internal_revenue_service number release date index number ------------------------------- ----------------------------------- ---------------------------------------------- re ----------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------- id no ------------- telephone number --------------------- refer reply to cc psi plr-135284-15 date date legend decedent spouse date date ------------------------------------------- ----------------------------------------------- ------------------- ----------------------- attorney ---------------------- dear ------------- this letter responds to your personal representative’s letter of date requesting an extension of time pursuant to sec_301_9100-3 of the procedure and administration regulations to make the election under sec_2010 of the internal_revenue_code code portability election to allow a decedent’s surviving_spouse to take into account that decedent’s deceased spousal unused exclusion dsue amount the facts and representations submitted are as follows decedent died on date survived by spouse date is a date after the effective date of the amendment to sec_2010 which provides for portability of a dsue amount to a surviving_spouse to obtain the benefit of portability of decedent’s dsue amount to plr-135284-15 spouse decedent’s estate was required to file form_706 united_states estate and generation-skipping_transfer_tax return on or before the date that is nine months after decedent’s date of death or the last day of the period covered by an extension decedent’s form_706 was due on date but the estate did not file a form_706 to make the portability election spouse relied on attorney to timely file the form_706 and make the portability election attorney failed to timely file the form_706 the estate discovered its failure to elect portability after the due_date for making the election spouse as executor of decedent’s estate and trustee of the living_trust represents that the value of decedent’s gross_estate is less than the basic exclusion amount in the year of the decedent’s death including gifts made during his lifetime as executor spouse requests an extension of time pursuant to sec_301_9100-3 to elect portability of decedent’s dsue amount pursuant to sec_2010 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_2010 provides that a credit of the applicable credit_amount shall be allowed to the estate of every decedent against the tax imposed by sec_2001 sec_2010 provides that the applicable credit_amount is the amount of the tentative_tax that would be determined under sec_2001 if the amount with respect to which such tentative_tax is to be computed were equal to the applicable_exclusion_amount on date congress amended sec_2010 effective for estates of decedents dying and gifts made after date to allow portability of a decedent’s unused applicable_exclusion_amount between spouses tax relief unemployment insurance reauthorization and job creation act of pub_l_no sec_303 124_stat_3296 sec_2010 provides that the applicable_exclusion_amount is the sum of the basic exclusion amount and in the case of a surviving_spouse the dsue amount sec_2010 generally provides that the basic exclusion amount is dollar_figure to be adjusted for inflation annually after calendar_year sec_2010 defines the dsue amount to mean the lesser_of a the basic exclusion amount or b the excess of -- i the applicable_exclusion_amount of the last deceased spouse of the surviving_spouse over ii the amount with respect to which the tentative_tax is determined under sec_2001 on the estate of such deceased spouse plr-135284-15 sec_2010 provides that a dsue amount may not be taken into account by a surviving_spouse under sec_2010 unless the executor of the estate of the deceased spouse files an estate_tax_return on which such amount is computed and makes an election on such return that such amount may be so taken into account the election once made shall be irrevocable no election may be made if such return is filed after the time prescribed by law including extensions for filing such return sec_2010 provides that the secretary shall prescribe regulations as may be necessary or appropriate to implement sec_2010 sec_20_2010-2t a of the estate_tax regulations as in effect on date provides that to allow a decedent’s surviving_spouse to take into account that decedent’s dsue amount the executor of the decedent’s estate must elect portability of the dsue amount on a timely-filed form_706 under sec_20_2010-2t a the due_date of an estate_tax_return required to elect portability is nine months after the decedent’s date of death or the last day of the period covered by an extension if an extension of time for filing has been granted under sec_20_2010-2t a the portability election is made by timely filing a complete and properly prepared estate_tax_return unless the executor satisfies the requirements for the election not to apply in sec_20_2010-2t a i sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 provides that the term statutory election means an election whose due_date is prescribed by statute the term regulatory election means an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute a request for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax plr-135284-15 professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election the due_date for the portability election is prescribed by statute in the case of an estate required to file an estate_tax_return under sec_6018 see sec_2010 sec_6075 and sec_6018 in the case of an estate that is not required to file an estate_tax_return under sec_6018 the due_date is prescribed by regulation see sec_20_2010-2t a see also sec_20_2010-2 and revproc_2014_18 2014_7_irb_513 sec_2 accordingly in the latter case a taxpayer may seek an extension of time to elect portability under the provisions of sec_301_9100-3 sec_6018 requires the filing of an estate_tax_return in all cases where the gross_estate exceeds the basic exclusion amount in effect under sec_2010 for the calendar_year which includes the date of death for purposes of this determination under sec_6018 the basic exclusion amount is reduced but not below zero by the sum of -- a the amount of the adjusted_taxable_gifts within the meaning of sec_2001 made by the decedent after date plus b the aggregate amount allowed as a specific exemption under sec_2521 as in effect before its repeal by the tax reform act of with respect to gifts made by the decedent after date as executor spouse represents that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is not required to file an estate_tax_return under sec_6018 under these facts the commissioner has discretionary authority under sec_301_9100-3 to grant to decedent’s estate an extension of time to elect portability based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly we grant an extension of time of days from the date of this letter in which to elect portability under sec_2010 the election should be made by filing a complete and properly-prepared form_706 and a copy of this letter within days from the date of this letter to the cincinnati service_center at the following address internal_revenue_service cincinnati service_center stop cincinnati oh for purposes of electing portability a form_706 filed by decedent’s estate within days from the date of this letter will be considered to be timely filed 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 if it is later determined that based on the value of the gross_estate and taking into account any taxable_gifts decedent’s estate is required to file an estate_tax_return pursuant to sec_6018 the commissioner is without authority under sec_301_9100-3 to plr-135284-15 grant to decedent’s estate an extension of time to elect portability and the grant of the extension referred to in this letter is deemed null and void 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 your authorized representative sincerely yours associate chief_counsel passthroughs special industries by leslie h finlow leslie h finlow senior technician reviewer branch office of associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes cc


department of the treasury internal_revenue_service washington d c contact person identification_number telephone number employer_identification_number tax_exempt_and_government_entities_division release number release date date date vil legend o i z z i a t o n dear we have considered your request dated date for a ruling with regard to whether income produced by rental and exempt_activities related to your debt-financed_property will be included in the computation of your unrelated_business_income under sec_512 of the internal_revenue_code code b made a charitable_bequest to m an ecumenical ministry that offers a broad range of social service programs to the poor and distressed or underprivileged m consists of several territories including n and you b made the gift to m to construct community centers in underserved urban areas throughout the country that would attend to spiritual and physical needs combat juvenile delinquency and provide opportunities for community building the trust requires m to place one-half of the gift in a capital building fund to purchase real properties and construct furnish and equip the community centers and place the other half in a separate endowment fund to be used for employee salaries and other operating_expenses m plans to divide the gift equally between the territories which will allocate the funds in accordance with the trust provisions before b died she gave funds to n to build a prototype community center n found that the portion of the funds allocated to the endowment fund produced only percent of the revenue necessary to cover its operating costs at this time nis temporarily redirecting