Senate Repeals 60/40 Tax Treatment, Then Reverses Decision

Obama Budget Plan Proposes End to 60/40 Tax Treatment
Feb. 4, 2010

            The Obama administration on Feb. 1, 2010 released its budget proposal for fiscal 2011. The proposal, which serves only as a recommendation for the budget and tax writing committees of Congress, contains a provision requiring “ordinary treatment of income from day-to-day dealer activities” in commodities and equity options. The provision effectively would do away with the current 60/40 tax treatment that allows dealers to pay a blend of capital gains and ordinary tax rates on their gains and losses from trading futures and options.
            Documents released by the Office of Management and Budget explained why the administration supports this provision. 
           "Under current law, certain dealers in securities, equity options, commodities, and commodities derivatives treat the income from section 1256 contracts entered into in their capacity as a dealer as generating 60% long-term capital gain (or loss) and 40% short-term capital gain (or loss)," the OMB documents stated. "Dealers in other types of property uniformly treat the income generated by their dealer activities as ordinary income. There is no reason to treat dealers in different types of property differently. The Administration's proposal would therefore require dealers in securities, equity options, commodities, and commodities derivatives to treat the income (or loss) from their dealer activities as ordinary in character."
            Since 1981, futures and options dealers have been operating under the 60/40 treatment. Under this tax rule, 60 cents of each dollar earned by a futures or options dealer is taxed at the capital gains rate while the remaining 40 cents is taxable at the ordinary rate, resulting in a blended tax rate. The budget plan estimates that doing away with this special tax treatment could raise roughly $2.6 billion over the next 10 years.
            The proposed elimination of the 60/40 tax rule will not be implemented unless and until it is approved by the Congressional committees that have jurisdiction over budgetary and tax issues. The administration proposed the elimination of 60/40 tax treatment in its fiscal 2010 budget plan, but Congress did not include that proposal in any of the tax bills that were enacted.

May 19, 2003 --After weeks of negotiations on a broad package of tax reductions and economic stimulus measures, the Senate on May 15 narrowly approved the Jobs and Growth Tax Relief Reconciliation Act of 2003. During the voting process, the Senate agreed to a manager's amendment containing a number of revenue enhancements designed to limit the overall cost of the legislation. One of these measures repealed section 1256(a)(3) of the Internal Revenue Code and thereby eliminated the current 60/40 tax treatment applied to gains and losses on futures and options transactions.

Responding to an intensive 3-day lobbying campaign from the futures and options industry, the Senate on May 20 approved a "technical corrections" bill that among other things removed the 60/40 repeal from the tax bill. Republican leaders are now negotiating ways to combine the House and Senate versions of the tax bill. The 60/40 repeal is not contained in the House version, and now that it has been struck from the Senate bill, the current tax regime for futures and options is no longer a part of the current tax discussions.

The FIA, together with leading U.S. futures exchanges, played an important role in persuading key members of Congress to reject the hastily approved repeal of 60/40. In letters and conversations with lawmakers, the FIA stressed the damaging repercussions of such a change on the markets and their participants, including investors in commodity pools and hedge funds. In addition, the FIA pointed out that the provision would have eliminated the 60/40 treatment, but leave untouched other sections of the tax code that require the assessment of taxes on unrealized gains and losses at year-end. In effect, the Senate bill would have made it impossible for market participants to record any long-term gains or losses on futures and options transactions.