internal_revenue_service number release date index number department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ------------------ telephone number ---------------------- refer reply to cc psi plr-104740-17 date date ---------------------- ------------------------- --------------------------------- re ----------------------- legend date husband wife guardian guardian trust state state trustee power_of_appointment committee dear ------------ ------------------ ------------------------------------------------- --------------------------------------------- --------------------------- -------------------- -------------------------------------- ----------- -------------- -------------------------- ----------------------------------------------------------------------------- ----------------------------------------------------------------------------- ----------------------------------------------------------------------------- ----------------------------------------------------------------------------- ---------------------------------------------------------------- this responds to a letter dated date and subsequent correspondence requesting rulings under the internal_revenue_code plr-104740-17 facts the facts submitted and representations made are as follows on date grantors husband and wife created an irrevocable_trust trust for the benefit of grantors and beneficiaries which means a class consisting of grantors’ issue and the fathers of grantors trust is a domestic_trust governed by the laws of state a corporate trustee trustee is the sole trustee of trust grantors are married and reside in state a community_property_state the terms of trust provide that until the death of the predeceased grantor at any time or times the trustee shall distribute to the beneficiaries and or either or both of the grantors such amounts of the net_income or principal of trust as the power_of_appointment committee committee appoints while the committee is in existence the trustee shall make no distributions except as the committee appoints from and after the death of the predeceased grantor and until the death of the surviving grantor at any time or times the trustee shall distribute to the beneficiaries and or the surviving grantor such amounts of the net_income or principal of trust as the committee appoints while the committee is in existence the trustee shall make no distributions except as the committee appoints any appointment direction determination or action by the committee requires either the unanimous written consent of the then serving members of the committee unanimous member power or the written consent of either or both of the grantors or the survivor of them and a majority of the then serving members of the committee grantor’s consent power the members of the committee serve and act in a non- fiduciary capacity the committee may direct that distributions be made equally or unequally to or for the benefit of any one of more of the beneficiaries to the exclusion of others trust provides that the members of the committee shall initially consist of the grantors’ fathers guardian and guardian or any other individual s who have legal authority to act on behalf of grantors’ issue guardian and guardian represent grantors’ two minor children if at any time the committee includes three or more members then all the members of the committee may by unanimous vote at any time and from time to time add one or more members to the committee provided that such members are beneficiaries and provided further that if any one or more of them is a minor then serving members of the committee shall by unanimous vote designate an individual who has legal authority under the trust to serve as guardian if at any time a committee member resigns or fails or ceases to so serve then the position of such committee member shall remain vacant the committee shall cease to exist upon the first to occur of the plr-104740-17 death of the surviving grantor or the date upon which the committee is reduced to one member if the committee ceases to exist prior to the distribution date the trustee may distribute to the beneficiaries such amounts of net_income or principal as the trustee determines if the committee ceases to exist then until the death of the predeceased grantor trustee may distribute to either or both grantors such amounts of net_income or principal as trustee determines if the committee ceases to exist then from and after the death of the predeceased grantor trustee may distribute to the surviving grantor such amounts of net_income or principal of trust as trustee determines trust provides that at all times the trustees of all trusts created under trust must be independent trustees who are not members of grantors’ family independent_trustee is defined as any bank or individual who is not either of the grantors and who is not within the meaning of sec_672 of the internal_revenue_code related or subordinate to either of the grantors grantors’ family is defined to include the issue of each of the grantor’s grandparents including the grantors and charities as defined in trust any net_income not distributed by trustee will be accumulated and added to principal each of the grantors has the power in a non-fiduciary capacity at any time and from time to time to appoint to any one or more of the grantors’ issue amounts of principal including the whole thereof as the grantor deems advisable to provide for the health maintenance support and education of grantors’ issue grantor’s sole power upon the death of the predeceased grantor trustee shall distribute the predeceased grantor’s entire_interest in the property of trust to or for the benefit of any person or persons or entity or entities other than the predeceased grantor’s estate the predeceased grantor’s creditors or the creditors of predeceased grantor’s estate as the predeceased grantor may appoint by will predeceased grantor’s testamentary power upon the death of the predeceased grantor any property remaining of the predeceased grantor’s entire one-half interest in trust that has not been effectively appointed by will shall be distributed as follows five percent to each member of the committee other than the grantors’ issue if there are one or more grantors’ issue then living the balance is to be distributed per stirpes to the grantors’ issue who are then living or held in a_trust for their benefit as provided by trust the surviving grantor’s balance in trust continues to be held by trust and administered pursuant to the terms of trust until the surviving grantor’s death upon the death of the surviving grantor trustee shall distribute the surviving grantor’s balance of trust to or for the benefit of any person or persons or entity or entities other plr-104740-17 than the surviving grantor’s estate the surviving grantor’s creditors or the creditors of surviving grantor’s estate as the surviving grantor may appoint by will surviving grantor’s testamentary power upon the death of the surviving grantor any property remaining of the surviving grantor’s balance of trust that has not been effectively appointed by will shall be distributed as follows five percent to each member of the committee other than the grantors’ issue if there are one or more grantors’ issue then living the balance is to be distributed per stirpes to the grantors’ issue who are then living or held in a_trust for their benefit as provided by trust trust provides that all transferred property to trust is community_property and grantors may hereafter either singly or jointly transfer other_property to trust which either is community_property or is being transmuted into community_property moreover any and all property transferred to trust prior to the death of the first grantor to die predeceased grantor is and shall retain its character as community_property any distribution pursuant to the terms of trust to either grantor prior to the death of the predeceased grantor is and shall be a distribution of community_property all distributions of the net_income or principal prior to the death of the predeceased grantor whether made by the committee the trustee or a grantor’s exercise of the powers retained by such grantor to a beneficiary shall be a distribution out of community_property prior to the death of the predeceased grantor any exercise of either grantor’s sole power shall be funded equally from each grantor’s share of community_property held in trust each grantor consents to all such distributions by the other grantor with respect to each grantor’s testamentary powers any such appointment by the predeceased grantor shall be funded solely from the predeceased grantor’s one-half interest in property in trust each grantor affirmatively agrees and confirms that upon any distribution from trust other than to one of the grantors and other than the exercise of the predeceased grantor’s testamentary power such property shall be funded equally from each grantor’s share of community_property in trust it is represented that trustee grantors and members of committee are all united_states persons within the meaning of sec_7701 no distribution by trustee to a beneficiary and distributions to a beneficiary pursuant to the exercise of a power_of_appointment granted hereunder shall discharge any individual’s legal_obligation to support the beneficiary plr-104740-17 taxpayer has requested the following rulings as long as the committee is serving no portion of the items of income deductions and credits against tax of trust shall be included in computing the taxable_income deductions and credits of the grantors or any member of committee under sec_671 the contribution of property to trust by grantors will not be a completed_gift subject_to federal gift_tax any distribution_of_property by the committee from trust to either grantor will not be a completed_gift subject_to federal gift_tax by any member of the committee any distribution_of_property by the committee from trust to any beneficiary of trust other than the grantors will not be a completed_gift subject_to federal gift_tax by any member of the committee no member of the committee upon his or her death will include in his or her estate any property held in trust because such member is deemed to have a general_power_of_appointment within the meaning of sec_2041 over property held in trust the basis of all community_property in trust on the date of death of the predeceased grantor will receive an adjustment in basis to the fair_market_value of such property at the date of death of the predeceased grantor ruling sec_671 provides that where it is specified in subpart e of part i of subchapter_j that the grantor or another person shall be treated as the owner of any portion of a_trust there shall then be included in computing the taxable_income and credits of the grantor or the other person those items of income deductions and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account under chapter in computing taxable_income or credits against the tax of an individual sec_672 provides for purposes of subpart e the term adverse_party means any person having a substantial_beneficial_interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust sec_673 through