department of the treasury internal_revenue_service washington d c t a x e x e m p t a n d g o v e r n m e n t e n t i t i e s d i v i s i o n number release date se t eora t2 uil employer_identification_number contact person id number telephone number date legend m n dear ------------- this is in reference to your letter of date requesting advance approval of your grant procedures under sec_4945 of the internal_revenue_code you are planning to institute a scholarship program for high school students to attend private high schools you are recognized as exempt from federal_income_tax under sec_501 of the internal_revenue_code and have been classified as a private_foundation as defined by sec_509 of the code the name of your scholarship program is m you presently plan to award one scholarship per year unless under special circumstances for a four year period your scholarships will pay for tuition room and board for private_schools in the area the administrators of high schools located in n county and all contiguous counties will nominate candidates for your scholarships by submitting a nomination form your board_of directors will initially be your selection committee however your board_of directors may in the future delegate this responsibility to other persons each member of your board_of directors must disclose any relationship of any candidate for a scholarship in which he or she may derive a direct or indirect private benefit if any candidate are selected over other candidates your scholarship candidates must be enrolled or about to enroll as a full time student in a private high school your scholarship candidates must meet the following criteria the candidate shows sufficient academic ability to enable him or her to complete courses of study necessary to graduate from his or her selected private high school the candidate has the necessary character and motivation to obtain an education the candidate exhibits need for financial assistance your scholarships will be awarded to recipients for study toward a degree at an educational_organization described in sec_170 of the code all high school students are eligible to be nominated for your scholarships your scholarship recipients must use the funds for tuition board room fees books supplies travel costs and incidental_expenses for attendance at the recipient’s respective school none of your scholarships may be awarded to the children of your board_of directors or officers to the children of any disqualified_person or to the children of the selection committee members or children of persons aiding in the selection process you plan to pay your scholarship funds to the respective private high schools sec_501 of the code provides for the exemption from federal_income_tax of organizations organized and operated exclusively for charitable scientific or educational_purposes no part of the net_earnings of which inures to the benefit of any individual sec_1_501_c_3_-1 of the income_tax regulations provides that the term charitable is used in sec_501 in its generally accepted legal sense charitable as used in its generally accepted legal sense includes advancement of education sec_4945 and b of the code impose certain excise_taxes on expenditure defined as taxable_expenditures by sec_4945 sec_4945 of the code provides that the term taxable_expenditure means any amount_paid or incurred by a private_foundation as a grant to an individual for travel study or other similar purposes by such individual unless such grant satisfies the requirements of sec_4945 sec_4945 of the code provides that sec_4945 shall not apply to an individual grant awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the secretary if it is demonstrated to the satisfaction of the secretary that the grant constitutes a scholarship or fellowship_grant which is subject_to the provisions of sec_117 and is to be used for study at an educational_organization described in sec_170 sec_53_4945-4 of the foundation and similar excise_taxes regulations provides that to secure approval for a grant-making procedure a private_foundation must demonstrate to the satisfaction of the commissioner that a the grant procedures include an objective and nondiscriminatory selection process b the procedure is designed to result in the performance o f the activities intended to be financed and c the foundation will obtain reports to determine whether the grant funds are being properly used reports are not required if the foundation pays the scholarship grants to an educational_institution see sec_53_4945-4 and sec_53_4945-4 of the foundation excise_tax regulations sec_53_4945-4 of the foundation and similar excise_taxes regulations provides that a foundation is under a duty to investigate and attempt to recover any misuse of grants since you are aiding students to attend private high schools your scholarship program would be a charitable activity of advancing education under sec_501 of the code based on the information submitted and assuming your scholarship procedures will be conducted as proposed we rule that your procedures for awarding scholarships comply with the requirements contained in sec_4945 of the code because a your scholarship procedures include an objective and nondiscriminatory selection process your applicants are rated by objective and nondiscriminatory criteria by persons experienced in rating of students on their accomplishments and potential b your recipients must be enrolled in a degree program to receive your scholarship grants your recipients must be enrolled in an educational_organization described in sec_170 of the code thus your procedures are designed to result in the performance of the activities that you intend to finance c you will satisfy the report requirement by paying of your scholarship grants directly to the respective private high schools you have submitted information showing that you will investigate and seek recovery_of any misuse of your grants based upon the information submitted and assuming your program will be conducted as proposed with a view to providing objectivity and nondiscrimination in the awarding of your scholarship grants we rule that your grants comply with requirements of sec_4945 of the code expenditures made in accordance with these procedures will not constitute taxable_expenditures within the meaning of sec_4945 of the code and as such are eligible for the exclusion from income provided for in sec_117 of the code to the extent that such grants are actually used for qualified_tuition_and_related_expenses within the meaning of sec_117 of the code this ruling is conditioned on the understanding that there will be no material changes in the facts upon which it is based it is further conditioned on the understanding that no grants will be awarded to the children of your organization’s creators officers directors trustees or members of the selection committee or for a purpose inconsistent with the purposes described in sec_170 of the code the approval of your grant-making procedures is a one time approval of your system of standards and procedures for selecting recipients of grants that meet the requirements of sec_4945 of the code thus approval will apply to succeeding grant programs only as long as the standards and procedures under which they are conducted do not differ materially from those described in your request we are informing the ohio te_ge office of this action please keep a copy of this ruling with your organization’s permanent records this ruling is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited as precedent if you have any questions about this ruling please contact the person whose name and telephone number are shown in the heading of this letter sincerely jane baniewicz manager exempt_organizations technical group


internal_revenue_service national_office technical_advice_memorandum date number release date third party communication none date of communication not applicable index uil no case-mis no tam-114306-10 director ------------------- taxpayer's name taxpayer's address taxpayer's identification no date of conference ---------------------------------------------- ---------------------------------------- ------------------------------ ---------------- ---------------------- legend bonds borrower indenture issuer state trustee -------------------------------------------------------------------------------- ------------------------------- ---------------------------- -------------------------------------------------------------------------------- --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- ------- ---------------------------------------------- ------------ -------------------------------------------------------------------------------- ----------------------------------------- tam-114306-10 ------------------- ------- date year issue whether the entrance fees collected by borrower are properly characterized as replacement_proceeds within the meaning of sec_148 of the internal_revenue_code the code and sec_1_148-1 of the income_tax regulations conclusion the entrance fees collected by borrower are not properly characterized as replacement_proceeds within the meaning of sec_148 of the code and sec_1_148-1 of the income_tax regulations because the bondholders have no reasonable assurance that the fees will be available to pay debt service on the bonds facts on date issuer issued its bonds and loaned the proceeds of such bonds to borrower an organization described in sec_501 of the code borrower used the proceeds of the bonds to expand its retirement community facility the facility and to refund a prior series of tax-exempt_bonds which were used to construct the initial facility prior to occupying a unit of the facility residents are required to remit to borrower an entrance fee borrower is not required to refund the resident’s entrance fee or the applicable_percentage thereof until a resident has left the facility and the vacated unit is re-occupied by a new resident who has paid an entrance fee in rare cases borrower may decide in its sole discretion to refund an entrance fee without these conditions having been met upon a resident’s demonstration of a hardship borrower is not required to hold the entrance fees collected from its residents in trust for the residents on the contrary pursuant to borrower’s agreements with its residents borrower may invest the entrance fees or otherwise use these amounts for its own purposes pursuant to the indenture and related documents executed in connection with the issuance of the bonds borrower granted trustee a first priority security_interest in its revenues including the entrance fees and certain other collateral not presently at issue this security_interest was recorded via the filing of one or more financing statements under the state uniform commercial code tam-114306-10 trustee has not taken physical possession of nor does it control the entrance fees which are commingled with borrower’s other cash however pursuant to its security_interest filing trustee has the ability to take possession of the entrance fees and other commingled moneys to perfect its security_interest until possession is taken borrower has unrestricted use of the entrance fees including use of such fees to pay other creditors the amount of cash in borrower’s accounts varies with the occupancy of the facility borrower uses its cash including the