Kurtz v. Commissioner

• Decision Date: 12 August 1985
• Docket Number: 11086-82.,Docket No. 10985-82
• Citation: 1985 TC Memo 410,50 TCM (CCH) 695
• Parties: James B. Kurtz and Katharine C. Kurtz v. Commissioner. W. C. Kurtz, Jr., and Almae Mae Kurtz v. Commissioner.
• Court: U.S. Tax Court

50 T.C.M. (CCH) 695 (1985)

T.C. Memo. 1985-410.

James B. Kurtz and Katharine C. Kurtz v. Commissioner.

W. C. Kurtz, Jr., and Almae Mae Kurtz v. Commissioner.

Docket Nos. 10985-82, 11086-82.

United States Tax Court.

Filed August 12, 1985.

William S. Huff, Charles A. Ramunno, and Bruce N. Lemons, 1700 Broadway, Denver, Colo. for the petitioners.^* Theodore J. Kletnick, William F. Garrow and Gary Kirschenbaum, for the respondent.

Memorandum Findings of Fact and Opinion

WHITAKER, Judge:

In docket No. 10985-82, respondent determined a deficiency in income tax for the 1978 taxable year of James B. Kurtz (JBK) and wife Katharine C. Kurtz in the amount of $379,432.00. In docket No. 11086-82, respondent determined a deficiency in income tax for the 1978 taxable year of W. C. Kurtz, Jr. (WCK) and wife Alma Mae Kurtz in the amount of $373,230.00. In these consolidated cases, the principal issue for decision is the deductibility of short-term losses in excess of $900,000 incurred by each petitioner-husband in commodities futures straddle trading where the investment plan followed the typical tax straddle strategy.¹ In addition, in docket No. 10985-82 respondent, prior to trial, raised, a new issue — that a component of the loss claimed by JBK and wife, a loss of $480,740 incurred on the disposition of a gold futures position on November 16, 1978, would in any event be disallowed under section 267.² Although not raised in the statutory notice or contained in any pleading, the parties have tried this issue and we will treat it as properly before the Court.

Finding of Fact

Some of the facts have been stipulated and are so found. At the time each of the petitions was filed, each petitioner was a resident of the state of Colorado. Petitioners filed their respective Federal income tax returns on the calendar year basis using the cash receipts and disbursements method of accounting. JBK and WCK are brothers (collectively the Brothers and sometimes severally the Brother). Their wives are parties only by reason of having filed joint income tax returns with their respective husband.

Background Information

Following military service in World War II, JBK and WCK returned to Colorado to participate actively in their incorporated family lumber business. In early 1978, at the time of the sale of that business, JBK was the president. The principal shareholders were JBK, WCK, their sister, and members of these three families (including trusts). The outstanding stock was sold to Boise Cascade Corporation on April 12, 1978 for an aggregate cash price of slightly over $19 million dollars. Long-term capital gains were realized by JBK and his wife in the amount of $3,333,691.00, and by WCK and his wife in the amount of $3,286,203.00.

Both Brothers, as well as the family lumber company, had long used the accounting and tax planning services of the public accounting firm of Ernst & Ernst, now known as Ernst & Whinney. In 1978 the Brothers' regular accountant with that firm was Herbert LaMee, but they also knew and had utilized from time to time Nels Tamplin, now deceased, but then a senior tax partner and tax planner with that accounting firm. Tamplin was well versed in the mechanics and tax consequences of commodities futures trading. In 1978, JBK had little if any understanding of commodities futures trading while WCK had had limited exposure to that subject.

During the summer of 1978, JBK was contacted by Douglas Gray, an account executive with E. F. Hutton & Co., Inc. (Hutton), who was soliciting pension fund business. In the course of conversations with JBK, Gray found out about the large capital gain from sale of the family business and commenced to solicit other trading business. In late August or early September 1978, the Brothers met with Gray, James Robb, a Hutton regional commodities director with extensive experience in commodity futures trading, Tamplin, and perhaps with LaMee to explore futures trading in some detail. Prior to that time, the Brothers had had conversations among themselves and probably with Gray or Tamplin or both which were sufficient to interest the Brothers in the possibility of investing in futures both for profit, as an inflation hedge, and for the tax advantages of tax straddles.³ Prior to this meeting Tamplin and Robb had together participated in the planning and execution of futures trades for other clients of Tamplin.

