department of the treasury internal_revenue_service washington d c cc dom fs fi p uilc date internal_revenue_service national_office field_service_advice number release date memorandum for district_counsel from deborah a butler assistant chief_counsel field service cc dom fs subject this field_service_advice fsa is a supplement to an earlier fsa dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent legend taxpayer b c d e f date date date date date date date date date date date amount amount amount amount issue whether the facts in this transaction should be characterized to better reflect the proper federal_income_tax consequences conclusion there are three alternative ways to characterize this transaction for federal_income_tax purposes facts the field_service_advice that was issued on date presented a comprehensive set of facts only a brief recital of the facts is necessary here on date c a u s_corporation sold computer equipment to b a belgian national and individual for amount b financed this purchase by obtaining loans from e on date b leased the same equipment to c on date b sold his rights to the lease receivables ie the rents to d a u s bank b sold his rights to receive rental income for months until date upon his sale of the rights to rental income b accelerated his income and realized income from the sale in date instead of from date through date b was not subject_to u s federal taxation on date b and the taxpayer which owned all of the stock of f engaged in a purported sec_351 transaction the taxpayer contributed cash to f in exchange for common_stock in f b contributed his interest in the equipment and lease in exchange for preferred_stock in f f claimed depreciation expenses and a sec_1231 loss for the date through date tax years f did not recognize gain from b’s sale of the rents because f was not yet the owner of the equipment accordingly a foreign individual not subject_to u s federal taxation received the income from the rental stream but a u s_corporation took the depreciation_deductions law and analysis a overview in our earlier field_service_advice fsa we stated that the strongest argument against the parties’ tax treatment of the lease-stripping transaction is that it is a sham and thus its form should be disregarded in determining the proper tax treatment in this supplemental fsa we propose a number of possible characterizations of the transaction for you to consider in determining the economic_substance of the transaction while the characterizations in this supplemental fsa are similar to the characterizations described in the sec_482 discussion of the earlier fsa we view these characterizations as alternatives to the sec_482 characterizations as we stated in the prior fsa as part of the sec_482 analysis the sale- leaseback between c and b coupled with the sale by b to d of the right to receive rents from c appears to be a loan of amount from d to c we shall not repeat the earlier analysis concerning sec_482 we revisit the conclusion because it is the starting point in this fsa for determining the substance of the purported transfer of the equipment to f in addition to the characterizations present in the prior fsa we offer three possible characterizations for you to consider as you evaluate the facts and circumstances of this case the purported sec_351 transfer of the equipment to f may be characterized as a sale in which c sold to f the equipment including the right to receive rent a sale in which c sold a residual_interest in the equipment to f or a financing in which f loaned money to c in pursuing an economic_substance argument in this case we also suggest considering recently published revrul_99_14 1999_13_irb_1 where the service concluded that lease-in lease-out transactions do not produce the desired tax result of deductible lease and interest payments because they have no economic_substance according to case law it is also possible that in disregarding b’s role c could be treated as having transferred the property to f in a sec_351 transaction this possibility was discussed in the earlier fsa under issue b the term of the c lease this is similar to the approach taken by the tax_court in 46_tc_363 acq 1967_2_cb_1 and 46_tc_375 acq 1967_2_cb_3 in alstores the taxpayer purchased a building for dollar_figure million paying dollar_figure cash and granting the seller a right to 2½ years’ rent-free occupancy under a leaseback agreement the taxpayer argued that the transaction in substance was a in form the following amounts were paid_by the parties in the various transfers conveyance of a future_interest with the seller reserving to itself a term of 2½ years in the property the tax_court disagreed and concluded that the transaction was in both form and substance a sale_and_leaseback in doing so the court relied in part on certain features of the legal documents that resembled a lessor-lessee relationship the court then determined that the taxpayer’s cost_basis in the property was equal to the cash paid plus the fair_market_value of the lease received and that the taxpayer had taxable rental income in the year_of_sale in the amount of dollar_figure alstores t c pincite in the companion case 46_tc_375 the tax_court determined that the seller in turn had an amount_realized that included the fair_market_value of the lease and had an amortizable_basis in the lease equal to its fair_market_value steinway t c pincite see 80_tc_378 holding that amounts of rental income reserved to the seller are taxable to the buyer of the properties because in substance the amounts were deferred payments of the purchase prices of the properties see also 399_f2d_800 5th cir reaching a similar result where the sales contract between the parties reserved to the seller production payments to be satisfied from an undivided one-tenth of the property’s gross_income until the amount_paid totaled the required contractual amount plus interest consistent with alstores f may be treated as having purchased the equipment from c for the equipment’s fair_market_value including the right to receive rental income during the term of the c lease thus f’s cost_basis would be composed of f’s assumption of the e loan the balloon notes which f would be treated as having issued to c in the sale rather than as having assumed from b and the fair_market_value of the right to receive rents during the term of the c lease which depending on the facts may be approximated by the outstanding principal balance of the installment notes alstores the court held that the buyer who leased the property back to the seller had rental income in the year of the sale equal to the fair_market_value of the lease if the same timing rule applies in the instant case in compare sec_467 granting treasury the authority to promulgate regulations leveling advance rental income sec_1_1273-2 treating payments made by a borrower to a lender other than for property or services provided by the lender as reducing the issue_price of the debt_instrument rather than constituting immediate income to the lender sec_1_446-3 allocating up-front payments on swaps over the term of the swap notice_89_21 1989_1_cb_651 c tax_court in mcculley 18_tc_405 acq 1952_2_cb_1 buyer purchased real_property from the seller and contractually agreed to permit the seller to retain possession of the property for several months following the sale the seller retained all rents collected during this period of retained possession and also paid real_estate_taxes insurance premiums and other expenses of the property during that period similar to alstores the issue was whether the buyer purchased only a remainder_interest in the rental property with the seller retaining there the the legal right to the rental income or whether the buyer purchased the entire property and then assigned the rents to the seller to be applied toward the purchase_price unlike alstores the court in mcculley ashlock concluded that the seller legally retained the rents and that the buyer purchased only a remainder_interest in the property in reaching this decision the court focused on the contracts executed by the parties as well as the fact that the seller retained the benefits_and_burdens_of_ownership of the property during the period that it retained the right to receive the rental income mcculley ashlock t c pincite compare ellison supra distinguishing the result reached in mcculley ashlock based on who the court concluded retained the benefits_and_burdens_of_ownership of the property during the period the seller retained the rental income of the property 67_tc_764 aff’d per curiam 622_f2d_995 9th cir there the buyers purchased an interest in land and depreciable assets subject_to a pre- existing lease the buyers paid dollar_figure for the depreciable assets and attempted to take depreciation_deductions on the assets prior to the termination of the pre- existing lease the court determined that the buyers’ interest in the property was a remainder_interest and that they could not take depreciation_deductions in their dollar_figure investment until their interest became a present one which would occur when the lease terminated similar to mcculley the court focused on the parties’ choice of form in their agreements as well as which party retained the benefits_and_burdens_of_ownership of the depreciable assets see also 87_tc_178 see generally wagner v commissioner tcmemo_1974_42 rev’d 518_f2d_655 10th cir d agreements read in light of the attendant facts and circumstances 24_tc_1124 aff’d 241_f2d_288 9th cir this is a question of fact as evidenced by the written in determining whether a sale of the equipment should be respected the relevant factors are the investor's equity_interest in the property as a percent of the purchase_price renewal or purchase options at the end of the lease_term based on fair_market_value of the equipment whether the useful_life of the property exceeded the lease_term whether the projected residual_value of the equipment plus the cash-flow generated by the rental of the equipment allowed the investors to recoup at least their initial cash investment whether at some point a turnaround was reached whereby depreciation