The U.S. Treasury’s 2010 revenue proposal, released May 11, included a bombshell for the futures and options industry: the possibility of the end of preferential 60/40 tax treatment for futures and options. Under the 60/40 rule, for U.S. futures contracts, 60% of gains are considered long-term gains, taxed up to 15% and the remaining 40% of gains are considered short-term gains, taxed as regular income up to 35%, soon to be 39.1%. The Treasury’s proposal would eliminate 60/40 treatment, which was first enacted in 1981.
On June 4, the heads of the Chicago Board Options Exchange (CBOE), Boston Options Exchange, International Securities Exchange, Options Clearing Corporation and NYSE Euronext sent a letter to House Ways and Means Committee Chairman Charles Rangel expressing opposition to the proposal. The letter said that the 72% tax increase for market makers on the exchanges that would result from the proposal for the tax years after 2010 would cause some market-makers to abandon their market making role. “Their departure will diminish liquidity and depth on the U.S. options markets and will increase the cost of hedging stock positions for individual investors and mutual and pension fund managers,” the letter said, adding that remaining options market-makers would have to deal with an increased cost of doing business stemming from higher taxes by widening bid/ask spreads and decreased liquidity, making transactions more expensive.
In a member advisory, CBOE echoed these concerns, saying the proposal would pass on options market makers’ cost of doing business to end users and cause wider spreads and increased transaction costs.
“60/40 tax treatment was enacted, not as an arbitrary ‘tax break,’ but as part of a delicate tax formula designed to preserve the vital role of market maker,” said CBOE Chairman Bill Brodsky in the statement.
“The financial industry and derivatives segment are very easy targets for any new regulatory or legislative proposal,” says Andy Nybo, head of derivatives at Tabb Group. “The market-making community receives preferential treatment because they are marked to market on a daily basis and they’re making markets and providing liquidity for these instruments. If you remove [60/40] treatment, you will cause distortions in their business models in how they price and make markets. It will be detrimental to liquidity.”