t c memo united_states tax_court diesel performance inc petitioner v commissioner of internal revenue respondent docket no filed date richard s calone and jason w harrel for petitioner neal o abreu and christian a speck for respondent memorandum opinion parr judge respondent determined deficiencies of dollar_figure and dollar_figure in petitioner's federal income taxes for the taxable years ending date and date respectively and an accuracy-related_penalty of dollar_figure under sec_6662 for all section references are to the internal_revenue_code in effect for the taxable years in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated after concessions ’ the issues for decision are whether petitioner made a timely election to waive the carryback period with respect to its net_operating_loss for its tax_year ending date we hold it did not whether the period of limitations bars the assessment and collection of the deficiency in income_tax for the tax_year ending date we hold it does not whether the duty_of_consistency doctrine or in the alternative the theory of equitable_estoppel applies under these circumstances we hold they do not this case was submitted fully stipulated under rule the stipulated facts and the accompanying exhibits are incorporated herein by this reference at the time the petition in this case was filed petitioner's principal_place_of_business was located in stockton california ‘petitioner conceded respondent's determination with respect to the sec_481 adjustment for the taxable_year ending date respondent conceded that the accuracy-related_penalty under sec_6662 does not apply to petitioner for the taxable_year ending date background diesel performance inc diesel performance is a corporation permitted to do business in california it was incorporated on date for the tax_year ending date petitioner timely filed its corporate_income_tax return form_1120 the originally filed form_1120 for the tax_year ending date showed a profit taxable_income for petitioner due to accounting errors related to sec_263a adjustments petitioner's accountant discovered that the original form_1120 for the tax_year ending date was incorrect after discovering the error petitioner prepared an amended form 1120x for the tax_year ending date which was filed on date the form 1120x for the first time showed petitioner had actually sustained a loss for that period respondent does not dispute the accuracy of the loss reported on petitioner's form 1120x for the period ending date on the form 1120x petitioner attached a statement which read blection to relinquish net_operating_loss_carryback period diesel performance inc bin form_1120 fiscal_year ended date taxpayer incurred a net_operating_loss in its taxable_year ended date and is entitled to a three- year carryback period with respect to that loss under code sec_172 of the internal_revenue_code pursuant to code sec_172 c the taxpayer hereby elects to relinquish the entire carryback period with respect to the net_operating_loss incurred in its taxable_year ended date on petitioner's form_1120 filed for the tax_year ending date petitioner claimed a reduction in gross_income in an amount representing the net_operating_loss from the date period in auditing petitioner's date form_1120 respondent disallowed the net_operating_loss_carryover from date on the grounds petitioner had not included a valid election to waive the carryback period on a return filed by the original due_date respondent issued a notice_of_deficiency for the taxable_year ending date disallowing dollar_figure of the net_operating_loss petitioner attempted to carry forward to the date taxable_year on petitioner's original forms for the taxable years ending date and petitioner reported net taxable_income of dollar_figure and dollar_figure respectively on petitioner's original form_1120 for the taxable_year ending date petitioner reported a loss of dollar_figure petitioner included with the original return its election to waive the carryback period for the reported loss on petitioner's amended form 1120x for the taxable_year ending date filed on or about date petitioner reported a loss of dollar_figure discussion respondent determined that petitioner did not make a timely election to waive the carryback period on the amended_return for the tax_year ending date petitioner asserts that it did make a valid election to relinguish the carryback period with respect to its net_operating_loss for the tax_year ending date in general sec_172 allows a deduction for an amount equal to the aggregate of the net_operating_loss carryovers to a taxable_year plus the net_operating_loss carrybacks to that year see sec_172 sec_172 as in effect for the years at issue required that a net_operating_loss first be carried back to each of the previous taxable years and if it was unabsorbed by those years that the remaining portion be carried forward to the following taxable years see sec_172 and sec_172 b however provides that a taxpayer may elect to relinquish the entire carryback period and carry forward the loss to the taxable years following the loss_year that section further provides such election shall be made in such manner as may be prescribed by the secretary and shall be made by the due_date including extensions of time for filing the taxpayer's return for the taxable_year of the net_operating_loss for which the election is to be in effect such election once made for any taxable_year shall be irrevocable for that taxable_year the regulations in accord with the statute provide that the election must be made by the later of the time including extensions thereof prescribed by law for filing income_tax returns for such taxable_year or date sec b temporary income_tax regs fed reg date which regulation is entitled various elections under the tax reform act of as to the manner in which the election is to be effected sec_2 temporary income_tax regs fed reg date provides d manner of making election unless otherwise provided in the return or ina form accompanying a return for the taxable_year the elections described shall be made by a statement attached to the return or amended_return for the taxable_year fthe statement regquired when making an election pursuant to this section shall indicate the section under which the election is being made and shall set forth information to identify the election the period for which it applies and the taxpayer's basis or entitlement for making the election the regulation was redesignated in as sec_301 12t temporary income_tax regs fed reg date in 83_tc_831 affd 783_f2d_1201 5th cir this court concluded that the taxpayer's amended_return is irrelevant in determining substantial compliance with the election requirements in rejecting the taxpayer's argument that section d temporary income_tax regs fed reg date provides that an election may be made in an amended_return the court explained this is true however in order to square the regulation with the directive of the statute an election made in a subsequently filed return can only be effective if the subsequently filed return is filed before the due_date of the return young v commissioner supra pincite n we accept that petitioner made an honest mistake when filing its original return for the tax_year ending date furthermore we accept that it attempted to elect to relinquish the carryback period on its amended_return for the tax_year ending date the due_date with extensions of petitioner's return for the tax_year ending date however was date petitioner did not file the amended_return with the election until date therefore petitioner did not make a timely election to waive the carryback period on its amended_return for the tax_year ending date see young v commissioner supra klyce v commissioner tcmemo_1999_198 menaged v commissioner tcmemo_1991_79 petitioner next argues that the period of limitations under sec_6501 bars the assessment and collection of the deficiency in income_tax for the tax_year ending date petitioner's amended_return for the tax_year ending date was filed on date according to sec_6501 petitioner argues the period of limitations for the tax_year ending date expired date an amended_return even if accepted by the irs is considered a mere supplement and the original return is used for purposes of determining the period of limitations on assessment see 293_us_172 therefore petitioner is correct in that generally the period of limitations for the tax_year ending date would expire on date however the tax_year in issue for which a deficiency was determined ended on date respondent is not barred from assessment and collection of a deficiency in income_tax for the tax_year ending date by the period of limitations next petitioner argues that the duty_of_consistency is applicable in this case we may exercise equitable principles so that the duty_of_consistency applies in this court see 103_tc_525 affd 100_f3d_778 10th cir however it does not apply to the facts of this case the duty_of_consistency doctrine prevents a taxpayer from taking a position one year and then a contrary position in a later year after the period of limitations has expired on the first year see id pincite see also 532_f2d_809 2d cir estate estopped to deny decedent's u s citizenship after she represented to the u s government for a period of more than years that she was a citizen_of_the_united_states petitioner argues that under certain circumstances the duty_of_consistency may also apply to the commissioner see eg 311_fsupp_5 e d n y commissioner estopped to apply ruling retroactively to recordkeeping system that had been substantially accepted for a long period of time and reviewed by many agents at different levels of authority this type of situation is not present here petitioner made an honest mistake in preparing a return which respondent discovered on audit the duty_of_consistency does not apply against respondent although petitioner argues the duty_of_consistency applies petitioner also mentions equitable_estoppel and argues on brief that respondent was not timely in reviewing the invalid election and thereby provided a wrongful misleading silence upon which the taxpayer relied to invoke estoppel against the government the party seeking estoppel must show at a minimum the existence of a false representation or wrongful misleading silence by the other party ignorance of the facts reasonable reliance on the false representation or wrongful misleading silence of the other party error in a statement of facts and not in an opinion or statement of law and a resulting detriment to the party relying on the false statement or misleading silence see garland v commissioner tcmemo_1993_190 petitioner has not proven any of the elements of equitable_estoppel for the foregoing reasons decision will be entered under rule


