t c memo united_states tax_court james p donoghue and elaine s donoghue petitioners v commissioner of internal revenue respondent docket no filed date james p donoghue and elaine s donoghue pro sese derek w kelley for respondent memorandum findings_of_fact and opinion ashford judge beginning in petitioners engaged in a thoroughbred horse breeding and racing activity they continued to engage in the activity until despite reporting a loss for every year of its existence respondent audited petitioners’ joint form sec_1040 u s individual_income_tax_return for taxable_year sec_2010 sec_2011 and sec_2012 years at issue and determined that the loss deductions they claimed related to their horse activity should be disallowed consequently by statutory_notice_of_deficiency dated date respondent determined deficiencies in petitioners’ federal_income_tax and accuracy-related_penalties pursuant to sec_6662 a for the years at issue as follows year deficiency dollar_figure big_number big_number accuracy-related_penalty sec_6662 dollar_figure big_number big_number the issues for decision are whether for the years at issue petitioners engaged in their horse activity for profit within the meaning of sec_183 and are liable for accuracy-related_penalties we resolve both issues in favor of respondent 1respondent also determined that petitioners had unreported short-term_capital_gain on the sale of certain securities for each of the years at issue the parties now agree that petitioners had unreported long-term rather than short- term capital_gain for each of the years at issue respondent also made a computational adjustment to the taxable_amount of social_security_benefits petitioners reported for each of the years at issue 2unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure some monetary amounts are rounded to the nearest dollar findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and attached exhibits are incorporated herein by this reference petitioners resided in massachusetts when they timely filed their petition with the court i petitioners’ background during the years at issue mr donoghue worked full time for w b mason co inc as a programmer and mrs donoghue was disabled mr donoghue has also previously managed a family construction business and mrs donoghue has been a paralegal and an executive in various departments of a corporation they both have college degrees--mr donoghue in finance with a minor in business and mrs donoghue in communication arts ii petitioners’ horse activity mrs donoghue fell in love with horses as a child attributing this to her grandfather who was a successful breeder of thoroughbred racing horses and frequently took her to racetracks and breeding farms when she was young as she grew older she fell in love with the business he ran and she diligently began reading trade publications on horse breeding and racing in in an attempt to follow in the footsteps of mrs donoghue’s grandfather who had passed away by then petitioners decided to start their horse activity they formed an equal partnership named marestelle farm to breed and race world class thoroughbred horses mrs donoghue handled the operations side of marestelle farm ie studying horse bloodlines searching for horses to breed with their horses and managing the care and training of their horses in for example after petitioners’ first horse successfully delivered a male foal at fulmer international farm in south carolina mrs donoghue spent some time there working with the foal and as an apprentice for robert hall a licensed thoroughbred race trainer mrs donoghue also served as the bookkeeper for marestelle farm mr donoghue handled the remaining financial aspects of marestelle farm ie serving as the controller including ensuring that marestelle farm’s filing obligations with the internal_revenue_service irs were met during the years at issue petitioners owned and marestelle farm consisted of a total of six horses they did not however breed race or sell any of their horses during these years the industry norm for racing a horse i sec_24 races per year the last year petitioners raced any of their horses was they stopped their horse activity in from its inception in through their activity never had a profitable year a petitioners’ horses petitioners owned six horses during the years at issue in connection with marestelle farm lilac domino lainies calliope canajorie dr davies run the credits and whaleman lilac domino a mare born in was the first horse petitioners owned with respect to their horse activity mrs donoghue spent three years researching horse bloodlines before petitioners purchased lilac domino in on the basis of mrs donoghue’s research they thought that lilac domino had fantastic bloodlines but they were able to purchase her for a bargain price because she was severely lame lilac domino was mrs donoghue’s dream horse and she was the only horse petitioners acquired other than through breeding in after lilac domino was nursed back to health petitioners bred her with a stallion named secretary of state she successfully delivered a male foal 3for further discussion of marestelle farm’s financial performance see infra pp 4as discussed infra pp before the years at issue lilac domino foaled sir manatee and lainies calliope foaled whaleman seal e dan and fine artist but by whaleman was the only one of these foals that petitioners continued to own named sir manatee at fulmer international farm in lilac domino was bred with secretary of state again and successfully delivered a female foal named lainies calliope lilac domino died in petitioners entered sir manatee in a couple of races and bred him before selling him in for dollar_figure petitioners never raced lainies calliope instead she became petitioners’ second generation broodmare lainies calliope produced six foals for petitioners whaleman seal e dan canajorie dr davies run the credits and fine artist in lainies calliope foaled whaleman a stallion at overbrook farm in kentucky whaleman’s racing career consisted of racing times from to at suffolk downs racetrack in massachusetts which petitioners considered their local track and once in at belmont park in new york earning a total 5aside from sir manatee and lainies calliope lilac domino successfully delivered one other horse but this was at a time when petitioners did not own lilac domino 6petitioners did not report this sale on their joint form_1040 which reported income attributable to marestelle farm of zero 7petitioners most frequently raced their horses at suffolk downs mrs donoghue secured a license to race their horses in florida in furtherance of her dream to participate in the florida derby in homage to her grandfather who had raced at gulfstream park in florida but that dream never came to fruition at a time not established by the record petitioners also tried racing in new york in continued of dollar_figure at the time of trial petitioners were leasing him as a riding horse in maine and no longer incurring expenses with respect to him petitioners would like to sell him but he has a problem with colic in lainies calliope foaled seal e dan a stallion petitioners sold him in for dollar_figure in lainies calliope foaled canajorie a stallion he was diagnosed with an insect disease and never generated any income petitioners put canajorie up for sale but at the time of trial they were no longer trying to sell him because of the insect disease canajorie is in massachusetts and petitioners are incurring expenses for him in lainies calliope foaled dr davies a mare dr davies raced times earning a total of dollar_figure since or petitioners have been training her for sale they would like to sell her for dollar_figure at a time not established by the record petitioners received an offer of dollar_figure but they rejected it in lainies calliope foaled run the credits a mare she never generated any income petitioners have been trying to sell run the credits since two to three years after her birth continued pursuit of larger racing purses but they found the daily fees charged to race in new york too expensive to continue racing there in lainies calliope foaled fine artist a stallion petitioners however never owned or had any rights to fine artist and did not receive a fee for this breeding b marestelle farm’s operations marestelle farm was a virtual farm petitioners never actually owned a farm or a facility where they kept and trained their horses but instead paid other farms to do so although petitioners lived in massachusetts during all of the years of their horse activity the farms they used were in multiple states including massachusetts south carolina kentucky florida and new york when their horses were in active race training petitioners paid day rates to these farms for them to feed care for exercise and train their horses petitioners also sometimes entered into special arrangements with these farms to reduce their boarding expenses these arrangements included rough boarding where petitioners traveled daily to a farm for approximately weeks to care for their horse or horses boarded there and performance training where petitioners leased their horse or horses to be used and trained for performance activities in return for free boarding finally petitioners bartered for boarding expense relief in exchange for allowing another farm to breed one of their mares and own the resulting foal petitioners used advertising when they attempted to sell or breed any of their horses during the years at issue they paid a total of dollar_figure for advertising services during these years otherwise they advertised their horses on a free internet registry over the years petitioners funded marestelle farm through a combination of their available cash distributions from an individual_retirement_account ira and mortgage borrowing from to the funding amounts included dollar_figure in total cash dollar_figure from ira_distributions and dollar_figure of mortgage borrowing c time petitioners devoted to marestelle farm operating marestelle farm never developed into a full-time activity for petitioners and during the years at issue petitioners kept neither kept a mileage log nor a contemporaneous time log reporting the hours spent with respect to marestelle farm however during the audit of their joint form sec_1040 for the years at issue petitioners created two spreadsheets--one for and another for 2011--which reported the total hours they each purportedly spent with respect to marestelle farm the spreadsheet reported big_number and big_number hours spent by mrs and mr donoghue