t c memo united_states tax_court timothy j coburn petitioner v commissioner of internal revenue respondent docket no filed date richard a seigal and mark s gregory for petitioner michael j proto for respondent memorandum opinion wells judge respondent determined a deficiency in petitioner’s federal_income_tax of dollar_figure and a sec_6662 accuracy-related_penalty of dollar_figure the issue to be decided is whether petitioner must recognize discharge_of_indebtedness income in with respect to a loan on which petitioner defaulted unless otherwise indicated all section references are to the internal_revenue_code as amended and all rule references are to the tax_court rules_of_practice and procedure background the parties submitted the instant case fully stipulated without trial pursuant to rule the parties’ stipulations of fact are hereby incorporated by reference and are found as facts in the instant case at the time of filing the petition petitioner resided in glastonbury connecticut during petitioner received stock of phymatrix corporation phymatrix and carematrix corporation carematrix which had an aggregate value of dollar_figure at the time of receipt petitioner incurred a federal_income_tax liability of dollar_figure related to the receipt of the stock petitioner borrowed from carematrix an amount equal to the federal_income_tax liability the loan pledging big_number shares of phymatrix common_stock the collateral as security for the loan the loan and the pledge of the collateral are hereinafter collectively referred to as the loan transaction 1the record does not reveal the separate amount or value of the carematrix stock or the value of the phymatrix stock at the time of receipt by petitioner 2petitioner appears to have taken an aggregate basis in the stock of both carematrix and phymatrix equal to the aggregate dollar_figure value of these stocks at the time of receipt on date to complete the loan transaction petitioner executed the following three documents a promissory note the promissory note a stock pledge agreement the stock pledge agreement and a stock transfer power the stock transfer power the promissory note stock pledge agreement and stock transfer power are sometimes hereinafter referred to as the loan documents the promissory note provided that the principal and interest were due and payable on the earlier of either date or the date of the registration of any shares of phymatrix stock received by petitioner pursuant to an agreement dated date the promissory note further provided that petitioner would secure the liability underlying the promissory note with the collateral the stock pledge agreement also provided that petitioner was required to pledge the collateral as security for the liability underlying the promissory note and set forth the rights and duties of petitioner and carematrix with respect to the collateral the stock transfer power provided that petitioner sold assigned and transferred the collateral for value received at all relevant times abraham d gosman mr gosman served as chief_executive_officer and chairman of the board_of carematrix and was responsible for the terms of the loan documents as of date the collateral had an aggregate market_value of approximately dollar_figure which represented percent of the outstanding principal due on the promissory note at the request of carematrix petitioner delivered the loan documents to carematrix’s counsel on or about date carematrix took possession of the loan documents and the stock certificate for the collateral from its counsel the promissory note became due and payable on date at which time the outstanding principal and interest due was dollar_figure carematrix subsequently demanded payment but petitioner refused to pay alleging that the promissory note was nonrecourse and that carematrix held the collateral carematrix made no further collection efforts 3the parties stipulated the following with respect to the value of the collateral as of date pursuant to the note the shares pledged had an aggregate market_value of of the principal borrowed - approximately dollar_figure as noted above petitioner appears to have taken a basis in the carematrix and phymatrix stock equal to the value of the phymatrix and carematrix stock at the time the stock was received by petitioner during however the record provides no evidence that the value of the phymatrix stock was the same on date the date of the loan transaction as it was on the date that the stock was transferred to petitioner during because the value of the collateral may have fluctuated from the date that petitioner received the phymatrix stock until the date that petitioner pledged the phymatrix stock as collateral the aforementioned stipulation as to the value of collateral on date is insufficient to establish petitioner’s basis in the collateral on that date consequently we are unable to determine from the record petitioner’s basis in the collateral on date phymatrix filed a bankruptcy plan_of_reorganization which became effective on date the plan provided for the conversion of phymatrix stock to shares of the newly reorganized entity however the plan required that any phymatrix shares be tendered for conversion by date the collateral was not timely tendered for conversion respondent determined that petitioner’s default on the promissory note resulted in cancellation_of_indebtedness_income in the amount of dollar_figure and that petitioner should be subject_to an accuracy-related_penalty of dollar_figure discussion sec_61 provides that gross_income includes income_from_discharge_of_indebtedness which generally equals the amount due on the obligation less the amount of any consideration paid for the discharge 23_f3d_1032 6th cir affg tcmemo_1992_673 sec_61 provides that gross_income includes gains derived from dealings in property sec_1001 provides that gain from the sale_or_other_disposition of property is the excess of the amount_realized over the property’s adjusted_basis and that loss from the sale_or_other_disposition of property is the excess of the 4we note that sec_4 of the stock pledge agreement appears to require petitioner to tender the collateral for conversion pledge shares of the newly reorganized entity as security on the loan and deliver such pledged shares to carematrix property’s adjusted_basis over the amount_realized relying on 88_tc_435 respondent contends that petitioner’s default on the loan results in discharge_of_indebtedness income to petitioner pursuant to sec_61 petitioner contends that the loan default is treated as a sale_or_other_disposition of the collateral pursuant to sec_61 and sec_1001 rather than a discharge_of_indebtedness the facts and circumstances of the instant case demonstrate that petitioner abandoned the collateral in carematrix took possession of the loan documents and the stock certificate during the loan transaction carematrix demanded payment from petitioner in but petitioner refused to pay on grounds that 5respondent also cites carlins v commissioner tcmemo_1988_79 which relied on our holding in 88_tc_435 6we apply a facts and circumstances analysis to determine if or when an abandonment occurred cozzi v commissioner supra pincite the proper test is whether under the facts and circumstances it is clear for all practical purposes that the taxpayer will not retain the property an overt act of abandonment by the taxpayer is not necessary 188_f3d_866 7th cir affg tcmemo_1997_469 in 163_f3d_313 5th cir affg tcmemo_1997_298 the court_of_appeals for the fifth circuit stated that sec_61 applies if the debtor is relieved of the obligation to repay the debt and the debtor is relieved of title to the collateral however the court did not hold that sec_61 cannot apply in absence of a formal transfer of title consequently the formal passage of legal_title does not necessarily establish the time of abandonment l c springs associates v commissioner supra pincite the loan was nonrecourse and that carematrix held the collateral carematrix took no further action to collect the outstanding principal and interest on the loan from petitioner in an affidavit stipulated by the parties mr gosman stated that petitioner and carematrix intended that in the event of a default repayment would be made only from the collateral and no other source consequently we conclude that petitioner abandoned the collateral upon his default accordingly we consider the federal_income_tax consequences of petitioner’s default on the loan and abandonment of the collateral the parties in the instant case dispute whether the loan is recourse or nonrecourse the regulations under sec_1001 distinguish between a debtor’s disposition of collateral in satisfaction of an underlying nonrecourse_liability and a debtor’s disposition of collateral in satisfaction of an underlying recourse_liability specifically sec_1 a income_tax regs provides that the amount_realized on the 7respondent concedes that the loan constitutes bona_fide indebtedness 8such a distinction may affect the character of any gain_or_loss on the transaction and the availability of certain exclusions from gross_income see sec_1221 sec_108 sec_1_1001-2 income_tax regs discharge of liabilities -- a inclusion in amount_realized in general -- except as provided in paragraph a and of this section the amount_realized from a sale or other continued sale_or_other_disposition of property generally includes the amount of liabilities from which the debtor is discharged but that the amount_realized on the disposition of property securing a recourse_liability does not include discharge_of_indebtedness income consequently a debtor’s transfer or abandonment of property to a creditor in satisfaction of a nonrecourse_liability is treated as a sale_or_other_disposition of the property and any resulting income constitutes gain on the disposition of property rather than discharge_of_indebtedness incomedollar_figure 188_f3d_866 7th cir affg tcmemo_1997_469 in contrast a debtor’s transfer of property to a creditor in satisfaction of a recourse_liability results in gain from the sale_or_other_disposition of property to the extent that the fair_market_value of the property continued disposition of property includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition discharge_of_indebtedness --the amount_realized on a sale_or_other_disposition of property that secures a recourse_liability does not include amounts that are or would be if realized and recognized income from the discharge_of_indebtedness under sec_61 10if the amount of the nonrecourse_liability exceeds the value of the property at the time of the transfer the debtor realizes gain to the extent that the liability exceeds the debtor’s basis in the property at the time of transfer 461_us_300 exceeds its basis and to the extent that the liability exceeds the property’s fair_market_value discharge_of_indebtedness income is realized 111_tc_243 sec_1_1001-2 income_tax regs in the instant case petitioner contends that the loan is nonrecourse as to the recourse nature of the loan respondent is not of one mind respondent’s trial memorandum refers to the liability on the loan as nonrecourse respondent’s opening brief contends that the federal_income_tax result in the instant case does not depend on whether the loan is recourse or nonrecourse respondent’s reply brief however contends that the loan is recourse for the reasons discussed below we conclude that petitioner’s abandonment of the collateral did not result in discharge_of_indebtedness income to petitioner during petitioner’s taxable_year regardless of whether the liability underlying the promissory note is recourse or nonrecoursedollar_figure as stated above a debtor’s abandonment of collateral in satisfaction of a nonrecourse_liability is treated for federal_income_tax purposes as a sale of the collateral pursuant to sec_1001 l c springs associates v commissioner supra pincite consequently in the instant case assuming that the 11consequently we need not decide whether the loan is recourse or nonrecourse loan is nonrecourse we conclude that any