internal_revenue_service number release date index number -------------------------------- ----------------------------------- -------------------------------------------- -------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------- id no ------------- telephone number -------------------- refer reply to cc corp plr-129089-07 date date ------------------------- -------------------------------------- legend distributing -------------------------------------------------------------------------------- ----------------------------------------------------------------------------- controlled ------------------------------------------------------------------------------------- ----------------------------------------------------------------------------- distributing common_stock ------------------------------------------------------------------------------------------------------------- controlled common_stock busine sec_1 -------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------ --------------------------------------------------------------- --------------------------------------------------------------- --------------------------- -------------------------------------------------------------- --------------------------------------------------------------------------------------- --------------------------------------------------------------- --------------------------------------------------------------- ----------------------------------------------------- --------------------------------------------------------------- ------------------------------------------ busine sec_2 controlled note -------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- - plr-129089-07 --------------------------------------------------------------- --------------------------------------------------------------- --------------------------------------------------------------- --------------------------- ------------------------------ llc ------------------------------------------------------------------------------------------------- ----------------------- -------------------------------------------------------------- ------ --------------------- ----------------------- ----------------------------------- --------------------------------------------- ------------------------------------------------ state l shareholder a shareholder b shareholder c shareholder d ------------------------------------------------------------------------------------------------------------------ shareholder e date a date b date c date d a b c d w x y z ---------------------------------------- -------------------------- --------------------- -------------------- ------------------- ------------------ ----------------- ----------------- ---------- ----- --- plr-129089-07 dear-------------------------- this letter responds to your letter dated date requesting rulings as to the federal_income_tax consequences of a proposed transaction additional information was submitted on date date date and date the information submitted is summarized below the rulings contained in this letter are based on facts and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party this office has not verified any of the materials submitted in support of the request for rulings verification of the information representations and other data may be required as part of the audit process moreover no information provided by the taxpayer has been reviewed and no determination has been made regarding whether the proposed transaction i satisfies the business_purpose requirement of sec_1_355-2 of the income_tax regulations ii is used principally as a device for the distribution of the earnings_and_profits of the distributing_corporation or the controlled_corporation or both see sec_355 of the internal_revenue_code the code and sec_1_355-2 or iii is part of a plan or series of related transactions pursuant to which one or more persons will acquire directly or indirectly stock representing a fifty percent or greater interest in the distributing_corporation or the controlled_corporation see sec_355 and sec_1_355-7 summary of facts distributing is an accrual basis state l corporation and the common parent of an affiliated_group_of_corporations that files a consolidated federal_income_tax return distributing has a single class of voting common_stock outstanding which is widely held and publicly traded each share of distributing common_stock also evidences one preferred share purchase right to purchase distributing common_stock on the occurrence of certain events involving a change in control of distributing the distributing purchase rights shareholders a b c d and e each own more than five percent of distributing common_stock the institutional investors other than shareholder e no institutional investor has a representative on distributing’s board_of directors controlled has a single class of voting common_stock outstanding each share of controlled common_stock evidences a purchase right similar to the distributing purchase rights the controlled purchase rights prior to date a distributing owned all of the outstanding_stock of controlled distributing conducts busine sec_1 controlled presently conducts busine sec_2 through llc a state l limited_liability_company that is wholly owned by controlled and is disregarded for federal_income_tax purposes financial information has been received plr-129089-07 indicating that each of busine sec_1 and busine sec_2 has had gross_receipts and operating_expenses representative of an active trade_or_business for each of the past years busine sec_1 and busine sec_2 have increasingly competed for the same customers in order to resolve the conflicts that have arisen as a result of the operation of both businesses in the same affiliated_group distributing plans to distribute all of the issued and outstanding shares of controlled common_stock beneficially owned by distributing to holders as of the record_date of the issued and outstanding shares of distributing common_stock the distribution which is intended to improve the business prospects of both businesses depending on market conditions distributing may purchase up to w percent an amount greater than twenty percent of its outstanding shares after the distribution such purchases will be through either open market purchases block purchases accelerated share repurchase transactions a modified dutch auction tender offer or some combination thereof for instance in order to facilitate large stock purchases and to enhance the effectiveness of its stock purchasing program distributing may purchase its shares from an investment or commercial bank broker bank pursuant to an accelerated share repurchase program asr in an asr distributing purchases a specified number of its common shares from broker bank and pays to broker bank an estimated price per share the initial price which is equal to the average price of distributing common_stock on the previous day broker bank obtains the shares delivered to distributing by borrowing shares of distributing common_stock from the stock market in the subsequent weeks the broker bank buys shares on the open market in an amount equal to the number of borrowed shares and returns the shares it borrowed to the initial stock lenders once the purchase program is completed distributing and broker bank true-up to take into account any difference between the initial price when distributing purchased the shares and the average price broker bank paid for the shares over the subsequent weeks to help minimize the exposure to market price fluctuations on the true-up price distributing may enter into an agreement with the broker bank to establish a minimum and maximum price distributing is willing to pay for its share repurchases under such an agreement the true-up cannot exceed certain parameters distributing may also purchase shares through block purchases allowed under rule 10b-18 of the securities exchange act of such purchases may be privately negotiated purchases either directly or through distributing’s broker while the identity of the seller may be known to distributing or its broker all such sales will occur in compliance with the provisions of rule 10b-18 distributing will not make any block purchases of shares from any institutional investor or any shareholder who owns five plr-129089-07 percent or more of the stock in or the securities of distributing at the time of the purchase depending on market conditions controlled may purchase up to x percent an amount that is not greater than twenty percent of its outstanding shares after the distribution through open market purchases the controlled repurchases proposed transaction in accordance with the distribution the following transaction has been proposed and partially consummated i prior to date a controlled distributed the controlled note to distributing on date b a foreign_subsidiary of controlled borrowed a from its credit facilities and distributed the proceeds to controlled on date c controlled used the proceeds from such borrowings to pay b in principal and c in interest on the controlled note using the net_proceeds from the initial_public_offering of its common_stock described in step iii below and available cash controlled fully paid the balance of the controlled note on date d ii prior to date a intercompany notes and accounts_receivable from controlled exclusive of the controlled note were set off against intercompany notes and accounts_payable to controlled with d of net notes and accounts_receivable being distributed as a dividend_in_kind from controlled to distributing iii on date a controlled issued y shares of controlled common_stock to the public in an initial_public_offering as a result of this offering distributing’s percentage ownership of the controlled common_stock decreased to z percent iv distributing will distribute all of the issued and outstanding shares of controlled common_stock beneficially owned by distributing which will represent a number greater than eighty percent of the outstanding shares of the controlled common_stock to holders as of the record_date of the issued and outstanding shares of distributing common_stock the distribution will be by means of a dividend of controlled common_stock to distributing’s shareholders on a pro_rata basis no holder of distributing common_stock will be required to pay any cash or any other consideration for the shares of controlled common_stock to be received in the distribution or to surrender or change shares of distributing common_stock in order to receive shares of controlled common_stock distributing plr-129089-07 shareholders will receive cash in lieu of fractional shares in the distribution distributing and controlled have recently entered into a series of agreements governing the distribution and the relationships between distributing and