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 br 1-plr-109133-99 date date legend x y p1 p2 a d1 country this responds to your letter dated date and subsequent correspondence written on behalf of x requesting a ruling that x be given an extension of time to elect to be treated as a partnership for federal tax purposes for its taxable_year beginning d1 facts x is a limited_liability_company formed on d1 under the laws of country with p1 a domestic limited_partnership as its owner and p2 as its owner on that date p1 and p2 transferred to x their interests in y a country limited_liability_company that is treated as a partnership for u s tax purposes of which x was its over owner because x has limited_liability it defaults into corporate status under sec_301_7701-3 x’s representative’s in county intended that x be taxed as a partnership for plr-109133-99 u s federal tax purposes and relied on x’s u s owners to take any_action necessary to ensure partnership tax treatment the u s owners however failed to file a timely election pursuant to sec_301_7701-3 of the procedure and administration regulations for x to be taxed as a partnership for federal tax purposes as of d1 in support of its request for late election relief x makes the following representations since country real_estate and assets relating to the ownership and operation of the country real_estate have been the sole assets of y since d1 the interest in y and assets relating to the ownership of y have been the sole assets of x since d1 the interest in x and assets relating to the ownership of x have been the sole assets of p1 before d1 the interest in y and assets relating to the ownership of y were the sole assets of p1 the country real_estate is subject_to a long-term_lease that commenced in and as extended currently expires in y has reported net taxable_income with respect to its ownership of the country real_estate in every year since and y makes distributions of available cash to its partners with respect to such income at least twice each calendar_year a became an owner of y immediately prior to the transfers by p1 and p2 of their interests in y to x and a remains an owner of y p1 will satisfy all reporting requirements under sec_6038b with respect to the transfer of its interest in y to x law and analysis sec_301_7701-3 provides that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes a business_entity is any entity recognized for federal tax purposes that is not properly classified as a_trust under sec_301_7701-4 or otherwise subject_to special treatment under the code sec_301_7701-2 an eligible_entity with more than a single owner can elect either to be classified as an association and thus a corporation under sec_301_7701-2 or to be taxed as a partnership plr-109133-99 sec_301_7701-3 provides that unless a foreign eligible_entity elects otherwise the entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member to elect to be classified other than as provided in sec_301_7701-3 an eligible_entity must file form_8832 entity classification election with the designated service_center sec_301_7701-3 an election can be effective on the date specified on the form_8832 or on the date filed if no such date is specified the effective date specified on the form_8832 cannot be more than days prior to the date the election is filed sec_301_7701-3 sec_301_9100-1 provides that the commissioner has discretion to grant a reasonable extension of time under the rules set forth in sec_301_9100-3 to make a regulatory election sec_301_9100-1 defines a regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301 a a taxpayer is deemed not to have acted reasonably and in good_faith if the taxpayer uses hindsight in requesting relief if the specific facts have changed since the due_date for making the election that make the election advantageous to a taxpayer the irs will not ordinarily grant relief in such a case the irs will grant relief only when the taxpayer provides strong_proof that the taxpayer’s decision to seek relief did not involve hindsight sec_301_9100-3 conclusions based solely on the facts submitted and representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time to elect to be treated as partnership for federal tax purposes as of d1 x has until days from the date of this letter to file form_8832 with the applicable service_center to elect to be treated as a partnership for federal tax purposes plr-109133-99 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 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 this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely signed paul f kugler paul f kugler 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 --------------- ------------------------------ -------------------------------------- in re --------------- 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 b04 plr-145704-13 date may legend grantor child child child child date date trust a_trust trust trust trust corporate trustee individual state foundation dear -------------- ----------------- ------------------------------------------- ------------------------------------------ ------------------------------------------- ------------------------------------------- --------------------------- --------------------- -------------- ---------------------------- --------------------------- ----------------------- ------------------------ ----------------------------- ---------------------------- ------------ --------------------------- this letter responds to your authorized representative’s letter dated date requesting rulings under sec_2041 and sec_2514 of the internal_revenue_code the facts submitted and representations made are as follows on date grantor created an irrevocable_trust trust a that created separate trusts for the benefit of each of grantor’s four children trust trust trust and trust were created respectively for the benefit of child child child and child children’s trusts state law governs all questions relating to the management administration investment distribution and duration of the children’s trusts plr-145704-13 pursuant to the terms of trust a each of the children’s trusts has three initial trustees the investment trustee the administrative trustee and the distribution trustee all three trustees must serve at all times grantor is the initial investment trustee corporate trustee an unrelated corporate trust company is the administrative trustee the property of each of the children’s trusts is held by corporate trustee distributions of trust property are made by corporate trustee but only at the direction of the distribution trustee prior to date an independent person who is not a current beneficiary or a_related_or_subordinate_party within the meaning of sec_672 serves as the sole distribution trustee of each of the children’s trusts individual is currently serving as the independent distribution trustee on or after date when the named beneficiary of the respective children’s trust attains the age of the named beneficiary may serve as the distribution trustee in conjunction with the independent distribution trustee on or after date when the named beneficiary attains the age of the named beneficiary may serve as the sole distribution trustee pursuant to the terms of trust a distributions of trust property from the children’s trusts and the administration of the children’s trusts are subject_to the review of an approval committee the approval committee is comprised of child child child and child approval committee members are not fiduciaries but may not act capriciously maliciously or fraudulently if any child of grantor ceases to be a member of the approval committee no replacement of that member is to be named and the remaining children will continue to act as the sole members of the approval committee the approval committee will terminate at such time that no child of grantor is serving under the terms of trust a the distribution trustee holds the following powers subject_to approval committee consent with respect to the children’s trusts power to amend prior to date with the unanimous consent of the approval committee the independent distribution trustee may a amend the trust a instrument any designation filed by any officeholder or any declaration filed by any beneficiary and b invalidate or override any such designation or declaration or failure to designate or declare article c overriding power_of_appointment prior to date with the unanimous consent of the approval committee the independent distribution trustee may a distribute the trust property to or for the benefit of such one or more persons or organizations including children through as the independent distribution trustee determines in his discretion and b exercise any power granted to the approval committee elsewhere in the trust a instrument article c lifetime distributions to trust beneficiaries during the child’s life the administrative trustee is to pay to the child so much or all of the income and principal as plr-145704-13 the distribution trustee decides is advisable with the consent of the approval committee after giving priority to payments to the child during the child’s life the administrative trustee is to pay to one or more of the child’s descendants so much or all of the income and principal as the distribution trustee decides is advisable with the consent of the approval committee for purposes of this paragraph consent of the approval committee mean sec_50 percent vote if three or more members are acting or unanimous vote if two or fewer members are acting article under the terms of trust a the approval committee has at all times the following powers with respect to the children’s trusts a testamentary distributions - nongeneral_power_of_appointment at the death of the named beneficiary the named beneficiary has a nongeneral_power_of_appointment over the remaining property of his or her respective trust the approval committee acting by majority vote may override the primary beneficiary’s exercise of his or her power_of_appointment in favor of the primary beneficiary’s surviving_spouse in whole or in part by notice thereof delivered to each trustee and the spouse within nine months after the child’s death the approval committee acting by unanimous vote may override in whole or in part the primary beneficiary’s exercise of his or her power_of_appointment for the benefit of any entity or person other than the primary beneficiary’s surviving_spouse for any reason considering only whatever circumstances it determines appropriate by notice thereof delivered to each trustee and appointee within nine months after the child’s death article sec_2 c and b testamentary