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standpoint the transaction was likely to produce economic benefits
aside from a tax deduction. Casebeer v. Commissioner, 909 F.2d
1360 (9th Cir. 1990), affg. in part and revg. in part on another
ground Larsen v. Commissioner, 89 T.C. 1229 (1987).
A review of the actual transactions and their characteristics
demonstrates that the substance of the Merit transactions did not
reflect their form. The form was the investment in financial
products; the substance was the production of tax deductions.
A. Structure of the Merit Markets
Economically insubstantial tax-straddle programs are often
characterized by trading exclusively in tax-advantaged assets and
by stressing the tax-avoidance aspect of those assets. Realistic
projections of actual economic returns, however, are notably absent.
Fox v. Commissioner, 82 T.C. 1001 (1984); Leslie v. Commissioner,
T.C. Memo. 1996-86, affd. 146 F.3d 643 (9th Cir. 1998).
Here, the principal attraction of the Merit markets plainly was
the ability to generate tax deductions far in excess of the amounts
invested. Merit’s T-bills and T-bonds were both traded as options.
Thus, yearend losses on T-bill options could be ordinary losses,
which, unlike capital losses, could be fully used as deductions to
reduce ordinary income from other sources.
Similarly, the T-bond options were created and traded in a way
that they could produce capital losses and, in some defined
circumstances, long-term capital gains. The T-bond PPM sets forth
explicitly the provisions of Rev. Rul. 78-182, 1978-1 C.B. 265,
which discuss the circumstances for generating tax advantages. To
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