Fox v. Commissioner
Opinion
Ps are commodities dealers who entered into futures straddle transactions on the London Metal Exchange similar to those evaluated by this Court in
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Ps are commodities dealers who entered into futures straddle transactions on the London Metal Exchange similar to those evaluated by this Court in
MEMORANDUM OPINION
NIMS,
Respondent determined the following deficiencies in and additions to petitioners' Federal income taxes:
| Addition to Tax | |||
| Docket No. | Year | Deficiency | Sec. 6653(a) |
| 3453-79 | 1974 | 87,809.00 | -- |
| 10069-79 | 1975 | 239,511.00 | -- |
| 10233-79 | 1975 | 501,133.00 | -- |
| 10234-79 | 1975 | 104,034.00 | -- |
| 10236-79 | 1975 | 88,429.00 | -- |
| 10237-79 | 1975 | 1,339,103.00 | -- |
| 10238-79 | 1975 | 515,853.00 | -- |
| 10239-79 | 1975 | 155,041.00 | -- |
| 10240-79 | 1975 | 1,874,215.00 | -- |
| 10241-79 | 1975 | 672,734.00 | -- |
| 10242-79 | 1975 | 689,265.00 | -- |
| 10243-79 | 1975 | 1,654,083.00 | -- |
| 10244-79 | 1975 | 191,566.00 | -- |
| 13246-80 | 1976 | 258,416.00 | 12,921.00 |
| 13247-80 | 1976 | 79,839.00 | 3,992.00 |
| 13248-80 | 1976 | 16,832.00 | 842.00 |
| 21879-80 | 1976 | 459,735.00 | -- |
| 22240-80 | 1976 | 720,918.00 | -- |
| 22291-80 | 1976 | 2,684,599.00 | -- |
| 22292-80 | 1976 | 982,189.00 | -- |
| 22293-80 | 1976 | 205,152.00 | -- |
| 22294-80 | 1976 | 871,515.00 | -- |
| 22295-80 | 1976 | 2,062,269.00 | -- |
| 22296-80 | 1976 | 664,905.00 | -- |
| 22297-80 | 1976 | 616,521.00 | -- |
| 23476-81 | 1977 | 6,211,615.00 | -- |
| 23477-81 | 1977 | 532,023.00 | -- |
| 23478-81 | 1977 | 2,279,247.00 | -- |
| 23479-81 | 1977 | 8,251,560.00 | -- |
| 23480-81 | 1977 | 364,896.00 | -- |
| 23614-81 | 1977 | 4,384,235.00 | -- |
| 31359-81 | 1977 | 301,742.50 | -- |
| 974-82 | 1977 | 724,640.58 | -- |
| 13919-82 | 1978 | 195,019.00 | -- |
| 13920-82 | 1978 | 161,366.00 | -- |
| 16675-83 | 1977 | 82,626.00 | -- |
| 1978 | 39,613.00 | -- | |
| 1979 | 5,313.00 | -- | |
| 21394-83 | 1978 | 87,606.00 | -- |
| 1979 | 205,160.00 | -- | |
| 1980 | 74,953.00 | -- |
*605 After concessions, 2 the sole issue for decision is whether the per se profit motivation rule
BACKGROUND
At the time their petitions were filed, the States of residence of the respective petitioners were as follows:
| States of | |
| Name | Residence |
| Reed and Audrey I. Clark | New York |
| Ralph and Jean Kazi | New York |
| Jack M. and Marliss S. Fox | Hawaii |
| Terence J. and Jean Horn | New York |
| Dwight B. and Joann V. Massey | New Jersey |
| Joseph L. and Evelyn Fraites | New Jersey |
| Dominick and Jean Cademartori | New York |
| Daniel and Judith Gutman | New York |
| Hilary and Judith Gardner | New York |
| Charles and Joan Falk | New York |
| Charles and Barbara Lerman | New Jersey |
| Arturo Sterling | New York |
*606 All of the petitioner-wives are parties to these proceedings only by virtue of their filing joint returns with petitioner-husbands. All of the petitioner-husbands (hereinafter petitioners) were associated with Czarnikow-Rionda Company, Inc., a subchapter S corporation, Czarnikow-Rionda Trading Company, Inc. or Rionda de Pass Ltd. (hereinafter referred to collectively as "Rionda"). During the years in issue, Rionda was a member of the New York Coffee and Sugar Exchange (Exchange). The Exchange is now known as the New York Coffee, Sugar and Cocoa Exchange. The Exchange has been designated as a contract market by the Commodity Futures Trading Commission (CFTC) and Rionda was registered as a futures commission merchant with the CFTC.
