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 pa apjp b01 plr-110410-06 date date - sec_3406 -- backup withholding backup withholding sec_6041 -- information_at_source fixed or determinable gains profits or income payments specifically included sec_6045 -- returns of broker sec_6045 returns of brokers sec_6049 -- returns regarding payments of interest reportable interest legend taxpayer ------------------------------------------------------------- fund ------------------------------------------------------------- x -------------------------------------------- y --------------------------------------------- z ---------------------- a ----------------------- years -------------- year ------ dollar_figurea ---------------- dear ------------------ plr-110410-06 this letter responds to the letter dated date submitted on behalf of the fund requesting the following rulings settlement payments from the fund to mutual_fund investors are not subject_to information reporting under sec_6041 of the internal_revenue_code except in the case of payments made directly to participants in tax-qualified retirement plans settlement payments from the fund to mutual_fund investors are not subject_to information reporting under sec_6045 settlement payments from the fund to mutual_fund investors are not subject_to information reporting under sec_6049 for purposes of meeting any obligations it may have under sec_3406 as a payor of reportable payments the fund need not solicit taxpayer identification numbers tins from the individuals to whom it will make distributions the fund may obtain the tins from the mutual funds or tax-qualified plans in which such individuals held accounts or from transfer agents performing services for the funds or plans facts based upon the facts and the representations made the fund is a qualified_settlement_fund qsf as described in sec_468b and the regulations thereunder the fund was created in year to resolve an administrative_proceeding brought by the securities_and_exchange_commission commission against x y z and a relating to investment advice provided to certain mutual funds the proceeding related to the inadequate or nonexistent disclosure of x’s and y’s policies allowing market timing trading of mutual_fund units units and to the oversight monitoring or management of trades of such units trades from at least year through the middle of year in an order instituting proceedings oip the commission alleged that x and y made various material omissions and misrepresentations regarding market timing of funds and that z and a committed certain other wrongful acts relating to trades in the units improper market timing impairs the value of mutual_fund shares by depressing their net asset value improper market timing also generates excess trading volume and thus increases the advisory fees mutual funds must pay to investment advisors such as x and y thus the conduct of x y z and a resulted in damage to the investors and a loss of capital the commission based on the improper conduct described above and the resulting damage to mutual_fund investors sought profit disgorgement and civil penalties after investigation and negotiations x y z and a agreed to pay dollar_figurea to settle the commission’s claims pursuant to section a of the sarbanes-oxley_act of u s c the oip authorized a fair fund for the disgorgement and penalty components of the settlement thus permitting both components to be paid to injured investors plr-110410-06 those investors holding units of the mutual funds during any portion of the time period specified in the oip will be eligible to receive distributions from the fund the distributions will be based on the commission’s orders the amount available for distribution is the net settlement pool which includes the sum of dollar_figurea the amount transferred by x y z and a into the fund and the amount of net_income earned by the fund investors will be allocated portions of the net settlement pool the commission’s orders provide that investors will first receive their proportionate share of losses suffered by the mutual funds due to market timing and then a proportionate share of advisory fees paid_by the mutual funds that suffered such losses during the period of market timing law and analysis ruling sec_1_468b-2 of the treasury regulations provides that in general distributions by a qsf are subject_to certain information reporting and withholding requirements sec_1_468b-2 provides that a qsf must make a return for or must withhold tax on a distribution to a claimant if one or more transferors would have been required to make a return or withhold tax had that transferor made the distribution directly to the claimant the regulations further provide that for purposes of sec_6041 and sec_6041a if a qsf makes a distribution on behalf of a transferor or a claimant the fund is deemed to make the distribution to the recipient of that payment or distribution in the course of a trade_or_business in such a situation the qsf is also deemed to have made the distribution to the transferor or claimant see sec_1_468b-2 c - d sec_6041 requires all persons engaged in a trade_or_business and making payment in the course of such trade_or_business to another person of rent salaries wages premiums annuities compensations remunerations emoluments or other fixed or determinable gains profits and income of dollar_figure or more in any taxable_year to file an information_return with the service and to furnish an information statement to the payee sec_1_6041-1 provides that payments are fixed when they are paid in amounts definitely predetermined income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained sec_1 a requires a payor to report sec_6041 amounts on form_1099 thus payments that are not fixed or determinable are not subject_to information reporting under sec_6041 amounts a taxpayer receives to restore a loss of capital are not income except to the extent that the payment exceeds the taxpayer’s basis in the injured property that is the subject of the payment 144_f2d_110 1st cir fund payments to investors for losses the mutual funds suffered from market timing appear to constitute compensation_for a loss of capital market timing permitted by x and y depressed the net asset value of mutual_fund shares plr-110410-06 compensation from the fund will compensate at least partially for this damage because the fund has no access to the investors’ tax basis in their mutual_fund accounts and has no need or occasion to collect information on tax basis the fund is unable to calculate how much of this compensation_for mutual_fund losses constitutes fixed or determinable income accordingly the fund has no information reporting obligations under sec_6041 for such compensation as noted above a portion of the fund payments will compensate investors for improper advisory fees paid_by the mutual funds to x and y although such payments may constitute gross_income to investors the fund cannot due to limitations on its data collecting authority determine whether the payments will constitute gross_income to investors the payments therefore are not fixed or determinable income within the meaning of the regulations under sec_6041 accordingly subject_to the exception noted below regarding distributions to qualified_retirement_plan participants the fund has no information reporting obligations under sec_6041 the fund states that it may make a certain number of distributions directly to participants in tax-qualified retirement plans sec_72 of the code controls the taxation of such distributions and the distributions must be reported on form 1099-r pursuant to sec_6041 subject_to the dollar_figure reporting threshold set forth in sec_6041 and sec_1_6041-1 ruling sec_1_468b-2 provides that a qsf must make a return for a distribution to a claimant if one or more transferors would have been required to make a return had that transferor made the distribution directly to the claimant sec_6045 provides generally that every person doing business as a broker shall when required by the secretary make a return in accordance with such regulations as the secretary may prescribe sec_6045 defines the term broker to include a dealer a barter_exchange and any other person who for a consideration regularly acts as a middleman with respect to property or services the regulations further define the term broker to mean a person that in the ordinary course of a trade_or_business during the calendar_year stands ready to effect sales to be made by others see sec_1_6045-1 sec_1_6045-1 provides generally that a broker shall make an information_return for each sale effected by the broker in the ordinary course of the broker’s trade_or_business sec_1_6045-1 defines a sale as any disposition of securities commodities regulated_futures_contracts or forward contracts for cash and as including redemptions of stock retirements of indebtedness and entering into short_sales plr-110410-06 the fund’s payments to investors do not result from a sale as that term is defined above the fund therefore has no information reporting obligations under sec_6045 with respect to these payments ruling sec_6049 provides that every person who makes payments of interest aggregating dollar_figure or more to any other person during any calendar_year or receives payments of interest as a nominee and who makes payments aggregating dollar_figure or more during any calendar_year to any other person with respect to the interest so received shall make a return according to the forms or regulations prescribed by the secretary sec_6049 b provides that the term_interest includes interest on any obligation issued in_registered_form or of a type offered to the public other than any obligation with a maturity at issue of a year or less which is held by a corporation pursuant to sec_6049 interest also includes interest on deposits with brokers as defined in sec_6045 the fund distributions in the present case do not relate to deposits with brokers or obligations issued in_registered_form and do not otherwise qualify as interest within the meaning of sec_6049 this is so even though interest earnings have accrued on the funds to be paid to investors from the time x y z and a paid such funds to the fund the fund distributions to investors relate to violations of securities law and compensation_for financial harm not to obligations issued in_registered_form or other instruments that generate interest as sec_6049 defines that term accordingly the fund has no information reporting obligations under sec_6049 regarding its distributions to the investors ruling sec_3406 generally provides that in the case of any reportable_payment if a the payee fails to furnish his or her tin to the payor in the manner required b the secretary notifies the payor that the tin furnished by the payee is incorrect c there has been a notified_payee_underreporting of interest and dividends or d there has been a certification failure collectively referred to as payee failures then the