respectively and the spreadsheet reported big_number and big_number hours spent by mrs and mr donoghue respectively all of these reported hours were estimates and no actual dates were associated with them instead the hours were reported by activity performed petitioners created these spreadsheets on the basis of their discussions in conjunction with reviewing dozens of pendaflex file folder labels contained in the multiple cabinets of files in their business office petitioners did not create a spreadsheet for d petitioners’ business plans and expert advice pertaining to marestelle farm petitioners had written business plans for marestelle farm from to their initial plan included sections titled business executive summary business objective business goal and business financials petitioners reproduced this plan annually and up through except for the business financials section the other sections did not change from year to year the business executive summary section stated in pertinent part that marestelle farm is in the business of breeding world class thoroughbred horses for racing b usiness income will be derived from thoroughbred racing purses and breeding income derived from successful race horse offspring of lilac domino and p rofits will be produced when race purse and breeding income exceed business_expenses 8in their answering brief petitioners state that the hours spent with respect to marestelle farm for were similar to those in the business objective section stated in pertinent part that marestelle farm’s objective is to produce well tempered reliable and trainable thoroughbred race horses based on selective line breeding which when put into service reduce the risk of race training injury and increase the potential to which the horse can be trained and ultimately produce generations of winning race horse stock for profit the business goal section stated in pertinent part how the goal of marestelle farm was to produce a profitable breeding race horse stock from a single foundation broodmare with top bloodlines the business financials section stated marestelle farm’s planned income and expenses never did this section state that marestelle farm was projected to earn a profit more specifically petitioners’ plans stated the following year planned income planned expenses planned loss dollar_figure big_number big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number petitioners’ plans differed from their plans in that they no longer included the aforementioned sections instead they included sections titled business activity plans racing plans sales plans training plans and management plans these sections were virtually identical from year to year the business activity plans section stated in pertinent part that petitioners would continue to market breeding sales contracts efforts for run the credits dr davies and lainies calliope and continue horse management activities for all horses in inventory the racing plans section stated that petitioners would wait for rumored casino activities to restore profitable horse racing in massachusetts the sales plans section stated that petitioners would work on buyers in performance horse disciplines and thoroughbred breeding disciplines the training plans section recited that petitioners would increase value of inventory through performance horse training the management plans section stated that petitioners would work to sell horses lease horses keep all horses healthy keep sales horses in training keep pensioned broodmare healthy stay abreast of rumored casino activities and reduce expenses with horse leases none of petitioners’ plans stated projected income expenses or profit loss for marestelle farm petitioners did not consult with anyone in preparing any of their business plans at a time not established by the record mrs donoghue did speak with two individuals who were training petitioners’ horses for sale about whether to sell their horses their advice to her was to hang onto your asset to wait for the economy to turn around apart from this advice the record is silent as to any specific business advice petitioners sought or received to make marestelle farm profitable e marestelle farm’s books_and_records petitioners maintained a separate bank account for marestelle farm for at least part of through they kept a listing of marestelle farm’s income and expenses for the years at issue using the computer_software program quicken this listing had three categories of income breeding sales and racing none of these categories showed income for the years at issue this listing had various categories of expenses such a advertising boarding per each horse equipment fees gifts postage shipping supplies taxes training travel veterinarian truck payment and life_insurance f marestelle farm’s financial performance from to marestelle farm incurred expenses totaling dollar_figure but realized income totaling only dollar_figure resulting in accumulated losses of dollar_figure petitioners have never earned a profit from their horse activity on their joint form sec_1040 for to they reported the following losses attributable to marestelle farm 9beginning at least as early as and continuing through petitioners reported their horse activity on schedules c profit or loss from business attached to their joint form sec_1040 despite the fact that marestelle farm was formed as a partnership in additionally on each schedule c mr donoghue was listed as the sole_proprietor of their horse activity for and the years at issue petitioners reported their horse activity on forms u s continued year net profit loss no gain_or_loss reported dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1as discussed infra p petitioners’ joint form_1040 and attached schedule e reported a loss of dollar_figure attributable to marestelle farm however marestelle farm’ sec_2011 form_1065 reported a loss of dollar_figure and the notice_of_deficiency determined a schedule e adjustment of dollar_figure for the record is silent as to what contributes to the discrepancy continued return of partnership income and accordingly on schedules e supplemental income and loss attached to their joint form sec_1040 g petitioners’ tax returns throughout the history of their horse activity petitioners employed several different tax_return preparation accounting firms to prepare their joint form sec_1040 as well as marestelle farm’s forms at least for the years at issue despite employing these firms petitioners did not receive any advice regarding the deductibility of items relating to their horse activity h_r block prepared and timely filed petitioners’ joint form_1040 the income section of this form reported wages attributable to mr donoghue of dollar_figure taxable interest of dollar_figure ordinary dividends of dollar_figure taxable refunds credits or offsets of state_and_local_income_taxes of dollar_figure and social_security_benefits attributable to mrs donoghue of dollar_figure dollar_figure of which was the taxable_amount the income section also reported a loss of dollar_figure for rental real_estate royalties partnership s_corporations trusts etc this loss is the loss attributable to petitioners’ horse activity as reflected on marestelle farm’ sec_2010 form_1065 and their attached schedule e the tax and credits section of the form claimed itemized_deductions totaling dollar_figure and two exemptions one for mr donoghue and the other for mrs donoghue and reported total_tax of dollar_figure on the basis of taxable_income of dollar_figure finally the form reported payments totaling dollar_figure dollar_figure for federal_income_tax withheld from mr donoghue’s wages and dollar_figure for the making_work_pay_credit for a total claimed refund of dollar_figure h_r block also prepared and timely filed petitioners’ joint form_1040 the income section of this form reported wages attributable to mr donoghue of dollar_figure taxable interest of dollar_figure taxable refunds credits or offsets of state_and_local_income_taxes of dollar_figure and social_security_benefits attributable to mrs donoghue of dollar_figure zero of which was the taxable_amount the income section also reported a loss of dollar_figure for rental real_estate royalties partnership s_corporations trusts etc attributable to petitioners’ horse activity as reflected on marestelle farm’ sec_2011 form_1065 and their attached schedule e the tax and credits section of the form claimed itemized_deductions totaling dollar_figure and two exemptions again one for mr donoghue and the other for mrs donoghue and reported total_tax of zero on the basis of taxable_income of zero finally the form reported federal_income_tax withheld from mr donoghue’s wages of dollar_figure for a total claimed refund of dollar_figure mr donoghue prepared and timely filed petitioners’ joint form_1040 on this form they reported wages attributable to mr donoghue of dollar_figure taxable interest of dollar_figure taxable refunds credits or offsets of state_and_local_income_taxes of dollar_figure and social_security_benefits attributable to mrs donoghue of dollar_figure zero of which was the taxable_amount they also reported in the income section of this form a loss of dollar_figure attributable to the dollar_figure loss from their horse activity as reflected on marestelle farm’ sec_2012 form_1065 and their attached schedule e and a dollar_figure loss from a partnership named global world shares in the tax and credits section of the form they claimed itemized_deductions totaling dollar_figure and two exemptions again one for mr donoghue and the other for mrs donoghue and reported total_tax of zero on the basis of taxable_income of zero finally they reported federal_income_tax withheld from mr donoghue’s wages of dollar_figure for a total claimed refund of dollar_figure h audit and determination following an audit of petitioners’ joint form sec_1040 for the years at issue respondent in pertinent part disallowed petitioners’ claimed loss deductions with respect to marestelle farm on the ground that they did not materially participate in marestelle farm10 and asserted accuracy-related_penalties against them in his answer respondent asserts as an additional and now predominant reason for disallowance of petitioners’ claimed losses attributable to marestelle 10respondent also disallowed amortization expenses of dollar_figure shown on marestelle farm’s forms for each of the years at issue due to lack of substantiation farm that they did not engage in their horse activity for profit within the meaning of sec_183 the record includes a