internal_revenue_service number release date index no department of the treasury p o box ben franklin station washington dc person to contact telephone number refer reply to cc psi -- plr-169431-02 date may taxpayer generator state a state b state c state d state e state f commission division a division b division c entity member legend plr-169431-02 company a company b company c company d company e facility substation a substation b substation c substation d substation e date date date date date date a b c d plr-169431-02 e f g h dear this letter responds to taxpayer’s letter dated date requesting a letter_ruling concerning whether the transfer of interconnection facilities to taxpayer is a nonshareholder contribution_to_capital excludable from taxpayer’s income under sec_118 of the internal_revenue_code taxpayer represents that the facts are as follows facts taxpayer is a corporation organized under the laws of state a and is subject_to regulation by commission taxpayer is under the audit jurisdiction of division a generator an entity under the audit jurisdiction of division b is a not-for-profit power supply cooperative formed to provide wholesale electric services to its members on a cost effective basis generator’s members include a customer-owned electric distribution cooperatives that sell electric services to retail customers in portions of state b state c and state d power is provided to the member distribution cooperatives pursuant to long-term all-requirements wholesale power contracts which obligate generator to supply and the member distribution cooperatives to purchase all of their capacity and energy requirements under the wholesale power contracts generator is responsible for transmitting energy to its member distribution cooperatives those transmission costs along with all of generator’s cost of purchasing or generating power are paid_by the member distribution cooperatives under their respective wholesale power contracts generator also sells power to member member which is not a distribution cooperative was formed by the member distribution cooperatives among other business reasons to help reduce the member distribution cooperatives’ power costs by selling to the open market any power generated by generator that is in excess of the member distribution cooperatives’ needs company a is a state b limited_liability_company whose sole member is generator company a is treated as a disregarded_entity and as a division of generator for federal_income_tax purposes generator created company a to accommodate certain business and financing objectives during the development of plr-169431-02 facility generator currently anticipates that at some time during the next b months company a will be liquidated and all of its interest in facility will be transferred to generator company b a state d corporation is under the audit jurisdiction of division c company b is a wholly owned subsidiary of company c which is engaged in the production and sale of energy company a and company b are jointly developing facility to produce electricity for resale as an exempt wholesale generator company b will sell the energy generated by its interest in facility exclusively into the wholesale electric market title to the energy produced by company b’s interest in facility will pass at facility’s busbar to the purchaser of such energy as currently structured company a will be an exempt wholesale generator which will enter into a wholesale power purchase contract obligating it to sell all of its energy to generator under this arrangement title to the energy will pass to generator at facility’s busbar generator is participating in the construction of facility principally to provide electric capacity and related energy to its member distribution cooperatives however there will be times when the energy produced by generator’s interest in facility exceeds the energy required by the member distribution cooperatives and this excess will by sold to member member will then sell that energy on the open market if company a’s interest in facility is eventually transferred directly to generator then generator will sell its interest in energy generated by facility which exceeds the member distribution cooperatives’ needs to member title to the energy sold by member will pass at facility’s busbar to the purchaser bare_legal_title to the energy sold by generator to its member distribution cooperatives will pass at the respective distribution points however under the various wholesale power contracts the member distribution cooperatives incur all the risks and costs of transmitting the energy produced at facility based on the burdens and benefits of ownership it is represented that ownership of the transmitted power will pass to the member distribution cooperatives prior to transmission on the grid the property where facility is located currently has electric service and the system upgrades are not needed to provide electric service to facility it is anticipated that electricity provided to facility will be from a combination of self-generation company d and the company e spot market facility will be generating for resale a far greater amount of energy than the amount of energy that it will be purchasing to run facility projections indicate that during the first ten taxable years the energy that facility will receive from company d and the company e spot market will equal less than of the total energy generated by facility in no event will facility purchase energy from taxpayer energy generated by facility must be transmitted to consumers over plr-169431-02 transmission assets operated and owned by other public_utilities under the federal energy regulatory commission ferc policy of open access the owners of transmission assets must transmit energy pursuant to cost-based rates regardless of where it is produced or by whom it is purchased facility is located in an area served by a system of interrelated transmission assets known as the company e transmission grid which is operated and controlled by company e company e is a regional transmission organization and an independent system operator subject_to regulatory jurisdiction by ferc under the federal power act company e is responsible for operation and control of the bulk electric power transmission system in all or portions of state a state b state c state d state e and state f transmission charges are generally paid to company e by the purchaser of the energy not the generator for the transmission of purchased energy across the company e transmission grid the basis for these transmission charges are controlled by the company e open access transmission tariff oatt filed with ferc under the oatt transmission customers generally are charged a basic transmission rate that allows company e to reimburse transmission asset owners for their investment in transmission assets the developers of new generating facilities such as facility must bear all costs related to upgrades or new_construction of transmission assets needed to interconnect the new generating facility to the company e transmission grid the members of company e are public_utilities that own transmission assets that interconnect with each other to create the company e transmission grid although company e is responsible for operation and control of the company e transmission grid and the provision of transmission services across the company e transmission grid the members of company e still retain title to their transmission assets each member of company e is compensated for_the_use_of its transmission assets by company e in accordance with a cost of service rate tariff filed with ferc additionally title to all system upgrades remains with the public_utility that owns the underlying transmission assets not company e or the new generating facility that is paying for the system upgrades in accordance with the oatt and to evidence company a and company b the joint owners and company e’s respective rights and obligations under the oatt the joint owners and company e have entered into an interconnection service agreement the isa dated date which authorizes the construction of facilities for the purpose of connecting facility to the company e transmission grid taxpayer is a member of company e and is one of the company e transmission asset owners with interconnected transmission and distribution facilities in southeastern state a northeastern state c and elsewhere the taxpayer transmission system the isa provides that as a condition to interconnecting to the company e transmission grid the joint owners must pay for the system upgrades company e has determined that system upgrades must be made to the taxpayer transmission plr-169431-02 system among others to accommodate the electric output of facility the joint owners executed an interconnection agreement the ia with taxpayer effective date and filed with ferc on date pursuant to article of the ia it will remain in full force and effect from the date it is executed until or unless terminated in connection with the ia the joint owners and taxpayer have negotiated three construction agreements the joint owners have appointed generator as their construction agent in its role as construction agent generator entered into the construction agreements these agreements provide for the construction of new facilities or modifications to existing facilities within the taxpayer transmission system which are necessary for facility to interconnect with the company e transmission grid the first construction agreement dated date relates to the construction and modification of facilities at the portion of the taxpayer transmission system known as substation a this agreement provides for the replacement of c circuit breakers as well as modification to d other circuit breakers the initial estimate of costs for the portion of the construction and or modifications made pursuant to this agreement was dollar_figuree the second construction agreement dated date also relates to facilities at substation a this agreement provides for line modifications to an existing right of way to provide for a connection for facility to the company e transmission grid the initial estimate of costs for the modifications made pursuant to this agreement was dollar_figuref the third construction agreement the original of which was effective and filed with ferc on date has subsequently been amended the amended version as of yet has not been filed with ferc this agreement relates to the construction of facilities at substation b substation c substation d and substation e this agreement contemplates the replacement of a total of g circuit breakers at the substations the estimate of costs for the construction performed pursuant to this agreement was dollar_figureh the terms of the construction agreements are all substantially_similar except for provisions in the second agreement relating to certain facilities to be constructed and owned by the joint owners pursuant to the construction agreements at the sole cost of the joint owners taxpayer is responsible for the design purchase construction and installation of the various facilities taxpayer is also responsible for obtaining all permits licenses or approvals necessary to construct purchase install own operate and maintain the facilities the costs and expenses associated with such permits licenses or approvals are to be paid_by the joint owners article of each of the construction agreements provides that the joint owners shall be responsible for all costs including any applicable tax gross-up that taxpayer actually incurs in performing its obligations under the construction agreements taxpayer is required to provide the joint owners with invoices based on estimates of plr-169431-02 anticipated costs and the joint owners are required to prepay the estimated costs the payments from the joint owners to taxpayer are to be made quarterly and are to correlate with the work to be performed by