t c memo united_states tax_court robert a franklin petitioner v commissioner of internal revenue respondent docket no filed date robert a franklin pro_se jeffrey s luechtefeld for respondent memorandum opinion wells judge respondent determined that petitioner is not entitled to an abatement of interest pursuant to sec_6404 e for and the issue for decision is whether 1unless otherwise indicated all section references are to the internal_revenue_code as amended respondent’s refusal to abate interest constitutes an abuse_of_discretion background the parties’ stipulations are incorporated into this memorandum opinion by reference and accordingly are found as facts in the instant case at the time he filed his petition petitioner resided in tampa florida on date internal_revenue_service irs agent julie a kelley agent kelley initiated examination of petitioner’s return on date agent kelley initiated examination of petitioner’s return on date agent kelley worked on notices of proposed adjustments to items reported on petitioner’s income_tax returns for and on date agent kelley sent petitioner a letter requesting an extension of the limitations_period for assessing petitioner’s taxes for agent kelley drew up a revenue_agent report on date petitioner discussed the revenue_agent report with agent kelley on date subsequently petitioner discussed the revenue_agent report with his representative laymond cloud mr cloud and informed agent kelley on date that he would not agree to sign a report until adjustments to all of his returns under audit were consolidated into one report on date agent kelley started the examination of petitioner’s tax_return on date agent kelley prepared notices of proposed_adjustment to items reported on petitioner’s return for that year agent kelley her supervisor group manager patricia carter group manager carter petitioner and mr cloud held a telephone conference on date the parties to the telephone conference agreed that mr cloud had until date to decide whether the case should be closed unagreed on date petitioner retained fred schultz mr schultz as his representative on date mr schultz contacted agent kelley by phone and faxed her a power_of_attorney form on date agent kelley prepared a notice of proposed_adjustment regarding petitioner’s return for on date agent kelley continued working on the case on date agent kelley prepared notices of proposed_adjustment to items reported on petitioner’s returns for and during early date agent kelley faxed mr schultz a revised revenue_agent report and scheduled a conference with mr schultz for date at the date conference agent kelley and mr schultz could not reach an agreement consequently agent kelley and mr schultz scheduled a subsequent meeting and mr schultz agreed to provide additional information before that conference on date mr schultz provided the additional information on date agent kelley mr schultz petitioner and group manager carter attended a conference at which they could not agree during date agent kelley was temporarily reassigned on february and agent kelley informed mr schultz of the temporary reassignment agent kelley was temporarily reassigned during parts of february and date on date agent kelley contacted mr schultz and worked on petitioner’s case on date respondent determined that the case should be closed unagreed on date respondent closed the case unagreed on date respondent issued petitioner a letter 30-day_letter for and on date mr schultz requested consideration by respondent’s appeals_office on date respondent’s tampa appeals_office received petitioner’s file on date respondent assigned petitioner’s case to appeals officer roger caruso ao caruso and mailed petitioner a letter informing him of ao caruso’s receipt of the case on date respondent sent petitioner a form_872 consent to extend the time to assess tax for and initially mr schultz informed respondent that petitioner did not want to extend the period of limitations however later in july mr schultz agreed to extend the period of limitations to date and ao caruso prepared a new form_872 on date ao caruso received the form_872 signed by petitioner extending the period of limitations to date for assessment of petitioner’s income taxes from september through ao caruso attended mediation training on date the parties agreed to hold an appeals_conference on date on date appeals officer nelson leduc ao leduc replaced ao caruso mr schultz and respondent each left a voicemail for the other in october on date ao leduc prepared a form to extend the period of limitations for assessment until date however at the appeals_conference held on date mr schultz declined to extend the period of limitations for assessment and instead requested weeks to review relevant tax law between november and date mr schultz and ao leduc discussed extending the period of limitations respondent received from petitioner a signed extension of the period of limitations on assessment on date extending the limitations_period to date for and ao leduc was on annual leave from date to date on january and ao leduc contacted petitioner to ascertain petitioner’s position regarding an appeals_conference that had been scheduled for date on date ao leduc received petitioner’s written position as scheduled ao leduc petitioner and mr schultz met for an appeals_conference on date mr schultz contacted ao leduc on date and stated that the requested documents would be mailed the next day after receiving the documents on date ao leduc initiated review of the material on date after reaching a decision on date ao leduc mailed the decision to mr schultz and also sent the case to respondent’s technical section for final computation on date ao leduc mailed to mr schultz form 870-ad offer to waive restrictions on assessment and collection of tax_deficiency and to accept overassessment after a telephone call from each party ao leduc received the signed form 870-ad on date signed it and sent it to appeals team manager chester kreidich atm kreidich on date ao leduc prepared an appeals transmittal and case memo on date atm kreidich signed the form 870-ad on date the tampa appeals_office closed petitioner’s case the tampa appeals_office thereafter sent petitioner’s case file to the jacksonville appeals_office to complete processing the case on date the jacksonville appeals_office received the file on date the assessment_date was entered into the irs’s computer system on date the irs assessed deficiencies in petitioner’s income_tax with interest as follows for a deficiency of dollar_figure and dollar_figure of accrued interest interest calculated from date to date for a deficiency of dollar_figure and dollar_figure of accrued interest interest calculated from date to date for a deficiency of dollar_figure and dollar_figure of accrued interest interest calculated from date to date on date petitioner filed form_843 claim_for_refund and request for abatement petitioner requested interest abatement as follows for dollar_figure of interest abatement for dollar_figure of interest abatement and for dollar_figure of interest abatement subsequently the irs sent petitioner a letter stating that petitioner’s request for interest abatement had been forwarded to respondent’s memphis office for review after assignment of the request for interest abatement to revenue_agent susan harbin agent harbin in jacksonville florida on date agent harbin suspended the interest which had accrued during a portion of the examination and otherwise proposed to deny petitioner’s request for interest abatement agent harbin informed petitioner of her decisions by letter on date the irs adjusted petitioner’s account to reflect statutory suspension of interest of dollar_figure for for date to date and of dollar_figure for for date to date on date petitioner sent the irs a letter requesting abatement in full the jacksonville appeals_office sent petitioner a letter on date acknowledging receipt of petitioner’s request for interest abatement on date mr schultz contacted the irs to inquire about petitioner’s request for interest abatement on date respondent informed mr schultz that petitioner’s request for interest abatement would be forwarded to the area director after the irs assigned petitioner’s request for interest abatement on date to appeals officer charles kelly ao kelly in the jacksonville appeals_office ao kelly sent petitioner a letter dated date acknowledging receipt of petitioner’s request for interest abatement ao kelly sent petitioner a letter dated date summarizing petitioner’s request for interest abatement it included a timeline of petitioner’s case and analyzed his request in the letter ao kelly informed petitioner that respondent had determined that delays in petitioner’s case were not unreasonable ao kelly also requested that petitioner provide contrary authority after the aforementioned statutory suspension of interest the irs prepared an appeals transmittal_memorandum and case memo on date and the irs issued a full disallowance final_determination regarding petitioner’s request for interest abatement which incorporated by reference the date letter to petitioner discussion pursuant to sec_6404 the commissioner may abate an assessment of interest on a deficiency attributable to an unreasonable error or delay by an irs official in performing a ministerial or managerial act or a payment of tax to the extent that an error or delay by the taxpayer in paying such tax is attributable to an irs official being erroneous or dilatory in performing a managerial or ministerial_act in deciding whether to grant relief an error or delay by an officer_or_employee of the irs shall be taken into account only if no significant aspect of such error or delay can be attributed to the taxpayer involved and after the irs has contacted the taxpayer in writing with respect to such deficiency or payment id sec_6404 is not intended to be routinely used to 2congress amended sec_6404 in to permit abatement of interest for unreasonable error and delay in performing a ministerial or managerial act taxpayer bill of right sec_2 publaw_104_168 and 110_stat_1457 that amendment applies to tax years beginning after date id sec_301 110_stat_1457 avoid payment of interest rather congress intended abatement of interest only where failure to do so would be widely perceived as grossly unfair h rept pincite 1986_3_cb_1 s rept pincite 1986_3_cb_1 the term ministerial_act means a procedural or mechanical act that does not involve the exercise of judgment or discretion and that occurs during the processing of a taxpayer’s case after all prerequisites to the act such as conferences and review by supervisors have taken place see