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Cemco Investors, LLC v. United States

515 F.3d 749 (2008)

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Cemco Investors, LLC v. United States

United States Court of Appeals for the Seventh Circuit

515 F.3d 749 (2008)

Facts

Cemco Investors, LLC (Cemco) (defendant) and Cemco Investment Partnership (the partnership) had two partners, Steven Kaplan and Forest Chartered Holdings, Inc. (the shell company), a shell company owned by a tax attorney named Paul Daugerdas. Cemco Investors Trust (the trust) had two beneficiaries, Kaplan and the shell company. Daugerdas was the trust’s trustee. Together, Cemco, the trust, and the partnership formed a tax shelter designed to create a loss for the benefit of Kaplan and Daugerdas. The trust simultaneously purchased a long option from Deutsche Bank and sold a short option to Deutsche Bank. Each option entitled the purchasing entity to $7.2 million if the euro exchange rate was below a certain rate on the exercise date—$0.8652 for the long option and $0.8650 for the short option. Therefore, the options would exactly offset each other, except that Deutsche Bank would pay $7.2 million to the trust if the euro exchange rate was exactly $0.8651 on the exercise date, which was extremely unlikely. The option premiums were almost the same—the premium for the long option the trust purchased from Deutsche Bank was $3.6 million, and the trust paid Deutsche Bank $36,000, the difference between the option premiums. The options expired unexercised, and Deutsche Bank refunded $30,000 to the trust, leaving the trust with a loss of $6,000. After a series of transactions involving the options, Cemco claimed a loss of $3.6 million on its 2000 income-tax return. Cemco believed it could claim the loss based on one tax court case, Helmer v. CIR, 34 T.C.M. 727 (1975). The Internal Revenue Service (IRS) (plaintiff) disallowed the loss. In doing so, the IRS cited Notice 2000-44, 2000-2 C.B. 255, which warned taxpayers that Helmer could not be relied on, and that artificially high losses would be disallowed. In 2003 the IRS formalized the warning into a temporary regulation, Treasury Regulation § 1.752-6 (the treasury regulation), which was made permanent two years later. The treasury regulation explained that it applied retroactively to transactions that occurred between October 1999 and June 2003. The regulation applied to transactions from October 1999 because Congress, in enacting the Community Renewal Tax Relief Act of 2000, stated that IRS regulations related to basis-reduction rules for partnerships could be retroactive to October 1999. Cemco argued that the treasury regulation should not apply retroactively. The district court upheld the IRS’s disallowance, and Cemco appealed.

Rule of Law

Issue

Holding and Reasoning (Easterbrook, C.J.)

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