controlled subsequent to the distribution including the provision of services and providing for the allocation of tax and certain other liabilities and obligations arising from periods prior to the distribution collectively the separation agreements distributing and controlled will have certain other continuing relationships following the distribution all of which will be based on terms and conditions arrived at by the parties bargaining at arms’ length representations the following representations have been made with respect to the distribution a no part of the controlled common_stock to be distributed by distributing to its shareholders will be received by a shareholder as a creditor employee or in any capacity other than that of a shareholder of distributing b the five years of financial information submitted on behalf of busine sec_1 and busine sec_2 is representative of the present operations of busine sec_1 and busine sec_2 and with regard to such businesses there have been no substantial operational changes since the date of the last financial statements submitted c following the transaction distributing and controlled will each continue the active_conduct of its business independently and with its separate employees except for services to be provided by distributing to controlled or vice versa for a transitional period following the distribution pursuant to the separation agreements d the distribution is carried out for the corporate business_purpose of the reducing conflict between franchisees of distributing and franchisees of controlled and eliminating conflict between the managements of distributing and controlled which will improve the business prospects of both brands the distribution is motivated in whole or substantial part by one or more of these corporate business purposes the e the distribution will not be used principally as a device for the distribution of the earnings_and_profits of distributing or controlled or both f the distributing purchase rights and the controlled purchase rights are each of the type described in revrul_90_11 plr-129089-07 g distributing neither accumulated extraordinary payment of its payables in anticipation of the transaction receivables nor made its h no intercorporate debt will exist between distributing and controlled at the time of or subsequent to the distribution except that distributing or its successors may owe controlled or controlled may owe distributing or its successors amounts payable under the separation agreements or in the ordinary course of business any such indebtedness owed by controlled to distributing upon completion of the distribution will not constitute stock_or_securities i immediately before the distribution items of income gain loss deduction and credit will be taken into account as required by the applicable intercompany_transaction regulations see sec_1_1502-13 and sec_1 as in effect before the publication of t d 1995_32_irb_6 and as currently in effect sec_1_1502-13 as published by t d furthermore distributing’s excess_loss_account if any with respect to controlled common_stock or the excess_loss_account that distributing may have in the stock of another member that is required to be taken into account by sec_1_1502-19 will be included in income immediately before the distribution see sec_1_1502-19 j payments made in connection with all continuing transactions if any between distributing and controlled will be based on terms and conditions arrived at by the parties bargaining at arms’ length k no two parties to the transaction are investment companies as defined in sec_368 and iv l the distribution is not part of a plan or series of related transactions within the meaning of sec_1_355-7 pursuant to which one or more persons will acquire directly or indirectly stock representing a fifty percent or greater interest within the meaning of sec_355 in distributing or controlled including any predecessor or successor of any such corporation m to the best knowledge of the management of distributing there is no plan or intention on the part of any particular shareholder of distributing to sell exchange transfer by gift or otherwise dispose_of any stock in or securities of either distributing or controlled after the distribution other than i ordinary market trading ii donations sales or other dispositions by employees officers and directors of distributing or controlled of shares of distributing or controlled including shares obtained upon the exercise plr-129089-07 of stock_options for personal tax planning or personal financial planning reasons and iii sales by institutional investors described hereinafter to the best knowledge of the management of distributing no institutional investor other than shareholder d has any plan or intention to sell exchange transfer by gift or otherwise dispose_of any stock in distributing or controlled after the distribution notwithstanding the forgoing any institutional investor may in the future determine to dispose_of or purchase stock of distributing or controlled in the normal course of its business based upon market conditions and investment needs in existence at that time n there is no plan or intention by controlled directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the transaction other than the through the controlled repurchases o distributing will not make any block purchases of shares after the transaction from any of the institutional shareholders nor will it make any block purchases from any other shareholder who owns five percent or more of the stock in or the securities of distributing at the time of the purchase p the payment of cash in lieu of fractional shares of controlled common_stock is solely for the purpose of avoiding the expense and inconvenience to controlled of issuing fractional shares and does not represent separately bargained for consideration the total cash that will be paid in the distribution to shareholders in lieu of fractional shares of controlled common_stock will not exceed one percent of the total consideration that will be distributed in the distribution the fractional share interests of each distributing shareholder will be aggregated and no distributing shareholder will receive cash in an amount equal to or greater than the value of one full share of controlled common_stock rulings based solely on the information submitted and the representations set forth above we rule as follows no gain_or_loss will be recognized by distributing on the distribution sec_355 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of the shareholders of distributing common_stock on the receipt of the controlled common_stock from distributing sec_355 plr-129089-07 the aggregate basis of the distributing common_stock and the controlled common_stock including fractional interests that will be sold on behalf of such shareholders in the hands of distributing shareholders immediately after the distribution will be the same as the aggregate basis of the distributing common_stock held by such shareholders in proportion to the fair_market_value of each in accordance with sec_1 a sec_358 b and c the distribution allocated immediately prior to the holding_period of the controlled common_stock including fractional interests received by distributing shareholders will include the holding_period of the distributing common_stock with respect to which the distribution was made provided that such distributing common_stock is held as a capital_asset on the date of the distribution sec_1223 any payment of cash in lieu of fractional shares of controlled common_stock will be treated for federal_income_tax purposes as if the fractional shares were issued in the distribution and then were redeemed by controlled the cash payments will be treated as having been received as a distribution in full payment in exchange for the shares redeemed as provided in sec_302 provided the fractional share interest is a capital_asset in the hands of the recipient shareholder the gain_or_loss will constitute capital_gain or loss subject_to the provisions and limitations of subchapter_p of chapter revrul_66_365 1966_2_cb_116 revproc_77_41 c b earnings_and_profits will be allocated between distributing and controlled in accordance with sec_312 sec_1_312-10 and sec_1 e controlled’s distribution of the controlled note to distributing and the in-kind distribution by controlled of the d of net notes and accounts_receivable to distributing will be treated for federal_income_tax purposes as an intercompany distribution to which sec_301 and sec_1_1502-13 apply payments made by distributing to controlled or by controlled to distributing under the separation agreements that i have arisen or will arise for a taxable_period ending on or before the distribution or for a taxable_period beginning before and ending after the distribution and ii will not become fixed and ascertainable until after the distribution will be treated as occurring immediately before the distribution see plr-129089-07 344_us_6 73_sct_71 97_led_6 1952_2_cb_136 revrul_83_73 1983_1_cb_84 caveats no opinion is expressed about the tax treatment of the distribution under other provisions of the code or regulations or the tax treatment of any conditions existing at the time of or effects resulting from the distribution that are not specifically covered by the above rulings in particular no opinion is expressed regarding whether the proposed transaction i satisfies the business_purpose requirement of sec_1_355-2 ii is used principally as a device for the distribution of the earnings_and_profits of the distributing_corporation or the controlled_corporation or both see sec_355 and sec_1_355-2 or iii is part of a plan or series of related transactions pursuant to which one or more persons will acquire directly or indirectly stock representing a fifty percent or greater interest in the distributing_corporation or the controlled_corporation under sec_355 procedural statements this ruling is directed only to the taxpayer that requested it sec_6110 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 instead of attaching a copy of this letter to the returns taxpayers filing their returns electronically may attach a statement to the return that provides the date and control number of the letter_ruling in accordance with the power_of_attorney on file in this office a copy of this ruling letter will be forwarded to your authorized representative sincerely ___________________ michael j wilder senior technician reviewer branch office of associate chief_counsel corporate


