internal_revenue_service number release date index number ------------------------ ------------------------------------------------------ ------------------------------------ ------------------------------ --------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------------- id no ---------------- ----------------- telephone number ---------------------- refer reply to cc corp b01 plr-141865-13 date date legend distributing ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ------------------------------------- distributing ----------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ----------------------------------------------------- sub -------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ----------------------------------------------------- sub ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------- sub ------------------------------- ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- sub ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ---------------------------------------- sub ------------------------ ----------------------------------------------------------------------------------------- plr-141865-13 --------------------------------------------------------------------------------------- sub ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------- sub --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ---------------------------------------- sub -------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------- sub ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ------------------------- spinco ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- -------------------------------------- splitco --------------------------------------------------------------------------------------------------------------------- -------------------------------------- ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ----------------- llc ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ------------------------------------- llc ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------- llc ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ----------------------------------- llc ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- ------------------------------------ llc ------------------------- plr-141865-13 ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- partnership --------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------- entity state a state b state c state d a b c d e f g h i j k l business a business b ------------------------------------ -------------- -------------- ------- ----------- ------------------------ ---------------------- -------------------------- -------------------------- -------------------------- ---------------------- ------------------------ ------------- ------ ---- ---- ---------- ------------------------------------------------------ ------------- -------------------------------- plr-141865-13 business c -------------------------------------------------------------------------------------------------------------- ------------------------------------------------------ business c1 facility a facility b facility c date ------------------------------------------------------ ------------------------------------------------------ ------------- ------------------------------------------------------ ----------- ------------------------------------------------------ -------------------- ------------------------------------------------------ --------------------------------------- ------------------------ dear ------------------ this letter responds to your authorized representatives’ letter dated date requesting rulings on certain federal_income_tax consequences of a proposed transaction the proposed transaction the information provided in that request and in subsequent correspondence is summarized below this letter supersedes the letter dated date the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this office expresses no opinion as to the overall tax consequences of the transaction described in this letter including qualification under sec_332 and sec_355 or as to any issue or step not specifically addressed by this letter rather the rulings contained in this letter only address one or more discrete legal issues involved in the transaction further except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter summary of facts plr-141865-13 distributing is a state a corporation and is the common parent of a consolidated_group the distributing group distributing 2’s stock is publicly traded and widely held the distributing group is engaged in several lines of business relevant to this request are business a business b and business c distributing owns all of the common_stock of distributing and sub both state b corporations distributing has non-voting preferred_stock outstanding that is owned by unrelated parties distributing owns all of the common_stock of sub and spinco both state b corporations sub owns all of the common_stock of sub a state b corporation spinco owns all of the stock of sub and splitco each a state b corporation and sub a state c_corporation sub owns a of the stock of sub a state b limited_liability_company treated as a corporation the remaining b of the stock of sub is owned by distributing distributing owns c sub owns d and sub owns e of sub a state d corporation splitco owns all of the stock of sub an entity and sub a state b corporation splitco and its subsidiaries have a net intercompany payable to distributing and its subsidiaries the splitco intercompany payable sub owns all of the interests in llc a state b limited_liability_company treated as a disregarded_entity sub owns directly or indirectly all of the interests in llc llc llc and llc each a state b limited_liability_company treated as a disregarded_entity llc owns f of the interests in partnership llc owns g of the interests in partnership and an unrelated third-party owns the remaining interests in partnership partnership owns facility a llc owns facility b and llc owns facility c distributing is directly and indirectly engaged in business a business b business c and other lines of business sub sub sub and sub are engaged in business a splitco sub and sub are engaged in business b spinco historically has held directly and indirectly assets relating to business a business b and business c partnership llc and llc are engaged in business c1 which is a part of business c through their respective ownership of facility a facility b and facility c distributing has an excess_loss_account within the meaning of sec_1 a an ela in its distributing stock the distributing ela at the time the ruling_request was submitted distributing estimates that its ela in the distributing stock was approximately dollar_figureh distributing did not have an ela in its spinco stock and spinco did not have an ela in its splitco stock distributing anticipates that i there will be no ela in the stock of either spinco or splitco immediately before the internal distribution described in step viii below and ii with the application of the rulings provided in this letter there will be no ela in the stock of splitco following the spinco liquidation described in step ix below and immediately before the external distribution described in step x below prior to the proposed transaction distributing consolidated most of distributing 1’s assets and liabilities that comprise business b under a holding_company splitco via a plr-141865-13 combination of contributions and sales collectively the prior restructuring transactions the prior restructuring transactions were completed on or prior to date following the business c1 acquisition described in step v below and prior to the spinco liquidation spinco and members of its separate_affiliated_group as defined in sec_355 the spinco sag will directly engage in business c1 after the spinco liquidation distributing and members of its separate_affiliated_group as defined in sec_355 the distributing sag will directly engage in business c1 employees of distributing and sub will have conducted operational and management activities with respect to business c1 of partnership llc and llc throughout the five-year period ending on the date of the internal distribution employees of the spinco sag will conduct operational and management activities with respect to business c1 of partnership llc and llc following the internal distribution and prior to the spinco liquidation employees of the distributing sag will conduct operational and management activities with respect to business c1 of partnership llc and llc following the spinco liquidation financial information has been submitted that business c1 has had gross_receipts and operating_expenses indicating the active_conduct_of_a_trade_or_business for each of the past five years proposed transaction distributing is entering into the proposed transaction in part to split off business b to its public shareholders the relevant steps of the proposed transaction are described below i distributing spinco and certain of their affiliates will sell certain assets related to business b to splitco the business b transfers ii the splitco intercompany payable will be refinanced into a term_loan owed by splitco to distributing the splitco note splitco is also expected to assume intercompany debt owed by distributing the assumed debt iii splitco will enter into a term_loan facility with distributing term_loan facility and a term_loan facility with third-party lenders term_loan facility iv splitco will effect an initial_public_offering of no more than i of the splitco stock the splitco ipo concurrent with the closing of the splitco ipo splitco expects to borrow the full amount under term_loan facility such borrowings the