The general principle of U.S federal taxation is that a taxpayer should have a realizable event before a tax is imposed. This realization principle is so heavily eroded in the area of financial transactions, however, that there are now probably more transactions that fall under the exceptions than within the general rule. For example, securities dealers must account for their gains and losses using a market-to-market system, and securities traders are permitted to elect to use such a system. Similarly, `1256 contracts must be marked to market at year-end and at certain other times. In addition, the straddle rules prevent the recognition of a loss on the sale of one asset to the extent that a taxpayer has an unrecognized gain in an “offsetting position.” Recently, Congress passed the “constructive sale” rules of 1259, which require recognition of gain where there are certain transactions with respect to the appreciated property, even when the taxpayer clearly has title to that property and does not intend to dispose of it.
Many commentators criticize the piecemeal rules for determining the correct time for taking into account gain and loss for taxation purposes and suggest that there should be a consistent rule, providing either for cash-flow or market-to-market taxation. However, the likelihood of comprehensive tax reform in this area is remote, and so practitioners continua to sort through a maze of rules to determine when a taxpayer reports gain and loss on its tax return, and how much gain and loss should be reported
The distinction between ordinary income or capital gains and losses is significant for a number of reasons under U.S federal income tax law. For individuals, the maximum tax rate on ordinary income is 39.6%, while the minimum rate for long term capital gain for those in the same tax brackets is 20%. In addition, an individual is only permitted to deducts capital losses against capital gains, plus $3,000 of ordinary income. A corporation is only permitted to deduct capital losses against capital gains, but there is no rate differential
The U.S federal government imposes a 30% withholding tax on certain types of U.S sources of income unless the income is effectively connected with the conduct of a U.S trade or business or the tax is reduced or expected by the treaty. The types of U.S source income that are subject to withholding include interest, dividends, rents, salaries, wages, and other “fixed or determinable annual or periodical gains, profits or income” (known in the tax worlds as “FDAP”). Although FDAP is not defined anywhere, practitioners ask as a rule of thumb whether the income in question has a high ratio of net income to gross income (i.e., there are few significant deductions attributable to the income).
Tax law has developed its own analysis to determine who owns the property. The indicia of tax ownership developed by the courts and IRS focuses on the benefits and burdens of ownership, as well as legal title, and the right to dispose of the property. For stock, indicia of ownership also includes the right to vote the shares, obtain information from the company, sell, pledge or otherwise use the stock, and obtain distributions upon liquidations.