t c memo united_states tax_court robert l and brenda j tarter petitioners v commissioner of internal revenue respondent docket no filed date eric johnson for petitioners christian a speck for respondent memorandum findings_of_fact and opinion laro judge petitioners petitioned the court to redetermine respondent’s determination of a income_tax deficiency of dollar_figure a sec_6662 a accuracy-related 1rule references are to the tax_court rules_of_practice and procedure unless otherwise noted section references are to the applicable versions of the internal_revenue_code code penalty of dollar_figure and a sec_6651 addition_to_tax of dollar_figure for failure_to_file timely with regard to the income_tax deficiency we decide whether petitioners’ claimed trade_or_business expense deductions are allowable we hold they are not we also decide whether petitioners are liable for the accuracy-related_penalty we hold that they are petitioners do not dispute that their income_tax return was filed untimely and do not assert that a reasonable basis existed for their late filing we sustain the addition_to_tax without further comment findings_of_fact the parties have filed with the court stipulated facts and exhibits the stipulated facts are found accordingly petitioners are husband and wife and they jointly filed a form_1040 u s individual_income_tax_return they resided in lincoln california when their petition was filed with the court a petitioner’s business history robert tarter petitioner went into business for himself in approximately beginning b b construction b b b b was engaged in the business of preparing and pouring concrete foundations and flatwork for residential projects b b operated as a sole_proprietorship at its inception and was still operating as a sole_proprietorship at the beginning of on date petitioner formed bbt enterprises limited bbt a limited_partnership the partners of bbt were petitioner and b b complex_trust with petitioner having a 1-percent interest and b b complex_trust having a 99-percent interest by at least date b b began to operate as bbt no form_1065 u s return of partnership income was filed for bbt for no form_1041 u s income_tax return for estates and trusts was filed for the b b complex_trust for petitioner reported all claimed income and deductions of the concrete business for as those of a sole_proprietorship on their schedule c profit or loss from business a checking account for bbt d b a b b was opened on date bbt account at that time a checking account existed in the name of b b and petitioners b b account sometime after august or date operating_expenses for the concrete construction business were paid out of the bbt account after date funds represented by checks from the bbt account were not funds that came from the b b account b additional entities on date petitioner set up the entity v e leasing ltd a california limited_partnership v e leasing the partners of v e leasing were petitioner and granite bay complex_trust upon formation of v e leasing petitioner held a 1-percent interest and granite bay complex estate_trust held a 99-percent interest the depreciable vehicles and smaller equipment assets that petitioner used for the concrete construction business were transferred to v e leasing during no form_1065 was filed for v e leasing for also on date petitioner set up the entity b b concrete pumping ltd a california limited_partnership b b concrete pumping the partners of b b concrete pumping were petitioner and granite bay complex_trust upon formation of b b concrete pumping petitioner held a 1-percent interest and granite bay complex estate_trust held a 99-percent interest in b b concrete pumping the bigger more expensive concrete pumps that petitioner used for the concrete construction business were transferred to b b concrete pumping during no form_1065 was filed for b b concrete pumping for c payments to workers beginning in date petitioner began to use a payroll system under which b b’s approximately to employees were leased to an employee_leasing company labor force partners ltd payroll company through this leasing arrangement the payroll company became the primary legal employer of record the individuals who originally presented and promoted the payroll system to petitioner were david clancy and ray vallejo in date petitioner arranged for an all-employee meeting for b b workers at that meeting clancy and vallejo told the employees about the new payroll system petitioner did not recall ever telling the employees they were fired the payroll company did not make any of the decisions regarding the employees for example who would be hired or fired and how much they would be paid or otherwise supervise the day-to-day activities of the workers after the fall of petitioner continued to make all the hiring and firing decisions with respect to employees of the concrete business similarly after the fall of petitioner or supervisors of b b continued to give the day-to-day instructions to employees of the concrete business in general employees were the same individuals performed the same type of work were supervised the same way and were paid the same amounts both before and after petitioner began paying the employees through the payroll company the payroll company set up two payroll accounts with paychex a large processing company pursuant to this new payroll system instead of receiving one paycheck each employee received two the first paycheck covered the minimum wage that state law required the balance due an employee called a dividend payment was paid in a second check from an account under the name of labor force partners trust petitioner did not pay employment_taxes or workers compensation on the portion of the wages greater than the minimum wage shortly after the new payroll system began petitioners’ return preparer shannon perez perez assumed bookkeeping for the concrete business perez also prepared petitioners’ form_1040 that form_1040 was prepared in haste in order for petitioners to satisfy a requirement to close on a new home neither petitioners nor perez thought the return was accurate when prepared and filed and they anticipated its amendment on the form_1040 petitioners reported approximately dollar_figure million in receipts and slightly more in expenses resulting in a net schedule c loss of approximately dollar_figure perez kept track of the expenses of the concrete business by categorizing and entering those expenses into a computer quickbooks data file using bank statements check stubs and canceled checks that petitioner provided to prepare petitioners’ return perez ran reports from the quickbooks database d disallowed deductions petitioners’ form_1040 was selected for audit and respondent in the notice_of_deficiency mailed to petitioners on date determined that petitioner failed to substantiate five categories of expenses on schedule c employee_benefits payroll_taxes outside services rent lease depreciation and sec_179 expense dollar_figure big_number big_number big_number vehicles machinery equipment big_number these disallowed amounts are the amounts that petitioner claimed in the referenced categories on his schedule c e substantiation perez no later than date acknowledged errors in every category of expense claimed on petitioner’s schedule c with the possible exception of depreciation neither perez nor petitioners kept books_and_records of expenses of the concrete business for that reflected the deduction amounts claimed in the categories listed on petitioner’ sec_2001 schedule c f financial statements perez prepared financial statements that she knew were inconsistent with petitioners’ tax_return which she had prepared the financial statements made petitioner’s business look more profitable than it appeared on his schedule c the profit and loss statement purporting to show petitioners’ net_income from the concrete business was intended to be used to obtain a license in nevada and showed dollar_figure more in net_income than the net_income reflected on petitioner’s schedule c g discovery before trial on date respondent served interrogatories on petitioners asking them to list every item claimed as an expense deduction on the schedule c perez prepared petitioners’ responses to those interrogatories for every item except depreciation that respondent disallowed in the notice_of_deficiency petitioners’ interrogatory responses reflected deduction amounts greater than the amounts reported on the schedule c h the seizures on date agents of respondent’s criminal_investigation_division cid executed simultaneous search warrants at petitioner’s business and at the payroll company from date through the trial in this case cid has retained originals or copies of all electronic or paper records seized pursuant to the search warrants at the time of the seizures cid created an inventory of the seized paper documents the seized paper records consist of approximately boxes of materials seized from b b construction and boxes of materials seized from the payroll company opinion the burden_of_proof is on petitioners to show that respondent’s determinations set forth in the notice_of_deficiency are incorrect see rule a see 290_us_111 deductions are strictly a matter of legislative grace and petitioners must show that their claimed deductions are allowed by the code petitioners must also keep sufficient records to substantiate any deduction that would otherwise be allowed by the code see sec_6001 292_us_435 in order to meet their burden_of_proof petitioners must introduce sufficient evidence to make a prima facie case establishing that respondent committed the errors alleged in the petition and overcome the evidence submitted by or otherwise favorable to respondent see lyon v commissioner 1_bta_378 for the burden to shift to respondent petitioners must comply with the substantiation and record-keeping requirements of the code see sec_7491 and b we conclude that the burden_of_proof has not shifted to respondent with respect to any of the issues affecting petitioners’ tax_liability because we find that petitioners failed to comply with substantiation requirements of the code a employee_benefits and payroll_taxes respondent’s notice_of_deficiency disallowed the amounts petitioner claimed on his schedule c for employee_benefits and payroll_taxes dollar_figure and dollar_figure respectively respondent determined that the expenses were disallowed because petitioners did not provide information to support the deductions and did not establish that the expenses were ordinary and necessary respondent argues on brief that petitioners have never established that these costs were not claimed on the schedule c as labor costs under cost_of_goods_sold in support of their benefits and payroll tax deductions petitioners detailed amounts paid to kaiser for medical insurance invoices and amounts paid to the payroll company for disability insurance from the evidence presented it appears that payments were made for medical and disability benefits however these proofs of payment in no way address nor negate respondent’s argument that those items may already be included in petitioner’s schedule