distributing instrument and the full amount available under term_loan facility splitco anticipates that it will use the net_proceeds of the splitco ipo together with the borrowings under term_loan facility and term_loan facility in part to repay all of splitco’s related_party debt owed to plr-141865-13 distributing and its affiliates including the splitco note and the assumed debt if any v spinco will acquire business c1 the business c1 acquisition as follows sub will distribute its interests in llc llc llc and llc to sub in redemption of a portion of sub 6’s sub stock sub will in turn distribute its interests in llc llc llc and llc to sub in redemption of a portion of sub 4’s sub stock sub will in turn distribute its interests in llc llc llc and llc to spinco spinco will purchase the f interest in partnership held by llc and spinco will hire as its employees certain distributing employees who hold management positions and an operational position with respect to business c vi spinco will contribute all of the stock of sub to sub the sub contribution vii spinco will distribute to distributing all of the stock of sub and certain intercompany receivables viii distributing will distribute all of the stock of spinco to distributing the internal distribution ix spinco will convert under state law to a limited_liability_company which will be treated as a disregarded_entity and as such a branch or division of distributing the spinco liquidation x pursuant to one or more offers to exchange all of its shares of splitco for shares of distributing held by its shareholders distributing will exchange splitco shares for distributing shares an exchange_offer the one or more exchange_offer s collectively the split-off if the split-off is undersubscribed any remaining shares of splitco will be distributed pro_rata to distributing 2’s shareholders within j months following the initial exchange the clean-up spin-off and together with the split-off the external distribution representations a the assets transferred in the sub contribution the business b transfers and any other assets excluding the assets transferred in the prior restructuring transactions owned by spinco at the commencement of the proposed transaction that are contributed by spinco or by distributing to a related corporation as part of the proposed transaction collectively the reincorporated assets constitute no more than k of the value of the assets of spinco for purposes of this representation a corporation is a related corporation if distributing owns directly or indirectly more than of the value of the stock of the corporation and for purposes of determining distributing plr-141865-13 2’s ownership the constructive_ownership rules of sec_318 as modified by sec_304 apply for purposes of computing the value of the assets owned by spinco distributing has included all of the assets spinco owns as a matter of applicable local law including those assets acquired in the prior restructuring transactions b the five years of financial information submitted on behalf of spinco is representative of business c1’s present operations and with regard to business c1 there have been no substantial operational changes since the date of the last financial statements submitted c following the internal distribution and prior to the spinco liquidation the spinco sag will continue the conduct of business c1 independently and with its separate employees with the exception of certain operational activities that will be performed by employees of the distributing sag for partnership llc and llc and services performed by independent contractors consistent with industry standards following the spinco liquidation the distributing sag will continue the conduct of business c1 independently and with its separate employees with the exception of services performed by independent contractors consistent with industry standards d splitco’s borrowing pursuant to the distributing instrument is solely to facilitate the proposed transaction e following the external distribution and as long as distributing distributing or any of their affiliates retain the distributing instrument none of distributing 2’s or distributing 1’s directors or officers will serve as directors or officers of splitco f distributing will dispose_of its interest in the distributing instrument as soon as practicable and in all events not later than l after the issuance of the distributing instrument rulings based solely on the information submitted and the representations set forth above we rule as follows provided that the internal distribution and the external distribution each satisfies the requirements of sec_355 and provided that the spinco liquidation satisfies the requirements of sec_332 no adjustment under sec_1_1502-19 or under sec_358 shall be made with respect to the proposed transaction as a whole or with respect to any step thereof for federal_income_tax purposes i distributing will be treated as having acquired all of the stock of spinco prior to the time spinco adopts a plan of plr-141865-13 liquidation and ii spinco will be treated as transferring to distributing x all of the assets it owns as a matter of local law at the time of the internal distribution and the spinco liquidation and y no other assets the reincorporated assets and the assets transferred in the prior restructuring transactions will not preclude the spinco liquidation from constituting a complete_liquidation within the meaning of sec_332 with respect to the internal distribution spinco will satisfy the active_trade_or_business_requirement of sec_355 provided that the external distribution would otherwise satisfy the requirements of sec_355 if all of the splitco stock were to be distributed pursuant to only one exchange_offer and provided that any subsequent exchange_offer s and or the clean-up spin-off if needed will be completed within j months of the completion of the initial distribution of splitco stock pursuant to the initial exchange_offer the external distribution will be treated as a single distribution in determining whether the requirements of sec_355 are met provided that the distributing instrument constitutes indebtedness the retention of the distributing instrument by distributing will not cause either the internal distribution or the external distribution to fail to meet the requirements of sec_355 splitco will not be a successor to distributing for purposes of sec_1504 caveats no opinion is expressed or implied about the federal_income_tax consequences of any other aspect of any transaction or item discussed or referenced in this letter or the federal_income_tax treatment of any conditions existing at the time of or effects resulting from the proposed transaction that are not specifically covered by the above rulings in particular no opinion is expressed regarding whether the distributing instrument constitutes debt or equity plr-141865-13 procedural statements this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely mark s jennings branch chief branch office of associate chief_counsel corporate


department of the treasury internal_revenue_service washington d c date cc dom fs proc tl-n-6665-98 uilc number release date internal_revenue_service national_office field_service_advice memorandum for from deborah a butler assistant chief_counsel field service cc dom fs subject interest on overpayments this field_service_advice responds to your memorandum dated date seeking advice on the extent of the government’s liability for interest on an overpayment_of_tax used as a credit against a later tax_deficiency this field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent legend x year year year year year year year year year issue where the service offsets overpayments in years against underpayments for later years and is x entitled to additional statutory interest under sec_6611 of the internal_revenue_code from the statutory due_date of the underpaid tax against which the overpayment is credited to the later date that the underpayment actually arose and the offset was effective conclusion the statutory terms of sec_6611 should not be construed to allow x overpayment interest up until the date the underpayment actually arose and the offset was effective overpayment interest runs only to the due_date of the income_tax return for the year in which the overpayment is applied not the actual date the underpayment arose facts x reported overpayments on its returns for years and and elected pursuant to sec_301_6402-3 to apply them to its estimated_tax liabilities for the next succeeding years years and respectively see code sec_6402 the return overpayments were used to pay the third installment of estimated_taxes in the succeeding years later on audit the service determined x had overpaid its income taxes in years and had underpaid in years and the deficiencies the service subsequently determined for years and were less than the overpayments reported on x’s returns thus although x had originally overpaid its taxes in these years the excessive credits it had taken against estimated_taxes wiped out the surplus and created deficiencies the service offset overpayments determined on examination of year sec_1 through against the underpayments for years and see sec_6402 see also sec_1 when the taxpayer makes such an election no interest is allowed on the portion of the overpayment that is credited sec_301_6611-1 the overpayments for year sec_1 through are separate and distinct from the return overpayments x originally reported for the years and sec_301_6402-1 the service proposes to compute interest on the overpayments from the date the overpayments arose to the due_date of the tax for years and pursuant to sec_6611 seeking symmetrical treatment