t c memo united_states tax_court larry l beeler and cynthia j beeler petitioners v commissioner of internal revenue respondent docket no filed date j paul raymond and marie de marco for petitioners judith c winkler and benjamin a de luna for respondent memorandum findings_of_fact and opinion colvin judge respondent determined a deficiency of dollar_figure in petitioners' income_tax for after concessions the issue for decision is whether petitioners may defer recognition of all of the gain that they received for an exchange involving real_property in under sec_1031 as petitioners contend or only part of the gain as respondent contends our decision on this issue depends on whether we decide as respondent contends that petitioners exchanged in addition to real_estate_assets which do not qualify under sec_1031 such as property_held_for_sale ie sand certain business operating permits goodwill and going- concern value or whether we decide as petitioners contend that petitioners exchanged only property that qualifies under sec_1031 we agree with petitioners and hold that all of the gain they received in the exchange qualifies under sec_1031 section references are to the internal_revenue_code as in effect for the relevant periods rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are so found a petitioners petitioners are married and lived in port richey florida when they filed the petition in this case b the real_property petitioners owned a mobile home park called brentwood estates in pasco county florida on date they paid dollar_figure to buy about acres of vacant land zoned for a 1respondent determined in the notice_of_deficiency that petitioners could not defer any gain under sec_1031 for their exchange of property in respondent conceded at trial and in the posttrial brief that the land qualifies for like-kind_exchange treatment mobile home park the acres next to brentwood estates so they could expand their mobile home park this was their primary purpose in buying and holding the land until they listed the property for sale_or_exchange described below at par d-1 the acres had natural mounds of sand on it petitioners bought the acres on the condition that they could obtain a pasco county permit to mine sand from it their contract with the seller required that petitioners pay the seller dollar_figure per cubic yard of sand that they removed c petitioners' sand mining activitie sec_1 issuance of mining permit to petitioners petitioners applied to pasco county for a permit to mine sand from the acres at that time pasco county required an applicant for a permit to mine sand to submit a plan showing how he or she intended to mine and reclaim the property pasco county required the applicant to submit engineering studies subsurface boring tests a legal description an environmental impact statement a drainage and flood development plan a processing plan and a transportation plan the applicant had to show that he or she had a legal_interest in the land the applicant also needed to show financial responsibility usually by obtaining a performance bond for the required work pasco county staff reviewed the plan made comments and returned it to the applicant the applicant responded to the staff comments the staff then prepared a recommendation for a development review committee that consisted of assistant county administrators that committee reviewed it and submitted recommendations to the board_of county commissioners b c c the b c c held a public hearing and made a decision petitioners obtained a mining permit on date that allowed them to extract big_number cubic yards of sand from about of the acres they stated on their application that they ultimately intended to use the acres as a mobile home park permit procedures when property is transferred a permit holder may not sell or transfer his or her pasco county sand mining permits pasco county would have immediately suspended the permit if its code enforcement staff discovered that a permit holder had tried to sell or transfer it if property in pasco county for which a sand mining permit has been issued is sold the buyer may not mine sand unless the county issues a permit to the buyer the buyer must apply for a permit under the procedures described above a buyer may use the engineering studies that had been submitted by the seller if nothing has changed the b c c may approve approve with conditions or deny the application the current permit holder and the person who wants the permit may apply jointly approval is sometimes called a transfer of the permit but pasco county not the prior permit holder decides whether to transfer a permit petitioners' sand mine petitioners sold sand to customers on the acres from to date petitioners called their business sunset sand mine their business office was a small recreational vehicle at the mine site petitioners did not own any equipment to mine the sand they subcontracted removal and loading of sand the subcontractor brought in a loader and operator to dig the sand and put it in trucks petitioners' first subcontractor was aaro excavating inc aaro aaro had financial difficulty and closed petitioners then rented equipment and hired an operator for a short time they later subcontracted with bolton road landfill inc bolton landfill to dig and load the sand milo dakic dakic and raymond fontana fontana owned bolton landfill builders excavating companies and trucking companies bought sand from petitioners petitioner cynthia j beeler mrs beeler or her mother sold sand and collected money mrs beeler was at the site about days a week petitioners reported the income from the sand business on a schedule c attached to their income_tax returns petitioners claimed depletion deductions for the sand totaling dollar_figure from to date modification of petitioners' permits on date the b c c approved petitioners' request to modify petitioners' sand mining permit the modification allowed petitioners to extract dollar_figure million cubic yards of sand from the acres in petitioners asked the b c c to modify the permit a second time to increase the amount of sand that they could remove from the acres to dollar_figure million cubic yards by permitting removal of sand up to feet below the surface on the application to modify the permit petitioners stated that they intended to apply for a construction and demolition debris dump permit after mining is complete and later to use the acres as a mobile home park the b c c approved petitioners' second request to modify the permit on date d petitioners' exchange of the acre sec_1 listing the property for sale petitioners listed the acres with a realtor to sell as a mobile home park sand mine or construction and demolition debris dump there was a large demand for construction and demolition debris dumps in pasco county when petitioners listed the acres for sale david gilmore gilmore wa sec_2petitioners sold about big_number cubic yards of sand while they owned the acres petitioners' attorney he represented them in the exchange of the acres petitioners did not have a construction and demolition debris dump permit when they listed the acres for sale petitioners applied to pasco county for a construction and demolition debris dump permit they stated on their application that they ultimately intended to use the acres as a mobile home park the b c c approved petitioners' application potential buyers became more interested in the property after petitioners obtained a construction and demolition debris dump permit the pasco county permit was not the only permit petitioners needed to operate a construction and demolition debris dump on the acres they did not operate a dump while they owned the acres and they did not have all the permits required to do so a prospective buyer of the acres retained triggs catlett associates in date to estimate the value of the land and various values and costs related to the prospective buyer's operation of a sand mine on the acres frank a catlett catlett a real_estate appraiser estimated that the value of the land was dollar_figure before taking into account any costs of equipment or other assets required to operate a sand mine or any going-concern value of petitioners' sand mine catlett's client did not buy the acres or petitioners' sand mine business the buyers dakic and fontana the buyers wanted to buy a construction and demolition debris dump site in pasco county they had one landfill that was nearly full operating a construction and demolition debris dump was more profitable to the buyers than operating a sand mine the sand on the acres had no value to the buyers the buyers would have preferred to have obtained land with a hole in the ground the buyers did not want to acquire petitioners' sand mine business they did not ask to see petitioners' sand mine business records petitioners did not show their business records to the buyers initially dakic negotiated for the buyers later attorney robert c burke burke represented the buyers to help them acquire the acres and pasco county permits the only item or property that petitioners conveyed was the acres petitioners did not have a customer list trucks or other equipment the buyers did not want those items and did not obtain them from petitioners gilmore negotiated the exchange of the acres for petitioners the subject of conveying petitioners' business was not discussed during the negotiations contract for like-kind_exchange on date petitioners signed a contract entitled real_estate contract for like-kind_exchange the contract to convey the property to the buyers an addendum to the contract gave the buyer sec_30 days after signing the contract to perform field tests to see whether the acres was suitable for use as a landfill and sand mine the buyers could have their deposit returned only if they decided that the acres was not suitable for use as a construction and demolition debris dump and sand mine or if they did not obtain construction and demolition debris dump and sand mine