The MF Global Tax Trap & How to Handle 2011 Tax Extensions

Discussion in 'Retail Brokers' started by Robert A. Green, Apr 4, 2012.

  1. There is still significant money missing from MF Global customers’ futures accounts. The bankruptcy trustee sent MF Global customers 2011 Form 1099-Bs showing their realized and unrealized trading gains and losses from Section 1256 contracts. (Note: The cost-basis reporting crisis does not extend to futures. Taxpayers and tax preparers can rely on Form 1099-Bs for futures, whereas they cannot for securities 1099-Bs.)

    MF Global’s bankruptcy trustee James W. Gibbons added this note to the Form 1099-Bs: “Although you may not have recovered the entire value of your MFGI account in the SIPA Proceeding (bankruptcy process), your Form 1099 reflects all transactions credited to your MFGI account during 2011. You should consult your tax advisor to determine whether you may claim a deduction or loss for income tax purposes as a result of your not having recovered the full amount of your account.”

    Gibbons doesn’t say which year the loss may be taken. It’s the consensus of our CPAs and tax attorneys — and the consensus of others we have seen on the Internet — that a MF Global deposit loss recognition event most likely occurs after 2011.

    Tax law for writing off deposit losses
    The loss is not determined and the trustee still hopes to recover the entire amount (or much more) of missing customer monies. Certainly, they should, as these monies were taken inappropriately and as I pointed out in my Dec. 9 Forbes blog “How To Pay Back MF Global Customers 100%,” why can’t those last-minute transactions to pay counterparties with customer funds be reversed, and the monies recovered? I still believe that not doing this recovery is illegal and wrong. But, this has no affect on my discusson of tax posture.

    The loss is not yet realized. Tax law for deposit impairment, casualty or theft loss or capital losses all require a known loss and a realization event of that loss. Again, the missing MF Global monies are being recovered slowly and some hold out hope for full or significant recovery. Although the bankruptcy and liquidation happened Oct. 31, 2011 and some courts ruled in early December 2011 on certain matters, the “missing money” file remains open and that is telling for tax purposes.

    The tax code isn’t always logical or fair
    It doesn’t matter if taxpayers took withdrawals of their trading gains during the year at MF Global or not — it has no effect on reporting their underlying trading gains and losses. If you made $200,000 trading futures in 2011 and $90,000 went missing — at no fault of your own — shouldn’t you be able to report $110,000 of net income on your 2011 tax returns? Then, if monies are recovered later, you would report that amount paid during the year it was received. This seems logical but currently it’s not an option.

    The tax code works in strange ways that seem logical to accountants, but not so much to taxpayers. Accounting and tax principles always call for reporting transactions on a gross basis, without netting and offsetting transactions to change the character of income or loss. Taxpayers need to report their trading gains and losses separate from any loss on their deposits, just as Gibbons said in his note.

    An example of the tax trap
    It’s tax time and we need to make decisions in spite of any uncertainty for a client with missing monies at MF Global. Mr. Gibbons sent our client a 2011 Form 1099-B showing $1.7 million of Section 1256 trading gains. Our worksheet shows our client has still not recovered $1 million of his funds as of this date.

    We’ve waited as long as we can for news, and now we must finalize his 2011 tax extensions due April 17, 2012. We’ve already entered his $1.7 million of Section 1256 contract trading gains on Form 6781. The good news is the lower 60/40 tax rates apply, so 60 percent is considered a long-term capital gain. But we don’t see a way to deduct all or a portion of his $1 million of unrecovered customer funds in 2011. Our client shows a significant tax liability and balance due with the extension filing. We have some ideas for clients who need to pay less below.

    Business traders fare better in the tax trap
    Let’s assume the worst — that our client never recovers the missing $1 million. If the trustee gives up and the money is declared fully lost in 2012, what happens next? Our client is luckier than many others since he qualifies for trader tax status (business treatment on trading futures) in 2012, and therefore his realized deposit-impairment loss will be a business bad debt. This means he’s entitled to Section 162 ordinary gain or loss treatment on a bad-debt loss, so it’s a full ordinary business loss. If there’s negative taxable income after this loss offsets any type of income, the client will have a net operating loss (NOL) carryback and/or carryforward.

    MF Global customers can’t accrue a reserve or provision for 2011 taxes
    Could a business trader on the accrual method of accounting accrue a reserve or provision before year-end 2011? Our tax attorney Mark Feldman said “no” and provided us with this tax research from RIA: “Reserves are generally not accruable. Although it is sound accounting and good business practice to deduct from current income estimated amounts to cover a variety of contingencies, these reserves (except for those few expressly authorized by the Code) are not deductible for tax purposes.” We reviewed the list of expressly authorized “reserves” or “provisions” which are allowed as tax deductions, and a deposit loss is not on that list.

    RIA observation: “The underlying principle is that the income tax law is concerned only with realized losses and expenses. Furthermore, since the amount of a contingent liability ordinarily cannot be ascertained with any definite degree of accuracy, the underlying reserve is not susceptible of computation within a reasonably narrow limit, there is no assurance that the amount of the reserve will accurately reflect the actual future liability.”

    Investors get a shorter end of the tax stick.................

    See the full blog here
  2. Wow what a total joke that part of the tax code is. In UK for example you would be able to write this bad debt/loss off as soon as it was 'reasonable' to assume it was going to be bad i.e. in 2011 tax year (in fact I had this situation one year with about 60k euros investment that went up in smoke, but that took years until known 100% could not be recovered). Obviously this totally screws someone who made say 1 million in profit on a 100k account, and now owes more than their entire net worth despite *losing* 1 million overnight - effectively you would bankrupt a viable business/individual who had done nothing wrong, seize their pre-existing life savings, house, car etc, just because someone else stole their account. Sounds like you need urgent reform of this section of the tax code - the obvious thing would be to allow the option of writing off a bad debt as soon as it becomes probable, and then if it eventually gets recovered, you repay the tax owed then.

    It also means traders can't keep their year earnings in their account, but must withdraw them and put them into t-bills individual owned and lodged direct with the government. Each day you must wire out your P&L in case the broker goes under and leaves you with a tax liability you have no means to pay.
  3. Correction to earlier post. It's Mr. James W. Giddens, as MF Global trustee.
  4. Caught Between MF Global And The Tax Man

    My Forbes blog version.

    Does anyone have any other ideas for tax treatment on MF Global accounts with unrecovered funds in 2011 and 2012?

    I want this thread to discuss these tax issues and how best to handle them.

    Has everyone received a 1099-B from the bankruptcy trustee?

    It's an unfortunate situation and sometimes you can count on tax treatment or relief to help turn garbage into gold, but in this case the tax treatment is not as good as it should be.
  5. IRS issues tax guidance on MF Global missing customer funds

    Forbes blog version.

    As posted on the Commodity Customer Coalition(CCC) Website, the CCC requested tax guidance from the IRS on how to handle missing customer funds from MF Global for tax years 2011 and 2012.

    The CCC Website shows this IRS reply letter and the IRS tax guidance matches the tax guidance we gave in our blog The MF Global Tax Trap & How to Handle 2011 Tax Extensions.

    CCC sent an email update to its members on April 12, 2012 which included our Forbes blog for further tax guidance. Excerpt:

    Information for Your Tax Preparer
    CCC members should consult with their own legal, tax or financial advisor before filing any tax returns with the Internal Revenue Service. The following is not meant to provide any legal or financial advice but rather provide CCC members with an update from the IRS and general information concerning MF Global tax issues.

    1. IRS Responds to CCC on Tax Issues

    2. article about MF Global Tax Issues