Leslie v. C.I.R.

• Decision Date: 27 May 1998
• Docket Number: No. 96-70880,96-70880
• Citation: 146 F.3d 643
• Parties: -2153, 98-2 USTC P 50,494, 98 Daily Journal D.A.R. 5505 Robert G. LESLIE and Marilyn B. Leslie, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 643

146 F.3d 643

81 A.F.T.R.2d 98-2153, 98-2 USTC P 50,494,

98 Daily Journal D.A.R. 5505

Robert G. LESLIE and Marilyn B. Leslie, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 96-70880.

United States Court of Appeals Ninth Circuit.

Argued and Submitted Dec. 2, 1997.

Decided May 27, 1998.

Kevin M. McGuire, Law Offices of Federico Castelan Sayre, Newport Beach, California, for petitioners/appellants.

Laurie Snyder, United States Department of Justice, Tax Division, Washington, DC, for respondent/appellee.

Appeal from the United States Tax Court; William M. Fay, Judge, Presiding. T.C. No. 9814-87.

Before: FERGUSON, THOMPSON, and O'SCANNLAIN, Circuit Judges.

O'SCANNLAIN, Circuit Judge:

We examine the lingering federal income tax consequences of participation in gold-futures "straddle" transactions in the early 1980's, when the top tax-rate bracket was 70%.

I

On their 1980, 1981, and 1982 federal income tax returns, Robert and Marilyn Leslie claimed gains and losses resulting from gold-futures "straddle" transactions that Robert entered into with futures commission merchant F.G. Hunter & Associates ("Hunter"). A futures contract, in a nutshell, is an agreement either to buy or to sell a specific quantity of a specific commodity during a designated month in the future. A contract--called a "position"--is "long" if it requires its holder to purchase the commodity, and "short" if it mandates a sale. For purposes relevant to this case, a "straddle" occurs when a single individual (in this instance, Robert) holds both (1) a long position requiring delivery in one month and (2) a short position in the same commodity requiring delivery in a different month. Each of the two positions constitutes a "leg" of the overall straddle transaction. A straddle leg is generally "closed out" by acquiring an offsetting position. See Miller v. Commissioner, 836 F.2d 1274, 1276 (10th Cir.1988). ¹

In 1980, the Leslies reported ordinary losses from Robert's straddle transactions in the amount of $1,530,268 and short term capital gains in the amount of $198,030. They also claimed as deductions $17,500 in fees paid to Hunter. In 1981, the Leslies reported ordinary losses in the amount of $55,302 and long term capital gains in the amount of $97,160. And in 1982, they reported long term capital gains from Hunter transactions in the amount of $1,172,950.

On February 20, 1987, the Commissioner of the Internal Revenue Service ("the Commissioner") issued to the Leslies a Notice of Deficiency, disallowing deductions of straddle losses totalling approximately $1.5 million for 1980, 1981, and 1982. A two-day trial was held in Los Angeles in early 1995. Finding that Robert's primary motivation in entering into the Hunter straddle transactions was to generate tax benefits, and not to realize profits, the Tax Court concluded that the losses incurred on the straddle transactions were not deductible. The court also rejected the Leslies' claim that they were entitled to a "net loss" deduction for 1982 in the amount that their straddle losses exceeded their straddle gains, denied their claimed deduction of fees paid to Hunter in setting up their straddle transactions, and imposed an enhanced-interest penalty of 120% of the rate otherwise payable on their tax underpayments.

The Leslies appealed, challenging each of the Tax Court's several conclusions. We have jurisdiction pursuant to 26 U.S.C. § 7482. We address of the Leslies' contentions in turn. ²

II

The central issue in this appeal is whether the Leslies are entitled to deduct losses on Robert's Hunter investments, as claimed on their 1980, 1981, and 1982 tax returns. The Deficit Reduction Act of 1984 ("DEFRA") permits the deduction of a loss sustained through participation in a pre-1982 tax straddle only "if such loss is incurred in a trade or business, or if such loss is incurred in a transaction entered into for profit though not connected with a trade or business." DEFRA § 108(a), Pub.L. No. 98-369, 98 Stat. 494, as amended retroactively by § 1808(d) of the Tax Reform Act of 1986, Pub.L. No. 99-514, 100 Stat. 2817 (emphasis added). ³ The Leslies have not alleged that Robert incurred his losses in the course of a trade or business. Consequently, we must focus our attention on the question whether Robert's motives for entering into the tax straddle transactions sponsored by Hunter were aimed at generating profit (which would render the losses deductible), or instead were aimed at saving taxes (which would render them nondeductible). The Commissioner's initial determination that Robert's primary motivation was to secure tax savings is presumptively correct, see Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933), and the burden of proving profit-motive is on the taxpayer, see Wolf v. Commissioner, 4 F.3d 709, 713 (9th Cir.1993). The Tax Court agreed with the Commissioner and concluded that Robert's "motives in entering into these transactions, despite [the Leslies'] arguments to the contrary, were primarily to obtain substantial tax benefits." Leslie v. Commissioner, 71 T.C.M. (CCH) 2233, 2242 (1996).