id office uilc cca_2009042715311737 ---------- number release date from ------------------- sent monday date pm to -------------------- cc ----------- subject re procedures for cases where pass-through partner wants to agree and pay del_order covers closing agreements for tefra partnership items the courts that have addressed the issue have concluded that section c is just a subsection of sec_7121 which governs closing agreements that relate to tefra partnership items furthermore it is the last sentence of section c which makes settlement agreements by pass-though entities binding on the indirect partners del_order governs settlement of tefra partnership items under section c so that is the delegation_order that should be used for such settlements


t c memo united_states tax_court travis a mathis and bettina c jary-mathis petitioners v commissioner of internal revenue respondent docket nos filed date james frederick martens kelli h todd and jeffrey s taylor for petitioners roberta l shumway and bryan j dotson for respondent memorandum findings_of_fact and opinion goeke judge petitioners owned a cutting horse farm in florence texas they continued to operate the farm despite sustaining significant losses for each of the years of its existence respondent audited petitioners’ form sec_1040 u s individual_income_tax_return for the years to respondent determined petitioners were not operating the farm for profit consequently they issued a notice_of_deficiency denying the related deductions and determining a deficiency for each of those years respondent also imposed accuracy-related_penalties associated with the resulting deficiencies the issues for decision are whether petitioners engaged in their cutting horse activity from to for profit within the meaning of sec_183 we hold that they did not and whether petitioners are liable for accuracy-related_penalties under sec_6662 for and we hold that they are not findings_of_fact i petitioners petitioners resided in texas when they filed the petition bettina jary-mathis grew up in south texas and spent much of her youth assisting her uncle on a cattle ranch as a teenager she developed a passion for cutting horses cutting is an equestrian event in which judges score a horse and rider on their ability to isolate a cow or calf from a herd when mrs jary-mathis unless otherwise indicated all section references are to the internal_revenue_code in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure was in high school her father who was an architect designed a house on a cutting horse farm for one of his clients while her father worked on the house mrs jary-mathis hovered around the barn and learned all she could about cutting horses in mrs jary-mathis married travis mathis mr mathis comes from a wealthy family--his grandfather co-founded brown root a lucrative engineering and construction company petitioners earn millions of dollars in investment_income every year ii la brisa farm in petitioners purchased property in florence texas and started la brisa farm to train cutting horses from until mrs jary-mathis managed the farm primarily as a training operation she bred her mares to high- quality stallions to produce horses capable of competing in the premier cutting events she employed accomplished onsite trainers to develop her young horses’ talent but the prize money she earned did not cover the expenses she incurred she also found retaining qualified trainers difficult because the best trainers wanted to demonstrate their skills on horses from many different farms after sustaining losses in each of the first five years and losing her onsite trainers mrs jary-mathis decided to shift the farm’s focus to breeding rather than training she created a written business plan which stated the operation’s new objective breeding cutting horses with proven and desirable bloodlines for which customers will be willing to pay a premium a young cutting horse’s value depends largely on its bloodlines purchasers evaluate a young horse’s potential on the success of its parents horses born to parents that have won significant cutting competitions or have produced other winners sell for more than those with less accomplished parents to build la brisa farm’s reputation mrs jary-mathis sought to develop a premier band of broodmares she purchased broodmares with strong bloodlines and kept only those that produced successful foals she often sold young horses to top-level trainers cheaply because she knew those trainers could win competitions with them those horses’ success would increase the value of future foals by the end of la brisa farm possessed an exceptional broodmare collection iii mrs jary-mathis’ role on the farm petitioners hired an onsite breeding manager to perform day-to-day activities but mrs jary-mathis oversaw all aspects of the farm’s operations and made all important decisions she typically worked hours per week on farm activities she spent most of that time researching performance records and identifying stallions to breed with her mares her work volume increased to hours per week during the premier cutting competitions during cutting events she and her daughter maria showed la brisa farm’s horses mrs jary-mathis frequently attended cutting horse seminars and attended one on ranching for profit she continually consulted with cutting horse trainers and other owners to improve her breeding operation mrs jary-mathis also chose the farm’s marketing methods she periodically advertised in print and online publications but the farm did not have a web site she identified buyers for her horses primarily by talking with owners and trainers at cutting events although mrs jary-mathis generally visited la brisa farm no more than once a week she regularly interacted with her horses mrs jary-mathis often kept young foals on her personal farm until they were weaned so she could watch them play and monitor their growth iv financial reporting petitioners hired deborah gorman to keep the farm’s books and track their personal finances she used a computer_program to generate financial reports which mrs jary-mathis reviewed at least monthly the financial statements included petitioners’ personal items but the farm items were clearly identifiable petitioners provided complete and accurate financial reports to a certified_public_accountant who prepared their annual returns petitioners have used the same accounting firm throughout the farm’s history and the same individual has prepared their returns for each year since v la brisa farm financial performance la brisa farm has never earned a profit from to petitioners reported cumulative losses on their schedules f profit or loss from farming of dollar_figure petitioners’ largest losses occurred in the three years at issue here since petitioners’ schedule f losses have decreased substantially as a result of lower reported expenses petitioners’ reported farming income has not increased petitioners reported the following schedule f net losses for the years at issue and beyond year loss dollar_figure big_number big_number big_number big_number big_number on date la brisa farm owned cutting horses which petitioners’ appraiser valued at dollar_figure petitioners have never sold a horse for more than dollar_figure and typically received much less i burden_of_proof opinion the taxpayer generally bears the burden of proving the commissioner’s determinations are erroneous rule a the burden_of_proof may shift to the commissioner if the taxpayer satisfies certain conditions sec_7491 however we decide the sec_183 issue on the preponderance_of_the_evidence and therefore the burden_of_proof is not relevant see 124_tc_95 ii sec_183 for-profit requirement sec_183 limits the sec_162 trade_or_business expense deductions a taxpayer may claim for expenses attributable to an activity_not_engaged_in_for_profit taxpayers may not deduct such expenses to the extent they exceed income generated by the activity less deductions attributable to the activity allowable without regard to whether the taxpayer engaged in the activity for profit sec_183 taxpayers engage in an activity for profit when they entertain an actual and honest profit objective in engaging in the activity 78_tc_642 aff’d without opinion 702_f2d_1205 d c cir sec_1_183-2 income_tax regs whether the requisite profit objective exists is determined by looking at all the surrounding facts and circumstances 94_tc_41 sec_1_183-2 income_tax regs we give greater weight to objective facts than to a taxpayer’s mere statement of intent 84_tc_1244 aff’d 792_f2d_1256 4th cir sec_1_183-2 income_tax regs evidence from years after the years in issue is relevant to the extent it creates inferences regarding the taxpayer’s requisite profit objective in earlier years e g foster v commissioner tcmemo_2012_207 bronson v commissioner tcmemo_2012_17 sec_1_183-2 income_tax regs provides a list of factors to consider in evaluating a taxpayer’s profit objective the manner in which the taxpayer carried on the activity the expertise of the taxpayer or his or her advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that the assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer’s history of income or loss with respect to the activity the amount of occasional profits earned if any the financial status of the taxpayer and whether elements of personal pleasure or recreation are involved no single factor controls 72_tc_411 aff’d without published opinion 647_f2d_170 9th cir after careful consideration of these factors we find that petitioners did not engage in their cutting horse activity with a profit_motive we present our analysis below a manner in which the taxpayer carries on the activity the fact that the taxpayer carries on an activity in a businesslike manner and maintains complete and accurate books_and_records may indicate a profit_motive sec_1_183-2 income_tax regs characteristics of a businesslike operation include the preparation of a business plan and in the case of horse breeding and sales a consistent and concentrated advertising program bronson v commissioner tcmemo_2012_17 the regulations further provide that a taxpayer’s change in operating methods or adoption of new techniques to improve profitability may indicate an overall profit_motive sec_1_183-2 income_tax regs petitioners maintained complete and accurate books for their cutting horse activity their bookkeeper prepared financial reports and mrs jary-mathis reviewed them monthly the reports provided mrs jary-mathis an accurate account of the farm’s financial performance petitioners did not create a business plan when they started la brisa farm in but they did when the farm’s focus shifted to breeding in the business plan indicates that petitioners planned to promote their horses so effectively that customers will be willing to pay a premium petitioners have maintained a consistent advertising program the farm frequently displays its horses at shows and has advertised in print publications and online mrs jary- mathis also marketed her horses by talking