Brown v. Comm'r of Internal Revenue
| Decision Date | 18 December 1985 |
| Docket Number | Docket Nos. 29929-82,3083-83,3503-83.,2313-83 |
| Parties | DENNIS S. BROWN, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners claimed deductions for fees and losses allegedly incurred with respect to forward contracts for purchase and sale of Ginnie Maes and Freddie Macs. HELD, the forward contracts and related transactions were factual shams and the deductions for fees and losses are disallowed. HELD, FURTHER, the addition to tax under section 6653(a) as determined by respondent against one petitioner is sustained and damages in the amount of $5,000 are imposed against certain petitioners under section 6673. JOSEPH WETZEL, RUSSELL SANDOR, for the petitioners.
RALPH C. JONES, JOYCE BRITT, for the respondent.
Respondent determined deficiencies in petitioners' Federal income tax as follows:
+----------------------------------------------+
¦ ¦ ¦ ¦Additions to tax¦
+-------------+----+----------+----------------¦
¦Petitioner2 ¦Year¦Deficiency¦sec. 6653(a)3 ¦
+-------------+----+----------+----------------¦
¦Brown ¦1979¦$49,562.50¦ ¦
+-------------+----+----------+----------------¦
¦Sochin ¦1979¦9,402.00 ¦ ¦
+-------------+----+----------+----------------¦
¦ ¦1980¦25,535.00 ¦ ¦
+-------------+----+----------+----------------¦
¦ ¦1981¦18,288.00 ¦ ¦
+-------------+----+----------+----------------¦
¦Morgan ¦1977¦2,283.00 ¦$114.00 ¦
+-------------+----+----------+----------------¦
¦ ¦1979¦104,022.00¦5,217.35 ¦
+-------------+----+----------+----------------¦
¦ ¦1980¦194,141.55¦10,141.55 ¦
+-------------+----+----------+----------------¦
¦Leinbach ¦1979¦205,181.69¦ ¦
+-------------+----+----------+----------------¦
¦ ¦1980¦263,728.31¦ ¦
+-------------+----+----------+----------------¦
¦ ¦1981¦218,036.46¦ ¦
+----------------------------------------------+
After concessions, the issues remaining for decision are: (1) whether petitioners realized deductible losses under section 165(c)(2) on forward contracts as claimed on their income tax returns for 1979, 1980, and/or 1981; (2) whether the fees paid by petitioners with respect to such contracts are deductible; (3) whether petitioners, Ellison C. Morgan and Linda Morgan, are liable for additions to tax under section 6653(a); and (4) whether any of the petitioners are liable for damages under section 6673.
Some of the facts have been stipulated and are so found. The stipulations and exhibits associated therewith are incorporated herein by reference.
All of the petitioners resided in Oregon at the time their petitions were filed and all of them filed income tax returns for 1979, 1980, and 1981 with the Internal Revenue Service Center at Ogden, Utah. On the returns, petitioners claimed to have suffered losses in the following amounts from the cancellation of forward contracts for the purchase or sale of certain mortgage certificates:
+-----------------------------+
¦Petitioner¦Year¦Loss claimed ¦
+----------+----+-------------¦
¦Brown ¦1979¦$106,160 ¦
+----------+----+-------------¦
¦Sochin ¦1979¦20,621 ¦
+----------+----+-------------¦
¦ ¦1980¦48,054 ¦
+----------+----+-------------¦
¦ ¦1981¦38,785 ¦
+----------+----+-------------¦
¦Morgan ¦1979¦224,416 ¦
+----------+----+-------------¦
¦ ¦1980¦390,614 ¦
+----------+----+-------------¦
¦Leinbach ¦1979¦394,676 ¦
+----------+----+-------------¦
¦ ¦1980¦482,245 ¦
+----------+----+-------------¦
¦ ¦1981¦401,412 ¦
+-----------------------------+
All of the above losses allegedly4 occurred with respect to activities promoted by Gregory Government Securities, Inc. and Gregory Investment and Management, Inc. Over 1,400 other cases now pending before this Court have been identified as involving similar issues and factual situations. Upon learning of the number of such cases, the Chief Judge assigned all of them to this Division of the Court. With the assistance of respondent and his counsel, and most of the 1,400 petitioners and their counsel, these four cases were selected as being generally representative with respect to the issues common to all the cases.5 An Order was then entered consolidating these four cases and setting them for trial of the common issues while all activity in the other cases was suspended pending the decision herein.
