internal_revenue_service national_office technical_advice_memorandum date 263a 263a tam-113231-99 cc dom it a b7 number release date index uil no case mis no chief examination taxpayer’s name taxpayer’s address taxpayer’s identification no years involved date of conference legend x b c d e f issues do bank customer deposit account arrangements constitute debt for purposes of sec_263a of the internal_revenue_code and sec_1_263a-9 of the income_tax regulations is the taxpayer required to capitalize any interest in connection with expenditures it made for the production of its office facility conclusion bank customer deposit account arrangements fall within the scope of eligible_debt as defined in sec_1_263a-9 and are therefore subject_to application of the interest capitalization_rules of sec_263a and sec_1_263a-9 the taxpayer as a producer of property of a type subject_to the requirements of sec_263a and sec_1_263a-8 must capitalize production_period interest allocable to expenditures it made for its office facility the taxpayer must incorporate its tam-113231-99 debt which includes customer deposit accounts and associated interest into the calculations required under the avoided_cost_method prescribed by sec_1_263a-9 to determine the amount of interest which has to be capitalized facts the taxpayer x is a banking corporation that uses an accrual_method of accounting and files a return on a fiscal-year basis x hired an unrelated contractor to construct a new main office facility for it at a cost of approximately b construction took place during the period from c to d x made periodic progress payments to the contractor throughout the construction_period x did not obtain a separate loan to cover the cost of construction instead all construction payments were made out of funds provided through the normal operation of its banking business customer deposit accounts were the primary source of operating funds interest payments were made to customers on these accounts which included a variety of demand savings and other time deposit arrangements in its tax returns for the fiscal years ending e and f each of which included a portion of the construction_period x did not capitalize any interest associated with construction expenditures as a cost of the property constructed law and analysis sec_263a provides that in the case of any property to which sec_263a applies the direct costs of such property and the property’s proper share of indirect_costs including taxes part or all of which are allocable to such property shall be capitalized sec_263a provides that sec_263a applies to real or tangible_personal_property produced_by_the_taxpayer sec_263a provides that capitalization is required only for interest costs which are paid_or_incurred during the production_period and allocable to real or certain tangible_personal_property produced_by_the_taxpayer sec_263a provides that in determining the amount of interest required to be capitalized with respect to any property interest on any indebtedness directly attributable to production_expenditures with respect to such property shall be assigned to such property and interest on any other indebtedness shall be assigned to such property to the extent that the taxpayer’s interest costs could have been reduced if production_expenditures not attributable to indebtedness directly attributable to production_expenditures had not been incurred tam-113231-99 sec_1_263a-8 provides that capitalization of interest under the avoided_cost_method described in sec_1_263a-9 is required with respect to the production of designated property sec_1_263a-8 provides that interest that is capitalized is treated as a cost of the designated property and is recovered in accordance with sec_1 263a- c which provides for recovery through depreciation amortization cost_of_goods_sold or by an adjustment to basis at the time the property is used sold placed_in_service or otherwise_disposed_of by the taxpayer sec_1_263a-8 provides that designated property is property that is produced and that is either real_property or certain types of tangible_personal_property sec_1_263a-8 provides that real_property includes land unsevered natural products of land buildings and inherently permanent structures sec_1_263a-8 provides that a taxpayer is treated as producing any property that is produced for the taxpayer by another party under a contract with the taxpayer or an intermediary sec_1_263a-9 describes the avoided_cost_method which must be used to calculate the amount of interest required to be capitalized under sec_263a sec_1_263a-9 provides that generally any interest that the taxpayer theoretically would have avoided if accumulated production_expenditures had been used to repay or reduce outstanding debt must be capitalized under the avoided_cost_method the application of the avoided_cost_method does not depend on whether the taxpayer actually would have used the amounts expended for production to repay or reduce debt instead the avoided_cost_method is based on the assumption that debt of the taxpayer would have been repaid or reduced without regard to the taxpayer’s subjective intentions or to restrictions including legal regulatory contractual or other restrictions against repayment or use of the debt proceeds sec_1_263a-9 provides that the avoided_cost_method requires the capitalization of the traced_debt amount and the excess expenditure amount for each taxable_year or shorter computation period that includes the production_period sec_1_263a-9 provides that eligible_debt includes all outstanding debt as evidenced by a contract bond debenture note certificate or other evidence_of_indebtedness certain limited exclusions are prescribed sec_1_263a-9 provides that the traced_debt amount is equal to the total interest incurred on outstanding eligible_debt that is allocated to accumulated production_expenditures tam-113231-99 sec_1_263a-9 provides that the excess expenditure amount for a computation period equals the product of the average excess expenditures the average amount by which accumulated production_expenditures exceed traced_debt at each measurement date during the computation period by the weighted average interest rate determined by dividing interest incurred on nontraced debt during the period by average nontraced debt for the period nontraced debt means all eligible_debt on a measurement date other than any debt that is treated as traced_debt sec_1_263a-9 provides that the avoided_cost_method is applied without regard to any financial or regulatory accounting principles for the capitalization of interest the issue presented here is whether x’s customer deposit account arrangements constitute debt for purposes of sec_263a and sec_1_263a-9 if so interest_paid or incurred during the production_period which is deemed to be attributable to expenditures_for the production of designated property would have to be capitalized the internal_revenue_code and the income_tax regulations do not contain any provision which excludes banks from the capitalization requirements of sec_263a sec_263a and sec_1_263a-9 which provide rules for the allocation of interest to the cost of property produced by a taxpayer make no provision for the exclusion of bank customer deposit arrangements from treatment as debt which is subject_to application of the interest capitalization_rules eligible_debt is broadly defined in sec_1_263a-9 to include all outstanding debt as evidenced by a contract bond debenture note certificate or other evidence_of_indebtedness sec_1 263a- a goes on to list certain types of debt which are not treated as eligible_debt however bank customer deposit arrangements do not fall within the scope of any of the specified exclusions x’s customer deposit account arrangements qualify as a certificate or other evidence_of_indebtedness and thus constitute eligible_debt this conclusion is supported by the treatment of bank deposit arrangements as other evidence_of_indebtedness elsewhere in the code and regulations other evidence_of_indebtedness a term which appears in the sec_1_263a-9 definition of eligible_debt was defined in sec_1_1232-1 to include certificates of deposit time deposits bonus plans and other deposit arrangements with banks certificates of deposit are included in the definition of indebtedness in sec_1275 and sec_1_1275-1 which define a debt_instrument as a bond debenture note or certificate or other evidence_of_indebtedness as well as any instrument or contractual arrangement that constitutes indebtedness under general principles of federal_income_tax law including a certificate of deposit or a loan the determination that bank customer deposit account arrangements constitute tam-113231-99 indebtedness for purposes of the interest capitalization_rules is further supported by their treatment as debt under other provisions of the code and regulations which deal with interest_expense first interest_paid or accrued on customer deposit accounts is deductible as interest on indebtedness under sec_163 specifically sec_1_163-1 provides that in the case of banks and loan or trust companies interest_paid within the year on deposits such as interest_paid on moneys received for investment and secured_by interest-bearing certificates of indebtedness issued by such bank or loan or trust company may be deducted from gross_income second sec_6049 dealing with returns regarding payments of interest defines interest to include interest on deposits with persons carrying on the banking business third interest has been defined in sec_265 and sec_291 dealing with interest on debt incurred to carry tax exempt obligations to include amounts whether or not designated as interest_paid in respect of deposits investment certificates or withdrawable or repurchasable shares these provisions clearly indicate that bank customer deposit arrangements are treated as debt under the code and regulations with the interest thereon to be accounted for accordingly thus not only is the language of sec_1_263a-9 which defines eligible_debt for purposes of interest capitalization broad enough to encompass bank customer deposit arrangements by its terms but consistency with other code and regulation provisions points to this as the correct result thus x’s customer deposit accounts are eligible_debt subject_to application of the rules of sec_1_263a-9 x would be deemed under sec_1_263a-8 to be the producer of its office facility since the property was produced for x under contract with another party the contractor as a producer of property of a type designated in sec_1_263a-8 as being subject_to the interest capitalization requirements sec_263a and sec_1_263a-9 require x to capitalize production_period interest allocable to the property produced which is to be calculated by application of the avoided_cost_method pursuant to sec_1_263a-9 and sec_1_263a-9 the avoided_cost_method is to be strictly applied without regard to x’s subjective intentions restrictions including legal regulatory contractual or other restrictions against repayment