taxpayer in the subsequent three months although the joint owners will pay all costs of construction and installation of the facilities taxpayer will hold the legal_title to them however taxpayer will not include the facilities or costs in its rate base in determining the rates charged for use of its transmission assets including rates charged to company e ruling requested taxpayer requests the service to rule that the transfer by the joint owners to taxpayer of the interconnection facilities is not a contribution_in_aid_of_construction ciac under sec_118 and is excludable from taxpayer’s gross_income as a nonshareholder contribution_to_capital under sec_118 law and analysis sec_61 and sec_1_61-1 of the income_tax regulations provide that gross_income means all income from whatever source derived unless excluded by law sec_118 provides that in the case of a corporation gross_income does not include any contribution_to_the_capital_of_the_taxpayer sec_118 as amended by a of the tax_reform_act_of_1986 the act and a of the small_business job protection act of provides that for purposes of subsection a except as provided in subsection c the term contribution_to_the_capital_of_the_taxpayer does not include any ciac or any other contribution as a customer or potential customer sec_1_118-1 of the income_tax regulations provides in part that sec_118 also applies to contributions to capital made by persons other than shareholders for example the exclusion applies to the value of land or other_property contributed to a corporation by a governmental_unit or by a civic group for the purpose of enabling the corporation to expand its operating facilities however the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered or to subsidies paid to induce the taxpayer to limit production the legislative_history to sec_118 indicates that the exclusion_from_gross_income for nonshareholder contributions to capital of a corporation was intended to apply to those contributions that are neither gifts because the contributor expects to derive indirect benefits nor payments for future services because the anticipated future_benefits are too intangible the legislative_history also indicates that the provision was intended to codify the existing law that had developed through administrative and court decisions on the subject h_r rep no 83rd cong 2d sess s rep no 83d cong 2d sess plr-169431-02 notice_88_129 1988_2_cb_541 as modified and amended by notice_90_60 1990_2_cb_345 and notice_2001_82 2001_2_cb_619 provides specific guidance with respect to the treatment of transfers of property to regulated public_utilities by qualifying small power producers and qualifying cogenerators collectively qualifying facilities as defined in sec_3 of the federal power act as amended by section of purpa the amendment of sec_118 by the act was intended to require utilities to include in income the value of any ciac made to encourage the provision of services by a utility to a customer see h_r rep no 99th cong 2d sess conference_report in a ciac transaction the purpose of the contribution of property to the utility is to facilitate the sale of power by the utility to a customer in contrast the purpose of the contribution by a qualifying_facility to a utility is to permit the sale of power by the qualifying_facility to the utility accordingly the fact that the amendments to sec_118 render ciac transactions taxable to the utility does not require a similar conclusion with respect to transfers from qualifying facilities to utilities notice_88_129 provides in part that with respect to transfers made by a qualifying_facility to a utility exclusively in connection with the sale of electricity by the qualifying_facility to the utility a utility will not realize income upon transfer of an intertie by a qualifying_facility an intertie may include new connecting and transmission facilities or modifications upgrades or relocations of a utility’s existing transmission network the possibility that an intertie may be used to transmit power to a utility that will in turn transmit the power across its transmission network for sale by the qualifying_facility to another utility wheeling will not cause the contribution to be treated as a ciac further the notice provides in part that a transfer from a qualifying_facility to a utility will not be treated as a qualifying_facility transfer qf transfer under this notice to the extent the intertie is included in the utility’s rate base moreover a transfer of an intertie to a utility will not be treated as a qf transfer under this notice if the term of the power purchase contract is less than ten years notice_88_129 also provides in part that a utility that constructs an intertie in exchange for a cash payment from a qualifying_facility pursuant to a purpa contract will be deemed to construct the property under contract and will recognize income from the construction in the same manner as any other taxpayer constructing similar_property under contract subsequent to the construction of the property the qualifying_facility will be deemed to transfer the property to the utility in a qf transfer that will be treated in exactly the same manner as an in-kind qf transfer notice_2001_82 amplifies and modifies notice_88_129 notice_2001_82 extends the safe_harbor provisions of notice_88_129 to include transfers of interties from non- qualifying facilities and transfers of interties used exclusively or in part to transmit power over the utility’s transmission grid for sale to consumers or intermediaries plr-169431-02 wheeling the notice requires that ownership of the electricity wheeled passes to the purchaser prior to its transmission on the utility’s transmission grid this ownership requirement is deemed satisfied if title passes at the busbar on the generator’s end of the intertie further notice_2001_82 provides that a long-term interconnection agreement in lieu of a long-term power purchase contract may be used to satisfy the safe_harbor provisions of notice_88_129 in wheeling transactions finally notice_2001_82 requires that the generator must capitalize the cost of the property transferred as an intangible asset and recovered using the straight-line method over a useful_life of years in the instant case the transfer of the interconnection facilities is subject_to the guidance set forth in notice_88_129 notice_90_60 and notice_2001_82 for the following reasons facility is a stand-alone generator as contemplated under notice_2001_82 the joint owners and taxpayer have entered into a long-term interconnection agreement the interconnection facilities will be used in connection with the transmission of electricity for sale to the member distribution cooperatives member or third parties wheeling the cost of the interconnection facilities will not be included in taxpayer’s rate base based on all available information during the ten taxable years beginning with the year in which facility is placed_in_service no more than percent of the total power flows over the interconnection facilities will flow to the joint owners ownership of the electricity wheeled passes to the purchaser prior to its transmission on the company e transmission grid and the cost of the interconnection facilities will be capitalized by the joint owners as an intangible asset and recovered using the straight-line method over a useful_life of years thus we conclude that the deemed contribution of the interconnection facilities by the joint owners to taxpayer meets the safe_harbor requirements of notice_88_129 as amended and modified by notice_90_60 and notice_2001_82 next we must decide whether the transfer qualifies as a contribution_to_capital under sec_118 the legislative_history of sec_118 provides in part as follows this sec_118 in effect places in the code the court decisions on the subject it deals with cases where a contribution is made to a corporation by a governmental_unit chamber of commerce or other association of individuals having no proprietary interest in the corporation in many such cases because the contributor expects to derive indirect benefits the contribution cannot be called a gift yet the anticipated future_benefits may also be so intangible as to not warrant treating the treating the contribution as a payment for future services s rep no 83d cong 2d sess in 319_us_98 the court held that payments by prospective customers to an electric utility company to cover the cost of plr-169431-02 extending the utility’s facilities to their homes were part of the price of service rather than contributions to capital the case concerned customers’ payments to a utility company for the estimated cost of constructing service facilities primary power lines that the utility company otherwise was not obligated to provide the customers intended no contribution to the company’s capital later in 339_us_583 the court held that money and property contributions by community groups to induce a shoe company to locate or expand its factory operations in the contributing communities were nonshareholder contributions to capital the court reasoned that when the motivation of the contributors is to benefit the community at large and the contributors do not anticipate any direct benefit from their contributions the contributions are nonshareholder contributions to capital id pincite finally in 412_us_401 the court in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government held that the governmental subsidies were not contributions to the taxpayer’s capital the court recognized that the holding in detroit edison co had been qualified by its decision in brown shoe co the court in chicago burlington quincy railroad co found that the distinguishing characteristic between those two cases was the differing purpose motivating the respective transfers in brown shoe co the only expectation of the contributors was that such contributions might prove advantageous to the community at large thus in brown shoe co since the transfers were made with the purpose not of receiving direct services or recompense but only of obtaining advantage for the general community the result was a contribution_to_capital the court in chicago burlington quincy railroad co also stated that there were other characteristics of a nonshareholder contribution_to_capital implicit in detroit edison co and brown shoe co from these two cases the court distilled some of the characteristics of a nonshareholder contribution_to_capital under both the and codes first the payment must become a permanent part of the transferee’s working_capital structure second it may not be compensation such as a direct payment for a specific quantifiable service provided for the transferor by the transferee third it must be bargained for fourth the asset transferred foreseeably must benefit the transferee in an amount commensurate with its value fifth the asset ordinarily if not always will be employed in or contribute to the production of additional income and its value assured in that respect chicago burlington quincy railroad co u s pincite the proposed transfer of the interconnection facilities by generator and the joint owners to taxpayer possesses the characteristics of a nonshareholder contribution_to_capital as described in chicago burlington quincy railroad co first the interconnection facilities will become a permanent part of the taxpayer transmission system second the transfer is not compensation_for services provided for the joint owners by taxpayer third the transfer is a bargained-for exchange because taxpayer the joint owners entered into the necessary agreements willingly and at plr-169431-02 arm’s length fourth the transfer will foreseeably result in a benefit to taxpayer commensurate with its value because the interconnection facilities will become a part of the taxpayer transmission system fifth the interconnection facilities will be used by taxpayer in its trade_or_business for producing gross_income therefore taxpayer’s receipt from the joint owners of the interconnection facilities will be a contribution_to_capital under sec_118 accordingly based solely on the foregoing analysis and the representations made by taxpayer and the joint owners we rule that the transfer of the interconnection facilities by the joint owners to taxpayer will not be a ciac under sec_118 and will be excludable from the gross_income of taxpayer as a nonshareholder contribution_to_capital under sec_118 except as specifically set forth above no opinion is expressed or implied concerning the federal_income_tax consequences of the above described facts under any other provision of the code or regulations specifically no opinion is expressed or implied as to whether taxpayer’s representation that less than percent of the total projected power flows over the interconnection facilities from taxpayer to facility is a reasonable projection for purposes of the five-percent test in notice_88_129 in addition no opinion is expressed or implied as to whether the member distribution cooperatives have the requisite benefits_and_burdens_of_ownership to the power prior to its transmission on the grid 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 sincerely walter h woo senior technician reviewer branch office of associate chief_counsel passthroughs and special industries enclosure copy cc


