internal_revenue_service national_office technical_advice_memorandum date third party communication none date of communication not applicable index uil no case-mis no number release date director field operations ----------------------------------- 263a 263a tam-103875-06 taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference -------------------------------- ------------------- ------------------------------ ---------------- --------------- ------------------------- legend company sub one sub two b-type business c-type business d-type services e-type services state one state two year property one property two subactivities f g h j and k federal_agency dollar_figuren ----------------------------------------------------------------------------- --------------------------------- ---------------------------------------- --------------------------------------------------- ---------------------- --------------------- ---------------- ---------- ------------ ---------------------------------------------------------- ----------------------------------------------------------------------------- ---------------------- --------------------------- ----------------------------------------------------------------------------- ----------------------------------------- ---------------------------------------------------------------- ---------------- ---------------- ---------------- --------------- ---------------- --- ------- ------------------------------- --------------------------------- tam-103875-06 dollar_figurer dollar_figuret dollar_figureu dollar_figurew aa bb cc dd issue whether company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two meets the requirements of sec_263a of the internal_revenue_code conclusion under sec_263a company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is subject_to the requirements of sec_1_263a-1 whether those requirements are satisfied is a factual determination that must be made by the director based on company’s facts and circumstances facts company is a b-type business through subs one and two company is engaged in production of property one and production and acquisition for resale of property two production and acquisition for resale of property two may be divided into subactivities f g h j and k as a result of production of property one and production and acquisition for resale of property two company provides d-type services in state one through sub one and provides d-type and e-type services in states one and two through sub two company’s customers include both direct customers and c-type businesses during year company produced property one and property two since company has been required to account for its production_costs in accordance with sec_263a and the regulations thereunder prior to and during year company and subs one and two maintained their books_and_records in compliance with generally_accepted_accounting_principles gaap and the mandates of federal_agency the method_of_accounting for tax purposes for company and subs one and two mirrored their method_of_accounting for financial reporting purposes prior to year hereinafter referred to as the prior method tam-103875-06 during year company filed a form_3115 application_for change in accounting_method under revproc_97_27 1997_1_cb_680 requesting advanced consent to change its method_of_accounting for certain items part of company’s request was to elect the simplified_service_cost_method with the production cost allocation_ratio to determine capitalizable mixed_service_costs incurred during the year for both property one and property two the service has not granted consent to company to change its method_of_accounting pursuant to the form_3115 request and the request is still pending the service has not determined whether company’s property one qualifies as eligible_property under sec_1_263a-1 see revrul_2005_53 2005_35_irb_425 even though consent has not been granted company began using its new method beginning in year in implementing the requested accounting_method change company utilized the simplified_service_cost_method with the production cost allocation_ratio to determine capitalizable mixed_service_costs for year hereinafter referred to as the new method company performed this calculation by adding the costs of producing property one plus the costs of producing and acquiring for resale property two and dividing the sum by company’s total costs this amount was then multiplied by company’s total mixed_service_costs to determine its capitalizable mixed_service_costs for year company then allocated its capitalizable mixed_service_costs between property one and property two based on the relative contribution that each type of property made to the numerator of the simplified_service_cost_method with the production cost allocation_ratio company determined the relative contribution of each type of property by dividing the cost_of_producing and acquiring for resale in the case of property two that type of property by company’s total production and acquisition for resale costs for property one and property two company described this formula used to allocate costs between property one and property two in its form_3115 submitted during year if sub one had used its prior method in year sub one would have incurred dollar_figuren of mixed_service_costs of this amount its capitalizable mixed_service_costs would have been dollar_figurer or approximately aa percent of dollar_figuren almost one-half of its total mixed_service_costs sub one would have allocated all of the dollar_figurer to property one and none of the dollar_figurer to property two sub one would have deducted the non-capitalizable portion of its mixed_service_costs under the new method_of_accounting it began using in year sub one incurred the same amount of mixed_service_costs as under its prior method or dollar_figuren sub one’s capitalizable mixed_service_costs under its new method were determined to be dollar_figuret almost twice dollar_figurer the amount of capitalizable mixed_service_costs under its prior method the request for technical_advice in this case states that although the request for technical_advice focuses on sub one’s activities the facts and analysis apply equally to sub two’s activities accordingly although the following analysis of costs is based on sub one’s facts the analysis applies to both sub one and sub two tam-103875-06 dollar_figuret is approximately bb percent of dollar_figuren almost nine-tenths of company’s total mixed_service_costs sub one capitalized cc percent or dollar_figureu of dollar_figuren to property one and capitalized dd percent or dollar_figurew of dollar_figuren to property two sub one deducted the non- capitalizable portion of its mixed_service_costs compared to its prior method sub one’s total mixed_service_costs under its new method almost doubled while sub one’s capitalizable mixed_service_costs allocated to property one decreased to dollar_figureu more than times less than the amount allocated to property one under its prior method_of_accounting sub one’s capitalizable mixed_service_costs allocated to property two increased from zero to dollar_figurew representing more than four-fifths of sub one’s total mixed_service_costs of dollar_figuren and more than nine-tenths of sub one’s total capitalizable mixed_service_costs of dollar_figuret law and analysis the request for technical_advice in this case focuses on whether company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two meets the requirements of sec_263a the director asserts that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1 263a- f the director further asserts that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two fails to satisfy those requirements because it is not a reasonable allocation method within the meaning of sec_1_263a-1 in particular the director argues that the amount capitalized by company under its new method differs significantly from the amount that would have been capitalized under its prior method and that accordingly the new method is not a reasonable method under sec_1 263a- f i in contrast company reasons that its method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is part of the simplified_service_cost_method described in sec_1_263a-1 and does not have to satisfy the requirements of sec_1_263a-1 company also asserts that its allocation method satisfies the requirements sec_1_263a-1 in any event for the reasons described below company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1 263a- f however in determining whether the amount capitalized by company under its new method differs significantly from the amount that would have been capitalized under any other permissible method under sec_1_263a-1 the relevant comparison is between the amount capitalized under company’s allocation method and the amount that would be capitalized under any other permissible method not just amounts capitalized under company’s prior method as noted below company asserts that the tam-103875-06 amount capitalized under its present allocation method does not differ significantly from the amount that would be capitalized under the simplified_production_method the determination of whether company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two meets the requirements of sec_1_263a-1 including whether or not there is a significant difference between the amount capitalized using company’s allocation method and the amount capitalized using any other permissible method must be made by the director based on all of company’s facts and circumstances analyzes whether company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is part of the simplified_service_cost_method described in sec_1_263a-1 and concludes that it is not part of that simplified_method this is followed by the analysis of whether company’s allocation method must satisfy the requirements of sec_1_263a-1 procedural background after first discussing the procedural background of this case this memorandum as noted above in year company filed a form_3115 application_for change in accounting_method requesting advanced consent to change its method_of_accounting for certain items part of company’s request was to elect the simplified_service_cost_method with the production cost allocation_ratio to determine capitalizable mixed_service_costs incurred during the year for both property one and property two this technical_advice request is only with respect to whether company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two meets the requirements of sec_263a this memorandum does not consider whether any of company’s property including but not limited to property one qualifies as eligible_property under sec_1_263a-1 see revrul_2005_53 further this memorandum does not consider whether company’s determinations and definitions of mixed_service_costs were proper under sec_263a as noted above company’s form_3115 is still pending with the service and company has not yet been granted or denied consent to make the requested change in its accounting_method