Summitt v. Commissioner

MARK D. AND JENNIFER L. SUMMITT, PETITIONERS v.

COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT

Docket No. 13893–07. Filed May 20, 2010.

P–H is a 10-percent shareholder in S, an S corporation. On

Sept. 23, 2002, S paid premiums to acquire two major foreign

currency options from B and received premiums when it sold

two written minor foreign currency options to B. The pur-

chased major foreign currency options were a reciprocal put

and call, exactly offsetting each other. The written minor for-

eign currency options also were a reciprocal put and call,

exactly offsetting each other. On Sept. 25, 2002, S assigned

the major foreign currency call option and the minor foreign

currency call option to a charity pursuant to an assignment

agreement in which the charity was substituted for S with

respect to all obligations under the minor foreign currency call

option. R filed a motion for partial summary judgment

seeking a determination (1) that S did not recognize loss

under sec. 1256, I.R.C., upon its assignment of the major for-

eign currency call option to charity, and (2) that S must recog-

nize gain upon its assignment of the minor currency call

option to charity. Ps contend (1) that the major foreign cur-

rency call option assigned to the charity is a sec. 1256, I.R.C.,

foreign currency contract so that loss, if any, on the assign-

ment of that option was recognized by S in 2002 under the

marked-to-market rules of sec. 1256(a) and (c), I.R.C., and (2)

that gain, if any, on the assignment of the minor foreign cur-

rency call option to the charity was not recognized by S

because the minor foreign currency option was not a sec.

1256, I.R.C., contract and the assignment by S to the charity

did not terminate the option. Held: Under sec. 1256, I.R.C.,

the major foreign currency call option is not a foreign cur-

rency contract as defined in sec. 1256(b)(2) and (g)(2), I.R.C.,

and the marked-to-market provisions of sec. 1256, I.R.C., do

not apply to enable S to recognize the loss on the assignment

of the major foreign currency option to the charity. Held, fur-

ther, there are genuine issues of material fact remaining with

respect to the income tax treatment of the assignment of the

minor foreign currency call option to the charity that require

trial.

248

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00001 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 249

John E. Rogers and Colin C. Laitner, for petitioners.

John Comeau and Jeffrey Dorfman, for respondent.

OPINION

HAINES, Judge: This case is before the Court on respond-

ent’s motion for partial summary judgment pursuant to Rule

121. 1 Respondent raises two issues for decision in his

motion: (1) Whether under the marked-to-market rules of

section 1256 J. Summitt, Inc. (Summitt), an S corporation,

recognized loss upon its assignment to charity of a major for-

eign currency call option, and (2) whether Summitt was

required to include in its income, upon its assignment to

charity of a minor foreign currency call option, the premium

it received as writer of that option.

The following facts are based upon the parties’ pleadings,

affidavits, and exhibits in support of and in opposition to the

motion for partial summary judgment. They are stated solely

for the purpose of deciding the motion and not as findings of

fact in this case. See Fed. R. Civ. P. 52(a).

Background

The loss petitioners claim came from Summitt’s offsetting

foreign currency option transactions, the income tax effects of

which flowed through to petitioners’ joint 2002 Federal

income tax return. Summitt is a California corporation with

its principal place of business in San Clemente. Summitt was

incorporated on March 25, 1996, and elected on April 1,

1997, to be treated as an S corporation under section

1361(a)(1). Petitioner Mark D. Summitt (petitioner) is a 10-

percent shareholder in Summitt. Petitioners resided in Mon-

rovia, California, at the time the petition was filed.

During 2002 Summitt engaged Multi National Strategies,

LLC (Multi National), located in New York City, to provide

advice with respect to foreign currency option transactions

and to serve as depositary for funds needed for the trans-

actions. On September 10, 2002, Summitt entered into agree-

ments with Beckenham Trading Co., Inc. (Beckenham), with

its principal place of business in Fort Lee, New Jersey, to

1 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code),

as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Amounts are rounded to the nearest dollar.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00002 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

250 134 UNITED STATES TAX COURT REPORTS (248)

engage in cross-currency transactions. The agreements

between Beckenham and Summitt recited that the trans-

actions were intended to be exempt from, and otherwise not

subject to, regulation under the Commodity Exchange Act.

Beckenham was designated the calculation agent for the

transactions to determine all amounts due to or from each

party in accordance with terms specified in the agreements

with Summitt.