with respect to interest on the overpayments in years that were used to offset the underpayments in years and x claims interest should run on the overpayments up until the date of the offset the due_date of the third installment for estimated_taxes september year and september year not the original due dates of year and taxes march year and march year law and analysis in the case of any overpayment the secretary within the applicable_period of limitations may credit the amount of such overpayment including any interest allowed thereon against any liability in respect of an internal revenue tax on the part of the person who made the overpayment sec_6402 see also sec_301 commissioner may credit any overpayment_of_tax including interest thereon against any outstanding liability interest however is not recoverable on an obligation owed by the government unless explicitly provided by statute or contract 323_us_658 x claims a right to interest under sec_6611 that section provides interest shall be allowed and paid i n the case of a credit from the date of the overpayment to the due_date of the amount against which the credit is taken sec_6611 emphasis supplied under the general_rule of sec_301_6611-1 the due_date of the amount against which the overpayment is credited means the last day fixed by law or regulations for the payment of the tax code sec_6151 provides that when a return of tax is required under this title or regulations the person required to make such return shall pay such tax at the time fixed for filing the return determined without regard to any extension of time for filing the return see also sec_1_6151-1 code sec_6072 governs the time for filing income_tax returns returns of corporations required under sec_6012 made on the basis of a calendar_year shall be filed on or before the 15th day of march following the close of the calendar_year and returns made on the basis of a fiscal these are the dates the government was actually deprived of the use of x’s return overpayments as a payment of the year taxes and the year taxes because this was when the return overpayments were applied as estimated_tax payments in the succeeding years sec_6012 a requires every corporation subject_to taxation under subtitle a to make returns of income year shall be filed on or before the 15th day of the third month following the close of the fiscal_year sec_6072 see also sec_1_6072-2 thus the last day fixed by law for the payment of income_tax is the due_date of the return determined without regard to any extension of time accordingly the due_date of the amounts here the underpayments for years and against which the overpayment was credited is the due_date of the returns for the years in which the taxes were underpaid overpayment interest runs only to the due_date of the income_tax return for the year in which the overpayment is applied not the actual date the underpayment arose case development hazards and other considerations evidenced by 36_fedclaims_680 acq aod cc-1997-008 date and 588_f2d_342 2d cir have employed a use-of-money analysis in interpreting the statutory terms of sec_6601 which are substantially_similar to the terms used in sec_6611 and regulation sec_301_6611-1 nevertheless the conclusion that interest runs only to the due_date of the income_tax return is compelled by our interpretation of the regulation as having a fixed meaning for the term due_date for the payment of tax the courts as by george e bowden technical assistant cc dom fs cc


department of the treasury internal_revenue_service washington d c oct tax_exempt_and_government_entities_division uics legend company a company b company e plan x province c country d ladies and gentlemen this is in response to the letter as supplemented by correspondence dated you request a series of letter rulings under sec_401 sec_401 sec_401 sec_402 sec_404 sec_415 sec_4972 and sec_4979 of the internal_revenue_code the following facts and representations support your ruling_request in which and company e sponsors plan x a profit-sharing_plan with a cash or deferred feature described in code sec_401 it is represented that plan x is qualified under code sec_401 company e has converted one or more group annuity_contracts held in plan x to a group_annuity_contract issued by company a which contains an mve feature described below plan x currently invests in the annuity_contract with company a which contains the mve feature company a is a united_states subsidiary of company b a multinational insurance and financial services company company a has its principal offices in province c country d company a markets group annuity_contracts to employee benefit plans that are primarily participant-directed code sec_401 plans the group annuity_contracts page typically provide specific investment alternatives that the plan_sponsor has selected from the range of investment alternatives made available by company a company a’s investment alternatives are generally held in separate_accounts or sub-accounts established by company a and include equity funds fixed income funds and money market accounts company a uses sales agents to market its group annuity_contracts and its sales agents are generally paid commissions that are a percentage of the value of the group_annuity_contract a plan may choose to pay its commissions in full or it may choose to amortize any commission over the life of a contract if a plan chooses to amortize any commission owed company a its base asset charge is increased in order for company a to recover from the plan the commissions that company a has advanced to its sales agents company a’s group annuity_contracts include a discontinuance charge for early termination whenever commissions have been amortized over the life of a contract typically a termination prior to the end of the seventh contract_year is considered an early termination discontinuance charges enable company a to recover the commissions which it has advanced to qualified_plans on occasion a plan will shift an annuity_contract or contracts held with another company to company a in order to facilitate its ability to generate additional business ie to increase the willingness of plan sponsors to purchase its group annuity_contracts company a proposes to offer to gross up a plan’s individual accounts by the amounts which a previous contract vendor deducts as a contract discontinuance charge company a refers to this practice as a ‘gross-up or as a market_value equalizer hereinafter mve in cases where company a has provided an mve to a plan that has converted group annuity_contracts held with another company to group annuity_contracts held with company a the plan remains obligated to repay the mve in full your authorized representative asserts that the mve represents the transfer to a new vendor company a of an obligation owed an old vendor your authorized representative gives as an example a discontinuance change_of which is not assessed at the time vendors change but which company a recaptures by amortizing the one percent cost of the mve over the early-termination period applicable under the new contract issued by company a if a plan terminates its contract with company a before the end of the contract’s early termination period company a’s discontinuance charge will include an amount to recover any outstanding mve page oe company a’s mve recapture feature insures that plans that convert annuity_contracts purchased from other companies to company a’s annuity_contracts will fully repay the mve to company a either through ongoing-plan amortization changes or through discontinuance charges an mve constitutes the entire amount of an early discontinuance charge that is paid either by a plan or occasionally by company a to a prior service provider in short an mve is a new fee imposed by company a that is triggered by the payment of a discontinuance charge to a prior vendor in effect an mve is a separate fee that replaces a discontinuance fee thus in summary an mve is a fee imposed by company a in addition to the early discontinuance charge that company a imposes on all plans that defer the payment of sales charges owed to company a in addition to the mve-related charges company a will also amortize any company a sales charges that have been deferred by increasing the annual asset charge over a period set in a contract-generally seven years in turn there would be an early discontinuance charge for the deferred sales charges if a plan discontinues company a’s services prior to the completion of the seven year period which sales charge declines over the seven year period if the plan which incurs an obligation to repay an mve is a defined_contribution_plan the mve is allocated pro_rata or proportionally to the accounts of all affected plan participants based on the above you through your authorized representative request the following letter rulings that the mve described above paid_by company a to the accounts of affected plan participants will not constitute a contribution or other payment subject_to the provisions of either code sec_404 or code sec_4972 will not adversely affect the qualified status of a plan pursuant to either code sec_401 or code sec_415 will not when made to a plan result in taxable_income to affected plan participants or their beneficiaries will not constitute a plan contribution for purposes of code sec_401 page will not constitute a plan contribution for purposes of code sec_401 will not constitute a plan contribution for purposes of code sec_402 will not constitute a plan contribution for purposes of code sec_4979 with respect to your ruling requests code sec_401 generally provides that the contributions or benefits provided under a qualified_retirement_plan may not discriminate in