t c memo united_states tax_court max burton enterprises inc petitioner v commissioner of internal revenue respondent docket no filed date james a jensen charles j ingber and joel p leonard for petitioner robert s scarbrough for respondent memorandum findings_of_fact and opinion cohen chief_judge respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax for the tax_year ended date the issue for decision is whether deductions claimed by petitioner for salary and bonuses paid to its officers who were also shareholders exceeded reasonable_compensation unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference at the time the petition was filed petitioner’s principal_place_of_business was in tacoma washington during the year in issue petitioner produced and sold stove-top grills stove-top burner covers and other kitchen accessories petitioner was incorporated in the state of washington on date by max burton max burton was the father of linda burton ms burton and alfred burton mr burton and the husband of evelyn burton ms burton was married to robert denovan denovan from date through date max burton served as president and treasurer and mr burton served as vice president and secretary of petitioner from date through his death on date max burton was president and treasurer ms burton was vice president and mr burton was secretary of petitioner from date through date ms burton was president denovan was vice president and mr burton was secretary and treasurer of petitioner immediately prior to max burton’s death the outstanding shares of petitioner were owned as follows owner shares owned william mueller max burton linda burton alfred burton robert denovan total big_number big_number big_number the shares of stock owned by william mueller were redeemed by petitioner for dollar_figure during the tax_year ended date as of date the outstanding shares of petitioner were owned as follows number of shares held percentage of shares held linda burton alfred burton evelyn burton robert denovan big_number big_number in date max burton was diagnosed with cancer he underwent chemotherapy and surgery during his illness petitioner’s business as described by ms burton pretty much ran itself attempts to sell the business had been unsuccessful and max burton was anxious to have the business continue max burton spoke to ms burton mr burton and denovan about continuing the business ms burton was initially reluctant but agreed only when max burton consented to her ideas about increasing the level and scope of business activity in date max burton and ms burton went to korea where the burner covers that were sold by petitioner were manufactured they observed a cooking concept known as bulgogi in which meat was cooked on a metal plate placed over hot charcoal as of date ms burton took over the affairs of petitioner by petitioner primarily through the efforts of ms burton had adapted the bulgogi cooking concept to american stove burners the burton stove top grill was first sold in the u s market in ms burton attended community college for years after high school after taking over petitioner’s business she attended continuing education classes in finance for small businesses computers advertising letter writing brochure writing and employee relations between and she worked with her father as he started the burner cover business but she was not paid for that work after completing her years of college she worked for alaska airlines for a year she then worked for the port of seattle police department for years but she left there in when she married denovan who was a sergeant with the port of seattle police department in ms burton was employed in petitioner’s business at that time ms burton made initial sales calls developed sales promotional material and developed an in-house system of tracking customers to increase sales because of declining business and differences with her father about business decisions ms burton left petitioner in and began to work for continental airlines ms burton worked at continental airlines until and remained as an employee on inactive status until while at continental airlines she was a customer service agent for about months and then was promoted to a supervisory position she very much enjoyed that job and particularly the valuable travel benefits available by reason of that employment after the death of max burton no employee of petitioner had executive responsibilities other than ms burton mr burton and denovan ms burton was responsible for the general management of petitioner she directly supervised the other two officers established company goals and philosophies and directed manufacturing quality control she was responsible for seeking overseas manufacturers and she personally negotiated manufacturing and shipping agreements with them many of the contracts that were negotiated by ms burton were with korean companies she traveled to foreign countries including korea taiwan and china in order to seek overseas manufacturers and to negotiate manufacturing and shipping agreements ms burton established and was personally involved in the operation of petitioner’s public relations division creating various advertising and sales-related literature and other promotional materials she designed the packaging material for petitioner’s products and promoted petitioner to various national and regional newspapers as petitioner’s spokespersons and goodwill ambassadors ms burton and denovan planned and personally participated in national trade shows to promote petitioner’s products since ms burton implemented a strategic change in petitioner’s marketing focus prior to her becoming president petitioner had sold its goods primarily to small giftware shops she eliminated petitioner’s catalog retail sales and concentrated on selling petitioner’s products on a wholesale basis to implement the change in marketing focus away from the small giftware shops to the large national department stores new sales representatives were required denovan replaced petitioner’s existing force of giftware sales representatives with houseware sales representatives denovan assembled a nationwide team of sales representatives managed through a network of sales organizations ms burton and denovan negotiated commission agreements with petitioner’s sales representatives and agreed to pay the sales representatives a commission of up to percent as a result of its change in marketing strategy petitioner secured national department stores including j c penney’s bloomingdale’s the bon marche dayton hudson marshal field’s and dillards as new customers for petitioner’s products when ms burton became president of petitioner petitioner had a dollar_figure line of credit with the bank of puget sound when the bank of puget sound refused to increase petitioner’s line of credit ms burton approached other banks seafirst bank agreed to provide petitioner with a dollar_figure line of credit from through ms burton and mr burton worked closely with robert drugge a vice president of seafirst bank to increase petitioner’s line of credit to finance petitioner’s expansion seafirst bank began providing letters of credit that were used by petitioner and issued to manufacturers of petitioner’s products on or about date seafirst bank increased petitioner’s line of credit to dollar_figure during the relevant periods ms burton mr burton and denovan signed personal guaranties to guaranty the repayment of lines of credit extended by the bank of puget sound and seafirst bank mr burton as secretary and treasurer of petitioner was responsible for all accounting functions of petitioner prepared financial plans and budgets prepared loan applications and was in charge of relations with seafirst bank mr burton studied accounting and computer operations at a community college beginning in mr burton designed installed and maintained the computer system of petitioner part of that system included a program that tracked customer responses to advertisements and a program used for the company’s accounting at all relevant times mr burton also worked for a company known as fiserv installing computer systems for banks as vice president of petitioner denovan developed and executed sales and marketing strategies and was responsible for organizing and managing petitioner’s national sales representatives he was responsible for hiring employees and was in charge of the shipping of petitioner’s products from suppliers to vendors during the calendar_year petitioner employed a total of employees at all relevant times denovan was employed full time by the port of seattle police department where he was responsible for training and scheduling special teams of police petitioner had gross_receipts and retained earnings for its tax years as follows gross_receipts retained earnings dollar_figure dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number on date bonus checks were issued by petitioner bonuses were paid to ms burton mr burton and denovan in the amounts of dollar_figure dollar_figure and dollar_figure respectively twenty percent of these amounts was withheld and paid to the internal_revenue_service as federal_income_tax the proceeds of the bonus checks were immediately returned to petitioner in exchange for promissory notes dated date the bonuses that were paid to petitioner’s employees during the calendar_year other than amounts paid to its officers were each less than dollar_figure the total compensation salary and bonus deducted by petitioner for its tax years was as follows linda burton dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure alfred burton big_number dollar_figure big_number big_number big_number big_number big_number robert denovan big_number big_number petitioner had a group medical and life_insurance plan for