Lead Opinion
OPINION
Respondent determined deficiencies in petitioners’ Federal income tax for 1977 and 1978 in the amounts of $90,512 and $3,158, respectively. Respondent also determined that petitioner Edward Katz was liable for additions to tax pursuant to section 6653(b)
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by reference.
Petitioners resided in Tenafly, New Jersey, when they filed their petition.
During 1977 and 1978, Edward Katz (hereinafter singly referred to as petitioner) was president of MMR Leasing Corp., a truck leasing business in which his brothers also were involved.
In 1974, petitioner purchased a seat on and was elected to membership in the New York Mercantile Exchange (NYMEX). There are two types of members of the NYMEX— floor traders and floor brokers. Both floor traders and floor brokers are allowed on the trading floor and receive reduced charges for their trades on the NYMEX. The main distinguishing characteristic between the two types of members is that floor brokers are qualified to exеcute trades for third parties; floor traders may trade only for their own accounts. Floor brokers are required to be registered with the Commodity Futures Trading Commission (CFTC), the regulatory body having authority over the NYMEX. Petitioner was a floor trader, never a floor broker, and he was not registered with the CFTC.
In 1971, the NYMEX introduced trading in futures contracts in silver coins. In 1977, trading began on the NYMEX in 400-ounce gold futures contracts. During the years in issue, petitioner traded futures contracts for silver coins and 400-ounce gold.
Spread positions also may be achieved by “legging in” rather than by actual spread trading. Legging in is accomplished by executing one leg of a spread at a different time than the opposite leg. Each leg is executed at a specific price, instead of by price differentials, and need not be opposite the same broker and account as was the opposite leg. The second leg of the spread may be executed within minutes after the initial leg is executed, or the spread may not be completed until some time much later. NYMEX rules do not require a spread position completed in that manner to be reported as a spread trade.
Petitioner, as a floor trader member of the NYMEX, could execute trades for his own account; however, he in fact did not. Stanley Buckwalter, a registered floor broker, executed for petitioner all of the trades in silver coin futures and 400-ounce gold futures at issue in the instant case. All of
Thе 21 gold and silver transactions at issue were executed as 10 sets of trades and were reflected in petitioner’s account as follows:
Number and type of Date contracts bought Price spread Net Date differential Gain/ gain/ sold (sold/bought) (loss)
Silver coins
24 Jan78 7/25/77 8/16/77 ($2.67) ($64,080) $420 ($64,500)
24 Apr78 10/18/77
24 Jul78 8/16/77 1/03/78 3.44 82,560 420 82,140
24 Oct78 1/03/78 10/18/77 0.29 6,960 420 6,540
Total for the first series of trades 0 1,680 (1,680)
400-oz. Gold
20 Sep78 11/16/77 11/22/77 (4.95) (39,600) 1,200 (40,800)
20 Dec78 1/03/78 11/16/77 (7.50) (60,000) 1,200 (61,200)
20 Jun78 11/22/77 1/03/78 12.45 99,600 1,200 98,400
.Total for the second series of trades 0^ 3.600 (3,600)
40 Mar79 10/31/78 9/29/78 (20.00) (320,000) 3,200 (323,200)
20 Sep79
20 Sep79 9/29/78 1/05/79 3.10 24,800 (
20 Mar80 1/05/79 10/31/78 16.90 135,200
Total for the third series of trades 0
As shown in the fifth column of the above chart, in each of the three series of trades, petitioner’s net gains and losses, before commissions, exactly offset each other. Hereinafter, the trades transacted from July 1977 through January 1978 sometimes are referred to as the 1977 spreads, and the trades transacted from September 1978 through January 1979 sometimes are referred to as the 1978 spreads.
Commodity Year reported Acquired Sold Gain/(Loss)
Silver coins 1977 7/77 8/77 ($64,500)
Silver coins 1977 7/77 10/77 (25,860)
Gold 1977 11/77 11/77 (40,800)
Gold 1978 10/78 9/78 (323,200)
Gold 1978 9/78 10/788 158,478
In the notice of deficiency, respondent determined that the foregoing losses were disallowed and that petitioner’s capital gains for 1978 should be decreaáed in the amount of the $158,478 reported gain on gold.
Petitioner’s tax returns did not reflect the two silver transactions and the two gold transactions completed on January 3, 1978. Those unreported transactions were reflected in petitioner’s account as showing, after commissions, a loss of $61,200 (gold) and gains of $6,540 (silver), $82,140 (silver), and $98,400 (gold). The notice of deficiency did not address the transactions completed on January 3, 1978, apparently on the same basis upon which the reported gains and losses were disallowed, i.e., gains and losses from the spread transactions should not be recognized and included in petitioner’s taxable income.