income realized by petitioner on the abandonment of the collateral in satisfaction of the loan is properly treated for federal_income_tax purposes as a gain on the sale_or_other_disposition of the collateral rather than discharge_of_indebtedness income id see sec_1_1001-2 income_tax regs accordingly we would hold that petitioner realized no discharge_of_indebtedness income in were we to assume that the underlying liability is nonrecourse as noted above respondent’s trial memorandum and opening brief contend that the default resulted in discharge_of_indebtedness income to petitioner in respondent’s reply brief surprisingly contends for the first time that petitioner is alternatively liable for gain in the amount of dollar_figure representing an amount_realized of dollar_figure and a basis of zero however respondent does not offer any evidence to support respondent’s contention of a zero basis and the record contains no such evidence under such circumstances respondent is prohibited from raising such an issue for the first time on brief see 116_tc_450 petitioner would be prejudiced were we to consider such an issue indeed we note that respondent objected to petitioner’s motion for leave to supplement the evidentiary record with evidence of the value and basis of the collateral filed after respondent’s new argument in respondent’s reply brief which motion we denied petitioner obviously was surprised by respondent’s raising of a new issue on brief that required additional evidence to decide moreover we find respondent’s reliance on 88_tc_435 to be misplaced in cozzi the commissioner contended that the taxpayers realized discharge_of_indebtedness income upon their abandonment of worthless collateral securing a nonrecourse_liability the taxpayers in cozzi contended that they did not realize discharge_of_indebtedness income because they did not abandon the collateral during the year in issuedollar_figure id pincite we held that the facts and circumstances evidenced an abandonment of worthless collateral by the taxpayers during the year in issue and that such an abandonment of worthless collateral securing a nonrecourse_liability established a discharge of the underlying liability id pincite cozzi did not involve a dispute of whether a debtor’s abandonment of collateral should be treated for federal_income_tax purposes as generating income from a sale or from a discharge of the underlying nonrecourse_liability we now turn to an analysis of the federal_income_tax treatment of the loan default and abandonment of the collateral based upon the assumption that the loan was recourse in contrast to a nonrecourse_liability a debtor’s abandonment of 12the taxpayers in cozzi appear to have conceded that discharge_of_indebtedness income would result from an abandonment of the collateral collateral securing a recourse_liability upon the debtor’s default on the liability alone does not extinguish the underlying liability 94_tc_252 unlike collateral securing a nonrecourse_liability the collateral securing a recourse_liability does not represent the only source of repaymentdollar_figure in the instant case the loan documents provide carematrix with the right to enforce petitioner’s repayment of the loan irrespective of whether petitioner abandoned the collateral to carematrixdollar_figure 13black’s law dictionary 7th ed provides the following definitions of a recourse note and a nonrecourse note recourse note a note that may be satisfied upon default by pursuing the debtor’s other assets in addition to the collateral securing the note cf nonrecourse note nonrecourse note a note that may be satisfied upon default only by means of the collateral securing the note not by the debtor’s other assets cf recourse note 14we recognize and petitioner does not dispute that the terms of the loan documents on their face provide for a recourse_liability petitioner instead contends that the loan is nonrecourse based upon two alternative contentions the first contention is that the substance rather than the form of the transaction should govern and that the underlying facts and circumstances support the conclusion that the loan is nonrecourse alternatively petitioner contends that the parties intended for the loan to be nonrecourse that the parties made a mutual mistake in executing a promissory note that did not accurately reflect their intent and that the terms of the loan documents should be reformed to accurately reflect such intent petitioner contends that petitioner transferred the collateral to carematrix in satisfaction of a nonrecourse_liability that the transfer of the collateral is properly treated as the sale continued specifically the promissory note provides that a release of the collateral by petitioner does not satisfy petitioner’s obligation the petitioner’s liability hereunder shall remain unimpaired notwithstanding the release of all or any part of security the promissory note also does not waive the right of carematrix to pursue legal remedies upon nonpayment carematrix shall not by any act delay omission or otherwise be deemed to waive any of its rights or remedies hereunder unless such waiver be in writing and signed by carematrix and then only to the extent expressly set forth therein the stock pledge agreement provides that the pledge is to remain in effect until the loan is paid in full at which time carematrix is to return the collateral to petitioner termination of pledge this pledge shall remain in effect until all terms and conditions of the note have been satisfied in full and the indebtedness has been paid in full whereupon the lender shall forthwith assign transfer and deliver to petitioner without representation warranty or recourse against the appropriate receipts all the pledged shares if any then held by it in pledge hereunder additionally the period of limitations for carematrix to commence an action to enforce petitioner’s repayment does not expire until date see mass gen laws ch continued of the collateral during petitioner’s taxable_year and that such a sale does not result in discharge_of_indebtedness income supp dollar_figure the foregoing demonstrates that petitioner’s abandonment of the collateral assuming the loan was recourse did not discharge petitioner from the loan during petitioner’s taxable_year carematrix would have until at least date to enforce payment on the loan if it is recourse a taxpayer must recognize income from the discharge_of_indebtedness where a liability exists at the time of the alleged discharge and the taxpayer was in fact discharged from such liability babin v commissioner f 3d pincite waterhouse v commissioner tcmemo_1994_467 in the instant case the loan default does not result in discharge_of_indebtedness income assuming the loan was recourse because petitioner was never discharged from liability on the loan accordingly we hold that petitioner realized no discharge_of_indebtedness income with respect to the loan for petitioner’s taxable_year 15in the instant case the promissory note provides this note shall be governed by and construed in accordance with the laws of the commonwealth of massachusetts to the maximum extent the parties may so lawfully agree similarly the stock pledge agreement provides this agreement shall in all respects be construed and interpreted in accordance with and governed by the laws of the commonwealth of massachusetts consequently the laws of massachusetts govern the interests and rights of the parties with respect to these documents see 80_tc_512 mass gen laws ch sec provides that an action to enforce payment of a note must be commenced within years after the due_date stated in the note as noted above the promissory note provided for a due_date of date on the basis of the foregoing we hold that petitioner did not realize discharge_of_indebtedness income with respect to the loan default and abandonment of the collateral and that petitioner is not liable for a sec_6662 accuracy-related_penalty we have considered all contentions that the parties have raised to the extent not addressed herein those contentions are without merit or unnecessary to reach to reflect the foregoing decision will be entered for petitioner


internal_revenue_service number release date index number --------------------------------- ----------------------- ---------------------------------- ------------------------ legend department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------------- telephone number --------------------- refer reply to cc intl b05 plr-115677-11 date date -------------------------------- parent u s sub ---------------------------------------------------------------- cfc1 cfc2 ------------------------------------------- ------------------------------------------------------- cfc3 --------------------------------------------------------- state a country a agency annual report x y z ------------------ -------- ----------------------------------------- ---------------------------------------------------------------- ---------------------------------------------------------------- ---------------------------------------------------------------- ---------------------------------------------------------------- ----------------- ------------- ------------------- dear --------------- we respond to your letter dated x and your supplemental letter dated z requesting a ruling that certain reserves held by certain foreign subsidiaries for life_insurance and annuity_contracts required to be set forth on the financial statements and filed with the life_insurance regulators of country a are an appropriate means of measuring income within the meaning of sec_954 of the internal_revenue_code_of_1986 as amended hereinafter all section references are to the internal_revenue_code_of_1986 as amended the rulings given in this letter are based on facts and representations submitted by parent and its subsidiaries and accompanied by a penalties 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 facts parent is a publicly-traded domestic_corporation that is engaged through its many subsidiaries in various lines of business which primarily include domestic life_insurance asset management and international life_insurance parent owns all the stock of us sub a state a holding corporation for parent s life_insurance subsidiaries operating in foreign countries us sub directly and indirectly owns all the stock of cfc1 cfc2 and cfc3 cfc1 cfc2 and cfc3 were formed under the laws of country a and are engaged in the life_insurance business in country a each is a controlled_foreign_corporation as defined in sec_957 us sub also owns the stock of other foreign_corporations engaged in the life_insurance business in other foreign countries and certain corporate-center assets and liabilities related to the international insurance_business country a regulates any insurance_business conducted in country a through its insurance laws and regulations a government agency the aagency is responsible for enforcing insurance laws and regulations in country a an insurance_company must obtain a license from the agency to conduct an insurance_business in country a cfc1 cfc2 cfc3 are licensed by the agency to sell life_insurance and annuity_contracts to residents of country a and are subject_to regulation by the agency as life_insurance_companies each derives more than percent of its aggregate net written premiums from its issuance of life_insurance and annuity_contracts covering risks in connection with the lives or health of residents of country a and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in code sec_954 neither cfc1 cfc2 nor cfc3 carries on non-life insurance businesses other than certain businesses which are incidental to the life_insurance business the life_insurance and annuity_contracts issued by cfc1 cfc2 and cfc3 are regulated as life_insurance and annuity_contracts by the agency parent has represented that cfc1 cfc2 and cfc3 would be subject_to tax under subchapter_l if they were domestic corporations as required by country a s insurance laws and regulations i cfc1 cfc2 and cfc3 file annual reports