ANALYSIS – U.S. trader tax plan faces big hurdles

February 19, 2010

By Kim Dixon and Doris Frankel

WASHINGTON/CHICAGO, Feb 19 (Reuters) – The Obama administration’s proposal to end preferential tax treatment for derivatives traders — a move that critics say would raise the cost of trading — faces steep hurdles if it is ever to become law.

Among the obstacles standing in the way of the administration’s plan to increase taxes for derivatives professionals: a political stalemate in Congress, an influential lobby on Capitol Hill and the fact that the plan is not included in any financial reform legislation.

“I don’t think this has much of a chance at all — this is a very strong lobby and prior efforts have been roundly rejected,” said Anne Mathias, an analyst at Concept Capital.

The proposal would eliminate the treatment of booked profits for options market makers and futures professionals as capital gains, and instead subject them to much steeper ordinary income tax rates. The tax breaks were implemented when market makers were first required to mark their positions at year-end and pay taxes on booked profits.

The tax provision allows 60 percent of profits to be treated as long-term capital gains and the rest as short-term. That means that market makers pay a blended capital gains/ordinary tax rate of 23 percent of their income instead of up to 35 percent in 2010, or 39.6 percent as of 2011 if the proposal makes it into law.

Market makers are regulated firms that add liquidity on exchanges, taking the opposite side of customers’ buy and sell orders.

In the 2011 budget plan, the proposal would raise $2.6 billion over a decade. The president’s budget is just a blueprint; the Congress actually makes decisions about what is included.

The administration says the tax change is needed because “there is no reason to treat dealers in commodities, commodities derivatives dealers, dealers in securities and dealers in options differently from dealers in other types of property,” according to a summary of the proposal.

Critics of the proposal, including market-making firms and exchanges, argue that higher taxes would hurt the quality of the options markets and drive up costs for customers.

“With these higher taxes, (option) market makers would have to widen their bid/ask spreads to compensate for the loss in net income. Since the spread is wider, the cost will be passed on to the retail and institutional customers,” said Scott Morris, president of Morris Consulting LLC, a firm that works with the options industry.

The industry was pleased when a tax bill introduced by bipartisan senators last week did not contain it.

“From our perspective that is a positive thing. But any time there is a tax bill there is an opportunity to include this,” said Susan Milligan, senior vice president of government relations for the Options Clearing Corp (OCC), the world’s largest derivatives clearing organization by contract volume and open interest.



Proposals to tax those working in the financial industry and the institutions themselves are in vogue in Washington.

“The idea that someone is perceived as getting away with something – that is what gets them excited in Washington,” said Roger Lorence, a tax attorney at Sadis Goldberg.

One perennial Wall Street tax issue is to eliminate the tax treatment enjoyed by hedge fund and private equity fund managers.

That proposal has more steam, with a bill passed in the U.S. House of Representatives several times, in addition to backing from Obama. But like more and more things in Washington these days, the idea hits a roadblock in the Senate.

Plans to alter the 60/40 rule are not included in any legislation in financial reform proposals circulating on Capitol Hill, nor does it appear to have any major lawmaker as a sponsor.

The OCC, an opponent of the proposed change in taxation for derivatives professionals, has its backers.

“We have support from several members of the (tax-writing) House Ways and Means Committee both on the Republican and Democratic side,” OCC’s Milligan said. (Editing by Dan Grebler) ((; +1 202 354-5864; Reuters Messaging:

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