other resources to cover the deficit you are concerned that since your allocation of funds will be identical your reserves would also be insufficient to cover the operating costs of your new centers to ensure an adequate level of funding for your new centers’ ongoing operations you plan to finance your centers differently you would issue construction bonds and use the proceeds to purchase investment securities that would comprise a reserve fund capable of generating a significant portion of the income necessary to cover operating costs and to serve as a sinking_fund for retiring the construction bonds you agree that the outstanding bond indebtedness is acquisition_indebtedness as defined in sec_514 of the code you have received your part of the gift and identified several communities that you believe would get the most benefit one center is currently operating and the others are in the planning and construction stages but you expect them to be substantially_similar you intend to e integrate the spiritual ministry with other services provided by the centers e link the centers’ programs to the existing social-service programs that you have established in the communities e provide high-quality personal development opportunities that build character confidence and competence in young people families and individuals in an inclusive manner including opportunities in education recreation and the arts and e ensure that the centers are accessible to and target a population of children families and individuals that are underserved you selected the communities that showed the most need based on the information collected from the local offices of federal state and local governments as to population economic and demographic statistics for example the information you gathered with regard to one community showed that percent of the population lives in poverty about twice the citywide figure residents in this community have twice the citywide rate of public assistance single- parent families and households with children under you base your representations and approximations on the center that is currently operating all of your centers would offer memberships to the public you gathered fee information from the health and fitness centers in the communities and set your annual membership fees at less than percent of the fees charged by the other commercial centers in the neighborhoods your annual fees would include use of all areas of the centers except for classes skating camps and programs you would also offer fees on a sliding scale based on government standards for assistance and scholarships to anyone who demonstrates a financial need if a person is unable to pay but does not qualify for a scholarship you have committed to reduce the fee to an amount that the person can pay you state that you would turn no one away because of inability to pay you state that you would devote percent or more of your property to programs that further exempt purposes for example you would devote percent of your properties to religious and educational programs the faith and family center would include a worship area nursery food pantry and dedicated spaces for senior and youth programs the learning and technology center would offer computer usage classrooms seminar rooms tutoring technology instruction programs literacy instruction ged training vocation-specific programs and creative arts classes finally the visual performing arts theater center would offer public performances in music and dance youth family and community theater music lessons dance programs visual arts and crafts instruction and exhibition you would also use approximately percent of your properties for recreational programs your indoor recreational area would offer a fitness center basketball and sports gymnasium indoor running walking track game room and locker rooms you would offer a general-purpose swimming pool leisure pool for children’s entertainment relaxation fitness and swim instruction and a therapeutic whirlpool for relaxation and rehabilitation outdoor area for outdoor sports recreation and a soccer field softball little league fields grass volleyball court general-purpose recreation fields a skateboarding park outdoor amphitheater children’s playground and horticultural center for family and youth development finally you would provide an your special programs which would comprise percent of your facilities would offer a healthy living center childcare center kitchen library gathering space and emergency disaster services you would use your kitchen to provide free meals every monday through friday to persons who are homeless unemployed or otherwise cannot afford a hot meal you plan to rent space for various purposes you would rent space at cost to clubs community foundations church groups schools and other non-profit organizations and individuals that respond to community needs you estimate that you would rent approximately two percent of floor space and use less than one percent of total open hours for other activities you would not provide any services in connection to your rental income and you do not anticipate using the facility for any long-term rental activities rulings requested provided that substantially_all the use of the centers will be used as described the rental income if any that you derive from the use of the centers will qualify for the exclusion provided by sec_514 the income that you will receive from the various recreational charitable religious and educational activities conducted at the centers as described herein will not constitute income from an unrelated_trade_or_business as defined under sec_513 because those activities are substantially related to your tax-exempt purposes law sec_511 of the internal_revenue_code code imposes a tax on the unrelated_business_taxable_income as defined in sec_512 of organizations described in sec_401 and sec_501 sec_512 of the code states that the term unrelated_business_taxable_income means the gross_income derived by any organization from any unrelated_trade_or_business as defined in sec_513 regularly carried on by it less the deductions allowed by this chapter which are directly connected with the carrying on of such trade_or_business both computed with the modifications provided in subsection b sec_512 of the code states that any rents_from_real_property and incidental related personal_property are not treated as unrelated_business_income unless the real_property is debt-financed under sec_514 sec_513 of the code states in pertinent part that the term unrelated_trade_or_business means in the case of any organization subject_to the tax imposed by sec_511 any trade_or_business the conduct of which is not substantially related to the exercise or performance by such organization of its charitable educational or other purpose or function constituting the basis for its exemption under sec_501 except that such term does not include any trade_or_business which is carried on by the organization primarily for the convenience of its members students patients officers or employees sec_513 of the code states that the term unrelated_trade_or_business includes any activity that is carried on for the production_of_income from the sale_of_goods or the performance of services for purposes of the preceding sentence an activity does not lose identity as a trade_or_business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors which may or may not be related to the exempt purposes of the organization sec_514 of the code states that there shall be included with respect to each debt- financed property as an item_of_gross_income derived from unrelated_trade_or_business an amount which is the same percentage of the total gross_income derived during the taxable_year from or on account of such property as a the average_acquisition_indebtedness for the taxable_year with respect to the property is of b the average amount of the adjusted_basis of such property during the period it is held by the organization during such taxable_year sec_514 of the code states that the term debt-financed_property means any property which is held to produce income and with respect to which there is an acquisition_indebtedness as defined in subsection c at any time during the taxable_year except that such term does not include any property substantially_all the use of which is substantially related aside from the need of the organization for income or funds to the exercise or performance by such organization of its charitable educational or other purpose or function constituting the basis for its exemption under sec_501 sec_514 of the code states that the term acquisition_indebtedness means with respect to any debt-financed_property the unpaid amount of the indebtedness incurred by the organization in acquiring or improving such property the indebtedness incurred before the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement and the indebtedness incurred after the acquisition or improvement of such property if such indebtedness would not have been incurred but for such acquisition or improvement and the incurrence of such indebtedness was reasonably foreseeable at the time of such acquisition or improvement sec_1_501_c_3_-1 of the treasury regulations regulations states that the term charitable is used in sec_501 in its generally accepted legal sense and is therefore not to be construed as limited by the separate enumeration in sec_501 of other tax- exempt purposes which may fall within the broad outlines of charity as developed by judicial decisions such term includes in part relief of the poor and distressed or of the underprivileged advancement of religion advancement of education or science and the promotion of social welfare by organizations designed to accomplish any