internal_revenue_service department of the treasury number release date index no 468b washington dc person to contact telephone number refer reply to cc ita - plr-114666-00 date date legend taxpayer corporation pi trust item date date date b c d agency e state site site year date date date dear f g h j this letter responds to your letter requesting a private_letter_ruling concerning the application of various sections of the internal_revenue_code code to taxpayer’s settlement of certain liabilities you also requested rulings concerning the pi trust which taxpayer will fund to pay some of those liabilities facts plr-114666-00 you represent the facts to be as follows taxpayer’s history taxpayer and its subsidiaries are engaged in the manufacture and distribution of certain products taxpayer which was incorporated as a subsidiary of corporation during date has used the accrual_method of accounting since its incorporation before date corporation had been named as a defendant in numerous lawsuits claiming damages for personal physical injury physical sickness or death from exposure to item that was included in products that corporation sold until year corporation manufactured products in site and site these manufacturing operations generated large amounts of hazardous materials that either remain on those sites or were transported to landfills or have contaminated other sites including wetlands and groundwater consequently the agency and the state have undertaken operations to investigate and remediate the hazardous_substance contaminations caused by corporation’s operations in site and site during date taxpayer became the parent_corporation of corporation taxpayer then devised a restructuring plan under which it acquired valuable business_assets from corporation divested itself of its corporation shares and attempted to divest itself of corporation’s item-related liabilities thereafter taxpayer was named a co-defendant with corporation in numerous item-related lawsuits as successor in liability to corporation subsequently federal courts have held that taxpayer was a successor to corporation’s item-related liabilities and issued an order barring taxpayer from continuing to litigate the issue of its successor liability for corporation’s liabilities plan_of_reorganization during date taxpayer filed for chapter bankruptcy protection in a united_states bankruptcy court the bankruptcy court during date taxpayer entered into a memorandum of understanding with its unsecured creditors the unsecured creditors the terms of which have been incorporated into a consensual plan_of_reorganization the plan the plan and each of its provisions were confirmed in their entirety in the order the order of the bankruptcy court that was entered on date the order also stated that the bankruptcy court has and will retain exclusive jurisdiction of the litigation and of the pi trust which was established by the plan composition of the unsecured creditors almost all of the unsecured creditors consist of the following groups the pi claimants who are all individuals holding present or future item-related personal injury tort claims against corporation for which taxpayer has successor liability and the environmental claimants the environmental claimants consist of the agency the state and one private party holding environmental claims under federal and state environmental laws against taxpayer in the chapter proceeding the claims held by the pi claimants and the plr-114666-00 claims of the environmental claimants have been estimated at approximately dollar_figureb and dollar_figurec respectively description of the unsecured creditors’ share the plan provides that the unsecured creditors will receive taxpayer stock available cash and tax benefits these assets are referred to collectively as the unsecured creditors’ share taxpayer stock consists of stock of the reorganized taxpayer the unsecured creditors through the pi trust in the case of the pi claimants will receive d percent of taxpayer stock and taxpayer’s pre-existing shareholders will retain e percent of taxpayer stock taxpayer stock’s overall value was appraised in a qualified_appraisal described in sec_1_468b-3 of the income_tax regulations taxpayer provided a copy of this appraisal to the administrator of the pi trust on date and attached a copy of the appraisal to its income_tax return in the time and manner required by sec_1_468b-3 the available cash determined when the plan was consummated equaled dollar_figuref it consisted of the amount of cash that was not reasonably needed to meet certain estimated near-term cash operating needs and capital needs of the reorganized debtor on the effective date of the plan the tax benefits are described in the plan’s tax assignment and assumption_agreement the tax agreement under the tax agreement the pi claimants and the other unsecured creditors collectively will receive present and future federal and state_income_tax savings relating to transfers to the pi trust and to the implementation of the settlement plan taxpayer is obligated by the tax agreement to take all reasonable actions necessary to obtain the tax benefits and to pay them over to the unsecured creditors as expeditiously as possible taxpayer anticipates that most of the net_operating_loss nol resulting from the contribution of taxpayer stock and available cash to the unsecured creditors will be carried back years this nol is anticipated to result in a tax_refund of approximately dollar_figureg the balance will be carried forward payment to the unsecured creditors of the tax_benefit resulting from the carryback as well as the use by taxpayer of the carryforward will then give rise to future tax benefits that must also be transferred to the unsecured creditors pursuant to the tax agreement all tax benefits will be paid in cash the governments’ agreement division of the unsecured creditors’ share the pi claimants and the environmental claimants agreed in a governments’ settlement agreement the governments’ agreement to divide the unsecured creditors’ share into sub-shares under the governments’ agreement a de_minimis sub-share of the unsecured creditors’ share was allocated to the allowed claims of unsecured creditors other than the pi claimants and the environmental claimants the pi claimants and the environmental claimants also agreed on how to allocate the amount of the unsecured plr-114666-00 creditors’ share remaining after the allowed claims were paid of that remaining amount h percent was to be transferred into the pi trust the pi trust would assume taxpayer’s tort liability to the pi claimants by processing and paying their claims in accordance with specified procedures pi trust distribution procedures the environmental claimants which have no interests in the pi trust would receive the remaining j percent of the unsecured creditors’ share discharge of liabilities upon taxpayer’s transfer of the taxpayer stock and its payments of available cash and tax benefits taxpayer’s obligations to the pi claimants and environmental claimants were discharged terms of the pi trust agreement and the pi trust distribution procedures you represent that under the present terms of the pi trust agreement and the pi trust distribution procedures the pi trust may not make a payment to a pi claimant except with respect to a personal physical injury that manifests itself before the date of the payment you also represent that payments from the pi trust to the pi claimants are solely for compensatory_damages on account of currently manifested personal physical injuries within the meaning of sec_104 and that the present pi trust documents do not allow payments from the pi trust to the pi claimants for interest punitive_damages or any other item of taxable_income because numerous pi claimants are expected to file claims against the pi trust over its lifetime the pi trust would not find it practical to require pi claimants to provide prior-year tax returns or otherwise to have access to those returns for purposes of determining whether such claimants have taken any medical expense deductions under sec_213 relating to any personal injuries with respect to which any amounts may be paid_by the pi trust expenses of the pi trust the pi trust expects to incur costs including the costs related to recovery_of amounts on certain item-related claims and causes of action transferred to the pi trust by taxpayer the pi trust does not expect to recover any claims for insurance proceeds transferred to the pi trust by taxpayer law and analysis taxpayer's requested rulings fall into two broad categories the first of these involves the legal status federal_income_tax consequences and information reporting requirements of the pi trust ruling_request sec_1 through the second the federal tax consequences to taxpayer resulting from its transfers to and fulfillment of its obligations to the unsecured creditors ruling requests through rulings relating to the pi trust ruling_request is the pi trust a qualified_settlement_fund plr-114666-00 sec_468b provides that nothing in any provision of law shall be construed as providing that an escrow account settlement fund or similar fund is not subject_to current income_tax the secretary shall prescribe regulations providing for the taxation of any such account or fund whether as a grantor_trust or otherwise sec_1_468b-1 provides that the following requirements must be met for a fund account or trust to be classified as a qualified_settlement_fund qsf it must be established pursuant to an order of or be approved by the united_states or any agency_or_instrumentality including a court of law thereof and be subject_to the continuing jurisdiction of that governmental authority it must be established to resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event or related series of events that has occurred and that has given rise to at least one claim asserting liability arising out of tort breach of contract or violation of law and the fund account or trust must be a_trust under applicable state law or its assets must otherwise be segregated from other assets of the transferor the pi trust meets each of the requirements of sec_1_468b-1 first the pi trust was approved by the bankruptcy court and is subject_to that court’s continuing jurisdiction second the pi trust was established to resolve item-related tort claims third the pi trust is organized as a_trust under applicable state law accordingly based on the information submitted and representations made we conclude that the pi trust is a qsf under sec_1_468b-1 ruling_request is the pi trust subject_to income_tax only on its modified gross_income sec_1_468b-2 provides that a qsf is subject_to tax on its modified gross_income for any taxable_year at a rate equal to the maximum rate in effect for that taxable_year under sec_1 the modified gross_income of a qsf is its gross_income as defined in sec_61 computed with the modifications listed in sec_1_468b-2 - as noted above the pi trust is a qsf accordingly based on the information submitted and representations made we conclude that only the modified gross_income of the pi trust is subject_to federal_income_tax ruling_request are the amounts of taxpayer’s transfers of taxpayer stock tax benefits and available cash to the pi trust excludable from the pi trust’s gross_income sec_1_468b-2 provides in general that amounts transferred to a qsf by or on behalf of a transferor to resolve or satisfy a liability for which the fund is established are excluded from a qsf’s gross_income taxpayer’s transfers to the pi trust of taxpayer stock tax benefits and available cash fall squarely within sec_1 b plr-114666-00 these transfers are in full satisfaction of the pi claimants’ present and future claims against taxpayer the pi trust in turn was established for the express purposes of assuming taxpayer’s tort liabilities