t c memo united_states tax_court estate of james j renier deceased kent l renier and dubuque bank trust company co-executors petitioner v commissioner of internal revenue respondent docket no filed date james l malone iti and sheri l everson for petitioner james s stanis and david s weiner for respondent memorandum findings_of_fact and opinion gale judge respondent determined a deficiency in federal estate_tax of dollar_figure and an addition_to_tax under sec_6662 of dollar_figure against the estate of james j renier estate after concessions we must decide the following - - what was the fair_market_value of the big_number shares of stock in the renier company held by james j renier decedent at his death on date valuation_date whether the estate is liable for an addition_to_tax under sec_6662 for a substantial_estate_or_gift_tax_valuation_understatement unless otherwise noted all section references are to the internal_revenue_code in effect as of the date of decedent’s death and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are so found we incorporate by this reference the stipulation of facts and attached exhibits at the time of filing the petition co- executor kent l renier resided and co-executor dubuque bank trust company had its principal_place_of_business in dubuque iowa decedent resided in dubuque iowa on the date of his death and his will was probated in the iowa district_court for dubuque county ' the estate also alleged in the petition that respondent erred in disallowing a deduction by the estate for charitable_bequests totaling dollar_figure however the estate made no argument at trial or on brief concerning that allegation and we consider it abandoned see 91_tc_524 ndollar_figure bowman v commissioner tcmemo_1997_52 n affd without published opinion 149_f3d_1167 4th cir since the renier family has conducted a retail business in dubuque beginning in the 1950's the renier company renier switched its business focus from musical instruments to the sale of televisions and stereo equipment in the 1980's it expanded its product mix to include video camcorders and vcr’s on the valuation_date televisions and vcr’s comprised percent of renier’s sales with audio systems and components making up another percent and camcorders and car stereos constituting percent another percent of renier’s sales consisted of batteries and electronic accessories while the remaining percent consisted of cordless telephones the national annual compound rate of growth from through for televisions and vcr’s was dollar_figure percent for audio systems and components dollar_figure percent for camcorders and car stereos dollar_figure percent for batteries and electronic accessories dollar_figure percent and for cordless telephones dollar_figure percent when weighted to reflect the percentage of sales by renier for each product_area the national annual compound rate of growth for renier’s product mix from through was dollar_figure percent renier’s actual sales increased at a compound rate of percent from date through date however the majority of renier’s growth during that period occurred between date and date during which time sales increased percent in part as a result of a major flood in the area that caused many residents to replace their consumer electronic products considering only q4e- date through date renier’s compound annual growth was just percent renier’s retail operation consisted of a single big_number square-foot store located ina strip mall in dubuque renier was open for busine sec_68 hours per week hours a day on monday through friday hours on saturday and hours on sunday in the city of dubuque had an estimated population of big_number dubuque’s population had declined over percent since and was not expected to grow rapidly after the valuation_date on the valuation_date renier had seven employees including kent and maria renier decedent’s son and daughter-in-law kent and maria kent served as store manager and as a salesperson and maria performed clerical and bookkeeping functions kent was also responsible for about one-third of renier’s total sales at various times during the years and approximately months preceding the valuation_date decedent and five other members of his family were employed by renier until date decedent remained active in the business meeting customers and handling renier’s advertising and finances after date health problems prevented decedent from working the sales floor but he continued to be involved in renier’s advertising and finances renier’s primary competition consisted of national retail chains which operated stores in the dubuque area these chain stores offered a much broader consumer electronics product - - selection than did renier and included such stores as wards wal- mart k-mart target radio shack and sears additional competition came from local independent businesses in dubuque that sold consumer electronic products the dubuque area retail environment became more competitive in the 1980's and early 1990's as large discount stores chain stores and warehouse clubs increased product offerings and offered low prices to gain market share these larger businesses purchased inventory at low prices due to volume purchases utilized sophisticated inventory control systems to manage inventory and effectively leveraged advertising expenditures due to the operation of numerous retail outlets although renier could not purchase inventory at the prices available to the chains and discount stores it was able to achieve some discounts through participation in a buying cooperative made up of independent retailers in addition because renier was not highly leveraged and maintained ample working_capital it was further able to reduce its inventory costs by taking advantage of prompt payment discounts offered by many vendors renier computed its income for tax and financial reporting purposes on the basis of a fiscal_year ending june renier’s pretax profit margin from date through the valuation_date substantially exceeded the national industry average for retailers of consumer electronics however no meaningful growth -- - trend during this period is discernible because for some time prior to its fiscal_year ended date renier overestimated its cost_of_goods_sold as the result of an error in its inventory_accounting system and consequently underreported its net_income this error was addressed in at which time renier filed amended corporate_income_tax returns for and reporting increased taxable_income for those years these changes resulted in renier’s having additional income_tax liabilities totaling dollar_figure for the period beginning date and ending on the valuation_date ’ which renier paid in renier also revised its financial statements to reflect the changes after the revisions renier had total pretax net_income from date through the valuation_date of dollar_figure and after-tax net_income of dollar_figure decedent became president of renier in the 1960's and served in that position until his death at his death decedent owned big_number of the big_number outstanding shares of renier’s common_stock renier’s shares have never been listed on any stock exchange or available on any over-the-counter market and have never been publicly traded or privately traded the co-executors hired jules steinberg to appraise renier’s shares for estate_tax purposes based on mr steinberg’s renier had increased tax_liability for its fiscal_year of dollar_figure and increased tax_liability of dollar_figure ona prorated basis for the first dollar_figure months of renier’s fiscal_year that occurred prior to the valuation_date - appraisal the estate reported decedent’s interest in renier at a value of dollar_figure or dollar_figure per share on the valuation_date in the notice_of_deficiency respondent valued decedent’s interest in renier at dollar_figure or dollar_figure per share on the valuation_date ultimate finding of fact the fair_market_value of decedent’s big_number shares of renier on the valuation_date was dollar_figure or dollar_figure per share opinion i renier’s fair_market_value we must decide the fair_market_value of decedent’s shares of stock in renier on the valuation_date both parties rely on expert opinions to support their claimed values fair_market_value is defined as ‘the price at which the property would change hands between a willing buyer and a willing seller neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts ’ 411_us_546 quoting sec_20_2031-1 estate_tax regs the best_method to value a corporation’s stock is to rely on actual arm’s-length sales of the stock within a reasonable period of the valuation_date see 79_tc_938 since renier’s stock was never publicly or privately traded all the experts used less direct methods of valuation --- - expert opinions sometimes aid the court in determining valuation other times they do not see 92_tc_101 we evaluate such opinions in light of each expert’s qualifications and all other evidence of value in the record see 94_tc_193 we are not bound however to accept any expert opinion when that opinion contravenes our judgment see id we may accept an expert opinion in its entirety see 74_tc_441 or we may selectively use any portion thereof see 86_tc_547 a the experts respondent presented the testimony and expert report of leonard j sliwoski to support the deficiency determination the estate presented the testimony and expert reports of yale kramer of mcgladrey pullen llp and allan l r lannom of houlihan valuation advisors to support the reported value of renier’s stock respondent’s expert mr sliwoski considered an asset income and market approach to value renier and concluded that an income approach using the capitalized value of expected future earnings should be used exclusively based on this approach mr sliwoski concluded that renier had a total value of dollar_figure and that decedent’ sec_88 percent interest therein had an approximate value of dollar_figure on the valuation_date --- - the estate’s first expert mr kramer also considered an asset income and market approach and ultimately concluded that renier’s valuation should be based on an average of the results indicated by the income and market approaches through this averaging process mr kramer concluded that renier’s shares had an estimated value of dollar_figure per share and that decedent’s big_number shares therefore had a total value of dollar_figure on the valuation_date the estate’s second expert mr lannom did not use an asset or income approach but made two market approach calculations using data on the sales of privately held companies supplied by the institute of