permits from pasco county the addendum allowed petitioners to operate the sand mine until the transfer to the buyers closed this benefited the buyers who wanted sand to be removed the buyers had the right to review petitioners' records to verify that petitioners did not jeopardize the property eg create liens the addendum provided that if the buyers obtained new permits and then defaulted on the contract the buyers agreed to pay petitioners' expenses to obtain the permits that petitioners had obtained before signing the contract on date the parties extended the closing date under the contract because the buyers did not know if pasco county would permit them to deposit debris from outside the county in a dump on the acres the buyers had the right to cancel the contract if they could not do so petitioners transferred the acres to the buyers by warranty deed on date the buyers paid dollar_figure million for the acres petitioners mined about big_number cubic yards of sand from the acres during the time the contract was executory the buyers did not request any price adjustment florida had a bulk_sale law when petitioners exchanged the acres with the buyers that required parties to a transfer of a business to list all equipment materials and stock_in_trade to avoid the presumption that the transfer is a fraudulent conveyance fla stat ann sec_676 west repealed by fla laws ch sec_3 burke did not try to comply with the bulk_sale law because he believed petitioners exchanged real_estate not a business with equipment or stock_in_trade the buyers did not receive a bill of sale for any chattels burke obtained land title insurance and paid for real_estate documentary stamps based on the dollar_figure million contract_price the acres remained zoned for a mobile home park during the time petitioners held it in exchange for the acres petitioners received title to the mosquito control building palm coast storage and a bank building the acquired properties the acquired properties were rental properties petitioners identified the acquired properties within days of date they received title to the acquired properties within days of date the acquired property was real_property held for productive use in a trade_or_business or for investment permits for the buyers burke obtained new permits from pasco county for the buyers to operate a sand mine and a construction and demolition debris dump at the acres he obtained all of the permits that the buyers would need to operate a construction and demolition debris dump including permits from the florida department of natural_resources the buyers paid more than dollar_figure to their attorneys engineers and to pasco county to obtain the permits the buyers gave sand away from the acres the buyers incorporated their business as sunset sand mine inc and transferred the acres to it e pasco lakes inc in larry gilford gilford owned percent of the stock of pasco lakes inc pasco lakes in date pasco lakes paid dollar_figure for vacant land zoned for agricultural use pasco lakes obtained permits to mine sand from the land gilford sold the stock of pasco lakes to environmental capital holdings inc environmental on date environmental bought stock instead of the land because it wanted the permits and an operating business otherwise it would have been required to apply to pasco county and follow the rigorous procedure to obtain permits for itself f petitioners' income_tax returns petitioners filed a joint income_tax return for they reported on form_4797 sale of business property that they exchanged for dollar_figure million sand mine property that they bought in they attached a statement to the return which was entitled exchange of sand mine for like business real_estate in their statement they reported that they took depletion deductions from to totaling dollar_figure opinion a contentions of the parties and background a taxpayer may defer recognition of gain_or_loss from qualifying exchanges of like-kind_property sec_1031 a like-kind_exchange occurs if property held for productive use in a trade_or_business or for investment is exchanged solely for property of like_kind that is to be held either for productive use in a trade_or_business or for investment sec_1031 a taxpayer recognizes gain in a like-kind_exchange under sec_1031 to the extent of the fair_market_value of any nonqualifying property exchanged sec_1031 petitioners contend that the only property they exchanged was the acres and that they may defer recognition of the gain from the dollar_figure million exchange price for the acres under sec_1031 respondent concedes that petitioners may defer the gain under sec_1031 to the extent that it relates to the land however respondent contends that petitioners exchanged certain business operating permits goodwill going- concern value and property_held_for_sale ie sand which are nonqualifying properties under sec_1031 b what petitioners transferred to the buyer sec_1 whether petitioners transferred tangible_property other than land petitioners contend that they transferred only land to the buyers respondent contends that petitioners exchanged land and other assets we agree with petitioners mrs beeler dakic burke the buyers' attorney and gilmore petitioners' attorney testified that the only asset petitioners transferred was real_property the deed conveying the acres states that petitioners conveyed land to the buyers it does not state that petitioners conveyed anything else there are no other documents conveying title from petitioners to the buyers for any other_property the parties treated the land as the only property transferred for title insurance and real_estate transfer_tax purposes there were no bills of sale for any chattels there is no evidence to support respondent's contention that petitioners exchanged an office a fence vehicles equipment or anything other than land respondent contends that we should give no weight to the testimony of mrs beeler dakic burke and gilmore because it was self-serving and unbelievable we disagree we may not arbitrarily disregard unimpeached competent and relevant testimony 39_f3d_658 6th cir affg 99_tc_370 and tcmemo_1992_614 211_f2d_210 6th cir revg a memorandum opinion of this court mrs beeler dakic burke and gilmore testified in a manner fully consistent with the documents related to the transaction at issue and with each other's testimony respondent produced no evidence to the contrary we conclude that petitioners transferred land and no other tangible_property to the buyers whether petitioners exchanged their mining and construction and demolition debris dump permits respondent contends that petitioners exchanged their pasco county sand mining and construction and demolition debris dump permits with the acres we disagree the parties to the exchange and their attorneys testified that petitioners did not exchange their pasco county permits the documents conveying property in the exchange did not list the permits cynthia jolly jolly was the code enforcement director for pasco county at the time of trial she was very knowledgeable about pasco county permit procedures respondent relies on the fact that jolly answered in the affirmative when asked is a permit transferrable respondent misses the point made clear by jolly's other testimony that a permit may be transferred only by pasco county and not by a permit holder jolly testified clearly that petitioners could not transfer their pasco county permits and that the b c c must independently approve issuance of a permit to a new permittee thus petitioners could not sell or exchange their pasco county sand mine or construction and demolition debris dump permits respondent contends that pasco county permits are analogous to easements grazing rights fcc licenses and liquor licenses which are generally transferrable e g in re atlantic bus and community dev corp 994_f2d_1069 3d cir 58_f2d_757 9th cir 87_tc_575 81_tc_983 affd 766_f2d_909 5th cir 31_tc_803 15_tc_922 respondent's argument does not apply because petitioners did not transfer their pasco county permits respondent called catlett as an expert witness to appraise the acres as of date he testified that the acres would be worth dollar_figure with permits and dollar_figure without permits respondent contends that this shows that petitioners transferred the permits we disagree the dollar_figure million exchange value is consistent with catlett's appraisal of the acres because it was contingent on issuance by pasco county of the needed permits to the buyers not because petitioners transferred their permits to the buyers the effect on the value of the land of a seller having pasco county permits is analogous to the effect of receipt of a favorable zoning classification the existence of both depends on governmental action both can add value to the land a new buyer may expect that zoning will not change and may pay more for property because of that expectancy similarly a buyer of land the seller of which has a pasco county permit may expect that his or her application_for a new permit will be approved and may pay more for the land because of that expectancy however a seller cannot sell either a permit or a zoning classification we conclude that petitioners did not sell their pasco county permits whether petitioners conveyed goodwill or going-concern value respondent contends that petitioners transferred dollar_figure of goodwill or going-concern value with the acres respondent points out that petitioners called their sand business the sunset sand mine and the buyers formed a corporation named sunset sand mine inc respondent contends this shows that petitioners sold goodwill and a going-concern to the buyers respondent points out that petitioners had a good business location and customers and that the contract for exchange required petitioners to operate and maintain their business going-concern value is the ability of a business to produce income even though there has been a change in ownership goodwill is the