On September 21, 2002, Summitt authorized Multi

National to purchase two 180-day major foreign currency

options 2 and to sell on behalf of Summitt two 180-day writ-

ten minor foreign currency options. 3 On September 23, 2002,

Summitt purchased from Beckenham two major currency

options, each pegged to the U.S. dollar (USD) and the Euro-

pean Union euro (EUR). The major currency options were a

reciprocal put and call, exactly offsetting each other. The

purchased major options moved inversely in value to one

another over the 180-day period, thus ensuring that Summitt

would hold a loss position in one of the two purchased

options. The EUR call option (3032) and the EUR put option

(3033) had a notional value of EUR 357,580,711, a strike price

of $0.9788 USD/EUR, and an expiration date of March 21,

2003. 4

The party obligated to perform if the holder exercises the

option is the writer of the option. Beckenham was the writer

of the major currency options and obligated itself to perform

at the discretion of Summitt. As the purchaser and holder of

the major currency call option, Summitt, by exercising the

option, could require Beckenham to deliver the euro at a

price of $0.9788 USD/EUR. As the purchaser and holder of the

put option, Summitt, by exercising the option, could require

Beckenham to take delivery of the euro at a future date or

dates at a price of $0.9788 USD/EUR. The price specified in

2 A major foreign currency is a ‘‘currency in which positions are * * * traded through regu-

lated futures contracts’’. Sec. 1256(g)(2)(A)(i). The term ‘‘regulated futures contract’’, as defined

in sec. 1256(g)(1), means ‘‘a contract—(A) with respect to which the amount required to be de-

posited and the amount which may be withdrawn depends on a system of marking to market,

and (B) which is traded on or subject to the rules of a qualified board or exchange.’’ Major cur-

rencies include the U.S. dollar, British pound, Japanese yen, Swiss franc, and European Union

euro.

3 Minor currencies include the Danish krone.

4 The numbers in parentheses are trade references used to identify the various option trans-

actions.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00003 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 251

the contract at which the euro would be purchased pursuant

to exercise of the put or call option is the strike price.

On the same day that Summitt purchased the major cur-

rency options, Summitt wrote and sold to Beckenham two

minor currency options, each pegged to the USD and the

Danish krone (DKK). The written minor currency options

were a reciprocal put and call, exactly offsetting each other.

The written minor options moved inversely in value to one

another over the 180-day period, thus ensuring that Summitt

would hold a gain position in one of the two minor currency

options. The DKK call option (3034) and the DKK put option

(3035) had a notional value of DKK 2,661,225,000 with a

strike price of 7.6035 DKK/USD and a bonus payout of DKK

10,162,040 if the DKK/USD strike price was greater than

7.2586 DKK. The expiration date for both minor currency

options was March 21, 2003.

Summitt, the writer of the minor currency options, obli-

gated itself to perform at the discretion of Beckenham. As

the purchaser and holder of the minor currency call option,

Beckenham, by exercising the option, could require Summitt

to deliver Danish kroner at a price of 7.6035 DKK/USD. As the

purchaser and holder of the put option, Beckenham, by exer-

cising the option, could require Summitt to take delivery of

kroner at a future date or dates at a price of 7.6035 DKK/USD.

The values of the two foreign currencies underlying the

purchased major and written minor options historically have

demonstrated a very high positive correlation with each

other. As the currencies change in value because of exchange

rate fluctuations, Summitt could reasonably expect to have

the following potential gains and losses in substantially off-

setting positions: (1) A loss in a purchased major option and

a gain in a written minor option, and (2) a gain in a pur-

chased major option and a loss in a written minor option. At

any time, Summitt’s loss in the purchased major option that

had declined in value might be more or less than Summitt’s

gain in the offsetting written minor option that had appre-

ciated in value. Similarly, Summitt’s gain in the remaining

purchased major option might be more or less than

Summitt’s loss in the remaining written minor option.

The premiums Beckenham charged for the major currency

options totaled $19,967,500, consisting of a $9,983,750 pre-

mium for the EUR call option (3032) and a $9,983,750

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00004 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

252 134 UNITED STATES TAX COURT REPORTS (248)

premium for the EUR put option (3033). The premiums

charged by Summitt for the minor currency options totaled

$19,950,000, consisting of a $9,975,000 premium for the DKK

call option (3034) and a $9,975,000 premium for the DKK put

option (3035). The net premium paid by Summitt in respect

of the two major and two minor options was $17,500. 5

Two days later, on September 25, 2002, Summitt assigned

to the Foundation for Educated America, Inc. (charity), the

EUR call option (3032) and the DKK call option (3034). 6 At the

time of the assignment, the potential loss on the EUR call

option (3032) was $1,750,535, and the potential gain on the

DKK call option (3034) was $1,745,285. On December 12,

2002, Summitt closed out the EUR put option (3033) and the

DKK put option (3035) by agreeing with Beckenham to offset

those options against each other.

In 2003 Summitt filed a Form 1120S, U.S. Income Tax

Return for an S Corporation, for 2002 (original return)

reporting gross receipts of $21,258,592 less $18,739,492 cost

of goods sold, resulting in a gross profit of $2,519,100.

Summitt also reported the following currency transactions on

Statement 6 attached to the return:

5 Total premiums of $19,967,500 charged for the two major currency options less total pre-

miums received of $19,950,000 for the two minor currency options.