and paying the claims of the pi claimants accordingly based on the information submitted and representations made we conclude that the amounts transferred to the pi trust - its sub-share of taxpayer stock tax benefits and available cash - are excludable from the pi trust’s gross_income under sec_1_468b-2 ruling_request is the pi trust allowed to deduct its administrative costs sec_1_468b-2 allows a qsf to deduct administrative costs and other incidental_expenses incurred in connection with the operation of the qsf that would be deductible under chapter of the code in determining the taxable_income of a corporation administrative costs and other incidental_expenses include state and local_taxes legal accounting and actuarial fees relating to the operation of the qsf and expenses arising from the notification of claimants and the processing of their claims administrative costs and other incidental_expenses do not include legal fees incurred by or on behalf of claimants accordingly based on the information submitted and representations made we conclude that the pi trust is allowed a deduction in computing its modified gross_income for those administrative costs and incidental_expenses it incurs that would be deductible under chapter of the code in computing the gross_income of a corporation no opinion is expressed however whether any particular expense incurred by the pi trust is an expense that is deductible under sec_1_468b-2 ruling_request is the pi trust’s basis in taxpayer stock the fair_market_value of that stock on the date it is transferred by taxpayer to the pi trust sec_1_468b-2 provides that a qsf’s initial basis in the property it receives from a transferor or from an insurer or other person on behalf of a transferor is the fair_market_value of that property on the date of transfer to the fund taxpayer is a transferor under sec_1_468b-1 with respect to the transfer of taxpayer stock to the pi trust accordingly based on the information submitted and representations made we conclude that the pi trust’s initial basis in taxpayer stock is the fair_market_value of that stock on the date taxpayer transfers that stock to the pi trust the governments’ agreement indicates that the environmental claimants may transfer taxpayer stock to the pi trust under certain circumstances you have not requested a ruling and we do not rule regarding the tax consequences of any transfer of taxpayer stock by the environmental claimants either to the pi trust or to any other person plr-114666-00 ruling_request is the pi trust subject_to the information reporting requirements of sec_6041 for payments it makes to pi claimants sec_6041 requires all persons engaged in a trade_or_business and making payment in the course of such trade_or_business to another person of fixed or determinable gains profits and income of dollar_figure or more in any taxable_year to file an information_return with respect to such payments sec_1_6041-1 provides that income is fixed when it is to be paid in amounts definitely predetermined income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained sec_104 provides that except in the case of amounts attributable to and not in excess of deductions allowed under sec_213 relating to medical etc expenses for any prior taxable_year gross_income does not include the amount of any damages other than punitive_damages received whether by suit or agreement and whether as lump sums or as periodic_payments on account of personal physical injuries or physical sickness sec_1_468b-2 provides that payments and distributions made by a qsf are subject_to the information reporting requirements of part iii of chapter of the code sec_1_468b-2 requires a qsf to file information returns on a distribution to a claimant if one or more transferors to the fund would have been required to make a return had that transferor made the distribution directly to the claimant sec_1_468b-4 states that the determination whether a distribution to a claimant is includible in the claimant's gross_income is generally made by reference to the claim in respect of which the distribution is made and as if the distribution were made directly by the transferor you represent that all payments made by the pi trust to pi claimants will be made on account of personal physical injuries under sec_104 accordingly based on the information submitted and representations made we conclude that the pi trust is not required to file information returns under sec_6041 for any payments it makes to the pi claimants that are not subject_to the tax_benefit_rule discussed below payments that would otherwise be excludable from gross_income under sec_104 are includible in income to the extent there was a prior tax_benefit - that is to the extent such payments are attributable to and not in excess of an individual's prior years’ deductions allowed under sec_213 even if such payments are taxable to the pi claimants however the payments do not constitute fixed and determinable income we decline to rule on whether the payments are in fact excludable from the income of any particular pi claimant under sec_104 because we have no pi claimant before us see sec_2 revproc_2002_1 2002_1_irb_1 plr-114666-00 within the meaning of sec_6041 because the pi trust will neither find it practical to require pi claimants to provide the pi trust with prior-year tax returns nor otherwise have access to those returns the pi trust will not have the information from which to ascertain the extent if any of a prior-year medical_expense_deduction accordingly based on the information submitted and representations made we also conclude that the pi trust is not required to file information returns under sec_6041 with respect to the portion of the payments it makes to pi claimants attributable to and not in excess of the pi claimants’ sec_213 deductions rulings regarding the effects of certain transfers on taxpayer ruling_request does sec_1032 apply to taxpayer’s transfer of taxpayer stock to the unsecured creditors so that taxpayer does not recognize any gain on that transfer sec_61 provides that gross_income includes gains derived from dealings in property sec_1001 provides generally that gain_or_loss from the sale_or_other_disposition of property is the difference between the amount_realized and the basis of the property as determined under sec_1011 sec_1001 states that except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under sec_1001 on the sale_or_exchange of property shall be recognized sec_1_468b-3 provides that a transferor must treat a transfer of property to a qsf as a sale_or_exchange for purposes of sec_1001 with the amount_realized by the transferor being the fair_market_value of the property on the date the transfer is made sec_1032 provides that no gain_or_loss will be recognized to a corporation on the receipt of money or other_property in exchange for stock of such corporation although sec_1032 refers to an exchange for money or other_property and does not expressly refer to exchanges of stock for debt it is generally acknowledged that sec_1032 applies to an exchange of a corporation’s stock for its debt subject_to sec_61 and sec_108 which provide that a corporation may have income from cancellation of indebtedness on an exchange of its stock for its own debt that is cancellation_of_indebtedness_income can be realized and recognized when debt is satisfied with stock of the debtor_corporation even though no gain is recognized on the issuance of the stock in this case taxpayer will transfer d percent of its stock to the unsecured creditors as a result of which the item-related tort and environmental claims held by those creditors will be discharged under the bankruptcy statute in the case of the pi claimants the discharge will occur as a result of the pi trust’s assumption of taxpayer’s item-related liabilities in the case of the environmental claimants the discharge will occur directly plr-114666-00 accordingly based on the information submitted and representations made we conclude that taxpayer will not recognize any gain_or_loss on its stock in exchange for the satisfaction of its debts to the pi claimants through the pi trust and the environmental claimants ruling_request will taxpayer recognize gain_or_loss by entering into the tax agreement under which it is obligated to transfer_tax benefits in future years to the unsecured creditors as just noted a transfer of property whether to a qsf or another person in exchange for money or other_property generally is a sale_or_exchange - and thus a realization event - under sec_1001 and sec_1_468b-3 however sec_1_468b-3 also provides that because the issuance of a transferor’s debt an obligation to provide services or property in the future or an obligation to make a payment described in sec_1_461-4 are generally not transfers of property by the transferor the issuance of that debt or obligation generally does not result in gain_or_loss to the transferor under that section sec_1_461-4 pertains to liabilities requiring a payment or series of payments to another person that arises under any workers compensation act or out of any tort breach of contract or violation of law under this provision a liability arising out of a tort breach of contract or violation of law includes a liability arising out of a settlement of a dispute in which a tort breach of contract or violation of law is alleged by entering into the tax agreement taxpayer has undertaken the obligation to pay future tax benefits to the unsecured creditors through the qsf in the case of the pi claimants taxpayer’s liability to the pi claimants arises under alleged violations of tort law its liability to the environmental claimants are based on alleged violations of federal and state environmental law thus both types of claim are described in sec_1_461-4 accordingly based on the information submitted and representations made we conclude that taxpayer will not realize any gain_or_loss under sec_1001 as a result of entering into the tax agreement in addition when taxpayer receives future-year tax refunds you represent that taxpayer will pay those refunds over in cash to fulfill its obligations under the tax agreement accordingly we conclude that these payments if made in cash will not constitute a realization event under sec_1001 ruling_request is taxpayer allowed a deduction under sec_162 in the years it transfers taxpayer stock available cash and cash arising from the tax benefits to the pi trust and the environmental claimants sec_162 provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying_on_a_trade_or_business plr-114666-00 sec_461 provides that a deduction shall be taken for the taxable_year that is the proper taxable_year under the method_of_accounting used in computing taxable_income sec_461 provides that in determining whether an amount has been incurred with respect to any item during any taxable_year the all_events_test shall not be treated as met any earlier than when economic_performance with respect to the item occurs sec_1_461-1 provides that under an accrual_method of accounting a liability is incurred and generally is taken into account for federal_income_tax purposes in the taxable_year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability sec_461 and d and sec_1_461-4 provide that with respect to liabilities arising out of tort or a violation of law economic_performance occurs as payment is made to the person to whom the liability is owed sec_1_468b-3 provides that for purposes of sec_461 economic_performance occurs with respect to a liability described in sec_1_468b-1 to the extent the transferor makes a transfer to a qsf to resolve or satisfy the liability liabilities described in sec_1_468b-1 include tort liabilities payments made in settlement of a lawsuit or potential lawsuits are generally deductible under sec_162 if the acts that gave rise to the