existence of preexisting business relationships which may be expected to continue indefinitely 97_tc_253 affd 17_f3d_684 4th cir whether goodwill and going-concern value exist is a question of fact id pincite the parties did not discuss transferring or exchanging the sand mine business petitioners did not transfer any customer lists to the buyers petitioners did not transfer management systems or records to the buyers the record does not show that petitioners had any property rights to the business name petitioners did not charge the buyers for transferring rights to use the business name dakic burke gilmore and mrs beeler testified that petitioners did not transfer to the buyers goodwill going-concern value or an ongoing business the documents conveying property from petitioners to the buyers did not refer to goodwill or going-concern value we conclude that any goodwill or going-concern value transferred by petitioners to the buyers was de_minimis c whether the sand was stock_in_trade or property_held_primarily_for_sale respondent contends that petitioners' unmined sand was stock_in_trade or other_property held primarily for sale a taxpayer may not defer gain_or_loss under sec_1031 for the exchange of stock_in_trade or other_property held primarily for sale sec_1031 whether property is stock_in_trade or held primarily for sale for purposes of sec_1031 is a question of fact see 43_tc_429 respondent points out that petitioners operated a sand mine on the acres throughout the time they owned it they obtained a pasco county sand mine permit before they bought the land and had the permit modified twice to increase the amount of sand they could remove from big_number cubic yards to dollar_figure million cubic yards of which they eventually removed dollar_figure million cubic yards while petitioners did mine sand from the acres that was not their primary purpose in holding the land their primary purpose was to expand their adjacent mobile home park and that purpose never changed during the time they owned the acres this intent is shown by mrs beeler's testimony and by petitioners' consistent statements on permit applications filed with pasco county in and respondent points out that earl hoover hoover respondent's expert testified that the unmined sand was inventory and not real_estate hoover estimated that there were about dollar_figure million cubic yards of unmined sand on the acres that was worth dollar_figure at the time of the exchange he also estimated that the air space to be used as a dump was worth dollar_figure his analysis is unpersuasive because those two amounts total dollar_figure more than the arm's-length exchange price of dollar_figure million for the land hoover treated the unmined sand as inventory he gave the real_estate no value we believe that the land had value catlett who was not respondent's employee estimated that the land was worth dollar_figure we give hoover's testimony little weight if property is exchanged as part of the land it is not property_held_primarily_for_sale 74_tc_1005 unharvested crop exchanged as part of land not property_held_primarily_for_sale for purposes of sec_1031 6_tc_183 coal in an abandoned coal mine was part of the real_property not a separate asset here sand was not separated from and was part of the land when petitioners exchanged it the parties to the transaction did not list sand as property petitioners exchanged petitioners received no consideration from the buyers for unmined sand the parties to the exchange believed they were not required to comply with florida's bulk sales law which applied to sales of stock_in_trade from the time petitioners first agreed to exchange the property for dollar_figure million to the time they closed on the exchange petitioners sold about big_number cubic yards of sand petitioners did not adjust the price of the acres based on the sales respondent cites 345_us_544 to support the contention that petitioners held the unmined sand primarily for sale at the time of the exchange in that case the taxpayer sold an orange grove with unharvested oranges the buyer wanted to operate the orange grove and sell oranges including the unharvested oranges the issue was whether the portion of the price attributable to the unharvested oranges was taxable as a capital_gain or as ordinary_income the supreme court pointed out that the parties attributed substantial value to the unharvested oranges and held that income from the sale of the unharvested oranges was ordinary_income id pincite- the seller sold and the buyer bought a crop of growing oranges and the real_property on which it grew the supreme court distinguished watson from butler consol coal co v commissioner supra and cases in which the sale of land included minerals not separated from its natural state and not in the course of annual growth leading to a seasonal separation watson v commissioner supra pincite we think the instant case is more like butler consol coal co v commissioner supra because the unmined sand was not separated from the land respondent contends that butler consol coal is distinguishable from this case respondent points out that petitioners operated the sand mine until the day they exchanged the land while the taxpayer in butler consol coal stopped operating the mine years before the transaction at issue we disagree that the distinction is material the court in butler consol coal observed that coal in place is a part of the realty primarily for that reason the court rejected the commissioner's argument that the coal in place was held by the taxpayer for sale to customers in the ordinary course of business in the present case similarly the sand in question had not been mined or otherwise separated from the realty in addition we have found that the parties to the sale did not intend to sell and buy sand as part of the transaction respondent contends that the instant case is like clemente inc v commissioner tcmemo_1985_367 there the taxpayer exchanged the right to extract gravel from one parcel of land but did not exchange the land itself for another parcel of land the issue before the court was whether land and the right to extract gravel from land were of a like_kind that case does not apply here because respondent concedes that the real_property petitioners exchanged was of like_kind respondent contends that petitioners' subcontract with bolton landfill to remove sand was a joint_venture between petitioners and dakic and contends that this establishes that petitioners exchanged unmined sand we disagree petitioners and dakic did not have a joint_venture respondent contends that we should decide whether petitioners transferred assets other than land to the buyers based on the substance of the transfer and not its form we disagree that the substance of this transaction differs from its form we conclude that the unmined sand was not stock_in_trade or property_held_primarily_for_sale for purposes of sec_1031 d conclusion we conclude that petitioners conveyed only land and no other assets in exchange for property worth dollar_figure million petitioners are entitled to defer recognition of gain on the dollar_figure million because they received like-kind_property in exchange sec_1031 to reflect the foregoing decision will be entered for petitioners


department of the treasury internal_revenue_service washington d c date of f i c e of c h i e f c ou n s e l number release date tl-n-6209-00 uilc internal_revenue_service national_office field_service_advice memorandum for cc lm mct phi from cc corp subject tl-n-6209-00 this chief_counsel_advice responds to your memorandum dated date in accordance with sec_6110 this chief_counsel_advice should not be cited as precedent legend taxpayer bank p s city a month a month b month c date b year year year year tl-n-6209-00 year year year year year year year dollar_figurex dollar_figurex dollar_figurex dollar_figurex dollar_figurex dollar_figurex dollar_figurex dollar_figurex a issues whether sec_382 or l of the internal_revenue_code_of_1986 code require the value of the p loss group to be reduced for the purpose of the limitations on net_operating_loss carryovers and if so by how much conclusion the value of the p loss group should be reduced by dollar_figurex thus the value of the p loss group for the purposes of sec_382 is dollar_figurex taxpayer is a thrift holding_company whose principal subsidiary is facts bank taxpayer is registered as a savings and loan holding_company and is subject_to office of thrift supervision ots regulation examination supervision and reporting requirements taxpayer is required to maintain certain capital tl-n-6209-00 reserves taxpayer itself only engages in limited business operations independent of its subsidiaries taxpayer’s principal asset is its investment in the capital stock of bank and taxpayer’s ability to comply with its reserve requirement is dependent upon its ability to obtain dividends from bank under applicable federal regulations bank may pay dividends within certain limits and only after notice to the ots s a reverse mortgage_lender based in city a was incorporated in year reverse mortgage loans are contracts that require the lender to make monthly advances throughout the borrower’s life or until the borrower relocates prepays or the home is sold at which time the loan becomes due and payable since reverse mortgages are nonrecourse obligations the loan repayments are generally limited to the sale proceeds of the borrower’s residence and the mortgage balance consists of cash advanced interest compounded over the life of the loan and a premium which represents a portion of the shared appreciation in the home’s value if any or a percentage of the value of the residence p a holding_company acquired all of the stock of s in month c year thereafter p and s filed consolidated federal_income_tax returns early in year p raised dollar_figurex in an initial_public_offering ipo of its stock s made loans when real_estate prices were high in