department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division number release date date date uil contact person identification_number contact number employer_identification_number form required to be filed tax years dear this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final because you do not qualify for exemption as an organization described in code sec_501 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file instructions and do not send them to this office failure_to_file the returns timely may result in a penalty file the returns in accordance with their we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions follow the instructions in notice if you agree with our deletions you do not need to take any further action lf you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service at if you have any questions about your or the irs customer service number for businesses the irs customer service number for people with hearing impairments is sincerely lois g lerner director exempt_organizations initiator se t eo ra t reviewer se t eo ra t department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date date uil contact person identification_number contact number fax number employer_identification_number dear we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code sec_501 based on the information provided we have concluded that you do not qualify for exemption under code sec_501 the basis for our conclusion is set forth below facts you were originally incorporated on date in the state of a as a mutual not-for-profit insurance_company on date you re-domesticated and filed a certificate of conversion in the state of b your amended and restated articles of incorporation specifically state that your primary purpose is to be a non-profit risk retention captive_insurance_company your articles further authorize you to provide or enter into arrangements for the provision of insurance of various liability risks of not-for-profit community healthcare clinics in the state of c your primary objective is to provide a quality affordable and stable insurance provider providing medical malpractice and general liability coverage to your community clinic members your members are not-for-profit community clinics funded primarily by the federal government or the state government the clinics are composed of both rural and urban locations providing medical dental and mental health services to lower income individuals in the state of c part iv of the form_1023 application_for recognition of exemption under sec_501 of the internal_revenue_code asks for a narrative description of your activities your response to part iv directs us to see the business plan that accompanies your application the business pian entitled plan of operations past present states that upon re- domestication you will be licensed in the state of b as a cla sec_3 risk retention group_captive insurance_company as stated in your articles under the heading objectives and goals it further states that your original primary objective ie to provide a quality affordable and stable insurance provider providing medical malpractice and general liability coverage to community clinics continues however since the company entered run-off on date it has also been the goal to provide your membership with a fall-back option should the medical malpractice market turn and place undue burdens on its membership you expect to stay in run-off status for the next five years as an alternative to procuring insurance from you your membership formed a purchasing group the purchasing group contracted with a mutual_insurance_company to provide its members with medical malpractice and general liability insurance although you continue to exist in run-off status your surplus increased due to excellent underwriting results and continued investment_income that outpaced general and administrative expenses which also allowed you to settle your claims with the increase in capital and surplus you have been able to implement a new insurance_company to assist members with their workers’ compensation crisis and you continue to look for additional services and or additional insurance products that the company can provide for example you have been able to assume a small portion of the risk of the purchasing group via a reinsurance arrangement with the mutual_insurance_company the reinsurance agreement calls for you to reinsure the physicians’ administrative defense pad coverage that the mutual_insurance_company provides to the members of the purchasing group via an endorsement on the policy you further stated that you have been providing pad coverage for several years and that you expect to continue operating as a reinsurance provider you state that your activities are the same now as they were before you converted from a for-profit to a non-profit corporation and that you have always been in the business of providing insurance coverage either directly or through reinsurance you provided an organization chart which shows that you own the preferred_stock in a holding_company the holding_company holds a percent interest in an insurance_company organized by your board_of directors to assist members with their workers’ compensation crisis you and the related subsidiaries share a common board one of your executive directors is also the managing director of a management company that provides bookkeeping services to you and the related subsidiaries law sec_501 of the internal_revenue_code code provides for the exemption from federal income_taxation of organizations described in sec_501 sec_501 of the code describes organizations which are organized and operated exclusively for charitable purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_501 of the code provides that an organization