King v. Comm'r of Internal Revenue
| Decision Date | 09 September 1987 |
| Docket Number | Docket No. 15350-84 |
| Citation | 89 T.C. No. 35,89 T.C. 445 |
| Parties | MARLOWE KING, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner was engaged in the trade or business of commodities futures trading. In 1978, petitioner took delivery of 10,000 ounces of gold pursuant to the terms of 100 long gold futures contracts. In 1980, petitioner disposed of the gold pursuant to 100 short gold futures contracts. Petitioner realized a long-term capital gain with respect to his disposition of the gold. During the years 1979 and 1980, petitioner deducted interest expenses resulting from carrying the physical gold. HELD, to the extent a trader has incurred debt in order to carry on ordinary trading activities as part of his trade or business of trading, the interest paid thereon is not subject to the investment interest limitations of section 163(d), I.R.C. HELD FURTHER, the carrying of the physical gold by petitioner was part of his trade or business of trading commodity futures and section 163(d), I.R.C., is therefore not applicable to the interest incurred thereon. Stephen Lewis, Bradford Ferguson, Frederick Hickman, Peter Freeman, and Michael Clark, for the petitioner.
Judy Jacobs and Alan Jacobson, for the respondent.
Respondent determined deficiencies in petitioner's Federal income taxes as follows:
+------------------+
¦Year¦Deficiency ¦
+----+-------------¦
¦1979¦$19,989.34 ¦
+----+-------------¦
¦1980¦1,525,852.76 ¦
+------------------+
Following the granting of petitioner's motion for partial summary judgment in King v. Commissioner, 87 T.C. 1213 (1986), the only issue remaining for our decision is whether section 163(d) 1 is applicable to certain interest deductions claimed by petitioner for the years in issue.
Some of the facts have been stipulated and are so found. The stipulation and attached exhibits are incorporated herein by this reference. Petitioner resided at Highland Park, Illinois at the time the petition herein was filed.
Petitioner is a registered member of the Chicago Mercantile Exchange (CME), a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission. Petitioner is also a member of the International Monetary Market (IMM), a division of the CME, and has been a member of the IMM since its establishment in 1972. From approximately 1954 through 1985, petitioner was also a member of the Chicago Board of Trade (CBOT).
Petitioner has spent his entire business career in various aspects of the commodity futures business. Following his graduation from New York University in 1948, petitioner worked in New York for two years for two firms dealing in butter and eggs, and cheese, respectively. Since 1950, when petitioner moved to Chicago and purchased a seat on the CME, his principal source of income has been the trading of regulated futures contracts on the CME, IMM, and CBOT. Petitioner engaged in such trading from 1950 to the present. In the 1950's, petitioner principally traded egg and onion futures. Petitioner began trading pork belly and live cattle futures in the early 1960's, and also traded futures for hogs and feeder cattle at various times. After the IMM was established, petitioner also began trading foreign currency, gold, and Treasury bill futures.
Until 1968, in addition to trading for his own account, petitioner also acted as a broker. In 1962, petitioner and his brother established King & King, Inc., which engaged in brokerage and in trading for speculation. King & King is a clearing member of the CME and IMM (i.e., a member of the CME Clearing House which the CME organization established to guarantee performance of and provide for settlement of all contracts traded on the CME) and clears petitioner's trades and the trades of a few other customers. In 1979 and 1980, petitioner was the president and sole shareholder of King & King. Since 1968, petitioner has traded primarily for his own account.
Petitioner monitors the trading on the CME and IMM on a regular basis on most days that the exchanges are open for trading. Since 1975, petitioner has not conducted his trading activity on the trading floor. Rather, he monitors trading through television screens in his offices and Highland Park home, and telephones instructions to King & King for execution by floor brokers. During the years in issue, petitioner had an office in Palm Springs, California and an office in King & King's offices in Riverside Plaza in Chicago.