city a with the expectation that real_estate values would continue to rise however home prices in city a dropped between year sec_1 and in year s’s reverse mortgage portfolio which had a carrying value of approximately dollar_figurex had to be written down to approximately dollar_figurex due to operating difficulties and other factors s ceased originating reverse mortgages in the first quarter of year however s continued to service its outstanding mortgages in month a of year p announced that it planned to sell off all of its loans and liquidate itself in month b of year bank acquired over a percent of p’s stock at a price of dollar_figurex per share for an aggregate purchase_price of dollar_figurex at such time p still retained over dollar_figurex of the ipo proceeds in cash or cash equivalents and s had net operating losses nols of approximately dollar_figurex shortly after the acquisition bank caused p to distribute its remaining dollar_figurex of ipo proceeds to bank thus bank’s out-of-pocket cost for its p stock was dollar_figurex in its year and year annual reports taxpayer states that bank utilized s’s available liquidity to fund the purchase_price of s’s stock we understand that representatives for taxpayer have said that p transferred the dollar_figurex to bank because bank was in a better position to oversee the investment of the funds than p and that the funds would the annual report refers specifically to s but bank actually acquired the stock of p and the dollar_figurex received by bank came from p tl-n-6209-00 have been made available to s had its business operations required additional capital on date b year p merged into s s was included as a subsidiary on taxpayer’s year consolidated_return on date b year s was merged into bank in a complete_liquidation s continued to service its mortgages until it merged into bank at which time bank took over servicing the mortgages in its year annual report taxpayer predicted that by year s’s pool of reverse mortgages would begin to generate a positive cash_flow in fact s had sufficient assets to service its reverse mortgages and pay its business_expenses neither taxpayer nor bank contributed capital to p or s to replace any of the funds that p distributed to bank taxpayer or bank opened a dollar_figurex credit facility in favor of p or s at the time of the distribution it does not appear that p or s borrowed against this facility law and analysis background sec_382 of the code limits the use of a loss corporation’s net_operating_loss nol carryforwards if there is a substantial change in ownership of the loss_corporation this so-called sec_382 limitation is triggered only after an ownership_change of the loss_corporation occurs as described in sec_382 if an ownership_change takes place sec_382 provides that all nols are disallowed if the new_loss_corporation ie the loss_corporation following the ownership_change does not continue the business_enterprise of the old_loss_corporation the loss_corporation prior to the ownership_change at all times during the two-year period following the date of the ownership_change sec_382 this test is generally the same as the continuity of business_enterprise rule that is generally applicable to tax-free reorganizations see s rep no pincite if there is an ownership_change and the continuity of business_enterprise requirement is satisfied the taxable_income of a loss_corporation available for offset by pre-acquisition nol carryforwards is limited to an annual amount equal to a prescribed rate times the fair_market_value of the loss corporation’s stock including any stock described in sec_1504 immediately before the ownership_change sec_382 sec_382 and sec_382 this limitation is increased to include the unused portion of prior years’ sec_382 limitations and certain built-in gains recognized by the loss_corporation during the five years following the ownership_change sec_382 and sec_382 certain built-in losses recognized by the tl-n-6209-00 loss_corporation during that five-year period are subject_to limitation in the same manner as nols sec_382 i sec_382 provides rules to prevent taxpayers from circumventing the sec_382 limitation s rep no pincite under a special rule if a redemption or other corporate_contraction occurs in connection with an ownership_change the value of the loss corporation’s stock is determined after taking the redemption into account emphasis added sec_382 this rule applies whether the redemption or contraction occurs before or after the ownership_change s rep no pincite the rule is effective for ownership changes occurring after date prior to the enactment of the technical corrections act of sec_382 referred to redemption and did not include the language referring to any other corporate_contraction in broadening the rule congress stated that the rule was always intended to apply to transactions that effect similar economic results without regard to formal differences in the structure used or the order of events id for instance the provision could apply to a ‘bootstrap’ acquisition in which aggregate corporate value is directly or indirectly reduced or burdened by debt to provide funds to the old shareholders id congress intended the rule to apply to cases in which debt used to pay the loss corporation’s shareholders remains an obligation of an acquisition corporation or an affiliate where the acquired loss_corporation is directly or indirectly the source of the funds for repayment of the obligation emphasis added id furthermore sec_382 provides that if immediately after an ownership_change the new_loss_corporation has substantial non-business assets the value of the old_loss_corporation shall be reduced the old_loss_corporation is treated as having substantial_nonbusiness_assets if at least of the value of the total assets of such corporation consists of nonbusiness_assets the term nonbusiness_assets generally includes any asset held for investment including cash and marketable_stock or securities cash and marketable_stock or securities are non- business_assets even if they are not strictly held for investment certain investment entities eg regulated_investment_companies reits and real_estate mortgage investment conduits are exempt from this rule moreover assets held as an integral part of the conduct_of_a_trade_or_business eg assets funding reserves of an insurance_company or similar assets of a bank would not be considered nonbusiness_assets general explanation of the tax_reform_act_of_1986 h_r no 99th cong hereinafter explanation this memorandum does not address limitations on built-in losses tl-n-6209-00 sec_1_1502-99a states that for a period ending before date a consolidated_group is permitted to use one of several specified methods to determine the amount of the sec_382 limitation that applies to limit the use of taxable_income in any post-change_year ending before on or after date the taxpayer must consistently apply the selected method the group may use a group or subgroup methodology may reasonably apply the sec_382 rules on a separate_entity basis or may use a method approved by the commissioner upon the application by the common parent sec_1_1502-91a through 93a set forth the rules for determining an ownership_change under sec_382 for members of consolidated groups and the sec_382 limitations with respect to pre-change consolidated nols of a loss group these rules generally provide that an ownership_change and the sec_382 limitation are determined with respect to the group or loss subgroup following an ownership_change of a loss group or subgroup the amount of consolidated_taxable_income for any post-change_year which may be offset by pre-change consolidated attributes shall not exceed the consolidated sec_382 limitation or subgroup limitation for such year in the instant case s filed a separate_return until it began filing a consolidated_return with p in year all of the losses s incurred prior to joining the p consolidated_group are srlys with respect to the p consolidated_group sec_1_1502-21t the facts do not indicate whether or not s underwent a sec_382 change_of_ownership at the time it was acquired by p you have not asked us to address whether there are any limitations on s’s nols as a result of p’s acquisition of s and that matter is not developed in this memorandum when s joined the p consolidated_group s and p became a loss group the p group for the purposes of sec_382 with respect to losses that did not arise and are not treated under sec_1_1502-21t as arising in a srly sec_1_1502-91a the p group apparently underwent a sec_382 ownership_change in year as a result of p selling its stock in an ipo you have not asked us to address the year sec_382 ownership_change and that matter is not developed in this memorandum corporate_contraction under sec_382 we agree with your determination that sec_382 should apply to the year sec_382 ownership_change in which bank acquired over a percent of p’s stock just prior to p’s acquisition in month b of year p held dollar_figurex which had been raised in the ipo bank paid the p shareholders an aggregate price of dollar_figurex for their stock we understand that the taxpayer used the group methodology to calculated its loss limitation tl-n-6209-00 and received a distribution of dollar_figurex from p shortly thereafter taxpayer in its year annual report states that s’s available liquidity was utilized to fund the purchase_price of s the transaction had the same economic result as if p used the dollar_figurex to redeem an aggregate of dollar_figurex shares of its stock from the p shareholders and immediately thereafter p shareholders sold over a percent of their remaining aggregate stock for dollar_figurex to bank under both scenarios the selling p shareholders would receive a total aggregate price of dollar_figurex for their shares bank would acquire over a percent of the shares of p p would distribute dollar_figurex and bank’s out-of-pocket cost for its p shares would be dollar_figurex congress