payor shall deduct and withhold from such reportable_payment a backup withholding amount totaling of such payment sec_3406 provides that the term reportable_payment means any reportable_interest_or_dividend_payment and any other_reportable_payment sec_3406 provides that the term other_reportable_payment includes any payment of a kind and to a payee required to be shown on a return under sec_6041 or sec_6045 in light of rulings one through three above only direct payments by the fund to participants in tax-qualified plans will be reportable payments subject_to backup withholding under sec_3406 in order to meet its obligations under sec_3406 and to include tins on information returns it must provide for these reportable plr-110410-06 payments the fund plans to obtain those tins from one of the following sources the plan_administrator the mutual funds in which the participants invested or the transfer agents that provide services to the administrator or mutual funds obtaining the tins in this manner should prove more reliable and less burdensome and costly to the fund than soliciting the tins from the plan participants in light of the authority it has been granted by the commission the fund will be able to obtain the tins of plan participants from the plan administrators mutual funds or transfer agents the fund will not be required to solicit tins from the participants for purposes of applying the backup withholding rules of sec_3406 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 furthermore this letter expresses no opinion about information reporting requirements for fund distributions that are not made directly to the injured investors this letter also expresses no opinion about the income_tax consequences to investors of fund distributions this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative 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 enclosure carol p nachman acting senior technician reviewer office of associate chief_counsel procedure and administration administrative provisions and judicial practice sincerely


department of the treasury po box ben franklin station washington dc person to contact telephone number esd sry bist 7--plr-121824-98 april internal_revenue_service uil re legend tin ssn ssn trust trustor spouse trustee state date date a dear we received your letter dated november in which you requested rulings regarding the estate gift and generation- skipping transfer gst irrevocable qualified_terminable_interest_property qtip_trust a and of the internal under sec_2044 revenue code tax consequences related to an trustor created trust on date and transferred trustor's separate_property with a fair_market_value of transfer into trust united_states gift and generation-skipping_transfer gst tax trustor return return for the tax_year ending date allocated dollar_figurea of trustor's gst tax exemption to the trust of schedule a of trustor's return and its attachment showed two schedule a gifts that trustor made for the year ending date trustor reported the gift on form_709 dollar_figurea at the date of part ofl part listed a marital_deduction in the amount of the trust resulting in met the requirements of that section was made on the form_709 a deemed qtip_election under sec_2523 no reverse_qtip_election if the trust article i of the trust provides that all of the property truster transferred into the trust is the sole and separate_property of the trustor article ii paragraph a subparagraph of the trust provides that during the life of the trustor's spouse the trustee shall distribute to spouse in convenient installments not less often than annually all of the net_income the trustee may also distribute to spouse such of the trust sums from the principal of the trust as shall be necessary or desirable in the discretion of the trustee to provide for the health maintenance and support of spouse having a view to maintaining spouse's standard of living as nearly as practicable at the level existing at the date hereof ftrustor's spouse no person shall have the power to appoint any part of the principal or income of the trust to any person other than spouse trust is administer such trust and make distributions accordingly trustor's principal purpose in establishing the to care for spouse and the trustee is instructed to during the life of of the trust states article ii paragraph a subparagraph i dollar_figure or that in addition to the distributions provided in the immediately proceeding subparagraph trustor hereby confers upon spouse the power to direct the trustee to pay to spouse from the principal of the trust estate for each full applicable calendar_year the and interest in or amount of the greater of of the principal of the trust estate not to exceed in value fair_market_value of the principal of the trust estate at such of the last time day of the particular calendar_year power for any calendar_year only by giving written notice thereof to the trustee before the end of the year and only if she lives to the extent spouse fails to exercise this through the year power for any calendar_year spouse's power to do so for that year shall lapse the fair_market_value shall be determined as spouse may exercise such ii article ii paragraph a subparagraph of the trust provides that upon the death of spouse any undistributed_income of the trust shall be distributed to the personal representative of the the remaining principal of the estate of spouse in all events trust shall be distributed to the personal representative of the the remaining principal of the estate of spouse in all events of trust shall be distributed under the provisions of paragraph c this article ii provided however that before making such principal distribution the trustee shall pay to the personal representative of the estate of spouse the difference between the amount of estate and inheritance taxes payable by reason of the death of spouse and the amount of such taxes otherwise payable had the principal of the trust not been included in the gross_estate of spouse for purposes of calculating such taxes under article ii paragraph b in the administration of the trust the trustee shall have all of the powers privileges and the - authority that are given to the trustee herein except power without the consent of spouse to hold assets unproductive the power to allocate receipts and disbursements of income as to principal or income in a manner other than as specified in iii those powers the possession or the state trust code and exercise of which would disqualify the assets of the trust for the marital_deduction for federal gift_tax purposes ii article ii paragraph c subparagraph provides that as soon as practicable after the death of spouse the trustee shall hold the assets to be disposed of under this paragraph in separate trusts of equal initial value for the use and benefit of should any of trustor's children then be trustor's children deceased and have then surviving issue the share to which each such deceased child would have been entitled had he or she survived shall be held in separate trusts for such then surviving during the term of each such trust for any issue per stirpes beneficiary the trustee may distribute such portions of the net_income and principal thereof as may be necessary or desirable in the discretion of the trustee to provide for the health education maintenance and support of such beneficiary article ii paragraph c subparagraph states that in a_trust which are not addition to the above-described distributions the trustee may distribute such sums from the net_income of distributed to the beneficiary thereof as shall be necessary or desirable in the discretion of the trustee to provide for the health education maintenance and support of the beneficiary's issue without regard to equality of distribution or the need for is trustor's desire equalizing distributions on termination that the trustee consult with the beneficiary concerning distributions to his or her issue but the trustee shall exercise its sole discretion which shall be binding upon all parties a beneficiary may be made although distributions to the issue of under this subparagraph such issue shall not be included during the life of such beneficiary in the term beneficiary when applying the remaining provisions of this paragraph c it article ii paragraph c subparagraph provides that each trust created for the benefit of continue for the lifetime of such child after which it shall a child of trustor or upon the terminate death of any other beneficiary prior to the termination of the trust for his or her benefit the remaining assets of the trust for the deceased beneficiary shall be held in separate trusts for the then surviving issue of the deceased beneficiary per upon the death of a child of trustor shall stirpes under the same terms set forth in this paragraph c there are no surviving issue of such deceased beneficiary the remaining assets of the trust for the deceased beneficiary shall be distributed to the then surviving issue per stirpes of the an nearest ancestor of such beneficiary who is either trustor or issue of trustor and who has then surviving issue provided however that should one of such issue be entitled to receive a portion of such assets and should a_trust created hereunder for his or her benefit not then be terminated such portion shall not be distributed free of trust to such person but shall be added to the trust created herein for his or her benefit and shall thereafter be held and administered in accordance with all of the terms and conditions of such trust if article ii paragraph c subparagraph further provides that when any beneficiary other than a child of trustor shall attain or has attained the age of to such beneficiary in addition to any other distributions provided for herein not less than all of the net_income of such trust calculated annually the child of trustor shall attain or has attained the age of trust created for the benefit of such beneficiary shall terminate and the remaining assets of such trust shall be distributed free of trust even to such beneficiary years the trustee shall distribute when any beneficiary other than a article ii paragraph c subparagraph should all of trustor's issue fail to survive the last to die of spouse or trustor or fail to survive to receive a final distribution hereunder then the assets remaining in the trusts created hereunder shall be distributed to trustor's heirs at law determined under the applicable statutes of descent and distribution then in force in state in the same shares in which such persons would take according to the provisions of such statutes with respect to each type of property being distributed as if trustor had died at the time of such succession article ii paragraph c subparagraph provides that notwithstanding anything to the contrary herein the trustee shall distribute the remaining principal and income of the trust created for any beneficiary under this paragraph c manner outright in trust or otherwise