure 99-17, which provides the exclusive rules for a taxpayer to make the election, implements that legislative intent.

B. Assuming that a disregarded LLC is a section 7701(a)(1) “person” separate from its single member, treating the disregarded LLC as the relevant section 475(f) person would be manifestly incompatible with section 475(f)'s purposes.

Assuming that a disregarded LLC such as OGI was a separate section 7701(a) “person” regarded as an entity separate from its single member, applying that person definition to section 475(f) would be manifestly incompatible with Congress's intent with respect to section 475(f). See Resp. Response, pp. 16-20. Congress's intent was to prevent a taxpayer from selectively marking to market only some of its securities, especially with the benefit of hindsight. See Resp. Response, pp. 18-19. As a result, section 475(f) applies to all securities held by an electing taxpayer, unless the taxpayer can establish under section 475(f)(1)(B) that certain securities are not held in connection with its trading activity and the securities have been identified in accordance with section 475(f)(1)(B). That the Service has not proposed regulations concerning the application of section 475(f) to transfers of securities involving disregarded LLCs is not surprising given the general agreement among courts, taxpayers, and the Service that a disregarded LLC is “disregarded for Federal tax purposes as an entity separate from [its owner].” See, e.g., Whirlpool Fin. Corp. & Consol. Subs. v. Comm'r, 154 T.C. 142, 156 (2020).

Although the use of separate taxpayers that are related parties is not the issue in this case, petitioner is wrong that Congress's statutory scheme condones selectivity among related parties and that such activity is not proscribed or regulated. Pet. Reply, pp. 12-13. Specifically, petitioner alleges that 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.” Pet. Reply, p. 12. First, Congress's intent to prevent selectivity involving coordination of securities investments between related parties is evidenced by its enacting section 475(g), which 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. . . .

Moreover, Congress discussed a specific example of such related-party selectivity abuse in section 475's legislative history. H.R. Rep. No. 103-213, at 615-16 (1993) (Conf. Rep.) provides:

For instance, assume that an individual who is not subject to the mark-to-market rules contributes a security that has a built-in loss in the hands of the individual to a partnership that is subject to the mark-to-market rules. Consistent with rules that govern the treatment of a security that ceases to qualify for one of the exceptions to the mark-to-market rules in the hands of a single taxpayer, the Treasury regulations may provide that any loss that arose prior to the contribution to the partnership may not be taken into account by the partnership under the mark-to-market rules and that suspended loss may be taken into account when the security is sold.

Had Congress intended to allow taxpayers to use related parties to selectively mark securities, it would not have identified this specific abuse that it believed should be prevented. Contrary to petitioner's claim that respondent has prescribed no regulations to prevent mark-to-market selectivity through related parties, Treasury has proposed and finalized various regulations for that purpose. See Treas. Reg. § 1.475(a)-3 (providing timing and character rules for any built-in gain or loss attributable to a security acquired by a dealer in a substituted basis transaction); Treas. Reg. § 1.1502-13(c)(7)(ii)(K) (applying matching principles to prevent circumvention of section 475 on transfers between dealers and non-dealers in a consolidated group); Prop. Treas. Reg. § 1.475(f)-2(c), 64 Fed. Reg. 4374, 4378 (January 28, 1999) (proposed regulations making the dealer in securities regulations applicable to electing traders in securities). Thus, petitioner's claim that selectivity among related parties is not proscribed or regulated is incorrect. The issue here, selectivity within a single taxpayer, is addressed by Rev. Proc. 9917, which sets forth the exclusive rules for a taxpayer to make a section 475(f)election. Selectivity is further addressed by both the legislative history regarding the identification standards set forth in the statute and the requirements of section 475(f)(1)(B), which provide the standards that a taxpayer must meet to fall under the exception to marking all of its securities. See discussion in section III.C., infra.

C. Congress intended “person” in section 475(f) to mean “taxpayer.”

In light of the regulations and caselaw discussed in section II above under which a disregarded LLC is disregarded as an entity separate from its owner, GWA is the relevant person and taxpayer for section 475(f) purposes. Even assuming that OGI is a section 7701(a) “person” separate from GWA, OGI still could not be the section 475(f) “person” because it is not a taxpayer.

