t c memo united_states tax_court julie leigh domeny petitioner v commissioner of internal revenue respondent docket no filed date brett l gibbs and barbara n morrison for petitioner matthew a williams for respondent memorandum opinion gerber judge respondent determined a dollar_figure deficiency in petitioner’s federal_income_tax for and a dollar_figure accuracy- 1this case was originally docketed as small_tax_case in accord with petitioner’s designation at trial petitioner moved without objection from respondent that this case be removed from the small_tax_case category the court granted petitioner’s motion and the docket number has been changed accordingly related penalty under sec_6662 the parties have resolved all issues other than whether dollar_figure petitioner received from her employer was excludable from gross_income under sec_104 unless otherwise indicated all section references are to the internal_revenue_code in effect for the taxable_year in issue and all rule references are to the tax_court rules_of_practice and procedure background petitioner resided in california at the time her petition was filed after completing high school petitioner obtained a degree in visual merchandising cost and design she worked in theater and visual merchandising for approximately years in the san francisco area following those positions petitioner became involved in professional fundraising for nonprofit_organizations after approximately 2½ years as a professional fundraiser petitioner was employed by the pacific autism center for education pace in during before her employment with pace petitioner was diagnosed with multiple sclerosis ms at the onset of her m sec_2petitioner conceded that she failed to report a dollar_figure state_income_tax refund and dollar_figure of interest_income petitioner also conceded that she failed to report dollar_figure of wage compensation_for respondent conceded that petitioner acted in good_faith and with reasonable_cause and that she is not liable for any penalty under sec_6662 she experienced numbness from the waist down the numbness receded to her feet leaving them numb she also experienced fatigue lightheadedness vertigo and sometimes a burning sensation behind her eyes petitioner found the prescribed treatment which did not ameliorate the symptoms of her condition more profoundly troublesome than her symptoms so she chose to manage her symptoms without medication she left her position as a professional fundraiser before being hired by pace because she was seeking a job situation were she would not have to spend as much time on her feet petitioner’s duties with pace included community development fund raising and writing grants petitioner enjoyed her work with pace and she was motivated by the children and parents who were involved with pace’s autism program the fact that petitioner was ill with ms motivated her involvement with the cause of autism and the underlying fundraising activities after a while pace appointed a new executive director who was to be petitioner’s supervisor the new executive director did not want petitioner to socialize or be involved with parents of autistic children although she was required to somehow approach them for fundraising purposes petitioner had a strained relationship with her supervisor who restricted her duties by these concerns and conditions in petitioner’s workplace caused her ms symptoms to flare up in date it came to petitioner’s attention that the director was embezzling funds from pace’s students’ personal accounts petitioner went to pace’s board members with this information and she was told that they would take care of the situation petitioner felt tension concerning her supervisor’s alleged embezzlement in particular she was upset that pace sent her out to raise funds from parents knowing that funds were being embezzled by her supervisor petitioner advised her superiors on several occasions of her unhealthful work environment including her stress from the embezzlement and pace’s failure to take any_action the series of events involving the embezzlement and resulting severance of the residential director caused petitioner much distress and during that time her ms symptoms intensified petitioner’s symptoms continued to worsen and on date she left work on the next day she visited her primary care physician dr chris e chung at that time dr chung determined that petitioner was too ill because of her ms symptoms to return to work and that she should not return to work until after date petitioner’s date symptoms from ms included vertigo shooting pain in both legs difficulty walking due to numbness in both feet a burning sensation behind her eyes and extreme fatigue on or about date petitioner notified pace by facsimile of dr chung’s diagnosis and of the doctor’s instructions that she not return to work until after date after sending the facsimile on date petitioner received a telephone call from pace’s executive director who notified her that her employment would be terminated effective date after that telephone conversation petitioner’s physical ms symptoms were spiking including shooting pain up her legs fatigue burning eyes spinning head vertigo and lightheadedness during the taxable_year petitioner was employed by pace from january through march because of these circumstances petitioner contacted a lawyer to seek redress from pace she explained the circumstances of her employment illness and dismissal to the lawyer who agreed that she had a cause of action and petitioner retained the lawyer to pursue pace petitioner’s lawyer negotiated with pace lawyers and a settlement was reached the settlement agreement was entitled severance agreement and release of claims the agreement in the agreement petitioner released the following list of numerous possible causes of action or rights a any and all rights and claims relating to or in any manner arising from the petitioner’s employment or the termination of her employment b any and all rights and claims arising under the california fair employment and housing act c any and all claims arising under the civil rights act of d e f g h any and all rights and claims arising under the americans with disabilities act any and all rights and claims arising sic the age discrimination in employment act of any and all rights and claims arising under the family_and_medical_leave act or the california family rights act any and all claims for violation of the fair labor standards act the california labor code or the california wage orders and any and all claims for breach of contract breach of the covenant of good_faith and fair dealing invasion of privacy infliction of emotional distress defamation and misrepresentation under the agreement dollar_figure was the total amount pace agreed to pay of the dollar_figure dollar_figure was compensation due to petitioner which pace agreed to send directly to petitioner’s attorney petitioner reported the dollar_figure on her federal_income_tax return as wage compensation another dollar_figure was sent directly to petitioner’s attorney and petitioner was not issued a form 1099-misc miscellaneous income or form_w-2 wage and tax statement by pace for that amount pace paid the remaining dollar_figure to petitioner without withholding deductions and issued a form 1099-misc reflecting that the amount was nonemployee compensation petitioner did not attend the negotiations between her lawyer and pace’s lawyer at the time petitioner received her dollar_figure settlement it was her understanding that it was to compensate her for physical injuries that occurred in a hostile work environment which pace allowed to exist over an extended time petitioner’s intense ms symptoms which occurred during her pace employment prevented her from working until sometime in discussion the sole question to be considered is whether the dollar_figure settlement amount petitioner received is excludable from her gross_income under sec_104 more specifically the parties disagree about whether petitioner received the settlement for her physical condition sec_104 provides in pertinent part sec_104 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 for purposes of paragraph emotional distress shall not be treated as physical injury or physical sickness the preceding sentence shall not apply to an amount of damages not in excess of the amount_paid for medical_care described in subparagraph a or b of sec_213 attributable to emotional distress to prevail petitioner must show3 that her claim against pace was based on tort or tort type rights and that the damages were received on account of physical4 injuries or sickness 515_us_323 see also 543_us_426 the agreement pursuant to which the dollar_figure was paid contains a list of numerous possible causes of action or rights that petitioner was releasing in exchange for the payment in all respects the settlement agreement is ambiguou sec_5 regarding any specific reason for the payment respondent relies on that ambiguity as showing that pace had no specific intent when making the settlement payment when a settlement agreement lacks express language stating the specific purpose of the settlement payment the most important factor for courts to consider is the intent of the payor see 917_f2d_1033 7th cir affg tcmemo_1989_149 accordingly we must 3petitioner acknowledges on brief that she bears the burden of going forward with evidence and the ultimate burden_of_proof no question concerning the shifting of the burden under sec_7491 was raised by either party 4the requirement that to be excludable the compensation must be for physical injuries or physical sickness was added to sec_104 by the small_business job protection act of publaw_104_188 sec 110_stat_1838 5during trial respondent conceded that petitioner is in no way limited from showing the specific intent for the payment because of the ambiguity of the settlement agreement decide the reason or intent for the payment this is a purely factual inquiry there can be no doubt that petitioner’s claim against pace was based on tort or tort type rights the parties do not dwell on this requirement the focus of the parties’ arguments is on the second requirement of the schleier test that the damages be received on account of physical injury or sickness it has been held that the second test can only be satisfied if there is ‘a direct causal link’ between the damages and the personal injuries sustained 340_f3d_1074 9th cir quoting 223_f3d_1261 11th cir revg 111_tc_305 affg in part and revg in part tcmemo_2002_5 revd on other grounds sub nom commissioner v banks supra when damages are paid in connection with a settlement agreement we first look to the underlying agreement to determine whether it expressly states that the damages compensate for personal physical injuries or physical sickness under sec_104 see 180_f3d_859 7th cir if the agreement is ambiguous or lacks express language specifying the purpose of the compensation courts then proceed to examine the intent of the payor id pincite kurowski v commissioner supra pincite 349_f2d_610 10th cir affg tcmemo_1964_33 the payor’s intent can be based on all the facts and circumstances of the case including the complaint that was filed and the details surrounding the litigation see eg allum v commissioner tcmemo_2005_177 affd 231_fedappx_550 9th cir petitioner’s exposure to a hostile and stressful work environment exacerbated her ms symptoms to a point where she was unable to work this fact was confirmed by her doctor who prescribed weeks off petitioner notified her employer of her condition and faxed to her employer her doctor’s diagnosis together with his instructions that she take time off from work because of illness a short time later the executive director advised petitioner by telephone that her employment would be terminated effective date petitioner obtained the services of an attorney and explained in greater detail the circumstances of her employment illness and termination from employment the attorney met with petitioner’s employer’s attorney and worked out a settlement of petitioner’s claim against her employer the agreement contained a blanket release from any and all 6petitioner’s failure to bring