6 Schedule A to the assignment agreement, corporate minutes, and correspondence all des-

ignate Sept. 25, 2002, as the effective date.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00005 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

VerDate 0ct 09 2002

11:08 May 24, 2013

(248)

Jkt 372897

Property Date Cost or other

PO 20009

Option description Trade acquired Trade Date sold Gross sale price1 basis 2 Gain/loss

EUR Call EUR 357,580,711 3032 9/23/02 3040 312/12/02 $8,233,215 4 $9,992,500 ($1,759,285)

EUR Put EUR 357,580,711 3033 9/23/02 3041 5 9/25/02 11,724,660 9,983,750 1,740,910

DKK Put DKK 2,661,225,000 3035 9/23/02 3043 12/12/02 9,975,000 11,720,285 (1,745,285)

Frm 00006

--- AUD 80,594,595 --- 11/6/02 --- 11/6/02 868,084 870,584 (2,500)

--- AUD 80,594,595 --- 11/8/02 --- 11/8/02 1,332,625 1,329,514 3,111

--- EUR 37,500,000 --- 12/11/02 --- 12/11/02 480,636 483,136 (2,500)

--- EUR 37,500,000 --- 12/12/02 --- 12/12/02 583,748 580,998 2,750

Fmt 2847

--- AUD 60,000,000 --- 12/26/02 --- 12/26/02 531,768 533,768 (2,000)

--- AUD 60,000,000 --- 12/31/02 --- 12/31/02 308,539 306,689 1,850

Total (1,762,949)

Sfmt 2847

1 The gross sale price for each minor option was the premium paid by Beckenham to Summitt, writer of the options. The gross sale price for each

major option was determined by Beckenham.

2 The cost or other basis for each major option was the premium paid by Summitt to Beckenham. The cost for each minor option was determined by

Beckenham.

SUMMITT v. COMMISSIONER

3 Note the mistake in dates on the first two trades listed. The first trade listed is option 3032, and the second is option 3033. The return transposes

the dates transferred/closed: 3032 was transferred on Sept. 25, 2002, and 3033 was closed on Dec. 12, 2002.

4 Note that the amount reported on the return is $9,992,500. The premium was $9,983,750, and the $8,750 difference is unexplained.

5 The date should be Dec. 12, 2002, per n.3 to above Statement 6.

V:\FILES\SUMMITT.134

SHEILA

253

254 134 UNITED STATES TAX COURT REPORTS (248)

Summitt did not report gain from the disposition of the DKK

call option (3034) on its original return. The $1,762,949 loss

from Statement 6 was subtracted from gross profit of

$2,519,100 to arrive at total income of $756,151. Business

deductions of $691,424 were claimed, resulting in ordinary

income of $64,727. As a 10-percent shareholder of Summitt,

petitioner reported $6,473 ordinary income from Summitt on

his timely filed joint Form 1040, U.S. Individual Income Tax

Return, for 2002.

Summitt filed a first amended Form 1120S for 2002 (first

amended return) on January 8, 2004, reporting the same

gross receipts, cost of goods sold, and gross profit shown on

the original return. However, Summitt amended the currency

transactions reported on Statement 6 attached to the return

by adding the following entry to report the gain on the DKK

call option (3034):

Gross Cost or

Property Date Date sale other

Option description Trade acquired Trade sold price basis Gain/loss

DKK DKK

call 2,661,225,000 3034 9/23/02 3042 9/25/02 $9,975,000 $8,229,715 $1,745,285

By reporting the gain of $1,745,285 from the disposition of

the DKK call option (3034), the $1,762,949 loss reported on

the original return was reduced to $17,664 on the first

amended return. As a result, rather than reducing gross

profit of $2,519,100 by $1,762,949, gross profit was reduced

by $17,664 on the first amended return resulting in total

income of $2,501,436. Subtracting the claimed business

deductions of $691,424, unchanged from the original return,

resulted in reported ordinary income of $1,810,012.

On January 9, 2004, petitioners filed a first amended

return for 2002 on which they increased their flow-through

income from Summitt to $181,001. Petitioners’ first amended

return reported an additional tax due of $64,779. The

Internal Revenue Service (IRS) assessed this additional tax

and on April 5, 2004, petitioners paid the tax, including

interest, in the total amount of $67,432.

On February 14, 2007, Summitt attempted to file a second

amended return for 2002, which reinstated its position that

the receipt of a premium on the DKK call option (3034) was

not taxable. The second amended return was a restatement

of the original return. Petitioners also attempted to file a

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00007 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 255

second amended return for 2002 to be consistent with

Summitt’s second amended return. Neither of the second

amended returns was accepted by the IRS.

On March 15, 2007, respondent issued a notice of defi-

ciency to petitioners for 2002 which disallowed a $1,767 flow-

through loss from Summitt’s foreign currency option trans-

actions disclosed on the first amended return. 7 On June 12,

2007, petitioners mailed a petition to this Court. 8 In their

petition, petitioners disavowed portions of their first

amended return and asserted that their share of the

$9,975,000 premium Summitt received for the sale of the

DKK call option (3034) option was not includable in 2002

income.