distributions - default allocations at death on the primary beneficiary’s death the administrative trustee shall allocate any trust property not disposed of by the primary beneficiary’s nongeneral_power_of_appointment per stirpes among the named beneficiary’s then living descendants or if none per stirpes among grantor’s living descendants if the primary beneficiary fails to exercise his or her power_of_appointment in whole or in part or to the extent the approval committee overrides the primary beneficiary’s exercise of a power_of_appointment the approval committee acting by majority vote may override the default allocation at the primary beneficiary’s death by allocating the trust property among such one or more of grantor’s descendants in such proportions as the approval committee decides acting by majority vote by notice thereof delivered to each trustee and descendant of grantor within nine months after the primary beneficiary’s death article sec_2 d and termination event the independent distribution trustee if any shall determine if a termination event has occurred with respect to a primary beneficiary however the approval committee acting by majority vote may negate the independent distribution trustee’s determination that a termination event has occurred the approval committee by percent vote if three members are acting or unanimous vote if two or fewer members are acting separately may determine that a termination event has occurred with respect to a primary beneficiary article a plr-145704-13 minimization powers after termination unless the approval committee acting by majority vote provides otherwise or the approval committee acting by a percent vote separately invokes a minimization power defined below following the occurrence of a termination event with respect to a primary beneficiary and until such primary beneficiary’s trust early termination_date the independent distribution trustee if any shall reduce such primary beneficiary’s benefits from the trust by exercising any one or more of the following minimization powers a limit distributions to such primary beneficiary to minimal support or eliminate distributions entirely b restrict limit or eliminate the provisions of primary beneficiary’s special_power_of_appointment c deem the primary beneficiary deceased for the purpose of acting as or appointing any officeholder under any trust hereunder except that a child of grantor may not be removed from the approval committee and d deem the primary beneficiary deceased for all purposes of article except article d allocations at death article b distribution upon trust early termination_date upon a primary beneficiary’s trust early termination_date the approval committee can exercise its overriding power_of_appointment to distribute so much or all of the trust property of the trust named for the primary beneficiary to or for the benefit of one or more of grantor’s descendants and foundation in such proportions as the approval committee directs prior to the early termination_date if the approval committee does not act by the early termination_date the default allocation i sec_50 percent among the named beneficiary’s living descendants per stripes or if none per stirpes among grantor’s living descendants and percent to foundation article c rulings requested while more than one of grantor’s children are acting on the approval committee none of the committee powers will be considered a general_power_of_appointment under sec_2041 while more than one of grantor’s children are acting on the approval committee none of the committee powers will be considered a general_power_of_appointment under sec_2514 ruling sec_2033 provides that the value of the gross_estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death sec_2041 provides that the value of the gross_estate shall include the value of all property to the extent of any property with respect to which the decedent has at the time of his death a general_power_of_appointment created after date plr-145704-13 or with respect to which the decedent has at any time exercised or released such a power_of_appointment by a disposition that is of such nature that if it were a transfer of property owned by the decedent such property would be includible in the decedent’s gross_estate under sec_2035 to inclusive sec_2041 provides that a general_power_of_appointment is a power that is exercisable in favor of the decedent the decedent’s estate the decedent’s creditors or the creditors of the decedent’s estate sec_20_2041-1 of the estate_tax regulations provides in part that the term power_of_appointment includes all powers which are in substance and effect powers of appointment regardless of the nomenclature used in creating the power and regardless of local property law connotations for example if a_trust instrument provides that the beneficiary may appropriate or consume the principal of the trust the power to consume or appropriate is a power_of_appointment similarly a power given to a decedent to affect the beneficial_enjoyment of trust property or its income by altering amending or revoking the trust instrument or terminating the trust is a power_of_appointment sec_20_2041-1 provides in part that a power_of_appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or classes other than the decedent or his creditors or the decedent’s estate or the creditors of the estate sec_2041 provides in part that in the case of a power_of_appointment created after date which is exercisable by the decedent only in conjunction with another person -- if the power is not exercisable by the decedent except in conjunction with a person having a substantial interest in the property subject_to the power which is adverse to exercise of the power in favor of the decedent -- such power shall not be deemed a general_power_of_appointment for purposes of sec_2041 a person who after the death of the decedent may be possessed of a power_of_appointment with respect to the property subject_to the decedent’s power which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the decedent’s power sec_20_2041-3 provides in part that an interest adverse to the exercise of a power is considered as substantial if its value in relation to the total value of the property subject_to the power is not insignificant a taker in default of appointment under a power has an interest which is adverse to an exercise of the power a co-holder of the power has no adverse_interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power however a co-holder of a power is considered as having an adverse_interest where he may possess the power after the decedent’s death and may exercise it at that time in plr-145704-13 favor of himself his estate his creditors or the creditors of his estate thus for example if x y and z held a power jointly to appoint among a group of persons which includes themselves and if on the death of x the power will pass to y and z jointly then y and z are considered to have interests adverse to the exercise of the power in favor of x similarly if on y’s death the power will pass to z z is considered to have an interest adverse to the exercise of the power in favor of y in this case the approval committee is composed of only grantor’s four children with respect to each of the children’s trusts the approval committee has broad powers to amend the trust to alter distributions made by the distribution trustee and to make distributions from the trusts while the approval committee is acting no funds can be distributed from any trust without the approval committee’s consent we conclude therefore that the members of the approval committee have interests that are adverse to the other members because every distribution is subject_to approval committee consent including the default allocations provided under the terms of trust a the approval committee is empowered to prevent all distributions from all of children’s trust sec_1 through after date the approval committee has a jointly-held overriding power_of_appointment to appoint to any person or organization including themselves on the death of one child of grantor the power will pass jointly to the surviving three children of grantor thus as in the example in sec_20_2041-3 the surviving three children are considered to have interests adverse to the exercise of the power of the deceased child accordingly based on the facts submitted and the representations made we conclude that while more than one of grantor’s children are acting on the approval committee none of the committee powers will be considered a general_power_of_appointment under sec_2041 ruling sec_2501 provides for the imposition of a gift_tax on the transfer of property by gift sec_2511 provides that the gift_tax applies whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2514 provides that the exercise or release of a general_power_of_appointment created after date shall be deemed a transfer of property by the individual possessing such power sec_2514 provides that the term general_power_of_appointment means a power which is exercisable in favor of the individual possessing the power possessor the possessor’s estate the possessor’s creditors or the creditors of the possessor’s estate plr-145704-13 sec_25_2514-1 of the gift_tax regulations provides in part that the term power_of_appointment includes all powers which are in substance and effect powers of appointment received by the donee of the power from another person regardless of the nomenclature used in creating the power and regardless of local property law connotations for example if a_trust instrument provides that the beneficiary may appropriate or consume the principal of the trust the power to consume or appropriate is a power_of_appointment similarly a power given to a donee to affect the beneficial_enjoyment of a_trust property or its income by altering amending or revoking the trust instrument or terminating the trust is a power_of_appointment sec_25_2514-1 provides in part that a power_of_appointment is not a general power if by its terms it is exercisable only in favor of one or more designated persons or classes other than the possessor or his creditors or the possessor’s estate or the creditors of the estate sec_2514 provides that in the case of a power_of_appointment created after date which is exercisable by the possessor only in conjunction with another person -- if the power is not exercisable by the possessor except in conjunction with a person having a substantial interest in the property subject_to the power which is adverse to the exercise of the power in favor of the possessor -- such power shall not be deemed a general_power_of_appointment for purposes