business appraisers in addition mr lannom applied four different rules of thumb to value renier using his market approach and rules of thumb mr lannom arrived at various values for renier ranging from a low of dollar_figure to a high of dollar_figure mr lannom then added a key-man_discount egual to percent of the value of the operating_assets finally mr lannom concluded that decedent’ sec_88 4-percent interest in renier was worth approximately dollar_figure on the valuation_date although mr lannom testified that his estimate of the value of decedent’s interest in renier was dollar_figure the calculations in his report as amended in his trial testimony indicate that he actually concluded that decedent’s interest was worth dollar_figure and apparently made a transposing error -- - we place no weight on mr lannom’s opinion his report contains no explanation of or analytical support for the various rules of thumb employed in reaching several of its valuation estimates thus we are largely unable to assess the merits of mr lannom’s conclusions see rule f to the extent we are able to form a judgment we find his analysis unpersuasive one of his market approach calculations and three of his rules of thumb used gross revenue as the primary determinative factor without taking profitability into account this raises doubts about the basis for his conclusions given that renier’s profitability was high in relation to the industry average furthermore while mr lannom’s second market approach calculation used renier’s earnings and one of his rules of thumb used renier’s cash-flow mr lannom provided no justification for the earnings and cash-flow figures he used finally mr lannom’s report provided no factual support for his key-man_discount because of the summary nature and obvious shortcomings of mr lannom’s report we give it no further consideration both mr sliwoski and mr kramer ultimately concluded that their asset approaches did not account for the goodwill inherent in renier as a going concern we therefore restrict our analysis to the income and market approaches as applied to renier by mr sliwoski and mr kramer we now consider each in turn b income approach in connection with their respective income approaches to valuation both mr sliwoski and mr kramer concluded that some of renier’s assets were not necessary for its core retail operation after excluding the income and expenses associated with these nonoperating assets both experts estimated the value of renier’s operating_assets on the valuation_date by capitalizing an estimate of renier’s expected future income fach expert then added his income-based valuation of renier’s operating_assets to an asset-based estimate of the nonoperating assets to produce a total valuation figure as part of their income capitalization approaches the experts agreed that the appropriate starting point for estimating renier’s expected future income was to take an average of renier’s historical reported net_income the experts further agreed that it was necessary to make certain adjustments to although mr sliwoski believed that cash-flow rather than net_income was the appropriate income base to capitalize he concluded that net_income was an adequate approximation for cash- flow in reaching this conclusion he assumed that renier’s accounts_receivable and inventory levels were sufficient as of the valuation_date to sustain probable future growth that required equipment additions would equal renier’s depreciation expense and that no interest-bearing liabilities other than short-term liabilities would be required to finance probable future sales growth in addition as discussed infra since mr sliwoski used a capitalization rate based on returns to both equity and debt it was necessary for him to add back renier’s interest_expense to the income base used in his capitalization formula mr kramer used net_income as his base for capitalization but believed that an adjustment to the capitalization rate was required to account for the fact that he was employing net_income rather than cash-flow as his base reported net_income in order to normalize it that is to convert renier’s historical average net_income into income that a hypothetical purchaser could expect in the future by eliminating anomalous transactions and capital structures however the experts exhibited significant differences regarding the necessary normalizing adjustments they also had significant differences in computing the capitalization rate that should be applied to normalized income and to a lesser extent differences in the methodology for valuing renier’s nonoperating assets the foregoing differences produced dramatically different results mr sliwoski valued renier’s operating_assets at dollar_figure to which he added his estimate of the value of renier’s nonoperating assets of dollar_figure for a total value of dollar_figure on the valuation_date mr kramer’s income approach by contrast resulted in a value for renier’s operating_assets of dollar_figure an amount approximately two-thirds lower than mr sliwoski’s computation the difference in mr kramer’s estimate for renier’s nonoperating assets was not as dramatic mr kramer’s estimate was dollar_figure versus mr sliwoski’s dollar_figure although mr sliwoski recognized he had double counted a liability of dollar_figure he did not modify his computations to correct for this error had he done so renier’s nonoperating assets would have increased by dollar_figure and its total value would have equaled dollar_figure in any event respondent has not sought an increase in his deficiency determination in connection with this error unlike mr sliwoski’s value for nonoperating assets this continued mr kramer’s value estimates for renier’s operating and nonoperating assets produced a total value of dollar_figure on the valuation_date we shall consider their differences computation of normalized income the experts agreed that the starting point for computing normalized income should be the average of renier’s reported net income’ for the 33-month period preceding the valuation_date date through date base period’ further to avoid unwarranted controversy mr kramer adopted several of mr sliwoski’s normalizing adjustments prior to normalizing continued number is corrected to account for the double counting of a dollar_figure liability in mr kramer’s original report ’ mr sliwoski started with pretax net_income and after making his normalizing adjustments subtracted federal and state income taxes at an estimated combined rate of approximately percent mr kramer started with after-tax net_income and when making normalizing adjustments also accounted for the income_tax impact of the normalizing adjustments at an estimated income_tax rate of percent except for the difference in assumed income_tax rates their respective methodologies to account for taxes would produce the same result although mr kramer’s report states that he used the period from date through the valuation_date an examination of the data in the exhibits to his report shows that the period used included the fiscal_year starting date as well although mr sliwoski treats the period from date through the valuation_date as consisting of years and mr kramer uses at various times dollar_figure and months to describe this period for the sake of consistency we have adopted and treat the experts as having adopted a base_period of dollar_figure months -- renier had pretax net_income of dollar_figure during the base_period and after-tax net_income of dollar_figure the experts had differences in their normalizing adjustments as follows a reasonable_compensation for related-party employees there is a large difference in the experts’ approaches in accounting for excess compensation paid to related-party employees during the base_period renier employed decedent and several members of his family including kent and maria on the valuation_date both mr sliwoski and mr kramer concluded that related-party employees were overcompensated necessitating a normalizing adjustment to reported net_income to approximate income if only arm’s-length amounts had been paid for the services rendered the experts dispute however the amount of overcompensation to compute a reasonable_compensation amount for the services provided by related parties mr sliwoski assumed that during the base_period renier required the services of only two family members one providing management and sales services and the other serving as bookkeeper and office manager kent and maria respectively were providing these services on the valuation_date using data from a dubuque area wage survey mr sliwoski concluded that for renier’s fiscal_year ended date the retail manager salesperson would earn approximately dollar_figure per hour and work big_number hours per year hours per - - week for an annual salary of dollar_figure he further concluded that a bookkeeper office manager for renier with maria’s qualifications reasonably would have been paid dollar_figure per hour and worked big_number hours per year for a total annual salary of dollar_figure to these amounts mr sliwoski added a fringe benefit equal to percent of base wages for each employee finally mr sliwoski adjusted these results using changes in the consumer_price_index for through to determine reasonable_compensation for each year in the base_period mr sliwoski then treated all compensation to related employees that exceeded the foregoing amounts plus associated payroll_taxes as excess compensation that should be added back to produce normalized income this resulted in increases to renier’s reported net_income for the base_period of dollar_figure or an average of dollar_figure per year mr kramer by contrast calculated the excess compensation to related employees to be only dollar_figure per year which he divided by and then multiplied by dollar_figure to arrive at a total excess compensation of dollar_figure during the base_period in reaching the dollar_figure per year figure mr kramer concluded that approximately percent of the time devoted to management duties by related parties was attributable to duplicated effort and therefore constituted excess compensation after considering the reasonable_compensation adjustments proposed by each expert we conclude that neither accurately -- - accounts for renier’s related-party excess compensation mr kramer’s method was unsupported by any objective criteria his report’s assertion that there was a duplication of effort equal to percent of the amounts paid to related-party management appears to be no more than a conclusory guess the estate cites no data to support the claim that