litigation were performed in the ordinary conduct of the taxpayer’s business here taxpayer’s payments of damages to satisfy its tort liabilities for personal physical injuries caused by item to pi claimants are business_expenses under sec_162 in addition taxpayer’s payments to the environmental claimants to settle taxpayer’s violation of federal and state environmental law liabilities which will compensate those claimants for a portion of their costs of performing environmental remediation at sites formerly owned by taxpayer’s predecessors in interest are also business_expenses under sec_162 the transfers of taxpayer stock tax benefits and available cash are deductible in the years of transfer because the all events and economic_performance tests will be satisfied in each of those years both prongs of the all_events_test - the fact of taxpayer’s liability to both classes of claimants and the amount of that liability - were met not later than date when the bankruptcy court approved the plan under sec_1_461-4 economic_performance occurs with respect to taxpayer’s liability to the environmental claimants when the transfers are made to those claimants under sec_1_468b-3 economic_performance occurs with respect to taxpayer’s liability to the pi claimants as transfers are made to the pi trust in addition with respect to the transfer of taxpayer stock you represent that taxpayer has obtained a qualified_appraisal as required by sec_1_468b-3 and has met the requirements of sec_1_468b-3 therefore based on the information submitted and the representations made we conclude that taxpayer is allowed a deduction under sec_162 in an amount equal to the plr-114666-00 fair_market_value of taxpayer stock in the taxable_year during which that taxpayer stock is transferred to the environmental claimants and the pi trust additionally taxpayer will be allowed a deduction under sec_162 for the taxable years in which cash payments of tax benefits and available cash are made ruling_request will taxpayer realize cancellation of indebtedness cod income when the claims of the unsecured creditors are discharged sec_61 provides that gross_income includes income from the discharge_of_indebtedness such income also known as cancellation_of_indebtedness_income or cod income is ordinary in nature and equals the difference between what is owed and what is actually paid to satisfy the liability cod income must generally be reported by the debtor in the year the discharge occurs sec_108 provides that no income shall be realized from the discharge_of_indebtedness to the extent that payment of the liability would have given rise to a deduction the documentation submitted by taxpayer suggests that prior to the plan’s consummation a few of the item-related tort and environmental claims against taxpayer were liquidated to the extent those claims were discharged under the plan for amounts that were less than their face value taxpayer presumptively would have discharge_of_indebtedness income under sec_61 167_f3d_1323 10th cir however because payment of the liquidated claims would have given rise to a sec_162 deduction as discussed in ruling_request above the sec_108 exception applies accordingly taxpayer did not realize discharge_of_indebtedness income with respect to any liquidated claims that were discharged under the plan the great majority of the item-related tort and environmental claims however were unliquidated prior to consummation of the plan in the case of unliquidated claims - that is in the case of claims in which the amount of debt owing is disputed - the settlement of those claims does not give rise to discharge_of_indebtedness income rather if the dispute concerning the amount of the debt is in good_faith settlement of the dispute is ‘treated as the amount of debt cognizable for tax purposes ' preslar supra pincite quoting from 916_f2d_110 3rd cir 11_fsupp_537 w d ky accordingly based on the information submitted and representations made we conclude that taxpayer did not realize discharge_of_indebtedness income from its settlement of the item-related tort and environmental claims ruling_request will taxpayer’s payments to the unsecured creditors qualify as specified liability losses under sec_172 plr-114666-00 sec_172 allows a deduction for the taxable_year an amount equal to the aggregate of the the net_operating_loss carryovers to such year plus the net_operating_loss carrybacks to such year sec_172 provides that in the case of a taxpayer that has a specified_liability_loss as defined in sec_172 for a taxable_year such specified_liability_loss shall be a net_operating_loss_carryback to each of the taxable years preceding the year of such loss sec_172 and sec_172 define the term specified_liability_loss sec_172 defines a specified_liability_loss to mean any amount allowable as a deduction under sec_162 or sec_165 for amounts which are attributable to product_liability or expenses_incurred in investigating settling and opposing claims against the taxpayer on account of product_liability sec_172 provides that the term product_liability includes a the liability of the taxpayer for damages on account of physical injury or emotional harm to individuals on account of any defect in any product that is manufactured leased or sold by the taxpayer but only if b such injury or harm arises after the taxpayer has completed or terminated operations with respect to and has relinquished possession of such product sec_172 defines a specified_liability_loss to include any amount allowable as a deduction under chapter of subtitle a of the code other than sec_468 or sec_468a which is in satisfaction of a liability under a federal or state law requiring the remediation of environmental contamination sec_172 provides that a liability shall be taken into account under sec_172 only if i the act or failure to act giving rise to such liability occurs at least three years before the beginning of the taxable_year and ii the taxpayer used an accrual_method of accounting throughout the period or periods during which such act or failure to act occurred the item liability claims made by the pi claimants are product_liability claims because they arose out the settlement of claims for physical injury to individuals due to exposure to item which taxpayer’s predecessor manufactured and sold and which injuries arose after taxpayer’s predecessor relinquished control of the items the claims made by the environmental claimants are for environmental remediation required by federal and state law and taxpayer’s and or taxpayer’s predecessor corporation’s act or failure to act arose from actions that occurred more than three years before the taxable_year of the transfer moreover taxpayer has used an accrual_method of accounting since its incorporation during date and thus was on that method during any period or periods in which its act or failure to act occurred accordingly based on the information submitted and representations made we conclude that - plr-114666-00 the transfers to the pi claimants through the pi trust of taxpayer stock available cash and tax benefits are specified liability losses within the meaning of sec_172 which therefore may be carried back to each of the taxable years preceding the year of such loss taxpayer’s transfers to the environmental claimants of taxpayer stock available cash and tax benefits to satisfy environmental remediation claims for site and site are specified liability losses within the meaning of sec_172 to the extent that corporation used the accrual_method of accounting throughout any period or periods during which determined separately for site and site an obligation was imposed upon corporation for environmental remediation of those sites under the earlier of - a federal_law for example the comprehensive environmental response compensation and liability act u s c sec_9601 et seq or b applicable state law to the extent the above conditions are met taxpayer may carry back these losses to each of the taxable years preceding the year of such loss rulingrequest12 will taxpayer’s carryforwards of its net operating losses be subject_to the loss limitation rules of sec_382 sec_382 places limitations on the nol carryforwards and certain built-in losses of a loss_corporation that can be utilized following an ownership_change in that loss_corporation once sec_382 is activated by a prescribed change-of-ownership event the limitation of sec_382 takes hold and restricts the amount of the new loss corporation's taxable_income that can be offset by the taxpayer's net_operating_loss carryforwards in taxable years after the change_of_ownership sec_382 limits the amount of income that can be offset by the carryforwards to the sec_382 limitation however sec_382 and sec_1_382-9 prescribe special rules for corporations under the jurisdiction of a bankruptcy court sec_382 provides that sec_382 shall not apply to an ownership_change if i the old_loss_corporation is immediately before the ownership_change under the jurisdiction of the court in a title_11_or_similar_case and ii the shareholders and creditors of the old_loss_corporation determined immediately before such ownership_change own after such ownership_change and as a result of being shareholders or creditors immediately before such change percent or more of the stock in vote and value of the reorganized corporation under sec_1_382-9 a qualified_creditor is a beneficial_owner immediately before the ownership_change of qualified indebtedness of the loss_corporation these regulations also provide that a qualified_creditor owns stock of the new_loss_corporation only to the extent that the qualified_creditor receives stock in full or partial satisfaction of plr-114666-00 qualified indebtedness in a transaction ordered by the court or pursuant to a plan approved by the court in a title_11_or_similar_case under sec_1_382-9 indebtedness of the loss_corporation is qualified indebtedness if it - a b has been owned by the same beneficial_owner since the date that is months before the date of the filing of the title_11_or_similar_case or arose in the ordinary course of the trade_or_business of the loss_corporation and has been owned at all times by the same beneficial_owner sec_1_382-9 provides that beneficial_ownership of indebtedness is determined without applying attribution_rules sec_1_382-9 provides that ordinary course indebtedness includes claims arising out of a tort or breach of a statutory duty and indebtedness incurred with respect to expenses that would be deductible under sec_162 sec_1_382-9 permits tacking of the holding_period for a qualified_transfer if the transferee’s basis is determined under sec_1014 or sec_1015 or with reference to the transferor's basis in the indebtedness sec_1014 provides basis rules for property held by a person who acquired the property from a decedent or to whom the property passed from a decedent taxpayer has represented that the environmental claimants held their claims for more than months prior to the chapter filing that they have been the only holders of their claims and that the claims arose in the ordinary course of taxpayer’s business accordingly based on the information submitted and representations made we conclude that - the environmental claimants will be qualified creditors of the old_loss_corporation because they held qualified indebtedness of taxpayer before the change in ownership the pi claimants will be considered qualified creditors of the old_loss_corporation because they will be treated as directly owning taxpayer stock placed in the pi trust as of the original date of transfer by taxpayer and thus of owning a deemed stock interest a pi claimant will be considered to hold qualified indebtedness if that claimant i has held the claim for more than months prior to the chapter filing or ii has been the only holder of the claim and the claim arose in the ordinary course of taxpayer’s business plr-114666-00 taxpayer’s carryforwards of its nols will not become subject_to the loss limitation rules of sec_382 if an individual receives a deemed stock interest in the pi trust from a deceased pi claimant as long as all other requirements are fulfilled see sec_1_382-9 which provides that a transfer from a decedent will be considered a qualified_transfer caveats a copy of this letter must be attached to any income_tax return to which it is relevant we enclose a copy of the letter for this purpose also enclosed is a copy of the letter_ruling showing the deletions proposed to be made in the letter when it is disclosed under sec_6110 of the internal_revenue_code pursuant to powers of attorney on file in this office copies of this letter have been furnished to your authorized representatives this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent temporary or final regulations pertaining to one or more of the issues addressed in this ruling have not yet been adopted therefore this ruling will be modified or revoked by adoption of temporary or final regulations to the extent the regulations are inconsistent with any conclusion in the letter_ruling see section dollar_figure of revproc_2002_1 i r b or its successor except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any item discussed or referenced in this letter sincerely michael j montemurro senior technician reviewer office of associate chief_counsel income_tax accounting enclosures copy of letter copy for sec_6110 purposes cc