Petitioner did not attempt to explain why Congress used “taxpayer” and “person” interchangeably both in section 475 and in the legislative history for the dealer in securities rules, the rules for electing dealers in commodities and electing traders in securities and commodities, and the rules for nonfinancial customer receivables. See Resp. Response, pp. 21-22. Instead, petitioner speculates as to why Congress might rationally have decided to apply section 475(f) to a person rather than to a taxpayer. Pet. Reply, p. 14 & n.16. Regardless, petitioner rests on the presumption that Congress intended to use the term “person” in section 475(f) without pointing to support from the statutory scheme as a whole or from the exclusive use of “taxpayer” in the legislative history for section 475(f). See Pet. Reply, pp. 15-16. Respondent explained at length in his Response why Congress's inconsistent and interchangeable use of “person” and “taxpayer” rebuts the presumption that its word choice was intentional in section 475(f). See Resp. Response, pp. 20-28.

Petitioner further argues that respondent's own guidance regarding the procedures for a taxpayer to make a section 475(f) election set forth in Rev. Proc. 99-17 requires the electing taxpayer to make the election in accordance with Rev. Proc. 98-60, 1998-2 C.B. 761. Petitioner states that Rev. Proc. 98-60 provides that the term “taxpayer” has the same meaning as the term “person” as defined in section 7701(a)(1) instead of “taxpayer” as defined in section 7701(a)(14). Pet. Reply, pp. 16-17. Petitioner argues that this definition applies to Rev. Proc. 99-17 without citing to the relevant section of Rev. Proc. 98-60 that defines “taxpayer” as having the same meaning as a “person.” That definition is found in section 3.02(1) of Rev Proc. 98-60 (definitions section). But Rev. Proc. 99-17 references only section 5.04 (section 481(a) adjustment) and section 6.02 (filing requirements) of Rev. Proc. 98-60. See Rev. Proc. 99-17, section 6.02(2) and (3) (discussing a change in method of accounting). Rev. Proc. 99-17 modifies certain of those filing requirements in section 6.02 of Rev. Proc. 98-60, including those relating to timely duplicate filing, waiver of taxable year filing requirement, extensions, label on the Form 3115, signature requirements, additional statement required, no user fee and where to file the copy. There is no part of Rev. Proc. 99-17 that refers to section 3.02 of Rev. Proc. 98-60. Rev. Proc. 99-17 does provide that a “taxpayer” makes the section 475(f) election. As discussed in Respondent's Response at 24-25, the transition rules for the section 475(f) election in section 1001(d)(4) of Pub. L. 10534, 111 Stat. 908 (1997) provide that the trader election is made by a “taxpayer.” Rev. Proc. 99-17 implements that rule. The legislative history to section 475(f) was clear that the mark-to-market method election will be made in the time and manner prescribed by the Secretary. H.R. Rep. No. 105-220, at 516 (1997) (Conf. Rep.). Furthermore, section 1 of Rev. Proc. 99-17 provides that this revenue procedure is the exclusive procedure for dealers in commodities and traders in securities and commodities to make an election to use the mark-to-market method of accounting under section 475. There is nothing in Rev. Proc. 99-17 that imports the definition of taxpayer from section 3.02 of Rev. Proc. 98-60. Petitioner is incorrect when it asserts that respondent's own guidance requires use of the term “taxpayer” in Rev. Proc. 99-17 to mean “person”.

IV. The “Activities Clause” applies to section 475(f).

A. Attributing OGI's trading activities to GWA supports the Congressional intent for section 475(f).

Petitioner argues that attributing OGI's activities to GWA under Treas. Reg. § 301.7701-2(a) (the “activities clause”) is “manifestly incompatible with the intent of section 475(f)(1), which is unambiguously expressed by its text,” and doing so “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) . . . But petitioner fails to explain why such attribution conflicts with the purpose of section 475(f)(1). Instead, petitioner begs the question by arguing that the activities clause cannot be used to define the word “person” in section 475(f) because section 475(f) contains the word “person.” Petitioner offers no other explanation (such as Congressional intent or statutory construction) for this purported incompatibility.