entrance fees to cover operating deficits the replacement of its facilities and other capital needs at the end of year the amount of cash that borrower had invested was approximately one half of the total amount of entrance fee revenue borrower had received as of the end of year law and analysis sec_103 provides that except as provided in sec_103 gross_income does not include interest on any state_or_local_bond sec_103 provides that sec_103 shall not apply to any arbitrage_bond within the meaning of sec_148 sec_148 provides that for purposes of sec_103 the term arbitrage_bond means any bond issued as part of an issue any portion of the proceeds of which are reasonably expected at the time of issuance of the bond to be used directly or indirectly to acquire higher_yielding_investments or to replace funds which were used directly or indirectly to acquire higher_yielding_investments for purposes of sec_148 a bond shall be treated as an arbitrage_bond if the issuer intentionally uses any portion of the proceeds of the issue of which such bond is a part in a manner described in or of the previous sentence sec_148 defines the term higher_yielding_investments as any investment_property which produces a yield over the term of the issue which is materially higher than the yield on the issue sec_1_148-0 provides that sec_148 was enacted to minimize the arbitrage benefits from investing gross_proceeds of tax-exempt_bonds in higher_yielding_investments and to remove the arbitrage incentives to issue more bonds to issue bonds earlier or to leave bonds outstanding longer than is otherwise reasonably necessary to accomplish the governmental purposes for which the bonds were issued to accomplish these purposes sec_148 restricts the direct and indirect investment of bond proceeds in higher_yielding_investments and requires that certain earnings on higher_yielding_investments be rebated to the united_states violation of these provisions causes the bonds in the issue to become arbitrage_bonds the interest on which is not excludable from the gross_income of the owners under sec_103 the regulations in sec_1_148-1 through sec_1_148-11 apply in a manner consistent with these purposes tam-114306-10 sec_1_148-1 provides that in general amounts are replacement_proceeds of an issue if the amounts have a sufficiently direct nexus to the issue or to the governmental purpose of the issue to conclude that the amounts would have been used for that governmental purpose if the proceeds of the issue were not used or to be used for that governmental purpose for this purpose governmental purposes include the expected use of amounts for the payment of debt service on a particular date the mere availability or preliminary earmarking of amounts for a governmental purpose however does not in itself establish a sufficient nexus to cause those amounts to be replacement_proceeds replacement_proceeds include but are not limited to sinking funds pledged funds and other replacement_proceeds to the extent that those funds or amounts are held by or derived from a substantial beneficiary of the issue a substantial beneficiary of an issue includes the issuer and any related_party to the issuer and if the issuer is not a state the state in which the issuer is located a person is not a substantial beneficiary of an issue solely because it is a guarantor under a qualified guarantee a sinking_fund includes a debt service fund redemption fund reserve fund replacement fund or any similar fund to the extent reasonably expected to be used directly or indirectly to pay principal or interest on the issue a pledged fund is any amount that is directly or indirectly pledged to pay principal or interest on the issue a pledge need not be cast in any particular form but in substance must provide reasonable assurance that the amount will be available to pay principal or interest on the issue even if the issuer encounters financial difficulties a pledge to a guarantor of an issue is an indirect pledge to secure payment of principal or interest on the issue revrul_78_348 1978_2_cb_95 provides that for purposes of determining whether certain collateral constitutes replacement_proceeds a pledge of collateral need not be cast in a particular legal form thus for example the bondholders need not take actual or constructive possession of the collateral however there must be a reasonable assurance that the collateral will be available if needed to pay debt service even if the issuer encounters financial difficulties thus for example an arrangement will not have the effect of a pledge of collateral if the issuer has discretion to defeat the pledge merely by liquidating the collateral and disposing of the proceeds in the present case borrower pledged all of its revenues including the entrance fees as security for the bonds therefore a nexus exists between the entrance fees and the bonds however the pledge does not provide reasonable assurance that the entrance fees will be available to pay debt service on the bonds in the event borrower encounters financial difficulties and there are no other facts such as provisions in the indenture or other financing documents such as financial covenants that require the maintenance of certain asset levels from which such reasonable assurance can be inferred borrower has commingled all of its revenues in its accounts borrower is not limited in its ability to spend these moneys additionally at the end of year borrower’s investment balance was approximately one-half of its collected entrance fee revenues although there are no facts regarding the level of cash in borrower’s checking account during year it is reasonable to conclude that borrower would only have transferred tam-114306-10 cash from its investments to its checking account to the extent necessary to cover its immediately anticipated operating_expenses thus borrower spent a substantial portion of its cash including the entrance fees after the bonds were issued and continues to expect to spend its cash as necessary on future expenditures both without any interference by trustee borrower’s creditors or the residents thus it is reasonable to conclude that in the absence of further action by trustee the moneys could and would be dissipated to cover operating shortfalls and to finance other items prior to any payment to the bondholders there are also no facts to suggest that borrower’s level of cash when the bonds were issued was such that bondholders considering the nature of the facility and borrower’s level of operating_expenses could have reasonably relied on this level being maintained while the bonds were outstanding consequently even though there is a nexus between the entrance fees and other revenues and the bonds there is no reasonable assurance that the entrance fees will be available to pay debt service on the bonds in the event borrower encounters financial difficulties therefore the entrance fees are not properly characterized as replacement_proceeds caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service number release date index number ----------------------------------------------------- -------------------- ------------------------------- re -------------------------------- 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 b04 plr-139540-15 date date legend decedent spouse date date ------------------------------------------------- -------------------------- --------------------- --------------------- dear ------------- this letter responds to your personal representative’s letter of date requesting an extension of time pursuant to sec_301_9100-3 of the procedure and administration regulations to make the election under sec_2010 of the internal_revenue_code portability election to allow a decedent’s surviving_spouse to take into account that decedent’s deceased spousal unused exclusion dsue amount the facts and representations are as follows decedent died on date survived by spouse date is a date after the effective date of the amendment to sec_2010 which provides for portability of a dsue amount to a surviving_spouse to obtain the benefit of portability of decedent’s dsue amount to spouse decedent’s estate was required to file form_706 united_states estate and generation-skipping_transfer_tax return on or before the date that is nine months after decedent’s date of death or the last day of the period covered by an extension decedent’s form_706 was due on date but the estate did not file a form_706 to make the portability election the estate discovered its failure to elect portability after the due_date for making the election plr-139540-15 it is represented that the value of decedent’s gross_estate is less than the basic exclusion amount in the year of decedent’s death including any taxable_gifts made during his lifetime you request an extension of time pursuant to sec_301_9100-3 to elect portability of decedent’s dsue amount pursuant to sec_2010 law and analysis sec_2001 imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2010 provides that a credit of the applicable credit_amount shall be allowed to the estate of every decedent against the tax imposed by sec_2001 sec_2010 provides that the applicable credit_amount is the amount of the tentative_tax that would be determined under sec_2001 if the amount with respect to which such tentative_tax is to be computed were equal to the applicable_exclusion_amount on date congress amended sec_2010 effective for estates of decedents dying and gifts made after date to allow portability of a decedent’s unused applicable_exclusion_amount between spouses tax relief unemployment insurance reauthorization and job creation act of pub_l_no sec_303 124_stat_3296 sec_2010 provides that the applicable_exclusion_amount is the sum of the basic exclusion amount and in the case of a surviving_spouse the dsue amount sec_2010 generally provides that the basic exclusion amount is dollar_figure to be adjusted for inflation annually after calendar_year sec_2010 defines the dsue amount to mean the lesser_of a the basic exclusion amount or b the excess of -- i the applicable_exclusion_amount of the last deceased spouse of the surviving_spouse over ii the amount with respect to which the tentative_tax is determined under sec_2001 on the estate of such deceased spouse sec_2010 provides that a dsue amount may not be taken into account by a surviving_spouse under sec_2010 unless the executor of the estate of the deceased spouse files an estate_tax_return on which such amount is computed and makes an election on such return that such amount may be so taken into account the election once made shall be irrevocable no election may be made if such return is filed after the time prescribed by law including extensions for filing such return plr-139540-15 sec_2010 provides that the secretary shall prescribe regulations as may be necessary or appropriate to implement sec_2010 sec_20_2010-2t a of the estate_tax regulations as in effect on date provides that to allow a decedent’s surviving_spouse to take into account that decedent’s dsue amount the executor of the decedent’s estate must elect portability of the dsue amount on a timely-filed form_706 under sec_20_2010-2t a the due_date of an estate_tax_return required to elect portability is nine months after the decedent’s date of death or the last day of the period covered by an extension if an extension of time for filing has been granted