shall be treated as an organization organized and operated exclusively for charitable purposes if such organization is organized and operated solely to perform on a centralized basis certain specified services among them purchasing including the purchasing of insurance on a group basis which if performed on its own behalf by a hospital which is an organization described in subsection c and exempt from taxation under subsection a would constitute activities in exercising or performing the purpose or function constituting the basis for its exemption and to perform such services solely for two or more hospitals each of which is an organization described in subsection c further such organization must be organized and operated on a cooperative basis and allocate or pay within months after the close of its taxable_year all net earning to patrons on the basis of services performed for them if such organization has capital stock all of such stock outstanding must be owned by its patrons sec_501 of the code provides that an organization described in sec_501 or shall be exempt only if no substantial part of its activities consists of providing commercial-type_insurance sec_501 of the code provides that for purposes of sec_501 the term commercial-type_insurance shall not include insurance provided at substantially below cost to a class of charitable recipients sec_1_501_c_3_-1 of the income_tax regulations regulations provides that an organization must be both organized and operated exclusively for one or more of the purposes specified in sec_501 of the code in order to be exempt as an organization described in such section sec_1_501_c_3_-1 of the regulations provides that an organization is a b organized exclusively for one or more exempt purposes only if its articles of incorporation limit the purposes of such organization to one or more exempt purposes and do not expressly empower the organization to engage otherwise than as an insubstantial part of its activities in activities which in themselves are not in furtherance of one or more exempt purposes organized and operated exclusively for one or more exempt purposes if its articles expressly empower it to carry on otherwise than as an insubstantial part of its activities activities which are not in furtherance of one or more exempt purposes even though such organization is by sec_1_501_c_3_-1 of the regulations provides that an organization is not the terms of such articles created for a purpose that is no broader than the purposes specified in sec_501 thus an organization that is empowered by its articles to engage in a manufacturing business or to engage in the operation of a social_club does not meet the organizational_test regardless of the fact that its articles may state that such organization is created for charitable purposes within the meaning of sec_501 of the code sec_1_501_c_3_-1 of the regulations provides that an organization will be it is engaged regarded as operated exclusively for one or more exempt purposes only if primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose sec_1_501_c_3_-1 of the regulations provides that an organization is not operated exclusively for one or more exempt purposes if its net_earnings inure in whole or in part to the benefit of private shareholders or individuals sec_1_501_a_-1 defines the term private_shareholder_or_individual as persons having a personal and private interest in the activities of the organization revrul_71_529 1971_2_cb_234 concerns an organization formed to aid organizations exempt from tax under sec_501 of the code by assisting them to manage more effectively their endowment or investment funds the organization receives capital from the participating exempt_organizations which capital is then placed in one or more common funds in the custody of various banks membership in the organization is restricted to colleges and universities exempt under sec_501 its board_of directors is composed of representatives of the member organizations most of the operating_expenses of the organization including the costs of the services of the investment counselors and the custodian banks are paid for by grants from independent charitable organizations the member organizations pay only a nominal fee for the services performed these fees represent less than fifteen percent of the total costs of operation the ruling states that by providing the services described above to its members the organization is performing an essential function for charitable organizations by performing this function for the organizations for a charge that is substantially below cost the organization is performing a charitable activity within the meaning of sec_501 of the code in 326_us_279 the supreme court said that the presence of a single non-exempt purpose if substantial in nature will destroy the exemption regardless of the number or importance of truly exempt purposes in 32_fedclaims_277 the court of federal claims considered whether a group self-insurance risk poo with membership consisting of unrelated nonprofit_corporations qualified as a tax-exempt_organization the organization was formed to provide reasonably priced liability coverage to its members at stable prices not available from commercial insurers noting that the sale of insurance is an inherently commercial activity ordinarily carried on by commercial for-profit companies the court found the plaintiff's activities to be commercial in nature because plaintiff was engaged in the actual underwriting of insurance policies and contracts with other firms to secure reinsurance for claims in excess of a certain amount the court found that plaintiff's activities possessed many of the attributes of a mutual_insurance_company such as accumulated_profits that inure to the benefit of members further