suit or make formal allegations against pace is not necessarily detrimental to her efforts to establish the existence of an underlying tort- type cause of action 180_f3d_859 7th cir claims that petitioner might have had but had no specific or express statement of the payor’s intent an inference can be drawn however from the terms of the settlement agreement the manner in which pace agreed to pay out the settlement compensation reveals some recognition of petitioner’s claim and condition the dollar_figure settlement was segregated into three separate and distinct payments one amount dollar_figure was reflected as employee compensation due to petitioner which pace agreed to pay directly to petitioner’s attorney petitioner reported that dollar_figure on her federal_income_tax return as wage compensation another dollar_figure was sent directly to petitioner’s attorney and no form 1099-misc or form_w-2 was issued to petitioner by pace for that amount the remaining dollar_figure was paid_by pace to petitioner and the payment was not reduced by withholding pace issued a form 1099-misc reflecting that the dollar_figure was nonemployee compensation the differing tax and reporting treatments used for the three payments show that pace was aware that at least part of petitioner’s recovery may not have been subject_to tax ie was due to physical illness coupled with that inference is the fact that petitioner advised pace of her illness before her employment was terminated and the likelihood that her attorney represented petitioner’s circumstances to pace in the course of the settlement negotiations petitioner made no other claim we find that pace intended to compensate petitioner for her acute physical illness caused by her hostile and stressful work environment in summary petitioner has shown that her work environment exacerbated her existing physical illness petitioner’s condition and her ms flareup caused by her working conditions was intense and long lasting petitioner was physically unable to work until sometime in more than year following her termination she has shown that the only reason for the dollar_figure payment was to compensate her for her physical injuries to reflect the foregoing and to account for concessions of the parties decision will be entered under rule 7it is of no consequence that petitioner had the ms condition before the flareup caused by her hostile work environment


internal_revenue_service department of sug lo washington dc contact person telephone number in reference to t epra t3 nov uic db legend taxpayer a taxpayer b taxpayer c date date date date date date company m tra x dear this is in response to your request for a private_letter_ruling dated submitted on your behalf by your authorized representative in which you request several letter rulings with respect to sec_401 of the internal_revenue_code in support of your request your authorized representative has submitted the following facts and representations taxpayer a was born on date and attained age on date taxpayer a established ira x with company m on date and designated her children taxpayers b and c as equal beneficiaries of her ira x on the same date through use of a form provided by the ira x custodian entitled beneficiary designation taxpayer b was born on date and taxpayer c was born on date thus taxpayer b is older than taxpayer c page taxpayer a’s date of death was date which was subsequent to her required_beginning_date with respect to the commencement of required minimum distributions under sec_401 of the internal_revenue_code from ira x which was date prior to her death taxpayer a received code sec_401 required distributions from her ira x which required distributions were based on her recalculated single life expectancy the ira x custodial agreement agreement contains the following pertinent provisions relating to minimum required distributions sec_2 under article iv of the agreement provides unless otherwise elected by the time distributions are required to begin to the depositor under paragraph or to the surviving_spouse under paragraph other than in the case of a life_annuity life expectancies shall be recalculated annually such election shall be irrevocable as to the depositor and the surviving_spouse and shall apply to ali subsequent years the life expectancy of a nonspouse beneficiary may not be recalculated taxpayer a prior to attaining her required_beginning_date of date did not file an election with the custodian of ira x to elect out of the recalculation method with respect to determining her required minimum distributions although she could have made such an election pursuant to the provisions of sec_2 of article iv of the ira agreement she did not section under article vili of the ira agreement provides for distributions requested pursuant to article iv life expectancy and joint life and last survivor expectancy shall be calculated based on information provided by the depositor or the depositor’s authorized agent beneficiary executor or administrator using the expected retum multiples in sec_1_72-9 of the income_tax regulations sec_3 under article iv of the ira agreement provides the depositor’s entire_interest in the custodial_account must be or begin to be distributed by the depositor’s required_beginning_date april following the calendar_year end in which the depositor reaches age by that date the depositor may elect in a manner acceptable to the custodian to have the balance in the custodial_account distributed in a a single-sum payment b an annuity_contract that provides equal or substantially equal monthly quarterly or annual payments over the life of the depositor c an annuity_contract that provides equal or substantially equal monthly quarterly or annual payments over the joint and last survivor lives of the depositor and his or her designated page beneficiary d equal or substantially equal annual payments over a specified period that may not be longer than the depositor’s life expectancy e equal or substantially equal annual payments over a specified period that may not be longer than the joint life and last survivor expectancy of the depositor and his or her designated_beneficiary taxpayer a did not elect a specific distribution period with the custodian of ira x pursuant to the provisions of sec_3 of article iv of the ira x agreement sec_5 under article iv of the ira agreement provides in the case of distributions under paragraph determine the initial life expectancy or joint life and last survivor expectancy using the attained ages of the depositor and designated_beneficiary as of their birthdays in the year the depositor reaches age sec_4 under article iv of the ira agreement provides if the depositor dies before his or her entire_interest is distributed to him or her the entire remaining interest will be distributed as follows a if the depositor dies on or after distribution of his or her interest has begun distribution must continue to be made in accordance with paragraph in the calendar_year that taxpayer a attained age taxpayer b had the shorter life expectancy of the two beneficiaries of taxpayer a’s ira x taxpayers b and c taxpayer b’s remaining life expectancy wa sec_43 years in the calendar_year that taxpayer a attained age the remaining term-certain life expectancy with respect to taxpayer b as of the calendar_year following the calendar_year of taxpayer a’s death i sec_33 years taxpayer c’s remaining single life expectancy wa sec_45 years in the calendar_year that taxpayer a attained age the remaining term certain period with respect to taxpayer c as of calendar_year i sec_35 years based on the above you through your authorized representative request the following letter rulings that taxpayer b is a designated_beneficiary for purposes of sec_401 of the code with respect to ira x that taxpayer b was timely selected as a designated_beneficiary of ira x for purposes of sec_401 of the code page that taxpayer a's use of the single recalculated life expectancy in determining her required minimum distributions from her ira x during her lifetime does not preclude the use of the term certain life expectancy of the oldest designated_beneficiary taxpayer b in the calendar_year after the death of taxpayer a and subsequent calendar years and that in determining the required minimum distributions after the death of taxpayer a taxpayer b may use the remaining term-certain life expectancy of taxpayer b since she is the older of the two beneficiaries of ira x taxpayers b and c commencing in calendar_year and reduced by one for each calendar_year thereafter with respect to your ruling requests sec_408 of the code defines an individual_retirement_account as a_trust which meets the requirements of sec_408 through a sec_408 of the code states that under regulations prescribed by the secretary rules similar to the rules of sec_401 and the incidental death_benefit requirements of sec_401 shall apply to the distribution of the entire_interest of an individual for whose benefit the ira trust is maintained sec_401 of the code sets forth the general rules applicable to required minimum distributions from qualified_plans sec_401 of the code provides that a_trust shall not constitute a qualified_trust under this subsection unless the plan provides that the entire_interest of each employee will be distributed beginning not later than the required_beginning_date in accordance with regulations over the life of such employee or over the lives of such employee and a designated_beneficiary or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated_beneficiary sec_401 of the code provides that for purposes of this paragraph with respect to iras the term required_beginning_date means april of the calendar_year following the year in which the employee ira holder attains age sec_401 of the code provides that where distributions have begun under subparagraph a ii a_trust shall not constitute a qualified_trust under this section unless the plan provides that if -- i the distribution of the employee's interest has begun in accordance with subparagraph a ii and ii the employee dies before his entire_interest has been distributed to him the remaining portion of such interest will be distributed at least as rapidly as under the method of distributions being used under subparagraph a ii as of the date of his death sec_1_401_a_9_-1 of the proposed income_tax regulations proposed_regulations question answer d-2 a provides in pertinent part that designated beneficiaries are only individuals who are designated as beneficiaries under the plan in general it provides that an page individual may be designated as a beneficiary under the plan either by the terms of the plan or if the plan provides by an affirmative election by the employee or the employee's surviving_spouse specifying the beneficiary a beneficiary designated as such under the plan is an individual who is entitled to a portion of an employee's benefit contingent on the employee's death or another specified event sec_1_401_a_9_-1 of the proposed_regulations q a d-3 a provides that for purposes of calculating the distribution period described in sec_401 for distributions before death the designated_beneficiary will be determined as of the employee's required_beginning_date if as of that date there is no designated_beneficiary under the plan to receive the employee's benefit upon the employee's death the distribution period is limited to the employee's life or a period not extending beyond the employee's life expectancy in the present case taxpayer b was designated as a beneficiary under ira x by an affirmative election specifying the beneficiary by taxpayer a dated date through use of a form provided by the ira x custodian entitled beneficiary designation pursuant to said form taxpayer b was entitled to a portion of taxpayer a's benefit contingent on taxpayer a's death since taxpayer b was named a beneficiary of taxpayer a’s ira x on date which was prior to taxpayer a’s required_beginning_date of date taxpayer b was selected in a timely manner for purposes of calculating the distribution period described in sec_401 of the code accordingly with regard to ruling_request one we conclude that taxpayer b isa