On February 9, 2009, respondent filed the motion for par-

tial summary judgment seeking determinations (1) that the

marked-to-market rules of section 1256 do not apply to the

EUR call option (3032), and (2) that Summitt must include in

income in 2002 the premium received upon the issuance of

the DKK call option (3034) because the assignment of the

option to charity caused a novation. Petitioners filed an

objection to the motion on March 19, 2009. Respondent filed

a reply on April 27, 2009, and a supplemental memorandum

on May 20, 2009. The Court held a hearing on the motion on

June 10, 2009. Posthearing memoranda were received from

petitioner and respondent on August 7 and September 24,

2009, respectively.

Discussion

I. Procedure

Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials. Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988). The Court may grant

summary judgment when there is no genuine issue of mate-

rial fact and a decision may be rendered as a matter of law.

Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518,

520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Zaentz v.

Commissioner, 90 T.C. 753, 754 (1988). The moving party

7 Petitioners executed a Form 872, Consent to Extend the Time to Assess Tax, extending the

time to assess for 2002 to Apr. 15, 2007.

8 The Court received the petition on June 18, 2007, but the petition was postmarked and

deemed filed on June 12, 2007.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00008 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

256 134 UNITED STATES TAX COURT REPORTS (248)

bears the burden of proving that there is no genuine issue

of material fact. Dahlstrom v. Commissioner, 85 T.C. 812,

821 (1985); Naftel v. Commissioner, 85 T.C. 527, 529 (1985).

The Court will view any factual material and inferences in

the light most favorable to the nonmoving party. Dahlstrom

v. Commissioner, supra at 821; Naftel v. Commissioner,

supra at 529.

After reviewing the record, we are satisfied that there is no

genuine issue of any material fact on the section 1256 issue

and that a decision may be rendered as a matter of law.

Respondent’s motion will be granted denying the purported

loss on assignment of the major foreign currency call option

to charity. On the second issue with respect to purported

gain on the assignment of the minor foreign currency call

option, there are issues of material fact that require a trial,

and respondent’s motion will be denied.

II. Background

This is a case of first impression that requires interpreta-

tion of the term ‘‘foreign currency contract’’ as defined in sec-

tion 1256. The term first appeared in the Code in 1982, and,

although the Secretary was granted authority in 1982 to

issue regulations to determine what types of contracts were

included or excluded by the term, no such regulations have

been issued. Nor has the term been interpreted by the courts.

As we shall see, section 1256 applies to futures and options

contracts that are traded on a qualified exchange. A qualified

exchange means a national securities exchange which is reg-

istered with the Securities and Exchange Commission, a

domestic board of trade designated as a contract market by

the Commodity Futures Trading Commission, or any other

exchange, board of trade, or other market which the Sec-

retary determines has rules adequate to carry out the pur-

poses of section 1256. Sec. 1256(g)(7).

Section 1256 also covers contracts that are not traded on

a qualified exchange; i.e., foreign currency contracts that are

negotiated with any one of a number of commercial banks

which provide an informal market for such trading. The issue

before us is whether a major foreign currency call option, a

non-exchange-traded contract, comes within the meaning of

‘‘foreign currency contract’’ so as to qualify for section 1256

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00009 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 257

treatment. Petitioners argue that the plain meaning of the

definition of ‘‘foreign currency contract’’ in section 1256

should be interpreted broadly to include a major foreign cur-

rency option. Respondent argues that the plain meaning of

that definition should be interpreted narrowly to include only

a forward contract, not an option.

The issue arises in the context of what are sometimes

known as ‘‘major/minor’’ transactions. In the typical major/

minor transaction, the taxpayer assigns to a charity 9 a major

foreign currency call option that has a potential loss. The

charity also assumes the taxpayer’s obligation under the off-

setting minor foreign currency call option that has a poten-

tial gain.

Because the taxpayer takes the position that the major for-

eign currency call option assigned to the charity is a section

1256 foreign currency contract, the taxpayer relies on sec-

tion 1256(c) and Greene v. United States, 79 F.3d 1348 (2d

Cir. 1996), to mark to market the major foreign currency call

option when the option is assigned to the charity in order to

recognize a loss at that time. 10 The taxpayer may argue that

the loss is characterized as ordinary if the transaction also

qualifies as a section 988 transaction. 11

In contrast, because the taxpayer takes the position that

the assumed minor foreign currency call option is not a sec-

tion 1256 foreign currency contract, the taxpayer claims that

the charity’s assumption of the written minor obligation does

not cause the taxpayer to recognize gain and that the tax-

payer also does not recognize gain when the option either

expires or terminates.

III. Section 1256

When Congress enacted section 1256 as part of the Eco-

nomic Recovery Tax Act of 1981 (ERTA), Pub. L. 97–34, sec.

503(a), 95 Stat. 327, the section applied only to regulated

futures contracts that required physical delivery of personal

9 A charity is an organization defined in sec. 170(c)(2) contributions to which are deductible

for income tax purposes as charitable contributions.

10 Unlike the present case, Greene v. United States, 79 F.3d 1348 (2d Cir. 1996), dealt with

transfers of regulated futures contracts to charity. Regulated futures contracts, as will be shown,

are sec. 1256 contracts. Sec. 1256(b)(1), (g)(1).

