t c memo united_states tax_court edwin a helwig petitioner v commissioner of internal revenue respondent docket no filed date martin a shainbaum and david b porter for petitioner dale a zusi and michael f steiner for respondent memorandum findings_of_fact and opinion gerber judge in a notice_of_deficiency addressed to petitioner and barbara g helwig ’ respondent determined income_tax deficiencies as follows ' petitioner and barbara g helwig filed a joint petition but barbara g helwig’s cause of action was severed from that of petitioner year amount dollar_figure big_number big_number big_number the amounts remaining in controversy in great part derive from guestions about whether petitioner’s s corporation’s claimed deductions for losses and interest are allowable in particular the controversy involves whether advances from the s_corporation to a second corporation constitute debt or equity if the advances are held to be debt then we must decide whether it was business debt and whether it became worthless as claimed we also decide whether petitioner is entitled to deduct interest_paid on indebtedness incurred to purchase a yacht findings_of_fact petitioner resided and or conducted business in the state of california at the time his petition was filed during the years in issue petitioner was the sole shareholder of k h finishing inc k h an s_corporation in k h began providing painting services to computer manufacturers in the silicon valley california area as the business matured and through the years before the court k h would purchase and inventory parts assemble and finish them and then sell and deliver them to the manufacturer customer although k éh did not place the the parties’ stipulations of facts and exhibits are incorporated by this reference computer components into the enclosures it painted occasionally k h installed electric wiring or cable into the enclosures by the early 1990's k h’s contracts were becoming larger but the industry was also becoming more competitive and the type of computer enclosure was changing to molded materials that did not require painting thus reducing the need for k h’s services as of k h operated in a big_number square-foot facility with employees and petitioner as president earned an annual salary ranging from dollar_figure to dollar_figure during the years through due to the changes in the industry k h sought labor-intensive work and advertised that it did material handling scheduling and quality control for different materials including sheet metal fabrication and plastic forming and injection molding other ways in which k h was able to secure a larger portion of the market were to perform complete or turn-key projects and to assist its customers financially by purchasing the parts and providing financial float for customers while petitioner was performing its services on occasion k h advanced cash and acted as a guarantor for third parties in some of those instances petitioner had an equity_interest in the borrowing entity k h also invested time and expended capital ina project with a company known as polytracker which was attempting to develop a locking shopping cart wheel if successful k h would have manufactured the wheel and its profits might have permitted k h to recoup its costs the level of production necessary to permit k h to recoup its costs was never achieved when k h purchased materials to fulfill contracts with customers to the extent that it had not been repaid and or had not yet billed the customer k h either treated the outstanding amount as an asset or advance to the customer or if it pertained to research_and_development claimed it as an expense in one instance k h at its own expense built a dedicated facility for apple computer apple and then recouped its capital outlay by means of a production contract with apple k h built conveyance assembly and painting equipment and purchased the enclosures that were delivered to k h’s facility where they were assembled coated and or painted and then shipped to apple the sales of the product to apple permitted the recoup of its capital outlay and also produced a 15-percent profit for k h hot snacks inc snacks a c_corporation in date commenced a business with the goal of creating a computer- controlled vending machine that would dispense a french fried product freshly fried in oil one of k h’s employees brought the opportunity in snacks to petitioner’s attention this opportunity was part of k h’s attempt to find new customers and a source for revenue petitioner invested dollar_figure in snacks at a time when a prototype of the computer-controlled vending machine existed as of date petitioner owned percent of the outstanding shares of snacks stock petitioner’s accountant and the accountant’s wife jointly invested dollar_figure in exchange for percent of snacks stock in addition to petitioner’s and his accountant’s stock ownership in snacks during new investors donald parker purchased percent of snacks stock for just over dollar_figure and al marquez obtained percent of snacks stock with a value exceeding dollar_figure petitioner and the accountant had begun their professional relationship during during although the accountant believed that snacks would not be successful he also believed that the vending machine patent could have residual_value for future development and decided to pay petitioner dollar_figure for petitioner’s shares in snacks that sale caused petitioner to claim a dollar_figure loss dollar_figure of which was claimed as an ordinary_loss under sec_1244 this loss is not presently at issue before the court snacks entered into a relationship with k h involving the development and manufacture of a vending machine expecting to be repaid k h incurred costs in attempting to develop a merchantable vending machine petitioner was designated a sec_37 section references are to the internal_revenue_code as amended and in effect for the years under consideration rule references are to this court’s rules_of_practice and procedure president of snacks and was given authority to deal directly with k h in accord with certain waivers that were made by snacks’ shareholders snacks had also entered into joint_venture agreements with korean companies for certain aspects of the manufacture of the vending machines to be used in southeast asia k h advanced cash to snacks and each such advance was formalized in a promissory note due year from its date of execution the notes signed by petitioner on behalf of snacks were dated from date through date and totaled dollar_figure generally the advances were used for snacks’ operating_expenses the advances were carried on snacks’ and k h’s financial records and k h’s tax returns as loans or debt k h on its federal_income_tax returns reported interest_income from the notes a foreign company paid snacks dollar_figure for a license to sell the vending machine in a particular locality and from that dollar_figure was repaid to k h during date other than the dollar_figure repayment no other repayments were made and no attempt was made to collect the balance because snacks was unprofitable k h expected to earn income and profits from its relationship with snacks by assembling vending machines it was estimated that k h would make dollar_figure per vending machine and that there would be a big_number unit market demand resulting in projected income of dollar_figure million for k h ké h was not directly involved in the research_and_development of the vending machine k h determined the amount of partial worthlessness of the advances made to snacks each year by comparing the prior year’s ending advance balance with snacks’ cumulative losses to arrive at a ratio the resulting ratio was then applied to the prior year’s ending advance balance to arrive at the claimed writeoff snacks’ net_worth as of date and was a negative dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure respectively each caused by an excess of liabilities over assets for its fiscal years ended date and date k h claimed that the advances to snacks had become partially worthless a bad_debt and deducted the amounts of dollar_figure and dollar_figure respectively respondent in the notice_of_deficiency determined that the claimed bad_debt deductions were not allowable k h advanced snacks more than dollar_figure through date and additional_amounts of dollar_figure and dollar_figure during the fiscal years ended date and for the period ended date k h based on the accountant’s advice sold to the accountant dollar_figure of the notes for dollar_figure in an attempt to fix the time and amount of the loss respondent determined that the dollar_figure ordinary_loss deduction claimed by petitioner for was not allowable for its and fiscal years k h paid interest on indebtedness incurred to purchase a yacht in the amounts of dollar_figure dollar_figure dollar_figure and dollar_figure respectively opinion the principal and threshold question for our consideration is whether the advances from k h to snacks were debt or equity thereby determining the proper deduction if any allowed to petitioner as sole shareholder of k h a pass-thru_entity if we find that the advances are debt we must consider whether the debt was business debt and became worthless as claimed in the setting of this case the answer to the debt versus equity question will decide whether the claimed losses are ordinary or capital if allowable some of the factors that we consider here in deciding whether advances are debt or equity include the existence of debt instruments the parties’ intent and their representations of the advances the existence of fixed maturity dates rights to enforce payment whether the advances enhanced participation in the debtor’s management the status of the advances relative to other creditors whether the borrowing entity is thinly capitalized repayment activity and the type of expenditures made with the advances see eg 74_tc_476 cerand co v commissioner tcmemo_1998_423 see also 464_f2d_394 n 5th cir a r lantz co v united st424_f2d_1330 9th cir the facts and circumstances of each case must be considered and no single factor is considered determinative see 326_us_521 ultimately we must decide whether k h intended to create a debt with a reasonable expectation of repayment and whether those aspects comported with economic reality see cerand co v commissioner supra there can be no doubt that the form in which the advances were cast was debt and not equity there is also no doubt that the parties treated the advances as debt rach advance was memorialized by a promissory note bearing a fixed rate of interest and due year from its execution in addition each of the parties to the notes recorded the accumulated balances as debts or loans on books_and_records and financial statements it is also clear that for tax purposes each party consistently reported the advances as debt and k h reported interest_income attributable to the notes in the face of petitioner’s strong position on the form of the transactions respondent contends that in substance the advances were equity in nature in support of this contention respondent points out that only petitioner and no other shareholder signed the notes and no efforts were made to collect matured notes petitioner counters that he was given authority and consent by the other shareholders petitioner also points out that the fact that petitioner signed all the notes does not link the advances to petitioner’s capital_investment in snacks petitioner also explains that the failure to enforce collection on mature notes was not due to a legal inability but instead to the knowledge that snacks was not in a position to pay in addition petitioner points out that snacks repaid k h dollar_figure when funds became available because of a transaction with a foreign licensee that repayment petitioner contends is clear evidence of debt and not equity respondent also argues that the advances were used to pay the day-to-day operating_expenses in a setting where snacks had not been shown capable of generating profit this aspect respondent contends means that the repayment advances are placed at the risk of the business meaning ostensibly that the advances represent capital and not debt petitioner has shown otherwise at the time petitioner paid dollar_figure for share holdings in snacks a prototype of the vending machine existed there was active development of the product and its marketplace throughout the period under consideration after petitioner invested in snacks foreign businesses became interested in the vending machine and during other investors acquired several hundred thousand dollars of snacks’ stock representing substantially smaller percentages of the snacks shares than those acquired by petitioner in addition southeast asian manufacturing companies entered into a joint_venture agreement in connection with the vending machines’ manufacture and sales in their geographical area those facts represent independent evidence of perceived potential for snacks to be profitable accordingly petitioner’s belief as to the potential profitability of snacks is confirmed by the actions of other lenders and business interests who became