t c memo united_states tax_court ajai prakash and swarn prakash petitioners v commissioner of internal revenue respondent docket no filed date ajai prakash pro_se william j gregg and bartholomew cirenza for respondent memorandum findings_of_fact and opinion ruwe judge respondent issued a final_determination denying petitioners’ claim to abate interest on their and federal_income_tax liabilities petitioners timely filed a petition to this court under section h the sole issue for decision is whether respondent abused his - - discretion by denying petitioners’ claim to abate interest findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in new york when they filed their petition at all relevant times petitioner ajai prakash owned of the outstanding shares of stock in sutphin drugs inc sutphin a subchapter_s_corporation petitioners filed joint federal_income_tax returns for the taxable years and on january and and date respectively the following table summarizes the tax reported due by petitioners on their returns payments made by petitioners and penalties and interest added to petitioners’ account unless otherwise indicated all section references are to the internal_revenue_code in effect at all relevant times and all rule references are to the tax_court rules_of_practice and procedure petitioners were granted extensions of time to file their and tax returns until date date and date respectively item ty ty ty tax reported on return dollar_figure dollar_figure dollar_figure penalty for not prepaying dollar_figure dollar_figure dollar_figure penalty for late filing dollar_figure dollar_figure dollar_figure penalty for late payment dollar_figure dollar_figure dollar_figure interest dollar_figure dollar_figure dollar_figure withholding big_number big_number big_number payment with return big_number big_number big_number balance due dollar_figure dollar_figure dollar_figure petitioners paid the above-listed balances due for the taxable years and on march and and date respectively in early the internal_revenue_service irs initiated an audit of sutphin and examined sutphin’s forms 1120s u s income_tax return for an s_corporation for the taxable years and as part of the audit the irs requested copies of petitioners’ individual income_tax returns petitioners prepared form sec_1040x amended u s individual_income_tax_return for the taxable years and and personally delivered these returns to the irs on date petitioners filed the amended returns because income from sutphin was incorrectly reported on their originally filed tax returns the following table illustrates the tax reported due by petitioners on their original returns compared with the tax reported due on their amended returns tax reported tax reported increase in year original return amended_return tax reported dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number petitioners did not include payment with the amended returns for the increase in tax reported due on date petitioners executed two form sec_872 consent to extend the time to assess tax extending the time for assessment of tax for the taxable years and until date at a date not specified in the record petitioners executed three form sec_872 for the taxable years and extending the time for assessment of tax until date on date the irs opened an audit of petitioners’ individual tax returns for the taxable years and on date pursuant to their request petitioners received from the irs a record of account concerning their individual income_tax for the tax period ending date the record of account provided information regarding the taxable_year including the filing_date of petitioners’ form_1040 u s individual_income_tax_return date a zero account balance transactions payments penalties and interest related to the filing of petitioners’ tax_return and an itemized summary of petitioners’ tax_return on date respondent issued to petitioners an examination_report from the audit of their individual tax returns for the taxable years and the following table illustrates petitioners’ tax as determined by respondent in the examination_report compared with the self-reported tax_liabilities in petitioners’ amended returns tax reported tax due year amended_return examination_report increase dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number the tax_liabilities determined in the examination_report were higher than the tax_liabilities that petitioners self reported on their amended returns because of adjustments unrelated to sutphin eg unreported interest_income deduction for health insurance exemptions etc on date petitioners paid in full all tax_liabilities identified in the examination_report on date respondent issued to petitioners notices cp22e for the taxable years and on november the notices for and showed an increase in interest of dollar_figure dollar_figure and dollar_figure respectively each notice requested that continued petitioners paid the interest assessed in the notices cp22e for the taxable years and on date petitioners filed a form_843 claim_for_refund and request for abatement requesting interest abatement from date to date pertaining to the taxable years and by letter dated date respondent notified petitioners that the form_843 was being forwarded to the irs’ interest_abatement_coordinator on date respondent issued to petitioners a letter stating that their interest abatement claim for the taxable years and was not allowed because t here was not unreasonable error or delay relating to the performance of a ministerial or managerial act in processing the examination of your return on date respondent issued to petitioners a letter stating that the interest abatement claim for the taxable years and was being denied on date respondent issued to petitioners a final_determination disallowing petitioners’ interest abatement claim in full for the taxable years and the final_determination states we did not find any errors or delays on our part that merit the abatement of interest in our review of available continued petitioners pay the amount of interest by date records and other information for the period from date to date petitioners timely filed a petition with this court disputing respondent’s final_determination opinion interest on a federal_income_tax deficiency generally accrues at the rate specified by sec_6621 from the last date prescribed for payment until the date on which the tax is paid sec_6601 however sec_6404 authorizes the irs to abate the assessment of interest in some situations sec_6404 provides in general --in the case of any assessment of interest on-- a any deficiency attributable in whole or in part to any unreasonable error or delay by an officer_or_employee of the internal_revenue_service acting in his official capacity in performing a ministerial or managerial act or b any payment of any_tax described in sec_6212 to the extent that any unreasonable error or delay in such payment is attributable to such officer_or_employee being erroneous or dilatory in performing a ministerial or managerial act the secretary may abate the assessment of all or any part of such interest for any period for purposes of the preceding sentence an error or delay shall be taken into account only if no significant aspect of such error or delay can be attributed to the taxpayer involved and after the internal_revenue_service has contacted the taxpayer in writing with respect to such deficiency or payment congress intended for the commissioner to abate interest under sec_6404 where failure to abate interest would be widely perceived as grossly unfair and did not intend abatement to be used routinely to avoid payment of interest h_r rept no pincite 1986_3_cb_1 s rept no pincite 1986_3_cb_1 a ministerial_act is a procedural or mechanical act that does not involve the exercise of judgment or discretion by the commissioner sec_301_6404-2 proced admin regs a managerial act is an administrative act that occurs during the processing of a taxpayer’s case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel sec_301_6404-2 proced admin regs even when there has been an error or delay with respect to a ministerial or managerial act the secretary has discretion to decide whether to abate interest sec_6404 see grandelli v commissioner tcmemo_2008_55 tax ct memo lexi sec_55 at we have jurisdiction to determine whether the failure of the irs to abate interest was an abuse_of_discretion see sec_6404 rule sandberg v commissioner tcmemo_2011_72 tax ct memo lexis the burden_of_proof is on the taxpayer and to prevail the taxpayer must show that the irs abused its discretion rule a sandberg v commissioner tax ct memo lexis at the irs abuses its discretion if it exercised that discretion arbitrarily capriciously or without sound basis in fact or law 112_tc_19 to meet this burden the taxpayer must identify an error or delay by the commissioner in performing a ministerial or managerial act establish a correlation between the error or delay and a specific period for which interest should be abated and show that he or she would have paid the tax_liability earlier but for the error or delay see sec_6404 see also paneque v commissioner tcmemo_2013_48 at braun v commissioner tcmemo_2005_221 tax ct memo lexi sec_221 at petitioners argue that they were misled by the irs concerning their outstanding tax_liabilities for the taxable years and because they requested an account transcript in and received a ‘record of account’ showing a zero balance through date petitioners argue that the record of account showing a zero balance is a ministerial_act and error by the examining officer and the error justif ied petitioner s’ belief that all prior tax_liabilities had been paid accordingly petitioners argue that they are entitled to interest abatement for the timeframe of date to date petitioners cite douponce v commissioner tcmemo_1999_398 tax ct memo lexi sec_453 to support their contention that respondent provided inaccurate information concerning their account balance which they relied on in douponce the taxpayer called the irs to ascertain his outstanding tax balances for the taxable years and id tax ct memo lexi sec_453 at an employee of the irs informed the taxpayer that the following amounts remained outstanding zero for dollar_figure for and dollar_figure for id on date the taxpayer paid the balances for and id on date the