internal_revenue_service p o box cincinnati oh release number release date date date legend c dollars amount d dollars amount dear department of the treasury employer_identification_number contact person - id number contact telephone number uil you asked for advance approval of your scholarship grant procedures under internal_revenue_code sec_4945 this approval is required because you are a private_foundation that is exempt from federal_income_tax you requested approval of your scholarship program to fund the education of certain qualifying students our determination we approved your procedures for awarding scholarships based on the information you submitted and assuming you will conduct your program as proposed we determined that your procedures for awarding scholarships meet the requirements of code sec_4945 as a result expenditures you make under these procedures won't be taxable also awards made under these procedures are scholarship or fellowship grants and are not taxable to the recipients if they use them for qualified_tuition_and_related_expenses subject_to the limitations provide in code sec_117 description of your request your letter indicates you will operate a scholarship program the purpose of which is to provide grants to individuals to enable students to reach the educational attainment of a diploma or degree of their choice you will offer scholarship benefits and student aid to high school technical college college or graduate school students to enable the recipients to complete high school to complete technical or community college certificate-granting programs or to obtain bachelor’s or advanced degrees letter catalog number 58263t an applicant must meet one or more of the following criteria a show sufficient academic ability including without limitation as demonstrated by prior academic performance or performance on tests designed to measure ability and aptitude to enable him or her to complete courses of study necessary to graduate from the educational_institution selected by him or her and which will admit him or her as a student or b have such character good citizenship and motivation to obtain an education for a field in which he or she may be expected to work hard and seriously to continue and complete his or her education or c exhibit clear need for financial assistance to enable him or her to complete his or her course of studies and can demonstrate such fact by information submitted with the application determinations of financial need will be based upon all pertinent factors with respect to the student's ability to complete his or her higher education without assistance determinations with respect to academic ability and character will be based upon such ’ facts which are deemed pertinent by your grant selection committee and may include transcripts and recommendations of an applicant's high school or college advisor teachers or mentors all individual grants will be processed and awarded on an objective and non-discriminatory basis grants will generally range from c dollars to d dollars individually per year the individual scholarship sizes may fluctuate over time depending upon the availability of funds and the applicant’s need scholarship funds may only be used for a b tuition and fees required for enrollment or attendance of the student at a qualifying institution fees books supplies and equipment required for courses of instruction at such an educational_institution and c room and board you intend to establish a website where publication advertisement and solicitation for applications will occur the website will be established before informing anyone of possible grants with full opportunity at least days notice to submit a request for a grant each grantee must provide you with proof of use of funds received in the appropriate manner such as a receipt or letter from the educational_institution affirming appropriate use of the funds you will award scholarships and grants annually and they may be letter catalog number 58263t renewed annually provided that a student is in good academic and disciplinary standing and is progressing satisfactorily towards completion of a graduate or post-graduate degree with progress to a minimum of a grade b average or the equivalent grade reports shall be sent from the grantee student to you when so provided to the grantee student by the school in which they attend whether quarterly or annually your board_of directors will serve on the grant selection committee which may but is not required to have additional members additional individuals may apply to serve on the grant selection committee with approval of the current committee members such approval shall be based upon experience as an educator or equivalent experiences in the wholesome development of young people to become successful citizens who graduate from schools and or colleges the grant selection committee shall have at least three members at all times and the chairman of the committee shall be a member of your board_of directors upon completion of the purpose for which the grant was awarded you will review grantee reports annually ensure that the funds were used for their intended purpose and take all reasonable and appropriate steps to recover any funds that are not used for their intended purpose if it is found that any funds were used for any purpose other than their intended purpose you will withhold further payments to grantees until you obtain grantees’ assurances that future diversions will not occur and that grantees will take all necessary precautions to prevent future diversions from occurring you will maintain all records relating to individual grants including information obtained to evaluate recipients identify whether a recipient is a disqualified_person establish the amount and purpose of each grant and provide evidence that you supervised the use of the grants basis for our determination the law imposes certain excise_taxes on the taxable_expenditures of private_foundations code sec_4945 a taxable_expenditure is any amount a private_foundation pays as a grant to an individual for travel study or other similar purposes however a grant that meets all of the following requirements of code sec_4945 is not a taxable_expenditure e other conditions that apply to this determination the foundation awards the grant on an objective and nondiscriminatory basis the irs approves in advance the procedure for awarding the grant the grant is a scholarship or fellowship subject_to the provisions of code sec_117 the grant is to be used for study at an educational_organization described in code sec_170 this determination only covers the grant program described above this approval will apply to succeeding grant programs only if their standards and procedures don't differ significantly from those described in your original request letter catalog number 58263t e this determination applies only to you it may not be cited as a precedent you cannot rely on the conclusions in this letter if the facts you provided have changed substantially you must report any significant changes to your program to the cincinnati office of exempt_organizations at internal_revenue_service exempt_organizations determinations p o box cincinnati oh you cannot award grants to your creators officers directors trustees foundation managers or members of selection committees or their relatives all funds distributed to individuals must be made on a charitable basis and further the purposes of your organization you cannot award grants for a purpose that is inconsistent with code sec_170 you should keep adequate_records and case histories so that you can substantiate your grant distributions with the irs if necessary please keep a copy of this letter in your records if you have questions please contact the person listed at the top of this letter sincerely jeffrey cooper director exempt_organizations rulings and agreements letter catalog number 58263t


u ll date deg department of the treasury internal_revenue_service washington d c contact person id number telephone number ceo legend employer_identification_number i l i i w dear sir or madam this is in response to a ruling_request dated date and supplemented date both the original ruling_request and the supplemental information were submitted on your behalf by your authorized representatives you are seeking rulings on the federal_income_tax consequences of a proposed transaction as more fully set forth below x is a for-profit corporation which is not itself engaged in an active trade_or_business x is a majority member of a limited_liability_company that does engage in the active_conduct_of_a_trade_or_business x is a substantial_contributor to y and as such is a disqualified_person with respect to y pursuant to sec_4946 of the internal_revenue_code y is a non-profit corporation that has been recognized as exempt from federal_income_tax under sec_501 of the code and as a private_foundation described in sec_509 y makes grants in accordance with its charitable purpose and targets though not exclusively programs relating to certain areas of health care children's issues quality of life self-sufficiency culture and arts x has recently pledged to y an option to purchase shares of x common_stock at an option_price representing the fair_market_value of the common_stock as determined by x’s board_of directors on the date x pledged the option the option is exercisable in whole or in part at any time and from time to time during the period specified in the stock_option pledge agreement y may transfer and assign the option or any portion thereof only to one or more unrelated charitable organizations described in sec_170 and sec_501 of the code a permitted transferee you have represented that an unrelated charitable_organization means a charitable_organization that is not controlled by y and is not controlled by dy any person or entity that is a disqualified_person as defined in code sec_4946 with respect to y a permitted transferee may not transfer or assign the option or any portion thereof without the written conseni of x generally the option is exercisable in whole or in part and from time to time by a written notice of exercise delivered to x payment of the purchase_price of any shares with respect to which the option will be exercised generally will be by certified or bank cashier’s or teller’s check or wire transfer and will be delivered with the notice of exercise upon exercise of the option the certificate or certificates for shares of common_stock as to which the option was exercised will be registered in the name of the person