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 their grain.

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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