with industry insiders petitioners argue that the farm’s shift in focus from training to breeding represents a change in operating method that indicates a profit_motive we find that petitioners changed their focus not to improve profitability but because they could not keep top-level trainers the best cutting horse trainers want to demonstrate their skills by training and riding horses from a variety of farms because they could not keep good trainers at la brisa farm petitioners decided to focus on breeding instead on balance this factor favors petitioners they maintained complete and accurate records created a business plan marketed their horses and generally ran the farm in a professional manner b the expertise of the taxpayer or her advisers the taxpayer’s expertise research and extensive study of an activity as well as his or her consultation with experts may indicate a profit_motive see sec_1_183-2 income_tax regs mrs jary-mathis grew up around ranching and learned about cutting horses when she was in high school when she began her own cutting horse operation she had help from experienced trainers since she started la brisa farm mrs jary-mathis has frequently discussed training and breeding strategies with prominent figures in the cutting horse industry she continually performs online research to identify the best horses in the country and she has attended seminars to learn more about the cutting horse business mrs jary-mathis has developed expertise in breeding quality cutting horses but she lacks business expertise mrs jary-mathis attended a seminar on ranching for profit but that does not make her an expert moreover she attended the seminar long after she started the activity petitioners’ failure at the outset to consult experts on the financial aspects of running a cutting horse farm indicates that they lacked a profit_motive see 809_f2d_355 7th cir aff’g tcmemo_1985_523 smith v commissioner tcmemo_1997_503 aff’d without published opinion 182_f3d_927 9th cir c the time and effort expended by the taxpayer in carrying on the activity the taxpayer’s devotion of much of his or her personal time and effort to carrying on an activity may indicate a profit_motive particularly if the activity does not involve substantial personal or recreational aspects sec_1 b income_tax regs mrs jary-mathis devotes considerable time and effort to la brisa farm she typically spend sec_40 hours a week on the cutting horse activity and hours a week during the top cutting events although mrs jary-mathis works hard her work involves substantial personal and recreational aspects she works with cutting horses which have been her passion since she was young she spends time with her daughter at horse shows and she derives a sense of personal pride from owning high-quality cutting horses on balance this factor weighs in petitioners’ favor but the personal and recreational aspects of the activity limit its effect on our overall analysis d the expectation that assets used in the activity may appreciate in value an expectation that assets used in the activity will appreciate in value may indicate a profit_motive even if the taxpayer derives no profit from current operations sec_1_183-2 income_tax regs however we may infer a profit objective from such expected appreciation only when the appreciation exceeds operating_expenses and would be sufficient to recoup the accumulated losses of prior years foster v commissioner tcmemo_2012_207 see golanty v commissioner t c pincite mrs jary-mathis testified that she expects her horses to appreciate in value as her broodmares produce successful foals however petitioners have failed to present evidence that the appreciation will recoup the accumulated losses petitioners have reported over dollar_figure million in losses and the highest price they have ever received for a horse is dollar_figure petitioners’ expert appraised la brisa farm’s entire horse inventory at dollar_figure as of date any appreciation on petitioners’ horses only minimally offsets the very large losses petitioners have sustained since beginning their cutting horse activity petitioners also provided some evidence that the la brisa farm property has increased in value but this does not indicate that they had a profit_motive for their cutting horse activity petitioners did not purchase the property for investment they purchased it to breed and train cutting horses we must evaluate any profit_motive petitioners had in operating the farm separately from any profit_motive they had in purchasing the land see sec_1_183-1 income_tax regs providing that the farming and holding of land will ordinarily be considered a single activity only when the taxpayer engages in the farming activity to offset the carrying costs of the land although the land’s appreciation would be relevant to petitioners’ motive in holding the land it is not relevant to their motive in operating the cutting horse farm even if the land’s appreciation were relevant to petitioners’ profit_motive in operating the cutting horse farm they have not presented sufficient evidence that the appreciation offsets the farm’s substantial losses the evidence in the record concerning appreciation in the farm’s assets fails to persuade us that future profits motivated petitioners to continue the cutting horse activity e the success of the taxpayer in other similar activities sec_1_183-2 income_tax regs provides the fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit even though the activity is presently unprofitable none of petitioners’ past activities provides evidence of a profit_motive here f taxpayer’s history of income or losses a history of continued losses with respect to an activity may indicate that the taxpayer lacked a profit_motive see sec_1_183-2 income_tax regs although a series of losses during the initial or startup stage of an activity may not necessarily indicate a lack of profit_motive a record of large losses over many years is persuasive evidence that the taxpayer did not have such a motive golanty v commissioner t c pincite foster v commissioner tcmemo_2012_207 petitioners realized no profits from la brisa farm in years petitioners claim that they engaged in two separate activities during that period training from to and breeding from to present they argue that the breeding operation remained in its startup phase during the years at issue so the losses during those years do not indicate the absence of a profit_motive we find that the change was not significant enough to constitute the start of a new activity petitioners have bred and trained horses on their farm throughout the entire period they focused more on breeding after and moved the training operation offsite but these changes do not amount to a change in activity accordingly we decline to reset the clock as of simply because petitioners shifted their focus the startup_period for petitioners’ cutting horse activity passed before respondent conducted his audit and the history of losses strongly indicates petitioners lacked a profit_motive petitioners reported smaller schedule f losses for the years following those respondent audited they cite the diminishing losses as a sign that the farm is nearing profitability however the smaller net losses did not result from increased sales only from lower reported expenses petitioners reported lower expenses only after they received notice of the audit which indicates that the audit not a desire to earn profits may have triggered the reductions accordingly we give little weight to the decline in expenses petitioners reported in determining whether they had a profit_motive the current and expected losses of an activity should not be of such a magnitude that an overall profit going forward would not be possible 45_tc_261 aff’d 379_f2d_252 2d cir petitioners have accumulated over dollar_figure million in losses from their cutting horse activity it is unrealistic to expect that petitioners would not continue to accumulate significant losses they have presented no convincing evidence that future profits could possibly offset these losses accordingly this factor weighs heavily against finding a profit_motive g amount of occasional profits the amount of profits in relation to the amount of losses_incurred may provide evidence of the taxpayer’s intent sec_1_183-2 income_tax regs petitioners have never earned a profit from the cutting horse activity yet they continue to operate the farm this indicates that they are running the farm for personal rather than business reasons h taxpayer’s financial status substantial income from sources other than the activity may indicate that the activity is not engaged in for profit sec_1_183-2 income_tax regs a taxpayer with substantial income unrelated to the activity can more readily afford a hobby foster v commissioner tcmemo_2012_207 this is particularly true if the losses from the activity might generate substantial tax benefits golanty v commissioner t c pincite petitioners’ substantial investment_income has allowed them to continue the cutting horse operation despite consecutive years of substantial losses petitioners’ cutting horse activity also generated tax savings in the form of net losses that offset petitioners’ investment_income this factor weighs against finding a profit objective i elements of personal pleasure or recreation the presence of personal motives and recreational elements in carrying on an activity may indicate that the activity is not engaged in for profit sec_1 b income_tax regs mrs jary-mathis enjoys working with horses and derives substantial personal satisfaction from her cutting horse operation she enjoys watching the young horses and often brings them to her personal farm to watch them grow however running a large-scale breeding operation takes many hours of hard work and mrs jary-mathis has sacrificed family and personal time to promote her horses this factor weighs slightly against a profit_motive j conclusion after weighing all the facts and circumstances in light of the relevant factors we conclude that petitioners did not engage in their cutting horse activity with the requisite profit objective mrs jary-mathis is determined to be a successful horsewoman she wants to build a reputation as a producer of top-level cutting horses however she has pursued this goal independently of any desire to earn profits she has continued training and breeding cutting horses for years without ever approaching profitability yet she has never seriously considered discontinuing operations accordingly we sustain respondent’s determination that petitioners did not engage in the cutting horse activity for profit iii accuracy-related_penalties respondent determined that petitioners were liable for an accuracy-related_penalty pursuant to sec_6662 for each of the tax years at issue sec_6662 and b and imposes a penalty of on any underpayment attributable to among other things negligence