t c summary opinion united_states tax_court denise diana dennis petitioner v commissioner of internal revenue respondent docket no 22198-09s filed date denise diana dennis pro_se joline m wang for respondent wells judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and 1unless otherwise indicated section references are to the internal_revenue_code_of_1986 in effect for the year at issue and rule references are to the tax_court rules_of_practice and procedure this opinion shall not be treated as precedent for any other case respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax and an accuracy-related_penalty of dollar_figure pursuant to sec_6662 the issues we must decide are whether proceeds from the settlement of a racial discrimination lawsuit under the missouri human rights act alleging emotional distress are excludable from gross_income whether petitioner failed to report wages of dollar_figure and whether petitioner is liable for the accuracy-related_penalty pursuant to sec_6662 background some of the facts and certain exhibits have been stipulated the parties’ stipulations of facts are incorporated in this opinion by reference and are found accordingly at the time she filed her petition petitioner was a resident of missouri petitioner was employed at grandview care center inc grandview from approximately date until she resigned in date during that time she suffered racial harassment from grandview’s residents who spoke to her using racial epithets although she complained to her supervisors the situation did not improve and she eventually resigned because her work environment was so unpleasant after resigning petitioner filed a lawsuit against grandview under the missouri human rights act claiming damages for loss of self-esteem humiliation emotional distress and mental anguish and pain and related compensatory_damages petitioner suffered no physical injuries as a result of the harassment during date grandview entered into a confidential settlement agreement and release settlement with petitioner pursuant to the settlement grandview paid petitioner dollar_figure of that amount dollar_figure constituted legal expenses dollar_figure was for attorney’s fees and petitioner received a check for dollar_figure on date petitioner signed a document from her attorneys titled settlement distribution - tax consequences which stated among other things counsel has informed client that there are complicated issues surrounding the taxability of employment discrimination awards and or settlements counsel has further informed client sic that payment for non-physical injuries are generally taxable counsel informed client sic that the law is unsettled as to whether emotional damages in non-physical injury cases are taxable counsel informed client about the decision in 460_f3d_79 holding that such damages are not always taxable counsel has urged client to obtain professional tax_advice and provide a copy of the attached case to the tax professional to determine what if any impact it has on the resolution of the issue of the tax consequences associated with this settlement counsel has informed client sic that there has been an appeal of that case and the case may be overturned and or may not be followed by the courts in missouri the case mentioned in that document 460_f3d_79 d c cir was later vacated by the court_of_appeals for the district of columbia circuit on date murphy v irs aftr 2d ustc par big_number d c cir the court_of_appeals subsequently heard additional arguments before issuing another decision on date in which it held that the taxpayer’s compensatory award for emotional distress was taxable 493_f3d_170 d c cir however petitioner was not aware of those developments petitioner received a form 1099-misc miscellaneous income reporting her income from the settlement petitioner spoke with several tax_return_preparers about her tax_return she first spoke with someone at jackson hewitt to whom she gave a copy of her form_1099 the tax_return_preparer at jackson hewitt asked her about the lawsuit petitioner told her well i am not supposed to disclose but it is emotional distress the tax_return_preparer at jackson hewitt was unsure about the tax consequences of the settlement so she called someone however that person apparently did not know either and jackson hewitt never gave petitioner an answer about the tax consequences petitioner then left jackson hewitt because she did not think the people there knew what they were doing petitioner called another tax_return_preparer and inquired on the phone about whether the proceeds of a settlement from a lawsuit seeking damages for emotional distress were taxable she could not remember whom she had called but she remembered that the office was pinciteth and troost the person with whom petitioner spoke on the phone told her that the proceeds of the settlement were not taxable next petitioner sought advice from jarods accounting services however petitioner did not give the tax_return_preparer at that firm a copy of her form_1099 because she could not find it she told the tax_return_preparer that she had received a confidential settlement but did not ask the preparer about the tax consequences of the settlement the tax_return_preparer did not ask petitioner for the form_1099 and she omitted from petitioner’s return the income from the settlement during petitioner received dollar_figure in wages from a woman named barbara biederman ms biederman for whom petitioner provided caretaking services however petitioner did not report those wages on her return because she had not received a form w- wage and tax statement petitioner called ms biederman once to inquire about the form_w-2 and was told it would be mailed to her petitioner believed that ms biederman was withholding income_tax from her wages but ms biederman actually withheld only social_security and medicare taxes petitioner did not report the wages she received from ms biederman on her tax_return respondent mailed petitioner a notice_of_deficiency for her tax_year on date in the notice_of_deficiency respondent determined that petitioner’s income should be increased to reflect wages of dollar_figure received from ms biederman and other income of dollar_figure from the settlement respondent allowed petitioner a deduction of dollar_figure for her attorney’s fees and legal expenses petitioner timely filed her petition with this court discussion as a general_rule the commissioner’s determinations set forth in a notice_of_deficiency are presumed correct and the taxpayer bears the burden of proving otherwise rule a 290_us_111 gross_income generally includes all income from whatever source derived sec_61 the definition of gross_income is broad in scope while exclusions from income are narrowly construed 515_us_323 damages other than punitive received on account of personal physical injuries or physical sickness may generally be excluded from gross_income sec_104 for the damages to be excluded under this provision the underlying cause of action must be based in tort or tort-type rights and the proceeds must be damages received on account of personal physical injury or sickness commissioner v schleier supra pincite emotional distress is not treated as a personal physical injury or physical sickness except for damages not in excess of the amount_paid for medical_care attributable to emotional distress sec_104 flush language petitioner has cited 460_f3d_79 d c cir to argue that the proceeds of her settlement compensating her for emotional distress should be exempt from income however as noted above the murphy decision petitioner cites was later vacated by the court_of_appeals accordingly we reject petitioner’s argument that her income from the settlement was nontaxable we next consider whether petitioner owes income_tax on the wages of dollar_figure she received from ms biederman petitioner did not dispute that she failed to report her wages from ms biederman on her tax_return however she contended that ms biederman had told her that her federal_income_tax was being withheld from her wages respondent determined that petitioner’s federal_income_tax had not been withheld because petitioner bears the burden_of_proof and offered no evidence to the contrary we conclude that no income_tax had been withheld from the wages petitioner received from ms biederman and that petitioner failed to pay income_tax on those wages finally we consider whether petitioner is liable for the accuracy-related_penalty pursuant to sec_6662 generally the commissioner bears the burden of production with respect to any penalty including the accuracy-related_penalty sec_7491 116_tc_438 to meet that burden the commissioner must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty higbee v commissioner supra pincite the commissioner has the burden of production only the ultimate burden of proving that the penalty is not applicable remains on the taxpayer id subsection a of sec_6662 imposes an accuracy-related_penalty of percent of any underpayment that is attributable to causes specified in subsection b including a substantial_understatement_of_income_tax sec_6664 provides that the accuracy-related_penalty shall not apply to any portion of an underpayment if it is shown that there was reasonable_cause for the taxpayer’s position with respect to that portion and that the taxpayer acted in good_faith with respect to that portion the determination of whether the taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account the relevant facts and circumstances sec_1_6664-4 income_tax regs circumstances that may indicate reasonable_cause and good_faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances including the experience knowledge and education of the taxpayer id generally the most important factor is the extent of the taxpayer’s efforts to assess the proper tax_liability id an honest misunderstanding of fact or law that is reasonable in the light of the experience knowledge and education of the taxpayer may indicate reasonable_cause and good_faith remy v commissioner tcmemo_1997_72 petitioner is obviously unfamiliar with tax law she was advised by the attorneys who handled her lawsuit that she should seek professional advice regarding the tax treatment of her income from the settlement by advising her of the court of appeals’ holding in 460_f3d_79 d c cir those attorneys also provided her with a reason to believe that the income from the settlement might not be taxable petitioner consulted three different tax preparation services and none of them advised her that the income from the settlement was taxable on the basis of petitioner’s background education and actions seeking advice on a complex tax issue we conclude that petitioner had reasonable_cause for her position and acted in good_faith on her belief although mistaken when she failed to 2as noted above by the time petitioner signed the settlement distribution - tax consequences document prepared by her attorneys on date the decision in 460_f3d_79 d c cir had been vacated by murphy v irs aftr 2d ustc par big_number d c cir vacated date and the court_of_appeals had decided 493_f3d_170 d c cir decided date accordingly the information provided to petitioner by her attorneys was inaccurate even when she signed the document report her income from the settlement consequently we hold that petitioner is not liable for the accuracy-related_penalty on the portion of her underpayment attributable to income from the settlement petitioner contends that she acted reasonably in not reporting her income from ms biederman because she did not receive a form_w-2 and mistakenly believed that ms biederman had already withheld her federal_income_tax however it was not necessary that petitioner receive a form_w-2 in order for her to know that she had received compensation_for her services for ms biederman see eg brunsman v commissioner tcmemo_2003_291 it was not reasonable for petitioner to simply omit that compensation on her tax_return accordingly petitioner is not excused from liability for the accuracy-related_penalty on the income she received from ms biederman in reaching these holdings we have considered all the parties’ arguments and to the extent not addressed herein we conclude that they are moot irrelevant or without merit to reflect the foregoing decision will be entered under rule


