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Florida Tax Review

Abstract

The thesis of this Essay is that, for purposes of income tax, publicly-traded securities should be marked to market, with gain or loss recognized as it accrues and not deferred until realization. This thesis is based on a theoretical analysis of the realization doctrine and on the practical advantages of taxing gain from publicly-traded securities as they accrue.

Part II will examine the realization doctrine from a theoretical perspective as a deviation from the accepted definition of income. Its adoption is required when it is impractical to tax gain as it accrues. However, when circumstances allow the application of fundamental principles there is no justification to defer accounting for the gain just because the taxpayer has chosen to continue holding the asset.

Part III will explore the practical advantages of imposing tax on gain from publicly-traded securities on an accrual basis. Part III.A. discusses the economic effects of the alternate tax regimes. It will explain how deferring tax until realization can cause economic resources to be diverted from their most efficient uses and can contribute to the volatility of the stock market. On the other hand, mark-to-market taxation interferes to a lesser extent with the free flow of economic resources and may actually constitute a factor in mitigating stock market volatility. Part III.B. considers tax planning strategies that attempt to exploit the realization doctrine in order to avoid or minimize tax liability. Part III.C. discusses the deduction of losses. It will show that the serious restrictions imposed on the deduction of capital losses, limitations that contract the ideal of a tax imposed on accession to wealth and are the source of both inequity and economic inefficiency, are a direct consequence of the realization doctrine and are unnecessary under an accrual tax regime. Thus, mark-to-market taxation would allow unrestricted deduction (or a freely usable credit in lieu) of capital losses from the holding of publicly-traded securities.

Part IV will contend with arguments in favor of retaining the realization rule for publicly-traded securities. Part IV.A. considers the claim that unrealized gain should not be taxed because of the possibility that the value of the security will decrease in the future, erasing some or all of the already-reported gain. Part IV.B. will discuss the effect of prevailing public opinion that “paper gain” is not an appropriate subject for taxation. Part IV.C. will examine the argument that taxing publicly-traded securities on an accrual basis while other gain is taxed only at realization would create a disequilibrium in the tax structure and that the negative consequences of such a disequilibrium would overwhelm the positive consequences of mark-to-market taxation. Part IV.D. will consider the argument that it is possible to achieve results similar to those obtainable through mark-to-market taxation without abandoning the realization doctrine. Part V will summarize the findings.

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