of sec_2514 a person who after the death of the possessor may be possessed of a power_of_appointment with respect to the property subject_to the possessor’s power which he may exercise in his own favor shall be deemed as having an interest in the property and such interest shall be deemed adverse to such exercise of the possessor’s power sec_25_2514-3 provides in part that an interest adverse to the exercise of a power is considered as substantial if its value in relation to the total value of the property subject_to the power is not insignificant a taker in default of appointment under a power has an interest which is adverse to an exercise of the power a co-holder of a power_of_appointment has no adverse_interest merely because of his joint possession of the power nor merely because he is a permissible appointee under a power however a co-holder of a power is considered as having an adverse_interest where he may possess the power after the possessor’s death and may exercise it at that time in favor of himself his estate his creditors or the creditors of his estate thus for example if x y and z held a power jointly to appoint among a group of persons which includes themselves and if on the death of x the power will pass to y and z jointly then y and z are considered to have interests adverse to the exercise of the power in favor of x similarly if on y’s death the power will pass to z z is considered to have an interest adverse to the exercise of the power in favor of y plr-145704-13 in this case the approval committee is composed of only grantor’s four children with respect to each of the children’s trusts the approval committee has broad powers to amend the trust to alter distributions made by the distribution trustee and to make distributions from the trusts while the approval committee is acting no funds can be distributed from any trust without the approval committee’s consent we conclude therefore that the members of the approval committee have interests that are adverse to the other members because every distribution is subject_to approval committee consent including the default allocations provided under the terms of trust a the approval committee is empowered to prevent all distributions from all of children’s trust sec_1 through after date the approval committee has a jointly- held overriding power_of_appointment to appoint to any person or organization including themselves on the death of one child of grantor the power will pass jointly to the surviving three children of grantor thus as in the example in sec_25_2514-3 the surviving three children are considered to have interests adverse to the exercise of the power of the deceased child accordingly based on the facts submitted and the representations made we conclude that while more than one of grantor’s children are acting on the approval committee none of the committee powers will be considered a general_power_of_appointment under sec_2514 in accordance with the power_of_attorney on file with this office we have sent a copy of this letter to your authorized representative except as expressly provided herein we neither express nor imply any opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express no opinion on the trust provisions that permit the distribution trustee to distribute income or principal to trustees of other qualified trusts decanting we also express no opinion on the tax consequences of trust a or any beneficiary if the language of trust a is amended the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination plr-145704-13 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent sincerely ___________________________________ leslie h finlow senior technician reviewer branch office of the associate chief_counsel passthroughs special industries enclosures copy for sec_6110 purposes copy of this letter cc


t c memo united_states tax_court randall l kirst and mary m kirst petitioners v commissioner of internal revenue respondent docket no filed date curt r craton for petitioners willis b douglass for respondent memorandum opinion wright judge respondent determined a deficiency of dollar_figure in petitioners' federal_income_tax for taxable_year respondent further determined that petitioners are liable for the accuracy-related_penalty under sec_6662 a in the amount of dollar_figure after concessions the issues for decision are whether petitioners may defer recognition of gain realized from the sale of petitioner husband's former principal_residence under sec_1034 we hold that they may not whether petitioners are liable for the accuracy-related_penalty under sec_6662 we hold that they are this case was submitted fully stipulated pursuant to rule the stipulation of facts and attached exhibits are incorporated herein petitioners resided in newport beach california at the time the petition was filed in this case petitioners were married on date prior to their marriage petitioner-husband's mr kirst principal_residence was located pincite1 superior street sepulveda california the sepulveda property and petitioner-wife's mrs kirst principal_residence was located pincite toulon street newport beach california the newport beach property neither petitioner owned an interest in the other's principal_residence prior to their marriage after the couple were married mr kirst changed his principal_residence and began residing with mrs kirst at the newport beach property 1unless otherwise indicated all section references are to the internal_revenue_code in effect during the year at issue and all rule references are to the tax_court rules_of_practice and procedure mrs kirst purchased the newport beach property in by assuming the former owner's existing mortgage the newport beach mortgage in date the principal balance remaining on that mortgage was dollar_figure on date mr kirst sold the sepulveda property for dollar_figure the sepulveda proceeds he realized a gain of dollar_figure on this sale sometime thereafter mr kirst transferred dollar_figure of the sepulveda proceeds to petitioners' joint bank account the joint account mrs kirst withdrew at least dollar_figure from this account for personal and business reasons she also withdrew dollar_figure from the joint account in order to pay a personal debt prior to petitioners' marriage mr kirst maintained a checking account at a local bank this account became the couple's joint checking account the couple's joint checking account after their marriage since date petitioners paid the mortgage on the newport beach property with checks drawn against the couple's joint checking account using form_2119 petitioners deferred recognition of the gain realized from the sale of the sepulveda property they attached this form to their timely filed return and indicated thereon that mr kirst had not purchased a replacement_property but that he intended to do so within the applicable replacement_period mr kirst did not have record title to the newport beach property at anytime prior to the submission of this case however on date petitioners executed a written_agreement entitled agreement regarding residential property occasionally the agreement the agreement purports to memorialize an oral agreement allegedly made on date in which mrs kirst agreed to transmute an interest in the newport beach property to mr kirst in exchange for certain consideration the preamble to this agreement indicates that petitioners intended for it to be effective as of date issue principal property sec_1034 as a general_rule gain realized from the sale_or_other_disposition of property must be recognized sec_1001 sec_1034 provides an exception to this general_rule and allows a taxpayer to defer recognition of all or part of any gain realized on the sale of a principal_residence if other_property is purchased and used by the taxpayer as a new principal_residence within the period beginning years before the date of the sale and ending years after that date the replacement_period under sec_1034 gain is recognized only to the extent that the adjusted_sales_price of the old property exceeds the cost of purchasing the new property petitioners argue that mr kirst purchased an interest in the newport beach property and that the amount of consideration that he paid for that interest exceeded the adjusted_sales_price of the sepulveda property respondent maintains that mr kirst did not purchase a new principal_residence within the meaning of sec_1034 in advancing this argument respondent argues that petitioners are not entitled to nonrecognition treatment because mr kirst did not obtain record title to the newport beach property during the replacement_period we agree with respondent sec_1034 is strictly construed see 65_tc_378 see also lokan v commissioner tcmemo_1979_380 bazzell v commissioner tcmemo_1967_101 if a taxpayer is to receive nonrecognition treatment under sec_1034 it is essential that he or she maintain continuity of title marcello v commissioner 380_f2d_499 5th cir affg on this issue and remanding on other issues tcmemo_1964_299 boesel v commissioner supra see also de ocampo v commissioner tcmemo_1997_161 allied marine sys inc v commissioner tcmemo_1997_101 edmondson v commissioner tcmemo_1996_393 snowa v commissioner tcmemo_1995_336 may v commissioner tcmemo_1974_54 sec_1 b income_tax regs this requirement operates to prevent taxpayers from enjoying the benefits of tax_deferral while placing themselves in a position as nontitleholders to escape future recognition see boesel v commissioner supra pincite petitioners concede that mr kirst did not obtain record title to the newport beach property during the replacement_period they contend however that obtaining record title was not necessary because mrs kirst effectively transmuted an interest in the newport beach property to mr kirst and that such transmutation satisfies sec_1034's continuity of title requirement specifically petitioners contend that in exchange for consideration consisting of a portion of sepulveda proceeds and the assumption of the newport beach mortgage mrs kirst orally agreed to transmute an interest in the newport beach property to mr kirst this agreement according to petitioners occurred on date and was executed on date the purported agreement was reduced to writing on date petitioners maintain that while their oral agreement was not reduced to writing during the replacement_period the effect of their written_agreement relates back to the date on which they entered their oral agreement a date which petitioners maintain occurred during the replacement_period we are unpersuaded by petitioners' argument that the effect of their written transmutation agreement which was executed roughly years after