Opinion ID: 1253249
Heading Depth: 2
Heading Rank: 1

Heading: The Straddle, and Simulated Straddle, Transactions

Text: In the late 1970s, a company owned by Josephberg and Feldman, Cralin Associates, Inc. (Cralin), entered into an agreement with a company owned by one Bernard Manko, pursuant to which Josephberg and his Cralin business associates would syndicate  i.e., sell interests in (Trial Transcript (Tr.) 130-31)  limited partnerships that were created to invest in tax shelter straddle transactions involving United States Treasury bills (T-Bills) (collectively the Manko tax shelters or tax shelter partnerships). A straddle is the simultaneous ownership of a contract to buy a commodity for delivery in a future month and a contract to sell the same amount of the same commodity in a different future month, see generally United States v. Atkins, 869 F.2d 135, 137-38 (2d Cir.) ( Atkins ), cert. denied, 493 U.S. 818, 110 S.Ct. 72, 107 L.Ed.2d 39 (1989). As each Manko tax shelter partnership owned both contracts to buy and contracts to sell, either the purchase contracts or the sale contracts could be sold at a loss. Each year the partnerships sold the category of contracts that had decreased in value, thereby realizing losses. As the losses (or gains) realized by a partnership flow through to the individual partners in proportion to their respective ownership interests, see generally United States v. Helmsley, 941 F.2d 71, 84 n. 5 (2d Cir.1991), cert. denied, 502 U.S. 1091, 112 S.Ct. 1162, 117 L.Ed.2d 409 (1992); 26 U.S.C. §§ 701-04, the individual investors in a given Manko tax shelter partnership claimed their shares of those losses as deductions on their income tax returns for that year. The partnership's sale of the offsetting profitable contracts was deferred until the following year; but tax shelter straddle transactions were repeated through 1980, with the amounts escalating each year ( see Tr. 142) in order to generate losses that would offset the gains that had been rolled forward from the year before ( see id. at 133-34). While an ordinary straddle is not risk free because there is no assurance that the gain on the second leg will be equal in amount to the loss on the first leg, Atkins, 869 F.2d at 137, Josephberg and his Cralin associates sought to structure their straddles or simulated straddles in ways that would ensure that everything washe[d] out, i.e., that if there was a profit it was the same amount as [the] loss (Tr. 154). In 1981, the accumulated deferred gains for Josephberg, Feldman, and their tax shelter partners totaled some $140 million; absent an offsetting loss, taxes on those gains would have been owing in 1982. These gains could not be offset by further Manko tax shelters, however, because of a provision in the Economic Recovery Tax Act of 1981 requiring generally that a straddle owner claiming a straddle loss must recognize the gain in the offsetting commodity contract in the same year as the claimed loss, even if the gain was as yet unrealized. See 26 U.S.C. § 1092. In order to obtain losses to offset the $140 million in gains rolled into 1981, Josephberg and his associates entered into an agreement with a government bond dealer, New York Hanseatic (Hanseatic), whose principal was Charles Atkins, to generate tax losses in T-bill transactions by using repurchase agreements (or repos), which are devices for financing the purchase or sale of securities, Atkins, 869 F.2d at 138. T-bills are purchased at a discount and appreciate through the dates of their maturity. Repo transactions were used by Josephberg and his associates to simulate a straddle (Tr. 145) by deducting the financing expense in one year and realizing the gain from the T-bills' appreciation in the following year. In 1981 Cralin paid Hanseatic approximately $1 million to purchase $140 million in T-bill repo losses (without any physical securities being involved ( id. at 151)), and the individual investors claimed their shares of those losses as deductions on their income tax returns to offset the tax-shelter-deferred gains ( see id. at 150). The Manko tax shelter straddles had been designed to create deductions amounting to four times the investor's capital contribution. ( See id. at 131-32.) Both the Manko and the Hanseatic-related shelter transactions were pre-arranged, manipulated, rigged, and riskless ( e.g., id. at 150-51, 159, 168-69); and Josephberg and his partners engaged in these transactions not for the purpose of producing profits but solely for the purpose of generating losses that investors could deduct from income on their tax returns ( see id. at 142-43, 147-55). Indeed, in 1981, when Cralin entered into its first transaction with Hanseatic, Cralin could have made a profit of more than $20 million at the second planned stage of the financing process, due to an anomalous and precipitous decline in interest rates; but instead of financing the repo expense at the lower rate, Cralin chose to pay the originally planned, non-prevailing, higher interest rate in order to achieve the desired $140 million loss. ( See id. at 146-50.) Cralin continued these simulated straddle transactions until the IRS began an investigation of the transactions with Hanseatic. ( See Tr. 155-56.) The last Hanseatic repo deal occurred in 1984, with losses taken in that year and the gains deferred into 1985. ( See id. at 155.) Feldman, who described the Manko and Hanseatic transactions at trial, and had pleaded guilty to conspiring to commit tax fraud with respect to the purchase of $140 million in tax losses from Hanseatic in 1981 ( see id. at 158, 161), testified [w]e didn't care about profits ( id. at 196). Among those claiming shares of the losses generated by these tax shelter transactions on their individual tax returns were Josephberg and other Cralin principals, who received syndication fees for creating and marketing the Manko partnerships. ( See id. at 931-33.) Because of their roles as syndicators, the Cralin principals were not even required to make cash investments in the Manko tax shelter partnerships in order to claim losses; Josephberg and his partners simply received an allocation of the losses in the structure of the transaction. ( Id. at 133.) Because of the losses claimed, the tax returns of the Cralin principals for the years in question generally showed no tax liability. ( See id. at 933.) In 1978, for example, Josephberg reported more than $250,000 in wages and other income on his personal income tax return; but, claiming more than $260,000 in losses attributable to the Manko-related transactions, he paid nothing in taxes. For the period 1977-1985, Josephberg earned more than $3,672,000, a significant portion of which came from his sales, through Cralin, of the Manko and Hanseatic-related tax shelters; because of the tax shelter losses he claimed, he paid a total of only $41,000 in taxes for those nine years. ( See GX JD-12.)