t c no united_states tax_court richard leo warbus petitioner v commissioner of internal revenue respondent docket no filed date p a member of a federally recognized tribe of american indians purchased a boat that he used in treaty fishing-rights-related activity as defined in sec_7873 i r c in p obtained a commercial loan for items related to the fishing boat from the same lender who financed the purchase of the boat the loan repayment was guaranteed by the bureau of indian affairs bia when p failed to make payments on the loan as they became due the lender repossessed and sold the boat in pursuant to its loan guaranty the bia paid to the lender outstanding principal and interest which it deemed uncollectible from p as a result of the bia payment and cancellation of his debt p enjoyed discharge_of_indebtedness income in p did not report discharge_of_indebtedness income believing it to be exempt from tax as income from indian fishing-rights-related activity as described in sec_7873 held discharge_of_indebtedness income received by p from the bia is not excludable from income under sec_7873 because it was not derived by p directly or through a qualified_indian_entity from a fishing- rights-related activity daniel a raas for petitioner christal w hillstead for respondent opinion parr judge this case was heard by special_trial_judge john f dean pursuant to sec_7443a and rule sec_180 sec_181 and sec_182 the court agrees with and adopts the opinion of the special_trial_judge which is set forth below opinion of the special_trial_judge dean special_trial_judge respondent determined a deficiency in petitioner's federal_income_tax of dollar_figure and additions to tax of dollar_figure under sec_6651 and dollar_figure under sec_6654 petitioner concedes that he received unreported rental income of dollar_figure and nonemployee compensation of dollar_figure subject_to self-employment_tax that he failed to file a federal_income_tax return for the year and that he did 1unless otherwise indicated all section references are to the internal_revenue_code as amended all rule references are to the tax_court rules_of_practice and procedure not make estimated_tax payments for the taxable_year the sole issue for decision is whether certain discharge_of_indebtedness income he received in the year is not subject_to tax because it is income derived from indian fishing-rights-related activity all of the facts of this case are contained in a stipulation of facts that along with an attached exhibit is incorporated herein by reference background petitioner resided in bellingham washington at the time the petition was filed in this case petitioner was in and is still a member of the lummi nation nation a federally recognized tribe of american indians the lummi nation is a signatory of the treaty between the united_states and the dwámish suquámish and other allied and subordinate tribes of indians in washington territory concluded on january at point elliott washington territory 2petitioner made no argument and presented no evidence to show that his failure_to_file was due to reasonable_cause and not to willful neglect nor did he argue or prove that his failure to make estimated_tax payments is excused because of a statutory exception we therefore deem these issues to be conceded by petitioner rule b see 90_tc_488 87_tc_1 n stat in which the nation reserved fishing rights at all of its usual and accustomed fishing grounds and stations see also 520_f2d_676 9th cir in or sometime before_1984 petitioner purchased a fishing boat named the denise w the boat purchase was financed through a combination of a commercial loan and a promissory note given to the former owners of the denise w in petitioner obtained a loan of dollar_figure from the same commercial lender that financed part of the boat purchase the dollar_figure was used to make a payment toward the purchase of a salmon net to make a payment on the note held by the former owners of the denise w to make insurance and mortgage payments and for miscellaneous items the loan was guaranteed through a federal loan guaranty program administered by the bureau of indian affairs bia petitioner operated the denise w in treaty fishing-rights- related activities of the nation from about through during that period petitioner was licensed to fish in waters within the nation and the denise w was registered by the nation for use in the treaty fishing-rights-related activities of the nation there came a time in or around the year when petitioner did not make his loan payments as they became due as a result the denise w was repossessed and sold by the commercial lender to satisfy the unpaid loan amount the bia in pursuant to its loan guaranty paid lenders a total of dollar_figure of which dollar_figure was applied to principal and the balance to interest for the year petitioner was sent a form 1099-g from the bia reporting income in the amount of dollar_figure from the discharge_of_indebtedness petitioner did not file a federal_income_tax return for the year the parties agree that petitioner is entitled to one personal_exemption and a standard_deduction based on married- filing-separate status for the year discussion it is petitioner's position that the income_from_discharge_of_indebtedness he received in is not subject_to tax because it is income derived by an indian from the exercise of fishing rights under sec_7873 sec_7873 provides in relevant part sec_7873 in general -- income and self-employment taxes --no tax shall be imposed by subtitle a on income derived-- a by a member of an indian_tribe directly or through a qualified_indian_entity or b by a qualified_indian_entity from a fishing_rights-related_activity of such tribe employment_taxes --no tax shall be imposed by subtitle c on remuneration paid for services performed in a fishing_rights-related_activity of an indian_tribe by a member of such tribe for another member of such tribe or for a qualified_indian_entity b definitions --for purposes of this section-- fishing_rights-related_activity --the term fishing_rights-related_activity means with respect to an indian_tribe any activity directly related to harvesting processing or transporting fish harvested in the exercise of a recognized fishing right of such tribe or to selling such fish but only if substantially_all of such harvesting was performed by members of such tribe recognized_fishing_rights --the term recognized_fishing_rights means with respect to an indian_tribe fishing rights secured as of date by a treaty between such tribe and the united_states or by an executive_order or an act of congress qualified_indian_entity -- a in general --the term qualified_indian_entity means with respect to an indian_tribe any entity if-- i such entity is engaged in a fishing_rights-related_activity of such tribe ii all of the equity interests in the entity are owned by qualified indian tribes members of such tribes or their spouses iii except as provided in regulations in the case of an entity which engages to any extent in any substantial processing or transporting of fish percent or more of the annual gross_receipts of the entity is derived from fishing rights-related activities of one or more qualified indian tribes each of which owns at least percent of the equity interests in the entity and iv substantially_all of the management functions of the entity are performed by members of qualified indian tribes for purposes of clause iii equity interests owned by a member or the spouse of a member of a qualified indian_tribe shall be treated as owned by the tribe b qualified indian_tribe --for purposes of subparagraph a an indian_tribe is a qualified indian_tribe with respect to an entity if such entity is engaged in a fishing_rights-related_activity of such tribe the parties agree that petitioner operated the denise w in a fishing_rights-related_activity see sec_7873 and from this agreed starting point petitioner argues that the purchase of the denise w and expenditures_for associated equipment and operating_expenses are fishing-rights related and that therefore the income_from_discharge_of_indebtedness incurred to meet these expenses is fishing-rights related every item of a person's gross_income is subject_to federal_income_tax unless there is a statute or some rule_of law that exempts the person or the item from gross_income 450_us_1 tax exemptions including those affecting native peoples are not granted by implication if congress intends to exempt certain income it must do so expressly 78_tc_1014 lazore v commissioner tcmemo_1992_404 affd in part and revd in part 11_f3d_1180 3d cir under sec_7873 income derived by a member of an indian_tribe directly or through a qualified_indian_entity from a fishing_rights-related_activity of such tribe is not subject_to income_tax for purposes of sec_7873 income derived from fishing_rights-related_activity means income derived from activity directly related to harvesting processing transporting or selling fish in the exercise of recognized_fishing_rights of an indian_tribe sec_7873 in order for petitioner's argument to prevail we must find that his discharge_of_indebtedness income is derived from activity directly related to harvesting processing transporting or selling fish in the exercise of recognized_fishing_rights of an indian_tribe to make that determination we must examine the nature of petitioner's income the income at issue results from petitioner's discharge_of_indebtedness for funds he borrowed in part to purchase property with which to engage in fishing-rights-related activity in or around petitioner's creditor seized collateral to satisfy part of his unpaid loan amount in the bia paid off petitioner's debts to the original lenders pursuant to we presume the terms of the indian loan guaranty and insurance fund see indian financing act of publaw_93_262 sec 88_stat_79 current version pincite u s c sec this payment satisfied the remaining original loan amount paying it in full upon payment of petitioner's obligations however the bia assumed the rights of the debtors insured under the fund including the right to cancel as uncollectible any portion of petitioner's obligations see u s c sec_1491 petitioner therefore received his discharge_of_indebtedness income from the bureau of indian affairs department of the interior an instrumentality of the united_states see an act to provide for the appointment of a commissioner of indian affairs and for other purposes july ch 4_stat_564 r s sec_462 current version pincite u s c sec_1 borrowed funds are not included in a taxpayer's income nor are repayments of a loan deductible from income when however one's obligation to repay the funds is settled for less than the amount of the loan one ordinarily realizes income_from_discharge_of_indebtedness sec_61 790_f2d_1409 9th cir affg in part and revg in part