Petitioner normally spends approximately six hours per day on trading and activities related to his trading. Petitioner normally arrives in his office one hour before the opening of the futures markets. He ordinarily calls a consultant to discuss information on the cash markets for the commodities he is trading. Petitioner also customarily consults with a clerk on the CME floor to obtain any statistics published by the CME. Petitioner also, if possible prior to the opening of the markets, calls to consult other traders around the country with whom petitioner is acquainted and who, like petitioner, trade on the basis of supply and demand.
Once the futures markets on the CME open, petitioner continually monitors the activity, via a television screen, in markets in which he has positions. The television screen shows petitioner the last sales price, the high and the low for the particular commodity, as well as news events. If petitioner wishes to place an order, he calls his 800 number for the King & King Chicago office and instructs the clerk to place an order with a floor broker. Once the order is filled, a King & King runner telephones petitioner with the confirmation of the trade. Petitioner monitors the activities on the CME until the exchange closes. Following the close of trading, he ordinarily telephones a consultant to obtain information on closing market prices and other information on deliveries.
During the period 1978 through 1980, petitioner maintained nine trading accounts with King & King for trading futures contracts traded on the CME. In addition, petitioner maintained accounts with Rosenthal & Co. and Marc Commodities for trading futures contracts traded on the CBOT and the New York Mercantile Exchange, respectively. During the taxable years in issue, petitioner traded, with varying degrees of frequency, in futures contracts for 20 different commodities, including gold, Swiss francs, Japanese yen, Canadian dollars, British pounds, Mexican pesos, Treasury bills, Deutschemarks, lumber, broiler chickens, live hogs, live cattle, feeder cattle, frozen pork bellies, eggs, wheat, corn, soybeans, GNMA collateralized deposit receipts, and potatoes.
A commodity futures contract is an executory contract representing a commitment to deliver or receive a specified quantity and grade of a commodity during a specified month in the future at a price designated by the trading participants. One who commits to deliver pursuant to a futures contract is commonly referred to as a ‘seller.‘ A seller is said to have a ‘short‘ position in the futures market. Opposite the seller in the execution of every futures contract is one who commits to receive pursuant to a futures contract, commonly referred to as a buyer. A buyer is said to have a ‘long‘ position in the futures market.
A futures contract may be satisfied either by offset — acquisition of an equal and opposite futures position to the position previously held — or by making or receiving delivery of the physical commodity required to be delivered or received under the futures contract. Futures and physical prices are inextricably linked at all times through the ability of a trader holding futures contracts to make or insist on receiving delivery. Most professional traders will at one time or another be involved in deliveries and in the ownership of physical commodities. From the standpoint of the professional trader, the physical commodity market, or ‘cash market,‘ is part and parcel of the futures market.
Trading in a futures contract for a particular commodity and delivery month may begin as much as two or more years prior to the delivery month, while delivery pursuant to the contract can only occur during the delivery month. Ninety-seven to ninety-nine percent of futures contracts are satisfied through offset, rather than delivery. However, if a contract is held to the delivery month, it is more than likely that the contract will be satisfied by delivery rather than offset. Every delivery month entails varying quantities delivered against the expiring contract, and, in terms of the means of satisfaction of futures contracts once the designated delivery month has arrived, delivery is commonplace.
When a trader accepts delivery under a futures contract, he is required to pay in cash the delivery price. The cash outlay required to hold the physical commodity is substantially more than the cash outlay required for holding a futures contract, which may be held on margins as little as 5 or 10 percent of the total price of the contract. As a result, when a professional trader takes delivery pursuant to a futures contract, the trader will ordinarily find it necessary to borrow money to pay the delivery price.
Petitioner employed a ‘fundamentalist‘ approach to trading, acquiring positions and holding them for varying lengths of time depending upon his view of supply trends in the cash market and the impact of such supply on cash and futures prices. Petitioner did not employ a ‘charting‘ approach — disposing of or acquiring a position based on market movement in comparison with historical price trends — or a ‘scalping‘ approach — rapidly trading positions based on market movement from the volume of bids coming into the pits. Petitioner frequently adjusted his positions...
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