completed civil penalty approval form for sec_6662 accuracy-related_penalties due to substantial understatements of income_tax for the years at issue and a letter ie 30-day_letter to petitioners reflecting the irs’ proposed changes to their federal_income_tax for the years at issue including the imposition of these penalties the completed civil penalty approval form includes a signature on the line provided on the form for group manager approval to assess penalties identified above dated date the same date as the 30-day_letter and before the issuance of the notice of deficiencydollar_figure 11as explained infra pp we are reopening the record to admit the civil penalty approval form and a declaration of irs revenue_agent kimberly b mccarthy insofar as it authenticates the civil penalty approval form for purposes of fed r evid as also explained infra pp we are reopening the record to now admit exhibit 23-p in its entirety exhibit 23-p is much of the irs examination and office of appeals files pertaining to petitioners and marestelle farm and includes the 30-day_letter in addition to the civil penalty approval form at trial respondent objected to the admission of this exhibit and the court sustained that objection i burden_of_proof opinion in general the commissioner’s determinations set forth in a notice_of_deficiency are presumed correct and the taxpayer bears the burden of proving otherwise rule a 290_us_111 moreover tax deductions are a matter of legislative grace and the taxpayer bears the burden of proving entitlement to any deduction claimed 503_us_79 292_us_435 but when the commissioner raises a new_matter or raises an increase in the deficiency or pleads affirmative defenses in the answer he bears the burden_of_proof as to the new_matter or the increased deficiency or affirmative defenses rule a 141_tc_569 a new_matter includes a new_theory that either alters the original deficiency or requires the presentation of different evidence 93_tc_500 and cases cited thereat in his answer respondent asserted a new_theory to wit that petitioners did not engage in their horse activity for profit pursuant to sec_183 respondent concedes that he has the burden_of_proof with respect to the sec_183 issue as for respondent’s determinations set forth in the notice_of_deficiency petitioners suggest only in passing in their answering brief that the burden_of_proof should shift to respondent under sec_7491 under sec_7491 if the taxpayer produces credible_evidence with respect to any factual issue relevant to ascertaining his federal_income_tax liability and meets certain other requirements the burden_of_proof shifts from the taxpayer to the commissioner as to that factual issue the record however does not establish that the requirements for shifting the burden_of_proof have been met therefore the burden_of_proof remains on petitioners to the extent of respondent’s determinations reflected in the notice_of_deficiency ii sec_183 generally the code allows deductions for ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying_on_a_trade_or_business or for the production_of_income sec_162 sec_212 under sec_183 if an activity is not engaged in for profit such as an activity primarily carried on for sport as a hobby or for recreation then no deduction attributable to that activity is generally allowed except as provided for in subsection b dollar_figure see sec_1_183-2 income_tax regs taxpayers such as petitioners that operate an activity as a partnership must show that they engaged in the activity with an actual and honest objective of making a profit at the partnership level 78_tc_471 aff’d 722_f2d_695 11th cir see also 91_tc_371 78_tc_642 aff’d without published opinion 702_f2d_1205 d c cir sec_1_183-2 income_tax regs profit in this context means economic profit independent of tax savings hulter v commissioner t c pincite whether the requisite profit objective exists is determined by looking at all the surrounding facts and circumstances sec_1_183-2 income_tax regs see also estate of power v commissioner tcmemo_1983_552 46_tcm_1333 aff’d 736_f2d_826 1st cir we accord greater weight to objective facts than to subjective statements of intent sec_1_183-2 income_tax regs see also estate of power v commissioner t c m cch pincite sec_183 allows deductions that would have been allowable had the activity been engaged in for profit but only to the extent of gross_income derived from the activity reduced by deductions attributable to the activity that are allowable without regard to the whether the activity was engaged in for profit in this case we gauge the profit intent of marestelle farm from that of petitioners its equal partners evidence from years outside the years at issue is relevant to the extent it creates inferences regarding the taxpayer’s requisite profit objective in the subject years see eg smith v commissioner tcmemo_1993_140 pursuant to sec_183 an activity consisting in major part of breeding training showing or racing horses is presumed to be engaged in for profit if the activity produces gross_income in excess of deductions for any two of the seven consecutive years which end with the taxable_year unless the commissioner establishes to the contrary see 112_tc_247 marestelle farm never produced gross_income in excess of deductions for purposes of invoking the presumption accordingly the presumption does not apply here sec_1_183-2 income_tax regs provides a nonexclusive list of nine factors to consider in evaluating a taxpayer’s profit objective these factors are the manner in which the taxpayer carried on the activity the expertise of the taxpayer or his or her advisers the time and effort spent by the taxpayer in carrying on the activity the expectation that the assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer’s history of income or loss with respect to the activity the amount of occasional profits earned if any the financial status of the taxpayer and whether elements of personal pleasure or recreation were involved sec_1_183-2 income_tax regs see also 224_f3d_16 1st cir aff’g tcmemo_1999_92 no single factor or group of factors is determinative and more weight may be given to some factors than others 72_tc_411 aff’d without published opinion 647_f2d_170 9th cir vitale v commissioner tcmemo_1999_131 slip op pincite aff’d without published opinion 217_f3d_843 4th cir see also green v commissioner tcmemo_1989_436 57_tcm_1333 noting that all nine factors do not necessarily apply in every case sec_1_183-2 income_tax regs we examine each of these factors in turn a manner in which the activity is conducted the fact that a taxpayer conducts an activity in a businesslike manner may indicate a profit_motive sec_1_183-2 income_tax regs in making this determination we consider whether the taxpayer maintained complete and accurate books_and_records for the activity prepared a business plan conducted the activity in a manner substantially_similar to comparable activities that were profitable changed operating procedures adopted new techniques or abandoned unprofitable methods in a manner consistent with an intent to improve profitability and in the case of horse breeding and sales ran a consistent and concentrated advertising program judah v commissioner tcmemo_2015_243 at and cases cited thereat see also williams v commissioner tcmemo_2018_48 at petitioners contend that they operated marestelle farm in a businesslike manner because they kept reasonable books_and_records conducted their horse activity with professional advisors and in a manner comparable to other profitable horse businesses in massachusetts during in particular the great recession which they characterize as beginning in and the years at issue maintained reasonable business plans and made changes to their operating procedures in response to issues they encountered such as the great recession the evidence in the record however belies petitioners’ contentions during the years at issue petitioners did not breed race or sell any of their horses according to mr donoghue the industry norm for racing a horse wa sec_24 races per year yet petitioners never had a horse that raced times in one year and the last year that one of their horses raced was the last year petitioners bred one of their horses was and with that breeding they did not receive a breeding fee or own or have any rights to the foal it stands to reason that a thoroughbred horse breeding and racing business if truly a business and not a hobby sport or recreational activity would be actively engaged in either breeding or racing horses marestelle farm did neither during the years at issue although petitioners maintained a separate bank account for marestelle farm for at least part of through and kept a list of marestelle farm’s income and expenses for the years at issue using quicken their books_and_records were far from accurate and complete for many years petitioners reported their income and expenses related to marestelle farm as if it was a sole_proprietorship owned by mr donoghue alone despite the fact that since its inception in it was actually a partnership in petitioners sold sir manatee for dollar_figure but on their joint form_1040 for that year they reported income attributable to marestelle farm of zero petitioners also failed to keep a mileage log or a contemporaneous time log reporting the hours spent with respect to marestelle farm for the years at issue for at least the years at issue petitioners did not maintain their books_and_records with the objective of making a profit as we have previously stated a taxpayer must maintain books_and_records for the purpose of cutting expenses increasing profits and evaluating the overall performance of the operation judah v commissioner at citing betts v commissioner t c memo marestelle farm’s net losses during each of the years at issue were greater than in or in fact marestelle farm never had a profitable year indeed it is apparent that petitioners did not properly use the written business plans they had in place from to they prepared each plan on their own without consulting anyone the plans did not change from year to year and each plan projected a net_loss the plans were virtually identical and no financial projections were set forth in these plans these plans illustrate that petitioners intended or at least projected that marestelle farm would lose money year after year which of course is the polar opposite of an activity engaged in for profit petitioners attempt to justify marestelle farm’s lack of profit by asserting that it was in a startup phase or a series