sec_301_6404-2 proced admin regs a decision concerning the proper application of federal tax law is not a ministerial_act see id the term managerial act means an administrative act that occurs during the processing of a taxpayer’s case involving the temporary or permanent loss of records or the exercise of judgment or discretion relating to management of personnel see sec_301_6404-2 proced admin regs a decision concerning the proper application of federal tax law is not a managerial act see id the standard for reviewing the commissioner’s decision regarding abatement of interest is abuse_of_discretion see sec_6404 camerato v commissioner tcmemo_2002_28 generally the taxpayer must show that by denying an abatement of interest the commissioner exercised his discretion arbitrarily capriciously or without sound basis in fact or law 113_tc_145 112_tc_19 however the commissioner is in the best position to know what actions were taken by irs officers and employees during the period for which petitioners’ abatement request was made and during any subsequent inquiry based upon that request jacobs v commissioner tcmemo_2000_123 petitioner alleges that the irs committed unreasonable errors or delays in performing managerial or ministerial acts in order to qualify for relief pursuant to sec_6404 a taxpayer must generally establish a direct causal link between an unreasonable error or delay by the irs in performing ministerial or managerial acts and a specific period during which interest accrued guerrero v commissioner tcmemo_2006_201 braun v commissioner tcmemo_2005_221 petitioner failed to establish a direct causal link between a claimed unreasonable error or delay by the irs and a specific period during which interest accrued on his liabilities consequently the commissioner’s final_determination letter did not address that claim accordingly petitioner’s argument is without merit additionally petitioner alleges that there was an unreasonable error or delay in the return of the case to the agent from review since the report was written incorrectly however we can find no evidence in the administrative record of any error or delay in the preparation of a report petitioner also alleges that there was an unreasonable error or delay in the time the case was in the appeals_division and transferred to the miami office and then back to tampa however we can find no evidence in the administrative record that petitioner’s case was ever transferred to the miami appeals_office we conclude that petitioner has failed to show that any of respondent’s employees or officers committed an unreasonable error or delay in performing ministerial or managerial acts accordingly we hold that respondent’s denial of petitioner’s request for interest abatement was not arbitrary capricious or without sound basis in fact or law and we uphold respondent’s final_determination not to abate interest in reaching all of our holdings herein we have considered all arguments made by the parties and to the extent not mentioned above we find them to be irrelevant moot or without merit to reflect the foregoing decision will be entered for respondent


department of the treasury internal_revenue_service te_ge division tax_exempt_and_government_entities_division date number release date uil org taxpayer_identification_number form tax_year s ended person to contact id number contact numbers telephone fax certified mail- return receipt requested dear we have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization's exempt status is necessary if you do not agree with our position you may appeal your case the enclosed publication the examination process explains how to appeal an internal_revenue_service irs decision publication also includes information on your rights as a taxpayer and the irs collection process if you request a conference we will forward your written_statement of protest to the appeals_office and they will contact you for your convenience an envelope is enclosed if you and appeals do not agree on some or all of the issues after your appeals_conference or if you do not request an appeals_conference you may file suit in united_states tax_court the united_states court of federal claims or united_states district_court after satisfying procedural and jurisdictional requirements as described in publication letter catalog number v you may also request that we refer this matter for technical_advice as explained in publication exempt_organization appeal procedures for unagreed issues if a determination_letter is issued to you based on technical_advice no further administrative appeal is available to you within the irs on the issue that was the subject of the technical_advice if you accept our findings please sign and return the enclosed form_6018 consent to proposed adverse action we will then send you a final letter modifying or revoking exempt status if we do not hear from you within days from the date of this letter we will process your case on the basis of the recommendations shown in the report of examination and this letter will become final in that event you will be required to file federal_income_tax returns for the tax period s shown above file these returns with the ogden service_center within days from the date of this letter unless a request for an extension of time is granted file returns for later tax years with the appropriate service_center indicated in the instructions for those returns you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at internal_revenue_service office_of_the_taxpayer_advocate local office 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 letter catalog number v sincerely rosie c johnson director eo examinations thank you for your cooperation enclosures publication publication form_6018 report of examination envelope letter catalog number v form886a i name oftaxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx legend org organization name 2nd board member program program c0-3 3rd company bm-3 xx date 3rd board member bm-1 1st board member bm-2 attorney co-l 1st company attorney c0-2 2nd company cpa cpa tls tls city city c0-4 4th company i issues a is org org an insurance_company exempt from tax pursuant to sec_501 for the taxable years 20xx and 20xx definition of an insurance_company org failed to use its capital and efforts primarily to earn income from its insurance activity org was not issuing insurance contracts or reinsuring the risks of others during 20xx and 20xx i warranty repair replacement insurance b does org a foreign company which made an election under sec_953 continue to qualify for exemption from federal_income_tax as an organization described in sec_501 org is not described in sec_501 during the years under exam org cannot rely on its determination_letter sec_7805 relief ii facts a org' income statement org reported the following on its income statement for the taxable years 20xx 20xx and 20xx1 20xx 20xx 20xx sum receipts premiums earned dollar_figure dollar_figure dollar_figure dollar_figure financial information for 20xx is provided for background and historical purposes only form a rev department of the t reasuty - internal_revenue_service page -1- i form886a i name oftaxpayer org interest_income gross amt from sales less cost_basis less equity earnings miscellaneous income total revenue percentage premiums expenses accounting formation cost travel interest and bank charges policy administration other expenses total expenses b org' balance_sheet department of the treasuty- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx -0- -0- -0- -0- -0- dollar_figure -0- -0- -0- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -0- dollar_figure ---- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure _dollar_figure dollar_figure dollar_figure -0- dollar_figure dollar_figure _1 -0- -0- dollar_figure dollar_figure dollar_figure dollar_figure _dollar_figure dollar_figure dollar_figure _dollar_figure dollar_figuredollar_figure dollar_figure dollar_figure dollar_figure org reported the following on its balance sheets for the taxable years xx xx and xx xx xx xx assets cash in checking cash in savings notes loan receivable investments in securities premium receivable total assets liabilities bank overpayment accounts_payable related_party payables total liabilities net_worth capital stock paid in capital retained earnings total fund balance dollar_figure -0- -0- -0- dollar_figure_ -0- -0- -0- -0- dollar_figure dollar_figure -0- _1 u dollar_figuredollar_figuredollar_figure -0- dollar_figure ___dollar_figure_ dollar_figure_ u dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figuredollar_figure __dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure ___dollar_figure_ dollar_figure dollar_figure dollar_figuredollar_figure _ dollar_figure dollar_figuredollar_figuredollar_figure dollar_figuredollar_figure dollar_figure __ dollar_figure dollar_figuredollar_figure dollar_figure total liab net_worth dollar_figuredollar_figure dollar_figuredollar_figure dollar_figure form a rev department of the treasury- internal_revenue_service page -2- form886a name oftaxpayer org c oro's form_990 department of the treasury- internal_revenue_service ex lanation of items schedule no or exhibit year period ended xx xx org filed a return of an organization exempt from income_tax form_990 for the taxable years 19xx 20xx 20xx and 20xx org filed form_1120 for 20xx on its forms org reported premium income ofdollar_figure dollar_figurein 20xx and 20xx respectively related to its sec_501 tax-exempt status as a result of its tax-exempt status net_income from passive sources totalingdollar_figurein 20xx and dollar_figure in 20xx was not subject_to income_tax pursuant to sec_512 and or sec_501 d organization org org is owned by three individual shareholders bm-1 and bm-2 husband and wife each own a interest oforg bm-3 sister ofbm-2 owns the remaining interest org was formed in october 19xx as a country company that elected to be treated as a u s entity pursuant to sec_953 d org had less than dollar_figurein net_premiums per year and therefore qualified as a tax-exempt_insurance_company pursuant to sec_501 the irs issued a determination_letter to org on january 20xx granting org tax-exempt status e implementation ofthe insurance strategy attorney attorney promoted the program to the shareholders of org a promotional package entitled alternative risk mechanisms - offshore insurance_companies program was developed by attorney specifically for presentation to bm -1 attorney made the presentation in june 19xx the promotional materials included a letter dated june 19xx from attorney to bm-1 the letter represented the fee agreement for legal and consulting services