To the contrary, attributing OGI's activities to GWA under the activities clause fully supports the statutory scheme in section 475(f). Under Treas. Reg. § 301.7701-2(a), the activities of a disregarded LLC become the activities of the owner, and the two are treated as a single taxpayer. See Whirlpool, 154 T.C. at 156; Costello v. Comm'r, T.C. Memo. 2016-184 at *12. Applied here, OGI's securities trading activity is attributed to GWA, and GWA is considered “a person who is engaged in a trade or business as a trader in securities.” Section 475(f)(1)(A). As the person engaged in securities trading, GWA was required to mark-to-market “any security held in connection with such trade or business. . . .” Section 475(f)(1)(A)(i). The broad reach Congress intended for section 475(f) is fully operational under these circumstances, as the mark-to-market accounting method applies to any security connected to OGI's trading business whether owned by GWA or OGI.

In contrast, petitioner advocates for a rule that would substantially limit the broad “held in connection with” standard instituted by Congress. For example, GWA's Barrier Transactions were held in connection with the security trading business conducted through OGI. That is, GWA used OGI's accounts to supplement the trading strategies conducted through the Basket Transactions. See Resp. Response, p. 6; Goldberg Decl. in support of Resp. Response 4. OGI and GWA expressly agreed in a Master Netting Agreement that OGI's securities trading account and GWA's Basket Transaction would “constitute a single business and contractual relationship. . . .” See Goldberg Decl. in support of Resp. Response ¶ 19. Petitioner does not contest this close connection in its Motion or Reply but, instead, seeks to limit the reach of section 475(f) by limiting the activities clause. Accordingly, it is petitioner's interpretation that is incompatible with the Congressional intent for section 475(f).

B. Pierre, RERI Holdings, and Seaview Trading do not limit the activities clause.

Respondent previously explained that the holdings in Pierre v. Comm'r, 133 T.C. 24 (2009) and RERI Holdings I, LLC v. Comm'r, 143 T.C. 41 (2014) do not limit the application of the activities clause for purposes of section 475(f). See Resp. Response, pp. 36-38. As in Seaview Trading, the holdings in Pierre and RERI Holdings turn on state law considerations but in the valuation context. Ignoring these key features, petitioner argues that the activities clause was significant to holdings in Pierre and RERI Holdings because “[i]f 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.” Pet. Reply, p. 19.

Petitioner fails to focus on the point in those cases. In both Pierre and RERI Holdings, this Court analyzed how to value a transferred disregarded LLC interest, not whether activities of the disregarded LLCs were attributed to the owners prior to the transfer. Central to the holding in Pierre were the historical state law principles underlying the gift tax regime. See Pierre, 133 T.C. at 28-30. The Court held that state law property rights must be applied to the “willing buyer, willing seller” rule used to determine the value of transferred property for gift tax purposes. Id. at 35-36; see Treas. Reg. § 25.2512-1 (setting forth “willing buyer, willing seller” rule for property valuation). The Court in RERI Holdings adopted the holding in Pierre, since the charitable contribution in that case was valued under the same “willing buyer, willing seller” standard. RERI Holdings, 143 T.C. at 52; see Treas. Reg. § 1.170A-1(c)(2). The Court in RERI Holdings noted the distinct problem with disregarding an LLC under the “willing buyer, willing seller” standard: “'[w]here the property transferred is an interest in a single-member LLC . . . validly created and recognized under State law, the willing buyer cannot be expected to disregard that LLC.'” RERI Holdings, 143 T.C. at 52 (quoting Pierre, 133 T.C. at 37 (Cohen, J. concurring)).