of successive startup phases for each generation of foals from to we reject that notion we have previously held that the startup phase for a horse breeding activity i sec_5 to years see 72_tc_659 in this case marestelle farm’s startup phase ended in at the latest yet it continued to suffer losses according to petitioners in order to improve marestelle farm’s profitability they changed its operations and procedures by no longer racing or breeding their horses and instead offering them up for sale and also by cutting expenses by leasing rough boarding and putting into training arrangements some of their horses however it is incredible to think that ceasing racing and breeding no matter the amount of expenses cut could lead to profitability petitioners never ran a consistent and concentrated advertising program in attempting to sell or breed their horses they spent only a total of dollar_figure on advertising during the years at issue their only other advertising activity was to list their horses on a free internet registry see bronson v commissioner tcmemo_2012_17 slip op pincite citing golanty v commissioner t c pincite aff’d 591_fedappx_625 9th cir accordingly this factor weighs heavily in favor of respondent’s position b expertise of petitioners or their advisors a taxpayer’s own expertise research and extensive study of an activity or consultation with experts may indicate a profit objective sec_1_183-2 income_tax regs this factor focuses on whether the taxpayer received advice from the experts as to the accepted principles and economics of profitably running a business and not merely the general advice that a horse enthusiast would seek in training and showing horses as a hobby betts v commissioner slip op pincite and cases cited thereat as a child mrs donoghue read trade publications on horse breeding and racing and over several decades has diligently researched horse bloodlines mrs donoghue also presumably received some advice and guidance from her grandfather who was a successful horse breeder although this would have been before petitioners commenced their horse activity as he had passed away by then in after lilac domino successfully foaled sir manatee at fulmer international farm she spent some time there as an apprentice for robert hall a licensed thoroughbred race trainer thus to be sure she has some training and likely expertise in the breeding of horses and mr donoghue has a college degree in finance with a minor in business however there is no evidence in the record that either mr or mrs donoghue acquired or even sought expertise as to the economics of profitably running a horse breeding and racing activity beyond the advice an enthusiast would seek when petitioners were trying to decide whether to sell their horses mrs donoghue received advice from two individuals who were training their horses for sale in their answering brief petitioners contend that these two individuals were respected expert profession al s with ‘international’ family backgrounds whose families had been involved with the horse industry for multiple generations and experts in the field of re-training and selling horse livestock and were also acting as expert consultants who advised them on current ma horse industry economics however there is no evidence in the record of these so-called advisors’ expertise and what specific expertise or advice they conveyed to petitioners in order to help make marestelle farm profitable indeed the record instead reflects that these so-called advisors imparted very general advice hang onto your asset to wait for the economy to turn around which clearly did not improve the profitability of marestelle farm accordingly this factors weighs in favor of respondent’s position c petitioners’ time and effort devoted to the activity the fact that a taxpayer devotes much of his personal time and effort to carrying on an activity may indicate a profit objective particularly if the activity does not involve substantial personal or recreational aspects sec_1_183-2 income_tax regs but the time and effort spent on an activity that has substantial personal and recreational aspects may be due to a taxpayer’s enjoyment of the activity rather than an objective of making a profit judah v commissioner at petitioners did not devote the necessary time and effort to establish that they had the requisite objective of making a profit they never actually owned a farm or facility where they kept and trained their horses although during certain periods unclear from the record they rough boarded some of their horses ie they traveled to a farm daily and took care of their horse or horses for several weeks as indicated infra pp petitioners mrs donoghue in particular clearly derived great pleasure from their horse activity and they acknowledged that operating marestelle farm never developed into a full-time activity indeed during the years at issue they did not race breed or sell any of their horses nevertheless in an effort to show the hours they purportedly devoted to marestelle farm petitioners rely on two spreadsheets--one for and another for 2011--that they created during the audit they did not create a spreadsheet for but state that the hours spent with respect to marestelle farm for were similar to the spreadsheet reported big_number and big_number hours spent by mrs and mr donoghue respectively with respect to marestelle farm and the spreadsheet reported big_number and big_number hours spent by mrs and mr donoghue respectively with respect to marestelle farm however these spreadsheets are not trustworthy as they were created on recollection and the hours reflected therein were estimates not associated with actual dates but by activity performed and there is no contemporaneous documentary_evidence in the record corroborating the hours reported by activity in their answering brief petitioners also state that their plan was to wait out the great recession in massachusetts during the years at issue and to wait for massachusetts state gaming legislation to improve the state’s thoroughbred racing industry economics other than this waiting there is no evidence in the record that petitioners expended any substantial time and effort to make marestelle farm profitable see rodriguez v commissioner tcmemo_2013_221 at holding that taxpayers’ inaction was not consistent with a for-profit business accordingly this factor weighs in favor of respondent’s position d expectation that assets used in the activity may appreciate in value an expectation that assets used in the activity will appreciate in value and therefore may produce an overall profit may indicate a profit_motive even if the taxpayer derives no operational profit sec_1_183-2 income_tax regs however a profit objective may be inferred from the expected appreciation of assets only where the appreciation exceeds operating_expenses and would be sufficient to recoup accumulated losses of prior years carmody v commissioner tcmemo_2016_225 at and cases cited thereat a vague and unauthenticated notion that assets are appreciating in value does not constitute a bona_fide expectation that the appreciation will offset past and future losses la musga v commissioner tcmemo_1982_742 45_tcm_422 because petitioners operated marestelle farm as a virtual farm their only potential appreciable assets were their horses there is no evidence in the record as to the values of their horses however petitioners had hoped to sell one of their horses dr davies for dollar_figure and there is evidence in the record that they received an offer of dollar_figure for dr davies which they rejected there is also evidence in the record that petitioners sold seal e dan in for dollar_figure and sir manatee in for dollar_figure during the years at issue petitioners owned just five horses after their dream horse lilac domino died in even assuming that petitioners had been able to sell their remaining five horses for dollar_figure each in an expectation they did not have they would have received only dollar_figure yet marestelle farm had cumulative losses from to of dollar_figure therefore even using the rather artificial aforementioned expected appreciation for their horses petitioners would not come close to recouping the significant losses they incurred with respect to marestelle farm over the nearly years they operated it consequently a profit objective cannot be inferred from any expected appreciation accordingly this factor weighs in favor of respondent’s position e success in carrying on other similar or dissimilar activities the fact that a taxpayer engaged in similar activities and converted them to profitable enterprises may indicate that the taxpayer engaged in the present activity for profit even though it is presently unprofitable sec_1_183-2 income_tax regs see also lundquist v commissioner tcmemo_1999_83 slip op pincite aff’d 211_f3d_600 11th cir petitioners have not carried on any other horse activities in the past and they offered no evidence of successful dissimilar activities or that they used any business expertise they may have acquired from other business ventures in their horse activity see dodge v commissioner tcmemo_1998_89 slip op pincite aff’d without published opinion 188_f3d_507 6th cir we consider this factor neutral f petitioners’ history of income or losses with respect to the activity a taxpayer’s history of income or loss with respect to an activity may indicate the presence or absence of a profit_motive sec_1_183-2 income_tax regs see also golanty v commissioner t c pincite a series of losses during the initial or startup stage of an activity does not necessarily indicate that the activity is not engaged in for profit but losses that extend beyond the customary startup stage may sec_1_183-2 income_tax regs see also engdahl v commissioner t c pincite the goal however must be to realize a profit on the entire operation which presupposes not only future net_earnings but also sufficient net_earnings to recoup losses_incurred in the intervening years see 45_tc_261 aff’d 379_f2d_252 2d cir as indicated marestelle farm has not earned a profit since its inception in from its inception to it realized income totaling dollar_figure and incurred expenses totaling dollar_figure resulting in cumulative losses of dollar_figure in their answering brief petitioners attempt to justify the continued losses asserting that marestelle farm was a startup business and that it remained in the startup phase in all years of operations however as we indicated supra p we have previously found that the startup phase for a horse