designated_beneficiary for purposes of sec_401 with respect to ira x with respect to ruling_request two we conclude that taxpayer b was timely designated a beneficiary of ira x for purposes of sec_401 of the code with respect to your remaining ruling requests sec_1_401_a_9_-1 of the proposed_regulations q a e-8 a provides in pertinent part that if the life expectancy of the employee ira holder is being recalculated the recalculated life expectancy will be reduced to zero in the calendar_year following the calendar_year of the ira holder’s death sec_1_401_a_9_-1 of the proposed_regulations q a e-8 b provides guidance on calculating the applicable life expectancy when the employee's life expectancy is being recalculated and the life expectancy of his designated_beneficiary is not recalculated it provides in relevant part that if the designated_beneficiary is not the employee's spouse and the life expectancy of the employee is being recalculated annually the applicable life expectancy for determining the minimum distribution for each distribution calendar_year will be determined by recalculating the employee's life expectancy but not recalculating the beneficiary's life expectancy such applicable life expectancy is the joint and last survivor expectancy using the employee's attained age as of the employee's birthday in the distribution calendar_year and an adjusted age of the designated_beneficiary the adjusted age of the designated_beneficiary is determined as follows first the beneficiary's applicable life expectancy is calculated based on page the beneficiary's’ attained age as of the beneficiary's birthday in the calendar_year described in e- reduced by one for each calendar_year which has elapsed since that calendar_year the age rounded if necessary to the higher age in table v of sec_1_72-9 is then located which corresponds to the designated beneficiary's applicable life expectancy such age is the adjusted age of the designated_beneficiary as provided in paragraph a upon the death of the employee the life expectancy of the employee is reduced to zero in the calendar_year following the calendar_year of the employee's death thus for determining the minimum distribution for such calendar_year and subsequent calendar years the applicable life expectancy is the applicable life expectancy of the designated_beneficiary determined under this paragraph sec_1_401_a_9_-1 of the proposed_regulations q a e-1 a provides generally that for required distributions under sec_401 of the code life expectancies are calculated using the employee's and the designated beneficiary's attained age as of the employee's birthday and the designated beneficiary's birthday in the calendar_year in which the employee attains age sec_1_401_a_9_-1 of the proposed_regulations q a e-5 a provides generally that if more than one individual is designated as a beneficiary with respect to an employee as of the applicable_date for determining the designated_beneficiary the designated_beneficiary with the shortest life expectancy will be the designated_beneficiary for purposes of determining the distribution period because taxpayer a's life expectancy was being recalculated in the calendar_year following the calendar_year of her death in accordance with q ae-8 a of sec_1_401_a_9_-1 of the proposed_regulations her life expectancy was reduced to zero although her benefit was paid in the form of a single life expectancy upon her death her life expectancy was not the last applicable life expectancy because she timely designated her beneficiaries by her required_beginning_date in accordance with q a d-3 a of the proposed_regulations therefore pursuant to q a e-8 b of sec_1_401_a_9_-1 of the proposed_regulations for purposes of determining the minimum distribution in the calendar_year after the death of taxpayer a the applicable life expectancy is the life expectancy of the designated_beneficiary as determined under that section since more than one individual was designated as a beneficiary with respect to taxpayer a as of date pursuant to sec_1_401_a_9_-1 of the proposed_regulations q a e- a the beneficiary who is the oldest and correspondingly who has the shortest life expectancy will be the designated_beneficiary for purposes of determining the distribution period under taxpayer a’s ira x therefore with regard to ruling_request three we conclude that taxpayer a's use of the single recalculated life expectancy in determining the required minimum distributions during her page lifetime does not preclude the use of the term-certain life expectancy of the oldest designated_beneficiary taxpayer b in the calendar_year following the calendar_year of taxpayer a’s death as noted above taxpayer b had the shorter life expectancy of the two beneficiaries of taxpayer a’s ira x as of her code sec_401 required_beginning_date of date furthermore taxpayer a did not change the beneficiaries of her ira x prior to her death therefore taxpayer b is the designated_beneficiary whose life expectancy will be used when determining the minimum distribution period under ira x for the calendar_year commencing after the year of taxpayer a's death and for all subsequent years thereafter pursuant to q as e-1 a and e-8 b of the proposed_regulations taxpayer b's applicable life expectancy is calculated based on her attained age as of her birthday in the calendar_year in which taxpayer a attained age reduced by one for each calendar_year which has elapsed since that calendar_year taxpayer b’s remaining single life expectancy in the year that taxpayer a attained age wa sec_43 therefore as of the calendar_year the remaining term-certain period with respect to taxpayer b i sec_33 years pursuant to q a e-8 b this period is reduced by one for each calendar_year subsequent to accordingly with respect to ruling_request four we conclude that taxpayer b may use taxpayer b’s remaining term-certain life expectancy in determining the required minimum distributions after taxpayer a's death since she is the older of the two beneficiaries of ira x commencing in the calendar_year and reduced by one for each calendar_year thereafter the above ruling is contingent upon the continuation of ira x as one described under sec_408 of the code this ruling is directed solely to the taxpayer that requested it sec_6110 of the code provides that it may not be used or cited by others as precedent page pursuant to a power_of_attorney on file in this office a copy of this letter mling is being sent to your authorized representative sincerely yours jrewyl boar frances v sloan manager employee_plans technical group tax_exempt_and_government_entities_division enclosures deleted copy of letter_ruling form_437 bue


department of the treasury internal_revenue_service washington d c date number release date uil cc psi cam-145001-02 memorandum for from chief planning and special programs area sb senior technician reviewer branch passthroughs and special industries cc psi subject denial of consent for change in accounting_method in accordance with a of revproc_2003_1 2003_1_irb_1 this chief_counsel_advice advises you that consent for a change in accounting_method has been denied to a taxpayer within your jurisdiction pursuant to sec_6110 k this chief_counsel advise is not to be cited as precedent legend taxpayer date amount taxpayer filed the form_3115 application_for change in accounting_method under revproc_97_27 c b to request permission to change its method of computing depreciation for certain residential_rental_property taxpayer is a partnership that operates a low-income_housing development to generate rental income the property was financed using the proceeds of tax-exempt_bonds taxpayer previously depreciated the residential_rental_property of issue under the general depreciation system of sec_168 of the internal_revenue_code taxpayer believes this method is improper taxpayer proposes to depreciate the residential_rental_property under the alternative_depreciation_system of sec_168 the depreciation deduction provided by sec_167 for tangible_property placed_in_service after generally is determined under sec_168 this section prescribes two methods cam-145001-02 of accounting for determining depreciation allowances one method is the general depreciation system in sec_168 and the other method is the alternative_depreciation_system in sec_168 sec_168 provides that in the case of any tax-exempt_bond_financed_property the depreciation deduction provided by sec_167 is determined under the alternative_depreciation_system except as otherwise provided in sec_168 sec_168 defines the term tax-exempt_bond_financed_property as meaning any property to the extent such property is financed directly or indirectly by an obligation the interest on which is exempt from tax under sec_103 sec_168 provides that the term tax-exempt_bond_financed_property does not include any qualified_residential_rental_project within the meaning of sec_142 sec_142 defines a qualified_residential_rental_project for purposes of sec_142 as any project for residential_rental_property if at all times during the qualified_project_period such project meets either a the test if percent or more of the residential units in such project are occupied by individuals whose income i sec_50 percent or less of area_median_gross_income or b the test if percent or more of the residential units in such project are occupied by individuals whose income is percent or less of area_median_gross_income whichever is elected by the issuer at the time of the issuance of the bonds with respect to such project see also sec_1_103-8 of the income_tax regulations in the present case taxpayer represents that the low-income_housing project subject_to taxpayer’s form_3115 constitutes a qualified_residential_rental_project within the meaning of sec_142 accordingly pursuant to sec_168 taxpayer’s qualified_residential_rental_project is not included in the term tax-exempt_bond_financed_property therefore the depreciation deduction provided by sec_167 for taxpayer’s residential_rental_property does not have to be determined under the alternative_depreciation_system taxpayer’s present method_of_accounting for the residential_rental_property is a permissible method_of_accounting in addition taxpayer did not elect to depreciate the residential_rental_property at issue under the alternative_depreciation_system sec_168 provides that if a taxpayer makes an election under this paragraph with respect to any class of property for any taxable_year the alternative_depreciation_system under sec_168 will apply to all property in such class placed_in_service during such taxable_year notwithstanding the preceding sentence in the case of nonresidential_real_property or residential_rental_property such election may be made separately with respect to each property an election made under sec_168 is irrevocable sec_301_9100-7t of the procedure and administration regulation provides that the election under sec_168 must be made in the same taxable_year in which the property is placed_in_service in the present case taxpayer placed the residential_rental_property in service on date therefore taxpayer needed to make the election under sec_168 on its federal tax_return for the taxable_year ending cam-145001-02 date taxpayer did not make a timely election under sec_168 for the residential_rental_property subject_to taxpayer’s form_3115 the method changes would have been effective with the taxable_year beginning date and would have resulted in a positive sec_481 adjustment increase in taxable_income of amount if you have any questions on this matter do not hesitate to call me at kathleen reed____________ kathleen reed cc