commissioner notified the taxpayer by issuing a notice_of_intent_to_levy that he owed additional interest of dollar_figure with respect to his taxable_year id at we held that the commissioner abused his discretion in not abating interest concerning the taxable_year that accrued from date to date id at in doing so we stated the taxpayer asked an employee of the irs what the total amount due was for and the irs’ employee told the taxpayer the total amount due and the taxpayer promptly paid in a typewritten attachment to the form_843 petitioners explain that three months is a reasonable_time for review by the irs of their amended tax returns and therefore interest should be abated beginning on date those amounts however the employee did not include all of the accrued but unassessed interest in the amounts given to the taxpayer the taxpayer promptly discharged his liability for interest when he was notified of it on date it is reasonable to assume the only reason for the delay of in excess of months was caused by the irs’ failure to tell the taxpayer the correct amounts due when the taxpayer requested that information on date id at petitioners compare the record of account provided by the irs to petitioners on date to the incorrect ‘total amount due’ given by an employee in douponce we disagree and find petitioners’ case distinguishable from douponce on the facts the taxpayer in douponce called the appropriate irs service_center and inquired about his balance due for the taxable_year and an irs employee incorrectly informed the taxpayer that there was no outstanding balance douponce v commissioner tax ct memo lexi sec_453 at however unlike the taxpayer in douponce petitioners requested information concerning the taxable_year and received from the irs a record of account pertaining only to that taxable_year the record of account clearly provides that it is for tax period date and sets forth transactions and summaries pertaining to petitioners’ filed form_1040 for the taxable_year the record of account does show a zero balance however this balance concerns only petitioners’ taxable_year and has no relevance to the outstanding tax_liabilities for the taxable years and nothing in that record of account applies to any taxable_year other than the taxable_year and we find petitioners’ professed reliance on this document to be unreasonable petitioners also argue that respondent failed to issue a notice of balance due within a reasonable timeframe after the filing of their amended returns for the taxable years and petitioners argue that respondent’s failure to perform this critical ministerial_act caused interest to compound on petitioners’ account from date when the irs began the audit of petitioners’ individual returns to date when the irs issued the examination_report without their knowledge we disagree the interest accrued on petitioners’ account because they knowingly failed to pay the large amount of tax reported on their amended returns the record establishes that a significant aspect of the delay in payment on petitioners’ account is attributable to petitioners see sec_6404 petitioners filed amended returns for the taxable years and on date these amended returns reported corrected tax_liabilities substantially higher than the tax_liabilities petitioners reported on their original tax returns but only dollar_figure less than the tax_liabilities ultimately determined as a result of respondent’s audit despite the significant increase of tax_liabilities reported on their amended returns petitioners did not submit payment with the filing of the amended returns petitioners self reported their income_tax_liability on their amended returns for the taxable years and and chose to forgo making payments see hill v commissioner tcmemo_2010_200 aff’d 436_fedappx_410 5th cir on brief petitioners contend that they intended to pay the tax_liabilities that were self reported on the amended returns and had the capability to do so but there is no credible_evidence to explain why they decided to forgo payment of these liabilities we find that petitioners’ decision not to include payment with the filing of their amended returns reflects a conscious decision on their behalf not to satisfy their federal_income_tax liabilities until the conclusion of respondent’s audit we are unable to conclude that any delay in payment on petitioners’ account was not due in significant part to their own act of nonpayment see sec_6404 thus we hold that there was no abuse of in the form_843 petitioners assert that they believed payment was included with the filing of the amended returns as it was their normal practice to include payment when filing a return petitioners assert that t he irs agent did not inform us that checks or any items were missing from these amended returns we simply do not believe that petitioners thought that they paid the large amount of additional tax reported on their amended returns discretion by respondent in denying petitioners’ claim for interest abatement for the taxable years and in reaching our decision we have considered all arguments made by the parties and to the extent not mentioned or addressed they are irrelevant or without merit to reflect the foregoing decision will be entered for respondent


department of the treasury internal_revenue_service washington d c march cc dom fs fi p tl-n-7368-98 uilc number internal_revenue_service national_office field_service_advice memorandum for from district_counsel deborah a butler assistant chief_counsel field service cc dom fs subject this field_service_advice responds to your memorandum dated date 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 issuer developer developer developer bond sec_1 bond sec_2 bond sec_3 a dollar_figure b c d e f g h i j k dollar_figure l x maturity_date amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure amount dollar_figure date date date date date date dates issue s whether there are sufficient facts to support an argument that bond sec_2 were a reissuance of bond sec_1 what further factual development is necessary to support an argument that the bond sec_2 are arbitrage_bonds conclusions there are probably sufficient facts to support an argument that there has been a reissuance of bond sec_1 we want to see some additional facts in this regard however more importantly the focus should be on whether there was an another reissuance when bond sec_2 were sold on the secondary market we need to step the land sale and defeasance with another reissuance if there was a reissuance then we need to determine whether these bonds were obligations under sec_103 or arbitrage_bonds more factual development is necessary we recommend that additional information be provided and a supplemental fsa be requested to determine whether we have sufficient facts to proceed with a technical_advice additional information is necessary to support an argument that bond sec_2 or bond sec_3 are arbitrage_bonds there are several theories under the arbitrage rules for which we should continue to develop support that these bonds are not tax- exempt including those principles set forth in revrul_94_42 1994_2_cb_15 stepped transactions sham guarantees and the reissuance argument we recommend pursuing these theories rather than the general anti-abuse_rules regarding abusive arbitrage devices set forth in the arbitrage regulations in this case some facts support an argument that there was a prearrangement of transactions that should be stepped together to support a finding of either taxable arbitrage_bonds or obligations not qualifying under sec_103 we recommend that you further develop this case along the lines set forth below facts first transaction on date the issuer issued bond sec_1 in the amount of a the interest rate on a portion of those bonds was b percent the interest rate on the remaining bonds was c percent the bonds matured on date these bonds were callable and interest was due semiannnually bond proceeds were to be used to fund the acquisition construction and installation of the source of payment for the debt service on the bonds was to be general annual ad valorem property taxes the conduit borrower developer executed a development agreement whereby it would pay from to in amount these fees were to be used to pay debt service on the bonds until the property generated the required amount of property taxes developer had the right to develop the property and sell on property it owned within the development area on date developer defaulted on its obligation to pay the and declared bankruptcy the issuer foreclosed on developer 1's property in the development area since that was the security for its obligations to we are unable to tell from this description if the security for these bonds is similar to the pledged property taxes for bond sec_2 or whether there is some general obligation also involved the issuer the issuer obtained d acres of land most of the infrastructure had been completed because developer defaulted on its obligation to pay the facilities development fees and no homes had yet been built which could generate property taxes the issuer could not meet debt service on the bonds on date the issuer filed a chapter bankruptcy proceeding on date the bankruptcy court approved the issuer’s debtor plan second transaction as part of its bankruptcy plan the issuer was to exchange bond sec_1 for bond sec_2 bond sec_2 had a new maturity dates extended maturity dates beyond that of bond sec_1 and were zero coupon bonds which could not be called before maturity bond sec_2 were secured_by pledged limited tax revenues arising from the development property and the mortgage to the property acquired from developer if the pledged revenues were not sufficient to pay the principal and interest when the bonds matured the issuer would sell the property at the time of issuance on the bond sec_2 there was still no residences in the development so no property taxes could be levied as part of the plan to exchange bond sec_1 for bond sec_2 the issuer agreed to pay bondholders e cents on the dollar for bond sec_1 and to exchange bond sec_1 for like amounts of bond sec_2 developer then offered to pay bondholders f cents on the dollar for their bond sec_2 bondholders then recouped a total of g cents on the dollar of their original investment developer held all of bond sec_2 third transaction on date the issuer purchased h acres of land from developer developer had originally purchased the land located in the issuer’s development area for use as residential lots the issuer paid amount and executed notes payable for amount this amounted to about amount per acre the issuer stated in required_documentation that the purchase_price paid for the land was not in excess of fair_market_value there does not appear to be any question that this was an arms-length transaction fourth transaction on date the issuer sold approximately i acres of land including some of land obtained from developer 1's bankruptcy and its purchase from developer to developer for amount this was about amount per acre this was a substantial difference from the amount it recently paid for some of these acres amount per acre the purchaser of the land developer was also the bondholder for bond sec_2 and the land sold to it was the underlying_security for those bonds your office has also found a document entitled the dated date around the time of issuance of bond sec_2 which shows that the issuer had prior knowledge that it would be selling the land to developer for a then unknown amount fifth transaction the issuer used the sale proceeds from the land sale to purchase u s treasuries and placed them in an escrow account for the payment of principal and interest on bond sec_2 the amount of the land sale equals the exact amount that is needed to pay off debt service on bond sec_2 at maturity when that amount is invested at the interest