or persons exercising the option in addition the option agreement provides a cashless exercise procedure a net exercise in which no consideration is paid to x by the holder of the option under the net exercise procedure y may elect to receive ail or some of the option shares of common_stock equal to the value of the amount of the option being exercised on the date of the exercise if y were to elect the net exercise procedure y would notify x of the amount of the option being exercised along with written notice of y’s election to utilize the net exercise procedure and x would issue to y the number of shares of the common_stock computed using the formula specified in the stock_option pledge agreement it is expected that y will collect the option piedge in two parts with respect to a portion of the option will utilize the net exercise procedures to effect a transfer of common_stock from xin satisfaction of its pledge obligation for the second portion it would be expected that y will transfer the option to an unrelated permitted transferee and that the permitted transferee will pay to y a price for the option equal to the difference between the fair_market_value of the common_stock subject_to the option on the date of the transfer and the exercise price of the option less an agreed upon discount it is represented that these terms will be negotiated at arms-length it is further expected that the permitted transferee will thereafter exercise the option prior to its expiration the relative size of each of the separately exercised options will depend on several factors including whether there is a public market for x's stock and whether x’s stock issued pursuant to the exercise of the option would be restricted_stock under state and federal securities it is further represented that the business_purpose of the pledge of the option is to further the charitable purposes of y and other charitable organizations sec_4941 a of the code imposes a tax on each act of self-dealing between a disqualified_person and a private_foundation sec_4941 of the code provides that the term self-dealing includes any lending of money or other extension of credit between a private_foundation and a disqualified_person sec_53 d -2 c of the foundation and similar excise_taxes regulations provides that the making of a promise pledge or similar arrangement to a private_foundation by a disqualified_person whether evidenced by an oral or written_agreement a promissory note or other instrument of indebtedness to the extent motivated by charitable intent and unsupported by consideration is not an extension of credit within the meaning of this paragraph before the date of maturity sec_53_4941_d_-1 of the regulations provides that the term indirect self-dealing includes any transaction between a disqualified_person and an organization controlled by a private_foundation within the meaning of sec_53 d -1 b sec_53 d -1 b of the regulations provides for purposes relative to acts of indirect self-dealing under sec_4941 of the code two basic tests for determining whether an organization is controlled by a private_foundation there is control if the foundation or one of its foundation managers acting only in such capacity may only by aggregating their votes or positions of authority require the organization to engage in a transaction which if engaged in with the private_foundation would constitute seif-dealing or in the case of a transaction between the organization and a disqualified_person if such disqualified_person together with one or more persons who are disqualified persons by reason of such a person's relationship within the meaning of sec_4946 through g to such disqualified_person may only by aggregating their votes or positions of authority with that of the private_foundation require the organization to engage in such a transaction the regulation also provides that an organization will be considered to be controlled by a private_foundation or by a private_foundation and disqualified persons if such persons are able in fact to control the organization even if their aggregate voting power is less than percent of the total voting power of the organization's governing body or if one or more of such persons has the right to exercise veto power over the actions of such organization relevant to any potential acts of self-dealing sec_4942 of the code imposes a tax on the undistributed_income_of_a_private_foundation the undistributed_income is defined in part as the amount by which qualified distributions are less than a minimum_investment_return of five percent of the aggregate fair_market_value of all assets of the foundation other than specifically excluded assets sec_53_4942_a_-2 of the regulations further explains the computation of the minimum_investment_return sec_53_4942_a_-2 of the regulations state that any pledge to the foundation of money or property whether or not the pledge may be legally enforced is not to be included in determining the minimum_investment_return sec_4946 a of the code defines disqualified_person for purposes of chapter sec_53_4946-1 of the regulations provides that for purposes of sec_4944 only the term disqualified_person shall not include any organization which is described in sec_501 other than an organization described in sec_509 sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations described in sec_501 of the code sec_512 of the code defines unrelated_business_taxable_income as the gross_income earned by an organization from an unrelated_trade_or_business which is regularly carried on less applicable deductions sec_512 of the code excludes from unrelated_business_taxable_income gains or losses from the sale exchange or other_disposition of property other than a stock_in_trade or other_property of a kind which would property be includible in inventory if on hand at the close of the taxable_year or b property_held_primarily_for_sale to customers in the ordinary course of the trade_or_business in 755_f2d_404 sth cir the court held that gain from the sale of timberland was excluded from the computation of an organization's capital_gain net 2b income the court stated that property that produces capital_gain through appreciation is not an independent category of property whose disposition will be taxable and that the regulations to the extent that they imply it is are invalid because they exceed the scope of the code provisions because the pledge of the option was given without any consideration for the purpose of furthering the charitable purposes of y and other unrelated charitable organizations the pledge of the option by x to y does not constitute an act of self dealing between x and y regs d -2 c x’s pledge of the option to y was entirely gratuitous and unsupported by consideration such pledges are not extensions of credit pursuant to sec_53 d -2 c of the regulations x pledged the option and will satisfy the option with common_stock equal in value to the pledged option because the pledged option was given gratuitously the substitution of common_stock in satisfaction of the pledged option before the due_date will not result in a self-dealing sale_or_exchange of property between y and x thus y’s use of the net exercise provisions to collect x’s pledge obligation will not result in a self-dealing sale_or_exchange of property between y and x the transfer of the option by y to a permitted transferee will not be an act of self-dealing since the cancellation of the enforceable pledge will be for consideration paid_by a non-disqualified person or an entity not controlled by a disqualified_person the consideration will be an amount equal to the difference between the fair_market_value of the stock subject_to the option on the date of the transfer less an agreed upon discount since you have represented that the permitted transferee will not be controlled by y as defined in sec_53 d -1 b of the regulations the exercise of the pledged stock_option by the permitted transferee will not constitute an act of self-dealing between y and a disqualified_person the option will be excluded from the assets taken into account in computing the amount of the minimum_investment_return of y for purposes of determining the tax on failure to distribute income under sec_4942 of the code since sec_53_4942_a_-2 of the regulations provides that pledges of property are not included in computing the minimum_investment_return as concluded in zemurray foundation v u s cited above the tax on capital_gain through appreciation applies only to non-charitable assets susceptible to use to produce interest dividends rents and royalties stock_options are not such assets accordingly y's proceeds from the sale of the option to a permitted transferee would be excluded from the computation of y's net_investment_income under sec_4940 of the code because y will not hold the option either as stock_in_trade inventory or for sale in the ordinary course of business the gain on the sale of the option will be excluded from the computation of unrelated_business_taxable_income gain on the sale of the option by y to a permitted transferee will not produce any unrelated_business_taxable_income because the sale comes within the exclusion under sec_512 of the code the exceptions to the exclusion do not apply because y does not resemble a merchant who acquires or produces property to sell to customers furthermore y's receipt of common_stock pursuant to the net exercise of the option is simply the collection of a pledge obligation that will not create unrelated_business_income under sec_512 of the code based on the information submitted and the representations made therein we rule as follows the pledge of the option by x to y does not constitute an act of self-dealing between a private_foundation and a disqualified_person under the provisions of sec_4941 of the code the exercise of the option by y pursuant to the net exercise procedures will not constitute an act of self-dealing between y and a disqualified_person under sec_4941 of the code the exercise of the option by an unrelated charitable_organization to whom the option will be transferred will not constitute an act of self-dealing between y and a disqualified_person under sec_4941 of the code we have referred your fourth ruling_request which concerned sec_170 of the cade to the office of the associate chief_counsel domestic income_tax and accounting for consideration they will respond directly to you the option will be excluded from the assets taken into account in computing the amount of the minimum_investment_return of y for purposes of determining the tax on failure to distribute income under sec_4942 of the code y's receipt of common_stock pursuant to the net exercise procedures will be excluded from the computation of y's net_investment_income under sec_4940 of the code y's proceeds from the sale of the option to an unrelated organization exempt under sec_501 of the code are excluded from the computation of y's net_investment_income under sec_4940 of the code y’s receipt of common_stock pursuant to the net exercise procedures will not be subject_to the tax on unrelated_business_taxable_income imposed by sec_511 of the code gain on y's sale of the option to unrelated sec_501 c organizations will not be subject_to the tax on unrelated_business_taxable_income imposed by sec_511 of the code these rulings are based on the understanding that there will be no material changes in the facts upon which they are based o these rulings do not purport to rule under any other chapter provision or any other provisions of the code these rulings are directed only to the organization that requested them sec_6110 of the internal_revenue_code provides that they may not be used or cited by others as precedent please keep a copy of this ruling letter in your permanent records sincerely robert c harper jr manager exempt_organizations technical group


