What Is Form 8275, and Do Prediction Market Traders Need It?

Form 8275 tells the IRS about a position on your return, and it can protect you from parts of a penalty. Prediction market traders mostly hear about it for Section 1256, because the IRS hasn’t said whether event contracts qualify. It’s optional, it needs a reasonable basis to work, and it doesn’t make the position correct.

What does the form do?

The IRS instructions say the form is filed to avoid the parts of the accuracy-related penalty due to disregard of rules or to a substantial understatement of income tax, if the return position has a reasonable basis. Preparers can also use it for their own penalty exposure.

It can’t remove every penalty. The instructions say disclosure doesn’t avoid penalties for:

• Negligence.
• Disregard of regulations.
• A substantial understatement on a tax shelter item.
• A claim of tax benefits from a transaction lacking economic substance.

The tax and interest stay owed if the IRS disagrees. The form only affects those penalties.

When does it come up for prediction markets?

• Section 1256. Camuso and Mukherjee conclude it isn’t available for event contracts, and warn that preparers claiming it without documented analysis and a Form 8275 disclosure take on risk. White & Case argues for it. Both sides.
• A carryback. The instructions say carryback items are disclosed for the year they originate, so you don’t file another form for the carryback year. How the carryback works.
• Preparers. A preparer can owe a penalty for a position without substantial authority, unless it’s disclosed and has a reasonable basis. So yours may ask for this form. Why a preparer might say no.

How do you fill it out?

Part I is a table for the guidance you rely on, the item, a description, and the form, line and amount. Part II is where you explain. The instructions say it must include the relevant facts and information that can reasonably be expected to tell the IRS the identity of the item, its amount, and the nature of the controversy or potential controversy. Attaching other documents in place of this doesn’t count as disclosure.

Your disclosure generally needs to cover:

• The exchange and the contracts, and that the exchange is CFTC-regulated.
• The amount reported, and the form and line it’s on.
• That no IRS guidance addresses event contracts, and the legal question: whether they’re Section 1256 contracts.
• How you handled open positions at year-end.

How and when do you file it?

• File it with your original return and keep a copy. You may be able to file it with an amended return.
• Check your software before you commit. Old TurboTax community threads say it isn’t supported there. Software steps.
• For a recurring item, ask your preparer whether you need a new form each year.

Should you file one?

That’s a question for a preparer, and it matters most with a large Section 1256 position. It gives up some privacy about your position in return for some protection from penalties. Before you decide, compare all four methods on your trades. If the gap between Section 1256 and capital gains is small, the position may not be worth taking.

Questions about Form 8275

General information about US federal tax, not tax advice.