c as labor costs under cost_of_goods_sold we sustain respondent’s determination on this issue b outside services respondent’s notice_of_deficiency disallowed the amount petitioner claimed on his schedule c for outside services dollar_figure respondent claims that petitioners did not provide information to support the deductions and that petitioners did not establish that the expenses were ordinary and necessary in support of their outside services deduction petitioners explain on brief that the amount represents legal and engineering fees perez tried to substantiate the expenses for outside services with a list that included several payments to operating engineers perez claimed operating engineers belonged in that category because they provided engineering services or certifications as shown in their invoices however operating engineers was the union for the concrete pump truck operators in the check registers the payments to operating engineers were categorized as subcontractors according to the interrogatory responses items categorized as subcontractors were part of the cost_of_goods_sold although we find it likely that the payments claimed by petitioners were in fact made for legal and engineering costs those fees may already be included in petitioner’s schedule c as a part of cost_of_goods_sold also to the extent that those fees were for services performed for bbt and not b b they are not deductible by petitioners petitioners provide no information on those components that make up the cost_of_goods_sold amount claimed on the schedule c nor do they distinguish fees paid_by b b from those paid_by bbt in the light of this absence of evidence the credible_evidence in the record does not permit us to find that the outside services deduction is supportable as an independent schedule c deduction 2for example a fee for legal services dated date is directed to bbt enterprises dba b b construction indicating that bbt had already set itself forth as a business_entity by that date c rent lease vehicles machinery equipment respondent’s notice_of_deficiency disallowed the amount petitioner claimed on his schedule c for renting or leasing of vehicles machinery and equipment dollar_figure the notice_of_deficiency stated that this cost was disallowed because petitioners did not provide information to support the deductions and did not establish that the expenses were ordinary and necessary petitioners support this deduction with a stipulation listing checks and a record of check stubs we note that the checks paid from the beginning of the year through date were paid out of the b b account while the checks paid after that date were paid out of the bbt account all checks dated from date through the end of were issued from the bbt account bbt did not file a form_1065 for nor did b b complex_trust the 99-percent partner of bbt file a form_1041 for petitioner cannot claim a deduction on his schedule c for the rent lease of vehicles machinery and equipment if those expenses were in fact incurred by bbt in the light of all the evidence we hold that the deductions on schedule c are limited to only those expenses stipulated by the parties to have been paid out of the b b account d depreciation respondent’s notice_of_deficiency disallowed the amount claimed on schedule c for depreciation dollar_figure the notice stated that the depreciation was disallowed because petitioners did not provide information to support the deductions and did not establish that the expense was ordinary and necessary in support of the depreciation expense petitioners offer a one-page depreciation schedule that includes the bases of certain stated assets the method_of_depreciation and the deprecation claimed sec_167 allows a deduction for a reasonable allowance for the exhaustion wear_and_tear and obsolescence of property used in a trade_or_business or held_for_the_production_of_income the basis on which a depreciation deduction is allowable with respect to any property under sec_167 is the adjusted_basis of the property determined under sec_1011 for the purpose of determining gain on the sale_or_other_disposition of the property see sec_167 petitioners’ depreciation schedule lacks an essential piece of information the owner of the assets for possible asset owners include petitioners bbt v e leasing b b concrete pumping or perhaps one of the partners of one of these partnerships and it is certainly possible if not likely that ownership of the itemized assets changed throughout although we are satisfied that a concrete business would have depreciable assets we cannot find evidence in the record by which we can determine the amount of the depreciation expense for petitioner’s schedule c therefore we sustain respondent’s determination with respect to depreciation e accuracy-related_penalty respondent determined that petitioners are liable for an accuracy-related_penalty under sec_6662 sec_6662 imposes an accuracy-related_penalty equal to percent of the portion of an underpayment that is attributable to among other things negligence petitioners will avoid this penalty if the record shows that they were not negligent ie they made a reasonable attempt to comply with the provisions of the code and they were not careless reckless or in intentional disregard of rules or regulations see sec_6662 243_f3d_1212 10th cir affg leema enters inc v commissioner tcmemo_1999_18 negligence connotes a lack of due care or failure to do what a reasonable and prudent person would do under the circumstances see 92_tc_1 affd 925_f2d_348 9th cir an 3as noted above on date cid agents executed simultaneous search warrants at petitioner’s business and the payroll company and respondent has remained in possession of those materials through the date of trial the record does not provide support that this circumstance impaired petitioners’ preparations for and offering of evidence at trial in fact after this case was set for trial respondent moved for continuance but petitioners opposed that motion and the request for continuance was denied further perez testified that the information she had used to prepare petitioner’s schedule c came from the quickbooks accounting system that she used and that she had been able to restore that information from quickbooks files backups that had not been seized accuracy-related_penalty is not applicable to any portion of an underpayment to the extent that a taxpayer has reasonable_cause for that portion and acts in good_faith with respect thereto see sec_6664 respondent bears the burden of production with respect to the accuracy-related_penalty sec_7491 to meet this burden of production respondent must produce sufficient evidence that it is appropriate to impose an accuracy-related_penalty once respondent has produced sufficient evidence the burden_of_proof is upon petitioners see 116_tc_438 petitioners may carry their burden by proving that with respect to their underpayment there existed reasonable_cause and they acted in good_faith sec_6664 respondent has satisfied the burden of production in that the record establishes that petitioners failed to substantiate their claimed deductions sec_6001 imposes on petitioners a duty to maintain books_and_records sufficient to support items reported on their returns and petitioners’ breach of that duty is contrary to what a prudent and responsible taxpayer would have done under the circumstances see sec_1_6662-3 income_tax regs further petitioners have failed to persuade us that their failure to maintain the requisite substantiation was excused by reasonable_cause and good_faith therefore we sustain respondent’s determination that petitioners are liable for the accuracy-related_penalty under sec_6662 we have considered all arguments by petitioners for holdings contrary to those which we reach herein to the extent not discussed we conclude that those arguments are irrelevant or without merit decision will be entered under rule


t c summary opinion united_states tax_court michael paquin and kathy thomas-paquin petitioners v commissioner of internal revenue respondent docket no 25886-08s filed date michael paquin and kathy thomas-paquin pro sese wesley j wong for respondent marvel judge this case was heard pursuant to the provisions of section of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court 1unless otherwise indicated all section references are to the internal_revenue_code as amended in effect for the relevant period and all rule references are to the tax_court rules_of_practice and procedure and this opinion shall not be treated as precedent for any other case respondent determined deficiencies in petitioners’ federal income taxes of dollar_figure and dollar_figure and accuracy-related_penalties under sec_6662 of dollar_figure and dollar_figure for and respectively after concessions the issues for decision are whether petitioners’ motocross racing activity was an activity_not_engaged_in_for_profit in and within the meaning of sec_183 and whether petitioners are liable for the sec_6662 accuracy-related_penalties for and background some of the facts have been stipulated the stipulation of facts is incorporated herein by this reference petitioners michael paquin mr paquin and kathy thomas-paquin mrs thomas- paquin are married individuals who filed joint federal_income_tax returns for and petitioners resided in nevada when they filed their petition 2all monetary figures have been rounded to the nearest dollar 3respondent concedes that the expenses claimed on petitioners’ and schedules c profit or loss from business were actually incurred and were related to petitioners’ motocross racing activity the remaining adjustments are computational in nature mr paquin was employed full time in and as a project superintendent for q d construction and he worked on average more than hours per week mrs thomas-paquin was employed full time in and as an operations manager for united rentals and she worked hours per week with occasional overtime petitioners reported wage income of dollar_figure and dollar_figure for and respectively mr paquin is an avid fan of motocross motorcycle racing in mr paquin became interested in starting a motocross racing business and he discussed the idea with mrs thomas- paquin although neither petitioner had any experience in motocross racing or the business of motocross racing petitioners agreed to give the idea a try petitioners did not intend to personally compete in motocross races but instead planned to sponsor other riders--including mr paquin’s son mp petitioners’ decision to sponsor mp was not based on mp’s skill at motocross racing or even his interest in the sport indeed mp initially was reluctant to compete mr paquin also identified more experienced riders who were unrelated to petitioners and invited them to join his racing team mr paquin did not hold formal tryouts