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payments that he received represented compensation for bringing
business to his employer.
Since 1979 Mr. Kelly has been registered with the Chicago
Board of Options Exchange and the National Association of
Securities Dealers, Inc. (NASD), as an "options principal". In
this capacity he was authorized to approve customer accounts for
options trading and oversee compliance with the rules of NASD and
other rules concerning options transactions within the brokerage
office. Mr. Kelly did not need to be a registered options
principal in order to engage in any of his options trades; any
Shearson Lehman customer satisfying certain financial and other
criteria was qualified to trade options.
On their Forms 1040 for earlier taxable years not in issue,
1983 through 1985, petitioners reported Mr. Kelly's occupation as
"stockbroker-dlr". The Schedule C filed with their return for
1983 describes his main business activity as "dealer in options".
Nevertheless, for each of these years petitioners treated
Mr. Kelly's net loss from options trading as a capital loss and
reported it on Schedule D.
In February 1987, before the preparation of his tax return
for 1986, Mr. Kelly read newspaper articles discussing the then
recent decision of the U.S. Supreme Court in Commissioner v.
Groetzinger, 480 U.S. 23 (1987). On the basis of these articles,
he understood the case to stand for the proposition that where a
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