and interest deductions were less than income received from the lease whether the net tax savings for the investors were less than their initial cash investment whether there was the potential for realizing a profit or loss on the sale or release of the equipment whether the documentation was consistent with the substance of the transactions and whether the parties acted in a manner consistent with the purported sale 91_tc_838 the tax_court has said the following factors are neutral in making the determination of ownership in sale-leaseback transactions the existence of a net_lease the absence of significant positive net cash-flow during the leaseback term or rent geared to interest and principal amortization and the use of nonrecourse_liability 89_tc_1229 aff’d in part rev’d in part 909_f2d_1360 9th cir 84_tc_412 but see 69_f3d_982 9th cir distinguishing transaction with economic_substance from sham transactions in which nonrecourse notes were a significant part of the transaction 899_f2d_905 10th cir w hen lack of cash_flow is created by extraordinary management fees and inflated purchase prices any element of neutrality rapidly dissipates case development hazards and other considerations recharacterizing the form of this transaction presents certain litigating hazards and requires additional factual development additional facts to develop include all communication between c the taxpayer and f in addition to the case development recommended in the prior fsa in this case please call if you have any further questions by ___________________ joel e helke branch chief financial institutions products branch field service division


internal_revenue_service department of the treasury washington dc number release date index number person to contact telephone number refer reply to cc psi - plr-109998-01 date date x a b d1 year dear this letter responds to a letter and subsequent correspondence written on behalf of x by its authorized representative requesting a ruling under sec_1362 of the internal_revenue_code the information submitted states that x began operating on d1 of year a and b are the shareholders of x a the president of x represents that it was intended for x to be an s_corporation beginning in year its first taxable_year however no timely form_2553 election by a small_business_corporation was filed with the service_center on behalf of x for year for year x filed form_1120s u s income_tax return for an s_corporation 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 has established reasonable_cause for failing mr albert g powers to make a timely election to be an s_corporation for x’s first 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 sent to x’s authorized representatives branch sincerely yours jeanne m sullivan assistant to the chief 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-170491-03 cc ita b02 number release date index uil no case-mis no ------------------------------------------------------- ---------------------------------- -------------------------- -------------------------- taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference legend ---------------------------------- ----------------------------------------- ------------------------- ---------------- -------------------------------- ------------------------- ----------------------------------- -------------------------------------------- --------------------------------------------------------- ------------------------------------------------ --------------------------------- -------------------------------- corp x sub a sub b sub c group d tax_year sec_1 through issue whether the taxpayer’s conveyances of its railroad rights-of-way to qualified trail providers pursuant to u s c sec_1247 constitute charitable_contributions deductible under sec_170 conclusions the taxpayer’s conveyances of its railroad rights-of-way are transfers of partial_interests in real_property provided that the transfers otherwise satisfy the requirements of sec_170 the transfers would constitute deductible charitable_contributions only if the possibility that the property will revert to the taxpayer or its assigns is remote under tam-170491-03 income_tax regulations sec_1_170a-7 the determination of remoteness is factual for each conveyance the parties have taken an unusual procedural stance in this tam they have effectively argued that the conveyances at issue are deductible or not under sec_170 as a matter of law examination reads the conditions imposed by the rails to trails act on rail bank transfers as creating an impermissible substantial remainder in the taxpayer taxpayer reads the same provisions as transferring its interest except for a remote possibility of reversion to trail providers for public charitable purposes we disagree with both parties’ interpretation we have concluded that the relevant provisions of u s c title neither prevent nor compel deductions under sec_170 the ultimate determination of deductibility is factual ie how remote is the possibility of the property reverting to the taxpayer or its assigns because examination and the taxpayer did not provide us with an agreed factual record we return this case to examination for factual development and the ultimate determination of remoteness under the legal standards discussed herein facts corp x and subs a b and c are railroads collectively referenced here as the taxpayer in tax_year sec_1 through taxpayer conveyed its interests in certain railroad rights-of- way for interim trail use under u s c sec_1247 there were seven such conveyances all of which followed taxpayer’s required applications to the interstate commerce commission icc or the surface transportation board stb to abandon the taxpayer’s rights-of-way ceasing rail service and abandoning railroad rights-of-way are important business decisions railroads decide to abandon line that they consider unprofitable and economically unsustainable the file documents the taxpayer’s extensive consideration of the proposal to abandon the lines of subs a and c the taxpayer’s decision making process on sub b’s line is less documented but the taxpayer represents that the consideration of all abandonment decisions is similarly thorough and extensive railroads are regulated public_utilities and must receive governmental approval of changes in operation especially abandonment pursuant to the relevant administrative procedures the taxpayer applied to the icc and stb to cease rail service and to abandon its rights-of-way the government regulators may take one of two actions allow the railroad to abandon the right-of-way outright and permanently or allow the railroad to cease operations and abandon the right-of-way temporarily often indefinitely during a period of interim trail use under u s c sec_1247 u s c sec_1247 was added to the national trails system act to encourage interim trail use and discourage outright abandonment under the process a railroad indicates that it desires to convey an interim trail use to a qualified trail provider under the rails to trails regime a qualified trail provider is defined as a state political_subdivision or qualified private organization that is prepared tam-170491-03 to assume full responsibility for management of railroad rights-of-way and for any legal liability arising out of such transfer or such use and for the payment of any and all taxes that may be levied or assessed against the railroad rights-of-way sec_1247 if the railroad intends to enter into an interim trail use or rail bank agreement the stb will issue either a certificate of interim trail use or abandonment citu or in the case of a proceeding involving the exemption of a route from federal regulation a notice of interim trail use or abandonment nitu the citu or nitu will provide that any interim trail use is subject_to future restoration of rail service and conditioned on the trail provider continuing to meet the financial obligations of the right- of-way when the stb issues a citu or nitu the railroad can discontinue operations remove track and take any other measures consistent with the cessation of railroad operations the railroad and the trail provider execute an agreement governing the interim trail use conveyance or transfer agreement typically the railroad will be allowed to discontinue current service while retaining the right to resume rail operations on the line in the future in the interim the right-of-way may be used as a trail as long as the trail provider continues to assume responsibility for the property interim trail use under a citu or a nitu may cease on the occurrence of either of two events the trail provider decides to cease trail operations or railroad service resumes reactivation the railroad that conveyed the interim use may petition the stb to vacate the trail use order so that it may reactivate the line also parties other than the conveying railroad for example competitor railroads or customers in the service area may request permission to reactivate the rail line third parties seeking reactivation must obtain the concurrence of the abandoning railroad if available and must obtain authorization under u s c or exemption under u s c to construct and operate a rail line over the right-of-way see iowa power inc -construction exemption-council bluffs ia i c c 2d trail use agreements typically address the possibility of reactivation four of the seven conveyances include agreements requiring the railroad to compensate the trail provider should the taxpayer reactivate the lines in two of the agreements the taxpayer is required to pay the provider the fair_market_value of the right-of-way upon reactivation the other two agreements do not specify an amount of compensation but require the taxpayer to pay a reasonable amount for any improvements that the user made to the property taxpayer conveyed its railroad rights-of-way to the trial providers via quitclaim_deed in some instances the taxpayer and its subsidiaries owned some of the property underlying the rights-of-way in fee simple more commonly the taxpayer had a non-fee interest an easement law and analysis rails to trails tam-170491-03 as the demand for rail transportation