the close of the replacement_period 2california is a community_property_state and property owned by a person before marriage remains the separate_property of that person after marriage cal civ code secs west however a married person's separate_property may be transmuted into community_property if the parties execute a written transmutation agreement cal civ code sec relates back to the date of the purported oral agreement the authority upon which petitioners rely does not espouse their argument see marriage of garrity cal app 3d ct app suffice it to say that the federal tax law cannot be circumvented in the manner advocated by petitioners mr kirst failed to obtain record title to the newport beach property during the replacement_period this alone prevents petitioners from deferring the gain realized from the sale of the sepulveda property as explained above continuity of title is essential if a taxpayer is to receive nonrecognition treatment under sec_1034 marcello v commissioner supra boesel v commissioner supra 3it is interesting to note that petitioners' argument is inconsistent with the evidence of record that is petitioners maintain that in exchange for certain consideration mrs kirst orally agreed in date to transmute an interest in the newport beach property to mr kirst according to petitioners that exchange occurred on date however when petitioners completed form_2119 which was attached to their timely filed return for and was presumably prepared in they indicated that mr kirst had yet to purchase a replacement principal_residence petitioners fail to explain why the form_2119 indicates that mr kirst had yet to purchase a replacement principal_residence while petitioners now argue that the exchange or transmutation involved in their agreement occurred in date 4we do not consider the effect of a written transmutation agreement that is executed during the replacement_period accordingly we hold that petitioners are required to recognize the gain realized from the sale of the sepulveda property issue sec_6662 respondent determined that petitioners are liable for the accuracy-related_penalty pursuant to sec_6662 sec_6662 imposes a penalty equal to percent of the portion of an underpayment_of_tax that is attributable to any substantial_understatement of tax sec_6662 and b an understatement_of_tax is substantial when it exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6662 the amount of an understatement will be reduced if a taxpayer has substantial_authority for the way an item was treated or if the facts that affect the item's tax treatment are adequately disclosed on the return and there is a reasonable basis for the tax treatment of such item sec_6662 moreover the accuracy-related_penalty does not apply to any portion of an underpayment if there was reasonable_cause for such portion and the taxpayer acted in good_faith sec_6664 a taxpayer has the burden of proving that respondent's determination is in error rule a 5we have considered each of petitioners' allegations with respect to this issue and to the extent not discussed herein find them to be irrelevant or without merit petitioners fail to address this issue in meaningful detail they limit their argument to the contention that there is no underlying deficiency accordingly under the facts and circumstances of this case we conclude that petitioners have not carried their burden of refuting respondent's determination with respect to this issue respondent's determination is sustained to reflect the foregoing decision will be entered under rule 6respondent also argues that petitioners were negligent but because we hold petitioners liable for the accuracy-related_penalty due to their substantial_understatement_of_income_tax we do not address the negligence issue


office_of_chief_counsel internal_revenue_service memorandum number release date cc tege eoeg et2 dmparkinson posts-127932-08 uilc date date to lmsb --------------- ----------------------------------------------- ---------------------------- from branch chief ------------------------------------------------------------------------------------------------------------------ ----------------------------------- tax exempt government entities subject qualified_employee_discounts under sec_132 this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent legend contract -------------------------------- issue sec_1 whether discounts provided to the employer’s employees who purchase or lease property from the company constitute taxable fringe_benefits how are the fringe_benefits valued whether the discounts constitute wages for purposes of the federal insurance contributions tax act fica should the claims for refund be allowed posts-127932-08 conclusion sec_1 the discounts provided to the employer’s employees who purchase or lease property from the company constitute taxable fringe_benefits the fringe_benefits are valued at fair_market_value the discounts provided to the employer’s employees constitute wages for purposes of the federal insurance contributions tax act fica the claims for refund should be disallowed facts the employer filed claims for refund to recover fica_taxes that the employer says were erroneously paid and or collected with respect to certain discounts on the purchase or lease of company property by the employer’s employees the employer ----------------------------------------------- ----- was formerly owned by the company after ----------years of ownership by the company the employer became an independent entity and the company ----------------- --------------------- ------------------the employer during the relevant period the company offered a discount program to eligible employees of the employer the discount program offers discount purchasing and leasing opportunities for property manufactured by the company and its affiliates all full-time employees of the employer retirees surviving spouses and immediate_family members are eligible to participate in the discount program immediate_family member eligibility has been extended to include brothers- and sisters-in-law siblings’ spouses and spouses’ siblings sons- and daughters-in-law stepbrothers and stepsisters grandchildren and step-grandchildren surviving spouses may also sponsor full half- and step-siblings of deceased company employees or retirees to participate in the discount program eligible employees obtain authorization numbers from the company under program guidelines an eligible_employee presents the authorization number to an authorized seller of the company’s products the property is priced at the cost to the seller of the company’s products plus handling fees the employer received data transmitted by the company as to the value of the discounts the employer notified its employees and former employees that the discount was a taxable fringe benefit in accordance with irs regulations the discount was reflected on the information returns issued to the employees and former employees the employer paid employment_taxes on the discount amounts attributable to the employees posts-127932-08 the employer historically treated the amount of discount as taxable_income to its employees including active and retired employees who purchased or leased items pursuant to this program the employer also imputed_income equal to the discount to any surviving_spouse or family members of deceased employees who participated in the program employment_taxes were collected following the company’s notification to the employer of an employee purchase or lease and the income was reported on each employee’s form_w-2 in the case of former employees the employer historically filed forms 1099-misc reporting the discount as income but did not collect or deposit employment_taxes with respect to the reported income the employer stated that as of a certain date the company stopped transmitting the discount data to the employer therefore after that point the employer no longer withheld and paid the employment_taxes attributable to the discount amounts the employer now claims that the discounts were nontaxable accordingly the employer is seeking a refund of the fica_taxes it paid with respect to the discounts the employer’s benefit handbooks consistently described the discounts offered under this program as taxable fringe_benefits in accordance with irs regulations according to the handbooks the discount is deemed a taxable benefit in accordance with irs regulations and is therefore subject_to taxation additionally letters are sent to inform the individuals of taxes to be taken out of their paychecks memoranda between the employer and the company indicate that the employer periodically sought to extend and continue the program for the benefit of its eligible employees other memoranda indicate that the program has repeatedly been extended by the company in response to these requests over the years the memoranda indicate that the program has also been extended to other classes of the employer’s employees by the company the employer periodically provides information to the company about the names of new employees who are eligible for the company discounts as well as those who left the employer’s employment and are no longer eligible for the company discounts while the precise details of the purchases and leases that were made by the general_public were not made available for comparison purposes a sampling of the employer’s employees was made to determine if they received benefits in excess of rebates incentives etc that the general_public received the sampling was made of employees who received discounts for a relevant two year period most of the individuals had used the discount program at least twice personally and one had used it five or six times two had used it at least twice for family members according to information provided by employees and by the company the property discount was in addition to all other rebates incentives etc available to the public the company suggested that eligible employees’ family members be reminded that they can combine their discount with the most current incentives for an even better deal information provided indicated that the discount was a benefit on top of any rebates regional incentives etc available to the general_public posts-127932-08 legal authority internal_revenue_code code sec_61 defines gross_income as all income from whatever source derived including but not limited to compensation_for services such as fees commissions fringe_benefits and similar items regulations sec_1_61-1 provides that gross_income includes income realized in any form whether in money property or services for example regulations sec_1_61-21 provides that a fringe benefit