t c memo united_states tax_court philip h and anna friedman petitioners v commissioner of internal revenue respondent1 docket no filed date jay j freireich harvey r poe and gerald s rotunda for petitioners susan g lewis albert g kobylarz and guy g lavignera for respondent supplemental memorandum findings_of_fact and opinion gerber judge this case has been the subject of three prior opinions of this court the last of which held that anna this opinion supplements a previously released opinion friedman v commissioner tcmemo_1993_549 97_tc_606 concerning continued friedman petitioner was not an innocent spouse within the meaning of sec_6013 the decision entered following the third opinion was affirmed in part and reversed in part and the case was remanded to this court for further proceedings friedman v commissioner tcmemo_1993_549 affd in part and revd in part 53_f3d_523 2d cir to qualify for innocent spouse relief a taxpayer must meet all four of the requirements of sec_6013 we found that petitioner had shown that she filed a joint_return and that a certain tax_shelter investment constituted a grossly erroneous item within the meaning of sec_6013 however we found that petitioner did not qualify for relief because she failed to meet the third requirement ie the requirement that she did not know and did not have reason to know that the deduction would give rise to a substantial_understatement having reached that conclusion we did not consider whether petitioner met the fourth continued whether grossly_erroneous_items could have been contained on a refund claim form_1045 rather than on the form_1040 within the meaning of sec_6013 friedman v commissioner tcmemo_1992_89 concerning whether the testimony of an expert witness could be offered to show whether one of petitioners was a truthful witness and friedman v commissioner tcmemo_1993_549 which concerned whether anna friedman was an innocent spouse within the meaning of sec_6013 all section references are to the internal_revenue_code in effect for the taxable_period under consideration and all rule references are to this court's rules_of_practice and procedure unless otherwise indicated test ie whether under the circumstances it would be inequitable to hold her jointly liable for the deficiencies the u s court_of_appeals for the second circuit reversed our holding that petitioner failed the third or knowledge test as to the tax_shelter_item only and remanded the matter to this court to find additional facts if necessary and to decide whether petitioner has shown that under the circumstances it would be inequitable to hold her jointly liable for the deficiencies findings of fact4 petitioner met philip friedman in when she was hired as his secretary they were married in the year that philip obtained a divorce from his prior wife in the course of that divorce philip gave almost everything he owned to his first wife petitioner was a young widow with two small children and depleted savings at the time of her first husband's death petitioner had only a few assets when she married philip including a cooperative residence and an automobile when petitioners were first married they lived in a rented apartment in new york new york with petitioner's two daughters by this reference the facts found in friedman v commissioner tcmemo_1993_549 are incorporated to the extent that they are in accord with the opinion of the u s court_of_appeals for the second circuit which affirmed in part and reversed in part our decision we repeat some of these findings here as relevant to the issue now before us the parties have agreed that we may proceed to find facts and decide this matter on remand based on the existing record and the briefs that have been filed in this court by the parties who were and years old at that time petitioner and philip were splitting their time between the new york apartment and an apartment in north miami beach florida the new york apartment was in a building with a doorman and a beautiful lobby the florida apartment was a two-bedroom unit in petitioners bought a condominium condo in bayside queens new york because they thought it would be a better environment in which to raise children the condo was a three-bedroom two-bathroom nicely furnished unit one of the bedrooms was converted into an office for philip the condo was purchased jointly without a mortgage for dollar_figure the condo was worth dollar_figure and had unpaid liens of dollar_figure against it at the time of trial during and the condo had a similar value and outstanding liens of dollar_figure petitioners hired an interior decorator to decorate the condo in and again in spending a total of over dollar_figure petitioners also owned a home on fire island new york philip purchased the land in and built a three-bedroom house in all without a mortgage on the property that home cost in the range of dollar_figure to dollar_figure and had a value of approximately dollar_figure at the time of trial philip transferred the fire island property to petitioner as sole owner in an equity loan and dollar_figure mortgage were taken on the fire island house by petitioner in date and philip was jointly liable for the mortgage and responsible for making the payments on that obligation petitioners went on an annual week-long vacation to puerto rico and occasionally petitioner's daughters would go with them petitioner and philip went on numerous gambling trips together on some of those trips petitioners' room food beverage entertainment and sometimes transportation ie airfare were paid for by the casino although petitioner did not gamble much she did obtain the benefit of the amenities provided by the resort or casino philip gave petitioner a diamond wedding band but petitioner did not receive much additional jewelry during their marriage during date philip purchased an automobile for petitioner at a cost of almost dollar_figure petitioner had a visa credit card and other credit cards for major new york city area department stores including saks fifth avenue bloomingdale's fortunoff a s and macy's during the years in issue petitioner obtained a black mink coat she also enjoyed the theater and attended many shows petitioner's daughters' tuition and some expenses for private school education tutoring and college were paid for by philip philip paid for food clothing and other expenses for petitioner's daughters including the acquisition of an automobile for one of the daughters during petitioner transferred stocks and bonds with a dollar_figure value from her and philip's joint account with merrill lynch to the account of one of her daughters petitioner paid her daughters' and mother's income_tax out of her joint bank account with philip philip paid a total of approximately dollar_figure for petitioner's daughter's wedding expenses petitioners had a joint bank account from which to pay household expenses philip would deposit either cash or checks into the account for petitioner to use to pay various expenses petitioners also paid a variety of their expenses in cash philip would give petitioner the cash to pay for groceries dry cleaning domestic help etc the cash philip gave petitioner was in addition to the money he deposited in their joint account philip also had several individual bank accounts petitioners' recreation was combined with gambling they went to las vegas nevada on their honeymoon and took other vacations where gambling was a focal point such as their annual trip to puerto rico philip would go on day trips to atlantic city new jersey or take weekend trips to las vegas nevada petitioner would occasionally accompany philip on the weekend trips or they would both go with their good friends adrienne and elwood lerman lerman lerman was also petitioners' accountant and financial adviser some of these gambling trips would be comped ie the casino would pay for travel meals and hotel room while on these trips philip would spend most of his time gambling in the casinos he usually played at the craps table and preferred the tables with a large minimum bet while philip gambled petitioner would either play at a different table or go shopping petitioner was aware of the amount of time philip spent gambling and they would often argue about it philip gambled with large amounts of money he often signed markers to the casinos to get more cash with which to gamble philip tried to pay off the markers before they could be noticed by petitioner when petitioner was with him philip tried to hide the size of his bets and his winnings or losings from her petitioners would often go together or with the lermans for an evening at the racetrack petitioner would make small bets during the evening while philip made larger more substantial bets he tried to keep the tickets hidden or show petitioner tickets with smaller bets so that she would not know how much money he was risking petitioners even invested in racehorses they had an interest in several racehorses during the years in issue for the years in question philip reconstructed the amounts expended on gambling as follows --- cash marker checks year philip --- dollar_figure -0- big_number big_number big_number total dollar_figure big_number big_number personal checks to casino total --- -0- dollar_figure big_number dollar_figure big_number big_number big_number big_number petitioner did not provide any evidence of gambling expenditures_for the reconstruction is to some extent overstated because some of the source documents were shown not to reflect gambling expenditures in addition it has not been established that the amounts reflected were expended solely for gambling the expenditures do not reflect the source of the funds expended some of the funds may represent winnings and some may represent philip's and petitioner's cash-flow from other income_tax savings or other sources petitioner was aware that philip was an avid gambler both when she married him and during their marriage during the years in issue petitioner was not aware of the full extent of philip's gambling expenditures philip wrote checks and depleted both his and the couple's checking accounts to the point where checks on the account used by petitioner for household matters were returned because of insufficient funds by petitioner and philip argued and their relationship deteriorated due to philip's gambling and the overdrawn accounts petitioner's and philip's joint income_tax returns for the taxable years through reported income in the amounts of dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure the income_tax deficiencies determined by respondent for the taxable years through are as follows income_tax deficiency year total dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure of the total of dollar_figure for the years approximately percent or dollar_figure is attributable to respondent's disallowance of the tax_shelter deductions and carryback losses which represent the grossly erroneous item on date philip and petitioner entered into a separation agreement pursuant to the agreement philip assigned a partnership_interest to petitioner at the time of trial income distributions from the partnership amounted to dollar_figure per month the separation agreement provided that upon petitioner's vacating the condo philip would be entitled to live there and would be required to pay all expenses taxes utilities etc connected therewith by allowing philip to reside in the condo petitioner did not waive her ownership rights in the property in the event of philip's death petitioner would receive full ownership of the condo petitioner was given the other residential_real_property and certain specific personalty which was then located in the condo petitioner also received a automobile under the separation agreement the separation agreement contained federal_income_tax provisions as follows any refund payable with respect to any joint tax_return now or hereafter filed shall be paid to the husband and the wife shall endorse refund checks such sic payment if there is any deficiency or tax_liability