has declined railroads have sought to discontinue service on unprofitable lines and abandon certain rights-of-way before legislative intervention a railroad that with regulatory approval discontinued rail service on its right-of-way had two options hold and maintain the unused right-of-way or abandon its right-of-way the first option preserved the railroad’s property for potential reactivation of the line but it was usually too economically burdensome the second option was unattractive because it was permanent and did not preserve the reactivation option railroad rights of way are normally easements carved from underlying fee estates under common_law most local law an abandoned easement reverts to the underlying fee estate most abandoned railroad easements would revert permanently to the owners of the land from which the easement was carved unconditional or permanent abandonment terminates the right-of-way and eliminates the possibility of future rail service in that corridor congress enacted the legislation described below to allow railroads to cease rail service and to avoid the costs of maintaining an unused right-of-way while preserving the rights-of-way for possible future rail use in enacting legislation congress stated that it viewed the preservation of railroad rights-of-way as an important national interest congress first enacted the national trails system act in pub l codified as amended pincite u s c sec_1241 et seq to establish a nationwide system of nature trails congress reserved to itself the right to designate scenic and historic trails and delegated to the secretaries of the interior and of agriculture the authority to designate recreational trails and to develop and administer the entire trail system see u s c sec_1243 sec_1244 sec_1246 as originally enacted the trails act made no specific provision for the conversion of railroad rights-of-way to trails in concerned about the loss of railroad rights-of-way congress included in the railroad revitalization and regulatory reform act of pub l several provisions to promote the conversion of railroad lines to trails among other things the act authorized the secretary of the interior to provide financial educational and technical assistance to various government entities for programs to convert unused railroad rights-of-way to recreational and conservation uses in congress determined that previous measures were not successful in encouraging conversion of railroad rights of way to trails h_r rep no 98th cong 1st sess s rep no 98th cong 1st sess a major impediment was the state of the property interest the rights-of-ways were easements adjacent property owners claimed that the abandoned property easements reverted to them upon abandonment congress removed the impediment with a provision known as the rails to trails act a part of the national trails system act amendments of pub l codified as u s c sec_1247 this law provided if a state political_subdivision or qualified private organization is prepared to assume full responsibility for management of such rights-of-way and for tam-170491-03 any legal liability arising out of such transfer or use and for the payment of any and all taxes that may be levied or assessed against such rights-of- way then the board shall impose such terms and conditions as a requirement of any transfer or conveyance for interim use in a manner consistent with this chapter and shall not permit abandonment or discontinuance inconsistent or disruptive of such use this amendment ensures that the interim trail use of a railroad right-of-way will not be treated for purposes of any law as a permanent abandonment of such right-of-way for railroad purposes by deeming interim trail use to be like discontinuance rather than abandonment congress prevented property interests from reverting under state law 494_us_1 the provision preserves the right-of- way for future railroad use even though service is discontinued presently and the tracks removed h_r rep no pincite the statutory scheme accomplishes a very specific goal preservation of the railroad right-of-way in case of future need in effect a railroad may discontinue rail service and permanently abandon the right-of-way only if the railroad cannot reach an agreement with a trail provider within the time period prescribed by the citu or nitu and any extensions both the conveying railroad and any other interested railroads retain the right to request reactivation of the rights-of-way transferred for trail use the conveying railroad has a possibility of reverter of the easement right-of-way the conveying railroad reactivates the right-of-way by petitioning the stb to vacate the trail use order third parties seeking reactivation must obtain the concurrence of the abandoning railroad if available and must obtain authorization or exemption to construct and operate a rail line over the right-of-way under the statutory scheme an incentive for railroads to contribute the use of the rights- of-way is a possible charitable deduction u s c sec_1246 states for the conservation_purpose of preserving or enhancing the recreational scenic natural or historical values of the national trails system landowners are authorized to donate or otherwise convey qualified_real_property interests to qualified organizations consistent with sec_170 of title_26 including but not limited to right-of-way open space scenic or conservation easements without regard to any limitation on the nature of the estate or interest otherwise transferable within the jurisdiction where the land is located the conveyance shall be deemed to further a federal conservation policy and yield a significant public benefit for purposes of section of public law describing sec_1246 house report states that the statute authorizes a wide variety of interests in land which can be utilized to protect trail areas and environs such as easements which would not require a qualified grantee to own fee title to appurtenant lands tam-170491-03 this provision does not change existing tax law or regulations but is intended to better define the types of interests in land that qualify under existing law when related to trail purposes the committee's intent is that easements donated pursuant to this provision shall have the same tax benefits to the donor as provided in sec_170 h rep nodollar_figure pincite under u s c sec_1246 contributions of rights-of-way for interim trail use are deemed to further a federal conservation policy as well as yield a significant public benefit and consequently may qualify as charitable_contributions if they otherwise meet the requirements of sec_170 however u s c sec_1246 does not create or constitute an independent basis for deduction under sec_170 as the taxpayer at one point in this case argued charitable_contribution_deduction under sec_170 sec_170 allows a deduction for charitable_contributions described in sec_170 in relevant part sec_170 defines the term charitable_contribution as a contribution or gift to or for_the_use_of qualifying entities not operating for private benefit engaging in prohibited lobbying and political activities etc the taxpayer has represented that the trail providers are qualifying entities and examination has not challenged that representation sec_170 generally disallows a deduction for the contribution of a partial interest in property the taxpayer makes several arguments to avoid the prohibition of the deduction under this section full interest not conveyed first the taxpayer argues that it transferred its full interest in the property to the trail provider that is taxpayer had only an easement interest in the property transferred that easement interest retained no real_property interest and has only an option to repurchase the easement if so the transfer would not be a gift of a partial interest under sec_170 and would qualify for a deduction under sec_170 as a charitable_contribution defined in sec_170 taxpayer would also contend that the transfer of its full interest in the property to the trail provider would be a qualified_conservation_contribution within the meaning of sec_170 because u s c sec_1246 deems a rail bank conveyance to further a federal conservation policy and yield a significant public benefit examination disagrees it views the conveyances as transfers of only part of the taxpayer’s interest in the property to the trail providers that is the taxpayer retains a partial interest in the property the right to use the easement in the future upon tam-170491-03 application to the appropriate government authority for reactivation of rail service we agree with examination the taxpayer states that the transfer agreements generally require the taxpayer to pay the trail provider to reactivate rail service four of the agreements actually provide that the taxpayer would have to pay the trail provider compensation of either the fair_market_value of the easement or for any improvement costs with respect to the three remaining agreements not specifically providing for compensation the taxpayer argues that compensation would be imputed the taxpayer argues that in effect it has to repurchase the full interest in the easement held by the trail user the taxpayer reasons that if it has to repurchase what it conveyed to the trail provider the taxpayer must have conveyed its full interest in the easement in other words the taxpayer would not have to buy the property had it retained such interest the taxpayer cites revrul_76_151 1976_1_cb_59 as support for this position the ruling held that a corporation’s conveyance of land and a building to a charitable_organization was a charitable_contribution even though the corporate donor reserved the right to repurchase the land and building at its fair_market_value if the charitable_organization ceased to use the property for charitable purposes and decided to dispose_of it the revenue_ruling merely mentioned the reserved repurchase option and did not analyze its impact on the contribution we agree with the taxpayer that revrul_76_151 implies that repurchase at fair_market_value may be a factor indicating that the taxpayer conveyed substantially_all its interest in the property