may include for example an employer-provided discount on property or services regulations sec_1_61-21 provides that a fringe benefit provided in_connection_with_the_performance_of_services is considered to have been provided as compensation_for such services regulations sec_1_61-21 provides that a taxable fringe benefit is included in the income of the person performing the services in connection with which the fringe benefit is furnished thus a fringe benefit may be taxable to an employee even though that employee did not actually receive the fringe benefit this could occur for example when a benefit is provided to a relative of an employee under regulations sec_1_61-21 the provider of a fringe benefit is that person for whom the services are performed regardless of whether that person actually provided the fringe benefit to the recipient the provider of the fringe benefit need not be the employer of the recipient of the fringe benefit but may be for example a client or customer of the employer thus a fringe benefit need not be provided by the common_law employer to be includible in an employee’s gross_income regulations sec_1_61-21 provides that to the extent a particular fringe benefit is specifically excluded from gross_income pursuant to another code section that section shall govern the treatment of that fringe benefit many fringe_benefits specifically addressed in other sections of the code are excluded from gross_income only to the extent certain requirements are met code sec_132 excludes from gross_income certain fringe_benefits provided to an employer’s employees sec_132 provides that gross_income does not include any fringe_benefits which constitute qualified_employee_discounts code sec_132 defines a qualified_employee_discount as any employee_discount with respect to qualified_property_or_services to the extent that the discount does not exceed certain specified limits under code sec_132 the term qualified_property_or_services means any property other than real_property and other than personal_property of a kind held for investment or services which are offered to customers in the ordinary course of the line_of_business of the employer in which the employee is performing services posts-127932-08 code sec_414 provides that all employees who are treated as employed by a single employer under the controlled_group provisions of sec_414 c or m are treated as employed by a single employer for purposes of sec_132 regulations sec_1_132-1 provides that for purposes of qualified_employee_discounts the term employee includes i any individual who is currently employed by the employer in the line_of_business ii any individual who was formerly employed by the employer in the line_of_business and who separated from service with the employer by reason of retirement or disability and iii any widow or widower of an individual who died while employed by the employer in the line_of_business or who separated from service with the employer in the line_of_business by reason of retirement or disability regulations sec_1_132-3 provides that the exclusion for qualified_employee_discounts does not apply to property or services provided by another employer pursuant to a written reciprocal agreement that exists between employers to provide discounts on property or services to employees of the other employer regulations sec_1_132-3 provides that a qualified_employee_discount may be provided either directly by the employer or indirectly through a third party for example an employee of an appliance manufacturer may receive a qualified_employee_discount on the manufacturer’s appliances purchased at a retail store that offers such appliances for sale to customers the general explanation of the revenue provisions of the deficit_reduction_act_of_1984 defra ’84 p l which added sec_132 certain fringe_benefits to the code provides background for the fringe benefit rules and why congress thought such rules necessary c ongress was concerned that without any well defined limits on the ability of employers to compensate their employees tax-free by providing noncash benefits having economic value to the employee new practices will emerge that could shrink the income_tax base significantly this erosion of the income_tax base results because the preferential treatment of fringe_benefits serves as a strong motivation to the employers to substitute more and more types of benefits for cash compensation a similar shrinkage of the base of the social_security payroll tax could also pose a threat to the viability of the social_security program the house report provides that the discount exclusion is not available for goods or services provided by another employer whether or not a reciprocal agreement exists except where commonly controlled businesses are treated as one employer h_r rep no part ii legal analysis issue whether discounts provided to the employer’s employees who purchase or lease property through the company’s program constitute a taxable fringe benefit posts-127932-08 the company discounts are not excluded from gross_income under code sec_132 and c as qualified_employee_discounts code sec_132 provides that qualified_employee_discounts are limited to discounts on qualified_property_or_services sec_132 limits qualified_property_or_services to property or services offered for sale to customers in the ordinary course of the line_of_business of the employer in which the employee is performing services the legislative_history clearly provides that the discount exclusion is not available for goods and services provided by another employer h_r rep no part ii the discounts in this case are not qualified_employee_discounts because the discounted property was not offered for sale to customers by the same employer for which the employees receiving the discount performed services moreover a qualified_employee_discount can only be provided as an excludable fringe benefit to individuals who satisfy the definition of employee in regulations sec_1_132-1 sec_1_132-1 defines employee as current employees spouses of employees dependent_children of employees former employees who have left the service of the employer due to retirement or disability and widows and widowers of employees who died while employed in the line_of_business or left service due to retirement or disability however the employer_provided the discounts to a much broader group eg siblings siblings’ spouses and spouses’ siblings grandchildren and step-grandchildren the discounts provided to this latter group are not excludable under code sec_132 in this case the discounts are offered in_connection_with_the_performance_of_services by full-time employer employees or retirees others who receive the discount derive their right to the discount from their blood or legal relationship with the employer’s employee or retired employee the employer periodically provides information to the company about the names of new employer employees who are eligible for the company discounts as well as those who left the employer’s employment and are no longer eligible for the company discounts a participant in the company discount program is required to present an authorization number when the property is selected the authorization number can only be obtained by current employees former employees who retired or are disabled and surviving spouses of such current and former employees the other individuals who participate in the company’s discount program must obtain an authorization number from their relative a current employee a former employee who retired or survivors of the employer’s employees the employer periodically received information from the company about the employer’s employees who took advantage of the company discounts thus the employer and the company monitored the status of the employer’s employees to ensure that the program was only offered to individuals eligible to participate by virtue of current employment or prior employment surviving spouses and individuals who derive their right to a discount by virtue of a blood or legal relationship with those employer employees therefore the facts and circumstances establish that the employer’s employees and related individuals received the discounts on account of the employer’s employees’ employment relationship with the employer posts-127932-08 moreover evidence suggests that the discount program is a bargained for benefit a memorandum from the company concerning the program states y our recent request was approved at the august meeting in similar manner another memorandum states that the extension of the program has been granted the negotiated aspect of the agreement is also reflected in the changing terms of the program as extended another memorandum provides that the extension does not apply to employer employees hired after the ---------- in contrast a later memorandum provides that this extension cover s all active employer employees including acquired subsidiaries such as and taken as a whole these memoranda suggest that the company and employer have bargained for and negotiated the extension and re-extension of the program as a fringe benefit for the employer’s employees the fact that the benefit was bargained for indicates that the employer intended for the benefit to be compensatory the benefit was not merely a benefit unilaterally provided by a third party outside the control of the employer the employer asserts that if the program discounts are wages for employment_tax purposes then the company is responsible for the withholding and reporting because the company was the statutory employer within the meaning of code sec_3401 code sec_3401 is not controlling with respect to non-cash fringe_benefits code sec_3501 provides that taxes imposed with respect to non-cash fringe_benefits shall be collected or paid_by the employer regulations sec_31_3501_a_-1t q a-5 provides in this regard that t he provision of noncash fringe_benefits by an entity to an employee of another employer does not make such entity the employer of such employee with respect to such noncash fringe_benefits for any purposes of subtitle c so long as such noncash fringe_benefits are incidental to the provision of wages by the employer to such employee the company discounts are incidental_benefits and the employer is responsible for taxes imposed with respect to the discounts regulations sec_31_3501_a_-1t q a-6 provides that t he employer must take the steps necessary to obtain the relevant information from the provider of the benefits in order to enable the employer to satisfy in a timely manner its obligation under subtitle c to collect and pay taxes with respect to noncash fringe_benefits provided by