favor of highly compensated employees code sec_401 contains participation and nondiscrimination standards applicable to elective contributions made to qualified cash or deferred arrangements codas an elective contribution is generally an employer_contribution made to a coda that was subject_to a cash or deferred election of a plan participant code sec_401 contains nondiscrimination tests for matching_contributions and certain employee contributions a matching_contribution generally is any employer_contribution to a defined_contribution_plan on account of an employee contribution to such plan any employer_contribution to a defined_contribution_plan on account of an elective_deferral and any forfeiture allocated on the basis of employee matching or elective contributions an employee contribution means generally any mandatory or voluntary contribution to the plan that is treated at the time of the contribution as an after- tax employee contribution code sec_402 limits the dollar amount of elective_deferrals for any individual in a taxable_year an elective_deferral includes an employer_contribution under a coda to the extent that it is not includible in gross_income for a year under codes sec_402 code sec_404 provides that if contributions are paid_by an employer to or under a stock bonus pension profit-sharing or annuity plan or if compensation is paid_or_accrued on account of any employee under a plan deferring the receipt of such compensation then such contributions or compensation shall not be deductible under this chapter but if they would otherwise be deductible they shall be deductible under this section however subject_to the limitations contained therein code sec_415 provides in part that a_trust which is part of a pension profit-sharing or stock_bonus_plan shall not constitute a qualified_trust under sec_401 if a in the case of a defined_benefit_plan the plan provides for the payment of benefits with respect to a participant which exceeds the limitations of subsection b or b in the case of defined_contribution_plan contributions and other additions under the page plan with respect to any participant for any taxable_year exceed the limitations of subsection c sec_1 b of the income_tax regulations provides that the term annual_additions includes employer contributions which are made under the plan sec_1 b further provides that the commissioner may in an appropriate case considering all of the facts and circumstances treat transactions between the plan and the employer or certain allocations to participants' accounts as giving rise to annual_additions code sec_4972 imposes on an employer an excise_tax on nondeductible_contributions to a qualified_plan sec_4972 defines nondeductible_contributions as the excess if any of the amount contributed for the taxable_year by the employer to or under such plan over the amount allowable as a deduction under sec_404 for such contributions determined without regard to subsection e thereof and the amount determined under subsection c for the preceding year reduced by the sum of the portion of the amount so determined returned to the employer during the taxable_year and the portion of the amount so determined deductible under sec_404 for the taxable_year determined without regard to subsection e thereof code sec_4979 imposes a percent excise_tax on the sum of any excess_contributions and any excess_aggregate_contributions under a plan if the excess_contributions and the excess_aggregate_contributions are not distributed before the close of the first months of the following plan_year for purposes of sec_4979 a plan includes a plan qualified under code sec_401 or sec_403 in general excess_contributions are the excess of employer contributions contributed to the plan on behalf of highly compensated employees over the maximum amount of such contributions that are permitted under limitations found in the code in general excess_aggregate_contributions are the excess of matching_contributions and after-tax employee contributions made to a plan on behalf of highly compensated employees over the maximum amounts of such contributions permitted under limitations found in the code code sec_402 generally provides that amounts held in a_trust that is exempt from tax under code sec_501 and that is part of a plan that meets the qualification requirements of code sec_401 will not be taxable until such time as such amounts are actually distributed to distributes under such plan with respect to your ruling requests as noted above the mve represents an additional_charge that company a fronts to a plan and subsequently recovers over a period of years thus at the time company a fronts an mve to a plan company a is entitled to receive the mve back over a period of time that generally will not exceed seven years thus in general an mve is not intended to represent a permanent addition page to a plan or to the accounts of affected plan participants in many or most instances plan participants may benefit from the gains if any attributable to an mve during the period that it remains in the plan thus the issue presented in this case is whether a company a mve an addition to a plan that represents a fee substituting for a discontinuance charge owed and paid to another insurance vendor is a contribution as that term is used in the code sections referenced above the service has analyzed the facts in this case and has arrived at the conclusion that an mve is not to be treated as a contribution for purposes of the above-referenced code sections to begin with the service notes the intended general lack of permanency cited above furthermore the service notes that a contract early discontinuance fee for which an mve is a substitute must be paid either from amounts previously contributed to a plan which were subject_to the limits found in the code sections referenced above at the time s the contributions were made or from gains attributable to such contributions which gains are not subject_to said limits since contract discontinuance fees described above either have already been funneled through code sec_401 sec_404 sec_415 etc or do not have to be so funneled mves which substitute for contract plan discontinuance fees will be given the same treatment thus the service will not subject an mve to testing under code sec_401 sec_404 sec_415 sec_4972 etc since the mve will be treated as having already been so tested or in the alternative as gains on contributions and as such not subject_to testing furthermore it is apparent that an mve when placed in a plan including plan x will in many cases not accrue to the benefit of affected plan participants and will not be distributed to them therefore with respect to your ruling requests the service concludes as follows that the mve described above paid_by company a to the accounts of affected plan participants will not constitute a contribution or other payment subject_to the provisions of either code sec_404 or code sec_4972 will not adversely affect the qualified status of a plan pursuant to either code sec_401 or code sec_415 will not when made to a plan result in taxable_income to affected plan participants or their beneficiaries page will not constitute a plan contribution for purposes of code sec_401 will not constitute a plan contribution for purposes of code sec_401 will not constitute a plan contribution for purposes of code sec_402 will not constitute a plan contribution for purposes of code sec_4979 this ruling is based on the facts and representations contained therein no opinion is expressed as to the federal_income_tax consequences with respect to the transactions described above under any other provisions of the code additionally the representations made herein that the mves described in this letter_ruling will substitute for contract discontinuance fees like all factual representations made to the internal_revenue_service in applications for rulings are subject_to verification on audit by service field personnel a copy of this letter has been sent to your authorized representative in accordance with the power_of_attorney on file in this office if you have any questions please call at t ep ra t3 sincerely yours foren jan frances v sloan manager technical group employee_plans division enclosures deleted copy of letter notice of intention to disclose