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 fip b02 plr-163304-05 date may ------------------------------------------------------------ legend taxpayer -------------------------------------------------------------------- subsidiary date --------------------------- date notes ----------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------ ------------------- ----------------------------------------------------- trust ------------------------------------------------------------------------ ----------------------------------------------------------------------------------------------------------------- a b c dear ------------------ ------------------- ------------------- --------------- plr-163304-05 this is in reply to a letter dated date and supplemental correspondence dated date requesting certain rulings on behalf of taxpayer the requested rulings concern the treatment of bond_issuance_premium under sec_856 of the internal_revenue_code the code facts estate investment_trust reit under part ii of subchapter_m of the code sections for its tax_year ending on date taxpayer’s stock is publicly traded on a national stock exchange taxpayer’s principal activity is to invest in mortgages and mortgage backed securities taxpayer is a domestic_corporation that initially elected to be treated as a real subsidiary is a wholly-owned subsidiary of taxpayer taxpayer has represented that subsidiary is a qualified_reit_subsidiary of taxpayer under sec_856 of the code subsidiary’s principal activity is to originate mortgage loans when subsidiary accumulates a certain amount of mortgage loans it transfers those loans to an owner trust and issues notes in the owner trust to investors mortgage loans held in the trust all of the mortgage loans are secured_by real_property and are not contingent payment debt instruments on date taxpayer through subsidiary issued the notes which are secured_by certain of the notes were issued with bond_issuance_premium the premium notes the premium notes were issued with an issue_price of a and a stated_redemption_price_at_maturity of b resulting in bond_issuance_premium of c taxpayer represents that it amortizes bond_issuance_premium using a constant_yield_method of accounting for federal_income_tax purposes taxpayer represents that the trust will be classified as a taxable_mortgage_pool pursuant to sec_7701 of the code taxpayer owns of the beneficial_interest in the trust the notes are publicly offered and the stated_interest and principal on the notes are payable monthly to the extent principal is prepaid on the underlying mortgage loans in excess of regularly scheduled principal payments on such loans the trust makes additional principal payments to the holders of the notes taxpayer represents that the notes are debt instruments to which sec_1272 of the code applies law and analysis sec_856 of the code provides that in order for a corporation to be considered a reit at least percent of the corporation's gross_income excluding gross_income from prohibited_transactions must be derived from dividends interest rents_from_real_property gain from the sale_or_other_disposition of stock securities and real_property other than property in which the corporation is a dealer abatements and plr-163304-05 refunds of taxes on real_property income and gain derived from foreclosure_property commitment_fees and gain from certain_sales or other dispositions of real_estate_assets under sec_856 of the code in order for a corporation to qualify as a reit at least percent of the corporation's gross_income excluding gross_income from prohibited_transactions must be derived from rents_from_real_property interest on obligations secured_by real_property gain from the sale_or_other_disposition of real_property other than property in which the corporation is a dealer dividends from reit stock and gain from the sale of reit stock abatements and refunds of taxes on real_property income and gain derived from foreclosure_property commitment_fees gain from certain_sales or other dispositions of real_estate_assets and qualified_temporary_investment_income sec_1_856-2 of the regulations provides that for purposes of both the numerator and denominator in the computation of the percentage requirements of sec_856 and of the code the term gross_income has the same meaning as that term has under sec_61 and the regulations thereunder the legislative_history underlying the tax treatment of reits indicates that the central concern behind the gross_income restrictions is that a reit's gross_income should largely be composed of passive_income for example h_r rep no 86th cong 2d sess pincite 1960_2_cb_819 pincite states o ne of the principal purposes of your committee in imposing restrictions on types of income of a qualifying real_estate_investment_trust is to be sure the bulk of its income is from passive_income sources and not from the active_conduct_of_a_trade_or_business sec_61 of the code provides that except as otherwise provided gross_income includes all income from whatever source derived sec_1_61-12 of the regulations provides that an issuer does not realize gain_or_loss upon the issuance of a debt_instrument sec_1275 of the code defines a debt_instrument as a bond debenture note or certificate or other evidence_of_indebtedness sec_1_163-13 of the regulations defines bond_issuance_premium as the excess if any of the issue_price of a debt_instrument over its stated_redemption_price_at_maturity conclusion bond_issuance_premium on the premium notes will not be treated as other than qualifying_income for purposes of the gross_income tests under sec_856 and c plr-163304-05 except as expressly provided herein no opinion is expressed concerning any federal_income_tax consequences related to the facts herein under any other provisions of the code specifically no opinion is expressed or implied as to whether the notes are debt instruments to which sec_1272 applies or as to the reasonableness of taxpayer’s method_of_accounting for bond_issuance_premium or whether such method clearly reflects income furthermore we express no opinion as to whether taxpayer qualifies as a reit whether subsidiary qualifies as a qualified_reit_subsidiary under part ii of subchapter_m of the code or whether trust is properly classified as a taxable_mortgage_pool pursuant to sec_7701 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 temporary or final regulations pertaining to one or more issues addressed in this ruling have not yet been adopted therefore this ruling may be modified or revoked by the adoption of temporary or final regulations that are inconsistent with any conclusion in the ruling see section dollar_figure of revproc_2007_1 2007_1_irb_1 however a private_letter_ruling is not generally revoked or modified retroactively if the taxpayer can demonstrate that the criteria in section dollar_figure of revproc_2007_1 are satisfied in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives a copy of this letter must be attached to any income_tax return to which it is relevant sincerely david b silber david b silber senior technician reviewer branch office of associate chief_counsel financial institutions products


t c memo united_states tax_court foretravel inc petitioner v commissioner of internal al revenue respondent docket no filed date george w connelly jr and linda s paine for petitioner lillian d brigman and susan v sample for respondent memorandum findings_of_fact and opinion clapp judge respondent determined deficiencies in and additions to petitioner's federal corporate income taxes as follows fye additions to tax june deficiency sec_6661 sec_6662 dollar_figure dollar_figure -- big_number -- dollar_figure after concessions by the parties the issues for decision are whether petitioner is entitled to a deduction for its fiscal_year ended date in the amount of dollar_figure advanced to solve the financial problems of a dealership we hold that petitioner is so entitled whether petitioner is entitled to exclude from gross_income or deduct under sec_162 in its fiscal years ended date and date the respective amounts of dollar_figure and dollar_figure as incentives to its dealerships we hold that petitioner is entitled to exclude the respective amounts from gross_income whether petitioner is liable for an addition_to_tax pursuant to sec_6661 for its fiscal_year ended date we hold that petitioner is not whether petitioner is liable for an addition_to_tax pursuant to sec_6662 for its fiscal_year ended date we hold that petitioner is not 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 unless otherwise indicated findings_of_fact some of the facts are stipulated and are so found we incorporate by reference the stipulation of facts and attached exhibits background petitioner is foretravel inc foretravel a corporation organized in under the laws of the state of texas with its principal_place_of_business in nacogdoches texas during the years in issue petitioner filed its tax returns on a june fiscal_year basis petitioner manufactured and sold class a self-contained motor homes coaches ranging from to feet in length petitioner sold its coaches under the trade names of grand villa and unihome the grand villa sold for retail prices from dollar_figure to dollar_figure while the unihome sold for retail prices from dollar_figure to dollar_figure foretravel personnel included the following clarence m fore mr fore president don franklin franklin vice president and chief financial officer james don moore moore vice president and general manager ruth marie fore mrs fore secretary and treasurer bill weaver weaver comptroller and assistant treasurer and floyd wilcox wilcox director of marketing operations mr fore spent his time designing and selling coaches while moore essentially ran petitioner's operations until his death in mr fore built his first motor home in his spare time in and incorporated foretravel one year later to manufacture motor homes foretravel remained a family business until when mr fore along with his friend moore quit their jobs and went to work full time for foretravel franklin also joined foretravel about that time and foretravel began advertising in travel magazines while the fores attended recreational vehicle shows to display foretravel coaches as petitioner's coaches began to gain popularity its salespeople sold coaches to existing vehicle dealerships and directly to customers by to dealers were selling foretravel coaches and foretravel was making approximately coaches a year from its inception petitioner sought to build a high quality coach with top quality components petitioner carved out its market niche of expensive high quality coaches for the affluent traveler who enjoyed extended vacations petitioner sponsored regional clubs that offered courses in motor home maintenance and organized domestic and international caravans for motor home owners during the years in issue the foretravel motorcade club had over big_number active members petitioner suffered setbacks in the late 1970s due to the energy crunch and high interest rates these factors also affected independent dealers' interest in stocking foretravel coaches and as a result only two independent dealers continued to sell foretravel coaches petitioner's sales fell below the anticipated level of production and petitioner had to lay off employees petitioner decided to become more involved at the dealer level and in petitioner took over a dealership in california the california dealership that owed petitioner money the fores traveled to california to run the california dealership and they managed to boost sales from coaches a month to over a month the fores continued to operate the california dealership until the middle of when they returned to nacogdoches texas due to the success of the california dealership petitioner purchased other dealerships in texas tennessee and florida in each case these other dealerships were existing businesses that sold other vacation vehicles such as trailers and inexpensive motor homes in addition to selling foretravel coaches the california dealership was the only dealership suffering financial problems when purchased by petitioner by petitioner owned percent of the stock of foretravel of arizona inc the arizona dealership but the arizona dealership closed in following a change in arizona state law petitioner also owned percent of the stock of investments in general inc iig iig had four wholly owned subsidiaries foretravel of california inc the california dealership foretravel of florida inc the florida dealership murphy motor manors inc the tennessee dealership and foretravel of texas inc the texas dealership which apparently included two separate dealerships one located in dallas and the other located in nacogdoches we