involved with snacks on the same or similar terms as k h and petitioner these factors also bolster the estimates that there was potential for k h to earn substantial profits projected at big_number machines and profit of dollar_figure per machine or dollar_figure million the facts and circumstances in this case reflect that snacks was not thinly capitalized and that the advances were in form and substance debt with a reasonable expectation of repayment accordingly we hold respondent’s determination that the advances were equity to be in error next we consider whether the loans to snacks were business or nonbusiness as they related to k h sec_166 which permits deductions for bad_debts distinguishes between business and nonbusiness bad_debts see sec_166 sec_1_166-5 income_tax regs a partial or wholly worthless business_bad_debt may be deducted whereas only a wholly worthless nonbusiness_bad_debt is deductible see sec_166 to qualify as a business_bad_debt it must be established that the debt was proximately related to the conduct of the taxpayer’s trade_or_business see 405_us_93 sec_1 b income_tax regs whether a debt is proximately related to a trade_or_business is dependent upon a taxpayer’s dominant motive for lending the money see united_states v generes supra pincite a taxpayer’s dominant motive must be business related as opposed to investment related for a loan to be proximately related to the taxpayer’s trade_or_business see 66_tc_652 affd 601_f2d_734 5th cir united_states v generes supra petitioner contends that the dominant motivation for the loans was developing business opportunities for k h by we consider the business versus nonbusiness question next because petitioner through k h seeks to claim losses due to partial worthlessness a treatment that is not available for nonbusiness bad_debts see sec_166 b involvement in the manufacture of vending machines conversely respondent contends that the securing of future business was not the dominant motive respondent argues that the potential for profit from the appreciation of snack share holdings was the dominant motive for k h advancing funds to snacks to some extent we have tangentially addressed this question by holding that k h’s advances to snacks were debt loans rather than equity in addressing the debt versus equity question we have already decided that the advances were not equity and were not investment motivated petitioner who earned substantial salaries from k h realized that competition had forced his company to seek out additional business and provide incentives for potential or existing customers one of the ways that k h accomplished this was to either advance money to or lessen the financial burden of customers leading up to and during the years in issue k h lent funds purchased inventory and provided float for customers and built manufacturing facilities to address customers’ needs the transaction with snacks fit within that pattern of k h’s business activity there was business potential and reasonable expectation of profit for k h in its relationship with snacks we note that neither party makes distinctions between petitioner and his wholly owned s_corporation for example respondent connects petitioner’s share ownership with his s corporation’s advances that potential was corroborated by unrelated third parties we find that k h’s dominant motive for advancing or lending snacks funds was for the purpose of developing business opportunities and that the debt was thus proximately related to its trade_or_business accordingly we hold that the advances in question were business bad_debts within the meaning of sec_166 the final step in this three part inquiry is to decide whether petitioner has shown that any portion of the business bad_debts became worthless during the years claimed by petitioner this inquiry is also one of facts and circumstances and worthlessness occurs in the year in which identifiable events clearly mark the futility of any hope of further recovery 57_tc_848 portions of the business_bad_debt were written off as partially worthless for the and fiscal years the amounts of partial worthlessness were computed by means of a ratio generated by comparing the total losses of snacks to the outstanding balance of the advances both of which were increasing annually because the vending machines’ capability depended on its computer hardware and software the accountant considered the known propensity of these items to become technologically outmoded in choosing the method to compute worthlessness and in reaching the conclusion that loss deductions should be claimed snacks had a negative net_worth for its and years of dollar_figure and dollar_figure respectively snacks’ negative net_worth was steadily increasing throughout the period under consideration the remaining dollar_figure in outstanding notes was sold to the accountant in a transaction for convenience for dollar_figure during the year also in petitioner sold his stock holdings in snacks for dollar_figure to the accountant and claimed a dollar_figure capital_loss deduction at that time petitioner owned about percent of snacks respondent’s focus with respect to the worthlessness question concerns the fact that k h continued to make advances during the and period for which bad_debt_loss deductions were claimed relying on two memorandum opinions of this court respondent argues that continued extension of credit is not consistent with the claim of worthlessness one of those opinions involved a taxpayer who was reselling a substantial percentage of its purchases to an insolvent customer in that case the holding that the taxpayer was not entitled to claim partial worthlessness was based on the fact that the customer was deeply insolvent and that its situation did worsen markedly and the taxpayer continued to sell a significant amount of merchandise extend credit to the customer see veego foods inc v commissioner tcmemo_1958_203 the other opinion relied on by respondent involved a situation where the taxpayer claimed partial worthlessness where the debtor’s liabilities were seven times its assets the court in denying the taxpayer’s claim found that although the liabilities exceeded assets by a ratio of to the assets had considerable value in the year of the taxpayer’s claim and the following year the debtor made repayments and the repayments continued until the debt was reduced to an amount smaller than claimed loss see miller realty co v commissioner tcmemo_1977_440 in petitioner’s circumstances snacks’ negative net_worth was steadily increasing the increases during the and periods however