tcmemo_1984_611 income from the discharge_of_indebtedness results from the release of a taxpayer from an obligation to repay a debt that causes a net increase in assets equal to the forgiven portion of the debt 499_us_573 461_us_300 ndollar_figure the doctrine relies on a freeing-of-assets theory to attribute ordinary_income to the debtor upon cancellation 284_us_1 88_tc_435 an accession to income due to a freeing of assets petitioner's discharge_of_indebtedness income is the result of the freeing of his assets from obligations by the bia in 3depending upon the solvency of the taxpayer and the source or use of the funds borrowed an amount of income_from_discharge_of_indebtedness may be deferred or excluded from income under sec_108 petitioner has not raised exclusion under sec_108 and the record does not support one 4in an earlier case 271_us_170 forgiveness of indebtedness was described as a transaction that did not result in gain from capital and labor or from either of them or in profit gained through the sale or conversion of capital see discussion in 790_f2d_1409 9th cir affg in part and revg in part tcmemo_1984_611 not from any activity by him directly related to harvesting processing transporting or selling fish in the exercise of recognized_fishing_rights of an indian_tribe we note that even had petitioner's loan proceeds been income in the first instance in their source was not activity directly related to harvesting processing transporting or selling fish in the exercise of recognized_fishing_rights of an indian_tribe forgiveness of the repayment of those loan proceeds by a third party cannot convert the freeing of petitioner's assets into fishing-rights-related income merely because the loan proceeds were used to purchase equipment used in such an activity the bia does not engage in harvesting processing transporting or selling fish and is not a qualified_indian_entity under sec_7873 petitioner's income was generated in the year by the bia's discharge of his indebtedness petitioner therefore did not receive directly or through a qualified_indian_entity income from a fishing-rights- related activity 5the parties stipulated that petitioner was engaged in fishing-rights-related activity in the years through we find to be correct respondent's determination that petitioner's discharge_of_indebtedness income is includable in income in decision will be entered for respondent


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi 2-plr-115000-01 date date legend x a b d1 d2 year dear this letter responds to your representative’s letter dated date and subsequent correspondence submitted on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code the represented facts are as follows x was incorporated on d1 a and b the shareholders of x on d1 intended x to be an s_corporation effective for the year taxable_year but form_2553 election by a small_business_corporation was not filed timely this intent is evidenced by a resolution of the officers of x dated d2 which states that x will elect to be taxed under subchapter_s accordingly x requests a ruling that it will be treated as an s_corporation effective d1 sec_1362 of the code provides that if -- a an election under sec_1362 is made for any taxable_year after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make such election the secretary may treat such an election as timely made for such taxable_year based solely on the facts and the representations submitted we conclude that x plr-115000-01 has established reasonable_cause for failing to make a timely election to be an s_corporation for x’s year taxable_year accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 with the appropriate service_center effective for its year taxable_year within days following the date of this letter then such election will be treated as timely made for x’s year taxable_year a copy of this letter should be attached to the form_2553 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code including whether x was or is a small_business_corporation under sec_1361 of the code this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being forwarded to x’s authorized representative sincerely yours j thomas hines chief branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service national_office technical_advice_memorandum date third party communication none date of communication not applicable tam-141891-09 number release date index uil no case-mis no director ------------------ taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference --------------------------------------------------------------- ------------------------- ---------------------------------------------- ----------------------------------- -------------------------------------------------------------- ---------------- --------------------------- legend issuer ------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------ state company bonds ------------------------------------------------- ------------------------------------------------------------------ ------------------------------------------------------------------------------------------ ------------------------------------------ municipality ----------------------------------- date date ---------------- ------------------ tam-141891-09 a b issue ---- ------- whether the facility as described below or any portion thereof constitutes a sewage_facility within the meaning of sec_142 of the internal_revenue_code and sec_1_142_a_5_-1 of the income_tax regulations conclusion the facility is a sewage_facility under sec_142 because it consists of a property used for the collection storage and processing of wastewater which property is necessary for secondary treatment under sec_1_142_a_5_-1 and b property that is functionally related and subordinate to such property under sec_1 a - b vi facts issuer is a public instrumentality and body corporate and politic of state issuer was created pursuant to state law to provide financing for qualifying projects including without limitation industrial facilities commercial facilities pollution_control_facilities and public facilities located in state on date company and issuer entered into an agreement agreement whereby issuer would issue bonds and loan the proceeds to company to finance the construction and acquisition of the facility on date issuer issued bonds to finance the facility as a sewage_facility within the meaning of sec_142 and sec_1 a - b bonds are payable from and secured_by loan payments to be made by company to issuer under the agreement company is a pharmaceutical company that discovers develops manufactures and markets a range of products used to improve human and animal health company owns and operates a research and manufacturing_facility plant in state the plant generates wastewater that contains organic pollutants having a raw biochemical oxygen demand of less than milligrams per liter this wastewater is discharged to municipality’s publicly owned treatment works potw under a permit permit issued by the potw to company the potw performs secondary treatment of wastewater from the plant and from other sources the potw is located approximately a miles away from the plant using bond proceeds company financed the construction of a wastewater equalization and neutralization facility facility located adjacent to the plant and owned and tam-141891-09 operated by company the facility is comprised of equalization tanks a concrete containment dike piping and associated platforms a ph neutralization system mixing equipment an air scrubber an approximately b square foot building building and miscellaneous related site work eg utilities and roadways the building houses two laboratories office space a control room a mechanical room an emergency generator room restrooms a garage and a loading dock the office space is directly related to the day-to-day operations of the facility the facility performs two functions first it collects the plant wastewater in the equalization tanks and equalizes the pressure of the wastewater this pressure equalization reduces the impact of the plant wastewater on the potw by controlling peak discharge flow rates second the equalized wastewater is neutralized and adjusted to a ph level that is acceptable to the potw under the permit such neutralization is required for the proper operation of the potw’s wastewater treatment methods because the potw treats wastewater by using biological methods to remove solids and nutrients breakdown organic matter and destroy pathogens wastewater with ph outside the acceptable range can be harmful to the bacteria that digest organic material once the wastewater is collected equalized and neutralized it is discharged from the facility to the potw no preliminary treatment primary treatment secondary treatment advanced or tertiary treatment or pretreatment of the wastewater is conducted at the facility and no septage is processed at the facility as those terms are used in sec_1_142_a_5_-1 law and analysis sec_103 provides that except as provided in sec_103 gross_income does not include interest on any state_or_local_bond sec_103 provides that sec_103 shall not apply to any private_activity_bond which is not a qualified_bond within the meaning of sec_141 sec_141 provides in part that the term qualified_bond means any private_activity_bond that is an exempt_facility_bond issued as part of an issue which meets the applicable_requirements of sec_146 and sec_147 sec_142 provides in pertinent part that the term exempt_facility_bond means any bond issued as part of an issue percent or more of the net_proceeds of which are used to provide sewage facilities sec_142 provides that an office shall not be treated as an exempt facility under sec_142 unless the office is located on the premises of the facility and not more than a de_minimis amount of the functions to be performed at such office is not directly related to the day-to-day operations of the facility tam-141891-09 sec_1_103-8 provides that an exempt facility includes any land building or other_property functionally related and subordinate to such facility property is not functionally related and subordinate to a facility if it is not of a character and size commensurate with the character and size of such facility sec_1_142_a_5_-1 defines the term sewage_facility for purposes of sec_142 sec_1_142_a_5_-1 provides that a sewage_facility is property - i except as provided in sec_1_142_a_5_-1 and d used for the secondary treatment of wastewater however for property treating wastewater reasonably expected to have an average daily raw wasteload concentration of biochemical oxygen demand bod that exceeds milligrams per liter as oxygen measured at the time the influent enters the facility the bod limit sec_1_142_a_5_-1 applies only to the extent the treatment is for wastewater having an average daily raw wasteload concentration of bod that does not exceed the bod limit ii used for the preliminary and or primary treatment of wastewater but only to the extent used in connection with secondary treatment without regard to the bod limit described in sec_1_142_a_5_-1 iii used for the advanced or tertiary treatment of wastewater but only to the extent used in connection with and after secondary treatment iv used for the collection storage use processing or final disposal of - a wastewater which property is necessary for such preliminary primary secondary advanced or tertiary treatment or b sewage sludge removed during such preliminary primary secondary advanced or tertiary treatment without regard to the bod limit described in sec_1_142_a_5_-1 