Basket options used by hedge funds to convert short-term capital gains to long-term ones no longer will be allowed, the IRS said.
In notices posted on its website Wednesday, the IRS declared basket options to be listed transactions, meaning ones used for tax avoidance. “The contract allows the taxpayer to trade the securities referenced in the contract while the contract purportedly remains open … Consequently, option treatment is not warranted, and the income deferral and conversion to long-term capital gain is improper,” said one of two related IRS notices.
Both notices will be published in Internal Revenue Bulletin 2015-30 on July 27.
Sen. Ron Wyden, D-Ore., the ranking member of the Senate Finance Committee, pressed the IRS in June to issue the guidance “to shut down a tax shelter” that he said avoided more than $1 billion in taxes.
Basket options were the subject of a Senate hearing in July 2014 that focused on their use by Renaissance Technologies and other hedge funds offering the strategy to banks. At that hearing, Mark Silber, executive vice president, chief financial officer, chief compliance officer and chief legal officer for Renaissance Technologies, said the arrangements, also known as barrier options, were entered into “for substantial non-tax business purposes,” mainly to protect against losses when trading at high leverage.
Mr. Wyden praised the IRS’ latest action, which he said in a statement brought “the hammer down on these basket options once and for all.”
“There was very little legal support for what they are doing,” said Steven Rosenthal, a tax lawyer and visiting fellow at the Tax Policy Center in Washington, in an interview, calling the notices “the final nail in the coffin for basket options.”