between the parties the agreement described the scope of attorney's services as follows generally i have been requested to represent you and provide specific counsel as to the implementation formation and creation of a captive insurance program in the country in addition to the above i will also provide counsel during the first operating year of any insurance_company formed for such purpose the agreement included in the promotional material was signed by attorney only although the agreement does not include bm-1 's signature subsequent faxes between parties shows that the terms were agreed and accepted by bm-1 form a rev department of the t reaswy - internal_revenue_service page -3- form886a name of taxpayer org department of the treasury- internal_revenue_service ex lanation of items schedule no or exhibit year period ended 20xx 20xx specifically my efforts will be devoted toward creating a program suitable to your needs i will design the program create all supporting forms and documents form an insurance_company in a suitable domicile and put the program into full operation however my services do not extend to the tax qualifications or filings necessary to perfect the insurance company's tax exempt status which i understand will be the task of your chosen accountant nor do i warrant or guarantee the economic viability of the insurance_company or its program which may be subject_to the vagaries of the underlying activities of an associated program all counsel or advice as to the ramifications of federal or state tax law statutes or regulations shall be the responsibility of your chosen accountant or tax advisor my services in this matter will be billed to you at a flat rate ofdollar_figureplus costs of travel lodging and expenses_incurred in my work on this matter subsequent discussions between attorney and bm-1 took place by fax transmissions in a fax dated august xx attorney informed bm-1 that oro' insurance application was approved in co-l attorney organized business meetings with several clients including bm-1 which took place on city country during the week of october xx the purpose of the business meeting was to finalize the insurance filings with possession of the insurance_policy abthorities and to take c0-2 city sent an engagement letter to bm-1 on december 19xx c0-2 duties included filing the sec_953 election completing the form_1024 application form and preparing the initial form_990 return for oro oro does not have a formal business plan according to the minutes ofthe xx annual director's meeting held in december xx oro would cease to write warranty insurance coverage and would instead insure the following exposures on c0-2 professional indemnity computer breakdown damage business interruption deductible reimbursement program in its november xx response to information_document_request attorney indicated that during years xx through xx the warranty repairs policy was the only policy sold by oro in addition the policy incorporates all three lines business approved by the board in the december xx minutes f capital structure oforg oro was capitalized in xx withdollar_figuredollar_figurein cash by its shareholders bm-1 bm-2 and bm-3 bm-1 and bm-2 husband and wife each own interest oforg the remaining interest is owned by bm-3 sister ofbm-2 form t rev department of the treasury - internal_revenue_service page -4- form886a i name of taxpayer org department of the treasmy- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx in addition to their ownership in org bm-1 and bm-2 are equal co-owners of the c0-2 a real_estate consulting firm which is the sole policyholder oforg the shareholders contributed additional paid in capital ofdollar_figurein 20xx checks from the c0-2 were used to make the initial and additional capital contributions the shareholders did not contribute appreciated assets to org from its inception through the end of the year under audit as ofdecember 20xx org reported capital stock ofdollar_figuredollar_figureand paid-in capital ofdollar_figuredollar_figure org reported no loss_reserves for 20xx note b of the 19xx financial statement states the following policies written provide for coverage on a claims-made basis up to the date of the approval of these financial statements no claims have been received the company has not made a reserve for policy losses and related expenses to be determined the net amounts that will ultimately be paid to settle any liability are not presently determinable the shareholders did not contribute additional capital to org in 20xx g employees and officers of org org had no employees during 20xx and 20xx org did not pay a salary to its officers for xx and 20xx as reflected on org' forms for each of the years instead org' officers were paid as employees ofc0-2 c0-3 c0-3 provided insurance management services for org including interfacing with the insurance regulators in the country and the handling of correspondence sent to org the effective date of the contract was october xx org paid only minimal management fees during 20xx and 20xx h org' insurance activity for 20xx and 20xx org was formed on october xx in the country bm-1 formed the company for the purpose of providing warranty insurance to a primary company c0-2 c0-2 which is co owned by bm-1 and his wife bm-2 the initial insurance_policy policy number on november xx for xx the policy was in effect from november xx to december xx c0-2 incurred an insurance premium liability ofdollar_figureto org for the short_year the premium income was recorded as an accounts_receivable balance on the books of org was executed between org and c0-2 form 886-a rev department of the treasury internal_revenue_service page -5- form886a i name of taxpayer org departmem of the treaswy- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx under the terms ofthe policy oro agreed to indemnify valid certificate holders only in the event repairs or replacement under c0-2's then prevailing express warranties are performed by a party other than c0-2 as a result of c0-2's inability to so perform due to c0-2's insolvency liquidation or assignment for the benefit of creditors or as a result of an act of god oro' liability under the policy is limited todollar_figuredollar_figureper claim up to an aggregate ofdollar_figure the policy is renewal on an annual basis upon payment of the deposit premium equal to of prior year's audited premium the policy with c0-2 was renewed for tax years 20xx and 20xx in 20xx the terms of the policy remained primarily unchanged the terms of the policy were modified to increase oro' aggregate liability from dollar_figureto dollar_figure c0-2 was liable for premiums ofdollar_figureto oro during the year oro received premium cash payment ofdollar_figureand the balance ofdollar_figuredollar_figurewas established on oro' books as a receivable oro sold no other insurance policies during the year oro incurred no claims nor did oro establish any loss_reserves for potential future claims oro incurred minimal operating costs for the year oro used its net_proceeds to invest in securities during the year oro purchased investments with a fair_market_value ofdollar_figuredollar_figure the policy with c0-2 was renewed for year 20xx oro received premiums ofdollar_figurefor year 20xx premiums were paid_by the insured c0-2 although the c0-2 is the insured the coverage benefited its customers in the event of c0-2's insolvency for each year a new declaration page was executed between the parties outlining the renewed terms of the warranty repairs and replacement policy as was the case in 20xx oro incurred no claims during the 20xx year because none of the events that caused the coverage to start occurred no other insurance policies were sold by oro since its inception in 19xx oro did not file form_990 as a tax-exempt_insurance_company for 20xx i application_for c exemption on september 20xx oro sent the irs in city xyz a form_1024 application_for recognition of exemption under sec_501 with form_2848 and attached attached to the form_1024 application was a document pages entitled oro c0-4 under sec_953 and form_990 for 19xx pages the form_1024 included signed memorandum of association pages and articles of incorporation pages oforg also submitted with the application was a form_8718 user_fee for exempt_organization determination_letter request page aggregate liability increased to dollar_figureper resolution passed by board_of directors on form a rev department of the t reaswy - internal_revenue_service page -6- ' form886a name of taxpayer org department of the treaslll '- imemal revenue sej vice e lanation of items schedule no or exhibit year period ended 20xx 20xx the internal_revenue_service reviewed the application and in a letter dated october 20xx advised org its application was referred to the assistant_commissioner internal_revenue_service in a letter dated october 20xx the service requested additional information from org pages cpa with c0-2 sent letters dated november 20xx and january 20xx to tls confirming extensions to respond to december 20xx and january 20xx respective c0-2 submitted the response on behalf oforg on january 20xx the january 20xx letter consisted of a two page cover letter and three exhibits exhibit 1--a copy of the insurance_policy with c0-2 pages exhibit 2--a copy of the 19xx financial statements page and exhibit 3--a copy of the sec_953 election on january 20xx the service issued org a determination_letter granting org exempt status as an i r c sec_501 c organization pages these documents which were exchanged by the parties during the application process and which comprise the administrative record formed the basis for the determination aside from the documents identified in the above paragraph no other documents were exchanged during the exemption application process the form_1024 application provided actual financial information for the short tax_year of october 19xx through december 19xx only no proposed budgets for 20xx and 20xx were included with the application the application showed org received insurance premiums ofdollar_figurein 19xx no investment_income was earned during the short tax_year no other revenue was reported in 19xx the form_1024 application reported total assets ofdollar_figurefrom cash and accounts_receivable for 19xx no physical assets were reported on the application_for the short tax_year org filed forms for the years 20xx and 20xx org did not report any changes in operation on form_990 filed with the internal_revenue_service for the years 20xx and 20xx org did not submit additional documents or otherwise provide notice to the internal_revenue_service of changes in operations subsequent to the