to or for the benefit of any one or more of trustor's issue surviving spouses of deceased issue of trustor and charities as the beneficiary of any such trust may appoint only by specific reference thereto in his or her will admitted to probate provided that such power to appoint may not be exercised in favor of the beneficiary his or her estate his or her creditors or the creditors of his or her estate and further provided that the exercise of such power may not direct the disposition of more than of the assets subject_to such power to charities collectively and may not direct the disposition of more than of the assets subject_to such power in such among spouses of deceased issue of trustor collectively it being trustor's intention that at least of the assets subject_to such power shall pass to the issue if any beneficiary whether by exercise or non-exercise of this power fo the extent that any beneficiary fails to exercise his or her power to appoint with respect to the principal or income of any trust then such portion thereof not effectively appointed shall be distributed as otherwise provided herein of such article ii paragraph d provides that anything in this article ii to the contrary notwithstanding upon the death of spouse the trustee shall distribute the remaining principal of the trust in such manner outright in trust or otherwise to or for the benefit of any one or more of the members of including only the following trustor trustor's issue and charities provided that the exercise of this power may direct no more than of the assets subject_to such power to charities collectively as spouse may appoint only by specific reference thereto in spouse's will admitted to probate provided that such power to appoint may not be exercised in favor of spouse spouse's estate spouse's creditors or the creditors of spouse's estate a group the trustee requests the following rulings the trustor's transfers to the trust qualify for the marital_deduction for federal gift_tax purposes under sec_2523 trustor has made a valid qtip_election under sec_2523 with respect to the property trustor transferred to the trust at trustor's death no part of the trust property will be includible in trustor's gross_estate for federal estate_tax purposes on the death of spouse the trust property will be includible in spouse's gross_estate under sec_2044 and will be treated as passing from spouse for federal estate_tax purposes spouse is the transferor of the trust property for gst tax purposes because trustor did not make a reverse_qtip_election if an election pursuant to pursuant to sec_2523 had not been made to treat such property as sec_2652 the allocation of trustor's gst tax exemption to the trust is void because the trust had no gst tax potential for trustor at the time of the allocation and therefore trustor's gst tax exemption is available for allocation to other transfers o2e2 sec_2001 provides that a tax is hereby imposed on the a citizen transfer of the taxable_estate of every decedent who is or resident_of_the_united_states sec_2044 sec_2044 provides that the value of the gross_estate will include the value of any property to which this section applies in which the decedent had a qualifying_income interest says that sec_2044 applies to any for life a deduction was allowed with respect to the property if- transfer of the property to the decedent- a under sec_2056 by reason of sec_2523 thereof and certain life estates did not apply with respect to a disposition by the decedent of part or all of such property sec_2519 relating to disposition of b under sec_2523 by reason of sec_2056 thereof or sec_2056 b i provides that the term qualified which passes terminable_interest property means property from the decedent qualifying_income_interest_for_life election under sec_2056 applies in which the surviving_spouse has a to which an iii ii and sec_2056 b ii provides that the surviving_spouse has a qualifying_income_interest_for_life if-- i the surviving_spouse is entitled to all the income from the property payable annually or at more frequent intervals or has a usufruct no person has power interest for life in the property and to appoint any part of the property to any person other than the surviving_spouse that sec_2056 exercisable only at to the extent provided in regulations an annuity shall be a manner similar to an income_interest in property treated in regardless of whether the property from which the annuity is payable can be separately identified or after the death of the surviving_spouse b ii ii shall not apply to a power b ii further provides sec_2056 ii sec_2523 provides that where a donor transfers during the calendar_year by gift an interest in property to a donee who at the time of the gift is the donor's spouse there shall be allowed as calendar_year an amount with respect to such interest equal to its value a deduction in computing taxable_gifts for the sec_2523 provides that where on the lapse of time on the occurrence of an event or contingency or on the failure of an event or contingency to occur such interest transferred to the spouse will terminate or fail with respect to such interest no deduction shall be allowed sec_2523 provides that if the donor retains in himself or transfers or has transferred for less than an adequate_and_full_consideration in money_or_money's_worth to any person other than such donee spouse or the estate of such spouse an interest in such property and if by reason of such retention or transfer the donor or his heirs or assigns or such person or his heirs or assigns may possess or enjoy any part of such property after such termination or failure of the interest if the donor immediately transferred to the donee spouse or after the transfer to the donee spouse has a power to appoint an interest in such property which he can exercise either alone or in such manner that the appointee in conjunction with any person may possess or enjoy any part of such property after such termination or failure of the interest transferred to the donee spouse considered as having immediately_after_the_transfer to the donee spouse such power to appoint even though such power cannot be exercised until after the lapse of time upon the occurrence of an event or contingency or on the failure of an event or contingency to occur for purposes of this paragraph the donor shall be sec_2523 further provides that an exercise or release in conjunction with any a power to appoint an interest in property even at any time by the donor either alone or person of though not otherwise a transfer shall for purposes of sec_2523 provided in impossible to ascertain the particular person or persons who may receive from the donor an interest in property so transferred by him considered as transferred to spouse except as sec_2523 where at the time of the transfer it sec_2523 be a person other than the donee such interest shall for purposes of a transfer by him be considered as is sec_2523 provides that in the case of qualified terminable_interest property- a for purposes of property shall be treated as transferred to the donee spouse and no part of such property shall b be considered as retained in the donor or transferred to any person_other_than_the_donee_spouse for purposes of sec_2523 sec_2523 such sec_2523 provides that for the purposes of sec_2523 the term qualified_terminable_interest_property means any property- a which is transferred by the donor spouse in which the donee spouse has a qualifying_income interest b to which an election under sec_2523 applies for life and c sec_2523 also provides that for purposes of sec_2523 rules similar to the rules of clauses ii iv sec_2056 shall apply and the rules of sec_2056 b shall apply of iii and sec_2523 a provides that an election under sec_2523 with respect to any property shall be made on or before the date prescribed by sec_6075 for filing a gift_tax_return with respect to the transfer determined without regard to sec_6019 and shall be made in such manner as the secretary shall by regulations prescribe that an election under sec_2523 once made shall be irrevocable sec_2523 b provides sec_2601 imposes a tax on every generation-skipping_transfer gst within the meaning of sec_2611 through sec_2611 defines the term gst as a taxable_termination and distribution a taxable a direct_skip sec_2612 provides that the term taxable_termination lapse of time release of power means the termination by death or otherwise of an interest in property held in a_trust unless-- a immediately after such termination a non-skip_person has an interest in such property or termination may a distribution including distributions on termination be made from such trust to a skip_person at no time after such b sec_2631 provides that for purposes of determining the inclusion_ratio every individual is allowed a gst_exemption of dollar_figure which may be allocated by such individual or his executor to any property with respect to which such individual sec_2631 provides that any allocation is the transferor under sec_2631 once made is irrevocable sec_2632 provides that any allocation by an individual of his gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual's estate determined with regard to extensions regardless of whether such a return is required to be filed b any trust with sec_2652 provides a special election for qualified terminal interest property in the case of- a respect to which a deduction is allowed to the decedent under any trust with respect to which a deduction sec_2056 and to the donor spouse is allowed under sec_2523 the estate of the decedent or the donor spouse as the case may be may elect to treat all of the property in such trust for purposes of chapter if the election to be treated as a qtip had not been made this election is referred to as the reverse_qtip_election a reverse_qtip_election is that the decedent consequence of remains for gst tax purposes the transferor of the qtip_trust for which the election is made exemption may be allocated to that qtip_trust as a result that decedent's gst the as sec_26_2632-1 i of the gst tax regulations provides in part that an allocation of gst_exemption to a_trust is also void if the allocation is made with respect to a_trust that has no gst potential with respect to the transferor making for this purpose the allocation at the time of the allocation so a_trust has gst potential even if the possibility of remote as to be negligible a gst is based on the facts and representations submitted with your request we have determined the following the trustor's transfers to the trust qualify for the marital_deduction for federal gift_tax purposes under sec_2523 a because trustor gave spouse an interest in property the trust at the time of the transfer trustor made a valid qtip_election under sec_2523 by gifting to his spouse qualified_terminable_interest_property property that trustor transferred to the trust property in which spouse has a qualifying_income_interest_for_life sec_2523 applies election on trustor's