Statutory language trumps tax policy.

• Author: Beavers, James A.

The Sixth Circuit held that a contract does not have to require delivery or settlement of a foreign currency to be a foreign currency contract for purposes of Sec. 1256 and, thus, a foreign currency option could be a foreign currency contract.

Background

Terry Wright and his wife, Cheryl Wright, each owned a 50% interest in an investment company called Cyber Advice LLC, which was taxed as a partnership. In December 2002, the Wrights, on the advice of a promoter, undertook what commonly is called a major/minor transaction through Cyber Advice. On Dec. 20, 2002, Cyber Advice purchased a euro put option for $36,177,750 and a euro call option with mirror-image terms from a counterparty. At the same time, Cyber Advice also sold a Danish krone call and a krone put to the counterparty on mirror-image terms.

On Dec. 23, 2002, Cyber Advice assigned the euro put option and krone put option to a charity, the Foundation for an Educated America. At the time of the assignment, the euro put option was valued at $33,018,574 and the krone put option was valued at $33,012,274. Cyber Advice also sold the euro call option to the counterparty and repurchased the krone call option from the counterparty.

The Wrights took the position that they did not need to recognize the gain from the assignment of the krone put option to the charity because over-the-counter options on minor foreign currencies such as the krone were not Sec. 1256 contracts to which mark-to-market accounting applied. The Wrights also took the position that recognition of a shortterm capital loss from the assignment of the euro put option to the Foundation for an Educated America was proper because the euro put option was a "foreign currency contract" subject to Sec. 1256 and thus the assignment resulted in a termination under Sec. 1256(c). The Wrights reported a $2,970,822 flowthrough loss on their return, which aided in reducing their other capital gains of more than $3.4 million to $454,477.

On examination, the IRS concluded that the Wrights could not claim the capital loss passed through from Cyber Advice because the euro put option was not a foreign currency option subject to the Sec. 1256 mark-to-market rules and issued a notice of deficiency for $603,093. The Wrights subsequently petitioned the Tax Court, contesting the IRS's determination.

The determination of whether the euro put option was a foreign currency contract is based on Sec. 1256(g)(2)(A), which states:

(A) Foreign currency...