Moving to close what they called, "the most glaring loophole" in federal tax laws, two influential congressmen introduced legislation yesterday to prohibit taxpayers from deducting deliberate commodity trading losses from their income taxes.
A few of "the very wealthiest taxpayers" use artificial commodity trading losses to avoid paying almost $4 billion a year in taxes, charged Rep. Charles Vanik (D-Ohio).
Vanik and Rep. Benjamin Rosenthal (D-N.Y.) asked Congress to eliminate the $4 billion loophole by outlawing deductions produced by so-called "tax straddles."
To use a tax straddle, an investor simultaneously buys and sells commodity futures contracts. Because the two tranactions exactly match, there is no risk. The investor makes money on one deal and loses the same amount on the other.
The loss can be deducted immediatey from any other income. The profits can be deferred indefinitely, so no taxes are paid or they are paid at a much lower rate.
Vanik said one wealthy executive who earned more than $500,000 a year used a tax straddle to deduct his entire income and claim a $38,000 refund from the Internal Revenue Service.
In the past few months the IRS has filed more than 50 lawsuits against taxpayers to try to make them pay taxes on income they wrote off against tax-straddle losses.
The IRS now must prove the taxpayers are trying to avoid paying taxes, Rosenthal explained. The bill would rewrite the law so commodity trading losses are taxed in much the same way as losses on stock transactions.
The two congressmen said the IRS believes about 30,000 taxpayers a year use tax straddle to avoid paying some or all of the taxes they normally would owe.
Use of tax straddles is being promoted by some of the largest stock and commodity brokers in the country, Vanik complained. In at least one case, the fee for the investment is based on the amount of taxes saved.
Investments in silver or Treasury bill futures contracts are used most commonly to avoid taxes, but the same technique can be used with any commodity, Vanik said.
Rosenthal said his support for the bill came after hearings held recently by a subcommittee he heads on silver speculation by the Hunt brothers of Texas. "You might call this the Vanik-Rosenthal-Hunt Bill," he said.
The proposal isn't meant to increase the taxes paid by professional commodity traders, the two representatives said. Grain and other commodity traders often take straddle positions for normal business reasons.
The technique is called a straddle because the investor takes both sides of the deal at once.
In the more elaborate version of the technique, known as a "butterfly spread," the investor buys and sells four commodity futures contracts.
In most cases the transaction is made at the end of the year so the taxpayers can write off the loss one year and delay the profit until the next. By doing another straddle the following year, the first year's profits can be deferred again. The process can be repeated indefinitely.