In this case, there is no valuation of a transferred LLC interest controlled by state law principles and no “willing buyer, willing seller” standard to navigate. The only question here is whether the activities clause in Treas. Reg. § 301.7701-2(a) requires GWA and OGI to be treated as a single person for purposes of section 475(f)(1). The holdings in Pierre and RERI Holdings have no bearing on the issue here.

After discussing Pierre and RERI Holdings, Petitioner's Reply turns back to Seaview Trading, arguing that “Seaview Trading 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.” Pet. Reply, p. 21. Petitioner overstates the scope of the holding in Seaview Trading. In Seaview Trading, the Ninth Circuit only held that a disregarded entity qualifies as a “pass-through partner” under rules in section 6231(a)(1)(B). And while the court, in dicta, suggested that a disregarded entity “could still” fall within the definition of “person,” it limited that possibility to instances were “the relevant regulation is concerned with the factual circumstances of partnership-interest ownership.” Seaview, 858 F.3d at 1287. As previously discussed, the Court's decision did not hold that a disregarded entity is a section 7701(a) “person.” The Court simply determined that there was “no compelling reason to contravene the consistent stance of the IRS and the tax courts, which have uniformly treated disregarded single-member LLCs as pass-thru partners.” Id. Furthermore, in introducing the disregarded entity concept, the Ninth Circuit recited the activities clause in broad terms and specifically noted the only exceptions to that rule: “The activities of a disregarded entity 'are treated in the same manner as a sole proprietorship, branch, or division of the owner,' except in regard to the application of certain special employment and excise tax rules.'” Seaview Trading, 858 F.3d at 1284. Having described the reach of the activities clause, the Ninth Circuit never indicated that its holding was intended to limit it.

C. The Tax Court broadly applies the activities clause.

Petitioner alleges that the Tax Court cases cited by respondent applying the activities clause to various Code sections “have no bearing on the question presented in the Motion.” Pet. Reply, p. 22. Petitioner asserts that this Court's consistent treatment of disregarded LLCs as disregarded for federal tax purposes is irrelevant because the cases do not specifically analyze the issue of whether the term “person” includes a disregarded entity. Pet. Reply, pp. 22-26.

For example, in discussing respondent's analysis of the disregarded airplane lease between the owner and his disregarded LLC in Brown v. Comm'r, T.C. Memo. 2013-275 (see Resp. Response, pp. 30-31), petitioner states that “[a]lthough the Court noted that the lease between the disregarded entity and its owner had to be ignored, the relevant Code section [280F] focused on a 'taxpayer.'” Pet. Reply, pp. 24-25. But petitioner failed to acknowledge section 280F(c)(l), which excludes from section 280F “property leased or held for leasing by any person regularly engaged in the business of leasing such property.” (Emphasis added). Under petitioner's reasoning, the LLC in Brown could qualify for exemption from 280F (and the alternative depreciation system) to the extent the LLC “regularly engaged in the business of leasing such property.” See I.R.C. § 280F(c)(1). But there was no need for the Court to analyze the application of that subsection because, as the Court noted, the LLC was a disregarded entity and, under Treas. Reg. § 301.7701-2(a), the lease was disregarded for tax purposes. See Brown, T.C. Memo. 2013-275, at *12 n.16.

The use of “person” in section 280F(c)(1) and “taxpayer” in section 280F(d)(6) illustrates the problems inherent in petitioner's position. If adopted, petitioner's position will undoubtedly create uncertainties regarding the interpretation of Code sections that happen to contain the word “person.” Fortunately, the activities clause in Treas. Reg. § 301.7701-2(a), and this Court's application of that clause in its opinions, resolved that uncertainty by requiring a disregarded LLC to be “disregarded for Federal tax purposes as an entity separate from [its owner]” and the disregarded LLC's activities to be attributed to its owner. Whirlpool, 154 T.C. at 156.