aannual reports and financial statements with the agency ii the annual reports of cfc1 cfc2 and cfc3 are audited by an outside accounting auditor in addition to the company s auditor iii the accounting_records of cfc1 cfc2 and cfc3 that form the basis for preparing the annual reports are subject_to inspection by the agency at any time and iv the annual reports of cfc1 cfc2 and cfc3 are made available to the public cfc1's cfc2's and cfc3’s annual reports are used for financial purposes in addition to regulatory purposes such as for credit rating purposes month y is the official year-end for life_insurance_companies operating in country a in accordance with required rules for life_insurance_companies conducting business in country a cfc1 cfc2 cfc3 each set forth the computation method for its underwriting reserves on its license application the computation method must be based on an actuarial calculation must be reasonable and appropriate and must conform to any other standards prescribed by the agency any change in the method of calculating such reserves requires advance notice to the agency and may not be allowed by the agency to comply with country a s insurance laws regulations and other guidance promulgated by the agency cfc1 cfc2 cfc3 must establish and maintain certain reserves for obligations to holders of their life_insurance and annuity_contracts and must set forth the amount of such reserves on the annual report these reserves are underwriting reserves including reserves for variable_contracts and loss_reserves the rules for calculating these reserves are prescribed by insurance laws regulations and other agency guidance and are summarized below underwriting reserves must be held to secure the performance of obligations arising in the future from the life_insurance and annuity_contracts issued by cfc1 cfc2 and cfc3 in country a underwriting reserves are comprised of insurance premium reserves unearned_premium reserves and risk reserves the sum of insurance premium reserves and unearned_premium reserves referred to as the astandard valuation reserve for life_insurance and annuity_contracts may not be less than the amount calculated in accordance with the designations of the agency concerning the reserve_method interest rate mortality rate and other coefficients the agency requires life_insurance_reserves to be determined as follows the prescribed reserve_method for life_insurance is the net_level_premium anlp method the prescribed mortality_table is the standard mortality_table generated by the institute of actuaries of country a and the prescribed standard interest rate assumption is based on 10-year government bonds of country a the agency requires fixed annuity reserves to be determined using the same assumptions as life_insurance_reserves except that a different mortality_table is prescribed under the prescribed rules for variable_annuity reserves the total of amounts credited to the separate_accounts for policyholders must be held as premium reserves notwithstanding that the nlp reserve_method is the agency-prescribed reserve_method the agency has granted cfc1 cfc2 and cfc3 approval to use the 5-year zillmer method to calculate its standard valuation reserve for a period of time before reaching nlp reserves when the 5-year zillmer method is used cfc1's cfc2's and cfc3’s standard valuation reserves may be less than those reserves would be under the nlp reserve_method as a result in such a case the agency also requires cfc1 cfc2 and cfc3 to maintain additional risk reserves the risk reserves are comprised of a mortality risk reserve and an interest rate assumption risk reserve the predominate part of the mortality risk reserve is for ordinary death risk which is generally equal to per net amount_at_risk under the policy the interest rate assumption risk reserve is calculated as the sum of i a factor depending on the interest rate assumption times the standard valuation reserve for current issues the factor is and ii percent of the standard valuation reserve currently cfc1 cfc2 and cfc3 each holds reserves determined under the nlp method each of cfc1 and cfc3 also currently holds some reserves determined under the zillmer method and special risk reserves comprising both mortality risk reserves and interest rate assumption risk reserves with respect to their zillmer reserves the zillmer reserve and special risk reserves of cfc1 and cfc3 are less than the underwriting reserve that would need to be maintained if cfc1 or cfc3 determined such reserves under the nlp method currently the total underwriting reserves held by cfc1 cfc2 and cfc3 for life_insurance and fixed annuity_contracts are less than the standard valuation reserves would be for such contracts if calculated using the nlp method loss_reserves must be held for outstanding claims including incurred but not reported claims under life_insurance and annuity_contracts issued by cfc1 cfc2 and cfc3 in country a cfc1 cfc2 and cfc3 calculate the reserves using the company s individual loss experience in accordance with rules and regulations prescribed by the agency in accordance with required rules for life_insurance_companies licensed to do business in country a cfc1 cfc2 and cfc3 have each appointed a qualified actuary to be involved in matters prescribed by the agency as actuarial matters specifically including the method of calculating reserves the actuary must have necessary knowledge and experience concerning actuarial matters and must meet requirements prescribed by the agency the actuary is required to submit a written opinion to the board_of directors of the company and to the agency concerning whether or not the reserves relating to the insurance contracts prescribed by the agency are established and maintained in accordance with actuarial soundness parent and certain of its subsidiaries have requested a ruling that the underwriting reserves and loss_reserves which are required to be maintained by cfc1 cfc2 and cfc3 by the agency for their life_insurance and annuity_contracts on annual reports are an appropriate means of measuring income within the meaning of sec_954 and accordingly are the amount of reserves that may be used in determining each company s foreign_personal_holding_company_income under sec_954 law in general a united_states_shareholder of a controlled_foreign_corporation acfc must include in gross_income its pro-rata share of the cfc s subpart_f_income for each year sec_951 subpart_f_income includes among other types of income foreign_base_company_income sec_952 sec_954 defines the term aforeign base_company income to include among other types of income foreign_personal_holding_company_income sec_954 sets forth the types of income eg interest and dividends that are considered to be foreign_personal_holding_company_income sec_954 sec_954 provides that for purposes of sec_954 foreign_personal_holding_company_income does not include aqualified insurance_income of a aqualifying insurance_company sec_953 defines a aqualifying insurance_company as any controlled_foreign_corporation which a is subject_to regulation as an insurance_company by its home_country and is licensed authorized or regulated by the applicable_insurance_regulatory_body for its home_country to sell insurance or annuity_contracts to persons other than related_persons within the meaning of code sec_954 in such home_country b derives more than percent of its aggregate net written premiums from the issuance by such controlled_foreign_corporation of contracts covering applicable_home_country_risks of such corporation and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in code sec_954 and c is engaged in the insurance_business and would be subject_to tax under subchapter_l if it were a domestic_corporation sec_953 defines the term aapplicable home_country risks to include risks in connection with the lives or health of residents of the home_country of the qualifying_insurance_company issuing the contract covering the risks sec_954 defines the term aqualified insurance_income to mean income of a qualifying_insurance_company falling into either of two categories first income received from unrelated persons and derived from investments made by a qualifying_insurance_company or qualifying_insurance_company_branch collectively referred to as a aqic either of its reserves allocable to exempt contracts or of percent of its unearned premiums from exempt contracts as both are determined in accordance with sec_954 sec_954 second income received from unrelated persons and derived from investments made by a qic of an amount of its assets allocable to exempt contracts equal to in the case of property casualty or health insurance contracts one-third of the premiums earned on those contracts during such year and in the case of life_insurance or annuity_contracts percent of the reserves described in sec_954 for such contracts sec_954 exempt contracts are defined under sec_953 to include insurance or annuity_contracts issued by a qualifying_insurance_company in connection with the lives or health of residents of a country other than the u s but only if such company derives more than percent of its net written premiums from otherwise exempt contracts which cover applicable_home_country_risks and with respect to which no policyholder insured annuitant or beneficiary is a related_person within the meaning of sec_954 sec_954 generally provides that in the case of life_insurance and annuity_contracts a qic s reserves allocable to exempt contracts are equal to the greater of the net_surrender_value of the contract or the reserve determined under sec_954 sec_954 however provides the amount of the reserves under code sec_954 shall be the foreign statement reserve for the contract less any catastrophe deficiency equalization or similar reserves if pursuant to a ruling_request submitted by the taxpayer or as provided in published guidance the secretary determines that the factors taken into account in determining the foreign statement reserve provide an appropriate means of measuring income code sec_954 was enacted by sec_614 of the job creation and worker assistance act of the staff of the joint_committee on taxation explains this provision as follows the provision does however permit a taxpayer in certain circumstances subject_to approval by the irs through the ruling process or in published guidance to establish that the reserve for such contracts is the amount taken into account in determining the foreign statement reserve for the contract reduced by catastrophe equalization or deficiency reserve or any similar reserve irs approval is to be based on whether the method the interest rate the mortality and morbidity assumptions and any other factors taken into account in determining foreign statement reserves taken together or separately provide an appropriate means of measuring income for federal_income_tax purposes in seeking a ruling the taxpayer is required to provide the irs with necessary and appropriate information as to the method interest rate mortality and morbidity assumptions and other assumptions under the foreign reserve rules so that a comparison can be made to the reserve amount determined by applying the tax_reserve_method that would apply if the qualifying_insurance_company were subject_to tax under subchapter_l of the code with the modifications provided under present law for purposes of these exceptions the irs also may issue published guidance indicating its approval staff of the joint comm on taxation technical explanation of the ajob creation and worker assistance act of jcx-12-02 date analysis cfc1 cfc2 and cfc3 are each subject_to regulation as a life_insurance_company by country a each is licensed authorized and regulated by the agency which is the insurance regulatory body for country a to sell life_insurance and annuity_contracts to persons other than related_persons within the meaning of code sec_954 in country a cfc1 cfc2 and cfc3 have each represented that it derives more than percent of its aggregate net written premiums from its issuance of life_insurance and