of the above purposes or to lessen neighborhood tensions or combat community deterioration and juvenile delinquency sec_1_513-1 of the regulations states that gross_income derives from unrelated_trade_or_business within the meaning of sec_513 if the conduct of the trade_or_business which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities which generate the particular income in question - the activities that is of producing or distributing the goods or performing the services involved - and the accomplishment of the organization’s exempt purposes sec_1_513-1 of the regulations provides that trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes other than through the production_of_income and it is substantially related for purposes of sec_513 only if the causal relationship is a substantial one thus for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes whether activities productive of gross_income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved sec_1_513-1 of the regulations states that in determining whether activities contribute importantly to the accomplishment of an exempt_purpose the size and extent of the activities involved must be considered in relation to the nature and extent of the exempt_function which they purport to serve thus where income is realized by an exempt_organization from activities which are in part related to the performance of its exempt functions but which are conducted on a larger scale than is reasonably necessary for performance of such functions the gross_income attributable to that portion of the activities in excess of the needs of exempt functions constitutes gross_income from the conduct of unrelated_trade_or_business such income is not derived from the production or distribution of goods or the performance of services which contribute importantly to the accomplishment of any exempt_purpose of the organization sec_1_513-1 of the regulations states that gross_income derived from charges for the performance of exempt functions does not constitute gross_income from the conduct of unrelated_trade_or_business sec_1_513-1 example of the regulations described an organization that operated a school to train children in the performing arts the organization derived gross_income from admission charges for the performances the student's participation in performances before audiences was an important part of their training since the income realized from the performances derived from activities which contributed importantly to the accomplishment of the organization’s purposes it did not constitute gross_income from unrelated_trade_or_business sec_1_513-1 of the regulations states that a facility necessary to the conduct of exempt functions may also be employed in a commercial endeavor in such cases the mere fact of the use of the asset or facility in exempt functions does not by itself make the income from the commercial endeavor gross_income from unrelated_trade_or_business the test instead is whether the activities productive of the income in question contribute importantly to the accomplishment of exempt purposes sec_1_514_b_-1 of the regulations states that to the extent that the use of any property is substantially related aside from the need of the organization for income or funds or the use it makes of the profits derived to the exercise or the performance by an organization of its charitable educational or other purpose or function constituting its basis for exemption under sec_501 such property shall not be treated as debt-financed_property see sec_1_513-1 for principles applicable in determining whether there is a substantial relationship to the exempt_purpose of the organization sec_1_514_b_-1 of the regulations states that if substantially_all of any property is used in a manner described in subdivision i of this subparagraph such property shall not be treated as debt-financed_property in general the preceding sentence shall apply if percent or more of the use of such property is devoted to the organization’s exempt_purpose the extent to which property is used for an exempt_purpose shall be determined on the basis of all the facts and circumstances these may include where appropriate - a b c a comparison of the portion of time such property is used for exempt purposes with the total time such property is used a comparison of the portion of such property that is used for exempt purposes with the portion of the property that is used for all purposes or both the comparisons described in a and b of this subdivision revrul_59_310 1959_2_cb_146 holds that a nonprofit corporation organized for the purpose of establishing maintaining and operating a public swimming pool playground and other recreational facilities for the children and other residents of a community is exempt from federal_income_tax under sec_501 of the code the organization in question operated in a community consisting principally of low-income groups who are unable to pay the cost of privately sponsored recreation facilities the income derived from charges for admission to the pool was minor in amount revrul_79_360 1979_2_cb_236 held that the operation of a health club by an exempt_organization constituted an unrelated_trade_or_business within the meaning of sec_513 of the code it found that the operation of the health club was separate from and in addition to the organization's genera physical fitness program and also that the commercially comparable annual dues or fees charged for the health club memberships and for use of the health club facilities were sufficiently high to restrict use of health club facilities to a limited number of members of the community in isabel 21_tc_55 the tax_court held that providing convenient swimming and recreation facilities for all persons residing in the particular school district and especially those who could not afford to acquire and maintain such facilities was charitable as defined under sec_501 since it promoted the social welfare of the community analysis you requested rulings with regard to whether activities associated with the community centers that you plan to acquire with construction bond proceeds will produce unrelated_business_taxable_income ubit as defined in sec_512 of the internal_revenue_code code generally income produced by debt-financed_property is treated as ubit unless substantially_all of its use is substantially related to exempt purposes the information that you provided including the careful placement and promotion of your new facilities types of facilities services and programs offered and the manner in which you plan to operate clearly show that your community centers would further your exempt purposes and benefit a significant segment of the communities since substantially_all of the use of your property is substantially related to your exempt purposes your community centers will not be treated as debt-financed_property within the meaning of sec_514 you state that you are exempt from federal tax because you further a religious purpose sec_1_501_c_3_-1 of the regulations states that the term charitable is used in sec_501 of the code in its generally accepted legal sense it is therefore not to be construed as limited by the separate enumeration in sec_501 of other tax-exempt purposes which may fall within the broad outlines of charity as developed by judicial decisions in the general law of charity the promotion of the happiness and enjoyment of the members of the community is also a charitable purpose some of these trusts can be supported on the ground that they tend to promote the health of the community or involve a form of education but it is sufficient that they promote the general happiness of the community restatement second of trusts sec_374 iv a scott the law of trusts section dollar_figure 3d ed the principles set forth in sec_1_513-1 of the regulations apply in determining whether the operation of your community centers has a substantial relationship to your exempt_purpose see sec_1_514_b_-1 of the regulations in the statutory sense the relationship must be a causal and a substantial one purpose the activities conducted by your community centers must contribute importantly to the achievement of your exempt purposes sec_1_513-1 of the regulations by placing your new centers in communities where more households operate at or below the poverty level in other words to be substantially related to an exempt and have children under the age of you would provide relief to the poor or the underprivileged and combat community deterioration you have taken steps to make sure that all income levels within the community would be aware of and make use of the programs you would offer you would make centers even more accessible by linking the programs to the existing social-service programs that you have already established in the communities many of the programs that you plan to offer including the faith and family learning and technology and visual theater art as well as disaster relief and library services would contribute importantly to the accomplishment of your educational religious and other charitable purposes the term unrelated_trade_or_business essentially means any trade_or_business that is not substantially related aside from the need of the organization for income or funds to an organization’s exempt_purpose generally income from the performance of exempt functions does not constitute gross_income from the conduct of an unrelated_trade_or_business see sec_1_513-1 example of the regulations a facility that is necessary to the conduct of exempt functions may be employed in a commercial endeavor if the activities that produce the income in question contribute importantly to the accomplishment of exempt purposes see sec_1_513-1 of the regulations for