issuance of the january 20xx determinations ruling letter iii law and analysis is organ insurance_company exempt from tax pursuant to sec_501 for the taxable years 20xx and 20xx the first issue is whether org is an insurance_company exempt from tax pursuant to sec_501 for the taxable years 20xx and 20xx sec_501 provides that certain entities are exempt from taxation included in these entities are i nsurance companies or associations other form a rev department of the t reaswy - internal_revenue_service page -7- ' form886a i name of taxpayer org department of the t reaslll ' internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx than life including interinsurers and reciprocal underwriters if the net written premiums or if greater direct written premiums for the taxable_year do not exceeddollar_figure sec_501 l5 a definition of an insurance_company neither sec_501 nor its corresponding regulations define an insurance_company subchapter_l ofthe code i r c however addresses the taxation of insurance_companies the term_insurance company has the same meaning under sec_501 l5 as it does in subchapter_l see h conf_rep no 99th cong 2nd sess vol ii reprinted in vol c b sec_816 formerly sec_801 defines a life_insurance_company as part of this definition i r c sec_816 provides the term 'insurance company' means any company more than half of the business ofwhich during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies sec_1_801-3 defines an insurance_company as a company whose primary and predominant business activity during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies thus though its name charter powers and subjection to state insurance laws are significant in determining the business which a company is authorized and intends to carry on it is the character of the business actually done in the taxable_year which determines whether a company is taxable as an insurance_company under the internal_revenue_code sec_1_801-3 emphasis added see also 285_us_182 the irs has not ruled on whether the more stringent greater than half' test set forth in sec_816 applies to an insurance_company other than a life_insurance_company instead to determine whether a non-life insurance_company qualifies as an insurance_company for tax purposes the primary and predominant business activity test set forth in sec_1_801-3 applies see revrul_68_27 1968_1_cb_315 if an entity is a part of a consolidated_group all net written premiums or direct written premiums of the members of the group are aggregated to determine whether the insurance_company meets the requirements of sec_501 c a a consolidated_group during 20xx and 20xx therefore there are no other premiums to aggregate with the premiums org received during 20xx and 20xx pursuant to sec_501 c b sec_501 c b here org is not part of form a rev department of the treasury- internal_revenue_service page -8- - - - - - - - - - - - - - - - - ' form886a i name of taxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx the courts and the irs have also at times looked to whether the transaction has characteristics traditionally associated with insurance and whether the company conducts business like an insurance_company in order for org to be considered an insurance_company entitled to tax exempt status under sec_501 for the taxable years 20xx and 20xx its primary and predominant business activity during the years must have been issuing insurance contracts or reinsuring insurance risks see sec_816 sec_1_801-3 org was not issuing insurance contracts or reinsuring the risks of others during 20xx and20xx neither the internal_revenue_code nor the regulations specifically define the term_insurance contract the courts have generally required that a transaction involve both risk shifting from the insured's perspective and risk_distribution from the insurer's perspective in order to be characterized as insurance 312_us_531 914_f2d_396 3rd cir 19xx risk shifting occurs when a person facing the possibility of a loss transfers some or all of the financial consequences of the loss to the insurer revrul_88_72 1988_2_cb_31 clarified by revrul_89_61 1989_1_cb_75 the risk transferred pursuant to an insurance_contract must be a risk of economic loss 66_tc_1068 affd 572_f2d_1190 7th cir cert_denied 439_us_835 risk_distribution refers to the operation of the statistical phenomenon known as the the law of large numbers when additional statistically independent risk exposure units are insured although the potential total losses increase there is also an increase in the predictability of average loss this increase in the predictability of the average loss decreases the amount of the capital that an insurance_company needs per risk unit to remain at a given solvency level see revrul_89_61 1989_1_cb_75 the warranty repair insurance_policy based on the review of the activities conducted by org during the period of october 19xx through december 20xx it was determined that org wrote only a single insurance_policy annually the annual policy provided warranty insurance to c0-2 which is owned by two ofthe three directors of org it appears that the primary and predominant activity of org is not insurance the contracts executed between org and the c0-2 does not constitute insurance because the policy lacks the characteristic of risk_distribution in order for the contracts to be insurance the characteristics of risk shifting and risk_distribution must be present form l rev department of the treasury internal_revenue_service page -9- form886a i name oftaxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx with respect to the warranty repairs policy insured by org during years 19xx through 20xx the irs concedes that the policy holders shifted the risks associated with the policy ultimately to org at issue therefore is whether org had adequate risk_distribution on the policy one treatise on insurance in explaining risk_distribution states that w hen insurance is considered from the viewpoint of an insurer it is appropriately viewed as a system for risk_distribution as well as risk transference insurers deal with the uncertainty of whether a given insured will sustain a loss by combining the risks ofloss for many ventures of a given type into a pool keeton and widiss insurance law a guide to fundamental principles legal doctrines and commercial practices p west group the courts have not spent a great deal of time explaining what they mean by risk_distribution no court has squarely held that there can be no risk_distribution ifthere is only one or a few insureds a fair reading of the court opinions addressing the issue however supports the irs s position see 801_f2d_984 ih cir risk distributing is the spreading of the risk ofloss among the participants in an insurance program see also 183_f2d_288 2d cir such spreading is effectuated by pooling among unrelated insureds r isk distribution means that the party assuming the risk distributes his potential liability in part among others beech aircraft coro v united_states f 2d f 2d loth cir risk_distribution is accomplished where the risk is distributed among insureds other than the entity that incurred the loss see 401_f2d_464 5th cir the sixth circuit touched on the issue of risk_distribution in 881_f2d_247 6th cir noting there was adequate risk_distribution where the captive insures several separate corporations within an affiliated_group and losses can be spread among the several distinct corporate entities the ninth circuit has also measured risk_distribution by explaining i nsuring many independent risks in return for numerous premiums serves to distribute risk by assuming numerous relatively small independent risks that occur randomly over time the insurer smoothes out losses to match more closely its receipt of premiums 811_f2d_1297 9th cir there cannot be risk_distribution when there is only one insured during 19xx through 20xx org failed to adequately distribute the risks associated with its warranty repair policy during these years the warranty repairs policy with c0-2 is the only policy insured by org in addition c0-2 is owned by officers shareholders of org org did not maintain numerous or several independent risks in exchange for numerous premiums compared to the taxpayers in humana and clougherty insuring a single warranty repairs policy at any given time does not qualify as adequate risk_distribution conclusion form a rev department of the treasury- internal_revenue_service page -10- ' form886a i name oftaxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx we conclude that the warranty repair and replacement policy sold by org to c0-2 lacks the characteristic of risk_distribution and therefore is not insurance within the meaning of 312_us_531 because the primary and predominant activity of org is not insurance org does not qualify as an insurance_company within the meaning of part i or part ii of subchapter_l and does not qualify for tax-exempt status under sec_50l c l5 as a small insurance_company b does org a foreign company which made an election under sec_953 continue to qualify for exemption from federal_income_tax as an organization described in sec_501cl5 facts org was incorporated in the country on october 19xx c0-3 was the initial subscriber of org shares of org stock were subsequently transferred to its current shareholders bm-1 interest bm-2 interest and bm-3 c interest org a country co-l company elected to be treated as a u s entity pursuant to sec_953 org filed an application on form_1024 for recognition of exempt status under sec_50l c the form_1024 application postmarked september 20xx was received by the internal_revenue_service on september xx a form_8718 user_fee for exempt_organization determination_letter request was also received by the internal_revenue_service on september 20xx the application package included a co-l memorandum of association for org dated october 19xx and co-l articles of incorporation for org dated october 19xx by letter dated october 20xx the internal_revenue_service acknowledged receipt of the application and advised the applicant the form_1024 application had been referred to the national_office for ruling in its application_for recognition of exempt status org represented it operated and would operate in the future as follows org is organized and is currently functioning as an insurance_company under the laws of the country org commenced insurance operations in 19xx to provide warranty insurance org insures the customers of c0-2 for any warranty claims which may arise during the insolvency of c0-2 or during an assignment for the benefit of creditors of c0-2 or non-performance by c0-2 as a result of an act of god there are currently no