annuity_contracts covering risks in connection with the lives or health of residents of country a and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in code sec_954 finally cfc1 cfc2 and cfc3 are engaged in the life_insurance business and would be subject_to tax under subchapter_l if they were domestic corporations accordingly cfc1 cfc2 and cfc3 are qics cfc1 cfc2 and cfc3 issue life_insurance and annuity_contracts in connection with the lives and health of residents of country a a country other than the u s moreover cfc1 cfc2 and cfc3 each derive more than percent of its net written premiums from contracts that cover country a risks with respect to which no policyholder insured annuitant or beneficiary is a related_person within the meaning of sec_954 such contracts are therefore exempt contracts within the meaning of sec_953 we have determined that the underwriting reserves held by cfc1 cfc2 and cfc3 for their exempt contracts that are life_insurance or annuity_contracts are foreign statement reserves within the meaning of code sec_954 for the following reasons cfc1 cfc2 and cfc3 must establish maintain and calculate their underwriting reserves in accordance with the insurance laws and regulations of country a and guidance prescribed by the agency the agency generally requires a life_insurance_company to determine the amount of its underwriting reserves under the nlp method however the agency allows cfc1 cfc2 and cfc3 to calculate their underwriting reserves under the zillmer method provided these companies also maintain special risk reserves for mortality and investment risk currently cfc1 cfc2 and cfc3 each holds reserves under the nlp method each of cfc1 and cfc3 also currently holds some reserves determined under the zillmer method and special risk reserves comprising both mortality risk reserves and interest rate assumption risk reserves with respect to their zillmer reserves the zillmer reserve and special risk reserves of cfc1 and cfc3 are less than the underwriting reserve that would need to be maintained if cfc1 or cfc3 determined their reserves under the nlp method cfc1 cfc2 and cfc3 must set forth their underwriting reserves on the annual reports which must be filed annually with the agency as such these reserves are the measure of the legal obligations to contractholders on the financial statement used for regulatory purposes by life_insurance_companies doing business in country a generally whether u s -owned locally owned or owned by companies headquartered in other foreign countries the agency requires that cfc1 cfc2 and cfc3 hold their underwriting reserves to enable them to fulfill claims owed to contractholders and their beneficiaries under these circumstances the underwriting and risk reserves are not catastrophe deficiency equalization or similar reserves we have also determined that the loss_reserves held by cfc1 cfc2 and cfc3 for their exempt contracts that are life_insurance or annuity_contracts are foreign statement reserves within the meaning of code sec_954 for the following reasons cfc1 cfc2 and cfc3 must establish maintain and calculate loss_reserves in accordance with the insurance laws and regulations of country a and guidance issued by the agency cfc1 cfc2 and cfc3 must set forth their loss_reserves on the annual reports which must be filed annually with the agency as such they are the measure of the legal obligations to the contractholders on the financial statement used for regulatory purposes by life_insurance_companies doing business in country a generally whether u s -owned locally owned or owned by companies headquartered in other foreign countries the agency requires cfc1 cfc2 and cfc3 to hold loss_reserves for the fulfillment of the claims of contractholders and their beneficiaries cfc1's cfc2’s and cfc3's loss_reserves are not catastrophe deficiency equalization or similar reserves rulings based on the information submitted and the representations made we rule as follows under the facts set forth above the underwriting reserves including risk reserves of cfc1 cfc2 and cfc3 for their exempt contracts that are life_insurance or annuity_contracts as required to be calculated for purposes of the annual reports filed with the agency are an appropriate means of measuring income within the meaning of sec_954 and accordingly are the amount of these reserves that may be used in determining each company s foreign_personal_holding_company_income under sec_954 the loss_reserves of cfc1 cfc2 and cfc3 for their exempt contracts that are life_insurance or annuity_contracts as required to be calculated for purposes of the annual reports filed with the agency are an appropriate means of measuring income within the meaning of sec_954 and accordingly are the amount of reserves that may be used in determining each company s foreign_personal_holding_company_income under sec_954 caveats we express no opinion on any provisions of the code or regulations not specifically covered by the above ruling in particular no opinion is expressed regarding whether the irs would determine if some or all of the risk reserves would constitute foreign statement reserves within the meaning of code sec_954 in circumstances where such risk reserves cause total underwriting reserves to exceed the standard valuation reserve using the reserve_method prescribed by the agency for such contracts in addition our rulings are solely determinations that certain foreign reserves are an appropriate means of measuring income within the meaning of sec_954 and for no other purpose procedural statements this ruling is directed only to parent and certain of its subsidiaries sec_6110 provides that it may not be used or cited as precedent parent should attach a copy of this ruling letter to its federal_income_tax return for the taxable years to which this letter applies plr-115677-11 in accordance with the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representatives sincerely steven d jensen senior counsel branch international


internal_revenue_service number release date index number ----------------------- ------------------------------------------------- ------------------------------------- ----------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------- id no ----------------- telephone number -------------------- refer reply to cc psi b05 plr-137108-10 date march legend taxpayer ------------------------------------------------- ------------------------- corp ---------------------------------------------------- ---------------------------- corp ------------------------------------------------------ generator ---------------------------------------------------- --------------------------- state state facility site ------------- ------------- ---------------------------- ---------------------------------------------------------------- substation ------------------------------------------------- substation --------------------------------------------- date -------------------------- agreement ----------------------------------------------------------- plr-137108-10 agreement -------------------------------------------------------- agreement ------------------------------------------------- c d e f g ------------- ------------- ------ --- -- dear ---------------- this letter responds to your letter dated date requesting a letter_ruling concerning whether the transfer of an intertie from generator to taxpayer is a nonshareholder contribution_to_capital excludable from taxpayer’s income under sec_118 of the internal_revenue_code taxpayer is a state corporation engaged in the business of generating transmitting and distributing electrical energy to wholesale and retail customers predominantly in state taxpayer is a wholly-owned subsidiary of corp a state corporation taxpayer and corp file a consolidated federal_income_tax return on a calendar_year basis using the accrual_method of accounting generator a state limited_liability_company will own operate and maintain facility located at site generator submitted applications to taxpayer for interconnection of facility with the transmission and distribution system belonging to taxpayer and corp collectively the grid at substation on date taxpayer filed agreement agreement and agreement collectively the agreements between taxpayer and generator under the agreements generator requests that taxpayer interconnect facility to taxpayer’s distribution system via a dedicated position at substation taxpayer will engineer design procure construct install own operate and maintain the facilities required to interconnect facility to taxpayer’s distribution system the interconnection facilities taxpayer also will engineer design procure construct install own operate and maintain certain upgrades to its distribution system distribution upgrades generator is responsible for the costs of those assets which are estimated to be dollar_figurec agreement specifies the terms and conditions under which taxpayer will engineer design procure construct install own operate and maintain the ----------- plr-137108-10 facilities and for generator to pay for the ------------facilities the ------------facilities are the facilities necessary to connect facility’s switchyard to the interconnection facilities at substation other than the interconnection facilities and the distribution upgrades the cost of the ------------facilities is estimated to be dollar_figured the interconnection facilities the distribution upgrades and the -------------- facilities together are referred to as the intertie agreement sets forth taxpayer’s agreement to provide distribution service for e megawatts produced by facility from facility’s interconnection at substation to the grid at substation agreement terminates on the earliest of f years from the commencement of distribution service under agreement or the termination of agreement agreement has a term of f years and is automatically renewed for each successive g-year period taxpayer will be the owner and sole operator of the intertie and the intertie will become a permanent part of taxpayer’s transmission and distribution system generator has entered into contracts and expects to enter into additional contracts with end users and power marketers to sell power from facility taxpayer represents that the intertie will not be included in taxpayer’s rate base and that taxpayer will not take any depreciation_deductions with respect to the intertie generator represents facility is a stand-alone generator as contemplated under notice_2001_82 the intertie will be used in connection with the transmission and distribution of electricity for sale to third parties title to the electricity will pass to purchasers at the busbar on facility’s end of the intertie generator will capitalize the contribution as an intangible asset and recovered using the straight-line method_of_accounting over a useful_life of years and any portion of the intertie that is a dual use intertie within the meaning of notice_88_129 1988_2_cb_541 is reasonably expected to carry no more than a de_minimis amount of electricity to facility or to generator or a related_person defined as no more than percent of the projected power flows in both directions over the intertie during generator’s first years after the intertie is placed_in_service taxpayer requests a ruling that the contribution of cash for construction of the intertie by generator to taxpayer will not be considered a contribution_in_aid_of_construction under sec_118 ciac and will be excludable from taxpayer’s income as a non-shareholder contribution_to_capital under sec_118 sec_61 and sec_1_61-1 of the income_tax regulations provide that gross_income means all income from whatever source derived unless excluded by law sec_118 provides that in the case of a corporation gross_income does not include any contribution_to_the_capital_of_the_taxpayer sec_118 as amended by a of the tax_reform_act_of_1986 the act and a of the small plr-137108-10 business job protection act of provides that for purposes of subsection a except as provided in subsection c the term contribution to the