or use of the debt proceeds or any financial or regulatory accounting principles for the capitalization of interest sec_1_263a-9 requires that x must capitalize interest to the extent of its traced_debt amount and excess expenditure amount relative to the property produced x has no traced_debt amount as it incurred no debt specifically allocable to accumulated production_expenditures however x must calculate and capitalize its excess expenditure amount which in this case would be the amount of interest it computes under sec_1_263a-9 by multiplying its average accumulated production_expenditures by its weighted average interest rate as prescribed for the computation period the applicable_interest_rate would be based on x’s average nontraced debt tam-113231-99 which has to include the amount of its customer deposit accounts a bank’s customer deposit account arrangements constitute debt which is subject_to the interest capitalization requirements of sec_263a and sec_1_263a-9 caveats a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service department of the treasury number release date index number 468a washington dc person to contact telephone number refer reply to cc psi 6-plr-119833-00 date date legend buyer seller seller seller seller seller seller seller seller seller seller seller seller plant state commission plr-119833-00 a b c d e f g h i j k l m n o p q r s this letter responds to your request dated date and subsequent correspondence on behalf of seller sec_1 and that we rule on certain tax consequences of the sale of the plants from sellers to buyer as set forth below you have requested rulings regarding the tax consequences under sec_468a of the internal_revenue_code to the sellers’ qualified nuclear decommissioning fund as well as rulings regarding the proper realization and recognition of gain and loss on the sale of the plant and the proper allocation_of_basis you have represented the following facts and information relating to the ruling_request the sellers are unregulated tax-exempt municipal utilities and utilities regulated by various state public_utility commissions and the federal energy regulatory commission ferc as a result of deregulation encouraged by the state public_utility commissions and the ferc the sellers are in the process of withdrawing from the electric power generation business and intend to sell the plant and related assets to the buyer each seller owns as tenant-in-common a fee simple ownership_interest in one or more of the plant’s units and facilities and assets associated with the plant seller sec_1 and are members of the same consolidated_group seller owns an a percent interest in each of unit and unit and a c percent interest in unit seller owns a b percent interest in each of unit and unit and a d percent interest in unit seller sec_3 and own respectively f h i l m e g k and j percent of unit seller operates all three units of the plant but does not have an ownership_interest plr-119833-00 in any of the units seller owns some assets associated with the plant that will be sold to the buyer pursuant to several sales agreements seller sec_1 and maintain nuclear decommissioning funds that qualify under sec_468a each of the sellers except seller maintain nonqualified nuclear decommissioning funds for each of the units of the plant which are trusts under the laws of state and which are considered grantor trusts under sections the three units of the plant are generally managed on a site-wide basis they share functions such as chemistry corrective action programs training warehousing contract management communication business services facilities management and engineering plant procedures such as security have been managed collectively for all three units the plant site is surrounded by a single security fence the only significant functions that take place on a unit-by-unit basis are the operational functions that take place in the control rooms this is necessary because of the technical differences between the units in carrying out the sellers’ divestiture plan the commission instructed the auction agent to solicit bids for each unit individually and for the three units on a consolidated basis in order to assure that the maximum value was realized however all bids submitted in the auction including buyer’s bid were bids for all three units together no interested_party bid on any of the units separately seller believed that the sellers interests were best served by including unit with unit sec_2 and in the sale the number of common facilities common service requirements and unit interdependencies would make ownership of unit by an unaffiliated entity undesirable from a management and safety standpoint for example unit sec_1 and share a number of common walls which are mutually dependent for resistance to seismic events therefore the continued structural integrity of unit necessitating a delay in the dismantling of unit until unit sec_2 and are dismantled is essential to unit 2's design and license compliance similarly control_over unit by the owner of unit sec_2 and is important because the spent nuclear fuel stored in unit could present a hazard if mishandled common ownership of the three units also is important for security reasons because there is no practical way to construct an internal barrier within the shared security area to separate_unit from unit sec_2 and finally ownership of all three units would allow a site-wide decommissioning and spent fuel storage strategy that will provide economies of scale and greater assurances of adequacy of decommissioning funding pursuant to several agreements dated n the sellers will transfer to the buyer all the assets of the plant including all the assets in the qualified and nonqualified nuclear decommissioning funds maintained by the various sellers the buyer will hold both the qualified and nonqualified decommissioning funds solely for the purpose of decommissioning the plant the funds will be under the general supervision of the ferc and the nuclear regulatory commission nrc the buyer will not make additional contributions to the qualified nuclear decommissioning funds unless plr-119833-00 permitted by future legislative changes to sec_468a any funds that exceed the amount necessary to satisfy all decommissioning liabilities will be distributed to the buyer the buyer will assume liabilities associated with the plant including decommissioning and other environmental liabilities unit of the plant is currently being decommissioned and is not an operating asset in the hands of the sellers and will not be an operating asset in the hand of the buyer the buyer will pay the sellers o p and q respectively for unit sec_1 and in addition the buyer will pay r and s respectively for nuclear fuel attributable to unit sec_2 and sellers and buyer represent that they will treat the transaction as an asset purchase for tax purposes subject_to sec_1060 apart from the purchase and sale agreements as a result of prior legal actions seller sec_1 and entered into settlement agreements with certain of the other owners of unit to allocate on a non-pro-rata basis the cash consideration received by the other owners at the time of the sale and the amount that the other owners must contribute to their respective decommissioning trust funds at the time of the sale requested ruling the sellers’ qualified nuclear decommissioning funds will not be disqualified on the date of closing when the assets in the funds are transferred to the buyer’s qualified nuclear decommissioning funds requested ruling the sellers’ qualified nuclear decommissioning funds will not recognize gain_or_loss upon the transfer of their assets at closing to the buyer’s qualified nuclear decommissioning funds requested ruling the sellers will not recognize income attributable to the assets in the qualified nuclear decommissioning funds upon the transfer of the assets at closing to the buyer’s qualified nuclear decommissioning funds requested ruling the buyer’s qualified nuclear decommissioning funds established to hold the assets transferred from the sellers’ qualified nuclear decommissioning funds will be treated as a qualified nuclear decommissioning fund under sec_468a requested ruling neither the buyer nor the buyer’s qualified nuclear decommissioning funds will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets from the sellers’ qualified nuclear decommissioning funds to the buyer’s qualified nuclear decommissioning funds and after closing the buyer’s qualified nuclear decommissioning funds will retain the same basis in the assets received as the sellers’ qualified nuclear decommissioning funds had prior to closing sec_468a provides that a taxpayer may elect to deduct payments made to a nuclear decommissioning reserve fund the qualified_fund sec_468a limits the annual deduction of the electing taxpayer to the lesser_of the ruling_amount or the amount of decommissioning costs included in the electing taxpayer’s cost of service for ratemaking purposes for the taxable_year plr-119833-00 sec_468a provides that the ruling_amount means the amount determined by the service to be necessary to a fund that portion of the nuclear decommissioning cost with respect to the nuclear power plant that bears the same ratio to the total nuclear decommissioning costs with respect to such nuclear power plant as the period for which the fund is in effect bears to the estimated_useful_life of the nuclear power plant and b prevent any excessive funding of such costs or the funding of such costs at a rate more rapid than level_funding sec_468a provides that the rate_of_tax on the income of a qualified_fund is percent sec_468a provides in pertinent part that the assets in a qualified_fund shall be used exclusively for satisfying the liability of any taxpayer contributing to the qualified_fund sec_1_468a-1 of the federal_income_tax regulations provides that an eligible_taxpayer is a taxpayer that possesses a qualifying interest in a nuclear power plant sec_1_468a-1 provides that a qualifying interest is a direct ownership_interest or a leasehold interest meeting certain additional requirements sec_1_468a-1 provides in part that a nuclear power plant is any nuclear power reactor that is used predominantly in the trade_or_business of the furnishing or sale of electric energy if the rates for such furnishing or sale have been established or approved by a public_utility commission sec_1_468a-5 sets out the qualification requirements for nuclear decommissioning funds it provides in part that a qualified_fund must be established and maintained pursuant to an arrangement that qualifies as a_trust under state law an electing taxpayer can establish and maintain only one qualified_fund for each nuclear power plant sec_1_468a-5 provides that if at any time during the taxable_year a nuclear decommissioning fund does not satisfy the requirements of sec_1_468a-5 the service may disqualify all or a portion of the fund as of the date that the fund does not satisfy the requirements sec_1_468a-5 