breeding activity i sec_5 to years not engdahl v commissioner t c pincite in the first year at issue petitioners were already in their 25th year of their horse activity all without a profit and well beyond the startup phase petitioners also argue that marestelle farm suffered losses due to the great recession while marestelle farm’s operations may have been harmed by the recession its history of losses long predates that recession and thus the recession cannot entirely account for the losses accordingly this factor weighs heavily in favor of respondent’s position g amount of occasional profits the amount of profits in relation to the amount of losses_incurred may provide a useful criterion in determining the taxpayer’s intent sec_1_183-2 income_tax regs see also giles v commissioner tcmemo_2006_15 slip op pincite a taxpayer’s belief that he could one day earn a substantial profit from his activity may indicate a profit objective if that belief is adequately supported see giles v commissioner slip op pincite see also sec_1_183-2 income_tax regs in their answering brief petitioners contend that thoroughbred horse breeding and racing is a highly risky activity but that it has a potential for large profits however from its inception in through its dissolution in marestelle farm has never had a profitable year let alone a substantial one thus petitioners’ alleged belief is not adequately supported accordingly this factor weighs heavily in favor of respondent’s position h petitioners’ financial status a lack of substantial income from sources other than the activity may indicate that the activity is engaged in for profit sec_1_183-2 income_tax regs see also helmick v commissioner tcmemo_2009_220 slip op pincite in contrast the fact that a taxpayer derives substantial income from sources other than the activity particularly if losses from the activity generate substantial tax benefits may indicate that the taxpayer is not engaged in the activity for profit especially if personal or recreational elements are involved sec_1_183-2 income_tax regs it is undisputed that petitioners received a total of over dollar_figure in wage and social_security income in each of the years at issue dollar_figure in dollar_figure in and dollar_figure in after applying their schedule e deductions attributable to marestelle farm dollar_figure in dollar_figure in and dollar_figure in petitioners reported total_tax due of dollar_figure in and zero in and sec_183 does not apply just to wealthy individuals as even taxpayers with modest tax_liabilities can have a motive to shelter those liabilities helmick v commissioner slip op pincite in this instance petitioners’ claimed losses allowed them to shield their other income from tax and significantly reduced the after-tax cost of their horse activity see hillman v commissioner tcmemo_1999_255 slip op pincite sullivan v commissioner tcmemo_1998_367 slip op pincite aff’d without published opinion 202_f3d_264 5th cir accordingly this factor weighs in favor of respondent’s position i elements of personal pleasure or recreation the presence of personal motives or recreational elements in carrying on an activity may indicate that the activity is not engaged in for profit sec_1 b income_tax regs however the fact that the taxpayer derives personal pleasure from engaging in the activity does not show that the taxpayer lacks a profit objective if other evidence shows the activity is conducted for profit id a business will not be turned into a hobby merely because the owner finds it pleasurable suffering has never been made a prerequisite to deductibility 59_tc_312 see also giles v commissioner slip op pincite but if the chance for profit is small relative to the potential for gratification the latter may emerge as the primary motivation for the activity see annuzzi v commissioner tcmemo_2014_233 at citing 23_tc_90 aff’d per curiam 227_f2d_779 6th cir petitioners clearly enjoyed owning horses they began their horse activity when mrs donoghue found her dream horse lilac domino as a child mrs donoghue fell in love with thoroughbred horses because of her grandfather a successful thoroughbred racing horse breeder indeed mrs donoghue’s sentimental feelings toward horse breeding and racing played a role not just in petitioners’ decision to begin their horse activity but also in the manner in which they conducted the activity for example the reason she secured a license to race their horses in florida was in homage to her grandfather who had raced at gulfstream park petitioners’ possibility of profit was small compared to the possibility for gratification to them mrs donoghue in particular from the activity and they left the most grueling aspects of caring for their horses to paid professionals accordingly this factor weighs in favor of respondent’s position j conclusion of the nine factors listed in sec_1_183-2 income_tax regs eight favor respondent and one is neutral after weighing the factors and the facts and circumstances of this case we conclude that petitioners did not have an actual and honest objective to operate marestelle farm for profit during the years at issue accordingly we sustain respondent’s disallowance of petitioners’ claimed loss deductions attributable to marestelle farm for the years at issue on the ground that they did not engage in their horse activity for profit within the meaning of sec_183 iii sec_6662 accuracy-related_penalties we now address whether petitioners are liable for accuracy-related_penalties under sec_6662 for the years at issue various grounds for the imposition of these penalties are set forth in the notice_of_deficiency although only one accuracy-related_penalty for a given year may be applied with respect to any given portion of an underpayment even if that portion is subject_to the penalty on more than one ground sec_1_6662-2 income_tax regs we need only address respondent’s claim that petitioners are liable for accuracy-related_penalties for the years at issue on the ground that petitioners’ underpayments of tax for these years were attributable to substantial understatements of income_tax under sec_6662 for purposes of sec_6662 an understatement_of_tax generally means the excess of tax required to be reported on the return over the amount shown on the return sec_6662 an understatement of income_tax is substantial in the case of an individual if it exceeds the greater of of the tax required to be shown on the return for the taxable_year or dollar_figure sec_6662 petitioners’ income_tax was understated by dollar_figure dollar_figure and dollar_figure respectively for and as determined in the notice_of_deficiency petitioners’ understatements of income_tax for the years at issue were substantial the commissioner bears the burden of production with respect to accuracy- related penalties sec_7491 once the commissioner meets this burden the taxpayer must come forward with persuasive evidence that the commissioner’s determination is incorrect see rule a welch v helvering u s pincite 116_tc_438 sec_6751 provides that n o penalty shall be assessed unless the initial determination of such assessment is personally approved in writing by the immediate supervisor of the individual making such determination or such higher level official as the secretary may designate in graev v commissioner graev iii 149_tc_485 supplementing and overruling in part graev v commissioner graev ii 147_tc_460 we held that the commissioner’s burden of production under sec_7491 includes establishing compliance with the supervisory approval requirement of sec_6751 further we recently held that for purposes of sec_6751 the irs’ 30-day_letter can be the initial determination clay v commissioner t c ___ ___ slip op pincite date trial of this case was held and the record was closed before we vacated in part our decision in graev ii and issued graev iii and issued clay in the light of graev iii we ordered respondent to file a response addressing the effect of sec_6751 on this case and directing the court to any evidence of sec_6751 supervisory approval in the record and petitioners to respond respondent was unable to direct the court to any evidence in the record that satisfies his burden of production with respect to sec_6751 and filed a motion to reopen the record to offer into evidence in pertinent part the declaration of ms mccarthy the irs revenue_agent who conducted the audit of petitioners’ joint form sec_1040 for the years at issue and recommended imposing sec_6662 accuracy-related_penalties for substantial understatements of income_tax for the years at issue and the civil penalty approval form for the years at issue dated contemporaneously with the 30-day_letter to petitioners and before the issuance of the notice_of_deficiency and signed by michael edelstein ms mccarthy’s immediate supervisordollar_figure respondent also separately filed a motion to withdraw his objection to the admission of the pages of exhibit 23-p which consist of the civil 13additionally with this motion respondent offers into evidence the declaration of irs appeals officer camesia v anderson who was assigned petitioners’ case in the irs office of appeals and recommended imposing sec_6662 accuracy-related_penalties for negligence or disregard of rules or regulations for the years at issue and a copy of the notice_of_deficiency that set forth the imposition of sec_6662 and accuracy-related_penalties as well as sec_6662 and accuracy-related_penalties and that was signed by mark c pettigrew ms anderson’s immediate supervisor the record contains a copy of the notice_of_deficiency without the signature page since we need only address respondent’s claim that petitioners are liable for sec_6662 accuracy-related_penalties it is unnecessary for us to address the admissibility of this proffered evidence penalty approval form as we indicated supra note exhibit 23-p includes in addition to this form the irs’ 30-day_letter which was also signed by mr edelstein petitioners objected to the introduction of any additional evidence with respect to the penalties and requested that the court deny respondent’s motions reopening the record for the submission of additional evidence lies within the court’s discretion 401_us_321 64_f3d_742 1st cir 114_tc_276 see also 503_f2d_359 9th cir t he tax court’s ruling denying a motion to reopen the record is not subject_to review except upon a demonstration of extraordinary circumstances which reveal a clear abuse_of_discretion aff’g tcmemo_1971_200 we will not grant a motion to reopen the record unless among other requirements the