were to some great extent attributable to advances from k h more importantly petitioner has not shown any identifiable events that clearly mark the futility of any hope of further recovery the accountant’s purchase of the notes for a nominal amount was a transaction for convenience and as a courtesy to petitioner and did not evidence the worthlessness of the notes we also agree with respondent’s observation that k h’s continued extension of credit is not consistent with the claim of worthlessness although the advances are business debt within the meaning of sec_166 no portion of them became worthless during petitioner’s or taxable_year we also note that even if the sale of the notes to the accountant for dollar_figure evidenced the worthlessness of the notes that sale did not occur until date at the conclusion of ké h’s year and hence petitioner’s tax_year in addition petitioner’s sale of his capital or equity_interest in snacks has not been shown to have had any particular effect on the worthlessness of the notes accordingly we find that petitioner has not substantiated his claim for partial worthlessness of the notes during the years in guestion two remaining issues were addressed by the parties on brief the first involved dollar_figure of snacks’ operating_expenses that were paid and claimed by k h for its taxable_year ended date respondent determined in the notice_of_deficiency that the expenses are not deductible because they were incurred on behalf of snacks and therefore are not trade_or_business_expenses of k h on brief respondent maintained the position that the expenses were not k h’s trade_or_business_expenses generally one taxpayer may not deduct expenses paid on behalf of another taxpayer see eg 881_f2d_336 6th cir affg tcmemo_1988_180 we to the extent that either party did not address an issue raised by the pleadings we assume that the issue has either been agreed to by the parties or is being abandoned by the party with the burden_of_proof have held that in certain limited circumstances a taxpayer may deduct the expenses of another taxpayer see 48_tc_679 for the application of our holding in lohrke we must first ascertain k h’s motive for paying snacks’ operating_expenses and then determine whether it was in furtherance or promotion of k h’s trade_or_business see id our consideration of whether the advances here were debt or equity and business or nonbusiness debts covered the question of whether the advances were to promote k h or whether they were investment in snacks that is the same inguiry that is called for under the above-stated lohrke standard because k h’s relationship with snacks was to secure additional business and profits for k éh it follows that k h’s payment of snacks’ operating_expenses in this limited setting would be deductible by k h accordingly petitioner through k h is entitled to the dollar_figure deduction for his taxable_year the final item addressed by the parties’ briefs concerns respondent’s disallowance of interest_paid by k h on indebtedness incurred to purchase a yacht the amounts disallowed for petitioner’s through taxable years are dollar_figure dollar_figure dollar_figure and dollar_figure respectively the record consists of only two exhibits that pertain to these adjustments one exhibit a security_agreement reveals that during a used carver boat was purchased and dollar_figure of the purchase_price was financed attached to the agreement is an amortization schedule showing a breakdown of the principal and interest to be paid the other exhibit is a date memorandum from petitioner’s accountant’s office to respondent’s agent the memorandum contains summarized information provided by the accountant pursuant to the request of respondent’s agent the memorandum contains the following pertinent statements about the yacht business_purpose and expenses of yacht - per ed helwig the boat yacht is a misnomer as the vessel i sec_42 foot trailer-able boat is used to entertain customers as the boat is not docked ina slip but is parked at his house there are no monthly expenses related to maintenance pursuant to sec_274 the boat is not depreciated for federal_income_tax purposes any expenses related to the entertainment of customers on the boat are out-of- pocket costs reimbursed to e a helwig by the corporation or corporate credit card charges both of which are charged to the meals and entertainment accounts and limited to deductible a schedule of use is not available based on the above respondent contends that no deduction is allowable for any expenditure paid with respect to an entertainment_facility after date pursuant to sec_274 and sec_1_274-2 income_tax regs respondent further contends that pursuant to sec_1 e income_tax regs a yacht is considered an entertainment_facility petitioner does not question respondent’s contention but instead counters that the interest_deduction is allowable under sec_274 that section entitled interest taxes casualty losses etc exempts from the sec_274 requirements any deduction allowable to the taxpayer without regard to its connection with his trade_or_business with respect to corporations taxpayers who are not individuals sec_274 is to be applied as though the taxpayer was an individual in that regard respondent argues that unless petitioner can show an exception to the general_rule of sec_163 that an individual’s personal_interest is not deductible no deduction is permissible petitioner simply argues that the language of sec_163 h in the case of a taxpayer other than a corporation no personal_interest is allowable would cause the allowance of an interest_deduction because k h is a corporation if this were simply a matter of applying sec_163 petitioner’s argument would ring truer the sec_274 limitations outlined above however specifically address this situation those limitations cause petitioner and or his s_corporation to be treated as an individual accordingly petitioner is not entitled to deduct interest on the indebtedness to acquire the yacht under sec_163 either in his own right or through his corporation to reflect the foregoing and because of concessions by the parties decision will be entered under rule