or disregard of rules or regulations or any substantial_understatement_of_income_tax an understatement is substantial if it exceeds the greater of dollar_figure or of the income_tax required to be shown on the return for the taxable_year sec_6662 the commissioner bears the burden of production with respect to this penalty sec_7491 the commissioner satisfies the burden by presenting sufficient evidence supporting the relevant penalty 116_tc_438 respondent determined that petitioners underpaid their income_tax by dollar_figure dollar_figure and dollar_figure for the years and respectively these amounts exceed the substantial_understatement threshold for each year in question thus respondent has carried his burden of demonstrating that petitioners substantially understated their income_tax pursuant to sec_6664 the accuracy-related_penalty under sec_6662 does not apply to any portion of an underpayment for which a taxpayer establishes that he or she had reasonable_cause and acted in good_faith a taxpayer’s failure to comply with sec_183 does not preclude a reasonable_cause and good_faith defense see eg rodriguez v commissioner tcmemo_2013_ at whether a taxpayer has acted with reasonable_cause and in good_faith depends on the facts and circumstances of the case relevant factors include the taxpayer’s efforts to assess the proper tax_liability the taxpayer’s knowledge and experience and the extent to which the taxpayer relied on the advice of a tax professional sec_1_6664-4 income_tax regs petitioners hired a certified_public_accountant to prepare their returns because the return preparer had signed all of their returns since she knew the farm’s financial history petitioners submitted complete and accurate books_and_records to their accountant and relied on her to properly prepare their returns although we find that petitioners lacked a profit_motive we acknowledge that they operated the farm in a professional manner and took their activity seriously we are persuaded that petitioners had reasonable_cause and acted in good_faith accordingly we find they are not liable for accuracy-related_penalties to reflect the foregoing decisions will be entered for respondent as to the deficiencies and for petitioners as to the accuracy-related_penalties under sec_6662


internal_revenue_service number release date index number 468a ---------------------- ----------------------------- -------------------------------------------- ----------------------------------- ------------------------------- legend seller department of the treasury washington dc person to contact ---------------------------- id no ------------- ---------------------------------------------------- telephone number --------------------- refer reply to cc psi b06 - plr-103076-04 date july ---------------------------------------------------- ------------------------ seller ------------------------------------------------------------ buyer -------------------------------------------------------- ----------------------------------------------- ------------------------ plant closing date seller 1's parent seller 2's parent buyer's parent commission location state a b c d e f g h i j k ------------------------------------------ ----------------------- --------------------------------------- ----------------------------------- ---------------------------------- ----------------------------------------------------- -------------------------------------------------- -------------- --- --- ----- ------- ------------------------- ----------------- ------------------------------------ ---------------------- ----------- --------------- -------- plr-103076-04 dear --------------- this letter responds to a letter dated date requesting a private_letter_ruling concerning the tax consequences of the sale of plant and associated assets and liabilities including nuclear decommissioning liability between seller seller and buyer specifically you have requested rulings regarding the tax consequences under sec_468a of the internal_revenue_code to the sellers' nuclear decommissioning funds and buyer s nuclear decommissioning fund as well as rulings regarding the proper realization and recognition of gain and loss on the sale of plant and associated assets the sellers and buyer in a jointly-filed ruling_request have represented the following facts and information relating to the ruling_request seller a regulated_public_utility company is a wholly-owned subsidiary of seller s parent an exempt public_utility holding_company seller is a member of seller s parent s consolidated_group and joins in filing a consolidated_return on a calendar_year basis using the accrual_method of accounting seller and seller s parent are under the audit jurisdiction of the industry director natural_resources lm nr immediately prior to the closing date seller owns as a tenant-in-common a a percent undivided_interest in the plant seller a regulated_public_utility company is a wholly-owned subsidiary of seller s parent a public_utility holding_company seller is a member of seller s parent s consolidated_group and joins in filing a consolidated_return on a calendar_year basis using the accrual_method of accounting seller and seller s parent are under the audit jurisdiction of the industry director natural_resources lm nr immediately prior to the closing date seller owns as a tenant-in-common a b percent undivided_interest in the plant seller and seller have each established with respect to plant a nuclear decommissioning fund qualifying under ' 468a and a nuclear decommissioning fund that did not meet the requirements of ' 468a after the sale the sellers will no longer be engaged in the trade_or_business of nuclear generation at plant or any other nuclear facility buyer is an indirect subsidiary of buyer s parent a public_utility holding_company buyer is a member of buyer s parent s consolidated_group and will join in filing a consolidated_return on a calendar_year basis using the accrual_method of accounting buyer and buyer s parent are under the audit jurisdiction of the industry director natural_resources lm nr immediately following the closing date buyer will own a c percent undivided_interest in the plant following the transfer of the plant to buyer buyer s wholesale electric power sales will be subject_to the jurisdiction of commission plr-103076-04 and its ownership and operation of plant will be subject_to the jurisdiction of the nuclear regulatory commission plant is located in location in state and consists of a single unit and associated assets located together on a single property plant began commercial service in d on e buyer entered into an asset sale agreement asa with the sellers the asa obligates the sellers to transfer to buyer at closing of the transaction the sellers' entire respective interests in the plant including all assets necessary to operate the plant in addition the sellers agree to transfer all assets of the qualified nuclear decommissioning funds maintained by seller and seller with respect to the plant to a qualified nuclear decommissioning fund established by buyer solely for the purpose of decommissioning plant the agreement contemplates that buyer pay a cash purchase_price to the sellers and assume all decommissioning liabilities associated with the plant the sellers and the buyer represent that they will treat the transaction as an asset purchase for tax purposes subject_to sec_1060 of the code and will agree to an allocation of the purchase_price among the purchased assets excluding the assets comprising the qualified nuclear decommissioning funds that is consistent with the allocation methodology provided by sec_1060 and sec_338 and the regulations thereunder as part of the asa buyer has also agreed to enter into power purchase agreements with each of the sellers the aggregate amount transferred from the sellers' qualified nuclear decommissioning funds to the buyer's qualified nuclear decommissioning fund may not be less than f dollars on a net cash_value basis the estimated cost of decommissioning plant is g dollars pursuant to the asa buyer agrees to complete at its expense all decommissioning of the plant including final restoration of the site after termination of its use for power generation in a manner consistent with the decommissioning study dated h submitted as part of the request for this letter_ruling the minimum transferred amount f represents i percent of the current cost of decommissioning plant buyer estimates that it will need to provide an additional j dollars to commission plant prior to the sale the sellers each had a qualifying percentage under sec_1_468a-3 of k thus it is clear that the portion of the cost of decommissioning the plant funded by the minimum transferred amount reasonably relates to the qualifying percentages of the sellers prior to the sale each seller is the grantor of its respective nonqualified nuclear decommissioning fund each of the sellers’ nonqualified nuclear decommissioning funds is managed by an independent_trustee all distributions from the sellers’ nonqualified nuclear decommissioning funds are made by their respective trustees prior to the sale under the terms of each seller's nonqualified nuclear decommissioning fund trust agreement all income as well as principal of that seller's nonqualified nuclear decommissioning fund was held to satisfy that seller's legal_obligation to decommission plant and upon completion of the decommissioning any remaining assets would be distributed to their respective grantors however as part of the sale sellers’ nonqualified nuclear plr-103076-04 decommissioning fund trust agreements will be amended to permit the release of the sellers’ nonqualified nuclear decommissioning funds from their obligation to the future decommissioning of plant therefore the sellers’ nonqualified nuclear decommissioning funds will no longer be retained for the purpose of decommissioning plant the assets held by the sellers in their respective nonqualified nuclear decommissioning funds will be retained by the sellers and disposed of as required by the applicable regulatory entities requested rulings and neither of the sellers' qualified nuclear decommissioning funds will become disqualified on the closing date by reason of the transfer of the assets in the qualified nuclear decommissioning funds to buyer s qualified nuclear decommissioning fund buyer s qualified nuclear decommissioning fund established to hold the assets transferred from the sellers' qualified nuclear decommissioning funds will be treated as a qualified nuclear decommissioning fund satisfying the requirements of sec_468a of the code sec_468a of the code provides that a taxpayer may elect to deduct payments made to a nuclear decommissioning reserve fund the qualified_fund sec_468a limits the annual deduction of the electing taxpayer to the lesser_of the ruling_amount or the amount of decommissioning costs