intended that the redemption provisions of sec_382 apply to transactions that effectively accomplish similar economic results without regard to formal differences in the structure used or the order of events by which similar consequences are achieved explanation pincite moreover congress specifically noted that a bootstrap acquisition in which the aggregate value of the loss_corporation is directly or indirectly reduced to provide funds to the old shareholders is generally subject_to sec_382 congress intended to include cases in which the source of funds for the obligation to acquire the stock of the acquired_corporation is the acquired_corporation the taxpayer’s year annual report states that the source of funds for the acquisition of the p group came from the p group thus sec_368 applies to the facts of the instant case 104_tc_584 aff’d 142_f3d_442 9th cir unpublished table decision makes it clear that a corporate_contraction includes loans or distributions between members of an affiliated_group a transaction in which an acquiring_corporation acquires a loss_corporation causes the loss_corporation to pay a substantial dividend immediately after the ownership_change and uses the proceeds of the distribution to pay the old shareholders of the loss_corporation constitutes a corporate_contraction id pincite the berry petroleum court concludes the transaction constitutes a corporate_contraction even if the distribution is structured as a loan that is intended to be forgiven instead of as a formal dividend id in the instant case the taxpayer’s assertion that taxpayer or bank would have contributed part or all of the dollar_figurex to the p group if the p group required such funding does not mitigate the fact that p’s distribution of the dollar_figurex to bank caused a corporate_contraction of the p group although we benefit from hindsight there does not appear to be any evidence that bank intended to return the dollar_figurex to the p group in any event the distribution had see n supra tl-n-6209-00 the effect of removing dollar_figurex in assets from the p group’s balance_sheet thus we conclude that there was a corporate_contraction furthermore because the year annual report states that the liquidity of the p group was used to fund the acquisition of the p group we conclude that the corporate_contraction occurred in connection with the sec_382 ownership_change accordingly the value of p is to be determined immediately after its contraction the value of p for the purposes of sec_382 is dollar_figurex substantial_nonbusiness_assets under sec_382 sec_382 reduces the sec_382 limitation of a loss_corporation with substantial_nonbusiness_assets in order to determine whether the p group had substantial_nonbusiness_assets it must be determined whether at least one-third of the fair_market_value of the new p group’s assets consisted of nonbusiness_assets the carrying value of s’s mortgages was reduced to approximately dollar_figurex at some time in year but we do not know if dollar_figurex was the value of the mortgages at the time of the sec_382 ownership_change the facts do not provide a determination of the value of all of the new p group’s assets immediately following the ownership_change the term nonbusiness_assets includes any asset held for investment including cash sec_382 explanation pincite in limited cases cash may be held as an integral part of the conduct_of_a_trade_or_business for example an insurance_company or a bank may be required_by_law to hold certain cash reserves id insurance_company and bank reserves are required_by_law in berry petroleum co v commissioner supra the court determined that legally required cash reserves are an integral part of the banking or insurance_business such assets are to be differentiated from assets held for future acquisitions and other business needs the test used for sec_382 is more stringent than the reasonable needs of business test of sec_537 id pincite sec_382 allows a corporation to hold up if p’s purpose was merely to allow bank to manage the funds p could have put the dollar_figurex into a bank account retaining the dollar_figurex on its balance_sheet and given bank authority to manage and invest the assets in the account instead the dollar_figurex was removed from p’s balance_sheet and became an asset on bank’s balance_sheet sec_382 provides an exception to the application of sec_382 for a regulated_investment_company to which part i of subchapter_m applies a real_estate_investment_trust to which part ii of subchapter_m applies a remic to which part iv of subchapter_m applies or a fasit to which part v of subchapter_m applies at the time of bank’s acquisition of the p group the p group did not qualify under this exception tl-n-6209-00 to one-third of its assets as working_capital before sec_382 applies it appears that sec_382 would apply where a new_loss_corporation holds working_capital in excess of one-third of the value of its total assets unless the cash is an integral part of the business or meets the stringent test suggested in berry petroleum the facts do not indicate whether s was legally required to maintain cash reserves in order to engage in its reverse-mortgage business p raised substantial capital in the ipo in anticipation of s needing cash to make new reverse-mortgage loans at the time of the year acquisition p still held dollar_figurex of the ipo funds but s was not making new loans s was merely servicing the loans it had made in the past it appears that the p group had raised more capital in the ipo than it ultimately needed to conduct its business it is reasonable to conclude that the dollar_figurex was a nonbusiness_asset taxpayer states that the p group distributed the dollar_figurex to bank because bank was in a better position to invest the funds than p or s this statement lends support to treating the dollar_figurex as an investment_asset rather than as a business asset case development hazards and other considerations although an argument may be advanced under sec_382 that the dollar_figurex distributed by p to bank is a nonbusiness_asset we presume taxpayer will assert that the cash was an integral part of s’s reverse mortgage business and that s would have resumed making new reverse mortgage loans had the real_estate market in city a turned around arguably if s resumed making loans s would have needed the dollar_figurex held by p the definition of a nonbusiness_asset is not clear congress provides in the way of example that cash is an integral part of a banking or insurance_business however the list is not exclusive neither congress nor berry petroleum specifically state that in order for cash to be an integral part of the business the cash must be a legally mandated reserve rather the berry petroleum court interprets the bank and the insurance_company cash reserves to stand for the proposition that congress intended a test of need which is more stringent than the reasonable business needs test of sec_537 however the court does not expound on the need test and we have no regulations that specify a standard for measuring whether the p group’s cash would satisfy this test the court found the facts in berry petroleum especially troubling because the new_loss_corporation sold business_assets and received passive_assets in their place in the instant case none of the p group’s business_assets are sold rather the old p group and the new p group held large amounts of cash p raised the cash in the ipo to raise working_capital because such capital was an essential element of making reverse mortgages it is not clear that in the instant case a court tl-n-6209-00 would determine the dollar_figurex was a nonbusiness_asset it is unclear whether funds held while awaiting business conditions to improve are business_assets or investment_assets if we make an argument under sec_382 we face the risk that a court will find that the dollar_figurex held by the new p group satisfies the need test we expect the taxpayer to argue that at least part if not all of the dollar_figurex was an integral part of the new p group’s business because s was required to pay out cash to the mortgagees every month they might argue that s had to maintain a large reserve of cash to meet these obligations apart from the dollar_figurex s would be dependent on capital from the sale of properties subject_to the reverse-mortgage loans s does not generally have control_over the timing of such sales in certain circumstances the property is sold upon the death of the borrower in other circumstances the property is volitionally sold by the borrower additionally s could not be expected to accurately predict the sales_price of the properties thus taxpayer may reasonably argue that although a cash reserve was not statutorily mandated it was not only a necessary and reasonable business practice for the p group to maintain a large cash reserve but an integral part of the reverse- mortgage business even though the cash reserve was held and managed by bank the taxpayer may convincingly argue that the money was available to p or s this writing may contain privileged information any unauthorized disclosure of this writing may have an adverse effect on privileges such as the attorney client privilege if disclosure becomes necessary please contact this office for our views please call if you have any further questions cc jasper l cummings jr associate chief_counsel corp by gerald b fleming senior technician reviewer cc corp