timely filed federal gift and gst tax_return and property to which the election under trustor also made a timely sec_2523 because trustor's transfers to the trust qualify for the marital_deduction under sec_2523 will be includible in trustor's gross_estate at trustor's death for federal estate_tax purposes no part of the trust property on the death of spouse the trust property will be includible in spouse's gross_estate under sec_2044 because a deduction was allowed for the transfer of the property to the trustor under sec_2523 by reason of will be treated as passing from spouse for federal estate_tax purposes sec_2523 the trust property the trustor did not make a reverse_qtip_election to treat trustor as the transferor of pursuant to sec_2652 the property for gst tax purposes as sec_2523 had not been made individual last subject_to estate or gift_tax on the transfer of the property and is considered the transferor of the trust property for gst tax purposes thus under sec_2044 spouse is the if an election pursuant to the allocation of trustor's gst tax exemption to the trust is void because the trust had no gst tax potential for trustor at the time of the allocation and therefore trustor's gst tax exemption is available for allocation to other transfers a ofs except as we have specifically ruled herein we express or imply no opinion as to the federal tax consequences of this transaction under the cited provisions or provisions of the code under any other this ruling is directed only to the taxpayer who requested sec_6110 of the code provides that it may not be it used or cited as precedent sincerely isigned christine elfisor christine e ellison branch chief branch office of the assistant chief_counsel passthroughs and special industries enclosure copy for sec_6110 purpose


t c memo united_states tax_court charles e bercy deceased elaine bercy successor_in_interest and elaine bercy petitioners v commissioner of internal revenue respondent docket no filed date mark bernsley for petitioners michael w berwind and linette b young for respondent memorandum findings_of_fact and opinion lauber judge with respect to petitioners’ federal_income_tax for the internal_revenue_service irs or respondent determined a deficiency of dollar_figure and an accuracy-related_penalty of dollar_figure the principal issue for deci- sion is whether petitioners are entitled to a business_bad_debt deduction under sec- tion a we hold that they are entitled to such a deduction and accordingly are not liable for an accuracy-related_penalty findings_of_fact some of the facts have been stipulated and are so found the stipulations of fact and the attached exhibits are incorporated by this reference petitioners were a married couple who resided in california when they filed their petition petition- er husband mr bercy or petitioner testified at trial but died several months after- wards a petitioner’s lending activity mr bercy was at all relevant times a licensed real_estate broker in califor- nia he was the co-founder president and major shareholder of the argus group argus a california entity that elected s_corporation status for federal_income_tax purposes argus was chiefly engaged in making mortgage loans secured_by real_estate typically short-term speculative loans for residential construction petitioner estimated that argus had lent at least dollar_figure million since its founding in 1unless otherwise indicated all statutory references are to the internal_revenue_code code in effect for the relevant year and all rule references are to the tax_court rules_of_practice and procedure we round all monetary amounts to the nearest dollar mr bercy also owned astin-carr a company that arranged real_estate syndications and regularly supplied capital to argus apart from his activities for these companies mr bercy loaned substantial sums for his own account he estimated that over the years he had made more than dollar_figure million of personal loans whenever a plausible borrower approached him about this type of loan mr bercy investigated the proposed project sought appraisals and consulted his personal guidelines for gauging risks and rewards most of the loans mr bercy made for his own account were real_estate related but he also made a variety of personal_property loans and even financed a few hollywood film scripts he estimated that he typically made one or two per- sonal property loans for his own account annually including one in and one in he pegged the outstanding volume of his personal_property loans in at about dollar_figure million we found his testimony on these points credible in early darryl aken an acquaintance of mr bercy’s approached him with a proposal for a personal loan mr aken operated a furniture business in los angeles through a limited_liability_company llc that did business under the trade_name girari girari manufactured high-end furniture which it sold directly to consumers from its showroom it also rented tables and chairs for use at social events museum openings and conferences girari’s high-end furniture was popular among los angeles party-goers and in mr aken sought capital to expand his business to las vegas he told mr bercy that he was looking to borrow dollar_figure disclosing that girari had dollar_figure of pre-existing debt its pre-existing debt consisted of dollar_figure owed to sylvan aken mr aken’s mother dollar_figure owed to sandra aken his daughter and dollar_figure owed to richard kern an unrelated party whom mr bercy believed to be a savvy investor the record does not disclose whether any of these lenders received or perfected security interests in girari’s assets although mr bercy several years previously had declined an invitation to acquire an equity stake in girari he told mr aken that he would consider a loan consistently with his due-diligence process mr bercy investigated girari he visited girari’s showroom and reviewed records of its rentals over the previous two years impressed by girari’s business plan and mr kern’s business reputa- tion mr bercy decided to lend money not wanting to lend the full dollar_figure himself mr bercy asked another lender dennis levitt to go with him mr bercy and mr levitt had previ- ously made a personal_property loan together each agreed to lend girari dollar_figure on substantially identical terms b the note the record includes copies of the loan documents that the parties thereto executed in date none of these documents which were prepared by ronald altman mr bercy’s lawyer contains original signatures mr bercy credibly testified that he had shredded the originals in a house-cleaning exercise mandated by his wife and mr aken kept no copies after he sold girari’s assets in however mr altman kept digital versions of the loan documents on his law firm’s computer system we find that these versions coupled with the testi- mony of messrs altman aken and bercy are sufficient to establish the basic terms of the loan the parties executed a promissory note whereby mr bercy and mr levitt each lent dollar_figure to girari the note bore interest pincite had a one-year maturity and was structured as a line of credit such that girari could draw up to dollar_figure in principal mr aken personally guaranteed the note the parties exe- cuted a security_agreement whereby girari gave messrs bercy and levitt equal se- curity interests in its assets and proceeds of any sale of assets 2mr bercy’s share of the loan was made by a grantor_trust and for our purposes he is treated as having lent the funds directly see sec_671 shortly after the closing messrs bercy and levitt each disbursed dollar_figure to girari each disbursed another dollar_figure to girari a month or so later although the loan was secured_by girari’s assets the lenders neglected to file financing statements with the california secretary of state to perfect their security interests c restructuring the debt the financial crisis was unkind to girari as demand for new homes shriveled so did demand for its furniture and as businesses conventions and party hosts scaled back their entertaining demand for high-end rental furni- ture cratered when the promissory note came due in date girari was un- able to repay as a real_estate lender mr bercy had bigger problems at that point so he declined to seek an immediate remedy for girari’s default enforcing the security_agreement would have required legal expenses and left him with large volumes of furniture for which there was little demand instead mr bercy resolved to let mr aken who had expertise in the furniture industry attempt to restructure girari and find a way to repay the loan mr aken regularly communicated with mr bercy mr levitt and his other lenders about his efforts to repay girari’s loans in mr aken concluded that selling girari was the only viable way to manage repayment he explored sale of the company to a canadian buyer and to cort furniture rental a large u s firm when those efforts failed he explored alliances with other party-rental companies but those overtures were likewise unsuccessful by early girari had not been sold and mr levitt had grown impatient he agreed to take dollar_figure in complete satisfaction of the dollar_figure that he was owed mr bercy and the other lenders believed that they stood to recover more if they waited until mr aken found a suitable buyer for girari they accordingly acquiesced in mr levitt’s exit on these terms mr levitt and girari executed an agreement under which he would receive in satisfaction of his dollar_figure loan dollar_figure in seven installments during the agreement stated that if girari failed to pay dollar_figure by date mr levitt would be free to pursue full recovery_of the dollar_figure by year end girari had made total payments to mr levitt of only dollar_figure mr aken eventually found a buyer in girari sold its assets to kool party rentals kool an arizona firm for dollar_figure kool paid dollar_figure in cash and executed a promissory note for the dollar_figure balance the note bore interest pincite annually and required that principal be repaid in monthly installments of dollar_figure plus applicable_interest girari used the dollar_figure cash payment to refurbish the rental furniture that was to be delivered to kool the first dollar_figure paid via monthly installments was allocated to mr levitt to satisfy the balance of his dollar_figure claim the creditors agreed and the kool note specified that the balance of the promissory note or dollar_figure would be paid to mr bercy to mr kern to sondra aken and to sylvan aken mr bercy’s share of the principal was thus dollar_figure dollar_figure mr bercy and the other lenders believed that girari’s and mr aken’s obligations to them originally totaling dollar_figure had been com- pletely extinguished upon their receipt during of ratable interests in the kool note kool made all payments of interest and principal as scheduled it sent these payments to argus which acted without fee as the servicer for the loan argus transmitted to mr