noting that competition with commercial firms is strong evidence of the predominance of a nonexempt commercial purpose the court said that by providing insurance coverage and charging premiums the plaintiff placed itself in competition with other commercial insurance firms exempt_organizations is not an activity that would normally be performed by the member organizations accordingly the court held that the plaintiff had failed the operational_test under sec_501 because of the existence of a substantial nonexempt commercial purpose the court then said that even assuming that plaintiff qualified as an organization described in sec_501 of the code plaintiff serving as a group self-insurance risk_pool must demonstrate that sec_501 of the code does not preclude its exempt status finally the court said that providing insurance to unrelated in 103_tc_140 aff'd 71_f3d_808 11th cir the tax_court said that for purposes of explicating sec_501 of the code the plain meaning of the phrase purchasing of insurance on a group basis denotes a commercial transaction in which a cooperative hospital_service_organization negotiates and executes the purchase of insurance for its members as a group noting that the petitioners in the case are organized and operated to provide a means for their respective member hospitals to join together as a group to insure against professional liability and workers’ compensation claims which purposes were effectuated by providing centralized cooperative insurance services to member hospitals through the employment of actuaries risk managers underwriters accountants and other insurance consultants the court said that flar from purchasing insurance petitioners have assumed the role of the insurer in the absence of specific statutory language permitting a cooperative hospital_service_organization to provide insurance services in this manner we are compelled to conclude that petitioners’ activities preclude them from qualifying for exempt status under sec_501 the court noted that the petitioners had asserted that the legislative_history of the provision indicates that congress intended the phrase purchasing of insurance on a group basis to be broadly interpreted to permit cooperative_hospital_service_organizations to provide malpractice and general comprehensive insurance on a self-insurance basis the court replied that there is no evidence to support petitioners’ contention that congress intended for the provision to be liberally or broadly construed rather the court said- given that sec_501 was amended shortly after the enactment of sec_501 which limits the tax-exempt status of organizations providing insurance a more plausible explanation is that congress intended the amendment to serve as a clarification that a cooperative hospital_service_organization may purchase insurance on behalf of its members without risking a violation of subsection m id pincite emphasis in original the court then said that sec_501 also served as sound authority for denying the petitioners exempt status under sec_501 disagreeing with the petitioner's argument that the insurance in question was not commercial-type_insurance the court citing its opinion in 102_tc_745 said that we understand that congress intended for sec_501 to apply to those organizations providing any ‘type of insurance that can be purchased in the commercial market d pincite rationale to qualify as an organization described in sec_501 that is exempt from federal income_taxation under sec_501 an organization must demonstrate that it is organized and operated exclusively for charitable or other specified exempt purposes and that no part of its net_earnings inures to the benefit of a private_shareholder_or_individual an organization that purchases insurance on a group basis for two or more hospitals will be treated as an organization organized and operated for charitable purposes if it is a cooperative hospital_service_organization that meets the requirements of sec_501 sec_1_501_c_3_-1 of the regulations explains that you cannot be exempt under sec_501 of the code if you do not meet the organizational_test under sec_1_501_c_3_-1 or the operational_test under sec_1_501_c_3_-1 organizational_test sec_1_501_c_3_-1 of the regulations explains that you would not meet the organizational_test if your articles empower you to engage as a substantial part of your activities in activities which in themselves are not in furtherance of one or more of the exempt purposes set forth in sec_501 you are organized for the primary purpose of being a non-profit risk retention captive_insurance_company under state law your amended and restated articles of incorporation authorize you to provide for or enter into arrangements for the provision of insurance of various actas anonprofit risk retention captive_insurance_company in such classes of liability risks of the clinics insurance under applicable law and as are approved by the insurance commissioner of the state of b general nonprofit corporation and applicable captive insurance laws of the state of b and to transact any other lawful business for which nonprofit_corporations may be incorporated under the b nonprofit_corporations act as explained below under the heading organizational_test the provision of insurance and operation as an insurance_company without more are commercial activities that are not in todo and transact any and every other kind of business which is permitted under the furtherance of any exempt_purpose described in sec_501 since you are organized for the primary purpose of being a risk retention captive_insurance_company and to that end your articles of incorporation empower you to engage in insurance_business we find that you do not meet the organizational_test under sec_1_501_c_3_-1 of the regulations the fact that