the nonemployer therefore the employer was required to obtain the information necessary to report and withhold on the discounts as it had done for several years preceding its change in position the employer stated that the company discount is essentially only a rebate program and the discount is not wages subject_to employment_taxes revrul_79_96 1976_1_cb_23 concerned the federal_income_tax treatment of rebates by a taxpayer to qualifying retail customers who purchased or leased its automobiles the ruling held that the rebates were deductible by the taxpayer as ordinary and necessary business_expenses and the rebates were not includible in the customers’ gross incomes the rebates represent a reduction in the purchase_price of the automobiles sold the employer states that the rationale in revrul_79_96 is reinforced in several private letter rulings with facts similar to the facts in their situation posts-127932-08 discounts arising from an employment relationship are not price rebates as described in revrul_76_96 because the discounts provided to the employer’s employees arise from the employees’ employment relationship with the employer see regulations sec_1_61-21 the rebates described in revrul_76_96 were available to the general_public and did not arise on account of an employment relationship the regulations specifically provide that discounts are considered a taxable fringe benefit and the taxable fringe benefit may be provided by a customer of the employee see regulations sec_1_61-21 and further private letter rulings have no precedential value see code sec_6110 a written_determination may not be used or cited as precedent see also 104_tc_472 the reasoning behind sec_6110 is more directly explained by the joint_committee on taxation under prior administrative rules a private_letter_ruling technical_advice_memorandum or determination_letter was not to be used as a precedent by the irs or any person if all publicly disclosed written determinations were to have precedential value the irs would be required to subject them to considerably greater review than is provided under present procedures the congress believes that the resulting delays in the issuance of determinations would mean that many taxpayers could not obtain timely guidance from the irs and the ruling program would suffer accordingly thus if the irs issued a written_determination to a taxpayer with respect to a specified transaction which occurred in a particular year the earlier determination could not be used by the taxpayer or the irs as a precedent for the subsequent year unless the determination specifies that it applies to a series of such transactions see staff of the joint comm on taxation 94th cong general explanation of the tax reform act of pincite joint comm the employer also asserts that the irs is treating taxpayers differently and notes the results of other examinations the irs strives to treat similarly situated taxpayers consistently and fairly however the irs is statutorily prohibited under code sec_6103 from discussing examinations of other taxpayers and particular facts that may have resulted in a particular conclusion in a particular audit cycle of a particular employer as the discussion would lead to disclosure of tax_return information the company property discount provided to current employees of the employer constitutes a taxable fringe benefit these amounts were reflected on forms w-2 for the tax periods in question and were treated as wages prior to the employer’s filing claims for refund of the employment_taxes paid the discount was a benefit the employer bargained for with the company and as such was intended to be compensatory for the employer’s employees since the discounts constitute a taxable fringe benefit they are considered wages and should be subject_to employment_taxes the employer as the common_law employer is responsible for withholding the appropriate amount of employment_taxes and for including any income on the form_w-2 posts-127932-08 of the employee who received the taxable fringe benefit even if the value of the discount is not transmitted by the company if the company refuses to transmit the discount data to the employer then the employer has the choice of discontinuing the discount program currently available to its employees or continuing the program using alternative methods of obtaining and reporting the data the provision of company discounts to the employer’s employees is a taxable fringe benefit and the employer has an obligation to withhold employment_taxes on this taxable fringe benefit and report the benefit as income and wages on forms w-2 any similar discounts for former employees such as retirees constitute taxable fringe_benefits the employer reflected these amounts on forms but these amounts should be treated as wages and reported as such on forms w-2 regulations sec_31_3121_a_-1 provides that remuneration for employment constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services are performed and the individual who performed them issue how are the fringe_benefits valued regulations sec_1_61-21 provides rules with respect to valuing fringe_benefits under subparagraph an employee must include in gross_income the amount by which the fair_market_value of the fringe benefit exceeds the sum of i the amount if any paid for the benefit by or on behalf of the recipient and ii the amount if any specifically excluded from gross_income by some other section of subtitle a of the code regulations sec_1_61-21 provides that in general fair_market_value is determined on the basis of all the facts and circumstances specifically the fair_market_value of a fringe benefit is the amount that an individual would have to pay for the particular fringe benefit in an arm’s length transaction thus for example the effect of any special relationship that may exist between the employer and the employee must be disregarded in valuing the benefit the employer’s employees have gross_income based on the fair_market_value of the fringe benefit the fair_market_value of the fringe benefit in this case is based on the amount an individual would have to pay to purchase or lease the property in an arm’s length transaction in this regard regulations sec_1_132-3 provides that the term employee_discount means the excess of i the price at which the property or service is being offered by the employer for sale to customers over ii the price at which the property or service is provided by the employer to an employee for use by the employee pursuant to the terms of the program the employer’s employees’ discount is -- of the retail price it would not be unreasonable to use the retail price as the measure of the fair_market_value of the taxable fringe benefit the -- represents the difference between the fair_market_value of the fringe benefit at the suggested price that the property is offered for sale to customers of the company’s products in the ordinary posts-127932-08 course of business and the price paid_by the employer’s employee and is a reasonable figure to use in computing the income attributable to the property discount the employer asserts that similar savings were also available to the employer’s employees under other_property discount programs offered by other manufacturers the employer argues that the company’s discounts would have a fair_market_value only to the extent the company’s discounts exceeded the discounts available under these other discount programs this argument is without merit the value of each fringe benefit is determined based on the value of that particular benefit the information provided to the irs for the years at issue discusses the discount program but does not discuss any similar discounts offered by other manufacturers or suppliers the information provided by the employer’s employees on a sample basis indicates that the discounts were approximately -- of the retail price as outlined in program materials the company transmitted to the employer a discount amount which was a deemed benefit to the employer’s employees who received the discount and that amount was at a minimum -- of the retail price it is irrelevant whether the employees received property discounts from other_property manufacturers the employer states that the amounts transmitted by the employer are no longer the correct amounts to value the discount because the -- of retail price is no longer a correct amount for the deemed benefit the employer asserts that -- is not the correct value for the benefit because the public may be able to negotiate for a more favorable price we note again that information provided by the company to the employer indicated that the value of the discount is equal to at least -- of the retail price if the employer’s position is that the company was transmitting incorrect data to the employer then the employer could have discontinued participation in the program by not requesting the renewals or requested that the company provide the level of detail for the purchases and leases so that the employer could properly determine the correct amount of the deemed benefit to be included in participating employees’ income issue whether the company discounts constitute wages for purposes of the federal insurance contributions tax act fica code sec_3121 sec_3102 and sec_3111 provide that every employer making payments of wages is required to withhold and pay fica_taxes sec_3121 provides that for fica purposes the term wages means all remuneration for employment unless otherwise excepted regulations sec_31_3121_a_-1t q a-1 provides that fringe_benefits are included in the definition of wages under sec_3121 unless specifically excluded from the definition of wages pursuant to sec_3121 through posts-127932-08 code sec_3121 provides that for fica purposes the term wages does not include any benefit provided to or on behalf of an employee if at the time such benefit is provided it is reasonable to believe that the employee will be able to exclude such benefit from income under sec_132 it was not reasonable to believe that the discounts provided by the company were excludable from the employees’ income under sec_132 code sec_132 and the regulations thereunder provide that the discount must be provided by the employer and that separate corporations like the employer and the company are not considered a single employer unless they are treated as a single employer under sec_414 c or m regulations sec_31_3121_a_-1 provides that generally the medium in which the remuneration is paid is immaterial wages may be paid in something other than cash such as goods remuneration paid in something other than cash is valued at the fair_market_value of the item at