nevertheless company began using the requested new method_of_accounting beginning in year consideration of this request for technical_advice does not grant or imply consent under sec_446 to company’s request to change its method_of_accounting company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is not part of the simplified_service_cost_method under sec_1_263a-1 tam-103875-06 having noted the scope of the request for technical_advice we next analyze whether company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is part of the simplified_service_cost_method described in sec_1_263a-1 company uses the simplified_service_cost_method with the production cost allocation_ratio to determine its capitalizable mixed_service_costs see sec_1_263a-1 after determining the amount of its capitalizable mixed_service_costs company then allocates that amount between property one and property two based on the relative contribution that each type of property made to the numerator of the simplified_service_cost_method with the production cost allocation_ratio company reasons that its method of allocating capitalizable mixed_service_costs between property one and property two not only complies with the technical requirements for using the simplified_service_cost_method but also is consistent with the underlying rationale for simplified methods such as the simplified_service_cost_method in contrast the director argues that the simplified_service_cost_method merely provides a method for determining a taxpayer’s aggregate capitalizable mixed_service_costs and does not encompass the allocation of that aggregate amount among various activities or properties for the reasons described below company’s method of allocating capitalizable mixed_service_costs is not part of the simplified_service_cost_method described in sec_1_263a-1 company’s argument that its method of allocating capitalizable mixed_service_costs is part of the simplified_service_cost_method described in sec_1_263a-1 is based on an analysis of sec_1_263a-1 and sec_1_263a-1 this analysis starts by noting that sec_1_263a-1 requires that costs be allocated or apportioned to a taxpayer’s various activities including production or resale activities the analysis next focuses on sec_1_263a-1 for the proposition that two alternative methods exist for determining the amount of capitalizable service_costs sec_1_263a-1 provides this paragraph e provides definitions and categories of service_costs paragraph g of this section provides specific rules for determining the amount of service_costs allocable to property produced or property acquired for resale in addition paragraph h of this section provides a simplified_method for determining the amount of service_costs that must be capitalized the final step in company’s analysis notes that sec_1_263a-1 explains that mixed_service_costs are costs that are partially allocable to production or resale activities and partially allocable to non-production and non-resale activities company concludes from this that allocating capitalizable mixed_service_costs to different items of property is an inherent part of the simplified_service_cost_method tam-103875-06 in support of its position that allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is part of the simplified_service_cost_method company cites the preamble to final regulations under sec_263a t d 1993_2_cb_77 the preamble indicates that the regulations provide a simplified_service_cost_method producers may use to allocate mixed_service_costs among their various activities in particular the preamble provides the temporary regulations provide a simplified_service_cost_method producers may use to allocate mixed_service_costs among their various business activities company’s assertion that its method of allocating capitalizable mixed service t d 1993_2_cb_77 company reasons that the use of the words among and various connote three or more and indicate that while in some instances the simplified_service_cost_method might be used to allocate mixed_service_costs between production activities and non-production activities in other instances the simplified_service_cost_method would be used to allocate mixed_service_costs among various activities such as among company’s property one property two and deductible activities costs between production of property one and production and acquisition for resale of property two is part of the simplified_service_cost_method described in sec_1_263a-1 is not persuasive and is not consistent with the simplified_service_cost_method sec_1_263a-1 permits taxpayers to use the simplified_service_cost_method to determine the aggregate portion of mixed_service_costs incurred during the taxable_year that are properly allocable to eligible_property sec_1_263a-1 provides that under the simplified_service_cost_method a taxpayer computes its capitalizable mixed_service_costs by multiplying its total mixed_service_costs by an allocation_ratio the allocation_ratio can be either the labor-based or production cost allocation_ratio see sec_1 263a- h and in this case company used the production cost allocation_ratio under sec_1_263a-1 and determined its capitalizable mixed_service_costs in accordance with the following formula sec_263a production_costs total costs total x mixed_service_costs capitalizable mixed_service_costs that is company used the above formula to determine the aggregate portion of mixed_service_costs that are properly allocable to the taxpayer’s production or resale method under sec_1_263a-1 after determining in the aggregate its total capitalizable mixed_service_costs using equation one company used the following equation to determine the aggregate amount of capitalizable mixed_service_costs to allocate to property one total x capitalizable mixed_service_costs service_costs capitalizable mixed property one tam-103875-06 property one sec_263a production_costs property one and property two total production_costs property two sec_263a production_costs property one and property two total production_costs company used the following equation to determine the aggregate amount of capitalizable mixed_service_costs to allocate to property two total x capitalizable mixed_service_costs service_costs capitalizable mixed property two in both of the two equations above property two production_costs include the costs of acquiring property two for resale neither the formula used by company to allocate capitalizable mixed_service_costs to property one nor the formula used to allocate capitalizable mixed_service_costs to property two are found in the regulations governing the simplified_service_cost_method see sec_1_263a-1 this indicates that company’s method of allocating capitalizable mixed_service_costs between the two activities is not part of the simplified_service_cost_method described in sec_1_263a-1 mixed_service_costs between production of property one and production and acquisition for resale of property two is not part of the simplified_service_cost_method is found in other parts of the regulations under sec_263a for example sec_1_263a-1 explains that sec_1_263a-1 provides a simplified_method for determining the amount of service_costs that must be capitalized in contrast sec_1_263a-1 provides rules for allocating costs to property produced or acquired for resale in particular sec_1_263a-1 provides as follows support for the proposition that company’s method of allocating capitalizable paragraph h of this section provides a simplified_method for determining the amount of mixed_service_costs required to be capitalized to eligible_property the methodology set forth in paragraph h of this section for mixed_service_costs may be used in conjunction with either a facts-and- circumstances or a simplified_method of allocating costs to eligible_property produced or eligible_property acquired for resale tam-103875-06 in short sec_1_263a-1 provides rules for allocating mixed_service_costs to property produced or acquired for resale in addition sec_1_263a-3 details how a taxpayer using the simplified_service_cost_method allocates mixed_service_costs in connection with the simplified_resale_method the existence of these separate rules indicates that company’s method of allocating capitalizable mixed_service_costs between the two activities is not part of the simplified_service_cost_method described in sec_1_263a-1 further support for this proposition is found in the preamble to the temporary regulations which preceded the final regulations the preamble provides that the simplified_service_cost_method shall only be used to determine the total amount of certain indirect_costs which are required to be allocated to inventory production under sec_263a inventoriable mixed_service_costs the allocation of such indirect_costs to particular items of inventory shall be made pursuant to other methods allowed under the temporary regulations t d 1987_1_cb_99 in short the simplified_service_cost_method does not provide a mechanism for allocating capitalizable mixed_service_costs to particular activities or property accordingly company’s method of allocating capitalizable mixed_service_costs between property one and property two is not part of the simplified_service_cost_method described in sec_1_263a-1 mixed_service_costs between property one and property two as part of the simplified_service_cost_method is consistent with the underlying logic of the simplified_service_cost_method it reasons that the simplified_service_cost_method is an alternative to the facts and circumstances methods of allocating costs in that unlike those methods the company nevertheless argues that treating its method of allocating capitalizable sec_1_263a-1 provides that to the extent mixed_service_costs labor costs or other costs are incurred in more than one trade_or_business a taxpayer must determine the amounts allocable to the particular trade_or_business for which the simplified_service_cost_method is being applied by using any reasonable allocation method consistent with the principles of sec_1_263a-1 company argues that this provision only applies in determining the amount of capitalizable mixed_service_costs and not in allocating those costs while the text of sec_1_263a-1 does not contain this limitation it is unnecessary to decide how sec_1_263a-1 applies in this case as the facts do not indicate that company has more than one trade_or_business further the phrase among their various business activities in t d 1993_2_cb_77 arguably refers to sec_1_263a-1 and taxpayers with costs that are incurred by more than one trade_or_business this weakens company’s argument that the phrase supports allocating mixed_service_costs among various activities such as among company’s property one property two and deductible activities company asserts that use of the word may in sec_1_263a-1 indicates that other methods of allocating capitalizable mixed_service_costs are also available to taxpayers this reasoning is not persuasive as the regulations do not provide for such other methods indeed the lack of such