specify the circumstances under which the grantor is treated as the owner of a portion of a_trust sec_673 provides that the grantor shall be treated as the owner of any portion of a_trust in which the grantor has a reversionary_interest in either the corpus or the income plr-104740-17 therefrom if as of the inception of that portion of the trust the value of such interest exceeds five percent of the value of such portion sec_674 provides in general that the grantor shall be treated as the owner of any portion of a_trust in respect of which the beneficial_enjoyment of the corpus or the income therefrom is subject_to a power of disposition exercisable by the grantor or a nonadverse_party or both without the approval or consent of any adverse_party sec_674 provides that sec_674 shall not apply to the powers described in sec_674 regardless of whom held sec_674 provides that sec_674 shall not apply to a power exercisable only by will other than a power in the grantor to appoint by will the income of the trust where the income is accumulated for such disposition by the grantor or may be so accumulated in the discretion of the grantor or a nonadverse_party or both without the approval or consent of any adverse_party sec_674 provides that sec_674 shall not apply to a power to distribute corpus to or for a beneficiary provided that the power is limited by a reasonably_definite_standard under sec_675 and applicable regulations the grantor is treated as the owner of any portion of a_trust if under the terms of the trust agreement or circumstances attendant on its operation administrative control is exercisable primarily for the benefit of the grantor rather than the beneficiary of the trust sec_676 provides that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such owner under any other provision of part i subchapter_j chapter where at any time the power to revest in the grantor title to such portion is exercisable by the grantor or a nonadverse_party or both sec_677 provides in general that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such owner under sec_674 whose income without the approval or consent of any adverse_party is or in the discretion of the grantor or a nonadverse_party or both may be distributed to the grantor or the grantor’s spouse held or accumulated for future distribution to the grantor or the grantor’s spouse or applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor’s spouse sec_678 provides that a person other than the grantor shall be treated as the owner of any portion of a_trust with respect to which such person has a power exercisable solely by himself to vest the corpus or the income therefrom in himself or such person has previously partially released or otherwise modified such a power plr-104740-17 and after the release or modification retains such control as would within the principles of inclusive subject a grantor of a_trust to treatment as the owner thereof sec_679 provides that a united_states_person who directly or indirectly transfers property to a foreign_trust shall be treated as the owner for his taxable_year of the portion of such trust attributable to such property if for such year there is a united_states_beneficiary of any portion of the trust based solely on the facts and representations submitted we conclude an examination of trust reveals none of the circumstances that would cause either grantor to be treated as the owner of any portion of trust under sec_673 sec_674 sec_676 sec_677 or sec_679 so long as trust remains a domestic_trust and committee remains in existence we further conclude that an examination of trust reveals none of the circumstances that would cause administrative controls to be considered exercisable primarily for the benefit of either grantor under sec_675 thus the circumstances attendant on the operation of trust will determine whether either grantor will be treated as the owner of any portion of trust under sec_675 this is a question of fact the determination of which must be deferred until the federal_income_tax returns of the parties involved have been examined by the office with responsibility for such examination also because none of the members of committee has a power exercisable by himself to vest trust income or corpus in himself none shall be treated as the owner of trust under sec_678 ruling sec_2 and sec_2501 provides for the imposition of a gift_tax for each calendar_year on the transfer of property by gift during such calendar_year by any individual sec_2511 provides that the gift_tax applies whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_25_2511-2 of the gift_tax regulations provides that a gift is complete as to any property or part thereof or interest therein with respect to which the donor has so parted with dominion and control as to leave the donor with no power to change the disposition of the property whether for the donor’s own benefit or for the benefit of another but if upon a transfer of property whether in trust or otherwise the donor reserves any power over its disposition the gift may be wholly incomplete or may be partially complete and partially incomplete depending upon all the facts in the particular case accordingly in every case of a transfer of property subject_to a reserved power the terms of the power must be examined and its scope determined sec_25_2511-2 provides an example where the donor transfers property in trust plr-104740-17 to pay the income to the donor or accumulate it in the discretion of the trustee and the donor retains a testamentary power to appoint the remainder among the donor’s descendants the regulation concludes that no portion of the transfer is a completed_gift however if the donor had not retained a testamentary_power_of_appointment but had instead provided that the remainder should go to x or his heirs the entire transfer would be a completed_gift sec_25_2511-2 provides that a gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself or herself a gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed_or_ascertainable_standard under sec_25_2511-2 a donor is considered as possessing a power if it is exercisable by the donor in conjunction with any person not having a substantial adverse_interest in the disposition of the transferred property or the income therefrom a trustee as such is not a person having an adverse_interest in the disposition of the trust property or its income sec_25_2511-2 provides that the relinquishment or termination of a power to change the beneficiaries of transferred property occurring otherwise than by death of the donor is regarded as the event which completes the gift and causes the gift_tax to apply sec_25_2511-2 provides that if a donor transfers property to himself as trustee or to himself and some other person not possessing a substantial adverse_interest as trustees and retains no beneficial_interest in the trust property and no power over it except fiduciary powers the exercise or nonexercise of which is limited by a fixed_or_ascertainable_standard to change the beneficiaries of the transferred property the donor has made a completed_gift sec_25_2511-2 does not define substantial adverse_interest sec_25_2514-3 provides in part that a taker in default of appointment under a power has an interest that is adverse to an exercise of the power sec_25_2514-3 also provides that a co-holder of a power is considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate in 308_us_39 the taxpayer created a_trust for the benefit of named beneficiaries and reserved the power_to_revoke the trust in whole or in part and to designate new beneficiaries other than himself six years later in the taxpayer relinquished the power_to_revoke the trust but retained the right to change the beneficiaries in the taxpayer relinquished the right to change the plr-104740-17 beneficiaries the court stated that the taxpayer’s gift is not complete for purposes of the gift_tax when the donor has reserved the power to determine those others who would ultimately receive the property accordingly the court held that the taxpayer’s gift was complete in when he relinquished his right to change the beneficiaries of the trust a grantor’s retention of a power to change the beneficial interests in a_trust causes the transfer to the trust to be incomplete for gift_tax purposes even though the power may be defeated by the actions of third parties 37_tc_897 see also 51_tc_352 in this case each grantor retained the grantor’s consent power over the income of trust under sec_25_2511-2 a donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse_interest in the disposition of the transferred property or the income therefrom the committee members are not takers in default for purposes of sec_25_2514-3 they are merely coholders of the power under sec_25_2514-3 a coholder of a power is only considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate in this case the committee ceases to exist upon the death of the last grantor to die accordingly the committee members do not have interests adverse to either grantor under sec_25_2514-3 and for purposes of sec_25_2511-2 if the committee ceases to exist the trustee has the power to distribute net_income to a beneficiary however the trustee’s power is not a condition_precedent to each grantor’s consent power each grantor’s consent power over income is presently exercisable and not subject_to a condition_precedent thus the trustee’s power to distribute net_income does not cause the transfer of property to be complete with respect to the income_interest in trust for federal gift_tax purposes therefore each grantor is considered as possessing the power to distribute income to any beneficiary himself or herself because he or she retained the grantor’s consent power each grantor also retained the power to appoint such amounts of principal including the whole thereof to any one or more of the beneficiaries grantor’s sole power under sec_25_2511-2 a gift is incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed_or_ascertainable_standard in this case the grantor’s sole power gives each grantor the power to change the interests of the beneficiaries finally each grantor consented to allow the other grantor to exercise the grantor’s sole power alone even though each grantor’s power is limited by an ascertainable_standard ie health education maintenance and support grantors’ powers are not fiduciary powers if the committee ceases to exist the trustee in its fiduciary capacity also has the power to distribute principal to one or more beneficiaries trustee is a corporate trustee and under the terms of the trust instrument cannot be related or subordinated within the plr-104740-17 meaning of sec_672 to the grantors the powers of the trustee are not conditions precedent to the grantors’ powers each grantor’s sole power over principal is presently exercisable and not subject_to a condition_precedent accordingly each grantor retains dominion and control_over the principal of trust until the trustee exercises his or her power to appoint principal see 37_tc_897 thus the trustee’s powers to distribute principal do not cause the transfer of property to be complete with respect to the remainder in trust for federal gift_tax purposes