bercy and the other lenders their shares of each monthly pay- ment together with a computerized statement of account showing a breakdown between principal and interest kool fully discharged the dollar_figure note in date two years early by making a lump-sum payment of the balance then due d tax reporting and trial on their federal_income_tax return petitioners claimed a business_bad_debt deduction of dollar_figure under sec_166 they reported this loss on sched- ule c profit or loss from business for mr bercy’s sole_proprietorship activity among the expenses of this business they included a dollar_figure item captioned loan charge off--girari inc petitioners’ accountant calculated the dollar_figure loss by valuing mr bercy’s interest in the kool note at dollar_figure applying a discount of roughly to the dollar_figure of principal that he was due the accountant believed this discount was warranted because the interest rate on the kool note wa sec_5 as opposed to the girari had contracted to pay repayment of the kool note was stretched out over several years and the kool note was a multiparty loan in which mr bercy held a minority interest supposedly complicating his ability to proceed with legal enforcement on his own the irs selected petitioners’ return for examination on date it issued them a notice_of_deficiency disallowing the claimed dollar_figure bad_debt deduction and determining the deficiency and accuracy-related_penalty set forth above see supra pp as the basis for the disallowance the notice stated you did not establish that the business_expense shown on your tax_return was paid_or_incurred during the taxable_year and that the expense was ordinary and necessary to your business petitioners timely petitioned for redetermination and trial was held in los angeles in date a burden_of_proof opinion the commissioner’s determinations in a notice_of_deficiency are generally presumed correct and the taxpayer bears the burden of proving those determina- tions erroneous rule a 290_us_111 the taxpayer generally bears the burden of proving his entitlement to deductions al- lowed by the code and of substantiating the amounts of claimed deductions 503_us_79 sec_1_6001-1 income_tax regs however rule a provides that respondent shall have the burden_of_proof in respect of any new_matter increases in deficiency and affirmative defenses pleaded in the answer the notice_of_deficiency issued to petitioners disallowed the loss deduction for lack of substantiation ie because petitioners had not established that the ex- pense was incurred during the taxable_year and was ordinary and necessary petitioners contend that the status of the girari debt as a business debt requires dif- ferent evidence and thus constitutes new_matter on which respondent should have the burden_of_proof see rule a 112_tc_183 because we find that the preponderance_of_the_evidence favors petitioners on this point we need not decide who has the burden_of_proof on the business debt question see 138_tc_306 supplementing tcmemo_2011_209 supplemented by 151_tc_160 b bad_debt deduction the code allows a deduction against ordinary_income for a business debt that becomes wholly or partially worthless during the taxable_year sec_166 d for a nonbusiness_bad_debt held by a taxpayer other than a corporation sec_166 does not apply and the taxpayer is allowed a short-term_capital_loss for the year in which the debt becomes worthless sec_166 sec_1 a income_tax regs we have found as a fact that mr bercy disbursed dollar_figure to girari in and respondent agrees that this extension of credit was a bona_fide loan the issues remaining for decision are whether the loan constituted a business or nonbusiness_debt whether the loan became wholly or partially worthless in and if so the amount of the deduction to which petitioners are entitled business vs nonbusiness_debt sec_166 describes a business debt as a debt created or acquired in connection with a trade_or_business of the taxpayer or a debt the loss from the worthlessness of which is incurred in the taxpayer’s trade_or_business the status of a debt as a business debt presents a question of fact see sec_1_166-5 income_tax regs to be eligible to deduct a loss as a business_bad_debt the taxpayer must show that he was engaged in a trade_or_business and that the debt was proximately related to that trade_or_business 66_tc_652 aff’d 601_f2d_734 5th cir sec_1 b income_tax regs to be engaged in a trade_or_business the taxpayer must participate in the activity with continuity and regularity and his primary purpose for engaging in the activity must be for income or profit 480_us_23 whether the debt has a proximate relationship to the taxpayer’s trade_or_business turns on the taxpayer’s dominant motivation in making the loan putoma corp t c pincite we find that mr bercy was engaged in a distinct trade_or_business of lend- ing money aside from his activities on behalf of argus and astin-carr mr ber- cy personally made loans to a variety of borrowers solely for his own account on a regular basis his personal lending activity was substantial comprising numer- 3argus was engaged in the business of making real_estate loans and mr bercy supplied capital to argus directly as a shareholder of that s_corporation and through astin-carr an entity he wholly owned petitioners do not contend that mr bercy should be deemed to be in the lending business solely by virtue of the activities conducted by his s_corporation cf 136_tc_263 holding that managing member of an llc was deemed to carry on the lending business of his llc ous loans totaling an estimated dollar_figure million and he engaged in this activity with the intent of making a profit mr aken credibly testified that he approached mr bercy because he knew that mr bercy was in the lending business the fact that the two men were unre- lated negated any familial motivation for the loan mr bercy agreed to lend only after investigating girari’s business and finances performing due diligence as he did for his other loans to hedge his bet he secured as a co-lender mr levitt with whom he had previously joined in making a personal_property loan his behavior in connection with the girari loan was consistent with his general business prac- tices and that loan was proximately related to his trade_or_business of lending money see ruppel v commissioner tcmemo_1987_248 53_tcm_829 since we have held that petitioner was in the trade_or_business of lending money it follows that the most significant loans created with respect to that business were proximately related to it unless the facts show some other reason for the loan respondent concedes that mr bercy was admittedly engaged in the busi- ness of real_estate lending but respondent contends that making personal prop- erty loans was outside the scope of that business and in respondent’s view the scale of mr bercy’s non-real-estate lending activity was insufficiently robust to constitute a trade_or_business distinct from his business of real_estate lending we are not persuaded to construe the term trade_or_business so narrowly in this context when previously considering the status of loans as business_debts under sec_166 we have not segmented the taxpayer’s lending business according to the nature of the loan or type of customer rather we have simply asked whether the taxpayer was in the business of lending money separate and distinct from any other gainful employment he or she may have had see eg yaryan v commissioner tcmemo_2018_129 at the parties agree that petitioners were not in a trade_or_business of lending funds owens v commis- sioner tcmemo_2017_157 114_tcm_188 inquiring whether the taxpayer’s personal lending was a trade_or_business hatcher v commissioner tcmemo_2016_188 112_tcm_415 finding that the taxpayer was not engaged in the trade_or_business of lending money aff’d 726_fedappx_207 5th cir ruppel t c m cch pincite requiring the taxpayer to show that he was in the trade_or_business of lending money jessup v commis- sioner tcmemo_1977_289 36_tcm_1145 finding that the tax- payer was in the business of making loans respondent errs in relying on rutter v commissioner tcmemo_2017_ 114_tcm_282 we there disallowed a business_bad_debt deduction because we found the taxpayer’s advances to his corporation to have been equity investments rather than loans id pincite but even if the advances constitut- ed debt we held that the taxpayer was not entitled to a business_bad_debt deduc- tion because there was no support in the record for his assertion that he was in the business of lending money id pincite in rutter as in other cases involving this question we asked whether the evidence established that the tax- payer was in the lending business id pincite answering that question affirm- atively here we find that the girari loan was a business debt for purposes of sec_166 worthlessness in sec_166 allows a deduction for the taxable_year in which a business debt becomes wholly or partially worthless the year in which a debt becomes worthless is fixed by identifiable events that make it reasonable for the lender to abandon any hope of recovery 77_tc_582 when a debt becomes worthless is to be decided by the trier of fact am off- shore inc v commissioner 97_tc_579 citing 871_f2d_64 7th cir aff’g t c memo ascertaining when a debt becomes worthless requires examination of all the circumstances 14_tc_1282 there is no standard test or formula for determining worthlessness but relevant factors include the debtor’s solvency the lender’s collection efforts and subse- quent dealings between the parties see 280_us_445 109_tc_400 am offshore inc t c pincite sec_1_166-2 income_tax regs the taxpayer must estab- lish objective facts from which worthlessness can be determined mere belief that a debt has gone bad is insufficient 50_tc_813 aff’d per curiam u s tax cas cch para 9th cir a taxpayer is not required to take legal action to enforce payment where it would in all probability not result in the satisfaction of execution on a judgment sec_1_166-2 income_tax regs in evaluating a taxpayer’s contention that a debt has become wholly or par- tially worthless we give weight to the creditor’s soundly exercised business judg- ment 56_tc_58 we do not re- quire a creditor to pursue theoretical possibilities of recovery that ignore the re- alities of the business environment abc beverage corp v commissioner tcmemo_2006_195 92_tcm_268 whether a bad_debt deduction is proper must be analyzed according to ‘reasonableness commonsense and economic reality ’ id pincite quoting 215_f2d_567 2d cir the sale of girari’s assets to kool was an identifiable_event that reasonably caused mr bercy to abandon any hope of recovery beyond the amount to which he was entitled under the kool note after mr levitt’s departure mr bercy and the other creditors joined in an agreement to accept pro_rata shares of the girari sale proceeds via the kool note in full settlement of girari’s obligation to them the creditors viewed the sale of girari’s assets as the only hope