Oringderff v. Commissioner
| Decision Date | 19 March 1979 |
| Docket Number | Docket No. 3879-77. |
| Parties | John N. Oringderff and Barbara Oringderff v. Commissioner. |
| Court | U.S. Tax Court |
William P. Trenkle, Jr., 208 West Spruce, Dodge City, Kansas and Jack E. Dalton, for the petitioners. Dale P. Kensinger, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined deficiencies in petitioners' Federal income tax for the taxable years 1973 and 1974 in the amounts of $145,507.14 and $30,052.32, respectively.
The issue for decision is whether petitioners' transactions in commodity futures during 1973 and 1974 resulted in capital losses or ordinary losses.
Some of the facts have been stipulated and are found accordingly.
Petitioners, John N. and Barbara Oringderff, who resided in Ingalls, Kansas at the time of filing their petition in this case, filed joint Federal income tax returns for the calendar years 1973 and 1974 with the Internal Revenue Service Center in Austin, Texas.
Mr. Oringderff (hereinafter referred to as petitioner) is known for his expertise in feedlot management. He is an expert in the fattening of feeder cattle and the marketing of fat cattle. He was born and raised on a farm in southeast Kansas where he was involved in farming activities. His farming activities continued during his education at a local junior college. After junior college, petitioner served in the military. Upon his return to civilian life, petitioner attended Kansas State University where he earned a Bachelor of Science degree in Animal Husbandry.
Upon graduation, petitioner entered the cattle industry as a commercial feedlot manager. For a fee, commercial feedlots custom feed cattle owned by others. The cattle enter the feedlot weighing between 550 and 650 pounds, for heifers, and between 600 and 800 pounds, for steers. After feeding for an average of 120 to 150 days, the cattle weigh between 1,000 and 1,300 pounds and are generally ready to be sold to packers. Packers are enterprises, such as Iowa Beef Processors, Inc., Swift and Company or Armour and Company, which need large quantities of finished cattle.
When the cattle begin the fattening process, they are called feeders; when sold, they are called finished or fat cattle. While in the feedyard, the cattle are kept in small pens, 200 to 300 square feet per animal, and are fed high energy grains, such as wheat and corn. Depending on where in their growth cycle they stand, the cattle are fed one of numerous ratios of the high energy feed.
Petitioner's first position following graduation from college was managing a small, 2,000-head feedyard in Dodge City, Kansas. He held that position from 1959 until September of 1961. In September of 1961, he was hired to manage a new feedyard in Ingalls, Kansas — the Ingalls Feedyard, Inc. (Ingalls Feedyard). At that time Ingalls Feedyard had a capacity of 2,500 head of cattle.
In 1962, petitioner and the assistant manager from the Ingalls Feedyard organized a corporation, R & O Cattle Company. Each owned 50 percent of the stock in the corporation, which was in the business of buying feeder cattle to be fattened and sold. R & O Cattle Company placed cattle with Ingalls Feedyard and paid Ingalls Feedyard the same fee as other customers to fatten its cattle. The shareholders of Ingalls Feedyard encouraged its employees, or entities in which they held an interest, to purchase feeder cattle and place them with Ingalls Feedyard for fattening.
During the time from 1961 until 1967, the commercial feedlot industry grew greatly in southwest Kansas and the plains area. The Ingalls Feedyard capacity grew to 11,000 by 1967. In the fall of 1967, the 5 shareholders of Ingalls Feedyard decided to expand their enterprise. By the fall of 1968, Ingalls Feedyard had a 30,000-head capacity. Additionally, a new mill and new offices were added to the operation.
In the late 1960's, petitioner entered a partnership, Irsik & Doll, with the 5 shareholders of Ingalls Feedyard. Petitioner had a one-sixth interest in the partnership. The partnership was in the business of buying feeder cattle to be fattened and sold as fat cattle. Petitioner also entered the business of buying feeder cattle to be fattened as an individual in 1967. The partnership cattle and petitioner's own cattle were placed at Ingalls Feedyard for fattening at the same fee charged to other customers.
In 1967, petitioner began trading in cattle futures. The other R & O Cattle Company shareholder was unwilling to have the corporation engage in futures transactions and the other partners of Irsik & Doll were not agreeable to having the partnership engage in such transactions.
