T.C. Memo. 2004-132
UNITED STATES TAX COURT
FRANK CHEN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1271-03. Filed June 1, 2004.
During 1999, P incurred a net loss of $84,794 in
connection with 323 transactions involving the purchase
or sale of securities, most of which P held for less
than 1 month. Approximately 94 percent (303) of those
transactions occurred during February, March, and April
1999, with no transactions occurring in 6 of the other
9 months. Attached to P’s petition was a purported
retroactive election under sec. 475(f)(1), I.R.C., of
mark-to-market accounting, available to “traders in
securities”, to be effective as of Jan. 1, 1999. P
claims that, pursuant to that election, he is entitled
to treat the loss arising out of his 1999 trading
activities as a fully deductible, ordinary loss
incurred in a trade or business under sec. 165(c)(1),
I.R.C.
1. Held: During 1999, P was not a “trader in
securities” eligible to make a mark-to-market election
under sec. 475(f)(1), I.R.C.
- 2 -
2. Held, further, P is entitled to deduct his
1999 net loss from purchases and sales of securities to
the extent of $3,000. Secs. 165(f), 1211(b)(1), I.R.C.
Frank Chen, pro se.
Paul T. Butler and Lindsey D. Stellwagen, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HALPERN, Judge: By notice of deficiency mailed to
petitioner on October 15, 20021 (the notice), respondent
determined a deficiency in petitioner’s 1999 Federal income tax
of $611,357 and additions to tax totaling $252,093. On brief,
respondent concedes the additions to tax. As a result of an
agreement between the parties, the only issue remaining for
decision is whether petitioner’s net loss of $84,794 from the
purchase and sale of securities during 19992 is, for that year,
deductible in full, or, pursuant to a limitation applicable to
capital losses, only to the extent of $3,000.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1999, and all Rule
1
Because of administrative error, the notice of deficiency
was dated Oct. 15, 2003.
2
We assume from the stipulation of the parties that the
net loss of $84,794 was realized upon actual sales of the
securities in question.
- 3 -
references are to the Tax Court Rules of Practice and Procedure.
All dollar amounts have been rounded to the nearest dollar.
FINDINGS OF FACT
Some facts are stipulated and are so found. The stipulation
of facts, with accompanying exhibits, is incorporated herein by
this reference.
At the time the petition was filed, petitioner resided in
Shanghai, China.
Petitioner’s Purchases and Sales of Securities
During 1999, petitioner maintained two brokerage accounts
for conducting securities transactions: one with Charles Schwab &
Co., Inc., and one with Datek Online Brokerage Services, which
subsequently merged with Ameritrade. During 1999, through those
two accounts, petitioner initiated 323 transactions involving the
purchase or sale of securities (including short sales), broken
down by month as follows:
Month Number of Trades
January 12
February 133
March 145
April 25
May 4
July 4
Petitioner held most of those securities for less than a
month, and petitioner’s 1999 short sales were generally covered
- 4 -
by the purchase of securities within a month. To assist him in
deciding which securities to invest or trade in, petitioner used
software that enabled him to receive up-to-date information such
as “Level II NASDAQ quotations” and Dow Jones “real time” data.
For all of 1999, petitioner resided in San Jose, California,
and was employed, full time, by MediaQ, Inc. as a computer chip
engineer. He received wages of $74,699 from his employer in
1999.
Petitioner’s Purported Election Under Section 475(f)
Petitioner did not timely file a Federal income tax return
for 1999. After receipt of the notice, petitioner timely filed
an “imperfect” petition3 on January 22, 2003, which was later
perfected by the filing of an amended petition on March 14, 2003.
Attached to the amended petition is a copy of a Form 1040, U.S.
Individual Income Tax Return, for 1999 together with various
documents attached to that return, including copies of (1) a
purported retroactive election, under section 475(f) (dated March
9, 2003, to be effective January 1, 1999), of the mark-to-market
method of accounting for traders in securities (the election),
and (2) a purported cover letter conveying the election to the
IRS and describing the election as “an application for making
election under section 475(f)”. In the election itself, under
3
The petition was signed by a representative of
petitioner’s who was not admitted to practice before this Court.
- 5 -
the heading “RULING REQUESTED”, petitioner “[requests] Service
authority [to] implement mark-to-market accounting methods [sic]
to Jan. 1, 1999,” and he affirmatively states that he became a
daily trader effective as of that date.