During the years at issue, Rionda regularly traded in physical sugar, sugar futures and options on sugar futures for its own account. It also acted as a broker in the purchase and sale of sugar futures and options on sugar futures. These transactions took place on the Exchange as well as on foreign exchanges.
Various petitioners were shareholders or officers of Rionda. Each petitioner was registered with the CFTC as an employee of Rionda. Petitioners *607Clark, Fraites, Falk and Massey were members of the Exchange during the years in issue, although Exchange rules may have limited full exercise of their membership privileges. Petitioner Gardner became a member of the Exchange in April, 1976.
At all times during the years in issue, Rionda maintained substantial positions in physical sugar and in sugar futures contracts on the Exchange. On a daily basis it purchased and sold sugar future contracts on the Exchange. Petitioners Clark, Fraites, Massey, Falk, Gardner, Sterling, Gutman, Horn, Lerman and Kazi participated in the decision-making processes of Rionda's business and executed futures trades on a directed or discretionary basis for customers of Rionda.
The issue for decision did not, however, arise from petitioners' option trading activities on behalf of Rionda. Rather, the issue before us concerns the consequences of various silver and tin option and future straddles which petitioners transacted on the London Metal Exchange (LME). Petitioners traded silver options and futures through Lonconex and tin option and futures through Bear Stearns on the LME. Petitioners' straddle transactions were designed to produce ordinary losses *608in the initial year and short-term capital gains in the subsequent years. The short-term capital gains would then be converted into long-term capital gains through executing new futures straddles in silver, copper and other commodities on other domestic or foreign exchanges.
Petitioners have stipulated that the London options transactions at issue in this case are of the same type as those described by the Court in "Section III A" of its Findings of Fact in
We turn now to a description of the actual transactions at issue in these consolidated cases. As previously noted, a typical London options transaction took place over a 2-year period in the form of either an option straddle or an option hedge. An option-straddle transaction, 11 the more prevalent trading strategy, was initiated by the following combination of trades in the first year of the transaction:
(1) An option straddle was put on, consisting of the simultaneous purchase *609and sale (grant) of either a call or put option (or both), for identical quantities of the same commodity with different delivery dates; and
(2) A futures straddle was also put on, consisting of the simultaneous purchase and sale of futures contracts for identical quantities of the same commodity with different delivery dates.
Shortly after the option straddle was put on, the legs would be closed out through the purchase and sale of identical offsetting positions. The premium (purchase price) paid to buy an offsetting option which closed out the sold (granted) option would exceed the premium that had been received on the granted option, resulting in an overall net loss on the sold option leg of the straddle. Conversely, the premium received on the sale of an offsetting option which closed out the purchased option would exceed the premium that had been paid for the purchased option, resulting in an overall net gain on the purchased option leg of the straddle. The net loss and gain, which were approximately equal, would be reported as an ordinary loss and short-term capital gain for the first year of the transaction. Since the expected tax result in the first year was generally an *610ordinary loss, such loss could be used to offset ordinary income from unrelated sources.
Next, in a switch transaction, the so-called loss leg of the futures straddle would be closed out through the purchase (or sale) of an identical offsetting position and replaced by a new position with a different delivery date. (Because an inverse relationship normally exists between the legs of a futures straddle, one leg will have an unrealized loss while the other will have an unrealized gain.) The net loss on the closed leg of the futures straddle would be reported as a short-term capital loss in the first year of the transaction and would approximately equal the short-term capital gain incurred on closing out the purchased option position.
The final step of a typical option-straddle transaction occurred in the subsequent year, although not earlier than 6 months after the switch. Both legs of the futures straddle would be closed out by offsetting trades, resulting in a gain approximately equal to the loss incurred on the switch transaction in the previous year. The gain incurred would be reported as either a short-term or long-term capital gain in the second year of the transaction.