included in the electing taxpayer s cost of service for ratemaking purposes for the taxable_year sec_468a provides in pertinent part that the assets in a qualified_fund shall be used exclusively for satisfying the liability of any taxpayer contributing to the qualified_fund sec_1_468a-5 of the federal_income_tax regulations sets out the qualification requirements for nuclear decommissioning funds it provides in part that a qualified_fund must be established and maintained pursuant to an arrangement that qualifies as a_trust under state law an electing taxpayer can establish and maintain only one qualified_fund for each nuclear power plant sec_1_468a-5 provides that if at any time during the taxable_year a nuclear decommissioning fund does not satisfy the requirements of sec_1_468a-5 the service may disqualify all or a portion of the fund as of the date that the fund does not satisfy the requirements sec_1 468a- c provides that if a qualified_fund is disqualified the fair_market_value with certain adjustments of the assets in the fund is deemed to be distributed to the electing taxpayer and included in that taxpayer s gross_income for the taxable_year sec_1_468a-6 generally provides rules for the transfer of an interest in a nuclear power plant and transfer of the qualified_fund where after the transfer the transferee is an eligible_taxpayer under sec_1_468a-6 the service may treat any disposition of an interest in a nuclear power plant occurring after date as satisfying the requirements of the regulations if the service determines that such treatment is necessary or appropriate to carry out the purposes of sec_468a under the specific facts herein the service will exercise its discretion to treat this transaction under sec_1_468a-6 as a disposition qualifying under the general plr-103076-04 provisions of sec_1_468a-6 this exercise of discretion however applies to the provisions of sec_1_468a-6 except those outlined in sec_1_468a-6 with respect to the calculation of a schedule of ruling amounts subsequent to a sale thus under sec_1_468a-6 the sellers' qualified nuclear decommissioning funds will not be disqualified upon the transfer of the assets of those funds to buyer's qualified nuclear decommissioning fund and buyer's qualified nuclear decommissioning fund will be treated as a qualified nuclear decommissioning fund as defined in sec_468a requested rulings and the sellers' qualified nuclear decommissioning funds will not recognize gain_or_loss upon the transfer of their assets to buyer s qualified nuclear decommissioning fund upon the sale of the plant on the closing date the sellers will not recognize income attributable to the assets of the sellers' qualified nuclear decommissioning funds upon the transfer of the assets of the sellers' qualified nuclear decommissioning funds to buyer's qualified nuclear decommissioning fund on the closing date the transfer will not constitute a payment or contribution of assets by buyer to the buyer's qualified nuclear decommissioning fund sec_1_468a-6 provides that neither a transferor nor its fund will sec_1_468a-6 provides that for purposes of the regulations under recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets from a transferor s qualified_fund to a transferee s qualified_fund thus neither the sellers nor the qualified nuclear decommissioning funds maintained by the sellers for plant will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the qualified nuclear decommissioning funds assets to buyer's qualified nuclear decommissioning fund sec_468a the transfer of a transferor's qualified nuclear decommissioning fund will not constitute a payment or a contribution of assets by a transferee to its qualified nuclear decommissioning fund consequently the transfer of the assets of the sellers' qualified nuclear decommissioning funds to buyer's qualified nuclear decommissioning fund will not constitute a payment or contribution of assets by buyer to buyer's qualified nuclear decommissioning fund requested ruling neither buyer nor buyer's qualified nuclear decommissioning fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets of the sellers' qualified nuclear decommissioning funds to buyer s qualified nuclear decommissioning fund after the closing date buyer's qualified nuclear decommissioning fund will retain the same basis in the assets received as those assets had in the sellers' qualified nuclear decommissioning funds prior to the closing date sec_1_468a-6 provides that neither a transferee nor its fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets from a transferor s qualified_fund to a transferee s qualified_fund thus neither buyer nor buyer's qualified nuclear decommissioning fund sec_1_468a-6 provides that transfers of assets of a qualified nuclear plr-103076-04 will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets of the sellers' qualified nuclear decommissioning funds to buyer's qualified nuclear decommissioning fund decommissioning fund to which sec_1_468a-6 applies do not affect basis thus buyer's qualified nuclear decommissioning fund will have a basis in the assets received from the sellers' qualified nuclear decommissioning funds that is the same as the basis of those assets in the sellers' funds immediately before the date of transfer requested ruling buyer will not recognize any gain or otherwise take any income into account by reason of the purchase of the plant and its associated assets sec_1060 provides that in the case of an applicable_asset_acquisition the consideration received for such assets shall be allocated among the acquired assets in the same manner as amounts are allocated to assets under sec_338 sec_1_1060-1 provides that in the case of an applicable_asset_acquisition sellers and purchasers must allocate the consideration under the residual_method as described in sec_1_338-6 and sec_1_338-7 in order to determine respectively the amount_realized from and the basis in each of the transferred assets sec_1060 defines the term applicable_asset_acquisition as the transfer of assets constituting a trade_or_business if the acquirer's basis is determined wholly by reference to the consideration paid for such assets sec_1_1060-1 defines a seller's consideration as the amount in the aggregate realized from selling the assets in the applicable_asset_acquisition under sec_1001 sec_1060 provides no independent basis for determining the amount a taxpayer realizes on the sale of assets or the time such amount may be taken into account the amount_realized and the time such amount is taken into account are determined solely under generally applicable tax_accounting principles see sec_1001 and sec_461 sec_1_1060-1 defines a purchaser's consideration as the amount in the aggregate of its cost of purchasing the assets in the applicable_asset_acquisition that is properly taken into account in basis sec_1060 provides no independent basis for determining a taxpayer's cost of acquired assets cost is determined solely under generally applicable rules of tax_accounting the residual_method is based on a division of assets into seven classes class i generally consisting of cash and general deposit accounts held in banks savings and loan associations and other depository institutions class ii generally consisting of actively_traded personal_property such as u s government securities and publicly traded stock but also including certificates of deposit and foreign_currency even if they are not actively_traded personal_property class iii accounts_receivable mortgages and credit card receivables from customers which arise in the ordinary course of business class iv stock_in_trade of the taxpayer or other_property of a kind which plr-103076-04 would properly be included in the inventory of taxpayer if on hand at the close of the taxable_year or property held by the taxpayer primarily_for_sale_to_customers in the ordinary course of its trade_or_business class v all assets other than class i ii iii iv vi and vii assets class vi all sec_197 intangibles as defined in sec_197 except goodwill and going_concern_value and class vii goodwill and going_concern_value whether or not they qualify as sec_197 intangibles consideration is first reduced by the amount of class_i_assets transferred by the seller the remaining consideration is then allocated among the class_ii_assets pro_rata to the extent of their fair_market_value then among the class_iii_assets pro_rata to the extent of their fair_market_value then among the class_iv_assets pro_rata to the extent of their fair_market_value then among the class_v_assets pro_rata to the extent of their fair_market_value then among the class_vi_assets pro_rata to the extent of their fair_market_value and finally any remaining consideration is allocated among the class_vii_assets pro_rata according to their fair_market_value see sec_1 c b and b if under general tax principles there is a subsequent adjustment to the consideration eg if it is later determined that the actual amount of the liability assumed differs from the value that the parties assigned to such liability on the date of the applicable_asset_acquisition that amount is allocated in a manner that produces the same allocation that would have been made at the time of the acquisition had such amount been paid_or_incurred on the acquisition_date see sec_1_1060-1 sec_1_1060-1 and sec_1_338-7 the plant together with its related equipment and operating_assets constitutes a trade_or_business in its sellers’ hands and the gain_or_loss recognized by each seller with respect to those assets will be determined wholly by reference to each seller's amount_realized thus sellers’ transfer of the plant its equipment and operating_assets to buyer in exchange for cash and the assumption of certain liabilities and obligations including the decommissioning liability except to the extent funded by the qualified_fund is an applicable_asset_acquisition as defined in sec_1060 and the regulations thereunder as such the federal tax treatment of the plant's acquisition is determined under sec_1060 and the regulations thereunder the following example illustrates the operation of sec_1060 for a seller on date an applicable_asset_acquisition is made the assets sold consist of class_i_assets in the amount of dollar_figure class_ii_assets with a fair_market_value of dollar_figure and a basis in the hands of the seller of dollar_figure class_iii_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_iv_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_v_assets half of which are sec_1231 assets with a fair_market_value of dollar_figure and a basis of dollar_figure and the other half of which are not sec_1231 assets with a fair_market_value of dollar_figure and a basis of dollar_figure and class_vi_assets which are sec_1231 assets with a fair_market_value of dollar_figure and a basis of dollar_figure the consideration consists of dollar_figure cash and