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc intl 3-plr-110922-99 date date ty legend a b province r fund x indenture y dear this is in response to your representative’s letter dated date as amended by letters dated date and date requesting rulings regarding the taxability of income received by a under the income_tax treaty between canada and the united_states the treaty the information submitted is substantially as set forth below the rulings contained in this letter are predicated 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 a ruling it is subject_to verification on examination b is a_trust company organized under the laws of canada engaged in the business of offering its services as trustee to the public a a corporation incorporated under the laws of province r in canada provides investment advisory services to clients pursuant to indenture y between a and a predecessor to b a pooled investment_trust was created a represents that fund x is one section of such trust and that fund x is treated as a separate trust under canadian law fund x was created to facilitate pooled investments by certain clients of a to which a provides advisory services a plr-110922-99 represents that fund x is a resident of canada for canadian income_tax purposes fund x’s objective is to earn income and profits for its unitholders by purchasing holding and selling a diverse group of securities to achieve its objectives fund x acquires among other things u s debt and equity securities fund x receives interest and dividend income from debt and equity instruments issued by u s issuers indenture y provides that the interest of each beneficiary of fund x will be denominated in units of fund x and that a unitholder may request the redemption of all or any of the unitholder’s units as of any valuation_date a unit of the fund will be redeemable for a price equal to the portion of the net asset value represented by the unit determined in accordance with valuation rules set forth in indenture y a represents that as a canadian resident fund x will potentially be liable for canadian income_tax as well as certain other taxes in particular a canadian trust may be liable for income_tax under part i of the income_tax act canada the canadian act which sets out the primary income_tax provisions applicable to canadian taxpayers a however also represents that part i of the canadian act provides a special tax regime for canadian trusts including sub sec_104 of part i which provides that in computing its income for purposes of part i of the canadian act a_trust is permitted to deduct any amount including realized taxable capital_gains that is paid or payable in the year to beneficiaries of the trust a represents that indenture y requires the trustee to make payable to unitholders in each year an amount sufficient to ensure that the fund will not have any income subject_to regular part i tax and that fund x will make payable all earnings to its unitholders each year in accordance with indenture y unless the unitholder requests payment in cash the amount payable to the unitholder is reinvested in fund x a represents that fund x will not carry on a trade_or_business in the united_states and will not earn income from a related_person within the meaning of article xxi of the treaty a proposes that the units of fund x will be purchased and held by one or more of the following types of entities a_trust governed by a registered pension_plan that is tax exempt pursuant to paragraph o of the canadian act rpp a_trust governed by a registered retirement savings_plan that is tax exempt pursuant to sub sec_146 and paragraph r of the canadian act rrsp a_trust governed by a registered retirement income fund that is tax exempt pursuant to sub sec_146 and and paragraph x of the canadian act rrif a_trust governed by a deferred profit sharing plan that is tax exempt pursuant to paragraph s of the canadian act dpsp a_trust governed by an employees profit sharing plan that is tax exempt pursuant to paragraph p of the canadian act epsp a_trust governed by a registered supplementary unemployment benefit plan that is tax exempt pursuant to paragraph q of the plr-110922-99 canadian act subplan a vacation pay trust that is tax exempt pursuant to paragraph y of the canadian act vacation pay trust a_trust all of the beneficiaries of which are investors described in through mixed pooled_fund and a segregated fund of an insurance_company resident in canada that is deemed to be an inter_vivos_trust by paragraph a of the canadian act and under which all of the related insurance contracts are entered into with investors described in through segregated fund sec_894 of the code provides that the provisions of the code shall be applied with due regard to any treaty obligation of the united_states which applies to a taxpayer article iv residence paragraph of the treaty provides for the purposes of this convention the term resident of a contracting state means any person who under the laws of that state is liable to tax therein by reason of his domicile residence place of management place of incorporation or any other criterion of a similar nature but in the case of an estate_or_trust only to the extent that income derived by such estate_or_trust is liable to tax in that state either in its hands or in the hands of its beneficiaries article xxi exempt_organizations paragraph provides subject_to the provisions of paragraph income referred to in articles x dividends and xi interest derived by a a_trust company organization or other arrangement that is a resident of a contracting state generally exempt from income_taxation in a taxable_year in that state and operated exclusively to administer or provide pension retirement or employee_benefits or b a_trust company organization or other arrangement that is a resident of a contracting state generally exempt from income_taxation in a taxable_year in that state and operated exclusively to earn income for the benefit of an organization referred to in subparagraph a shall be exempt from income_taxation in that taxable_year in the other contracting state emphasis added article xxi paragraph provides the provisions of paragraph sec_1 and shall not apply with respect to the income of a_trust company organization or other arrangement from carrying_on_a_trade_or_business or from a related_person other than a person referred to in paragraph plr-110922-99 or prior to amendment by article of the third protocol to the treaty which generally entered into force on date paragraph b of article xxi read as follows a_trust company or other organization which is resident in a contracting state not taxed in a taxable_year in that state and constituted and operated exclusively to earn income for the benefit of an organization referred to in subparagraph a emphasis added the technical explanation to article of the third protocol states in part that the other changes all in paragraph are intended to improve and clarify the language in subparagraph b the phrase not taxed in a taxable_year was changed to generally exempt from income_taxation in a taxable_year to ensure uniformity throughout the convention this change was not intended to disqualify a_trust or other arrangement that qualifies for the exemption under the wording of the present convention article xxix a limitation_on_benefits paragraph provides for purposes of the application of this convention by the united_states a a qualifying person shall be entitled to all of the benefits of this convention and b except as provided in paragraph and a person that is not a qualifying person shall not be entitled to any benefits of the convention article xxix a paragraph provides in part for the purposes of this article a qualifying person is a resident of canada that is h an organization described in paragraph of article xxi exempt_organizations and established for the purposes of providing benefits primarily to individuals who are qualifying persons persons who were qualifying persons within the five preceding years or residents or citizens of the united_states based solely on the information submitted and on the representations made by the taxpayer and provided that the entity deriving the dividends and interest is a resident of canada within the meaning of article iv of the treaty and a qualifying person within the meaning of article xxix a of the treaty we conclude that plr-110922-99 i an rpp is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty ii an rrsp is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty iii an rrif is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty iv a dpsp is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty v an epsp is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty vi a subplan is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty vii a vacation pay trust is a_trust or other arrangement described in article xxi a of the treaty consequently dividends and interest derived by such a_trust or arrangement will be exempt from u s income_tax pursuant to article xxi a of the treaty viii provided that the unitholders of fund x consist at all times exclusively of rpps rrsps rrifs dpsps epsps subplans vacation pay trusts mixed pooled funds and or segregated funds dividends and interest derived by fund x will be exempt from u s income_tax pursuant to article xxi b of the treaty the above rulings are not applicable to any dividend or interest_income derived from carrying_on_a_trade_or_business in the united_states or from a corporation which is a related_person under article xxi of the treaty plr-110922-99 your representative also originally requested rulings concerning the treatment of mixed pooled funds and segregated funds that include as investors organizations resident in canada and described in article xxi of the treaty however your representative withdrew those requests upon learning that this office was adverse 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 a copy of this letter must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative 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 sincerely m grace fleeman assistant to the branch chief branch associate chief_counsel international cc