other methods indicates that the word may has a restrictive meaning in sec_1_263a-1 taxpayers are limited to using only the specified methods tam-103875-06 simplified_service_cost_method allocates costs based on a single factor either the production cost allocation_ratio or the labor-based allocation_ratio rather than a variety of factors company asserts that this produces a simple and administrable result this reasoning is not persuasive because as noted above sec_1_263a-1 provides that the simplified_service_cost_method may be used in conjunction with various simplified methods of allocating costs finally company also analogizes its method of allocating costs between property x total labor costs total mixed_service_costs labor costs allocable to activity one and property two to the allocation of mixed_service_costs among classes of activities in the context of the simplified_resale_method under sec_1_263a-3 under this section a taxpayer using the simplified_service_cost_method determines the amount of mixed_service_costs allocated to and included in purchasing costs storage costs and handling costs of the simplified_resale_method using the following formula sec_1_263a-3 company notes that this allocation method is similar to the method it used and is a permissible method under sec_263a company reasons that its allocation method should also be permissible company’s reasoning is not persuasive for several reasons first the method described in sec_1_263a-3 for allocating mixed_service_costs in the context of the simplified_resale_method follows with only technical and minor changes the method that congress directed the treasury_department to provide to taxpayers acquiring property for resale see h_r conf_rep no at ii-305-308 reprinted in c b vol ii-1 ii-305-308 congress did not direct the treasury_department to provide the same mixed service_cost_method for taxpayers producing property who choose to use the simplified_production_method second although the simplified_resale_method uses two absorption ratios it ultimately applies a single combined_absorption_ratio to a taxpayer’s total sec_471 costs remaining on hand at the end of the taxable_year the preamble to the final regulations explains that the final regulations provide several simplified allocation_methods for allocating direct and indirect_costs to property produced and property acquired for resale in general these simplified methods determine aggregate amounts of additional sec_263a costs allocable to ending inventory emphasis added company does not assert that it is actually entitled to use the methodology described in sec_1_263a-3 the simplified_resale_method is not a permissible method for company because its production activities are not de_minimis under sec_1_263a-3 having determined that company’s method of allocating capitalizable mixed tam-103875-06 t d 1993_2_cb_77 the simplified_resale_method and its accompanying calculations regarding capitalizable mixed_service_costs determine one aggregate capitalized amount of additional sec_263a costs company’s division of its aggregate capitalizable mixed_service_costs amount into two separate amounts an amount capitalizable to property one and an amount capitalizable to property two performs the exact opposite function consequently company’s analogy of its method to the simplified_resale_method and the associated simplified_service_cost_method of sec_1 263a- d i f is not persuasive in determining whether company’s method meets the requirements of sec_1_263a-1 company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1_263a-1 service_costs between production of property one and production and acquisition for resale of property two is not part of the simplified_service_cost_method under sec_1 263a- h we next consider whether that allocation method is subject_to the requirements of sec_1_263a-1 the director asserts that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1 263a- f the director further asserts that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two fails to satisfy those requirements because it is not a reasonable allocation method within the meaning of sec_1_263a-1 in particular the director argues that the amount capitalized by company under its new method differs significantly from the amount that would have been capitalized under its prior method and that accordingly the new method is not a reasonable method under sec_1 263a- f i in contrast company also asserts that its allocation method satisfies the requirements sec_1_263a-1 for the reasons described below company’s method of allocating capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two is subject_to sec_1_263a-1 the director’s assertion that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1_263a-1 finds support in the regulations under sec_263a as noted above sec_1_263a-1 provides rules for allocating costs to property produced or acquired for resale in particular sec_1 263a- f provides as follows paragraph h of this section provides a simplified_method for determining the amount of mixed_service_costs required to be capitalized to eligible_property the methodology set forth in paragraph h of this section for tam-103875-06 mixed_service_costs may be used in conjunction with either a facts-and- circumstances or a simplified_method of allocating costs to eligible_property produced or eligible_property acquired for resale in short sec_1_263a-1 provides that paragraph f sets forth various detailed or specific facts and circumstances cost allocation_methods that taxpayers may use to allocate direct and indirect_costs to property produced and property acquired for resale it also provides that sec_1_263a-1 provides general rules for applying these allocation_methods to various categories of costs ie direct materials direct labor and indirect_costs including service_costs in addition in lieu of a facts-and-circumstances allocation method taxpayers may use the simplified methods provided in sec_1_263a-2 and sec_1_263a-3 to allocate direct and indirect_costs to eligible_property produced or eligible_property acquired for resale in this case company is not using one of the simplified methods provided in sec_1_263a-2 and sec_1_263a-3 accordingly it is necessary to determine whether company’s method of allocating capitalizable mixed_service_costs complies with sec_1_263a-1 simplified methods of allocating costs has a choice of methods under sec_1_263a-1 through 263a-1 f the methods described in sec_1_263a-1 and sec_1_263a-1 are a specific_identification_method a burden rate method and a standard_cost_method the director asserts and the company does not dispute that the company’s method is not a specific_identification_method burden rate method or standard_cost_method under sec_1_263a-1 and sec_1_263a-1 a taxpayer that does not use one of these methods may use any other reasonable allocation method within the meaning of sec_1_263a-1 sec_1_263a-1 provides that a taxpayer that does not use one of the under sec_1_263a-1 a taxpayer may use any other reasonable method to properly allocate direct and indirect_costs among units of property produced or property acquired for resale during the taxable_year an allocation method is reasonable if with respect to the taxpayer’s production or resale activities taken as a whole the total costs actually capitalized during the taxable_year do not differ significantly from the aggregate costs that would be properly capitalized using another permissible method described in this section or in sec_1_263a-2 or sec_1_263a-3 with appropriate consideration given to the volume and value of the taxpayer’s production or resale activities the availability of costing information the time and cost of using various allocation_methods and the accuracy of the allocation method chosen as compared with other allocation_methods the allocation method is applied consistently by the taxpayer and the allocation method is not used to circumvent the requirements of the simplified methods in sec_1_263a-1 or in sec_1_263a-2 or sec_1_263a-3 or the principles of sec_263a company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition of property two tam-103875-06 must satisfy these requirements in order to constitute a reasonable allocation method within the meaning of sec_1_263a-1 sec_1_263a-1 does not permit a taxpayer to avoid application of the reasonableness standard of sec_1_263a-1 any argument that sec_1_263a-1 refers taxpayers directly to sec_1_263a-1 for rules on allocating mixed_service_costs and thereby bypasses sec_1_263a-1 is contrary to sec_1_263a-1 itself indeed the allocation_methods permitted by sec_1_263a-1 include certain specified methods that are not at issue in this case and as an alternative to those specified methods permit the use of any other reasonable allocation method as defined under the principles of sec_1_263a-1 see sec_1_263a-1 and sec_1_263a-1 accordingly an argument that sec_1_263a-1 is overridden by more specific rules contained in sec_1_263a-1 is not persuasive further as noted above in footnote sec_1 263a- h incorporates the principles of sec_1_263a-1 into the simplified_service_cost_method in the context of allocating costs between different trades_or_businesses having determined that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two must satisfy the requirements of sec_1_263a-1 we next examine the director’s argument that company’s method of allocating its capitalizable mixed_service_costs between production of property one and production and acquisition for resale of property two fails to satisfy those requirements because the amount capitalized by company under its new method differs significantly from the amount that would have been capitalized under its prior method with the result that the new method is not a reasonable method under sec_1_263a-1 this argument is not persuasive because the standard of comparison under sec_1 f i is between the total costs actually capitalized during the taxable_year using the taxpayer’s allocation method and the total that would be capitalized using another permissible method described in sec_1_263a-1 sec_1_263a-2 or sec_1_263a-3 in short a taxpayer’s allocation method will satisfy sec_1_263a-1 if the amount capitalized does not differ significantly from the amount capitalized using any other permissible method thus the mere fact that the amount capitalized by company under its allocation method differs significantly from the amount capitalized under its prior method does not end the inquiry sec_1_263a-1 in any event because the amount capitalized under its new method does not differ significantly from the amount that would be capitalized using the simplified_production_method described in sec_1_263a-2 the request for technical_advice in this case did not raise this issue further the determination under sec_1_263a-1 of whether the amount capitalized under company’s allocation method differs significantly in amount from the amount capitalized using the simplified_production_method is factual in nature and as such is best made by the director based on all of company’s facts and circumstances company asserts that its allocation method satisfies the requirements of tam-103875-06 caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