example you would devote percent of your facilities to religious and educational programs and percent to special programs both of which contribute importantly to the accomplishment of your exempt purposes therefore any income produced by most of the activities you conduct within these programs would not be ubit however income from one particular activity may be deemed unrelated even where the activity is an integral part of a larger activity that is in furtherance of an exempt_purpose necessary to examine more closely the types of activities you would conduct in your centers to determine whether they contribute substantially to the accomplishment of your exempt purposes sec_513 of the code and d of the regulations therefore it is you plan to use percent of your facilities to offer general aquatic and outdoor recreation programs to your members business income generated by recreational facilities can be exempt from unrelated taxable business income under sec_5171 if the facilities benefit a significant segment of the population see revrul_79_360 supra an exempt_organization can demonstrate that it provides a significant benefit by setting its membership fees so that they are affordable to a broad segment of the community you plan to place your centers in areas that are underserved for example you would place one center in an area where percent of the population lives in poverty further you plan to charge fees that local residents can afford you would charge annual fees at rates that are less than percent of the fees charged by other local commercial centers you state that your centers would turn no one away because of inability to pay your annual fees include use of all areas of the center except for classes skating camps and programs you would offer fees on a sliding scale based on government standards for assistance and scholarships to anyone who demonstrates financial need ifa person is unable to pay but does not qualify for a scholarship you have committed to reduce the fee to an amount that the person can pay as the tax_court determined in isabel peters supra and as the service recognized in revrul_59_310 supra providing recreational facilities can be charitable provided the facilities are available to the general community since you would encourage the public to participate in general aquatic and outdoor recreation at your centers and you would set affordable fees and turn no one away because of an inability to pay your centers would benefit a significant segment of the community and the membership fees generated by your centers would not be ubit you plan to rent space in your centers generally sec_512 of the code excludes rental income from the definition of unrelated_business_taxable_income however if the rent-producing property is debt financed the rental income may be included as an item_of_gross_income from an unrelated_trade_or_business unless the rental_activity is substantially related to your exempt_purpose you state that your centers would be debt-financed within the meaning of sec_514 of the regulations however the regulations exclude property from the term debt- financed if percent or more of the use of such property is devoted to the organization's exempt_purpose sec_1_514_b_-1 of the regulations the extent to which you use your property for a particular purpose is a determination that is based on all the facts and circumstances that determination may include a comparison of the portion of the time that you use the property for exempt purposes with the total time you use such property a comparison of the portion of the property that you use for exempt purposes with the portion of the property that you use for all purposes or both you stated that you would devote percent or more of your property to activities that further religious charitable and educational_purposes you supported that statement with estimates of the portion of your total property that you would use for each activity that furthers your exempt purposes which totals more than percent your religious and educational programs percent recreational programs percent and special programs percent all further your exempt purposes by enhancing your social services and improving the overall positive impact your centers will have on the community the remaining percent of your property that you use for other purposes would not produce ubit because the percent rule prevails accordingly your property is not debt-financed because substantially_all of your community center activities would be substantially related to your exempt purposes under sec_513 and sec_514 of the code and sec_1_513-1 of the regulations and the income generated by those activities including income from short-term rentals would be exempt from unrelated taxable business income summary your property is excluded from the definition of debt-financed_property because substantially_all of its use would be substantially related to the exercise or performance of the exempt purposes that constitute the basis of your exemption this conclusion is supported by your representation that you would devote percent or more of your properties to activities that further exempt purposes supplemented by detailed descriptions of the use of your property the rental income from the use of your facilities will be minimal certainly less than percent and thus qualifies for the exclusion from the definition of debt-financed_property provided by sec_514 and explained in sec_1_514_b_-1 of the regulations further provided that your activities continue to contribute importantly to your exempt_purpose your membership fees and the revenue that you generate from the operation of your other facilities is not unrelated_business_taxable_income based on the foregoing we rule as requested as follows provided that substantially_all the use of the centers will be used as described the rental income if any that you derive from the use of the centers will qualify for the exclusion provided by sec_514 the income that you will receive from the various recreational charitable religious and educational activities conducted at the centers as described herein will not constitute income from an unrelated_trade_or_business as defined under sec_513 because those activities are substantially related to your tax-exempt purposes this ruling will be made available for public inspection under sec_6110 of the code after certain deletions of identifying information are made for details see enclosed notice notice of intention to disclose a copy of this ruling with deletions that we intend to make available for public inspection is attached to notice if you disagree with our proposed deletions you should follow the instructions in notice this ruling is directed only to the organization that requested it sec_6110 of the code provides that it may not be used or cited by others as precedent this ruling is based on the facts as they were presented and on the understanding that there will be no material changes in these facts this ruling does not address the applicability of any section of the code or regulations to the facts submitted other than with respect to the sections described because it could help resolved questions concerning your federal_income_tax status this ruling should be kept in your permanent records if you have any questions about this ruling please contact the person whose name and telephone number are shown in the heading of this letter in accordance with the power_of_attorney currently on file with the internal_revenue_service we are sending a copy of this letter to your authorized representative sincerely ron shoemaker manager exempt_organizations technical group enclosure notice


t c summary opinion united_states tax_court james j mccarron iii and michelle mccarron petitioners v commissioner of internal revenue respondent docket no 8383-00s filed date james j mccarron iii pro_se richard a stone for respondent dean special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time that the petition was filed unless otherwise indicated subsequent 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 the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority respondent determined deficiencies in petitioners' federal income taxes additions to tax for failure_to_file and accuracy- related penalties as follows year deficiency dollar_figure big_number big_number addition_to_tax sec_6651 penalty sec_6662 dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure the issues for decision are l whether petitioners received unreported income during and whether petitioners are entitled to deductions on schedule a itemized_deductions and deductions on schedule c profit or loss from business for and in excess of those allowed by respondent whether petitioners are entitled to earned_income credits for and whether petitioners are liable for additions to tax for and for failure_to_file timely returns and whether petitioners are liable for accuracy-related_penalties for and background the stipulation of facts and the exhibits received into evidence are incorporated herein by reference petitioners resided in silver spring maryland at the time the petition was filed 1the amounts of any liabilities for and deductions of self- employment_taxes depend on the resolution of the other issues in this case at trial respondent moved to dismiss the case as to petitioner michelle mccarron for failure to prosecute mrs mccarron did not sign the stipulation of facts or appear at the trial on her own behalf the court will grant respondent's motion to dismiss mrs mccarron for lack of prosecution the court will enter a decision in this case in an amount that will apply to both mr and mrs mccarron see 64_tc_651 affd 566_f2d_2 6th cir mr mccarron was a tax_return_preparer and stockbroker