capital of taxpayer does not include any ciac or any other contribution as a customer or potential customer sec_1_118-1 of the income_tax regulations provides in part that sec_118 also applies to contributions to capital made by persons other than shareholders for example the exclusion applies to the value of land or other_property contributed to a corporation by a governmental_unit or by a civic group for the purpose of enabling the corporation to expand its operating facilities however the exclusion does not apply to any money or property transferred to the corporation in consideration for goods or services rendered or to subsidies paid to induce the taxpayer to limit production the legislative_history to sec_118 indicates that the exclusion_from_gross_income for nonshareholder contributions to capital of a corporation was intended to apply to those contributions that are neither gifts because the contributor expects to derive indirect benefits nor payments for future services because the anticipated future_benefits are too intangible the legislative_history also indicates that the provision was intended to codify the existing law that had developed through administrative and court decisions on the subject h_r rep no 83rd cong 2d sess s rep no 83d cong 2d sess notice_88_129 1988_2_cb_541 as modified and amended by notice_90_60 1990_2_cb_345 and notice_2001_82 2001_2_cb_619 provides specific guidance with respect to the treatment of transfers of property to regulated public_utilities by qualifying small power producers and qualifying cogenerators collectively qualifying facilities as defined in sec_3 of the federal power act as amended by section of purpa the amendment of sec_118 by the act was intended to require utilities to include in income the value of any ciacs made to encourage the provision of services by a utility to a customer see h_r rep no 99th cong 2d sess in a ciac transaction the purpose of the contribution of property to the utility is to facilitate the sale of power by the utility to a customer in contrast the purpose of the contribution by a qualifying_facility to a utility is to permit the sale of power by the qualifying_facility to the utility accordingly the fact that the amendments to sec_118 render ciac transactions taxable to the utility does not require a similar conclusion with respect to transfers from qualifying facilities to utilities notice_88_129 provides that with respect to transfers made by a qualifying_facility to a utility exclusively in connection with the sale of electricity by the qualifying_facility to the utility a utility will not realize income upon transfer of interconnection equipment intertie by a qualifying_facility the possibility that an intertie may be used to transmit power to a utility that will in turn transmit the power across its transmission plr-137108-10 network for sale by the qualifying_facility to another utility wheeling will not cause the contribution to be treated as a ciac further the notice provides that a transfer from a qualifying_facility to a utility will not be treated as a qualifying_facility transfer qf transfer under this notice to the extent the intertie is included in the utility’s rate base moreover a transfer of an intertie to a utility will not be treated as a qf transfer under this notice if the term of the power purchase contract is less than ten years the notice also provides that a utility that constructs an intertie in exchange for a cash payment from a qualifying_facility pursuant to a purpa contract will be deemed to construct the property under contract and will recognize income from the construction in the same manner as any other taxpayer constructing similar_property under contract subsequent to the construction of the property the qualifying_facility will be deemed to transfer the property to the utility in a qf transfer that will be treated in exactly the same manner as an in-kind qf transfer notice_2001_82 amplifies and modifies notice_88_129 notice_2001_82 extends the safe_harbor provisions of notice_88_129 to include transfers of interties from non- qualifying facilities and transfers of interties used exclusively or in part to transmit power over the utility’s transmission grid for sale to consumers or intermediaries wheeling the notice requires that ownership of the electricity wheeled passes to the purchaser prior to its transmission on the utility’s transmission grid this ownership requirement is deemed satisfied if title passes at the busbar on the generator’s end of the intertie further notice_2001_82 provides that a long-term interconnection agreement in lieu of a long-term power purchase contract may be used to satisfy the safe_harbor provisions of notice_88_129 in wheeling transactions finally notice_2001_82 requires that the generator must capitalize the cost of the property transferred as an intangible asset and recover such cost using the straight-line method over a useful_life of years in the instant case the transfer of the intertie is subject_to the guidance set forth in notice_88_129 notice_90_60 and notice_2001_82 for the following reasons facility is a stand-alone generator as contemplated under notice_2001_82 generator and taxpayer entered into a long-term interconnection agreement the intertie will be used in connection with the transmission of electricity for sale to third parties wheeling the cost of the intertie paid_by generator will not be included in taxpayer’s rate base taxpayer will not take any depreciation_deductions with respect to the intertie based on all available information the portion of the intertie that is a dual use intertie is reasonably expected to carry no more than percent of the projected power flows in both directions over the intertie during the first taxable years beginning in the year the intertie is placed_in_service ownership of the electricity produced by facility that is wheeled will pass to the purchaser prior to its transmission on taxpayer’s transmission grid and the cost of the intertie will be capitalized by plr-137108-10 generator as an intangible asset and recovered using the straight-line method over a useful_life of years thus we conclude that the deemed contribution of the intertie by generator to taxpayer meets the safe_harbor requirements of notice_88_129 as amended and modified by notice_90_60 and notice_2001_82 next we must decide whether the contribution qualifies as a contribution_to_capital under sec_118 the legislative_history of sec_118 provides in part as follows this sec_118 in effect places in the code the court decisions on the subject it deals with cases where a contribution is made to a corporation by a governmental_unit chamber of commerce or other association of individuals having no proprietary interest in the corporation in many such cases because the contributor expects to derive indirect benefits the contribution cannot be called a gift yet the anticipated future_benefits may also be so intangible as to not warrant treating the treating the contribution as a payment for future services s rep no 83d cong 2d sess in 319_us_98 the court held that payments by prospective customers to an electric utility company to cover the cost of extending the utility’s facilities to their homes were part of the price of service rather than contributions to capital the case concerned customers’ payments to a utility company for the estimated cost of constructing service facilities primary power lines that the utility company otherwise was not obligated to provide the customers intended no contribution to the company’s capital later in 339_us_583 1950_1_cb_38 the court held that money and property contributions by community groups to induce a shoe company to locate or expand its factory operations in the contributing communities were nonshareholder contributions to capital the court reasoned that when the motivation of the contributors is to benefit the community at large and the contributors do not anticipate any direct benefit from their contributions the contributions are nonshareholder contributions to capital id pincite finally in 412_us_401 the court in determining whether a taxpayer was entitled to depreciate the cost of certain facilities that had been funded by the federal government held that the governmental subsidies were not contributions to the taxpayer’s capital the court recognized that the holding in detroit edison co had been qualified by its decision in brown shoe co the court in chicago burlington quincy railroad co found that the distinguishing characteristic between those two cases was the differing plr-137108-10 purpose motivating the respective transfers in brown shoe co the only expectation of the contributors was that such contributions might prove advantageous to the community at large thus in brown shoe co since the transfers were made with the purpose not of receiving direct services or recompense but only of obtaining advantage for the general community the result was a contribution_to_capital the court in chicago burlington quincy railroad co also stated that there were other characteristics of a nonshareholder contribution_to_capital implicit in detroit edison co and brown shoe co from these two cases the court distilled some of the characteristics of a nonshareholder contribution_to_capital under both the and codes first the payment must become a permanent part of the transferee’s working_capital structure second it may not be compensation such as a direct payment for a specific quantifiable service provided for the transferor by the transferee third it must be bargained for fourth the asset transferred foreseeably must benefit the transferee in an amount commensurate with its value fifth the asset ordinarily if not always will be employed in or contribute to the production of additional income and its value assured in that respect the transfer of the intertie by generator to taxpayer possesses the characteristics of a nonshareholder contribution_to_capital as described in chicago burlington quincy railroad co first the intertie will become a permanent part of taxpayer’s working_capital structure second the transfer is not compensation_for services provided by for generator by taxpayer third the transfer is a bargained-for exchange fourth the transfer will foreseeably result in a benefit to taxpayer commensurate with its value because the intertie will become part of taxpayer’s transmission system fifth the intertie will be used by taxpayer in its trade_or_business for producing gross_income therefore taxpayer’s receipt from generator of the intertie will be a contribution_to_capital under sec_118 accordingly based solely on the foregoing analysis and the representations made by taxpayer we rule that the transfer of the intertie by generator to taxpayer will not be a ciac under sec_118 and will be excludable from the gross_income of taxpayer as a nonshareholder contribution_to_capital under sec_118 except as specifically set forth above no opinion is expressed or implied concerning the federal_income_tax consequences of the above described facts under any other provision of the code or regulations this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent this ruling is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an plr-137108-10 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 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely nicole r cimino nicole r cimino senior technician reviewer branch passthroughs special industries enclosure copy cc