however even if the taxpayer must expend funds in order to reactivate the line the right to repurchase in the present case is distinguishable from the situation in the revenue_ruling because the taxpayer has the power to reacquire the property independent of whether the donee wants to keep the property and continue using it for public purposes taxpayer retains a power adverse to the donee and can effectively terminate the donee’s interest by successfully applying to reactivate the rail line in revrul_76_151 control_over the possible reacquisition ran the other way the donee’s actions were the default condition triggering the donor’s option to repurchase in the present case the taxpayer controls the exercise of the option to reacquire and has the right to interfere with and terminate the donee’s use of the property we think that the taxpayer’s right to reacquire the property right-of-way easement adverse to the trail provider is tantamount to a retained property interest making the taxpayer’s contribution a partial interest under sec_170 substantial retained_interest taxpayer also argues that even if it retains an interest in the property right-of-way the retained_interest is so insubstantial that its deduction should be allowed sec_1_170a-7 provides an insubstantiality exception to sec_170’s prohibition on the deductibility of partial_interests 86_tc_243 is the leading case on the insubstantiality rule the internal_revenue_service has also recognized the principle in several published rulings analyzed in the stark opinion tam-170491-03 we think that insubstantiality rule embodies a de_minimis exception to the general prohibition against substantial private benefit redounding to a donor of a charitable gift at 86_tc_252 the stark court explained the basis of the exception we hold that the insubstantiality rule expressed in rev ruls and represent an accurate legal conclusion where the interest retained by the taxpayer is so insubstantial that he has in substance transferred his entire_interest in the property the tax treatment should so reflect such a taxpayer satisfies the original congressional purpose behind sec_170 and under sec_1_170a-7 income_tax regs a minor deviation from a literal application of the statute is appropriate examination views the taxpayer’s conveyances as attempts to gain a substantial economic benefit ie avoid the cost and burden of maintaining unused rights-of-way but retain the right to reactivate service a valuable asset in the future should it become economically advantageous examination stresses that absent u s c sec_1247 the taxpayer’s conveyances of its rights-of-way for non-railroad use would have failed under state law the taxpayer’s property interests easements would have terminated and the property would have permanently reverted back to the land from which they were carved in that event the taxpayer would have abandoned its easements and had no remaining property to convey to the trail provider u s c sec_1247 gave the taxpayer the ability to rail bank the property ie to prevent reversion by agreeing to interim use by a trail operator examination contends that section u s c sec_1247 operated to permit the taxpayer to retain a substantial interest in the property examination argues that the arrangement violates the prohibition against substantial retained interests in sec_1_170a-7 as explained we think that the taxpayer has retained a partial interest in the rights-of- way that it has conveyed to trail providers the interest is a possible reversion upon reactivation of rail service that retained_interest has potential value to the taxpayer the substantiality of a retained_interest is usually judged in terms of its value the stark court explained pincite_tc_252 and to be entitled to any deduction the taxpayer must prove that her situation comes within a particular statutory provision 292_us_435 we therefore construe the insubstantiality rule narrowly see 417_us_134 a charitable_contribution_deduction should be allowed only where the retained_interest has a de_minimis value cf e i dupont de nemours co v united stat432_f2d_1052 3d cir where in determining whether the transfer of patent rights constituted a sale the court stated to determine whether the taxpayer did transfer all of the substantial rights in the patents in question the key question is whether the transferor retained any rights which in the aggregate have substantial value emphasis supplied by the court tam-170491-03 moreover the insubstantial retained_interest must not potentially interfere in any manner with the donee's interest taxpayer makes two arguments that the agreements with the trail providers demonstrate that its possibility of reverter has de_minimis value first in order to reactivate the lines the taxpayer would have to either repurchase the right-of-way from the trail provider or compensate the provider for improvements to the property in other words the taxpayer would have to make quite substantial payments in order to realize the benefits second the potential value to the taxpayer of the reversion interest in the property discounted for the taxpayer’s payment to reacquire the use of the right-of-way would probably be insubstantial also the taxpayer contends that u s c sec_1246 states that rail bank conveyances shall be deemed to further a federal conservation policy and yield a significant public benefit for purposes of section of public law the taxpayer argues that the statute contains a clear indication that congress considered these conveyances to be predominately for the public benefit consequently congress must have viewed the private benefit inherent in the statutory scheme to be incidental and insubstantial the taxpayer also contends that the possibility of reacquisition and reactivation reverter is very remote therefore the interest can not be very valuable clearly remoteness affects value the value of a benefit with a remote possibility of realization is usually considered less than the value of a similar benefit likely to be realized however even though value and remoteness are closely related factors neither factor is completely determinative of the other the regulatory scheme distinguishes the factors and treats remoteness as a separate inquiry see sec_1_170a-7 we address remoteness separately in the next section however in 86_tc_243 the court cited another important factor for determining insubstantiality moreover the insubstantial retained_interest must not potentially interfere in any manner with the donee’s interest the taxpayer argues that its power to reacquire under the national trails act scheme is insubstantial because the statute gives other railroad carriers an equivalent or similar power to reactivate see norfolk and western railway - abandonment between st mary’s and minster in auglaize county oh i c c 2d iowa power inc -construction exemption-council bluffs ia i c c 2d the taxpayer thinks that the sharing of the power to reactivate with other parties and agency review of reactivation requests dilute the taxpayer’s ability to interfere with the donees’ interests the taxpayer’s argument is not persuasive because it concedes that it has retained the interest possibility of reverter in the property the easement examination stresses the fact that the taxpayer can initiate an administrative action for reactivation at its pleasure examination thinks that power enables the taxpayer to interfere with the donee’s property interest in contravention of the stark standard we agree that the taxpayer’s power to initiate unilaterally or in concert with potential tam-170491-03 customers and or other carriers an administrative action to reacquire and reactivate the lines could constitute a substantial interference with the donees’ trail providers’ interest in the property remoteness exception for partial_interests under sec_1_170a-7 a deduction of a partial interest of property will not be disallowed merely because the interest which passes to or is vested in the charity may be defeated by the performance of some act or the happening of some event if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible see also sec_1_170a-1 the language so remote as to be negligible in sec_1_170a-7 is identical to the language in the estate_tax regulations hence beginning with 72_tc_646 courts have used the standards in estate_tax precedent to determine remoteness for sec_170 purposes at 72_tc_656 and the briggs court explained the phrase so remote as to be negligible as it appears sec_20_2055-2 estate_tax regs has been defined as a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction 224_f2d_26 it is likewise a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance 47_tc_193 see 291_us_272 because the operative language of sec_20_2055-2 estate_tax regs is identical to that contained in sec_1_170a-1 income_tax regs we believe that these prior interpretations of the so remote as to be negligible language of sec_20_2055-2 estate_tax regs are instructive in this sec_170 case see also 95_tc_156 in addition courts have applied these standards regarding remoteness in conservation easements cases see satullo v commissioner t c memo aff’d without published opinion 67_f3d_314 11th cir stotler v commissioner t c memo the service has consistently ruled that the chances of an event occurring is so remote as to be negligible under estate_tax regulations when the chance that the event will occur is less than percent see revrul_85_23 1985_1_cb_327 revrul_78_255 1978_1_cb_294 revrul_77_374 1977_2_cb_329 probability and possibility are factual concepts sec_1_170a-7 contemplates a factual determination of the remoteness of the possibility of reverter the case law is consistent consequently we disagree with examination that the taxpayer’s conveyances of its rights-of-way to a trail providers pursuant to u s c sec_1247 fail as a matter of law to constitute charitable_contributions deductible under tam-170491-03 sec_170 whether the possibility of reverter is so remote as to be negligible depends on the facts of each transfer the case law looks to specific factors to determine the likelihood of the contribution being defeated a whether the donor and donee intend at the time of the donation to cause the event’s occurrence b the incidence of the event’s occurring in the past c the extent to which the occurrence of the event would defeat the donation and d whether the taxpayer has control_over the event’s occurrence examination should follow the standards described above to make its factual determination on remoteness of the possibility of reversion factual determination as stated above examination and the taxpayer have failed to submit an agreed statement of facts in largely parallel submissions the parties challenge each other’s assertions of critical facts concerning intent the number and scale of reactivations that have occurred in the past and the power of the taxpayer to effect a reactivation for that reason this office can not reach a conclusion on the facts underlying the issues of remoteness and substantiality therefore we are returning the case to examination for the final_determination based on further factual development 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