rate stated on the bonds sixth transaction after the issuer established the escrow for bond sec_2 developer sold bond sec_2 in the secondary market bond sec_3 for amount realizing a profit of amount we have no other information regarding the sale of the bonds on the secondary market since the issuer sold the land to developer2 there still has been no development or construction of residences some of the land has since been sold by developer to another company owned by developer for development of j law and analysis issue we agree with your analysis that the facts support an argument that there was a reissuance of bond sec_1 there were significant changes in timing of payments on debt service and the underlying_security for bond sec_2 there was an extension of maturity dates on bond sec_2 of and years bond sec_2 were not callable while bond sec_1 were callable bond sec_2 were bonds whereas interest was to be paid on bond sec_1 semi-annually the security for bond sec_1 was property taxes the original security for bond sec_2 was pledged property taxes secured_by the mortgage to the property in the development area within a year of issuance of bond sec_2 they became secured_by u s treasuries you need to provide additional according to the agent the issuer was also to receive amount from developer for the purchase of this amount as well as the amount received from the land sale were actually used to purchase the treasuries information to support that finding see discussion under case development but more importantly you need to focus on whether there has been a reissuance when bond sec_2 were sold on the secondary market it is this reissuance that is important for arguing that these are arbitrage_bonds the fact that the issuer sold the land and used the proceeds to purchase the treasuries create a defeasance in and of itself is not necessarily determinitive but if the defeasance is linked to a reissuance so that the result is bond sec_3 then it will be easier to establish the arbitrage play or that these are not obligation qualifying under sec_103 because bond sec_2 were issued prior to notice_88_130 and the proposed and final regulations under sec_1_1001-3 guidance was provided in the form of published rulings private letter rulings and 499_us_554 the changes discussed above support a reissuance argument under this guidance and under the current regulations if there was an additional reissuance when the bonds were sold on the secondary market then the proposed_regulations were in effect we need more information on this transaction before we can assess the strength of this argument see case development section issue in trying to develop arguments that support the position that bond sec_2 and bond sec_3 were separate issues with only bond sec_2 as tax-exempt several theories should be pursued and facts supporting them more fully developed the principles in revrul_94_42 provide guidance as well as the reissuance rules proceeds from the land sale were replacement_proceeds and that there was an investment_yield of x amount furthermore we disagree with your analysis that the revrul_94_42 provides that if a transaction in substance closely resembles a taxable arbitrage_bond that is it allows the benefit of borrowing at a tax-exempt rate and investing at a taxable rate the result will be inconsistent with the purposes of sec_103 and the payments will not be treated as payments on a municipal obligation that ruling provides that amounts paid_or_accrued under an agreement guaranteeing payment on bonds is not excludable from gross_income under sec_103 if the agreement is not incidental or is in substance a separate debt_instrument or similar investment when purchased an agreement is considered as both incidental and not a separate debt_instrument or similar investment if at the time it is purchased the amount_paid to obtain the agreement is reasonable customary and consistent with reasonable expectation that the issuer of the bonds rather than the insurer will pay debt service on the bonds this rationale applies regardless of whether the agreement acquired the bonds at original issuance or on the secondary market although the ruling was not issued until its principles can be used as support for the position that these are arbitrage_bonds or that these bonds are not obligations under sec_103 in the ruling the county issued zero coupon bonds having a year maturity and a stated redemption price of 204x the bonds were solely payable from the revenues of the facility acquired with the bonds at the time there was significant risk that revenues from the facility would be insufficient to pay debt service in an unrelated transaction one year later m the sole holder of the bonds entered into an agreement with g under the agreement m paid g 14x in exchange for g guaranteeing the payment of all scheduled debt service on the bonds to m or any subsequent holders g then purchased 14x of u s treasuries in connection with its agreement with m the treasuries had a yield of the treasuries were transferred to a_trust to secure the payment of the bonds the principal and interest on the treasuries will be sufficient to pay off all debt service on the bonds g is unrelated to either the county or m the agreement with g allowed m to obtain the highest rating for the bonds from a national rating agency m then sold the bonds to the general_public for a price of dollar_figurex giving the purchasers a annual yield of approximately in reaching its conclusion the service reasoned that the purchasers of the insured bonds acquired two obligations from m the obligation of the county on th bonds and the obligation of g under the agreement the question is whether amounts paid_or_accrued under the g agreement are excludable from the bondholders gross_income as a substitute for tax-exempt_interest to make that determination one must look to the economic_substance of the transaction rather than its form if treating amounts paid under the g agreement would in substance permit either g or m to obtain the benefit of borrowing at a tax- exempt rate and investing proceeds at the taxable rate then the transaction closely resembles a taxable arbitrage_bond under sec_148 this purpose is inconsistent with the purposes of sec_103 and therefore would not be treated as obligations under sec_103 although bond insurance or guarantees are allowed in some circumstances an agreement which is not incidental to the bonds or that is a separate debt_instrument or similar investment is not permitted for purposes of tax-exemption if the amount_paid for the agreement is reasonable customary and consistent with the reasonable expectation that the issuer of the bonds rather than the insurer will pay debt service on the bonds then the agreement is considered incidental and not a separate debt_instrument or similar investment in the ruling it was determined that the premium paid to g was not reasonable or customary and that m looked primarily to g for payment of debt service on the bonds as evidence of the reasonable expectations that g rather than the county would make payment on the bonds is m’s payment to g of an amount sufficient to fund substantially_all of the debt service in this case the economics of the transaction may be similar to the ruling zero coupon bonds were issued initially secured_by the pledged property_tax revenues in an area where no have been constructed making the collection of property taxes improbable it is very questionable whether property taxes would be sufficient to cover debt service at maturity dates since there are still no built to date no other sinking funds had been established except the escrow of u s treasuries which was established within one year of issuance of the bonds developer was the sole bondholder the issuer sold land in the development to developer in exchange for money the amount_paid to the issuer appears to a great deal above the fair_market_value of the land in fact the amount_paid by developer for the land sale equaled the amount necessary to invest at m percent and pay off bond sec_2 at maturity the issuer then used the sale proceeds to purchase u s treasuries and placed them in escrow to secure payment of debt service on the bonds after the treasuries were placed in the escrow developer sold the bonds on the secondary market for a large profit the payment for debt service on the bonds is reasonably expected to be made from the u s treasuries and not the pledged property taxes it is reasonable to conclude that a premium paid_by developer was used to purchase a guarantee for payment on the debt service of the bonds to enable the bonds to be remarketed which would not have been possible without the guarantee we need to establish that these transactions resulted in either the issuer or developer benefitting by borrowing at the tax-exempt rate and investing at the taxable rate for finding that we have a taxable arbitrage_bond ie what is the yield to the holder if the profits are considered we could also find that this purpose is inconsistent with the purposes of sec_103 and therefore this would not be a municipal obligation under sec_103 we also need to determine whether it is reasonable and customary to pay the amount for the guarantee and that it is expected that the issuer will pay debt service on the bonds in this case there are some differences that could present some problems for example the guarantee for payment on the bonds is possible because of the payment made from developer to the issuer there is no unrelated party involved as in the ruling although the ruling does not require that there be unrelated parties it may be more difficult to argue that the issuer is not reasonably expected to pay debt service since the treasuries were purchased by the issuer from the sale of its land if we can establish that there is a reissuance of bond sec_2 to bond sec_3 this may be less of a problem case development hazards and other considerations please call if you have any further questions by joel e helke branch chief financial institutions products branch


department of the treasury internal_revenue_service washington d c t a x e x e m p t a n d g o v e r n m e n t e n t i t i e s d i v i s i o n number release date se t eo ra t date uniform issue list number contact person contact’s identification_number telephone number legend c f x dear ------------------- this is in reply to corporation c’s letter requesting a ruling that c’s redemption of private_foundation f’s common_stock in c will not be an act of self-dealing under sec_4941 of the internal_revenue_code c is a for-profit corporation and is a disqualified_person under sec_4946 of the code with respect to private_foundation f c’s assets consist entirely of publicly listed securities and all of its gross_income is from passive sources dividends interest and sale of securities f is a nonprofit charitable corporation that is exempt from federal_income_tax under sec_501 of the code and is a private_foundation under sec_509 of the code f together with other disqualified persons effectively controls c under the proposed transaction c will pay in cash to f the fair_market_value of f’s common_stock in c c is the only one of the four common shareholders accepting the redemption offer the others have declined because they would incur large taxes from capital_gains c has agreed to value the stock on the basis of market quotations on the securities held by c and to redeem the stock within one month of the valuation the value of f’s shares will not be discounted for lack of marketability or for f’s minority ownership status the following ruling is requested c’s redemption of f’s x shares of stock in c will not constitute an act of self-dealing under sec_4941 of the code sec_501 of the code provides for the exemption from federal_income_tax of nonprofit_organizations organized and operated exclusively