- 61 -
income into 1984. Petitioners' actual trading patterns may indeed
have become more idiosyncratic, but the trades still represented
substantial tax avoidance.
Another indication of a lack of economic substance is the fact
that the prices of the items traded on the Merit markets were not
set by market forces. Instead, the prices were set by Merit itself,
according to formulas derived by its employees. As was the case in
Freytag v. Commissioner, supra, the parties have expended a great
deal of time, energy, and resources in arguing the theoretical
viability of Merit's pricing structure for options and forwards.
Those considerations are largely irrelevant. The loss legs of
tax straddles presented the opportunity for large tax losses at the
end of a taxable year. Economically, these are not losses at all,
because they are balanced by the offsetting (but unrealized for tax
purposes) gain legs. Thus, alleged negotiations between Merit and
its customers as to the prices of the legs are not particularly
significant, because the prices offset each other. We explained
that point in Smith v. Commissioner, 78 T.C. 350, 379 (1982):
Neither were petitioners' prices the product of an
economically adversarial or tax-consequence adversarial
process. While the relative prices of straddle legs are
of great economic consequence to a straddle trader, the
absolute prices have little or no economic significance.
The buyer or seller of a straddle suffers no economic
benefit or detriment by agreeing to leg prices above the
market or below the market. To the extent that one leg
is economically deprived of its true value by such
pricing, the other leg's value is equally enhanced. * *
* [Fn. ref. omitted.24]
24 Moreover, the historic stock prices, rates, and
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