V. GWA's Section 475(f) Election is Valid.

Petitioner erroneously claims that if GWA were the relevant person to make the section 475(f) election, then the election statement attached to GWA's 1998 Federal income tax return would be invalid because GWA did not file an election statement. Pet. Reply, pp. 31-32. Petitioner argues that the section 475(f) election related solely to OGI. Pet. Reply, p. 32. Petitioner in his Motion for Partial Summary Judgment and in his Reply highlights only those portions of GWA's section 475(f) election statement that reference OGI. Pet. Motion, p. 10 ¶ 18; Pet. Reply, p. 32. But the header of the section 475(f) election statement was as follows:

Goldberg Decl. ¶ 10. Petitioner now argues that the election applied only to OGI, but petitioner claimed otherwise in response to an Information Document Request (“IDR”). In response to an IDR, petitioner stated: “[u]nder section 475(c)(2)(E), the Barrier Options are securities and are subject to the mark-to-market election that [GWA] made, unless the Barrier Options can satisfy the exception set forth in section 475(f)(1)(B).” Goldberg Decl. ¶ 11. Nevertheless, in now arguing that the election applied only to OGI, petitioner ignores that under Rev. Proc. 99-17, it was GWA that filed the election, not OGI. In accordance with the procedures of Rev. Proc. 99-17, GWA, not OGI, attached the election statement to its timely filed Federal income tax return.

Respondent agrees with petitioner that Rev. Proc. 99-17 provides the exclusive procedures for traders in securities to make the section 475(f) election. See Pet. Reply, p. 30. To make a section 475(f) election that is effective for a taxable year beginning before January 1, 1999, and for which the original federal income tax return is filed after March 18, 1999, section 5.02 of Rev. Proc. 99-17 requires that the taxpayer make the election by attaching a statement that satisfies the requirements in section 5.04 of Rev. Proc. 99-17 to an original federal income tax return for the election year that is timely filed (including extensions). Section 5.04 of Rev. Proc. 99-17 provides that the written statement must describe:

Here, GWA satisfied each of the above requirements. GWA, the taxpayer, timely filed a statement that was attached to its 1998 federal income tax return, the return for the election year. The statement described the election being made — “ELECTION UNDER INTERNAL REVENUE CODE SECTION 475(f).” Goldberg Decl. ¶ 10. The statement further identified the “tax year ended December 31, 1998” and the trade or business: “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.” Goldberg Decl. ¶ 10. Thus, GWA met all the requirements of Rev. Proc. 99-17 and made a valid election.

Petitioner's reliance on cases where courts have held an election statement invalid is misplaced. In those cases, the taxpayer failed to follow the election requirements. See Kantor v. Comm'r, T.C. Memo. 2008-297, 2008 WL 5396607, at *4 (no section 475(f) election where there was no written election statement and no statement attached to a return); Knish v. Comm'r, T.C. Memo. 2006-268, 2006 WL 3725132, at *4 (no section 475(f) election made for 2000 taxable year where no timely election statement was attached to the 1999 return); Weschenfelder v. Comm'r, T.C. Memo. 2019-133, at *14 (election invalid where election was untimely and election statement was not placed on the front of return as required); New Gaming Sys., Inc, v. Comm'r, T.C. Memo. 2001-277, 2001 WL 1195782, at *4 (invalid election where taxpayer failed to provide most of the information required by the applicable regulation). Here GWA followed the requirements in Rev. Proc. 99-17.

Petitioner cites Plumb v. Comm'r, 97 T.C. 632 (1991) for support that an election statement is invalid where the statement purports to make an election unavailable to the taxpayer. In Plumb, the taxpayer was attempting to elect to forgo carrying back a regular net operating loss, while still carrying back an alternative minimum tax net operating loss. Id. at 634-35. Such an election was not permissible under section 172 under any circumstances. Id. at 640. The election under section 172 would have required petitioner to relinquish the carryback period applicable to both a net operating loss and an alternative minimum tax net operating loss. Id. In Plumb, the Court determined that because the election that the taxpayer tried to make was not legally available under any circumstance, the election was invalid. Id. at 640-41. Unlike in Plumb, here, GWA, as a trader in securities, made a legally permissible section 475(f) election.