assessed on any jointly filed tax_return such deficiency or tax_liability with any interest or penalties thereon shall be paid solely by the husband and the said husband does hereby forever save hold harmless indemnify and defend the wife of from and against any and all claim or claims that may be made against them or her for the payment collection or satisfaction of any such tax interest or penalty due or alleged to be or become due as a result of the filing and or failure_to_file any such joint tax_return the cost if any incurred or to be incurred by either of the parties in connection with the examination and or audit of any such joint_return shall be borne solely and exclusively by the husband on date petitioner with philip's consent filed for a divorce petitioner asserts that she and philip were divorced during as of the time of trial april and the separation agreement was still in effect however petitioner and philip continued to live together at the same location opinion the u s court_of_appeals for the second circuit outlined its mandate to this court as follows the resolution of this issue whether it would be inequitable to hold petitioner jointly liable for the tax deficiencies depends upon a fact-intensive inquiry into the surrounding facts and circumstances sec_6013 relevant factors include significant benefits received as a result of the understatements by the spouse claiming relief any participation in wrongdoing on the part of the innocent spouse and the effect of a subsequent divorce or separation see s rep no 91st cong 2d sess considering bill to amend the internal_revenue_code of reprinted in u s c c a n normal support measured by the circumstances of the parties is not considered a significant benefit for purposes of this determination flynn t c pincite the magnitude of friedman's gambling_losses which allegedly exceed the total_tax deficiencies owed would be a factor weighing heavily in favor of a finding that taxpayer did not personally benefit from the tax_shelter see pietromonaco f 3d pincite friedman v commissioner f 3d pincite the statute requires that petitioner show that taking into account all the facts and circumstances it is inequitable to hold her liable sec_6013 petitioner bears the burden_of_proof as to whether it would be inequitable to hold her liable for the tax_shelter portion of the deficiency rule a 98_tc_28 in deciding whether it was inequitable to hold a spouse liable courts have considered whether the purported innocent spouse benefited5 beyond normal support either directly or indirectly from the understatement_of_tax liability 992_f2d_1256 2d cir affg tcmemo_1992_228 93_tc_434 86_tc_228 affd 826_f2d_470 6th cir h rept part pincite2 sec_1 b income_tax regs deduction items to the extent that they reduce taxpayers' tax burden have the potential to benefit the purported innocent spouse 94_tc_126 affd 992_f2d_1132 11th cir normal support is determined in the context of the the statute once required a significant benefit but the wording of the statute for the years under consideration does not specify a significant benefit see 9_f3d_290 3d cir affg tcmemo_1992_580 circumstances of taxpayers 509_f2d_162 5th cir 93_tc_355 evidence of direct or indirect benefits may consist of property transfers including transfers received several years after the year in which the erroneous deductions were claimed see sec_1 b income_tax regs this would include the division of property in a subsequent divorce proceeding pettinato v commissioner tcmemo_1995_85 finally in deciding whether it is equitable to hold a spouse liable for deficiencies or innocent under sec_6013 we are to consider the probable future hardships that would be imposed on the spouse seeking relief if such relief was denied sanders v united_states supra pincite n 496_f2d_431 10th cir petitioner admits that her lifestyle may have been considered lavish but it was the standard she had enjoyed during her marriage with philip respondent contends that petitioner and philip entered into the marriage on a relatively equal financial footing and that any benefits to petitioner were earned and consumed during the marriage and the years in issue petitioner also contends that philip gambled away the tax_shelter benefits the tax benefits in question stem from a transaction for which losses were claimed for and in addition net_operating_loss deductions were carried back to and although petitioner and philip entered into their marriage on a similar footing as to assets philip had a substantial earning capacity and from the beginning was able to provide a high standard of living for himself petitioner and petitioner's daughters throughout the period under consideration petitioners lived in high-quality residences however the important factor here is that their standard of living did not increase either during or after the years that the grossly erroneous deductions drastically reduced their tax_liability ultimately in the separation agreement petitioner received a partnership_interest that provided her with about dollar_figure per month the right to the fire island property a moderately priced automobile and claim to her joint share of any equity in the condo the dollar_figure amount appears to approximate the monthly living expenditures attributable to petitioner at the time of the separation agreement the condo was substantially mortgaged the fire island property had a relatively large mortgage and the automobile was about years old the bulk of the assets received in accordance with the separation agreement was purchased for cash prior to the deduction of the grossly_erroneous_items in question other than a fur coat petitioner did not receive lavish assets or jewelry during the marriage petitioner did however enjoy the benefits of traveling to resorts in connection with gambling activities and some of that travel was lavish the amount of travel was about the same before during and after the tax years for which the grossly erroneous deductions were claimed philip's reported gross_income without considering deductions or the grossly erroneous amounts ranged from a low of dollar_figure to a high of dollar_figure from through the record reflects that his reported income in other years was similar in amount his income fluctuated due to the nature of his business activity--mortgage broker that amount of income would have provided petitioners with a high standard of living without considering the tax savings generated by the tax_shelter in question a substantial portion of the tax savings was likely consumed by philip's gambling_losses about dollar_figure of tax savings is attributable to the grossly erroneous deductions generated by the subject tax_shelter during the same period philip's gambling activity consumed as much as dollar_figure in subsequent years philip's gambling activity appears to have increased and his losses also likely increased ultimately ending in the conflict with petitioner that led to separation and allegedly to divorce our record does not reflect whether petitioner and philip were actually divorced but references to the divorce appear in the appellate briefs connected with this case we are also unaware of the ultimate divorce settlement but accept the separation agreement as the model for the ultimate division of property although petitioner continued to live with philip after entering into the separation agreement petitioner testified that she and philip lived separately at the same location until she was able to move the fact that petitioner and philip continued to live together as opposed to living separately and or being divorced militates against an inequity finding see sec_1 b income_tax regs we also note that philip in the separation agreement agreed to pay any_tax deficiencies and save petitioner harmless from any expense connected with tax audits the effect of such a promise has been considered by this court on several occasions the impact on the relative equities of holding a spouse liable if the other spouse promises to pay joint tax deficiencies is dependent on whether the promise is reliable or speculative although philip's actions toward petitioner have been amicable his gambling habit which was the root of petitioners' marital problems renders his promise to pay the tax inconsequential at the time of the separation agreement petitioners' bank accounts were overdrawn and significant pieces of property like the condo were fully mortgaged accordingly see eg stiteler v commissioner tcmemo_1995_279 foley v commissioner tcmemo_1995_16 buchine v commissioner tcmemo_1992_36 affd 20_f3d_173 5th cir henninger v commissioner tcmemo_1991_574 knapp v commissioner tcmemo_1988_109 in this case philip's promise to pay is not considered reliable see foley v commissioner tcmemo_1995_16 based on the record we find that petitioner has shown that she did not benefit beyond the amount of her normal support either directly or indirectly from the understatement_of_tax attributable to the grossly erroneous deductions accordingly we find that if petitioner did not know and had no reason to know as the u s court_of_appeals for the second circuit found it would be inequitable to hold petitioner liable for the portion of the deficiencies and additions to tax attributable to these tax_shelter items based on our findings and in accordance with the holding of the u s court_of_appeals for the second circuit we find that petitioner is an innocent spouse within the meaning of sec_6013 as to the deficiencies in income_tax and additions to tax attributable to the tax_shelter items only to reflect the foregoing decision will be entered under rule


internal_revenue_service appeals_office date date number release date a i legend a c certified mail dear department of the treasury person to contact employee id number tel fax refer reply to in re form required to be filed tax period s ended last day to file a petition with the united_states tax_court uil this is a final adverse determination as to your exempt status under sec_501 c of the internal_revenue_code irc it is determined that you do not qualify as exempt from federal_income_tax under sec_501 c effective the date of this letter our adverse determination was made for the following reason s your primary activity and purpose since your inception has consisted of the operation of bingo_games bingo does not in and of itself further an exempt_purpose you are a feeder_organization within the meaning of sec_502 which provides in part that such an organization shall not be exempt from taxation on the grounds that all of its profits are payable to one or more organizations_exempt_from_taxation accordingly you are not operated exclusively for exempt purposes as described in sec_501 see sec_1_501_c_3_-1 contributions to your organization are not deductible under code sec_170 you are required to file federal_income_tax returns on the form indicated above you should file these return s within days from the date of this letter unless a request for an extension of time is granted file the returns in accordance with their instructions and do not send them to this office processing of income_tax returns and assessment of any taxes due will not be delayed because you have filed a petition for declaratory_judgment under code section if you decide to contest this determination under the dedaratory judgment provisions of code section a petition to the united_states tax_court the united_states court of claims or the district_court of the united_states for the district of columbia must be filed within days from the date this determination was mailed to you contact the clerk of the appropriate court for rules for filing petitions for declaratory_judgment to secure a petition form from the united_states tax_court write to the united_states tax_court second street n w washington d c you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free 1-bn-777-4778 and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at