the sales management and bookkeeping functions being performed by related parties were actually worth dollar_figure per year in the dubuque area in addition the estate concedes on brief that in renier’s fiscal_year ended date mark renier decedent’s other son was paid dollar_figure in excess compensation mr kramer’s report however fails to account for this figure for these reasons we find more reliable mr sliwoski’s approach based on actual data from a dubuque area wage survey while we find satisfactory mr sliwoski’s basic methodology of attempting to estimate the market replacement cost of the necessary services that were provided by related parties and treating the excess of the amounts actually paid over their market_value as a normalizing add-back to income we nevertheless believe that mr sliwoski’s estimate of the replacement cost of the sales and management services provided by related parties significantly understates the services’ value mr sliwoski assumed that the sales and management functions being performed by kent could be accomplished in a 40-hour work week kent testified that he worked in excess of hours per week while this claim might be inflated the record establishes that renier was open hours per week we do not believe that kent’s sales and management functions could be duplicated with a 40-hour work week at dollar_figure per hour plus percent in fringe_benefits or total annual compensation of approximately dollar_figure as mr sliwoski’s postulates if one considers only kent’s sales function his annual compensation would exceed dollar_figure' before considering his multiple management and administrative duties in addition mr sliwoski failed to consider that except for the last approximately months of the base_period decedent also actively assisted in renier’s operation we therefore do not believe mr sliwoski’s computations of reasonable_compensation for the sales and management functions performed by related parties are reliable on this record we have no alternative but to substitute our best judgment of the value of the sales and management services that were performed by kent as of the valuation_date and various other family members during the base_period taking into account the hours claimed in kent’s testimony it is our judgment that the sales and management functions performed by him could be accomplished in a 60-hour work week using mr sliwoski’s respondent conceded that kent was responsible for approximately one-third of renier’s annual sales of dollar_figure million if kent received a commission of to percent on those sales commission which mr sliwoski himself conceded was reasonable in the business plus benefits equal to percent of this amount his compensation as a salesman would have exceeded dollar_figure - - documented wage and benefit figures this assumption produces an annual compensation package of dollar_figure hours at dollar_figure per hour time sec_52 weeks plus 20-percent fringe_benefits if this amount is adjusted for inflation for each of the years in the base_period the total for the period is dollar_figure when added to mr sliwoski’s reasonable_compensation estimate for the bookkeeping office manager functions performed by maria dollar_figure the rate and hours assumptions for which we find satisfactory and increased by renier’s average payroll tax expense of dollar_figure percent the total reasonable_compensation expense for related-party employees for the base_period is dollar_figure when this amount is subtracted from renier’s actual compensation to related-party employees during the base_period of dollar_figure the excess compensation to related-party employees equals dollar_figure or an average of dollar_figure per year thus we conclude that a normalizing adjustment in this amount to renier’s ‘t mr sliwoski used the consumer_price_index cpi published by the u s census bureau to adjust for inflation we make a similar adjustment in our computation see u s census bureau statistical abstract of the united_states the national data book 119th ed ‘2 renier’s average payroll tax expense was derived from the average payroll tax_rate incurred by renier during the base_period the difference between this rate and the statutory rate of dollar_figure percent applicable during most of the base_period is presumably due to fringe_benefits not subject_to payroll tax see sec_3111 sec_3121 '3 actual related-party compensation figures were taken from mr sliwoski’s report mr kramer provided no comparable figures reported net_income is appropriate b adjustment for income from excess working_capital both experts agreed that renier’s cash and short-term investments exceeded its working_capital needs that the excess should be treated as a nonoperating asset and consequently that the interest earned by the excess should be subtracted from reported net_income as a normalizing adjustment they disagreed however on the size of renier’s excess working_capital and the method of its calculation mr sliwoski concluded that renier only required working_capital equal to days of annual sales of annual sales which resulted in estimated working_capital needs during the base_period ranging from dollar_figure for to dollar_figure for the partial year ending on the valuation_date consequently mr sliwoski made a normalizing adjustment that subtracted all interest earned by renier during the base_period and added back an estimated amount of interest that would have been generated by the working_capital he estimated was needed mr kramer concluded that renier required working_capital egqual to months of average operating_expenses during the base_period plu sec_1 times average monthly inventory purchases in or dollar_figure on the valuation_date leaving dollar_figure in ‘4 mr sliwoski computed interest for this purpose at a rate of percent to avoid unwarranted controversy mr kramer adopted the same rate for purposes of his computations - - excess working_capital on that date to account for the interest generated by this excess working_capital mr kramer took the excess working_capital amount on the valuation_date multiplied it by percent divided the result by to get a monthly figure and then multiplied that amount by dollar_figure months the result was then subtracted from reported net_income as a normalizing adjustment using this formula renier’s excess working_capital generated dollar_figure in interest over the base_period as to which expert’s methodology best adjusts for excess working_capital we believe that mr sliwoski’s formula substantially underestimates renier’s working_capital needs for example for the year ended date mr sliwoski estimated renier would require working_capital of just dollar_figure however renier’s financial statement for that year indicates that it 's see supra note ‘ in his report mr kramer assumed renier had only dollar_figure in excess working_capital which would have generated approximately dollar_figure in interest over the base_period mr kramer’s computation of excess working_capital however does not account for the double-counted liability of dollar_figure conceded during trial by both experts when this double counting is corrected it results in a reduction in renier’s liabilities of dollar_figure and a corresponding increase in total assets because renier’s working_capital requirements using mr kramer’s formula are unaffected by this correction mr kramer’s computation of excess working_capital would increase by dollar_figure as a result from dollar_figure to dollar_figure therefore under mr kramer’s formula the interest generated over the base_period from the increased figure for excess working_capital is dollar_figure rather than dollar_figure - spent dollar_figure on inventory purchases and had operating_expenses of dollar_figure for total expenditures of dollar_figure thus although renier had outlays averaging over dollar_figure per month in fiscal mr sliwoski assumed renier would reguire less than one-fourth of that amount as working_capital this estimate is unduly low particularly in light of the fact that renier paid for its inventory with cash in order to take advantage of early payment cash discounts offered by trade creditors mr sliwoski’s estimates for the other years are no more reasonable given the obvious shortcomings of mr sliwoski’s working_capital estimates we reject his methodology in favor of that used by mr kramer which not only left sufficient working_capital to cover renier’s operating_expenses but also provided additional working_capital to purchase inventory with cash based on mr kramer’s formula as adjusted to account for the double-counted liability of dollar_figure we conclude that dollar_figure should be subtracted from renier’s reported net_income as a normalizing adjustment to account for the interest generated by its excess working_capital c spread for cost--of-goods-sold adjustment the parties agree that for a number of years renier had used an incorrect inventory_accounting system that overstated cost_of_goods_sold the errors in cost_of_goods_sold were corrected by means of adjustments to the and fiscal years which resulted in reported net_income for those years that substantially exceeded amounts in the preceding years the -- - experts disagree on the appropriate normalizing adjustment for the correction of the inventory error mr sliwoski believed that since average income for the 33-month base_period including the correction years was being used no further adjustment was necessary the averaging of the correction years’ income with the income of the precorrection years which income was almost certainly understated would produce an accurate average for the month period in his view this position effectively spread the cost_of_goods_sold adjustment over the 33-month base_period mr kramer however believed that the cost--of-goods-sold adjustment should be spread over years on the grounds that renier had sold the same product line for approximately years and it was estimated that the erroneous inventory_method had been used for at least half of that period as a result mr kramer spread the cost--of-goods-sold adjustment over a 10-year period and excluded from normalized income some dollar_figure months’ worth of the adjustment which fell outside the base_period with respect to the cost-of-goods-sold adjustment we conclude that the estate has failed to show error in respondent’s approach the estate has offered scant evidence of the nature of the inventory adjustment there is no evidence in the record of the exact nature or duration of the error in accounting for cost_of_goods_sold such evidence was presumably available to