t c no united_states tax_court anthony j kadillak petitioner v commissioner of internal revenue respondent docket no 2860-04l filed date p as a sales assistant with ariba technologies inc ariba received incentive stock_options isos subject_to an employment termination restriction whereby ariba had the right to repurchase nonvested stock on the date of termination for its exercise price on date p exercised his isos and was transferred all vested stock the nonvested stock was placed in escrow and transferred to p as the shares vested on a monthly basis over years p timely filed a sec_83 i r c election in date for the exercised isos p’s employment with ariba was terminated on date ariba timely exercised its repurchase rights with respect to nonvested stock p filed a federal_income_tax return for reporting the gain resulting from the exercise of the iso on the vested and the nonvested stock for alternative_minimum_tax amt purposes p subsequently submitted amended returns for and in which he claimed he was not subject_to amt for nonvested stock because the sec_83 i r c election was invalid p also claimed that the capital_loss limitations of sec_1211 and sec_1212 i r c do not apply for purposes of the amt so that he may use his capital losses realized in to reduce his alternative_minimum_taxable_income amti in r rejected p’s amended returns and issued to p a notice_of_federal_tax_lien and notice_of_intent_to_levy after a sec_6330 i r c hearing the appeals_office rejected p’s arguments and p timely petitioned this court for review of r’s lien and levy held p’s sec_83 i r c election required him to recognize as amti the excess of his vested and nonvested stock’s fair_market_value fmv over its exercise price on the date of exercise held further p acquired beneficial_ownership of the nonvested stock when he exercised his isos thus the nonvested shares were transferred to p within the meaning of sec_1 a income_tax regs held further p was not required to return the nonvested stock upon the happening of an event that was certain to occur pursuant to sec_1_83-3 income_tax regs thus the nonvested shares were properly transferred to p within the meaning of sec_1_83-3 income_tax regs held further p is not entitled to a deduction under sec_1341 i r c held further the capital_loss limitations of sec_1211 and sec_1212 i r c apply for purposes of calculating alternative_minimum_taxable_income held further p may not carry back alternative_minimum_tax net operating losses to reduce his amti in don paul badgley duncan c turner and brian g isaacson for petitioner kirk m paxson julie l payne and william c schmidt for respondent opinion haines judge petitioner filed a petition with this court in response to notices of determination concerning collection action s under sec_6320 and or for and years at issue pursuant to sec_6330 petitioner seeks review of respondent’s determinations the remaining issues for decision are whether petitioner’s sec_83 election for was valid this court holds the sec_83 election was valid whether petitioner is entitled to an alternative_minimum_tax amt ordinary_loss pursuant to sec_1341 for stock forfeited under a lapse provision this court holds he is not so entitled whether petitioner may carry back capital losses pursuant to sec_1211 to reduce the amount of his alternative_minimum_taxable_income amti for this court holds he may not whether petitioner may carry back alternative_minimum_tax net operating losses amtnol to reduce the amount of his amti for this court holds he may not unless otherwise indicated all section references are to the internal_revenue_code code as amended all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated amounts are rounded to the nearest dollar background the parties submitted this case fully stipulated pursuant to rule the parties’ stipulations of facts with attached exhibits are incorporated herein by this reference at the time the petition was filed petitioner resided in san francisco california a ariba technologies inc incentive stock_options from date through date petitioner was employed as a sales assistant with ariba technologies inc ariba at an annual salary of dollar_figure grants and exercise of stock_options in addition to his salary on date ariba issued to petitioner option no under its stock_option agreement agreement and stock_option plan plan option no which qualified as an incentive_stock_option iso granted petitioner the option to acquire big_number shares of ariba common_stock on date ariba issued option no to petitioner under its agreement and plan option no which qualified as an iso granted petitioner the option to acquire big_number shares of the stock granted under option no will not be discussed in this opinion when the isos granted under option no were exercised both the stock’s purchase_price and fmv were cents per share as a result no amti gain_or_loss was generated upon the exercise of these shares or their subsequent sale ariba common_stock at dollar_figure per share the option was exercisable any time after the grant_date pursuant to option no petitioner’s right to own the ariba stock was subject_to an employment termination restriction whereby if petitioner’s employment terminated for any reason before petitioner’s rights in the stock fully vested ariba had the right to repurchase all the nonvested stock petitioner’s vesting commencement_date was date upon petitioner’s completion of year of employment his rights to percent of the stock under option no vested and ariba’s right to repurchase those shares lapsed petitioner’s rights in the remaining shares under option no vested on a monthly basis approximately shares per month ending on date as petitioner’s rights in the stock vested the employment restriction no longer applied and ariba’s right to repurchase the stock lapsed in date date date and date ariba’s common_stock was subject_to a 2-for-1 stock split as a result the number of shares granted under option no increased from big_number to big_number on date petitioner exercised option no and purchased all big_number shares of ariba common_stock for dollar_figure38 per share or a total price of dollar_figure the shares had a fmv of dollar_figure per share and a total fmv of dollar_figure at the date of exercise ariba transferred to petitioner share certificates for the big_number shares that had vested by date and deposited the remaining big_number nonvested share certificates into an escrow account as the nonvested shares vested they were transferred to petitioner according to the agreement and plan when petitioner exercised the isos granted under option no he acquired stockholder rights in all shares subject_to the isos including the nonvested shares held in escrow pursuant to the agreement petitioner had the right to receive all regular cash dividends on the nonvested shares held in escrow sec_83 election petitioner timely filed a sec_83 election in date for the big_number exercised shares granted under option no the sec_83 election stated petitioner’s name address and social_security_number a description of the stock with respect to which the election was made the date the stock was transferred to petitioner and the taxable_year in which the election was made the nature of the restriction to which the property was subject the fmv at the time the stock was transferred with respect to which the election was being a sec_83 election must be filed no later than days after the date the property was transferred sec_1_83-2 income_tax regs made the amount_paid for the stock and a confirmation that copies of the election were furnished to ariba sale and repurchase of stock petitioner’s employment with ariba was terminated on date on date ariba gave petitioner notice it was exercising repurchase rights with respect to big_number nonvested shares granted under option no for a total purchase_price of dollar_figure on date petitioner sold to a third party the remaining big_number shares granted under option no all of those shares had vested b income_tax returns and assessment sec_1 original federal_income_tax returns prepared for and petitioner timely filed his form_1040 u s individual_income_tax_return for which was prepared by a certified_public_accountant and accepted by the internal_revenue_service irs the return reported wages of dollar_figure capital_gains of dollar_figure dividend income of dollar_figure itemized_deductions of dollar_figure and taxable_income of dollar_figure the return also reported amti of dollar_figure dollar_figure of which consisted of the gain recognized from the receipt of big_number vested and nonvested shares of ariba stock under option no the return reported a regular_tax of dollar_figure and an amt of dollar_figure for a total_tax liability of dollar_figure after applying a foreign_tax_credit of dollar_figure and withholding and estimated_tax payments of dollar_figure the remaining liability due was dollar_figure petitioner failed to remit the full amount of tax due with his return respondent assessed a tax_liability of dollar_figure irs reduced total_tax by dollar_figure foreign_tax_credit for and mailed petitioner a notice of balance due on date petitioner has not fully paid the balance petitioner filed hi sec_2001 federal_income_tax return on or about date which was also prepared by a certified_public_accountant and accepted by the irs the return reported wages of dollar_figure capital_loss of dollar_figure dividend income of dollar_figure and after itemized_deductions of dollar_figure zero taxable_income the return also reported zero tax and zero amt with an overpayment of dollar_figure the return did not report gain_or_loss from the forfeiture of the big_number nonvested shares granted under option no for regular_tax or amt purposes respondent assessed a tax_liability of zero for on date amended federal_income_tax returns for and on date relying on the advice of brian g isaacson a tax attorney petitioner filed a form 1040x amended u s individual_income_tax_return amending his federal the return was originally sent to the irs on approximately date and returned to petitioner on approximately date because petitioner’s signature was missing income_tax return amended_return together with an attached form_8275 disclosure statement the original return was amended to reflect petitioner’s assertion that the sec_83 election for the nonvested stock granted under option no was invalid petitioner contended no amti was realized the spread between fmv and the exercise price on the date of exercise in from the exercise of the option for nonvested shares the amti reported on the amended_return reflected only the spread between the fmv and exercise price of vested stock on the date of exercise and the remaining shares that vested each subsequent month until the end of the tax_year as a result the amended_return substantially