or auditions 4it is the policy of the court not to identify minor children accordingly we shall refer to mr paquin’s son as mp see rule a mp is mr paquin’s son from a previous marriage instead he approached riders who performed well at motocross events he attended and who had in his words the right attitude in addition to mp petitioners sponsored two riders in and tony merrell mr merrell and dee wade mr wade both of whom were years old in mr merrell and mr wade were friendly with mp but they were not close friends because of the age difference petitioners briefly sponsored a third rider cz but stopped sponsoring him when they concluded he did not have the skill or dedication to succeed at motocross petitioners made the following oral agreement with each of the unrelated riders6 they sponsored petitioners would pay the riders’ race entry fees maintain their motorcycles and transport them to and from motocross events in exchange for percent of the riders’ winnings at the amateur level mr paquin told the riders that he expected to recover his investment in them if and when the riders became professionals but 5it is not clear from the record whether cz is a minor child or an adult out of caution we shall refer to him by his initials 6it is not clear whether the same terms applied to mp 7as amateurs the riders’ winnings were limited to racing equipment and gift certificates some of which were redeemable for cash when a rider received racing equipment or a gift certificate that was redeemable for racing equipment petitioners did not attempt to divide the equipment but instead allowed the rider to keep it petitioners did not reach an agreement with any of the riders concerning petitioners’ share of the riders’ earnings as professionals motocross races are conducted at the amateur and professional levels all riders must begin as amateurs and may improve their amateur classification8 by competing and excelling in motocross races to compete at the professional level a rider must be at least years old must have attained the highest amateur class and must have accumulated a certain number of additional points on the basis of the rider’s performance in motocross events amateur riders may earn trophies and gift certificates some of which are redeemable for cash but amateur riders are generally ineligible for cash awards to be eligible for cash prizes a rider generally must compete at the professional level 8motocross racing organizations generally classify amateur riders on the basis of their skill and experience for example in and the american motorcyclist association ama classified amateur riders as a the highest class b the class below a or c the class below b while the sierra motocross racing association smra at least in classified riders as beginner junior or intermediate the smra’s and rulebooks are not in the record 9the and ama rulebooks define amateur riders as riders not competing for cash awards but state inconsistently that class a amateur riders may compete for money or certificates that may be exchanged for money up to a total purse of dollar_figure the record reflects that petitioners’ riders rarely if ever competed for cash prizes in and the ama rulebooks for and provide that the minimum purse for a motocross pro am event shall be dollar_figure it is virtually impossible for an amateur rider to make a profit at motocross--indeed petitioners admit that even if their riders had won every race they entered in and petitioners still would have lost money on the activity a professional rider however can earn a profit through a combination of cash prizes and corporate sponsorships all of the riders on petitioners’ team were amateurs in and and no rider was close to achieving professional statusdollar_figure petitioners observed few business formalities in the motocross racing activity petitioners did not prepare a written business plan did not create a separate_entity for the activity did not investigate whether they needed a business license and did not open a separate checking account petitioners paid motocross racing expenses from their personal accounts petitioners maintained some records of their motocross-related 10the recommended payout structure for riders calls for the first-place rider to take percent of the purse the second-place rider percent the third-place rider percent and so on with as many as riders sharing in the purse for a particular race professional motocross riders can also earn money for themselves and their teams by attracting corporate sponsors 11at the end of mp was not yet years old mr merrell was about halfway through the process of becoming a professional and mr wade was slightly more than halfway through the process of becoming a professional petitioners had only a rough idea of how close any rider was to becoming a professional activities and expenses but the records are incomplete for example petitioners deducted dollar_figure for race entry fees in but mr paquin testified that the actual entry fees were much greater than dollar_figure petitioners also failed to keep track of how much money they spent on gas to drive to and from motocross races in mr paquin estimated that he spent on average hours per week on the motocross racing activity during the years at issue mr paquin pursued the activity in his spare time while continuing to work full time at q d construction throughout and mrs thomas-paquin’s role in the activity was more limited although she sometimes attended motocross practices and races her primary role was to maintain the activity’s books_and_records it is not clear how much time mrs thomas-paquin who was employed full time during and devoted to the motocross activity petitioners reported the following income and deducted the following expenses with respect to the motocross racing activity on their and schedules c profit or loss from business income gross_receipts or sale sec_1 expenses advertising car and truck expenses contract labor depreciation and sec_179 expense insurance other than health interest office expenses repairs and maintenance supplies travel deductible meals other expense sec_2 total expenses net_profit_or_loss dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1petitioners’ schedule c income in and is attributable to gift certificates awarded on the basis of the riders’ performance in motocross races 2petitioners’ other expenses included dollar_figure and dollar_figure for entry fees dollar_figure and dollar_figure for fuel dollar_figure and dollar_figure for phone expenses dollar_figure and dollar_figure for small equipment and dollar_figure and dollar_figure for safety clothing in and respectively petitioners’ and federal_income_tax returns were prepared by a professional tax_return_preparer return preparer petitioners have used the same return preparer since dollar_figure mrs thomas-paquin provided receipts for the return preparer to use in preparing petitioners’ and schedules c before signing petitioners’ return mrs thomas-paquin called the 12the record does not establish whether the return preparer was a certified_public_accountant return preparer to ask questions mr paquin signed the and returns without carefully reviewing them as of the date of trial petitioners continued to sponsor mp’s motocross racing activities but were no longer sponsoring any other riders petitioners stopped sponsoring mr merrell and mr wade in because the riders apparently lost interest in motocross racing none of petitioners’ riders including mp had achieved professional status as of the date of trial on date respondent issued a notice_of_deficiency that treated petitioners’ income from the motocross racing activity in and as other income disallowed the net operating losses claimed with respect to the motocross racing activity and imposed an accuracy-related_penalty under sec_6662 for each of the years and petitioners timely filed a petition in this court discussion i burden_of_proof generally the commissioner’s determination_of_a_deficiency is presumed correct and the taxpayer bears the burden of proving the determination is erroneous rule a 290_us_111 if however the taxpayer presents credible_evidence with respect to any factual issue relevant to determining the taxpayer’s liability sec_7491 shifts the burden_of_proof to the commissioner but only if the taxpayer has complied with the requirements of the internal_revenue_code to substantiate items has maintained all required records and has complied with all reasonable requests by the commissioner for witnesses documents information and meetings sec_7491 petitioners do not contend that sec_7491 applies and the record does not permit us to conclude that petitioners have satisfied the requirements of sec_7491 accordingly petitioners bear the burden of proving they were entitled to deduct the net operating losses from their motocross racing activity for and ii petitioners’ motocross activity respondent contends that the losses from petitioners’ motocross racing for and are not deductible because the activity was not engaged in for profit within the meaning of sec_183 sec_183 disallows deductions attributable to an activity_not_engaged_in_for_profit except as provided in sec_183 sec_183 allows deductions that would be allowable without regard to whether or not such activity is engaged in for profit sec_183 and a deduction equal to the amount of the deduction that would be allowable if the activity were engaged in for profit but only to the extent that the gross_income from the activity for the taxable_year exceeds the deductions allowable under sec_183 sec_183 see also eg 91_tc_686 affd 893_f2d_656 4th cir sec_183 defines an activity_not_engaged_in_for_profit as any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 sec_162 allows a taxpayer to deduct all ordinary and necessary business_expenses paid_or_incurred during the taxable_year in carrying_on_a_trade_or_business sec_212 and allows a taxpayer to deduct all ordinary and necessary expenses paid_or_incurred during the taxable_year for the production_or_collection_of_income or for the management_conservation_or_maintenance_of_property_held_for_the_production_of_income the u s court_of_appeals for the ninth circuit has held that an activity is engaged in for profit if the taxpayer’s predominant primary or principal objective in engaging in the activity is to realize an economic profit independent of tax savingsdollar_figure 4_f3d_709 9th cir affg tcmemo_1991_212 whether a taxpayer is engaged 13although this case was tried as a small_tax_case subject_to sec_7463 and is not appealable this court generally applies the law of the circuit to which an appeal would normally lie if the case were appealable cf 54_tc_742 affd 445_f2d_985 10th cir but for the provisions of sec_7463 the decision in this case would be appealable to the u s court_of_appeals for the