all of its employees including its officers the officers decided to take their compensation in the form of salary and bonuses and not to adopt a pension or other retirement_plan petitioner did not pay dividends respondent determined that the amount of compensation that was paid to the above individuals was unreasonable the salaries that were claimed were allowed as reasonable_compensation but bonuses were reduced as follows ms burton’s salary bonus allowed total allowed dollar_figure big_number dollar_figure mr burton’s salary bonus allowed total allowed denovan’s salary bonus allowed total allowed opinion dollar_figure big_number dollar_figure dollar_figure big_number dollar_figure sec_162 allows as a deduction a reasonable allowance for salaries or other compensation_for_personal_services actually rendered sec_1_162-9 income_tax regs provides that bonuses paid to employees are deductible when such payments are made in good_faith and as additional compensation_for the services actually rendered by the employees provided that such payments when added to the stipulated salaries do not exceed a reasonable_compensation for the services rendered whether an expense that is claimed pursuant to sec_162 is reasonable_compensation for services rendered is a question of fact that must be decided on the basis of the particular facts and circumstances 58_tc_1055 affd without published opinion 474_f2d_1345 5th cir the burden is on petitioner to show that it is entitled to a compensation deduction larger than that allowed by respondent 819_f2d_1315 5th cir affg tcmemo_1985_267 under certain circumstances prior services may be compensated in a later year 281_us_115 59_tc_231 affd in part and revd in part 536_f2d_289 9th cir however in such instances the taxpayer must establish that there was not sufficient compensation in the prior periods and that in fact the current year’s compensation was to compensate for that underpayment 95_tc_525 affd on another ground 965_f2d_1038 11th cir the cases contain a lengthy list of factors that are relevant in the determination of reasonableness including the employee’s qualifications the nature extent and scope of the employee’s work the size and complexities of the business a comparison of salaries paid with gross_income and net_income the prevailing general economic conditions a comparison of salaries with distributions to stockholders the prevailing rates of compensation_for comparable positions in comparable concerns the salary policy of the taxpayer as to all employees and the amount of compensation paid to the particular employee in previous years 178_f2d_115 6th cir affg a memorandum opinion of this court see also 166_f2d_221 5th cir in 716_f2d_1241 9th cir revg and remanding tcmemo_1980_282 the court_of_appeals for the ninth circuit divided the factors into five broad categories to wit the employee’s role in the company comparison of the employee’s salaries with those paid_by similar companies for similar services the character and condition of the company including the complexities of the business and general economic conditions factors indicating a conflict of interest such as the employee’s shareholder status and internal consistency in a company’s treatment of payments to employees no single factor is determinative 399_f2d_603 9th cir affg tcmemo_1967_7 73_tc_1142 when the case involves a closely_held_corporation with the controlling shareholders setting their own level of compensation as employees the reasonableness of the compensation is subject_to close scrutiny owensby kritikos inc v commissioner supra elliotts inc v commissioner supra pincite respondent relies on 6_tc_999 and contends that the bonuses in question were not paid during petitioner’s tax_year respondent argues that the payments by checks dated date and immediate loans back to petitioner lacked economic_substance and were entered into solely for tax-avoidance purposes respondent acknowledges that because this argument was not set forth in the statutory notice respondent bears the burden_of_proof on this issue we are not persuaded that the evidence in the record supports the conclusion that bonuses were not actually paid during the tax_year in issue respondent has not proven that this case is comparable to maggio bros co v commissioner supra pincite where the stockholders had no intention of receiving the proceeds of the bonus checks as salary payments in the respective taxable years id we do however consider the facts concerning those transactions as part of our analysis of whether the compensation deducted by petitioner was reasonable a second area of dispute between the parties is whether the bonuses that were paid for the fiscal_year ended in were intended to compensate the recipients of those bonuses for undercompensation in earlier years ms burton mr burton and denovan each testified credibly that they accepted minimal compensation in the early developmental years in anticipation that their efforts would be rewarded in later years we are persuaded that the bonuses that were paid in date were intended in part to compensate for undercompensation in earlier years petitioner must also prove that its executive employees were in fact undercompensated in earlier years respondent argues that the executives were not undercompensated in earlier years based on limited sales and low or negative return on equity in the earlier years each party presented expert testimony in support of its positions on appropriate compensation levels we are not bound by the opinion of any expert when the opinion is contrary to our own judgment 92_tc_525 affd 933_f2d_1084 2d cir we may embrace or reject expert testimony whichever in our judgment is most appropriate 304_us_282 thus we are not restricted to choosing the opinion of one expert over another but may extract relevant findings from each in drawing on our own conclusions 92_tc_312 here the experts’ usefulness is primarily in the data that they collected and analyzed rather than in their ultimately subjective evaluations of petitioner’s officers respondent’s expert e james brennan iii brennan determined maximum and highest average annual total compensation levels for each position he acknowledged that in comparison to other officers in similar businesses petitioner’s officers were undercompensated he concluded that ms burton was entitled to a high level of compensation and that during fiscal years and ms burton was paid approximately dollar_figure below the average total compensation amounts paid to chief executive officers of bonus-paying companies of similar size brennan then attempted to justify the undercompensation by referring to ms burton’s limited relevant experience and lack of formal credentials he opined if petitioner’s top financial and sales executives who worked only part-time were similarly credited with half the highest average rates for experienced full-time executives in same-size enterprises that would create approximately dollar_figurek in undercompensation in fy88 and approximately dollar_figurek in fy89 such amounts are more than made up by granting them the highest averages in fy90 when they were still part-time executives with minimal objective credentials we agree that the executives’ limited experience and lack of formal credentials could be factors to be taken into account there is however no evidence in the record of the experience or credentials of those persons earning the salaries that the experts used for comparison and petitioner’s business is not of the character requiring formal education thus perceived deficiencies in formal training of the employees should not be used as a direct offset from compensation determined by the use of comparables petitioner’s expert tracy a bean bean of arthur andersen llp did not address the limited experience and credentials of the executives nor did she consider the lack of complexity of the business operations of petitioner she added dollar_figure for long-term incentives and dollar_figure for retirement benefits to the cash compensation averages of the comparable companies we believe that these additions are unwarranted without proof that petitioner’s employees could command such incentives in a business controlled by outside investors see elliotts inc v commissioner f 2d pincite bean did not determine reasonable salaries for each of the executives separately using comparisons at the 75th percentile she concluded that petitioner could have paid compensation to its executive team for to in the amount of dollar_figure we are not persuaded that the amounts should be aggregated in this manner rather compensation to each officer should be separately evaluated bean’s team approach inappropriately treats all three executives as performing above average services upon consideration of all of the data in the experts’ reports the stipulated facts and the testimony of petitioner’s officers concerning the roles that they performed in petitioner’s business we conclude that ms burton’s contributions were extraordinary but that those of mr burton and denovan were not thus ms burton’s compensation should take into account brennan’s highest maximum dollar_figure and bean’ sec_90th percentile dollar_figure compensation to chief executive officers and add undercompensation acknowledged by brennan for years in addition to her role as chief_executive_officer ms burton shared with denovan many duties of a sales executive and is entitled to a supplement for that role see elliotts inc v commissioner supra pincite mr burton’s compensation should take into account brennan’s highest average dollar_figure and bean’s median dollar_figure for chief financial officers as well as the undercompensation acknowledged by brennan for years denovan’s compensation should take into account brennan’s highest average dollar_figure and bean’s median dollar_figure for top sales executives and undercompensation acknowledged by brennan for years petitioner has not persuaded us that the undercompensation levels exceeded those acknowledged by brennan and thus has failed to meet its burden of proving greater entitlements using our best judgment on the entire record we conclude that for the fiscal_year ended date reasonable_compensation including compensation_for earlier years is dollar_figure for ms burton and dollar_figure for mr burton the amount determined in the same manner for denovan would exceed the amount_paid to him during that year and petitioner’s deduction is limited to the amount actually paid to take account of these conclusions decision will be entered under rule