reduced amt by dollar_figure for a total amt of dollar_figure and reported a regular_tax of dollar_figure with a tax owing of dollar_figure after deducting a foreign_tax_credit of dollar_figure and total payments of dollar_figure the amended_return prepared by mr isaacson was not accepted by the irs each return and amended_return mr isaacson prepared included a form_8275 disclosure statement which contained mr isaacson’s tax opinion letter to petitioner to avoid certain penalties form_8275 is used by taxpayers to disclose items or positions that are not otherwise adequately disclosed on a tax_return the form is filed to avoid an accuracy-related_penalty due to disregard of rules or regulations or due to a substantial_understatement_of_income_tax for non-tax-shelter items if the return position has a reasonable basis on date petitioner filed a form 1040x amending hi sec_2001 federal_income_tax return amended_return together with an attached form_8275 the return was prepared by mr isaacson and was initially accepted by the irs it reported the same regular income and itemized_deductions as the original return however unlike the original return the amended_return reflected petitioner’s assertion that the sec_83 election made in was invalid as to the nonvested shares as a result the amended_return reported dollar_figure of amti which was the spread between fmv and the exercise price for the ariba stock granted under option no which vested in petitioner throughout the tax_year after deducting a dollar_figure payment the return reported a total_tax liability of dollar_figure consisting entirely of amt petitioner failed to remit the full amount of tax due with his amended_return respondent assessed a tax_liability of dollar_figure for and sent a notice of balance due on date petitioner has not fully paid the balance other amended returns for and petitioner filed additional form sec_1040x for and based upon mr isaacson’s advice each form 1040x was prepared by mr isaacson and included form_8275 although neither was accepted by the irs the form 1040x explanation of changes to income deductions and credits stated the taxpayer’s original return erroneously reported an amount due based upon an incorrect valuation and or inclusion of stock_options both qualified and unqualified and the incorrect application on the amt net_operating_loss and amt credit a list of the legal grounds supporting the amended return’s valuation of stock_options and or exclusions of such options from income along with the correct application of the amt net_operating_loss and amt credit is attached to this form the application of the attached legal arguments to the taxpayer’s stock_option transactions will result in a change in the amount due for line sec_1 through and through on the front of thi sec_1040x form the exact amount of the refund will be determined pending the final_determination of facts and the release of a technical_advice memo or court decision respondent’s concession respondent concedes if this court finds petitioner’ sec_83 election to be valid and the liability reported on petitioner’s original return to be correct respondent will abate petitioner’ sec_2001 liability which was based upon petitioner’ sec_2001 amended_return and accept petitioner’s original return c collection actions on date respondent mailed petitioner a notice_of_federal_tax_lien filing and your right to a hearing regarding his unpaid taxes petitioner submitted form request for a collection_due_process_hearing to respondent requesting an administrative hearing under sec_6330 petitioner also sought the removal of any liens and a temporary reprieve from collection activity pending the release of a technical_advice_memorandum by the irs regarding the issues surrounding petitioner’s stock acquisitions on date respondent mailed to petitioner a final notice_of_intent_to_levy with respect to petitioner’ sec_2001 tax_liability petitioner’s counsel mr isaacson wrote to respondent and requested an administrative hearing appeals officer lawrence dorr conducted a telephonic hearing with mr isaacson on december and mr dorr declined to consider petitioner’s request for relief and issued notices of determination concerning collection actions for the years at issue on date and date respectively in the determination mr dorr found there was no mechanism in the collection_due_process venue for withholding collection in this circumstance mr dorr did not review the underlying liability for the years at issue petitioner timely filed a petition for lien or levy action with the court on date on date this case was set for trial during the date trial session in seattle washington on date respondent moved for a continuance and remand on date the court retained jurisdiction and remanded this case to respondent’s appeals_office for another administrative hearing to consider petitioner’s underlying tax_liabilities for the years at issue on date this case was reassigned to appeals officer lenora miles on date mr isaacson sent ms miles a written explanation of petitioner’s position on date ms miles held an administrative hearing with mr isaacson during which he argued petitioner’s sec_83 election was invalid even if the sec_83 election were valid petitioner could apportion a lesser value to the nonvested shares to reflect ariba’s repurchase at cost even if the sec_83 election were valid it could be revoked due to mistake of fact amt capital losses are not limited by sec_1211 and amt capital losses can be carried back as an amtnol after considering petitioner’s arguments on date ms miles sent a letter to petitioner setting forth her determination that there was no basis for settlement on date respondent issued a supplemental notice_of_determination concerning collection actions to petitioner regarding the years at issue respondent determined the filing of the notice_of_federal_tax_lien and the proposed levy action with respect to the unpaid assessments for the years at issue were appropriate on date this case was calendared for trial during the date trial session in seattle washington at petitioner abandoned the second and third arguments trial the parties agreed to submit this case fully stipulated under rule a standard of review discussion to determine the correct standard of review in a case instituted under sec_6320 and sec_6330 the court must first decide whether petitioner’s underlying tax_liability is properly at issue 114_tc_604 114_tc_176 the term underlying tax_liability under sec_6330 includes amounts self-assessed under sec_6201 together with penalties and interest sec_6201 122_tc_1 sec_301_6203-1 proced admin regs the amount of the underlying tax_liability may be placed at issue if the taxpayer did not receive a statutory_notice_of_deficiency or otherwise have an opportunity to dispute the tax_liability sec_6330 see 118_tc_572 in this case petitioner was not issued a notice_of_deficiency and did not have a prior opportunity to dispute his tax_liabilities for and therefore the proper standard of review for the arguments challenging the underlying tax_liability is de novo sego v commissioner supra pincite b isos generally sec_421 provides if the requirements of sec_422 are met a taxpayer does not recognize income for regular income_tax purposes either upon the granting8 of an iso to him or when the stock is transferred9 to the taxpayer upon exercise of an iso the recognition of income is deferred until the disposition of the stockdollar_figure sec_421 sec 14a 422a-1 q a-1 temporary income_tax regs fed reg date because of the application of sec_421 when petitioner was granted and exercised option no he did not recognize income for regular_tax purposes if sec_421 applies sec_83 does not sec_83 c sec_83 impact on the exercise of isos for amt purposes however sec_421 does not apply to amt sec_56 because it does not apply sec_83 controls the determination at all times from the date of granting the option until months before the date of exercise the option holder must be an employee of the company granting the option sec_422 the date on which a iso is granted is the date on which all corporate action necessary for the grant of the iso is completed sec_1 c income_tax regs for purposes of sec_421 through the term transfer means the transfer of ownership or substantially_all rights of ownership of a share of stock to an individual pursuant to his exercise of a statutory option sec_1 g income_tax regs a disposition of iso stock generally means any sale exchange or gift of or transfer of legal_title to the stock sec_424 of what income the taxpayer recognizes for amti purposes see sec_56 124_tc_165 affd 454_f3d_782 8th cir sec_1_83-7 income_tax regs sec_83 generally requires a taxpayer to recognize as amti the spread between the stock’s fmv and the exercise price when a taxpayer is transferred a share of stock pursuant to the exercise of an iso and its fmv exceeds the exercise price on the date of exercise sec_55 sec_56 sec_83 117_tc_237 affd 65_fedappx_508 5th cir a taxpayer generally will not recognize income for amt purposes under sec_83 if the stock included in an iso is subject_to a substantial_risk_of_forfeiture on the date of exercise sec_83 pursuant to sec_83 when petitioner exercised option no he would recognize as amti dollar_figure the excess of the vested stock’s fmv over its exercise price on the date of the fmv of the vested shares on the date of exercise was dollar_figure big_number vested shares on date of exercise x dollar_figure fmv per share of stock dollar_figure total fmv the vested shares exercise price on the date of exercise was dollar_figure big_number vested shares on date of exercise x dollar_figure38 exercise price per share dollar_figure total exercise price of vested shares the amti recognized from exercising the vested shares was dollar_figure dollar_figure total fmv of the vested shares - dollar_figure total exercise price of the vested shares dollar_figure exercise absent a sec_83 election petitioner would not recognize as amti dollar_figure the same spread for the nonvested shares because those shares were subject_to a substantial_risk_of_forfeiture ie ariba’s right to repurchase the nonvested shares sec_83 allows a taxpayer to elect to include in income in the year of receipt the excess of the value of the stock subject_to a substantial_risk_of_forfeiture determined without regard to any restriction other than a nonlapse_restriction over any amount_paid for the stock although a taxpayer who makes a sec_83 election after exercising isos will not recognize income for regular_tax purposes because sec_421 applies to the transfer the taxpayer will recognize ordinary_income for amt purposes if petitioner’s sec_83 election was validly made petitioner would recognize as amti the fmv of the nonvested shares on the date of exercise was dollar_figure big_number nonvested shares on date of exercise x dollar_figure fmv per share of stock dollar_figure total fmv the vested shares exercise price on the date of exercise was dollar_figure big_number vested shares on date of