OPINION
I. Background: Effect of Trader Status and a Mark-To-Market
Election Under Section 475(f)
Assuming that, during 1999, petitioner was engaged in a
trade or business (sometimes, without distinction, business) as a
“trader in securities”, he would have been eligible to elect to
“recognize gain or loss on any security held in connection with
such trade or business at the close of any taxable year as if
such security were sold at its fair market value * * * [at
yearend]”. Sec. 475(f)(1)(A)(i). In general, any gains or
losses with respect to such securities, whether deemed sold at
yearend under the mark-to-market method of accounting or actually
sold during the taxable year, “shall be treated as ordinary
income or loss.” Sec. 475(d)(3)(A), (f)(1)(D). If, during 1999,
petitioner was in business as a trader in securities and he made
a mark-to-market election under section 475(f)(1) with respect to
sales of securities held in connection with that business,
petitioner’s 1999 net loss from that business would be an
ordinary loss, deductible in full under section 165(c)(1).
Conversely, if petitioner is considered an investor in securities
during 1999, or, assuming trader status, he failed to make an
- 6 -
effective mark-to-market election for that year under section
475(f)(1), his 1999 net loss from purchases and sales of
securities would be a capital loss deductible only to the extent
of $3,000. See secs. 165(f), 1211(b)(1).
II. Arguments of the Parties
A. Petitioner’s Argument
Petitioner argues that, by virtue of the volume and short-
term nature of his securities trades during 1999, the time
devoted daily to his trading activities, and his substantial
investment in software used to provide information regarding up-
to-the-minute market conditions, he qualified as a “trader in
securities” for purposes of section 475(f)(1).4
Petitioner further argues that, because he was, in fact, a
trader as of January 1, 1999, and was unaware of the requirement
to timely elect mark-to-market accounting under section 475(f) in
order to treat his trading losses as fully deductible ordinary
losses under section 165(c)(1), he should be permitted to make an
untimely, retroactive election under that section. We interpret
petitioner’s “request” to “implement” mark-to-market accounting
and his defense of his right to do so untimely as, in substance,
an argument that we must find that (1) the election of mark-to-
market accounting attached to petitioner’s return was an informal
4
The term “trader in securities” is not further defined in
sec. 475 or in the regulations interpreting that section.
- 7 -
request, pursuant to section 301.9100-3, Proced. & Admin. Regs.,
for an extension of time to make the election, and (2) respondent
improperly denied that request.
B. Respondent’s Argument
Respondent argues that petitioner’s brief foray into high-
volume, short-term securities trading, during 1999, was of
insufficient duration to enable him to qualify as a “trader in
securities” for purposes of section 475(f)(1).
Respondent further argues that, even if petitioner qualified
as a trader in securities as of January 1, 1999, he failed to
make an effective mark-to-market election under section 475(f)
and Rev. Proc. 99-17, 1999-1 C.B. 503, pursuant to which an
election effective for taxable years beginning on or after
January 1, 1999, should have been filed “not later than the due
date (without regard to extensions) of the original * * * return
for the taxable year immediately preceding the election year”,
or, in this case, by April 15, 1999, the due date of petitioner’s
1998 return. See Rev. Proc. 99-17, 1999-1 C.B. at 504.
Lastly, respondent argues that petitioner “never made a
request for an extension of time to make the [section 475(f)]
election.”
- 8 -
III. Petitioner’s Status as a Trader in Securities
A. Applicable Principles of Law
In general, for Federal tax purposes, a person who purchases
and sells securities falls into one of three distinct categories:
dealer, trader, or investor. See King v. Commissioner, 89 T.C.
445, 458-459 (1987). Both traders and dealers are engaged in the
trade or business of buying and selling securities. Only the
dealer’s business, however, involves sales to customers in the
ordinary course of that business. Consequently, only the
dealer’s securities fall within the exception to capital asset
status that is provided for “property held by the taxpayer
primarily for sale to customers in the ordinary course of his
trade or business”. Sec. 1221(a)(1). Thus, “traders * * *
occupy an unusual position with respect to the tax laws. Traders
may engage in a trade or business which produces capital gains
and losses rather than ordinary income and losses.” King v.
Commissioner, supra at 457.
In order to qualify as a trader (as opposed to an investor)
petitioner’s purchases and sales of securities during 1999 must
have constituted a trade or business. “In determining whether a
taxpayer who manages his own investments is a trader, and thus
engaged in a trade or business, relevant considerations are the
taxpayer’s investment intent, the nature of the income to be
derived from the activity, and the frequency, extent, and
- 9 -
regularity of the taxpayer’s securities transactions.” Moller v.