evidence relied on is not merely cumulative or impeaching is material to the issues involved and probably would change some aspect of the outcome of the case butler v commissioner t c pincite see also 790_f2d_1450 9th cir explaining that the trial_court should take into account in considering a motion to hold open the trial record the character of the additional evidence and the effect of granting the motion overruled on other grounds by 486_us_622 in reviewing motions to reopen the record courts have considered when the moving party knew that a fact was disputed whether the evidentiary issue was foreseeable and whether the moving party had reason for the failure to produce the evidence earlier see eg 844_f2d_225 5th cir and cases cited thereat holding that refusal to reopen the case was not an abuse_of_discretion because the issue was foreseeable to the taxpayers and the court could see no excuse for the taxpayers’ failure to produce evidence earlier aff’g frink v commissioner tcmemo_1984_669 we also balance the moving party’s diligence against the possible prejudice to the nonmoving party in particular we consider whether reopening the record after trial would prevent the nonmoving party from examining and questioning the evidence as it would have during the proceeding see eg estate of freedman v commissioner tcmemo_2007_61 megibow v commissioner tcmemo_2004_41 the evidence that is the subject of respondent’s motions would not be cumulative of any evidence in the record and it would not be impeaching material respondent bears the burden of production with respect to penalties and would offer the evidence as proof that the requirements of sec_6751 have been met the subject evidence is material to the issues involved in the case and we conclude that the outcome of the case will be changed if we grant respondent’s motions petitioners seemingly suggest that irregularities occurred not during the audit of their form sec_1040 for the years at issue but during the audit of marestelle farm’s forms for these same years and there are irregularities with respect to the civil penalty approval form as for their first suggestion it is of no moment and unsupported in any event see 79_tc_185 and cases cited thereat as for their second suggestion we agree with respondent that the civil penalty approval form is a record kept in the ordinary course of a business activity and is authenticated by the declaration of ms mccarthy see fed r evid we also agree with respondent that the civil penalty approval form is material to the penalty issue in this case and is not cumulative thus we will admit the civil penalty approval form into evidence and the declaration for purposes of authentication under rule of the federal rules of evidence see 119_tc_183 similarly with the issuance of our opinion in clay exhibit 23-p which includes the 30-day_letter is material to the penalty issue in this case and is not cumulative and thus we will now admit this exhibit in its entirety into evidence respondent has met his burden of production for the accuracy- related penalties for substantial understatements of income_tax for the years at issue since respondent has met his burden petitioners must come forward with persuasive evidence that the penalties are inappropriate because for example they had reasonable_cause and acted in good_faith see sec_6664 higbee v commissioner t c pincite see also rodriguez v commissioner at finding a taxpayer’s failure to satisfy sec_183 does not preclude a reasonable_cause and good_faith defense the determination whether the taxpayer had reasonable_cause and acted in good_faith depends upon the pertinent facts and circumstances of a particular case sec_1_6664-4 income_tax regs we consider among other factors the experience education and sophistication of the taxpayer however the principal consideration is the extent of the taxpayer’s efforts to assess the proper tax_liability id see also higbee v commissioner t c pincite taking into consideration the taxpayer’s experience education and sophistication an honest misunderstanding of fact or law may indicate reasonable_cause and good_faith higbee v commissioner t c pincite citing remy v commissioner t c memo in addition reliance on professional advice may indicate reasonable_cause and good_faith if in the light of all the facts and circumstances such reliance was reasonable and the taxpayer acted in good_faith id pincite petitioners however have not presented evidence to show reasonable_cause or good_faith for the loss deductions they claimed with respect to marestelle farm for the years at issue petitioners admit that they did not receive any advice regarding the deductibility of their horse activity losses for any of the years at issue petitioners are both college educated and mr donoghue has a degree in finance additionally they both have experience in business in the past mr donoghue managed a construction business and mrs donoghue was a corporate executive their professional backgrounds make it unreasonable for them to have conducted their horse activity without soliciting advice as to the deductibility of their horse activity losses for the years at issue simply employing tax_return_preparers for and does not permit them to avoid accuracy-related_penalties see 115_tc_43 aff’d 299_f3d_221 3d cir petitioners suggest that they had reasonable_cause and acted in good_faith because they had a prior audit for which resulted in respondent’s ultimately conceding the asserted deficiency as reflected in a date decision of this court their suggestion however lacks merit as we stated in transupport inc v commissioner tcmemo_2016_216 at supplementing tcmemo_2015_179 aff’d 882_f3d_274 1st cir petitioner again argues that the methodology was used consistently over years and was therefore correct petitioner apparently believes that repeating a fallacy over and over again and ignoring contrary evidence will succeed it does not a well- established principle is that what was condoned or agreed to for a previous year may be challenged for a subsequent year auto club of mich v commissioner 353_us_180 55_tc_28 thus the results of a prior audit do not constitute substantial_authority accordingly we sustain respondent’s determination regarding the accuracy- related penalties for the years at issue we have considered all of the arguments made by the parties and to the extent they are not addressed herein we find them to be moot irrelevant or without merit to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury number release date index numbers washington dc person to contact telephone number refer reply to cc corp 2-plr-102678-02 date date legend distributing controlled_corporation x country a entity country a sub country b sub country c sub country d sub country e sub country f sub country g sub country h sub country i sub plr-102678-02 country j sub country j branch country k branch country l sub business a business b business c state x country a country b country c country d country e country f country g country h country i country j country k country l plr-102678-02 country m a b c d e dear this is in response to your authorized representative’s letter dated date requesting rulings on behalf of distributing with respect to a proposed transaction additional information was received in letters dated date date date date and date the material information submitted is summarized below distributing is a publicly traded state x corporation engaged directly and through subsidiaries in business a and business b which includes business c distributing is the common parent of an affiliated_group_of_corporations filing a consolidated_return on the basis of a fiscal_year ending september distributing previously received a private_letter_ruling dated date the prior ruling relating to a proposed spin- off of distributing’s business b business distributing no longer intends to spin off business b other than business c as discussed below it does still intend to separate business b other than business c from business a by dropping business a to a subsidiary the stock of which will be distributed to distributing shareholders that proposed transaction has been delayed immediately prior to the distribution of the controlled stock as described below distributing will have outstanding approximately a shares of common_stock and b shares of preferred_stock each outstanding share of distributing common_stock also evidences one preferred share purchase right that is a right to purchase a fraction of a share of distributing preferred_stock upon the occurrence of certain specified triggering events financial information has been received indicating that business a the business b sectors other than business c and business c have each had gross_receipts and operating_expenses representing the active_conduct_of_a_trade_or_business for each of the last five fiscal years plr-102678-02 in order to facilitate a business combination of business c through a merger with corporation x a corporation unrelated to distributing and in order to allow both distributing and corporation x to focus more efficiently on the development of their respective businesses distributing proposes the following series of transactions distributing has formed a subsidiary_corporation controlled distributing will contribute its business c assets including the stock of certain subsidiaries to controlled the contribution distributing will distribute on a one-for-one basis all the shares of controlled to the distributing shareholders the distribution except for a small number of controlled shares to be retained by distributing the retained shares as described below controlled will merge into corporation x in a transaction intended to qualify under sec_368 of the code the merger with corporation x surviving the merger in the merger each controlled shareholder will receive c shares of corporation x stock in exchange for one share of controlled stock cash will be paid in lieu of fractional shares of corporation x in the merger the corporation x shareholders will acquire less than of the combined voting power and less than of the total value of the merged company in the merger following the distribution distributing will retain no more than d of the controlled shares the retained shares in order to permit distributing to deliver both distributing shares and corporation x following the merger shares at such time as stock awards to the employees of distributing’s businesses other than business c vest under distributing’s performance plan distributing owns all of the interests in