internal_revenue_service number release date index number ---------------------- ---------------------------- ------------------------------------- ------------------------------ in re --------------------------------- 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 psi b09 plr-101050-04 date date legend taxpayer taxpayer trust -------------------------- -------------------- ------------------------------------------------------------------- ----------------------------------------------------- ---------------------------------------------------- ---------------------------------------------------------- ------------------------------------------------------ ---------- ---------------------------------------------- ----------------------- ----------------------- ------------- ----------- ----------- ------ marital trust decedent’s trust survivor’s trust state state statute date date a b c d dear ---- this is in response to your letter dated date and subsequent correspondence requesting rulings that the severance of a_trust into an exempt and non-exempt trust for generation-skipping_transfer gst tax purposes is a qualified_severance under ' a of the internal_revenue_code and that as a result of the severance a reverse qualified_terminable_interest_property qtip_election made under ' a for the trust will be effective to allocate gst_exemption to the exempt trust the facts and representations submitted are summarized as follows on date taxpayer and taxpayer formed a revocable_trust trust plr-101050-04 article of trust provides that upon the death of the first to die of taxpayer and taxpayer trust is to be divided into three trusts survivor’s trust decedent’s trust and marital trust the trustee is to allocate trust assets constituting the surviving spouse’s separate_property and the survivor’s share of the couple’s community_property to survivor’s trust the trustee is to allocate assets equal to taxpayer 1’s remaining unified_credit to decedent’s trust and the trustee is to allocate the remaining trust assets to marital trust article provides that the surviving_spouse is to receive all of the net_income of survivor’s trust at least quarter-annually the surviving_spouse has a general_power_of_appointment over survivor’s trust upon the surviving spouse’s death any property not effectively appointed is to be distributed free of trust to named beneficiaries article provides that the surviving_spouse is to receive all of the net_income of decedent’s trust at least quarter-annually and trust principal to provide for the surviving spouse’s health education and support upon the surviving spouse’s death the trust estate is to be distributed free of trust to named beneficiaries article provides that the surviving_spouse is to receive all of the net_income of marital trust at least quarter-annually and trust principal to provide for the surviving spouse’s health education and support income earned but not distributed prior to the surviving spouse’s death is to be distributed to the surviving spouse’s estate upon the surviving spouse’s death the trust estate is to be distributed free of trust to named beneficiaries it has been represented that some of these beneficiaries are skip persons within the meaning of ' taxpayer died on date taxpayer as the executor of taxpayer 1’s estate retained two tax professionals to prepare the form_706 united_states estate and generation-skipping_transfer_tax return for taxpayer 1’s estate the return reflected that marital trust was funded with dollar_figurea and decedent’s trust was funded with dollar_figureb on schedule m of the return taxpayer elected to treat marital trust as a qtip_trust under ' b on schedule r of the return taxpayer allocated dollar_figureb of taxpayer 1’s available gst_exemption to decedent’s trust and dollar_figurec of taxpayer 1’s available gst_exemption to marital trust in addition taxpayer made the reverse_qtip_election under ' a for marital trust on the schedule r marital trust was funded with assets that exceeded the gst_exemption allocated to marital trust on the schedule r the two tax professionals retained by taxpayer to prepare taxpayer 1’s estate_tax_return inadvertently failed to sever or advise taxpayer to sever marital trust into a gst exempt marital trust and a gst non-exempt marital trust plr-101050-04 the trustee of marital trust intends to petition state court pursuant to state statute to divide marital trust into a gst exempt marital trust and a gst non-exempt marital trust the formula for dividing marital trust’s assets will be computed as follows dollar_figurec taxpayer 1’s gst_exemption allocated to marital trust on schedule r of the estate_tax_return divided by dollar_figurea the date of death value of marital trust as reflected on schedule m of the estate_tax_return equals d percent the gst exempt marital trust will be funded with a fractional share of marital trust’s assets equal to d percent and the balance of marital trust’s assets will be allocated to the gst non-exempt marital trust the trustee of marital trust is requesting rulings that the severance of marital trust into a gst exempt marital trust and a gst non-exempt marital trust will be a qualified_severance under ' a and that as a result of the reverse_qtip_election and trust severance the gst exempt marital trust will have an inclusion_ratio of zero law and analysis sec_2001 imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2056 provides that for purposes of the tax imposed by ' the value of the taxable_estate is to be determined by deducting from the value of the gross_estate an amount equal to the value of any interest in property that passes or has passed_from_the_decedent to the surviving_spouse sec_2056 provides the general_rule that no deduction shall be allowed for an interest passing to the surviving_spouse if on the lapse of time on the occurrence of an event or contingency or on the failure of an event or contingency to occur the interest will terminate or fail and a an interest in such property passes or has passed for less than an adequate_and_full_consideration in money or money s worth from the decedent to any person other than the surviving_spouse or the estate of such spouse and b if by reason of such passing such person or his heirs or assigns may possess or enjoy any part of such property after such termination or failure of the interest so passing to the surviving_spouse sec_2056 provides that in the case of qualified_terminable_interest_property the entire property shall be treated as passing to the surviving_spouse for purposes of ' a and no part of the property shall be treated as passing to any person other than the surviving_spouse for purposes of ' b sec_2056 defines aqualified terminable_interest property qtip as property which passes from the decedent in which the surviving_spouse has a qualifying_income_interest_for_life and to which an election under ' b b v applies plr-101050-04 sec_2056 provides that an election under ' b with respect to any property shall be made by the executor on the return of tax imposed by ' the election once made is irrevocable under ' a any property in which the decedent possessed a qualifying_income_interest_for_life and for which a deduction was allowed under ' b is includable in the decedent s gross_estate sec_2601 imposes a tax on every generation-skipping_transfer gst sec_2602 provides that the amount of tax is the taxable_amount multiplied by the applicable_rate sec_2641 defines aapplicable rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer sec_2631 provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption of dollar_figure adjusted for inflation under ' c that may be allocated by such individual or by his or her executor to any property with respect to which such individual is the transferor sec_2631 provides that once an allocation of gst_exemption is made it is irrevocable under ' a the allocation of the gst_exemption may be made at any time on or before the date prescribed for filing the individual s estate_tax_return including extensions sec_2632 provides that in general any portion of an individual s gst_exemption which has not been allocated within the time prescribed by ' a shall be deemed to be allocated as follows -- a first to property which is the subject of a direct_skip occurring at the individual s death and b second to trusts with respect to which the individual is the transferor and from which a taxable_distribution or a taxable_termination might occur at or after the individual s death sec_2642 provides the method for determining the inclusion_ratio sec_2642 was enacted as part of the taxpayer relief act of and provides for the qualified_severance of a_trust for gst tax purposes sec_2642 is effective in the case of severances occurring after date and provides generally that if a_trust is severed in a qualified_severance the trusts resulting from such severance shall be treated as separate trusts thereafter for gst tax purposes sec_2642 provides that for purposes of ' a a the term qualified_severance means the division of a single trust and the creation