October 18, 1993
New Regulations Resolve Hedging Issues
WASHINGTON - The IRS today issued regulations on the character
of gains and losses from hedging transactions and proposed
regulations governing when those gains and losses are reported.
This completes a comprehensive IRS study of the tax history of
hedging. The character regulations are effective immediately and
for all open tax years, while the timing regulations are proposed to
be effective when they are finalized.
The character regulations state that the gains or losses from
most common business hedges are to be treated as ordinary--rather
than capital--gains or losses. As a result, hedging losses
generally are not subject to the tax law limits on the deductibility
of capital losses. To ensure that income from hedging transactions
in clearly reflected, the proposed timing regulations generally
would require taxpayers to take income or deductions form a hedge
into account in the same tax year as the income or deductions form
the hedged item.
"Resolution of the many issues concerning hedging transactions
has been a priority for this administration," IRS Commissioner
Margaret Milner Richardson said. "We believe that the character and
proposed timing regulations represent a balanced and thoughtful
approach to the treatment of hedging transactions."
A hedge is a financial transaction that reduces a taxpayer's
business risk. For example, many grain farmers take short futures
positions--contracts to sell for a fixed price at some fixed
date--to hedge their exposure to a drop in the market price for
Because the character regulations apply to all open tax years,
they will simplify ongoing audits and eliminate many pending cases
where the character of hedging losses in a dispute. After 1993, the
taxpayer must identify the transaction as a hedge in order to
receive ordinary treatment.
Much of the uncertainty regarding to the character of hedging
gains and losses grew out of the Supreme Court case "Arkansas Best
v. Commissioner". Based on that decision, the IRS, in individual
cases, treated various types of hedging transactions as giving rise
to capital gain or loss.
The preamble to the character regulations notes, however, that
a recent Tax Court case--"Federal National Mortgage Association v.
Commissioner"--"clearly found Arkansas Best not to be an impediment
to treating gains and losses on business hedging transactions as
ordinary rather than capital." Thus, the preamble state, "the
service has decided to abandon the position it has taken with
respect to the character of many common business hedged and to
resolve that issues with these regulations."
The character and proposed timing regulations were filed today
with the Federal Register and will be published on October 20, 1993.
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