Gregory Government Securities, Inc. (‘GGS‘) and Gregory Investment and Management, Inc. (‘GIM‘) were incorporated in 1979 by William H. Gregory under the laws of the State of Oregon. At all times material to these cases all of the stock outstanding in both corporations was owned by Mr. Gregory and his wife and their corporate activities were conducted under his general supervision and control. Prior to 1979, Mr. Gregory had been the tax partner and a specialist in accounting for wood products with Arthur Anderson and Company, an international accounting firm. He was also the chairman of the firm's steering committee on tax shelters. He left Arthur Anderson in July of 1979 in order to establish GGS and GIM. Shortly after its organization, GGS was registered with the Oregon Department of Commerce as a broker-dealer in securities. The registration continued through the balance of 1979 and throughout 1980 and 1981. No such registration was required of GIM in Oregon. Neither corporation was required to be registered as a broker-dealer under the Securities Exchange Act of 1934.
The promotion undertaken in 1979 by Mr. Gregory was purportedly to offer to ‘a limited number of knowledgeable, sophisticated investors, * * * who understand both the economic and tax ramifications of the transactions,‘ investments in forward contracts to purchase or to sell certificates issued by Government National Mortgage Association and Federal Home Loan Mortgage Corporation. These certificates are exempt from federal registration under the Securities Act of 1933. His program contemplated that GIM would serve as a financial advisor to the prospective investors and GGS, as a registered broker-dealer, would serve as either a seller or a buyer on every transaction entered into with the investors.
Government National Mortgage Association (‘GNMA‘) is a corporation wholly owned by the government through the Department of Housing and Urban Development. From time to time GNMA issues registered certificates which represent undivided interests in a specified pool of mortgages guaranteed by GNMA as well as by the Veterans Administration, the Federal Housing Administration, or the Farmers Home Administration. These certificates are referred to in the market as Ginnie Maes.
The Federal Home Loan Mortgage Corporation (‘FHLMC‘) is a corporation whose capital stock is owned by the Federal Home Loan Bank Board and whose directors are appointed by the President with the advice and consent of the Senate. The directors of the Federal Home Loan Bank Board act as the directors of FHLMC.
FHLMC also sells mortgage certificates which are known as participation certificates and which are referred to in the market as Freddie Macs. Each of these certificates represents an undivided fractional interest in a pool of conventional (non-VA and non-FHA) mortgages.
Each prospective investor,6 including petitioners herein, was given a disclosure memorandum by GIM in which the investment strategy developed by Mr. Gregory was described as follows:
Gregory Investment assists investors in profiting from changes in yields on U.S. Government securities. The investor provides us with his forecast of interest rates. We recommend a portfolio of U.S. Government securities that we believe will result in a gain, if the investor's forecast is correct.
The investment usually involves the purchase and sale of securities under arrangements that delay the actual delivery of the security for several months. This type of arrangement is referred to as a forward contract.
A forward contract is a bilateral executory agreement pursuant to which one party agrees to deliver a designated amount of an item at a certain price and time to another party, who agrees to acquire such item at such price and time. The forward contract does not require delivery until the settlement date designated in the contract. A forward contract is similar in concept to a futures contract. However, a futures contract is consummated through a board of trade or an exchange and contains standardized terms and conditions. The securities purchases and sales through forward contracts are limited to obligations of, or obligations guaranteed by, the United States Government, and securities issued by or guaranteed by United States Government corporations or agencies; e.g., Government National Mortgage Association (GNMA) or Federal Home Loan Mortgage Corporation (FHLMC). The customer is required by the contract to make delivery to, or take delivery from, the dealer of the security specified in the forward contract at settlement date.
It is contemplated that a customer will enter into several forward contracts with the dealer, some of which will require the customer to make forward delivery to the dealer of securities, while others will require the customer to take forward delivery from the dealer of securities. The forward contracts entered into by a particular customer will reflect a market strategy and interest rate forecast and could result in substantial gain or loss to the customer, depending on the volume of transactions and whether interest rate movement is in accordance with, or adverse to, his expectations.
The investment risk is diminished by the simultaneous purchase and sale of a forward contract. This purchase and...
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