The *611second trading strategy employed by broker-dealers was the option-hedge transaction. In an option-hedge transaction, the sale of a call and/or put option was hedged by the purchase of a futures contract (to hedge the call) and/or the sale of a futures contract (to hedge the put). Shortly thereafter, the option positions would be closed out at a net loss through the purchase of an identical offsetting call and/or put option. Simultaneously with the purchase of the closing option positions, futures contracts would be executed to hedge the previously purchased and/or sold futures, thus forming one or more futures straddles. Finally, in the following year, the futures straddles would be closed out at a gain approximately equal in amount to the loss incurred on the sold options.
Because both the option-straddle transaction and the option-hedge transaction strategies resulted in a capital gain in the second year of the transaction, many petitioners attempted to defer the gain (and possibly convert it into long-term gain) to the subsequent year by engaging in a rollover transaction. A rollover transaction simply entailed putting on another futures straddle in the second year of the transaction, *612subsequently closing out the loss leg in a switch, and then closing out the straddle at a gain in the following year.
11 The term "option-straddle transaction" as used herein denotes a type of trading strategy based upon the use of both options and futures contracts. The term is to be distinguished from the term "option straddle" which is simply a straddle consisting of option contracts.
Petitioners reported the following ordinary losses from their London options transactions, which respondent disallowed:
| Petitioner | 1975 | 1976 | 1977 |
| Clark | ($ 2,124,000) | $ 3,408,382) | -- |
| Kazi | ($ 518,000) | ($ 971,754) | ($ 202,320) |
| Fox | ($ 263,913) | ($ 606,564) | -- |
| Horn | -- | ($ 140,975) | ($ 155,118) |
| Massey | ($ 608,000) | ($ 970,195) | -- |
| Fraites | ($ 2,016,000) | ($ 2,480,548) | -- |
| Cademartori | ($ 127,260) | ($ 306,367) | ($ 28,986) |
| Gutman | -- | ($ 140,172) | -- |
| Gardner | ($ 767,752) | ($ 1,014,768) | ($ 755,914) |
| Falk | ($ 767,752) | ($ 1,014,768) | ($ 755,914) |
| Lerman | -- | ($ 195,168) | -- |
| Sterling | ($ 607,000) | ($ 882,000) | -- |
DISCUSSION
Petitioners' motion for summary judgment is premised upon the fact that they were dealers in commodities within the meaning of
Respondent's cross-motion for summary judgment is based upon the legal theory that irrespective of whether petitioners are dealers or nondealers, the straddle transactions in question are shams devoid of economic substance. He asserts *614that since the purported transactions are shams in substance, the per se rule of
In
We note at the outset that because the parties submitted their briefs prior to our entering the
We begin our analysis by considering whether the transactions in question are shams in substance. Unlike the taxpayers in
As we stated in
We do not, however, consider respondent's failure to produce a specific record of the offsetting straddle gains to be fatal. On the contrary, because petitioners stipulated that the capital gain incurred on closing out the second leg of the straddles was "approximately equal to the loss incurred * * * in the previous year," any inference we must make regarding the amount of petitioners' capital gains must be limited to an amount which would approximately offset the losses incurred on the prior straddle leg. We conclude, therefore, that whatever petitioners' actual gains were, they must by virtue of petitioners' stipulation necessarily fall within the parameters of the straddle transactions we found in
Our inference that petitioners' closed-out straddle produced nominal if any economic gain is consistent with the conduct the parties demonstrated in motioning this Court for summary judgment. Petitioners' dockets were removed from the trial calendar based upon the representation that the remaining controversies at issue therein could be resolved by our determining *619the narrow legal issue of "whether the holding of
We next consider whether petitioners' assumed dealer status will trigger the application of
(1) Taxpayer failed to address the threshold issue of whether the transactions were shams;
(2) Taxpayer failed to show *621that he is entitled to the presumption under
(3) Even if taxpayer were entitled to the presumption, a trial would nevertheless be required to resolve the "for profit" issue which is inherently factual.
The Commissioner, however, failed to allege or support any facts tending to demonstrate that King's trading transactions were shams in any sense. We held that "Under these circumstances, respondent has not shown that there is a genuine issue of sham for trial."