plans to alter the future business activities from those as described above form a rev department of the t reaswy - internal_revenue_service page -11- form886a i name oftaxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx question in part ii of the form_1024 application requests financial information as follows list the organization's present and future sources of financial support beginning with the largest source first org' application made the following claims about financial support oro's financial support is derived from the issuance of insurance contracts for a premium additional support is generated from investment_income part iii of the application financial data reflects org' actual figures for 19xx proposed budgets for 20xx and 20xx were not included in the application part iii of the application also shows revenue from insurance premiums in the amount ofdollar_figurefor 19xx covering the period october 19xx through december 19xx no projected figures for insurance premium revenues for 20xx and 20xx were reported the same premium income information dollar_figure is provided at schedule i no other sources of revenue were reported in part iii of the form_1024 application under part iii assets org lists cash on line ofdollar_figureand accounts_receivable on line ofdollar_figure no other assets were reported in part iii of the form_1040 application the application was signed september 20xx by bm-3 as director of org other directors listed on the application are bm-1 and bm-2 in a january 20xx letter prepared by c0-2 org disclosed that two directors bm-1 and bm-2 are also co-owners of the c0-2 on september 20xx bm-3 signed a form_2848 power_of_attorney authorizing c0-2 to represent org in connection with the form_1024 application forms for 19xx through 20xx and other returns pc 1120l 1120f for the same period the service by letter dated october 20xx requested additional information from org it asked for a description of the program a copy of all policies and or service contracts executed by org names and percentage of ownership of the c0-2 a copy of the annual report filed with co-l for 19xx and proof of its sec_953 election in its january 20xx response org provided a two page narrative responding to irs questions a copy of the warranty repair replacement insurance_policy no financial statement for year 19xx org disclosed that it does not reinsure any warranty insurance org insures the customers of the c0-2 for any warranty claims which may arise during the insolvency ofc0-2 bm-1 and bm-2 husband and wife owndollar_figure and respectively on the xx financial statement org reported premium income ofdollar_figure no investment_income was reported in the financial statement under assets the balance_sheet showed cash and accounts_receivable in the amount ofdollar_figure no liabilities or loss_reserves were reported four pages and a two-page 'lo ofc0-2 the service issued a favorable determination_letter to org on january xx the determination_letter issued to org states form 886-a rev department of the treasury - internal_revenue_service page -u- form886a name oftaxpayer org department of the treasmy- internal_revenue_service e lanation of items schedule no or exhibit year period ended 20xx 20xx based on the information supplied and assuming your operations will be as stated in your application_for recognition of exemption we have determined you are exempt from united_states income_tax under sec_501 of the code as an organization described in sec_501 commencing on october 19xx for tax_year s when your net written premiums or if greater your direct written premiums do not exceed thedollar_figurelimit as prescribed by this sec_501 this ruling is based on the financial and other information submitted in support of your application this ruling is not effective unless you actually operate as represented please notify the xyz employee_plans exempt_organizations ep eo customer service office if there is any change in your name address sources of support or method of operation org filed forms for the tax years 19xx through 20xx the internal_revenue_service examined org' form_990 for 20xx and 20xx the form_990 for 20xx was signed by the preparer at c0-2 on october xx and by bm -2 on november 20xx the 20xx form_990 was postmarked on november 20xx and received by the service_center on november 20xx the c0-2 preparer signed the form_990 for 20xx on october 20xx and bm-1 president signed the return on november 20xx the 20xx form_990 was postmarked on november 20xx and received by the service_center on november 20xx org is not tax-exempt for xx and years subsequent and filed form_1120 u s_corporation income_tax return on examination it was determined org had premium income ofdollar_figurein 20xx and dollar_figurein 20xx and investment_income totaling dollar_figurein 20xx and dollar_figure in 20xx these figures which were reflected on forms for 20xx were confirmed by review of books_and_records based on the examination of the activities and financial data for 20xx and xx and the inspection of prior years' returns the corporation's sole activity consisted of selling the initial warranty insurance_policy to c0-2 and renewing such policy on an annual basis the initial insurance_policy 19xx was purchased by c0-2 on november 19xx the policy includes the following language the org company agrees to provide insurance protection as specified in this coverage for the named insured s on whose behalf a premium has been paid named insureds shall be construed to mean valid holders of certificates of insurance issued hereunder as a result of their purchase of products or services produced and sold by c0-2 c0-2 under the terms of the policy org was responsible specifically to insure the customers of the c0-2 for any warranty claims that may arise during the insolvency of c0-2 or during an assignment for the benefit of creditors of c0-2 or non-performance by c0-2 as a result of an act of god form a rev department of the treasury - internal_revenue_service page -13- fonn886a name of taxpayer org department of the treaswy- internal_revenue_service ex lanation of items schedule no or exhibit year period ended 20xx 20xx since the inception of org the c0-2 has been the sole holder of a certificate of insurance referred to in the terms ofthe policy in addition the c0-2 is the only insured and the only payer of insurance premiums to org org has never sold warranty or any other type of insurance to any other party no other policyholders existed during the period of october 19xx to date in the november 20xx response to idr attorney provided the following information regarding the activities of org the only policy in effect during years 19xx through 20xx was policy number policy incorporates all three lines of business into a singular policy org had intentions of writing additional policies in accordance with the three lines ofbusiness approved in the 19xx minutes however no other policies were written during that time period it is the intent of org to expand its insurance coverage by writing wind water hurricane damage insurance currently org has taken an inactive status with the country insurance board until such time as final resolution ofthe current irs audit this from the date of inception through december 20xx org incurred no insurance claims because none ofthe acts initiating the coverage occurred nor were loss_reserves set-aside by org to cover any anticipated future insurance claims the 20xx 20xx c0-2 financial statements note e included the following statement policies written provide for coverage on a claims-made basis up to the date of the approval of these financial statements no claims have been received the company has not made a reserve for policy losses and related expenses however because of the length of time required for the ultimate liability for losses and loss expenses to be determined the net amounts that will ultimately be paid to settle any liability are not presently determinable the only other activity conducted by org during the period of october 19xx through december 20xx was the selling and purchasing of securities and approving loans to the c0- org reported minimal operating_expenses during this period it incurred typical organizational costs such as licensing and fees accounting fees insurance administration fees irs application fee and bank interest charges org did not report the payment of salaries and wages because it hired no employees or other staff to conduct its business org provided no evidence of any other activities that it conducted during the period of october 19xx through december 20xx policy executed with the c0-2 on november 19xx form 886-a rev department of the t reaswy internal_revenue_service page -14- form886a i name oftaxpayer org depanment of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended xx 20xx there was no evidence of any material changes in org' operations from those described in its form_1024 application and the operations actually conducted by org law sec_501 of the internal_revenue_code provides that organizations described in sec_501 shall be exempt from income_taxation sec_501 describes as exempt insurance_companies or associations other than life including interinsurers and reciprocal underwriters if the net written premiums or if greater direct written premiums for the taxable_year do not exceeddollar_figure sec_501 an organization is exempt under sec_501 only in those years in which it meets the dollar_figurelimitation on premium income the premium income test includes amounts received by all entities in the exempt organization's controlled_group sec_501 c the exempt status of an organization may be recognized by the internal_revenue_service through the application process described in a revenue_procedure issued by the service see revproc_2004_1 -1 i r b revproc_90_27 1990_1_cb_514 although not required to apply for a determination_letter in order to claim exempt status organizations seeking recognition of exemption from the internal_revenue_service under sec_501 must file a form_1024 application_for recognition of exemption under sec_501 a determination_letter recognizing tax exempt status is issued by the internal_revenue_service to an organization where its application and supporting documents establish that it meets the requirements of the category of exemption it claims revproc_90_27 sec_5 1990_1_cb_514 all information by the applicant must be provided under penalties of perjury rev_proc - dollar_figure 2003-1i r b the application process ends with the issuance of a determination_letter a determination_letter is a written_statement issued by the internal_revenue_service in response to a written