of recovery and they waited patiently for six years for mr aken to find a buyer once that sale was consummated the creditors treated the kool note as a final settlement that extinguished any claims by any of them against girari or mr aken personally respondent urges that mr bercy could have recovered more than his pro_rata share of the kool note but it is unclear what the source of that recovery could have been girari had sold all of its assets and mr aken in appeared to be as asset-poor as he had been when girari defaulted six years previously in 4the parties’ behavior following execution of the kool note is consistent with their understanding that they had no further claim against girari or mr aken if mr bercy believed that he could seek a deficiency judgment against either of them he presumably would not have shredded his original copy of the girari note any event mr bercy’s ability to sue on mr aken’s personal guarantee was uncertain under california law because more than four years had elapsed since girari defaulted on the note see cal civ proc code sec_337 west requiring that an action upon an obligation or liability be brought within four years respondent contends that mr bercy’s security_interest in girari’s assets though unperfected attached to the proceeds of the asset sale and he contends that this security_interest gave mr bercy under california law absolute priority over the claims of unsecured creditors from these premises respondent con- cludes that mr bercy had priority over girari’s three other creditors and was en- titled to receive of the proceeds from the kool note until he was re- paid in full accepting arguendo respondent’s premises we do not agree with his con- clusion there is no evidence in the record to indicate whether the loans extended by girari’s three previous creditors--sondra aken sylvan aken and mr kern-- were secured or unsecured more importantly mr bercy and they had agreed to accept undivided pro_rata shares of the kool note in full payment of their respec- tive claims against girari it is difficult to see how mr bercy could have reneged on that agreement by asserting an unperfected seven-year-old security_interest as a bar to their entitlements we find that mr bercy exercised reasonable business judgment in concluding that he stood to recover more by agreeing to divide the proceeds pro_rata than by engaging in a potentially costly priority dispute with the other creditors over what was in comparison with mr bercy’s other undertakings a relatively small amount of money in sum we find that mr bercy reasonably abandoned in any hope of recovering more from the girari loan than his pro_rata share of the kool note mr levitt a sophisticated businessman had previously agreed to accept cents on the dollar in full payment for his dollar_figure loan mr bercy held out longer and his patience was rewarded netting him cents per dollar through the kool note we give weight to mr bercy’s soundly exercised business judgment shared by girari’s other creditors that the kool transaction was the endgame see portland mfg co t c pincite mr bercy reasonably concluded that further legal action against mr aken girari or girari’s other creditors would in all probability not have result ed in the satisfaction of execution on a judgment sec_1_166-2 income_tax regs we accordingly find that the girari loan be- came worthless in except to the extent of the undivided_interest in the kool note that mr bercy received in partial satisfaction of his principal amount of deduction sec_166 provides that the amount of the deduction for any bad_debt shall be the adjusted_basis provided in sec_1011 for determining the loss from the sale_or_other_disposition of property sec_1011 cross-refers to sec_1012 which provides that the basis_of_property is generally its cost mr bercy’s original cost_basis in the girari loan was dollar_figure to deter- mine the bad_debt deduction we must adjust mr bercy’s basis for the value of the property he received in partial repayment of his principal see deutsch v com- missioner tcmemo_2012_318 104_tcm_573 the adjusted_basis of a note equals the face_amount of the debt minus any principal paid back by the debtor sec_1_166-1 income_tax regs as repayment of his princi- pal mr bercy received an undivided interest in the kool note the face value of mr bercy’s undivided interest in the kool note was dollar_figure which would produce a bad_debt deduction of dollar_figure petitioners re- ported a bad_debt deduction of dollar_figure applying a discount to the face value of the property interest mr bercy received petitioners’ accountant believed a discount was warranted because the interest rate on the kool note wa sec_5 as opposed to the girari had contracted to pay repayment of the kool note was stretched out over several years and the kool note was a multiparty loan in which mr bercy held a minority interest allegedly complicating his ability to proceed with legal enforcement on his own petitioners’ accountant did not testify at trial but his computation is set forth in workpapers he supplied to the irs during the examination petitioners have not carried their burden of proving that a discount is war- ranted or if so the proper amount of the discount the fact that the girari note bore a higher interest rate than the kool note is irrelevant the task at hand is to determine the fair_market_value of mr bercy’s share of the kool note the inter- est rate that girari agreed to pay seven years earlier is immaterial in answering that question and mr bercy cannot claim a tax loss for interest girari never paid a bad_debt deduction for accrued but unpaid interest is allowable only if the interest was previously reported by the taxpayer as taxable_income see 121_tc_279 a discount might be appropriate if the interest rate on the kool note was artificially low but petitioners have supplied no reason to believe that it was kool was unrelated to girari’s creditors and operated at arm’s length with them the accountant’s workpapers do not address and petitioners presented no evi- dence concerning kool’s creditworthiness prevailing interest rates in or comparable interest rates for a loan of this size and quality if the interest rate adequately compensated mr bercy for the time value of money--and there is no evidence to the contrary--it is immaterial that repayment stretched out over several years finally petitioners have not shown that a discount was justified on the ground that mr bercy held a minority interest in a multiparty note the four creditors agreed that argus mr bercy’s firm would service the loan kool made all payments to argus and it disbursed funds ratably to mr bercy and the other three creditors since argus controlled the cashflow and acted for the creditors as a group we are not convinced that mr bercy was meaningfully disadvantaged by his minority position or by inability to proceed with legal enforcement on his own in sum we find that mr bercy made in connection with his business of lending money a business loan of dollar_figure to girari in in partial satisfac- tion of that debt in he received a interest in a note with a face value of dollar_figure petitioners have not shown that any discount was justified so the prop- erty mr bercy received was worth dollar_figure the face value of his interest in the note at that point mr bercy had no reasonable prospect of recovering any more of his principal investment petitioners were thus entitled for to a business_bad_debt deduction of dollar_figure under sec_166 to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom p si plr-112167-99 date sept legend x state d1 d2 this responds to the letter dated date and subsequent correspondence submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code facts x was incorporated under state law on d1 x’s shareholders intended that x be a subchapter_s_corporation effective d2 however an s_corporation_election under sec_1362 was not timely filed s_corporation sec_1362 provides that a small_business_corporation may elect to be an law and analysis sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation’s taxable_year then that corporation will be treated as an s_corporation for the year in which the election is made if an s election is made after the first two and one-half months of a cc dom p si plr-112167-99 corporation’s taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made sec_1362 provides that if an election under sec_1362 is made for any taxable_year after the date prescribed for making such election for such taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make the election then the secretary may treat the election as timely made for such taxable_year x’s s_corporation_election was not filed timely for the election to be effective as of d2 nevertheless x has established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and assuming that x otherwise qualifies as a subchapter_s_corporation as of d2 we conclude that x will be recognized as an s_corporation effective as of d2 x should file a completed form_2553 with a copy of this ruling attached reflecting its election of subchapter_s_corporation status as of d2 with the applicable service_center within days of the date of this letter the form_2553 submitted with the ruling_request is returned herewith except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed concerning whether x otherwise satisfies the s_corporation eligibility requirements this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent signed david r haglund sincerely david r haglund senior technician reviewer branch office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number -------------------- ----------------------------- --------------------------------------------- ----------------------------------- ------------------------------------ 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 ita b03 plr-103497-14 date date ty ------- legend taxpayer ---------------------------------------------- industry ------------------------------------------------------------------------ division ---------------------------------- items ---------------------- product ------------ ---------------------------------- dollar_figurea ----------------- dollar_figureb ---------------- manufacturer ------------ agreement ------------------------------------------------------ payment ------------------------------ date --------------------------- year ------- dear ----------------- this is in response to a letter sent by your representatives dated date requesting a ruling that certain participation payments division made are not required to be capitalized under sec_263 of the internal_revenue_code facts taxpayer is the parent_corporation of a multinational group that provides products and services to industry division is a division of taxpayer that is engaged in the design manufacture and service of items and spare parts and components of items division enters into agreements with product manufacturers pursuant to which division