for the charitable and or other exempt purposes stated in that section sec_509 of the code describes organizations exempt from federal_income_tax under sec_501 that are private_foundations subject_to the provisions of chapter sec_4941 of the code imposes an excise_tax on any act of self-dealing between a private_foundation and a disqualified_person as defined in sec_4946 sec_4941 of the code provides in pertinent part that the term self-dealing means any direct or indirect sale of property between a private_foundation and a disqualified_person as defined in sec_4946 sec_53_4941_d_-1 of the foundation and similar excise_tax regulations provides that an act of self-dealing can be a direct or indirect transaction and it is immaterial whether the transaction results in a benefit to the private_foundation sec_4941 of the code provides that a stock_redemption transaction between a private_foundation and a corporation that is a disqualified_person as defined in sec_4946 is not an act of self-dealing under sec_4941 of the code if all of the securities of the same class as that held by the private_foundation are subject_to the same terms and such terms provided for the receipt by the private_foundation of no less than fair_market_value sec_53_4941_d_-3 of the regulations provides that a stock_redemption between a private_foundation and a corporation which is a disqualified_person will not be an act of self-dealing if such transaction is engaged in pursuant to a redemption recapitalization or other corporate adjustment so long as all the securities of the same class as that held prior to such transaction by the private_foundation are subject_to the same terms and such terms provide for receipt by the foundation of no less than fair_market_value further all of the securities are not subject_to the same terms unless pursuant to such transaction the corporation makes a bona_fide offer on a uniform basis to the foundation and every other person who holds such securities the fact that a private_foundation receives property such as debentures while all other persons holding securities of the same class receive cash for their interests will be evidence that such offer was not made on a uniform basis this may apply even if no other person holds any securities of the class held by the foundation in such event however the consideration received by holders of other classes of securities or the interests retained by holders of such other classes when considered in relation to the consideration received by the foundation must indicate that the private_foundation received at least as favorable treatment in relation to its interests as the holders of any other class of securities in addition the foundation must receive no less than the fair_market_value of its interests sec_53_4941_e_-1 of the regulations provides that fair_market_value shall be determined pursuant to the provisions of sec_53_4942_a_-2 sec_53_4942_a_-2 of the regulations sets forth one rule a -2 c i for securities including stocks for which market quotations are readily available and another rule a -2 c iv for other_securities the latter rule provides for annual valuation within the tax_year of the foundation with the following exception if however a private_foundation owns voting_stock of an issuer of unlisted securities and has or together with disqualified persons or another private_foundation has effective_control of the issuer within the meaning of sec_53_4943-3 then to the extent that the issuer's assets consist of shares of listed securities issues such assets shall be valued monthly on the basis of market quotations or in accordance with sec_4942 if applicable thus for example if a private_foundation and a disqualified_person together own all of the unlisted voting_stock of a holding_company which in turn holds a portfolio of securities of issues which are listed on the new york stock exchange in determining the net_worth of the holding_company the underlying portfolio securities are to be valued monthly by reference to market quotations for their issues unless a decrease in such value is authorized in accordance with sec_4942 such determination may be made by employees of the private_foundation or by any other person without regard to whether such person is a disqualified_person with respect to the foundation sec_4946 of the code defines the disqualified persons subject_to sec_4941 sec_4946 of the code provides that a disqualified_person includes a corporation in which certain persons as described in sec_4946 of the code own more than percent of the profits interest 885_f2d_848 court_of_appeals_for_the_federal_circuit date concerns a redemption under sec_4941 of the code and emphasizes that a private_foundation must receive fair_market_value for its stock redeemed in this case c will pay f the full fair_market_value of f’s x shares of common_stock in c it is represented that the fair_market_value here is objectively determinable by the use of quotes for the publicly_traded_securities and cash-type investments that are the property of c to which the common_stock is tied the valuation will occur within a month of the redemption as required by sec_53_4942_a_-2 of the regulations under the circumstances accordingly we rule as you have requested that c’s redemption f’s x shares of stock in c will not constitute an act of self-dealing under sec_4941 of the code because this ruling letter could help to resolve any questions please keep it in your permanent records this ruling letter is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited as precedent sincerely technical group jane baniewicz manager exempt_organizations


t c memo united_states tax_court edman and debbie kay hackworth petitioners v commissioner of internal revenue respondent docket no filed date william h thomas iii for petitioners james r rich for respondent memorandum findings_of_fact and opinion cohen judge respondent determined deficiencies and penalties with respect to petitioners’ federal income taxes for and as follows year deficiency penalties sec_6662 sec_6663 dollar_figure big_number dollar_figure big_number dollar_figure big_number after concessions by the parties the issue for decision is whether petitioners are entitled to a loss deduction for for the cash that petitioner edman hackworth forfeited to the state of south carolina as a result of his violation of south carolina’s gambling laws unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure all amounts have been rounded to the nearest dollar findings_of_fact some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference at the time that the petition in this case was filed petitioners resided in greer south carolina background during and petitioner edman hackworth petitioner owned and operated sand trap inc an s_corporation sand trap inc operated a bar named sand trap lounge the sand trap in greenville south carolina during those years in date the greenville county south carolina sheriff’s office gcso began an investigation of petitioner based upon information that he was operating an illegal gambling business out of his residence and out of the sand trap on or about date gcso began surveillance on the sand trap and on petitioners’ residence between august and date a gcso officer frequented the sand trap in an undercover capacity while working undercover at the sand trap this officer placed bets on various sporting events and observed other gambling and gambling-related activities on or about date gcso officers collected several trash bags from the roadside in front of petitioners’ residence one of these trash bags was filled with used gambling paraphernalia and business records from petitioner’s gambling operation on or about date gcso officers executed a search warrant on petitioners’ residence petitioner was at home at the time that this search warrant was executed and was placed under arrest for bookmaking and setting up a lottery shortly after arresting petitioner gcso officers placed petitioner debbie kay hackworth mrs hackworth under arrest at one of her business locations for bookmaking and brought her back to petitioners’ residence upon searching petitioners’ residence gcso discovered inter alia a betting room with seven telephone lines tape-recording devices two computers and gambling paraphernalia keys to petitioner’s safety deposit box at carolina first bank and a total of dollar_figure in cash all of which was seized the cash was discovered in the following amounts and locations in petitioners’ residence dollar_figure in a safe in the betting room dollar_figure in the kitchen dollar_figure in mrs hackworth’s purse and dollar_figure in mrs hackworth’s closet in the master bedroom also on or about this date gcso officers executed a search warrant on the sand trap and discovered and seized gambling paraphernalia dollar_figure in cash from a back room safe and dollar_figure in cash from behind the bar that was part of a betting pool on or about date gcso officers executed a search warrant on petitioner’s safety deposit box at carolina first bank and discovered and seized dollar_figure in cash contained therein with this seizure gcso had seized a total of dollar_figure in cash from petitioners on date petitioner voluntarily consented to forfeit to the state of south carolina dollar_figure of the cash that had been seized by gcso in connection with his arrest and the execution of the search warrants described above by signing and dating a document entitled consent forfeiture of monies derived from gambling consent form the consent form provided in pertinent part as follows defendant’s respondent’s property was seized as a result of an investigation and arrest of the defendant on sept for a violation of south carolina gambling statutes the defendant was charged with adventuring in lottery the parties now desire to enter into a compromise settlement to avoid litigation whereby the defendant agrees to voluntarily relinquish all rights and ownership to the defendant’s property it is therefore ordered that the defendant’s respondent’s property of dollar_figure one hundred and fifty-two thousand and sixteen dollars in united_states currency be forfeited pursuant to sec code of laws of south carolina as amended gcso gave petitioner a form that explained the consent form also on this date the dollar_figure in cash that had been seized from mrs hackworth’s purse and the dollar_figure in cash that had been seized from mrs hackworth’s closet were returned to petitioner on or about date petitioner pleaded guilty to adventuring in lotteries in violation of section of the code of laws of south carolina in connection with petitioner’s guilty plea he was issued a citation and paid a dollar_figure fine petitioners’ income_tax return for petitioners’ joint federal_income_tax return for was due to be filed with the internal_revenue_service irs center in atlanta georgia by date petitioners did not file their return however until date louis g manios prepared petitioners’ return petitioners attached three schedules c profit or loss from business to their return the first two schedules c related to businesses operated by mrs hackworth the third schedule c related to petitioner’s gambling activities on his schedule c petitioner reported gross_receipts of dollar_figure from his gambling activities which were referred to as services on this form petitioner also deducted dollar_figure for legal and professional services on this form this deduction was taken for the cash that petitioner forfeited to the state of south carolina as a result of his violation of south carolina’s gambling laws in the statutory_notice_of_deficiency sent to petitioners in addition to the adjustments no longer contested the irs disallowed the dollar_figure deduction claimed on petitioner’s schedule c the irs determined that petitioners had not established that any amount of this