department of the treasury i n t e r n al r e v e n u e s e r v i c e washington d c office_of_chief_counsel date uilc no number release date cc ita wta-n-109773-01 memorandum for mary engdahl tax specialist sb_se tec from subject lewis j fernandez deputy associate chief_counsel income_tax accounting by george baker federal emergency management agency payments-cerro grande fire - flood insurance and claim expenses this technical assistance memorandum is in response to your request dated date as supplemented by your requests dated date and date regarding the tax treatment of certain payments that the federal emergency management agency fema may make to individuals and businesses in new mexico that suffered losses due to the cerro grande fire these payments are authorized by the cerro grande fire assistance act the act pub_l_no 114_stat_511 technical assistance does not relate to a specific case and is not binding on directors or their offices or area directors appeals as those terms are described in revproc_2001_2 sec_1 2001_1_irb_79 pincite this document may not be cited as precedent issues must a homeowner include in income a reimbursement from fema for the cost of the homeowner’s flood insurance premium must a claimant under the act include in income fema’s payments for claim preparation expenses does sec_1033 apply to exclude gain resulting from insurance proceeds received for unscheduled personal_property that was destroyed in a presidentially_declared_disaster even though the property was not physically located in the taxpayer’s principal_residence at the time it was destroyed wta-n-109773-01 must a claimant include in income insurance proceeds or fema payments received under the act for inventory destroyed in the fire conclusions a homeowner need not include in income a payment received under the policies of the office of cerro grande claims to cover the homeowner’s expenses of paying a premium for flood insurance for the home a claimant should treat fema’s payments for claim preparation expenses as additional_amounts received from fema however the claim preparation expenses_incurred by the claimant are also treated as reductions in the total amount received in determining the amount_realized for purposes of determining any gain on damaged or destroyed property although sec_1033 refers to a taxpayer’s principal_residence or any of its contents the legislative_history indicates that congress meant to include all of a taxpayer’s personal_property associated with its principal_residence whether or not the property was actually located inside the principal_residence at the time of its destruction accordingly gain resulting from insurance proceeds received for unscheduled personal_property that was destroyed in a presidentially_declared_disaster may be excluded from income even though the property was not physically located in the taxpayer’s principal_residence at the time it was destroyed whether a claimant recognizes gain due to the receipt of insurance or fema payments for inventory destroyed in the fire depends both upon whether the amount received exceeds the basis of the inventory and whether the taxpayer elects to defer gain under sec_1033 facts the cerro grande fire resulted from a prescribed fire ignited on date by national park service fire personnel at the bandelier national monument new mexico the fire ultimately burned more than big_number acres in four counties and the pueblos of san ildefonso and santa clara and destroyed more than residential structures the severity of damage throughout northern new mexico resulted in a presidential disaster declaration fema-1329-dr fed reg date on date president clinton signed the act into law during calendar_year fema issued interim final regulations c f_r et seq and made wta-n-109773-01 partial payments on claims as authorized by act sec_104 and of the regulations the stated purposes of the act are to compensate victims of the fire for injuries and to provide expeditious consideration and settlement of claims for those injuries act sec_102 the act created within fema an office of cerro grande fire claims ocgc and requires that office to administer a program for fully compensating those who have suffered personal injury property losses business_losses and financial losses resulting from the fire act sec_104 explicitly states e ach injured person shall be entitled to receive from the united states- a compensation_for injury suffered by the injured person as a result of the cerro grande fire as well as additional damages itemized in the legislation the act limits payments to compensatory_damages measured by injuries suffered act sec_104 sec_104 authorizes fema to pay compensation_for uncompensated losses for damage to tangible assets or inventory sec_104 of the act authorizes fema to pay compensation_for specified uncompensated financial losses for a premium for flood insurance that is required to be paid on or before date if as a result of the cerro grande fire a person that was not required to purchase flood insurance before the cerro grande fire is required to purchase flood insurance the policy guidelines of the office of cerro grande claims for payment of flood insurance premiums provide that the office will reimburse any flood insurance premium due and payable on or before date for any property owner concerned about being at risk as a result of the cerro grande fire whether or not flood insurance purchase has been required by a lender or other authority the payment will not be made if the claimant either had flood insurance before the fire or was required to have flood insurance but did not implementing regulations at dollar_figure also provide that fema will reimburse claimants for the reasonable costs they incur in copying documentation requested by ocgc fema will also reimburse claimants for the reasonable costs they incur in providing appraisals or other third-party opinions requested by ocgc fema will not reimburse claimants for the cost of appraisals or other third party opinions not requested by ocgc under policies of the office of cerro grande fire claims at a fema will pay some claimant sec_1 of the claim up to dollar_figure in order to cover the claimant’s expenses of preparing the claim the act does not permit payments for certain other types of damages including punitive_damages or interest before settlement an individual seeking compensation under the act for injuries resulting from the cerro grande fire makes a final and conclusive election not to file a claim against the united_states for those injuries under wta-n-109773-01 chapter of title united_states_code commonly known as the federal tort claims act or any other provision of law act sec_104 law and analysis flood insurance sec_61 provides generally that gross_income means all income from whatever source derived in 348_us_426 1955_1_cb_207 the united_states supreme court held that the concept of gross_income encompassed accessions to wealth clearly realized over which taxpayers have complete dominion sec_262 provides that except as otherwise provided for in this chapter no deduction shall be allowed for personal living or family_expenses sec_1_262-1 further provides some examples of personal_living_and_family_expenses such as premiums_paid for life_insurance by the insured cost of insuring a dwelling owned and occupied by the taxpayer as a personal_residence and expenses of maintaining a household in this case homeowners not required to have flood insurance may as a result of the fire believe such insurance is now necessary this need may be attributable to the fire’s destruction of vegetation throughout the area which may have increased the risk of future flooding the reimbursement could be seen as the government’s direct provision of a substitute for the protection previously provided by the now-burned vegetation thus it is a reimbursement for a cost that would not have been incurred were it not for the damage caused by the government’s action or inaction equally it might be seen as a means of restoring the pre-fire value of flood protection afforded by vegetation that was destroyed by the cerro grande fire viewed in this light the insurance premiums resemble replacement_property and the reimbursements resemble additional compensation_for the damaged property regardless of the view adopted we believe that under the unique circumstances in which this reimbursement is paid the government’s reimbursements of flood insurance premiums need not be treated as gain payments for claim expenses under implementing regulations fema has undertaken to bear the cost through reimbursement of any documentation specifically required of claimants by fema fema has also made clear that it will not reimburse claimants for any expenses_incurred that were not specifically requested by ocgc in addition under policies of wta-n-109773-01 the office of cerro grande fire claims fema will pay some claimant sec_1 of the claim up to dollar_figure in order to