Testimony: Charitable Giving Problems (cont-7)
Offsetting Foreign Currency Option Contracts
This marketed promotion exploits the Code’s rules for recognizing gain or loss on foreign currency contracts. The taxpayer holds offsetting positions in contracts on a currency traded on a regulated futures exchange (these contracts are subject to section 1256 of the Code), and contracts on a currency that is not traded on a regulated futures exchange (these contracts are not subject to section 1256). Straddle positions are taken so that all gains are offset by losses.
Section 1256 of the Code requires a taxpayer to recognize the inherent gain or loss at the time of any assignment of a currency contract traded on a regulated futures exchange. However, assignments of contracts on currencies that are not traded on a regulated futures exchange are not subject to section 1256.
Before the close of the calendar year, a participating taxpayer assigns the offsetting section 1256 contracts and non-section 1256 contracts to a recognized public charity. Although this generates a small charitable deduction for the donor, the main feature is that the donor can recognize the loss on the section 1256 contracts without recognizing the corresponding gain on the non-section 1256 contracts. Rather, the charity, which is not subject to tax, recognizes this gain on the non-section 1256 contracts.
We have identified dozens of entities, both taxable and tax-exempt, that are involved in this type of transaction. Examinations are underway. Because we identified and began enforcement action on this issue early, we are still gathering data on the dollar impact of these transactions and we believe the revenue loss may have been minimized by early detection. However, preliminary data suggests the impact may exceed one million dollars per transaction. We listed this transaction in Notice 2003-81, 2003-51 I.R.B. 1223, which requires disclosure by participants.