Ingalls Feedyard was not expanded beyond the 30,000-head capacity of 1968, because the corporate management determined that further expansion would be inefficient. However, the 5 shareholders of Ingalls Feedyard and petitioner formed a separate corporation and started a second feedyard, Gray County Feedyard, Inc. (Gray County), with a 20,000-head capacity. The Gray County operation began in the late 1960's. Petitioner in 1973 and 1974 supervised the cattle sales and purchases made by the manager for that feedyard.
Petitioner's interests in the above operations continued through 1974. He was manager of Ingalls Feedyard; partner of Irsik & Doll; a shareholder in R & O Cattle Company; a shareholder in, and a consultant to, Gray County; and, an individual participant in the business of fattening feeder cattle for sale to packers.
In the late 1960's and early 1970's, because of the expansion of the commercial feedlot industry in southwest Kansas, buyers from the major packers began to purchase directly from the feedlots. Previously, the buyers could be found only in terminal markets such as Kansas City or St. Louis.
Buyers who are representatives of the packers travel a given territory to buy grain-fed cattle for the packer. Typically, a buyer will go to a feedlot and, upon finding a supply of finished cattle on hand, will bid on the cattle or request an estimated asking price. At this point, the feedlot management will get in touch with the owner of the cattle in question.
The owners of the cattle being fed in Ingalls Feedyard generally depended on petitioner, the feedlot manager, to advise them as to what was or was not a good price. Although a buyer is given up-to-date price information at the beginning and middle of his workday and upon reporting into his company during the day, petitioner due to his contacts in the futures market had price information at least as current as the buyer's.1 This information was advantageous to petitioner in the sale of his own cattle and in the advice he gave to customers of Ingalls Feedyard on the sales of their finished cattle.
The cattle industry is cyclic both in terms of numbers of cattle placed on the market and prices for cattle. In 1973, the industry was in a stage of preparing for rapid expansion. Owners were withholding heifers from the market and not culling cows so as to increase future production. In addition to this contraction of available cattle preparatory to rapid expansion in number of cattle available, other factors affected the cattle market in 1973 and 1974. There were wheat sales to the Soviet Union beginning in 1972, which caused grain prices to rise. Inflation was at a high level and was being increased by spiraling energy costs. In late 1973 and early 1974, weather conditions increased the cost of putting gain on feeder cattle. With cattle prices rising and a temporary short supply of cattle, sporadic consumer boycotts of meat began in February of 1973. In March of 1973, the President of the United States imposed a price ceiling on red meats at the retail and wholesale levels. Two weeks after price controls began, hoarding of meat occurred. In September of 1973, the ceiling on beef was removed. The price of other red meats had increased when the ceiling on prices was removed in July, and cattle owners had expected an increase in cattle prices when the price ceiling was removed in September. However, the price immediately dropped when the ceiling was removed. In December of 1973 and February of 1974, a truck strike occurred. In general, the period of 1973 and 1974 was one of great uncertainty in the cattle industry. Although generally cattle owners made profits through the first three quarters of 1973, losses became prevalent in the fourth quarter of 1973 and through 1974. It was not unusual for a cattle owner to experience a loss amounting to $100 to $150 a head at times in 1974, and in some instances, even a greater loss.
Because there is a large price risk in raising feeder cattle, some owners have used the futures market in commodities to reduce their risks. When feeder cattle are purchased to be fattened, the owner is taking a long position in the cash feeder cattle market. For protection against a price decline, the owner can take a short position in the futures finished cattle market by selling a finished cattle futures contract. Assuming uncontrollable variables, such as weather, feed costs, and death rates, are as expected, the owner by taking a short position in the futures market has locked-in his profit even if prices fall. On the other hand, if prices rise, the owner has limited his profit to the locked-in figure and does not profit from a market upsurge.
If that same owner, with a long position in the cash finished cattle market, is concerned not with the price he will ultimately receive for his cattle, but is concerned with the feed costs he might incur, he could take a long position in the futures grain market by purchasing a grain futures contract. Thus, if grain prices did increase, the owner would be protected. But, if grain prices went down, he would not increase his profit on the cattle because of the lower prices.
Often, a cattle owner, upon the sale of the finished cattle, will...
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