provides that if a qualified_fund is disqualified the fair_market_value with certain adjustments of the assets in the fund is deemed to be distributed to the electing taxpayer and included in that taxpayer’s gross_income for the taxable_year sec_1_468a-6 generally provides rules for the transfer of an interest in a nuclear power plant and transfer of the qualified_fund where after the transfer the transferee is an eligible_taxpayer under sec_1_468a-6 the service may treat any disposition of an interest in a nuclear power plant occurring after date as satisfying the requirements of the regulations if the service determines that such treatment is necessary or appropriate to carry out the purposes of sec_468a under the specific facts herein the service will exercise its discretion to treat this sale under sec_1_468a-6 as a disposition qualifying under the general provisions of sec_1_468a-6 this exercise of discretion is specifically based on the continued general supervision of the qualified_fund by the nuclear regulatory agency and the plr-119833-00 federal energy regulatory commission this exercise of discretion however applies to the provisions of except those outlined in 468a-6 e with respect to the calculation of a schedule of ruling amounts subsequent to a sale thus under sec_1_468a-6 the qualified nuclear decommissioning fund of the sellers will not be disqualified upon the sale when the assets are transferred to the buyer’s qualified funds and those funds holding the transferred qualified assets will be treated as qualified funds of the buyer sec_1_468a-6 provides that neither a transferor nor its fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets from a transferor’s qualified_fund to a transferee’s qualified_fund thus the sellers will not recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the sellers’ qualified funds assets to the buyer’s qualified funds similarly sec_1_468a-6 provides that neither a transferee nor its fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the assets from a transferor’s qualified_fund to a transferee’s qualified_fund thus the buyer will not recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of the transfer of the sellers’ qualified funds assets to the buyer’s qualified funds finally sec_1_468a-6 provides that transfers of assets of a qualified_fund to which sec_1_468a-6 applies do not affect basis accordingly under sec_1_468a-6 the buyer’s qualified funds will have a basis in their assets that is the same as the basis of those assets in the qualified funds of the sellers immediately before the sale thus the buyer’s qualified funds will after the sale have a carryover_basis in the assets after the sale requested ruling each seller’s gain_or_loss on the sale of the plant and its associated assets other than the qualified nuclear decommissioning funds will be the difference between such seller’s basis in such assets and its amount_realized sec_1001 provides that a taxpayer’s gain from the sale of property is the excess of the amount_realized over the taxpayer’s adjusted_basis provided in sec_1011 for determining gain and that the taxpayer’s loss from the sale of property is the excess of the taxpayer’s adjusted_basis provided in sec_1011 for determining loss over the amount_realized sec_1060 provides that in the case of an applicable_asset_acquisition the consideration received shall be allocated among the acquired assets in the same manner as amounts are allocated to assets under sec_338 sec_1 a provides that in the case of an applicable_asset_acquisition sellers and purchasers must allocate the consideration under the residual_method as described in sec_1_338-6 and sec_1_338-7 in order to determine respectively the amount_realized from and the basis in each of the transferred assets plr-119833-00 sec_1060 defines the term applicable_asset_acquisition as the transfer of assets constituting a trade_or_business if the acquirer’s basis in the transferred assets is determined wholly by reference to the consideration paid for such assets sec_1_1060-1 defines a seller’s consideration as the amount in the aggregate realized from selling the assets in the applicable_asset_acquisition under sec_1001 sec_1060 provides no independent basis for determining the amount a taxpayer realizes on the sale of assets or the time such amount may be taken into account the amount_realized and the time such amount is taken into account are determined solely under generally applicable tax_accounting principles see sec_1001 the residual_method is based on a division of assets into seven classes class i generally consisting of cash and general deposit accounts held in banks savings and loan associations and other depository institutions class ii generally consisting of actively_traded personal_property like u s government securities and publicly traded stock but also including certificates of deposit and foreign_currency even if they are not actively_traded personal_property class iii most debt instruments including receivables and assets that the taxpayer marks to market at least annually for federal tax purposes class iv stock_in_trade of the taxpayer or other_property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable_year or property held by the taxpayer primarily_for_sale_to_customers in the ordinary course of its trade_or_business class v all assets other than class i ii iii iv vi and vii assets class vi all sec_197 intangibles as defined in sec_197 except goodwill and going_concern_value and class vii goodwill and going_concern_value whether or not it qualifies as a sec_197 intangible sec_1_338-6 and sec_1_338-6 consideration is first reduced by the amount of class_i_assets the remaining consideration is then allocated among the class_ii_assets pro_rata to the extent of their fair_market_value then among the class_iii_assets pro_rata to the extent of their fair_market_value then among the class_iv_assets pro_rata to the extent of their fair_market_value then among the class_v_assets pro_rata to the extent of their fair_market_value then among the class_vi_assets pro_rata to the extent of their fair_market_value and finally any remaining consideration is allocated to the class_vii_assets sec_1_1060-1 sec_1_338-6 and sec_1_338-6 the following example illustrates the operation of sec_1060 on date1 an applicable_asset_acquisition is made the assets sold consist of class_i_assets in the amount of dollar_figure class_ii_assets with a fair_market_value of dollar_figure and a basis in the hands of the seller of dollar_figure class_iii_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_iv_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_v_assets with fair_market_value of dollar_figure and a basis of dollar_figure and class_vi_assets with a fair_market_value of dollar_figure and a basis of dollar_figure the consideration consists of dollar_figure cash and an assumed liability of dollar_figure that under applicable tax_accounting principles is taken into account at the time of the applicable_asset_acquisition plr-119833-00 the consideration will be first reduced by dollar_figure the amount of class_i_assets the remaining consideration will be allocated as follows dollar_figure to class_ii_assets pro_rata according to fair_market_value resulting in a dollar_figure gain dollar_figure to the class_iii_assets pro_rata according to fair_market_value resulting in no gain_or_loss dollar_figure to the class_iv_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain dollar_figure to the class_v_assets pro_rata according to the fair_market_value resulting in no gain_or_loss dollar_figure to the class_vi_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain and the remaining dollar_figure to the class_vii_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain the character of the amounts of gain_or_loss recognized by the seller as well as any applicable holding periods is determined by the nature of the underlying assets sec_1_1060-1 sec_1_1060-1 and sec_1_338-6 if under general tax principles there is a subsequent adjustment to the consideration that amount is allocated in a manner that produces the same allocation that would have been made at the time of the acquisition had such amount been paid_or_incurred on the acquisition_date sec_1_1060-1 sec_1_1060-1 and sec_1 with respect to the qualified nuclear decommissioning funds relating to the plant the federal tax treatment of the transaction is determined exclusively under sec_468a and the regulations thereunder with respect to the plant equipment operating_assets and assets of the nonqualified nuclear decommissioning funds however these assets comprise a trade_or_business in the sellers’ hands and the basis buyer takes in those assets will be determined wholly by reference to the buyer’s consideration thus each seller’s transfer of its interest in the plant its equipment operating_assets and assets of that seller’s nonqualified funds to buyer or in the case of seller the sale of its assets to buyer in exchange for cash and the assumption of the decommissioning liability except to the extent funded by the qualified nuclear decommissioning funds is a separate applicable_asset_acquisition as defined in sec_1060 as such each seller’s federal tax treatment of the sales is determined under sec_1060 and the regulations thereunder thus each seller must allocate the consideration to the applicable assets in accordance with the provisions of sec_1060 and the regulations thereunder specifically each seller will first reduce the consideration received by the amount of class_i_assets it transfers in the transaction including any class_i_assets held in any nonqualified_fund it transfers to the extent a seller’s consideration exceeds the class_i_assets it transfers such excess will be allocated to the class_ii_assets it transfers then to the class_iii_assets it transfers then to the class_iv_assets it transfers then to the class_v_assets it transfers then to the class_vi_assets it transfers and finally to the class_vii_assets it transfers such consideration is allocated to each class of assets pro_rata according to the fair_market_value of those assets up to their total fair_market_value the character and other attributes of the amounts of gain and loss are plr-119833-00 determined by that of the underlying assets accordingly on the sale of the plant and each sellers’ interests in the assets in their respective decommissioning trust funds other than the assets in the sellers’ qualified nuclear decommissioning funds each sellers’ gain_or_loss on each transferred asset will be the difference between the basis of the asset and the amount_realized with respect to that asset as a result of the sale taking into account the allocation of consideration pursuant to sec_1060 and the corresponding regulations requested ruling each seller’s amount_realized on the sale of the plant and its associated assets will include the cash consideration received from the buyer and the amount of its liabilities assumed by the buyer including