Petitioner further claims that even if GWA were treated as making the section 475(f) election, the election would be invalid because the election statement expressly limited the scope of the election to OGI's securities, and the section 475(f) election requires a taxpayer to mark all securities. GWA's election statement did not state that GWA was selectively marking only some of its securities. There was nothing on GWA's election statement that disclosed that GWA held securities directly, in addition to the securities it held through OGI. GWA made a timely and valid election under Rev. Proc. 99-17. GWA should have marked all of its securities held in connection with its securities trading business. GWA's failure to properly mark all of its securities held in connection with its securities trading business does not invalidate GWA's section 475(f) election.

GWA's situation is unlike Plumb where the election was not permissible under section 172 under any circumstances. Id. at 640. In finding that the election was invalid, the Plumb Court found it significant that the election statement provided that “[taxpayers elect to forego [sic] the carryback period for the REGULAR NOL in accordance with section 172(b)(3)(C) and will carry forward this NOL.” 97 T.C. at 641. The Court said that the use of the word “regular” in the election statement made it clear that the Plumb petitioner attempted to make an unavailable election. Compare Branum v. Comm'r, 17 F.3d 805, 809 (5th Cir. 1994) (distinguishing Plumb and finding a valid section 172 election where the face of the election provided that the taxpayer: “hereby elect [sic] to carry forward [sic] all losses sustained in the calendar year . . .” despite the taxpayer's claim that he intended to make a split election and that under Plumb the election was invalid). Here, nothing on the face of GWA's election statement revealed that GWA was attempting to selectively mark some securities, but not others. Accordingly, GWA's election is valid.

Moreover, under the doctrine of election, GWA is bound by the affirmative election made on its 1998 federal income tax return. The doctrine of election precludes a taxpayer from revoking or amending an election without the consent of the Commissioner. Ag Processing, Inc, v. Comm'r, 153 T.C. 34, 55 (2019). Courts apply this doctrine where “(1) there is a free choice between two or more alternatives and (2) there is an overt act by the taxpayer communicating the choice to the Commissioner.” Id. Here, GWA had a free choice between at least two alternatives — recognize gain or loss under section 1001 on the sale of securities or elect under section 475(f) to mark to market its securities. GWA chose to mark to market its securities by electing section 475(f) and through its overt act of attaching an election statement to its return, communicated that choice to the Commissioner. GWA may not now attempt to revoke or amend its election.⁶

In response to an IDR, petitioner explained that at the time GWA made its section 475(f) election:

[GWA] believed that under section 475(f)(3) it could make a “separate” mark-to-market election for its trading business conducted through OGI, as distinguished from [GWA] as an entity, and therefore was not required to satisfy the exception listed in section 475(f)(1)(B). However, section 475(f)(3) does not provide that a trader may elect that only part of its securities trading activity be subject to the mark-to-market election. Rather, section 475(f)(3) provides that separate elections may be made by traders for their securities trading activity or business or their commodities trading activity or business. Thus, unless the Barrier Options met the exception under section 475(f)(1)(B), they were subject to the mark-to-market election made by [GWA] on behalf of OGI.

Goldberg Decl. ¶ 11 (emphasis in original). In this IDR response, petitioner claims that GWA made a mistake of law in thinking that GWA could make an election to mark only part of its securities trading activity. The rule is that once the election is made, the taxpayer must mark to market all securities held in connection with such trade or business. I.R.C. § 475(f)(1)(A). GWA may not now try to invalidate, revoke, or amend its election based on a mistake of law. Grynberg v. Comm'r, 83 T.C. 255, 262 (1984) citing Stamps v. Comm'r, 55 T.C. 468, 474 (1970) (“[o]versight, poor judgment, ignorance of the law, misunderstanding of the law, unawareness of the tax consequences of making an election, miscalculation, and unexpected subsequent events have all been held insufficient to mitigate the binding effect of elections made under a variety of provisions of the Code.”) Accordingly, GWA's section 475(f) election is valid.