the time of payment see also regulations sec_31_3121_a_-1t q a1 fringe_benefits are wages unless specifically excluded the legislative_history accompanying defra ‘84 indicates congress’ intent to provide clear rules to achieve certainty with respect to the treatment of fringe_benefits the house report provides that t he second objective of the committee’s bill is to set forth clear boundaries for the provision of tax-free benefits h_r rep no pt pincite the conference_report provides statutory provisions under which certain fringe_benefits provided by an employer are excluded form the recipient’s gross_income and from the wage_base and any fringe benefit that does not qualify for exclusion under the bill and that is not excluded under another statutory fringe benefit provision of the code is includible in gross_income and in wages for employment_tax purposes h_r rep no pincite guidelines for reporting and withholding on the value of taxable noncash fringe_benefits are provided in announcement 1985_31_irb_31 pursuant to announcement an employer may elect for employment_tax and withholding purposes to treat taxable noncash fringe_benefits as paid on a pay_period quarterly semi-annual annual or other basis provided that the benefits are treated as paid no less frequently than annually for example an employer may treat the annual value of noncash fringe_benefits as wages paid in december of each year and use the annual withholding table in circular_e publication employer’s tax guide see also regulations sec_31_3501_a_-1t the property discounts provided to employees were indeed taxable and were required to be reported on forms w-2 to these employees as remuneration for services posts-127932-08 performed in the employment of the employer moreover property discounts provided to retirees are wages for employment_tax purposes regulations sec_31_3121_a_-1 provides that remuneration for employment constitutes wages even though at the time paid the relationship of employer and employee no longer exists between the person in whose employ the services are performed and the individual who performed them with respect to non-cash fringe_benefits an employer has two options collect from the employee the amount of the employees’ portion of employment_taxes or gross- up the employee’s wages see rev_rul 1986_1_cb_304 and revproc_81_48 1981_2_cb_623 issue should claims for refund be allowed although for the years at issue the employer treated the discount amounts as taxable the employer’s current position is that the discount amounts are nontaxable the employer now believes that its inclusion of the discounts in income and wages on information returns was erroneous the company’s property discounts are taxable fringe_benefits that the employer provides to its current employees and former employees such as retirees in its original reporting the employer correctly reflected the discount amounts for current employees as wages on forms w-2 these amounts are considered additional taxable wages for fica purposes these amounts were correctly reported as wages on form sec_941 all elements necessary to establish employment_tax liability are present the claims for refund should be disallowed in full the employer filed true-up claims after soliciting employee consents and statements as required by regulations sec_31_6402_a_-2 however inasmuch as the original wage reporting was correct there is no overpayment of employment_taxes and no refund should be made this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views if you have any further questions please call don parkinson of my staff at _____________________________ lynne camillo branch chief employment_tax branch exempt_organizations employment_tax government entities tax exempt government entities


t c summary opinion united_states tax_court larry t cooper petitioner v commissioner of internal revenue respondent docket no 16331-04s filed date larry t cooper pro_se thomas l fenner for respondent dean special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code unless otherwise indicated section references are to the internal_revenue_code as in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority respondent determined for a deficiency in petitioner’s federal_income_tax of dollar_figure and additions to tax under sec_6651 sec_6651 and sec_6654 of dollar_figure dollar_figure and dollar_figure respectively the issues for decision are whether petitioner’s wife2 engaged in her horse barrel-racing activitie sec_3 in with the primary objective of making a profit petitioner is liable for an addition_to_tax under sec_6651 for failure to timely file an income_tax return petitioner is liable for an addition_to_tax under sec_6651 for failure to timely pay tax and petitioner is liable for an addition_to_tax under sec_6654 for failure to pay estimated income_tax some of the facts have been stipulated and are so found the stipulated facts and the exhibits received into evidence are incorporated herein by reference at the time the petition in this case was filed petitioner resided in willis texas background during petitioner was employed in automotive sales and earned wages of dollar_figure from wright motor co inc his wife 1these figures are rounded to the next dollar 2petitioner’s wife stephanie cooper was not listed on the notice_of_deficiency and therefore is not a party to this case 3horse barrel-racing is a timed rodeo event in which a participant must ride a complete circle around each of barrels and return to the starting point with the fastest time to win stephanie cooper mrs cooper pursued dog breeding and horse barrel-racing activities resulting in losses of dollar_figure and dollar_figure respectively since she wa sec_2 years old mrs cooper has enjoyed riding horses mrs cooper who wa sec_38 years old at the time of trial stopped riding after she graduated from high school and did not resume riding until petitioner’s wages financed his wife’s riding activities during mrs cooper was a district_director for the national barrel horse association for whom she heard grievances and complaints she also applied to be a member of the professional rodeo riders society an affiliation that could have helped her obtain sponsors for her riding activities mrs cooper failed to follow through with the application process mrs cooper had competition winnings of dollar_figure during she also gave free riding lessons to friends acquaintances and fellow competitors mrs cooper did not keep documentation regarding her activities and time spent in those activities during mrs cooper’ sec_2001 expenses for her horse barrel-racing activities were reported as follows car and truck expenses depreciation and sec_179 expense office expense repairs and maintenance travel meals and entertainment entry fees feed hay vet meds tack maintenance farrier dollar_figure big_number big_number big_number big_number big_number big_number big_number petitioner failed to timely file a federal_income_tax return for respondent prepared a substitute for return sfr for respondent determined a deficiency in petitioner’s federal_income_tax and that petitioner is liable for additions to tax petitioner had not yet filed a federal_income_tax return for when the notice_of_deficiency was issued respondent had also prepared sfrs for petitioner for and respondent in preparing sfrs for petitioner treated him as a single_taxpayer on date petitioner faxed to respondent an unsigned joint form_1040 u s individual_income_tax_return for attached to the return were various schedules including schedule a itemized_deductions schedule b interest and ordinary dividends and two schedules c profit or loss from business respondent accepted all the items on the return except for the ordinary_loss of dollar_figure claimed in connection with mrs 4the parties agree that petitioner should be treated as filing a joint_return with his wife for cooper’s horse barrel-racing activities respondent contends that mrs cooper’s horse barrel-racing activities were not engaged in with the primary objective of earning a profit discussion the commissioner’s determinations are presumed correct and generally the taxpayer bears the burden of proving otherwise 290_us_111 because petitioners did not comply with the requirements of sec_7491 sec_7491 is inapplicable here under sec_7491 respondent has the burden of production with respect to petitioner’s liability for the additions to tax a mrs cooper’s horse barrel-racing activities sec_183 provides that if an activity is not engaged in for profit no deduction attributable to such activity shall be allowed under this chapter except as otherwise provided in this section thus to properly deduct certain expenses a taxpayer must engage in an activity with an actual and honest objective of making a profit see 78_tc_642 affd without opinion 702_f2d_1205 d c cir moreover the court_of_appeals for the fifth circuit in which jurisdiction petitioner resides has stated that taxpayers whose activities are challenged under sec_183 bear the burden of proving that their activities were engaged in with the primary purpose of earning a profit 68_f3d_868 5th cir affg per curiam tcmemo_1993_634 emphasis added if a taxpayer engages in an activity without a profit objective deductions attributable to the activity are allowed only to the extent of the income derived from the activity sec_183 see 76_tc_759 the determination of whether an activity is engaged in for profit is to be made by reference to objective standards taking into account all the facts and circumstances of each case 78_tc_471 affd 722_f2d_695 11th cir 66_tc_312 sec_1_183-2 income_tax regs greater weight is given to the objective facts than to the taxpayer’s own statements of intent sec_1_183-2 income_tax regs the burden_of_proof is on the taxpayer to show that he or she engaged in an activity with the objective of realizing an economic profit rule a sec_1_183-2 income_tax regs sets forth a nonexclusive list of factors that should normally be taken into account in determining whether the requisite profit objective has been shown the factors are 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 expectation that assets used in activity may appreciate in value the success of the taxpayer in carrying on 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 sec_1_183-2 income_tax regs the following discussion applies the nine factors to mrs cooper’s horse barrel-racing activities factor manner in which the taxpayer carried on the activity mrs cooper did not carry on her horse barrel-racing activities in a businesslike manner see sec_1_183-2 income_tax regs she failed to charge fees for riding lessons she gave and she