On the days of petitioner’s trades, petitioner’s trade volume compared to the total number of contracts traded on the NYMEX was as follows:
Total Petitioner’s market Date volume volume Total Petitioner’s market Date volume volume
07/25/77 Silver 48 75 11/22/77 Gold 40 80
08/16/77 Silver 48 122 01/03/78 Gold 40 648
10/18/77 Silver 48 248 09/29/78 Gold 80 99
01/03/77 Silver 48 576 10/31/78 Gold 80 80
11/16/77 Gold 40 238 01/05/79 Gold 40 61
On 5 of the 10 days on which petitioner traded, his transactions made up at least one half of the total volume of the NYMEX. On 6 of the 10 trade days, his trades in lots of 20, 24, or 40 contracts were the only trades of more than 10 contracts of the commodity on that day. In general, then, petitioner’s 1977 and 1978 spreads were large multicontract lots executed in a low-volume market. In addition, even though the spread transactions were large lots in a low-volume market, none was executed as a split fill (a multicontract purchase or sale executed in segments of the total purchase or sale quantity, at different times, and often, but not necessarily, at different prices and with different opposite brokers).
Petitioner’s broker, Mr. Buckwalter, was charged by the CFTC and ultimately was found to have violated 7 U.S.C. sec. 6c(a) and 17 C.F.R. sec. 1.38 by executing trades that were wash sales and accommodation trades and by causing non-bona fide prices to be reported to the NYMEX. Sеe In the Matter of Stanley Buckwalter, et al., CFTC docket No. 80-28, Comm. Fut. L. Rep. (CCH) [1984-1986 Transfer Binder] par. 22,782, at 31,268 (Sept. 27, 1985). Those findings against Mr. Buckwalter were based, in large part, on petitioner’s 1977 and 1978 spreads.
OPINION
The first issue for decision is whether petitioner’s spread losses should be disallowed. Petitioner’s primary argument is that the disposition of this case is governed by section 108 of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986.
The parties disagree about whether petitioner was a commodities dealer for purposes of section 108;
Section 108(a) provides that in the case of straddle transactions, such as the spreads in issue, deductions are allowed for incurred losses if the straddle transactions were entered into for profit. See Glass v. Commissioner,
It is well established that income tax deductions are a matter of legislative grace and that the burden of clearly showing the right to the claimed deduction is on the taxpayer. Interstate Transit Lines v. Commissioner,
The facts surrounding trading on the NYMEX in gold and silver coin futures strike us as being quite similar to those before the Court in United States v. Winograd,
Respondent’s expert witness in the instant case, Edward O’Brien, also testified as an expert witness in the case in
Although the findings in Buckwalter are not determinative of the issues in the instant case, the analysis in that case was based on the same transactions. The analysis in Buckwalter thus is helpful in setting the framework for our analysis in the instant case. First, however, we must ascertain the meaning of the terms “accommodation trades” and “wash sales” in the context of commodities futures law. For purposes of commodities law, “accommodation trading” is defined as wash trading entered into by a trader, usually to assist another with illegal trades, and “wash trading” is defined as entering into, or purporting to enter into, transactions to give the appearance that purchases or sales have been made, usually without a change in the trader’s market position. Sundheimer v. Commodity Futures Trading Commission,
Petitioner has introduced no evidence whatsoever to indicate that his 1977 and 1978 spread transactions would not fit under the foregoing descriptions of wash trades and accommodation tradеs. Indeed, the fact that petitioner exactly broke even, exclusive of commissions, on each of his three series of spreads supports a conclusion that the trades were rigged or prearranged and not bona fide, competitive, market trades. That each series of spreads exactly broke even seems to us too convenient to be explained away by the long arm of coincidence. See Mahoney v. Commissioner,
The absence of split fills in the execution of petitioner’s spreads also indicates a lack of competitive trades. Mr. O’Brien’s expert report asserted that it was highly unlikely that these comparatively large multicontract lots could be competitively traded at a single price and time of execution on futures markets which otherwise had very limited volume. As was similarly noted in Buckwalter, it is an unexplained, “seemingly odd coincidence that so frequently when a large order appeared on the floor another trader appeared willing to take the entire order.” See In the Matter of Stanley Buckwalter, et. al., supra at 31,250. Petitioner has not advanced sufficient evidence to persuade us that the spreads in issue were executed in accordance with all the rules of the NYMEX. In fact, the exact equality of all gains and losses, the thinness of the silver coin and 400-ounce gold markets, and the absence of split fills, when taken together, indicate that the 1977 and 1978 spreads were wash sales or accommodation trades in violation of the rules of the NYMEX. We accordingly find that the per se rule of section 108(b) is not available with respect to petitioner’s 1977 and 1978 spread transactions. Cook v. Commissioner, supra.
