Couple Petitions Supreme Court to Review Tenth Circuit Decision on Economic Substance

Sala invested approximately $8.9 million in a foreign currency option program (the "Deerhurst Program") in 2000. The initial investment phase of the program occurred during the last two months of 2000. The initial phase generated a significant tax benefit, and it also served several business purposes, including the creation of a test period which introduced the investors to a complicated investment strategy and to an investment manager with whom they had no prior experience. If the initial phase proved profitable, the investors were required to leave their funds invested with the Deerhurst Program for five years, or pay a penalty. However, if there was no profit during the initial investment period, the investors could withdraw their funds without further commitment. The District Court found the initial phase protected Sala and other investors "from plunging headfirst into an uncertain five-year strategy" because it involved the same trading strategy of acquiring and disposing positions in foreign currency options that was intended for the entire investment period. (Pet. App. 34).

Sala purchased and sold hundreds of option contracts during the initial phase, including the 24 option contracts that directly produced the tax loss at issue. These option contracts were contributed by an S corporation wholly owned by Sala (Solid Currencies, Inc.) to a partnership (Deerhurst GP), which held them until it was liquidated prior to year end. Although the liquidation was important to achieving the tax benefit, the District Court found that "each transaction entered into by Sala with regard to the partnership -- including Solid Currencies' contribution of the loss generating options contracts to Deerhust GP -- and by the partnership with regard to Sala -- including liquidating the option contracts at year end -- had a substantial business purpose other than the creation of tax losses." (Pet. App. 48).

The investment in the 24 option contracts had the purpose of producing profits for Sala: he actually made $90,000 to $110,000 on a $728,000 investment. (Id. at 41-42). The contracts had the potential to produce profits in excess of that amount: the experts for both parties agreed that the options had a maximum upside profit potential of at least $550,000. (Id. at 39-40). Because the initial phase was profitable, as required, Sala left almost $9 million invested with the Deerhurst Program for a five year period.

The tax loss claimed by Sala was based on the application of a rule of law established by Helmer v. Comm'r, 34 T.C.M. (CCH) 727 (1975), 1975 Tax Ct. Memo. LEXIS 212, and its progeny. The partnership tax rules generally require that a partner's basis in his partnership interest be increased for property contributed to the partnership, 26 U.S.C. § 722, and decreased for liabilities assumed by the partnership, 26 U.S.C. § 752(b). The Helmer court adopted the position urged by the IRS: a short option is a contingent liability, and therefore does not affect a partner's basis. Id. at *14-15. This resulted in the Helmer partner being taxed on "a distribution in excess of basis" under 26 U.S.C. § 731(a)(1), even though the partnership retained the obligation to perform on the option. Id. at *13-14. Although the partner's "gain" was not "economic," that did not relieve him of the obligation to pay tax. Following Helmer, the courts have consistently held that contingent liabilities, including short options, are not taken into account for purposes of § 752. Long v. Comm'r, 660 F.2d 416, 419 (10th Cir. 1981), aff'g 71 T.C. 1 (1978); LaRue v. Comm'r, 90 T.C. 465, 479-80 (1988).

Following the rules of § 752 as interpreted by the courts, Sala was required to increase his basis in Deerhurst GP by the purchase price of the long options ($60,987,866) that he contributed to the partnership. However, because Sala's short options represented contingent liabilities of $60,259,568, the tax law did not provide for a downward basis adjustment by the amount of the contingent obligations.¹ This resulted in a substantial tax loss when the option positions and Deerhurst GP were liquidated prior to year end, even though the investment resulted in substantial economic gain.

B. Proceedings In The District Court.

With respect to whether a transaction has economic substance, many courts have stated that the ultimate question is whether the transaction had "any practicable economic effects other than the creation of income tax losses." Dow Chemical v. United States, 435 F.3d 594, 605 (6th Cir. 2006), cert. denied, 549 U.S. 1205 (2007); ACM Partnership v. Comm'r, 157 F.3d 231,248 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999). Factors to consider include whether the transactions had a business purpose and whether there was a reasonable possibility of profit. James v. Comm'r, 899 F.2d 905, 908 (10th Cir. 1990).² The test is satisfied if the transactions in question alter the legal relationships between the parties. Estate of Strangi v. Comm'r, 293 F.3d 279, 282 (5th Cir. 2002) (recognizing the partnership because the partnership agreement "changed the legal relationships between decedent and his heirs and creditors").