v used for the treatment collection storage use processing or final disposal of septage without regard to the bod limit described in sec_1_142_a_5_-1 and vi functionally related and subordinate to property described in sec_1 a - b such as sewage disinfection property sec_1_142_a_5_-1 provides definitions of certain terms used in sec_1_142_a_5_-1 i advanced or tertiary treatment means the treatment of wastewater after secondary treatment advanced or tertiary treatment ranges from biological treatment tam-141891-09 extensions to physical-chemical separation techniques such as denitrification ammonia stripping carbon adsorption and chemical precipitation ii nonconventional pollutants are any pollutants that are not listed in c f_r or appendix a to part iii preliminary treatment means treatment that removes large extraneous matter from incoming wastewater and renders the incoming wastewater more amenable to subsequent treatment and handling iv pretreatment means a process that preconditions wastewater to neutralize or remove toxic priority or nonconventional pollutants that could adversely affect sewers or inhibit a preliminary primary secondary advanced or tertiary treatment operation v primary treatment means treatment that removes material that floats or will settle usually by screens or settling tanks vi priority pollutants are those pollutants listed in appendix a to cfr part vii secondary treatment means the stage in sewage treatment in which a bacterial process or an equivalent process consumes the organic parts of wastes usually by trickling filters or an activated sludge process viii sewage sludge is defined in cfr and includes septage ix toxic pollutants are those pollutants listed in cfr c f_r dollar_figure provides a list of conventional pollutants which includes biochemical oxygen demand bod total suspended solids nonfilterable tss ph fecal coliform and oil and grease sec_1_142_a_5_-1 provides that property other than property described in sec_1_142_a_5_-1 is not a sewage_facility thus for example property is not a sewage_facility or functionally related and subordinate property if the property is used for pretreatment of wastewater whether or not this treatment is necessary to perform preliminary primary secondary advanced or tertiary treatment or the related collection storage use processing or final disposal of the wastewater the request for technical_advice questions whether the functional relationship between the facility property used to collect store equalize and neutralize the plant’s wastewater and the secondary treatment of the wastewater performed by the potw is sufficient for such property to be considered necessary as that term is used in tam-141891-09 sec_1_142_a_5_-1 or whether some additional relationship eg common ownership or geographic proximity must exist between the facility and the potw we conclude that the functional relationship between the property used to collect store equalize and neutralize the plant’s wastewater ie the facility and the secondary treatment performed by the potw is sufficient for such property to be considered necessary under sec_1_142_a_5_-1 the secondary treatment of the plant wastewater at the potw involves biological methods in which bacteria remove solids and nutrients breakdown organic matter and destroy pathogens the viability of this bacteria are necessary conditions for the proper operation of potw’s wastewater treatment methods anything introduced into the potw that threatens the viability of this bacteria threatens the ability of the potw to perform the secondary treatment of the plant wastewater the facility neutralizes the plant wastewater’s ph level before the wastewater is discharged to the potw because without such neutralization the ph of the wastewater can result in harm to the bacteria utilized by the potw in the secondary treatment of the wastewater in addition the facility controls the peak discharge flow rates to the potw by equalizing the pressure of the plant’s wastewater this pressure equalization reduces and controls the impact of the wastewater on the potw by controlling the peak discharge flow rate from the plant to the potw the remainder of the facility including the air scrubber the two laboratories the office space the restrooms and the garage and loading dock constitute property functionally related and subordinate to property described in sec_1_142_a_5_-1 nothing in sec_142 or sec_1_142_a_5_-1 requires the existence of one or more specific relationships such as common ownership or geographic proximity between the facility and the potw in addition to the relationship described above when determining whether the facility is a sewage_facility under sec_1 a - b iv a accordingly we conclude that the facility is a sewage_facility under sec_142 because it consists of a property used for the collection storage and processing of wastewater which is necessary for the secondary treatment of the wastewater under sec_1_142_a_5_-1 and b property functionally related and subordinate to such property under sec_1_142_a_5_-1 of the regulations 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


tcmemo_1996_68 united_states tax_court charles a ballard petitioner v commissioner of internal revenue respondent docket no filed date b is an s_corporation involved in the business of yacht chartering p the sole shareholder of b claimed losses passed through from b r disallowed p’s losses on the ground that b’s activity was not engaged in for profit held b’s yacht chartering activity was not engaged in for profit within the meaning of sec_183 sec_2 held further sec_6653 i r c addition_to_tax is not sustained against p held further sec_6661 i r c addition_to_tax is sustained against p james s kaplan for petitioner moira l sullivan and paul t muniz for respondent memorandum findings_of_fact and opinion halpern judge by notice_of_deficiency dated date respondent determined deficiencies and additions to tax against petitioner as follows additions to tax sec sec deficiency a a a b dollar_figure big_number dollar_figure big_number --- dollar_figure sec year percent of interest due on deficiency amount unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure after concessions by the parties the issues remaining for decision are whether petitioner may deduct losses_incurred by his wholly owned s_corporation ballard marine inc ballard marine in its operation of its yacht chartering business or whether such deductions are nondeductible because they were incurred in an activity_not_engaged_in_for_profit within the meaning of sec_183 and whether petitioner is liable for the additions to tax determined by respondent findings_of_fact some of the facts have been stipulated and are so found the stipulations of fact filed by the parties and attached exhibits are incorporated herein by this reference at the time of filing the petition petitioner resided in philadelphia pennsylvania petitioner during and petitioner was a managing director of an investment banking firm the firm in date a major portion of the firm was sold and as a result thereof petitioner received in excess of dollar_figure million prior to the formation of ballard marine discussed infra petitioner did not participate in boating for recreation he had no experience as a seaman or with the mechanical operation of yachts and he had very little personal experience in boating prior to he was not a member of any yacht club petitioner became interested in yacht chartering as a result of his activities in arranging entertainment for clients and others connected with the firm from late to the middle of petitioner visited numerous boat shows at those boat shows vendors described yacht investment plans prior to forming ballard marine and causing it to purchase a boat petitioner did not prepare a formal business plan he did consider the economics of the yacht chartering business as follows he planned to spend approximately dollar_figure on a boat he believed that many operating costs eg captain crew and fuel would be paid_by the charterer he assumed that charterers would be forthcoming and willing to pay a large enough daily charter fee so that he would break even on his investment with the boat being chartered only to days a month petitioner made his federal_income_tax returns for and on the basis of a calender year ballard marine ballard marine a maine corporation was organized on date the articles of incorporation of ballard marine fail to state any purpose for which the corporation was organized petitioner was the sole initial director of the corporation the initial officers of ballard marine were a president and a treasurer petitioner was appointed to both offices ballard marine elected to be an s_corporation within the meaning of sec_1361 ballard marine’s election to be an s_corporation was effective for its first taxable_year ballard marine is a calender year taxpayer by contract dated date ballard marine purchased a 49-foot my mk iii gulfstar motor yacht the yacht for a total_contract_price of dollar_figure ballard marine also paid a florida sales_tax of dollar_figure ballard marine financed dollar_figure of the purchase_price of the yacht with a bank loan the yacht was delivered to ballard marine on date in annapolis maryland in connection with ballard marine’s purchase of the yacht ballard marine or petitioner consulted with legal counsel ballard marine hired walter schintzius schintzius a yacht broker for advice on among other things the operating characteristics of the yacht its acceptability as a charter boat and its residual_value schintzius did not advise petitioner on the day-to-day operations or economics of a yacht chartering business ballard marine obtained insurance against various risks associated with operating the yacht on date the u s coast guard issued a certificate of documentation with respect to the yacht which shows that the vessel was then documented for pleasure use florida in late date ballard marine hired captain george newman newman owner of newman marine services newman marine to move the yacht from annapolis maryland to the lighthouse point yacht club lighthouse point lighthouse point florida in petitioner purchased land in lighthouse point florida on which he eventually built a house for his own use ballard marine also hired newman to oversee both the outfitting of the yacht and its maintenance and repair while it was in florida newman was not engaged in the charter business in or on date ballard marine moved the yacht to the boca raton resort and club which is in southern florida and which was the site of a meeting of the securities industry association petitioner attended that meeting a colleague of petitioner’s from the firm had reserved the yacht for his use on the evening of date however that individual canceled the reservation while at the boca raton resort and club the yacht was visited by betty corson corson a yacht charter agent whom petitioner had known for some time and through whom petitioner had chartered yachts in connection with his employment or his work with the securities industries association from date through date petitioner contacted other charter agents and several individuals and informed them of the availability of the yacht for charter by memorandum dated date petitioner offered a 25-percent discount on charters to certain colleagues at the firm in date ballard marine had printed big_number brochures describing the yacht and stating that it was available for charter brochures were sent to corson and others ballard marine offered the yacht for bareboat charter under that