cover the claimant’s expenses of preparing the claim these payments may appropriately be treated as additional_amounts received on account of the claim in order to receive those amounts the claimant may be put to some specific expense such as for documentation required by fema or such as payments that can be substantiated as being for expenses of preparing the claim including for example fees to third parties for their expertise in the case of cerro grande act payments it therefore seems that such costs of claimants may be treated as an adjustment to the total amount they receive in order to arrive at the amount_realized for purposes of determining gain on the destruction of property to which the payment may relate since gain if any resulting from converting the property into the payment from fema is determined in the same manner as if the property had been sold offsetting the expenses of making the claim against the claim proceeds may be viewed as similar to a selling expense that would be offset against proceeds if the property had been sold instead of being damaged or destroyed accordingly under the specific facts presented by the cerro grande act while the reimbursements of claim expenses constitute an additional_amount received the service should permit payments that can be substantiated as being for expenses of preparing the claim to be treated also as reducing the total amount received in determining the amount_realized for purposes of determining any gain on damaged or destroyed property payment for contents not located in the residence sec_1033 provides special rules for principal residences and personal_property destroyed as a result of a presidentially_declared_disaster sec_1033 provides for the nonrecognition of gain by reason of receipt of insurance proceeds for unscheduled personal_property which was part of the contents of a taxpayer’s principal_residence other personal_property of a taxpayer ie property not located in the principal_residence which might be involuntarily converted by the same disaster is not specifically mentioned in the statute although a literal reading of the statute might lead to the conclusion that insurance proceeds for such personal_property is not subject_to the gain exclusion we believe congress did not intend to exclude any personal_property customarily insured as unscheduled personal_property on a homeowner’s or renter’s policy merely because it was not physically located in the residence when it was destroyed sec_1033 was added to the omnibus_budget_reconciliation_act_of_1993 pub_l_no just prior to the bill’s finalization by the conference committee this provision was first introduced in as part of h_r which was vetoed by the president on other grounds it was also introduced in as s the provision contained in these earlier bills was incorporated into pub_l_no with virtually wta-n-109773-01 no changes in describing the earlier senate version of the provision senator feinstein stated t his legislation would exclude capital_gains on any unscheduled personal_property insurance proceeds rarely if ever reimburse a taxpayer fully for their loss and this would minimize the recordkeeping involved in listing losses of all personal_property and the replacement cost of normal household property cong rec date senator feinstein’s remarks suggest that congress was concerned with allowing taxpayers to replace normal household property with a minimum of record keeping and without having to report capital_gains when they are usually not reimbursed fully for their losses many individuals have normal household property which they do not routinely keep in their homes for example some individuals may store their golf clubs or baby strollers in the trunks of their cars additionally some individuals may keep radios or exercise equipment at their offices if a homeowner’s or renter’s policy covers such items when they are not physically located in the principal_residence and they are destroyed in a presidentially_declared_disaster then a taxpayer should not be denied the gain exclusion of sec_1033 simply because an item was in the trunk of a car or on the desk at work instead of in the basement or attic of his or her principal_residence payments for destroyed inventory sec_61 of the internal_revenue_code provides generally that gross_income means all income from whatever source derived however with regard to manufacturing merchandising or mining businesses the term gross_income means the total sales less cost_of_goods_sold plus any income from investments and from incidental or outside operations or sources see sec_1_61-3 a taxpayer determines its costs of goods sold during a year by subtracting inventory on hand at the end of the year from the sum of the inventory on hand at the beginning of the year and the cost of purchases see 88_tc_1500 in footnote of our memorandum in wta-n-130562-00 dated date we indicated that sec_1033 is not available for deferring gain recognized on involuntary_conversions of inventory we have reconsidered this issue and under these circumstances now believe the better technical view to be that a taxpayer who receives insurance or other proceeds for involuntarily converted inventory may elect to defer recognition of any resulting gain as provided in sec_1033 if however gain is recognized it will result in ordinary_income rather than capital_gain because sec_1221 explicitly excludes inventory from the definition of capital_asset nor would the gain qualify as wta-n-109773-01 sec_1231 gain treated as capital_gain because sec_1231 excludes inventory from the type of property that gives rise to sec_1231 gain accordingly the determination of whether a taxpayer recognizes gain due to the receipt of insurance proceeds or fema payments under the act connected with destroyed inventory depends both upon whether the payments exceed the basis of the inventory and whether the taxpayer elects to defer gain under sec_1033 we hope this memorandum is helpful if you have any further questions please contact george baker at


internal_revenue_service number release date index number ------------------ ------------------------------------ ------------------------ ------------------------------------- ------------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------------- id no ---------------- ----------------- telephone number ---------------------- refer reply to cc corp b5 plr-129385-18 date date legend parent ------------------------------------------------------------ -------------------------- sub ------------------------------------------------------------ ---------------------------------------- sub ------------------------------------------------------------ ----------------------------------------- sub ------------------------------------------------------------ ----------------------------------------------------- sub ------------------------------------------------------------ ---------------------------------------- de ------------------------------------------------------------ -------------------------------------- de ------------------------------------------------------------ --------------------------------------- de ------------------------------------------------------------ ------------------------------ de newco ---------------------- ------------------------ -------------------------------- plr-129385-18 ------------------------------------------------------------ busine sec_1 busine sec_2 ---------------------- ------------------------- bankruptcy court ------------------------------------------------------------------------------------------------------------------ -------------------------------------------------------------------------------- -------------- --------- ----------- -------- -------- --------------------------- ---------------------- ------------------------ -------------------------- ------ ------ ------ ---- -------------- ------------ ---------------- ---------------- state a state b state c year year date date date date a b c d e f g h dear ------------ plr-129385-18 this letter responds to your authorized representatives’ letter dated date requesting rulings under sec_1502 of the internal_revenue_code with respect to certain tax consequences of the proposed transaction defined below the information provided in that request is summarized below the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination summary of facts parent is a state a corporation and the common parent of an affiliated_group_of_corporations that join in the filing of a u s consolidated federal_income_tax return the parent consolidated_group the parent consolidated_group is currently engaged in two distinct business segments i busine sec_1 and ii busine sec_2 the relevant corporate structure of the parent consolidated_group prior to the proposed transaction is as follows parent wholly owns de which in turn wholly owns de de and de are state a limited_liability companies that are disregarded for federal_income_tax purposes de wholly owns sub a state b corporation in turn sub wholly owns i sub a state c_corporation and ii multiple directly and indirectly owned subsidiaries sub wholly owns multiple directly and indirectly owned subsidiaries the busine sec_1 subs certain busine sec_1 subs are debtors to third-party creditors the underlying assets and operations of busine sec_1 are held and operated by the busine sec_1 subs and by sub and certain of its subsidiaries other than the busine sec_1 subs sub also owns directly and indirectly through its ownership of de and de approximately a by value and b by vote of the issued and outstanding shares of sub a state a corporation de and de are state a limited_liability companies that are disregarded for federal_income_tax purposes the remaining c by value and