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60/40 Treatment of Futures, Options under Assault

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WASHINGTON (–The U.S. Senate’s vote for the Jobs and Growth Tax Relief Reconciliation Act of 2003 came with a last-minute kicker–a manager’s amendment containing various revenue enhancers including the abolition of the current 60/40 tax treatment for gains and losses on futures and options transactions.

The Futures Industry Association, Washington, opposes any such change. Its president, John M. Damgard, said Tuesday that he is very curious about the origins of the idea.

“Somebody in the bowels of the treasury has a drawer full of what they call ‘revenue enhancers’–what we call tax increases–and this one comes out of the drawer regularly,” he said. Furthermore, the “scoring” (i.e. the calculation of the amount of revenue the amendment would raise) is suspect. “Funny arithmetic sometimes is necessary to make things work,” he said.

In this case, it “worked” in the sense of securing passage but just barely. Despite the revenue-enhancing amendments, proposed by Sen. Chuck Grassley (R-Iowa) in order to firm up the commitment of wavering senators worried about ballooning the deficit, the bill carried only 51 to 50, with the tie-breaking vote of Vice President Dick Cheney.

Mr. Grassley, chair of the Senate Finance Committee and floor manager for the bill, proposed the amendments as part of a package that included a two-year phase-in of an exemption of dividend income from the federal income tax. The proposed dividend tax relief, long a priority of the Bush administration, comes with a sunset provision for 2007.

The resulting bill, passed by the Senate May 15, is in many ways quite different from the version passed by the House of Representatives on May 9. The House bill reduces but does not eliminate tax rates on dividends and capital gains, and its reduction (to 15%) does not expire until 2013. The House bill also contains no change in the 60/40 rule. The conference committee will have to hash all this out.

The 60/40 tax rule dates to 1981, when it was part of a compromise to a dispute over whether taxpayers should be required to mark their “butterfly straddles” to market value. Internal Revenue Code ?1256 was created to require taxpayers to characterize the gains or losses on futures contracts as 60% long-term and 40% short-term capital gains or losses, regardless of how long the contracts had been held.