its liability to decommission the plant but reduced by the amount of such liability to be funded by such seller’s qualified nuclear decommissioning funds sec_1001 provides that a seller’s amount_realized from the sale of property is the sum of any money received plus the fair_market_value of the property other than money received sec_1_1001-2 provides that a seller’s amount_realized from the sale of property includes the amount of liabilities from which the seller is discharged as a result of the sale this may include debt and non-debt liabilities see 84_tc_1319 assumption of lessee’s repair liability was part of amount_realized on sale of leasehold as set forth with respect to requested ruling the decommissioning liability from which sellers will be relieved is fixed and determinable as owners and operators of a nuclear plant sellers are required_by_law to provide for eventual decommissioning see cfr sec_50 accordingly each seller's amount_realized on the sale of its interests in the plant and associated assets not including the assets in the sellers' qualified nuclear decommissioning fund will include the cash consideration received by the seller as a result of the sale and the liabilities from which the seller is relieved as a result of the sale to the extent these liabilities are taken into account for federal_income_tax purposes the liabilities taken into account would include the appropriate amount of each seller's decommissioning liability not including any portion of the liability attributable to a seller's qualified nuclear decommissioning fund requested ruling each seller will be entitled to a deduction equal to the amount of its liability to decommission the plant expressly assumed by the buyer and included in the seller’s income in the year the liability is assumed reduced by the amount of the liability to be funded by such seller’s qualified nuclear decommissioning funds sec_1_446-1 provides that under an accrual_method of accounting a liability is incurred and generally taken into account for federal_income_tax purposes in the year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic plr-119833-00 performance has occurred with respect to the liability sec_461 makes clear that generally the all_events_test is not treated as having been met any earlier than the taxable_year in which economic_performance has occurred with respect to a liability see also sec_1 a sec_461 provides that in the case of a liability that requires the taxpayer to provide services economic_performance occurs as the taxpayer provides the services sec_1_461-4 provides that economic_performance occurs with respect to such service liabilities as the taxpayer incurs costs in connection with the satisfaction of the liability sec_1_461-4 provides an exception to the general economic_performance rule for services where the taxpayer sells a trade_or_business where the purchaser expressly assumes a liability arising out of the taxpayer’s trade_or_business that the taxpayer but for the economic_performance requirement would have been entitled to incur as of the date of the sale economic_performance with respect to the liability occurs as the amount of the liability is properly included in the amount_realized on the sale by the taxpayer the first prong of the all_events_test requires that the fact of the liability be established at the time of the deduction this prong of the all_events_test is satisfied in the instant case here each of the sellers clearly has the obligation to decommission the plant the fact of the obligation arose many years ago at the time the sellers obtained their license to operate the plant see c f_r section dollar_figure and sec_72 requiring the operator of a nuclear power plant to decommission it moreover congress recognized the existence of the decommissioning liability when in it enacted sec_461 and sec_468a noting that g enerally under federal and state laws utilities that operate nuclear power plants are obligated to decommission the plants at the end of their useful lives h_r conf_rep no see also s prt no vol 98th cong 2d sess the second prong of the all_events_test requires the amount of the liability to be reasonably determinable see sec_1_461-1 this prong is also satisfied in the instant case the amount of the sellers’ decommissioning liability has been determined by experts in the nuclear decommissioning industry their calculations have been reviewed and accepted by both the nrc which is charged with ensuring that sufficient funds are available to decommission the plant and in some cases by ferc in addition there is also support in the code for finding that the amount of the decommissioning liability is reasonably determinable at the time of sale sec_468a generally permits a current deduction for a ruling_amount based on estimated future decommissioning expenses to the extent the decommissioning costs are sufficiently determinable to entitle the utility to a deduction under sec_468a it is reasonable to conclude that the costs must also be sufficiently determinable to satisfy the second prong of the all_events_test plr-119833-00 - given that the two prongs of the all_events_test are satisfied economic_performance with respect to the decommissioning liability occurs as of the date of the sale to the extent the liability is included in the sellers’ amount_realized at that time each of the sellers will be entitled to a deduction for the amount of its decommissioning liability associated with the plant expressly assumed by the buyer and included in that seller’s amount_realized requested ruling the buyer will not recognize any gain or otherwise take income into account by reason of the purchase of the plant and its associated assets except to the extent that the aggregate amount of cash and other class_i_assets received from all sellers exceeds the aggregate amount of consideration provided by the buyer to all the sellers generally a taxpayer does not realize income upon its purchase of a business’ assets even where those assets include cash or marketable_securities and in connection with the purchase the taxpayer assumes liabilities of the seller see 194_f2d_190 2d cir revrul_55_675 1955_2_cb_567 in this case buyer cannot acquire the plant without assuming the decommissioning liability which is inextricably associated with the ownership and operation of the plant and there is no indication that the transaction is other than a bona_fide purchase of the business and its associated assets and liabilities the exception to the general_rule set forth in revrul_71_450 1971_2_cb_78 does not apply in revrul_71_450 unlike the present situation the purchaser agreed to assume the prepaid subscription liability in return for a separate cash payment and the liability was not reflected in the sales_price of the business however we have determined that under the circumstances of this case the buyer must perform a separate allocation under sec_1060 for the assets received from each seller therefore we do not agree that the aggregate amount of class_i_assets received from all sellers should be compared to the aggregate consideration provided by the buyer to all sellers in determining whether income is recognized accordingly with respect to the acquisition of interests in the plant and its equipment and operating_assets and the assets in a nonqualified decommissioning fund from a particular seller buyer will not recognize income except to the extent the class_i_assets as defined in sec_1_338-6 it receives from that seller exceed its total cost determined under sec_1012 which will be the sum of its cash consideration and the amount of any other consideration it provides to that seller that is under applicable tax principles taken into account on the date of the applicable_asset_acquisition requested ruling the buyer will have a tax basis in the assets purchased including the assets in the buyer’s nonqualified nuclear decommissioning funds but excluding the assets in the buyer’s qualified nuclear decommissioning funds equal to the sum of the purchase_price and the assumed_liabilities and obligations that will be taken into account as liabilities for federal_income_tax purposes as of the closing date plr-119833-00 - sec_1012 provides in part that the basis_of_property shall be the cost of such property buyer claims that its cost of acquiring the sellers’ interests in the plant and the related assets including the decommissioning funds includes the amount of the assumed decommissioning liability buyer cites 331_us_1 and 194_f2d_190 as support for the proposition that for purposes of determining basis the cost of property generally includes assumed_liabilities to which the acquired property is subject_to the extent such liabilities can be accurately valued and are not contingent at the time of purchase since the buyer will pay cash and assume the liabilities and obligations of the sellers which includes the decommissioning liabilities in connection with the acquisition of the assets purchased its total cost of the assets purchased excluding the qualified nuclear decommissioning fund will equal the cash paid plus the liabilities and obligations assumed consequently its tax basis under sec_1012 equals the sum of the cash paid and the amount of the liabilities and obligations assumed the service however rejects including the amount of the future assumed decommissioning liability in the buyer’s cost_basis as of the closing the assumed decommissioning liability cannot be treated as incurred for any federal_income_tax purpose -- including basis -- until economic_performance occurs with respect to that liability the legislative_history underlying the enactment of sec_461 makes it clear that congress intended to exclude an item from being taken into account for tax purposes until economic_performance occurs this treatment applies to capital and well as non-capital transactions h_r rep no pt 98th cong 2d sess s prt no vol 98th cong 2d sess despite criticism from some commentators that the service lacks authority to apply the economic_performance rules broadly enough to include the calculation of basis and cost_of_goods_sold the service explicitly stated in the preamble to the final regulations implementing sec_461 that the service and treasury believe the intended scope of the statutory provision is indeed broad enough to apply in this manner preamble to t d fed reg date c b consistent with this position the service amended the regulations under sec_446 to clarify that a liability is incurred and generally is taken into account for federal_income_tax purposes in the taxable_year in which the all_events_test is satisfied and economic_performance has occurred with respect to the item sec_1 c ii a the regulations further clarify that applicable provisions of the code the regulations and other guidance published by the secretary prescribe the manner in which a liability that has been incurred is taken into account and specifically cite to the capitalization provisions of sec_263 as an example of a code provision