inquiry by an individual or an organization that applies to the particular facts sec_601_201 a if the commissioner revokes the tax -exempt status of an organization the remaining question is whether the revocation should be applied prospectively or retroactively generally revocation of a determination_letter is prospective revproc_2003_4 dollar_figure cross-referencing dollar_figure et seq revocation of a determination_letter may however be retroactive if the organization omitted or misstated a material fact or operated in a manner materially different from that originally represented sec_601_201 revproc_90_27 revproc_2003_4 dollar_figure cross-referencing dollar_figure et seq analysi sec_1 org is not described in sec_501 during the years under exam to be exempt from federal_income_tax under sec_501 as an entity described in sec_501 c the entity must be an insurance_company or association other than life including form i rev department of the treasury internal_revenue_service page -15- ' form886a i name oftaxpayer org department of the treaswy- internal_revenue_service e xplanation of items schedule no or exhibit year period ended 20xx 20xx inter-insurers and reciprocal underwriters in addition it must meet a premium income requirement a producer-owned_reinsurance_company porc like org is an insurance_company or association for purposes of sec_501 if it issues insurance contracts distributes and transfers insurance risks and otherwise conducts business like an insurance_company as discussed at page sec_2 through of this report org did not operate in accordance with the standards recognized by the internal_revenue_service for an insurance_company and therefore is not an insurance_company for federal_income_tax purposes because the examination showed org is not an insurance_company it is not eligible to retain its exempt status under sec_501 in addition an entity described in sec_501 in a given year must not have net written premiums or if greater direct written premiums for that taxable_year in excess ofdollar_figure sec_501 the premium income test applies to all entities in the exempt organization's controlled_group sec_501 c org is not a member of a controlled_group within the meaning of sec_831 b b ii org did not have net written or direct written premiums in excess ofdollar_figure because org was not an insurance_company or association during the year under exam it is not exempt from federal_income_tax under f a as an entity described in sec_501 c and revocation of the service's recognition of exempt status is appropriate org cannot rely on its determination_letter an organization may not rely on a favorable determination_letter if the organization omitted or misstated a material fact in its application or in supporting documents an organization also may not rely on a favorable determination if there is a material_change inconsistent with exemption in the organization's character purposes or methods of operation after the determination_letter is issued sec_601_201 revproc_2005_4 i r b date the conclusion that org is not an insurance_company during the years 20xx and 20xx rests primarily on an analysis of its sources of revenue and its business activities see pages of this report in order to understand an organization's financial structure and activities and conclude that the organization is an insurance_company and therefore entitled to be recognized as exempt it is critical for the service to have complete financial information and also a fair and accurate description of the organization's activities primary source of financial support the form_1024 application at part ii line requires an applicant to identify its primary source of financial support org listed insurance premiums first org made the following representations org's financial support is derived from the form a rev department of the t reasmy - internal_revenue_service page -16- t' form886a name of taxpayer org department of the treasmy- internal_revenue_service e lanation of items schedule no or exhibit year period ended 20xx 20xx issuance of insurance contracts for a premium additional support is generated from investment_income on its form_1024 application org represented that it was formed on october xx financial information on the form_1024 was presented for a short time frame from october 19xx through december xx org' representation on the form_1024 that it had actual revenue for xx ofdollar_figurefrom insurance activity for the short_year period made sense in this context and bolstered the applicant's representation that it was engaged in legitimate start-up insurance activities the form_1024 application did not provide projected revenues for 20xx and xx nor were projected revenues for 20xx and 20xx requested in correspondence received from eo technical in the section of the application requiring org to include proposed budgets for xx and xx org responded by entering n a org filed its initial form_990 for xx and reported income from insurance premiums ofdollar_figureas its only source of support examination oforg showed the source and amount oforg's program service revenue differed significantly from representations made in the form_1024 application the chart below shows the contrast between projected program service revenue for xx and xx as reflected on the form_1024 application and actual revenue earned for xx and xx projections form_1024 figures from actual revenue 20xx program service revenue investment_income dollar_figure -0- dollar_figure -0- other revenue dollar_figure -0- dollar_figure program service revenue dollar_figure -0- dollar_figure dollar_figure dollar_figure investment_income dollar_figure -0- dollar_figure other revenue dollar_figure -0- dollar_figure the applicant's description bears only a slight relationship to org' actual operations from its inception in october 19xx through december 20xx the method of operations described by org in its form_1024 application differed from its actual operations in that org appears to insure c0-2 while its application indicates that it insures the customers of c0-2 the examination revealed that org issued a single insurance_policy in november xx which was renewed annually for years xx 20xx and xx for warranty repair and replacement form a rev department of the treasury - internal_revenue_service page -17- form886a i name of taxpayer org department of the treaswy- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx insurance the c0-2 is the only named insured in the policy in addition the c0-2 is the only payer of insurance premiums to org each year although the policy allows customers of the c0-2 to have products under warranty repaired or replaced org does not collect insurance premiums directly from customers of the c0-26 the information presented on the form_1024 gave the clear impression that org would insure a pool of risks by executing numerous individual warranty repair and replacement policies with customers of the c0-2 while in fact org' actual business is that of insuring only the risk of the c0-2 which is co-owned by two of its shareholders bm-1 and bm-2 org did not assume any insurance risks in addition to the warranty repair and replacement coverage org did not once come back to the internal_revenue_service to correct its description of activities or it income projections for 20xx or 20xx nor did org provide additional facts relating to those projections as specified in org' determination application the following facts are critical to a determination of recognition of exemption under sec_501 source_of_income primary source org's primary source of revenue for 20xx and 20xx was insurance premium income premiums comprised however the service determined that the premium income is not derived from insurance activities as defined in 312_us_531 org did not file form_990 as a tax-exempt_insurance_company for 20xx of total income for 20xx and for 20xx use of capital and efforts no actual sales of insurance products the only insurance product ever sold by org was the warranty repair and replacement policy sold to the c0-2 c0-2 is co-owned by two of org' shareholders no other warranty repair or any other policies were sold by org to unrelated parties the initial warranty repair policy with the c0-2 was renewed on an annual basis during years 20xx through 20xx minimal effort org devoted little time to its insurance activities including the development and marketing of insurance products since its inception org has not paid any claims under the warranty repair policy because none of the events that cause the policy to take effect have occurred ie bankruptcy of the c0-2 group inc nor is there any evidence that customers pay insurance premiums to the c0-2 which in turn are reinsured by org org is not engaged in reinsurance activities org is a direct writer of the warranty repairs and replacement insurance that is sold to the c0-2 form a rev department of the t reaswy internal_revenue_service page -18- form886a name of taxpayer org department of the treasmy- internal_revenue_service ex lanation of items schedule no or exhibit year period ended 20xx 20xx as detailed above org' form_1024 application omitted relevant financial data during the application process org omitted source_of_income projections for 20xx and 20xx in addition org misrepresented that org would insure customers of the c0-2 when according to the policy the insured is in fact the c0-2 all of these facts representations and omissions were in our view material to the ruling on the application and go to the essence of the issues raised on examination we do not urge erroneous projections standing alone are the equivalent of misstatements of material facts we grant in an uncertain world revenue projections can miss the mark with respect to a possible future request for relief under sec_7805 org may argue the projections at issue are not part of the retroactivity equation presumably however the irs gives weight to financial projections during the application process if so the irs presumably insists and requires the applicant disclose all known and relevant financial information that bear on those projections at the application stage to permit fair consideration of the financial picture of an applicant organization as noted above it is not the erroneous projections but omission of material facts relating to these projections that is significant these omissions of critical financial information affected the service's consideration of the form_1024 application on its form_1024 org also misrepresented its insurance activities reinsurance activities material misstatements in part ii of the form_1024 application org misrepresented that org would insure