arrangement the chartering party charters the boat and independently contracts for a captain and crew sometimes the chartering party will be qualified to operate the boat and may not need a captain or crew effective date the bareboat charter rates for the yacht were as follows bareboat charter rate sec_1 chesapeake bay dollar_figure florida bahamas dollar_figure seven day week2 days nights five day week2 days nights big_number weekend sec_2 days night big_number day rate sec_3 ½ day3 hourly3 big_number big_number excludes cost of fuel dockage and stores limited to a party of four limited to a party of six those rates were within to percent of the rates set by ballard marine during the preceding or months that it held the yacht out for charter and those rates were not changed during the remainder of time that ballard marine owned the yacht petitioner was accorded a discount of percent when he chartered the yacht from ballard marine on date an entity named gulfcoast farms chartered the yacht for the stated rate of dollar_figure a week for a 7-day trip to key west florida no other charters were made before the yacht was moved north at the end of date except that petitioner used the yacht on three occasions petitioner was expected to pay for his use of the yacht petitioner did not pay for his use of the yacht until sometime in maryland on date newman moved the yacht from lighthouse point to mears great oak landing which is in maryland and on the chesapeake bay he returned the yacht to lighthouse point on date mears great oak landing is 2-hours travel time by car from petitioner’s home in philadelphia petitioner arranged with an individual david hart hart to maintain and keep up the yacht while it was at mears great oak landing hart was to try and obtain charters at mears great oak landing there was a meeting center with approximately rooms and a 9-hole golf course the yacht was the only yacht for charter at mears great oak landing the meeting director at mears great oak landing and possibly other meeting center personnel also were asked to try and obtain charters except for use made by petitioner of the yacht there were no charters of the yacht during the time it was at mears great oak landing petitioner made substantial use of the yacht on weekends petitioner paid for his use of the yacht in florida after the yacht was returned to florida in date no use of it was made by anyone other than petitioner trade-in of the yacht and termination of charter business in date ballard marine disposed of the yacht in a transaction whereby it acquired another boat a 56-foot hatteras flying bridge motor yacht the second yacht ballard marine agreed to pay dollar_figure for the second yacht but was credited with dollar_figure as the trade-in value of the yacht ballard marine was not successful in chartering the second yacht sometime in ballard marine terminated its charter operations books_and_records ballard marine’s tax returns petitioner kept records of ballard marine’s income and expenses on a computer petitioner opened a bank account for ballard marine ballard marine obtained oil company credit cards in its own name it dealt in its own name with the power company in florida it had its own stationery ballard marine made returns of income for and on forms 1120s u s income_tax return for an s_corporation on those forms ballard marine reported the following items of income and deduction gross_income dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number --- deductions interest depreciation insurance legal fees consulting fees transport crew fuel mooring docking miscellaneou sec_50 big_number telephone utilities repairs and maintenance big_number --- big_number big_number big_number big_number big_number --- --- big_number advertising and promotion professional fees income loss dollar_figure dollar_figure barry m strauss strauss the managing principal of --- --- big_number big_number barry m strauss associates ltd associates is a tax attorney and c p a specializing in advising investment bankers in accounting tax and financial matters ballard marine’s federal_income_tax returns for and were prepared by an employee of associates petitioner’s tax returns petitioner made returns of income for and on form sec_1040 u s individual_income_tax_return on those forms petitioner reported losses from ballard marine in the amounts of dollar_figure and dollar_figure respectively petitioner’s federal_income_tax returns for and were prepared by an employee of associates strauss had come to represent petitioner in when the firm retained associates to either prepare or review the tax returns of managing directors to assure that all tax matters were properly reported by them associates was so retained in order to avoid having the firm embarrassed either by the securities_and_exchange_commission or the general media on account of the tax problems of managing directors not an activity engaged in for profit ballard marine’s activity of holding the yacht for charter was not an activity engaged in for profit negligence substantial_understatement no portions of petitioner’s underpayments for and were due to negligence the principal purpose of ballard marine was not tax_avoidance i introduction opinion under sec_1366 a shareholder in an s_corporation is entitled to take into account his or her pro_rata share of the corporation’s losses see sec_1366 ballard marine was an s_corporation for and and we must determine the extent of ballard marine’s allowable losses for those years respondent’s explanation for her adjustments with respect to those losses is that they were incurred in an activity not entered into for profit respondent has also determined additions to tax as set forth above ii deficiencies a section 183--for-profit requirement sec_183 provides in the case of an activity engaged in by an individual or an s_corporation if such activity is not engaged in for profit no deduction attributable to such activity shall be allowed under this chapter except as provided in this section sec_183 provides for purposes of this section the term activity_not_engaged_in_for_profit means any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 the question we must decide is whether ballard marine’s activity with regard to holding the yacht for charter the charter activity constituted an activity_not_engaged_in_for_profit b actual and honest profit objective an activity is engaged in for profit if the taxpayer has an actual and honest objective of making a profit 94_tc_41 although the sec_183 analysis with respect to the activities of a subchapter_s_corporation is applied at the corporate level sec_1 f income_tax regs a taxpayer’s intent is attributable to his wholly owned subchapter_s_corporation sousa v commissioner tcmemo_1989_581 moreover although the expectation of profit need not be reasonable it must be shown that a bona_fide profit objective did exist 72_tc_411 affd without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs profit in this context means economic profit independent of tax savings 91_tc_371 whether ballard marine engaged in the charter activity with the requisite profit objective is a question of fact to be determined from all the facts and circumstances petitioner bears the burden_of_proof rule a keanini v commissioner supra pincite golanty v commissioner supra pincite sec_1_183-2 income_tax regs sec_1_183-2 income_tax regs provides a nonexclusive list of factors to be considered in determining whether an activity is engaged in for profit no single factor is determinative keanini v commissioner supra pincite 88_tc_464 sec_1_183-2 income_tax regs taking into account the factors set forth in sec_1 b income_tax regs and based on the record as a whole we conclude that the charter activity was not an activity entered into for profit and we have so found c petitioner had no objective to make a profit the regulations provide that although a reasonable expectation of profit is not required the facts and circumstances must indicate that the taxpayer entered into the activity with the objective of making a profit sec_1_183-2 income_tax regs we conclude that although petitioner certainly would have liked ballard marine to make a profit that was not his objective in organizing and operating ballard marine in determining petitioner’s objective in organizing and operating ballard marine we have the benefit of neither a statement of corporate purpose in ballard marine’s articles of incorporation nor a formal business plan nevertheless petitioner has made clear his business plan buy an asset a yacht that he hoped would retain its value and lease charter it out for short periods at rates that will quickly return the capital cost of the asset indeed petitioner proposes that we find as facts the following petitioner was an expert at the firm in designing investment programs for the short-term utilization of capital assets at lease rates equal to a high percentage of their initial cost petitioner noted significant similarities between the yacht charter business and these programs in that they both involved assets that retain a high percentage of their initial value a benefit accruing to the asset’s owner petitioner also proposes that we find petitioner believed that he would have an advantage in obtaining yacht charters because of his contacts with firms in the securities industry which he knew from his own direct experience were potential frequent users of yacht charters respondent has made various objections to those proposed findings and we have not made findings_of_fact in accordance with those proposed findings the parties have stipulated however and we have found that petitioner had no experience as a seaman or with the mechanical operation of yachts and he had very little personal experience in boating numerous factors lead us to conclude that petitioner had no objective to make a profit petitioner testified that he had calculated the amount of revenue he needed to break even he did not testify however that he or anyone else determined how realistic it was to expect ballard marine to earn such revenue ballard marine hired schintzius a yacht broker who advised on the operating characteristics of the yacht its acceptability as a charter boat and its residual_value schintzius however did not advise petitioner on the day-to-day operations or economics of a yacht chartering business before organizing ballard marine from late to petitioner visited numerous boat shows at those boat shows vendors described yacht investment plans we do not doubt that before forming ballard marine petitioner considered that he might reduce or even recoup his cost in purchasing a yacht by holding it out for charter he knew that there was at least some market for yacht charters indeed he had arranged entertainment for clients of the firm on chartered yachts we are unconvinced however that petitioner’s objective in causing ballard marine to purchase and operate the yacht was to earn a profit did petitioner contemplate the possibility of earning a profit yes we believe that he did at least in the sense that a profit was possible if and that is a big if the value of the yacht would decrease at a rate lower than the rate at which its cost could be recouped out of charter revenues although petitioner may have been an expert in certain aspects of commercial transactions that accomplished just that the insight at the core of both those commercial transactions and petitioner’s hopes with regard to the yacht seems to us quite commonplace we do not equate an objective to make a profit with the realization even