your articles further provide that you shall not possess or exercise any power or authority that will or might prevent you from qualifying or continuing to qualify as a corporation described in sec_501 of the code does not change the fact that your articles empower you to conduct a business that is not in furtherance of any exempt_purpose operational_test sec_1_501_c_3_-1 explains that you would be regarded as operated exclusively for one more exempt purposes only if you engage primarily in activities which accomplish one or more of the exempt purposes specified in sec_501 of the code the presence of a single nonexempt purpose if substantial in nature will destroy the exemption regardless of the number or importance of the truly exempt purposes see better business bureau of washington d c inc v united_states above we find that you do not meet the operational_test under sec_1_501_c_3_-1 of the regulations for many of the same reasons that the plaintiff organization in nonprofits’ insurance alliance of cal v united_states above did not meet that test like the plaintiff organization in that case you were formed to provide reasonably priced insurance coverage for a membership consisting of numerous unrelated entities the community clinics like the plaintiff organization your activities possess many of the attributes of a mutual_insurance_company you provide your members medical malpractice insurance general liability insurance and physicians’ administrative defense coverage either directly or by reinsuring a portion of the risk under policies issued by a for-profit insurance_company in providing insurance coverage for your members you are engaged primarily in an inherently commercial activity ordinarily carried on by commercial for-profit companies in conducting the same activities you conducted as a for-profit organization you are undoubtedly in competition with other commercial insurers in addition you would not meet the operational_test under sec_1_501_c_3_-1 of the regulations if you allowed your net_earnings to inure to the benefit of persons having a personal and private interest in your activities one of your executive directors is also the manager director of a management company that provides bookkeeping services to you and the related subsidiaries you have not provided sufficient details of this arrangement to enable us to assess whether it offends sec_1_501_c_3_-1 or otherwise indicates that you are organized or operated for the benefit of private shareholders or individuals within the meaning of sec_1 c -1 d ii sec_501 while an organization that purchases insurance on a group basis for two or more hospitals would be treated as an organization organized and operated for charitable purposes if it is a cooperative hospital_service_organization under sec_501 of the code we find that you do not meet the requirements under that section because you are neither engaged in purchasing insurance on a group basis as contemplated under sec_501 nor are you organized and operated on a cooperative basis as contemplated under sec_501 in florida hospital trust fund v comm’r above the tax_court said that the plain meaning of the phrase ‘purchasing of insurance on a group basis’ denotes a commercial transaction in which a cooperative hospital_service_organization negotiates and executes the purchase of insurance for its membership as a group in so reading the phrase we find the operative word is ‘purchasing’ the court found that the petitioners rather than purchasing insurance had themselves assumed the role of insurer which activities precluded them from qualifying for exempt status under sec_501 similarly you do not purchase insurance on a group basis for your members rather you are organized and operated as a risk retention captive_insurance_company for the purpose of providing medical malpractice and general liability insurance to your members at present you reinsure the physicians’ administrative defense coverage provided to members of the purchasing group since you provide rather than purchase insurance you do not qualify for tax-exempt status as a cooperative hospital_service_organization under sec_501 since we find that you are neither organized nor operated exclusively for a charitable or other exempt_purpose whether as a cooperative hospital_service_organization or otherwise you do not qualify as an organization described in sec_501 of the code sec_501 aside from the issue of whether you are described in sec_501 of the code you would be precluded from exemption from federal taxation under sec_501 by operation of sec_501 sec_501 says that an organization described in sec_501 is not entitled to exempt status under sec_501 if a substantial part of its activities consists of providing commercial-type_insurance in florida hospital trust fund v comm’r above the tax_court distinguished between purchasing insurance for a hospital group versus providing insurance for a hospital group with the latter being a non-exempt commercial type activity the court said that in employing the term ‘commercial-type’ insurance we understand that congress intended for sec_501 to apply to those corporations providing any ‘type of insurance that can be purchased in the commercial market’ saying that there is no dispute that hospital professional liability and workers’ compensation insurance are normally offered by commercial insurers the court concluded that petitioners were providing commercial-type_insurance within the meaning of sec_501 similarly we find that the coverage your provide your members - medical malpractice insurance general liability insurance and physicians’ administrative defense coverage - are types of insurance that can be purchased on the commercial market nevertheless you contend that your activities do not constitute