offic e of c h ief c o u n sel number release date index nos department of the treasury i n t e r n al r e v e n u e s e r v i c e w as h i n g t o n d c date cc dom it a frev-105428-99 memorandum for internal_revenue_service from lewis j fernandez deputy assistant chief_counsel income_tax accounting subject tax treatment of certain adoption assistance payments legend state department z section x dollar_figurev dollar_figurex dollar_figurey dollar_figurez this technical assistance responds to your memorandum dated date you requested our views on the tax treatment of certain adoption assistance payments made by state to adoptive parents of special needs children specifically you have asked whether adoption assistance payments to adoptive parents are taxable_income and whether state must issue a form_1099 to the adoptive parents technical assistance does not relate to a specific case and is not binding on examination or appeals this document is not to be cited as precedent state operates a program under which it makes certain types of adoption assistance payments to adoptive parents of special needs children the payments may be provided to persons who are legally free for adoption for whom state’s department z department is legally responsible who are state residents and who the department has determined have special needs which make it reasonable to conclude that the child cannot be adopted without such assistance the payments are authorized by section x consistent with the requirements of federal_law state adoption assistance payments are not means-tested title iv-e of the social_security act u s c sec_674 is a federal grant program that reimburses in whole or in part state outlays to adoptive parents for nonrecurring adoption_expenses and ongoing child_support costs the federal grant program specifically prohibits states from using means-testing in determining adoptive parents’ eligibility to receive such payments cfr sec_1356 c however state may consider other circumstances of the adoptive parents and special needs children in determining the types and amounts of assistance under its program in general state considers a child a special needs child only if the following conditions are met there has been a judicial determination that either the child is abused neglected or dependent or there is probable cause to so believe and the department has determined that the child will suffer further abuse or neglect or will not be adequately cared for if returned to the parents and there has been an unsuccessful effort to place the child with adoptive parents without providing adoption assistance and the prospective adoptive parents have informed the department they are not willing or able to adopt the child without adoption assistance and the child has disabilities that are irreversible noncorrectable or correctable with surgery treatment or other specialized services or is at least three years of age or is a member of a sibling group being placed together if certain other conditions are met section x specifically describes three types of adoption assistance payments that the department makes the first type of payment is for the nonrecurring costs of adopting in fiscal_year state received dollar_figurex in adoption assistance grant awards under this program this condition may be waived if the department determines that alternative adoptive placement is not in the child’s best interests because the child has developed significant emotional ties with the prospective parents while in their foster care a child eg adoption fees court costs attorney fees not exceeding dollar_figurey per adopted_child nonrecurring payments the second type of payment described in section x is for the ongoing monthly costs of the child’s support ongoing payments the ongoing payments are not to exceed the licensed foster care payment level subject_to adjustment every two years or more frequently based on the changes in the circumstances of the adoptive parents and the needs of the adopted_child the department determines whether and if to make ongoing payments in each individual case by considering the circumstances of the adoptive parents and the needs age and type of placement of the child adjusted for any benefits the child receives such as social_security_benefits the third type of payment described in section x is payment for certain medical_care costs not payable through insurance or other public resources that are associated with or result from a condition whose onset occurred prior to completion of the adoption medical assistance payments state also makes adoption assistance payments when special needs children with pre-existing medical conditions or risk factors require care that was not needed at the time of adoption ongoing payments and medical_care payments are made only if the special needs child has been cared for by a person other than the natural parents for at least one year except for a disabled child and the child is eligible for certain state and federal benefits eg ssi benefits currently state reports the adoption assistance payments it makes in box nonemployee compensation of form 1099-misc a recipient of these payments has asked you whether state should be reporting these payments on form 1099-misc sec_61 of the internal_revenue_code provides the general_rule that except as otherwise provided by law gross_income includes all income from whatever source derived however the internal_revenue_service has held that payments under legislatively provided social benefit programs for the promotion of general welfare are not includible in an individual’s gross_income the general welfare exception in determining whether the general welfare exception applies to such payments the internal_revenue_service generally requires that the payments be made from a governmental general welfare fund be for the promotion of the general welfare ie on the basis of need rather than to all residents without regard to for example financial status health educational background or employment status and not be made with respect to services rendered by the recipient compare revrul_76_131 1976_1_cb_16 with revrul_98_19 1998_1_cb_840 relocation payments authorized under sec_105 of the housing_and_community_development_act_of_1974 u s c a made by a local jurisdiction to an individual moving from a flood-damaged residence is in the nature of general welfare and not includible in the individual’s gross_income under sec_61 in this case the special needs children have been displaced from their homes because state has determined that they i are neglected abused or dependent or there is probable cause to so believe and ii will suffer further abuse or neglect or will not be adequately cared for if they are returned to their parents the payments though made to the parents reimburse the parents for the support and maintenance of the children thus the payments are made from a governmental welfare fund are based on the needs of the special needs children and are not for services rendered because the payments are intended to reimburse the parents’ expenses of promoting the health and well-being of these special needs children the interposition of the parents as recipients of the payments does not preclude application of the general welfare exception state’s adoption assistance payments made pursuant to section x are therefore not includible in the recipients’ gross incomes consequently state should not issue forms for adoption assistance payments authorized under section x that are made directly to the adoptive parents of the special needs children we hope this memorandum is responsive to your request if you have any further questions please contact at


t c memo united_states tax_court estate of william j desmond deceased donn kemble executor petitioner v commissioner of internal revenue respondent docket no filed date donn kemble for petitioner jeffrey a schlei and michael h salama for respondent memorandum findings_of_fact and opinion vasquez judge respondent determined a deficiency of dollar_figure in and a sec_6662 penalty of dollar_figure on the federal estate_tax of the estate of decedent william j desmond all section references are to the internal_revenue_code in effect at the date of decedent's death and all rule references are to the tax_court rules_of_practice and procedure after concessions ’ the sole issue for decision is the fair_market_value of decedent's interest in deft inc deft and real_property located pincite rue verte newport beach california the newport property and pincite navajo road indian wells california the indian wells property findings_of_fact william j desmond decedent died on date at the time of his death decedent resided in orange county california on or about date an estate_tax_return on his behalf was filed for purposes of valuing his gross_estate petitioner’ elected to use the alternate_valuation_date date at the time the petition was filed petitioner resided in newport beach california at the time of his death decedent as trustee held big_number shares of deft stock this represented dollar_figure percent of deft's total outstanding shares the deft stock is closely held unlisted stock all stock in deft was subject_to a restrictive share agreement which provided that a shareholder could transfer his or her stock toa nonshareholder only after the shareholder offered the shares to the remaining shareholders the parties stipulated that petitioner is not liable for the negligence_penalty under sec_6662 additionally on brief respondent conceded that petitioner is entitled to deductions related to administrative expenses and for interest_paid references to petitioner are to the executor of decedent's_estate deft is an s_corporation that manufactures and sells industrial coatings for military and commercial aircraft heavy duty trucks and construction eguipment deft also manufactures and sells finishes and wood stains deft like other paint companies is a hazardous waste producer from until deft disposed of its hazardous waste at three disposal sites as a result of its waste disposal deft faced large potential environmental liabilities on decedent's_estate tax_return petitioner reported that the fair_market_value of decedent's interest in deft was dollar_figure this included a dollar_figure reduction for deft's potential environmental liabilities kpmg peat marwick kpmg computed this figure for purposes of preparing the estate_tax_return in addition to owning deft stock decedent also owned two pieces of real_property at his death on the estate_tax_return petitioner reported that on the alternate_valuation_date the fair_market_value of the newport property was dollar_figure on or about date the newport property was sold for a net sales_price of dollar_figure on the estate_tax_return petitioner reported that on the alternate_valuation_date the fair_market_value of the indian wells property was dollar_figure on or about date the indian wells property was sold for a net sales_price of dollar_figure opinion rt value of decedent's interest in deft a valuation of closely held unlisted stock property 1s included in a decedent's gross_estate at its fair_market_value as of the date of the decedent's death or if the executor elects as of the alternate_valuation_date see sec_2031 sec_2032 sec_20_2031-1 estate_tax regs under sec_2032 the alternate_valuation_date is the date months after the decedent's death fair_market_value is the price at which property would change hands between a willing buyer and a willing seller neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts see 411_us_546 88_tc_38 sec_20_2031-1 estate_tax regs the willing buyer and the willing seller are hypothetical persons see eg 94_tc_193 determining the fair_market_value of closely held unlisted corporate stock is difficult because it involves property that has no public market the valuation of such stock is a matter of judgment rather than of mathematics see 325_f2d_934 8th cir affg tcmemo_1961_347 the best_method for valuing closely held unlisted stock is by reference to actual arm's-length sales of the stock in the normal course of business within a reasonable_time before or after the valuation_date see 79_tc_938 sec_20_2031-2 estate_tax regs in the absence of arm's-length sales the court decides the stock's fair_market_value by considering factors such as the company's net_worth prospective earning power dividend-paying capacity management goodwill position in the industry the economic outlook in its industry and the values of publicly traded stock of comparable corporations see sec_2031 b 92_tc_312 estate of andrews v commissioner supra there is no fixed formula