by any means available under the governing instrument or under local law of two or more plr-101050-04 trusts if the single trust was divided on a fractional basis and the terms of the new trusts in the aggregate provide for the same succession of interests of beneficiaries as are provided in the original trust sec_2642 provides that if a_trust has an inclusion_ratio of greater than zero and less than a severance is a qualified_severance only if the single trust is divided into two trusts one of which receives a fractional share of the total value of all trust assets equal to the applicable_fraction of the single trust immediately before the severance in such case the trust receiving such fractional share shall have an inclusion_ratio of zero and the other trust shall have an inclusion_ratio of sec_2642 provides that the term qualified_severance includes any other severance permitted under regulations prescribed by the secretary sec_2642 provides that a severance pursuant to ' a b may be made at any time sec_2652 provides that in the case of any trust with respect to which a deduction is allowed to the decedent s estate under ' b the estate of the decedent may elect to treat all of the property in the trust for purposes of the gst tax as if the election to be treated as qtip had not been made this election is referred to as the reverse_qtip_election the consequence of a reverse_qtip_election is that the decedent remains for gst tax purposes the transferor of the qtip_trust for which the election is made as a result the decedent s gst_exemption may be allocated to the qtip_trust this election is not effective unless it is made for all of the property in the trust for which the qtip_election applies sec_26_2652-2 of the generation-skipping_transfer_tax regulations provides that the reverse_qtip_election is to be made on the return on which the qtip_election is made state statute provides in relevant part that a trustee has the powers granted by the court upon petition that are necessary or appropriate to accomplish a purpose of the trust based upon the facts submitted and the representations made and provided that marital trust is severed according to applicable state law the proposed severance of marital trust into a gst exempt marital trust and a gst non-exempt marital trust will constitute a qualified_severance within the meaning of ' a further provided the gst exempt marital trust is funded with assets equal to d percent of marital trust’s assets the reverse_qtip_election will be effective to allocate gst_exemption of dollar_figurec to the gst exempt marital trust and the inclusion_ratio of the gst exempt marital trust will be zero plr-101050-04 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely melissa liquerman melissa liquerman branch chief branch passthroughs special industries cc -------------------------------------- --------------------- -------------------------- --------------------------------- ------------------------------------------------------ ----------------------------------------- ----------------------------------- ------------------------------ ----------------------- ------------------------------------------ ---------------------------------------------------- ------------------------------


t c no united_states tax_court earl g higbee and lesley a higbee petitioners v commissioner of internal revenue respondent docket no filed date ps filed a petition seeking redeterminations of r’s disallowance of several deductions and imposition of an addition_to_tax and accuracy-related_penalty the parties settled most of the issues regarding the disallowed deductions except one regarding certain schedule c deductions at trial ps claimed additional deductions on account of a casualty_loss charitable_contributions unreimbursed employee_expenses and schedule c and e expenses that were neither claimed by ps on their tax returns nor raised in the notice_of_deficiency the examination in the instant case took place after the effective date of sec_7491 i r c as amended by the internal_revenue_service restructuring and reform act of publaw_105_206 sec 112_stat_685 held because ps failed to introduce credible_evidence ps failed to meet the requirements of sec_7491 i r c as amended so as to place the burden_of_proof on r for the factual issues relating to the deductions in issue held further to meet his burden of production pursuant to sec_7491 i r c as amended r must come forward with sufficient evidence indicating that it 1s appropriate to impose a penalty addition_to_tax or additional_amount held further r met his burden of production with regard to the addition_to_tax and accuracy-related_penalty farl g higbee and lesley a higbee pro sese erin k huss for respondent opinion vasquez judge respondent determined the following deficiencies in addition to and accuracy-related_penalty on petitioners’ and federal income taxes addition_to_tax penalty year deficiency sec_6651 a sec_6662 a dollar_figure dollar_figure --- big_number -- dollar_figure unless otherwise stated 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 we must decide whether petitioners are entitled to the following deductions dollar_figure for a casualty_loss dollar_figure for charitable_contributions dollar_figure for unreimbursed employee_expenses certain amounts paid on - - account of a failed business as part of a chapter bankruptcy proceeding and various expenses related to two rental properties finally we must decide whether petitioners are liable for an addition_to_tax under sec_6651 and an accuracy-related_penalty under sec_6662 background petitioners contest respondent’s determinations with regard to their and tax years in the notice_of_deficiency respondent disallowed the following deductions for a dollar_figure capital_loss dollar_figure in expenses listed on petitioners’ schedule a itemized_deductions dollar_figure in expenses listed on petitioners’ schedule c profit or loss from business and dollar_figure in expenses listed on petitioners’ schedule e supplemental income and loss after concessions the parties agreed that petitioners are entitled to the dollar_figure capital_loss dollar_figure in itemized_deductions ’ dollar_figure in schedule c expenses with the remainder still in dispute and the dollar_figure schedule e expenses with regard to the tax_year respondent disallowed the following deductions a dollar_figure capital_loss dollar_figure in ' the parties agreed that petitioners are entitled to deduct the following amounts dollar_figure for taxes dollar_figure for interest dollar_figure for charitable_contributions dollar_figure for union dues and dollar_figure for unreimbursed employee_expenses we remind the parties that when making their rule calculations miscellaneous_itemized_deductions must be adjusted for the 2-percent floor see sec_67 q4e- itemized_deductions and dollar_figure in schedule e expenses after concessions the parties agreed that petitioners are entitled to the dollar_figure capital_loss dollar_figure in itemized_deductions ’ and the dollar_figure schedule e expenses at trial the only issue remaining with regard to the notice_of_deficiency was whether petitioners were entitled to the dollar_figure in schedule c deductions reported on petitioners’ tax_return and disallowed by respondent petitioners however raised new issues at trial by claiming additional deductions for a casualty_loss charitable_contributions unreimbursed employee_expenses and schedule c and e expenses that were neither claimed on their returns nor raised in the notice_of_deficiency we combine our findings_of_fact and opinion under each separate issue heading some of the facts have been stipulated and are so found the stipulation of facts the supplemental stipulations of facts and the attached exhibits are incorporated herein by this reference at the time petitioners filed their petition they resided in phoenix arizona the parties agreed that petitioners are entitled to deduct the following amounts dollar_figure for taxes dollar_figure for charitable_contributions and dollar_figure for unreimbursed employee_expenses we note that petitioners claimed other expenses on their schedule a in the section entitled job expenses and most other miscellaneous deductions because petitioners have not raised any arguments with regard to those amounts we treat their failure to raise any assignments of error as a concession see 92_tc_661 - - discussion i disallowed deductions deductions are a matter of legislative grace and a taxpayer bears the burden of proving that he is entitled to the deductions claimed see rule a 503_us_79 292_us_435 the taxpayer is required to maintain records that are sufficient to enable the commissioner to determine his correct_tax liability see sec_6001 sec_1_6001-1 income_tax regs in addition the taxpayer bears the burden of substantiating the amount and purpose of the claimed deduction see 65_tc_87 affd per curiam 540_f2d_821 5th cir sec_7491 a new provision created by internal_revenue_service restructuring and reform act of rra publaw_105_206 sec 112_stat_685 places the burden_of_proof on respondent with regard to certain factual issues sec_7491 applies to examinations commenced after date see rra sec c 112_stat_727 the examination in the instant case commenced after date accordingly we evaluate whether respondent bears the burden_of_proof pursuant to sec_7491 sec_7491 provides that if in any court_proceeding the taxpayer introduces credible_evidence with -- - respect to factual issues relevant to ascertaining the taxpayer’s liability for a tax under subtitle a or b the burden_of_proof with respect to such factual issues will be placed on the commissioner for the burden to be placed on the commissioner however the taxpayer must comply with the substantiation and record-keeping requirements of the internal_revenue_code see sec_7491 a and b in addition sec_7491 a requires that the taxpayer cooperate with reasonable requests by the commissioner for witnesses information documents meetings and interviews sec_7491 b finally the benefits of sec_7491 are unavailable in the cases of partnerships corporations and trusts unless the taxpayer meets