accordingly the retention of grantor’s consent power and grantor’s sole power causes the transfer of property to trust to be wholly incomplete for federal gift_tax purposes further each grantor retained either a predeceased grantor’s testamentary power or the surviving grantor’s testamentary power depending on the order of the deaths of the grantors to appoint property in trust to any person or persons or entity or entities other than his or her respective estate his or her respective creditors or the creditors of his or her respective estate under sec_25_2511-2 the retention of a testamentary power to appoint the remainder of a_trust is considered a retention of dominion and control_over the remainder accordingly the retention of this power causes the transfer of property to trust to be incomplete with respect to the remainder in trust for federal tax purposes accordingly based on the facts submitted and the representations made we conclude that the contribution of property to trust by the grantors will not be a completed_gift subject_to federal gift_tax however any distribution made from trust to a beneficiary is a completed_gift at the time of the distribution made one-half by each grantor further upon either grantor’s death the fair_market_value of his or her interest in the property in trust is includible in his or her respective gross_estate for federal estate_tax purposes trust provides that any distribution pursuant to the terms of trust to either grantor prior to the death of the predeceased grantor is and shall be a distribution of community_property accordingly any distribution from trust to either grantor is merely a return of each grantor’s property therefore we conclude that any distribution_of_property by the committee from trust to either grantor will not be a completed_gift subject_to federal gift_tax by any member of the committee further upon the predeceased grantor’s death the fair_market_value of the predeceased grantor’s interest in trust is includible in the predeceased grantor’s gross_estate for federal estate_tax purposes moreover upon the surviving grantor’s death the fair_market_value of the balance in trust is includible in the surviving grantor’s gross_estate for federal estate_tax purposes ruling sec_4 and sec_2514 provides that the exercise or release of a general_power_of_appointment created after date shall be deemed a transfer of property by the individual possessing such power plr-104740-17 sec_2514 provides that the term general_power_of_appointment means a power which is exercisable in favor of the individual possessing the power possessor the possessor’s estate the possessor’s creditors or the creditors of the individual’s estate sec_25_2514-1 provides in part that a power_of_appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or classes other than the possessor or his creditors or the possessor’s estate or the creditors of the estate sec_2514 provides that in the case of a power_of_appointment created after date if the power is exercisable by the possessor only in conjunction with the creator of the power such power is not deemed a general_power_of_appointment sec_2514 provides that in the case of a power_of_appointment created after date if the power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject_to the power which is adverse to the exercise of the power in favor of the possessor such power shall not be deemed a general_power_of_appointment for purposes of sec_2514 a person who after the death of the possessor may be possessed of a power_of_appointment with respect to the property subject_to the possessor’s power which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the possessor’s power sec_25_2514-3 provides in part that a co-holder of a power_of_appointment has no adverse_interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power however a co-holder of a power is considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditor or the creditors of his estate thus for example if x y and z held a power jointly to appoint among a group of persons which includes themselves and if on the death of x the power will pass to y and z jointly then y and z are considered to have interests adverse to the exercise of the power in favor of x similarly if on y’s death the power will pass to z z is considered to have an interest adverse to the exercise of the power in favor of y sec_2041 provides that the value of the gross_estate shall include the value of all property to the extent of any property with respect to which the decedent has at the time of death a general_power_of_appointment created after date or with respect to which the decedent has at any time exercised or released such a power by a disposition which is of such nature that if it were a transfer or property owned by the decedent such property would be includible in the decedent’s gross_estate under sec_2035 to inclusive plr-104740-17 under sec_2041 the term general_power_of_appointment is defined in relevant part to mean a power which is exercisable in favor of the decedent his estate his creditors or the creditors of his estate sec_2041 provides however that in the case of a power_of_appointment created after date which is exercisable by the decedent only in conjunction with another person if the power is not exercisable by the decedent except in conjunction with a person having a substantial interest in the property subject_to the power which is adverse to the exercise of the power in favor of the decedent - such power shall not be deemed a general_power_of_appointment for purposes of sec_2041 a person who after the death of the decedent may be possessed of a power_of_appointment with respect to the property subject_to the decedent’s power which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the decedent’s power sec_20_2041-3 of the estate_tax regulations provides in part that a co-holder of a power_of_appointment has no adverse_interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power however a co-holder of a power is considered as having an adverse_interest where he may possess the power after the decedent’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate thus for example if x y and z held a power jointly to appoint among a group of persons which includes themselves and if on the death of x the power will pass to y and z jointly then y and z are considered to have interests adverse to the exercise of the power in favor of x similarly if on y’s death the power will pass to z z is considered to have an interest adverse to the exercise of the power in favor of y the powers held by the committee members under the grantor’s consent power are powers that are exercisable only in conjunction with the creators the grantors accordingly under sec_2514 and sec_2041 the committee members do not possess general powers of appointment by virtue of possessing this power further the powers held by the committee members under the unanimous member powers are not general powers of appointment for purposes of sec_2514 and sec_2041 as in the examples in sec_25_2514-3 and sec_20_2041-3 the committee members have substantial adverse interests in the property subject_to this power accordingly any distribution made from trust to a beneficiary other than grantors pursuant to the exercise of these powers the grantor’s consent power and the unanimous member powers are not gifts by the committee members instead such distributions are gifts by the grantors based upon the facts submitted and representations made we conclude that any distribution_of_property by the committee from trust to any beneficiary of trust other than the grantors will not be a completed_gift subject_to federal gift_tax by any member of the committee further we conclude that any distribution_of_property from trust to a plr-104740-17 beneficiary other than grantors will be a completed_gift by the grantors trust provides that all distributions of the net_income or principal prior to the death of the predeceased grantor whether made by the committee the trustee or a grantor’s exercise of the powers retained by such grantor to a beneficiary is and shall be a distribution out of community_property accordingly distributions to beneficiaries other than grantors will be gifts made one-half by each grantor finally we conclude that the powers held by the committee members are not general powers of appointment for purposes of sec_2041 and accordingly the possession of these powers by the committee members will not cause trust property to be includible in any committee member’s gross_estate under sec_2041 ruling sec_1014 provides in part that except as otherwise provided in this section the basis_of_property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent will if not sold exchanged or otherwise_disposed_of before the decedent’s death by such person be the fair_market_value of the property at the date of the decedent’s death sec_1014 provides that in the case of decedents dying after date property which represents the surviving spouse’s one-half share of community_property held by the decedent and the surviving_spouse under the community_property_laws of any state is considered for purposes of sec_1014 to have been acquired from or to have passed_from_the_decedent if at least one-half of the whole of the community interest in such property was includible in determining the value of the decedent’s gross_estate sec_2036 provides that the value of the gross_estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer except in case of a bona_fide sale for adequate_and_full_consideration in money or money’s worth by trust or otherwise under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death the possession or enjoyment of or the right to the income from the property or the right either alone or in conjunction with any person to designate the persons who shall possess or enjoy the property or the income therefrom sec_2038 provides that the value of the decedent’s gross_estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer except in case of a bona_fide sale for adequate_and_full_consideration in money or money’s worth by trust or otherwise where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power in whatever capacity exercisable by the decedent alone or by the decedent in conjunction with any other person without regard to when or from what source the plr-104740-17 decedent acquired such power to alter amend revoke or terminate or where any such power is relinquished during the three-year period on the date of the decedent’s death grantors reside in state a community_property_state trust provides that all transferred property to trust is community_property or is being transmuted into community_property moreover any and all property transferred to trust prior to the death of the predeceased grantor is and shall retain its character as community_property as concluded above upon the death of each grantor his or her respective interest in trust as either the predeceased grantor or the surviving grantor will be includible in his or her respective gross_estate for federal estate_tax purposes accordingly based upon the facts submitted and representations made we conclude that the basis of all community_property in trust on the date of death of the predeceased grantor will receive an adjustment in basis to the fair_market_value of such property at the date of death of the predeceased grantor except as specifically ruled herein we express no opinion on the federal tax consequences of the transaction under the cited provisions or under any other provisions of the code specifically we express no opinion on the trust provisions permitting trustee to distribute income or principal to trustees of other trusts decanting or any other trust provisions not referenced in this private_letter_ruling this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely lorraine e gardner lorraine e gardner senior counsel branch office of associate chief_counsel passthroughs special industries enclosures copy for sec_6110 purposes copy of this letter