during the years in issue mrs mccarron did temporary work during through and was a horse riding instructor during petitioners failed to file timely their tax returns for and as a result those tax years were selected for examination as part of the nonfiler initiative pertaining to tax_return_preparers the examination revealed petitioners had unreported income of dollar_figure in dollar_figure in and dollar_figure in in those years petitioners also had unexplained bank_deposits of dollar_figure dollar_figure and dollar_figure respectively the examination of the returns at issue here for and commenced as a continuation of the earlier examination petitioners filed delinquent income_tax returns for and the return was filed on date and the return was filed on date petitioners' return was timely filed attached to each return was a schedule a and schedules c petitioners reported adjusted_gross_income of dollar_figure dollar_figure and dollar_figure for and respectively a examination of petitioners' tax returns in a letter dated date petitioners were informed that respondent was proceeding with the examination of their tax_year for which a return had not yet been filed additionally the examination had been expanded to include the form sec_1040 individual_income_tax_return they filed for and forms information_document_request idrs were enclosed with the letter because of the audit results of petitioners' prior years unreported income and the lack of substantiation of business deductions were significant areas of inquiry mr mccarron petitioner met with respondent on date and presented an original delinquent_return for for filing petitioner did not have any documentation used in sec_7491 which shifts the burden_of_proof to the secretary in certain circumstances is inapplicable to this case see 118_tc_579 n sec_7491 is effective for court proceedings arising in connection with examinations commencing after date affd 80_fedappx_16 9th cir calculating the income and deductions shown on the return or any of the information requested in the idrs petitioners also failed to provide information for their or return respondent issued a notice_of_deficiency for and in which various adjustments were made to petitioners' income and deductions and additions to tax and penalties were determined b petitioners' income petitioners held bank accounts at sandy spring national bank sandy spring during through and at john hanson savings bank john hanson during and respondent conducted a bank_deposits analysis to determine the amount of fees petitioner received in connection with his schedule c business as a tax_return_preparer which checks petitioner received in connection with his schedule c business activities as a stockbroker and the identity of other unexplained deposits using the internal revenue service's irs return preparer listing information database respondent compiled a report of the individual income_tax returns bearing petitioner's social_security_number and identifying him as the paid return preparer during the years in issue the database revealed that petitioner prepared individual returns in each year as follows return sec_139 returns returns petitioner gave respondent information indicating that he had prepared returns as follows return sec_76 return sec_66 returns respondent compared the irs database listing to the corresponding deposits of fees into petitioners' bank accounts and identified an additional returns prepared by petitioner in alone ten of those returns were business returns which would not have appeared in the irs database for tax_year at least returns and their related preparation fees were not identified as having been deposited in whole or in part respondent determined petitioners had omitted gross_receipts received from petitioner's schedule c tax_return preparation business of dollar_figure for dollar_figure for and dollar_figure for after reducing total unexplained bank_deposits by unreported fees identified by respondent as well as income reported on forms w-2 wage and tax statement and forms 1099-misc miscellaneous income respondent's analysis determined petitioners had remaining unexplained bank_deposits as follows dollar_figure big_number big_number petitioner failed to provide any documentation proving that these deposits were from nontaxable sources during and petitioner also worked for mr ragnar sundstrom preparing tax returns mr sundstrom filed forms misc for payments he made to petitioner for services rendered during petitioner received two additional checks from mr sundstrom totaling dollar_figure check no for dollar_figure and check no for dollar_figure the sundstrom payments the notation on check no states friendship the notation on check no states bal of friendship payment petitioner contends the sundstrom payments were loans but he never gave respondent any evidence or documentation to support his claim further petitioner did not take any_action to produce mr sundstrom to testify about the nature of the payments c petitioners' deductions and credits petitioners claimed itemized_deductions as follows real_estate_taxes home mortgage interest cash charitable_contributions noncash charitable_contributions total dollar_figure big_number -0- big_number dollar_figure big_number -0- big_number dollar_figure big_number big_number respondent limited petitioners deductions for cash charitable_contributions to those amounts evidenced by canceled checks as follows dollar_figure for the dollar_figure noncash charitable_contribution claimed on their return petitioners submitted documentation consisting of a salvation army receipt for one refrigerator and four bags of clothes petitioners attributed a value of dollar_figure to the total contribution respondent reduced the value of the contribution to dollar_figure dollar_figure for the refrigerator and dollar_figure for each bag of clothes the reduction of the charitable_contribution_deduction for reduced petitioners' total itemized_deductions to dollar_figure the standard_deduction for joint filers in was dollar_figure respondent applied the higher amount of the standard_deduction in calculating the tax due for additionally petitioners claimed various deductions on their and schedules c for their tax preparation stock brokerage and horse riding instruction activities respondent allowed deductions for the business_expenses that were sufficiently documented by canceled checks respondent disallowed many of the deductions including a dollar_figure deduction for self-employment health insurance because petitioners failed to substantiate them and failed to establish that the amounts were expended for a business_purpose petitioners knew respondent had questioned their documentation of expenses in prior years here petitioners failed to respond to documentation requests via the idrs and did not present any evidence at trial to demonstrate their entitlement to additional deductions on their returns for each of the years in issue petitioners also claimed earned_income credits for their two children of dollar_figure in dollar_figure in and dollar_figure in respondent determined petitioners were not eligible to claim these credits and petitioners knew respondent had denied their claimed earned_income credits in prior years d additions to tax and penalties respondent determined that petitioners are liable for additions to tax under sec_6651 for failure_to_file timely their tax returns for and for each of the years in issue respondent also determined that petitioners are liable for an accuracy-related_penalty under sec_6662 discussion respondent's determinations in the notice_of_deficiency are presumed correct and generally petitioners bear the burden of proving that respondent's determination of income_tax deficiencies is incorrect see 290_us_111 a petitioners' income it is a taxpayer's responsibility to maintain adequate books_and_records sufficient to establish his or her income see sec_6001 96_tc_858 affd 959_f2d_16 2d cir when a taxpayer fails to maintain adequate_records the commissioner may determine income under the bank_deposits method dileo v commissioner supra pincite a bank deposit is prima facie evidence of income id pincite 87_tc_74 estate of mason v commissioner t c pincite see also 132_f2d_775 2d cir affg 45_bta_104 the bank_deposits method of reconstruction assumes that all money deposited into a taxpayer's account is taxable as income unless the taxpayer can show a nontaxable source for the income see 335_f2d_671 5th cir dileo v commissioner supra pincite the use of the bank_deposits method for computing income has long been sanctioned by the courts dileo v commissioner supra pincite estate of mason v commissioner supra pincite the fact that the commissioner was not completely correct does not invalidate the method employed 380_f2d_494 5th cir affg in part and revg in part tcmemo_1964_302 175_f2d_500 2d cir affg 7_tc_245 thus petitioners not respondent bear the burden of proving that respondent's determination of underreported income computed using the bank_deposits method of reconstructing income is incorrect 94_tc_654 70_tc_1057 petitioner gave respondent incomplete information regarding his return preparation income and failed to deposit all the fees he received petitioner also failed to call mr sundstrom a witness he claimed could corroborate that certain deposits were loan proceeds given the importance of mr sundstrom in substantiating this purported loan the court assumes from his absence that his testimony would not have corroborated petitioner's testimony 925_f2d_180 7th cir affg tcmemo_1989_393 see also 6_tc_1158 holding that if a party having the burden_of_proof fails to call a witness who is available to testify and that witness could corroborate the taxpayer's testimony