subordinate to the economic_performance requirement specifically the regulations state for example an amount that a taxpayer expends or will expend for capital improvements to property must be incurred before the taxpayer may take the amount into account in computing its basis in the property sec_1_446-1 thus critical to determining whether the buyer is entitled to treat the future decommissioning liability as a component of its cost_basis in the purchased assets at plr-119833-00 - the time of the closing is deciding whether the liability will be incurred for tax purposes as of the closing it will not economic_performance does not occur with respect to a service liability such as the decommissioning obligation until and to the extent that costs are incurred in satisfaction of that liability sec_1_461-4 because the buyer will not have performed any services relating to the decommissioning liability at the time of the plant’s purchase economic_performance will not have occurred and the liability will not have been incurred at that time for any purpose under the internal_revenue_code including the cost_basis provisions of sec_1012 as indicated above a particular seller’s transfer of its interest in the plant its accordingly we rule that on the acquisition_date the buyer’s basis in the assets equipment operating_assets and assets of that seller’s nonqualified decommissioning funds to buyer or in the case of seller the sale of its assets to buyer in exchange for cash and the assumption of the decommissioning liability except to the extent funded by the qualified nuclear decommissioning funds is a separate applicable_asset_acquisition as defined in sec_1060 as such the buyer’s federal tax treatment of these acquisitions is determined under sec_1060 and the regulations thereunder acquired from a particular seller must be determined by allocating its cost ie the consideration provided by buyer on the acquisition_date allocable to that seller which includes the allocable portion of the cash but not the assumption of any future decommissioning liability among the assets acquired from that seller including the assets from that seller’s nonqualified decommissioning fund in accordance with the provisions of sec_1060 and the regulations thereunder specifically buyer will first reduce its consideration by the amount of the class_i_assets it receives in the transaction with that seller to the extent the class_i_assets received exceed the consideration buyer provides buyer will recognize income to the extent buyer’s consideration exceeds the class_i_assets it receives such excess will be allocated to the class_ii_assets it receives from that seller pro_rata according to the fair_market_value of those assets up to their total fair_market_value then among the class_iii_assets it receives from that seller pro_rata to the extent of their fair_market_value then among the class_iv_assets it receives from that seller pro_rata to the extent of their fair_market_value then among the class_v_assets it receives from that seller pro_rata to the extent of their fair_market_value then among the class_vi_assets it receives from that seller pro_rata to the extent of their fair_market_value and finally any remaining consideration is allocated to the class_vii_assets it receives from that seller when and to the extent additional_amounts are paid_or_incurred for the assets acquired in the applicable asset acquisitions eg when and to the extent a nonqualified_fund pays or incurs future decommissioning expenses such amounts will be taken into account as increases to the buyer’s consideration and allocated in the same manner and subject_to the same conditions as though they were paid_or_incurred on the acquisition_date sec_1_1060-1 sec_1_1060-1 sec_1_338-6 and sec_1_338-7 requested ruling the buyer’s nonqualified nuclear decommissioning funds will be treated as grantor trusts under section and the buyer will be treated as the grantor of such funds plr-119833-00 - sec_671 provides that where it is specified in sec_673 through that the grantor or another person shall be treated as the owner of any portion of a_trust there shall be included in computing the taxable_income and credits of that person those items of income deduction and credits against tax of the trust which are attributable to that portion of the trust to the extent that such items would be taken into account in computing taxable_income or credits against the tax of an individual sec_1_671-2 provides that for purposes of part i of subchapter_j chapter of the internal_revenue_code a grantor includes any person to the extent such person either creates a_trust or directly or indirectly makes a gratuitous transfer within the meaning of sec_1_671-2 of property to a_trust for purposes of sec_1_671-2 the term property includes cash sec_1_671-2 provides that a gratuitous transfer is any transfer other than a transfer for fair_market_value sec_1_671-2 provides that for purposes of sec_1_671-2 a transfer is for fair_market_value only to the extent of the value of property received from the trust services rendered by the trust or the right to use property of the trust sec_677 provides that the grantor shall be treated as the owner of any portion of a_trust whether or not he is treated as such under sec_674 whose income without the approval or consent of any adverse_party is or in the discretion of the grantor or a nonadverse_party or both may be distributed to the grantor or held or accumulated for future distribution to the grantor sec_1_677_a_-1 provides that under sec_677 a grantor is in general treated as the owner of a portion of a_trust whose income is or in the discretion of the grantor or a nonadverse_party or both may be applied in discharge of a legal_obligation of the grantor because buyer is treated as purchasing the assets of sellers’ nonqualified funds for federal_income_tax purposes buyer is treated as contributing those assets as grantor to the buyer’s nonqualified decommissioning funds all income as well as principal of the buyer’s nonqualified decommissioning funds is held to satisfy buyer’s legal_obligation to decommission the plant and upon completion of the decommissioning any remaining assets will be distributed to buyer accordingly buyer is treated as the owner of the entire buyer’s nonqualified decommissioning funds under sec_677 and sec_1_677_a_-1 buyer shall include in computing its taxable_income and credits all items of income deduction and credits against tax of the buyer’s nonqualified decommissioning funds to the extent that such items would be taken into account in computing taxable_income or credits against the tax of buyer this letter_ruling is directed only to the taxpayers that requested it seller sec_1 and sec_6110 provides that this ruling may not be used or cited as precedent except as specifically determined above no opinion is expressed or implied plr-119833-00 - concerning the federal_income_tax consequences of the transaction described above in particular no opinion is expressed or implied regarding the effect of the settlement agreements between seller sec_1 and and certain other of the sellers in accordance with the powers of attorney the original of this letter is being sent to the authorized representative of seller sec_1 and in accordance with the powers of attorney a copy is being sent to seller sec_1 and and we are sending an additional copy of this ruling letter to your additional authorized representative we are also sending a copy of this letter to the appropriate director of the large and mid- size business division sincerely charles b ramsey chief branch office of associate chief_counsel passthroughs and special industries


department of the treasury attn mandatory review mc dal internal_revenue_service commerce st tax_exempt_and_government_entities_division dallas tx date date number release date legend org - organization name xx - date address - address org address employer_identification_number person to contact id number contact numbers voice fax certified mail - return receipt requested dear in a determination_letter dated may 20xx you were held to be exempt from federal_income_tax under sec_501 of the internal_revenue_code the code based on recent information received we have determined you have not operated in accordance with the provisions of sec_501 of the code accordingly your exemption from federal_income_tax is revoked effective january 20xx this is a final adverse determination_letter with regard to your status under sec_501 of the code we previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary at that time we informed you of your right to contact the taxpayer_advocate as well as your appeal rights on august 20xx you signed form 6018-a consent to proposed action agreeing to the revocation of your exempt status under sec_501 c of the code you have filed taxable returns on form s u s_corporation income_tax return for the years ended march 20xx 20xx with us required to file form_1120 with the appropriate service_center indicated in the instructions for the return for future periods you are you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please contact the person whose name and telephone number are shown at the beginning of this letter sincerely nanette m downing director eo examinations cc tax_exempt_and_government_entities_division department of the treasury internal_revenue_service north evergreen dr n e grand rapids ml date date org address dear taxpayer_identification_number form tax_year s ended person to contact id number contact numbers telephone fax we have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization’s exempt status is necessary these we have also enclosed publication exempt_organization appeal procedures for unagreed issues and publication the examination process publications include information on your rights as a taxpayer including administrative appeal procedures within the internal_revenue_service if you request a conference with appeals we will forward your written_statement of for your convenience an protest to the appeals_office and they will contact you envelope is enclosed if you and appeals do not agree on some or all of the issues after your appeals_conference the appeals_office will advise you of its final_decision if you elect not to request appeals consideration but instead accept our findings please sign and return the enclosed form 6018-a consent to proposed adverse action we will then send you a final letter modifying or revoking your exempt status under sec_501 if we do not hear from you within days from the date of this letter we will process your case on the basis of the recommendations shown in the report of examination and send a final letter advising of our determination in either situation outlined in the paragraph above execution of form 6018-a or failure to respond within days you are required to file federal_income_tax returns for the tax period s shown above for all years still open under the statute_of_limitations and for all later years file