the net_worth requirements of sec_7430 a see sec_7491 a c respondent argues that because petitioners have failed to meet the requirements of sec_7491 and the burden_of_proof should remain with petitioners as to the remaining issue associated with respondent’s determination of petitioners’ tax_liability we therefore examine the evidence to establish whether petitioners have presented credible_evidence and have met the other requirements of sec_7491 and so as to place the burden_of_proof on respondent a casualty losses pursuant to sec_165 and c a taxpayer is allowed a deduction for an uncompensated loss that arises from fire storm shipwreck or other_casualty sec_165 however states that any loss shall be allowed only to the extent that the amount of the loss to such individual arising from each casualty exceeds dollar_figure and only to the extent that the net_casualty_loss exceeds percent of the adjusted_gross_income when property is damaged rather than totally destroyed by casualty the proper measure of the amount of the loss sustained is the difference between the fair_market_value of the property immediately before and after the casualty not to exceed the property’s adjusted_basis see sec_1_165-7 income_tax regs the fair market values reguired by the treasury regulations must generally be ascertained by competent appraisal see sec_1_165-7 income_tax regs as an alternative the treasury regulations provide that if the taxpayer has repaired the property damage resulting from the casualty the taxpayer may use the cost of repairs to prove the casualty_loss see sec_1_165-7 income_tax regs in general estimates of the cost of repairs are not evidence of the actual costs of repairs unless the repairs are actually made see 70_tc_391 57_tc_714 --- - petitioners claim a casualty_loss deduction in the amount of dollar_figure on account of alleged damage to their home and personal_property which was not deducted on their tax_return mr higbee testified that the dollar_figure represents the damage to petitioners’ property which was not reimbursed by their insurance_company but awarded by a small claims_court in support petitioners provided a form document entitled small claims complaint summons answer which appears to be issued by the glendale justice court in glendale arizona but which does not bear any type of notation or certification by a governmental official in order for sec_7491 to place the burden_of_proof on respondent the taxpayer must first provide credible_evidence the statute itself does not state what constitutes credible_evidence the conference committee’s report states as follows credible_evidence is the quality of evidence which after critical analysis the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted without regard to the judicial presumption of irs correctness a taxpayer has not produced credible_evidence for these purposes if the taxpayer merely makes implausible factual assertions frivolous claims or tax protestor- type arguments the introduction of evidence will not meet this standard if the court is not convinced that it is worthy of belief if after evidence from both sides the court believes that the evidence is equally balanced the court shall find that the secretary has not sustained his burden_of_proof h conf rept pincite 1998_3_cb_747 petitioners assert that the judgment remains unpaid --- - further the conference_report explains the purpose of the limitations set forth in sec_7491 a nothing in the provision shall be construed to override any requirement under the code or regulations to substantiate any item accordingly taxpayers must meet applicable substantiation requirements whether generally imposed or imposed with respect to specific items such as charitable_contributions or meals entertainment travel and certain other expenses substantiation requirements include any requirement of the code or regulations that the taxpayer establish an item to the satisfaction of the secretary taxpayers who fail to substantiate any item in accordance with the legal requirement of substantiation will not have satisfied the legal conditions that are prerequisite to claiming the item on the taxpayer’s tax_return and will accordingly be unable to avail themselves of this provision regarding the burden_of_proof thus if a taxpayer required to substantiate an item fails to do so in the manner required or destroys the substantiation this burden_of_proof provision is inapplicable see eg sec_6001 and sec_1 requiring every person liable for any_tax imposed by this title to keep such records as the secretary may from time to time prescribe id pincite c b pincite certain fn refs omitted petitioners’ evidence does not meet the requirements of sec_7491 besides the fact that the form document entitled small claims complaint summons answer does not actually indicate whether litigation in small claims_court was commenced or completed the document itself does not gualify as a competent appraisal or reliable estimate of the cost of any repairs because petitioners have failed to provide credible -- - evidence of a casualty_loss the burden_of_proof as to this issue is not placed on respondent further for similar reasons regarding our discussion of petitioners’ evidence for purposes of sec_7491 we conclude that petitioners have not met their burden_of_proof see rule a consequently we reject petitioners’ claimed casualty_loss deduction b charitable_contributions sec_170 provides that a taxpayer may deduct any charitable_contribution payment of which is made within the taxable_year a charitable_contribution shall be allowable as a deduction only if verified under regulations prescribed by the secretary pursuant to the treasury regulations contributions of money are required to be substantiated by canceled checks receipts from the donee organizations showing the date and amount of the contributions or other reliable written records showing the name of the donee date and amount of the contributions see sec_1_170a-13 income_tax regs similarly contributions of property other than money must be substantiated at a minimum by a receipt from the donee showing the name and address of the donee the date and location of the contribution and a description of the property in detail reasonably sufficient under the circumstances see sec_1_170a-13 income_tax regs where it is unrealistic to obtain a receipt taxpayers must maintain reliable written records of their contributions see id to substantiate additional charitable_contributions of dollar_figure for not previously claimed on their return for that year petitioners offered several documents to the court some of the documents do not have any indication of being provided by a donee organization but instead appear to have been generated by petitioners other documents consist of preprinted forms issued by alleged charitable organizations which petitioners filled in with the type and number of items donated and the estimated value of the donation in addition petitioners submitted checks and receipts which appear to be for the purchase of goods and services lastly at trial petitioners attempted to buttress their claims by describing the types of goods allegedly donated while the preprinted forms appear authentic we nevertheless conclude that petitioners’ self-generated receipts and other documents are not credible_evidence of the order necessary to substantiate the deductions claimed in the instant case see tokh v commissioner tcmemo_2001_45 further we do not find petitioners’ testimony credible we hold that petitioners have failed to introduce credible_evidence to substantiate the actual items contributed and their fair market values see sec for instance on one of the preprinted forms petitioners listed a charitable_contribution of dollar_figure for cribs and dollar_figure for baby clothes because petitioners have failed to establish how -- a and a consequently the burden_of_proof is not placed on respondent because petitioners have failed to present us with any credible_evidence they have not met their burden_of_proof pursuant to rule a to support their claimed deductions we therefore hold that petitioners are not entitled to a deduction for charitable_contributions in excess of the dollar_figure that respondent has already allowed cc unreimbursed employee_expenses and schedule c and e expenses petitioners argue that they are entitled to a deduction of dollar_figure for unreimbursed employee_expenses instead of the dollar_figure deduction returned on their schedule a for aside from mrs higbee’s self-serving testimony at trial that these additional expenses related to her employment at a beauty salon petitioners have failed to provide us with sufficient and credible_evidence for us to rule in their favor petitioners also claim additional schedule c deductions of dollar_figure for and dollar_figure for on account of amounts allegedly owed and paid with regard to their failed beauty salon business petitioners contend that they paid these amounts while they arrived at those fair market values we are unable to allow such deductions further petitioners have not produced any other independent and credible_evidence indicating that those donations were actually made in a chapter bankruptcy proceeding in support petitioners submitted to the court a document entitled debtor receipts and disbursements summary which provides general information about the deposits made by petitioners with the trustee of the bankruptcy_estate and the disbursements to creditors by the trustee as to the bankruptcy-related expenses claimed petitioners have failed to provide us with sufficient credible_evidence that petitioners had outstanding business_debts which were paid while in bankruptcy further petitioners have failed to explain the origin of these expenses in sufficient detail for us to find that these expenses would be allowable for the tax years in issue petitioners have failed to meet the substantiation and record-keeping requirements of sec_7491 the burden_of_proof therefore is not placed on respondent finally we conclude that petitioners have not met their burden_of_proof to support the claimed deductions and therefore we sustain