customers of the c0-2 when according to the policy the insured is in fact the c0-2 in its january 20xx correspondence with the internal_revenue_service org provided a copy of the warranty repair and replacement policy which includes the following language the org agrees to provide insurance protection as specified in this coverage for the named insured s on whose behalf a premium has been paid this policy is issued in trust to c0-2 for the benefit of customers of c0-2 to whom c0-2 has sold its various products or services but c0-2 shall have no fiduciary duty to any party other than as custodian of the policy for purposes of org' request for b relief this provides an additional ground to deny relief materiality analysis a fact listed below developed on examination that was not provided by org on its form_1024 application form 886-a rev department of the treasury internal_revenue_service page -19- form886a i name of taxpayer org department of the treaswy- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx org failed to include income projections from its insurance activities and other sources for 20xx and 20xx in summary we think the availability of this factual information would likely have prompted the exempt_organizations division to conclude org was not operated as an insurance_company accordingly in our view org may not rely on its favorable determination_letter sec_7805 relief while revocation of a determination_letter is generally not retroactive revocation of a determination_letter may be retroactive if the organization omitted or misstated a material fact or operated in a manner materially different from that originally represented sec_601 20l n i see also revproc_2004_1 2004_1_irb_1 revproc_90_27 dollar_figure cross-referencing dollar_figure et seq 1990_1_cb_514 or misstated a material fact revocation may be retroactive to all open years under the statute see sec_601_201 in cases where revocation is due to a material_change inconsistent with exempt status in the character the purpose or the method of operation revocation will ordinarily take effect as of the date of the material_change sec_601_201 revproc_90_27 in any event revocation will ordinarily take effect no later than the time at which the organization received written notice that its exemption ruling or determination_letter might be revoked sec_601_201 in cases where the organization omitted in this case the agent recommends that revocation should be revoked for the year that org' activities were not consistent with the requirements of sec_501 the service determined that org did adequately disclose its operations in the form_1024 application however during the examination of tax years 20xx and 20xx the service concluded that org did not operate primarily and predominantly for an insurance purpose because its agreement with c0-2 group did not constitute insurance thus org does not meet the requirements under sec_501 and revocation of its tax exempt status is proposed accordingly it is recommended that org' tax exempt status be revoked effective january xx the first day of the year under audit in addition the service determined that org' election to be treated as a domestic_corporation for tax purposes under sec_953 is not valid and org should be treated as a controlled_foreign_corporation for tax years beginning january 20xx sec_953 of the code allows a foreign_insurance_company to elect to be treated as a domestic company for tax purposes if it meets certain requirements one such requirement is that the foreign company must be a company that would qualify under part i or ii of subchapter_l for the taxable_year if it were a domestic_corporation see sec_953 form a rev department of the t reaswy - internal_revenue_service page -20- ' ' form886a i name of taxpayer org depanment of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20x x if it is determined that a controlled_foreign_corporation cfc does not qualify as an insurance_company under part i or part ii of subchapter_l it will fail to meet the requirements for electing under sec_953 to be treated as a domestic_corporation therefore it will be treated as a foreign_corporation for tax purposes as a foreign_corporation with u s shareholders it will potentially be subject_to the subpart_f passive_foreign_investment_company pfic and foreign_personal_holding_company fphc regimes based on the facts reviewed it is determined that org has not operated as an insurance_company within the meaning of subchapter_l of the internal_revenue_code since the date in which it was granted exempt status under sec_50l c the primary and predominant activity of org is not the conduct of an insurance_business therefore revocation of exempt status under sec_501 is proposed effective january xx the first day of the tax_year under audit n taxpayer's position a preliminary revenue_agent's_report was mailed to attorney on december 20xx attorney requested and received an extension oftime to respond to the report until february 20xx during a february 20xx telephone conversation attorney's initial response was to agree that the contract between org and the c0-2 is not insurance because the contract lacks risk_distribution attorney indicated that he will not contest the sec_501 l5 exempt status of org however attorney wanted to know if there would be any subpart_f consequences resulting from the proposed loss oforg's tax-exempt status attorney followed up the telephone conversation by submitting a fax on february 20xx in the fax attorney requested that the possibility for protesting the proposed revocation of exemption remain open attorney indicated that the organization disagreed that it is a controlled_foreign_corporation cfc a passive_foreign_investment_company pfic or a foreign_personal_holding_company fphc no other position was expressed by the attorney or the organization in response to the preliminary revenue_agent's_report v conclusions a org is not an insurance_company exempt from tax pursuant to sec_50l c l5 for the taxable years 20xx and 20xx and thus revocation of exempt status under sec_501 is proposed effective january 20xx form 886-a rev department of the treasury- internal_revenue_service page -21- t fonn886a i name oftaxpayer org department of the treasury- internal_revenue_service explanation of items schedule no or exhibit year period ended 20xx 20xx b org a foreign company which made an election under sec_953 does not continue to qualify for exemption from federal_income_tax as an organization described in sec_501 c because org is not an insurance_company it made an invalid sec_953 election to be taxed as a domestic_corporation for the taxable years 20xx and 20xx instead org is a controlled_foreign_corporation and its shareholders are subject_to tax on oro's subpart_f_income alternatively the irs could apply sec_269 to disregard the tax benefits derived by the shareholders and c0-2 for the taxable years 20xx and 20xx derived from its formation of org form 886-a rev department of the t reaswy internal_revenue_service page -22-


t c summary opinion united_states tax_court wayne robert risley and nanette risley petitioners v commissioner of internal revenue respondent docket no 10857-05s filed date robert l risley for petitioners kevin w coy and kelly r morrison-lee for respondent laro judge petitioners petitioned the court to redetermine respondent’s determination of deficiencies in and accuracy-related_penalties related to their joint and federal_income_tax returns return return and return respectively collectively subject returns petitioners filed their petition pursuant to the provisions of sec_7463 this case is now before the court on respondent’s motion for summary_judgment we hold that respondent is entitled to summary_judgment and shall enter a decision accordingly pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case background i preliminaries petitioners are husband and wife they resided in california when their petition was filed they filed the subject returns jointly ii tax_shelter petitioners participated in a fraudulent tax_shelter tax_shelter promoted and sold by the national audit defense network nadn the nadn advertised itself as a conglomerate of former internal_revenue_service agents enrolled agents certified public accountants and tax attorneys who could help u s taxpayers pay no federal_income_tax the nadn informed petitioners that they could qualify for significant tax benefits by forming a web site and then paying the nadn to modify the web 1section references are to the applicable versions of the internal_revenue_code rule references are to the tax_court rules_of_practice and procedure site to comply with the americans with disabilities act of ada publaw_101_336 104_stat_355 codified pincite u s c sec a the ada generally provides that any person who owns leases or operates a place of public accommodation shall not discriminate against disabled individuals in the full and equal enjoyment of goods services facilities privileges advantages and accommodations of the place of public accommodation the nadn informed petitioners that they had to pay the nadn dollar_figure and issue to the nadn a dollar_figure promissory note as to each year in which they wanted to participate in the tax_shelter payments on a note were to be made from the revenue generated by the web site or if no revenue was generated years after the note’s making the nadn informed petitioners that they could claim a dollar_figure tax_credit pursuant to sec_44 and deduct at least dollar_figure of business_expenses pursuant to sec_162 for each year that they participated in the tax_shelter the nadn advised petitioners that it was not providing them nor was it engaged in the rendering of any legal accounting or other professional service and that they should retain a competent professional if they wanted any legal advice or other expert assistance with respect to the tax_shelter petitioners paid the nadn dollar_figure in each subject year to participate in the tax_shelter petitioners also signed at least one dollar_figure promissory note payable to the nadn or to an affiliate thereof iii subject returns a return petitioners prepared their return themselves petitioners attached a schedule c profit or loss from business sole_proprietorship to their return reporting that petitioner wayne r risley mr risley operated an electronic shipping and information service business during the only item_of_income or expense reported on the schedule c was a dollar_figure expense identified as excess expenditures_for modifications made for disabled access to business petitioners also attached a form_8826 disabled_access_credit to their return the form_8826 reported