claimed deduction represented a deductible expense was an ordinary and necessary business_expense or was expended for the purpose designated accordingly the irs increased petitioners’ taxable_income for by dollar_figure opinion petitioners seek a deduction for the cash that petitioner voluntarily forfeited to the state of south carolina under section forfeiture of wagers of the code of laws of south carolina as a result of his violation of south carolina’s gambling laws petitioners have not argued that this deduction falls under sec_162 as an ordinary and necessary business_expense so we rely on the general principle that a deduction for property forfeited under federal or state forfeiture laws if allowed at all falls under the loss deduction provisions of sec_165 see 213_f2d_102 10th cir affg 20_tc_308 69_tc_114 69_tc_75 affd per curiam 611_f2d_1160 5th cir see also 91_tc_826 n bailey v commissioner tcmemo_1989_674 affd without published opinion 929_f2d_700 6th cir mack v commissioner tcmemo_1989_490 farris v commissioner tcmemo_1985_346 affd without published opinion 823_f2d_1552 9th cir accordingly we must decide whether petitioners are entitled to a loss deduction under sec_165 for sec_165 allows a deduction for any loss sustained during the taxable_year and not_compensated_for_by_insurance_or_otherwise in the case of an individual the deduction is limited to losses_incurred in the individual’s trade_or_business or in any transaction entered into for profit and to certain casualty losses sec_165 the facts disclose that petitioner was operating an illegal gambling enterprise in thus the deduction asserted by petitioners falls conceptually within the ambit of sec_165 and c courts have consistently found that a loss deduction will be denied however where the deduction would frustrate a sharply defined federal or state policy see eg 863_f2d_417 5th cir 226_f2d_115 4th cir fuller v commissioner supra pincite 88_tc_677 affd without published opinion 867_f2d_605 1st cir holmes enters inc v commissioner supra pincite holt v commissioner supra pincite murillo v commissioner tcmemo_1998_13 affd without published opinion 166_f3d_1201 2d cir bailey v commissioner supra mack v commissioner supra farris v commissioner supra 195_fsupp_474 n d iowa see also 152_f3d_1200 9th cir 129_f2d_363 7th cir affg 43_bta_973 respondent contends that petitioners should not be allowed a loss deduction for the cash that petitioner forfeited to the state of south carolina because the allowance of such a deduction would frustrate south carolina’s sharply defined policy against illegal gambling petitioners assert without citation of authority that respondent has the burden of proving by clear_and_convincing evidence that the public policy exception applies to deny the loss deduction for the cash that petitioner forfeited petitioners rely vaguely on the legislative design under sec_162 neither the statutory language of sec_165 nor the caselaw interpreting that section supports petitioners’ proposition in any event the issue in this case is essentially legal and the outcome does not depend on the burden_of_proof south carolina had a sharply defined policy against illegal gambling in as expressed in its statutes and enforced by the gcso petitioner acknowledged that the forfeiture was made pursuant to the laws of south carolina and pleaded guilty petitioner’s claim that his consent to the forfeiture was revoked is uncorroborated and unpersuasive to allow petitioners a deduction for a loss arising out of petitioner’s illegal activities would undermine south carolina’s policy by permitting a portion of the forfeiture to be borne by the federal government thus taking the sting out of the forfeiture see 356_us_30 wood v united_states supra pincite holt v commissioner supra pincite murillo v commissioner supra mack v commissioner supra farris v commissioner supra hopka v united_states supra pincite in accordance with these controlling precedents petitioners are not entitled to a loss deduction under sec_165 for for the cash that petitioner forfeited to the state of south carolina petitioners contend that petitioner’s forfeiture is invalid because it was disproportionate to his crime and violated the eighth amendment to the constitution and also because it did not comply with the laws of south carolina accordingly petitioners conclude that they should be allowed a loss deduction for the cash that petitioner forfeited because the public policy exception applies only when the underlying action by the government is legal and properly conducted by the state authorities under their own laws and the laws of the united_states petitioners’ contention as to the validity of the forfeiture however is not properly an issue in this court the tax_court is a court of limited jurisdiction and we may exercise our jurisdiction only to the extent authorized by congress see sec_7442 85_tc_527 see also 320_us_418 this court lacks jurisdiction over petitioners’ collateral attack on the forfeiture petitioners further contend that the damage done to south carolina’s policy against illegal gambling is outweighed by congressional intent that business_losses be allowed to be deducted and that the income_tax be imposed upon a taxpayer’s net_income in support of this contention petitioners cite 343_us_90 356_us_27 383_us_687 48_tc_15 and 232_f2d_107 5th cir as we discuss below petitioners’ reliance on these cases is misplaced consequently petitioners’ contention is unpersuasive in lilly v commissioner supra opticians sought to deduct payments that they made to eye doctors as ordinary and necessary business_expenses these payments were made pursuant to agreements that reflected an established and widespread practice in that industry whereby the eye doctors agreed to recommend their patients to certain opticians and the opticians agreed to pay those referring eye doctors one-third of the retail sales_price that they received for the eyeglasses that they sold the court_of_appeals for the fourth circuit held such payments nondeductible on the grounds that they were against public policy the supreme court reversed however holding that the payments did not stand on the same basis as expenditures that violated some federal or state law or that were incidental to such violations the court drew a distinction between these payments which were at most professionally unethical and outlawed expenditures which by virtue of their illegality frustrated some sharply defined federal or state policy petitioner’s proceeds from his illegal gambling enterprise were not akin to the payments in dispute in lilly the moneys seized from petitioner were presumptively the essence of his illegal venture the forfeiture was incidental to petitioner’s violation of south carolina’s gambling laws therefore the holding in lilly does not support petitioner’s argument in commissioner v sullivan supra the supreme court held that an illegal gambling enterprise is a business for federal tax purposes and that deductions for ordinary and necessary business_expenses involved in operating the enterprise were allowable the court reasoned that to deny such deductions would result in taxing the gross_receipts of the business rather than its net_income in commissioner v tellier supra the taxpayer sought a deduction for legal fees incurred in the unsuccessful defense of a criminal prosecution relating to his business the commissioner conceded that the fees were ordinary and necessary business_expenses the only question was whether the allowance of a deduction would frustrate public policy the supreme court held that no public policy was frustrated by allowing these legal fees to be deducted as ordinary and necessary business_expenses sullivan and tellier stand for the proposition that a taxpayer may be allowed to deduct legitimate ie ordinary and necessary business_expenses in the operation of an illegitimate enterprise that concept is not determinative in our analysis of this case because we are dealing with a forfeiture that does not qualify as an ordinary and necessary business_expense under sec_162 furthermore the allowance of a loss deduction in this case would undermine the impact of south carolina’s sharply defined policy against illegal gambling accordingly sullivan and tellier are inapposite in grossman sons inc v commissioner supra we considered a situation in which a taxpayer sought a deduction for the amount that it had paid to the united_states in settlement of a proceeding under the false claims act u s c secs the version after examining the record of the settlement negotiations and the settlement agreement between the united_states and the taxpayer we concluded that this payment was made to reimburse the government for its damages for breach of contract and was not a penalty or forfeiture we also examined the false claims act and concluded that the act was partly remedial and compensatory in nature and partly punitive based upon that conclusion we rejected the argument that no amounts paid_or_incurred in satisfaction of claims of the united_states under the false claims act whether by judgment or by settlement were deductible because of public policy accordingly we allowed the taxpayer to deduct the settlement amount as an ordinary and necessary business_expense under the pre-1969 version of sec_162 in grossman sons inc the taxpayer settled a breach of contract dispute with the government and was allowed to deduct the settlement amount as an ordinary and necessary business_expense unlike the facts of grossman sons inc petitioner’s payment ie forfeiture to the state of south carolina resulted from his violation of south carolina’s gambling laws and not from a settlement of a breach of contract dispute in edwards v bromberg supra the taxpayer sought a loss deduction for the theft of his money the taxpayer had agreed to provide money to another individual in order to bet on a fixed horse race the individual absconded with the taxpayer’s money after deciding that there was no scheme to defraud anyone except the taxpayer himself the court allowed the deduction bromberg is also distinguishable petitioner’s funds were seized by the state of south carolina in the enforcement of its gambling laws the purpose of the seizure and forfeiture was to cripple petitioner’s illegal gambling activities if a loss deduction were allowed in this case the federal government would in effect be carrying a portion of the loss inflicted on petitioners by the state of south carolina because of petitioner’s illegal activities finally petitioners contend that imposing a liability for federal income taxes on the cash that petitioner forfeited without allowing a loss deduction for the forfeited amount violates the double_jeopardy clause of the fifth_amendment to the constitution in support of this contention petitioners cite 490_us_435 the double_jeopardy clause protects individuals only against the imposition of multiple criminal punishments for the same offense 522_us_93 abrogating united_states v halper supra on this issue see also 303_us_391 the imposition of a liability for a federal_income_tax deficiency is remedial and is not a criminal punishment see 112_tc_304 see also 98_tc_165 cf 13_f3d_432 1st cir affg tcmemo_1993_61 a fortiori the denial of a deduction ie the item that gave rise to the income_tax deficiency in this case is not a criminal punishment see eg murillo v commissioner tcmemo_1998_13 affd without published opinion 166_f3d_1201 2d cir accordingly denying petitioners a loss deduction for the cash that petitioner forfeited does not violate the double_jeopardy clause we have considered the arguments of the parties that were not specifically addressed in this opinion those arguments are either without merit or irrelevant to our decision to reflect the foregoing and the concessions of the parties decision will be entered under rule