the taxpayer's failure to do so creates a presumption that the witness's testimony would have been unfavorable affd 162_f2d_513 10th cir the court holds that respondent’s determination of additional income in the amounts set forth in the notice_of_deficiency is sustained b petitioners' deduction sec_1 schedule c and schedule a deductions sec_162 allows a taxpayer deductions for ordinary and necessary business_expenses incurred during the taxable_year in carrying_on_a_trade_or_business deductions however are a matter of legislative grace and the taxpayer bears the burden of proving the entitlement to any deductions claimed see 503_us_79 512_f2d_882 9th cir affg tcmemo_1972_133 generally a taxpayer must establish that deductions taken pursuant to sec_162 are ordinary and necessary business_expenses and must maintain records sufficient to substantiate the amounts of the deductions claimed sec_1_6001-1 income_tax regs under sec_6001 petitioner bears the sole responsibility for maintaining his business records if a claimed business_expense is deductible but the taxpayer is unable to substantiate it the court is permitted to make as close an approximation as it can bearing heavily against the taxpayer whose inexactitude is of his or her own making 39_f2d_540 2d cir the estimate however must have a reasonable evidentiary basis 85_tc_731 with respect to certain business_expenses sec_274 supersedes the cohan doctrine see sec_1_274-5t temporary income_tax regs fed reg date applying more stringent substantiation requirements sec_274 disallows deductions for traveling expenses gifts and meals and entertainment as well as for listed_property unless the taxpayer substantiates by adequate_records or by sufficient evidence corroborating the taxpayer's own statement the amount of the expense the time and place of the expense the business_purpose of the expense and the business relationship to the taxpayer of the persons involved in the expense petitioners' charitable_contribution deductions are governed by sec_170 sec_170 allows a deduction for any charitable_contribution to or for_the_use_of an organization described in sec_170 payment of which is made during the taxable_year and verified under regulations prescribed by the secretary in general the amount of a charitable_contribution made in property other than money is the fair_market_value of the donated property at the time of the contribution 109_tc_258 affd without published opinion 166_f3d_332 4th cir sec_1_170a-1 income_tax regs to be eligible for a charitable_contribution_deduction for property petitioners must among other requirements establish the fair_market_value of the property at the time of the contribution and show the method they used to estimate the value see jennings v commissioner tcmemo_2000_366 affd 19_fedappx_351 6th cir sec_1_170a-13 income_tax regs petitioners attached a form provided by the salvation army upon which petitioners had written the amount of dollar_figure they presented no detailed information regarding the property its cost or the manner in which the dollar_figure amount claimed as a deduction was determined respondent disallowed all or part of petitioners' schedule c and schedule a deductions as well as their above-the-line deduction for self-employment health insurance because of lack of substantiation petitioners did not keep books_and_records which would support an allowance of deductions in excess of the amounts respondent has already allowed and they did not produce any documentary_evidence at trial the only available evidence as to any of petitioners' expenses in excess of those documented by canceled checks is petitioner's own self-serving testimony which we are not required to accept and which we do not in fact find to be credible see 99_tc_202 in view of their failure to substantiate the court holds that petitioners are not entitled to deductions in excess of the amounts allowed by respondent in the notice_of_deficiency respondent's determinations are sustained since the remaining itemized_deductions respondent allowed for tax_year were less than the standard_deduction for that year respondent allowed petitioners the higher amount of the standard_deduction see 71_tc_633 respondent's determination is sustained earned_income_credit sec_32 allows an eligible_individual an earned_income_credit against the individual’s income_tax_liability however sec_32 limits the amount of credit allowable sec_32 specifies the amounts of adjusted_gross_income at which the earned_income_credit is phased out and the taxpayer is no longer eligible for the credit in the case of an eligible_individual with two qualifying children the phaseout amounts are dollar_figure for revproc_92_102 1992_2_cb_579 dollar_figure for sec_32 and dollar_figure for revproc_94_72 1994_2_cb_811 the court has sustained respondent's determinations that petitioners had additional income in the amounts set forth in the notice_of_deficiency the result is that petitioners' adjusted_gross_income for and increased by dollar_figure dollar_figure and dollar_figure respectively these adjusted_gross_income amounts exceed the earned_income_credit phaseout amounts the court holds therefore that petitioners are not entitled to earned_income credits for and c additions to tax and penaltie sec_1 addition_to_tax under sec_6651 sec_6651 imposes an addition_to_tax for failure_to_file a timely tax_return the addition_to_tax is equal to percent of the amount of the tax required to be shown on the return if the failure_to_file is not for more than month id an additional percent is imposed for each month or fraction thereof in which the failure_to_file continues to a maximum of percent of the tax id the addition_to_tax is imposed on the net amount due sec_6651 the addition_to_tax is applicable unless a taxpayer establishes that the failure_to_file was due to reasonable_cause and not willful neglect sec_6651 if a taxpayer exercised ordinary business care and prudence and was nonetheless unable to file the return by the date prescribed by law then reasonable_cause exists sec_301_6651-1 proced admin regs to prove reasonable_cause a taxpayer must show that he exercised ordinary business care and prudence but nevertheless could not file the return when it was due see 92_tc_899 sec_301_6651-1 proced admin regs willful neglect means a conscious intentional failure_to_file or reckless indifference 469_us_241 petitioners failed to offer any evidence that their failure to timely file their and tax returns was due to reasonable_cause and not willful neglect in fact petitioners offered no explanation at all this is particularly troubling given that petitioner is a tax_return_preparer the court sustains respondent's determination that petitioners are liable for the additions to tax under sec_6651 accuracy-related_penalty under sec_6662 respondent also determined petitioners are liable for an accuracy-related_penalty pursuant to sec_6662 for each of the years in issue sec_6662 imposes a penalty of percent of the portion of the underpayment which is attributable to inter alia negligence or disregard of rules or regulations sec_6662 negligence is the 'lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances ' 85_tc_934 quoting marcello v commissioner f 2d pincite it includes any failure by the taxpayer to keep adequate books_and_records or to substantiate items properly sec_1_6662-3 income_tax regs the term disregard includes any careless reckless or intentional disregard sec_6662 no penalty shall be imposed if it is shown that there was reasonable_cause for the underpayment and the taxpayer acted in good_faith with respect to the underpayment sec_6664 the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all pertinent facts and circumstances the most important factor is the extent of the taxpayer's effort to assess the taxpayer's proper tax_liability circumstances that may indicate reasonable_cause and good_faith include an honest misunderstanding of fact or law that is reasonable in light of the experience knowledge and education of the taxpayer sec_1_6664-4 income_tax regs emphasis added see 296_f3d_607 7th cir affg tcmemo_2000_20 this subjective analysis operates in effect to hold knowledgeable tax professionals to a higher standard of care than a regular taxpayer see reynolds v commissioner supra pincite experience knowledge and education proviso was fatal to taxpayer who was attorney c p a and irs audit supervisor knoll v commissioner tcmemo_2003_277 lawyer experienced in tax-advantaged financing liable for accuracy-related_penalty for negotiating and structuring settlement agreement to secure tax advantages valid in form but lacking substance mitchell v commissioner tcmemo_2001_269 lawyer-accountant held liable for accuracy-related_penalty for deducting farm_losses with no credible plan to make profit emerson v commissioner tcmemo_2001_186 lawyer liable for accuracy-related_penalty for failing to keep adequate_records required by sec_6001 petitioner has been a tax_return_preparer since at least between and he prepared at least tax returns and was paid for his services given petitioner's experience in preparing tax returns and his knowledge that petitioners were previously held liable for omitting income and failing to substantiate expenses this court concludes that he failed to act with reasonable_cause and in good_faith in determining his tax_liability see wilkerson v commissioner tcmemo_1998_68 c p a and wife experienced return preparers who failed to report fees and other income were held liable for negligence_penalty the court holds that petitioners are liable for the accuracy-related_penalties under sec_6662 reviewed and adopted as the report of the small_tax_case division to reflect the foregoing an order of dismissal will be entered as to petitioner michelle mccarron and decision will be entered under rule