tax_exempt_and_government_entities_division department of the treasury internal_revenue_service attn mandatory review mc dal commerce st dallas tx date date number release date legend org organization name xx date address address org address uil employer identification person to contact id number contact numbers voice fax certified mail - return receipt requested dear in a determination_letter dated february 19xx you were held to be exempt from federal_income_tax under sec_501 of the internal_revenue_code based on recent information received we have determined you have not operated in accordance with the provisions of sec_501 of the code accordingly your exemption from federal_income_tax is revoked effective july 20xx this is a final adverse determination_letter with regard to your status under sec_501 of the code we previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary at that time we informed you of your right to contact the taxpayer_advocate as well as your appeal rights on november 20xx you signed form 6018-a consent to proposed action agreeing to the revocation of your exempt status under sec_501 of the code you have filed taxable returns on form s u s_corporation income_tax return for the year s ended june 20xx and june 20xx with us for future periods you are required to file form_1120 with the appropriate service_center indicated in the instructions for the return you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please contact the person whose name and telephone number are shown at the beginning of this letter sincerely marsha a ramirez director eo examinations tak exempt and -government entities division org address department of the treasury internal_revenue_service wells fargo place east 7th street - suite 1130b st paul mn date taxpayer_identification_number form tax_year s ended person to contact id number contact numbers telephone fax certified mail - return receipt requested dear we have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization's exempt status is necessary if you do not agree with our position you may appeal your case the enclosed publication the examination process explains how to appeal an internal_revenue_service irs decision publication also includes information on your rights as a taxpayer and the irs collection process if you request a conference we will forward your written_statement of protest to the appeals_office and they will contact you for your convenience an envelope is enclosed if you and appeals do not agree on some or all of the issues after your appeals_conference or if you do not request an appeals_conference you may file suit in united_states tax_court the united_states court of federal claims or united_states district_court after satisfying procedural and jurisdictional requirements as described in publication letter catalog number 34801v you may also request that we refer this matter for technical_advice as explained in publication exempt_organization appeal procedures for unagreed issues ifa determination_letter is issued to you based on technical_advice no further administrative appeal is available to you within the irs on the issue that was the subject of the technical_advice if we do not hear from you within days from the date of this letter we if you accept our findings please sign and return the enclosed form_6018 consent to proposed adverse action we will then send you a final letter modifying or revoking exempt status will process your case on the basis of the recommendations shown in the report of examination and this letter will become final in that event you will be required to file federal_income_tax returns for the tax period s shown above file these returns with the ogden service_center within days from the date of this letter unless a request for an extension of time is granted file returns for later tax years with the appropriate service_center indicated in the instructions for those returns you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please call the contact person at the telephone number shown in the heading of this letter the most convenient time to call if we need to contact you if you write please provide a telephone number and letter catalog number 34801v thank you for your cooperation enclosures publication publication form_6018 report of examination envelope sincerely marsha a ramirez director eo examinations letter catalog number 34801v form 886-a explanation of items sched or exhibit year period ended name of taxpayer org june 20xx june 20xx legend org organization name xx date co-1 company co-2 company issue revocation of exempt status facts org was organized to conduct social activities for the members of the co-1 according to irs records the club was granted exemption from income_tax as an organization described in sec_501 in the members are also members of the org according to the form_1024 the social activities which will be conducted consisted of golf outings dances fish fries and other social activities the organization also conducted fundraising activities in the form of raffles according to the taxpayer receipts will principally be due from bar sales rental of facilities management fee from and bingo all activities were open to members and nonmembers with the exception of the management fee however the organization did not keep record of the amount of member and nonmember income for the bar and pull-tab sales org conducted charitable gaming on-site and off-site the bar was operated on-site however the off-site location for the operation of pull-tab sales were at the co-2 all gambling and bar operations were reported on form 990-t as unrelated_business_income the organization has made its lawful expenditures donations the organization filed forms and 990-t for the years ending june 20xx and june 20xx law internal_revenue_code sec_501 provides for the exemption from federal income taxes for social clubs income_tax regulation sec_1_501_c_7_-1 states that if a social_club makes its social and recreational facilities available to the general_public it will not qualify for tax-exempt status however revproc_71_17 as amended by public law provides certain gross_receipts safe harbors ie social clubs may receive up to of their total gross_receipts including investment_income from sources outside of their membership without jeopardizing their tax-exempt status within thi sec_35 limit no more than of a club’s gross_receipts may be derived from nonmember use of the club’s facilities and or services or from other activities not furthering social or recreational purposes for members if these standards are exceeded a social_club will not qualify for exemption pursuant to sec_501 the committee reports for public law senate report no 2d session c b state that it is intended that social clubs should be permitted to receive up to percent of their gross_receipts including investment_income from sources outside of their memberships without losing their exempt status within thi sec_35 percent amount not more than percent of the gross_receipts should be derived from the use of a social club’s facilities or services by the general_public this means that an exempt social_club may receive department of the treasury - internal_revenue_service form-886-a rev page form 886-a explanation of items sched or exhibit year period ended _ name of taxpayer org june 20xx june 20xx legend org organization name xx date co-1 company co-2 company up to percent of its gross_receipts from a combination of investment_income and receipts from non-members so long as the latter do not represent more than percent of total receipts additionally activities conducted by a social_club need to further its exempt purposes traditional business activities are those activities that further a social_club even if conducted solely on a membership basis activities that are not in furtherance of a social club’s exempt_purpose are referred to as nontraditional business activities a social_club is prohibited from conducting more than an insubstantial amount of nontraditional business activities the prohibition against the conduct of nontraditional business activities applies equally to business with member and nonmembers government’s position it was determined the gambling activity carried on off-site at the co-2 by nontraditional business activity the selling of pull-tabs at a location separate from the facility where the social and recreational activities are carried out does not promote the social and recreational purposes of the club isa during the examination the following were noted co-2 receipts off-site total gross_receipts percentage 20xx 20xx dollar_figure dollar_figure dollar_figure dollar_figure since the sales from the co-2 were unable to be traced to members all sales will be treated as sales from non- members as a result the organization had a non-member percentage of for 20xx and for 20xx for off-site gambling these percentages are more than the allowed percentage fro non-members additionally activities conducted by a social_club need to further its exempt purposes traditional business activities are those activities that further a social_club even if conducted solely on a membership basis activities that are not in furtherance of a social club’s exempt_purpose are referred to as nontraditional business activities a social_club is prohibited from conducting more than an insubstantial amount of nontraditional business activities the prohibition against the conduct of nontraditional business activities applies equally to business with member and nonmembers during the examination the following were noted department of the treasury - internal_revenue_service form-886-a rev page form 886-a explanation of items org june 20kx june 20xx xx date co-1 company co-2 company name of taxpayer legend org organization name sched or exhibit year period ended co-2 receipts off-site on-site gambling - non-member on-site bar concessions hall rentals - non- member total gross_receipts from ubi total gross_receipts percentage 20xx 20xx dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure thus gambling activities are more than insubstantial and also the club consistently exceeds the permitted threshold of receiving up to percent of their gross_receipts including investment_income from sources outside of their memberships without losing their exempt status within thi sec_35 percent amount not more than