Petitioners assert that "The
The per se rule of
In contrast with his unsupported allegation of sham in
it is appropriate before applying the per se rule of
As discussed above, petitioners stipulated that their straddle transactions were similar to the generic
To reflect the foregoing,
(a) GENERAL RULE. -- For purposes of the Internal Revenue Code of 1954, in the case of any disposition of 1 or more positions --
(1) which are entered into before 1982 and form part of a straddle, *625and
(2) to which the amendments made by title V of such Act [Economic Recovery Tax Act of 1981] do not apply,
any loss from such disposition shall be allowed for the taxable year of the disposition if such loss is incurred in a trade or business, or if such loss is incurred in a transaction entered into for profit though not connected with a trade or business.
(b) LOSS INCURRED IN A TRADE OR BUSINESS. -- For purposes of subsection (a), any loss incurred by a commodities dealer in the trading of commodities shall be treated as a loss incurred in a trade or business.
(c) NET LOSS ALLOWED. -- If any loss with respect to a position described in paragraphs (1) and (2) of subsection (a) is not allowable as a deduction (after applying subsections (a) and (b)), such loss shall be allowed in determining the gain or loss from dispositions of other positions in the straddle to the extent required to accurately reflect the taxpayer's net gain or loss from all positions in such straddle.
(d) OTHER RULES. -- Except as otherwise provided in subsections (a) and (c) and in sections 1233 and 1234 of such Code, the determination of whether there is recognized gain or loss with respect to a position, *626and the amount and timing of such gain or loss, and the treatment of such gain or loss as long-term or short-term shall be made without regard to whether such position constitutes part of a straddle.
(e) STRADDLE. -- For purposes of this section, the term "straddle" has the meaning given to such term by
(f) COMMODITIES DEALERS. -- For purposes of this section, the term "commodities dealer" means any taxpayer who --
(1) at any time before January 1, 1982, was an individual described in
(2) was a member of the family (within the meaning of section 704(e)(3) of such Code) of an individual described in paragraph (1) to the extent such member engaged in commodities trading through an organization the members of which consisted solely of --
(A) 1 or more individuals described in paragraph (1), and
(B) 1 or more members of the families (as so defined) of such individuals. *627
(g) REGULATED FUTURES CONTRACTS. -- For purposes of this section, the term "regulated futures contracts" has the meaning given to such term by
(h) SYNDICATES. -- For purposes of this section, any loss incurred by a person (other than a commodities dealer) with respect to an interest in a syndicate (within the meaning of
Footnotes
1. Cases of the following petitioners are consolidated herewith: Reed Clark and Audrey I. Clark, docket Nos. 10240-79, 22291-80 and 23479-81; Ralph G. and Jean Kazi, docket Nos. 10233-79, 22296-80 and 23478-81; Jack M. Fox and Marliss S. Fox, docket Nos. 10069-79 and 21879-80; Terence J. Horn and Jean Horn, docket Nos. 10236-79, 13248-80 and 16675-83; Dwight B. Massey and Joann V. Massey, docket Nos. 10241-79, 22297-80 and 23614-81; Joseph L. Fraites and Evelyn S. Fraites, docket Nos. 10243-79, 22295-80 and 23476-81; Dominick A. Cademartori and Jean E. Cademartori, docket Nos. 10244-79, 22293-80, 23480-81 and 21394-83; Daniel Gutman and Judith Gutman, docket Nos. 10234-79 and 13247-80; Hilary P. Gardner and Judith C. Gardner, docket Nos. 10238-79, 22240-80 and 31359-81; Charles H. Falk and Joan A. Falk, docket Nos. 10242-79, 22292-80, 974-82 and 13920-82; Charles S. Lerman and Barbara Lerman, docket Nos. 10239-79 and 13246-80; Arturo Sterling, docket No. 10237-79; Arturo Sterling and Lydia Sterling, docket Nos. 22294-80, 23477-81 and 13919-82.↩
2. Three cases, docket Nos. 23478-81, 23480-81 and 21394-83 also involve unrelated issues. "Piggyback" agreements have been entered into regarding these issues so that we need not consider them at this time. All other adjustments have been resolved. ↩
3. See Appendix A for text of
section 108↩ of Division A of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 630, as amended by section 1808(d) of the Tax Reform Act of 1986, Pub. L. 99-514. 100 Stat. 2085, 2817.
1988 T.C. Memo. 570 (Fox v. Commissioner) — published by Counsel Stack Legal Research, free access to 12M+ legal documents.