On August 6, 2026, the U.S. Tax Court issued an opinion in SIH Partners LLLP v. Commissioner, applying the anti-abuse rule in Treasury Regulation Section 1.246-5(c)(1)(vi) to a portfolio swap that complied with the regulation’s mechanical 70% substantial-overlap test. The decision denies qualified dividend income treatment for purposes of Section 1(h)(11) and related foreign tax credits arising from a highly structured Swiss dividend transaction. More broadly, the court’s reasoning creates substantial uncertainty for the use of “70/30” baskets to hedge appreciated holdings while avoiding adverse holding-period, straddle, or constructive-sale consequences.
Background
Section 1(h)(11) and Section 901(k) provide a reduced tax rate and tax credits to dividends on certain stocks. They incorporate the Section 246(c) holding period requirements, which excludes from the holding period the time when the taxpayer’s risk of loss is diminished by holding a position in substantially similar or related property.
Regulation Section 1.246-5 contains special rules for “positions” reflecting more than one stock. A position reflecting at least 20 unrelated issuers is treated as a portfolio position (basket), which is generally treated as substantially similar or related to the taxpayer’s long stock holdings only if the basket and the taxpayer’s holdings substantially overlap. Under the mechanical test, substantial overlap exists when the relevant “subportfolio” equals or exceeds 70% of the value of the stocks represented in the position.
These rules have long been viewed as permitting a taxpayer to hedge appreciated stocks through a short basket in which less than 70% of the basket consists of the appreciated stock and at least 30% consists of other stocks. Subject to an anti-abuse rule, practitioners often concluded that the basket would not be disaggregated and treated as a collection of separate single-name shorts.
Notwithstanding the mechanical portfolio rules, under an anti-abuse rule in the regulations, a multistock position is treated as substantially similar or related property if:
- Changes in the value of the position or the stocks reflected in it are reasonably expected to virtually track, directly or inversely, the taxpayer’s stock holdings or an appropriate portion of those holdings.
- The position is part of a plan whose principal purpose is to obtain tax savings, including tax deferral, whose value significantly exceeds the expected pretax economic profits from the plan.
The SIH Transactions
SIH Partners, an affiliate of Susquehanna International Group, acquired long positions in Nestlé, Novartis, Roche, and Swisscom and held the shares over their respective ex-dividend dates. Simultaneously, SIH obtained identical short exposure to the four Swiss stocks through a Morgan Stanley portfolio swap.
The swap also incorporated a preexisting firmwide hedge consisting of broad market-index shorts. The market-index positions increased the size of the swap sufficiently that the long Swiss stocks represented only approximately 64% of the basket. The Swiss-stock positions themselves, however, were fully hedged.
For 2012, SIH reported approximately $170.8 million of dividends as qualified dividend income and claimed approximately $25.6 million in foreign tax credits. SIH paid approximately $130.2 million of substitute dividends to Morgan Stanley under the swap.
The transaction was actively managed. SIH changed the swap’s components 214 times during 2012, including 200 changes corresponding to Swiss dividend dates. Those changes synchronized the physical long positions and synthetic shorts and maintained a complete hedge of the Swiss shares.
The Tax Court’s Decision
The IRS initially argued that the portfolio swap should be disaggregated under substance-over-form principles and treated as separate short positions in each underlying stock. The Tax Court rejected that argument. It found that the transaction was a conventional portfolio swap in both form and substance and that the regulation expressly contemplates changes in portfolio composition.
The court also held that the basket passed the mechanical substantial-overlap test. On the relevant testing date, approximately 64% of the basket overlapped with SIH’s long Swiss-stock holdings. The other 36% consisted of the unrelated firm hedge. The court therefore concluded that the basket was not substantially similar or related property under the mechanical portfolio exception.
The court nevertheless applied the anti-abuse rule. In interpreting its virtual-tracking requirement, the court did not compare the value of the entire swap with the value of the Swiss stocks. Instead, it focused on the individual Swiss-stock components reflected in the swap. Because those components were exact shorts against SIH’s corresponding long positions, the court held that they virtually tracked the long positions.