exercise x dollar_figure38 exercise price per share dollar_figure total exercise price of vested shares the amti recognized from exercising the vested shares was dollar_figure dollar_figure total fmv of the vested shares - dollar_figure total exercise price of the vested shares dollar_figure a nonlapse_restriction is a permanent limitation on the transferability of property sec_1_83-3 and i income_tax regs dollar_figure the excess of the vested and nonvested stock’s fmv over its exercise price on the date of exercisedollar_figure there is no dispute sec_421 applies to the grant and exercise of option no and that no income for regular income_tax purposes was recognized in from the exercise of isos there also is no dispute that petitioner’s sec_83 election complied with the procedural requirements set out in sec_1_83-2 income_tax regsdollar_figure petitioner contends however the sec_83 election was invalid as to the nonvested ariba stock because the nonvested shares were not legally transferred to him which results in his not having to recognize as amti the excess of the fmv of the nonvested stock on the date of exercise over the exercise price until the underlying shares vested ie the substantial_risk_of_forfeiture lapsed dollar_figure total fmv - dollar_figure total exercise price dollar_figure when a sec_83 election is made the taxpayer is betting that the value of the stock will continue to appreciate the purpose of making a sec_83 election is to accelerate recognition of ordinary_income when the stock’s fmv is comparatively low thereby eliminating the chance of having to recognize a larger amount of ordinary_income when the stock is no longer subject_to a substantial_risk_of_forfeiture but the election can backfire if the stock depreciates rather than appreciates over that period or if the stock is forfeited in which event sec_83 bars the deduction of the amount previously recognized as income having gambled and lost petitioner now wants to invalidate his own election petitioner abandoned his argument that he revoked his sec_83 election pursuant to sec_1_83-2 income_tax regs d whether the transfer of nonvested stock pursuant to the sec_83 election was valid sec_83 and the california commercial code petitioner argues he did not receive a beneficial_ownership interest in the nonvested stock granted under option no on the date of exercise because he was not a holder in due course under the california law cal com code sec west accordingly petitioner reasons his sec_83 election was invalid stock is property for purposes of sec_83 103_tc_634 affd without published opinion 89_f3d_856 11th cir sec_1_83-3 income_tax regs property is transferred for purposes of sec_83 when a taxpayer acquires a beneficial_ownership interest in the property disregarding any lapse restrictions facq v commissioner tcmemo_2006_111 sec_1_83-3 income_tax regs a beneficial_owner is one who does not have title to property but has rights in the property which are equivalent to normal incidents_of_ownership sec_1_83-3 income_tax regs see hilen v commissioner tcmemo_2005_226 359_fsupp2d_1129 w d wash 345_fsupp2d_1046 n d cal beneficial_ownership is identified by a taxpayer’s command over property or enjoyment of its economic benefits 74_tc_1513 a sale or transfer occurs when a taxpayer acquires a beneficial_ownership interest in property rather than meeting the technical requirements for a transfer of an instrument under state law see id schnurr v commissioner tcmemo_1989_275 according to the agreement and plan when petitioner exercised the iso granted under option no he acquired stockholder rights in all exercised shares including the nonvested shares held in escrow pursuant to the agreement petitioner also was entitled to receive all regular dividends on the nonvested shares held in escrow because petitioner acquired beneficial_ownership of the nonvested stock held in escrow upon the exercise of the iso granted under option no the nonvested shares were transferred to petitioner within the meaning of sec_1_83-3 income_tax regs an event certain to occur petitioner argues the transfer of the nonvested stock was ineffective pursuant to sec_1_83-3 and income_tax regs because his termination of employment from ariba was certain to occur and upon his termination he was required to surrender the nonvested stock for its option_price instead of fmv sec_1_83-3 and income_tax regs states requirement that property be returned similarly no transfer may have occurred where property is transferred under conditions that require its return upon the happening of an event that is certain to occur such as the termination of employment in such a case whether there is in fact a transfer depends upon all the facts and circumstances factors which indicate that no transfer has occurred are described in paragraph a and of this section relationship to fair_market_value an indication that no transfer has occurred is the extent to which the consideration to be paid the transferee upon surrendering the property does not approach the fair_market_value of the property at the time of surrender emphasis added whether property is transferred under conditions that require its return upon the happening of an event that is certain to occur depends on a facts and circumstances analysisdollar_figure sec_1_83-3 income_tax regs sec_1_83-3 income_tax regs is one factor to consider when determining whether a valid transfer occurred however it is unnecessary to reach the facts and circumstances analysis in cases where a condition certain to occur has not been established although the restriction placed upon petitioner’s nonvested shares is conditioned upon his termination all the stock could the factors considered indicative that no transfer has occurred include the following the extent to which the arrangement is similar to an option sec_1_83-3 income_tax regs the extent to which the consideration to be paid the transferee upon surrender is less than the fmv of the property sec_1_83-3 income_tax regs and the extent to which the transferee does not incur the risk of a beneficial_owner ie the extent to which the transferee does not bear the risk of loss with respect to the investment as well as the opportunity for gain sec_1_83-3 income_tax regs have vested in petitioner before he was terminated all isos were granted to petitioner pursuant to a lapse_restriction which required petitioner to be employed by ariba for year for percent of the shares to vest and another years for the remaining percent to vest once the stock petitioner acquired upon the exercise of option no had vested petitioner was not required to return the shares under any condition because the condition under which petitioner was required to return the stock was not permanent ie it was a lapse_restriction it was not certain that petitioner’s services would be terminated before the stock vested see sec_1_83-3 example and income_tax regsdollar_figure the ariba stock was not transferred on the date of exercise under a condition that was example on date x corporation sells for dollar_figure to s a salesman of x shares of stock in x corporation with a fair_market_value of dollar_figure the stock is nontransferable and subject_to return to the corporation for dollar_figure if s’s sales do not reach a certain level by date disregarding the restriction concerning s’s sales since the restriction is a lapse_restriction s’s interest in the stock is that of a beneficial_owner and therefore a transfer occurs on date in contrast to petitioner and the taxpayer in example the taxpayer described in example sec_1_83-3 income_tax regs exemplifies a situation where the taxpayer’s stock is subject_to a nonlapse_restriction requiring the taxpayer to return the stock upon termination of employment which is always certain to occur and without the option to acquire ownership of the stock before termination thus in example the stock will be returned upon the happening of an event that is certain to occur because termination is certain to occur and the taxpayer will never have the opportunity to keep the shares after termination certain to occur it follows that consideration of sec_1 a income_tax regs is unnecessary because the prerequisite condition was not satisfied accordingly the stock was properly transferred to petitioner pursuant to sec_83 when petitioner exercised option no dollar_figure after petitioner exercised option no on date he made a timely sec_83 election applicable to all the nonvested stock subject_to the employment restriction as a result he recognized amti in to the extent the fmv of the underlying shares of stock on the date of exercise exceeded the option_price see sec_83 e claim of right if the sec_83 election is valid petitioner argues that because he forfeited big_number shares of nonvested ariba stock for its exercise price on date he is entitled to a tax deduction under sec_1341 equal to the amt attributable to the inclusion of amti of dollar_figure a taxpayer qualifies for a deduction under sec_1341 if an item was included in the taxpayer’s gross_income in a petitioner also argues that the transfer of nonvested stock was invalid because it was subject_to the claims of ariba’s creditors petitioner cites the definition of property as his authority sec_1_83-3 income_tax regs there is nothing in the record to support petitioner’s claim that creditors of ariba could reach petitioner’s shares of nonvested stock while in escrow furthermore shares of stock clearly constitute property and the nonvested shares were transferred to petitioner subject_to a lapse provision prior year it appeared that the taxpayer had an unrestricted right to the item in the prior year and the taxpayer is entitled to a deduction in excess of dollar_figure under another section of the code for the loss resulting from the restoration of the item to another in the current tax_year sec_1341 sec_1_1341-1 income_tax regs sec_1_1341-1 income_tax regs continues with the definition income included under a claim of right means an item included in gross_income because it appeared from all the facts available in the year of inclusion that the taxpayer had an unrestricted right to such item and restoration to another means a restoration resulting because it was established after the close of such prior taxable_year or years that the taxpayer did not have an unrestricted right to such item or portion thereof although petitioner may recognize losses on the sale of stock for amt purposes there is no deduction for a loss attributable to a forfeited nonvested share of stock subject_to a sec_83 election pursuant to sec_83 if property to which a sec_83 election is made is subsequently forfeited no deduction shall be allowed in respect of such forfeiture similarly pursuant to sec_1_83-2 income_tax regs if property for which a sec_83 election is in effect is forfeited while substantially nonvested such forfeiture shall be treated as a sale_or_exchange upon which there is realized a loss equal to the excess if any of-- the amount_paid if any for such property over the