11 See sec. 988(a)(1)(A) and sec. 1.988–3(a), Income Tax Regs., which override the characteriza-

tion of capital losses specified in sec. 1256 if sec. 988 also applies.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00010 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

258 134 UNITED STATES TAX COURT REPORTS (248)

property. The pertinent parts of section 1256 originally pro-

vided:

SEC. 1256. REGULATED FUTURES CONTRACTS MARKED TO

MARKET.

(a) GENERAL RULE.—For purposes of this subtitle—

(1) each regulated futures contract held by the taxpayer at the close

of the taxable year shall be treated as sold for its fair market value on

the last business day of such taxable year (and any gain or loss shall

be taken into account for the taxable year),

(2) proper adjustment shall be made in the amount of any gain or loss

subsequently realized for gain or loss taken into account by reason of

paragraph (1),

(3) any gain or loss with respect to a regulated futures contract shall

be treated as—

(A) short-term capital gain or loss, to the extent of 40 percent of

such gain or loss, and

(B) long-term capital gain or loss, to the extent of 60 percent of such

gain or loss.

* * * * * * *

(b) REGULATED FUTURES CONTRACTS DEFINED.—For purposes of this sec-

tion, the term ‘‘regulated futures contract’’ means a contract—

(1) which requires delivery of personal property (as defined in section

1092(d)(1)) or interest in such property;

(2) with respect to which the amount required to be deposited and the

amount which may be withdrawn depends on a system of marking to

market; and

(3) which is traded on or subject to the rules of a domestic board of

trade designated as a contract market by the Commodity Futures

Trading Commission or of any board of trade or exchange which the Sec-

retary determines has rules adequate to carry out the purposes of this

section.

(c) TERMINATIONS.—The rules of paragraphs (1), (2), and (3) of sub-

section (a) shall also apply to the termination during the taxable year of

the taxpayer’s obligation with respect to a regulated futures contract by

offsetting, by taking or making delivery, or otherwise. For purposes of the

preceding sentence, fair market value at the time of the termination shall

be taken into account.

Stevie D. Conlon and Vincent M. Aquilino, in their treatise

Principles of Financial Derivatives: U.S. & International Tax-

ation, par. A1.03 (2009) (citing Hull, Options, Futures and

Other Derivative Securities 3–5 (2d ed. 1993)), define a

futures contract as an agreement to deliver specified

commodities or other property at a future date at an agreed

price. Futures contracts are standardized agreements,

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00011 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 259

tradable on regulated exchanges. A key aspect of regulated

futures contracts is the margin requirement. In enacting sec-

tion 1256, Congress concluded that the daily receipt of profits

and the daily payment of losses employed by commodity

futures exchanges in the United States for determining

margin requirements made it appropriate to compute gains

and losses for tax purposes under a similar, albeit annual,

marked-to-market system of accounting. H. Rept. 97–201, at

157 (1981), 1981–2 C.B. 352, 475. The marked-to-market rule

was also applied to futures transactions occurring before

December 31 of each year if taxpayers terminated the futures

contract before that date. Sec. 1256(c).

The Technical Corrections Act of 1982 (1982 Act), Pub. L.

97–448, sec. 105(c)(5), 96 Stat. 2385, made four significant

changes to section 1256 that are pertinent to this case. First,

the 1982 Act removed the requirement of physical delivery

for futures contracts so that cash-settled futures contracts,

newly authorized to trade on futures exchanges by the Com-

modity Futures Trading Commission, would also qualify for

section 1256 treatment. Id.

Second, the 1982 Act expanded the phrase ‘‘regulated

futures contract’’ by adding ‘‘Such term includes any foreign

currency contract’’ at the end of section 1256(b). Id. As the

House Ways and Means Committee explained:

Trading in foreign currency for future delivery is conducted through regu-

lated futures contracts, and is also conducted through contracts negotiated

with any one of a number of commercial banks which comprise an informal

market for such trading (bank forward contracts). Bank forward contracts

differ from regulated future contracts in that they are private contracts in

which the parties remain entitled to performance from each other. They

further differ from regulated futures contracts in that they do not call for

daily variation margin to reflect market changes, and in that the inter-

bank market has no mechanism for settlement terminating a taxpayer’s

position prior to the delivery date. Prior to ERTA, taxpayers who used both

the futures exchanges and the interbank market to conduct short-term

trading in foreign currency were subject to substantially comparable tax

treatment for both types of contract. Although bank forward contracts

differ from regulated futures contracts, the volume of trading through for-

ward contracts in foreign currency in the interbank market is substantially

greater than foreign currency trading on futures exchanges, and prices are

readily available. Such contracts are economically comparable to regulated

futures contracts in the same currencies and are used interchangeably

with regulated futures contracts by traders. [H. Rept. 97–794, at 23

(1982).]