under sec_20_2010-2t a the portability election is made by timely filing a complete and properly prepared estate_tax_return unless the executor satisfies the requirements for the election not to apply in sec_20_2010-2t a i sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 provides that the term statutory election means an election whose due_date is prescribed by statute the term regulatory election means an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute a request for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election the due_date for the portability election is prescribed by statute in the case of an estate required to file an estate_tax_return under sec_6018 see sec_2010 sec_6075 and sec_6018 in the case of an estate that is not required to file an estate_tax_return under sec_6018 the due_date is prescribed by regulation see sec_20_2010-2t a see also sec_20_2010-2 and revproc_2014_18 2014_7_irb_513 sec_2 plr-139540-15 accordingly in the latter case a taxpayer may seek an extension of time to elect portability under the provisions of sec_301_9100-3 sec_6018 requires the filing of an estate_tax_return in all cases where the gross_estate exceeds the basic exclusion amount in effect under sec_2010 for the calendar_year which includes the date of death for purposes of this determination under sec_6018 the basic exclusion amount is reduced but not below zero by the sum of -- a the amount of the adjusted_taxable_gifts within the meaning of sec_2001 made by the decedent after date plus b the aggregate amount allowed as a specific exemption under sec_2521 as in effect before its repeal by the tax reform act of with respect to gifts made by the decedent after date it is represented that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is not required to file an estate_tax_return under sec_6018 under these facts the commissioner has discretionary authority under sec_301_9100-3 to grant to decedent’s estate an extension of time to elect portability based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly we grant an extension of time of days from the date of this letter in which to elect portability under sec_2010 the election should be made by filing a complete and properly-prepared form_706 and a copy of this letter within days from the date of this letter to the cincinnati service_center at the following address internal_revenue_service cincinnati service_center stop cincinnati oh for purposes of electing portability a form_706 filed by decedent’s estate within days from the date of this letter will be considered to be timely filed 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 if it is later determined that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is required to file an estate_tax_return pursuant to sec_6018 the commissioner is without authority under sec_301_9100-3 to grant to decedent’s estate an extension of time to elect portability and the grant of the extension referred to in this letter is deemed null and void this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent plr-139540-15 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel passthroughs special industries by lorraine e gardner lorraine e gardner senior counsel branch passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


internal_revenue_service number release date index number ----------------------- ------------------------ ---------------------- --------------------------- --------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ------------------ telephone number ---------------------- refer reply to cc psi plr-110362-16 date date legend donor date trust son daughter-in-law enrolled_agent dear -------------- -------------------------------------------------- --------------------------- --------------------------------------------------------------------------------- ----------------------- ----------------- ---------------------- this letter responds to the letter dated date submitted by your authorized representative requesting an extension of time pursuant to sec_2642 of the internal_revenue_code and sec_301_9100-3 of the procedure and administration regulations to allocate generation-skipping_transfer gst_exemption to transfers to a_trust facts the facts and representations submitted are as follows on date a date after date donor created an irrevocable_trust trust for the benefit of son daughter-in-law and their living issue trust has gst potential also on date donor transferred two undivided interests in the same real_property to trust enrolled_agent prepared and timely filed donor’s form_709 united_states gift and generation-skipping_transfer_tax return reporting the transfers to trust however enrolled_agent improperly reported the gifts on part gifts subject only to gift_tax of schedule a of the form_709 rather than on part indirect skips accordingly enrolled_agent failed to allocate donor’s gst_exemption to the gifts plr-110362-16 donor requests an extension of time to make an election under sec_2642 to allocate gst_exemption to the transfers to trust effective as of the date of the transfers to trust law and analysis sec_2601 imposes a tax on every gst a gst is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2602 provides that the amount of the tax imposed by sec_2601 is the taxable_amount multiplied by the applicable_rate sec_2641 defines the applicable_rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer under sec_2642 the inclusion_ratio with respect to any property transferred in a gst is the excess if any of one over the applicable_fraction the applicable_fraction as defined in sec_2642 is a fraction the numerator of which is the amount of the gst_exemption under sec_2631 allocated to the trust and the denominator of which is the value of the property transferred to the trust sec_2631 provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption amount which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_2632 provides that any allocation by an individual of his or her gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual’s estate determined with regard to extensions regardless of whether such a return is required to be filed sec_2632 provides that for purposes of sec_2632 the term indirect_skip means any transfer of property other than a direct_skip subject_to the tax imposed by chapter made to a gst_trust as defined in sec_2632 sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute sec_301_9100-3 provides in part that requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government plr-110362-16 sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied donor is granted an extension of time of days from the date of this letter to allocate her available gst_exemption to the transfers to trust the allocations will be effective as of the date of the transfers and the values of the transfers as determined for federal gift_tax purposes will be used in determining the amount of donor's gst_exemption to be allocated to the transfers this allocation should be made on a supplemental form_709 and filed with the cincinnati service_center at the following address internal_revenue_service cincinnati service_center - stop cincinnati oh a copy of this letter should be attached to the supplemental form_709 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent 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 plr-110362-16 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel passthroughs special industries by lorraine gardner lorraine e gardner senior counsel branch passthroughs special industries enclosures copy of the letter copy for sec_6110 purposes cc


internal_revenue_service number release date index number ---------------------- --------------------------------------- ---------------------------- ------------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ------------ telephone number -------------------- refer reply to cc psi b07 plr-134331-05 date date --------------------- ---------------------------- -------------------------- ---------------------------- ---------------------- ----------------------- -------------------------------- ---------------------------- ------------------------ ----------------------- legend legend t ------------------------ ----------------------- ---------------------------- ----------------------- x y z dear ------------------ we received a request for permission to compute t’s credit_for_increasing_research_activities group credit using the regular_method under sec_41 of the internal_revenue_code this letter responds to that request the represented facts are as follows -------------------------- ------- ------- -------------------------------------- ---------------------- plr-134331-05 t is a sec_41 controlled_group t’s group credit was computed using the alternative_incremental_research_credit airc rules of sec_41 for the y taxable_year through the z taxable_year a request for permission to compute t’s group credit using the regular_method under sec_41 for the taxable_year ending on x was submitted timely for taxable years beginning after date taxpayers may elect to determine their research_credit under the airc rules of sec_41 sec_41 provides that any election under sec_41 shall apply for the taxable_year in which made and all succeeding taxable years unless revoked with the consent of the secretary based solely on the facts submitted and representations made we grant permission to determine t’s group credit using the regular_method under sec_41 for the taxable_year ending on x and all succeeding taxable years unless a new election is made to compute t’s group credit using the airc rules of sec_41 except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter further we express or imply no opinion concerning expenditures any member of t treated as qualified_research_expenses this ruling is directed only to the taxpayer requesting it sec_6110 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 a copy of this letter must be attached to any income_tax return to which it is relevant 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 brenda m stewart senior counsel branch passthroughs special industries-