coupled with the willingness to act on that realization that if sufficient revenues could be produced a profit could be earned indeed petitioner has failed to show us that substantial charter revenue was realistic for ballard marine certain trappings of a profit objective are here ballard marine was formed as a business corporation it had advisers it kept certain records of its income and expenses it did offer the yacht out for charter it did produce advertising brochures and it did deal with petitioner as an outsider although at a 40-percent discount those trappings however are insufficient to convince us of petitioner’s objective to earn a profit petitioner was the sole shareholder of ballard marine so that ballard marine’s policy of charging him for his use of the yacht makes little sense except as a for-profit trapping for tax purposes indeed although petitioner claims on brief that his out-of-pocket costs were far in excess of any_tax benefits he has failed to detail for us the facts that would prove that conclusion clearly ballard marine was unsuccessful in the charter business nevertheless petitioner did not consider a general reduction in prices to try and attract more business finally we are influenced by the fact that petitioner did make personal_use of the yacht he used it on weekends when he was free from work in the winter he kept it in florida at lighthouse point where in he purchased land to build a house in the summer he kept it on the chesapeake bay which is only hours from his home in philadelphia the tax cost of paying ballard marine for his personal_use seems to us a small cost for petitioner to have paid if it would have helped him establish the bona fides of a profit objective we need not determine what petitioner’s objective was in acquiring the yacht to resolve this case it is sufficient that we determine only whether it was to earn a profit nevertheless we believe that petitioner’s objective in acquiring the yacht was to have it available for his personal_use as we have said we believe that petitioner would have liked to make a profit with the yacht nevertheless we do not believe that that was his objective in causing ballard marine to acquire and operate the yacht cf 91_tc_686 affd 893_f2d_656 4th cir chartering a yacht to others in order to afford to keep it through tax savings for one’s personal enjoyment is not the same as having a profit objective d conclusion ballard marine’s activity of holding the yacht for charter was not an activity engaged in for profit within the meaning of sec_183 accordingly ballard marine’s expenses attributable to that activity are allowable as deductions only to the extent provided for in sec_183 iii additions to tax a negligence respondent has determined additions to tax under sec_6653 and b for both and sec_6653 imposes an addition_to_tax equal to percent of the entire underpayment if any portion of such underpayment is due to negligence sec_6653 imposes an addition_to_tax equal to percent of the interest payable under sec_6601 with respect to the portion of the underpayment due to negligence negligence is lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances e g 85_tc_934 petitioner was unable to carry his burden of proving that ballard marine had the objective of making a profit however the mere fact that petitioner’s proof was inadequate does not require us to find that the underpayment with respect to the charter activity was due to negligence in another recent yacht case we found no negligence based in part on the passive role of the taxpayer in the decision to engage in the charter activity antonides v commissioner supra pincite petitioner’s role here certainly was not passive nevertheless we find another mitigating circumstance both ballard marine’s and petitioner’s returns were prepared by an employee of barry m strauss associates ltd associates associates had been retained by the firm to assure that tax returns of managing directors contained matters properly reported barry m strauss testified and we are satisfied that associates’ personnel were qualified as tax experts reviewed petitioner’s returns were aware of ballard marine’s activities and advised petitioner that his reporting positions were proper petitioner can rely on such advice to avoid an addition_to_tax for negligence see eg 90_tc_908 51_tc_467 accordingly we have found that petitioner was not negligent and we sustain no addition_to_tax for negligence b substantial_understatement of liability respondent has determined an addition_to_tax under sec_6661 for sec_6661 provides for an addition to the tax for any year for which there is a substantial_understatement_of_income_tax a substantial_understatement is defined as an understatement which exceeds the greater of percent of the tax required to be shown on the return for the year or dollar_figure sec_6661 the amount of the addition_to_tax i sec_25 percent of the underpayment attributable to a substantial_understatement 90_tc_498 the amount of the understatement however is reduced by amounts attributable that extends to certain adjustments relating to itemized_deductions that were the subject of the second stipulation of facts and that were conceded by petitioner to items for which there existed substantial_authority for the taxpayer's position or the taxpayer disclosed relevant facts concerning the items with his tax_return sec_6661 if however the understatement is attributable to a tax_shelter disclosure of the item will not enable the taxpayer to avoid the addition and the substantial_authority test will not apply unless the taxpayer can show that he reasonably believed the treatment causing the understatement was more_likely_than_not proper sec_6661 the term tax_shelter includes an entity such as an s_corporation if the principal purpose of such entity is the avoidance or evasion of federal_income_tax sec_6661 sec_1 b iii income_tax regs interprets the term tax_shelter as follows the principal purpose of an entity is the avoidance or evasion of federal_income_tax if that purpose exceeds any other purpose we do not believe that the principal purpose of ballard marine was the avoidance of federal tax and we have so found no doubt ballard marine facilitated petitioner’s tax claim of a profit objective by among other things providing him with a way to pay for his own use of the yacht nevertheless we are convinced that petitioner had purposes for forming ballard marine such as limiting his liability whose importance to him exceeded any_tax avoidance purpose petitioner’s understatement is not attributable to a tax_shelter within the meaning of sec_6661 petitioner does not claim that adequate_disclosure for purposes of sec_6661 was made on his or ballard marine’s return and consequently we do not address that issue petitioner does claim that substantial_authority supports his position with regard to the losses from ballard marine disallowed under sec_183 the sec_183 losses we must decide whether petitioner’s deduction of the sec_183 losses is supported by substantial_authority in evaluating whether a taxpayer’s position regarding treatment of a particular item is supported by substantial_authority the weight of authorities in support of the taxpayer’s position must be substantial in relation to the weight of authorities supporting contrary positions sec_1 b income_tax regs an authority that is materially distinguishable on its facts generally will have little or no relevance in determining whether substantial_authority supports the tax treatment at issue antonides v commissioner t c pincite sec_1 b income_tax regs petitioner sets forth five cases as substantial_authority feldman v commissioner tcmemo_1988_126 slawek v commissioner tcmemo_1987_438 zwicky v commissioner tcmemo_1984_471 dickson v commissioner tcmemo_1983_723 mclarney v commissioner tcmemo_1982_461 all of those cases involve a boat chartering activity and our decision that the taxpayer entered into the activity for profit for the most part we find those cases to involve facts that are materially distinguishable from the facts at hand in feldman v commissioner supra the taxpayer purchased a boat with a proven charter record and an established clientele the taxpayer made no personal_use of the boat he negotiated a favorable management agreement with a guaranteed minimum level of revenue in dickson v commissioner supra the taxpayer leased the boat to a charter agency for guaranteed annual payments and made limited personal_use of the boat in mclarney v commissioner supra the taxpayer regularly spent a substantial amount of time and energy running the business the taxpayer changed the mode of operation to increase profitability his personal_use of the boat was small in comparison to the number of charters in zwicky v commissioner supra the taxpayer devoted substantial amounts of time to the charter operation the taxpayer engaged in numerous promotional activities to gain charters the taxpayer made minimal recreational use of the boat slawek v commissioner supra most closely resembles the case at hand in that there we found that the taxpayers made no real investigation of the charter boat business before undertaking their charter activity and they made no projections of income and expenses as a basis for estimating whether or not the activity could be profitable we also found however that they advertised in a national newspaper the wall street journal and that they made no significant use of the boat for personal purposes even granting that slawek is relevant we do not find that there is substantial_authority supporting petitioner’s position the following cases are an example of cases involving facts similar to those at hand but in which the court found no profit objective ward v commissioner tcmemo_1987_215 blake v commissioner tcmemo_1981_579 affd 697_f2d_473 2d cir lyon v commissioner tcmemo_1977_239 we find that the authority supporting petitioner’s deduction of the sec_183 losses is insubstantial petitioner has made no argument with respect to adequate_disclosure or substantial_authority in connection with those adjustments that petitioner has conceded we thus conclude that petitioner concedes that sec_6661 is inapplicable to those adjustments and we so find accordingly we sustain respondent’s determination of an addition_to_tax under sec_6661 except to the extent necessary to take account of concessions made by respondent under rule decision will be entered


