Forseth v. C.I.R., 86-1209

• Decision Date: 06 May 1988
• Docket Number: No. 86-1209,86-1209
• Parties: -1197, 88-1 USTC P 9331 Arnold T. FORSETH, Gerald R. Formsma and Constance Y. Formsma, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 746

845 F.2d 746

61 A.F.T.R.2d 88-1197, 88-1 USTC P 9331

Arnold T. FORSETH, Gerald R. Formsma and Constance Y.

Formsma, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 86-1209.

United States Court of Appeals, Seventh Circuit.

Argued Oct. 1, 1987.

Decided May 6, 1988.

Edward G. Lavery, Hercules & Lavery, Dallas, Tex., for petitioners-appellants.

Kenneth L. Greene, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.

Before CUDAHY and MANION, Circuit Judges, and WILL, Senior District Judge. ^*

WILL, Senior District Judge.

This is a somewhat complicated case involving the tax treatment of losses allegedly incurred by taxpayers as a result of their investment in a commodity straddle tax shelter. Although here we are dealing with only three appellants (Mr. and Mrs. Formsma and Mr. Forseth), the case was originally a consolidated trial at the tax court level involving several different persons similarly situated. The five other parties involved in the tax case have already appealed the tax court's adverse decision to the Fifth, Sixth, Ninth, and Eleventh Circuits. In each of these appeals, the decision of the tax court has been affirmed. Bramblett v. Commissioner, 810 F.2d 197 (5th Cir.1987) (unpublished opinion); Mahoney v. Commissioner, 808 F.2d 1219 (6th Cir.1987); Enrici v. Commissioner, 813 F.2d 293 (9th Cir.1987); Wooldridge v. Commissioner, 800 F.2d 266 (11th Cir.1986). Moreover, in each of these cases, the other appellants (who were represented by the same counsel as the instant appellants) raised issues identical to the issues appellants are now raising here. Thus, it appears we have a serious case of multiple forum shopping.

The particular facts of the case are detailed in the lengthy published opinion below. Forseth v. Commissioner, 85 T.C. 127 (1985). Essentially, the tax court held that the purported commodities trades giving rise to the "losses" allegedly incurred by appellants were shams and accordingly that such losses were not deductible. In concluding that the entire tax straddle arrangement was an artifice, the tax court found that Interact (an advisory firm providing informational services as to how to contact broker-traders who deal in foreign markets), LMEI (a commodity firm), and LMEC (LMEI's successor) took advisory fees and alleged "margin deposits" from appellants; entered into forward contracts for gold or platinum with appellants on an unregulated foreign market for which there were no published prices (and without laying off the contracts with any real third-party brokers); created fictitious losses for appellants by closing out "losing" positions at prices and terms set by LMEI/LMEC to generate a theoretical tax loss that largely offset the type and amount of income the taxpayers needed to shelter; and then closed out the winning position in a subsequent year at a price set by LMEI/LMEC to generate losses that uniformly equaled the amount of margin deposits, which were in reality fees for delivering the artificial tax "losses." Thus, the tax court concluded that the straddle transactions were shams lacking economic substance because the appellants had really just paid a fee to buy fictitiously generated tax losses. Accordingly, the tax court disallowed the deductibility of the tax losses.

Discussion

In the instant case, taxpayers, Mr. Forseth and Mr. and Mrs. Formsma, appeal the tax court's decision as to the deductibility of the tax losses sustained by them. To be deductible under the Code a transaction must be "entered into for profit." I.R.C. Sec. 165(c). As the Sixth Circuit has noted, although this phrase is "a term of art that has not been interpreted the same by all courts, it is clear that the transaction cannot be a complete sham. If it is a sham, then such niceties as whether it was 'primarily' for profit, or whether the test is an objective or subjective one are simply not involved. Regardless of the definition, the transaction must be bona fide." Mahoney v. Commissioner, 808 F.2d 1219, 1220 (6th Cir.1987).

Here, because the tax court determined that the commodities straddle transactions were a sham, it never reached the "entered for profit" issue. The tax court's finding that the forward contracts were shams, is reviewable under the "clearly erroneous" standard because it is "essentially a factual determination." Thompson v. Commissioner, 631 F.2d 642, 646 (9th Cir.1980), cert. denied, 452 U.S. 961, 101 S.Ct. 3110, 69 L.Ed.2d 1972 (1981). See also Enrici, supra, 813 F.2d at 295.

In finding that the alleged gold and platinum straddles were no more than preconceived shams, the tax court relied on the following six factors:

1. The remarkable correlation of the tax needs of each taxpayer and the nature and the amount of tax losses delivered by LMEC/LMEI and Interact. Tax losses were correlated to tax needs in two ways: first, the taxpayer generally suffered losses equal to the amount of income each taxpayer needed to shelter; and second, the type of loss created matched the type of income that needed to be sheltered.

2. Interact's "extraordinary" ability to predict the amount of losses that would be incurred depending upon the margins posted.

3. The willingness of LMEI/LMEC to commence trading in clients' accounts before receipt of the required margin deposits with the result that they were not protected against client default. Had actual bona fide trades been carried out on behalf of appellants, at least some appellants would have been required to post additional margin deposits to cover trading losses.

4. The margin balances in the accounts were "zeroed out" by closing out the clients' gains at prices that made the taxpayers' overall losses equal the margin deposits the appellants initially placed with LMEI/LMEC.

5. Opposite positions were never actually entered into with market making brokers to "lay off" trades.

6. The apparent manipulation of certain trading records by LMEI/LMEC.

Forseth v. Commissioner, 85 T.C. 127, 149-166 (1985).

To demonstrate that the trades were not shams, appellants primarily argue that many of these grounds would also have existed even if they had entered into straddles on the open commodities market, and that the losses suffered in their forward straddles were in fact correlated to the losses and gains they would have suffered in the American commodities market. Each court of appeals that has reviewed the...