ninth circuit see sec_7482 in an activity for the primary purpose of making a profit is a question of fact 72_tc_411 affd without published opinion 647_f2d_170 9th cir see also synnestvedt v commissioner tcmemo_1987_31 motocross racing activity involving taxpayers’ son was an activity_not_engaged_in_for_profit within the meaning of sec_183 the taxpayer’s objective of making a profit need not be reasonable but must be actual and honest 78_tc_642 affd without published opinion 702_f2d_1205 d c cir golanty v commissioner supra pincite sec_1_183-2 income_tax regs in determining whether a taxpayer had a bona_fide profit objective greater weight is given to objective facts than to the taxpayer’s statement of intent dreicer v commissioner supra pincite sec_1_183-2 income_tax regs sec_1_183-2 income_tax regs sets forth a nonexclusive list of factors that should normally be considered in determining whether a taxpayer has the required profit objective with respect to an activity the manner in which the taxpayer carries on the activity the expertise of the taxpayer or his advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer’s history of income or losses with respect to the activity the amount of occasional profits if any which are earned the financial status of the taxpayer and elements of personal pleasure or recreation no single factor is determinative and the determination should not be made solely because the number of factors indicating a lack of profit objective exceeds the number of factors indicating a profit objective or vice versa golanty v commissioner supra pincite sec_1_183-2 income_tax regs rather all facts and circumstances with respect to the activity must be taken into account sec_1_183-2 income_tax regs all nine factors do not necessarily apply in every case green v commissioner tcmemo_1989_436 see also akelis v commissioner tcmemo_1989_182 a manner in which the taxpayer carries on the activity the fact that a taxpayer conducts an activity in a businesslike manner and maintains complete and accurate books_and_records may indicate the activity is engaged in for profit sec_1_183-2 income_tax regs see stephens v commissioner tcmemo_1990_376 taxpayer operated his horse breeding activity in a businesslike manner where he entered into formal written contracts with stallion owners but see synnestvedt v commissioner supra taxpayers’ use of a separate checking account to pay their son’s motocross racing expenses was insufficient to establish a businesslike manner of operation similarly a change in operating methods or abandonment of unprofitable methods may indicate that the taxpayer has the requisite profit objective sec_1_183-2 income_tax regs petitioners did not carry on the motocross racing activity in a businesslike manner petitioners did not prepare a written business plan did not create a separate legal entity did not investigate whether they needed a business license did not open a separate checking account and did not maintain complete and accurate books_and_records moreover petitioners did not carefully evaluate their riders’ skills before inviting them to join the team--indeed one of the riders was mr paquin’s son who petitioners admit had no particular skill in motocross racing most troubling of all petitioners never reached agreements with the unrelated riders regarding petitioners’ share of any income the riders might earn as professionals absent such an agreement it is difficult to imagine how petitioners could have ever earned a profit from the motocross racing activity this factor strongly favors respondent b the expertise of the taxpayer or his advisers preparation for an activity by extensive study of its accepted business economic and scientific practices or consultation with experts in such practices may indicate the activity is engaged in for profit sec_1_183-2 income_tax regs in analyzing this factor a distinction must be drawn between expertise in the mechanics of an activity and expertise in the business practices of the activity zidar v commissioner tcmemo_2001_200 citing 809_f2d_355 7th cir affg t c memo in zidar v commissioner supra we held that a taxpayer’s stock car racing activity was an activity_not_engaged_in_for_profit where the taxpayer had a longstanding interest in stock car racing but no expertise in the economics or business of owning a stock car the facts of this case are analogous mr paquin had a longstanding interest in motocross racing but there is no evidence that petitioners studied or understood the accepted business practices of motocross racing or consulted experts in the field petitioners’ lack of knowledge and expertise was evident from their testimony petitioners were uncertain how an amateur motocross rider becomes a professional and had only a general idea how close any of their riders were to achieving professional status this factor strongly favors respondent c the time and effort expended by the taxpayer in carrying on the activity the time and effort devoted to an activity may indicate that the activity is engaged in for profit particularly where the activity does not have a substantial personal or recreational aspect sec_1_183-2 income_tax regs see also sousa v commissioner tcmemo_1989_581 amount of time spent on a fishing and boating activity not necessarily indicative of profit objective where taxpayer derived great personal pleasure from the activity a taxpayer’s withdrawal from another occupation to devote most of his time to the activity may also indicate that the activity is engaged in for profit sec_1_183-2 income_tax regs although mr paquin devoted a substantial amount of his spare time to the motocross racing activity in and the record reflects that mr paquin derived a great deal of personal pleasure from the activity accordingly the amount of time mr paquin spent on the activity is not necessarily indicative of a profit objective this factor is neutral d expectation that assets used in activity may appreciate in value petitioners concede that they had no expectation that any of the assets used in the motocross racing activity would appreciate in valuedollar_figure this factor does not apply 14in at least two prior cases we have considered whether a motocross racing activity was an activity_not_engaged_in_for_profit within the meaning of sec_183 see mccarthy v commissioner tcmemo_1997_436 vacated and remanded without published opinion 164_f3d_618 2d cir synnestvedt v commissioner tcmemo_1987_31 we did not discuss in either case whether the taxpayer expected the assets used in the business to appreciate in value e the success of the taxpayer in carrying on other similar or dissimilar activities even if an activity is presently unprofitable the fact that the taxpayer has previously converted a similar activity from unprofitable to profitable status may indicate the activity is engaged in for profit helmick v commissioner tcmemo_2009_ sec_1_183-2 income_tax regs on the other hand the taxpayer’s lack of prior experience does not necessarily indicate that the activity was not engaged in for profit pirnia v commissioner tcmemo_1989_627 citing sec_1_183-2 income_tax regs petitioners had no prior experience in motocross racing or the business of motocross racing before engaging in the activity this factor does not apply f the taxpayer’s history of income or losses with respect to the activity a taxpayer’s history of income or loss with respect to an activity may indicate the presence or absence of a profit objective sec_1_183-2 income_tax regs see also golanty v commissioner t c pincite a series of losses during the startup phase of an activity does not necessarily indicate the activity is not engaged in for profit sec_1 b income_tax regs but where losses continue to be sustained beyond the customary startup_period that may be an indication the activity is not engaged in for profit id petitioners reported net losses from the motocross racing activity of dollar_figure and dollar_figure in and respectively and have never earned a profit from the activity petitioners suggest however that the activity was still in its startup phase during the years at issue and imply that the limited history of losses should not count against them petitioners presented no evidence regarding the customary startup_period in the motocross racing industry moreover petitioners continued to sponsor mr merrell and mr wade until when mr merrell and mr wade stopped racing for personal reasons and continued to sponsor mp as of the trial datedollar_figure petitioners’ continued investment in the motocross racing activity despite substantial losses suggests the activity was not carried on for profit this factor favors respondent g the amount of occasional profits if any which are earned the amount of occasional profits if any in relation to the amount of losses and in relation to the taxpayer’s investment may indicate the presence or absence of a profit objective sec_1_183-2 income_tax regs see also harston v commissioner tcmemo_1990_538 affd without published opinion 936_f2d_570 5th cir an opportunity to earn a substantial profit in a speculative venture is ordinarily 15the record does not establish whether petitioners continued to deduct motocross racing expenses after sufficient to demonstrate that the activity is engaged in for profit sec_1_183-2 income_tax regs petitioners’ motocross racing activity generated negligible gross income--dollar_figure in and dollar_figure in 2006--relative to the expenses_incurred petitioners testified that they hoped to recover their investment and earn a substantial ultimate profit when their riders became professionals however petitioners had no agreements with their riders concerning petitioners’ share of any prize or sponsorship money the riders might one day earn as professionals absent such an agreement petitioners’ likelihood of earning a profit from the activity was not merely speculative but nonexistent this factor favors respondent h the financial status of the taxpayer the fact that the taxpayer has substantial income from sources other than the activity may indicate the activity is not engaged in for profit particularly if losses from the activity generate tax benefits sec_1_183-2 income_tax regs conversely the fact that the taxpayer does not have substantial income from other sources may indicate the activity is engaged in for profit id petitioners earned wage income of dollar_figure and dollar_figure in and respectively by deducting the losses associated with motocross racing petitioners were effectively able to shelter dollar_figure and dollar_figure of their income from tax in and respectively this factor favors respondent i elements of personal pleasure or recreation personal motives for carrying on an activity may indicate the activity is not engaged in for profit especially where there are recreational or personal