percent of the gross_receipts should be derived from the use of a social club’s facilities or services by the general_public thus nontraditional business activities are more than insubstantial and also the club consistently exceeds the of gross_receipts from nonmember sources additionally the organization kept no contemporaneous_records of nonmember use of its facility and activities org operated the bar there were no contemporaneous_records of these events were available pull-tab sales and hall rentals were open to nonmembers as well as members and no tecords of nonmember income were kept due to the substantial amount of nontraditional income and because the club consistently receives more than of its gross_receipts from sources outside the membership no longer meets the requirements of sec_501 the taxpayer’s exempt status should be revoked effective july 20xx as a taxable entity the organization is required to file form_1120 u s_corporation income_tax return for the periods open under statue under g these periods include the years ending june 20xx and june 20xx department of the treasury - internal_revenue_service form-886-a rev page form 886-a explanation of items sched or exhibit year period ended name of taxpayer org june 20xx june 20xx legend org organization name xx date co-1 company co-2 company taxpayer’s position the taxpayer’s position is unknown the taxpayer will be given days to respond to the proposed change conclusion if you agree an officer should sign and return the form 6018-a to me along with forms for the years ending june 20xx and june 20xx if you disagree please let me know and we can arrange a meeting with the group manager based upon the information noted above it is proposed the exempt status of the organization be revoked as of the fiscal_year ending june 20xx form_1120 u s_corporation income_tax return should be obtained for the fiscal years june 20xx to the present if the proposed revocation becomes final appropriate state officials will be notified of such action in accordance with internal_revenue_code of c the organization may re-apply for tax exemption under sec_501 as long as it can be determined their activities further their exempt_purpose please keep in mind forms needs to be prepared so that they comply with sec_277 i have attached a worksheet to demonstrate the allocation between member and nonmember income and deductions a general_rule - in the case of a social_club or other membership_organization which is operated primarily to furnish services or goods to members and which is not exempt from taxation deductions for the taxable_year attributable to furnishing services insurance goods or other items of value to members shall be allowed only to the extent of income derived during such year from members or transactions with members department of the treasury - internal_revenue_service form-886-a rev page


t c summary opinion united_states tax_court thomas patrick and christine e dawson petitioners v commissioner of internal revenue respondent docket no 20323-06s filed date thomas patrick and christine e dawson pro sese harry j negro for respondent ruwe judge this case was heard pursuant to the provisions of section of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case unless otherwise indicated all section references are to the internal_revenue_code code in effect for the year in issue respondent determined a dollar_figure deficiency in petitioners’ federal_income_tax for and an dollar_figure accuracy-related_penalty under sec_6662 due to negligence the issues for decision are whether petitioners are entitled to net their gambling_losses against their gambling winnings in computing adjusted_gross_income and whether they are liable for a sec_6662 accuracy-related_penalty due to negligence background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated by this reference petitioners resided in williamstown new jersey at the time they filed their petition during petitioner thomas dawson was employed full time as a building inspector and petitioner christine dawson was employed full time as a registered nurse during petitioners gambled at casinos in atlantic city new jersey most of petitioners’ gambling consisted of playing dollar_figure- or dollar_figure-pull slot machines neither petitioner was a professional gambler their combined jackpots received from atlantic city casinos in totaled dollar_figure however their combined gambling_losses for exceeded the dollar_figure jackpots that they won in other words petitioners’ gambling activities during resulted in a net_loss on their federal_income_tax return petitioners reported adjusted_gross_income of dollar_figure which did not include any of the jackpots petitioners did not claim deductions on their return for any of their gambling_losses petitioners did not report their gambling jackpots and losses because their gambling activities failed to produce net winnings in after examining petitioners’ return respondent determined that petitioners’ casino jackpots were gambling winnings and increased petitioners’ adjusted_gross_income by dollar_figure respondent also determined that petitioners were entitled to itemized_deductions for gambling_losses of dollar_figure while respondent allowed itemized_deductions for gambling_losses in the same amount that he increased petitioners’ adjusted_gross_income the increase in adjusted_gross_income triggered certain limitations on other deductions as a result respondent disallowed a dollar_figure tuition deduction disallowed job-related and miscellaneous expenses of dollar_figure decreased total itemized_deductions by dollar_figure and disallowed a dollar_figure deduction for personal exemptions these adjustments based on respondent’s adjustment to petitioners’ adjusted_gross_income are computational adjustments required_by_law in their petition petitioners claim that it makes no sense to increase their adjusted_gross_income because their gambling activities produced a net_loss for petitioners are contesting only the propriety of increasing their adjusted_gross_income they have not contested the accuracy of the computational adjustments that flow from increasing their adjusted_gross_income discussion gross_income includes all income from whatever source derived including gambling income see sec_61 jackson v commissioner tcmemo_2007_373 the jackpots that petitioners received constitute gambling income a taxpayer in the trade_or_business of gambling may deduct wagering losses to the extent allowable in computing adjusted_gross_income a taxpayer who was not in the trade_or_business of gambling may deduct wagering losses only to the extent allowable as an itemized_deduction to compute taxable_income see calvao v commissioner tcmemo_2007_57 petitioners were not professional gamblers and were not in the trade_or_business of gambling therefore their gambling_losses were not deductible in arriving at adjusted_gross_income and respondent’s determination to increase petitioners’ adjusted_gross_income by the amount of jackpots received in was correct since that resolves the only issue petitioners raised regarding the tax_deficiency respondent’s deficiency determination of dollar_figure is sustained with regard to respondent’s determination that petitioners are liable for the accuracy-related_penalty under sec_6662 due to negligence petitioners argue that when they prepared their return they concluded that since their gambling activity produced a net_loss they had no gambling income to report petitioner thomas dawson testified that this was the way petitioners had filed returns in prior years and that he was not aware of the previously stated rules that precluded the netting of gambling winnings and losses in determining adjusted_gross_income he explained that he used simple logic in determining that petitioners’ gambling activity did not produce income sec_6662 defines negligence as any failure to make a reasonable attempt to comply with the provisions of the code after hearing the testimony presented we conclude that petitioners made an honest attempt to comply with their reporting requirements petitioners do not purport to be tax experts and when preparing their returns concluded that they did not have to report gambling income because their nonbusiness gambling activity resulted in a net_loss while their conclusion was incorrect we do not think that their error negates the reasonableness of their attempt to comply with their reporting requirements we hold that petitioners are not liable for the sec_6662 penalty due to negligence decision will be entered for respondent as to the deficiency and for petitioners as to the accuracy-related_penalty


t c memo united_states tax_court frank and virginia muhich petitioners v commissioner of internal revenue respondent midwest portraits corp petitioner v commissioner of internal revenue respondent docket nos filed date jennifer prager sodaro and joe alfred izen jr for petitioners william t derick and luanne s dimauro for respondent memorandum findings_of_fact and opinion laro judge these cases are before the court consolidated for purposes of trial briefing and opinion frank and virginia muhich the muhichs and midwest portraits corp midwest separately petitioned the court to redetermine respondent’s determinations of the following deficiencies and accuracy-related_penalties under sec_6662 a frank and virginia muhich docket no penalty year deficiency sec_6662 a dollar_figure dollar_figure big_number big_number midwest portraits corp docket no penalty year ended deficiency sec_6662 a date dollar_figure dollar_figure date big_number big_number date big_number big_number we must decide the following issues whether the trusts implemented and used by the muhichs during and should be disregarded for tax purposes because the trusts lacked economic_substance we hold they should ' whether the muhichs' and gross_income includes compensation paid_by midwest in the amounts of dollar_figure and dollar_figure respectively we hold it does ' respondent also raises the alternative argument that petitioners are taxable on trust income because the trusts were grantor trusts given our holding that the trusts are shams we need not and do not reach this issue whether sec_162 allows midwest to deduct payments to a_trust promoter in the amounts of dollar_figure and dollar_figure for and respectively we hold it does not whether sec_162 allows midwest to deduct payments to the trusts in the amounts of dollar_figure dollar_figure and dollar_figure for and respectively we hold it does whether the muhichs are liable for accuracy-related_penalties under sec_6662 and b for and we hold they are whether midwest is liable for accuracy-related_penalties under sec_6662 and b for and we hold it is to the extent discussed herein whether the muhichs are liable for a penalty under sec_6673 we hold they are not ’ findings_of_fact some of the facts have been stipulated and are so found the stipulated facts and exhibits submitted therewith are incorporated herein by this reference the muhichs resided in mahomet illinois when they petitioned the court midwest had its principal_place_of_business in mahomet illinois when it petitioned the court rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated section references are to the internal_revenue_code in effect for the years at issue petitioner’ attended years of college but did not obtain a degree from through the years in issue petitioner owned operated and was the president of midwest midwest was a photography business and it earned_income by participating in fund-raising programs of local community service organizations from forward midwest worked exclusively with fire rescue and ambulance departments in the four-state region of illinois iowa wisconsin and indiana in addition to taking the photographs midwest supplied the various departments with professionals to assist in soliciting donations and handing out complimentary certificates under this arrangement midwest received approximately percent of the donations plus the income from the sales of additional photographs midwest conducted its business in the four-state region by employing road people to solicit donations take the complimentary photographs and sell additional photographs midwest employed two people in its home_office before the subject years petitioner drew a salary from midwest for the work he performed midwest deducted his salary as officer compensation petitioner essentially compensated himself on a commission basis setting his salary upon midwest's -references to petitioner are to frank muhich financial performance petitioner had a wide variety of duties including serving as midwest's president and salesman kim and denise martin martins are certified public accountants and have been petitioners' tax advisers since the martins prepared all of petitioners’ tax returns from to date and the martins maintained petitioners' books_and_records for each of the subject years introduction to the multitrust scheme in early date petitioner met with a financial planner james myers myers myers was a representative of heritage assurance group heritage an entity that promoted multitrust schemes as a means to avoid paying taxes myers introduced petitioner to heritage's scheme which worked generally as follows an individual transfers his or her assets and right to receive income to a newly created family_trust in exchange for a certificate_of_beneficial_interest cbi a cbi gives the individual the right to receive any distributions that the trustee who is the same as the transferring individual decides to make the family_trust pays and deducts all of the trustee's personal expenses and distributes any excess corpus to a charitable_trust created under the scheme the individual creates other trusts to circulate funds among and between myers presented petitioner with promotional materials containing flowcharts and explanations detailing the above sequence of transactions these materials touted the tax deductibility of all of the transferring individual's personal expenses the materials generally claimed that the individual would pay no tax on his or her income the materials made no mention of any nontax benefit to be gained from the trust scheme after meeting with myers the muhichs traveled over miles to the offices of heritage there they met with edward bartoli bartoli an attorney who was the principal promoter of heritage's scheme bartoli introduced petitioner to james savino savino a certified_public_accountant associated with heritage at or about the time of this meeting the muhichs submitted to heritage a form containing their financial information and assets on this form they stated that their number one objective was tax_avoidance creation of the five trusts in date very soon after meeting with bartoli the muhichs without consulting the martins implemented the multi- trust scheme to avoid taxes petitioner caused midwest to pay dollar_figure to heritage and heritage supplied petitioners with a comprehensive packet of forms and documents that could be customized to create and operate the trust scheme petitioners used the promotional materials presented by myers as a model for their trust arrangement on date the muhichs created the muhich asset management_trust asset trust petitioner signed the trust declaration as the investor bartoli signed as creator and trustee and ms muhich signed as trustee within days ms muhich transferred virtually all of her property to petitioner this property included an exhaustive list of housewares jewelry electronics china and other personalty in turn petitioner transferred virtually all of his property which now included ms muhich's transferred property to the asset trust including the right to receive compensation_for his services in exchange ms muhich and petitioner each received a cbi representing and units respectively within days bartoli resigned as trustee and petitioner was appointed trustee this left the muhichs as sole trustees and sole beneficiaries of the asset trust on date the asset trust established the muhich charitable_trust charitable_trust the asset trust funded the corpus with a cbi from the asset trust representing units of ownership in exchange the asset trust received a cbi for reasons that are unclear the muhichs did not transfer all of their significant property to the trust as relevant here they retained title to their residence pincite west dianne and petitioner's stock in midwest the charitable_trust never sought nor received tax exempt status under sec_501 representing units of ownership in the charitable_trust the muhichs were the trustees on date the asset trust created the muhich business_trust business_trust the asset trust funded the corpus with dollar_figure in exchange for a cbi representing units of ownership in the business_trust the muhichs were the trustees on date the business_trust established the muhich equity_trust equity_trust and the muhich vehicle trust vehicle trust the business_trust funded the corpus of each trust with dollar_figure in exchange for a cbi from each trust representing units of ownership in each the muhichs were the trustees the muhichs listed their personal_residence pincite west dianne as the address for the five trusts as sole trustees and exclusive beneficiaries of all five trusts the muhichs had exclusive control_over the trust property they had the right to receive distributions at their sole discretion and controlled all the bank accounts their ability to deal with and benefit from all trust property was as free and unrestricted as before the trusts were established midwest continued to operate as a corporation and continued to conduct business the same as before the trusts were created petitioner's work and duties at midwest remained the same but he no longer took a salary from midwest instead he caused midwest to contract with the asset trust for the provision of his services the asset trust was to receive dollar_figure per month plus additional consideration based upon company performance operation and tax reporting of the five trusts upon creation of the trusts the muhichs hired aegis co aegis to help operate them aegis was affiliated with heritage regarding the asset trust the muhichs named themselves as executive trustees and executive secretaries charging themselves with the duty to manage the trust in return the asset trust agreed to pay the muhichs' housing transportation health care and education expenses the asset trust did not engage in the active_conduct of any trade_or_business at any time during the years at issue for and the asset trust had approximately dollar_figure and dollar_figure in available funds deposited into its accounts over which the muhich's had signatory authority the funds included dollar_figure and dollar_figure for and respectively in consulting fees received by the asset trust for the services of petitioner the balance of the funds for each year was composed primarily of transfers from midwest and other trusts characterized by the muhichs as loans and a small amount of interest_income that was payable to petitioner from the available funds for and the asset trust paid the muhichs' housing transportation health care education and miscellaneous expenses these payments included -- - dollar_figure in construction costs interest costs and closing costs for their new residence pincite north shore drive all of the education costs for the muhichs ' college-aged children utilities for the muhichs' personal_residence personal automobile expenses of the muhichs' mortgage payments on the muhichs' personal_residence pincite west dianne and trustee fees to the muhichs in each year the asset trust paid to the charitable_trust the funds that remained after all these payments for and the asset trust filed tax returns with respondent form sec_1041 wherein its reported income included the consulting fees paid_by midwest for petitioner's services and petitioner's interest_income after deducting therefrom the above-described personal expenses of the muhichs and the amounts paid to the charitable_trust the asset trust reported zero taxable_income in each year the other trusts did not engage in any business activity during or the charitable_trust distributed some money in each year to various charities with the balance the charitable_trust participated in a series of circular the asset trust did not deduct the dollar_figure in construction costs also the asset trust elected to treat a large payment to the charitable_trust as a charitable_contribution_deduction on its return under sec_642 transactions with the other trusts and midwest ’ throughout the year petitioner moved funds among and between the asset trust the charitable_trust and the equity_trust in a circular fashion petitioner labeled the movements of funds loans or loan repayments for tax purposes the charitable_trust filed and returns claiming it was a nonexempt_charitable_trust under sec_4947 and it paid no tax for either year the equity_trust the business_trust and the vehicle trust were dormant in and and each filed and income_tax returns showing no taxable_income all of the above-described trust tax returns for were prepared by savino the martins were not aware of petitioners' participation in the trust scheme until late when they prepared midwest's tax_return for that fiscal_year the martins discovered that midwest purportedly paid no wages to petitioner ’ one such series of transactions occurred on date when petitioner caused midwest to pay the asset trust dollar_figure on that same day all of the following occurred the asset trust paid dollar_figure by check to the charitable_trust the charitable_trust paid dollar_figure by check to the equity_trust and the equity_trust paid the dollar_figure by check back to the asset trust also on date petitioner repeated three more times this exact same series of movements of funds in a circular fashion in the exact same amount dollar_figure petitioner labeled all of these advances loans finally petitioner caused the asset trust to pay back the dollar_figure to midwest by check dated date and they began inquiring soon thereafter and at the request of the muhichs mr martin attended one of heritage's seminars mr martin left the seminar with concerns about the legitimacy of the trust scheme and he conveyed his concerns to petitioner petitioner dismissed mr martin's concerns and indicated he would rely on the advice given by