After a two-week trial on the merits, the District Court held that the arrangements between the parties had "economic substance" sufficient to support the tax losses claimed by Sala. (Pet. App. 82-83). The court based this holding upon its findings regarding the transactions, as well as the behavior of Sala, the other investors, and the promoters and managers of the Deerhurst Program. (Id. at 29-30).

In this case, the District Court considered numerous "practical economic effects" of the transactions. Reviewing the transactions, the District Court found:

• Each phase of the Deerhurst Program had independent business purpose;

• The formation, operation and liquidation of Deerhurst GP in 2000 had substantial business purpose;

• Hundreds of option contracts were purchased and sold, and substantial profits were realized and divided among the partners based on their respective partnership shares;

• The liquidation of Deerhurst GP at the end of 2000 allowed for easier accounting and redistribution of partnership assets, protected the investors against year-end volatility in the market, and allowed Deerhurst to "cash-in" the investments while they were significantly profitable;

• The 24 option contracts that directly gave rise to the tax loss were structured to produce a profit, and actually produced substantial profits;

• Sala was required to leave $8.9 million invested with Deerhurst for a five year period if the initial phase was profitable;

C. Proceedings In The Tenth Circuit.

The Tenth Circuit left the factual findings of the District Court concerning the business purpose and profitability of the transactions giving rise to the tax loss completely undisturbed. It is these factual findings, and the rule of law in Helmer, that led the District Court to determine that the loss claimed by Sala was allowable.³ Not challenging either of these critical findings and conclusions of the District Court, the Tenth Circuit nevertheless reversed. Applying a de novo standard of review, the Tenth Circuit: (1) created an ad hoc proportionality rule, concluding that the expected $60 million tax benefit "dwarfs any potential gain from [Sala's] participation in Deerhurst GP" (Pet. App. 12-13); and (2) concluded the loss was "wholly artificial and fictional" in that it did not correlate with "actual economic harm" and economic outlay. (Id. at 7).

The Circuit Courts of Appeals are in sharp conflict regarding the correct standard of review to apply to the trial courts' ultimate determination on economic substance. Recognizing the split, the Tenth Circuit held that "the ultimate characterization of the transactions as shams" should be reviewed de novo even though a number of other "circuits treat sham determinations as questions of fact." James, 899 F.2d at 909, n.5 (10th Cir. 1990). Twenty years later, Circuit Courts of Appeals are still deeply divided: five support deferential review; three support de novo review; and four have conflicting intra-circuit precedent. Specifically, the Second, Third, Fourth, Seventh, and D.C. Circuits apply the clearly erroneous standard.⁴ By contrast, the Sixth, Tenth and Federal Circuits have adopted the de novo standard.⁵ The presence of conflicting intra-circuit authorities makes the standard impossible to ascertain in the Fifth,⁶ Eighth,⁷ Ninth⁸ and Eleventh Circuits.⁹

When setting out the applicable standard of review, for the most part, the Circuit Courts of Appeals' decisions simply cite prior opinions, with little analysis as to why the selected standard is appropriate. At the same time, in a set of opinions arising outside of tax law, this Court has developed a principled body of jurisprudence for settling standard of review questions. This jurisprudence firmly supports the application of a deferential standard with respect to a trial court's determination regarding economic substance.

This case illustrates compelling reasons for adopting a deferential standard of review. The trial court made many careful factual findings related to the practical economic effects of the transactions giving rise to the tax loss, including business purpose and profitability. The District Court arrived at these findings after listening to eight days of trial testimony from numerous fact witnesses and experts for each side, and assessing each witness's credibility. These factual findings compelled the District Court's conclusion that the transaction had economic substance. The Tenth Circuit did not conclude any of these factual findings were clearly erroneous. Instead, the Tenth Circuit employed the de novo standard of review to make an ultimate determination that is completely unsupported by the findings of fact. Applying a de novo standard of review to questions of economic substance invites appellate courts to substitute their own judgment for that of the trial court on what is essentially a fact-based inquiry.