The wash sale or accommodation nature of the spread trades also indicates that petitioner’s 1977 and 1978 spreads were not bona fide, i.e., that they were risk-free transactions devoid of any true economic substance. Petitioner has not advanced sufficient evidence for us to conclude that the spread trades were bona fide. Petitioner testified that he knew nothing about any prearrangement of trades for his account, and that his instructions to Mr. Buckwalter were to close out the spread positions as soon as possible after yearend so as to break even or yield a profit. Even if petitioner truly did not know his trades were executed noncompetitively and were not bona fide, however, his ignorance does not change the true nature of the trades. Where transactions in fact are devoid of economic substance, they are economic shams and are not to be recognized for tax purposes. See Lynch v. Commissioner,
In conclusion, based upon our careful review of the entire record, we find that petitioner has failed to prove that his 1977 and 1978 spreads were bona fide trades. We therefore uphold respondent’s determinations with respect to the reported losses and gains on the 1977 and 1978 spreads.
In his brief, petitioner offers an alternative argument if we should hold that his 1977 and 1978 gold and silver transactions are to be disregarded. Specifically, petitioner argues that his 1977 taxable income should be deсreased by the amount of short-term capital gain reported by him as being attributable to dispositions of silver coin contracts in January 1977.
Petitioner’s argument apparently is based on the reasoning that the disallowance of the 1977 and 1978 spreads should cause the nonrecognition of all other transactions on the NYMEX in gold and silver coin futures. Petitioner’s reasoning, however, overlooks several vital facts with regard to his 1976 spreads: (1) Those transactions were held in an account with Chartered New England Corp., not Rosenberg Commodities, and there is no evidence whatsoever that the floor broker for those 1976 spreads was Mr. Buckwalter or any other broker sanctioned by the CFTC; (2) none of the prearranged transactions at issue in the Buckwalter case took place before July 5, 1977, i.e., several months after petitioner’s 1976 spreads were completed; and (3) the record contains no evidence whatsoever to indicate that petitioner’s 1976 spreads were wash trades, accommodation
We next turn to the final issue — whether petitioner is liable for the addition to tax for fraud pursuant to section 6653(b).
The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Gajewski v. Commissioner,
At the outset, we note an absence of the usual badges of fraud. Petitioner did not consistently underreport his income (Hollаnd v. United States,
Respondent bases his allegation of fraud on his assertions that petitioner had actual knowledge that the 1977 and 1978 spreads were prearranged and without economic substance, and that petitioner thus took deductions for transactions which he knew were lacking in economic substance. Rеspondent, however, has failed to prove clearly and convincingly that petitioner actually knew of the prearranged and noncompetitive nature of the 1977 and 1978 trades. At best, the record as a whole provides only a suspicion that petitioner might have known that Mr. Buckwalter and the other sanctioned brokers were fixing or prearranging the contracts. This Court, however, will not sustain a finding of fraud based upon circumstances which at the most create only suspicion. Green v. Commissioner,
Decision will be entered for respondent, except as to the addition to tax pursuant to section 6653(b).
Notes
Unless otherwise indicated, all section references (except to sec. 108 of the Deficit Reduction Act of 1984, as amended by the Tax Reform Act of 1986) are to the Internal Revenue Code as amended and in effect during the taxable years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Petitioner also traded in futures contracts for potatoes during the years in issue, but respondent does not challenge petitioner’s potato trades except to the extеnt of asserting that petitioner failed to report a $425 gain from potato transactions in 1978. Petitioner has not argued that respondent’s determination with respect to that $425 gain was incorrect, and we take that as a concession as to that amount.
A more detailed discussion of commodity futures trading may be found in Perlin v. Commissioner,
Gain or loss is computed as follows:
Silver: price spread X $1000 per spread point X # of contracts.
Gold: price spread X 400 ounces per contract X # of contracts.
On those contracts for which the sell date is earlier than the buy date, petitioner might be said to have been “short” on those contracts until he purchased an identical contract tо offset that short position. Similarly, petitioner might be said to have been “long” on those contracts purchased before sold. Petitioner treated the spread transactions as being completed when a contract was both purchased and sold. In accordance with his spread (or straddle) strategy, when petitioner purchased contracts, he also sold on the same date the same number of contracts for the same commodity.
The September 1979 gold contracts were bought in a single 40-contract transaction and were sold in two 20-contract transactions.
The amounts of the commissions and net gains on the spreads closed in 1979 are not in the record.
This amount differs by $78 from the net results of the September 1979 gold contracts bought on Sept. 29 and sold on Oct. 31. Petitioner’s account statements from Rosenberg Commodities reflect a $77.50 credit for “Spread Comm. Adj.” on Nov. 1, 1978, and he apparently included that adjustment on his 1978 tax return as part of the reported gain on the Oct. 31 gold sale. Petitioner's account statements indicate, however, that the commission adjustment was attributable to an overcharge on a potato trade. We therefore find that the refund of the commission overcharge is properly includable in petitioner’s 1978 income as a decrease in the reported expenses of his potato trades, notwithstanding our holding on the gold and silver trades. Accordingly, we find that the gold gain in issue herein is $158,400, not $158,478.