refer to the dealers collectively as subsidiaries or dealerships moore served as president of the subsidiaries and the arizona dealership iig owned the dealerships' stock because petitioner wished to avoid the appearance that it sold its coaches through factory-owned dealers iig and the subsidiaries filed consolidated_returns in based on a december calendar_year in iig was liquidated and petitioner acquired the dealerships' stock the subsidiaries filed separate returns in based on a calendar_year ending december the pacific northwest dealership in walter p nicholson nicholson and william h fishfader fishfader became partners in a toyota agency in coeur d'alene idaho where they sold motor homes recreational vehicles and automobiles in they decided to sell recreational vehicles full time and became interested in the foretravel product line they contacted a foretravel representative on the west coast and eventually signed a dealer agreement with foretravel on date that enabled them to be the exclusive dealer of foretravel products for a 5-year period in idaho montana oregon and washington pursuant to the agreement fishfader and nicholson also could sell less expensive product lines but not product lines that would compete directly with foretravel the resulting dealership was named pacific northwest motorhomes northwest northwest stocked at least one line of motor homes other than foretravel the agreement between petitioner and northwest provided that they were independent contractors as to each other and not otherwise the agreement required petitioner to deliver three units per quarter and required northwest to maintain an inventory of parts and accessories and an inventory of coach models in a clean and orderly condition the agreement also required northwest to maintain a regular place of business and display units for sale while promoting and advertising foretravel within northwest's established territory the parties modified the original agreement to require northwest to purchase units in the first year units the second year and units for the remaining years petitioner did not perfect a security_interest under idaho law in the units shipped to northwest on credit between and northwest grew rapidly added a second location and soon became one of the largest dealers in that geographic region for high quality coaches in fishfader became interested in another dealership in spokane washington so he and nicholson made arrangements to purchase the spokane dealership fishfader had become disillusioned with the expense and time that it took to sell the higher quality coaches such as those manufactured by foretravel fishfader wanted to drop the entire foretravel line of coaches and focus on selling a higher volume of the less expensive coaches nicholson felt that focusing entirely on less expensive coaches would be a mistake and he wanted to continue selling the foretravel line fishfader and nicholson were unable to agree on whether to drop the foretravel line of coaches and in fishfader asked nicholson to purchase his interest in northwest nicholson did not have the funds to purchase fishfader's interest so he approached petitioner and asked for financial assistance petitioner had established similar relationships in the past and had recently acquired the arizona dealership but petitioner was not looking for additional company-owned dealerships nonetheless nicholson persuaded petitioner that northwest was doing an excellent job and that it would not be in petitioner's best interest for northwest to drop the foretravel product line petitioner concluded that if it did not assist nicholson there would no longer be a foretravel dealer in that region on date petitioner agreed to purchase fishfader's 51-percent interest in northwest for dollar_figure several weeks later petitioner and nicholson entered into a repurchase_agreement the repurchase_agreement which provided that northwest would issue big_number shares of class b common_stock to be purchased by petitioner for dollar_figure at the end of years nicholson was granted an option to repurchase petitioner's percent stock holdings of class a common_stock at book_value if petitioner's loans to northwest had been repaid and corporate debts guaranteed by petitioner had been paid nicholson viewed petitioner's ownership of the northwest stock as a temporary arrangement because he intended to purchase the stock back from petitioner in a very short time petitioner granted nicholson a further option to buy the shares of class b stock from petitioner at the end of years for dollar_figure plus interest but only if northwest had repurchased petitioner's class a stock petitioner also lent northwest dollar_figure to be repaid over years in a separate agreement dated date petitioner and its officers guaranteed the floorplan of northwest up to dollar_figure million financed by idaho first national bank idaho first prior to this time fishfader had guaranteed northwest's floorplan idaho first also required petitioner to pledge as additional collateral a certificate of deposit in the amount of dollar_figure a floorplan arrangement works as follows the dealership wanting coaches for inventory makes the necessary arrangements with a lender when the dealership orders a coach the manufacturer contacts the lender for approval to ship the coach to the dealership title documents are sent through the banking system to the lender who then pays the manufacturer the lender retains title to the coach the dealership owes interest on the amount financed by the lender until the coach is sold when the dealership sells the coach the dealership pays the lender the amount financed and the difference between the dealership's cost and the sale price is the dealership's profit in date northwest arranged to have chrysler first wholesale credit inc chrysler first finance its floorplan chrysler first no longer required petitioner's officers personally to guarantee the financing_arrangement and it did not require petitioner to pledge the dollar_figure certificate of deposit as additional collateral petitioner remained the sole guarantor of northwest's floorplan financing the chrysler first guarantee agreement provided that the obligation of the guarantor petitioner was primary and was a guarantee of payment not of collection therefore chrysler first could proceed against the guarantor jointly or severally without having commenced any_action against or having obtained any judgment against the obligor northwest in the spring of northwest's sales began to slow down other high-quality coach manufacturers began to offer deep discounts on their new coaches selling at cost or below cost in an attempt to move inventory this competition affected northwest's sales of new coaches northwest also had a large inventory of used coaches that had been taken in as trades used coach sales also declined and northwest suffered cash-flow problems from the cost to inventory the used coaches as the problems mounted northwest used the proceeds from the sales of coaches to pay the most pressing operating_expenses or floorplan costs rather than floorplan loans thus rendering itself out of trust nicholson admittedly robbed peter to pay paul in date checks from northwest payable to petitioner were rejected by the bank due to insufficient funds however northwest did eventually pay the checks that were rejected franklin began contacting nicholson on a regular basis about northwest's accounts_payable to petitioner nicholson pacified franklin by telling him whatever was needed to keep things going so that northwest could find a way to pull out of the slump northwest had a deficit equity of dollar_figure on date which increased to dollar_figure on date prior to date northwest's officers included nicholson as president moore as vice president weaver as treasurer and mrs fore as secretary while nicholson mr fore moore and franklin served on the board_of directors from the time petitioner purchased fishfader's stock in northwest through the fall of nicholson managed northwest and petitioner exerted no control_over northwest and did not dictate northwest's policy by late september or early date nicholson had stopped sending financial statements to chrysler first consistently chrysler first requested and received northwest's financial statement and realized that northwest's liabilities far exceeded its assets chrysler first notified nicholson and threatened to close northwest and take over the remaining assets neither nicholson nor northwest had the funds to pay chrysler first and in date nicholson contacted franklin and told him that northwest was in trouble because he was out of trust nicholson used proceeds from sales of consigned coaches as well as coaches sent by petitioner to pay operating_expenses instead of paying the consignee or petitioner chrysler first called franklin and told him that petitioner as guarantor would have to make good on the lines of credit franklin and wilcox traveled to coeur d'alene idaho to assess the situation at northwest northwest had no record of its coach inventory its parts inventory was overstated and disorganized and the administrative offices were in disarray after or days in idaho wilcox and franklin returned to nacogdoches texas chrysler first demanded dollar_figure immediately and on date petitioner agreed to lend northwest dollar_figure which northwest applied to the chrysler first loan guaranteed by petitioner moore in his capacity as vice president of northwest gave petitioner a 1-year interest-bearing promissory note dated date in the amount of dollar_figure the promissory notes that northwest gave to petitioner required that interest at the rate of percent per annum be paid in full annually according to the information available as of date northwest owed petitioner dollar_figure and moore acting as vice president of northwest gave petitioner a 1-year interest-bearing promissory note dated date in that amount wilcox returned to coeur d'alene idaho in date to install petitioner's accounting system at northwest which took approximately weeks during that time wilcox discovered that northwest owed more money to chrysler first after wilcox and nicholson met with chrysler first personnel in seattle washington wilcox requested an additional dollar_figure from petitioner to pay chrysler first pursuant to petitioner's guarantee on date petitioner agreed to lend northwest an additional dollar_figure and moore acting as vice president of northwest gave petitioner a 1-year interest- bearing promissory note dated date for that amount while establishing an accounting system for northwest wilcox closed old accounts opened new ones and placed various financial controls on northwest's future operations wilcox closed four of northwest's five existing bank accounts and the fifth was used as a depository_account to which nicholson did not have access wilcox opened a working fund account with a separate bank and if nicholson needed money from the working fund he would need petitioner's approval for the expenditure wilcox asked nicholson for additional assets to secure petitioner's receivables but nicholson had none to pledge other than his stock in northwest and his rights in two patents by this time nicholson's house and car were highly leveraged and he had a minimal balance in his checking account nicholson delivered his northwest stock to petitioner as collateral for petitioner's receivables in an auditor's report dated date petitioner's accountant recorded this transaction as a purchase of the remaining percent of issued and outstanding northwest voting_stock from nicholson on date but the accounting record does not disclose any purchase_price nicholson also transferred his patent rights to petitioner but those rights proved to be of no value petitioner continued to ship coaches to northwest and all of the units were shipped on credit with the cost of the unit carried on petitioner's books as a units account receivable the value of approximately seven units that petitioner shipped to northwest before date was included as part of petitioner's bad_debt deduction for most of the units that petitioner shipped to northwest from date through date were written off