The court also found that anticipated tax savings exceeded $25 million, while SIH’s contemporaneous analyses reflected expected pretax profit of no more than approximately $2.4 million. The court therefore held that the anti-abuse rule applied, reduced SIH’s holding periods and denied both qualified dividend income (QDI) treatment and the associated foreign tax credits. The opinion did not actually find a bad “principal purpose” but apparently inferred that from the mere excess of the tax savings over the pretax profit.
Significance of the Decision
The most significant aspect of SIH Partners is the court’s component-level application of the virtual-tracking test. It effectively reverses the mechanical test when the tax savings exceed the economic profit.
The regulation refers to changes in the value of “the position or the stocks reflected in the position.” The court read that language as permitting it to isolate selected stocks reflected in a portfolio and compare those stocks with the corresponding portion of the taxpayer’s long holdings. Under that reading, a basket can fail the anti-abuse rule even though the remaining 30% or more of the basket creates substantial aggregate market risk and prevents the overall basket from closely tracking the taxpayer’s appreciated stock. However, that interpretation does not neatly align with the term “position” as it is used in the regulations. A more straightforward reading of the phrase suggests a reference to all the stocks in the basket.
The decision therefore preserves the mechanical portfolio safe harbor but substantially limits its application to tax-motivated transactions and expands the concept of tax motivation to include all transactions producing more tax savings than economic gain. Under the court’s interpretation, a position reflecting a short in an appreciated single name may satisfy the virtual-tracking prong because that particular component inversely tracks the corresponding long stock. If avoiding current gain or preserving favorable holding periods is a principal purpose and the tax-deferral value exceeds the anticipated profit from the hedge, the anti-abuse rule may apply.
The court did not hold that every 70/30 basket fails. Both elements of the anti-abuse rule remain necessary. Transactions entered into for genuine investment, financing, or risk-management purposes may have strong arguments that obtaining tax savings was not a principal purpose or that the basket was not part of a tax-avoidance plan. Likewise, a position involving meaningful basis risk rather than an exact single-name short may not virtually track the taxpayer’s stock.
Nevertheless, bespoke baskets constructed principally to hedge an appreciated single name are now materially more difficult to defend. A static basket would likely be preferable to a repeatedly rebalanced transaction, but the opinion does not limit its holding to actively managed or dividend-date transactions.
Broader Implications
The direct consequences of SIH Partners concern QDI, the dividends-received deduction, and foreign tax credits. However, the ramifications of the opinion extend further.
Regulation Section 1.1092(d)-2 generally incorporates the Regulation Section 1.246-5 definition of “substantially similar or related property” for purposes of the stock-straddle rules. A basket previously treated as opaque may therefore create a straddle, potentially resulting in holding-period suspension, loss deferral, and other straddle consequences. Treasury confirmed this regulatory cross-reference when the rules were issued.
The decision may also affect constructive-sale planning. Section 1259 does not directly incorporate all of Regulation Section 1.246-5 into the initial constructive-sale determination, and the court in SIH Partners did not decide whether a 70/30 basket constitutes an offsetting notional principal contract with respect to an appreciated financial position. Nevertheless, practitioners have relied in part on Regulation Section 1.246-5, the constructive-sale cure provision, and legislative history addressing basket disaggregation. The court’s willingness to isolate a specific basket component under the anti-abuse rule weakens the argument that a nominally compliant basket necessarily remains opaque for constructive-sale purposes.
Arguments for basket opacity under the wash-sale and other substantially-identical-property rules may likewise require reconsideration.
Conclusion
SIH Partners does not formally eliminate the portfolio rules or hold that all 70/30 baskets are ineffective. It does, however, permit the anti-abuse rule to override mechanical compliance when there is precise hedging at the constituent level and tax benefits outweigh pretax profits. Unless the decision is narrowed or reversed, we advise caution before implementing bespoke baskets designed to hedge appreciated single-name positions, particularly when tax deferral is central to the transaction and the hedge has limited expected pretax profitability.
If you have any questions, or would like additional information, please contact one of the attorneys on our Federal & International Tax team.
You can subscribe to future advisories and other Alston & Bird publications by completing our publications subscription form.