commerce st room mc 10050al dallas tx we will notify the appropriate state officials of this action as required by code sec_6104 you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely team manager department of the treasury internal_revenue_service mis p o box ogden ut tax_exempt_and_government_entities_division march taxpayer_identification_number org address uil form s tax_year s ended person to contact number i contact numbers telephone fax certified mail - return receipt requested dear we have enclosed a copy of our report of examination explaining why we believe revocation of your exempt status under sec_501 c of the internal_revenue_code code is necessary if you accept our findings take no further action we will issue a final revocation letter if you do not agree with our proposed revocation you must submit to us a written request for appeals_office consideration within days from the date of this letter to protest our decision your protest should include a statement of the facts the applicable law and arguments in support of your position an appeals officer will review your case the appeals_office is independent of the director eo examinations the appeals_office resolves most disputes informally and promptly the enclosed publication the examination process and publication exempt_organizations appeal procedures for unagreed issues explain how to appeal an internal_revenue_service irs decision publication also includes information on your rights as a taxpayer and the irs collection process you may also request that we refer this matter for technical_advice as explained in publication if we issue a determination_letter to you based on technical_advice no further administrative appeal is available to you within the irs regarding the issue that was the subject of the technical_advice letter rev catalog number 34809f if we do not hear from you within days from the date of this letter we will process your case based on the recommendations shown in the report of examination if you do not protest this proposed determination within days from the date of this letter the irs will consider it to be a failure to exhaust your available administrative remedies sec_7428 of the code provides in part a declaratory_judgment or decree under this section shall not be issued in any proceeding unless the tax_court the claims_court or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted its administrative remedies within the internal_revenue_service we will then issue a final revocation letter we will also notify the appropriate state officials of the revocation in accordance with sec_61 c of the code you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please call the contact person at the telephone number shown in the heading of this letter if you write please provide a telephone number and the most convenient time to call if we need to contact you thank you for your cooperation sincerely marsha ramirez director eo examinations enclosures publication publication form 4621-a report of examination form 886-a explanation of items form_6018 consent to proposed action letter rev catalog number 34809f fonn 886-a rev date name of taxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december xx legend org organization name co-l c0-2 c0-3 xx date pt 2nd 3rct companies xyz state motto motto county county primary issue whether the org tax exempt status under sec_501 should be revoked because the primary activity of the organization is motto and the organization does not perform any charitable or educational activities alternate issue whether the org form 990-t for the year under examination should have unrelated_business_taxable_income recalculated and additional tax assessed facts primary issue this non profit organization was formed under the laws of the state of xyz the ruling date the irs recognized exemption under sec_501 of the internal_revenue_code is 20xx-10 the organization applied to the state of xyz for and was granted a certificate of authority under the xyz non-profit corporation act based on the exemption granted by the service motto games are legal in xyz as long as they are performed by exempt_organizations the organization filed their application_for exemption form_1023 in may of20xx they requested exemption based on the mission to raise funds for youth sports by primarily conducting motto games they stated in the application that 'at this time it is not anticipated the organization will conduct any other activities but motto' the primary activity of the organization continues to be motto games on october 20xx the service issued a determination_letter recognizing org as an organization described in sec_501 effective january 20xx the service's determination_letter also gave an advance_ruling period of five years ending december 20xx the organization has filed the required returns forms and 990t for the year s in question the return form_990 for the year under examination was received on october 20xx after the service had requested it from the organization during a compliance check but within the extension period this return does indicate that motto is the primary activity that the organization participates in and that they donate the majority of the profit earned to youth associations during the examination the revenue_agent requested the organization complete a schedule detailing all activities of the organization the organization completed the schedule indicating that traditional motto and instant motto are the only activities performed the motto games are open to the general_public this examination came about as part of a project examining organization's that had generated over dollar_figure in gross revenue from motto activities and had not filed form_990 the motto revenue information was received by the irs from the co-l co-l form 886-a catalog number 208iow page_ publish no irs gov department of the treasury-internal revenue service form886-a rev date name oftaxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december 20x x legend org organization name co-l c0-2 c0-3 pt 2nd 3rct companies xx date the co-l reported the following xyz state motto motto county county traditional motto instant motto total motto revenues gross revenue prizes paid out charitable_contributions net motto paid out revenues dollar_figure dollar_figure dollar_figure org also stated that they also receive revenues from rental income and interest_income for the tax_year ending december 20xx the rental income totaled dollar_figure and the interest_income totaled dollar_figure the organization reported on form_990 that they spentdollar_figureto provide financial support for c0-2 this assoc provides cash assistance to purchase equipment or improve facilities for youth organization of county this same amount is report on form 990-t as a charitable_contributions deduction from the unrelated_business_income of instant motto however as indicated in the above table this amount of charitable_contributions was not reported to the co-l the revenue_agent requested financial documentation to support the amount claimed on the return for donations given the organization has failed to provided any verification of these charitable donations and so the validity has not been verified law primary issue sec_6033 of the code provides except as provided in sec_6033 every organization exempt from tax under sec_50l a shall file an annual return stating specifically the items of gross_income receipts and disbursements and such other information for the purposes of carrying out the internal revenue laws as the secretary may by forms or regulations prescribe and keep such records render under oath such statements make such other returns and comply with such rules and regulations as the secretary may from time to time prescribe sec_501 of the code provides exemption for corporations and any community chest fund or foundation organized and operated exclusively for religious charitable scientific testing for public safety literary or educational_purposes or to foster national or international amateur sports competition or for the prevention of cruelty to children or animals no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_1 c -l a l of the regulations states that in order to be exempt as an organization described in sec_50l c an organization must be both organized and operated exclusively for one or more of the purposes specified in such section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1 50l c -l c l of the regulations provides that an organization will not be regarded as operated exclusively for one or more exempt purposes described in sec_50l c of the code if more than an insubstantial part of its activities is not in furtherance of a c purpose form 886-a l-1994 catalog number 20810w page_ pub1ish no irs gov department of the treasury-internal revenue service form 886-a rev date name of taxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december 20xx legend org organization name co-l c0-2 c0-3 1st 2nd 3rd companies xx date xyz state motto motto county county sec_1 c -1 d of the regulations provide that the term charitable is used in sec_50l c in its generally accepted legal sense and includes relief of the poor and distressed or of the underprivileged advancement of religion advancement of education or science erection or maintenance of public buildings monuments or works lessening of the burdens of government promotion of social welfare help the children inc v commissioner t c wl involved an organization whose exempt_purpose was to acquire funds and financial assistance for the care and assistance of needy children and children's institutions the organization's primary activity was the operation of motto games significant contributions were given to various individual doctors and charitable institutions the court stated that the record shows that one of the purposes for which petitioner was operated was to engage in commercial activities motto games for profit the organization has some other issues regarding the recipients of the contributions and revocation was upheld piety inc v commissioner t c wl involved an organization whose exempt_purpose was to raise funds for the furtherance of charitable groups religious groups and non profit ambulance service groups the organization's primary activity was conducting motto games the court's opinion states that to qualify for exemption as an organization described in sec_50l c petitioner piety inc must be operated exclusively for exempt purposes petitioner contends it satisfies this requirement because it will contribute the profits of the motto games to exempt_organizations respondent commissioner alleges sec_502 precludes petitioner from qualifying for exemption on that ground respondent is correct emphasis added the court went on to analyze piety inc in regards to sec_502 subject_to the exceptions provided by sec_502 sec_502 prevents an organization which is operated for the primary purpose of carrying_on_a_trade_or_business for profit from qualifying for exemption on the ground that its profits are payable to exempt_organizations petitioner is operated for the primary purpose of carrying_on_a_trade_or_business motto games for profit within the meaning of sec_502 sec_502 therefore precludes petitioner from qualifying for exemption by merely supporting exempt_organizations unless one of the exceptions in sec_502 is applicable the court also went out of its way to emphasize petitioner may qualify for exemption only if it directly serves some exempt_purpose revocation was upheld south community association v commissioner t c memo wl involved an organization whose exempt_purpose was to make contributions to various charities for the purposes of starting educational programs building a school and transporting handicapped individuals to various schools the organization funded its contributions almost entirely through its gaming operation the gaming operation consisted