as bad_debts by petitioner on date as follows date cost written off shipped by foretravel dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number total dollar_figure petitioner also shipped to northwest unit cost dollar_figure on date and unit cost dollar_figure on date and northwest reduced the balance due on unit by dollar_figure and paid for unit in full northwest made these payments in date in date petitioner sent pam clark clark to northwest as a general manager to manage the business side of northwest while nicholson focused on sales northwest's situation did not improve and later that same month jim ratliff ratliff a private investor demanded payment from northwest on a dollar_figure note which was not recorded on northwest's books nicholson had obtained floorplan financing from ratliff on less expensive coaches that were too old for chrysler first to floorplan nicholson had given ratliff a note for dollar_figure secured_by rights in one of nicholson's patents nicholson never informed petitioner about ratliff's note in date nicholson surrendered ownership of his stock in northwest to petitioner on date nicholson and petitioner amended the repurchase_agreement the amendment provided that petitioner owned percent of northwest's stock and that nicholson would regain the 49-percent interest in northwest when northwest repaid petitioner's accounts receivables due from northwest and repaid the advances made to northwest during on date petitioner agreed to advance northwest dollar_figure and moore acting as vice president of northwest delivered a 1-year interest- bearing promissory note to petitioner in that amount northwest repaid petitioner dollar_figure on date but no interest was paid for the time the note was outstanding in date tracy golden golden a partner from the accounting firm of axley rode who had been working on the foretravel account since was performing routine interim audit work on petitioner's financial statements when he became concerned that the receivables from northwest might affect his ability to express a clean opinion on petitioner's financial statements golden wanted to observe firsthand the situation at northwest he discussed the matter with weaver and they decided to inspect northwest and assess the situation on date petitioner settled a note given to fishfader by northwest petitioner paid chrysler first dollar_figure for two rockwood coaches floorplanned by chrysler first these coaches were then transferred to fishfader in exchange for the note given to him by northwest moore acting as president of northwest delivered to petitioner a 1-year interest-bearing promissory note dated date in the amount of dollar_figure about this same time late date ratliff produced another note signed by nicholson as president of northwest in the amount of dollar_figure petitioner sent a representative to coeur d'alene who met with nicholson and asked him to resign and not return in any capacity petitioner immediately consulted its lawyer about what options were available regarding northwest and nicholson petitioner's officers still felt that northwest was in a marketable area and had potential for success despite its poor financial condition in date golden and weaver made a surprise visit to northwest they found the parts inventory and parts room in disarray and some used coaches were missing while others were in disrepair they also went to northwest's accountant's office to inquire about some of the information on northwest's financial statements the accountant stated that he compiled the financial statements from the numbers he received from nicholson and previously fishfader the accountant never inspected bank statements check registers or receipts golden and weaver took an inventory of motor homes vans and cars and also inspected some of northwest's records looking for sources of collection for the amounts that northwest owed petitioner golden reviewed the assets at the dealership and he concluded that northwest was insolvent to the extent of roughly dollar_figure million golden's conclusion was contrary to compilation statements given to petitioner by northwest the year before golden and weaver boxed up as many of northwest's records as they could and shipped them back to nacogdoches texas for review after reviewing northwest's records in nacogdoches golden concluded that cash was missing from northwest but he was unable to determine where the cash might be petitioner did investigate the possibility that nicholson had pocketed the cash but by this time nicholson had few if any assets available for collection axley rode analyzed northwest's assets and liabilities to determine whether northwest's receivables were collectible after a review of northwest's records golden advised petitioner that northwest could not generate the cash-flow needed to pay the amount owed to petitioner northwest's receivables were pledged to the finance company new inventory of coaches not manufactured by petitioner x brand coaches was floorplanned by chrysler first and the value of the used coaches was inflated the total assets on the books were dollar_figure and liabilities were dollar_figure million of which dollar_figure to dollar_figure million was owed to petitioner northwest had lost dollar_figure in its year ended date and through date had lost approximately dollar_figure after golden had the axley rode tax department research the question he advised petitioner to deduct the northwest receivables as a bad_debt by the end of date petitioner believed that northwest could not pay and did not have the potential to pay the existing receivable balances mr fore was concerned that northwest's situation could cause bad publicity among potential customers and have a negative impact on petitioner on date petitioner wrote off as a bad_debt the following items attributable to northwest trade accounts_receivable in the amount of dollar_figure which included advertising insurance and other expenses that petitioner paid on northwest's behalf notes receivable in the amount of dollar_figure and unit accounts_receivable in the amount of dollar_figure the notes receivable in the amount of dollar_figure consisted of the note dated date in the amount of dollar_figure the note dated date in the amount of dollar_figure and the note dated date in the amount of dollar_figure the remaining dollar_figure in the notes receivable account consisted of the loan to northwest in when petitioner acquired percent of northwest's stock northwest recorded as income on its books the amount of petitioner's bad_debt writeoff after date petitioner did not receive any other assets cash or property owned or on the books of northwest as of date funds that petitioner received from northwest after date were attributable to units delivered to northwest after date foretravel incentive program for dealerships petitioner established uniform bookkeeping systems for the subsidiaries and the subsidiaries also used standard paperwork including forms distributed by the recreational vehicle dealer international association the dealerships were retail merchants that sold and serviced new motor homes including those manufactured by foretravel less expensive motor homes used motor homes trailers and other service recreational vehicles each dealership carried at least one x brand line of motor homes motor home manufacturers use a variety of incentive plans designed to promote the sale of their products petitioner was no exception through its incentive program petitioner sought to maintain a steady flow of coaches through its manufacturing operation thus avoiding fluctuations in employment supplies and general level of operation petitioner also sought to obtain positive publicity from its customers maintain customer goodwill alleviate cash-flow problems and maintain its reputation as a top quality coach manufacturer petitioner also used its incentive program to attract buyers for coaches with unpopular colors or unpopular sizes and display models that had been driven to recreational vehicle shows the x brand manufacturers also offered incentive programs to the foretravel dealerships one facet of petitioner's incentives began when mr fore operated the california dealership the california dealership would purchase foretravel coaches for sale to customers at times customers would make mr fore an offer on a foretravel coach but the purchase_price proposed by the customer would be less than the price the california dealership paid petitioner for the coach mr fore would call moore at foretravel and ask him if petitioner was interested in such a sale if petitioner was interested in selling the coach at the customer's suggested price then petitioner would make a commensurate adjustment in its price to the dealer via the foretravel incentive program this incentive method still was in place during the years in issue and was available to a dealer faced with a customer offer that produced a loss or resulted in a skinny deal a skinny deal is a transaction that has a dollar_figure profit or less a salesperson at the dealership could not turn down any deal proposed by the customer even a skinny deal the sales manager at the dealership had the authority as did the general manager to accept any deal with a profit in excess of dollar_figure when the profit fell below dollar_figure the dealership had to contact foretravel in nacogdoches to approve the transaction franklin or moore personally had to approve any loss_transaction if a used coach was taken in as a trade on the purchase of a foretravel coach then neither petitioner nor the dealership knew the exact profit or loss until the used coach was sold and even then another used coach might be taken in as a trade difficulty in predicting the resale value of a used coach added to the uncertainty thus petitioner made one yearend rebate instead of making an immediate rebate that might have to be reversed after the sale of the used coach to maintain a steady flow of coaches petitioner would force dealers to accept inventory so as to avoid the circumstances that petitioner faced in when some of the independent dealers refused to accept new inventory this refusal interfered with petitioner's ability to maintain steady production petitioner provided the dealerships with floorplan financing in and and petitioner charged the dealerships interest on this financing thus the additional inventory would result in additional finance costs for the dealer petitioner would take the additional inventory and associated finance costs into account when determining the incentives owed to a dealer to obtain positive publicity from its customers petitioner would authorize a special deal on a coach for a high profile motor home owner such as a leader or organizer of a motor home association or club petitioner felt that having that person own a foretravel coach could influence other members of that association or club to do the same to maintain customer goodwill petitioner would authorize a special deal or a favorable trade on another foretravel model when a customer returned a coach and complained of poor quality to alleviate temporary cash-flow problems petitioner might allow a dealer to sell a new or used coach financed by petitioner at a discount in order to generate cash-flow to petitioner to maintain its reputation as a top quality or highline coach manufacturer petitioner established relatively high wholesale and suggested retail prices the yearend incentive payments allowed petitioner to maintain its position in the public's eye as a top quality coach manufacturer while reducing the wholesale cost of the coach to the dealer when necessary petitioner also believed that a firm wholesale price provided salespeople with a floor that they could use to negotiate with customers petitioner took all of the various factors discussed above into account when determining the incentive payment for the dealerships petitioner had no written policy as to the amount of the incentive paid to each dealer franklin and moore discussed throughout the year the various transactions that would give rise to a rebate at the end of petitioner's fiscal_year franklin again discussed the various transactions with moore and