In determining what type of review is appropriate, the "standard of deference for appellate review of district court determinations [should] reflect an accommodation of the respective institutional advantages of trial and appellate courts." Salve Regina College v. Russell, 499 U.S. 225, 233-34 (1991) (reviewing state law determination under Erie). Accordingly, de novo review is appropriate where appellate courts can "identify[] recurrent patterns, and advanc[e] uniform outcomes." Thompson v. Keohane, 516 U.S. 99, 113 n.13 (1995) (reviewing "in custody" determination under Miranda).

On the other hand, the more deferential clearly erroneous review is appropriate in situations where, as in this case, "factual nuance may closely guide the legal decision." Buford v. United States, 532 U.S. 59, 65 (2001) (reviewing whether prior State court convictions were "consolidated" for purposes of the U.S. Sentencing Guidelines). Deferential review is also appropriate when de novo review will "fail to produce the normal law-clarifying benefits that come from an appellate decision on a question of law," as when "'multifarious, fleeting, special, narrow facts . . . utterly resist generalization.'" Pierce v. Underwood, 487 U.S. 552, 561-62 (1988) (reviewing "substantial justification" under Equal Access to Justice Act); see also Cooter & Gell v. Hartmarx Corp., 496 U.S. 384, 404 (1990) (reviewing Fed. R. Civ. P. 11 determinations).

"Treating issues of intent," for example, "as factual matters for the trier of fact [subject to deferential review] is commonplace" and required even when the finding is an "ultimate fact" dispositive of the case. Pullman-Standard v. Swint, 456 U.S. 273, 286, 288 (1982) (reviewing discriminatory purpose determination under Title VII); see also Hernandez v. New York, 500 U.S. 352 (1991) (reviewing discriminatory intent determination under Batson); Comm'r v. Duberstein, 363 U.S. 278, 290-92 (1960) (reviewing donative intent for "gift" determination under Internal Revenue Code). The reason for deference lies in "the unique opportunity afforded the trial court judge to evaluate the credibility of witnesses and to weigh the evidence." Inwood Labs., Inc. v. Ives Labs., Inc., 456 U.S. 844, 855 (1982) (reviewing mislabeling determination under Trademark Act); see also Bose Corp. v. Consumers Union, 466 U.S. 485, 500 (1984) (deference "tends to increase when trial judges have lived with the controversy for weeks or months instead of just a few hours.").

This Court has yet to apply these principles to decide the standard of review to be applied by appellate courts in reviewing economic substance determinations, which arise frequently in tax disputes. In the wake of this Court's silence on the issue, the Circuit Courts of Appeals have failed to reach uniformity in the review of economic substance determinations. The more recent elaborations of this Court's standard of review jurisprudence argue strongly for deferential review of the ultimate finding on economic substance.

The better reasoned cases agree that deferential review is appropriate for this type of question. In considering whether the taxpayer made bona fide sales of surplus inventory in Rexnord, Inc. v. United States, 940 F.2d 1094, 1096-97 (7th Cir. 1991), the Seventh Circuit noted that the dispute "seems to raise predominately factual questions" over which "[t]here is no reason to conclude that" appellate judges "are in a better position to weigh the relative significance of specific facts and assess the total character of [the matter] than the district court." Moreover, "[c]onsiderations which favor a de novo standard, such as the desire to create a uniform rule, are not present here since no single rule could embrace the varied fact patterns which may arise." Id. at 1097. In Thompson v. Comm'r, 631 F.2d 642, 646 (9th Cir. 1980), cert. denied, 452 U.S. 961 (1981), the Ninth Circuit explained its choice of the clearly erroneous standard for economic substance determinations:

This Court should resolve the conflict among the circuits because: (1) the circuits are deeply divided on the issue and have been for more than twenty years; and (2) courts adopting a de novo standard ignore the principles set out in this Court's standard of review jurisprudence, which strongly support application of the deferential clearly erroneous standard.

This case presents an ideal vehicle for resolving the split on this important issue because the record is well developed, the trial judge made extensive factual findings, and the standard of review is determinative in this case. Analysis of this case under a deferential standard would compel a decision for the taxpayer.

B. This Court Should Determine Whether Tax Losses Can Be Disallowed Because Of Their Magnitude Where The Losses Are Based Upon Transactions That Are Found To Have Substantial Economic Effects.

The Tenth Circuit's decision creates a conflict with every other circuit, and provides courts with complete discretion to disallow tax benefits that are based on actual transactions with real business purpose and profit potential if the court concludes the tax loss is "too large." No criteria are provided for determining how large is "too large." Taxpayers and courts can reasonably predict whether transactions giving rise to a tax loss have genuine business purpose and profit potential. The proportionality rule created by the Tenth Circuit renders the allowability of a tax loss completely unpredictable and subject to unfettered judicial discretion.