for applying these factors the weight accorded each factor is determined by the facts and circumstances of each case see 48_tc_502 as the trier of fact the court has broad discretion in weighing the various factors see 640_f2d_249 9th cir affg on this issue tcmemo_1978_191 when valuing unlisted stock it is sometimes appropriate to apply a lack of marketability discount to the price in order to reflect the absence of a recognized market for closely held stock and to account for the fact that closely held stock is generally not readily transferable see mandelbaum v commissioner tcmemo_1995_255 affd 91_f3d_124 3d cir estate of trenchard v commissioner tcmemo_1995_121 revrul_77_287 1977_2_cb_319 this discount also may reflect the expense of registering the unlisted stock for public sale see mandelbaum v commissioner supra estate of trenchard v commissioner supra some of the factors examined by courts in determining the amount of an appropriate lack of marketability discount are the cost of a similar corporation's public and private stock an analysis of the subject corporation's financial statements the corporation's dividend-paying capacity its history of paying dividends and the amount of its prior dividends the nature of the corporation its history its position in the industry and its economic outlook the corporation's management the degree of control transferred with the block of stock to be valued any restriction on the transferability of the corporation's stock the period of time for which an investor must hold the subject stock to realize a sufficient profit the corporation's redemption policy and the cost of effectuating a public offering of the stock to be valued see estate of gilford v commissioner supra pincite mandelbaum v commissioner supra revrul_77_287 supra additionally a control premium may be appropriate when valuing a large block of stock a control premium represents the additional value associated with the shareholder's ability to control the corporation through his dictation of its policies procedures or operations see 88_tc_1577 estate of trenchard v commissioner supra revrul_59_60 1959_1_cb_237 this premium for control is distinct and separate from any discount applied for lack of marketability see estate of trenchard v commissioner supra b expert reports regarding the fair_market_value of the deft stock in deciding valuation cases courts often look to expert opinions the court is not bound by the opinion of any expert and we may accept or reject in full or in part experts' opinions proffered by the parties see 304_us_282 102_tc_149 estate of newhouse v commissioner supra pincite 86_tc_547 84_tc_722 moreover the court is free to value property at a figure for which there is no specific testimony as long as it is within the range of figures that can be adduced from the evidence see 538_f2d_927 2d cir affg tcmemo_1974_285 110_tc_530 the parties herein rely on experts' opinions to establish the fair_market_value of decedent's interest in deft and whether and in what amount any discount or premium should be applied to that interest petitioner bears the burden_of_proof on these issues see rule a petitioner's expert petitioner relies on a report compiled by higgins marcus lovett inc hml to establish that the fair_market_value of the decedent's interest in deft on the alternate_valuation_date was dollar_figure initially hml determined the value of a 100-percent interest in deft without any discount using three methods of valuation the unadjusted values the adjusted net_worth_method the asset method the discounted_cash_flow_method the income_method and the guideline public companies method the market method under the asset method hml determined the unadjusted value on the alternate_valuation_date was dollar_figure in making this determination hml restated deft's tangible assets from book_value to fair_market_value hml then subtracted deft's liabilities from the fair_market_value of deft's tangible assets next hml determined the value of deft's intangible assets by capitalizing the excess if any of deft's current sustainable earning power over the normal expected_return of deft's tangible assets hml determined there was no excess therefore hml attributed no value to deft's intangible assets lastly hml added the net market_value of deft's tangible assets dollar_figure to the value of their intangible assets dollar_figure to derive the unadjusted value under this method petitioner also submitted a report prepared by tuerk associates analyzing the impact of the potential environmental liabilities on the marketability of the deft shares we find that report unhelpful and we do not rely on it these liabilities did not include deft's potential environmental liabilities hml determined the unadjusted value under the income_method was dollar_figure under this method hml determined the present_value of deft's future cash flows for the years following the valuation_date dollar_figure and the present_value of a terminal value computed for the fifth year dollar_figure using a 19-percent discount rate hml added these present values together to find the unadjusted value under this method under the market method hml examined eight publicly traded companies primarily engaged in the manufacture and sale of paint and coatings these companies had similar distribution channels to deft earned a profit over the last fiscal_year and possessed similar_business and financial characteristics to deft hml focused on the two companies that were most similar to deft---grow group and pratt lambert hml determined the average price to earnings multiple for each of the two companies although these two companies were the most similar to deft they were significantly larger than deft in terms of sales total assets and total market capitalization given these differences hml applied a 30-percent downward adjustment to the average market multiple of the two guideline public companies hml also added a 25-percent control premium to account for the fact that hml derived the multiples from information pertaining to minority interests hml determined that the unadjusted value under the market method was dollar_figure after determining the unadjusted value under each of the above methods hml weighted each of the methods equally and found -- - the weighted average of the unadjusted values was dollar_figure the weighted average unadjusted value hml then applied a lack of marketability discount of percent to the weighted average unadjusted value in arriving at this percentage hml considered several studies of typical marketability discounts used for minority interests in privately held entities based on its review of this empirical evidence hml concluded that a reasonable range for a lack of marketability discount for closely held common_stock wa sec_25 percent to percent hml then looked at the following factors to determine where deft's lack of marketability discount should fall within this range the availability of public market the company's recent financial performance the future outlook for the company and industry the company's distribution policy the restrictions on the transferability of the stock the expected holding_period of the stock the cost or expectation of a public offering the number of existing shareholders the size of the interest and the control inherent in the interest and the potential environmental liabilities based on hml's analysis of the foregoing factors hml concluded that deft's lack of marketability discount should fall at the low end of the range hml stressed the importance of the size of the interest being valued which favored a lower discount but noted that there was considerable uncertainty surrounding deft's potential environmental liabilities which favored a higher discount based on the factors in toto hml concluded the lack of marketability discount should be percent hml deducted the 25-percent marketability discount from the weighted average unadjusted value and concluded that the fair_market_value of a 100-percent interest in deft on the alternate_valuation_date was dollar_figure hml then divided the fair_market_value of a 100-percent interest by the number of outstanding shares big_number and found that deft's fair_market_value per share was dollar_figure hml multiplied deft's fair_market_value per share by the number of shares held by decedent at his death big_number and concluded the fair_market_value of the decedent's interest in deft on the alternate_valuation_date was dollar_figure respondent's expert respondent relies on a report compiled by business valuation services inc bvs bvs's analysis was limited to determining an appropriate lack of marketability discount for the decedent's interest in deft bvs did not determine the unadjusted value of deft respondent instructed bvs to assume that the unadjusted value including consideration of the potential environmental liabilities was dollar_figure bvs determined that an appropriate lack of marketability discount for decedent's interest should be between o percent and percent as instructed by respondent bvs did not consider deft's potential environmental liabilities in determining the appropriate discount c court's analysis and conclusions as noted earlier we are free to accept or reject in full or in part experts' opinions proffered by the parties see helvering v national grocery co u s pincite seagate tech inc consol subs v commissioner t c pincite estate of newhouse v commissioner t c pincite ekach of the experts' reports is susceptible to criticism we however believe the fair_market_value reached in the hml report better represents the fair_market_value of decedent's interest because of the limitations imposed by respondent on bvs we reject the bvs report and adopt in part as explained infra the hml report valuation methods accepted by court the hml report determined the weighted average unadjusted value based on the three different valuation methods was dollar_figure hml's application of the asset method was vague and generally unhelpful furthermore we believe hml may have improperly applied that method we do not rely on this method to determine the value of decedent's interest respondent does not object to hml's computations of the unadjusted value under the income_method and the market method we find hml's conclusions as to the unadjusted values under these two methods reasonable and we conclude that the unadjusted value under the income_method is dollar_figure and under the market method is dollar_figure furthermore we conclude each method deserves equal weight lack of marketability discount a availability of the discount a lack of marketability discount reflects the absence of a recognized market for closely held stock see mandelbaum v commissioner tcmemo_1995_255 estate of trenchard v commissioner tcmemo_1995_121 revrul_77_287 1977_2_cb_319 neither party disputes that the deft stock is closely held stock which is not readily_tradable we therefore shall apply a lack of marketability discount to the unadjusted values under both methods b proper blements in the discount hml applied a 25-percent lack of marketability discount to the weighted average unadjusted value hml considered numerous factors including deft's potential environmental liabilities in determining the amount of the discount courts have consistently recognized that potential liabilities can affect the value of corporate stock see estate of davis v commissioner t c pincite estate of hall v commissioner t c pincite payne v commissioner tcmemo_1998_227 estate of mitchell v commissioner tcmemo_1997_461 sackett v commissioner tcmemo_1981_661 richards v commissioner tcmemo_1976_380 we believe a hypothetical buyer of decedent's interest in deft would consider these potential liabilities when negotiating a purchase_price we find that these potential liabilities must be taken into account in the valuing of decedent's interest respondent argues that applying a discount for deft's potential environmental liabilities is improper because these liabilities have already been included in the unadjusted value calculation