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IMBIBE AND INVEST? THE DANGERS OF TRADING WHILE TIPPLING

August 26, 2004

During those happy times when the market seems to be headed ever upwards (oh, the '90s were so much fun!), it almost seems like investors are trading under the influence. In a case issued by the Tax Court today, we find an actual instance of trading while tippled:

   On each day that Paine Webber was open 
   for business, petitioner visited its office and
   invested approximately $500,000 to 
   $1 million in speculative securities. From the 
   time that petitioner arrived at Paine Webber’s 
   office, usually 6 to 6:30 a.m., he started 
   drinking alcoholic beverages, supplied by 
   Paine Webber, until he was high and happy 
   but not stumbling drunk. He authorized each 
   of his trades, and he was informed and
   knowledgeable as to all of his trades. Some 
   of the trades resulted in gains, and some of 
   them resulted in losses.

   During 1980, petitioner had exhausted most
   of his funds, and he ceased his regular 
   involvement with Paine Webber.

We thought they only did this in Las Vegas. Maybe that's what they mean by "full service" brokerage.

   In or about 1985, petitioner and his wife sued
   Paine Webber, Osborne, and others 
   (collectively, the defendants) in a U.S. 
   District Court, alleging that the defendants 
   were liable for securities fraud, negligence, 
   and breach of fiduciary duty in the handling 
   of petitioner’s accounts. The court dismissed 
   the lawsuit as time barred by the applicable 
   period of limitations and for failure to plead 
   properly as to fraud. That dismissal was 
   affirmed by the Court of Appeals for the 
   Ninth Circuit.

All that free liquor, and no gratitude whatever.

   On his 1986 Federal income tax return, 
   petitioner claimed an $800,000 deduction 
   for a casualty or theft loss. On his 1997,
   1998, and 1999 Federal income tax returns, 
   petitioner claimed that he was entitled to 
   deduct with respect to that loss NOL 
   (net operating loss) carryovers of $726,572, 
   $726,572, and $703,308, respectively.

How's that again? He claimed an 1986 loss of $800,000, generating $700,000+ losses each year for 1997, 1998, and 1999? Maybe the tax preparer lingered at Paine Webber before working on these returns.

   Petitioner argues in his brief that he is 
   entitled to deduct the NOL carryovers at 
   issue. According to petitioner, those 
   carryovers are attributable to a theft that 
   petitioner suffered in that “in essence Paine 
   Webber stole his money from him by
   supplying him with alcoholic beverages and 
   allowed him to make unwise investments 
   that benefitted them directly” in the form of
   higher commissions.

Even in the investment world, candy is dandy, but liquor is quicker.

Tax Court Judge Laro said the taxpayer failed to establish that there even was a net operating loss.

Even if there were a loss, the tax law doesn't allow you to use NOL deductions at your convenience. You are required to carry them back to years before the NOL incurred unless you make an election to carry the losses forward on your original timely return for the loss year. In 1986, the carryback period was three years (it's two years now). You have to claim the refund for the prior years within three years of the due date for the loss year return. The return for 1986, the loss year, was due April 15, 1987, so the refund claim was due April 15, 1990.

The only way the taxpayer could have used a 1986 loss eleven years later would be if would not have been offset by income in 1983-1985 or 1987-1996. Even then, you can only use a loss once. The taxpayer failed to introduce evidence in to the court to support that any NOLs would have survived until 1997.

The result? A loss by the taxpayer on all issues, $576,661 in additional taxes, and $115,372.20 in penalties.

The moral? Don't drink and day-trade. Oh, and don't sleep on those NOL carrybacks, either.

Cite: Michael E. Yoakum v. Commissioner, T.C. Memo. 2004-191

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