Source: https://www.law.cornell.edu/wex/dodd-frank_title_xvi_-_section_1256_contracts
Timestamp: 2020-05-26 10:05:50
Document Index: 221600796

Matched Legal Cases: ['§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256', '§ 1256']

Dodd-Frank: Title XVI - Section 1256 Contracts | Wex | US Law | LII / Legal Information Institute
Title XVI supplements Title VII and modifies Internal Revenue Code (IRC) § 1256 by exempting certain derivative contracts from treatment as § 1256 contracts for taxation purposes. Title VII imposes trading and margin requirements that inadvertently impose § 1256 requirements on certain derivative contracts known as swaps. For purpose of calculating taxable income, § 1256 requires taxpayers to treat qualifying contracts as if they had been sold for fair market value on the last day of the tax year. If Congress had not enacted Title XVI to restore the status quo of pre-Title VII derivative tax law, investors holding swaps might have been exposed to unintentional adverse tax consequences.
Title XVI is comprised of a single section that modifies IRC § 1256 by exempting certain derivative contracts from treatment as § 1256 contracts for taxation purposes. See 26 U.S.C. § 1256(b)(2). The exempt derivative contracts are securities futures contracts, options on securities futures contracts, interest rate swaps, currency swaps, basis swaps, interest rate caps, interest rate floors, commodity swaps, equity swaps, equity index swaps, credit default swaps and similar agreements. See id. Title XVI is the Dodd-Frank Act’s only tax-related provision.
To prevent these unintended tax consequences, Title XVI restores the status quo of pre-Title VII derivative tax law by expressly stating that certain swaps will continue to be exempt from IRC § 1256. Under § 1256, taxpayers must recognize taxable gains and losses on qualified derivative contracts as if the contract was sold for fair market value on the last day of the tax year. See 26 U.S.C. § 1256(a)(1). Regardless of how long the taxpayer has held the contract, the capital gains and losses on the hypothetical sale are arbitrarily categorized as 60% long-term and 40% short-term. See 26 U.S.C. § 1256(a)(3). Prior to Title VII’s enactment, taxpayers did not recognize any taxable income or losses on swaps until some sort of realization event occurred, such as selling the contract for cash. Additionally, income and losses derived from swaps were categorized as ordinary income or losses.
Title XVI prevents investors holding swaps from experiencing increased volatility in taxable capital gains and losses. Companies often invest in swaps to hedge against risks and usually consider tax implications when deciding whether or not to buy or sell derivative contracts. The fair market value of a swap depends on fluctuating market conditions and is therefore highly unpredictable. Under Title VII’s provisions, companies would have to recognize the unpredictable capital gains or losses from the hypothetical sale on the last day of the tax year, rather than waiting to buy or sell the swap at a time that is most beneficial for tax purposes. Thus, Title XVI prevents unexpected capital gains and losses, and consequently allows companies to engage in more effective tax planning.
Newton, John R. "Deactivating the Weapons of Mass Volatility: The Dodd-Frank Act Section 1256 and the Taxation of Derivatives." Society of Actuaries. May 2011.
‹ Dodd-Frank: Title XV - Miscellaneous Provisions up Securities Dispute Resolution ›