t c memo united_states tax_court thousand oaks residential care home i inc et al petitioners commissioner of internal revenue respondent v docket nos filed date r determined that a corporation’s compensation packages for its owner-employees were unreasonable and disallowed deductions for compensation paid for the through tax years held the compensation packages paid to the corporation’s owner-employees were reasonable and deductible under sec_162 for the and tax years to the extent determined herein the compensation paid to the owner-employees’ daughter grace-ann strick was unreasonable 1cases of the following petitioners are consolidated herewith thousand oaks residential care home i inc docket no and robert a fletcher and pearl fletcher docket no on date we granted motions to change the captions in docket nos and held further the corporation is liable for the sec_4972 excise_tax to the extent determined herein it is not liable for the sec_6651 and additions to tax ps are liable for a portion of the sec_6662 penalties as redetermined in this opinion matthew taggart ryan andrews michael b luftman and charles kolstad for petitioners kris h an for respondent memorandum findings_of_fact and opinion wherry judge these cases are before the court on petitions for redetermination of income_tax and excise_tax deficiencies additions to tax and penalties respondent determined for petitioners’ through tax years after concessions the issues remaining are 2unless otherwise indicated all section references are to the internal_revenue_code_of_1986 code as amended and in effect for the taxable years at issue all rule references are to the tax_court rules_of_practice and procedure 3petitioners robert a fletcher and pearl fletcher concede with respect to their personal federal_income_tax returns that they are not entitled to a deduction for depreciation expenses of dollar_figure reported on schedules e supplemental income and loss for each of the and tax years they also concede that they are not entitled to deduct certain taxes of dollar_figure dollar_figure and dollar_figure for the and tax years respectively reported on schedule e and respondent continued whether the compensation thousand oaks residential care home i inc torch paid to robert a and pearl fletcher was reasonable under sec_162 continued concedes that they are entitled to deduct those expenses on schedules a itemized_deductions for the applicable years the fletchers concede that they are also not entitled to deduct other schedule e taxes of dollar_figure dollar_figure and dollar_figure for the and tax years respectively and respondent concedes that they are entitled to deduct those expenses on schedule a the fletchers concede that they are not entitled to deduct schedule e insurance expenses of dollar_figure dollar_figure and dollar_figure for the and tax years respectively the parties agree that schedule e warehouse rental income should be decreased by dollar_figure and dollar_figure for the and tax years respectively the fletchers concede that they received unreported rental income of dollar_figure dollar_figure and dollar_figure for the and tax years respectively the fletchers concede that they are liable for the sec_6662 accuracy-related_penalty with respect to the disallowed schedule e expenses and unreported erbes property rental income petitioner thousand oaks residential care home i inc concedes that it is not entitled to deduct repairs and maintenance_expenses of dollar_figure for the tax_year this petitioner concedes that it is not entitled to deduct rental expenses of dollar_figure and dollar_figure for the and tax years respectively respondent concedes that this petitioner is entitled to deduct taxes and licenses expenses of dollar_figure dollar_figure and dollar_figure for the and tax years respectively this petitioner concedes that it is not entitled to deduct expenses of dollar_figure and dollar_figure for the and tax years respectively it also concedes that it is not entitled to other deductions of dollar_figure dollar_figure and dollar_figure for the and tax years this petitioner concedes that it is not entitled to deduct advertising expenses of dollar_figure or employee benefit programs expenses of dollar_figure for the tax_year respondent concedes that this petitioner is entitled to deduct dollar_figure for the disallowed contribution for the tax_year and this petitioner concedes that it is not entitled to deduct dollar_figure of the same for the tax_year this petitioner concedes that it is liable for the sec_6662 accuracy-related_penalty with respect to all of its concessions listed in this paragraph for the and tax years including the pension_plan contributions paid on behalf of robert a and pearl fletcher for the and tax years whether the compensation torch paid to the fletchers’ daughter grace-ann strick was reasonable under sec_162 for the and tax years whether torch is liable for excise_tax of dollar_figure and dollar_figure under sec_4972 for the and tax years respectively whether torch is liable for sec_6651 failure_to_file additions to tax of dollar_figure and dollar_figure for the and tax years respectively whether torch is liable for sec_6651 failure to pay additions to tax of dollar_figure and dollar_figure for the and tax years respectively and whether petitioners robert a and pearl fletcher are liable for the sec_6662 accuracy-related_penalty for the and tax years and whether torch is liable for the sec_6662 accuracy-related_penalty for the and tax years findings_of_fact the parties’ stipulation of facts and supplemental stipulation of facts with accompanying exhibits and the stipulations of settled issues are incorporated herein by this reference at the time they filed their respective tax_court petitions the individual petitioners resided in california and the corporate petitioner maintained its principal_place_of_business in california robert and pearl fletcher’s background--lighting the torch dr robert a fletcher began his career as an accountant for the salvation army grace hospital in windsor ontario he received formal training by taking charter accountant’s courses offered by an accountant’s association in windsor ontario he then became the business manager of the office staff at leamington memorial hospital in leamington ontario dr fletcher then moved to the united_states in and began working at seaside oil which merged with tidewater flying a oil co that then merged with getty oil co he then became the chief accountant for getty oil after leaving getty oil dr fletcher decided to attend cleveland chiropractic college in los angeles after graduation dr fletcher became a california licensed chiropractor and began a chiropractic business in starting in dr fletcher operated his chiropractic practice as an owner- employee of robert a fletcher chiropractic corp which was incorporated on date dr fletcher spent approximately hours per week at his chiropractic practice until he retired from practicing chiropractic medicine in ms fletcher is a registered nurse she went through three years of training at the grace hospital in toronto and received a nursing degree in after receiving her nursing degree ms fletcher’s first job was at hotel dieu hospital in windsor canada working in the operating room for about six months after that she worked at leamington memorial hospital in ontario where she ran the recovery room after the fletchers moved to california ms fletcher began working at the st francis hospital in santa barbara in the intensive care unit and in the labor and delivery room after a few years ms fletcher then went to work at the granada hills community hospital where she ran one of the shifts in the large extended care unit her duties there included overseeing the nurse’s aides dispensing medication writing all of the reports and recordings on patients’ charts overseeing lab results calling doctors taking orders and interacting with patients’ families thousand oaks residential care i corporation --carrying the torch on date the fletchers purchased a struggling corporation called thousand oaks residential care i from john and edith breen dr fletcher explained that they paid dollar_figure and assumed the debt obligations of the corporation which were several hundreds of thousands of dollars including the real_property mortgage the corporation owned and operated torch an assisted living facility in thousand oaks california dr fletcher was the corporation’s sole shareholder from to the corporation’s board_of directors consisted of three members robert a fletcher pearl fletcher and lorne muth pearl fletcher’s brother dr fletcher oversaw torch’s general operations handled its finances and supervised its maintenance workers he also performed substantial maintenance work himself after dr fletcher retired from his chiropractic practice in he 4although dr fletcher’s testimony was that they paid dollar_figure and assumed the debt obligations the corporation’s federal form_1120 u s_corporation income_tax return page balance_sheet for shows a common_stock balance of dollar_figure and the record does not reveal any stock redemptions we believe dr fletcher’s testimony that they initially paid dollar_figure for the corporation 5an assisted living center also known as a residential care home or residential care facility provides care and supervision to seniors above the age of without skilled nursing services a nursing home is a facility that provides rehabilitation and skilled nursing services worked full time for torch ms fletcher worked on and managed the assisted care personnel aspects of torch she worked with residents learned of their diagnoses handicaps and illnesses handled family matters communicated with the nurses and nurses’ aides communicated with doctors and pharmacists worked with dietitians and supervised the housekeeping staff the fletchers received forms w-2 wage and tax statement from torch reporting the following incomes year ms fletcher dr fletcher dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number -0- dollar_figure big_number big_number big_number big_number big_number -0- 6all amounts have been rounded to the nearest whole number no forms w- were presented for any year where the amount_paid was -0- total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- -0- big_number big_number big_number big_number big_number the corporation did not begin to cover its expenses and was losing money until the fletchers had owned it for months the corporation paid all of its other employees at the market rate for their services the corporation reported the following revenue information on its forms for the through tax years year gross_receipts dollar_figure big_number big_number big_number big_number taxable_income dollar_figure big_number big_number big_number big_number depreciation expense taxable_income before deprecation1 dollar_figure big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1the court has derived this column of information from the reported taxable_income and depreciation amounts on the forms 2the facility was sold in and thereafter the corporation did not receive any gross_receipts in date the corporation hired the fletchers’ daughter grace-ann strick at dollar_figure per hour beginning in date after the sale of torch see infra the corporation paid ms strick dollar_figure per month passing the torch on date the corporation sold its sole asset the assisted living facility in an installment_sale for dollar_figure to inga jakobavich the corporation allocated the dollar_figure sale proceeds as follows dollar_figure to furniture equipment and machines dollar_figure to a windstar van dollar_figure to goodwill and dollar_figure to building and land ms jakobavich has owned and operated an assisted living facility called hillcrest royale retirement community hillcrest since after the purchase ms jakobavich changed the name from torch to thousand oaks royale retirement community since ms jakobavich has paid herself dollar_figure a year as the owner-operator of hillcrest when torch was sold it had about residents and between and employees on staff as part of the sale agreement dr fletcher entered into an interim lease back and management agreement starting on date and ending on the earlier of date or when ms jakobovich obtained her own 7ms jakobovich agreed to pay the following amounts i dollar_figure pincite interest with a monthly payment of dollar_figure from date to date and ii dollar_figure pincite interest with a monthly payment of dollar_figure from date to date when the entire principal balance together with interest was due license the fletchers continued