The state of the doctrine has become more critical because of recent legislative changes codifying the judicially created economic substance doctrine and imposing a significant "no fault" penalty on transactions that lack economic substance. In March of 2010, Congress codified the economic substance doctrine in new 26 U.S.C. § 7701(o). P.L. No. 111-152, § 1409. The "economic substance doctrine" is defined as the "common law doctrine" as that doctrine is developed by the courts. § 7701(o)(5)(A) and (C). Congress thus intended that the courts have a singular and exclusive role in shaping the contours of that doctrine.

In conjunction with the codification of the doctrine, Congress created a new penalty for transactions lacking economic substance.¹⁰ 26 U.S.C. § 6662(b)(6). Unlike other penalties under § 6662, this penalty is not subject to the "reasonable cause and good faith" defense. 26 U.S.C. § 6664(c)(2). Almost unique in the Internal Revenue Code, it is a true "no-fault," strict liability penalty.

In light of this harsh new penalty imposed on transactions which lack economic substance, it is even more important that there is a clear and objective standard for the application of the economic substance doctrine. The Tenth Circuit's ruling exposes taxpayers to vastly expanded liability. Because there is an overriding need for national uniformity on this issue, especially in light of the codification of the economic substance doctrine and the strict liability penalty associated with transactions that fail on "economic substance" grounds, review by this Court is appropriate and timely.

Moreover, as this Court observed in another tax-related context more than a decade ago, "[t]he need to avoid litigation and to ensure efficient tax administration counsels in favor of a bright-line standard." Arizona Dep't of Revenue v. Blaze Construction Co., 526 U.S. 32, 37 (1999). In this case, that principle counsels in favor of certiorari where the integrity of the tax system is at stake. Granting certiorari will allow this Court to correct the erroneous, subjective rule announced by the Tenth Circuit, and replace it with one that provides clear and proper objective guidance to the Nation's taxpayers.

In determining whether the transaction had any practical economic effects other than the creation of income tax losses, prior focus has been on the bona fides of the transactions that produced the tax benefit, not the relative magnitude of the tax benefit.¹¹ The tax loss in this case is an artifact of the rule of law adopted by the Helmer court at the invitation of the IRS (and which rule favored the IRS in that case). Because the loss is a result of a rule of law, there is no reason that the amount of the loss should necessarily correlate with the net amount of the taxpayer's investment.

Earlier courts have been unanimous in their agreement with the proposition that transactions that have a true effect on the taxpayer's economic condition will not be disregarded under the economic substance doctrine merely because they were motivated by tax considerations. The Third Circuit explained:

While Sala was not indifferent to tax savings, the District Court found that the investment in the Deerhurst Program was primarily motivated by potential profitability, as any possible tax losses "were speculative and somewhat dependent on the whims of the IRS." (Pet. App. 53). Moreover, because the initial phase was profitable,¹² Sala was required to leave his $8.9 million investment with the Deerhurst Program for five years. (Id. at 25-26, 41). This dramatically illustrates that the transactions had "a practical economic effect" beyond the amount of any profit or loss for Sala.

C. This Court Should Accept Review To Determine Whether Economic Outlay By A Taxpayer Is Necessary To Support A Tax Loss Otherwise Allowable By The Code.

The Tenth Circuit's conclusion that a loss is not allowable unless the taxpayer suffers "actual economic harm" and "a financial loss," (Pet. App. 7, 11), is contrary to Gitlitz v. Comm'r, 531 U.S. 206 (2001). In Gitlitz, the basis increase claimed by the taxpayer (resulting in a loss) was not supported by any "economic outlay" on the part of the taxpayers. Id. at 212-14.¹³ This Court rejected the government's result-driven argument that a tax benefit must be supported by an economic outlay, because the statutes as written did not require the taxpayer to make an outlay to receive the tax benefit. Id. at 213-14.