office_of_chief_counsel internal_revenue_service memorandum number release date cc ita b03 mllam postf-135262-08 uilc date date to --------------------- -------------------------------------------- large mid-size business from christopher f kane branch chief branch income_tax accounting third party communication none date of communication not applicable subject --------------------------------------------------------------------------- -------------------------- ------------------------- this chief_counsel_advice responds to your request for assistance dated ------------------- ------- this advice may not be used or cited as precedent legend taxpayer club employer a player employee insurance co year s year t -------------------------- ---------------------------------------------------------- -------------------------------------------------- ----------------------- ------------------------------------ ------- ------- postf-135262-08 year u year v year w year x year y year z dollar_figureb dollar_figurec dollar_figured dollar_figuree issues ------- ------- ------- ------- ------- ------- ------------- ------------- --------------- --------------- whether taxpayer may exclude from gross_income under sec_104 of the internal_revenue_code dollar_figurec in proceeds received under a disability insurance_policy related to an injured employee and take a sec_162 deduction for dollar_figurec in payments made to this injured employee pursuant to an employment contract or whether the deduction is precluded by sec_265 conclusions the taxpayer may exclude dollar_figurec in proceeds received under a disability insurance_policy related to an injured employee under sec_104 and may not take a deduction because the insurance payment is a reimbursement for an expense under sec_162 or may be precluded from taking a deduction because the insurance payment is tax exempt_income and sec_265 disallows a deduction allocable to exempt_income facts for year x club was a member of the consolidated_group headed by taxpayer club employs player in year t player was transferred to club prior to this player had been employed by a player entered into an employment contract with a in year s the employment contract or contract player’s employment contract was for postf-135262-08 multiple years year s through year y and included an option for the year z when player was transferred to club club assumed the liability under this contract the contract indicates that the base salary for the year x was dollar_figured the terms of the contract guaranteed this base salary even in the event of injury the contract states ------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------ ----------------------------------- employment contract ----------------- an addendum to the employment contract also contains the following language --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- 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postf-135262-08 --------------------------------------------------------------------------------------------------- ------------------------------------------------- addendum ii to employment contract ------------------------------- in year s a disability insurance_policy on player was executed between insurance co and a when player was transferred to club this insurance_policy was transferred to club which assumed the liability to make premium payments and became the beneficiary of the policy according to the policy the participating organization ie club was required to pay premiums under the policy ------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ --------------------------------------------------------------------------------------- in year w player was injured and club began receiving benefits under its insurance_policy in year x player remained injured during year x club received proceeds totaling dollar_figurec under the disability insurance_policy club paid disability insurance premiums totaling dollar_figureb during year x for the disability insurance_policy these premium amounts were not included in player’s income during year x for tax purposes taxpayer considers the premiums to be non- deductible under sec_265 notwithstanding his injury during year x player received payments from club totaling dollar_figuree under his employment contract law and analysis issue whether taxpayer may exclude from gross_income under sec_104 dollar_figurec in proceeds received under the disability insurance_policy related to player’s injury sec_104 provides in relevant part that except in the case of amounts attributable to and not in excess of deductions allowed under sec_213 relating to medical etc expenses for any prior taxable_year gross_income does not include amounts received through accident_or_health_insurance or through an arrangement having the effect of accident_or_health_insurance for personal injuries or sickness the issue presented in this case is identical to the issue addressed in revrul_66_262 1966_2_cb_105 in revrul_66_262 the taxpayer was a professional baseball club that carried disability policies to protect itself against the accidental disability or death of any of its players its coaches and manager the club was the beneficiary under these policies the ruling concludes that since sec_104 provides an exclusion from income for amounts received through accident_and_health_insurance for personal injuries or sickness the disability insurance premiums are not deductible by the club under sec_265 of the code which provides that a deduction is postf-135262-08 not allowed for any expense which is allocable to exempt_income the ruling also notes that sec_104 applies to both employer corporations as well as individual employees see also 43_bta_1 addressing a predecessor section to a and finding that the exemption for amounts received through accident_and_health_insurance for personal_injury_or_sickness is not limited to individuals but extends to corporations which have an insurable interest the service argued for the application of revrul_66_262 in 100_tc_531 in rugby a personal service company was designated as the beneficiary of a disability policy on the company’s key_employee the company argued that although it was listed as the beneficiary under the disability policy it was the intention of the company’s officers accountants and insurance agents that any proceeds received under the policy would be paid over to the key_employee and not retained by the company the tax_court found however that the key employee’s legal right to the proceeds had not been established because the policy by its terms was payable to the corporation the court noted that notwithstanding the company’s intent to pay over to the employee any proceeds received under the disability policy nothing would have prevented the company from applying the proceeds to third-party claims the tax_court agreed with the service’s argument for the application of revrul_66_262 and ruled that the proceeds would have constituted exempt_income to the company under sec_104 and since the premiums_paid by the corporation were allocable to such income they were nondeductible under sec_265 the facts and issue in 12_tc_1052 are significantly different from the facts and issue presented in the case at issue in peoples the beneficiary of the insurance_policy was indebted to a corporation the corporation acquired its original interest in the policy by assignment to it as a creditor seeking security for the repayment of the indebtedness of the insured the corporation subsequently purchased the beneficiary’s insurance_policy and held it as an investment the tax_court held that the exclusion for accident and health proceeds under sec_22 the predecessor section to a did not extend to purchasers for value rather as the court stated the exclusion is intended to apply only to beneficiaries who suffer an otherwise uncompensated loss as the direct result of the sickness or injury of an insured in whom they have an insurance interest in peoples the corporation was receiving the disability amounts not as compensation_for the beneficiary’s injuries but rather as compensation_for the beneficiary’s unpaid indebtedness taxpayer in the case at issue is not a purchaser for value of the disability policy covering player thus peoples is not relevant rather the issue presented in this case is subject_to revrul_66_262 and rugby here as in the ruling and in rugby the named beneficiary of the disability policy is club and not player also like the postf-135262-08 employee in rugby player does not have a legal right to the proceeds payable under the policy indeed his employment agreement with club specifically provides that --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- ---------------------------------------------------- accordingly based on the service’s published position the proceeds received by the taxpayer are excludable from its income under sec_104 issue whether taxpayer may take a sec_162 deduction for dollar_figurec in payments made to player pursuant to the employment contract sec_162 provides that a taxpayer may deduct all ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying_on_a_trade_or_business see also sec_1_162-1 sec_1_162-7 of the income_tax regulations provides that there may be included among the ordinary and necessary expenses paid_or_incurred in carrying_on_a_trade_or_business a reasonable allowance for salaries or other compensation_for_personal_services actually rendered sec_1_162-10 however specifically limits the deduction for amounts paid_or_accrued as compensation_for injuries to the amount not_compensated_for_by_insurance_or_otherwise sec_1_162-10 provides that amounts paid_or_accrued by a taxpayer on account of injuries received by employees and lump-sum amounts paid_or_accrued as compensation_for injuries are proper deductions as ordinary and necessary expenses such deductions are limited to the amount not_compensated_for_by_insurance_or_otherwise amounts paid_or_accrued within the taxable_year for dismissal wages unemployment benefits guaranteed annual wages vacations or a sickness accident hospitalization medical expense recreational welfare or similar benefit plan are deductible under sec_162 if they are ordinary and necessary expenses of the trade_or_business sec_162 