of its sale of motto cards and instant pull-tab tickets the court commented that in order for petitioner south community association to prevail on the issue that we decide herein we must find that petitioner was both organized and operated exclusively for form 886-a catalog number 20810w page_ publish no irs gov department of the treasury-internal revenue service form886-a rev date name oftaxpayer org explanation of items tax identification_number legend org organization name co-l c0-2 c0-3 t 2nd 3rd companies xx date xyz state county county schedule number or exhibit year period ended december xx motto motto one or more exempt purposes the court went on to conclude that the gaming operation was petitioner's principal activity and was conducted by petitioner as a business for profit petitioner does not argue nor do we find that this activity was in furtherance of its exempt_purpose we therefore conclude that respondent properly revoked petitioner's tax-exempt status because petitioner was not operated exclusively for an exempt_purpose while congress allows certain organizations tax-exempt status for specific limited activities petitioner attempts to retain tax-exempt status for activities that are outside of those permitted revocation was upheld taxpayer's position primary issue the organization's protest letter explaining their position is attached hereto please see the attached government's position primary issue the statement in the protest letter from the organization the organization performs exactly the activities that were outlined in their application_for exemption filed on form_1023 in may 20xx is recognized as a true statement and the irs is not arguing this fact the position of the government is that exemption was granted erroneously and can not be permitted to continue as the organization does not qualify for exemption under sec_501 of the code and c -1 of the regulations as there is nothing inherently charitable about motto and motto is the only activity of this organization beyond the activity of granting money to other charitable_organization the organization claimed that they made charitable_contributions ofdollar_figurehowever an amount ofdollar_figurewas reported to the state of xyz given this fact along with the fact that the organization failed to provide any such substantiation of this claim this amount is regarded as invalid motto games while specifically excepted from the definition of an unrelated_trade_or_business per of the code are still considered a trade_or_business the fact that motto is a trade or section business is undisputable as it has been established time and again in court cases it is evident that the organization intended to and consistently did generate a profit from this activity while xyz state law may state that an organization qualifies for non-profit status as long as these profits are donated for charitable purposes the use of these profits are not a factor in this determination at the federal level the operation of a trade_or_business for profit can not be the primary purpose of an organization under sec_501 ofthe code all three of the court cases cited above determined that conducting motto games for profits constitutes a trade_or_business and motto does not in and of its self further an exempt_purpose the courts consistently upheld revocation of exempt status for organizations that had motto as their sole activity in piety inc the court liberally interpreted sec_502 to include any organization that conducts a trade_or_business and give the proceeds to charity the court specifically stated that the organization needed to have a direct charitable activity in south community association the court ruled that the organization's principal activity was conducting a business for profit the court was form 886-a catalog number 20810w page_ publish no irs gov department of the treasury-internal revenue service fonn886-a rev date name oftaxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december 20xx legend org organization name co-l c0-2 c0-3 l t 2nd 3rct companies xx date xyz state motto motto county county aware that the organization's purpose was to make contributions to charity but revocation was still upheld while xyz state law is taken into consideration and noted it remains subservient to federal_law the service realizes that this action creates a hardship on the organization with regards to operating in conflict with xyz state law this along with the fact that the service erroneously granted exemption may be cause for relief relating to the effective date of the revocation under sec_7805 b retroactivity of regulations however this is not a reason to continue to allow exemption a rebuttal letter has been mailed to the organization in response to their protest letter this is also attached hereto conclusion primary issue the government concludes that org does not qualify for exemption from federal_income_tax under sec_501 as a result of this finding the organization will be subject_to the income_tax imposed by sec_11 and is required to file forms for all tax periods ending after january 20xx alternate issue whether the org form 990-t for the year under examination should have unrelated_business_taxable_income recalculated and additional tax assessed facts alternate issue the organization filed form 990-t to report unrelated_business_income on may 20xx significantly late and only after the irs had contacted them and requested it during a compliance check the organization's form 990-t reported the following gross_receipts or sales expenses prizes salaries and wages taxes and licenses charitable_contributions rent total expenses net_income loss taxrate total_tax paid form 886-a catalog number 20810w page_ publish no irs gov department of the treasury-internal revenue service form 886-a rev date name oftaxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december 20xx legend org organization name c0-1 c0-2 c0-3 l t 2nd 3rct companies xx date xyz state motto motto county county some of these expenses they have deducted are large unusual and or questionable they claim they made charitable_contributions from this income ofdollar_figure yet there was a net_loss ofdollar_figure they reported dollar_figurein rent paid for this activity but on the form_990 they claimed that the total amount of rent paid for all activities was dollar_figure if the form 990-t tax_liability was refigured the calculation would be as shown below with the following corrections charitable_contributions deduction disallowed as it is not possible to distribute funds from a negative_amount and because the organization failed to substantiate the contributions rent expense deduction disallowed as this expense would have been incurred regardless as to whether they performed instant motto or not - the gross revenue and prized paid out based on amounts reported by the co-l co-l gross revenue prizes paid out net_revenues less directly related expense salaries and wages taxes and licensing specific deduction ubti tax_rate tax due less tax already paid additional tax owed dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure law alternate issue sec_511 of the internal_revenue_code imposes a tax on the unrelated_business_income of every organization described in sec_50l c sec_512 of the internal_revenue_code states that the term unrelated_business_taxable_income means the gross_income derived by an organization from any unrelated_trade_or_business regularly carried on by it less the allowable deductions which are directly connected with the carrying on of such trade_or_business sec_513 of the internal_revenue_code defines unrelated_trade_or_business as any trade_or_business the conduct of which is not substantially related aside from the need of such organization for income or funds or the use it makes of the profits derived to the exercise or performance by such organization of form 886-a catalog number 20810w page_ publish no irs gov department of the treasury-internal revenue service form886-a rev date name of taxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december xx legend org organization name co-l c0-2 c0-3 xx date xyz state motto motto l t 2nd 3rd companies county county its charitable educational or other purpose or function constituting the basis for its exemption under sec_501 sec_513 of the internal_revenue_code excludes from the term unrelated_trade_or_business the conducting of motto games motto games means any game of motto- a of a type in which usually the wagers are placed the winners are determined and the distribution of prizes is made in the presence of all persons placing wagers in such game b the conduction of which is not an activity ordinarily carried out on a commercial basis and c the conducting ofwhich does not violate any state or local law sec_1 a -l c of the regulations states that when facilities and personnel are used both to carry on exempt_activities and to conduct unrelated_trade_or_business activities expenses shall be allocated between the two uses on a reasonable basis 98_f3d_190 this case involved an organization exempt from income_tax per sec_501 the organization was assessed unrelated_business_income_tax on their instant motto sales the court found that instant motto games conducted by nonprofit tax-exempt_organization did not constitute game of motto within meaning of sec_513 excluding motto games from unrelated_business_taxable_income where instant motto game player did not place markers over randomly called numbers in attempt to form preselected pattern but rather purchased prepackaged card and removed pull-tabs to determine whether numbers on front of card matched numbers on back of card the court ruled that the organization was liable for unrelated_business_income_tax on their instant motto sales taxpayer's position alternate issue the organization has provided a letter of protest which is attached hereto please see the attached government's position alternate issue the organization filed form 990-t reporting that they did in fact have paid employees this is considered an admission to this fact and the form 990-t was signed under penalty of perjury it is considered unrealistic to assert that their paid employees became volunteers upon the conclusion of traditional motto games to sell pull-tabs the burden_of_proof would be on the taxpayer to clearly substantiate this claim adequate substantiation has not been provided to establish this assertion the organization's instant motto games constitute an unrelated_trade_or_business as described in sec_513 and as such is liable for the unrelated business tax per sec_511 the only direct expense that was identified was the prizes paid to instant motto winners the wages and taxes are accepted as previously reported rent and charitable_contributions are to be disallowed as they have been determined to be inaccurate form 886-a catalog number 20810w page_ publish no irs gov department of the treasury-internal revenue service form886-a rev date name oftaxpayer org explanation of items schedule number or exhibit tax identification_number year period ended december xx legend org organization name co-l c0-2 c0-3 1st 2nd 3rd companies xx date xyz state motto motto county county forms 990-t for all subsequent years after this year under examination should be amended to reflect correct and allowable deductions these amended returns should be submitted to the appropriate service_center for processing a rebuttal letter has been mailed to the organization in response to their protest letter this is also attached hereto conclusion alternate issue the government concludes that org is liable for the additional unrelated_business_income_tax ofdollar_figure in total for the period beginning january 20xx and ending december 20xx the organization should file or amend forms 990-t for periods january xx forward form 886-a catalog number 208iow page_ publish no irs gov department of the treasury-internal revenue service