then moore would decide the amount of the rebate to each dealer petitioner also paid incentives to independent dealers that sold foretravel coaches but those incentives were not necessarily identical to the incentives paid to petitioner's subsidiaries the incentives petitioner paid to the various subsidiaries were not necessarily identical either in part because sales fluctuated both seasonally and geographically petitioner offered the incentives needed to spur sales at the particular time the dealer incentives for the years in issue were as follows dealer arizona california dallas florida tennessee nacogdoches rebate for year ended june -- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -- total dollar_figure dollar_figure for weaver recorded the incentive payments as a credit to trade accounts_receivable and a debit to bad_debts on petitioner's books weaver recorded the incentive payments as a debit to the bad_debts account because he was stretched for time and took a shortcut he knew that the auditors from axley rode would reclassify or make an adjustment to the entries where appropriate in moore directed weaver to record the incentive payments as a credit to trade accounts_receivable from the subsidiaries because moore felt that this would be advantageous to petitioner for financial reporting purposes this resulted in a writeoff of the entire balance of petitioner's trade account receivables for the fiscal_year ended date for weaver recorded the incentive payments as a credit to unit receivables and a debit to bad_debts on petitioner's books moore did not instruct weaver how to record the incentive payments for weaver believed the credit to unit receivables was the correct entry on petitioner's books because the incentive was being matched to the sales of units as reflected in the unit receivables he thought a journal entry debiting sales which petitioner had done in prior years with a credit memo would not be proper without a credit memo golden supervised axley rode's preparation of petitioner's financial statements for its fiscal years ended date and even before he became managing partner of the foretravel account in golden knew that petitioner had a rebate policy after the audit group from axley rode completed the financial statements the relevant information was turned over to axley rode's tax department to prepare the tax returns golden then reviewed the completed tax returns for the years in issue golden was aware that the account weaver labeled as bad_debts also contained the rebates to the various dealerships golden treated the bad_debt account as a suspense_account that needed to be adjusted later in order to reclassify the rebates golden did not reclassify the incentive payments for financial_accounting purposes because he felt that doing so would not change the consolidated financial statements prepared by axley rode golden failed to reclassify the rebates and when the axley rode tax department prepared petitioner's federal corporate_income_tax returns nothing indicated that rebates to the dealers existed when golden reviewed the completed tax returns he compared the results with preliminary calculations he made using the financial statements but he failed to notice that the incentive payments had not been reclassified weaver reviewed petitioner's federal corporate_income_tax returns for the years in issue but he failed to realize that axley rode had not reclassified the incentive payments as a result petitioner reported the rebates as bad_debts on its tax returns for the years in issue the incentive payments were booked on the subsidiaries' financial statements for the years and as other income for the years in issue the subsidiaries reported the incentive payments as income in an amount equal to the bad_debt deductions taken by petitioner opinion deduction for payments made in connection with northwest the differences between the parties come down to a basic difference in the analysis and interpretation of the events that transpired between petitioner and northwest during the fiscal_year ended date respondent looks at the events during this period and particularly the advances made by petitioner to northwest as being either loans which created debt or contributions to capital respondent views petitioner as a stockholder of northwest and analyzes the advances by petitioner to northwest under the traditional debt-equity considerations see 464_f2d_394 5th cir applying debt-equity factors using that approach respondent concludes that no bona_fide debtor-creditor relationship between petitioner and northwest was created after date because the advances and extensions of credit by petitioner to northwest after that date were worthless when made see 352_us_82 taxpayer who voluntarily buys a debt with knowledge that he will not be paid is considered not to have acquired a debt petitioner on the other hand views the transactions during this period as an attempt to bail out and salvage a dealership that was important to petitioner northwest covered a territory which had substantial potential prior to the years in issue northwest had been profitable and responsible for many sales of petitioner's motor coaches petitioner wanted to keep northwest as a healthy profitable dealership because of its own self- interest in selling motor coaches as the scenario further developed and the bankruptcy of northwest became a real possibility petitioner was seriously concerned about the effect that this development would have on its reputation among owners and potential owners of foretravel coaches petitioner's original acquisition of percent of the stock of northwest from fishfader was made in order to keep northwest in existence the 51-percent ownership was not intended to be permanent it was expected that the stock would be sold to nicholson and that petitioner would be out of the picture in terms of stock ownership as the facts set forth above indicate this did not happen in fact the situation went the other way and nicholson began to develop financial problems petitioner's officers believed in their best business judgment that petitioner should advance cash to northwest to help northwest stay viable as the situation developed matters went from bad to worse all as outlined above petitioner continued to respond to each new crisis with more cash for the reasons already set forth petitioner got into the northwest situation deeper and deeper as problems developed petitioner argues that the advances made were for the purpose of bailing out and salvaging northwest all for the business purposes and best interests of petitioner petitioner also argues that the amounts advanced to northwest should be deductible either as bad_debts or as uncollectible accounts_receivable or some combination thereof without regard to the usual criteria for creating a debt respondent concedes that the debts associated with northwest and accrued by petitioner prior to date are deductible as bad_debts respondent argues that the funds advanced and the units shipped after date were capital contributions thus of the dollar_figure bad_debt deduction taken by petitioner for the year ended date only dollar_figure remains in dispute the dollar_figure consists of the note given to petitioner by northwest dated date in the amount of dollar_figure the note dated date in the amount of dollar_figure and the note dated date in the amount of dollar_figure with petitioner's accounts_receivable for units shipped to northwest after date making up the balance of dollar_figure the parties agree that all of the amounts due petitioner from northwest on date were worthless at that time sec_166 provides that there shall be allowed as a deduction any debt which becomes wholly or partially worthless within the taxable_year the taxpayer bears the burden of proving entitlement to a claimed bad_debt deduction rule a 77_tc_582 we must evaluate whether there was a genuine intention to create a debt with a reasonable expectation of repayment and whether that intention comports with economic reality 61_tc_367 baldwin v commissioner tcmemo_1993_433 in making this determination we will not ignore the realities of the business world 50_tc_536 c m gooch lumber sales co v 49_tc_649 remanded pursuant to stipulation of the parties 406_f2d_290 6th cir we agree with petitioner's analysis of what happened and decline to substitute respondent's different business judgment our first point of departure from respondent's analysis is the significance given to petitioner's ownership of northwest's stock respondent has overemphasized this fact petitioner was not interested in owning northwest but agreed to purchase the initial percent primarily to keep a foretravel dealer in that region petitioner and nicholson entered into a repurchase_agreement giving nicholson the option after years to repurchase petitioner's 51-percent stock holdings in date nicholson delivered the remaining percent along with patent rights to petitioner as collateral for petitioner's receivables the patent rights proved to be of no value nicholson eventually surrendered ownership of the remaining percent in date thus petitioner's ownership of the northwest stock was by default rather than by design there is no dispute that petitioner guaranteed the financing from chrysler first in the normal course of petitioner's trade_or_business of selling motor homes a guarantor of a corporate obligation may not deduct the payment to satisfy the guarantee if considering the circumstances when the guarantee was created the payment constitutes a contribution_to_capital 462_f2d_712 5th cir affg tcmemo_1970_182 we are satisfied that the guarantee originally entered into with idaho first on september was bona_fide prior to that date fishfader guaranteed northwest's financing and northwest showed signs of promise we conclude that petitioner's payments pursuant to the guarantee agreement were properly deducted by petitioner as bad_debts respondent concedes that the transactions before date created bona_fide debts we do not agree with respondent that the debt-equity analysis begins at ground zero on date forcing petitioner to run the entire debt-equity gauntlet for every transaction after date is artificial and ignores the facts of this case we focus on the events that transpired between early and date in date northwest wrote checks payable to petitioner that the bank rejected due to insufficient funds in date franklin learned that northwest was out of trust and that chrysler first expected payment from petitioner on the floorplan guarantee the entire motor home industry suffered a slowdown in the spring of as indicated by northwest's competitors' selling new coaches at cost or below cost in an attempt to move inventory thus petitioner could reasonably expect to see losses surface during this market slowdown after learning about northwest's financial setbacks franklin and wilcox traveled to coeur d'alene idaho to assess the situation at northwest after observing some of the fundamental problems at northwest wilcox returned to northwest in date and placed supervisory and financial controls on northwest's operations petitioner obtained additional collateral from nicholson patent rights and his northwest stock and petitioner sent clark to coeur d'alene so that she could manage the business side of northwest we find petitioner's response reasonable especially in light of the fact that petitioner exerted no management or financial controls over northwest prior to the fall of petitioner's officers decided to assist a dealership that provided an outlet for petitioner's products in a profitable region petitioner provided loans to northwest and applied financial and management controls over northwest's operations when additional problems surfaced petitioner engaged axley rode for advice and assistance in evaluating northwest's financial condition given northwest's success prior to the market slowdown in the spring of petitioner reasonably could conclude that northwest would be able to pay the amounts advanced see baldwin v commissioner tcmemo_1993_433 petitioner properly deducted the disputed amounts as bad_debts foretravel's incentive program petitioner argues that the incentive payments