to work at torch for nine months following its sale after the sale of torch the corporation created a defined_benefit_plan pension_plan effective date the fletchers and ms strick were the only participants of the plan the corporation paid dr fletcher form_w-2 wages of dollar_figure dollar_figure and dollar_figure in and respectively it also contributed dollar_figure and dollar_figure to the pension_plan for the benefit of dr fletcher in and respectively for a total compensation package of dollar_figure the corporation paid ms fletcher form_w-2 wages of dollar_figure dollar_figure and dollar_figure in and respectively it also contributed dollar_figure and dollar_figure to the pension_plan for the benefit of ms fletcher in and respectively for a total compensation package of dollar_figure the corporation’s annual board minutes dated date state compensation to administrators was approved for payment of back salaries that 8the schedules e for and appear to mistakenly leave off the dollar_figure and dollar_figure of executive compensation_for each of the fletchers the fletchers do not dispute receiving this income and their accountant explained at trial that the expense for the fletchers’ compensation was included in the cost of labor elsewhere on the return were not paid in prior years due to insufficient cash_flow the corporation’s annual board minutes dated date reiterated that the salaries approved in the prior year would remain the same and the annual board minutes dated date again state that the compensation paid to the fletchers was intended as catchup compensation_for inadequate compensation from prior years in the long-term debt of the corporation was dollar_figure in the long-term debt was dollar_figure but the corporation owed dollar_figure to its shareholders the corporation’s form_1120 page shows that at the end of the year the corporation had assets of dollar_figure in cash on hand dollar_figure in current_assets and dollar_figure in mortgage and real_estate loans it also shows that the corporation had liabilities of dollar_figure in loans from shareholders dollar_figure in mortgages notes bonds payable in a year or more dollar_figure in common_stock and dollar_figure in retained earnings ragnar storm-larsen’s accounting firm storm-larsen co inc has prepared petitioners’ returns and accounting_records since the early 1990s mr storm-larsen is an enrolled_agent and has an m b a degree from the california lutheran university it was mr storm-larsen’s regular business practice to ask the taxpayer to review and approve a return before it was filed dr fletcher approached mr storm-larsen when he believed that the sale of torch was imminent and that he and ms fletcher would be paying a large amount of tax mr storm-larsen researched catchup compensation and explained to dr fletcher that if he had not been paid reasonable_compensation in the past then he could make an adjustment and pay himself more mr storm-larsen also advised dr fletcher that a contribution to the pension_plan was a benefit and that he could include it as compensation not previously received mr storm-larsen advised the fletchers that the compensation was reasonable expert report--elizabeth newlon ph d respondent commissioned elizabeth newlon ph d a senior consultant of national economic research associates inc to assess the compensation dr and ms fletcher could reasonably expect for work performed at torch dr newlon has a b s degree in economics from ohio state university and an m a degree and a ph d in economics from carnegie mellon university she is a published writer and has worked on discrimination wage-and-hour and wrongful termination suits and provided compensation estimates for medical directors in order to compare the fletchers’ compensation with the nationwide data available dr newlon first determined that ms fletcher’s responsibilities were those of a medical and health services manager and that dr fletcher’s responsibilities were those of a general and operations manager although she questioned that there was a need for a full-time manager of this type dr newlon then compared the fletchers’ compensation with that of individuals doing similar types of work at residential care facilities in california dr newlon used labor rates from the bureau of labor statistics’ occupational employment statistics program that data is available only for therefore dr newlon deflated the compensation back to using the average decrease in compensation year to year working backwards from to dr newlon also adjusted the data to control for differences in the prevailing wages in california she increased the national figures using the ratio of the median california medical and health services manager wages for ms fletcher and the median general and operations manager wages for dr fletcher to the national median wages for those positions which worked out to be for both dr newlon then decreased dr fletcher’s estimated compensation to reflect the amount she believed he was working ie to of the estimated amount for the years his tax statements stated that he worked of his time at torch for the years after his retirement and for the years after the fletchers sold torch the following table shows dr newlon’s conclusions as to reasonable_compensation for the fletchers year ms fletcher dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number mr fletcher worked mr fletcher nov - dec jan - oct dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number procedural background big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number respondent issued notices of deficiency on date for dr and ms fletcher’s and tax years date for thousand oaks residential home inc for its tax years ended date and and date for thousand oaks residential care home for its tax years ended date and showing income_tax deficiencies and penalties of 9all values have been rounded to the nearest whole number petitioner robert a pearl fletcher docket no year deficiency accuracy-related_penalty sec_6662 dollar_figure big_number big_number dollar_figure big_number big_number petitioner tye dec deficiency accuracy-related_penalty sec_6662 torch docket no dollar_figure big_number big_number dollar_figure big_number big_number petitioner tye dec deficiency additions to tax sec_6651 and torch docket no i burden_of_proof dollar_figure big_number dollar_figure big_number dollar_figure big_number opinion the commissioner’s determination of a taxpayer’s liability for an income_tax deficiency is generally presumed correct and the taxpayer bears the burden of proving that the determination is improper see rule a 290_us_111 however pursuant to sec_7491 the burden_of_proof on factual issues that affect the taxpayer’s tax_liability may be shifted to the commissioner where the taxpayer introduces credible_evidence with respect to such issue the burden will shift only if the taxpayer has inter alia complied with substantiation requirements pursuant to the code and maintained all records required under this title and has cooperated with reasonable requests by the secretary for witnesses information documents meetings and interviews sec_7491 because we decide these cases on the preponderance_of_the_evidence we need not address who bears the burden_of_proof ii reasonable_compensation respondent contends that the compensation packages paid to the fletchers were not reasonable under sec_162 for the and tax years and disallowed deductions for all of the compensationdollar_figure petitioners contend that compensation paid in those years was reasonable and included catchup payments 10on brief respondent raises the issue of whether the fact that the corporation made only two payments to the defined_benefit_plan included in the fletchers’ compensation package makes the plan a temporary rather than a permanent one under sec_1_401-1 income_tax regs respondent never challenged the plan previously and we decline to address this argument here noting only that as petitioners correctly point out t he permanency requirement referred to in the regulations does not contemplate perpetual contributions 54_tc_953 aff’d 465_f2d_982 7th cir for prior years in which they were undercompensated in determining the reasonableness of compensation we look at the compensation package as a whole which includes salary and pension_plan contributions 66_tc_324 aff’d 553_f2d_93 2d cir a overview of sec_162 sec_162 provides a deduction for ordinary and necessary business_expenses including a reasonable allowance for salaries or other compensation_for_personal_services actually rendered the deductibility of compensation is determined through a two-prong test the amount of compensation must be reasonable and the payment must be purely for services rendered 503_f2d_359 9th cir aff’g tcmemo_1971_200 sec_1_162-7 income_tax regs we consider the reasonableness of the combined salary payments and the contributions to the defined benefit plandollar_figure see 853_f2d_1267 5th cir aff’g tcmemo_1986_407 bianchi v commissioner t c pincite 11contributions to defined benefit plans are not generally deductible under sec_162 unless they meet the requirements of sec_404 sec_404 incorporates the reasonable_compensation standard of sec_162 see 72_tc_377 b catchup compensation services actually rendered compensation_for prior years’ services is deductible in the current_year as long as the employee was actually under compensated in prior years and the current payments are intended as compensation_for past services r j nicoll co v commissione59_tc_37 when the compensation was actually for prior years_of_service it need not be reasonable in the year it was paid devine bros inc v commissioner tcmemo_2003_15 therefore we shall evaluate the fletchers’ compensation in its entirety in order for an employer to deduct compensation under sec_162 the compensation packages need to be both reasonable and for services actually provided nor-cal adjusters v commissioner f 2d pincite sec_1_162-7 income_tax regs the corporation’s annual board minutes dated date explicitly state compensation to administrators was approved for payment of back salaries that were not paid in prior years due to insufficient cash_flow the corporation’s annual board minutes dated date reiterated that the salaries approved in the prior year would remain the same and we infer that this means that the board also intended those compensation packages as payment of back salaries for prior years the corporation’s annual board minutes dated december again state that the compensation paid to the fletchers was for inadequate compensation from prior years we found the fletchers’ testimony that the compensation was intended as catchup compensation_for prior years credible and when viewed along with the corporation’s annual board minutes we find that the compensation was intended as compensation_for each of the three years at issue respectively and as catchup compensation_for prior services actually rendered now we must determine whether the catchup compensation was reasonable c reasonableness of payments the reasonableness of the payments is considered with reference to five broad factors set forth in 716_f2d_1241 9th cir rev’g tcmemo_1980_282 no single factor is dispositive id pincite the relevant factors are the employee’s role in the company a comparison of the employee’s salary with salaries paid_by similar companies for similar services