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Kirchman v. C.I.R., 862 F.2d 1486, 63 A.F.T.R.2d 89-588, 89-1 USTC P 9130

Facts

The case involves approximately 1400 taxpayers who engaged in commodity option and futures transactions on the London Metals Exchange from 1975 to 1980. They deducted significant first-year losses as ordinary losses under I.R.C. § 165(c)(2) but were assessed deficiencies by the Commissioner of the I.R.S. The tax court found that these transactions lacked a profit motive and were structured primarily for tax avoidance, leading to the conclusion that they were shams.

The Commissioner assessed a deficiency against approximately 1400 taxpayers for loss deductions taken for years 1975 through 1980 incurred in connection with commodity transactions entered into on the London Metals Exchange. Taxpayers' challenges were consolidated in a single case before the tax court. The tax court held that these transactions were shams with no legitimate economic substance because taxpayers had no profit motive, and upheld the Commissioner.

Issue

Whether the option straddle and futures straddle transactions were shams and whether the losses incurred were deductible under I.R.C. § 165(c)(2).

Rule

The sham transaction doctrine requires courts to look beyond the form of a transaction to determine if it has economic substance. If a transaction lacks economic substance and is entered into primarily for tax benefits, the losses incurred are not deductible.

The sham transaction doctrine requires courts and the Commissioner to look beyond the form of a transaction and to determine whether its substance is of such a nature that expenses or losses incurred in connection with it are deductible under an applicable section of the Internal Revenue Code.

Analysis

The court applied the sham transaction doctrine by examining the economic substance of the transactions. It found that the taxpayers engaged in a prearranged sequence of trading that was calculated to achieve tax-avoidance objectives rather than genuine profit motives. The court concluded that the transactions were shams because they were structured solely to produce tax deductions without any legitimate economic purpose.

The court held that these were sham transactions as a matter of law. Stated as such, the standard of review is de novo. See Miller v. Commissioner, 836 F.2d 1274, 1277 (10th Cir.1988) (legal conclusions by tax court reviewed de novo); see generally Frank Lyon Co. v. United States, 435 U.S. 561, 581 n. 16, 98 S.Ct. 1291, 1302 n. 16, 55 L.Ed.2d 550 (1978) ('The general characterization of a transaction for tax purposes is a question of law subject to review.').

Conclusion

The court affirmed the tax court's decision, holding that the losses incurred by the taxpayers in connection with the straddle transactions were not deductible under I.R.C. § 165(c)(2) because the transactions lacked economic substance.

We hold that taxpayers have not met their burden of showing that these transactions were not a sham. See Brown v. Commissioner, 85 T.C. 968, 998 (1985). Consequently, we affirm the tax court.

Who won?

The Commissioner of the I.R.S. prevailed because the court found that the taxpayers failed to demonstrate that their transactions had a legitimate profit motive and were not shams.

The court found that this was 'a prearranged sequence of trading calculated to achieve a tax-avoidance objective—not investments held for non-tax profit objectives.'

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Keywords

Related Cases

First National Trust & Savings Bank of San Diego, California v. United States Steel Corporation, nan

McDonald v. Commissioner of Internal Revenue, 52 T.C. 82

Commissioner of Internal Revenue v. Bollinger, 482 U.S. 913, 107 S.Ct. 3183 (Mem), 96 L.Ed.2d 672

Libson Shops, Inc. v. Koehler, 353 U.S. 382, 77 S.Ct. 990, 1 L.Ed.2d 924, 57-1 USTC P 9691, 51 A.F.T.R. 43, 1957-2 C.B. 891

Lynch v. Commissioner of Educ., 317 Mass. 73, 56 N.E.2d 896