the - - estate or executors on this record we do not believe the estate has shown that a 10-year spread of the inventory adjustment is appropriate we accordingly conclude that mr sliwoski’s treatment of the cost-of-goods-sold adjustment in computing normalized income is the appropriate one - d adjustment for partial year the experts also disagree on how to annualize the income from the partial fiscal_year from date through the date valuation_date for purposes of computing average income for the base_period mr sliwoski extended the partial year income data pro_rata to a full fiscal_year added this amount to the net_income from the previou sec_5 years and divided the result by mr kramer on the other hand simply added the net_income from the dollar_figure months of the partial fiscal_year to the income from the previou sec_5 years divided the result by dollar_figure months and multiplied the result by to compute the average the estate finds fault with mr sliwoski’s approach and we agree by simply extending the results of the dollar_figure months of the partial fiscal_year pro_rata into months mr sliwoski effectively postulates level income over each month of the fiscal_year we agree with the estate that this approach distorts renier’s income the first dollar_figure months of renier’s fiscal_year include the holiday season a period of high retail volume the assumption that the average of the first months of the fiscal_year would be replicated in the last is highly unlikely in addition both sides have conceded that income was anomalous due to the correction of the inventory error asa result we believe a more accurate average is achieved by averaging the actual results of the first dollar_figure months of fiscal with the preceding fiscal years as mr kramer has done - - e inclusion of interest_expense because mr sliwoski used a capitalization rate that incorporated an assumed cost of debt that a purchaser of decedent’s interest would incur to effect the purchase he was required for consistency to add back renier’s interest_expense to his income base so that normalized income would approximate the investment return available to both equity and debt mr kramer used a simpler return on equity to formulate the capitalization rate he employed as more fully discussed infra we conclude that the appropriate capitalization rate 1s a simple return on equity as used by mr kramer since the interest being valued here is an equity_interest accordingly it is not appropriate to add back renier’s interest_expense when computing expected future income available to equity alone f adjustment for income taxes both experts account for the effect of income taxes as part of normalizing renier’s income mr sliwoski normalized reported pretax net_income and then adjusted for federal and state income taxes at an assumed combined rate of approximately percent whereas mr kramer used reported after-tax net_income and then adjusted for income taxes associated with the net impact of the normalizing adjustments using the average of the actual combined federal and state income taxes paid_by renier over the base_period mr sliwoski provided no justification for his assumed rate while mr kramer’s rate reflected renier’s historic - - average because mr kramer’s approach is consistent with renier’s actual income_tax liabilities over the base_period we believe it is more accurate we therefore adopt his method of using after-tax net_income and taking account of the income_tax effect of normalizing adjustments at renier’s historic average rate of percent q conclusion based on the foregoing we conclude that the following normalizing adjustments should be made to renier’s reported net_income after taxes for the base_period adjustments to base_period net_income negative amounts in parentheses excess related-party compensation dollar_figure interest generated by renier’s excess working big_number capital depreciation’ big_number property taxes’ big_number automotive expenses’ big_number capital loss’ big_number rental income’ total adjustments before tax big_number tax on adjustments at blended federal and state rate of percent total adjustments after tax big_number ' the experts agreed to the normalizing adjustment amounts with respect to depreciation property taxes automotive expenses capital_loss and rental income o7 - by adding dollar_figure in adjustments to renier’s after-tax net_income for the base_period of dollar_figure we arrive at normalized income for the period of dollar_figure by dividing this figure by the dollar_figure months in the base_period and multiplying the result by we calculate renier’s expected future annual income available to eguity at dollar_figure calculating the capitalization rate the experts reached widely divergent conclusions regarding the appropriate rate to use in capitalizing renier’s expected future income mr sliwoski concluded that the rate should be percent whereas mr kramer set it pincite percent the principal source of this difference concerns whether the capitalization rate should be computed based on the return on equity that a hypothetical buyer would require mr kramer’s view or should consist of a weighted average of the return on equity as well as the return on an assumed amount of debt that a hypothetical buyer would incur to acquire decedent’s interest in renier mr sliwoski’s view in addition the experts disagreed regarding the estimate of the rate of growth in renier’s future earnings that should be factored into the computation of the capitalization rate a weighted average cost of capital or return on equity mr sliwoski estimated the return on equity that a hypothetical buyer would require in calculating a value for - - renier at dollar_figure percent guite close to mr kramer’s estimate of dollar_figure percent mr sliwoski then reduced this required rate of return by percent to account for renier’s estimated growth after the valuation_date ’ mr sliwoski also believed that the capitalization rate should reflect a weighted average cost of capital that is a blending of the rate of return on equity with the cost of debt incurred in a hypothetical purchase which rate he estimated would be percent above prime or dollar_figure percent on the valuation_date mr sliwoski further computed an after-tax cost of the debt by discounting it percent using the assumption that a purchase of decedent’s interest would be financed percent with debt and percent with equity mr sliwoski computed the weighted average cost of capital as follows weighted average cost of capital per mr sliwoski before tax after tax percentage of cost of cost of financing financing financing income_tax financing component component component adjustment component debt equity na total or approximately thus the effect of mr sliwoski’s weighted average is to reduce the capitalization rate from dollar_figure percent dollar_figure percent ‘7 mr kramer also believed that renier’s estimated growth rate should reduce its capitalization rate - - estimated return on equity less 6-percent growth rate in earnings to percent we are not persuaded by mr sliwoski’s approach this court has often rejected the use of a weighted average cost of capital in valuing an equity_interest ina closely_held_corporation see eg 92_tc_312 estate of maggos v commissioner tcmemo_2000_129 estate of hendrickson v commissioner tcmemo_1999_278 furman v commissioner tcmemo_1998_157 this approach has also been criticized in valuation commentary see bogdanski federal tax valuation par b supp and authorities therein cited although respondent cites gross v commissioner tcmemo_1999_254 as support for_the_use_of this method we note that in that case the corporation’s actual borrowing costs were incorporated in the formula here mr sliwoski has relied entirely on a set of assumptions about the cost and amount of debt that a hypothetical purchaser of renier would incur the estate argues and presented evidence that these assumptions were unrealistic we agree a local banker testified that financial institutions in the area would not have extended an acquisition loan with respect to a retail business like renier at anywhere near the amount postulated by mr sliwoski and further would have required personal guaranties such guaranties raise the effective cost of borrowing see pratt et al valuing small businesses and professional practice sec_220 -- - 3d ed it seems reasonable to recognize a premium of upwards of three percentage points to the face value interest rate if personal guarantees are required we do not have confidence that mr sliwoski’s attempt to estimate a weighted cost of capital is reliable even if we were satisfied that it represents an appropriate approach for valuing an equity_interest consequently we reject the capitalization rate proposed by mr sliwoski and conclude instead that the appropriate capitalization rate is one based upon a return to equity alone as proposed by mr kramer b computation of capitalization rate based on equity return as previously noted mr sliwoski and mr kramer largely agreed on the rate of return on equity that a purchaser of renier would require mr sliwoski concluded that an equity investor would require a 76-percent rate of return while mr kramer concluded that an equity investor would require a 90-percent return the discrepancy between the two figures can be attributed to the risk-free rate of return employed by each expert ’ mr sliwoski chose as his risk-free rate the percent return from 30-year u s treasury bonds on the valuation_date while mr kramer utilized the 40-percent rate of return on 20-year u s treasury bonds this 14-percent rate ‘8 while the experts’ other assumptions also differ these differences are exactly offsetting --- - difference equals the difference between mr sliwoski’s required rate of return on equity of dollar_figure percent and mr kramer’s rate of dollar_figure percent in the instant case the correct risk-free rate is that of 20-year u s treasury bonds used by mr kramer we so conclude because both experts developed their estimates of the required rate of return on equity using data from ibbotson associates which publishes egquity risk premium data related to 20-year coupon bond maturities but no such risk premium data for 30-year maturities ' for this reason we find more appropriate mr kramer’s required rate of return on equity of dollar_figure percent c estimate of barnings growth rate both experts agreed that the required rate of return on equity used to convert expected future earnings into a value figure should be adjusted to account for the estimated rate of growth in renier’s earnings after the valuation_date