internal_revenue_service number release date index number --------------------- ------------- ------------------------------------------------------------ -------------------------- ------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact -------------- id no ------------- telephone number --------------------- refer reply to cc fip b01 plr-150582-10 date date legend legend fund trust advisor subsidiary type a company state country dear ---------------- ------------------------------------------------------------ ----------------------- ---------------------------- -------------------------------------------- ------------------------------------------------------------------------ ----- ------------------------------------ -------------------- ---------------------- this responds to your letter dated date submitted by your authorized representative on behalf of fund fund requests that the internal_revenue_service rule that income derived from its investment in a wholly-owned subsidiary that is a controlled_foreign_corporation cfc constitutes qualifying_income under sec_851 of the internal_revenue_code_of_1986 as amended the code facts plr-150582-10 fund is registered as an open-end management investment_company under the investment_company act of u s c 80a-1 et seq as amended the act fund is a series of trust which is a state business_trust fund intends to qualify each year as a regulated_investment_company ric under subchapter_m of the code fund invests in subsidiary a wholly-owned subsidiary incorporated as a type a company under the laws of country under the laws of country a type a company provides limited_liability for all holders of shares a shareholder’s liability is limited to the amount if any unpaid with respect to the shares acquired by the shareholder subsidiary will file an election on form_8832 entity classification election to be taxed as a corporation for federal_income_tax purposes pursuant to sec_301_7701-3 of the procedure and administration regulations fund represents that although subsidiary will not be registered as an investment_company under the act subsidiary will comply with the requirements of section f of the act investment_company act release no and related sec guidance pertaining to asset coverage with respect to investments that would apply if the subsidiary were registered under the act fund will invest a portion of its assets in subsidiary subject_to the limitations set forth in sec_851 of the code the subsidiary invests in commodity-related investments the subsidiary also invests in short-term high quality securities to be used to support its commodity derivative investments it is expected that all of the subsidiary’s income will be subpart_f_income as defined in sec_952 subsidiary will be wholly-owned by fund and is thus expected to be classified as a cfc as defined in sec_957 fund will include its subpart_f_income attributable to the subsidiary under the rules applicable to cfcs under the code law and analysis sec_851 of the code provides that a corporation shall not be considered a ric for any taxable_year unless it meets an income test the qualifying_income requirement under this test at least percent of its gross_income must be derived from certain enumerated sources sec_851 defines qualifying_income in relevant part as - dividends interest payments_with_respect_to_securities_loans as defined in sec_512 and gains from the sale_or_other_disposition of stock_or_securities as defined in sec_2 of the act or foreign_currencies or other income including but not limited to gains from options futures or forward contracts derived with respect to the ric’s business of investing in such stock securities or currencies plr-150582-10 sec_2 of the act defines the term security as - any note stock treasury_stock security future bond debenture evidence_of_indebtedness certificate of interest or participation in any profit-sharing agreement collateral-trust certificate preorganization certificate or subscription transferable share investment contract voting-trust certificate certificate of deposit for a security fractional undivided_interest in oil gas or other mineral rights any put call straddle option or privilege on any security including a certificate of deposit or on any group or index of securities including any interest therein or based on the value thereof or any put call straddle option or privilege entered into on a national securities exchange relating to foreign_currency or in general any interest or instrument commonly known as a security or any certificate of interest or participation in temporary or interim certificate for receipt for guarantee of or warrant or right to subscribe to or purchase any of the foregoing in addition sec_851 of the code provides that for purposes of sec_851 there shall be treated as dividends amounts included in gross_income under sec_951 or sec_1293 for the taxable_year to the extent that under sec_959 or sec_1293 as the case may be there is a distribution out of the earnings_and_profits of the taxable_year which are attributable to the amounts so included sec_957 of the code defines a controlled_foreign_corporation cfc as any foreign_corporation in which more than percent of the total combined voting power of all classes of stock entitled to vote or the total value of the stock is owned by united_states_shareholders on any day during the corporation’s taxable_year a united_states_shareholder is defined in sec_951 as a united_states_person who owns percent or more of the total voting power of a foreign_corporation fund represents that it will own percent of the voting power of the stock of subsidiary fund is a united_states_person fund therefore represents that subsidiary will qualify as a cfc under these provisions sec_951 of the code provides that if a foreign_corporation is a cfc for an uninterrupted period of days or more during any taxable_year every person who is a united_states_shareholder of this corporation and who owns stock in this corporation on the last day of the taxable_year in which the corporation is a cfc shall include in gross_income the sum of the shareholder’s pro_rata share of the cfc’s subpart_f_income for the taxable_year sec_952 of the code defines subpart_f_income to include foreign_base_company_income determined under sec_954 under sec_954 foreign_base_company_income includes foreign_personal_holding_company_income determined under sec_954 plr-150582-10 under sec_964 foreign_personal_holding_company_income includes among other things dividends interest royalties rents and annuities gains in excess of losses from transactions in commodities including futures forwards and similar transactions but excluding certain hedging_transaction and certain active business gains and losses and subject_to certain exceptions net_income from notional_principal_contracts subsidiary’s income from its investments in commodity-related investments and short-term high quality securities to be used to support its commodity derivative investments may generate subpart_f_income fund therefore represents that it will include in income subsidiary’s subpart_f_income for the taxable_year in accordance with sec_951 conclusion based on the facts as represented we rule that subpart_f_income of the subsidiary attributable to the fund is income derived with respect to fund’s business of investing in the stock of subsidiary and thus constitutes qualifying_income under sec_851 without regard to whether that income is distributed by subsidiary to the fund this ruling is directed only to the taxpayer who requested it and is limited to the facts as represented by the taxpayer sec_6110 provides that this letter may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely diana imholtz diana imholtz branch chief branch office of associate chief_counsel financial institutions products


internal_revenue_service number release date index number --------------------------------- --------------------------------- --------------------------------------- ------------------------------------------------ -------------------------------------- legend department of the treasury washington dc person to contact ------------------------ id no ------------ telephone number --------------------- refer reply to cc fip b02 plr-152446-09 date date taxpayer ---------------------------------------------------------------------- ----------------------------------------- year business ------- -------------- properties ------------------------------------------------------------------------ --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- year op gp trs llc facility ------- -------------------------------------------- ---------------------------------------- ------------------------------------------- ------------------------------- --------------------------------------------------------- lessee ------------------------------------------------------------------------ ------------------------------------------------ year ------- plr-152446-09 date llc date date new trs a b c llc llc d e agreement llc llc llc llc llc ------------------ --------------------------------- ----------------------------- -------------------------- ------------------------------------- --- --- ------------- -------------------------------------------------------- --------------------------- --- --- ---------------------------------------------------- ------------------------------------------------ ------------------------------------ ----------------------------- ------------------------------ --------------------------------- dear --------------- this is in reply to a letter dated date and subsequent submissions requesting rulings on behalf of taxpayer the requested rulings concern the operation and management of taxpayer’s business properties for purposes of sec_856 and c of the internal_revenue_code plr-152446-09 facts taxpayer is a domestic_corporation that was formed in year to invest in own and lease commercial real_estate taxpayer’s primary business is to acquire and develop real_property and improvements primarily for long-term_lease to providers of business services such as those provided at the properties taxpayer also makes mortgage loans to business operators that are secured_by their real_estate_assets taxpayer elected to be taxed as a real_estate_investment_trust reit on its year federal_income_tax return taxpayer is a public reit and to its knowledge no person owns more than percent of its outstanding_stock taxpayer conducts all of its real_estate operations through a limited_partnership op the sole general_partner of op is gp which is wholly-owned by taxpayer taxpayer directly owns substantially_all of the limited_partnership interests in op taxpayer owns all of the issued and outstanding_stock of trs taxpayer and trs have jointly elected to have trs treated as a taxable_reit_subsidiary under sec_856 trs has made loans secured_by non-real estate assets to tenants of taxpayer’s properties for operating or working_capital purposes op is the sole owner of llc which is treated as a disregarded_entity for federal_income_tax purposes llc owns certain real_estate including the facility a business property llc leased the facility to lessee in year however due to defaults and the inability of lessee to meet its obligations to llc and other creditors llc terminated the lease on date lessee then filed for bankruptcy protection and submitted a plan_of_reorganization plan to the bankruptcy court on date llc lessee and llc an entity that was formed to become the new operator of the facility entered into a term sheet that contemplated an amendment to the plan subsequently on date the parties submitted the second amended plan_of_reorganization amended plan to the bankruptcy court upon approval of the amended plan the following steps will be taken taxpayer will create a new wholly-owned subsidiary new trs with which it will jointly elect to have treated as a trs of taxpayer under sec_856 llc will lease the facility to new trs under terms similar to those used for unrelated lessees new trs will sublease the facility to llc on terms similar to the terms of the new trs lease with llc in consideration of i the costs expenses and damages incurred by llc as a result of the default by lessee and the reletting of the facility ii plr-152446-09 taxpayer’s services in locating a replacement operator and iii the financing that taxpayer or its affiliate is willing to provide to llc new trs will receive an a percent membership interest in llc new trs’s membership interest in llc does not grant new trs any authority to direct the operations or management of the facility new trs’s governance rights in llc only arise in extraordinary circumstances set forth in an