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00012 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

260 134 UNITED STATES TAX COURT REPORTS (248)

A forward contract is an agreement to deliver a specified

commodity or other property at a future date at an agreed

price. Conlon & Aquilino, supra par. A1.02[2][a][i]. Typically,

neither party to a forward contract makes a payment at the

time the contract is executed.

Third, 1982 Act sec. 105(c)(5) added subsection (g)(1), a

definitional subsection, to flesh out general definitions in sec-

tion 1256(b). The newly enacted section 1256(g)(1) defined a

foreign currency contract to be a contract:

(A) which requires delivery of a foreign currency which is a currency in

which positions are also traded through regulated futures contracts,

(B) which is traded in the interbank market, and

(C) which is entered into at arm’s length at a price determined by ref-

erence to the price in the interbank market.

The requirement of delivery of the foreign currency reflected

the fact that ‘‘the interbank market has no mechanism for

settlement terminating a taxpayer’s position prior to the

delivery date’’. H. Rept. 97–794, supra at 23.

Fourth, 1982 Act sec. 105(c)(5) granted the Secretary

authority to prescribe regulations to determine the types of

contracts that could be included in or excluded from the defi-

nition of a foreign currency contract in section 1256(g)(2):

(2) REGULATIONS.––The Secretary shall prescribe such regulations as

may be necessary or appropriate to carry out the purposes of paragraph

(1), including regulations excluding from the application of paragraph (1)

any contract (or type of contract) if its application thereto would be incon-

sistent with such purposes.

As previously stated, no such regulations have ever been

issued.

The Deficit Reduction Act of 1984 (DEFRA), Pub. L. 98–369,

98 Stat. 494, made three significant changes pertinent to this

case. First, DEFRA sec. 722(a)(2), 98 Stat. 972, amended sec-

tion 1256(g)(1)(A) by adding the phrase ‘‘or the settlement of

which depends on the value of ’’ to the definition of a foreign

currency contract. The effect of this amendment is in dispute

in this case. Section 1256(g)(2)(A), as changed by DEFRA sec.

102(a)(3), defined a foreign currency contract to be a con-

tract—

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00013 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 261

(i) which requires delivery of, or the settlement of which depends on the

value of, a foreign currency which is a currency in which positions are also

traded through regulated futures contracts,

(ii) which is traded in the interbank market, and

(iii) which is entered into at arm’s length at a price determined by ref-

erence to the price in the interbank market.

[Emphasis added to highlight amendment.]

Second, DEFRA sec. 102 changed the term ‘‘regulated

futures contract’’ to the more general term ‘‘section 1256 con-

tract’’ and reorganized section 1256(b) to identify, in general

terms, contracts qualifying as section 1256 contracts.

Third, DEFRA sec. 102(a)(2) and (3) extended section 1256

to cover ‘‘any nonequity option’’, sec. 1256(b)(3), and ‘‘any

dealer equity option’’, sec. 1256(b)(4), and added specific

definitions for those terms in section 1256(g)(3) through (6)

inclusive.

The Consolidated Appropriations Act, 2001, Pub. L. 106–

554, app. G, sec. 401(g), 114 Stat. 2763A–649 (2000), added

‘‘any dealer securities futures contract’’ and an option on

such a contract as section 1256(b)(5).

After reflecting all amendments, section 1256(b) now pro-

vides:

SEC. 1256(b). SECTION 1256 CONTRACT DEFINED.—For purposes of this

section, the term ‘‘section 1256 contract’’ means—

(1) any regulated futures contract,

(2) any foreign currency contract,

(3) any nonequity option,

(4) any dealer equity option, and

(5) any dealer securities futures contract.

The term ‘‘section 1256 contract’’ shall not include any securities futures

contract or option on such a contract unless such contract or option is a

dealer securities futures contract.

IV. Petitioners’ Contentions

Petitioners contend that under the plain meaning of sec-

tion 1256(g)(2)(A), as amended in 1984, major foreign cur-

rency options are foreign currency contracts subject to the

marked-to-market rules of section 1256. To support their

position they maintain that section 1256(b)(2) refers to ‘‘any

foreign currency contract’’. Therefore, section 1256(g)(2)(A)

should be construed broadly because ‘‘contract’’ is an inher-

ently broad term, and an option, by definition, is a unilateral

contract. 1 Restatement, Contracts 2d, sec. 25 (1981). They

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00014 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

262 134 UNITED STATES TAX COURT REPORTS (248)

argue there are no legally significant differences among

futures, forwards, and options.

Second, petitioners note that no regulations have been

issued by the Secretary since 1982 which would limit the

definition of a foreign currency contract, and, in petitioners’

view, the application of section 1256 to various types of con-

tracts has been expanded and broadened over time. Peti-

tioners reason that this constant expansion, coupled with the

inherently broad original defining term ‘‘contract’’, suggests

that where a close call is to be made on this issue, the his-

tory favors including major foreign currency options within

the meaning of ‘‘foreign currency contract’’. 12

Third, petitioners maintain that there are no economically

significant differences among foreign currency forwards,

futures, and options. As petitioners state in their posthearing

memorandum:

All of these derivatives accomplish the same economic access to currency

risk. They reproduce the economic risks and rewards of holding a par-

ticular foreign currency over time. These derivatives only differ in their

pricing, timing and payment structure, and thus, can be modified or trans-

formed into one another by entering into other derivatives. For example,

an option writer fearing a movement in the underlying security adverse to

his position can purchase a future on that security to effectively offset his

risk, or he could write a contraindicated option as Petitioners did here.