amount_realized if any upon such forfeiture if such property is a capital_asset in the hands of the taxpayer such loss shall be a capital_loss petitioner is not a securities_dealer and he held his ariba shares strictly as an investor stock is a capital_asset sec_1221 thus petitioner’s nonvested ariba stock was a capital_asset in his hands and any loss realized upon its forfeiture is characterized as a capital_loss see sec_1 a income_tax regs furthermore the phrase amount_paid in sec_1 a income_tax regs refers to the value of any money or property paid for the transfer of property to which sec_83 applies sec_1_83-3 income_tax regs therefore pursuant to sec_1_83-2 and sec_1_83-3 income_tax regs a taxpayer is barred from recognizing as a capital_loss the previous amount included as compensation when nonvested stock subject_to a sec_83 election is subsequently sold for less than its fmv 85_f3d_440 9th cir revg tcmemo_1994_45 petitioner paid ariba dollar_figure in to exercise the option to acquire big_number shares of subsequently forfeited stock and elected to recognize the excess of the fmv over the exercise price on the date of exercise as compensation_for amt purposes ariba paid petitioner dollar_figure to repurchase the big_number shares in causing petitioner to realize an amt capital_loss of dollar_figure however pursuant to sec_83 and sec_1_83-2 income_tax regs petitioner cannot recognize the dollar_figure amt capital_loss because petitioner fails to satisfy the requirement under sec_1341 that the taxpayer is entitled to a deduction under another section of the code for the loss we need not consider whether petitioner satisfies other requirements of sec_1341 eg whether petitioner had an unrestricted right in the nonvested ariba stock in the year he made the sec_83 election f carryback of amt capital losses petitioner argues he may carry back capital losses pursuant to sec_1211 to reduce the amount of his amti for and that he may carry back an amtnol to reduce the amount of his amti for similar arguments by the same counsel have been rejected in 126_tc_205 127_tc_43 and spitz v commissioner tcmemo_2006_168 consistent with these cases the court finds petitioner may not carry back his amt capital losses to reduce his amti in and petitioner may not claim an amtnol carryback to reduce his amti for see merlo v commissioner supra in reaching these holdings the court has considered all arguments made and to the extent not mentioned concludes that they are moot irrelevant or without merit to reflect the foregoing and the concessions of the parties decision will be entered for respondent


internal_revenue_service number release date index number ---------------------------------------------- ---------------------------------------------- ----------------------------------- ------------------------ in re ---------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------- -------------------------- telephone number --------------------- refer reply to cc psi b04 plr-138461-14 date date legend grantor_trust date son son's wife year year state daughter foundation trust a_trust b_trust x company a llc a company b company c company d date state court date trust grandchild grandchild grandchild grandchild ggc ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- 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----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- plr-138461-14 ggc ggc ggc ggc ggc ggc ggc ggc year year date a b state statute state statute state statute ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- ------------------------------------------- dear --------------------------- this letter responds to your personal representative’s letter of date requesting income gift and generation-skipping_transfer gst tax rulings regarding the proposed modification of trust the facts and representations submitted are summarized as follows grantor created and funded trust on date for the benefit of son son’s wife and son’s descendants you represent that trust was irrevocable before date and that there have been no additions actual or constructive since that time grantor died in year section a of article i of trust provides that son in his capacity as initial trustee of trust shall hold manage control and administer the above-described property and such other money and property as the grantor may assign deliver or bequeath to him at any time s after the execution of this agreement in trust shall collect all the income thereof out of such income shall pay or provide for all proper taxes costs charges and expenses of every kind imposed upon or incurred by trust other than those imposed upon or incurred by it upon or by reason of its termination and other than capital losses and all gift_taxes on whomever imposed payable to state by reason of the execution of this agreement or by reason of any assignments transfers or deliveries made by grantor to the initial trustee at or within six months after the execution of this agreement and thereafter shall distribute the remaining net_income and corpus of trust as hereinafter provided plr-138461-14 section b of article i of trust provides in part that the remaining net_income of trust for each calendar_quarter shall be divided into equal shares of which there shall be a one share for grantor’s son son so long as he is living b one share for grantor’s said son’s wife so long as they both are living and she is his wife c one share for each of grantor’s said son’s lawful children then living and d one share for the then living descendants of each of grantor’s said son’s lawful children then deceased section c of article i of trust provides that upon the death of son the corpus of trust shall be distributed to such person or persons within a class including only the grantor’s lineal_descendants other than son and no other or others whatsoever particularly and expressly excluding from said class son son’s estate son’s creditors and the creditors of his estate and in such shares and proportions and at such time or times and in such manner absolutely or in trust as son by his will shall appoint or direct but not in such a way as to postpone the final distribution of this trust beyond the expiration of years after the death of the last survivor of all of grantor’s descendants living at the time this agreement is executed and any later final distribution directed by son shall be accelerated accordingly or as to all or any portion of this trust estate not so effectively appointed by son this trust shall continue until the death of the last survivor of the lawful children of son living at the time this agreement is executed and the corpus shall then be distributed free of trust per stirpes to the then living descendants of son or if no such descendants are then living then free of trust per stirpes to the then living descendants of grantor’s daughter daughter or if none of her descendants is then living then to foundation a charitable corporation on date state court ordered that trust be separated into two separate modified trusts with terms identical to trust except that different individuals may act as successor trustees of each resulting trust to facilitate different investment and management objectives the court found that the proposed modification of trust by reason of changed circumstances comported with the intentions of grantor and would have no effect upon the current or ultimate disposition of trust in addition state court issued an order that authorized the initial trustee to partition trust into two separate trusts trust a and trust b with identical terms except that the separate trusts may provide that different individuals may act as successor trustee of each modified trust after the partition son acted as trustee of trust a and trust b and trustee succession would continue to be governed by the terms of trust son transferred all assets from trust other than common_stock of company a to trust a and transferred the common_stock of company a to trust b company a is a corporation which would later be converted into a limited_liability_company llc a llc a was a holding_company that owned a controlling_interest in the business that had previously been spun-off from company b and was later operated as company c plr-138461-14 on date son died in his will son exercised the limited testamentary_power_of_appointment provided under section c of article i of trust over trust b to create trust to be held and administered as a separate trust under the terms of trust x a revocable_trust first established by son in year which became irrevocable upon son’s death you represent that no additions constructive or otherwise were made to trust b or trust since date distributions from trust are governed by trust x while the terms of trust continue to govern all other matters related to the administration of trust including termination son’s wife grandchild grandchild grandchild and grandchild are all the current income beneficiaries of trust ggc1 ggc ggc ggc ggc ggc ggc ggc ggc and several minors are the remainder beneficiaries of trust trust will terminate no later than years after the death of the last to die of grantor’s descendants who were living on date in year llc a sold its interest in company c to company d a publicly-traded corporation in exchange for cash and stock in company d at the end of year llc a made a partial liquidating_distribution to its members of cash received from the sale of company c a portion of this partial liquidating_distribution represented the amounts that trust was entitled to receive as a preferred distribution and was characterized by the trustee of trust as trust income the majority of the partial liquidating_distribution was characterized by the trustee of trust as trust principal in year llc a sold its stock in company d in the same year llc a made a final liquidating_distribution to its members of cash received from the sale of stock in company d this distribution was characterized by the trustee of trust as trust principal as a result of the transactions in year and year trust incurred a significant capital_gains_tax which was much greater than the annual income of trust the dispositive tax charging provision tax charging provision for trust which is contained in trust solely states that the trustee shall collect all the income from trust and out of such income the trustee shall pay or provide for all proper taxes the trustee believes the language of trust is ambiguous and incomplete regarding whether the capital_gains taxes due as a result of the transactions in year and year should be paid from trust income or trust principal as a result of the ambiguous language and the lack of specific direction regarding payment of taxes for capital_gains in the tax charging provision the trustee of trust petitioned state court to construe the tax charging provision to determine how the capital_gains_tax payment should be charged against trust principal and trust income to avoid costs fees and delays associated with litigation the current income