internal_revenue_service number release date date cc dom fs corp tl-n-1512-97 uilc internal_revenue_service national_office field_service_advice memorandum for district_counsel cc attn from deborah a butler assistant chief_counsel field service cc dom fs subject substance over form characterization of a transaction this field_service_advice responds to your memorandum 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 p s pb b b date c date d date e date f date g x amount issue whether s's alleged sales of the distributed assets to p are in substance dividend distributions to p conclusion s's alleged sales of the distributed assets to p are in substance dividend distributions to p facts background this case involves a transaction in which p may attempt to effectively claim the losses on the sales of the distributed assets twice once in selling the s stock since p's stock basis in s would not be reduced by the losses on the sales of the distributed assets and a second time in later selling the distributed assets since sec_267 provided that when p sold s outside the group p increased its basis in the distributed assets by the amount of the losses that s recognized on s's sale of the distributed assets to p facts --in general p the parent_corporation of a consolidated_group wholly-owned a subsidiary s pb a corporation unrelated to p wanted to acquire s but objected to purchasing certain unwanted assets held by s and its subsidiaries distributed assets s was engaged in the b business and certain state regulatory rules required s to maintain certain surplus balances these state regulatory rules which restricted s's ability to make distributions precluded s from making an outright distribution of the distributed assets to p p pb and b reached an agreement on date f for p to sell to b a subsidiary of pb its stock in s -- without the distributed assets -- with economic_effect as of date e this stock purchase agreement between p pb and b contemplated that s and its subsidiaries hereinafter referred to as just s were to sell the distributed assets before date c and p was to sell b its stock in s on date d while the agreement actually provided that p was to either sell the distributed assets or transfer the distributed assets not only did state regulatory rules restrict s's ability to distribute the distributed assets as previously indicated but the sales agreement to sell the s stock also provided that s could not distribute amounts that s received in selling the distributed assets to p the sales agreement also required s to have the permission of pb to pay a distribution and indicated that s could not make a distribution to the extent it could lower s's bests' ratings p pb and b structured the deal by agreeing to a base purchase_price for the s stock this base purchase_price reflected the value of the s stock without the distributed assets p pb and b then agreed to further increase this base purchase_price by amounts arising from s's sale rather than 1we express no opinion on any_tax consequences of the sale involving code sections under the jurisdiction of cc intl distribution of the distributed assets excess purchase_price or excess purchase_price amount in form s was to sell these distributed assets to p and consequently s was to hold the cash proceeds from these sales of the distributed assets which were to then factor into the amount of the excess purchase_price that b would pay to s or in other words b would pay an excess purchase_price to essentially purchase the cash proceeds that s received from p in selling the distributed assets to p b also agreed to pay p interest on these cash proceeds held by s the parties structured the deal so that the overall economic_effect of the deal was that the distributed assets were distributed to the seller as of date e and b purchased p's stock in s for the base purchase_price as of date e although s was to sell the distributed assets s and b essentially planned the transaction to effect the same economic result as one in which s instead distributed the distributed assets the p group acknowledged this in a proxy statement stating the transaction has approximately the same economic_effect as a transfer of the distributed assets without the payment of any consideration followed by a sale of the stock in s for the base purchase_price although in the transaction s was to sell the distributed assets to p p did not have sufficient cash to purchase the distributed assets consequently p negotiated short-term loans on date g to make the purchases according to the credit agreement for these loans p received the loans on the condition that p use the loan proceeds solely to acquire the distributed assets or to refinance certain distributed assets purchased and to repay these loans on the date on which s was sold to b the credit agreement also required s to retain liquid_assets equal to the outstanding debt balance p could have issued notes to s to purchase the distributed assets but p would have had to pay off these notes when p sold the s stock to b by offsetting the amount of the notes against the amount of the sales proceeds ie with the result that b would pay less than the full amount of the sales proceeds between date f and date d s sold distributed assets having a value of x to p the sales of the distributed assets would not have occurred but for the agreement for the sale of p's stock in s to b p also requested permission from the state to resell the distributed assets to s in the event the sale to b was not consummated you conclude that s in substance distributed the distributed assets from s to p we agree with this conclusion law analysis where the substance of a transaction does not coincide with the form chosen by the parties the transaction should be taxed in accordance with its substance 293_us_465 the substance over form inquiry involves determining whether the labels of a transaction match the economic_substance of the transaction as a whole 104_tc_75 the meaning of a transaction may be more than its separate parts and the transaction must be viewed in light of the setting they occur and collectively create gregory v commissioner 69_f2d_809 2d cir aff'd u c a transaction can be recharacterized where the form of the transaction does not match its substance and does not reflect the real rights and obligations of the parties see 88_tc_906 the form of the transaction in the instant case is a sale by s to p of the distributed assets for cash and a sale by p of its stock in s which held the cash received from p on s's sale of the distributed assets however the transaction's form does not match its substance in substance s distributed the distributed assets to p b acquired the s stock for the base purchase_price and b contributed cash to s in an amount equal to excess purchase_price in substance pb or b or both depending on the extent to which the cash originated in either party procured the bank debt b then provided funds to p to repay the debt for it b also paid interest to p to reimburse p for_the_use_of the funds in essence p was essentially used as a conduit of pb or b or both to first take out the debt and to then repay that debt p did not bear the obligations -- nor obtain the rights -- with respect to the debt the credit agreement required p to use the debt proceeds to purchase the distributed assets and to immediately repay the debt amounts from the sales proceeds received from b in addition s was required to hold liquid_assets equal to the debt balance further b reimbursed p for the interest amounts on s's holding of the debt proceeds moreover given its transitory nature the bank debt was arguably illusory additionally even from the creditor's perspective the bank arguably did not bear a creditor's risk on the debt because debt proceed amounts were essentially wired to first flow out to p and to later come back from p specifically p paid the debt proceed amounts to s which was then required to hold the debt proceed amounts until p transferred them from its control to b's control at which time b was required to simultaneously pay amounts to p for indirectly purchasing these debt proceed amounts and p in turn was required to then immediately pay off the bank debt from these amounts received from b however irrespective of whether this transitory debt should not be respected and should therefore be treated as nonexistent or should instead be treated as debt of pb or b or both for which p acted as a conduit p brought no cash to the transaction in substance p did not obtain the debt proceeds and p paid no consideration to s for s's transfer of the distributed assets to it in substance s distributed the distributed assets to p see 77_tc_1221 99_tc_561 in addition b paid to p only the base purchase_price for the s stock the excess purchase_price amount that b purportedly paid to p was in substance an amount that b contributed to s this characterization of the transaction is logical if this transaction were instead viewed as if the amount of the excess purchase_price ended up in s by some route other than a capital_contribution by b the transaction might instead be viewed as if b transferred cash to p for p to purchase the distributed assets and then p sold s to b this latter characterization is not only illogical but also begs the question of why b transferred cash to p in the first place additionally under this scenario b would essentially be viewed as having transferred cash over to p to just turn around and buy back this cash when p sold its s stock to b this latter characterization must fail in favor of the logical characterization that the excess purchase_price amount ended up in s as a capital_contribution by b