the character and condition of the company potential conflicts of interest and internal consistency id pincite7 the court_of_appeals for the ninth circuit to which an appeal in these cases would lie absent stipulation to the contrary adds an additional factor whether an independent investor would be willing to compensate the employee as he was so compensated 376_f3d_1015 9th cir aff’g 119_tc_8 the court_of_appeals notes that the perspective of an independent investor is but one of many factors that are to be considered when assessing the reasonableness of an executive officer’s compensation id pincite the reasonableness of compensation is a question of fact to be determined on the basis of all the facts and circumstances 399_f2d_603 9th cir aff’g tcmemo_1967_7 employee’s role in the company this factor looks to the overall significance of the employee to the company elliotts inc v commissioner f 2d pincite relevant considerations include the position held by the employee hours worked and duties performed am foundry v commissioner 536_f2d_289 9th cir as well as the general importance of the employee to the success of the company id the fletchers were hands-on owner-operators of torch although torch was only moderately profitable the fletchers explained that they bought the facility for very little cash ie dollar_figure plus assumed_liabilities when the revenues from the facility could not even cover its bills and that within months they had turned it around dr fletcher was the president and overall manager of torch and ms fletcher was the head nurse and was in charge of personnel and resident relations we find this factor weighs in favor of petitioners comparison with salaries paid_by similar companies the next relevant factor is a comparison of the employee’s salary with salaries paid_by similar companies providing similar services elliotts inc v commissioner f 2d pincite 177_f2d_264 9th cir petitioners did not provide the court with any evidence of employees of other companies providing similar services with the exception of ms jakobavich who testified that she has paid herself dollar_figure a year as the owner-operator of hillcrest since however we know nothing of ms jakobavich’s job description duties hours or the profitability of hillcrest respondent presented an expert witness to compare the fletchers’ compensation with nationwide datadollar_figure 12we note that we evaluate expert opinions in the light of each expert’s demonstrated qualifications and all other evidence in the record see 86_tc_547 we are not bound by an expert’s opinion and may accept or reject an expert opinion in full or in part in the exercise of sound judgment see 304_us_282 parker v commissioner t c pincite we may also reach a determination of value based on our own examination of the evidence in the record 538_f2d_927 2d cir aff’g tcmemo_1974_285 combining two of the tables supra we can summarize respondent’s expert’s findings as to the adequacy of dr fletcher’s and ms fletcher’s compensation ms fletcher estimate ms fletcher actual amount under-paid dr fletcher estimate dr fletcher actual amount under- paid dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- -0- -0- -0- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number year big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- -0- -0- -0- -0- - - big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -0- -0- -0- -0- -0- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number for the years for which a -0- appears in the above table petitioners did not supply a form_w-2 the fletchers credibly testified that for the years for which they did not have a form_w-2 from the corporation the corporation did not have sufficient funds to pay them a salary making a form_w-2 unnecessary respondent did not establish that the fletchers received a salary in any of those years and failed to produce any further forms w-2 looking at the above table even respondent’s own expert whom the court found knowledgeable agrees that the fletchers were underpaid in comparison with data from a national surveydollar_figure using the data from this chart respondent’s expert shows that before the years at issue ms fletcher was underpaid by dollar_figure and dr fletcher was underpaid by dollar_figure in the years at issue as we determined above dr fletcher received a total compensation package of dollar_figure and ms fletcher received a total compensation package of dollar_figure for services rendered after subtracting the amounts by which the fletchers were underpaid in prior years as determined by respondent’s expert dr fletcher’s combined compensation_for the years at issue was dollar_figure and ms fletcher’s combined compensation_for the years at issue was dollar_figure respondent’s expert dr newlon used labor rates from the bureau of labor statistics’ occupational employment statistics program to determine the figures represented in the table above that data for through shows that a combined compensation inflated for california wages and assuming full- time employment would be dollar_figure for dr fletcher and dollar_figure for ms fletcherdollar_figure because of the large difference between the actual compensation and 13we note that dr newlon did not account for the time_value_of_money because the fletchers were required to wait for compensation_for prior years their catchup compensation should also have been inflated for the time_value_of_money 14these figures were taken from a table included in dr newlon’s expert report that reported data from the bureau of labor statistics’ occupational continued respondent’s expert’s opinion this factor weighs in favor of finding that the fletchers’ compensation was unreasonable character and condition of the company under this factor we analyze the character and condition of the company focusing on the company’s size complexity net_income and general economic condition elliotts inc v commissioner f 2d pincite first we note that one of the reasons the fletchers determined to pay themselves catchup compensation is that in multiple years the corporation had insufficient cashflow and profit to pay them adequate compensation however the corporation’s profitability is not the only indication of the character and condition of the company in the long-term debt of the corporation was dollar_figure by the long-term debt had been reduced to dollar_figure and the corporation owed dollar_figure in loans from shareholdersdollar_figure had the fletchers chosen to pay themselves higher salaries in years they chose to aggressively pay down the loans the outstanding continued employment statistics program dr newlon did not reach any conclusions for these numbers however she did not believe that the fletchers were each fully employed by the corporation for each of years at issue 15with stated capital of only dollar_figure the corporation was thinly capitalized and some of the loans from shareholders might arguably in substance have been capital respondent has never raised this issue consequently we shall treat the loans as loans debt would have been higher when torch was sold and the fletchers would have made less on the sale also as we noted above torch was only moderately profitable but the fletchers bought the facility when the revenues it generated could not even cover its bills and within months had turned it around although the corporation was not profitable enough to pay the fletchers in some years the fletchers paid down long-term debt and upon purchasing torch managed to make it profitable enough to pay its own bills and to command a substantial price when it was sold therefore we find this factor slightly favors petitioners potential conflicts of interest this factor focuses on any indicia that there may be a conflict of interest id primarily we are concerned whether a relationship exists between the employee and the company that may permit the disguise of nondeductible corporate_distributions as salary expenditures id the fletchers as owner-operators who never received a dividend and who used all of the profits of torch’s sale to pay themselves income undoubtedly had a conflict of interest petitioners’ opening brief agrees that a conflict of interest clearly existed with petitioners’ concession we find that this factor weighs against finding that the compensation the fletchers received was reasonable and deductible under sec_162 internal consistency e vidence of an internal inconsistency in a company’s treatment of payments to employees may indicate that the payments go beyond reasonable_compensation elliotts inc v commissioner f 2d pincite in most of the years before the years at issue the fletchers’ compensation was indeed inconsistent with the payments to other employees but the fletchers discriminated against themselves in years when the corporation experienced cashflow problems or was not profitable they took no or very little salary respondent correctly points out that during the years at issue the fletchers had large salaries however as discussed above we found that the fletchers were paying themselves previously earned compensation_for years in which they were under compensated we find that this factor weights in favor of finding that the compensation the fletchers received was reasonable and deductible under sec_162 additional factor the independent investor while we found supra that the fletchers did intend the compensation as catchup compensation_for prior services rendered paying out compensation packages that deplete the rest of the corporation’s assets denies the corporation’s equity owners a fair return on their capital_investment in elliotts inc v commissioner f 2d pincite the court_of_appeals for the ninth circuit noted that if the bulk of the corporation’s earnings are being paid out in the form of compensation so that the corporate profits after payment of the compensation do not represent a reasonable return on the shareholder’s equity in the corporation then an independent shareholder would probably not approve of the compensation arrangement if however that is not the case and the company’s earnings on equity remain at a level that would satisfy an independent investor there is a strong indication that management is providing compensable services and that profits are not being siphoned out of the company disguised as salary fn ref omitted the fletchers purchased torch for dollar_figure in and the record does not indicate if they paid in any additional amountsdollar_figure a reasonable investor would expect to receive a return on this initial investment and would not approve of a 16the record does not reveal whether the fletchers were personally liable for the loans assumed upon the purchase of torch which would warrant an increased return on the investment and the record does not indicate whether the fletchers contributed additional_amounts to torch during the periods it could not cover its bills because the record is so sparse as to additional paid-in capital we will assume that torch took loans from the shareholders and then repaid them when there was money also as discussed supra note dr fletcher testified that the fletchers paid dollar_figure and assumed the debt obligations when they purchased the corporation however the corporation’s form_1120 page balance_sheet for shows a common_stock balance of dollar_figure and the record does not reveal any stock redemptions