the experts disagreed however in their estimates of renier’s long- term growth rate mr sliwoski reduced his required rate of return on equity by percent to account for expected growth in renier’s future income stream while mr kramer reduced his required rate of return by only percent we do not believe either expert used a reasonable estimate of the rate of growth mr sliwoski derived his 6-percent growth see ibbotson associates stocks bonds bills inflation yearbook see also pratt et al valuing a business the analysis and appraisal of closely held companie sec_163 ndollar_figure 3d ed - - rate based on growth within the consumer electronic products industry and normal inflationary price increases while mr kramer limited his growth rate to the rate of inflation neither of these estimates finds support in the record mr sliwoski’s 6-percent growth rate is based on the consumer electronics industry as a whole and is not tailored to renier’s specific product mix renier did not sell personal computers or cellular telephones both of which exhibited very high growth rates and were included in mr sliwoski’s growth-rate estimate as our findings indicate the national annual compound growth rate for the items in renier’s product mix weighted to reflect the percentage of sales of each was only dollar_figure percent from through although renier’s actual sales increased at a compound rate of percent from date through date the majority of that increase occurred in renier’s fiscal_year ended date sales in that year however were substantially boosted as a result of a major flood in the spring of if renier’s fiscal_year ended date is excluded renier’s compound growth rate equals just percent or slightly less than the national average for renier’s product mix we are thus faced with the problem of how to account for renier’s bumper sales during only a portion of which should although the flood likely also boosted sales in the fiscal_year that began on date mr sliwoski did not factor any of this period into his estimate of renier’s growth rate - - be projected into the future as sustainable growth mr kramer addressed this issue by adding percent to renier’s expected future annual income prior to capitalization we agree that this method correctly accounts for the recent strength in dubuque’s retail economy while excluding growth attributable to the area’s flood we therefore conclude that the most accurate long- term growth assumption for renier is dollar_figure percent however we also believe it 1s appropriate to adopt mr kramer’s methodology of adding percent to renier’s expected future annual income to account for the recent strength in dubugue’s retail economy in further support of this conclusion we note that renier faced stiff competition from a number of much larger chain retailers including k-mart radio shack sears and wal-mart putting in doubt renier’s ability to sustain a high sales growth rate after the valuation_date d conclusion income valuation of renier’s operating_assets based on the foregoing we conclude that the appropriate capitalization rate on the valuation_date equaled dollar_figure percent namely mr kramer’s discount rate of percent less an estimated long-term growth rate of dollar_figure percent furthermore as previously discussed this capitalization rate should be applied to percent of renier’s expected future annual income or dollar_figure dividing this amount by the capitalization rate we - -- conclude that renier’s operating_assets had a value of dollar_figure on the valuation_date valuing renier’s nonoperating assets finally to arrive at a total value for renier each expert added to his income valuation of renier’s operating_assets his estimate of the asset value of renier’s nonoperating assets the biggest discrepancy in the experts’ valuation of the nonoperating assets concerns their computation of renier’s excess working_capital under both experts’ methodology their estimate of excess working_capital is added to nonoperating assets because we previously rejected mr sliwoski’s estimate of renier’s working_capital requirements we adopt mr kramer’s figure and conclude that renier had excess working_capital of dollar_figure the experts largely agreed with respect to the value of renier’s remaining nonoperating assets which mr sliwoski valued at dollar_figure and which mr kramer using primarily mr sliwoski’s figures valued at dollar_figure ' to the extent mr kramer’s value exceeds mr sliwoski’s we consider the amount conceded by the estate and therefore conclude that renier had nonoperating assets totaling dollar_figure the remaining nonoperating assets consisted of a residence and two cars mr sliwoski valued the residence at dollar_figure and the two cars at dollar_figure and dollar_figure respectively for a total of dollar_figure mr kramer valued the residence at dollar_figure and the two cars at dollar_figure and dollar_figure respectively for a total of dollar_figure c market approach mr kramer also used a market approach to value renier while mr sliwoski considered but ultimately rejected this approach typically a market approach valuing the stock of a closely held company involves three considerations past transactions in the company’s stock past offers to purchase the company or if neither of these is available the market values of stocks of comparable companies see sec_20_2031-2 a - f estate_tax regs revrul_59_60 1959_1_cb_237 mr kramer concluded that a market approach comparing renier to publicly traded companies was inappropriate because there were no publicly traded companies sufficiently similar to renier to provide an adequate basis for comparison instead mr kramer utilized a market approach which he termed the business broker method in mr kramer’s analysis the business broker method postulates that the purchase_price of a business equals the market_value of the inventory and fixed assets plus a multiple of the seller’s discretionary cash-flow defined as the total cash- flow available to the owner of the business seller’s discretionary cash-flow is computed by adding owner’s compensation depreciation and interest_expense to pretax income the multiple applied to seller’s discretionary cash-flow is determined based on the strengths and risks associated with a particular business such multiples commonly range between and - - in mr kramer’s judgment the appropriate multiple for valuing renier wa sec_1 we do not find mr kramer’s application of the business broker method helpful in valuing renier mr kramer provided no justification for the multiple he chose to apply to renier’s discretionary cash other than his own judgment in the absence of any underlying data supporting mr kramer’s selection of a multiple we are unable to assess its appropriateness see rule thus on this record the reliability of the business broker method has not been established d conclusion both experts used an asset approach to value renier’s nonoperating assets and concede that such an approach would be inappropriate to value renier’s operating_assets we agree with their conclusions in this regard as mr sliwoski also disregarded his market approach and as we have rejected mr kramer’s business broker method we conclude that the income approach provides the best_method for valuing renier’s operating_assets therefore with nonoperating assets of dollar_figure using an asset approach and operating_assets of dollar_figure using an income approach we find renier had a fair_market_value on the valuation_date of dollar_figure or dollar_figure per share consequently we further conclude that decedent’s big_number shares in renier on that valuation_date had a value of dollar_figure il addition_to_tax -- - respondent also determined that the estate was liable for an addition_to_tax under sec_6662 which imposes a 20-percent addition for certain underpayments of tax the addition is imposed where there is an underpayment of estate_tax resulting from a substantial estate_tax_valuation understatement see sec_6662 b a substantial tax estate valuation_understatement occurs if the value of any property claimed on an estate_tax_return i sec_50 percent or less of the amount determined to be correct see sec_6662 in the instant case the estate reported renier’s stock on its return as having a value of dollar_figure per share as we have found that the correct value is dollar_figure per share no substantial_estate_or_gift_tax_valuation_understatement has occurred given our conclusion we need not address whether the estate qualifies for the reasonable_cause exception contained in sec_6664 to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi - plr-100865-01 date date x a d1 year dear this letter responds to a letter dated date and subsequent correspondence requesting a ruling under sec_1362 of the internal_revenue_code the information submitted states that x was incorporated on d1 in year a as the president of x represents that x was intended to be an s_corporation beginning year its first taxable_year the unanimous consent in lieu of first meeting of board_of directors of x evidences this intent however no form_2553 election by a small_business_corporation was timely filed with the internal_revenue_service sec_1362 of the code provides that if -- a an election under sec_1362 is made for any taxable_year after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make such election the secretary may treat such an election as timely made for such taxable_year based solely on the facts and the representations submitted we conclude that x has established reasonable_cause for failing to make a timely election to be an s_corporation for x's year taxable_year accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 with the appropriate service_center effective for its year taxable_year within days following the date of this letter then such election will be treated as timely made for x's year taxable_year a copy of this letter should be attached to the form_2553 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code including whether x was or is a small_business_corporation under sec_1361 of the code this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to x sincerely yours jeanne m sullivan acting senior technician reviewer branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