internal_revenue_service number release date index numbers --------------------------------------------------- ------------------------------- ------------------------------------------------------- --------------------------------------------- --------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------- id no ----------------- telephone number ------------------- refer reply to cc psi b03 plr-106561-11 date august x --------------------------------------------------------------------------------------------------- ----------------------- legend country --------------------- date ------------------- date ---------------------- dear -------------- this letter responds to a letter dated date submitted on behalf of x by its authorized representative requesting that x be granted an extension of time under sec_301_9100-3 of the procedure and administration regulations to elect to be treated as a disregarded_entity under sec_301_7701-3 facts x was formed under the laws of country on date x represents that it is a foreign_entity eligible to elect to be classified as a disregarded_entity for federal tax purposes x intended to be classified as a disregarded_entity effective date however due to inadvertence form_8832 entity classification election was not timely filed law sec_301_7701-3 provides in part that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes as provided in plr-106561-11 sec_301_7701-3 an eligible_entity with at least two members can elect to be classified as either an association and thus a corporation under sec_301_7701-2 or a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner sec_301_7701-3 provides that except as provided in sec_301 b unless the entity elects otherwise a foreign eligible_entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides in part that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 provides in part that except as provided in sec_301_7701-3 and v an eligible_entity may elect to be classified other than as provided in sec_301_7701-3 or to change its classification by filing form_8832 with the service_center designated on form_8832 sec_301_7701-3 provides in part that an election made under sec_301_7701-3 will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified on the election form the effective date specified on form_8832 can not be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 plr-106561-11 sec_301_9100-3 provides that requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government conclusion based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file a form_8832 with the appropriate service_center to elect to be treated as a disregarded_entity effective date a copy of this letter should be attached to the form_8832 this ruling is contingent on the owner of x filing within days of this letter all required returns and amended income_tax returns consistent with the requested relief being effective date to the extent appropriate these returns must include but are not limited to forms information_return of u s persons with respect to foreign disregarded entities such that these forms reflect the consequences of the relief granted in this letter except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we are sending a copy of this letter to your authorized representative the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed plr-106561-11 by an appropriate party while this office has not verified any of the material submitted in support of the ruling_request it is subject_to verification on examination sincerely associate chief_counsel passthroughs special industries by _____ s _________________ mary beth carchia senior technician reviewer branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


t c memo united_states tax_court russell d kinney and heather r kinney petitioners v commissioner of internal revenue respondent docket no filed date russell d kinney and heather r kinney pro sese ann l darnold for respondent memorandum findings_of_fact and opinion marvel judge respondent determined deficiencies in petitioners’ federal income taxes of dollar_figure and dollar_figure for and respectively as well as sec_6662 accuracy- related penalties of dollar_figure and dollar_figure for and respectively after concession sec_2 the issues for decision are whether during and petitioners’ direct marketing activity constituted an activity_not_engaged_in_for_profit whether petitioners are entitled to deductions claimed on their schedules c profit or loss from business for expenses not related to the direct marketing activity for and whether petitioners are entitled to deduct additional home mortgage interest of dollar_figure for whether petitioners have substantiated unreimbursed employee_expenses in excess of expenses conceded by respondent for whether petitioners are liable for the sec_6662 accuracy-related_penalties 1unless 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 monetary amounts are rounded to the nearest dollar 2respondent concedes that petitioners substantiated the union dues and welding license expenses claimed on schedule a itemized_deductions for as unreimbursed employee_expenses but the parties dispute the remaining unreimbursed employee_expenses respondent also concedes that petitioners are entitled to a dollar_figure home mortgage interest_deduction for but the parties dispute the remaining home mortgage deduction findings_of_fact the parties have stipulated some of the facts which we incorporate in our findings by this reference petitioners resided in oklahoma when their petition was filed petitioners were married and filed joint federal_income_tax returns for the years at issue but they were separated at the time of trial during the years at issue petitioners received wage and other income from several sources heather r kinney mrs kinney was employed by women’s health group inc earning dollar_figure and dollar_figure for and respectively russell d kinney mr kinney was a member of a local union and was employed as a welder by k l smith mechanical inc k l smith earning dollar_figure and dollar_figure in and respectively petitioners also reported gaming income of dollar_figure and dollar_figure for and respectively i petitioners’ direct marketing and prospective welding businesses a direct marketing activity in petitioners became involved with melaleuca inc melaleuca a direct marketing company selling health wellness and household products through individuals distributors melaleuca is structured as an upline-downline system in which distributors earn commissions when they recruit new distributors downlines and when their downlines recruit more distributors distributors also receive commissions on purchases of products by their downlines melaleuca’s distributors qualify for discounts on melaleuca products petitioners were recruited as downlines by another distributor upline before their involvement with melaleuca petitioners had no experience in running a business or conducting direct marketing activities initially petitioners concentrated on recruiting downlines but because of the dollar_figure initiation fee that prospective downlines had to pay petitioners were not able to attract anyone mrs kinney sold some products to neighbors friends and coworkers after petitioners realized they could not recruit downlines they considered quitting the melaleuca activity but decided to continue selling products because of their inventory in addition they remained hopeful that they would eventually sign up downlines petitioners had been told by their upline that if their potential downlines ordered melaleuca products at petitioners’ volume petitioners would recoup their startup costs in approximately year however petitioners did not calculate how many downlines they would have to recruit to make their marketing activity profitable both petitioners continued their full-time jobs petitioners owned a mobile home3 in a trailer park which after they ceased using it as a residence they converted for use 3mr kinney purchased the mobile home in and petitioners used it as their primary residence until exclusively as an office for their melaleuca activity including storing inventory although they purchased a computer and printer for their melaleuca activity petitioners did not have internet service at the mobile home and they placed online orders with melaleuca on their computer at home when petitioners became melaleuca distributors they consulted susan boyer ms boyer regarding business records they had to maintain although petitioners obtained computer_software from ms boyer they recorded all items on paper and retained receipts petitioners did not maintain a separate bank account for the melaleuca activity petitioners never generated a profit from the melaleuca activity in and petitioners reported gross_sales of dollar_figure and dollar_figure respectively b preparations to start welding business in the latter part of mr kinney prepared to start a welding business because he anticipated receiving orders for pipe fabrication from an acquaintance in mr kinney constructed gates built a pole building and purchased a welding machine and other supplies however for reasons beyond mr kinney’s control he did not actually begin to operate a business ii petitioners’ federal_income_tax returns petitioners timely filed their and form sec_1040 u s individual_income_tax_return and returns ms boyer prepared the returns schedule c attached to the return schedule c described petitioners’ melaleuca activity as marketing besides the melaleuca expenses on the schedule c petitioners also claimed mileage for vehicles and expenses for one cellular phone that pertained to mr kinney’s employment at k l smith petitioners’ schedule c attached to the return schedule c described petitioners’ business activity as marketing welding marketing referred to the melaleuca activity and welding referred to mr kinney’s prospective welding business gross_income of dollar_figure reported on the schedule c represented petitioners’ gross_sales of melaleuca products in addition to claiming deductions for the melaleuca activity and for the prospective welding business on the schedule c petitioners also claimed deductions for mileage for vehicles and expenses of one cellular phone that pertained to mr kinney’s employment at k l smith and work_clothes expenses for both petitioners’ jobs the schedule c did not separately identify the expenses related to the melaleuca activity the prospective welding business and petitioners’ employment petitioners deducted the following schedule c expenses on their and returns sch c expense category car and truck commissions and fees depreciation legal and professional services office expense rent or lease vehicles machinery and equipment other business property repairs and maintenance supplies taxes and licenses travel meals and entertainment other toll meetings phones work_clothes tools total dollar_figure -0- -0- dollar_figure big_number big_number -0- big_number big_number -0- -0- big_number -0- -0- big_number -0- big_number big_number -0- -0- -0- big_number big_number on the return petitioners itemized their deductions attaching to the return schedule a