the federal tax_return for the tax period s shown above with this agent within days from the date of this letter unless a request for an extension of time is granted file returns for later tax years with the appropriate service_center indicated in the instructions for those returns you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you have any questions please call the contact person at the telephone number shown in the heading of this letter the most convenient time to call if we need to contact you if you write please provide a telephone number and thank you for your cooperation sincerely nanette m downing nanette m downing director eo examinations enclosures publication publication form 6018-a report of examination envelope form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx legend org - organization name co-1 co-2 co-3 co-4 - ein - ein city - city companies state - state issues is org providing insurance to its policyholders does org qualify as an insurance_company under internal_revenue_code sec_501 for the years beginning january 20xx is org exempt from federal tax as an organization described under internal_revenue_code irc sec_501 for the years beginning january 20xx if org does not qualify for tax exempt status for years beginning january 20xx what are the consequences is org entitled to relief pursuant to sec_7805 if org does not qualify for exemption from federal tax as an organization described under sec_501 was is the effective date of revocation if org does qualify as an insurance_company under internal_revenue_code sec_501 does it meet the other requirements under internal_revenue_code sec_501 for tax exemption if org does qualify as an insurance_company under internal_revenue_code sec_501 but does not meet the other requirements under internal_revenue_code sec_501 what are the consequences if org does not meet the other requirements under internal_revenue_code sec_501 is it entitled to file an election under sec_831 and be taxed only on its investment_income fact org org was formed in the state of state as an unincorporated association on december 20xx org has three members co-1 j co-2 both state limited_partnerships and co-3 a state corporation each member gave dollar_figure as the initial capital of the organization the purpose as stated in the articles of association is to provide property and casualty insurance on a nonprofit basis for its members form 886-acrev department of the treasury - internal_revenue_service page -1- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx org filed the application form_1024 application_for recognition of exemption under sec_501 with the internal_revenue_service in 20xx its purpose as stated in the application form is to provide limited mutual insurance protection for owner investors who do their own repairs aim is to provide insurance to numerous small real_estate investors who typically own single family houses these investors are priced out of the commercial insurance market due to regulation and litigation these small investors are the do-it-yourselfers who perform their own maintenance on the properties they own first policies issued in 20xx organization will initially operate in the city state area each member contributes dollar_figure benefits of this type of insurance are publicized in the co-4 based on the information provided in application form_1024 org received a determination_letter dated may 20xx granting exemption under internal_revenue_code irc c the determination_letter states the new requirements for exemption under this code section that became effective for tax years beginning on or after january 20xx org filed the form 990-ez for year ending december 20xx on the form 990-ez org reported the following financial information two policies were issued for the 20xx - 20xx time frame all premiums were collected during the 20xx calendar_year no premiums received during 20xx no other policies issued after these two expired org was not involved in any reinsurance agreements premium sec_12 20kx total assets total revenue total liabilities total expenses investment_income form 990-ez information total excess deficit law and analysis form 886-a crev is org providing insurance to its policyholders the first issue is whether org is providing insurance determining whether this qualifies as insurance will assist in determining whether org can qualify for exemption pursuant to sec_501 department of the treasury - internal_revenue_service page -2- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx neither the internal_revenue_code nor the regulations specifically define the term_insurance contract the courts have generally required that a transaction involve both risk shifting from the insured’s perspective and risk_distribution from the insurer's perspective in order to be characterized as insurance 312_us_531 914_f2d_396 cir risk shifting occurs when a person facing the possibility of a loss transfers some or all of the financial consequences of the loss to the insurer revrul_88_72 1988_2_cb_31 clarified by revrul_89_61 1989_1_cb_75 the risk transferred pursuant to an insurance_contract must be a risk of economic loss 66_tc_1068 affd 572_f2d_1190 439_us_835 cir cert_denied risk shifting issues frequently arise in the case of captives in 811_f2d_1297 cir the court defined a captive in footnote on page as a corporation organized for the purpose of insuring the liabilities of its owner at one extreme is the case presented here where the insured is both the sole shareholder and only customer of the captive there may be other permutations involving less than ownership or more than’a single customer although at some point the term captive is no longer appropriate risk_distribution refers to the operation of the statistical phenomenon known as the the law of large numbers when additional statistically independent risk exposure units are insured although the potential total losses increase there is also an increase in the predictability of average loss this increase in the predictability of the average loss decreases the amount of the capital that an insurance_company needs per risk unit to remain at a given solvency level see revrul_89_61 1989_1_cb_75 the courts have not spent a great deal of time explaining what they mean by risk_distribution no court has squarely held that there can be no risk_distribution if there is only one or a few insureds a fair reading of the court opinions addressing the issue however supports the irs’s position see 801_f2d_984 cir risk distributing is the spreading of the risk of loss among the participants in an insurance program see also 183_f2d_288 cir such spreading is effectuated by pooling among r isk distribution means that the party assuming the risk unrelated insureds in part among others beech aircraft corp v united distributes his potential liability states 797_f2d_920 cir risk_distribution is accomplished where the risk is distributed among insureds other than the entity that incurred the loss see 401_f2d_464 cir form 886-acrev department of the treasury - internal_revenue_service page -3- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx the sixth circuit touched on the issue of risk_distribution in 881_f2d_247 cir noting that there was adequate risk_distribution where the captive insures several separate corporations within an affiliated_group and losses can be spread among the several distinct corporate entities the ninth circuit has also measured risk_distribution by explaining i nsuring many by independent risks in return for numerous premiums serves to distribute risk assuming numerous relatively small independent risks that occur randomly over time the insurer smoothes out losses to match more closely its receipt of premiums 811_f2d_1297 cg cir in revenue_ruling 20xx-90 20xx-2 cb the question was raised on whether a subsidiary’s arrangement to provide liability insurance coverage to of its parent company’s subsidiaries constituted insurance contracts for federal tax purposes and thus the amounts paid as premiums by each subsidiary were deductible as business_expenses under the arrangement the subsidiaries were charged arm’s length premiums according to customary industry ratings and none had liability coverage of less than percent or more than percent of the total risk insured by the subsidiary as a result the professional liability risks of the subsidiaries were shifted to the insurer subsidiary as required to constitute an insurance_contract for federal tax purposes the common ownership of the subsidiaries including the insurer by the parent did not affect the determination that the arrangements constituted insurance contracts as explained in the revenue_ruling that organization issued policies and shifted the risk to the subsidiaries as required org issued polices in 20xx and none in 20xx as in the revenue_ruling the risk shifted from the two insured to org in 20xx but thee was not adequate risk_distribution with only two policies issued in 20xx these policies expired and no new policies were issued so there was no risk shifting or risk_distribution because there were no policies it is the service position that since org did not issue any policies in 20xx there was no insurance provided therefore no risk shifting or risk_distribution as stated before the courts have generally required that a transaction involve both risk shifting from the insured’s perspective and risk_distribution from the insurer's perspective in order to be characterized as insurance with org there were no policies to have risk shifting or risk_distribution as stated in revrul_89_61 1989_1_cb_75 risk_distribution refers to the operation of the statistical phenomenon known as the the law of large numbers when additional statistically independent risk exposure units are insured although the potential total losses increase there is also an increase in the predictability of average form 886-a rev department of the treasury - internal_revenue_service page -4- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx loss this increase in the predictability of the average loss decreases the amount of the capital that an insurance_company needs per risk unit to remain at a given solvency level with org there was not the phenomenon known as the the law of large numbers in issuing only two policies in 20xx that carried over to 20xx there was inadequate risk_distribution due to the lack of a number of policies to help cover any losses with no policies issued in 20xx there was no risk shifting or risk_distribution for 20xx therefore it is the service’s position that since there were only policies in 20xx that carried over to 20xx and no new policies issued in 20xx org was not providing insurance to any policyholders does org qualify as an insurance_company under internal_revenue_code sec_501 for the years beginning october 20xx definition of an insurance_company neither sec_501 nor its corresponding regulations define an insurance_company subchapter_l of the code i r c sections however addresses the taxation