beneficiaries the adult remainder beneficiaries and a court appointed guardian ad litem representing the minor and unborn remainder beneficiaries later entered into a settlement agreement settlement agreement that modified the tax charging plr-138461-14 provision and allocated the year tax payment as being a percent from principal and b percent from income settlement agreement also provided that all capital_gains incurred in year and later years would be allocated to principal state court approved settlement agreement on date conditioned on a favorable private_letter_ruling from the internal_revenue_service the current trustee the current income beneficiaries and all adult remainder beneficiaries have each submitted a private_letter_ruling request requesting the following rulings the implementation of settlement agreement will not cause any beneficiary of trust to be treated as having made a taxable gift the implementation of settlement agreement will not cause trust to lose its exempt status for gst tax purposes the implementation of settlement agreement will not result in gain to trust or any beneficiary of trust or otherwise be treated as a taxable_exchange for federal_income_tax purposes law and analysis ruling sec_2501 imposes a tax on the transfer of property by gift by any individual sec_2511 provides that the gift_tax shall apply whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2512 provides that if the gift is made in property the value thereof at the date of the gift shall be considered the amount_of_the_gift sec_2512 provides that where property is transferred for less than an adequate_and_full_consideration in money or money’s worth then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift in 387_us_456 the court considered whether a state trial court’s characterization of property rights conclusively binds a federal court or agency in a federal estate_tax controversy the court concluded that the decision of a state trial_court as to an underlying issue of state law should not be controlling when applied to a federal statute rather the highest court of the state is the best authority on the underlying substantive rule_of state law to be applied in the federal matter if there is no decision by that court then the federal authority must apply what it finds to be state law after giving proper regard to the state trial court’s determination plr-138461-14 and to relevant rulings of other courts of the state in this respect the federal_agency may be said in effect to be sitting as a state court the relevant inquiry in determining whether transfers made pursuant to a settlement agreement are exempt from the gift_tax focuses on the bona fides and legitimacy of the claims see 674_f2d_761 9th cir thus an intrafamily settlement of litigation will be regarded as a bona_fide compromise_agreement when the parties’ claims are bona_fide and are satisfied to the extent feasible on an economically fair basis in the present situation in determining whether the gift_tax applies it is first necessary to determine if settlement agreement properly reflects the economic values of bona_fide claims of the respective parties with appropriate allowance for litigation uncertainty if the settlement does not so reflect those values then it will be necessary to consider whether any differences may be justified on the basis of a compromise thus with respect to each gift_tax issue it is pertinent to examine the law of the applicable jurisdiction to determine the legitimacy of the parties’ claims in the issues that are under our consideration for gift_tax purposes state statute provides that the trustee shall allocate money received in total or partial_liquidation of an entity to principal furthermore state statute provides that a tax required to be paid_by a trustee based on receipts allocated to principal must be paid from principal even if the tax is called an income_tax by the taxing authority however state statute provides that in allocating receipts and disbursements to income or principal or between income and principal a fiduciary shall first administer a_trust or estate in accordance with the terms of the trust or the will even if there is a different provision in the subchapter of state statutes accordingly under state law if a_trust instrument is clear and unambiguous in designating the payment of capital_gain taxes out of income the fiduciary must administer the trust in accordance with the terms despite state statutes that are contrary however in the absence of a specified direction from the grantor capital_gain taxes are payable from principal in this case the dispositive tax charging provision states that the trustee shall collect all the income from trust and out of such income the trustee shall pay or provide for all proper taxes the tax charging provision did not specifically address capital_gain taxes nor is the term all proper taxes defined a court could construe the tax charging provision as providing that the capital_gain taxes and specifically the significant capital_gains taxes incurred here as being extraordinary in nature and not within the language all proper taxes therefore the tax charging provision can be viewed as generally but not absolutely requiring the application of income to pay taxes because the tax charging provision is ambiguous and incomplete with respect to payment of capital_gains taxes and subject_to conflicting legal conclusions we conclude plr-138461-14 that the claims of the current income beneficiaries the trustee and the remainder beneficiaries regarding the allocation of the taxes are bona_fide with the outcome of the litigation of this issue being uncertain the allocation in settlement agreement represents the economic viability of the claims of the current income beneficiaries and the remainder beneficiaries accordingly based on the facts submitted and the representations made we conclude that implementation of settlement agreement will not cause any beneficiary of trust to be treated as having made a taxable gift this ruling is applicable to all current income beneficiaries of trust the adult remainder beneficiaries of trust and the minor and unborn remainder beneficiaries of trust ruling sec_2601 imposes a tax on every generation-skipping_transfer made after date under a of the tax_reform_act_of_1986 act and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the gst tax is generally applicable to gsts made after date however under b a of the act and sec_26_2601-1 the gst tax does not apply to a transfer under a_trust that was irrevocable on date but only to the extent that the transfer is not made out of corpus added to the trust after date or out of income attributable to corpus so added under sec_26_2601-1 any trust in existence on date will be considered irrevocable unless the decedent had a power that would have caused inclusion of the trust in his or her gross_estate under sec_2038 or sec_2042 if the decedent had died on date sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under sec_26_2601-1 or will not cause the trust to lose its exempt status under the regulation unless specifically provided otherwise these rules are applicable only for purposes of determining whether an exempt trust retains its exempt status for gst tax purposes thus unless specifically noted the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of gain for purposes of sec_1001 sec_26_2601-1 provides that a court-approved settlement of a bona_fide issue regarding the administration of the trust or the construction of terms of the governing instrument will not cause an exempt trust to be subject_to the provisions of chapter if the settlement is the product of arm’s length negotiations and the settlement is within the range of reasonable outcomes under the governing instrument and applicable state law addressing the issues resolved by the settlement a settlement that results in a compromise between the positions of the litigating parties and reflects plr-138461-14 the parties’ assessments of the relative strengths of their positions is a settlement that is within the range of reasonable outcomes in this case as stated above the tax charging provision is ambiguous incomplete and subject_to conflicting legal conclusions we conclude that the claims of the current income beneficiaries the trustee and the remainder beneficiaries regarding the allocation of the taxes are bona_fide with the outcome of the litigation of this issue being uncertain the allocation contained in settlement agreement is the product of arms-length negotiations and is within the range of reasonable outcomes under the instrument and applicable state law accordingly based on the facts submitted and the representations made we conclude that the implementation of settlement agreement will not cause trust to lose its exempt status for gst tax purposes ruling sec_61 and provides that gross_income includes gains derived from dealings in property and income from an interest in a_trust sec_1001 provides that the gain from the sale_or_other_disposition of property shall be the excess of the amount_realized therefrom over the adjusted_basis provided in sec_1011 for determining gain and the loss shall be the excess of the adjusted_basis provided in sec_1011 for determining loss over the amount_realized sec_1001 states that the amount_realized from the sale_or_other_disposition of property shall be the sum of any money received plus the fair_market_value of the property other than money received under sec_1001 except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under sec_1001 on the sale_or_exchange of property shall be recognized sec_1_1001-1 of the income_tax regulations provides that the gain_or_loss realized from the conversion of property into cash or from the exchange of property for other_property differing materially either in_kind or in extent is treated as income or loss sustained state court has approved settlement agreement and concluded that it resolves a bona_fide legal issue as to the construction of the tax charging provision thus the effect of settlement agreement carries out the terms of trust rather than resulting in a disposition of trust interests accordingly based on the facts submitted and the representations made we conclude that the implementation of settlement agreement as described will not result in the realization of gain_or_loss under sec_61 and sec_1001 to trust or any beneficiary of trust this ruling is applicable to all current income beneficiaries of trust the adult remainder beneficiaries of trust and the minor and unborn remainder beneficiaries of trust plr-138461-14 in accordance with the power_of_attorney on file with this office we have sent a copy of this letter to your authorized representatives except as expressly provided herein we neither express nor imply any opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent sincerely _________________________ melissa c liquerman chief branch office of the associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes copy of this letter cc