t c summary opinion united_states tax_court john scott kracke petitioner v commissioner of internal revenue respondent docket no 1092-03s filed date john scott kracke pro_se william c bogardus for respondent powell special_trial_judge this case was heard pursuant to the provisions of section of the internal_revenue_code in effect at the time the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated subsequent section references are to the internal_revenue_code in effect for the year in issue respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax the issue is whether dollar_figure of the dollar_figure payments petitioner made to his former wife constitute deductible_alimony payments or in the alternative nondeductible child_support payments petitioner resided in darien connecticut at the time the petition was filed background petitioner married julie skakel ms skakel-kracke on date petitioner and ms skakel-kracke had three children during their marriage john scott jr scotty born date george maxwell george born date and claire hayden born date the superior court judicial district of stamford norwalk state of connecticut entered a judgment on date whereby petitioner and ms skakel- kracke were divorced the separation agreement executed the same day provided in pertinent part iv periodic alimony the dollar_figurek monthly base_amount in a continuation of judge tierney’ sec_1 pendente lite order no the p l order the per month base_amount of dollar_figurek or dollar_figurek year shall be paid to the wife as unallocated periodic alimony and support the periodic alimony which amount is predicated on the husband’s current annual income of dollar_figure 7k as follows i the p l order shall continue in full force and effect until the last day of the month during which a judgment the judgment is entered in the action and ii on the fourth business_day of each succeeding month the husband shall pay the periodic alimony subject_to the other terms of this agreement the monthly amount shall be reduced by dollar_figurek on september 1st of the summer immediately succeeding each of scotty’s and george’s graduation from high school illustration assuming scotty graduates from high school on the periodic alimony would step down from dollar_figurek per month to dollar_figurek per month effective the additional periodic alimony re an increase in the husband’s compensation t he husband shall pay the payment of the gross amount of any bonuses commissions or additional salary received in a calendar_year to the wife as additional periodic alimony pursuant to the separation agreement petitioner paid ms skakel-kracke dollar_figure in which consisted of the dollar_figure monthly payments plus percent of his bonuses in preparing his federal_income_tax return petitioner deducted dollar_figure as alimony payments respondent in the notice_of_deficiency disallowed dollar_figure of the payments dollar_figure each per month for scotty and george discussion sec_215 allows a deduction for amounts paid for alimony or separate_maintenance payments that are includable in the recipient’s gross_income under sec_71 an alimony_or_separate_maintenance_payment is defined by sec_71 sec_215 sec_71 provides in pertinent part c payments to support children -- in general -- amounts received as alimony or separate_maintenance payments shall not apply to that part of any payment which the terms of the divorce_or_separation_instrument fix in terms of an amount of money or a part of the payment as a sum which is payable for the support of children of the payor spouse treatment of certain reductions related to contingencies involving child --for purposes of paragraph if any amount specified in the instrument will be reduced-- a on the happening of a contingency specified in the instrument relating to a child such as attaining a specified age marrying dying leaving school or a similar contingency or b at a time which can clearly be associated with a contingency of a kind specified in subparagraph a an amount equal to the amount of such reduction will be treated as an amount fixed as payable for the support of children of the payor spouse the separation agreement provides for a reduction of the unallocated periodic alimony and support payments by dollar_figure each for scotty and george on a certain date after each of their graduations from high school and that provision is clearly a contingency related to those children see hammond v commissioner tcmemo_1998_53 payments determined to be child_support when the payments terminated on the taxpayer’s child’s 18th birthday israel v commissioner tcmemo_1995_500 payment determined to be child_support when contingent on child residing with recipient spouse petitioner asserts that it is inequitable to treat the payments as child_support because it was intended by the parties that he would be able to deduct the payments in full this may have been what the parties intended but we cannot rewrite the separation agreement while we may be sympathetic with petitioner’s position this court also cannot rewrite statutes enacted by congress in order to reach what may be perceived as a more equitable result see 320_us_418 respondent is sustained reviewed and adopted as the report of the small_tax_case division to reflect the foregoing decision will be entered for respondent


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 ------------------------------------------------ telephone number -------------------- refer reply to cc psi b04 plr-115867-13 plr-115868-13 date date legend donor spouse trust date child child law firm consultant accounting firm year year year --------------------------------------------- ------------------------------------------------ ----------------------------------------------------------- -------------------------- ---------------------- ----------------------------- ------------------------------------------- -------------------------------- -------------------- ------ ------ ------ dear ---- ----------------------- this letter responds to your authorized representative’s letter dated date requesting an extension of time under sec_2642 of the internal_revenue_code and sec_301_9100-3 of the procedure and administration regulations to elect out of the generation-skipping_transfer gst_exemption automatic allocation rules the facts and representations submitted are summarized as follows on date a date in year donor established an inter_vivos irrevocable_trust trust for the primary benefit of donor’s children child and child child and child are the plr-115867-13 plr-115868-13 primary beneficiaries of trust and their descendants are eligible beneficiaries of trust trust was funded with a portion of donor and spouse’s interest_in_real_property law firm prepared the trust agreement the terms of trust provide that each child has the right to withdraw their respective share of trust‘s principal after attaining the age of additionally it was contemplated by trust that personal vacation residences would be constructed by trust