The Tax Court's determination that Leslie entered into the tax straddle at issue for tax savings rather than for profit is a finding of fact, and is therefore reviewable only for clear error. See Independent Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 727 (9th Cir.1986). Consequently, we must uphold the Tax Court's conclusion unless we are "left with the definite and firm conviction that a mistake has been committed." United States v. United States Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 92 L.Ed. 746 (1948). In other words, if the Tax Court's account of the evidence is "plausible in light of the record viewed in its entirety, [we] may not reverse it even though convinced that had [we] been sitting as the trier of fact, [we] would have weighed the evidence differently." Wolf, 4 F.3d at 712-13 (quoting Service Employees Int'l Union v. Fair Political Practices Comm'n, 955 F.2d 1312, 1317 n. 7 (9th Cir.1992) (quoting Anderson v. City of Bessemer City, 470 U.S. 564, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985))).

In Ewing v. Commissioner, 91 T.C. 396, 1988 WL 89128 (1988), aff'd without opinion, 940 F.2d 1534 (9th Cir.1991), the Tax Court considered precisely the same Hunter straddle scheme at issue in this case, and concluded that the investors involved there were motivated by tax savings and not by profit. See id. at 420. We, of course, recognize that the Ewing decision is not conclusive of the Leslies' appeal; the motivation inquiry is an individualized one, dependent upon the particular taxpayer's state of mind. It cannot be doubted, however, that Ewing--called "the test case for the F.G. Hunter transactions," Nolte v. Commissioner, 69 T.C.M. (CCH) 1828, 1829 (1995), aff'd without opinion, 99 F.3d 1146 (9th Cir.1996)--is highly relevant to the Leslies' case, and weighs in favor of affirming the Tax Court's decision.

Even aside from Ewing, uncontroverted objective evidence amply supports the Tax Court's conclusion that Robert's primary motive in participating in the Hunter straddle was to realize tax benefits. As the Tax Court pointed out, what sets the Hunter program apart from other straddle investment opportunities is its use of the alternative liquidation techniques of "cancellation" and "assignment" in place of the more traditional "offset" procedure. The unique close-out methods were designed to provide maximum tax savings in closing straddle contracts:

Specifically, the "cancellation" technique was devised so that its proponents could claim ordinary loss treatment rather than capital loss treatment. The "assignment" procedure was contrived so that Hunter investors could characterize straddle gains as long-term capital gains instead of short-term capital gains.

Id. at 2242. The promotional material distributed to prospective clients--which Robert stipulated he read--emphasized the tax advantages of the Hunter program, focusing specifically on the alternative liquidation procedures. For instance, one portion of the "Questions and Answers" section of the promotional materials provided:

3. Can I lose my investment?

Yes. As with any investment, the risk of loss is commensurate with the opportunities for profit. However, the opportunity for profit can be considerably enhanced, and the risk of loss substantially reduced by the proper choice of alternative methods of liquidating your contracts.

* * * * * *

8. How can the probability of gain be increased by choice of liquidation methods?

Income tax treatment of your gains or losses on each contract will be different depending upon the way your contract is closed out. There are ways to close out a contract in which you have a gain so that it will be taxed as a long term capital gain. For the contract in which you have a loss, you may liquidate so as to have ordinary loss. Depending upon your tax bracket, your risk of after tax loss on both these contracts will be very substantially reduced and will quite possibly be converted into an after tax gain. Any net pre-tax profit will be significantly increased.

The promotional literature read by Leslie also included a series of graphs demonstrating pre- and post-tax profit potential for Hunter straddle investments and provided a worksheet designed for calculating "Tax Savings" achieved through the Hunter program. In addition, prior to investing, Leslie received and reviewed a 24-page opinion letter "concerning the federal income tax consequences" of the straddle contracts and a document entitled "Summary of Federal Income Tax Consequences." Both the letter and the summary detailed the various close-out options provided by the Hunter straddle program and the income tax consequences of each of the options.

Robert didn't just read about the alternative liquidation options, however. He apparently put them to work. As pointed...