operating_agreement between the members of llc operating_agreement new trs’s a percent interest in the profits losses and distributions of llc will be reduced to a b percent interest in those items if and when new trs receives after-tax distributions of c million dollars from llc the remaining d percent equity_interest in llc will be owned by llc which will be owned by llc and certain other owners when new trs’s interest in llc is reduced llc 3’s interest in llc will increase to e percent llc will assume lessee’s agreement for the facility and will employ the persons providing services at the facility new trs will provide llc a working_capital loan to be secured_by among other things a first priority security_interest in llc 2’s accounts_receivable a wholly-owned subsidiary of llc llc will manage the facility pursuant to a management services agreement between llc and llc for a percentage of net_revenues this fee will be subordinated to the rent and loan obligations to new trs taxpayer represents that llc and affiliated entities are engaged in the active_conduct of the trade_or_business of managing business facilities and have managed or are managing the operation of business facilities for entities unrelated to taxpayer or new trs llc and llc are owned by persons unrelated to taxpayer for purposes of sec_856 and sec_52 and b under the operating_agreement and the management services agreement all decisions regarding the operations and management of the facility are made by either llc or llc under the operating_agreement new trs or another person designated by new trs is given the authority to take certain extraordinary actions following either the delivery to llc of notice of the occurrence of certain material events of default or notice to llc from taxpayer of termination of the sublease the extraordinary actions include the right to terminate the management agreement the right to remove and replace the general manager and the right to dissolve llc the extraordinary actions do not confer on new trs a right to operate or manage the facility llc is owned equally by llc and llc who are both in the business of operating business facilities llc is owned by an individual who also owns a controlling majority interest in and is the chief_executive_officer of llc the owners of llc and llc also own llc llc and llc are privately-held companies that manage multiple business facilities in several states through subsidiaries through its plr-152446-09 subsidiaries or op taxpayer currently leases business facilities to subsidiaries of both llc and llc taxpayer represents that all transactions between its affiliates and either llc or llc have been negotiated on an arm’s length basis to taxpayer’s knowledge no owner or affiliate of llc or llc owns any taxpayer stock when llc or llc acquire or develop a business facility it does so through a new llc or subsidiary these subsidiary entities have their own assets employees suppliers and vendors taxpayer represents that the subsidiary entities are separate independent operating entities as set forth in their organizational documents in addition taxpayer represents that all of its existing leases with subsidiaries of llc and llc require those entities to form separately organized single purpose subsidiaries to lease business facilities from a taxpayer subsidiary law and analysis sec_856 provides that at least percent of a reit's gross_income must be derived from among other sources rents_from_real_property sec_856 provides that at least percent of a reit's gross_income must be derived from among other sources rents_from_real_property sec_856 provides that rents_from_real_property include subject_to exclusions provided in sec_856 a rents from interests_in_real_property b charges for services customarily furnished or rendered in connection with the rental of real_property whether or not such charges are separately_stated and c rent attributable to personal_property leased under or in connection with a lease of real_property but only if the rent attributable to the personal_property for the taxable_year does not exceed percent of the total rent for the tax_year attributable to both the real and personal_property leased under or in connection with the lease sec_856 provides that any impermissible_tenant_service_income is excluded from the definition of rents_from_real_property sec_856 defines impermissible_tenant_service_income to mean with respect to any real or personal_property any amount received or accrued directly or indirectly by the reit for services furnished or rendered by the reit to tenants at the property or for managing or operating the property sec_856 provides certain exclusions from impermissible_tenant_service_income sec_856 provides that for purposes of sec_856 services furnished or rendered or management or operation provided through an independent_contractor from whom the reit does not derive or receive any income shall not be treated as furnished rendered or provided by the reit and there shall not be taken into account any amount which would be excluded from unrelated plr-152446-09 business taxable_income under sec_512 if received by an organization described in sec_511 sec_856 provides that amounts paid to a reit by a trs shall not be excluded from rents_from_real_property by reason of sec_856 when a reit leases a qualified_lodging_facility or qualified health_care_facility to a trs and the facility or property is operated on behalf of the trs by a person who is an eligible_independent_contractor sec_856 defines an independent_contractor as any person who does not own directly or indirectly more than percent of the reit’s shares and if such person is a corporation not more than percent of the total combined voting power of whose stock or percent of the total shares of all classes of whose stock is owned directly or indirectly by one or more persons owning percent or more of the shares of the reit sec_856 provides that the term eligible_independent_contractor means with respect to any qualified_lodging_facility or qualified_health_care_property any independent_contractor if at the time such contractor enters into a management agreement or similar service_contract with the trs to operate the facility or property the contractor or any related_person is actively engaged in the trade_or_business of operating qualified lodging_facilities or qualified health care properties for any person who is not a related_person with respect to the reit or the trs sec_856 provides that for purposes of sec_856 persons shall be treated as related to each other if such persons are treated as a single employer under subsections a or b of sec_52 sec_856 provides that a reit and a corporation other than a reit may jointly elect to treat such corporation as a trs to be eligible for treatment as a trs sec_856 provides that the reit must directly or indirectly own stock in the corporation and the reit and the corporation must jointly elect such treatment sec_856 provides that any corporation in which a trs owns directly or indirectly more than percent of the total voting power or value of the outstanding securities shall be treated as a trs sec_856 provides that a trs cannot directly or indirectly operate or manage a lodging_facility or a health_care_facility a healthcare facility is defined in sec_856 as a hospital nursing facility assisted living facility congregate care facility qualified_continuing_care_facility as defined in sec_7872 or other licensed facility which extends medical or nursing or ancillary services to patients and which was operated by a provider of such services that is eligible for participation in the medicare program under title xviii of the social_security act with respect to the facility plr-152446-09 in revrul_75_136 1975_1_cb_195 a corporation acting as an investment_advisor to a reit formed a wholly-owned subsidiary that entered into a property management agreement with the reit the ruling holds that the subsidiary is not precluded from qualifying as an independent_contractor if the subsidiary operates as a separate_entity with its own officers and employees and keeps separate books_and_records that clearly reflect its activities in the management of the property in revrul_76_534 1976_2_cb_215 a reit’s property manager was a wholly- owned subsidiary of the reit’s investment_advisor while the management company was operated as a separate company with separate officers and employees an employee of the investment_advisor served as a director of both the investment_advisor and the management company the revenue_ruling concludes that the relationship of the director to both the investment_advisor and the management company does not preclude the property manager from qualifying as an independent_contractor revrul_77_23 1977_2_cb_197 involves a situation in which an individual was both a trustee and a salaried employee of a reit and was also the sole shareholder and a director of a corporation that served as the reit’s property manager the ruling holds that although the property management company is directly related to the individual that is a trustee and employee of the reit the property manager is not precluded from qualifying as an independent_contractor the ruling explains that the proper relationship to be examined to determine independent_contractor status is the relationship between the reit and the property manager and not the relationship between the property manager and the reit trustee taxpayer represents that llc qualifies as an independent_contractor under sec_856 llc represents that it and its affiliates are engaged in the active_conduct of the trade_or_business of managing healthcare facilities and are managing the operation of healthcare facilities unrelated to those owned by taxpayer or new trs accordingly we conclude that llc will be treated as an eligible_independent_contractor with respect to the management and operation of the facility for purposes of sec_856 also llc will be treated as managing and operating the facility on behalf of new trs for purposes of sec_856 and with respect to the facility new trs will not be treated as operating or managing a business facility in violation of sec_856 rent paid_by new trs to llc is qualifying_income for purposes of the income tests under sec_856 and c in this case taxpayer through op leases business facilities to subsidiaries of either llc or llc as stated above these lessees are in part owned through certain individuals or entities by the owners of llc4 which owns llc the lessees are separate independent entities from llc and llc and are unrelated to taxpayer it is represented that the leases and any future leases were or will be entered into on an arms-length basis accordingly we conclude that the leases to plr-152446-09 subsidiaries of llc and llc9 will not affect whether llc may be considered an eligible_independent_contractor with respect to the facility under sec_856 except as specifically ruled upon above no opinion is expressed concerning any federal_income_tax consequences relating to the facts herein under any other provision of the code specifically we do not rule whether taxpayer otherwise qualifies as a reit under part ii of subchapter_m of chapter of the code this ruling is directed only to the taxpayer requesting it taxpayer should attach a copy of this ruling to each tax_return to which it applies sec_6110 of the code provides that this ruling may not be used or cited as precedent sincerely thomas m preston_____________ thomas m preston senior counsel branch office of associate chief_counsel financial institutions products