country a entity a country a entity that has elected classification as a disregarded_entity for federal_income_tax purposes country a entity is therefore treated as a branch of distributing country a entity owns all of the interests in country a sub a country a corporation except for e held by unrelated third-party shareholders country a sub owns both business c assets and other assets distributing plans to take the following steps to separate the business c assets from country a sub country a sub will create a new subsidiary new country a sub country a sub will contribute its business c assets to new country a sub country a sub will distribute its stock in business c sub to country a entity country a entity will distribute its stock in new country a sub to distributing distributing will contribute its stock in new country a sub to controlled distributing has actively tried to sell to a third party country b sub a first-tier distributing subsidiary engaged in manufacturing business c products and other plr-102678-02 products located in country b and certain related property directly held by distributing distributing has now decided that rather than sell country b sub and the related property to another third party distributing will sell country b sub and the related property to corporation x following the distribution and the merger in the following series of transactions distributing will transfer to corporation x the stock of country b sub and any us-based assets associated with the country b manufacturing_facility operation in exchange for a corporation x note with a face value equal to the fair_market_value of the stock and the assets transferred distributing will sell to country b sub the country b assets directly held by distributing in exchange for a country b sub note with a face value equal to the fair_market_value of the country b assets distributing will exchange the country b sub note for a corporation x note with the same face value and corporation x will contribute the country b sub note to country b sub and the note will be canceled distributing expects to recognize gains on the sales of country b sub and the related property distributing owns directly all of the stock of in the following subsidiaries country c sub a country c company state x sub a state x corporation that has business c assets in country d country e sub a country e corporation country f sub a country f company country g sub a country g company country h sub a country h company country i sub a country i corporation and country j sub a country j corporation country i sub owns all of the interests in country d sub a country d company country j sub owns all of the interests in country j branch a country j company country k branch a country k company and country l sub a country l company for federal_income_tax purposes country j branch and country k branch are disregarded entities and country l sub is a corporation country j branch also has business c assets in a branch in country m country m branch distributing plans to separate the business c assets of country d sub country f sub and country l sub in the following manner distributing will form new subsidiaries in country d country d new sub and country f country f new sub and a new branch of country j branch in country l country l branch distributing will contribute cash in the amount of the value of the non-business c assets held by country d sub country f sub and country l sub to country d new sub country f new sub and country l branch respectively country d sub country f sub and country l sub will sell their non-business c assets for cash to country d new sub country f new sub and country l branch respectively country j sub will distribute its stock in country l sub to distributing distributing will contribute its stock of country f sub country i sub which owns country d sub and country l sub to controlled plr-102678-02 distributing plans to separate the business c assets of country g sub country k branch country j branch country c sub country h sub country e sub country d sub and country m branch in the following manner distributing will form new subsidiaries in country g country g new sub country k country k new sub country j country j new sub and the united_states u s new sub distributing will contribute cash to country g new sub country k new sub and country j new sub in the amount of the wireless communications assets held by country g sub country k branch and country j branch respectively distributing will also contribute cash to u s new sub in the amount of the combined business c assets of country c sub country h sub country e sub country d sub and country m branch country g sub country k branch and country j branch will sell their business c assets for cash to country g new sub country k new sub and country j new sub respectively country c sub country h sub country e sub country d sub and country m branch will sell their business c assets for cash to u s new sub distributing will contribute all of its stock in country g new sub country k new sub country j new sub and u s new sub to controlled the transactions described in the immediately preceding six paragraphs are referred to hereinafter as the foreign restructuring transactions the following representations have been made in connection with the contribution and the distribution a b c d the retained shares are being retained to permit distributing to deliver both distributing shares and corporation x following the merger shares at such time as stock awards to the employees of distributing’s businesses other than business c vest under distributing’s performance plan the corporation x shares received by distributing in the merger for the retained shares will be disposed of as soon as the vesting period for such awards expires and in any event not later than five years after the date of the distribution the retention of the retained shares is not pursuant to a plan having as one of its principal purposes the avoidance of federal_income_tax distributing will vote the corporation x shares received in the merger in exchange for the retained shares in proportion to the votes cast by corporation x’s other shareholders a distribution of all of the stock of controlled would not be treated to any extent as a distribution of other_property under sec_356 plr-102678-02 e f g h i j k l any indebtedness owed by controlled or corporation x following the merger to distributing after the distribution will not constitute stock_or_securities no part of the consideration to be distributed by distributing will be received by a shareholder as a creditor employee or in any capacity other than that of a shareholder of distributing the five years of financial information submitted on behalf of distributing is representative of the corporation’s present operation and there have been no substantial operational changes since the date of the last financial statements submitted following the distribution distributing and controlled and after the merger corporation x will each continue the active_conduct of its business independently and with its separate employees the distribution is carried out for the following business purposes to facilitate a business combination of distributing’s business c with corporation x through a subsequent merger of controlled into corporation x and to allow both distributing and corporation x to focus more efficiently on the development of their respective businesses the distribution is motivated in whole or substantial part by these corporate business purposes except for the merger there is no plan or intention by any shareholder who own sec_5 or more of distributing and the management of distributing to its best knowledge is not aware of any plan or intention on the part of any particular remaining shareholder or security holder of distributing to sell exchange transfer by gift or otherwise dispose_of any stock in or securities of either distributing or controlled or after the merger corporation x after the transaction there is no plan or intention by distributing or controlled directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the transaction other than through stock purchases meeting the requirements of dollar_figure b of revproc_96_30 except for i the merger ii the sale of country b sub and the related property to corporation x as described above and iii the proposed spin- off by distributing of business a there is no plan or intention to liquidate distributing or controlled or after the merger corporation x to merge either corporation with any other corporation or to sell or otherwise plr-102678-02 m n o p q s dispose_of the assets of either corporation after the transaction except in the ordinary course of business for purposes of sec_355 immediately after the distribution no person determined after applying sec_355 will hold stock possessing of more of the total combined voting power of all classes of distributing or controlled stock entitled to vote or or more of the total value of shares of all classes of distributing or controlled stock that was acquired by purchase as defined in sec_355 and during the five-year period determined after applying sec_355 ending on the date of the distribution the distribution and the merger are not part of a plan or series of related transactions within the meaning of sec_355 pursuant to which one or more persons will acquire directly or indirectly stock possessing or more of the total combined voting power of all classes of either distributing stock or controlled stock or after the merger corporation x stock entitled to vote or stock possessing or more of the total value of all classes of stock of either distributing or controlled or after the merger corporation x the total adjusted bases and the fair_market_value of the assets to be transferred by distributing to controlled each equals or exceeds the sum of the liabilities if any assumed by controlled plus any liabilities to which the transferred assets are subject and the liabilities assumed in the transaction and to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred distributing neither accumulated its receivables nor made extraordinary payment of its payables in anticipation of the transaction except with respect to any future obligations arising out of the continuing relations described above no intercorporate debt will exist between distributing and controlled at the time of or subsequent to the distribution of controlled stock if any indebtedness is owed by controlled to distributing after the distribution of the controlled