elements involved sec_1 b income_tax regs however the mere fact that the taxpayer derives personal pleasure from an activity does not establish that the activity is not engaged in for profit if the activity is in fact engaged in for profit as evidenced by other factors id petitioners--particularly mr paquin--derived significant personal pleasure and recreation from the motocross racing activity none of the other factors discussed above indicate that petitioners’ motocross racing activity was in fact engaged in for profit this factor strongly favors respondent j summary of the nine factors listed in sec_1_183-2 income_tax regs six support the conclusion that petitioners’ motocross racing activity was an activity_not_engaged_in_for_profit in and one is neutral and two are not applicable accordingly we sustain respondent’s determination that petitioners’ motocross racing activity was an activity_not_engaged_in_for_profit within the meaning of sec_183 iii accuracy-related_penalty sec_6662 imposes a 20-percent penalty on any portion of an underpayment_of_tax required to be shown on a return the penalty applies to any portion of an underpayment that is attributable to inter alia negligence or disregard of rules or regulations sec_6662 or any substantial_understatement_of_income_tax sec_6662 for purposes of sec_6662 negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code and disregard includes any careless reckless or intentional disregard sec_6662 sec_1_6662-3 income_tax regs provides that negligence includes any failure to exercise ordinary and reasonable care in the preparation of a tax_return but does not include a return position that has a reasonable basis reasonable basis is a relatively high standard that is not satisfied by a return position that is merely arguable sec_1_6662-3 income_tax regs for a taxpayer other than a c_corporation a substantial_understatement is any understatement that exceeds percent of the tax required to be shown on the return for the taxable_year or dollar_figure whichever is greater sec_6662 the commissioner has the burden of production in any court_proceeding with respect to any penalty or addition_to_tax sec_7491 to meet his burden the commissioner must come forward with sufficient evidence that it is appropriate to impose the penalty or addition_to_tax but is not required to produce evidence relating to reasonable_cause or other defensesdollar_figure 127_tc_200 affd 521_f3d_1289 10th cir 118_tc_358 116_tc_438 once the commissioner has satisfied his burden of production the taxpayer bears the burden of proving that the commissioner’s determination to impose the penalty or addition_to_tax is incorrect higbee v commissioner supra pincite respondent satisfied his burden of production under sec_7491 by showing that the understatements of tax for and exceeded the greater of percent of the amount required to be shown on petitioners’ returns or dollar_figure thus petitioners must prove that the commissioner’s determination to impose the 16the commissioner’s obligation under sec_7491 is conditioned on the taxpayer assigning error to such penalty or addition_to_tax 127_tc_200 affd 521_f3d_1289 10th cir 118_tc_358 if the taxpayer fails to assign error to the penalty or addition_to_tax the taxpayer is deemed to have conceded the issue under rule b respondent contends that petitioners conceded the sec_6662 penalties because they did not assign error to the penalties in their petition we disagree although petitioners failed to assign error to the sec_6662 penalties in their petition they raised the issue at trial by offering testimony regarding the preparation of their and federal_income_tax returns and respondent did not object we therefore conclude the issue was tried by consent of the parties and is properly before the court see rule b sec_6662 penalties is inappropriate petitioners contend that the penalties are inappropriate because they had reasonable_cause for the understatements and acted in good_faith specifically petitioners argue that they relied on their return preparer to prepare their and federal_income_tax returns sec_6664 provides that the sec_6662 penalty shall not apply to any portion of an underpayment if it is shown that there was reasonable_cause for such portion and the taxpayer acted in good_faith whether a taxpayer acted with reasonable_cause and in good_faith is determined on a case-by-case basis taking into account all relevant facts and circumstances including the taxpayer’s experience knowledge and education sec_1_6664-4 income_tax regs generally the most important fact is the taxpayer’s effort to assess the proper liability id reliance on a tax professional may demonstrate that the taxpayer had reasonable_cause and acted in good_faith where the taxpayer establishes that the adviser was a competent professional with sufficient expertise to justify the taxpayer’s reliance the taxpayer provided the adviser with necessary and accurate information and the taxpayer actually relied in good_faith on the adviser’s judgment 133_tc_112 115_tc_457 113_tc_135 petitioners have not established that their reliance on their return preparer was reasonable or in good_faith first petitioners presented no evidence with respect to their return preparer’s experience or qualifications mrs thomas-paquin testified that she was uncertain of the return preparer’s qualifications or whether the return preparer was a certified_public_accountant second petitioners have not established that they provided necessary and accurate information to the return preparer mrs thomas-paquin testified that she discussed the motocross racing activity with the return preparer and provided her with all of the receipts from the business when she was asked specifically what she discussed with the return preparer however mrs thomas-paquin testified inconsistently that it was mr paquin who spoke with the return preparer petitioners presented no evidence regarding what if anything mr paquin discussed with the return preparer finally petitioners have not established that they actually relied in good_faith on the return preparer’s judgment on the contrary mrs thomas-paquin testified inconsistently with respect to her conversations with the return preparer and mr paquin testified that he simply signed the and returns without carefully reviewing them we therefore sustain respondent’s determination that petitioners are liable for the sec_6662 penalties for and iv conclusion on the basis of the foregoing we conclude that petitioners’ motocross racing activity was an activity_not_engaged_in_for_profit in and within the meaning of sec_183 and that petitioners were not entitled to deduct expenses associated with the activity except to the extent of their gross_income from motocross racing in and we further conclude that petitioners are liable for the sec_6662 accuracy- related penalties because it does not appear that respondent in computing the and deficiencies allowed petitioners to deduct expenses associated with the activity to the extent of the gross_income derived from the activity as provided by sec_183 a rule computation is necessary we have considered the parties’ remaining arguments and to the extent not discussed above conclude those arguments are irrelevant moot or without meritdollar_figure 17petitioners argued in their petition and at trial that the auditor who reviewed their case made various substantive and procedural errors we need not address this argument however because it is well established that a trial in the tax_court is a proceeding de novo and our determination must be based on the merits of the case and not on any previous record developed at the administrative level 62_tc_324 to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury index number washington dc number release date in re person to contact telephone number refer reply to cc ebeo plr-119826-99 date date legend dear w x y z retirement make-up plan thrift make-up plan industry date ruling a ruling b ruling c portion this is in reply to your request for a ruling concerning whether the nonqualified pension plans maintained for the benefit of employees of x and z constitute exempt governmental deferred_compensation plans for purposes of sec_3121 and sec_3121 of the internal_revenue_code the code facts x and z are each an integral part of w y is included in z x and z are exempt from federal_income_tax under sec_501 of the code as corporation s organized under act of congress which are instrumentalit ies of the united_states x and z jointly sponsor the following employee retirement plans for the benefit of their employees the retirement_plan for employees of w the retirement_plan the thrift_plan for employees of w the thrift_plan the retirement make-up plan for employees of w the retirement make-up plan the thrift make-up plan for employees of w the thrift make-up plan retirement make-up plan the retirement_plan is a tax-qualified defined benefit pension_plan the retirement make-up plan is an unfunded nonqualified defined benefit pension_plan established by x and z for the benefit of their employees whose benefits under the retirement_plan are limited by the application of sec_401 and or of the code generally the retirement make-up plan provides eligible participants and their beneficiaries with supplemental retirement and ancillary death_benefits equal to the difference between the benefits they are entitled to under the retirement_plan and the benefits they would have been entitled to under the retirement_plan if not for the application of sec_401 and sec_415 of the code benefits under the retirement make-up plan accrue and vest at the same time as the corresponding benefits under the retirement_plan benefits under the retirement make-up plan are not payable to a participant or his or her beneficiary prior to such participant’s retirement under the retirement_plan or death if earlier thrift make-up plan the thrift_plan is a tax-qualified defined_contribution_plan the thrift make-up plan is an unfunded nonqualified defined_contribution_plan established by x and z for the benefit of their employees whose matching_contributions under the thrift_plan are limited by application of sec_401 of the code generally the thrift make-up plan provides that a book account will be established for each thrift_plan participant whose employer_matching_contribution under the thrift_plan is limited by application of sec_401 of the code a participant’s thrift make-up plan account will be credited each month with an amount equal to the difference between the employer_matching_contribution such participant is credited with under the thrift_plan for that month and the employer_matching_contribution such participant would have been credited with under the thrift_plan for that month if not for the application of sec_401 of the code the participant’s