department of the treasury internal_revenue_service washington d c date number release date cc intl br6 uilc internal_revenue_service national_office field_service_advice memorandum for from jacob feldman field service special counsel office of associate chief_counsel international cc intl 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 used or cited as precedent legend agency a corp a corp a-fsc country a country group a date date product a product type a year year year year year x y z issue whether on the facts presented sales of product a to the united_states government by corp a through corp a-fsc generated foreign_trading_gross_receipts within the meaning of sec_924 conclusion sales of product a by corp a to the united_states government for its own use do not generate foreign_trading_gross_receipts within the meaning of sec_924 because the government was required_by_law or regulation to purchase products manufactured in the united_states within the meaning of sec_924 and temp sec_1 a -1t g i facts in year the united_states government entered into a memorandum of understanding mou with the governments of country group a regarding establishment of a program to develop product a the mou contemplated purchases of product a by agency a and by the other signatory countries from corp a and one other prime contractor as to product a production for agency a the mou called for industry in country group a to be granted subcontracts for a small portion x percent of the procurement value with final assembly in the united_states higher percentages of foreign industrial participation were provided with respect to product a production for the country group a signatories with final assembly to be abroad the mou provided that procurement of equipment and services for the product a program shall be consistent with department of defense regulations but that with respect to the non-domestic x percent industrial participation called for in the mou o ffers shall be evaluated without applying price differentials such as those required by ‘buy american’ and ‘balance of payment’ laws and regulations we further understand that agency a over the years has entered into y procurement contracts with corp a for product a each of these contracts appears to incorporate the buy american clause required by department of defense regulations dfars or fars the most recent of these contracts dating from year indicates in a footnote that a far waiver has been granted from this clause corp a-fsc is a wholly-owned subsidiary of corp a incorporated in country a on date corp a-fsc timely elected foreign_sales_corporation fsc treatment pursuant to sec_922 and sec_927 for year and all subsequent tax years and in all other respects has continuously maintained its status as a fsc as defined in sec_922 pursuant to a foreign sales commission agreement dated date corp a-fsc provides consultation and representation to corp a with respect to corp a’s export sales and corp a pays corp a-fsc a commission equal to the maximum amount permitted under the transfer_pricing provisions of sec_925 at issue are corp a’s export sales of product a to agency a during the taxable years year sec_4 through in claims for refund corp a now maintains that such product a sales were export transactions entitled to fsc benefits law and analysis under code sec_921 et seq portions of the foreign_trade_income of a fsc are exempt from tax foreign_trade_income is the gross_income of a fsc attributable to foreign_trading_gross_receipts sec_923 foreign_trading_gross_receipts of a fsc generally include gross_receipts from the sale of export_property by either the fsc or any principal for whom the fsc acts as a commission agent sec_924 temp sec_1 a -1t b export_property is defined in pertinent part as property manufactured in the united_states by a person other than a fsc held primarily for sale in the ordinary course of business by a fsc for direct use outside of the united_states and no more than percent of the value of which is attributable to articles imported into the united_states sec_927 temp sec_1_927_a_-1t accordingly in order for a sale transaction to be entitled to fsc benefits it must involve export_property and the receipts from the sale must qualify as foreign_trading_gross_receipts you have advised our office that there is no dispute regarding the qualification of product a as export_property as defined the sole dispute involves whether the sales of product a generated foreign_trading_gross_receipts within the meaning of sec_924 more specifically the issue is whether the buy american provision of sec_924 operates to disqualify the receipts from such sales as foreign_trading_gross_receipts sec_924 provides certain exclusions from the general definition of foreign_trading_gross_receipts in sec_924 noted above sec_924 provides that foreign_trading_gross_receipts shall not include receipts of a fsc from a transaction involving export_property that is for use by the united_states or any instrumentality thereof and such use of export_property is required_by_law or regulation temp sec_1 a -1t g i elaborates foreign_trading_gross_receipts of a fsc do not include otherwise qualifying gross_receipts if a sale of export_property is for use by the united_states or an instrumentality thereof in any case in which any law or regulation requires in any manner the purchase of property manufactured produced grown or extracted in the united_states for example a sale by a fsc of export_property to the department of defense for use outside the united_states would not produce foreign_trading_gross_receipts for the fsc if the department of defense purchased the property from appropriated funds subject_to either any provision of the department of defense federal acquisition regulations supplement cfr chapter or any appropriations act for the department of defense for the applicable_year if the regulations or appropriations act requires that the items purchased must have been grown reprocessed reused or produced in the united_states temp sec_1 a -1t g iii recognizes certain exceptions to this exclusion where the purchase of export_property is pursuant to a program for resale to a foreign government or a program involving international competitive bidding summarizing these provisions receipts from sales of export_property to the united_states government for its own use are generally excluded from the definition of foreign_trading_gross_receipts where the government was required in any manner by law or regulation to purchase only items produced in the united_states ie was required to buy american by letter dated date the office of general counsel of agency a has confirmed to us and corp a and corp a-fsc do not dispute that the product a sales were potentially subject_to buy american laws and regulations the defense department acquisition regulations dfars referenced in temp sec_1 a -1t g i quoted above implement the buy american act of u s c 10a et seq and require that procurement contracts include clauses implementing such legislation see c f_r each of the product a contracts between corp a and agency a expressly incorporates the clauses required by c f_r or some version of its predecessors aspr and dar moreover corp a and corp a-fsc do not maintain that any of the exceptions under temp sec_1 a -1t g iii are applicable however it is the position of corp a and corp a-fsc that the buy american restrictions were waived as to product a because foreign subcontractors supplied some of the components of product a under the mou among the united_states and country group a corp a and corp a-fsc maintain that such a waiver removed corp a’s sales of product a from the scope of the buy american exclusion of sec_924 and temp sec_1 a -1t g i with the result that the receipts from such sales constituted foreign_trading_gross_receipts for several reasons we find this conclusion fundamentally flawed first the plain language of the mou among the united_states and country group a did not purport to waive the central buy american requirement namely that the end product at issue be manufactured in the united_states indeed the mou expressly provided that the product a produced for agency a be assembled in the united_states with american components representing almost all z percent of the procurement value such assembly is a key indicator of a manufacturing process within the meaning of the fsc provisions see temp sec_1 a - 1t c sec_1_954-3 the only reference in the mou to non- application of buy american restrictions was with respect to offers from subcontractors within the permitted non-domestic x-percent industrial participation subcontracting arrangements are irrelevant to the application of buy american restrictions to the contract between corp a and agency a for the purchase and sale of product a what corp a sold to agency a was completed product a not the components purchased by corp a from others and incorporated into the final export product from a fsc standpoint corp a’s receipts at issue were from sales of the end product the buy american restrictions as implemented in the dfars by their terms also apply to the end product see c f_r b this clause implements the buy american act in a manner that will encourage a favorable international balance of payments by providing a preference to domestic end products over other end products emphasis added for dfar purposes a domestic end product is defined as an end product manufactured in the united_states if the cost of its components mined produced or manufactured in the united_states exceed sec_50 percent of the cost of all its components c f_r a ii this definition reinforces that the product subject_to the buy american restriction is the end product foreign components are relevant only as they may affect qualification of the end product as domestic similarly for fsc purposes the presence of foreign components is taken into account in determining the threshold issue of qualification of the end product as export_property under sec_927 discussed above but is irrelevant to the operation of the buy american exclusion under sec_924 second we asked the department of defense to review the history of the product a program including the reference to a far waiver in the year contract to determine whether there was any waiver of buy american restrictions with respect to the sales of product a by corp a to agency a during the taxable years at issue by letter dated date the office of general counsel of agency a advised us that there was never any such waiver and that the reference to a far waiver in the year contract could only have been referring to the permitted participation of foreign subcontractors to the extent of x percent of the procurement value as discussed above these subcontracting transactions are not the product a sale transactions for which fsc benefits are claimed third corp a’s and corp a-fsc’s claims are inconsistent with the purpose and policy underlying both