of insurance_companies the term_insurance company has the same meaning under sec_501 as it does in subchapter_l see h conf_rep no cong sess vol il reprinted in vol c b r c sec_816 formally sec_801 defines a life_insurance_company as part of this definition r c sec_816 provides the term ‘insurance company’ means any company more than half of the business of which during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies sec_1_801-3 defines an insurance_company as a company whose primary and predominant business activity during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies thus though its name charter powers and subjection to state insurance laws are significant in determining the business which a company is authorized and intends to carry on it is the character of the business actually done in the taxable_year which determines whether a company is taxable as an insurance_company under the internal_revenue_code the courts and the irs have also at times looked to whether the transaction has characteristics traditionally associated with insurance and whether the company conducts business like an insurance_company in order for org to be considered an form 886-a crev department of the treasury - internal_revenue_service page -5- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx insurance_company entitled to tax exempt status under sec_501 for the taxable years beginning october 20xx its primary and predominant business activity during that year must have been issuing insurance contracts or reinsuring insurance risks see r c sec_816 sec_1_801-3 based on the conclusions made regarding question above that only two policies were issued in 20xx that carried over to 20xx and no policies were issued in 20xx org was not providing insurance with org not providing insurance it can not qualifying as an insurance_company is org exempt from federal tax as an organization described under internal_revenue_code irc sec_501 for the years beginning october 20xx internal_revenue_code sec_501 exempts from federal_income_tax insurance_companies as defined in sec_816 other than life including interinsurers and reciprocal underwriters if- i the gross_receipts for the taxable_year do not exceed dollar_figure and il more than percent of such gross_receipts consist of premiums or ii in the case of a mutual insurance company- i the gross_receipts of which for the taxable_year do not exceed dollar_figure and il more than percent of such gross_receipts consist of premiums clause ii shall not apply to a company if any employee of the company or a member of the employee’s family as defined in sec_2032 is an employee of another company exempt from taxation by reason of this paragraph or would be so exempt but for this sentence based on the conclusion that org is not an insurance_company org does not qualify for exemption from federal_income_tax under sec_501 for years starting january 20xx sec_501 specifically exempts insurance_companies with org not qualifying as an insurance_company org can not qualify as an organization exempt from federal_income_tax under irc c if org does not qualify for tax exempt status for year ending january 20xx what are the consequences since org did not qualify for tax exemption per sec_501 for years beginning january 20xx the tax exempt status is hereby revoked starting january 20xx form 886-a crev department of the treasury - internal_revenue_service page -6- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx in revoking org’s tax exemption org must file forms for years beginning january 20xx is org entitled to relief pursuant to sec_7805 an organization may ordinarily rely on a favorable determination_letter received from the internal_revenue_service regulation sec_1_501_a_-1 rev_proc 20xx-4 dollar_figure cross-referencing dollar_figure et seq 20xx-1 c b an organization may not rely ona favorable determination_letter however if the organization omitted or misstated a material fact in its application or in supporting documents in addition an organization may not rely on a favorable determination if there is a material_change inconsistent with exemption in the organization’s character purposes or methods of operation after the determination_letter is issued regulation sec_601_201 revproc_90_27 1990_1_cb_514 any such changes must be reported to the service so that continuing recognition of exempt status can be evaluated the commissioner may revoke a favorable determination_letter for good cause regulation sec_1_501_a_-1 a favorable determination_letter may be revoked by written notice to the organization to whom the determination originally was issued regulation sec_601_201 cross-referencing reg i revproc_90_27 1990_1_cb_514 if the commissioner revokes the tax exempt status of an organization the remaining question is whether the revocation should be applied prospectively or retroactively generally revocation of a determination_letter is prospective rev_proc 20xx-4 dollar_figure cross-referencing dollar_figure et seq revocation of a determination_letter may however be retroactive if the organization omitted or misstated a material fact or operated ina manner materially different from that originally represented regulation sec_601_201 revproc_90_27 rev_proc 20xx-4 dollar_figure cross-referencing dollar_figure et seq in cases where the organization omitted or misstated a material fact revocation may be in cases retroactive to all open years under the statute regulation sec_601 i where revocation is due to a material_change inconsistent with exempt status in the character the purpose or the method of operation revocation will ordinarily take effect as of the date of the material_change regulation sec_601_201 revproc_90_27 in any event revocation will ordinarily take effect no later than the time at which the organization received written notice that its exemption ruling or determination_letter might be revoked regulation sec_601_201 under certain circumstances however the commissioner may in his discretion grant relief from retroactive revocation under r c b of the code sec_7805 of the internal_revenue_code provides form 886-arev department of the treasury - internal_revenue_service page -7- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx application to rulings the secretary may prescribe the extent if any to which any ruling including any judicial decision or any administrative determination other than by regulation relating to the internal revenue laws shall be applied without retroactive effect sec_301_7805-1 of the regulations delegates authority grated by sec_7805 to the commissioner or the commissioner’s delegate to request sec_7805 relief the organization must submit a statement in support of this application of sec_7805 as described in rev_proc 20xx-4 see also rev_proc 20xx-5 the organization's statement must expressly assert that the request is being made pursuant to sec_7805 the organization's statement must also indicate the relief requested and give reasons and arguments in support of the relief requested it must also be accompanied by any documents bearing on the request the organization’s explanation and arguments should discuss the five factors bearing on retroactivity listed in rev_proc 20xx-4 cross-referencing as they relate to the situation at issue these five items are in effect the same as the factors provided in regulation sec_601_201 and sec_601_201 statement of procedural rules which states except in rare or unusual circumstances the revocation or modification of a ruling will not be applied retroactively with respect to the taxpayer to whom the ruling was originally issued or to a taxpayer whose tax_liability was directly involved in such a ruling if there has been no misstatement or omission of material facts the facts at the time of the transaction are not materially different from the facts on which the determination_letter was based there has been no change in applicable law the determination_letter was originally issued for a proposed transaction and the taxpayer directly involved in the determination_letter acted in good_faith in reliance upon the determination_letter and revoking or modifying the determination_letter retroactively would be to the taxpayer's determinant if relief is granted under sec_7805 the effective date of revocation of a determination_letter is no later than the date on which the organization first received written notice that its exemption might be revoked regulation sec_601 n i 85_tc_743 affd 799_f2d_903 cir this does not preclude the effective date of revocation being earlier than the date on which the organization first received written notice that its exemption might be revoked virginia education fund v commissioner t c pincite form 886-acrev department of the treasury - internal_revenue_service page -8- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx the supreme court has held that the commissioner has broad discretion under r c b and its predecessor in deciding whether to revoke a ruling retroactively 353_us_180 see also 381_us_68 the commissioner's determination is reviewable by the courts only for abuse of that discretion 85_tc_743 in this case org issued only policies in 20xx that carried over to 20xx and did not issue any new policies in 20xx also org was not involved in any reinsurance agreements during 20xx org’s activities are considerably different from the activities that were described in its application form_1024 org has not been providing insurance to small investors as the application form stated therefore it is the service’s position that org is not entitled to relief under sec_7805 if org does not qualify for exemption from federal tax as an organization described under sec_501 was is the effective date of revocation since org does not qualify for tax exempt status under sec_501 the effective date of revocation is for years beginning january 20xx organization is liable for forms for years beginning january 20xx if org does qualify as an insurance_company under internal_revenue_code sec_501 does it meet the other requirements under internal_revenue_code sec_501 for tax exemption if for some reason org is considered an insurance_company under sec_501 then the question is whether org meets the other requirements to qualify under sec_501 internal_revenue_code sec_501 exempts from federal_income_tax insurance_companies as defined in sec_816 other than life including interinsurers and reciprocal underwriters if- i i the gross_receipts for the taxable_year do not exceed dollar_figure and ii more than percent of such gross_receipts consist of premiums or ii in the case of a mutual insurance company- the gross_receipts of which for the taxable_year do not exceed dollar_figure and i more than percent of such gross_receipts consist of premiums form 886-acrev department of the treasury - internal_revenue_service page -9- form 886a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx clause ii shall not apply to a company if any employee of the company or a member of the employee’s family as defined in