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Tax Naked Credit Default Swaps For What They Are: Legalized Gambling, James Blakey

University of Massachusetts Law Review

Credit default swaps (CDSs) gained notoriety for their role in the global financial crisis. In late 2011, the IRS proposed new regulations that would classify CDSs bought by someone who does not own the credit, known as "naked" CDSs, as "financial instruments" and thereby qualify them for the highly beneficial capital gains tax treatment. This classification is incorrect. Naked CDSs, which constitute about 80% or more of all CDSs, are not financial instruments at all. Rather, this article argues, they are gambling wagers -- the winnings on which are taxable at the ordinary income tax rate. This is not the …