Mr. Buckwalter also was found to have violated other provisions of the Commodity Exchange Act (tit. 7, U.S.C.) and the CFTC regulations by altering records and aiding and abetting other NYMEX members in their failure to maintain true records of customer accounts. Such findings were based on Mr. Buckwalter’s use of a fictitious name (the maiden name of his then deceased wife) to execute trades and exercise trading contr.ol over accounts opened with various NYMEX members, activities unrelated to petitioner’s spread trades.
CFTC regulations provide a limited exception whereby commodity transactions need not be “executed openly and competitively by open outcry of posting of bids and offers” if the contract market has written rules which provide for such an exception and which have been approved by the CFTC. See 17 C.F.R. sec. 1.38(a) (1987). The CFTC had not approved any exception from the general rule whereby trades in 400-oz. gold or silver coin futures were allowed to be executed noncompetitively on the NYMEX. In fact, on account of the NYMEX’ deficiencies in monitoring and enforcing its own trading rules with respect to silver coin and 400-oz. gold futures during the period of the spreads at issue, the CFTC fined the NYMEX $200,000 and threatened to close the NYMEX. In order to settle the charges brought by the CFTC, the NYMEX agreed to decertify (revoke its designation as a market for) silver coin and 400-oz. gold futures.
The parties do not dispute that the 1977 and 1978 spreads constitute straddle transactions, as contemplated in sec. 108. The provisions of sec. 108, as in effect both before and after the 1986 amendment, are discussed more fully in Glass v. Commissioner,
The parties’ disagreement centers on the definition of a “commodities dealer.” Petitioner asserts that the Conference report accompanying the Tax Reform Act of 1986 provides that any individual who “owns a seat on a commodities exchange” will be treated as a сommodities dealer, and that petitioner plainly meets that definition. See H. Rept. 99-841 (Conf.) (1986), 1986-3 C.B. (Vol. 4) at 845. Respondent, on the other hand, asserts that the language of the statute, sec. 108(f)(1), plainly provides that a “commodities dealer” is a person described in sec. 1402(i)(2)(B), and that petitioner does not meet that definition because he was never registered with any domestic board of trade, as required in sec. 1402(i)(2)(B). By virtue of our holdings below, we need not determine whether petitioner actually was a commodities dealer for purposes of sec. 108.
There is also evidence which indicates that petitioner may have sold his seat on the NYMEX in August or September 1978, before positions on any of the 1978 spreads were taken.
As in effect during the years in issue, that section provided:
Sec. 6c. Wash sales; cross trades; fictitious sales; privileges; offers; puts; calls; guaranties
(a) It shall be unlawful for any person to offer to enter into, enter into, or confirm the execution of, any transaction involving any commodity, which is or may be used for (1) hedging any transaction in interstate commerce in such commodity or the products or by-products thereof, or (2) determining the price basis for any such transaction in interstate commerce in such commodity, or (3) delivering any such commodity sold, shipped, or received in interstate commerce for the fulfillment thereof—
(A) if such transaction is, is of the character of, or is commonly known to the trade as, a “wash sale,” “cross trade,” or “accommodation trade,” or is a fictitious sale;
(B) if such transaction involves any commodity specifically set forth in section 2 of this title, prior to October 23, 1974, and if such transaction is of the character of, or is commonly known to the trade as, an “option,” “privilege,” “indemnity,” “bid,” “offer,” “put,” “call,” “advance guaranty,” or “decline guaranty,” or
(C) if such transaction is used to cause any price to be reported, registered, or recorded which is not a true and bona fide price.
Goldwurm involved “offsetting transactions to create artificial tax losses.” See Stoller v. CFTC,
See also DeMartino v. Commissioner,
On account of our finding that the spreads were not bona fide economic transactions, we need not reach the issue of petitioner’s profit motive. See Enrici v. Commissioner,
Apparently, petitioner is asserting that the amount of the contested income is $222,985— the total reported on his 1977 tax return as gain from silver contracts sold in January 1977. Brokerage statements which are in evidence address only approximately $174,500 of the gain, and the record is devoid of any evidencе with respect to the remainder of the gain. Petitioner’s brief does not offer any suggested amount by which his taxable income should be reduced.
We note that sec. 108 does not provide for any nonrecognition in the case of gains from straddle positions. In that vein, sec. 108 only allows recognition of losses from straddle positions to the extent necessary to reflect the net gain or loss from all positions in the straddle. Sec. 108(c). Petitioner has not suggested that any losses with respect to the 1976 spreads have been disallowed or that his net gain or loss from all positions in the 1976 spreads has not been reflected in his taxable income.
Respondent made no determination of fraud with respect to Phyllis Katz.