failed to follow through with membership affiliations that could help her obtain financial sponsorship for her activities mrs cooper also failed to keep detailed records of her activities for she did not present any evidence that she developed a profit plan before she began her horse barrel-racing activities or that she evaluated her activities in an attempt to make them profitable factor the expertise of the taxpayer or his advisers preparation for an activity by extensive study or consultation with experts may indicate a profit_motive where the taxpayer conducts the activity in accordance with such study or advice sec_1_183-2 income_tax regs mrs cooper has had an interest in horses for many years and is an avid rider she watched videos and read magazines to further her knowledge about horses she also held a leadership position with the national barrel horse association however her background and interest in horses are not necessarily synonymous with expertise in horse barrel-racing as a business mrs cooper’s knowledge regarding barrel-horse competition is not inconsistent with the pursuit of such an activity as a hobby she had no experience with the economics of a profitable barrel-horse operation and she did not make an extensive study of the profit potential of training horses or of competing as a horse barrel-racer while a formal market study is not required her failure to make basic investigation of the factors that would affect profit is indicative of a lack of profit objective dunwoody v commissioner tcmemo_1992_721 underwood v commissioner tcmemo_1989_625 burger v commissioner tcmemo_1985_523 affd 809_f2d_355 7th cir factor the time and effort expended by the taxpayer in carrying on the activity the fact that the taxpayer devotes much of his or her personal time and effort to carrying on an activity may indicate a profit_motive sec_1_183-2 income_tax regs however the regulations effectively provide that time and effort are somewhat discounted as a factor when the activity has substantial recreational aspects sullivan v commissioner tcmemo_1998_ affd without published opinion 202_f3d_264 5th cir mrs cooper testified that she participated in horse shows on holidays and every weekend sometimes twice in one weekend keeping and showing horses has strong recreational aspects especially given her long-term interest in horses although the court believes that mrs cooper spent considerable time with her horses the court finds that this factor is not dispositive factor the expectation that assets used in the activity may appreciate in value an expectation that assets used in the activity will appreciate in value may indicate a profit objective sec_1 b income_tax regs mrs cooper briefly testified about a horse scooter she believed to be valued at dollar_figure based on training and winnings earned during her subsequent testimony mrs cooper stated that scooter actually belongs to her mother she testified about two other horses but merely speculated about their value factor the success of the taxpayer in carrying on similar or dissimilar activities a taxpayer’s past successes in similar or dissimilar activities is relevant in determining a profit objective sec_1_183-2 income_tax regs during mrs cooper also had a dog-breeding business which generated gross_receipts of dollar_figure and a loss of dollar_figure mrs cooper testified that she did not report mileage expenses and the cost of purchasing a dog so that the dog breeding business would seem more profitable additionally she used money she received from dog sales to fund her horse activities no evidence was provided to demonstrate that petitioner participated in mrs cooper’s horse barrel-racing activities in any manner other than providing financing thus any success he may have had as an automotive salesperson has no bearing on the assessment of the horse barrel-racing activities factors and taxpayer’s history of income or losses with respect to the activity and the amount of occasional profits if any which were earned an activity’s history of income or loss may reflect whether the taxpayer has a profit_motive sec_1_183-2 income_tax regs unless explained by customary business risks or unforeseen or fortuitous circumstances beyond the taxpayer’s control a record of continuous losses beyond the period customarily required to attain profitability may indicate that the activity is not engaged in for profit id respondent prepared sfrs for petitioner’s accounts for and no allowances were made for any expenses regarding mrs cooper’s horse barrel-racing activities respondent disallowed the loss claimed by petitioner on his subsequently filed form_1040 petitioner has not yet filed returns for and therefore the court has no information in the record regarding the history of income or loss from those activities factor the financial status of the taxpayer petitioner had substantial income from his automotive sales employment during the year in issue based on the record it appears he was financially capable of supporting the losses generated by mrs cooper’s horse barrel-racing activities factor elements of personal pleasure or recreation the presence of personal motives in carrying on an activity may indicate that the activity is not engaged in for profit especially where there are recreational or personal elements involved sec_1_183-2 income_tax regs see also 480_us_23 where the court stated that a hobby or amusement diversion does not qualify as constituting a profit objective mrs cooper has been an avid rider of horses since early childhood additionally in conducting her horse-related activities she gave riding lessons without charge and failed to pursue memberships that would have enabled her to obtain independent financing of her activities based upon the facts presented the court concludes that mrs cooper engaged in her horse barrel-racing activities primarily for recreation and personal pleasure the court finds that mrs cooper did not engage in her horse-barrel racing activities in with the primary objective of making a profit and therefore sustains respondent’s determination that petitioner is not entitled to deduct any amount in excess of the income derived from mrs cooper’s horse- related activities b additions to tax sec_6651 and under sec_7491 the commissioner has the burden of production in any court_proceeding with respect to the liability of any individual for any penalty or addition_to_tax 116_tc_438 in order to meet his burden of production the commissioner must come forward with sufficient evidence indicating that it is appropriate to impose the addition_to_tax in the particular case id pincite once the commissioner meets his burden of production the taxpayer must come forward with evidence sufficient to persuade a court that the commissioner’s determination is incorrect id pincite respondent determined that petitioner is liable for additions to tax for failure to timely file a return for taxable_year pursuant to sec_6651 and failure to make timely payment of tax pursuant to sec_6651 sec_6651 imposes an addition_to_tax for failure to timely file a tax_return the addition_to_tax is equal to percent of the amount of tax required to be shown on the return if the failure_to_file is not for more than month see sec_6651 an additional percent is imposed for each month or fraction thereof in which the failure_to_file continues to a maximum of percent see id sec_6651 provides for an addition_to_tax of percent per month up to percent for failure to pay the amount shown or required to be shown on a return a taxpayer may be subject_to both paragraphs and in which case the amount of the addition_to_tax under sec_6651 is reduced by the amount of the addition_to_tax under sec_6651 for any month to which an addition_to_tax applies under both paragraphs and the combined amounts under paragraph and paragraph cannot exceed percent per month sec_6651 the additions to tax under sec_6651 and are imposed unless the taxpayer establishes that the failure_to_file and or pay was due to reasonable_cause and not willful neglect 469_us_241 32_tc_479 affd 283_f2d_227 8th cir reasonable_cause requires the taxpayer to demonstrate that he exercised ordinary business care and prudence united_states v boyle supra pincite willful neglect is defined as a conscious intentional failure or reckless indifference id pincite petitioner’ sec_2001 return was due on date he stipulated that the return was faxed to respondent date after the notice_of_deficiency was issued at trial mrs cooper blamed their accountant for not preparing their return timely however it appears from the record that petitioner did not timely provide the accountant with the relevant information with which he could prepare the return under sec_6651 a return the irs prepared under sec_6020 is treated as the return filed by the taxpayer for purposes of determining the amount of the addition under sec_6651 see spurlock v commissioner tcmemo_2003_124 respondent prepared an sfr for that meets the requirements of sec_6020 respondent has satisfied his burden of producing evidence to show the additions to tax are appropriate petitioner has failed to show that he had reasonable_cause for failing to timely file the return or for failing to pay the tax respondent’s determination as to the sec_6651 and additions to tax is sustained sec_6654 respondent also determined that petitioner is liable for an addition_to_tax for failure to pay estimated_tax pursuant to sec_6654 sec_6654 provides that in the case of an underpayment of estimated_tax by an individual there shall be added to the tax an amount determined by multiplying the underpayment rate established under sec_6621 to the amount of the underpayment for the period of the underpayment unless the taxpayer demonstrates that one of the statutory exceptions applies imposition of the sec_6654 addition_to_tax is mandatory where prepayments of tax either through withholding or by making estimated quarterly tax_payments during the course of the taxable_year do not equal the percentage of total liability required under the statute see sec_6654 99_tc_202 the amount of the addition_to_tax under sec_6654 stated in the notice_of_deficiency is based on the sfr respondent prepared for petitioner prior to the filing of the notice_of_deficiency nothing in the record indicates petitioner made the required amount of estimated_tax payments for taxable_year and petitioner does not argue and the record does not indicate that any of the statutory exceptions apply accordingly the court concludes that petitioner is liable for the addition_to_tax reviewed and adopted as the report of the small_tax_case division decision will be entered under rule