stock such indebtedness will not constitute stock_or_securities immediately before the distribution items of income gain loss deduction and credit will be taken into account as required by the applicable intercompany_transaction regulations see sec_1_1502-13 and sec_1 as in effect before the publication of t d 1995_32_irb_6 and as currently in effect sec_1_1502-13 as published by t d plr-102678-02 t u v further distributing’s excess_loss_account if any with respect to the controlled common_stock will be included in income immediately before the distribution see sec_1_1502-19 except pursuant to certain short-term transitional agreements payments made in connection with all continuing transactions if any between distributing and controlled will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length no two parties to the transaction are investment companies as defined in sec_368 a f iii and iv neither distributing nor controlled will have been a u s real_property holding corporation usrphc at any time during the five-year period ending on the date of the distribution and none of distributing controlled nor to the best of distributing’s knowledge corporation x will be a usrphc immediately after the distribution the following representation has been made in connection with the merger w the payment of cash in lieu of fractional shares of controlled in the merger is solely for the purposes of avoiding the expense and inconvenience to corporation x of issuing fractional shares and does not represent separately bargained-for consideration the method used for handling fractional share interests is designed to limit the amount of cash received by any one shareholder to less than the value of one full share of controlled common_stock based solely on the information submitted and the representations made we have concluded that the transfer by distributing to controlled of the assets as described above followed by the pro_rata distribution of all its controlled stock other than the retained shares as described above is a reorganization within the meaning of sec_368 distributing and controlled will each be a party to the reorganization within the meaning of sec_368 no gain_or_loss will be recognized by distributing upon the transfer of its business c assets including certain stock to controlled in exchange or constructive exchange for controlled stock and the assumption by controlled of certain liabilities sec_361 and b and a plr-102678-02 no gain_or_loss will be recognized by controlled on the receipt of the assets described above in exchange for controlled stock sec_1032 the basis of the assets received by controlled will be the same as the basis of such assets in the hands of distributing immediately prior to the exchange described above increased by the gain if any recognized by distributing sec_362 the holding_period of each asset received by controlled will include the period during which such asset was held by distributing before the contribution sec_1223 no gain_or_loss will be recognized by distributing upon the distribution of all the controlled stock other than retained shares as described above to the distributing shareholders sec_361 no gain_or_loss will be recognized by and no amount will be included in the income of the distributing shareholders upon receipt of the controlled stock sec_355 the aggregate basis of the distributing and the controlled stock in the hands of the distributing shareholders immediately after the distribution will be the same as the aggregate basis of the distributing stock held by the distributing shareholders immediately before the distribution allocated in accordance with sec_1_358-2 of the regulations sec_358 the holding_period of the controlled stock received by the distributing shareholders will include the holding_period of the distributing stock with respect to which the distribution is made provided that the distributing stock is held as a capital_asset on the date of distribution sec_1223 proper allocation of earnings_and_profits will be made between distributing and controlled under a of the regulations sec_312 payments made by distributing to controlled or by controlled to distributing under the tax_sharing_agreement i that have arisen or will arise for a taxable_period beginning on or before and ending after the distribution and ii that will not become fixed and ascertainable until after the distribution will be treated as occurring immediately before the distribution see 344_us_6 plr-102678-02 assuming the merger qualifies as a reorganization under sec_368 the payment of cash in lieu of fractional share interests in corporation x will be treated for federal_income_tax purposes as if the fractional shares were issued as part of the exchange and then were redeemed by corporation x the cash payments will be treated as having been received as distributions in full payment in exchange for the stock redeemed as provided in sec_302 provided that the fractional share interest is a capital_asset in the hands of the exchanging shareholder the gain_or_loss will constitute capital_gain or loss subject_to the provisions and limitations of sec_1221 and sec_1222 no opinion has is expressed as to the tax treatment of the transactions under other provisions of the code or regulations or about the tax treatment of any conditions existing at the time of or effects resulting from the transactions that are not specifically covered by the above ruling specifically no opinion has been requested and none is expressed as to the qualification of the merger under sec_368 of the code further no opinion is expressed regarding the international tax consequences of the transactions including a the application of sec_482 to any of the taxable asset transfers involving the foreign restructuring transactions b the consequences under sec_367 in respect of any of the foreign restructuring transactions c the applicability of sec_1503 to any dual_resident_corporation that is no longer a member of the distributing consolidated_group by reason of the distribution or that is involved in a putative triggering event in connection with any internal restructuring transaction d whether any or all of the above-referenced foreign_corporations are passive foreign investment corporations within the meaning of sec_1297 of the code if it is determined that any or all of the above-described foreign_corporations are passive foreign investment corporations no opinion is expressed with respect to the application of sec_1291 through to the proposed transactions in particular in a transaction in which gain is not otherwise recognized regulations under sec_1291 may require gain recognition notwithstanding any other provision of the code in accordance with a power_of_attorney on file in this office copies of this letter are being sent to your authorized representatives the rulings contained in this letter are predicated upon the facts and representations submitted by the taxpayer and accompanied by the signature of an plr-102678-02 appropriate party under penalties of perjury this office has not verified any of the materials submitted in support of the ruling_request the taxpayer as part of the audit process may be required to verify the information representations and other data provided this letter is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely yours ___________________________________ charles m levy reviewer branch office of associate chief_counsel corporate cc


internal_revenue_service number release date index number --------------------- ----------------------- -------------------------------------------- ---------------------------------- -------------- ---------------------------- tin ----------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ------------------ telephone number fax number ---------------------- ---------------------- refer reply to cc ita b04 plr-129819-16 date date legend taxpayer -------------------------------------------- year ------- dear ----------------- this is in reference to a form_1128 application to adopt change or retain a tax_year that the taxpayer filed requesting to change its taxable_year from a tax_year ending december to a tax_year ending march effective with the tax_year ending march year the taxpayer has requested that the form_1128 be considered timely filed under the authority contained in sec_301_9100-3 of the regulations on procedure and administration the taxpayer's form_1128 requesting a change in accounting_period to a tax_year ending march was required to be filed on or before july year the information furnished indicates that the application_for the change in accounting_period was filed late because of an oversight or misunderstanding on the part of the taxpayer’s tax professional section of revproc_2002_39 2002_1_cb_1046 provides that a taxpayer must file a form_1128 no earlier than the day following the end of the first effective year and no later than the due_date not including extensions of the federal_income_tax return for the first effective tax_year sec_301_9100-3 provides that requests for extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 automatic extensions such as the situation you present must be made under the rules of sec_301_9100-3 requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides plr-129819-16 evidence to establish that the taxpayer acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government based on the facts and information submitted and the representations made we conclude that the taxpayer has acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government accordingly the requirements of the regulations for the granting of relief have been satisfied in this case and the taxpayer's late filed form_1128 requesting permission to change to a tax_year ending march effective for the short_period of january to march year is considered timely filed 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 specifically we express no opinion as to whether the taxpayer is permitted under the code applicable regulations and revenue procedures to change to the tax_year requested in the form_1128 the form_1128 will be processed under the procedures of revproc_2002_39 and will require the taxpayer to submit a separate request under the revenue_procedure 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 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and its representatives 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 sincerely donna j welsh senior technician reviewer branch office of associate chief_counsel income_tax accounting