under the income_method and the market method we agree with respondent as to the market method but disagree as to the income_method under the income_method hml discounted deft's future cash flows to present_value using a discount rate determined by the capital_asset pricing model capm the discount rate represents the company's expected rate of return on equity the capm uses several variables including a variable representing the company's volatility relative to market returns beta deft's beta was determined based upon the betas of eight similar paint and finishing companies respondent contends that these paint and finishing companies had betas considerably higher than other companies’ because most paint and finishing companies have potential environmental liabilities that make the return on investment in these companies more volatile respondent argues that these betas already include the potential environmental liabilities of these companies therefore it is improper to also consider these liabilities in determining the proper discount we disagree with respondent respondent provided no evidence at trial that the betas of the eight comparable paint companies were higher than normal due to potential environmental liabilities faced by these companies we conclude that the unadjusted value under the income_method did not include deft's potential environmental liabilities and hml's consideration of deft's potential environmental liabilities within the lack of marketability discount was proper thus we shall apply a discount to the unadjusted value under the income_method for the potential environmental liabilities under the market method hml utilized the average price to earnings multiple for two similar paint and finishing companies in determining the unadjusted value respondent contends that these multiples already include the potential environmental problems faced by the similar companies therefore it is improper to also consider these liabilities in determining the proper discount respondent's expert testified that paint and finishing companies trade at lower multiples as a result of the potential environmental liabilities associated with the industry petitioner did not provide any other explanation for the lower multiples we conclude that the multiples used by hml took into account the potential environmental liabilities of the comparable companies therefore we shall not apply a discount to the unadjusted value under the market method for the potential environmental liabilities c computing the discount we must determine an appropriate lack of marketability discount for decedent's interest we base our finding ona -- - consideration of all of the evidence in the record paying special attention to the presence or absence of the factors discussed in revrul_77_287 1977_2_cb_319 the following factors favor a high lack of marketability discount there was no public market for deft's stock deft's profit margins were below the industry average all stock in deft was subject_to a restrictive share agreement which provided that a shareholder could transfer his or her stock toa nonshareholder only after the shareholder offered the shares to the remaining shareholders given the size and low profitability of deft a public offering of the stock was unlikely in the future the size of the interest is so large that it may be hard to find potential buyers in the future who could finance such a purchase and where not already considered deft has large potential environmental liabilities only one factor favors a low lack of marketability discount deft had an historical favorable distribution policy it distributed most of the company's earnings to its shareholders through higher-than-market compensation in the past we conclude that a 30-percent lack of marketability discount is appropriate for the deft stock of this 30-percent discount percent is attributable to deft's potential environmental liabilities we shall apply the 30-percent lack of marketability discount to the unadjusted value we determined under the income_method we however shall apply only a 20-percent lack of marketability discount to the unadjusted value we determined under the market method because as discussed supra the environmental liabilities have already been included in the unadjusted value under that method control premium a control premium may be necessary when valuing an interest which gives its holder unilateral power to direct corporate action select management decide the amount of distributions rearrange the corporation's capital structure and decide whether to liquidate merge or sell assets see estate of newhouse v commissioner t c pincite petitioner's expert testified that a holder of decedent's interest would have the power under california law to sell all of deft's assets dissolve the company and do virtually anything he or she wanted to do with deft decedent' sec_81 93-percent interest is a controlling_interest hml applied a control premium of percent in its calculations under the market method only whether or not a control premium is appropriate depends on the valuation method employed in reaching the unadjusted value of the stock where the method used values the stock as if it were a controlling_interest no control premium is necessary because the control aspect has already been accounted for within the unadjusted value see pratt et al valuing a business the analysis and appraisal of closely held companies 3d ed the income_method assumed the continuation of deft's present policies and did not account for a change in control this method therefore produced an unadjusted value based on a minority interest id pincite thus it would be proper to apply a control premium to the unadjusted value under this method id the market method is based on comparisons with publicly traded stocks this method produces an unadjusted value which represents the value of a minority interest and it generally would be proper to apply a control premium to the unadjusted value under this method id pincite hml determined that a 25-percent control premium was appropriate under the market method we find hml's determination reasonable and we conclude that a control premium of percent 1s appropriate we shall apply this premium to the unadjusted value we determined under the income_method conclusion utilizing the income_method and the market method we find the fair_market_value of decedent's interest in deft on the alternate_valuation_date was hml already included the control premium in its unadjusted value determined under the market method therefore we shall not apply a separate control premium to the unadjusted value under that method income market unadjusted value dollar_figure dollar_figure less marketability discount nonenvironmental big_number big_number environmental big_number add control premium big_number fair_market_value of percent interest big_number big_number x decedent's interest big_number big_number x weight given big_number big_number fair_market_value of decedent's interest big_number ' see supra note il value of real properties a generally on decedent's_estate tax_return petitioner reported that on the alternate_valuation_date the fair market values of the newport property and the indian wells property were dollar_figure and dollar_figure respectively within months of the alternate_valuation_date both properties were sold for amounts less than the fair market values reported on decedent's_estate tax_return petitioner claims that the fair market values for the newport property and the indian wells property should be dollar_figure and dollar_figure respectively based on their actual sales prices values submitted by a taxpayer on the estate_tax_return are admissions by the taxpayer and lower values cannot be substituted without cogent proof that the reported values are erroneous see estate of hall v commissioner t c pincite b the newport property at trial mark cardelucci a real_estate broker testified about the real_estate market conditions in newport from the time the newport property was valued for decedent's_estate tax_return until the property was later sold the interim period mr cardelucci testified that with regard to the newport property he believed no material_change in circumstances occurred during the interim period furthermore mr cardelucci testified that he believed that the newport property had been overvalued on the estate_tax_return respondent did not produce any evidence contradicting mr cardelucci's conclusions we conclude the fair_market_value of the newport property on the alternate_valuation_date was dollar_figure c the indian wells property conversely petitioner failed to produce any evidence that on the alternate_valuation_date the fair_market_value of the indian wells property equaled its sales_price months later we conclude that petitioner has failed to provide cogent proof showing that the amount reported on decedent's_estate tax_return was erroneous we conclude the fair_market_value of the indian wells property as of the alternate_valuation_date was dollar_figure in reaching all of our holdings herein we have considered all arguments made by the parties and to the extent not mentioned above we find them to be irrelevant or without merit to reflect the foregoing decision will be entered under rule


t c memo united_states tax_court daniel pierce petitioner v commissioner of internal revenue respondent docket no filed date daniel pierce pro_se jeffrey s luechtefeld and melinda g williams for respondent memorandum opinion swift judge this matter is before us on respondent’s motion for judgment on the pleadings all section references are to the internal_revenue_code applicable to the years in issue and all rule references are to the tax_court rules_of_practice and procedure background petitioner did not file federal_income_tax returns for or under sec_6020 and on the basis of information provided to respondent by third parties relating to payments made to petitioner respondent prepared substitute tax returns for petitioner and determined against petitioner the tax deficiencies and additions to tax set forth below additions to tax_year deficiency dollar_figure big_number big_number big_number sec sec_6651 a f sec sec dollar_figure big_number big_number big_number dollar_figure --- dollar_figure --- --- --- to be calculated in accordance with sec_6651 respondent also determined against petitioner a self- employment_tax liability on the basis of payments petitioner received for work as a janitor on date in response to respondent’s notice_of_deficiency petitioner filed a petition containing only tax- protester arguments by court order of date petitioner’s tax-protester arguments were stricken from the petition discussion after the above date court order the only viable remaining issue before the court is respondent’s determination of the sec_6651 addition_to_tax for fraudulent_failure_to_file tax returns and with the filing of the instant motion for judgment on the pleadings respondent concedes for each year the sec_6651 addition_to_tax for fraud however in opposing respondent’s motion for judgment on the pleadings and at a hearing that was held on date in tampa florida petitioner again raises only tax-protester arguments we may grant judgment on the pleadings where the pleadings do not raise genuine issues of material fact or law rule a 115_tc_523 karkabe v commissioner tcmemo_2007_115 petitioner raises only tax-protester arguments each of which has been stricken and respondent now concedes for each year the addition_to_tax for fraud for the reasons stated we shall grant respondent’s motion for judgment on the pleadings as to the tax_deficiency for each year and the tax_deficiency sustained for each year satisfies respondent’s burden of production under sec_7491 with regard to the sec_6651 and additions to tax and the sec_6654 addition_to_tax respondent’s determination of additional self-employment taxes due on payments petitioner received for janitorial work also is sustained sec_1401 to reflect the foregoing an appropriate order and decision will be entered