d by vote of the issued and outstanding shares of sub are publicly traded sub in turn wholly owns sub a state a corporation the underlying assets and operations of busine sec_2 are held and operated by sub and its subsidiaries the sub subgroup and by sub and certain of its subsidiaries other than members of the sub subgroup prior to the proposed transaction sub has an excess_loss_account within the meaning of sec_1_1502-19 ela in its sub stock including the plr-129385-18 shares held through de and de the sub ela of approximately dollar_figuree the sub ela was generated as a result of an intercompany dividend that sub made to sub in year and has been further adjusted by additional intercompany_dividends made to sub and investment adjustments under sec_1_1502-32 in subsequent years prior to the proposed transaction sub has an ela in its sub stock the sub ela of approximately dollar_figuref the sub ela was generated as a result of an intercompany dividend that sub made to sub in year and has been further adjusted by investment adjustments under sec_1_1502-32 in subsequent years as of date sub and certain of the busine sec_1 subs were obligated on approximately dollar_figureg of long-term debt sub is a guarantor with respect to a portion of this debt in addition as of date sub was obligated on an intercompany note to sub the intercompany note on date parent and certain of its subsidiaries filed for relief under chapter of the bankruptcy code with the bankruptcy court on date the bankruptcy court confirmed parent’s plan_of_reorganization the plan proposed transaction for what are represented by parent to be valid business reasons and in connection with the plan parent desires to undertake the following steps some of which have already occurred the proposed transaction i on date sub formed newco a state a corporation ii de and de distributed all of their sub stock to sub iii sub will convert to a state a limited_liability_company that will be treated as disregarded_entity for federal_income_tax purposes the sub conversion iv sub will be released from its guarantee of sub 1’s indebtedness v sub will contribute all of the stock of the busine sec_1 subs to newco in exchange for the common_stock and non-voting preferred_stock of newco the busine sec_1 subs transfer vi pursuant to a pre-arranged and binding commitment sub will sell the non-voting preferred_stock of newco to one or more third parties in exchange for cash the newco preferred_stock sale and together with the busine sec_1 subs transfer the newco transfer vii sub will distribute the common_stock of newco and the cash proceeds of the newco preferred_stock sale to sub plr-129385-18 viii sub and its subsidiaries will transfer certain assets used in busine sec_2 to the sub subgroup and the sub subgroup will transfer certain assets used in busine sec_1 if any to sub and its subsidiaries ix sub will merge with and into sub pursuant to a statutory merger under applicable state law with sub surviving the statutory merger the sub merger the public shareholders of sub will receive common_stock of sub as consideration in the sub merger x sub as successor to sub is estimated to receive approximately dollar_figureh as its recovery under the plan with respect to the intercompany note xi sub will issue non-voting preferred_stock to one or more third parties for cash the sub preferred_stock issuance xii parent will contribute newly issued common_stock and or warrants to sub xiii sub may but will not necessarily contribute consideration to one or more of its subsidiaries to be distributed to certain creditors under the plan the contribution xiv certain busine sec_1 subs that are issuers of third-party debt will each issue an intercompany note to sub in an amount not greater than the value sub will pay to certain creditors with respect to claims that are allocated to such certain busine sec_1 subs for tax purposes reduced by the amount of consideration contributed to such certain busine sec_1 subs in the contribution xv sub will transfer consideration which includes all of the common_stock of sub held by sub to certain creditors pursuant to the plan to the extent that sub contributes consideration to any subsidiary pursuant to the contribution such subsidiary will distribute such consideration to certain creditors pursuant to the plan no right of subrogation or contribution shall arise in favor of any subsidiary of sub with respect to or on account of any distributions under the plan representations i the sub ela and sub ela existed before the proposed transaction was contemplated ii the sub conversion will qualify as a complete_liquidation under sec_332 iii the fair_market_value of the assets of sub will exceed the amount of liabilities both immediately before and immediately after the sub conversion iv sub will recognize gain_or_loss to the extent permitted by sec_1 in the newco transfer under sec_1001 plr-129385-18 v the sub merger will qualify as a complete_liquidation under sec_332 with respect to sub and a reorganization under sec_368 with respect to sub 3’s public shareholders vi the fair_market_value of the assets of sub will exceed the amount of its liabilities both immediately before and immediately after the sub merger vii if the sub ela and or the sub ela were taken into account under sec_1_1502-19 the only federal tax consequence identified by parent is that the corresponding gain might result in positive investment adjustments which would be factored into any sec_1_1502-36 analysis and the relevant impacts of other provisions of the code or regulations as a result of such adjustments in connection with the transfer of the stock of sub rulings based solely on the information and representation submitted we rule as follows with respect to the proposed transaction i the sub ela will be eliminated without the recognition of gain as a result of the sub merger sec_1_1502-19 ii the sub ela will be eliminated without recognition of gain as a result of the sub conversion sec_1_1502-19 caveats except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in particular no opinion is expressed concerning any aspect of any transaction or item occurring as part of the plan whether prior to or following the proposed transaction or the effect of any such transaction or item on the rulings above procedural statements this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative plr-129385-18 a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of this letter_ruling sincerely gerald b flemings gerald b fleming senior technician reviewer branch office of associate chief_counsel corporate


internal_revenue_service department of the treasury index numbers washington dc number release date person to contact telephone number refer reply to cc dom p si - plr-119980-98 date date x a b c country d1 dear this letter responds to a letter dated date and subsequent correspondence submitted by your authorized representative on behalf of x requesting an extension of time to file an election for x to be treated as a partnership for federal_income_tax purposes under sec_301_7701-3 of the procedure and administration regulations for its taxable_year beginning d1 the information submitted indicates that x was incorporated on d1 under the laws of country a and b are the sole shareholders of x c the president of x and a represents that x was intended to be treated as a partnership for united_states tax purposes under the current classification rules x is required to make an election to be treated as a partnership for federal tax purposes however due to x’s attorney’s misunderstanding of the filing deadline for a form_8832 no election was timely filed sec_301_7701-3 provides guidance on the classification of a foreign eligible_entity for federal tax purposes generally a foreign eligible_entity is treated as an association_taxable_as_a_corporation if all members have limited_liability unless the entity makes an election to be treated otherwise if a foreign eligible_entity has more than one owner it may elect to be taxable as a partnership pursuant to the rules in sec_301_7701-3 which provides that an entity classification election must be filed on form_8832 and can be effective up to days prior to the date the form is filed or can be effective up to months after the date on which the form was filed under sec_301_9100-1 of the procedure and administration regulations the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i if the taxpayer demonstrates to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting the relief will not prejudice the interests of the government sec_301_9100-1 defines the term regulatory election as including an election whose deadline is prescribed by a notice published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government in the present situation the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time for making the election to be treated as a partnership for federal tax purposes until days following the date of this letter the election should be made by following the procedure set forth in form_8832 and a copy of this letter should be attached to the election except as specifically set forth above no opinion is expressed or implied as to the federal tax consequences of the transactions described above under any other provision of the code this ruling is directed only to the taxpayer on whose behalf it was requested sec_6110 provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being forwarded to your authorized representative sincerely yours paul f kugler assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ----------------------------------- ---------------------------- -------------------------------- re -------------- --------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ------------------ telephone number ---------------------- refer reply to cc psi plr-101483-17 date april legend decedent ----------------------- ---------------------------------------------------- ------------------- spouse --------------------- date date ----------------------- ------------------- dear ---------------- this letter responds to your personal representative’s letter of date and subsequent correspondence requesting an extension of time pursuant to sec_301_9100-3 of the procedure and administration regulations to make the election under sec_2010 of the internal_revenue_code code portability election to allow a decedent’s surviving_spouse to take into account that decedent’s deceased spousal unused exclusion dsue amount the facts and representations submitted are as follows decedent died on date survived by spouse date is a date after the effective date of the amendment to sec_2010 which provides for portability of a dsue amount to a surviving_spouse to obtain the benefit of portability of decedent’s dsue amount to spouse decedent’s estate was required to file form_706 united_states estate and generation-skipping_transfer_tax return on or before the date that is nine months after decedent’s date of death or the last day of the period covered by an extension decedent’s form_706 was due on date the estate discovered its failure to elect portability after the due_date for making the election plr-101483-17 decedent’s estate represents that the value of decedent’s gross_estate plus his lifetime adjusted_taxable_gifts is less than the basic exclusion amount in the year of the decedent’s death decedent’s estate requests an extension of time pursuant to sec_301_9100-3 to elect portability of decedent’s dsue amount pursuant to sec_2010 law and analysis sec_2001 imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2010 provides that a credit of the applicable credit_amount shall be allowed to the estate of every decedent against the tax imposed by sec_2001 sec_2010 provides that the applicable credit_amount is the amount of the tentative_tax that would be determined under sec_2001 if the amount with respect to which such tentative_tax is to be computed were equal to the applicable_exclusion_amount on date congress amended sec_2010 effective for estates of decedents dying and gifts made after date to allow portability of a decedent’s unused applicable_exclusion_amount between spouses tax relief unemployment insurance reauthorization and job creation act of pub_l_no sec_303 124_stat_3296 sec_2010 provides that the applicable_exclusion_amount is the sum of the basic exclusion amount and in the case of a surviving_spouse the dsue amount sec_2010 generally provides that the basic exclusion amount is dollar_figure to be adjusted for inflation annually after calendar_year sec_2010 defines the dsue amount to mean the lesser_of a the basic exclusion amount or b the excess of -- i the applicable_exclusion_amount of the last deceased spouse of the surviving_spouse over ii the amount with respect to which the tentative_tax is determined under sec_2001 on the estate of such deceased spouse sec_2010 provides that a dsue amount may not be taken into account by a surviving_spouse under sec_2010 unless the executor of the estate of the deceased spouse files an estate_tax_return on which such amount is computed and makes an election on such return that such amount may be so taken into account the election once made shall be irrevocable no election may be made if such return is filed after the time prescribed by law including extensions for filing such return plr-101483-17 sec_2010 provides that the secretary shall prescribe regulations as may be necessary or appropriate to implement sec_2010 sec_20_2010-2 a of the estate_tax regulations provides that to allow a decedent’s surviving_spouse to take into account that decedent’s dsue amount the executor of the decedent’s estate must elect portability of the dsue amount on a timely filed form_706 under sec_20_2010-2 the due_date of an estate_tax_return required to elect portability is nine months after the decedent’s date of death or the last day of the period covered by an extension if an extension of time for filing has been granted sec_20_2010-2 further provides that an extension of time to elect portability may be available under the procedures applicable under sec_301_9100-1 and sec_301_9100-3 for estates not required to file an estate_tax_return under sec_6018 sec_20_2010-2 provides that the portability election is made by timely filing a complete and properly prepared estate_tax_return unless the executor satisfies the requirements for the election not to apply in sec_20_2010-2 sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute a request for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election sec_6018 requires the filing of an estate_tax_return in all cases where the gross_estate exceeds the basic exclusion amount in effect under sec_2010 for the calendar_year which includes the date of death for purposes of this determination under sec_6018 the basic exclusion amount is reduced but not below zero by the sum of -- a the amount of the adjusted_taxable_gifts within the meaning of sec_2001 made by the decedent after date plus b the aggregate amount allowed as a plr-101483-17 specific exemption under sec_2521 as in effect before its repeal by the tax reform act of with respect to gifts made by the decedent after date decedent’s estate represents that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is not required to file an estate_tax_return under sec_6018 under these facts the commissioner has discretionary authority under sec_301_9100-3 to grant to decedent’s estate an extension of time to elect portability based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly we grant an extension of time of days from the date of this letter in which to elect portability under sec_2010 the election should be made by filing a complete and properly prepared form_706 and a copy of this letter within days from the date of this letter to the cincinnati service_center at the following address internal_revenue_service cincinnati service_center stop cincinnati oh for purposes of electing portability a form_706 filed by decedent’s estate within days from the date of this letter will be considered to be timely filed the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination if it is later determined that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is required to file an estate_tax_return pursuant to sec_6018 the commissioner is without authority under sec_301_9100-3 to grant to decedent’s estate an extension of time to elect portability and the grant of the extension referred to in this letter is deemed null and void see sec_20_2010-2 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent plr-101483-17 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel passthroughs special industries lorraine e gardner by _____________________________ lorraine e gardner senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service department of the treasury washington dc contact person telephone number in reference to op e eo t date mar uil s01 legend dear sir or madam this is in response to your ruling_request concerning the and of the internal tax implications under sec_501 revenue code of a transaction w serves as the parent entity of system sponsored by a religious_order c of the code and is described in sec_509 a a 4-state health care w is exempt under section m serves as the parent entity of is exempt sec_501 m system described in sec_509 religious_order within the same religious denomination is sponsored by another m of the code and is a regional health care a serves as a joint operating company coordinating the health care activities of two hospitals and various other health s includes e care organizations collectively referred to and h which are both hospitals serves as the managing member of shareholder of under sec_501 a a has two members w and m a also is the sole c which provides physician services the code and is described in section is exempt e and h s as of a a e operates a hospital since e has participated in an operating arrangement pursuant to which it has two members which serves as its corporate member and a which serves as its managing member exempt under sec_501 sec_509 e of the code and is described in e serves as one of the shareholders of and b a iii o w is h operates a hospital since h has participated in an operating arrangement pursuant to which h has two members m which serves as its corporate member and a which serves as its managing member and is described in sec_509 is exempt under sec_501 and b a iii of the code h c provides health care services through employed physicians all of the issued and outstanding at various practice settings stock of shareholders of is held by a is c c with e c serves as one of the two a taxable entity n was incorporated on date as a membership corporation having a as its sole corporate member below stock entity by merger into n is contemplated that c will convert from a taxable it as described o provides occupational therapy medical services at various practice settings equally by e and c the issued and outstanding_stock of o is held o is a taxable entity f was incorporated on date as a membership corporation having e and c described below taxable stock entity by merger into f it as its corporate members as is contemplated that o will convert from a the transaction in c became indirectly affiliated with a and one of its related hospitals through the acquisition by w of an approximate s0 stock interest in c stock continued to be beneficially owned by c’s physician- shareholders and held in a voting_trust physician voting_trust simultaneously