respondent’s determination as to this issue see rule a petitioners also claim additional schedule e deductions with regard to their rental activities for repairs dollar_figure for and dollar_figure for legal expenses dollar_figure for automobile expenses dollar_figure for and insurance dollar_figure for the claimed deduction of dollar_figure for encompasses the dollar_figure still in dispute with regard to respondent’s deficiency determination not previously deducted on their tax returns again we reiterate that petitioners have failed to provide this court with credible_evidence for us to allow petitioners’ claims with respect to the disallowed deductions we therefore reject all of petitioners’ contentions as to these issues il addition_to_tax and accuracy-related_penalty under rra congress also enacted a provision sec_7491 requiring the commissioner to carry the burden of production in any court_proceeding with respect to the liability of any individual for any penalty addition_to_tax or additional_amount penalties although the statute does not provide a definition of the phrase burden of production we conclude that congress’ intent as to the meaning of the burden of production is evident from the legislative_history the legislative_history of sec_7491 sets forth in any court_proceeding the secretary must initially come forward with evidence that it is appropriate to apply a particular penalty to the taxpayer before the court can impose the penalty this provision is not intended to require the secretary to introduce evidence of elements such as reasonable_cause or substantial_authority rather the secretary must come forward initially with evidence regarding the appropriateness of applying a particular penalty to the taxpayer if the taxpayer believes that because of reasonable_cause substantial_authority or a similar provision it 1s inappropriate to impose the penalty it is the taxpayer’s responsibility and not the secretary’s obligation to raise those issues h conf rept supra pincite c b pincite therefore with regard to sec_7491 we conclude that for the commissioner to meet his burden of production the -- - commissioner must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty the legislative_history to sec_7491 however also discloses that the commissioner need not introduce evidence regarding reasonable_cause substantial_authority or similar provisions in addition the legislative_history indicates that it is the taxpayer’s responsibility to raise those issues we therefore conclude that the taxpayer bears the burden_of_proof with regard to those issues finally we note that congress placed only the burden of production on the commissioner pursuant to sec_7491 congress’ use of the phrase burden of production and not the more general phrase burden_of_proof as used in sec_7491 a indicates to us that congress did not desire that the burden_of_proof be placed on the commissioner with regard to penalties see sec_7491 therefore once the commissioner meets his burden of production the taxpayer must come forward with evidence sufficient to persuade a court that the commissioner’s determination is incorrect we note that sec_6665 provides that any reference to tax shall be deemed also to refer to penalties however the application of sec_6665 is limited by the language except as otherwise provided in this title considering that limiting language of sec_6665 the reference in sec_7491 to tax_liabilities imposed by subtitle a or b whereas penalties are imposed by subtitle f and the structure of sec_7491 as a whole we believe that congress intended for sec_7491 and not sec_7491 to apply to penalties - having described the framework of sec_7491 we evaluate whether respondent has met his burden of production with regard to the sec_6651 addition_to_tax and the sec_6662 accuracy-related_penalty we also discuss whether petitioners have presented any evidence which would cause us not to sustain respondent’s determinations with regard to the addition_to_tax and the accuracy-related_penalty sec_6651 imposes an addition_to_tax fora taxpayer’s failure_to_file a required return on or before the specified filing_date including extensions the amount of the liability is based upon a percentage of the tax required to be shown on the return see sec_6651 the addition_to_tax 1s inapplicable however if the taxpayer’s failure_to_file the return was due to reasonable_cause and not to willful neglect see sec_665l1 a under sec_7491 as noted above the commissioner bears the burden of production with regard to whether the sec_6651 addition_to_tax is appropriate but he does not bear the burden_of_proof with regard to the reasonable_cause exception of sec_6651 a respondent determined that petitioners are liable fora sec_6651 addition_to_tax with regard to their tax_return the parties have stipulated that petitioners filed their return on date approximately year after it was due ’ accordingly we conclude that respondent has produced sufficient evidence to show that the sec_6651 addition_to_tax 1s appropriate unless petitioners prove that their failure_to_file was due to reasonable_cause petitioners have not provided any evidence indicating that their failure_to_file was due to reasonable_cause therefore an addition_to_tax of percent of the amount_required_to_be_shown_as_tax on the return is sustained in the instant case because the parties have made several concessions respondent’s original sec_6651 addition_to_tax computation must be adjusted to reflect such changes as a final matter we note that there is a discrepancy in the record with regard to petitioners’ amount of withholding see sec_6651 providing that the amount_required_to_be_shown_as_tax on the return for purposes of the sec_6651 addition_to_tax shall be reduced for timely payments or credits allowed to be claimed on the return the parties are asked to consider this discrepancy in their rule_155_computations pursuant to sec_6662 a taxpayer may be liable for a penalty of percent on the portion of an underpayment_of_tax attributable to a substantial_understatement of tax or in addition the tax_return which is part of the record reflects that it was not timely filed petitioners claimed withholding of dollar_figure on their tax_return it appears that respondent did not give credit for such withholding in the notice_of_deficiency - - due to negligence or disregard of rules or regulations see sec_6662 a substantial_understatement of tax is defined as an understatement_of_tax that exceeds the greater of percent of the tax required to be shown on the tax_return or dollar_figure see sec_6662 a the understatement is reduced to the extent that the taxpayer has adequately disclosed his or her position and has a reasonable basis for such position or has substantial_authority for the tax treatment of the item see sec_6662 b in addition sec_6662 defines negligence as any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code and disregard means any careless reckless or intentional disregard whether applied because of a substantial_understatement of tax or negligence or disregard of the rules or regulations the accuracy-related_penalty is not imposed with respect to any portion of the understatement as to which the taxpayer acted with reasonable_cause and in good_faith see sec_6664 the decision as to whether the taxpayer acted with reasonable_cause and in good_faith depends upon all the pertinent facts and circumstances see sec_1_6664-4 income_tax regs relevant factors include the taxpayer's efforts to assess his proper tax_liability including the taxpayer’s reasonable and good_faith reliance on the advice of a professional such as an accountant see id further an honest misunderstanding of fact or law that is reasonable in light of the experience knowledge and education of the taxpayer may indicate reasonable_cause and good_faith see remy v commissioner tcmemo_1997_72 for the tax_year respondent determined that petitioners are liable for an accuracy-related_penalty attributable to a substantial_understatement of tax or in the alternative due to negligence or disregard of rules or regulations petitioners have conceded that they are not entitled to dollar_figure in itemized_deductions relating to nol carryovers dollar_figure and certain taxes dollar_figure claimed on schedule a of their tax_return with regard to respondent’s determination that petitioners were negligent and disregarded rules and regulations respondent argues that he has met his burden of production under sec_7491 through petitioners’ above concessions along with evidence in the record indicating that petitioners were experienced in business affairs further respondent contends that because petitioners have failed to introduce any evidence to indicate that they were not negligent petitioners have failed to meet their burden_of_proof which they retain despite the application of sec_7491 respondent has shown that petitioners have failed to keep adequate books_and_records or to substantiate properly the items in question such a failure in the instant case is evidence of negligence see sec_1_6662-3 income_tax regs consequently we conclude that respondent has met his burden of - - production for his determination of the accuracy-related_penalty based on negligence or disregard of rules or regulations additionally with regard to that determination petitioners have failed to meet their burden of proving that they acted with reasonable_cause and in good_faith we therefore sustain respondent’s determination that petitioners are liable for the accuracy-related_penalty on the underpayment associated with the disallowed itemized_deductions conceded by petitioners ’ in reaching our holdings herein we have considered all arguments made and to the extent not mentioned above we find them to be moot irrelevant or without merit to reflect the foregoing decision will be entered under rule because of respondent’s concessions see supra p we conclude that the accuracy-related_penalty based on a substantial_understatement of tax is not applicable as the understatement does not exceed the greater of percent of tax required to be shown on the return or dollar_figure see sec_6662