Fourth, petitioners contend, under the plain meaning of

the statute, if the Court finds that (1) an option is a contract;

(2) the value of the option depends on the value of the euro;

(3) the euro is a major foreign currency traded on the inter-

bank market; and (4) the option was entered into at arm’s

length and with a price coinciding with the interbank market

price for such options, section 1256(g)(2)(A) ‘‘compels the

conclusion that all major foreign currency derivatives created

on the informal interbank market [including the major cur-

rency options at issue in this case] should be marked to

market’’.

V. Respondent’s Contentions

Respondent contends that under the plain meaning of sec-

tion 1256 a foreign currency option cannot be a foreign cur-

12 Neither party claims that the major foreign currency options in this case are nonequity op-

tions, dealer equity options, listed options, dealer securities futures contracts, or options on such

contracts pursuant to sec. 1256(b)(3) through (5) inclusive.

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00015 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 263

rency contract; i.e., a section 1256 contract. Respondent notes

that, as originally enacted in 1982, section 1256(g)(1)(A)

referred to a contract that required delivery of a foreign cur-

rency. The writer of a forward contract is required to deliver

a foreign currency at a future date at an agreed price. On the

other hand, respondent points out that, at the time an option

is signed, there is no obligation to deliver. An obligation to

deliver occurs only if the holder of the option exercises its

right to require delivery at some future time after the option

has been signed. The obligation to deliver may never occur

if the option holder allows the option to lapse. Consequently,

respondent argues that, because section 1256(g)(1)(A), as

originally enacted, referred to a contract that required

delivery of the foreign currency, the section, as so enacted,

could be applied only to forward contracts, not to options.

Respondent also contends that the addition of the phrase

‘‘or the settlement of which depends upon the value of ’’ in

DEFRA was intended to deal with uncertainty as to whether

cash-settled forward contracts were included in the definition

of foreign currency contracts. In respondent’s view, the

change was not intended to expand the application of section

1256 to foreign currency option contracts because the lim-

iting phrase ‘‘which requires delivery of ’’ was left in the

statute. Respondent argues that foreign currency contracts

can be physically settled or cash-settled, but they still must

require settlement at expiration. In support of his position,

respondent directs us to the House Ways and Means Com-

mittee report explaining the provisions of DEFRA, which

states:

Because certain contracts may call for a cash settlement by reference to

the value of the foreign currency rather than actual delivery of the cur-

rency, the bill provides that the delivery of a foreign currency requirement

is met where the contract provides for a settlement determined by reference

to the value of the foreign currency. [H. Rept. 98–432 (Part 2), at 1646

(1984); emphasis added.]

VI. The Court’s Holding on Section 1256

Each party claims that the plain meaning of section

1256(g)(2)(A)(i) supports his position. In Campbell v.

Commissioner, 108 T.C. 54, 62–63 (1997), we set out the

well-established and well-understood rules for construing a

provision of the Internal Revenue Code:

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00016 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

264 134 UNITED STATES TAX COURT REPORTS (248)

In construing * * * [a provision of the Internal Revenue Code], our task

is to give effect to the intent of Congress, and we must begin with the

statutory language, which is the most persuasive evidence of the statutory

purpose. United States v. American Trucking Associations, Inc., 310 U.S.

534, 542–543 (1940). Ordinarily, the plain meaning of the statutory lan-

guage is conclusive. United States v. Ron Pair Enters. Inc., 489 U.S. 235,

242 (1989). Where a statute is silent or ambiguous, we may look to legisla-

tive history in an effort to ascertain congressional intent. Burlington N.

R.R. v. Oklahoma Tax Commn., 481 U.S. 454, 461 (1987); Griswold v.

United States, 59 F.3d 1571, 1575–1576 (11th Cir. 1995). However, where

a statute appears to be clear on its face, we require unequivocal evidence

of legislative purpose before construing the statute so as to override the

plain meaning of the words used therein. Huntsberry v. Commissioner, 83

T.C. 742, 747–748 (1984); see Pallottini v. Commissioner, 90 T.C. 498, 503

(1988), and cases there cited.

We will therefore begin with the statute. The plain meaning

of the words used will control unless there is unequivocal evi-

dence of legislative purpose to override such meaning.

For convenience, we again set out section 1256(g)(2)(A),

which defines a foreign currency contract to be a contract—

(i) which requires delivery of, or the settlement of which depends on the

value of, a foreign currency which is a currency in which positions are also

traded through regulated futures contracts,

(ii) which is traded in the interbank market, and

(iii) which is entered into at arm’s length at a price determined by ref-

erence to the price in the interbank market.