that petitioners paid dollar_figure in total eligible_access_expenditures during and were claiming a dollar_figure disabled_access_credit for petitioners claimed the dollar_figure credit on their return b return petitioners prepared their return themselves petitioners attached a schedule c to their return reporting that mr risley operated an apple electronic shopping information business during the only item_of_income or expense reported on the schedule c was a dollar_figure expense identified as excess expenditures_for modifications made for sic petitioners also attached a form_8826 to their return the form_8826 reported that petitioners paid dollar_figure in total eligible_access_expenditures during that petitioners had a current_year disabled_access_credit of dollar_figure and that petitioners were claiming dollar_figure of the dollar_figure as an allowable disabled_access_credit for petitioners claimed the dollar_figure credit on their return c return petitioners’ return was prepared by h_r block petitioners’ return did not report any income or deductions as to the tax_shelter petitioners attached a form_8826 to their return the form_8826 reported that petitioners paid dollar_figure in total eligible_access_expenditures during and that petitioners were claiming a dollar_figure disabled_access_credit for petitioners claimed the dollar_figure credit on their return iv notice_of_deficiency respondent issued petitioners a notice_of_deficiency as to the subject returns respondent determined in the notice_of_deficiency that petitioners were not entitled to any of the deductions or credits claimed as to the tax_shelter for the respective years respondent determined deficiencies of dollar_figure dollar_figure and dollar_figure respondent also determined accuracy-related_penalties under sec_6662 and b of dollar_figure dollar_figure and dollar_figure respectively for negligence or disregard of rules and regulations i standard for summary_judgment discussion summary_judgment may be granted with respect to any part of the legal issues in controversy if the record before the court shows no genuine issue as to any material fact and that a decision may be rendered as a matter of law see rule a and b 119_tc_252 respondent bears the burden of proving the absence of any genuine issue of material fact and all facts are viewed in the light most favorable to petitioners see craig v commissioner supra pincite petitioners however must do more than merely allege or deny facts they must set forth specific facts showing that there is a genuine issue for trial see rule d 477_us_317 petitioners have failed to raise any genuine issue of material fact under that standard and this case is ripe for summary_judgment 2these deficiencies total dollar_figure and petitioners’ cash expenditures as to the tax_shelter total dollar_figure dollar_figure x petitioners reportedly realized an economic gain of dollar_figure from the tax_shelter dollar_figure - dollar_figure dollar_figure ii deficiencies petitioners make no claim that sec_44 and sec_162 actually allow them to deduct or credit the items that they reported as to the tax_shelter cf good v commissioner tcmemo_2008_245 holding on the merits that the taxpayers were not entitled to the sec_162 expenses and disabled business credits reported as to the tax_shelter petitioners’ primary argument in challenging respondent’s determination of the deficiencies is that respondent is equitably estopped from assessing against them any amount relating to the tax_shelter we disagree equitable_estoppel is a judicial doctrine that precludes a party from denying his or her acts or representations which induced another to act to his or her detriment see 98_tc_695 the following requirements must be satisfied where as here equitable_estoppel is asserted against the commissioner a false representation by the commissioner or his wrongful misleading silence an error in a statement of fact and not in an opinion or statement of law ignorance of the true facts a taxpayer’s reasonable reliance on the commissioner’s acts or statements and adverse effects of the commissioner’s acts or statement see 104_tc_13 affd 140_f3d_240 4th cir petitioners’ failure to establish any one of these five requirements means that their claim of equitable estopped must fail as well petitioners have failed to establish on the part of respondent either a false representation or a wrongful misleading silence as to the tax_shelter to that end we are unable to find as to the tax_shelter that respondent made any representation let alone any misrepresentation to petitioners or otherwise wrongfully concealed from petitioners any material fact instead the record establishes and we so find that respondent had no contact with petitioners as to the tax_shelter before his audit of the subject returns and that petitioners invested in the tax_shelter separate and apart from any_action taken by respondent petitioners argue that the statements of the the nadn’s workforce are imputed to respondent to the extent that those workers were registered with the internal_revenue_service as enrolled agents or tax preparers petitioners also argue that the tax_shelter is imputed to respondent because the nadn advertised that it employed those workers as well as former internal_revenue_service employees we disagree on both counts the record does not establish nor do petitioners claim that any of the nadn’s workers also were working for the internal revenue 3given this failure we need not and do not address any of the other four requirements of equitable_estoppel service at the same time moreover the mere fact that a former employee of the internal_revenue_service or an individual registered with the internal_revenue_service as an enrolled_agent or a tax preparer may have been affiliated with the nadn and or the tax_shelter does not estop respondent from challenging the legitimacy of the tax_shelter see auto club of mich v commissioner 353_us_180 holding that the commissioner is usually not estopped from correcting retroactively a mistake of law see also 283_f2d_503 9th cir 111_tc_215 n 41_tc_316 affd 353_f2d_429 3d cir nor do we believe as petitioners argued that respondent was sufficiently aware of the impropriety of the tax_shelter through petitioners’ filing of their return so that he is estopped from challenging any of the amounts that petitioners later claimed as to the tax_shelters for and petitioners also argue that the government should bear the loss of any federal income taxes owed by them as to the tax_shelter because respondent failed to inform petitioners that the tax_shelter was a fraud and is in a better position than they to recover the dollar_figure that they paid to the nadn we disagree while petitioners consider it inequitable that they have to pay taxes as to the tax_shelter when they have paid dollar_figure to the nadn for what they now consider to be a worthless investment we know of no reason the government should act as an insurer of that investment nor do we agree with petitioners that they are entitled for the subject years to deduct the dollar_figure as a theft_loss under sec_165 while sec_165 lets an individual deduct a theft_loss in the year during which the individual discovers the loss see sec_165 c e the record does not establish that petitioners discovered any such theft_loss during the subject years we hold that respondent is not estopped from disallowing the claimed amounts accordingly we sustain respondent’s determination of the deficiencies iii accuracy-related_penalties respondent determined that petitioners are liable for accuracy-related_penalties under sec_6662 and b sec_6662 and b imposes a penalty equal to percent of the portion of an underpayment_of_tax attributable to a taxpayer’s negligence or disregard of rules or regulations negligence connotes a lack of due care or failure to do what a reasonable and prudent person would do under the circumstances see 92_tc_1 affd 925_f2d_348 9th cir an accuracy-related_penalty is not applicable to any portion of an underpayment to the extent that the taxpayer had reasonable_cause for that portion and acted in good_faith with respect thereto see sec_6664 respondent bears the burden of production with respect to the applicability of the accuracy-related_penalties see sec_7491 that burden requires that respondent produce sufficient evidence that it is appropriate to impose the accuracy-related_penalties see 116_tc_438 once respondent meets this burden the burden_of_proof falls upon petitioners see id pincite petitioners may carry their burden by proving that they were not negligent ie that they made a reasonable attempt to comply with the provisions of the internal_revenue_code and were not careless reckless or in intentional disregard of rules or regulations see sec_6662 alternatively petitioners may establish that their underpayment was attributable to reasonable_cause and their acting in good_faith see sec_6664 we conclude that respondent has met his burden of production and that petitioners have failed to carry their burden_of_proof the record establishes that petitioners claimed significant amounts of tax benefits to which they neither were entitled nor had a reasonable claim the record does not establish that petitioners made a reasonable attempt to comply with the provisions of the internal_revenue_code that petitioners’ underpayment was attributable to reasonable_cause or that petitioners acted in good_faith as to the underpayment petitioners claim that the subject returns were prepared and reviewed by the nadn and that they reasonably relied on the nadn to prepare those returns correctly we reject that claim as factually and legally incorrect as a point of fact petitioners prepared their and returns themselves h_r block prepared their return and the nadn informed petitioners that it was not providing them with any legal or other professional service and that they should retain a competent professional if they wanted any legal advice or other expert assistance with respect to the tax_shelter as a point of law any such claimed reliance upon the nadn if it in fact had occurred would not be reasonable in the setting of this case given that the nadn was the tax shelter’s promoter see 115_tc_43 affd 299_f3d_221 3d cir we hold that petitioners are liable for the accuracy-related_penalties respondent determined accordingly we sustain respondent’s determination as to those penalties iv conclusion we have considered all of petitioners’ contentions and have concluded that those contentions not discussed herein are without merit to reflect the foregoing an appropriate order and decision will be entered for respondent