on the real_property transferred to trust and that trust’s interest in the vacation residences would be distributed to child and child prior to their attaining the age of consultant is a licensed cpa and was retained by donor and spouse in year to manage their business and personal affairs specifically consultant was hired to provide tax planning and tax reporting advice and communicate with donor and spouse’s accountants accounting firm regarding tax preparation in conjunction with the preparation of the trust agreement law firm sent a letter to donor and spouse in which it summarized the terms of trust in addition law firm recommended against allocating gst_exemption to the year transfers to trust because the property could be withdrawn by child and child once they attained the age of and because it was anticipated that the property would be distributed outright to child and child prior to their attaining age accounting firm prepared the form sec_709 united_states gift and generation- skipping tax_return and asked consultant if they should elect out of the automatic allocation of gst_exemption for the transfers to trust in year consultant was not aware that law firm had recommended against the automatic allocation of gst_exemption and thus failed to advise accounting firm accordingly the error was discovered when law firm received copies of the year form sec_709 at the end of year law and analysis sec_2601 provides that a tax is imposed on every generation-skipping_transfer gst sec_2611 provides that the term generation-skipping_transfer means a taxable_distribution a taxable_termination and a direct_skip sec_2602 provides that the amount of the tax imposed by sec_2601 is the taxable_amount multiplied by the applicable_rate sec_2612 provides that the term direct_skip means a transfer subject_to a tax imposed by chapter or of an interest in property to a skip_person plr-115867-13 plr-115868-13 sec_2613 provides in part that the term skip_person means -- a natural_person assigned to a generation which i sec_2 or more generations below the generation assignment of the transferor sec_2631 provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption amount which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_2631 provides that for purposes of sec_2631 the gst_exemption amount for any calendar_year shall be equal to the applicable_exclusion_amount under sec_2010 for such calendar_year sec_2632 provides that any allocation by an individual of his or her gst_exemption may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual's estate regardless of whether such a return is required to be filed sec_2632 provides that the manner in which allocations are to be made shall be prescribed by forms or regulations issued by the secretary sec_2632 provides that if any individual makes an indirect_skip during his lifetime any unused portion of such individual's gst_exemption shall be allocated to the property transferred to the extent necessary to make the inclusion_ratio for such property zero automatic allocation if the amount of the indirect_skip exceeds such unused portion the entire unused portion shall be allocated to the property transferred sec_2632 provides that for purposes of sec_2632 the unused portion of an individual's gst_exemption is that portion of such exemption which has not previously been allocated by such individual or treated as allocated under sec_2632 or sec_2632 sec_2632 provides that an individual may elect to have the automatic allocation rule_of sec_2632 not apply to a transfer sec_2641 defines the applicable_rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer sec_2641 provides that the term maximum_federal_estate_tax_rate means the maximum rate imposed by sec_2001 on the estates of decedents dying at the time of the taxable_distribution taxable_termination or direct_skip as the case may be plr-115867-13 plr-115868-13 under sec_2642 the inclusion_ratio with respect to any property transferred in a generation-skipping_transfer is the excess if any of over the applicable_fraction the applicable_fraction as defined in sec_2642 is a fraction the numerator of which is the amount of the gst_exemption allocated to the trust or to property transferred in a direct_skip and the denominator of which is the value of the property transferred to the trust or involved in the direct_skip reduced by the sum of any federal estate_tax or state death_tax actually recovered from the trust attributable to such property and any charitable deduction allowed under sec_2055 or sec_2522 with respect to such property sec_2642 provides that the secretary shall by regulation prescribe such circumstances and procedures under which extensions of time will be granted to make an allocation of gst_exemption described in sec_2642 or and an election under sec_2632 or c such regulations shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of this paragraph sec_2642 provides that in determining whether to grant relief under sec_2642 the secretary shall take into account all relevant circumstances including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the secretary deems relevant for purposes of determining whether to grant relief the time for making the allocation or election shall be treated as if not expressly prescribed by statute notice_2001_50 2001_2_cb_189 provides that under sec_2642 the time for allocating the gst_exemption to lifetime transfers and transfers at death the time for electing out of the automatic allocation rules and the time for electing to treat any trust as a generation-skipping_transfer_trust are to be treated as if not expressly prescribed by statute the notice further provides that taxpayers may seek an extension of time to make an allocation described in sec_2642 or b or an election described in sec_2632 or c under the provisions of sec_301_9100-3 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_9100-1 sec_301_9100-2 provides an automatic_extension of time for making certain elections sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose date is prescribed by a regulation and not expressly provided by statute in accordance with sec_2642 and notice_2001_50 taxpayers may seek an extension of time to make an allocation described in sec_2642 or b or an election described in sec_2632 or c under the provisions of sec_301_9100-3 plr-115867-13 plr-115868-13 sec_301_9100-3 provides in part that requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government sec_301_9100-3 provides in part except as provided in sec_301 b i through iii that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly donor and spouse are granted an extension of time of days from the date of this letter to make an election under sec_2632 that the automatic allocation rules do not apply to the year transfers to trust the election out will be effective as of the date of the transfers date the election should be made on supplemental form sec_709 for year the form sec_709 should be filed with the cincinnati service_center at the following address internal_revenue_service cincinnati service_center - stop cincinnati oh you should attach a copy of this letter to the supplemental form sec_709 we have enclosed a copy for this purpose in accordance with the power_of_attorney on file with this office we have sent a copy of this letter to your authorized representatives except as expressly provided herein we neither express nor imply any opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter further we express no opinions regarding the when the gifts were complete under state law the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination plr-115867-13 plr-115868-13 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent sincerely _________________________ leslie h finlow senior technician reviewer branch office of the associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes copy of this letter


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 plr-152462-10 date date legend parent sub sub fsub fsub fsub fsub --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- -------------------------------- --------------------------------------------------------------------------------- --------------------------------------------------------------------------------- ------------------------------- --------------------------------------------------------------------------------- ------------------------------- --------------------------------------------------------------------------------- --------------------------------- --------------------------------------------------------------------------------- ---------------------------------------- --------------------------------------------------------------------------------- ---------------------------------------- --------------------------------------------------------------------------------- ---------------------------------------- newco --------------------------------------------------------------------------------- --------------------------------------------------------- newco --------------------------------------------------------------------------------- plr-152462-10 business a country x court authority --------------------------------------------------------- --------------------------------------------------------------------------------- ---------------------------------- --------------------- ---------------------------------------------------------------- ------------------------------------------------------------- class a shares --------------------------------- class b shares --------------------------------- b c d e f g h i ----------------------- ----------------------- --------------------------------------------------------------------------------- --------------- --------------------------------------------------------------------------------- --------------- --------------------------------------------------------------------------------- --------------- --------------------------------------------------------------------------------- --------------- --------------------------------------------------------------------------------- --------------- --------------------------------------------------------------------------------- --------------- dear ----------------- this letter responds to your letter dated date in which you requested rulings regarding certain federal_income_tax consequences of a series of proposed transactions collectively the proposed transaction the information submitted in that letter and later correspondence is summarized below plr-152462-10 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 summary of facts parent is a widely-held domestic_corporation that is the common parent of a u s consolidated_group parent indirectly owns all the outstanding_stock of sub and directly owns all the outstanding_stock of fsub a foreign_corporation sub owns all the outstanding_stock of sub and fsub a foreign_corporation sub is the beneficial_owner of approximately b of the outstanding_stock of fsub a country x entity as described in sec_301_7701-2 ie a so-called per_se_corporation fsub holds sub 2’s beneficial_interest in fsub the remaining c of the outstanding_stock of fsub is publicly held the public shareholders and together with sub the shareholders fsub is engaged in business a through its wholly owned subsidiary fsub a foreign_corporation proposed transaction for what are represented to be valid business reasons taxpayer intends to complete the proposed transaction as follows preliminary step sec_1 sub will contribute approximately dollar_figured to sub in exchange for equity debt or a combination of both sub will contribute approximately dollar_figuree to fsub in exchange for fsub common_stock fsub will form newco a foreign company and transfer business a to newco in exchange for newco stock newco will elect to be treated as a disregarded_entity pursuant to sec_301_7701-3 reorganization steps through below the reorganization will require the approval of the shareholders and the court as well as filings with the authority to meet certain regulatory requirements in country x sub will form newco a country x entity treated as a corporation under sec_301_7701-3 with nominal share capital plr-152462-10 fsub will be re-registered as a country x entity treated as a corporation under sec_301_7701-3 and fsub 2’s existing shares will be cancelled in consideration new shares in fsub will be issued to newco newco will issue g class a shares to the public shareholders and h class b shares to sub in consideration for the cancellation of the shareholders’ fsub stock fsub will elect to be treated as a disregarded_entity fsub dre under sec_301_7701-3 the fsub election the effective date of the fsub election will be the day after newco issues its class a and class b shares respectively to the public shareholders and sub post-reorganization distribution following the reorganization taxpayer will undergo steps through the post-reorganization distribution the post-reorganization distribution will also require the approval of the shareholders and the court as well as filings with the authority to meet certain regulatory requirements