thrift make-up plan account is thereafter credited with earnings at a rate of return equal to the rate of return for the thrift_plan investments elected by the participant with respect to such participant’s employer_matching_contribution account for the same period amounts credited to a particpant’s thrift make-up plan account vest at the same time as the corresponding employer matching_contributions under the thrift_plan a participant’s thrift make-up plan account balance is not payable to a participant until after the participant terminates employment sec_401 of the code provides limitations on compensation that may be taken into account under a qualified_plan sec_415 of the code provides dollar limitations on benefits_and_contributions under a qualified_plan your request for a ruling concerns only the retirement make-up plan and the thrift make-up plan specifically you have requested a ruling that the retirement make-up plan and thrift make-up plan are exempt governmental deferred_compensation plans within the meaning of sec_3121 of the code and accordingly payments to or on behalf of a participant under such plans are not wages for purposes of employment_taxes under the federal_insurance_contributions_act fica and the federal_unemployment_tax_act futa law sec_3121 of the code provides for purposes of fica that the term wages means all remuneration for employment unless specifically excepted sec_3121 of the code provides that the term wages does not include any payment made to or on behalf of an employee or his beneficiary under or to an exempt_governmental_deferred_compensation_plan as defined in sec_3121 of the code sec_3121 of the code defines an exempt_governmental_deferred_compensation_plan as any plan providing for deferral of compensation established and maintained for its employees by the united_states by a state or political_subdivision thereof or by an agency_or_instrumentality of any of the foregoing such term shall not include - any plan to which code sec_83 sec_402 sec_403 sec_457 or sec_457 applies any annuity_contract described in code sec_403 and the thrift_savings_fund within the meaning of subchapter iii of chapter of title united_states_code none of the following code sections apply to the retirement make-up plan and the thrift make-up plan sec_83 sec_402 sec_403 sec_457 sec_457 or sec_403 neither plan is the thrift_savings_fund within the meaning of subchapter iii of chapter of title united_states_code code sec_457 and sec_457 apply only to deferred_compensation plans of an eligible_employer code sec_457 includes within the definition of eligible_employer a state political_subdivision of a state and any agency_or_instrumentality of a state or political_subdivision of a state and any other organization other than a governmental_unit exempt from tax under this subtitle because x and z are governmental units but not of a state or political_subdivision of a state they are not eligible employers and neither sec_457 nor sec_457 applies in addition neither the retirement make-up plan nor the thrift make-up plan is a qualified_governmental_excess_benefit_arrangement described in sec_415 of the code therefore this ruling should not be interpreted to suggest any answer on the issue of whether a plan under sec_457 sec_457 or sec_415 maintained by a state_or_local_government is subject_to fica sec_3121 provides special timing rules for the application of fica to nonqualified_deferred_compensation_plans however sec_3121 does not apply to amounts that are excluded from wages for fica purposes see sec_31 v - a v sec_31_3121_v_2_-1 of the employment_tax regulations states that a plan provides for the deferral of compensation with respect to an employee only if under the terms of the plan and the relevant facts and circumstances the employee has a legally binding right during a calendar_year to compensation that has not been actually or constructively received and that pursuant to the terms of the plan is payable to or on behalf of the employee in a later year an employee does not have a legally binding right to compensation if that compensation may be unilaterally reduced or eliminated by the employer after the service creating the right to the compensation has been performed for this purpose compensation is not considered subject_to unilateral reduction or elimination merely because it may be reduced or eliminated by operation of the objective terms of the plan and an employee does not fail to have a legally binding right to compensation merely because the amount of compensation is determined under a formula that provides for benefits to be reduced due to investment losses sec_3306 of the code provides for purposes of futa that the term wages means all remuneration for employment unless specifically excepted sec_3306 of the code provides that the term wages does not include any payment made to or on behalf of an employee or his beneficiary under or to an exempt_governmental_deferred_compensation_plan as defined in sec_3121 of the code discussion in order for the retirement make-up plan and the thrift make-up plan to be deemed exempt governmental deferred_compensation plans within the meaning of sec_3121 of the code they must be plans which provide for the deferral of compensation which are established and maintained by an agency_or_instrumentality of the united_states deferral of compensation the retirement make-up plan and thrift make-up plan each provide for the deferral of compensation under each make-up plan a participant has a legally binding right to benefits that accrue during a calendar_year but because each plan is unfunded such benefits are not actually or constructively received when accrued see revrul_69_650 1969_2_cb_106 participants are not entitled to payment of their accrued_benefits until either their retirement in the case of the retirement make-up plan or termination of employment in the case of the thrift make-up plan participants also have a legally binding right to their plan benefits upon accrual under the make-up plans a participant’s accrued_benefit cannot be unilaterally reduced or eliminated by an employer except that the objective terms of each of the make-up plans provide that unvested benefits are forfeited upon termination of employment additionally benefits under the thrift make-up plan can be reduced to reflect investment losses for purposes of determining whether a plan provides for a deferral of compensation benefit forfeitures or reductions pursuant to objective plan vesting provisions and account reductions due to investment losses are expressly permitted under the employment_tax regulations without causing a participant to fail to have a legally binding right to those benefits see sec_31_3121_v_2_-1 thus both the retirement make-up plan and thrift make-up plan provide for the deferral of compensation_for employment_tax purposes united_states agency_or_instrumentality in order to be classified as exempt governmental deferred_compensation plans the retirement make-up plan and thrift make-up plan must be established and maintained by an agency_or_instrumentality of the united_states for the benefit of such agency’s or instrumentality’s employees the retirement make-up plan and thrift make-up plan were established by x and z and are maintained jointly for the benefit of their respective employees the service utilizes certain factors in determining whether an entity is a government agency_or_instrumentality see eg revrul_57_128 1957_1_cb_311 providing factors to be considered in determining whether an organization is an instrumentality of a state or political_subdivision for purposes of code sec_3121 and revrul_89_49 1989_1_cb_117 providing factors to be considered in determining whether an organization is an agency_or_instrumentality of a government for purposes of code sec_414 these factors include whether the government exercises control and supervision over the organization whether there is specific_legislation creating the organization and the source of operating funds of the organization the service has consistently ruled that the components of z are instrumentalities of the united_states see eg ruling a ruling b and ruling c additionally on date the service ruled that w is an instrumentality of the united_states and the retirement_plan and thrift_plan maintained for employees of w are governmental plans for purposes of sec_414 of the code sec_414 of the code defines a governmental_plan as a plan established and maintained for its employees by the government of the united_states by the government of any state or political_subdivision thereof or by any agency_or_instrumentality of any of the foregoing x was created by an act of congress to perform governmental functions its members are appointed by the president with the advice and consent of the senate and it must regularly report to and consult with the full congress further congress has delegated to x broad powers that are inherently governmental in nature including the power to promulgate and enforce certain federal industry regulations and assess civil penalties that are payable to the united_states x is required to submit reports to congress including an annual report of its operations and weekly reports indicating the condition of z in addition the financial accounts of x are subject_to audit by the general accounting office although x is not funded through congressionally appropriated funds it is funded through profits of z which after payment of statutory dividends to members of z are otherwise earmarked for the united_states treasury the components of z were established under an act of congress as separate corporate entities z performs governmental functions such as performing industry services for the federal government and conducting examinations and inspections of certain industry institutions z is subject_to the oversight of x x appoints the portion of the directors of z and approves the compensation of all directors officers and employees of z based on the foregoing we conclude that x and z including y are instrumentalities of the united_states for purposes of sec_3121 of the code accordingly the retirement make-up plan and the thrift make-up plan are exempt governmental deferred_compensation plans within the meaning of sec_3121 of the code and payments to or on behalf of the participants in such plans are not wages for purposes of fica and futa in addition sec_3121 does not apply to amounts deferred under the retirement make-up plan or the thrift make-up plan this ruling is directed only to y the taxpayer requesting it and may not be relied upon by any other taxpayers sec_6110 of the code provides that it may not be used or cited as precedent sincerely patricia m mcdermott senior technician reviewer branch office of the associate chief_counsel employee_benefits exempt_organizations cc