Legal ruling 1995-6

Adoption of Mark-to-Market Method of Accounting for Dealers in Securities

Issue

1. Whether a taxpayer required pursuant to IRC section 475 to change its method of accounting for federal tax purposes may make the same change for California tax purposes, even though California does not require the change.
   
   
2. How does a taxpayer required to change its method of accounting for federal tax purposes pursuant to IRC section 475 implement the change for California tax purposes?
   
   
3. How does a taxpayer that has already filed its California returns for years prior to the date of this notice comply with the provisions set forth in this notice?

In each of the situations described below, the taxpayer is a dealer in securities as defined in IRC section 475, is a calendar year taxpayer and timely filed returns for1993 and 1994.  Prior to 1993, the taxpayer did not use the mark-to-market method of accounting for federal or state tax purposes.  As required by the statute, the taxpayer has filed federal returns using the mark-to-market method of accounting commencing with the year ended December 31, 1993.

Situation 1: For California tax purposes, the taxpayer prepared and filed returns for 1993 and 1994 using its historical method of accounting.  The taxpayer desires to continue to use the historical method of accounting for California purposes despite the required federal change.

Situation 2: For California tax purposes, the taxpayer prepared and filed returns for 1993 and 1994 using its historical method of accounting. The taxpayer desires to change to the mark-to-market method of accounting for California tax purposes in conformity with the federal requirements for taxable years commencing with 1993.

Situation 3: For California tax purposes, the taxpayer prepared and filed returns for 1993 and 1994 using the mark-to-market method of accounting. The taxpayer desires to continue to use the mark-to-market method of accounting for  California tax purposes.

Situation 4:  For California tax purposes, the taxpayer prepared and filed returns for 1993 and 1994 using the mark-to-market method of accounting. The taxpayer desires to continue to use its historical method of accounting for California tax purposes.

Law and Analysis

Internal Revenue Code ("IRC") section 475 was enacted in 1993 to require dealers in securities to use the mark-to-market accounting method for valuing certain dealer-held securities. Any taxpayer required to change its method of accounting to comply with IRC § 475 is deemed to have initiated the change and received consent from the Secretary of the Treasury. P.L. 103-66, § 13223(c)(2).

In general, the IRC amendment applies to all tax years ending on or after December 31, 1993; therefore, calendar year taxpayers had to comply with the rules for 1993.

California has not conformed to the provisions of IRC § 475 to date. This legal ruling is published to provide guidance concerning procedural compliance. For purposes of this legal ruling, all references to "securities held at year end" or "dealer-held securities" shall be to securities to which IRC § 475 applies.

Issue A - Permissible Methods for California

IRC § 475 requires a dealer in securities to use the mark-to-market method of valuing securities held by the dealer at year end. Prior to enactment of IRC § 475, the mark-to-market method was one of three permissible accounting methods for valuing securities. California conformed to the use of each of these three methods. Revenue and Taxation Code ("R&TC") §§ 17551, 24651. After enactment of IRC § 475, all dealers in securities had to account for securities held at year end using the mark-to-market method. If a taxpayer is required to change its method of accounting for federal tax purposes to comply with IRC § 475, the taxpayer shall be treated as having initiated the change in accounting method and received the consent of the Secretary. The net adjustment amount from the change in accounting method required pursuant to IRC § 481 shall be taken into account ratably over a 5-year period beginning with the year in which the change occurred.

Although California has not conformed to IRC § 475, the mark-to-market method of accounting for dealers in securities is a permissible method under current California tax law. Therefore, a taxpayer required to change to the mark-to-market method of accounting for federal tax purposes may use the mark-to-market method of accounting for California tax purposes as well.

Issue B - Election Provisions

For California tax purposes, a taxpayer required to file an application or seek consent for a change in accounting method is required to follow the rules dealing with taxpayer elections set forth in R&TC §§ 17024.5(e)&(f) and 23051.5(e)&(f). If a taxpayer is entitled to make an election for California tax purposes, an election filed with the Internal Revenue Service in accordance with the Internal Revenue Code or Treasury regulations shall be deemed an election submitted to FTB unless otherwise provided in the R&TC. R&TC §§ 17024.5(e)(1), 23051.5(e)(1). If a taxpayer desires California tax treatment different from that elected for federal tax purposes, such taxpayer may need to file a separate election with the FTB. R&TC §§ 17024.5(e)(3), 23051.5(e)(3).