in country x taxpayer will seek a private_letter_ruling in connection with the post-reorganization distribution newco will cancel its class a shares and newco will become obligated to pay in the aggregate dollar_figuref to the public shareholders fsub will distribute newco to newco through fsub dre sub will transfer approximately dollar_figured to newco in exchange for additional newco class b shares newco will borrow approximately dollar_figuree from fsub the fsub loan newco will pay dollar_figurei dollar_figured dollar_figuree to the public shareholders in part consideration for the cancellation of their newco class a shares newco will re-register as a country x entity described in sec_301_7701-2 ie a so-called per_se_corporation newco will issue shares representing c of its total share capital to the public shareholders in payment of the balance of the consideration due to them for the cancellation of the class a shares representations plr-152462-10 in connection with the reorganization the taxpayer has made the following representations a the fair_market_value of the newco class a and class b shares received by the public shareholders and sub respectively in the reorganization will be approximately equal to the fair_market_value of the fsub shares surrendered in the same exchange b immediately following the reorganization from a us federal_income_tax perspective newco will have the same assets and liabilities as those owned by fsub immediately prior to the reorganization c immediately following the reorganization except for a de_minimis amount of newco stock received by sub at the time of organizing newco with minimum regulatory capital the shareholders will own all the outstanding shares of newco solely by reason of their ownership of fsub stock d the shareholders newco and fsub will each pay their respective expenses if any incurred in connection with the reorganization e at the time of the reorganization fsub will not be under the jurisdiction of a court in a title or similar proceeding within the meaning of sec_368 f immediately prior to the reorganization no part of fsub 2’s earnings_and_profits will be comprised of effectively_connected_earnings_and_profits as defined in either sec_884 or sec_884 g at all times before the reorganization fsub has not and will not be a passive_foreign_investment_company within the meaning of sec_1297 h immediately after the reorganization newco will not be a passive_foreign_investment_company within the meaning of sec_1297 i sub will comply with the requirements of sec_1_367_b_-4 with respect to subsequent exchanges of newco stock received in the reorganization j fsub will not hold any united_states real_property interests as defined in sec_897 immediately before the reorganization and newco will not hold any such interests immediately after the reorganization k with respect to any existing gain_recognition_agreement entered into by any member of the u s group in connection with a prior transfer of stock_or_securities plr-152462-10 to fsub the u s group member will in accordance with sec_1_367_a_-8 enter into a new gain_recognition_agreement as described in sec_1_367_a_-8 that designates newco as the transferee foreign_corporation for purposes of sec_1_367_a_-8 and will comply with the notification requirements thereunder rulings based solely on the information submitted and the representations set forth above we rule as follows steps through will be integrated and treated as the transfer by fsub of all of its assets subject_to liabilities to newco in exchange for stock of newco followed by the distribution by fsub of the newco stock to its shareholders in liquidation and will constitute a reorganization within the meaning of sec_368 of the internal_revenue_code revrul_67_274 1967_2_cb_141 fsub and newco will each be a party to the reorganization within the meaning of sec_368 the post-reorganization distribution will not preclude the reorganization from qualifying as a sec_368 reorganization revrul_96_29 1996_1_cb_50 fsub will recognize no gain_or_loss upon the transfer of its assets to newco sec_361 and sec_357 newco will recognize no gain_or_loss upon its receipt of fsub 2’s assets in the reorganization for newco stock sec_1032 the basis of the assets held by newco will be the same as the basis of such assets in the hands of fsub sec_362 the public shareholders and sub will recognize no gain_or_loss upon the exchange of fsub shares for newco class a and b shares respectively sec_354 the shareholders’ basis in the newco class a and class b shares received in the reorganization will be the same as the shareholders’ basis in fsub stock surrendered in the reorganization immediately prior to the reorganization sec_358 provided the shareholders hold the fsub shares as a capital_asset at the time of the fsub election the holding_period of the newco class a and class b shares received in the reorganization will include the holding_period of the fsub shares surrendered in the reorganization sec_1223 plr-152462-10 the holding_period of each asset of fsub held by newco will include the holding_period of that asset in the hands of fsub sec_1223 fsub 2’s tax_year will not close on the effective date of the fsub election under sec_381 and sec_1_381_b_-1 and sec_1_367_b_-2 subject_to the conditions and limitations of sec_381 sec_382 sec_383 and sec_384 and treasury regulations thereunder newco will succeed to and take into account the tax_attributes of fsub described in sec_381 under sec_381 and sec_1 a -1 no amount will be included in income under sec_367 as a result of the steps that are being treated as a reorganization under sec_368 sec_1_367_b_-4 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 including under the international provisions of the code in addition no opinion is expressed with respect to the post-reorganization distribution further to the extent not otherwise specifically ruled upon above no opinion is expressed with respect to the adjustments to earnings_and_profits or deficits in earnings_and_profits if any with respect to any of the transactions to which sec_367 applies and other consequences under sec_367 with respect to any transaction described in this ruling letter 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 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 the letter_ruling plr-152462-10 in accordance with the power_of_attorney on file with this office a copy of this letter will be sent to your authorized representative sincerely _____________________________ lewis k brickates branch chief branch associate chief_counsel corporate cc