of that cash whether that cash first originated in pb or originated in b 624_f2d_1328 5th cir affirming ustc n d tex supports respecting the substance of this transaction as one in which s distributed the distributed assets to p and b contributed cash to s tsn liquidating is a case that concerns the substance of a transaction in particular the substance of a distribution on stock the transaction in that case involved in form a pre-sale distribution of securities from a corporation to be sold and then a buyer capital_contribution to that corporation of a different kind of securities the tsn liquidating court found that the substance of that transaction coincided with its form 2to the extent the cash originated in pb pb first contributed the cash to b which then contributed the cash to s in tsn liquidatinq community life_insurance_company community a financial company was sold to union mutual_life_insurance_company union mutual as a major part of its investment portfolio community held very speculative securities union mutual did not want to own these speculative securities in fact it viewed such ownership as inappropriate for an insurance_company however state regulators warned union mutual that it would not allow the sale if there was any significant corporate_contraction in assets of community under the final plan of sale community distributed the securities to its shareholder tsn shortly before the sale union mutual purchased community for a price which excluded the amount of the distribution and immediately replaced the value of the speculative securities with investment grade securities of the same value the government argued that the distribution to tsn actually represented part of the acquisition proceeds citing 430_f2d_1185 5th cir cert_denied 401_us_939 the court rejected the government's argument the court held that the distributed assets were speculative high risk securities which union mutual clearly had not negotiated to purchase thus it was improper to view these assets as acquisition assets rather they were distributed directly from the target_corporation moreover even though the securities which union mutual reinfused were of the same value as the assets distributed they were different assets in_kind and appropriately these securities were viewed as a capital_contribution the court in tsn liquidating distinguished the waterman situation where the target shareholder received cash while the taxpayer paid cash as well tsn liquidatinq defines the substance of a distribution on stock its rationale supports respecting s's distribution of the distributed assets as a distribution and b's contribution of cash to s as a capital_contribution the tsn liquidatinq court found that the substance of the transaction was a pre- sale distribution of assets of the corporation coupled with a capital_contribution by the purchaser to the corporation the court found the pre-sale securities distributed were different in_kind than the securities contributed by the purchaser 3in waterman steamship p negotiated to buy t for dollar_figure a corporate shareholder x held the stock of t with a basis of dollar_figure x and t filed consolidated_returns p and x renegotiated the deal such that t paid dividends to x in the amount of dollar_figure payable in days x agreed to sell all of the stock of t for dollar_figure t borrowed the money from p and paid off the dividends the same day as the sale in the instant case the distributed assets that s distributed to p were also different in_kind from the cash that b infused into s as a result tsn liquidating supports respecting the substance of this transaction as one in which s distributed distributed assets to p and b contributed cash to s this is not the form of the transaction but it is the substance of the transaction the court should respect the substance of the transaction and treat b as having bought s for only the base purchase_price and having made a cash capital_contribution to s in an amount equal to the excess purchase_price the instant case is not unlike various other substance over form cases involving conduits such as 927_f2d_1517 10th cir aff'g 720_fsupp_887 d kan and 46_tc_32 in associated wholesale grocers the court recharacterized the following two transactions as a complete_liquidation of the target_corporation into its parent the purported merger of the target_corporation into a second corporation where but for the court's recharacterization the parent of the target_corporation would have recognized the loss inherent in the parent's stock in the target_corporation followed by the second corporation's immediate transfer back by sale of most of the assets that the second corporation just acquired in the merger transaction to the parent of the target_corporation in that case parent owned of target and transferred back to the second corporation the consideration that the second corporation paid for those assets in the merger transaction the tenth circuit held that in substance the transaction constituted a complete_liquidation of the target_corporation the court which viewed the merger and sale transactions as planned by the parties in an attempt to permit the parent of the target_corporation to recognize the tax loss inherent in the parent's stock in the target_corporation was mindful that if the target_corporation had liquidated and transferred its assets directly to the parent the transaction would have constituted a sec_332 transaction that would have precluded any recognition of the loss the court in recharacterizing the transaction as a complete_liquidation disregarded the the tenth circuit inconsistently suggests that the loss at issue was a loss on the target corporation's assets rather than a loss on the parent's stock in the target_corporation see eg f 2d pincite however it appears that the loss at issue was a loss on the parent's stock in the target_corporation see f 2d pincite n 720_fsupp_887 however this is not totally clear from reading the case circuitous routing of the target corporation's assets to the second corporation in the merger transaction and then back to the parent in the sale transaction a second case that looks to the substance rather than the form of a transaction is west coast marketing in west coast marketing the court held that a transaction was in substance an exchange of an interest in land for stock in the corporation that acquired the land acquiring_corporation and ignored the intermediate steps structured by the parties to avoid having the petitioner recognize gain on the interest in the land the petitioner would have had to recognize gain had the interest in the land been transferred directly to the acquiring_corporation in exchange for acquiring_corporation stock to avoid this gain the interest in the land was first contributed to a newly formed corporation in a purported nonrecognition_transaction and then the stock in this newly formed corporation was transferred to the acquiring_corporation in exchange for acquiring_corporation stock in a purported tax-free reorganization finally the newly formed corporation was dissolved the court viewed the newly formed corporation as a conduit that the parties used to pass the title in the interest in the land from the petitioner to the acquiring_corporation in a taxable transaction case development hazards and other considerations we believe litigation hazards exist in pursuing the substance over form argument in this case the case would have provided a better substance over form argument if state regulatory rules had not required s to maintain certain surplus levels we also note that s as well as its subsidiaries ie not solely p sold distributed assets to p as a result to the extent p's subsidiaries sold distributed assets p's subsidiaries would have to be treated as having made distributions of the distributed assets up to s before s in turn made the distributions of the distributed assets to p an issue also exists concerning whether a court could recharacterize some or all of s's sales of the distributed assets as redemptions rather than distributions however we believe a court would be more likely to recharacterize the sales as distributions rather than redemptions see 99_tc_561 note that the tax consequences of the transaction are different under a redemption recast for example if all of the distributed assets are treated as distributed in redemption of s stock p would recognize a loss on its s stock to the extent redeemed since the redemption would receive sale_or_exchange treatment under sec_302 in determining that loss a portion of p's basis in its s stock would be allocated to the portion of p's stock treated as sold or exchanged in that redemption p would also recognize loss on the sale to b of its remaining s stock that was not redeemed in determining that loss p's basis in the portion of its s stock sold would only include that portion of p's basis in its s stock not allocated to the portion of p's s stock redeemed in contrast with the distribution recharacterization p's s stock sold to b would not be reduced by of the distribution which as you properly indicated in your request for advice would be the case if s is instead viewed as having distributed the distributed assets as a dividend assuming s has sufficient earnings_and_profits nevertheless in recharacterizing s's transfer of the distributed assets to p as a redemption of s stock p would also take a fair_market_value basis in the distributed assets received in the redemption transaction and thus could not attempt to effectively claim a second loss on any later sale of the distributed assets if you have any questions please call deborah a butler assistant chief_counsel field service by steven j hankin acting chief corporate branch field service division