an assumed liability of dollar_figure that under applicable tax_accounting plr-103076-04 principles is taken into account at the time of the applicable_asset_acquisition the dollar_figure consideration first will be reduced by dollar_figure the amount of class_i_assets the remaining consideration will be allocated as follows dollar_figure to class_ii_assets pro_rata according to fair_market_value resulting in a dollar_figure gain dollar_figure to the class_iii_assets pro_rata according to fair_market_value resulting in no gain_or_loss dollar_figure to the class_iv_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain dollar_figure to the class_v_assets pro_rata according to the fair_market_value resulting in a dollar_figure loss on the sec_1231 assets and a dollar_figure loss on the non- sec_1231 assets dollar_figure to the class_vi_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain and the remaining dollar_figure to the class_vii_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain therefore each seller's gain_or_loss on each of the purchased assets excluding the assets of sellers’ qualified funds will be the difference between each seller's basis in the asset and the amount_realized with respect to that asset taking into account the allocation of consideration pursuant to sec_1060 and the regulations thereunder in general a taxpayer does not realize income upon its purchase of a business' assets even where those assets include cash or marketable_securities and in connection with the purchase the taxpayer assumes liabilities of the seller see 194_f2d_190 2d cir revrul_55_675 1955_2_cb_567 in this case buyer cannot acquire an interest in the plant without assuming the decommissioning liabilities which are inextricably associated with the ownership and operation of the plant there is no indication that the transaction is other than a bona_fide purchase of the business and its associated assets and liabilities the exception to the general_rule set forth in revrul_71_450 1971_2_cb_78 does not apply in revrul_71_450 unlike the present situation the purchaser agreed to assume a prepaid subscription liability in return for a separate cash payment and the liability was not reflected in the sales_price of the business with respect to the acquisition of the plant equipment and operating_assets buyer will not recognize income except to the extent the class_i_assets as defined in sec_1_338-6 it receives exceed its total cost determined under sec_1012 which will be the sum of its cash consideration if any and the fair_market_value of any other consideration buyer provides to the sellers that is taken into account under applicable tax principles on the date of the applicable_asset_acquisition if buyer is thus required to take an amount into account as income and is subsequently permitted under general principles of tax law to take additional consideration into account eg when buyer satisfies the economic_performance requirement with respect to the decommissioning liability assumed buyer will be entitled to deduct and will not be required to capitalize such amount 344_us_6 accordingly buyer will not realize income from its acquisition of the plant except to the extent that under the rules of sec_1060 the amount of cash and other class i plr-103076-04 assets received by buyer exceeds the amount of consideration provided by buyer and taken into account in the year of the acquisition therefore we conclude that in the taxable_year of closing buyer will not recognize any gain or otherwise currently take any income into account by reason of the transfer of the sellers’ plant assets to buyer provided the class_i_assets buyer receives do not exceed its total cost for the plant requested ruling the buyer will have a tax basis in the assets purchased excluding the buyer's qualified nuclear decommissioning funds equal to the sum of the purchase_price and the assumed_liabilities that will be taken into account as liabilities for federal_income_tax purposes as of the closing date sec_1012 of the code provides in part that the basis_of_property shall be the cost of such property in cases similar to the instant case taxpayers have argued that the cost of acquiring the seller's interests in a nuclear power plant and the related assets including the decommissioning funds includes the amount of the assumed decommissioning liability in those similar cases taxpayers have cited 331_us_1 and 194_f2d_190 as support for the proposition that for purposes of determining basis the cost of property generally includes assumed_liabilities to which the acquired property is subject_to the extent such liabilities can be accurately valued and are not contingent at the time of purchase since buyer will pay cash and assume the liabilities and obligations of the sellers which includes the decommissioning liabilities in connection with the acquisition of the plant its total cost of the purchased assets excluding the qualified nuclear decommissioning funds will equal the cash paid plus the assumed_liabilities and obligations for any federal_income_tax purpose -- including basis -- until economic_performance occurs with respect to that liability sec_1_446-1 thus critical to determining whether buyer is entitled to treat the future decommissioning liability as a component of its cost_basis in the purchased assets at the time of the closing is deciding whether the liability will be incurred for tax purposes as of the closing it will not economic_performance does not occur with respect to a service liability such as the decommissioning obligation until and to the extent that costs are incurred in satisfaction of that liability sec_1_461-4 because buyer will not have performed any services relating to the decommissioning liability at the time of the purchase of the plant economic_performance will not have occurred and the liability will not have been incurred at that time for any purpose under the code including the cost_basis provisions of sec_1012 purchased excluding buyer’s qualified nuclear decommissioning funds equal to the sum of the purchase_price and the assumed_liabilities that will be taken into account as liabilities for federal_income_tax purposes the purchased assets and the liabilities incurred do not include the assets in the qualified nuclear decommissioning funds or the however the assumed decommissioning liability cannot be treated as incurred accordingly at the time of closing buyer will have a tax basis in the assets plr-103076-04 liability attributable to the qualified nuclear decommissioning funds because the tax effect of the qualified nuclear decommissioning funds is determined under sec_468a buyer will not be entitled to treat as a component of its cost_basis at the time of the closing any amount attributable to the future decommissioning liability because the transfer of the plant is an applicable_asset_acquisition as defined under sec_1060 of the code on the acquisition_date buyer's basis in the assets acquired must be determined by allocating its costs ie the consideration provided by buyer on the acquisition_date which includes cash but not the assumption of the decommissioning liability among the acquired assets in accordance with the provisions of sec_1060 and the regulations thereunder the following example illustrates the operation of sec_1060 for a purchaser on date an applicable acquisition is made the assets acquired consist of class_i_assets in the amount of dollar_figure class_ii_assets with a fair_market_value of dollar_figure class_iii_assets with a fair_market_value of dollar_figure class iv asserts with a fair_market_value of dollar_figure and class_v_assets with a fair_market_value of dollar_figure there are no class vi or vii assets the consideration paid consists of dollar_figure cash and an assumed liability for which economic_performance has not occurred on date the purchaser has provided dollar_figure of consideration that may be allocated as basis first it will be reduced by dollar_figure the amount of class_i_assets the remaining dollar_figure will be allocated to class_ii_assets pro_rata according to fair_market_value nothing is allocated to class iii or below on date economic_performance occurs with respect to the liability to the extent of dollar_figure at that time the purchaser has an additional dollar_figure of basis that may be taken into account of that amount dollar_figure is allocated to class_ii_assets which will then have been allocated their full dollar_figure fair market value--as determined on the acquisition_date and the remaining dollar_figure is allocated to the class_iii_assets pro_rata according to fair market value--as determined on the acquisition_date on date economic_performance occurs to the extent of an additional dollar_figure which is then taken into account as basis of that amount dollar_figure will be allocated to the class_iii_assets which will then have been allocated their full dollar_figure fair market value--as determined on the acquisition_date dollar_figure will be allocated to the class_iv_assets which will then have been allocated their full dollar_figure fair market value--as determined on the acquisition_date dollar_figure will be allocated to the class_v_assets which will then have been allocated their full dollar_figure fair_market_value as determined on the acquisition_date and the remaining dollar_figure will be allocated to the class_vii_assets as goodwill the last amount is allocated to goodwill even though goodwill was not identified as a separate asset having value on date if on date instead of an addition to purchaser's consideration there is a dollar_figure decrease in consideration the consideration previously allocated to the class_iii_assets would be reduced to zero and the consideration previously allocated to the class_ii_assets would be reduced by the remaining dollar_figure pro_rata according to fair_market_value accordingly with respect to the plant buyer will first reduce the consideration paid_by the amount of the class_i_assets it receives in the transaction to the extent the class_i_assets received exceed the consideration buyer provides buyer will recognize therefore we conclude that buyer's total consideration will be allocated among plr-103076-04 income to the extent buyer's consideration paid exceeds the class_i_assets it receives such excess will be allocated to the class_ii_assets pro_rata according to the fair_market_value of those assets up to their total fair_market_value any excess remaining after allocation to class_ii_assets will be allocated to class iii iv v vi and vii assets in accordance with sec_1_1060-1 and sec_1_338-6 when and to the extent additional_amounts are paid_or_incurred for the assets acquired in the applicable_asset_acquisition such amounts will be taken into account as increases to buyer's consideration paid and allocated in the same manner and subject_to the same