During the meeting Robb was requested to prepare and submit to the Brothers a letter summarizing the Hutton straddle proposal. The letter was prepared with some assistance from John Sawyer, a commodities account executive in Hutton's national commodities department in New York City. Sawyer had had extensive experience in the planning, implementation, and execution of tax straddle transactions for other Hutton customers located throughout the United States.

Transactions in Issue

The original of the Hutton letter dated September 18, 1978 was delivered to JBK and copies to WCK and to Tamplin. The letter explained certain aspects of commodities futures trading, defined terms and discussed the mechanics of a tax straddle. The letter states:

The goals of a tax straddle are as follows: First, to establish loss and eliminate 1978 tax liability. Second, to accomplish the gain. Third, to make that gain long term. Fourth, loss sic as little as possible in total cost (risk and commission) and fifth, to make a profit.

The letter served to illustrate to JBK and WCK how tax straddle trading could be used to reduce their 1978 capital gain tax liability by rolling part of the 1978 long-term capital gain forward to 1979 while minimizing the possibility of loss (economic loss and transaction costs). While profit is listed as one of the goals of a tax straddle,⁴ the two examples contained in the letter which show the results of deferring $100,000 and $500,000 of gain each results in a small out-of-pocket cost to the participants.

Thereafter, on or about October 26, 1978, the Brothers met with Tamplin and Robb to discuss the Hutton proposal. Handwritten notations made contemporaneously by each of the Brothers on their respective copies of the Hutton letter indicate that this discussion revolved around the acquisition of gold and silver futures straddles with the objective of each Brother realizing a tax loss of approximately one million dollars, which was expected to result in a substantial tax savings. The Brothers understood that the program would have to remain in effect for 6 months in order for gain in the long position to be treated as long-term capital gain when realized in 1979. The Brothers also understood the principal risk to be a loss of 11 percent of the sum of money required to be deposited with Hutton as margin, i. e., the sum of $100,000, and, in addition, payment of the deferred tax plus 6-percent interest if the transaction did not withstand respondent's audit. The profit potential was 100 percent or more of the margin deposit.⁵ Hutton's New York City office would develop and recommend the actual trades. Before agreeing to enter into the proposed tax straddle trading, the Brothers also consulted with a Denver, Colorado tax attorney who apparently confirmed the advice they had received but who suggested that the use of some open positions in addition to straddles would be helpful. Open positions were not, however, used.

On some date prior to November 13, 1978, the Brothers agreed to engage in commodities tax straddles involving gold and silver futures to be recommended by Sawyer, subject to the advice of, or the concurrence of, Tamplin. On October 31, 1978, JBK and WCK each established nondiscretionary commodities futures accounts with Hutton for this purpose.⁶ The trading activity and results are shown on the four charts which together constitute Appendix A hereto. The transactions on the charts illustrate typical tax straddle programs. At the time of the initial transaction on November 13, 1978, JBK and WCK each knew and intended to participate in such tax straddle programs. Although the positions acquired by each Brother are slightly different, they reflect identical trading strategies and were treated as such by Sawyer and Robb and presumably Tamplin.

With two exceptions there is no persuasive evidence that either Brother knew of or approved in advance any of the trades. The first exception is the conversion on November 22, 1978 of the simple silver spreads acquired on November 13, 1978 into butterfly spreads. The reason for the disposition of these initial silver spreads, in addition to the realization of tax losses, was the uncertainty as to the silver market caused by the activities of the Hunt brothers in their disastrous silver trading, apparently then starting to affect the silver commodity market. This factor was discussed with the Brothers. Thus, they probably did not know in advance what positions were to be acquired in the switch and may not have known what positions were to be disposed of; they did understand that some change would be made in their silver positions. What is principally significant, however, is not so much that the Brothers and their advisers were concerned that abnormal and unpredictable factors were affecting the silver futures market, materially increasing risks, but that they nevertheless maintained silver straddles with substantially the same economic potential and stayed with the program for the requisite 6-month period.

The second exception occurred after margin calls were made on each Brother. In December 1978 and again in January 1979 margin calls were made on WCK. In January 1979 margin calls were made on JBK. They then instructed their advisors to take action to make certain that no further margin calls would be made. On February 14, 1979, each Brother disposed of one-half the units of gold futures then held. The reduction in their investments in gold straddles apparently served to avoid further margin calls. It is again...