The Tenth Circuit's requirement that a loss reflect "actual economic harm" is also contrary to Cottage Savings Ass'n v. Comm'r, 499 U.S. 554 (1991), rev'g, 890 F.2d 848 (6th Cir. 1989). There, the taxpayer claimed a loss resulting from the exchange of a pool of mortgages for a pool of virtually identical mortgages. Id. at 557-58. The exchange was not treated as a sale for regulatory purposes, and the purpose of the exchange was solely to generate a tax loss. Id. at 557. This Court reversed the Sixth Circuit's holding that the loss was not allowable because the taxpayer wasn't "poorer" as result, holding the proper focus should be on whether the transaction generating the loss was at arm's length. Id. at 567-68.

Many Courts of Appeals have also rejected the notion that "economic outlay" is necessary to sustain the deductibility of a loss.¹⁴ In Compaq Computer Corp. v. Comm'r, 277 F.3d 778 (5th Cir. 2001), the taxpayer bought and sold, within an hour, 10 million trading units in Dutch stocks (ADRs). Id. at 780. Although the purchase of ADRs included entitlement to dividends, the sale did not. Id. at 779. The net result of these transactions was, like in Sala's case, an actual upswing in the taxpayer's economic position (the taxpayer had the sale proceeds plus the dividend right for a net pre-tax profit of about $1.894 million), but the taxpayer claimed a $20.7 million capital loss, and a foreign tax credit of $3.4 million. Id. at 780. While the Tax Court disallowed the loss solely on economic substance grounds, the Fifth Circuit reversed, stating:

RESPECTFULLY SUBMITTED this 17th day of February, 2011,

²James characterized transactions lacking economic substance as "substantive shams." James v. Comm'r, 899 F.2d 905, 908 n.4 (10th Cir. 1990). Nothing about the Deerhurst transactions was a sham -- trades were placed on the market. They made real profits which were distributed to the partners. They employed the same trading strategy that the investment manager had employed for years.

³ Although the Tenth Circuit recognized that the tax loss was based upon the tax treatment of short options pursuant to Helmer, it sidestepped the Helmer rule on the basis that the IRS indicated it would challenge transactions similar to Sala's in Notice 2000-44, 2000-2 C.B. 255. (Pet. App. 5 n.2). The Tenth Circuit did not articulate why an IRS Notice (which did not cite or discuss Helmer), could have altered longstanding judicial precedent. Moreover, when the IRS ultimately took steps to revise the regulations under 26 U.S.C. § 752 in 2003 (subsequent to Sala's transaction), it recognized that the proposed changes would effect a change in the law: "[t]he definition of a liability contained in these proposed regulations does not follow Helmer." 68 Fed. Reg. 37434, 37436.

⁴See, e.g., Nicole Rose Corp. v. Comm'r, 320 F.3d 282, 284 (2d Cir. 2002) ("Whether a transaction lacks economic substance is a question of fact that we review under the clearly erroneous standard."); ACM P'ship v. Comm'r, 157 F.3d 231, 245, n.25 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999) ("[W]e review [the Tax Court's] factual findings, including its ultimate finding as to the economic substance of a transaction, for clear error."); Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 92 (4th Cir. 1985) ("Whether . . . a particular transaction is a sham is an issue of fact, and our review of the tax court's subsidiary and ultimate findings on this factual issue is therefore under the clearly erroneous standard."); Black & Decker Corp. v. United States, 436 F.3d 431, 441 (4th Cir. 2006), following and citing Rice's Toyota World, Inc., 752 F.2d at 92; Yosha v. Comm'r, 861 F.2d 494, 499 (7th Cir. 1988) ("The question whether a particular transaction has economic substance, like other questions concerning the application of a legal standard to transactions or events, is governed by the clearly erroneous standard."); ASA Investerings P'ship v. Comm'r, 201 F.3d 505, 511 (D.C. Cir. 2000), cert. denied, 531 U.S. 871 (2000) (stating that, in tax cases, "mixed questions of law and fact are to be treated like questions of fact").

⁵See, e.g., Dow Chemical Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006), cert. denied, 549 U.S. 1205 (2007) ("The district court's ultimate conclusion that a transaction is or is not an economic sham is reviewed de novo."); James v. Comm'r, 899 F.2d 905, 909, n.5 (10th Cir. 1990) ("[W]e review de novo the ultimate characterization of the transactions as shams."); Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1357 (Fed. Cir. 2006), cert. denied, 549 U.S. 1206 (2007) (explaining that, in an economic substance dispute, "[t]he ultimate conclusion as to business purpose is a legal conclusion, which we review without deference").