with the acquisition of w’s interest restated corporate documents were filed to render c c also own sec_50 of the issued and outstanding capital stock of which provides occupational medical services o's stock is owned by e the remaining of the a stock corporation the other of on date a the voting_trust and w entered into an agreement of merger providing for the acquisition by a of all the issued and outstanding_stock of foregoing transaction a now holds all of the issued and outstanding shares of capital stock of a result of the as c cc conversion of c to nonstock corporation n n was organized on date as a nonstock nonprofit corporation with the purpose of assuming all of the assets liabilities and activities of entered into a conversion agreement dated january pursuant to which the parties are obligated to effect the conversion_transaction subject only to the receipt from the irs of ruling a determination_letter for n and a related private letter moreover m c and n have a c w to because c is a stock corporation various steps are a not-for-profit corporation necessary to convert it state law does not allow the conversion of stock form through either the amendment of organizational documents or a merger into a domestic nonstock corporation a domestic stock state law does allow though corporation and a foreign stock corporation and the merger of a foreign stock corporation with and into a domestic nonstock corporation process to convert c from a stock to a nonstock nonprofit corporation accordingly the parties will utilize a two-step a stock entity to non- the merger of ii c’s i following the conversion n will continue the historic activities and operations of component of concurrently with this ruling n received prospective recognition of exemption under sec_501 c and will operate as the physician an integrated regional health care delivery system of the code conversion of o to nonstock corporation f f was organized on date as a nonprofit corporation with the purpose of assuming all of the assets liabilities and activities of into a conversion agreement dated january which the parties are obligated to effect the conversion_transaction as described below subject only to the receipt from the letter_ruling a determination_letter for f and a related private o and f have entered pursuant to irs of o a m w as in the case of the c conversion a two-step process will be necessary to convert o corporation from a technical standpoint the conversion will be undertaken immediately following the c conversion this will guard against the membership interest in point in time a nonstock not-for-profit by a taxable entity c f being held at any to following the o conversion f will continue the historic activities and operations of o and will continue to provide occupational medical services as part of the integrated regional health care delivery system received prospective recognition exemption under sec_501 of the code concurrently with this ruling f operation of n and f as part of a a is organized and operated pursuant to an integration originally entered into in january the integration agreement was amended and restated several agreement between wand m times including most recently as of august connection with the buyout of the c stock agreement provides a multi-level dispute resolution process which includes non-binding mediation and ultimately binding arbitration explicit agreement to work in good_faith to resolve dispute questions all of these actions are prefaced by the parties the integration in a is directed and controlled by its community board_of directors which has a substantial conflicts of interest policy generally the persons comprising the board also serve as the boards of directors for all of the various s organizations pursuant to a’s bylaws the board with the support of various active standing committees is responsible for all of the health care activities conducted by a including those of f and m n e the activities of the board are assisted through the efforts of certain standing committees which are similarly subject_to the conflicts of interest policy include the finance and operations committee the strategic planning committee and the physician governance committee functions and composition of some of these committees are as follows these standing committees the finance and operations committee the responsibilities and authority of the finance and operations committee are to e s entities which are consistent with review and recommend annual capital and operating budgets of the long-term strategic and financial plans of approve all managed care contracts including global risk contracts full professional risk contracts ppo contracts discounts for services and prices approve allocation of capitation approve most personnel policies of a and n monitor monthly budget performance and monitor managed care contract performance s strategic planning committee the responsibilities and authority of the strategic planning committee are to e review and recommend the sdollar_figure strategic plan review and recommend proposals for new services and consolidation of services review analysis of physician capacity needs and recommend physician staffing review utilization of non-employed physicians on a contract basis and review and recommend affiliations and affiliation strategies authority of a over s entities a's board has the power to recommend to w and m the following e changes to the articles of incorporation and bylaws of a and changes to the articles of incorporation and bylaws of s entities action required to comply with canonical alienation requirements including but not limited to the long-term borrowing of money and the purchase or sale of property and any other long- term borrowing of money in excess of dollar_figure the dissolution merger or consolidation of the dissolution merger consolidation or withdrawal from s for other s entities a and the admission of new members of a and the admission of new s entities which do not become members of a the long-term strategic and financial plans of a which incorporates plans of all s entities and indebtedness incurred by a behalf of a s entities m or won a's board has the sole and exclusive authority to approve all of the following the role statement of that the role statement and management philosophy are lived out through a the s entities and assure tf the selection of the auditor for a and for dollar_figure entities who shall be the auditors of w or m the establishment of subsidiary corporations and partnerships of a and s all managed care contracts contracts with physicians or physician groups and prices discounts the exercise of all other authority over s provided for in the articles of incorporation and bylaws of a and as the annual capital and operational budget of a and the annual capital and operational budgets of entities which are consistent with long-term strategic and financial plans of a and which causes the budget of each s entity to provide that each s entity will pay and perform all of its financial and other covenants contained in applicable financing documents s rulings requested the conversions and the subsequent activities and operations of a and s will not adversely impact the continued tax-exempt status of e as part of n and f and m a h w subsequent to the conversions transactions and arrangements between n result in unrelated_business_taxable_income under sections of the code to any of these organizations a w e s f m and h will not law sec_501 sec_501 of the code provides an exemption from federal_income_tax for organizations described in sec_501 including organizations that are organized and operated exclusively for charitable educational or scientific purposes sec_1 c -1 d of the income_tax regulations provides that the term charitable is used in sec_501 of the code in its generally accepted legal sense revrul_69_545 1969_2_cb_117 recognizes that the promotion of health is sec_501 of the code a charitable purpose within the meaning of revrul_78_41 1978_1_cb_148 concludes that a_trust created by an exempt hospital for the sole purpose of accumulating and holding funds to be used to satisfy malpractice claims against the hospital is operated exclusively for charitable purposes and is exempt under sec_501 code of the providing management and consultants’ services to other unrelated exempt_organizations for a fee sufficient to produce a small profit does not further an exclusively exempt_purpose bsw group v commissioner t c inc see an organization providing laundry services on a centralized basis to exempt hospitals does not qualify for exemption under sec_501 see hcsc-laundry v united_states u s sec_513 of the code provides that in the case of a to one or more hospitals if such services hospital the term unrelated_trade_or_business does not include the furnishing of one or more of the services described in sec_501 a are furnished solely to such hospitals which have facilities to serve not more than inpatients such services if performed on its own behalf by the recipient hospital would constitute activities in exercising or performing the purpose or function constituting the basis for its exemption and such services are provided at a fee or cost which does not exceed the actual cost of providing such services revrul_77_72 1977_1_cb_157 provides that indebtedness a labor_union by its wholly-owned tax-exempt subsidiary owed to is not acquisition_indebtedness within the meaning of sec_514 of the code since the parent and subsidiary relationship shows the indebtedness to be merely a matter of accounting f 3rd in geisinger health plan v united_states 3rd geisinger the court recognized that an organization cir may qualify for exemption based on the integral_part_doctrine which arises from an