United States, 721 F.2d 810, 813 (Fed. Cir. 1983). In general,
investors purchase and hold securities “for capital appreciation
and income” whereas traders buy and sell “with reasonable
frequency in an endeavor to catch the swings in the daily market
movements and profit thereby on a short-term basis.” Liang v.
Commissioner, 23 T.C. 1040, 1043 (1955). For a taxpayer to be
considered a trader, the taxpayer’s trading activity must be
“substantial”, and it must be “frequent, regular, and continuous
to be considered part of a trade or business. * * * Sporadic
trading does not constitute a trade or business.” Boatner v.
Commissioner, T.C. Memo. 1997-379, affd. 164 F.3d 629 (9th Cir.
1998); see also Commissioner v. Groetzinger, 480 U.S. 23, 35
(1987) (“We accept the fact that to be engaged in a trade or
business, the taxpayer must be involved in the activity with
continuity and regularity * * *. A sporadic activity * * * does
not qualify.”).
B. Application of Trader Status Criteria to Petitioner
Respondent concedes that for “parts of the months of
February, March, and April, petitioner engaged in daily
transactions.” It also seems clear that, during those 3 months,
petitioner satisfied the first requirement for trader status,
that he buy and sell with frequency in order “to catch the swings
in the daily market movements”. See Liang v. Commissioner, supra
- 10 -
at 1043. Petitioner’s problem is that he fails to satisfy the
second, equally important requirement for trader status, that his
purchases and sales of securities be “frequent, regular, and
continuous”. See Boatner v. Commissioner, supra.
Because 303, or approximately 94 percent, of the 323
transactions in which petitioner either purchased or sold
securities during 1999 occurred in the February to April
timeframe, with the balance occurring in January, May, and July
and no trades occurring in any of the other 6 months,
petitioner’s 1999 trading activity reasonably qualified as
“frequent, regular, and continuous” only during February, March,
and April.5 Moreover, throughout 1999, petitioner maintained a
full-time job as a computer chip engineer.
In the cases in which taxpayers have been held to be traders
in securities, the number and frequency of transactions indicated
that they were engaged in market transactions almost daily for a
substantial and continuous period, generally exceeding a single
taxable year; and those activities constituted the taxpayers’
sole or primary income-producing activity. See Levin v. United
5
In his purported election of the mark-to-market
accounting method, petitioner represents that he became a “daily
trader” as of Jan. 1, 1999. Moreover, his 2000 and 2001 returns
report his gains and losses from purchases and sales of
securities on Schedule D, Capital Gains and Losses, not on
Schedule C, Profit or Loss From Business. Thus, the evidence
indicates that petitioner’s daily trading activities occurred
only during the 3 months of February, March, and April 1999.
- 11 -
States, 220 Ct. Cl. 197, 597 F.2d 760 (1979); Fuld v.
Commissioner, 139 F.2d 465 (2d Cir. 1943), affg. 44 B.T.A. 1268
(1941). Conversely, where, as in this case, (1) the taxpayer’s
daily trading activities covered only a portion of a single
taxable year, and (2) securities trading was not the sole or even
primary activity in which the taxpayer engaged for the production
of income, trader status was denied. See Paoli v. Commissioner,
T.C. Memo. 1991-351. Daily trading in securities for only a
quarter of a single taxable year is reasonably characterized as
“sporadic” rather than “frequent, regular, and continuous”, and,
therefore, insufficient to achieve trader status. Boatner v.
Commissioner, supra; see also Commissioner v. Groetzinger, supra.
C. Conclusion
Petitioner failed to qualify as a trader in securities
during 1999.
IV. Effect of Petitioner’s Purported Retroactive Election of the
Mark-to-Market Method of Accounting Under Section 475(f)
Because we find that petitioner was not a trader in
securities during 1999, a mark-to-market election under section
475(f) is not available to petitioner for that year. Sec.
475(f)(1). Therefore, we do not address petitioner’s argument
that he was improperly denied the right to make such an election.
- 12 -
V. Conclusion
Petitioner is entitled to deduct his 1999 net loss from
purchases and sales of securities to the extent of $3,000. See
secs. 165(f), 1211(b)(1).
Decision will be entered
under Rule 155.