itemized_deductions schedule a on the schedule a petitioners reported home mortgage interest of dollar_figure and unreimbursed employee_expenses of dollar_figure after applying the sec_67 limitation petitioners deducted dollar_figure of unreimbursed employee_expenses petitioners attached to their return a form 2106-ez unreimbursed 4for petitioners reported unreimbursed employee_expenses totaling dollar_figure but did not claim them because such expenses did not exceed the 2-percent limitation under sec_67 employee business_expenses but the form did not show how the amount was calculated iii notice_of_deficiency in the notice_of_deficiency respondent disallowed all of petitioners’ and schedule c deductions on the following grounds no amount in excess of zero has been adequately substantiated as to amount of deductibility in addition it has not been established that the requirements of internal_revenue_code sec_274 have been met for respondent also disallowed dollar_figure of petitioners’ itemized_deductions because of lack of substantiation this amount consisted of home mortgage interest_expense of dollar_figure and unreimbursed employee_expenses of dollar_figure respondent also determined that petitioners were liable for accuracy-related_penalties under sec_6662 of dollar_figure and dollar_figure for and respectively opinion the commissioner’s determinations are presumed correct and the taxpayer ordinarily bears the burden of proving that those determinations are erroneous rule a 290_us_111 moreover deductions are a matter of legislative grace and the taxpayer bears the burden of proving that he is entitled to any deduction claimed indopco inc v 5respondent also made computational adjustments to self- employment_tax and the sec_24 child_tax_credit for commissioner 503_us_79 petitioners do not contend that sec_7491 shifts the burden_of_proof to respondent and petitioners have not established that they satisfy the sec_7491 requirements i schedule c deductions related to the melaleuca activity a in general respondent argues that petitioners may not deduct the schedule c expenses attributable to the melaleuca activity because the melaleuca activity did not constitute a trade_or_business and was not engaged in for profit sec_162 allows a taxpayer to deduct ordinary and necessary expenses of carrying on the taxpayer’s trade_or_business to be engaged in a trade_or_business with respect to which deductions are allowable under sec_162 the taxpayer must be involved in the activity with continuity and regularity and the taxpayer’s primary purpose for engaging in the activity must be for income or profit 480_us_23 sec_183 restricts taxpayers from deducting losses for an activity that is not engaged in for profit sec_183 defines activity_not_engaged_in_for_profit as any activity 6in the notice_of_deficiency respondent disallowed schedule c deductions for lack of substantiation in the pretrial memorandum and at trial respondent also contended that petitioners’ melaleuca activity did not constitute a trade_or_business engaged in for profit within the meaning of sec_162 and sec_183 petitioners do not object on procedural grounds to respondent’s argument under sec_183 other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 absent a stipulation to the contrary see sec_7482 this case is appealable to the court_of_appeals for the tenth circuit see sec_7482 which has applied the dominant or primary objective standard to test whether an alleged business activity is conducted for profit 28_f3d_1024 10th cir affg 99_tc_132 949_f2d_345 10th cir affg tcmemo_1990_148 oswandel v commissioner tcmemo_2007_183 under the standard applied by the court_of_appeals for the tenth circuit the dominant or primary objective of petitioners’ melaleuca activity must be to earn a profit whether an activity was engaged in for profit is a factual determination to be resolved on the basis of all the surrounding facts and circumstances hildebrand v commissioner supra pincite factors enumerated in regulations under sec_183 generally are utilized in determining whether the requisite 7in both 28_f3d_1024 10th cir affg 99_tc_132 and 949_f2d_345 10th cir affg tcmemo_1990_148 the court_of_appeals for the tenth circuit applied the dominant or primary objective test at the partnership level in analyzing whether a partnership was engaged in an activity for profit under sec_183 profit objectives are present under sec_162 see cannon v commissioner supra pincite krause v commissioner supra pincite sec_1_183-2 income_tax regs sets forth a nonexclusive list of factors to be considered in determining whether a taxpayer has the requisite profit objective the factors are the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that 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 if any which are earned the financial status of the taxpayer and elements of personal pleasure or recreation no single factor is determinative and not all factors are applicable in every case see 86_tc_360 b applying the factors we analyze the most pertinent of the factors listed in the regulation to illustrate why we conclude that petitioners’ melaleuca activity was not an activity engaged in for profit the manner in which petitioners conducted the activity in deciding whether a taxpayer has conducted an activity in a businesslike manner we consider whether complete and accurate books_and_records were maintained whether the activity was conducted in a manner substantially_similar to other activities of the same nature that were profitable and whether changes in operating methods adoption of new techniques or abandonment of unprofitable methods were done in a manner consistent with an intent to improve profitability see 72_tc_659 sec_1_183-2 income_tax regs when petitioners signed up as downlines they consulted ms boyer regarding necessary recordkeeping and obtained from her a computer_program and a book for recording everything mr kinney testified that petitioners did not use the software but instead contemporaneously recorded all items in the book8 and retained receipts we are not convinced that petitioners’ recordkeeping represented anything other than an effort to substantiate expenses claimed on their return for a taxpayer’s books_and_records to indicate a profit_motive the taxpayer should use the books_and_records as analytic or diagnostic tools in an effort to achieve profitability nissley v commissioner tcmemo_2000_178 for example to enable a taxpayer to cut expenses increase profits and evaluate the overall performance of the operation see 72_tc_411 8petitioners did not give the book to the irs during the audit and did not introduce the book into evidence affd without published opinion 647_f2d_170 9th cir petitioners could not meaningfully analyze profitability and make informed decisions regarding their melaleuca activity on the basis of the collection of receipts and invoices they retained although they believed they would recoup their startup costs if they could recruit some downline distributors they did not estimate what sales level they had to maintain to break even although mrs kinney prepared spreadsheets to assist the tax_return preparation process petitioners did not use the spreadsheets to analyze profitability of the business or to identify cost-cutting measures petitioners failed to maintain certain records that individuals pursuing a similar activity with a profit objective are expected to maintain see nissley v commissioner supra in addition the records petitioners did maintain were neither complete nor accurate for example for petitioners reported dollar_figure in gross_sales but retained records reflecting only dollar_figure in gross_sales petitioners also did not prove that they made changes to their business activity in order to generate a profit for example petitioners offered no evidence that they considered switching companies or that they consulted successful direct marketers about how to improve sales and reduce expenses despite their losses petitioners continued to buy products without increasing their sales volume or changing their method of operation we conclude that petitioners did not conduct their melaleuca activity in a businesslike manner the expertise of petitioners or their advisers preparation for an activity by an extensive study of its accepted business economic and scientific practices or consultation with those who are experts therein may indicate a profit objective engdahl v commissioner supra pincite sec_1_183-2 income_tax regs efforts to gain experience and a willingness to follow expert advice may indicate a profit_motive see eg dworshak v commissioner tcmemo_2004_249 before signing up as downlines petitioners never engaged in any direct marketing activity or any other type of sales business petitioners relied only on advice from another melaleuca distributor under a direct marketing system like melaleuca an upline is an interested_party rendering advice to promote his own interest see ogden v commissioner tcmemo_1999_397 direct marketers may be biased when discussing their direct marketing activity because they have a natural desire to advance the organization and or obtain income from a downliner affd 244_f3d_970 5th cir petitioners never sought advice from an independent party on balance we conclude that petitioners did not have and did not acquire from others a sufficient grounding in direct marketing petitioners’ time and effort devoted to the activity the fact that a taxpayer devotes personal time and effort to carry on an activity may indicate an intention to derive a profit particularly where there are no substantial personal or recreational elements associated with the activity sec_1 b income_tax regs mr kinney’s testimony about the