exception to the feeder_organization rule set forth in sec_1_502-1 of the regulations which states that if would itself be exempt on the ground that its activities are an integral part of the exempt_activities of the parent organization its exemption will not be lost because as of accounting between the two organizations the subsidiary derives a profit from its dealings with the parent organization a subsidiary_organization of a tax-exempt_organization a matter ae an in this regard the a subsidiary_organization that is not the court also noted that an entity seeking exemption as integral part of another cannot primarily be engaged in activity which would generate more than insubstantial unrelated_business_income if engaged in by the other entity court followed the reasoning of sec_1_502-1 which contains an example of is operated for the primary purpose of exempt from tax because it carrying_on_a_trade_or_business which would be an unrelated_trade_or_business that is unrelated to exempt_activities if regularly carried on by the parent organization states that if for the purpose of furnishing electric power to consumers other than its parent organization and the parent’s tax-exempt is not exempt because such business subsidiary organizations it would be an unrelated_trade_or_business if regularly carried on by the parent organization owned by several unrelated exempt_organizations and is operated it for the purpose of furnishing electric power to each of them an unrelated trade or is not exempt since such business would be business if regularly carried on by any one of the tax-exempt organizations the examples a subsidiary_organization is operated primarily similarly if the organization is accordingly the court in geisinger determined that application of the integral_part_doctrine requires at that an organization be and that it not be carrying on an unrelated_trade_or_business that is unrelated to exempt purposes if regularly carried on by the parent a minimum in a parent and subsidiary relationship a joint operating_agreement between previously independent with respect to exemption qualification the courts have hospitals to provide corporate services among the participants raises exemption qualification and unrelated_trade_or_business issues been clear that exemption under sec_501 not generally available where an organization is established to provide corporate services to unrelated exempt_organizations other than through the application of sec_501 for cooperative_hospital_service_organizations inc under the integral_part_doctrine requires a parent and subsidiary see relationship and the absence of unrelated_trade_or_business geisinger supra and hcsc-laundry supra furthermore exemption of the code is see bsw group of the code rul and rev supra supra sec_511 through of the code sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations described in sec_50l c sec_512 of the code defines the term unrelated_business_taxable_income as the gross_income derived by any organization from any unrelated_trade_or_business regularly carried on by it with the modifications listed in sec_512 less certain allowable deductions computed sec_512 of the code provides generally that rents_from_real_property and its incidental related personal_property are not unrelated_business_income unless the property is debt- financed under sec_514 of the code does not include any property substantially related to the exercise or performance by such organization of functions debt-financed_property its charitable sec_512 b of the code requires that notwithstanding paragraphs respect to debt-financed_property must be included in unrelated_business_taxable_income the net_income realized with or sec_512 of the code exempts from the definition of unrelated_business_taxable_income all gains and losses from the sale exchange or other_disposition of non-inventory items and items not held_for_sale in the ordinary course of business sec_512 of the code limits the exclusion of interest annuities royalties and rents provided by sec_512 where such amounts are derived from a controlled organization and sec_1_512_b_-1 of the regulations provides that if an exempt_organization has control of another organization the controlling_organization shall include as in computing its unrelated_business_taxable_income the amount of interest annuities royalties and rents derived from the controlled organization determined in accordance with the formula described in sec_512 b -1 of the regulations of the code and section an item_of_gross_income sec_513 of the code defines unrelated_trade_or_business as any trade_or_business the conduct of which is not substantially related aside from the need of the organization for income or funds or the use it makes of the profits derived to the exercise of the organization's exempt purposes or functions sec_1_513-1 of the regulations provides that a trade_or_business is related to exempt purposes in the relevant sense only where the conduct of business activities has a causal relationship to the achievement of exempt purposes and it substantially related only if a the causal relationship is i sec_3h -10- substantial one the regulation states that for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes sec_514 of the code provides for the taxation under section sec_512 of income from debt -financed property b a i definition of debt-financed_property does not include any property substantially_all the use of which is substantially related to the exercise or performance by such organization of the charitable purposes constituting the basis for its exemption under sec_501 of the code however provides that the analysis e a based on all the facts and circumstances we conclude that h and m will not adversely affect their tax exempt w status under sec_501 transactions as they will continue to promote health within the meaning of revrul_69_545 supra the sharing of assets personnel and or resources pursuant to the joint operating_agreement will not adversely affect the sec_501 c status of any exempt participating entity member as this activity promotes health within the meanina of revrul_69_545 of the code because of the supra with respect to unrelated_trade_or_business sec_513 a hospital provides regularly then such services are unrelated trade or of the code makes clear that if carried on corporate services to another unrelated exempt_organization for a fee business unless they fall within the exception for certain hospital services provided by sec_513 participating exempt_organizations are in a parent and subsidiary relationship then necessary corporate services provided between them to accomplish their exempt purposes are treated as other than an unrelated_trade_or_business and the financial arrangements between them are viewed as merely a matter of accounting however if the see rev supra rul at issue then is whether the joint operating_agreement establishes a parent and subsidiary relationship where corporate services and payments between the participating entities will not be treated as unrelated_trade_or_business income because the activities are essential to their exempt purposes could be conducted by the participating entity for 1tself without giving rise to unrelated_trade_or_business income -1l1- and occur in the context of entities a close relationship among the based on all the facts and circumstances we conclude that a parent and subsidiary the joint operating_agreement effectively binds w and m under the common_control of a so the participating organizations are within a relationship analogous to that of pursuant to the authority of a’s governing board although all of the facts and circumstances are relevant to this conclusion importantly the participating entities have ceded authority under the joint operating_agreement to a’s governing body to establish their budgets including major expenditures debt contracts managed care agreements and capital expenditures to direct their provision of health care services to provide for dispute resolution and arbitration and to monitor and audit their compliance with its directives body and its committees meet regularly to exercise overall responsibility for operational decisions involving the day-to-day and long range strategic management decisions that have been delegated by the participating entities provided between the previously unrelated organizations through the joint operating_agreement are treated as other than an unrelated_trade_or_business in addition the governing therefore services rulings accordingly based on all the facts and circumstances described above we rule as follows the conversions and the subsequent activities and operations of n and f as part of a and s will not adversely impact the continued tax-exempt status of e and m a h w subsequent to the conversions transactions and arrangements between n not result in unrelated_business_taxable_income under sections of the code to any of these organizations and m will a w h e f s these rulings do not address the applicability of any section of the code or regulations to the facts submitted other than with respect to the sections described these rulings are directed only to the organizations that requested them they may not be used or cited as precedent sec_6110 of the code provides that these rulings are based on the understanding that there will no material_change in the facts upon which they are based be -12- any changes that may have a bearing on your tax status should be reported to the service director of these rulings your permanent records we are informing your key district please keep this ruling letter in the contact person’s identification_number is sincerely yours marvin friedlander marvin friedlander chief exempt_organizations technical branch