agrees to design and manufacture items for new products under the terms of an agreement a product manufacturer typically agrees to develop and manufacture the plr-103497-14 new product to secure any required approval to market the product and to market the product to customers while division typically agrees to design and develop the items to secure any required approval to market the item and to support the product manufacturer’s marketing and certification efforts both the product manufacturer and division commit to conduct their activities in accordance with a timeline that is agreed between the parties and division agrees to provide certain support and maintenance services to the product manufacturer and any customers pursuant to an agreement a product manufacturer generally agrees that division will be the exclusive or semi-exclusive supplier of items for the new product and division looks to future sales of product to recoup its investment if a new product is successful such sales will occur in connection with both the initial sales of the item to customers and any subsequent servicing and spare parts orders from those customers if a product is unsuccessful however division may not receive any orders for its items thus the product manufacturer does not guarantee that division will receive any orders or compensation but grants division the exclusive or semi-exclusive right to supply items for any orders that do materialize the amount that division receives for the items depends on the selling_price of the product to the customers and the volume of sales and is not specifically set by the agreement in exchange for the exclusivity rights granted by a product manufacturer under an agreement division typically agrees to develop and manufacture items at its own risk as well as to provide other services enumerated in the agreement for certain products division also agrees to make a series of contributions or payments to the product manufacturer at various stages of the new product’s development on date division entered into an agreement with manufacturer pursuant to which division agreed to design manufacture certify test and supply items for the manufacturer under the terms of the agreement manufacturer agreed that division would be the exclusive supplier of items for the new product to be developed by manufacturer in exchange for these exclusivity rights division agreed to absorb all the non-recurring costs and expenses that it incurs in the performance of the agreement and to contribute dollar_figurea to the manufacturer’s development and marketing costs the agreement provides that division’s contribution or payments will be paid in various amounts according to a schedule of milestones the first payment of dollar_figureb was made in year no other_payments have been made as of the date of this request the total amount of division’s contribution must be fully refunded if manufacturer does not comply with its exclusivity obligations as set forth in the agreement also if manufacturer cancels development of the product before the canceled product enters into production division’s total contribution will be reduced plr-103497-14 the agreement provides that manufacturer does not guarantee to division i any minimum amounts of p roducts to be purchased by manufacturer under this agreement ii any minimum amount of money to be paid_by manufacturer pursuant to this agreement and or iii any constant or fixed number of purchase orders to be placed by manufacturer with division in any given period of time and or iv the use of p roducts in any of its c ustomer’s product while division provides enumerated support services and materials to manufacturer and its customers from the outset of the development program it generally does so at no cost to the customers or to manufacturer further manufacturer has no obligation or commitment whatsoever to i start the program on any specific date ii comply with any specific time schedule for the performance or execution of the p rogram or iii having started the p rogram to continue or complete it under the terms of the agreement there is no guaranteed price for the items that may be purchased rather the price depends on what customers are willing to pay for manufacturer’s new product as the price of division’s item is determined based on specified percentages of the price of each product subject_to a price floor that is adjusted annually based on the consumer_price_index and adjustments due to division’s failure to meet its performance guarantees the specified percentages change based on the total number of products sold by manufacturer law and analysis taxpayer asks whether payments made with respect to the agreement constitute capital expenditures sec_263 generally prohibits deductions for capital expenditures sec_1_263_a_-4 of the income_tax regulations provides rules for applying sec_263 to amounts paid to acquire or create intangibles sec_1_263_a_-4 provides that in general a taxpayer must capitalize i an amount_paid to acquire an intangible ii an amount_paid to create an intangible iii an amount_paid to create or enhance a separate and distinct intangible asset iv an amount_paid to create or enhance a future benefit identified in the federal_register or in the internal_revenue_bulletin as an intangible for which capitalized is required under this section or v an amount_paid to facilitate the acquisition or creation of an intangible whether the taxpayer is the acquirer or the target sec_1_263_a_-4 provides that the term separate and distinct intangible asset means a property interest of ascertainable and measurable value in money's worth that is subject_to protection under applicable state federal or foreign law and the possession and control of which is intrinsically capable of being sold transferred or pledged ignoring any restrictions imposed on assignability separate and apart from a trade_or_business sec_1_263_a_-4 provides that amounts paid to another party to create originate enter into renew renegotiate or facilitate an agreement with plr-103497-14 that party that produces rights or benefits for the taxpayer are not treated as amounts that create or facilitate a separate and distinct intangible asset the payments made under the agreement in this case are not amounts paid to create or enhance a separate and distinct intangible asset within the meaning of sec_1 a - b because the benefit the taxpayer receives is not capable of being sold and would not have value if separated from the taxpayer’s manufacturing business as a result the payments are not required to be capitalized under sec_1_263_a_-4 further the payments do not result in a future benefit identified in published guidance accordingly sec_1_263_a_-4 does not apply in this case however the payments in this case constitute capital expenditures if they are amounts paid to acquire an intangible create an intangible or facilitate acquisition or creation of an intangible sec_1_263_a_-4 ii and v these provisions are examined below a amount_paid to acquire an intangible sec_1_263_a_-4 provides that in general a taxpayer must capitalize amounts paid to acquire an intangible as provided in sec_1_263_a_-4 sec_1_263_a_-4 provides that in general a taxpayer must capitalize amounts paid to another party to acquire any intangible from that party in a purchase or similar transaction the payments that division made or will make in this case are to support manufacturer’s effort to develop and market product under an agreement that grants division status as its exclusive or semi-exclusive supplier of items for a specific product division did not acquire or purchase an intangible from manufacturer under the agreement as a result the payments that division made or will make pursuant to the agreement do not constitute amounts paid to acquire an intangible within the meaning of sec_1 a - b i b amount_paid to create an intangible sec_1_263_a_-4 provides that in general a taxpayer must capitalize an amount_paid to create an intangible described in sec_1_263_a_-4 sec_1 a - d provides that unless the 12-month rule applies a taxpayer must capitalize amounts paid to create certain specified intangibles as noted above sec_1 a - b ii provides that amounts paid to another party to create originate enter into renew renegotiate or facilitate an agreement with that party are not treated as amounts that create or facilitate a separate and distinct intangible asset however sec_1 a - b ii provides a cross-reference to sec_1_263_a_-4 and which state that amounts paid to create or terminate certain types of agreements must be capitalized for the reasons described below the payments in this case are not required to be capitalized under these provisions plr-103497-14 sec_1_263_a_-4 sec_1_263_a_-4 generally provides that a taxpayer must capitalize amounts paid to another party to create originate enter into renew or renegotiate with that party certain financial interests among the financial interests described in sec_1 a - d i are forward contracts and options the payments in this case do not involve any of the items described in sec_1_263_a_-4 except possibly forward contracts or options described in sec_1_263_a_-4 the payments in this case are amounts paid to create an intangible if they are either a forward_contract or an option a forward_contract includes an agreement under which the taxpayer has the right and obligation to provide or to acquire property or to be compensated for such property regardless of whether the taxpayer provides or acquires the property sec_1_263_a_-4 a forward_contract is a contract to purchase or sell a security financial_instrument commodity or other_property at a designated interest rate on a fixed future date settlement_date and at a fixed price see 24_f3d_480 3d cir cert_denied 513_us_1032 861_f2d_494 7th cir 89_tc_849 aff d 904_f2d_1011 5th cir aff d 501_us_868 an option includes an agreement under which the taxpayer has the right to provide or to acquire property or to be compensated for such property regardless of whether the taxpayer provides or acquires the property an option is the right but not the obligation to purchase or sell a security or property at a fixed price strike_price and by a specified time expiration date see sec_1 a - d i c 125_tc_248 64_tc_752 aff d 544_f2d_1045 9th cir an amount_paid to another party is not paid to create originate enter into renew or renegotiate a financial interest with that party if the payment is made with the mere hope or expectation of developing or maintaining a business relationship with that party and is not contingent on the origination renewal or renegotiation of a financial interest with that party sec_1_263_a_-4 under the agreement the manufacturer is not required to purchase any specific number of items from division during the term of the agreements and the price of the any particular item is not fixed at the time the agreement was executed rather the price of the item is determined by at the time of the sale based on a