Date: August 25, 2021

WILLIAM M. PAUL
Acting Chief Counsel
Internal Revenue Service

By: LISA M. GOLDBERG
Special Trial Attorney (LB&I)
Tax Court Bar No. GL0399
33 Maiden Lane, 12th FL
New York, New York 10038
Lisa.M.Goldberg@irscounsel.treas.gov
(646) 259-8055

MICHAEL A. SIENKIEWICZ
Special Trial Attorney (LB&I)
Tax Court Bar No. SMI 161
33 Maiden Lane, 12th FL
New York, New York 10038
Michael.A.Sienkiewicz@irscounsel.treas.gov
(646) 259-8029

PHILIP S. YARBEROUGH
Senior Counsel (LB&I)
Tax Court Bar No. YP0022
600 Arch St., Suite 03-L14-01
Philadelphia, PA 19106
Philip.S.Yarberough@irscounsel.treas.gov
(267) 941-6574

OF COUNSEL:

ROBIN GREENHOUSE
Division Counsel
(Large Business & International)
JOHN M. ALTMAN
National Strategic Litigation Counsel
(Large Business & International)
ELIZABETH P. FLORES
Senior Level Strategic Litigation Counsel
(Large Business & International)

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Declaration of Lisa M. Goldberg in Support of Sur-Reply to Response to Response to Motion for Partial Summary Judgment

Declaration of Lisa M. Goldberg

1. I am an attorney admitted to practice before the United States Tax Court and I am one of the attorneys assigned to represent respondent in this case.

2. I am competent to testify as to formal matters involved in this case because I have reviewed documents and information from respondent's administrative file from this case, and have reviewed documents and information received in discovery in this matter.

3. This declaration is in support of Respondent's Sur-reply to Petitioner's Reply to Respondent's Response to Petitioner's Motion for Partial Summary Judgment.

4. Attached as Exhibit A is a true and correct copy of a Form 3115, Application for Change in Accounting Method and Statement 1, that was attached to an unsigned version of GWA, LLC's 1998 federal income tax return.

5. Attached as Exhibit B is a true and correct copy of a schedule titled “RBC Alternative Asset, LP” that was part of GWA, LLC's monthly workpapers for the month ending March 31, 2003, which reports the “total value of options” as $114,269,507.70.

6. Attached as Exhibit C is a true and correct copy of a GWA, LLC Balance Sheet dated March 31, 2003 that lists “marketable securities” of $114,269,508.

7. Attached as Exhibit D is a true and correct copy of a Royal Bank Trial Balance for March 1, 2003 through March 31, 2003 that was included as part of GWA, LLC's monthly workpapers for the month ending March 31, 2003, which reports “long inventory-securities” of $466,844,184.83 and “short inventory securities” of ($461,568,120.51).

8. Attached as Exhibit E is a true and correct copy of selected pages from the Deutsche Bank General Ledger Portfolio Detail, Long Inventory Securities (1300) for April 1, 2003 through April 30, 2003 that was included in GWA, LLC's Deutsche Bank Option Reconciliation workpapers for the month ending April 30, 2003, which reports certain “RB/DB Cross” trades.

9. Attached as Exhibit F is a true and correct copy of selected pages from the Deutsche Bank General Ledger Portfolio Detail, Short Inventory Securities (2000) for April 1, 2003 through April 30, 2003 that was included in GWA, LLC's Deustche Bank Option Reconciliation workpapers for the month ending April 30, 2003, which reports certain “RB/DB Cross” trades.

10. Attached as Exhibit G is a true and correct copy of a section 475(f) election statement that was attached to an unsigned version of GWA, LLC's 1998 federal income tax return.

11. Attached as Exhibit H is a true and correct copy of a December 5, 2013 response to an Information Document Request that GWA, LLC produced during the examination stage of the above-captioned case.

I declare under penalty of perjury that the foregoing is true and correct.

Executed on August 25, 2021

LISA M. GOLDBERG
Special Trial Attorney (LB&I)
Tax Court Bar No. GL0399
33 Maiden Lane, 12th FL
New York, New York 10038
Lisa.M.Goldberg@irscounsel.treas.gov
(646) 259-8055