the fsc regime in general and the buy american exclusion in particular analysis of the fsc regime is rooted in examination of the earlier domestic_international_sales_corporation disc regime from which the fsc provisions were largely drawn the legislative_history of the disc provisions makes explicit congress’ overall purpose to provide tax incentives for u s firms to increase their exports h_r rep no 92d cong 1st sess reprinted in 1972_1_cb_498 s rep no 92d cong 1st sess reprinted in 1972_1_cb_559 the disc statutory buy american exclusion at sec_993 provides that the secretary may by regulations exclude from qualified_export_receipts analogous to fsc foreign_trading_gross_receipts those receipts from sales and other transactions in domestic products for use by the united_states that are found to be required_by_law or regulations by excluding certain receipts from the general definition of disc qualified_export_receipts congress sought to limit the application of the tax- favored treatment to situations which in fact involve export transactions and to deny such treatment to receipts from enumerated types of transactions including those compelled or preferred by buy american constraints that were not really export transactions h_rep_no supra pincite_1_cb_533 s rep no supra pincite_1_cb_614 thus congress determined to carve out of the fsc regime transactions subject_to buy american constraints because such transactions would not advance the stated legislative purpose treasury further implemented and refined this carve-out throughout the process of developing the disc regulations the proposed_regulations gave an example of the buy american exclusion whereby purchases of domestic goods for resale at military commissaries abroad would be ineligible for disc benefits subject_to the exclusion because such purchases were found subject_to department of defense procurement regulations while purchases of goods for resale at military post or base exchanges would be eligible for disc benefits not subject_to the exclusion because they were believed not subject_to procurement regulations prop sec_1_993-1 sec_37 fed reg date during the ensuing several years further research and numerous comments received on the proposed regulation revealed that in fact commissary purchases were excepted from the buy american provisions of procurement regulations accordingly the final_regulation dropped the commissary px example and clarified that only those purchases in fact subject_to restrictions would be subject_to the disc exclusion t d 1977_2_cb_266 the eligibility of commissary purchases for disc benefits was later confirmed by revrul_88_11 1988_1_cb_296 when congress replaced disc with the fsc regime the legislative_history clarified that the purpose of fsc was to afford u s exporters treatment comparable to what exporters customarily obtain in territorial systems of taxation and that congress generally intends excluded_receipts to be the same as excluded_receipts under the disc rules s rep no vol 98th cong 2d sess moreover the preamble to the fsc regulations provides the detailed definitions of foreign_trading_gross_receipts of a fsc are taken in all important respects from the definition of qualified_export_receipts of a disc at sec_1_993-1 t d 1987_1_cb_184 specifically the fsc buy american exclusion at sec_924 quoted above and here at issue is substantially_similar to its disc counterpart congress and treasury thus have continued in the fsc regime to carve out buy american transactions as inconsistent with the legislative purpose product type a is in its nature and scale wholly unlike the commissary px merchandise treated as eligible for fsc benefits as confirmed by agency a and not disputed by corp a product a was subject_to buy american restrictions and was consistently treated by agency a as subject_to those restrictions in awarding the procurement contracts to corp a without any consideration of foreign competition at the end product level the only permitted foreign participation was with respect to components provided by subcontractors and then only to the extent of x percent of procurement value accordingly the receipts from sales of product a to agency a should be excluded from foreign_trading_gross_receipts of corp a-fsc under sec_924 and temp sec_1 a -1t g i if you have any further questions please call elizabeth beck senior technical reviewer branch office of associate chief_counsel international at _______________________________ jacob feldman field service special counsel office of associate chief_counsel international


t c summary opinion united_states tax_court valentine c anyanwu petitioner v commissioner of internal revenue respondent docket no 6011-14s l filed date celio w young for petitioner william j gregg and randall s trebat jr for respondent summary opinion buch judge this case was heard pursuant to sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 sec_1 unless otherwise indicated all section references are to the internal_revenue_code code in effect at all relevant times and all rule references are to the tax_court rules_of_practice and procedure all monetary amounts are rounded to the nearest dollar the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case this is a collection case in which the internal_revenue_service irs issued a notice_of_intent_to_levy and where the underlying liability is for penalties under sec_6695 that provision imposes a penalty if a return preparer fails to include an appropriate identifying number on a return that he prepared for compensation the evidence establishes that mr anyanwu received compensation_for preparing only of the returns for which respondent imposed penalties accordingly we find that mr anyanwu is liable for the sec_6695 penalty for each of returns and we sustain the levy determination to that extent background mr anyanwu is a certified_public_accountant and prepares tax returns part time as a second job he has prepared returns for more than years during calendar_year mr anyanwu prepared returns for tax_year mr anyanwu did not charge to prepare some of these returns estimating that about something something of the clients were nonpaying clients such as friends and relatives mr anyanwu reported the income he received from this tax preparation work on hi sec_2010 form_1040 u s individual_income_tax_return it was mr anyanwu’s practice to include his name address phone number signature and the last four digits of his social_security_number on the tax returns he prepared for tax_year he claimed he did not include his full social_security_number because he had been a victim of identity theft in the past and was concerned for his privacy i audit the irs audited mr anyanwu’ sec_2010 tax_return and this examination led the irs to also investigate the tax returns mr anyanwu prepared for tax_year the irs determined that mr anyanwu did not include all of the information required of a tax_return_preparer on those returns mr anyanwu provided the irs with a list of clients for whom he had prepared returns during calendar_year for tax_year and he informed the irs that he had billed only of those clients in addition to the list of clients provided by mr anyanwu the irs relied on another list generated by its service_center the examining agent was unclear on how this list was generated stating at trial that somebody would have pushed some kind of button i guess the examining agent did not review any of the actual returns that were identified on this list mr anyanwu did not maintain a separate bank account for his tax preparation business but he provided the irs with information from his checking and savings accounts from this bank account information the irs identified payments for tax preparation that mr anyanwu received ii assessment and collection activities on date respondent assessed a total return preparer penalty under sec_6695 of dollar_figure for the period ending date this penalty applies if a return preparer fails to include an appropriate identifying number on a return that he prepares for compensation the penalty assessed against mr anyanwu was based on the returns he prepared returns at dollar_figure per return the irs sent mr anyanwu a notice of penalty charge for this amount dated date on date the irs issued a final notice notice_of_intent_to_levy and notice of your right to a hearing mr anyanwu timely requested a collection_due_process cdp hearing on form request for a collection_due_process or equivalent_hearing on this form he challenged only the underlying liability stating i’m not liable for i don’t owe all or part of the taxes he did not request collection alternatives the cdp hearing was held on date mr anyanwu’s representative faxed a copy of a return he prepared for tax_year to the settlement officer after the hearing this return showed mr anyanwu’s name address phone number signature and the last four digits of his social_security_number and it was dated date the settlement officer reviewed the issues raised regarding the underlying penalty and the evidence provided by mr anyanwu and determined that a levy was warranted on date respondent issued a notice_of_determination sustaining the levy mr anyanwu resided in maryland when he timely petitioned for review of this notice_of_determination and trial was held in washington d c discussion this case comes before us on collection review of the irs determination sustaining the levy for when we review collection activities if the validity of the underlying liability is properly at issue we review that determination de novo if the validity of the underlying liability is not properly at issue we review the determination for an abuse_of_discretion here we are only asked to review the underlying liability 114_tc_604 114_tc_176 sego v commissioner t c pincite goza v commissioner 114_tc_3 pincite which is sec_6695 penalties we have jurisdiction under sec_6330 to review this penalty as part of a collection case respondent assessed penalties under sec_6695 against mr anyanwu for failing to furnish his identifying number on the tax returns he prepared tax_return_preparers who fail to provide their identifying numbers on the returns are liable for a penalty of dollar_figure per return with the maximum assessable penalty dollar_figure per calendar_year unless it is shown that such failure is due to reasonable_cause and not due to willful neglect the commissioner bears the burden of production on this penalty and must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty the preparer then bears the burden of proving that the failure to include an identifying number was due to