the trust promoters notwithstanding their concerns the martins prepared the trusts' returns after the martins prepared the charitable_trust return but refused to prepare any other trust returns petitioners' tax reporting and respondent's determination midwest midwest filed federal_income_tax returns forms for its fiscal years ended date and in its return midwest deducted the dollar_figure it paid to bartoli in connection with setting up the multitrust system during the fiscal_year midwest paid to aegis and deducted dollar_figure in fees related to administration of the trusts during fiscal years and midwest paid the asset trust dollar_figure dollar_figure and dollar_figure respectively pursuant to the consulting contract midwest labeled the payments consulting fees and deducted these amounts in its income_tax returns by notice_of_deficiency dated date respondent determined the above-described payments were not ordinary and necessary business_expenses under sec_162 and that they were nondeductible constructive dividends respondent disallowed these deductions in full the muhichs the muhichs filed federal_income_tax returns for and on these returns the muhichs did not report any income from midwest in the form of compensation or dividends by notice_of_deficiency dated date respondent determined the trust scheme was an abusive trust arrangement which should be ignored for tax purposes respondent determined that petitioner received constructive dividends from midwest in the amounts of dollar_figure and dollar_figure for and respectively for the constructive_dividend amount is composed of the dollar_figure paid_by midwest to bartoli and the dollar_figure in fees paid_by midwest to the asset trust during the year for the entire amount represents fees paid_by midwest to the asset trust during the year opinion economic reality of the trusts we first decide whether the trusts should be disregarded for tax purposes according to respondent they should because they lack economic_substance and are shams we agree respondent also made smaller miscellaneous upward and downward adjustments to the muhichs' income in both years which flowed from his determination that the trusts should be ignored for all issues in this case except the penalty under sec_6673 respondent's determination is presumed correct and petitioners bear the burden of proving it wrong see rule a 290_us_111 where an entity is created that has no real economic_effect and which affects no cognizable economic relationship the substance of a transaction involving the entity will control_over its form see 79_tc_714 affd 731_f2d_1417 9th cir markossian v commissioner 73_tc_1235 regarding economic_substance we recently stated the doctrine_of economic_substance becomes applicable anda judicial remedy is warranted where a taxpayer seeks to claim tax benefits unintended by congress by means of transactions that serve no economic purpose other than tax savings acm partnership v commissioner tcmemo_1997_115 affd in part revd on other grounds in part dismissed in part and remd in part 157_f3d_231 we find such lack of economic purpose in this case more specifically we have held a_trust is not recognized for tax purposes if it has no economic_substance apart from tax considerations see markosian v commissioner supra pincite- these principles apply even though an entity may have been properly formed and may have had a separate existence under applicable local law see zmuda v commissioner supra pincite when the settlor is a trustee and the beneficiaries are the settlor and his family the trusts must be closely scrutinized for economic_substance see markosian v commissioner supra pincite see also 309_us_331 we consider the following factors when deciding whether a_trust lacks economic_substance for tax purposes whether the taxpayer's relationship as grantor to the property differed materially before and after the trust's formation whether the trust had an independent_trustee whether an economic_interest passed to other beneficiaries of the trust and whether the taxpayer felt bound by any restrictions imposed by the trust itself or by the law of trusts see markossian v commissioner supra pincite5 see also buckmaster v commissioner tcmemo_1997_236 as to the first markosian factor the muhichs' relationship to their property did not differ materially before and after the formation of the trusts the muhichs' personal_residence was the address for all the trusts and their personal_use of their property was never restricted as sole trustees and sole owners of the cbi's the muhichs could manipulate distribute or otherwise use trust property at their whim in fact the trust instruments gave them sole discretion to deal in trust property and make distributions -- - petitioners argue that their residence pincite w dianne and then pincite north shore drive was the asset trust headquarters and therefore they could deduct all operational expenses connected thereto we disagree petitioners' attempt to legitimize payment of their personal expenses is unavailing in addition to the fact the trusts were not conducting a trade_or_business the expenses were personal in nature which preclude their deductibility the first factor weighs against petitioners as to the second markosian factor the trusts lacked an independent_trustee but for bartoli's 6-day stint as trustee of the asset trust the muhichs were at all times sole trustees of all trusts the fact that bartoli served as trustee for a limited time is meaningless it was a paper appointment solely for the purpose of facilitating the creation of the trust scheme the second factor weighs against petitioners as to the third markosian factor no economic_interest in the trusts ever passed to any beneficiary other than the muhichs the only beneficiaries were the muhichs or other trusts they created and controlled under the trust scheme the third factor weighs against petitioners as to the final markosian factor the muhichs were not bound by any restriction imposed by the trusts or the law of trusts as to the use of trust property the record demonstrates petitioners dealt freely with trust funds and property and they manipulated funds between the trusts in a circular and nonsensical manner this factor weighs against petitioners in addition to our analysis of the markosian factors all of which favor respondent other facts herein make clear that the tangled web woven by petitioners did little more than conceal the ownership of assets and disguise the true_earner of income for the purpose of avoiding taxes first petitioners created an elaborate scheme of documents and paperwork with an eye towards creating an aura of legitimacy for the trusts these canned documents were part of the mass-produced trust package marketed by heritage and paid for with the dollar_figure fee notwithstanding the muhichs spent time filling in the blanks these documents do not lend economic reality to the transactions they purport to memorialize and we place no weight on them second petitioner lacked a basic understanding of the scheme's operation he was generally unfamiliar with the intricacies and interworkings of the trust scheme and he was unfamiliar with basic terms such as grantor beneficiary and trust declarations instead of directly responding to guestions asked at trial petitioner often referred the court to the reams of paperwork submitted into the record with the suggestion that the answers could be found somewhere in those documents ’ petitioner's inability to discuss basic trust concepts is inconsistent with his contention that the trust scheme was a legitimate business arrangement in sum petitioners established the trusts with an aim to avoid improperly federal_income_tax none of the trusts ever reported taxable_income and none of them conducted a legitimate business activity petitioners' purpose for the trust scheme was to take untaxed money out of midwest and circulate it around the trusts to pay the muhichs' personal expenses the muhichs admitted as much at trial although the muhichs attempted to identify other nontax reasons for the trusts we find these the following colloquy between petitioner and respondent's counsel on cross-examination exemplifies petitioner's elusiveness and lack of knowledge as to the operation of the trust scheme q edward bartoli helped set up the initial trust for you is that right a right q and that would include the declarations for each of the trusts a i'm not that familiar with terms it's all written down you have the trust documents so whatever's in the documents is what we did we were similarly unimpressed with ms muhich she admitted she was only kind of familiar with two of the trusts and stated that she knew more about the entire scheme after sitting through the trial than she did before reasons incredible ’ because the trusts lacked economic reality the court will ignore them for tax purposes gross_income deductions by midwest we turn to the question of whether the muhichs' gross_income includes the consulting fees paid_by midwest to the asset trust and the dollar_figure paid_by midwest to the trust promoters issue related thereto is the question of whether sec_162 allows midwest to deduct these payments and the dollar_figure paid to the trust promoters in issue sec_3 and as to the consulting fees respondent determined that these fees were nondeductible constructive dividends_paid to petitioner by midwest and as such were includable in his gross_income midwest contends that these fees are deductible by ‘t petitioner for example testified he adopted the trust scheme to protect midwest and his assets if such was the case then why did the muhichs not transfer their most significant assets to the trusts immediately upon creation e their various real_estate holdings and the stock in midwest moreover midwest was already a corporation thus midwest enjoyed the benefits of limited_liability attendant to doing business in the corporate form ‘2 respondent does not contest petitioners' assertion that the amounts the charitable_trust paid to sec_501 organizations are deductible by the muhichs the parties shall take these deductions into account in the rule computation midwest as compensation_for petitioner's services ’ we agree with midwest that the consulting fees are deductible compensation_for petitioner's service we agree with respondent that these fees are includable in petitioner's gross_income but as compensation rather than dividends a payment to a shareholder employee is compensation if a the corporation intends the payment to be solely for services rendered by the shareholder employee and b the amount_paid is reasonable as to the services rendered see 56_tc_1324 affd without published opinion 496_f2d_876 5th cir sec_1_162-7 income_tax regs a corporation's intent to compensate for services is a condition_precedent to the underlying payment's deductibility see hlectric neon inc v commissioner supra and such an intent is determined when the payment is made see 58_tc_1055 affd without published opinion 474_f2d_1345 5th cir an intent to compensate is a question of fact which in the case of a corporation turns on the actions of the officers see 98_tc_511 we employ close scrutiny when a shareholder employee