we find dr fletcher’s testimony credible that they initially paid dollar_figure for the corporation salary package that entirely depletes the corporation’s assets id return on equity would satisfy independent investor l b pipe supply co v commissioner tcmemo_1994_187 investor would have been happy with either dividend return plus growth in retained earnings or growth in shareholders’ equity as the cases above show the court has found a return on investment of between and tends to indicate compensation was reasonabledollar_figure a return on dollar_figure compounded annually for years is roughly dollar_figure and a return is dollar_figure because torch was a small highly leveraged business purchased with a large amount of debt a hypothetical investor in torch might be satisfied with a return on this investment therefore the corporation should have had dollar_figure left for distribution after payment of the 17we note that in date the prime interest rate was between and and that a 10-year treasury note had a interest rate because of the nature of torch an investor would have expected to earn a higher rate of return than the treasury note 18although as explained in miller sons drywall inc v commissioner tcmemo_2005_114 this court has generally calculated a corporation’s roe return on equity by dividing its net_income after tax for a specific year by its shareholders equity instead of using compound growth rates we find that under the specific facts of these cases using compound growth rates paints a more accurate picture as the table supra page shows the corporation had minimal income in most of the years it was in business and in both and had negative income compensation packages because the compensation packages did not leave enough of the corporation’s assets to be paid back to the hypothetical investor as a return on investment we find that this factor weighs against a finding of reasonable_compensation conclusion after reviewing each factor discussed above we find that the compensation packages the fletchers received as compensation_for the and tax years were unreasonable taking into account the rate of return a reasonable investor would have expected we find that the fletchers were overpaid by a total of dollar_figure a reasonable investor would require at least this amount remain in 19we have found that the corporation should have had on hand dollar_figure to pay the hypothetical investor and the corporation had dollar_figure in retained earnings at the end of the tax_year we disallowed ms strick’s compensation of dollar_figure infra that in substance amounted to a dividend or distribution to shareholders and a gift by them to their daughter which increased the amount the corporation had left on hand therefore the fletchers were overpaid by a total of dollar_figure ie dollar_figure - dollar_figure - dollar_figure dollar_figure the fletchers’ combined total compensation_for the years at issue was dollar_figure dr fletcher’s combined compensation accounted for of that amount and ms fletcher’s accounted for therefore we attribute dollar_figure of the overpayment to dr fletcher and dollar_figure to ms fletcher of dr fletcher’s combined compensation his salary accounted for and the pension_plan contribution accounted for therefore we find that dr fletcher was overpaid in salary by dollar_figure which is not deductible and had a nondeductible pension_plan continued the corporation to be paid out to the investor as a return on the investment we again note that the reasonableness of compensation is a question of fact to be determined on the basis of all the facts and circumstances pacific grains inc v commissioner f 2d pincite iii compensation paid to grace-ann strick respondent contends that the compensation paid to ms strick was not reasonable under sec_162 for the and tax years as discussed supra sec_162 provides a deduction for ordinary and necessary business_expenses including reasonable_compensation for services rendered under the two- prong test the amount of compensation must be reasonable and the payment must be purely for services rendered nor-cal adjusters v commissioner f 2d pincite sec_1_162-7 income_tax regs in date the corporation hired ms strick at dollar_figure per hour the corporation was sold on date and beginning in date the corporation paid ms strick dollar_figure per month continued contribution of dollar_figure of ms fletcher’s combined compensation her salary accounted for and the pension_plan contribution accounted for therefore we find that ms fletcher was overpaid in salary by dollar_figure which is not deductible and had a nondeductible pension_plan contribution of dollar_figure petitioners contend that ms strick was hired to handle third-party vendors and worker’s compensation claims filed by former employees against the corporation petitioners provided documents related to worker’s compensation claims filed by paula muriel and amparo villasenor to substantiate ms strick’s employment ms muriel’s accident occurred on or about date and was settled on or about date as this was before ms strick began working for torch we do not find this evidence substantiates ms strick’s employment petitioners also provided documents related to the claim filed by amparo villasenor mr villasenor was injured on or about date although the file is much more extensive than that of ms muriel and it appears that petitioners hired and paid attorneys through to handle the appeal of the worker’s compensation claim ms strick’s name does not appear on any of the documents and she did not testify at trial to explain what services she provided on the basis of the preponderance_of_the_evidence we find that all of the compensation paid to grace-ann stick was not reasonable under sec_162 for the and tax years and the corporation is not entitled to deduct it iv sec_4972 excise_tax because torch did not file form_5330 return of excise_taxes related to employee benefit plans respondent contends that the corporation is liable for excise_tax of dollar_figure and dollar_figure under sec_4972 for the and tax years respectively sec_4972 imposes a tax on any nondeductible_contributions to qualified_employer plans see 99_tc_379 aff’d in part remanded in part 49_f3d_1410 9th cir because we found supra that a portion of torch’s contributions to the pension_plan was unreasonable_compensation and therefore not deductible under sec_162 and thereby sec_404 the sec_4972 excise_tax applies to that extent v sec_6651 and additions to tax respondent contends that the corporation is liable for sec_6651 failure_to_file additions to tax of dollar_figure and dollar_figure for the and tax years respectively as a general_rule any person made liable for any_tax shall make a return or statement according to the forms and regulations prescribed by the secretary sec_6011 see also citrus valley estates inc v commissioner t c pincite holding sec_6651 is applicable to the failure_to_file a form sec_6651 in the case of a failure_to_file a return on time imposes an addition_to_tax of of the tax required to be shown on the return for each month or fraction thereof for which there is a failure_to_file not to exceed in the aggregatedollar_figure the addition_to_tax will not apply if it is shown that such failure is due to reasonable_cause and not due to willful neglect sec_6651 respondent also contends that the corporation is liable for sec_6651 failure to pay additions to tax of dollar_figure and dollar_figure for the and tax years respectively because the corporation did not pay the excise_tax due to be shown on form_5330 sec_6651 provides for an addition_to_tax of per month up to for failure to pay the amount shown on a return unless it is shown that the failure is due to reasonable_cause and not due to willful neglect petitioners contend that they reasonably relied on the advice of mr storm- larsen that the compensation package was reasonable and therefore deductible thus torch need not file form_5330 they argue that the failure_to_file and failure to pay were due to reasonable_cause and not willful neglect when dr fletcher understood that after the sale of torch they would be paying a large amount of tax he sought mr storm-larsen’s advice mr storm-larsen researched 20the sec_6651 addition_to_tax is reduced by the amount of the sec_6651 addition_to_tax for any month or fraction thereof to which an addition_to_tax applies under both sec_6651 and see sec_6651 catchup compensation and explained to dr fletcher that if he had not been paid reasonable_compensation in the past then he could make an adjustment and pay himself more mr storm-larsen also told dr fletcher that a contribution to the pension_plan was a benefit and that he could pay himself for compensation not previously received mr storm-larsen advised the fletchers that the compensation was reasonable which would therefore not require a form_5330 filing the supreme court of the united_states has explained that courts have frequently held that reasonable_cause is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return even when such advice turned out to have been mistaken 469_us_241 we agree with petitioners that they reasonably relied on the advice of their accountant and torch is not liable for the sec_6651 and additions to tax vi sec_6662 accuracy-related_penalty respondent also contends that petitioners robert a and pearl fletcher are liable for the sec_6662 accuracy-related_penalty for the and tax years and petitioner torch is liable for the sec_6662 accuracy-related_penalty for the and tax years subsection a of sec_6662 imposes an accuracy-related_penalty of of any underpayment that is attributable to causes specified in subsection b respondent asserts that one or both of two causes justify the imposition of the penalty for each year a substantial_understatement_of_income_tax and negligence sec_6662 and there is a substantial_understatement_of_income_tax for any_tax year where in the case of an individual the amount of the understatement exceeds the greater of of the tax required to be shown on the return for the tax_year or dollar_figure sec_6662 in the case of corporations other than s_corporations or personal_holding_companies the amount of the understatement exceeds the greater of of the tax required to be shown on the return for the tax_year or dollar_figure sec_6662 sec_6662 also imposes a penalty for negligence or disregard of the rules or regulations under this section ‘negligence’ includes any failure to make a reasonable attempt to comply with the provisions of this title sec_6662 under caselaw ‘negligence is a lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the circumstances ’ 89_tc_849 quoting marcello v commissioner 380_f2d_499 5th cir aff’g on this issue 43_tc_168 and t c memo aff’d 904_f2d_1011 5th cir aff’d 501_us_868 there is an exception to the sec_6662 penalty when a taxpayer can demonstrate reasonable_cause for the underpayment and that the taxpayer acted in good_faith with respect to the underpayment sec_6664 regulations promulgated under sec_6664 further provide that the determination of reasonable_cause and good_faith is made on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income_tax regs reliance on the advice of a tax professional may but does not necessarily establish reasonable_cause and good_faith for the purpose of avoiding a sec_6662 penalty see boyle u s pincite reliance by a lay person on a lawyer or accountant is of course common but that reliance cannot function as a substitute for compliance with an unambiguous statute the caselaw sets forth the following three requirements in order for a taxpayer to use reliance on a tax professional to avoid liability for a sec_6662 penalty the adviser was a competent professional who 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 115_tc_43 aff’d 299_f3d_221 3d cir see also 425_f3d_1203 n 9th cir quoting and with approval the above three-prong test aff’g 121_tc_89 with respect to the employment plan contributions we find that petitioners actually relied on the advice of their accountant who was a competent professional and that they provided him with the necessary and accurate information therefore petitioners are not liable for the sec_6662 accuracy-related_penalty related to the contributions however as discussed supra we found that the compensation paid to ms strick was not for services actually rendered and therefore not reasonable_compensation we do not find that dr and ms fletcher actually relied on the advice of their accountant with respect to those payments and torch is therefore liable for the sec_6662 accuracy-related_penalty related to those amounts the court has considered all of the parties’ contentions arguments requests and statements to the extent not discussed herein the court concludes that they are meritless moot or irrelevant to reflect the foregoing decisions will be entered under rule