does not address whether or when insurance recoveries or the prospect of insurance recoveries prevent a taxpayer from deducting expenses that are otherwise deductible under that section a deduction for an expense for which there is a right or expectation of reimbursement may be disallowed on the grounds that the payments are not expenses of the taxpayer the extent to which the right must be established has varied some cases have denied the deduction because the right of reimbursement was fixed others have allowed the deduction because the right of reimbursement was uncertain and postf-135262-08 other cases have denied the deduction even if the taxpayer's right to reimbursement was subject_to a contingency a fixed or established right of reimbursement precludes a taxpayer from deducting expenses that would otherwise be deductible under sec_162 revrul_79_263 1979_2_cb_82 no deduction for portion of expenses for which the taxpayer knows he will be reimbursed since the taxpayer suffers no economic detriment with respect to these expenses a right to reimbursement is sufficiently fixed to preclude a deduction when the right has matured without further substantial contingency 68_tc_620 nonacq on other grounds 1978_2_cb_3 a fixed_right of reimbursement has been shown through written agreements specifically providing that the taxpayers' expenses were to be reimbursed or written statements from a third party authorizing the taxpayer to incur the expenses see 78_tc_989 61_f2d_950 2d cir webbe v commissioner tcmemo_1987_426 aff'd 902_f2d_688 8th cir revrul_78_388 1978_2_cb_110 a taxpayer's moving_expenses for which the taxpayer has a fixed_right of reimbursement are not deductible under sec_162 or sec_165 in 212_f2d_552 5th cir the taxpayer paid for roof repairs to a building the taxpayer rented for business purposes after questioning the high cost of the repairs the owner nonetheless agreed to pay and requested that the bills be forwarded the taxpayer instead paid for additional repairs and notified the owner but received no reimbursement the court held that the taxpayer was not entitled to deduct the cost of the repairs as an ordinary and necessary business_expense because the taxpayer had a right to reimbursement despite the owner's ultimate failure to reimburse if the right to reimbursement is not fixed the deduction may be allowed see 39_tc_846 taxpayer had no right to reimbursement at the time the expenses were incurred 28_tc_298 acq 1957_2_cb_3 deduction not precluded by contingent possibility of future reimbursement from assets of debtor of legal fees and costs for representation in bankruptcy proceeding in 37_tc_158 acq 1962_2_cb_4 the taxpayer was allowed a deduction in the year expenses were paid for moving machinery as the result of a condemnation action because there was no fixed_right of reimbursement but only an indefinite and general right to recover its expenses the court concluded that although the taxpayer had a general right to reimbursement of moving_expenses conflicting evidence at hearings to determine the amount of compensation indicated the lack of definiteness of the taxpayer's right in 31_f3d_651 8th cir a taxpayer was allowed a deduction under sec_162 in the taxable_year it transferred money to a_trust to provide for the satisfaction of a judgment after three insurers denied liability even though the taxpayer recovered some insurance proceeds in subsequent years postf-135262-08 an expectation of reimbursement rather than a fixed and absolute right of reimbursement has been held to be sufficient to preclude a deduction under sec_162 revrul_80_348 1980_2_cb_31 holds that travel_expenses that otherwise would be allowable as a deduction under sec_162 may not be deducted if there is an expectation of reimbursement even if the reimbursement is not received until a later year a line of cases has held that an attorney representing clients on a contingent_fee basis may not deduct advances to or expenses paid on behalf of the clients as ordinary and necessary business_expenses the amounts were to be repaid from any recovery and although generally the taxpayers screened cases they accepted to maximize recoveries the taxpayers never recovered of the expenditures 356_f2d_755 5th cir cert_denied 385_us_832 87_sct_77 17_led_68 63_tc_562 53_tc_217 aff'd 447_f2d_484 9th cir acq 1971_2_cb_2 nonacq in part 1982_2_cb_2 silverton v commissioner tcmemo_1977_198 aff'd 647_f2d_172 9th cir cert_denied 454_us_1033 102_sct_571 70_led_477 watts v commissioner tcmemo_1968_183 in 61_tc_140 aff'd 505_f2d_1302 5th cir which involved a fixed_right to reimbursement the court characterized burnett as holding that even a contingent right to reimbursement is sufficient to disallow a deduction based on these authorities we conclude that a right of reimbursement precludes a deduction for a business_expense under sec_162 even if there is not a certainty of reimbursement a mere possibility of reimbursement does not preclude a deduction in most cases if the taxpayer has an insurance_policy that on its face covers the item in question and there is no indication that an exception to coverage applies then a deduction under sec_162 should be disallowed as the taxpayer would have a fixed contractual right to reimbursement the facts in this case demonstrate a close nexus between the taxpayer’s right to receive proceeds under the disability insurance_policy and the employment contract with player the club entered into the employment contract with player with the anticipation that if the player was injured the disability insurance_policy would cover the club for its potential liability with respect to payment obligations to player the employment contract specifies that the club's obligation to pay the player is ------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ postf-135262-08 ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------thus the taxpayer entered into the employment contract with player with the anticipation that it would be reimbursed for its potential liability with respect to the payment obligations made to player by the disability insurance_policy the right to reimbursement under sec_162 is highly factual a deduction for an expense under sec_162 may be denied if based on the facts and circumstances the taxpayer has insurance coverage that appears to provide a right to reimbursement and there is no indication that an exception to coverage applies additional factual information regarding the insurance claim such as correspondence from the insurance co itself regarding the claim the past history of similar insurance claims standard industry practice regarding such claims as well as information used to determine the amount of the payments to be made under the insurance_contract may all be useful to assist in further establishing the connection between the insurance_policy and the employment contract in this case the employer certainly had an expectation of reimbursement for year x the employment contract and the disability insurance_contract had been in place since year s and employer had been collecting under the disability policy for several years employer knew the exact amounts it would receive under the policy as well as the exact amounts it would pay to employee under the employment contract the disability insurance_contract was taken out to cover the exact circumstances under which employer found itself in year x the fact that the insurance_policy pays the club benefits upon the disability of a player rather than pays salary reimbursement benefits is not a meaningful distinction the employment contract between player and club specifically provides for a continuation of salary payments even though player suffers a disability employment contract - ----------------- both the insurance_policy and the employment contract pay upon disability issue whether the deduction is denied due to the application of sec_265 which disallows deductions which are allocable to exempt_income sec_265 provides that an expense amount cannot be deducted if it is allocable to a class of tax-exempt_income other than interest sec_1_165-1 provides that a class of tax-exempt_income includes any class of income wholly excluded from gross_income under any provision of subtitle a of the code or under the provisions of any other law postf-135262-08 case law has established a rule that in order for a deduction to be denied under sec_265 there must be a n exus between the reimbursement income tax-exempt_income and the expense in order to establish that the expenses are allocable to to the exempt_income 78_tc_989 in manocchio taxpayer a veteran incurred flight training expenses which ordinarily would have been deductible under sec_162 however the taxpayer also received a nontaxable reimbursement from the veteran’s administration va for these expenses based on a percentage of the flight training expenses taxpayer incurred the tax_court held that the reimbursed expenses were allocable to the tax-exempt_income the reimbursement and therefore were nondeductible under sec_265 the ninth circuit affirmed manocchio but on different grounds 710_f2d_1400 9th cir in the case at issue club’s right to receive proceeds under the disability insurance was tied to the employment contract with player it is certainly arguable that club acquired the disability policy to recover losses it would incur under the employment contract in the event of player’s disability as a result the dollar_figurec in tax-exempt proceeds taxpayer received under the insurance_policy arguably constitutes a direct reimbursement of the dollar_figuree that taxpayer seeks to deduct as a result consistent with the court’s opinion in manocchio dollar_figurec of the total dollar_figuree amount taxpayer seeks to deduct is not deductible under sec_265 because it is an expense allocable to the dollar_figurec in exempt_income taxpayer received this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call us at if you have any further questions