commercial-type_insurance by reason of sec_501 which section carves out an exception to the term commercial-type_insurance for insurance that is provided at substantially below cost to a class of charitable recipients in support of your position you state that your coverage will always be at a reasonable price and that depending on market conditions this reasonable price may be substantially lower than the commercial pricing of similar coverage in the open market but the test under sec_501 is not whether your prices are substantially lower than commercial pricing but whether they are substantially below your costs in revrul_71_529 above we said that an organization providing investment management services to related_organization was performing a charitable activity within the meaning of sec_501 where the member organizations paid only a nominal fee for the services performed for then which fee represented less than fifteen percent of the total cost of operations you have not provided evidence that you are providing insurance to your members at anything approximating percent of cost on the contrary you state that you serve as a vehicle by which you would guarantee continuity of coverage to the clinics and that coverage will always be at a reasonable price you make no mention that you will provide coverage at rates that are below your cost you state in your application that your surplus grew substantially due excellent underwriting results and continued investment_income outpacing general and administrative expenses these financial results would indicate that you are not providing insurance at substantially below cost different than the activities you undertook as a for-profit entity we find that your primary purpose and a substantial amount of your activities consists of the provision of commercial- type insurance consequently you are precluded by sec_501 from exemption from tax under sec_501 in that event and insofar as your current activities are no conclusion you do not qualify for exemption under sec_501 of the code you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination your protest statement should be accompanied by the following declaration under penalties of perjury declare that have examined this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all the relevant facts and such facts are true correct and complete you also have a right to request a conference to discuss your protest this request should be made when you file your protest statement an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you if you want representation during the conference procedures you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not for more information about representation see publication practice already done so before the irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to protest as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do not need to take any further if we do not hear from you within days we will issue a final adverse determination action letter that letter will provide information about filing tax returns and other matters please send your protest statement form_2848 and any supporting documents to this address internal_revenue_service te_ge se t eo ra t exempt_organizations technical group constitution avenue nw washington dc you may also fax your statement using the fax number shown in the heading of this if you fax your statement please call the person identified in the heading of this letter to letter confirm that he or she received your fax if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely lois g lerner director exempt_organizations initiator se t eo ra t reviewer se t eo ra t


t c no united_states tax_court robert w and janet l carlson petitioners v commissioner of internal revenue respondent docket nos filed date p is a shareholder of a an s_corporation a is engaged in the business of selling residential timeshare units to individuals on an installment basis a elected under sec_453 a i r c to report installment_sale income under the installment_method p in his capacity as a shareholder paid additional tax equal to the interest on the amount of tax deferred as a result of a's use of the installment_method as required under sec_453 a i r c pursuant to sec_453 c ps deducted the payment as interest on their joint federal_income_tax returns for and r disallowed the interest deductions in full on the basis that the interest constituted nondeductible personal_interest under sec_163 h a i r c and sec_1_163-9t b temporary income_tax regs fed reg date held ps may not deduct the sec_453 a i r c interest on the tax incurred by p on installment_sales of timeshares by a because the interest is not properly allocable to a trade_or_business of p see sec_163 h a i r c john a sanders for petitioners william r mccants for respondent opinion nims judge in these consolidated cases respondent determined the following deficiencies with respect to petitioners' federal income taxes year deficiency dollar_figure big_number big_number unless otherwise indicated all section references are to sections of the internal_revenue_code in effect for the years in issue all rule references are to the tax_court rules_of_practice and procedure all dollar amounts are rounded to the nearest dollar the sole issue for decision is the deductibility of interest_paid by robert w carlson petitioner an s_corporation shareholder pursuant to an election under sec_453 a relating to installment_sales of timeshares and residential lots this case was submitted with fully stipulated facts under rule the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in freeport grand bahama bahamas when they filed their petitions background petitioner formed aqua sun investments inc aqua sun as a florida corporation in petitioner was the president