internal_revenue_service index no department of the treasury po box ben franklin station washington dc person to contact telephone number refer reply cc dom-p sl - plr-109810-99 to date sep a f a g t o n t t h k l i o p o o o p q i e i i i o l a b in a letter dated you requested rulings regarding your purchase of oil_and_gas_properties you represented that a a wholly owned entity disregarded for federal tax purposes purchased certain interests in gas producing properties from b c is the investor participant of a and a’s sole beneficary production from the interests is gas produced from devonian_shale and tight formations which are qualified_fuels under sec_29 of the internal_revenue_code_of_1986 as amended a will claim the credit under sec_29 only with respect to production from wells which have been determined to produce qualified_fuel by the applicable regulatory authorities in accordance with the natural_gas policy act of a paid cash equal to d a will also be obligated to pay a contingent promissory note a recourse promissory note and a production_payment retained by b y aly the contingent promissory amount to pay the contingent promissory note is payable each calendar_quarter and is g1 multiplied by the dollar amount of the estimated sec_29 credits attributable to sales of qualified devonian_shale fuels from the subject interests and g2 of the estimated credit attributable to fuels produced from tight formations adjustments are made to the estimated amounts at such times as the actual credit amounts become known the recourse promissory note is for dollar_figurex and bears interest at the rate of y the note is paid out of net_proceeds according to a schedule the note is due and payable on i the production_payment is payable solely out of the gross_proceeds from the sale of hydrocarbons from the subject interests the payments required are essentially equal to the gross_proceeds from the subject interests less the operating_expenses and payments on the recourse promissory note the production_payment will terminate when the production from the subject interests equals f percent of the current at the time of creation of the production_payment estimate of the economically recoverable reserves in the subject interests when the production_payment was created the estimated present_value of the production from the subject interests after the production_payment terminates was greater than of the present_value of the entire production stream from all the subject interests following termination of the production_payment a will be entitled to of the income from production attributable to the subject interests as part of the agreement b has an interest the contingent_interest in any reserves that might exist after production of of the reserves currently estimated to exist b was granted an option to re-acquire the subject interests for fair_market_value the repurchase option is exercisable effective h a has also entered into a management agreement with b’s affiliate the management agreement is typical of those within the industry a entered into a gas purchase agreement with b’s affiliate the rulings requested are a has acquired the entire economic_interest in the properties transferred to it the production_payment is properly characterized as a purchase_money_mortgage loan under sec_636 of the code the recourse promissory note is not an economic_interest in the properties the contingent promissory note is not an economic_interest in the properties any sec_29 credit attributable to production from the properties after their sale to a is attributable to a sec_1_611-1 of the income_tax regulations provides that an economic_interest is possessed in every case in which the taxpayer has acquired by investment any interest in mineral in place and secures by any form of legal relationship income derived from the extraction of the mineral to which the taxpayer must look for a return of the taxpayer’s capital sec_1_614-1 provides that the term_interest means an economic_interest in a mineral deposit within the meaning of sec_1_611-1 the term includes working or operating interests royalties overriding royalties net profits interests and to the extent not treated as loans under sec_636 production payments in 310_us_404 the taxpayer received payments which could be satisfied out of any sale of the fee simple title of the land as well as production of the oil because the taxpayer was not looking solely to the oil production for a return on his investment the court found he did not have an economic_interest sec_636 and sec_1_636-1 provide that a production_payment created and retained upon the transfer of the mineral_property burdened by the production_payment is treated as a purchase_money_mortgage loan on the burdened mineral_property - sec_1_636-3 defines the term production_payment to mean a right to a specified share of the production from mineral in place if as and when produced or the proceeds from the production the right must be an economic_interest in the mineral in place may burden more than one mineral_property and the burdened mineral_property need not be an operating_mineral_interest the right must have an expected economic life at the time of this creation of shorter duration than the economic life of one or more of the burdened mineral properties a right to mineral in place that can be required to be satisfied by other than the it oaas production of mineral from the burdened mineral_property is not an economic_interest in mineral in place a production_payment must be limited by a dollar amount a quantum of mineral or a period of time a right to mineral in place has an economic life of shorter duration than the economic life of a mineral_property burdened thereby ifthe right may not reasonably be expected to extend in substantial amounts over the entire productive life of the mineral_property sec_1_636-1 of the regulations states that the payor and payee shall determine their allowable deductions as if the production_payment were a loan and refers to sec_483 of the code sec_483 in turn refers to sec_1272 through for the treatment of original_issue_discount instruments - sec_29 provides a credit for qualified_fuel as defined in sec_29 sold by the taxpayer to an unrelated_person during the taxable_year the production of which is attributable to the taxpayer a transaction will be classified as a sale_or_exchange of a mineral_interest in cases in which the owner of a continuing property interest assigns that interest and retains a non-continuing interest in production economic_interest that is an interest that is not conterminous with the productive life of the transferred property in this case b will retain a production_payment that is limited to a specified number of units of mineral based on a stated percentage of the reserves currently known to exist at the time the transaction is consummated if additional reserves are found to exist after all reserves currently known to exist have been produced b will acquire a contingent_interest which is a specified percentage of any such additional reserves the production_payment is payable solely from production from the burdened properties and has an economic life of shorter duration than the economic life of the burdened properties because the interest b retained in any additional reserves does not come into being unless and until the additional reserves not at present believed to exist are determined to exist it is not a continuing interest accordingly based on the information submitted and the representations made the production_payment meets the requirements of sec_1_636-3 and is treated as a purchase_money_mortgage loan ‘ the contingent promissory amount is to be paid from sources other than the subject properties having an alternate source_of_income the note cannot be an economic_interest following anderson likewise the recourse promissory note must be paid off on if not already paid off from sources other than the subject properties and thus cannot be an economic_interest based solely on the representations made and the information submitted we conclude that a has acquired the entire economic_interest in the properties transferred to it until and unless b repurchases the property or the contingent_interest arises the production paymeni is properly characterized as a purchase_money_mortgage loan under sec_636 of the code the recourse promissory note is not an economic_interest in the properties the contingent promissory note is not an economic_interest in the properties any sec_29 credit attributable to production from the properties after their sale to a is attributable to a until and unless b repurchases the property or the contingent_interest arises no opinion is expressed or implied regarding the determination of the buyer’s basis in the subject interests no opinion is expressed or implied regarding the determination of amounts attributable to interest or principal pursuant to the non-recourse note or the production_payment except as ruled above we express or imply no opinion as to the federal tax consequences of this transaction under any other provision of the code specifically we express or imply no opinion whether any fuel produced from the properties is qualified_fuel within the mean of sec_29 however we do point out that following true oil company v commissioner of internal revenue no cir date production from any well which lacks a determination by a jurisdictional agency or review of such determination by ferc does not qualify for the credit under sec_29 ath this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this ruling should be attached to your tax_return filed for the year in which the transaction covered by this ruling was consummated a copy is enclosed for this purpose sincerely yours assistant chief_counsel passthroughs and special industries by joseph h makurath senior technician reviewer branch