Petitioner views the legal distinction between a forward

and an option to be insignificant. We disagree. A forward for-

eign currency contract is a bilateral contract between a seller

and a buyer that obligates the seller, at the time of signing,

to settle his obligation to perform by either delivering the

currency or making cash settlement. Conlon & Aquilino,

supra par. A1.02[2][a][i]. A foreign currency option is a uni-

lateral contract that does not require delivery or settlement

unless and until the option is exercised by the holder. An

obligation to settle may never arise if the holder does not

exercise its rights under the option. It is clear that, as origi-

nally enacted in 1982, section 1256(g)(1) applied only to for-

ward contracts. The statute referred to a contract which

required delivery of the foreign currency, not to a contract in

which delivery was left to the discretion of the holder.

It is also clear that the 1984 amendment ‘‘or the settle-

ment of which depends on the value of ’’ was inserted to allow

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00017 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

(248) SUMMITT v. COMMISSIONER 265

a cash-settled forward contract to come within the term ‘‘for-

eign currency contract’’. Foreign currency contracts can be

physically settled or cash-settled, but they still must require,

by their terms at inception, settlement at expiration. 13 The

statute’s plain language is dispositive. There is no evidence

in the legislative history that a literal reading of the statute

will defeat Congress’ purpose in enacting it. Campbell v.

Commissioner, supra at 62–63.

Petitioners argue, by negative inference, that if the Sec-

retary had wished to identify a foreign currency option as a

‘‘contract (or type of contract)’’ to be ‘‘[excluded] from the

application of subparagraph (A)’’ of section 1256(g)(2), the

Secretary would have exercised the authority, expressly dele-

gated by subparagraph (B), to prescribe regulations for that

purpose. We disagree. The Secretary has not issued regula-

tions bringing a foreign currency option within the definition

of a foreign currency contract. That determination is within

the province of the Secretary, not within the province of this

Court. Moreover, the statute, as we understand it, speaks for

itself.

Petitioners’ contention that an option is a contract and

that the addition by Congress of other option contracts to

section 1256 over the years evidences an intent to include

major foreign currency options also fails. Granted, an option

is a contract and Congress has added other option contracts

that qualify for section 1256 treatment. However, Congress’

additions have been restricted to nonequity options, dealer

equity options, and options on dealer securities futures, all of

which are traded on a qualified board or exchange. Sec.

1256(b)(3)–(5), (g)(3)–(6). Interbank markets have not been

designated as a qualified board or exchange. Sec. 1256(g)(7).

When Congress has specified the types of contracts that come

within the definition of a section 1256 contract, exclusion of

others from its operation may be inferred. 14 There is no evi-

13 The amendment is similar to that proposed by the Senate for cash-settlement of regulated

futures contracts in 1982. See S. Rept. 97–592, at 276 (1982), 1983–1 C.B. 475, 485–486.

14 The maxim expressio unius est exclusio alterius, meaning that to express or include one

thing implies the exclusion of the other, or of the alternative, applies. Black’s Law Dictionary

661 (9th ed. 2009); see United States v. Smith, 499 U.S. 160, 167 (1991) (‘‘ ‘Where Congress ex-

plicitly enumerates certain exceptions * * * additional exceptions are not to be implied, in the

absence of evidence of a contrary legislative intent.’ ’’ (quoting Andrus v. Glover Constr. Co., 446

U.S. 608, 616–617 (1980))).

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00018 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA

266 134 UNITED STATES TAX COURT REPORTS (248)

dence of legislative intent to designate foreign currency

options as section 1256 contracts.

Petitioners also contend that futures, forwards, and options

‘‘accomplish the same economic access to currency risk’’ and

should be treated the same way under the tax laws. How-

ever, petitioners admit that futures, forwards, and options

differ in their pricing, timing, and payment structures. It is

precisely these economic and legal distinctions that give rise

to disparate treatment under the tax laws.

VII. Conclusion and Holding

With respect to the first issue presented to us by respond-

ent’s motion for partial summary judgment, we hold that

under section 1256, the major foreign currency option

assigned by Summitt to the charity is not a foreign currency

contract as defined in section 1256(b)(2) and (g)(2), and the

marked-to-market provisions of section 1256 do not apply to

the transfer of the EUR call option (3032) to the charity. As

a result, petitioners did not recognize a loss in 2002 on the

EUR call option (3032) pursuant to section 1256.

The second issue raised by respondent’s motion for partial

summary judgment deals with the recognition of gain upon

assignment of the minor foreign currency call option to

charity. That issue cannot be dealt with isolated from the

facts involved in the transaction as a whole, and therefore,

respondent’s motion on the second issue will be denied.

To reflect the foregoing,

An appropriate order will be issued.

f

VerDate 0ct 09 2002 11:08 May 24, 2013 Jkt 372897 PO 20009 Frm 00019 Fmt 2847 Sfmt 2847 V:\FILES\SUMMITT.134 SHEILA