amount of time petitioners devoted to the melaleuca activity was confusing and unclear mr kinney testified that mrs kinney spent a couple of hours weekly trying to sell melaleuca products and that he spent approximately hour daily filling out order sheets however mr kinney testified he placed orders for merchandise once a month we cannot reconcile mr kinney’s testimony about the amount of time he and his wife spent on the activity9 with the small amount of sales reported nor do we understand what he did for an hour a day consequently we disregard mr kinney’s testimony on this point see 87_tc_74 petitioners maintained full-time jobs during the years at issue and in mr kinney also devoted time and effort to his prospective welding business in addition mrs kinney started 9copies of customer receipts indicate that in and petitioners made less than two sales per month and the average sale was dollar_figure we find it hard to believe that this sales volume required mr kinney to spend hour daily filling out order sheets gambling at some point and spent far more time gambling during the years at issue than selling melaleuca products or recruiting downlines petitioners’ other activities left little time for the melaleuca activity petitioners’ history of income or loss from the activity a taxpayer’s history of income or loss with respect to an activity may indicate the presence or absence of a profit objective see golanty v commissioner supra pincite sec_1_183-2 income_tax regs however a series of startup losses or losses sustained because of unforeseen circumstances beyond the control of the taxpayer may not indicate a lack of profit_motive kahla v commissioner tcmemo_2000_127 citing engdahl v commissioner t c pincite and sec_1_183-2 income_tax regs affd without published opinion 273_f3d_1096 5th cir petitioners’ activity never generated a net profit their melaleuca activity mostly provided them discounts on products for personal_use and deductions for personal expenses such as expenses related to their car cellular phone internet service and mobile home although the activity was in its early years petitioners recognized that they needed to build a downline organization to maintain a profit yet they did nothing to reduce costs or terminate the activity when they were unsuccessful at recruiting downline distributors we fail to see how petitioners could recoup their cumulative losses under these circumstances we conclude petitioners’ substantial losses from the activity indicate that the melaleuca activity was not engaged in for profit elements of personal pleasure or recreation the existence of personal pleasure or recreation relating to the activity may indicate the absence of a profit objective see sec_1_183-2 income_tax regs however an activity is not treated as an activity_not_engaged_in_for_profit merely because the activity may have recreational or pleasurable elements id petitioners’ melaleuca activity was so intertwined with social and recreational elements that it is difficult to discern what part if any of the activity was business and what part was pleasure for example on a date trip to a cheerleading convention10 petitioners invited their acquaintances to dinner during which they talked about cheerleading and melaleuca products petitioners treated the cost of the dinner as a deductible expense during another personal trip to new mexico texas and las vegas nevada petitioners delivered products to and discussed melaleuca with spouses of persons whom mr kinney had met through his employment petitioners deducted the cost of meals and some lodging_expenses we conclude that elements of 10during the years at issue petitioners’ daughter was a cheerleader personal pleasure and recreation indicate that petitioners did not engage in the melaleuca activity with a primary objective of realizing a profit conclusion the remaining factors either do not apply or do not favor petitioners’ position after considering the factors listed in sec_1_183-2 income_tax regs and the facts and circumstances of this case we conclude that petitioners did not engage in the melaleuca activity with the primary objective of realizing a profit accordingly we hold that petitioners’ melaleuca activity during the years in issue was not an activity engaged in for profit within the meaning of sec_162 and sec_183 ii deductibility of and schedule c expenses a schedule c expense sec_1 expenses related to the melaleuca activity because we have concluded that petitioners did not engage in the melaleuca activity for profit we now turn our analysis to what deductions if any petitioners may claim under sec_183 and sec_183 permits deductions which are otherwise allowable without regard to whether the activity is engaged in for profit such as state and local_taxes and interest sec_183 allows deductions that would be allowable if the activity were engaged in for profit but only to the extent of gross_income received from the activity reduced by deductions under sec_183 for petitioners provided records showing they paid tulsa county tax of dollar_figure an expense that appears to be deductible under sec_164 and allowable under sec_183 petitioners also paid rent for the lot for the mobile home totaling dollar_figure we are satisfied on the basis of mr kinney’s testimony that petitioners used the mobile home exclusively for the melaleuca activity we find that petitioners may deduct the county tax in full and may deduct the lot rent expenses up to dollar_figure the excess of the dollar_figure gross_profit from the melaleuca activity over the county tax given the sec_183 limitation we do not need to address whether petitioners substantiated other deductions related to the melaleuca activity on their schedule c expenses related to mr kinney’s employment erroneously claimed on the schedule c the schedule c included mileage and cellular phone expenses related to mr kinney’s employment at k l smith although those deductions should have been claimed on petitioners’ schedule a as miscellaneous_itemized_deductions subject_to the 2-percent adjusted_gross_income limitation under 11the record does not establish under which category of the schedule c petitioners claimed the lot rent expense and the county tax sec_67 we consider whether petitioners are entitled to these deductions a taxpayer may deduct unreimbursed employee_expenses as an ordinary and necessary business_expense under sec_162 79_tc_1 an employee cannot deduct such expenses to the extent that the employee is entitled to reimbursement from his or her employer for expenditures related to his or her status as an employee id pincite along with other miscellaneous_itemized_deductions unreimbursed employee_expenses are subject_to the 2-percent limitation of sec_67 we accept as credible mr kinney’s testimony that k l smith did not reimburse him for mileage and cellular phone expenses a car and truck expenses petitioners claimed dollar_figure in car and truck expenses on the schedule c which included van and truck expenses for the melaleuca activity and truck expenses for mr kinney’s employment passenger automobiles and any other_property used as a means of transportation are listed_property see sec_280f and ii and these expenses are subject_to the provisions of sec_274 sec_274 requires taxpayers to provide adequate_records or sufficient other evidence establishing the amount time place and business_purpose of the expense to corroborate the taxpayer’s statements mr kinney claimed that he maintained a contemporaneous log but he did not introduce it into evidence to substantiate mileage expenses petitioners presented calendars that used an alphabetical code for indicating business or personal_use of their vehicles although petitioners’ code system separates business and personal mileage it does not separate how many miles were driven for the melaleuca activity and for mr kinney’s employment the calendars have meager explanations about the purpose of a few trips only a few entries describe trip destinations we conclude the calendars do not satisfy the strict substantiation requirements of sec_274 and we sustain respondent’s determination disallowing car and truck expenses b cellular phone expenses on the schedule c petitioners claimed cellular phone expenses under the category other expenses petitioners introduced into evidence cellular phone bills that establish that they subscribed to a family plan for two cellular phones one for mr kinney and one for mrs kinney mr kinney did not use any other cellular phone cellular phones are listed_property see sec_280f and sec_274 provides that no deduction shall be allowed unless the taxpayer substantiates inter alia the business use of the property petitioners did not offer a detailed breakdown of personal and business use of mr kinney’s cellular phone petitioners failed to establish the additional charges if any they incurred because of mr kinney’s employment therefore petitioners are not entitled to the cellular phone expense deduction b the schedule c expense sec_1 expenses related to the melaleuca activity for petitioners did not claim any deductions that are allowable under sec_183 as discussed above sec_183 permits petitioners to offset expenses against gross_income from the melaleuca activity petitioners substantiated the following dollar_figure rent for the mobile home lot for january through date and dollar_figure of utilities attributable to the mobile home_office these substantiated expenses total dollar_figure leaving a small discrepancy between income from the activity and substantiated expenses petitioners claimed the following deductions related to the melaleuca activity a car and truck expenses dollar_figure as discussed above petitioners’ mileage records do not satisfy