conditions as though they were paid_or_incurred on the acquisition_date see sec_1_1060-1 sec_1_1060-1 sec_1_338-6 and sec_1_338-7 the purchased assets of the plant excluding the qualified funds for purposes of determining buyer's tax basis in any specific asset included in the purchased assets determined immediately after the closing and excluding the qualified funds pursuant to the residual_method as required by sec_1060 and the regulations thereunder requested ruling the sellers' nonqualified nuclear decommissioning funds to the extent not dissolved at closing will be treated as grantor trusts under sec_671 through of the code and each respective seller will be treated as the grantor of such seller's nonqualified nuclear decommissioning fund and the buyer will not be in constructive receipt of the sellers' nonqualified nuclear decommissioning funds through that the grantor or another person shall be treated as the owner of any portion of a_trust there shall be included in computing the taxable_income and credits of that person those items of income deduction and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account in computing taxable_income or credits against the tax of an individual of part i of subchapter_j chapter of the code a grantor includes any person to the extent such person either creates a_trust or directly or indirectly makes a gratuitous transfer within the meaning of sec_1_671-2 of property to a_trust for purposes of sec_1_671-2 the term property includes cash sec_677 provides that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such under sec_674 whose income without the approval or consent of any adverse_party is or in the discretion of the grantor or a nonadverse_party or both may be distributed to the grantor or held or accumulated for future distribution to the grantor sec_1_677_a_-1 provides that under sec_677 a grantor is in general treated as the owner of a portion of a_trust whose income is or in the discretion of the sec_1_671-2 of the income_tax regulations provides that for purposes sec_671 of the code provides that where it is specified in sec_673 plr-103076-04 grantor or a nonadverse_party or both may be applied in discharge of a legal_obligation of the grantor accordingly each of the sellers is treated as the grantor and owner of its respective nonqualified nuclear decommissioning fund under sec_671and of the code and under sec_1_677_a_-1 each seller shall include in computing its taxable_income and credits all items of income deduction and credits against tax of that seller’s nonqualified nuclear decommissioning fund to the extent that such items would be taken into account in computing taxable_income or credits against the tax of that seller except as specifically determined above no opinion is expressed or implied concerning the federal_income_tax consequences of the transaction described above this ruling is directed only to the taxpayers who requested it sec_6110 of the code provides it may not be used or cited as precedent in accordance with the powers of attorney we are sending copies of this ruling to authorized representatives of buyer and the sellers we are also sending a copy of this letter_ruling to the industry director natural_resources lm nr sincerely peter c friedman senior technician reviewer office of associate chief_counsel passthroughs special industries cc


internal_revenue_service number release date index no department of the treasury p o box ben franklin station washington dc person to contact telephone number refer reply to cc psi -- plr-128790-02 date date legend taxpayer generator power marketer corp corp state a state b state c state d city project b c plr-128790-02 f g h i j k m n o p t u v x y z aa bb dd ee ff dear this letter responds to your letter dated date and subsequent correspondence submitted on behalf of taxpayer requesting a letter_ruling concerning whether the transfer of an intertie from generator to taxpayer is a nonshareholder contribution_to_capital excludable from income under sec_118 of the internal_revenue_code plr-128790-02 facts taxpayer represents that the facts are as follows generator is a state d limited_liability_company that was formed in aa to develop build and own the project generator is an indirect-wholly owned subsidiary of corp for federal_income_tax purposes generator is treated as a disregarded_entity and is considered a division of corp a first-tier subsidiary of corp corp is a state d corporation that was formed in ff to develop build and own power plants that sell their output to the wholesale market corp files a consolidated federal_income_tax return for all companies in the affiliated_group of which corp is the common parent the project is a b megawatt natural-gas fired combined-cycle power plant that is currently under construction approximately c miles from city construction of the project started in bb and the interconnection facilities are expected to be completed in t taxpayer is a state a public_utility that generates purchases transmits distributes and sells electricity and natural_gas services within state a generator signed two contracts with taxpayer in dd governing the interconnection of the project to the grid one of the contracts the interconnection agreement is the legal document that permits generator to connect to the grid the other agreement the interconnection facilities agreement provide the terms under which taxpayer will be responsible for constructing and maintaining most of an intertie and generator will reimburse it for the cost interconnection will involve construction of a new switchyard the running of radial lines both from the project into the new switchyard and from the yard into an existing loop to link into two existing substations relocating transformer leads at one of the substations and installing circuit breakers busses and disconnect switches and making relevant changes in control panels and other equipment the interconnection agreement will remain in effect until one party gives f days’ written notice that it wants to terminate the agreement generator can give such notice for any reason taxpayer can only terminate the interconnection agreement if the interconnection facilities agreement has terminated or if the project has permanently ceased operating either party can terminate the agreement if the other has defaulted upon its obligations or if the part of the intertie owned by taxpayer is seized by a government agency using powers of eminent_domain the interconnection agreement requires taxpayer to accommodate up to g megawatts of electricity from generator on the grid during the summer and h megawatts in the winter generator is required to operate its power plant in a manner that maintains the integrity of the grid generator has the right to buy backup electricity for station use from taxpayer but it is not required to do so the agreement acknowledges that generator may buy its backup power from another source plr-128790-02 the interconnection facilities agreement has the same unrestricted term as the interconnection agreement and may be terminated by giving f days’ written notice in the same situations plus two others taxpayer can terminate if generator falls behind on project milestones also either party can terminate if taxpayer gives notice that an uncontrollable force will prevent it from completing the intertie by the x target date for completion and the uncontrollable force continues unremedied for at least j months the interconnection facilities agreement commits taxpayer to design and construct the portion of the intertie that it will own taxpayer has submitted an exhibit showing the boundary where taxpayer starts to own the intertie generator must reimburse it for the cost of the interconnection facilities generator had paid taxpayer a total of dollar_figurek through z payments began in y additional payments are expected to be made into v the agreement requires generator to pay taxpayer another dollar_figurem as a bonus if the utility completes construction of the intertie within n months of when generator gives a notice to proceed with the initial design work generator must pay an additional bonus of dollar_figureo for each f days that construction is completed in advance of n months the cost reimbursement apart from early completion bonuses are referred to as the interconnection payments taxpayer will be responsible for maintaining its portion of the intertie generator must pay an ongoing monthly maintenance charge which is p times basically the installed cost of the portion of the intertie that taxpayer will own pursuant to the agreement generator obtained an order from the federal energy regulatory commission under sec_211 of the federal power act essentially ordering taxpayer to wheel electricity from the plant generator will enter into a contract with power marketer under which power marketer may act as a broker for the project in placing some of the electricity with third parties and buy and resell the remaining electricity for its own account on ee the parties signed a term contract for the sale of i megawatts of capacity from generator to a third party the arrangement is a tolling agreement the term contact provides that it is a binding agreement that will be superceded by a tolling agreement if and when it is executed by both parties the delivery point for sales of electricity by generator to power marketer or other purchasers will be at the disconnect switches the busbar for the power plant is at the disconnect switches the disconnect switches along this portion of the intertie are owned and controlled by generator and give generator the ability to cut off the power supply to prevent damage to the grid or the power plant when the generators are not operating taxpayer represents that generator will treat the interconnection payments as basis in an intangible asset and recover its basis using the straight-line method over years taxpayer also represents that the intertie is equipped to carry backup power to generator however the parties expect that the amount of power flowing back over the intertie to generator will be less than percent of the projected power flows in both directions over the intertie during taxpayer’s first tax years after the intertie is placed_in_service taxpayer will not put the intertie into its rate base plr-128790-02 law and analysis sec_61 and sec_1_61-1 of the income_tax regulations provide that gross_income means all income from whatever source derived unless excluded by law sec_118 provides that in the case of a corporation gross_income does not include any contribution_to_the_capital_of_the_taxpayer sec_118 as amended by a of the tax_reform_act_of_1986 the act and a of the small_business job protection act of provides that for purposes of subsection a except as provided in subsection c the term contribution to the capital of taxpayer does not include any ciac or any other