to the dealerships are excludable from gross_income or in the alternative are deductible as ordinary and necessary business_expenses respondent argues that in substance petitioner's incentive payments were contributions to capital and were not reductions in sales prices or deductible under sec_162 we agree with petitioner petitioner concedes that it erroneously claimed the incentives as bad_debts for both years in issue this fact is not fatal to petitioner's claim that the payments were actually incentive payments where as here petitioner provides thorough and credible_evidence showing that the payments were mistakenly reported as bad_debts we look at the true nature of the payments despite the labels and bookkeeping entries used by petitioner 453_f2d_1144 2d cir affg in part revg in part and remanding 54_tc_912 356_f2d_755 5th cir remanding 42_tc_9 respondent argues that the incentive payments or rebates are not excludable from petitioner's gross_income or deductible expenses because the payments were unrelated to performance and there was no set sales volume that the dealer had to meet in order to qualify for a rebate respondent citing sun microsystems inc v commissioner tcmemo_1993_467 contends that in order to qualify as a volume discount the discount must be set forth in a formula and the volume of product to be purchased in order to qualify for the discount must be specified however the discounts here are not volume discounts many different arrangements can constitute a reduction in sale price cf 630_f2d_670 9th cir affg 69_tc_477 74_tc_476 73_tc_1217 tri-state beverage dis27_tc_1026 26_tc_707 convergent technologies inc v commissioner tcmemo_1995_ in 86_tc_627 we noted that the common thread running through max sobel dixie dairies haas brothers and pittsburgh milk is that there was an agreement between the taxpayer and its customers entered into prior to the sale of the product providing for the refund of some part of the purchase_price we are satisfied that this common thread runs through the rebates paid_by petitioner to its dealers there is no doubt that the various facets of petitioner's rebate program did not lend themselves to expression by a numerical formula nonetheless if the individual factors separately would qualify as a purchase_price reduction then the factors taken as a whole would qualify as a purchase_price reduction petitioner offered rebates of the finance costs imposed on a dealer from additional inventory and also used incentives to attract buyers for coaches with unpopular colors or unpopular sizes and display models that had been driven to recreational vehicle shows petitioner did not offer the rebate up front to the dealer but instead sold these coaches to the dealer at full price and then would accept a lower price from the dealership if the need arose in this circumstance there was an understanding between foretravel and its customers the dealerships entered into prior to the sale of the product to the ultimate user of the product if the dealership could immediately sell a coach at full retail price despite its unpopular size or color it would do so if it could not then the dealership could sell the coach for less than retail with a commensurate rebate to the dealership approved by petitioner the incentives generated by sales to high profile buyers or buyers who complained about the quality of a foretravel coach also qualified as a purchase_price reduction between petitioner and the dealers the reality of the marketplace would dictate the rebate needed to put the product in the hands of the consumer if a high profile buyer offered the dealership full retail price then there was no reason for petitioner to reduce the sale price of the coach to the dealer the more reasonable method was the method used by petitioner and its dealers whereby petitioner would adjust the price to the dealer via a rebate if necessary and then the dealer would in turn adjust the retail price to the consumer the rebates offered to dealers when petitioner was in need of cash also qualify as purchase_price reductions between petitioner and the dealers petitioner needed cash and petitioner had extended credit to the dealer petitioner offered the dealer a rebate with the general understanding that the dealer would reduce the retail price to the consumer the sale to the consumer put cash in the dealer's hands which enabled the dealer to reduce the credit balance owed to petitioner petitioner's need for cash and the rate of sales at the retail level coupled with the price the consumer was willing to pay the retailer for a coach would determine the rebate needed if any to put the product into the hands of the consumer these factors highlight why a numerical formula setting forth the amounts of the rebates may not be practicable in all instances the fact that a dealer may receive a used coach as a trade exacerbates the uncertainty because the used coach must be valued in order to determine the amount_realized by the dealer at the retail level the product sold by petitioner is unique and the particular rebates needed to move merchandise into consumers' hands could fluctuate to such an extent that the rebates could be determined appropriately only on a transaction-by-transaction basis we conclude that petitioner's failure to reduce its rebate policy into a numerical formula is not fatal to petitioner's claim of a rebate because petitioner was the sole manufacturer of a unique product particular purchasers might be prospects for a rebate offer from the manufacturer while others might not the retail price was subject_to negotiation between the consumer and the distributor and the demand for the unique products offered by petitioner fluctuated geographically and seasonally petitioner offered detailed testimony setting forth the factors taken into account in its incentive program and the objectives it intended to accomplish through its incentive program and we conclude that the disputed payments were bona_fide incentive payments made in furtherance of those various objectives we conclude that the incentive payments are excludable from petitioner's gross_income as a reduction in the sale price of coaches we are mindful of respondent's position that transactions between related parties should be subject_to close scrutiny because they may engage in transactions that are not arm's length see c m gooch lumber sales co v commissioner t c pincite 32_tc_390 affd 294_f2d_82 5th cir respondent has shown that the incentive payments by petitioner to its dealers for the year ending date consisted of the entire balance of petitioner's trade account receivables recorded on petitioner's books however we do not consider this conjunction of numbers to be fatal in the year ending date we conclude that moore arrived at the figure for incentive payments taking into account the many considerations set forth above additions to tax as a result of our findings above we need not address the additions to tax to reflect the foregoing and the concessions by the parties decision will be entered under rule


internal_revenue_service number release date index number ------------------------------ --------------------- ------------- ------------------------------------ in re --------------------------- ----------------------- ------------------------- ---------------------- department of the treasury washington dc person to contact ---------------------- id no --------------- telephone number --------------------- refer reply to cc intl br1 - plr-165152-04 date ty ------- ------------------ ---------------------- -------------------------- --------------------------- ------------------------ a date b country c date d dear --------------- a’s loss of lawful permanent resident status expatriation did not have for one of its principal purposes the avoidance of u s taxes under subtitle a or subtitle b of the code the information submitted for consideration is substantially as set forth below 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 a was born on date b in country c a surrendered his green card on date d a will be subject_to country c tax on his worldwide income and estate on the date of a's expatriation his net_worth exceeded the applicable_amount set forth in sec_877 this is in response to a letter dated date requesting a ruling that the rulings contained in this letter are based upon information and a former u s citizen whose net_worth or average tax_liability exceeds these sec_877 generally provides that a citizen who loses u s citizenship or a u s plr-165152-04 long-term_resident who ceases to be taxed as a lawful permanent resident individuals who expatriate within the 10-year period immediately preceding the close of the taxable_year will be subject_to the special rules of sec_877 for such taxable_year unless such loss did not have for one of its principal purposes the avoidance of u s taxes sec_2107 and sec_2501 provide special estate and gift_tax regimes respectively for individuals who expatriate with a principal purpose to avoid u s taxes a former u s citizen or former u s long-term_resident will be treated as having expatriated with a principal purpose to avoid u s taxes for purposes of sec_877 sec_2107 and sec_2501 if the individual's average income_tax_liability or the individual's net_worth on the date of expatriation exceed certain thresholds see sec_877 sec_2107 and sec_2501 thresholds however will not be presumed to have a principal purpose of tax_avoidance if that former citizen is described within certain statutory categories and submits a request for a ruling within one year of the date of loss of u s citizenship for the secretary's determination as to whether such loss had for one of its principal purposes the avoidance of u s taxes see sec_877 sec_2107 and sec_2501 former long-term_resident whose net_worth or average tax_liability exceeds the applicable thresholds will not be presumed to have a principal purpose of tax_avoidance if that former resident is described within certain categories and submits a complete and good_faith request for a ruling as to whether such loss had for one of its principal purposes the avoidance of u s taxes notice_98_34 requires that certain information be submitted with a request for a ruling that an individual's expatriation did not have for one of its principal purposes the avoidance of u s taxes and resident fully subject_to tax in country c the country in which he was born modified by notice_98_34 including additional information requested by the service after review of the submission under notice_98_34 1998_2_cb_29 modifying notice_97_19 1997_1_cb_394 a a is eligible to request a ruling pursuant to notice_98_34 because he is a citizen a submitted all of the information required to be submitted by notice_97_19 as accordingly based solely on the facts submitted and the representations made we conclude that a has made a complete and good_faith submission in accordance with sec_877 and notice_98_34 therefore a will not be presumed under section except as expressly provided herein no opinion is expressed or implied plr-165152-04 a to have had as one of his principal purposes for expatriating the avoidance of u s taxes we further conclude that the taxpayer will not be treated under sec_877 as having as one of his principal purposes for expatriating the avoidance of u s taxes because the information submitted clearly establishes the lack of a principal purpose to avoid taxes under subtitle a or b of the code concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in addition no opinion is expressed as to a's u s tax_liability for the taxable years prior to or after his expatriation under sections of the code other than sec_877 sec_2107 and sec_2501 which a obtained the ruling whether or not a is otherwise required to file a return the code provides that it may not be used or cited as precedent will be sent to a in accordance with a power_of_attorney on file in this office a copy of this letter this ruling is directed only to the taxpayer requesting it sec_6110 of a copy of this letter must be attached to a's u s income_tax return for the year in sincerely _______________ karen a rennie senior technical reviewer cc intl br1