percentage of the product’s price subject_to a floor price adjusted for index cpi and any applicable adjustments due to the price customers are willing to pay for a particular product adjusted for division’s failure to meet performance obligations further division does not have the right to provide any items to manufacturer as manufacturer may place no orders division provides support services and materials but it does so at no cost to plr-103497-14 manufacturer under these circumstances the agreement does not constitute a forward_contract or option because the price quantity and date of purchase of the items to be ordered are not specified accordingly the payments made pursuant to the agreement are not paid to create an intangible described in sec_1_263_a_-4 sec_1_263_a_-4 sec_1_263_a_-4 provides that a taxpayer must capitalize amounts paid to another party to create originate enter into renew or renegotiate with that party certain enumerated agreements or covenants these agreements include a an agreement providing the taxpayer the right to use tangible or intangible_property or the right to be compensated for_the_use_of tangible or intangible_property b an agreement providing the taxpayer the right to provide or to receive services or the right to be compensated for services regardless of whether the taxpayer provides such services taxpayer’s agreement provides it with an exclusive or semi-exclusive right to provide tangible_property and is not covered by sec_1_263_a_-4 sec_1_263_a_-4 sec_1_263_a_-4 provides that a taxpayer must capitalize certain contract termination_payments this provision does not apply to division’s participation payments as a result the payments division made or will make pursuant to the agreement in this case do not constitute amounts paid to create an intangible within the meaning of sec_1_263_a_-4 c amount_paid to facilitate acquisition or creation of an intangible sec_1_263_a_-4 provides that in general a taxpayer must capitalize amounts paid to facilitate the acquisition or creation of an intangible described in paragraph b i ii iii or iv sec_1_263_a_-4 provides that in general an amount is paid to facilitate the acquisition or creation of an intangible the transaction if the amount is paid in the process of investigating or otherwise pursuing the transaction the term transaction means all of the factual elements comprising an acquisition or creation of an intangible and includes a series of steps carried out as part of a single_plan sec_1_263_a_-4 although the payments the taxpayer makes under the agreement are part of a business strategy intended to result in sales of items the payments are not part of a plan to create or acquire any identifiable intangible described in sec_1_263_a_-4 thus plr-103497-14 division’s payments are not described in sec_1_263_a_-4 and do not constitute amounts paid to facilitate the acquisition or creation of an intangible ruling payments which division made or will make in connection with the agreement are not required to be capitalized under sec_263 except as expressly provided herein no opinion is expressed or implied concerning the federal_income_tax consequences of any aspect of any transaction or item discussed or referenced in this ruling for example we express no opinion on whether the payments in this case are properly deductible under sec_162 or subject_to capitalization under sec_263a 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 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 sean m dwyer assistant to the branch chief branch income_tax accounting - -------------------------------------------- ------------------------------------------------------------------------------------------------------- -------------------------------------------- ------------------------------------ ----------------------


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 psi b03 plr-145939-14 date june legend x ---------------------------------------- ------------------------------------------ y ------------------------------------------------ -------------------------------- ------------------------------------- state ----------------- date ---------------- date ----------------- date ------------- dear --------------- this letter responds to a letter dated date and subsequent correspondence submitted on behalf of x by its authorized representatives requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations for x to elect to treat y as a qualified_subchapter_s_subsidiary qsub under sec_1361 of the internal_revenue_code code facts plr-145939-14 the information submitted discloses that x was incorporated under the laws of state on date and timely elected to be treated as an s_corporation effective on that same date y was incorporated under the laws of state on date and timely elected to be treated as an s_corporation effective on that same date as of date x acquired all of the stock of y x failed to timely file form_8869 qualified_subchapter_s_subsidiary election law sec_1361 of the code provides that except as provided in regulations prescribed by the secretary for purposes of title_26 a corporation which is a qsub shall not be treated as a separate corporation and all assets liabilities and items of income deduction and credit of a qsub shall be treated as assets liabilities and such items as the case may be of the s_corporation sec_1361 defines the term qualified_subchapter_s_subsidiary as a domestic_corporation which is not an ineligible_corporation as defined in sec_1361 if percent of the stock of the corporation is held by an s_corporation and the s_corporation elects to treat the corporation as a qsub sec_1_1361-3 of the income_tax regulations provides the time and manner of making a qsub election sec_1_1361-3 provides that an s_corporation makes a qsub election with respect to a subsidiary by filing a form_8869 with the appropriate service_center section sec_1_1361-3 provides that a qsub election will be effective on the date specified on the form_8869 or on the date the form is filed if no date is specified the effective date cannot be more than two months and days prior to the date of filing and cannot be more than months after the date of filing sec_1_1361-3 provides that an extension of time to make a qsub election may be available under procedures applicable under sec_301_9100-1 and sec_301_9100-3 sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but not more than months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-2 provides an automatic_extension of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 sec_301_9100-3 provides that requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence including affidavits described in plr-145939-14 sec_301_9100-3 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 conclusion based solely on the facts submitted and the representations made we conclude that x has satisfied the requirements of sec_301_9100-3 with respect to the qsub election for y accordingly x is granted an extension of time of days from the date of this letter to elect to treat y as a qsub effective date the election should be made for y by filing a properly executed form_8869 with the appropriate service_center with a copy of this letter attached except as expressly provided herein we express or imply no opinion concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion as to whether x is a valid s_corporation or whether y is eligible to be a qsub further we express or imply no opinion as to state tax consequences of this ruling this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we are sending a copy of this letter to your authorized representatives the ruling contained in this letter is 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 ruling_request it is subject_to verification on examination sincerely associate chief_counsel passthroughs special industries holly porter branch chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


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 psi b03 plr-114908-09 date date legend x a ----------------------------------------------------------------------------------------------------- ----------------------- ------------------------------------ state ----------- date date ------------------- --------------------- dear ---------------- this letter responds to a letter dated date requesting relief under sec_1362 of the internal_revenue_code facts x was incorporated under the laws of state on date a the sole shareholder of x intended that x elect to be treated as an s_corporation effective date however x’s form_2553 election by a small_business_corporation was not filed timely x represents that both x and its shareholder have reported their income consistent with x’s intended status as an s_corporation x requests a ruling that it will be recognized as an s_corporation effective date plr-114908-09 law and analysis sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation sec_1362 provides that an election under sec_1362 may be made by a small_business_corporation for any taxable_year a at any time during the preceding_taxable_year or b at any time during the taxable_year and on or before the 15th day of the third month of the taxable_year sec_1362 provides that if a a small_business_corporation makes an election under sec_1362 for any taxable_year and b the election is made after the 15th day of the third month of the taxable_year and on or before the 15th day of the third month of the following taxable_year then the election is treated as made for the following taxable_year sec_1362 provides that if a an election under sec_1362 is made for any taxable_year determined without regard to sec_1362 after the date prescribed by sec_1362 for making the election for the taxable_year or no sec_1362 election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make the election the secretary may treat the election as timely made for the taxable_year and sec_1362 shall not apply conclusion based solely on the facts submitted and representations made and provided that x otherwise qualifies as an s_corporation we conclude that x will be treated as an s_corporation effective date within days from the date of this letter x should submit a properly completed form_2553 effective date to the appropriate service_center to replace the protective_election effective date a copy of this letter should be attached to the form_2553 a copy is enclosed for that purpose 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 no opinion is expressed or implied as to whether x is otherwise eligible to be an s_corporation for federal tax purposes this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with a power_of_attorney on file with this office we are sending a copy of this letter to your authorized representative plr-114908-09 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 sincerely s leslie h finlow senior technician reviewer branch passthroughs special industries enclosures a copy of this letter a copy for sec_6110 purposes