contribution as a customer or potential customer sec_1_118-1 of the income_tax regulations provides in part that sec_118 also applies to contributions to capital made by persons other than shareholders for example the exclusion applies to the value of land or other_property contributed to a corporation by a governmental_unit or by a civic group for the purpose of enabling the corporation to expand its operating facilities however the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered or to subsidies paid to induce the taxpayer to limit production the legislative_history to sec_118 indicates that the exclusion_from_gross_income for nonshareholder contributions to capital of a corporation was intended to apply to those contributions that are neither gifts because the contributor expects to derive indirect benefits nor payments for future services because the anticipated future_benefits are too intangible the legislative_history also indicates that the provision was intended to codify the existing law that had developed through administrative and court decisions on the subject h_r rep no 83rd cong 2d sess s rep no 83d cong 2d sess notice_88_129 1988_2_cb_541 as modified and amended by notice_90_60 1990_2_cb_345 and notice_2001_82 2001_52_irb_619 provides specific guidance with respect to the treatment of transfers of property to regulated public_utilities by qualifying small power producers and qualifying cogenerators collectively qualifying facilities as defined in sec_3 of the federal power act as amended by section of purpa the amendment of sec_118 by the act was intended to require utilities to include in income the value of any ciacs made to encourage the provision of services by a utility to a customer see h_r rep no 99th cong 2d sess in a ciac transaction the purpose of the contribution of property to the utility is to facilitate the sale of power by the utility to a customer in contrast the purpose of the contribution by a qualifying_facility to a utility is to permit the sale of power by the qualifying_facility to the utility accordingly the fact that the amendments to plr-128790-02 sec_118 render ciac transactions taxable to the utility does not require a similar conclusion with respect to transfers from qualifying facilities to utilities notice_88_129 provides in part that with respect to transfers made by a qualifying_facility to a utility exclusively in connection with the sale of electricity by the qualifying_facility to the utility a utility will not realize income upon transfer of interconnection equipment intertie by a qualifying_facility the possibility that an intertie may be used to transmit power to a utility that will in turn transmit the power across its transmission network for sale by the qualifying_facility to another utility wheeling will not cause the contribution to be treated as a ciac further the notice provides in part that a transfer from a qualifying_facility to a utility will not be treated as a qualifying_facility transfer qf transfer under this notice to the extent the intertie is included in the utility’s rate base moreover a transfer of an intertie to a utility will not be treated as a qf transfer under this notice if the term of the power purchase contract is less than ten years the notice also provides in part that a utility that constructs an intertie in exchange for a cash payment from a qualifying_facility pursuant to a purpa contract will be deemed to construct the property under contract and will recognize income from the construction in the same manner as any other taxpayer constructing similar_property under contract subsequent to the construction of the property the qualifying_facility will be deemed to transfer the property to the utility in a qf transfer that will be treated in exactly the same manner as an in-kind qf transfer notice_2001_82 amplifies and modifies notice_88_129 notice_2001_82 extends the safe_harbor provisions of notice_88_129 to include transfers of interties from non- qualifying facilities and transfers of interties used exclusively or in part to transmit power over the utility’s transmission grid for sale to consumers or intermediaries wheeling the notice requires that ownership of the electricity wheeled passes to the purchaser prior to its transmission on the utility’s transmission grid this ownership requirement is deemed satisfied if title passes at the busbar on the generator’s end of the intertie further notice_2001_82 provides that a long-term interconnection agreement in lieu of a long-term power purchase contract may be used to satisfy the safe_harbor provisions of notice_88_129 in wheeling transactions finally notice_2001_82 requires that the generator must capitalize the cost of the property transferred as an intangible asset and recovered using the straight-line method over a useful_life of years in the instant case the transfer of the intertie is subject_to the guidance set forth in notice_88_129 notice_90_60 and notice_2001_82 for the following reasons the project is a stand-alone generator as contemplated under notice_2001_82 generator and taxpayer have entered into a long-term interconnection agreement the intertie will be used in connection with the transmission of electricity for sale to third parties the cost of the intertie will not be included in taxpayer’s rate base plr-128790-02 the amount of power flowing back over the intertie to generator will be less than percent of the projected power flows in both directions over the intertie during taxpayer’s first tax years after the intertie is placed_in_service ownership of the electricity wheeled will not be with generator prior to its transmission on the grid and the cost of the intertie will be capitalized by generator as an intangible asset and recovered using the straight-line method over a useful_life of years thus we conclude that the transfer of the intertie by generator to taxpayer meets the safe_harbor requirements of notice_88_129 as amended and modified by notice_90_60 and notice_2001_82 next we must decide whether the contribution qualifies as a contribution_to_capital under sec_118 the legislative_history of sec_118 provides in part as follows this sec_118 in effect places in the code the court decisions on the subject it deals with cases where a contribution is made to a corporation by a governmental_unit chamber of commerce or other association of individuals having no proprietary interest in the corporation in many such cases because the contributor expects to derive indirect benefits the contribution cannot be called a gift yet the anticipated future_benefits may also be so intangible as to not warrant treating the treating the contribution as a payment for future services s rep no 83d cong 2d sess in 319_us_98 the court held that payments by prospective customers to an electric utility company to cover the cost of extending the utility’s facilities to their homes were part of the price of service rather than contributions to capital the concerned customers’ payments to a utility company for the estimated cost of constructing service facilities primary power lines that the utility company otherwise was not obligated to provide the customers intended no contribution to the company’s capital later in 339_us_583 1950_1_cb_38 the court held that money and property contributions by community groups to induce a shoe company to locate or expand its factory operations in the contributing communities were nonshareholder contributions to capital the court reasoned that when the motivation of the contributors is to benefit the community at large and the contributors do not anticipate any direct benefit from their contributions the contributions are nonshareholder contributions to capital id pincite finally in 412_us_401 the court in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government held that the governmental subsidies were not contributions to the taxpayer’s capital plr-128790-02 the court recognized that the holding in detroit edison co had been qualified by its decision in brown shoe co the court in chicago burlington quincy railroad co found that the distinguishing characteristic between those two cases was the differing purpose motivating the respective transfers in brown shoe co the only expectation of the contributors was that such contributions might prove advantageous to the community at large thus in brown shoe co since the transfers were made with the purpose not of receiving direct services or recompense but only of obtaining advantage for the general community the result was a contribution_to_capital the court in chicago burlington quincy railroad co also stated that there were other characteristics of a nonshareholder contribution_to_capital implicit in detroit edison co and brown shoe co from these two cases the court distilled some of the characteristics of a nonshareholder contribution_to_capital under both the and codes first the payment must become a permanent part of the transferee’s working_capital structure second it may not be compensation such as a direct payment for a specific quantifiable service provided for the transferor by the transferee third it must be bargained for fourth the asset transferred foreseeably must benefit the transferee in an amount commensurate with its value fifth the asset ordinarily if not always will be employed in or contribute to the production of additional income and its value assured in that respect based on the facts presented we conclude that the transfer of the intertie by generator to taxpayer possesses the characteristics of a nonshareholder contribution_to_capital as described in chicago burlington quincy railroad co therefore the transfer of the intertie by generator to taxpayer will be a contribution_to_capital under sec_118 accordingly based solely on the foregoing analysis and the representations made by taxpayer and generator we rule that the transfer of the intertie by generator to taxpayer will not constitute a ciac under sec_118 and will be excludable from the gross_income of taxpayer as a nonshareholder contribution_to_capital under sec_118 except as specifically set forth above no opinion is expressed or implied concerning the federal_income_tax consequences of the above described facts under any other provision of the code or regulations specifically no opinion is expressed or implied on whether the agreement between generator and power marketer is a sales contract or a service agreement we are also not ruling as to whether your representation that less than percent of the total projected power flows over the duel- use intertie from taxpayer to generator is a reasonable projection for purposes of the percent test in notice_88_129 plr-128790-02 this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent sincerely walter h woo senior technician reviewer branch office of associate chief_counsel passthroughs and special industries enclosure copy