⁶Compare, e.g., Estate of Strangi v. Comm'r, 293 F.3d 279, 281 (5th Cir. 2002) (stating that sham partnership determination reviewed "for clear error"), and Lukens v. Comm'r, 945 F.2d 92, 97 (5th Cir. 1991) ("The tax court's determination that the transaction was a 'sham' is a finding of fact, and therefore reviewable under the clearly erroneous standard."), with, e.g. Compaq Computer Corp. v. Comm'r, 277 F.3d 778, 780-81 (5th Cir. 2001) ("'[L]egal conclusions' that transactions are shams in substance are reviewed de novo.").

⁷Compare, Massengill v. Comm'r, 876 F.2d 616, 619 (8th Cir. 1989) (characterizing economic substance inquiry as "essentially factual," subject to clearly erroneous review), with, e.g., IES Indus., Inc. v. United States, 253 F.3d 350, 351 (8th Cir. 2001) (characterizing the economic substance of transaction as a question of law).

⁸Compare, e.g., Harbor Bancorp v. Comm'r, 115 F.3d 722, 727 (9th Cir. 1997), cert. denied, 522 U.S. 1108 (1998) ("[T]he Tax Court's [sham] determination . . . is a finding of fact we review for clear error."), Erhard v. Comm'r, 46 F.3d 1470, 1476 & n.7 (9th Cir. 1995), cert. denied, 516 U.S. 930 (1995) ("The tax court's determination that a transaction is lacking in economic substance is a factual determination that this court reviews for clear error."), and Casebeer v. Comm'r, 909 F.2d 1360, 1362 & n.6 (9th Cir. 1990) ("We review the tax court's ultimate conclusion that the transactions were shams for clear error."), with Sacks v. Comm'r, 69 F.3d 982, 986 (9th Cir. 1995) (stating that, in economic substance cases, "application of the legal standards to the facts found [is] reviewed de novo.").

⁹Compare Karr v. Comm'r, 924 F.2d 1018, 1023 (11th Cir. 1991), cert. denied, 502 U.S. 1082 (1992) ("[T]he Tax Court's finding that a transaction is a sham is normally subject to the clearly erroneous standard of review."), with United Parcel Service of America, Inc. v. Comm'r, 254 F.3d 1014, 1017 (11th Cir. 2001) ("The question of the effect of a transaction on tax liability, to the extent, it does not concern the accuracy of the tax court's fact-finding, is subject to de novo review."), and Kirchman v. Comm'r, 862 F.2d 1486, 1490 (11th Cir. 1989) (stating that, with respect to transactions held by Tax Court to be shams as a matter of law, the standard of review is de novo).

¹⁰ The penalty is 20%, or 40% if the relevant facts affecting the tax treatment are not "adequately disclosed" with the return. 26 U.S.C. § 6662(i)(2).

¹¹ The Tenth Circuit relied upon Rogers v. United States, 281 F.3d 1108, 1116 (10th Cir. 2002), for the proposition that disregarding transactions is authorized if "the economic realties [sic] of the transaction are insignificant in relation to the tax benefits of the transaction." (Pet. App. 13). The statement in Rogers was made in a discussion of the academic literature, where the court quoted a Treasury White Paper which stated that the "economic substance" doctrine is applicable where "the economic realities are insignificant in relation to the tax benefits of the transaction." 281 F.3d at 1116. Our research discloses that no prior court has ever held the size of a claimed loss, standing alone, authorizes a court to ignore a transaction where the transaction otherwise possessed economic substance, i.e., had business purpose, involved actual investments, and had significant profit potential in relation to the amount invested.

¹² Considering only the initial phase transactions, the 24 basis generating trades had a profit potential of $550,000, excluding the "pound-Japanese yen play," which in fact earned over 500% of its cost in one month. Sala's $728,000 investment in the basis trades earned actual net profits of between $90,000-$110,000, a monthly return well over 10%.

¹³ The losses at issue in Gitlitz were funded by loans from a bank (which later forgave the debt), rather than the taxpayers.

¹⁴ In George Freitas Dairy, Inc. v. United States, 582 F.2d 500 (9th Cir. 1978), the court held that a "deduction cannot be denied simply because the loss may not be wholly disadvantageous to the taxpayer. As the district judge found, this was not a sham transaction acted out for tax purposes." Id. at 502 (citation omitted).