reasonable_cause and not due to willful neglect cf eg 143_tc_157 sec_6695 sec_7491 see 116_tc_438 sec_6695 higbee v commissioner t c pincite tax_return_preparers are defined in the code as persons who prepare tax returns for compensation_for the year at issue tax_return_preparers were required to provide their social_security numbers or preparer tax identification numbers ptin on any returns they prepared for compensationdollar_figure in the irs first introduced ptins when it issued a news_release stating that tax_return_preparers could apply for ptins and could use either their ptins or their social_security numbers on returns they prepared the irs’ purpose for implementing ptins was to respond to concerns that a preparer’s social_security_number could be used inappropriately by clientele and others having access to a prepared return additional irs publications and forms alerted return preparers that they were required to use either their full social_security numbers ssn or ptins page of the form_1040 in the box for a paid preparer to fill out explicitly requires either the preparer’s ssn or ptin additionally irs publication return preparer review from date reiterates that the tax_return sec_7701 sec_6109 sec_7701 sec_1_6109-2 income_tax regs i r s news_release ir-99-72 date irs to issue alternative identification numbers for tax preparers i r s news_release ir-99-72 supra preparer must furnish either a social_security_number or a ptin on the return consequently for tax_year mr anyanwu was required to use either a ptin or his social_security_number on returns he prepared for compensationdollar_figure the commissioner can directly assess tax_return_preparer penalties because they are not subject_to deficiency procedures following that the commissioner can send notice_and_demand for payment and begin collection proceedings if the liability is not paiddollar_figure here we find that the underlying liability is properly before us because mr anyanwu did not receive a deficiency_notice and did not otherwise have an opportunity to dispute the penalties before the cdp hearingdollar_figure irs publication return preparer review date we note that for tax returns or claims for refund filed after date tax_return_preparers must use ptins as their identifying numbers see sec_1_6109-2 d income_tax regs see sec_6696 cf eg 133_tc_424 sec_6330 d i respondent has met his burden for some of the penalties respondent bears the burden of production in any court_proceeding with respect to the liability of any individual for any penalty imposed under title dollar_figure we find that he has met that burden for only of the returns for which the sec_6695 penalty was imposed respondent met his burden to show that mr anyanwu did not include his full social_security_number on the returns he prepared but respondent also presented evidence that mr anyanwu received compensation_for preparing only of those returns although mr anyanwu asserts that the number is perhaps lower than his own records establish this number accordingly we find that mr anyanwu was compensated for returns in because the code defines a tax_return_preparer as one who prepares for compensation and respondent bears the burden of production for these penalties we find that respondent has met his burden with respect to only of the returns for which he imposed penalties sec_7491 sec_7701 ii mr anyanwu has not shown his failure was for reasonable_cause and not due to willful neglect mr anyanwu claims that his failure to include his full identifying number on the returns he prepared was based on reasonable_cause and not due to willful neglect to support his claim mr anyanwu testified that he had been a victim of identity theft in the past and thus feared disclosing his full social_security_number mr anyanwu stated that he believed that the irs could properly identify him as the return preparer with only the last four digits of his social_security_number name address and phone number while we acknowledge that privacy concerns are important we find that mr anyanwu has failed to show that he had reasonable_cause mr anyanwu could have satisfied his privacy concerns within the rules by obtaining and using a ptin instead of his full social_security_number on the returns he prepared we have considered the parties’ arguments and to the extent not addressed here we find them to be irrelevant moot or without merit to reflect the foregoing decision will be entered under rule


number release date id office uilc cca_2011040809033242 -------------- from ------------------------- sent friday april am to ---------------- cc subject superceding return i apologize for the delay in answering your inquiry obviously litigation matters have taken precedence over general questions given the impending shutdown per my telephone message if a taxpayer is on extension and timely files an amendment within the extension period that later return supersedes the earlier return and becomes the taxpayer's original return please call if you have any further questions


third party communication date of communication month dd yyyy id uilc cca_2015111308384707 number release date from sent friday date am to cc bcc subject re hi ----- based on the facts you have presented i believe tefra applies sec_6231 states that if on the basis of a partnership return the irs reasonably determines that tefra applies then tefra will apply even if that determination is later determined to be erroneous if a partnership files a form_1065 for the entire year listing a flow-thru entity as one of its partners tefra applies and the irs may reasonably rely on the return filed by the partnership for the year in applying the tefra procedures even if the irs subsequently discovers that the partnership should not have filed the return the way it did and if the partnership had filed correctly for the year tefra would not apply thanks ------- --------------- --------------------- ------------- ------------------------------- ---------------------------


internal_revenue_service number release date index number ------------------- ------------------------------------- --------------------------------- ------------------- -------------------- ------------------ ----------------------------------- ---------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ------------- telephone number --------------------- refer reply to cc psi b03 plr-153330-08 date june legend x y --------------------------------------------------------------------------------------------------- ----------------------- ----------------------------- country ---------------------- date ------------------- dear ------------- we received your letter dated date and subsequent correspondence submitted on behalf of x requesting a ruling under sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations that x be granted an extension of time to file an election to be treated as an entity disregarded as separate from its owner under sec_301_7701-3 this letter responds to your request facts x was formed in country on date x is wholly-owned by y y intended that x be treated as an entity disregarded as separate from its owner for federal tax purposes effective date however x inadvertently failed to timely file a form_8832 entity classification election plr-153330-08 law and analysis sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes as provided in sec_301_7701-3 an eligible_entity with a single owner can elect to be classified as an association and thus a corporation under sec_301_7701-2 or to be disregarded as an entity separate from its owner sec_301_7701-3 provides that unless it elects otherwise a foreign eligible_entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 provides in part that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 or to change its classification by filing form_8832 with the service_center designated on form_8832 sec_301_7701-3 provides that an election made under sec_301_7701-3 will be effective on the date specified by the entity on form_8832 or on the date filed if no date is specified on the election form the effective date specified on form_8832 can not be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed if an election specifies an effective date more than days prior to the date on which the election is filed it will be effective days prior to the date it was filed sec_301_9100-1 provides that the commissioner has discretion to grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines a regulatory election to include an election whose due_date is prescribed by a regulation published in the federal_register sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 plr-153330-08 sec_301_9100-3 provides that requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government conclusion based solely on the facts submitted and the representations made we conclude that x has satisfied the requirements of sec_301_9100-1 and sec_301_9100-3 accordingly x is granted an extension of time of sixty days from the date of this letter to elect to be treated as an entity disregarded as separate from its owner for federal tax purposes effective date the election should be made by filing a properly executed form_8832 with the appropriate service_center a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely s curtis g wilson associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


department of the treasury internal_revenue_service washington d c o f f ic e o f c h ief c o u n sel date number info release date index number dear cc intl br genin-126319-02 this is in response to your letter dated date in which you requested certain general information concerning the source_of_income rules in sec_861 through of the internal_revenue_code and the regulations thereunder on date the internal_revenue_service published notice_2001_40 2001_1_cb_1355 which provides in part that the internal_revenue_service and the treasury_department are aware that certain persons are promoting the view that u s citizens and residents are not subject_to tax on their wages and other income earned or derived within the united_states based on the claim that the internal_revenue_code imposes taxes only on income derived from certain foreign-based activities the service and treasury are issuing this notice to inform taxpayers that this reporting position has no basis in law a copy of notice_2001_40 is attached as notice_2001_40 addresses the issues raised by your inquiry we have provided you all the general information we have on this topic sincerely barbara a felker chief branch office of the associate chief_counsel international enclosure notice_2001_40