If a taxpayer desires to use the same method of accounting for federal and state tax purposes, the federal request and consent to change is sufficient for California tax purposes. Therefore, a taxpayer required by IRC § 475 to change its method of accounting for securities that files a California return conforming to the federal tax accounting for securities has elected to use such accounting method for California tax purposes. The deemed consent set forth in IRC § 475 is sufficient for the required FTB consent.

A dealer in securities that chooses not to follow IRC § 475 to determine its California tax liability must affirmatively elect out of the mark-to-market method. Such election may be made by filing a California tax return that uses a different method of accounting for securities. A later change to the mark-to-market method of accounting for California purposes would be a change of accounting method for which FTB consent would be required. First Federal Savings and Loan Association of San Diego, Cal. St. Bd. of Equal., February 18, 1964. Note, in the event California enacts legislation at some future date conforming to IRC § 475 alternatives may be provided for adopting the mark-to-market method of accounting for securities.

Issue C - Retroactive Application Provisions

IRC amendments enacting IRC § 475 apply to tax years ending on or after December 31, 1993.Therefore, calendar year taxpayers adopted the requisite change of accounting method (for federal tax purposes) in calendar year 1993. Timely federal and state tax returns for 1993 (and possibly 1994) have already been filed.

If a dealer in securities that timely filed its returns desires to change its reported position in accordance with this FTB notice, such taxpayer shall be permitted to file an amended return for the first year in which IRC § 475 was required for federal tax purposes. Such amended return must be filed on or before March 31, 1996, in accordance with the rules specified in this notice. In addition, all returns filed for later years must be amended to conform with such California tax election, including the IRC § 481 income adjustment attributed to the change in accounting methods, and filed with FTB on or before March 31, 1996. Failure to file amended returns by such date shall constitute either an election not to use the mark-to-market method for California tax purposes or to use such method as required for federal tax purposes, as the case may be, depending on the position taken on the originally filed California return.

Situation 1: The California tax returns are filed as desired. No amended returns are required. Note, however, a subsequent change to the mark-to-market method of accounting will require the consent of the FTB absent contrary instructions in a statute conforming to IRC § 475, if any.

Situation 2: The taxpayer must prepare amended returns for 1993 and 1994 using the mark-to-market method of accounting. The amended returns must be filed no later than March 31, 1996.

Situation 3: The California tax returns are filed as desired. No amended returns are required.

Situation 4: The taxpayer must prepare amended returns for 1993 and 1994 using its historical method of accounting. The amended returns must be filed no later than March 31, 1996.

Note, although each factual situation presented involved a taxpayer that filed returns reflecting a calendar year, the same analysis would apply to a taxpayer who filed returns reflecting a fiscal year. In any event, any amended return required to apply the provisions of this ruling must be filed with the FTB on or before March 31, 1986.

Holdings

1. A taxpayer required to change its method of accounting pursuant to IRC § 475 may implement the same change for California purposes.
   
   
2. The federal change in accounting method shall be an automatic change for California unless the taxpayer affirmatively elects not to change its method of accounting for California tax purposes by filing its California tax return using its historical method of accounting.
   
   
3. A taxpayer that chooses to change from the position taken on its filed returns (to either conform to the federal return or to affirmatively elect California tax treatment different from the federal return) must file amended returns with the FTB no later than March 31, 1996. Amended returns filed after March 31, 1996 shall be ineffective to change the accounting method from that used on the original California return. This election is available only for the year of change for federal tax purposes.

The principal author of this legal ruling is Kimberly Mitchell Bott of the Franchise Tax Board Legal Division. For further information regarding this legal ruling, contact Ms. Bott at the Franchise Tax Board Legal Branch, P.O. Box 1720, Rancho Cordova, CA 95741-1720, (916) 845-3007.

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