petitioner fails to acknowledge that if the amounts are compensation he must include them in income controls the corporation's affairs see paula constr co v commissioner supra pincite while we held the trusts were shams and should be ignored for tax purposes we find the consulting contract helpful for the limited purpose of determining the intent of the parties the contract provides that midwest desires to contract the skills and services of one frank w muhich in the performance of services on behalf of midwest and we find that petitioner performed these services for midwest during the subject years before the subject years petitioner worked as a principal officer of midwest establishing its name recognition overseeing its business and playing a key role in its success his work- related duties did not change after the trusts were formed he continued to own and operate midwest exactly as before and midwest continued to pay compensation_for his services we conclude midwest paid the consulting fees intending to compensate petitioner for his services in disregarding the asset trust's existence for tax purposes we view these payments received directly by petitioner the true_earner of the income as to reasonableness each year petitioner based his salary upon the financial performance of midwest we view this as a reasonable way for an owner of a closely_held_business to compensate himself or herself the contract in this case specifically provides for compensation of dollar_figure per month plus additional_amounts based upon midwest's financial performance this compensation package is very similar to the commission type arrangement used before the trust scheme on the primary basis of the amount of compensation that midwest paid petitioner before the subject years the type and content of the services he performed during the subject years and the gross_receipts those services produced for midwest we conclude petitioner's compensation during the subject years was reasonable we hold midwest may deduct the consulting fees under sec_162 and petitioner must include these fees in income in the amounts of dollar_figure and dollar_figure for and respectively we now turn to the dollar_figure and dollar_figure payments made by midwest to the trust promoters in and respectively respondent determined these amounts were not deductible by midwest and that the dollar_figure was a constructive_dividend to petitioner petitioners contend that both amounts were deductible under sec_162 and that the dollar_figure is not includable in petitioner's income we disagree a taxpayer may deduct all ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business sec_162 the taxpayer must show that the ‘4 the issue of whether the dollar_figure payment was includable in petitioner's gross_income as a constructive_dividend is not before the court expenses were both ordinary and necessary see 127_f3d_643 7th cir affg tcmemo_1996_168 deductions are a matter of legislative grace see 503_us_79 in the context of sec_162 an expense is necessary if it is appropriate or helpful for the development of the taxpayer's business see welch v helvering u s pincite an expense is ordinary if it relates to a transaction commonly or frequently occurring in the taxpayer's business community see indopco inc v commissioner supra pincite discussing the requirements of sec_162 it follows from our holding that the trusts were shams and should be ignored for tax purposes that the payments in pursuance of the scheme were not ordinary and necessary business_expenses under sec_162 the expenses were not appropriate or helpful for the development of midwest's photography business nor was there any evidence they were a usual expense within midwest's business community we hold the payments to the trust promoters bartoli and aegis are not deductible under sec_162 turning to constructive dividends taxpayers must include dividends in gross_income see sec 6l1 a whena corporation distributes property to a shareholder as a dividend the shareholder must include in gross_income the distribution to the extent of the corporation's earnings_and_profits see sec_301 c and the shareholder must do so even though the corporation has not formally declared a dividend see 923_f2d_67 7th cir 496_f2d_1384 5th cir the shareholder need not receive the distribution directly payments on behalf of a shareholder are treated as if paid directly to the shareholder see 53_tc_459 in determining whether a shareholder has received a constructive_dividend we look to whether the payment by the corporation benefited the shareholder personally rather than furthered the interest of the corporation see 958_f2d_684 6th cir affg and remanding on other grounds tcmemo_1987_549 621_f2d_731 5th cir given our holding the trusts were shams and were created by the muhichs to avoid taxes we hold the dollar_figure payment to the trust promoters was solely to benefit petitioner and his family personally we hold petitioner must include the payment in his income as a constructive_dividend 's petitioners neither argued nor proved that midwest did not have sufficient earnings_and_profits for us to categorize the payment as a dividend under sec_316 sec_6662 a the muhichs respondent determined the muhichs are liable for the accuracy-related_penalty under sec_6662 and b for both years in issue this section imposes a penalty equal to percent of the portion of an underpayment that is attributable to among other things negligence petitioners will avoid this penalty if the record shows that they were not negligent l e they made a reasonable attempt to comply with the provisions of the internal_revenue_code and they were not careless reckless or in intentional disregard of rules or regulations see sec_6662 c 942_f2d_444 7th cir affg 94_tc_96 drum v commissioner tcmemo_1994_433 affd without published opinion 61_f3d_910 9th cir negligence connotes a lack of due care or a failure to do what a reasonable and prudent person would do under the circumstances see 92_tc_1 affd 925_f2d_348 9th cir 85_tc_934 the accuracy-related_penalty of sec_6662 is not applicable to any portion of an underpayment to the extent that an individual has reasonable_cause for that portion and acts in good_faith with respect thereto see sec_6664 such a determination is made by taking into account all facts and circumstances including the experience and knowledge of the taxpayer and his or her reliance ona - - professional tax adviser see sec_1_6664-4 income_tax regs the muhichs seek relief from the penalty by arguing they relied in good_faith on advice from the martins and bartoli good_faith reliance on the advice of counsel or a qualified accountant can in certain circumstances be a defense to the accuracy-related_penalty for negligence see eg 91_tc_396 affd without published opinion 940_f2d_1534 9th cir 86_tc_492 affd 864_f2d_1521 10th cir 59_tc_473 51_tc_467 in those cases the taxpayer must establish the adviser had sufficient expertise to justify reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied in good_faith on the adviser’s judgment see ellwest stereo theatres of memphis inc v commissioner tcmemo_1995_610 the record in this case demonstrates the muhichs did not act reasonably with respect to reporting their income for and the muhichs' claim that they relied in good_faith on the martins for advice as to the tax treatment of the trust scheme is unsupported by the evidence the muhichs failed to disclose to the martins they had purportedly divested themselves of most of -- p7 - their assets and adopted the trust scheme the martins never advised the muhichs about the scheme before the muhichs entered into it the muhichs had all the trusts' returns for the year of inception prepared by savino in an attempt to keep the existence of the trusts from the martins although the martins did prepare the returns for the trusts they did so reluctantly and only after informing petitioner of their concern as to the trusts' legitimacy nor are we persuaded that the muhichs reasonably relied upon a qualified expert in the form of bartoli bartoli's bias was obvious and his ability to benefit financially by luring individuals into the scheme should have sent up a red flag petitioner is an experienced businessman who should have been suspicious of bartoli's claims further the record contains no evidence as to bartoli's qualifications or expertise he was noticeably absent from the trial and petitioner was unable to locate him the only information the muhichs provided bartoli was a list of assets and a questionnaire wherein they documented their desire to avoid taxes we hold the muhichs are liable for the accuracy-related_penalties for negligence as determined by respondent midwest respondent determined that midwest is liable for the accuracy-related_penalty under sec_6662 and b for all - - years in issue this section imposes a penalty equal to percent of the portion of an underpayment that is attributable to among other things a substantial_understatement_of_income_tax an understatement is substantial if it exceeds the greater of percent of the tax required to be shown on the return or dollar_figure for corporations see sec_6662 the understatement is reduced if it is based on substantial_authority or is adequately disclosed on the return or in a statement attached to the return see sec_6662 the reasonable_cause exception under sec_6664 may also be used to avoid the penalty if proven by the taxpayer midwest made no relevant disclosures on its returns furthermore the record does not disclose midwest had substantial_authority for deducting the payments to the trust promoters accordingly for each year that the rule computation reflects a substantial_understatement within the meaning of sec_6662 d midwest will be liable for this penalty sec_6673 respondent moved the court at the end of trial to impose a penalty under sec_6673 respondent asserts the muhichs' position is frivolous and groundless and that they instituted this lawsuit primarily for delay as relevant sec_6673 a and b provides that the court may impose a penalty of up to dollar_figure wherever proceedings before us have - - been instituted or maintained by the taxpayer primarily for delay or wherever the taxpayer's position in a proceeding is frivolous or groundless we decline to impose a penalty under sec_6673 although the muhichs' position that the trusts had economic_substance was frivolous we have rejected respondent's position the consulting fees were dividends holding instead the fees were compensation the muhichs' position in this proceeding was somewhat meritorious to the extent they were defending against respondent's determination of constructive dividends we admonish the muhichs that we shall not be inclined to exercise our discretion under sec_6673 so favorably in the future if presented with similar arguments by them and we may impose a penalty in reaching all our holdings herein we have considered each argument made by the parties and to the extent not discussed above find those arguments to be irrelevant or without merit to reflect the foregoing an appropriate order will be issued denying respondent’s motion to impose a penalty under sec_6673 a and decisions will be entered under rule -- -