the substantiation requirements of sec_274 in addition the records do not separate miles driven for the melaleuca activity and miles driven for mr kinney’s employment accordingly none of the car and truck expenses may be deducted as an expense of the melaleuca activity b legal and professional services dollar_figure petitioners offered no evidence to substantiate that they paid for legal and professional services for c supplies dollar_figure petitioners did not substantiate what items they purchased and deducted as supplies or their business_purpose d tolls deducted as other expenses dollar_figure although tolls related to mr kinney’s employment may qualify as a deductible unreimbursed employee expense petitioners did not prove how to allocate the tolls expense between driving for the melaleuca activity and driving for mr kinney’s employment accordingly none of the tolls may be deducted as an expense of the melaleuca activity on the basis of the foregoing we conclude that petitioners have not substantiated melaleuca-related expenses in excess of dollar_figure unreimbursed employee_expenses erroneously claimed on the schedule c on the schedule c petitioners claimed dollar_figure of work_clothes expenses mr kinney testified that for his employment he wore heavy denim and khaki shirts steel-toed boots safety glasses and welding hats and mrs kinney wore scrubs to work clothing is a deductible expense only if it is required for the taxpayer’s employment unsuitable for general wear and not worn for personal_use see 74_tc_1266 30_tc_757 such costs are not deductible even if a taxpayer establishes that he would not have purchased the items but for the employment hynes v commissioner supra pincite the receipts introduced into evidence to substantiate mr kinney’s work_clothes expenses contain unclear abbreviated descriptions that do not allow us to determine what items were purchased with respect to mrs kinney’s work_clothes petitioners have not established that mrs kinney did not receive any reimbursement for her work_clothes the receipts presented to substantiate mrs kinney’s work_clothes expenses describe the items purchased as comfort wash elastic-waist pants comfort wash checked fashion warm-up and knit polo shirt by jerzees such descriptions are insufficient to establish that the clothes purchased are not suitable for general wear petitioners did not argue any special circumstances that prevented the use of the clothes outside of work accordingly we disallow a deduction for work_clothes for lack of substantiation besides the work_clothes expenses the schedule c also includes mileage and cellular phone expenses related to mr kinney’s employment at k l smith for the same reasons that we disallowed these deductions for we disallow car and truck and cellular phone deductions for expenses related to the prospective welding business the record establishes that the following deductions claimed on the schedule c related to mr kinney’s prospective welding business item on the schedule c amount rent or lease vehicles machinery and equipment dollar_figure big_number other business property repairs and maintenance tools big_number total as discussed above sec_162 allows a taxpayer to deduct ordinary and necessary expenses of carrying on the taxpayer’s trade_or_business see sec_162 sec_1_183-2 income_tax regs for the expense to be deductible under sec_162 however the taxpayer’s business operations must actually have commenced see 864_f2d_1521 10th cir affg 86_tc_492 the taxpayer has not ‘engaged in carrying on any trade or business’ within the intendment of sec_162 until such time as the business has begun to function as a going concern and performed those activities for which it was organized 345_f2d_901 4th cir vacated and remanded on other grounds 382_us_68 mr kinney never started operating the welding business rather he undertook preparatory steps such as constructing a building and locating a key clientdollar_figure accordingly the prospective welding business_expenses are not deductible under sec_162 iii itemized_deductions a home mortgage interest_deduction respondent disallowed the home mortgage interest_deduction of dollar_figure for lack of substantiation sec_163 allows a deduction for interest_paid on a qualified_residence sec_163 further defines qualified_residence as either the taxpayer’s principal_residence or another residence selected by the taxpayer and used as a residence taxpayers must be able to substantiate the amount claimed see sec_6001 sec_1 a income_tax regs petitioners provided no documentation or other evidence to substantiate that they are entitled to a home mortgage interest_deduction in excess of that allowed by respondent accordingly we sustain respondent’s disallowance of the home mortgage interest_deduction in excess of the dollar_figure allowed 12petitioners did not argue that the prospective welding business_expenses are startup expenditures eligible for amortization under sec_195 even if they had sec_195 requires a taxpayer to elect to treat startup expenditures as deferred expenses that may be amortized over a period of not less than months and the amortizaton period cannot begin any earlier than the month in which the active trade_or_business begins b unreimbursed employee expenses13 in the notice_of_deficiency respondent disallowed dollar_figure of unreimbursed employee_expenses respondent concedes that petitioners substantiated the union dues and other union assessment amounts as well as welding licenses expenses but maintains that the conceded amounts are projected to be less than the 2-percent limitation of sec_67 petitioner failed to substantiate amounts in excess of those conceded by respondent accordingly we disallow a deduction for unreimbursed employee_expenses in excess of deductions conceded by respondent iv other matters the court’s holding on the above adjustments in turn determines to what extent petitioners are entitled to the child_tax_credit for and whether petitioners are liable for self- employment_tax these adjustments will be addressed in a rule computation v accuracy-related_penalty under sec_6662 respondent contends that petitioners are liable for the accuracy-related_penalty on the grounds of negligence or disregard of rules or regulations under sec_6662 and b for and negligence or disregard of rules or 13we remind the parties that when making their rule calculations miscellaneous_itemized_deductions must be adjusted for the 2-percent limitation see sec_67 regulations and substantial_understatement of tax under sec_6662 and b and for sec_6662 and b authorizes the commissioner to impose a 20-percent penalty on the portion of an underpayment of income_tax attributable to negligence or disregard of rules or regulations negligence is defined as any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws sec_6662 sec_1_6662-3 income_tax regs negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction credit or exclusion on a return which would seem to a reasonable and prudent person to be ‘too good to be true’ under the circumstances sec_1_6662-3 income_tax regs sec_6662 and b also authorizes the commissioner to impose a 20-percent penalty if there is a substantial_understatement_of_income_tax an understatement is substantial if the amount of the understatement for the taxable_year exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6662 respondent bears the initial burden of production with respect to petitioner’s liability for the sec_6662 penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty see sec_7491 respondent has satisfied his burden with proof that in the amount of understatement exceeds the greater of dollar_figure or percent of the tax required to be shown on the return respondent also met his burden of production with respect to negligence by establishing that petitioners did not maintain required records or substantiate deductions as required by the code because respondent has met his burden of production petitioners must come forward with sufficient evidence to persuade the court that respondent’s determination is incorrect see 116_tc_438 petitioners did not do so petitioners offered no credible_evidence to establish that they should not be liable for the sec_6662 penalty they failed to properly substantiate their home mortgage interest_deduction and work_clothes expenses and improperly claimed schedule c deductions the accuracy-related_penalty is not imposed with respect to any portion of the underpayment if the taxpayer can establish that he acted with reasonable_cause and in good_faith sec_6664 petitioners bear the burden of producing evidence to demonstrate reasonable_cause under sec_6664 we determine reasonable_cause and good_faith on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income_tax regs the most important factor is the extent of the taxpayer’s effort to assess his proper tax_liability id the record does not establish that petitioners had reasonable_cause and acted in good faithdollar_figure therefore we sustain respondent’s determination to impose the a accuracy-related_penalty for and we have considered all of the arguments raised by either party and to the extent not discussed we find them to be irrelevant or without merit to reflect the foregoing decision will be entered under rule 14a taxpayer’s reasonable reliance on the advice of an independent professional adviser as to the tax treatment of an item may demonstrate reasonable_cause petitioners introduced no evidence to support a finding that ms boyer was a competent tax professional they also introduced no evidence that they provided all information to ms boyer or that they actually relied in good_faith on ms boyer’s return preparation 115_tc_43 affd 299_f3d_221 3d cir