sec_2032 is an employee of another company exempt from taxation by reason of this paragraph or would be so exempt but for this sentence sec clarification of exemption from tax for small property and casuaity insurance_companies of the pension funding equity act of 20xx p l amended sec_501 to change the definition of small property and casualty insurance_companies insurance_companies other than life_insurance_companies exempt from income taxes to a company whose gross_receipts for the taxable_year do not exceed dollar_figure and over half such gross_receipts consist of premiums currently whose net written premiums or if greater direct written premiums for the taxable_year do not exceed dollar_figure or a mutual_insurance_company a whose gross_receipts for the taxable_year do not exceed dollar_figure and more than percent of which consist of premiums and b none of whose employees or member of the employee's family is an employee of another company exempt from tax under sec_501 these changes were applicable after december 20xx notice 20xx-42 irb 20xx-19 provides guidance as to the meaning of gross_receipts for purposes of sec_501 of the internal_revenue_code this notice advises taxpayers that the service will include amounts received from the following sources during the taxable_year in gross_receipts for purposes of sec_501 a premiums including deposits and assessments without reduction for return_premiums or premiums_paid for reinsurance b items described in sec_834 gross_investment_income of a non-life insurance_company and c other items that are properly included in the taxpayer's gross_income under subchapter_b of chapter subtitle a of the code thus gross_receipts include both tax-free interest and the gain but not the entire amount_realized from the sale_or_exchange of capital assets because those items are described in sec_834 gross_receipts do not however include amounts other than premium income or gross_investment_income unless those amounts are otherwise included in gross_income accordingly the term gross_receipts does not include contributions to capital excluded from gross_income under sec_118 or salvage or reinsurance recovered accounted for as offsets to losses_incurred under sec_832 sec_834 of the internal_revenue_code includes under gross_receipts the gains from the sale or exchanges of capital assets to the extent provided in subchapter_p sec_1201 and following relating to capital_gains_and_losses form 886-acrev department of the treasury - internal_revenue_service page -10- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20kx sec_834 of the internal_revenue_code allows a deduction for capital losses to the extent provided in subchapter_p sec_1201 and following plus losses from capital assets sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends_and_similar_distributions to policyholders 20xx premiums written total premiums investment_income total gross_receipts premium reinsurance income to gross_receipts percentage- gross form 886-acrev based on the changes in the limitations under sec_501 and the operation of org during the year ending december 20xx it was determined by the chart above that org did not qualify for tax exempt status for years starting january 20xx org was able to meet the dollar_figure and dollar_figure gross_receipts limitation dollar_figure org was not able to meet the or requirements therefore org did not qualify for tax exempt status under sec_501 if org does qualify as an insurance_company under internal_revenue_code sec_501 but does not meet the other requirements under internal_revenue_code sec_501 what are the tax consequences to qualify for tax exempt status under sec_501 an organization must be operating as an insurance_company as well as meet the other requirements under this code section since org did not meet the other requirements it does not qualify for tax exempt status under sec_501 since org did not qualify for tax exemption per sec_501 for years beginning january 20xx the tax exempt status is hereby revoked starting january 20xx in revoking org’s tax exemption org is liable for forms 1120-pc if org does not meet the other requirements under internal_revenue_code sec_501 is it entitled to file an election under sec_831 and be taxed only on its investment_income sec_831 discusses tax on insurance_companies other than life_insurance_companies department of the treasury - internal_revenue_service page -11- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx sec_831 states as a general_rule taxes computed as provided in sec_11 shall be imposed for each taxable_year on the taxable_income of every insurance_company other than a life_insurance_company sec_831 provides an alternative_tax for certain small companies it states in sec_831 that in general in lieu of the tax otherwise applicable under subsection a there is hereby imposed for each taxable_year on the income of every insurance_company to which this subsection applies a tax computed by multiplying the taxable_investment_income of such company for such taxable_year by the rates provided in sec_11 sec_831 discusses the companies to which this subsection applies a in general this subsection shall apply to every insurance_company other than life including interinsurers and reciprocal underwriters if- i ii the net written premiums or if greater direct written premiums for the taxable_year do not exceed dollar_figure and such company elects the application of this subsection for such taxable_year the election under clause ii shall apply to the taxable_year for which made and for all subsequent taxable years for which the requirements of clause are met such election once made may be revoked only with the consent of the secretary regulations regs a discusses the time for making elections under i described in paragraph a of this section must be made by the later of- it states in general that except as otherwise provided in this section the elections a the due_date taking into account any extensions of time to file obtained by the taxpayer of the tax_return for the first taxable_year for which the election is effective or b date in which case the election generally must be made by amended_return regs a mentioned above includes sec_831 regs a describes the manner of making elections otherwise provided in this section the elections described in paragraph a of this section must be made by attaching a statement to the tax_return for the first taxable_year for which the election is to be effective it states except form 886-acrev department of the treasury - internal_revenue_service page -12- form_886 a name of taxpayer org ein explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service 20xx based on the code and regulation sections above org is not entitled to the relief under sec_831 for 20xx forward because it did not meet the requirements of reg sec_301_9100-8 and therefore would be required to report all income and expenses on form 1120-pc for each year as of this writing the election has never filed either with the filing of the form_990 990-ez or separately when an election is filed it would only allow the organization to receive relief under sec_831 in the year it is filed and all future years the election would not be retroactive to any prior years taxpayer’s position unknown at the time of this writing summary it is the service’s position based on the above facts law and analysis that the tax exemption status of org for the years beginning january 20xx should be revoked based on org not providing insurance and therefore not operating as an insurance_company thereby failing to meet the qualifications for exemption under sec_501 c forms would be required to be filed for years beginning january 20xx if it is determined that org was operating as an insurance_company the tax exempt status should still be revoked for years beginning january 20xx because org has not met the other requirements of sec_501 then forms 1120-pc would be required to be filed for years beginning january 20xx form 886-acrev department of the treasury - internal_revenue_service page -13-


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 b01 plr-158041-05 date date ------------------------------------------------------------------- internal_revenue_service number release date index number ------------------------------------------------------------ ----- --------------------------------------- ---------------------------------- --------------------------------------------------------- ------------------------------------------------------------ ---------- legend legend x -------------------------------------------------- country d1 d2 dear ---------------- ---------------------- ----------------------- ----------------------- this responds to a letter dated date submitted on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election to be treated as a partnership under sec_301_7701-3 facts the information submitted states that x was formed under the laws of country on d1 and began operations on d2 x represents that x is a foreign_entity eligible to elect to be treated as a partnership however x inadvertently failed to file a timely form_8832 entity classification election electing to treat x as a partnership effective d2 law and analysis sec_301_7701-3 provides guidance on the classification of a foreign_entity for federal_income_tax purposes generally a foreign eligible_entity is treated as plr-158041-05 an association_taxable_as_a_corporation if all members have limited_liability unless the entity makes an election to be treated otherwise if the foreign eligible_entity has more than one owner it may elect to be treated as a partnership pursuant to the rules in sec_301_7701-3 sec_301_7701-3 provides that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 by filing a form_8832 with the appropriate service_center under sec_301_7701-3 this election will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified on the election form the date specified on form_8832 cannot be more than days prior to the date on which the election is filed and cannot be more than months after the date on which the election is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election with a deadline prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 conclusion based solely on the facts submitted and representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly x is granted an extension of sixty days from the date of this letter to elect to be treated as a partnership effective d2 the election should be made by filing form_8832 with the appropriate service_center a copy of this letter should be attached to the election except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter plr-158041-05 this ruling is directed only to the taxpayer s requesting it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter will be sent to x’s authorized representative enclosures copy of this letter copy for sec_6110 purposes sincerely heather c maloy heather c maloy associate chief_counsel passthroughs and special industries