and sole shareholder of aqua sun from through in petitioner's son acquired a percent equity_interest in aqua sun reducing petitioner's ownership percentage to percent aqua sun was an s_corporation during the years at issue during that time aqua sun's primary business was the development construction and sale of residential timeshare units to individuals agua sun's timeshare development activities have involved both the acquisition and the renovation of existing buildings as well as the construction of new facilities all of agua sun's timeshare developments are located in either ormond beach daytona beach st petersburg or kissimmee florida during the years in issue aqua sun in the ordinary course of its business sold residential timeshare units to individuals on an installment basis whereby the sales_price of a unit was to be paid in installments over a specified period of time aqua sun elected to report the income from the installment_sales using the installment_method as permitted under sec_453 b during each year at issue petitioner in his capacity as a shareholder paid an additional tax equal to the interest on the tax deferred as a result of aqua sun's election of the installment_method the amount of interest was determined with reference to petitioners' tax_liability for the previous tax_year so that the interest_paid in and related to petitioners' federal_income_tax liability on aqua sun's installment_sales of timeshare units as reported on petitioners' returns for and respectively petitioners computed the interest on the deferred_tax_liability in accordance with sec_453 b and reported the interest as a business deduction on schedule e part ii of form sec_1040 for and in the following amounts year interest_paid dollar_figure big_number big_number big_number in the notices of deficiency respondent disallowed petitioners’ interest deductions in full because petitioners had failed to establish that said interest payments were allowable business_interest expense deductions discussion as stated the sole issue for decision is whether petitioners may deduct interest which they paid pursuant to an election under sec_453 b relating to installment_sales of timeshares and residential lots under sec_453 a an installment_sale of real_property held_for_sale to customers in the ordinary course of business is ineligible for installment_sale treatment since the sale is treated as a dealer_disposition as defined in sec_453 b dispositions of timeshares and residential lots are excepted from the dealer_disposition definition however if the taxpayer elects to have paragraph of sec_453 apply to any installment_obligations which arise from such dispositions there are conditions attached to the privilege of exercising the election the only significant condition for purposes of this case being the following the taxpayer must agree to pay an additional tax taken into account under sec_453 c as interest_paid or accrued during the taxable_year the parties stipulated that there is no dispute that aqua sun was in the business of selling residential timeshare units and was entitled to report income from its residential timeshare sales using the installment_method and there is no dispute concerning the amount of interest that petitioner was required to pay under sec_453 petitioners do not deny that the business of selling timeshares was conducted by aqua sun and not by petitioner they say in their opening brief that the sec_453 c interest_paid by petitioner arises out of and relates directly and exclusively to the taxes imposed on petitioners as a result of the trade_or_business activities of aqua sun they thus appear to be arguing that agua sun's trade_or_business is to be imputed to petitioner having made this connection petitioners go on to argue that the interest that petitioner paid falls within the personal_interest exception contained in sec_163 h a that section provides that personal_interest does not include interest_paid or accrued on indebtedness properly allocable to a trade_or_business other than the trade_or_business of performing services as an employee petitioners must get over one more hurdle in order to prevail namely the provisions of sec_1_163-9t b temporary income_tax regs fed reg date this section of the temporary regulations provides that personal_interest includes interest_paid under what was formerly sec_453c b and is now sec_453 c ie interest_paid on the tax deferred by reason of the installment_sale of timeshares and residential lots petitioners argue that this regulation is invalid respondent argues that the interest_paid by petitioner as a shareholder of an s_corporation pursuant to sec_453 is nondeductible personal_interest under sec_163 we agree with respondent because whether or not sec_453 interest can ever be deemed properly allocable to a trade_or_business under the exception to personal_interest treatment contained in sec_163 a the trade_or_business in this case was that of aqua sun and not that of petitioners s_corporations and partnerships among certain other entities are commonly known as passthrough entities in 410_us_441 the supreme court noted that while the partnership itself pays no taxes it must report the income it generates for this purpose the partnership is regarded as an independently recognizable entity emphasis added the partnership is thereafter treated as an agent or conduit through which the income passes i e as a passthrough_entity but nevertheless a freestanding entity see id under sec_1366 relating to pass-thru of items to shareholders and specifically subsection a nonseparately_computed_income_or_loss of an s_corporation is defined as gross_income minus the deductions allowed to the corporation under chapter of the internal_revenue_code thus for example assuming aqua sun were entitled to a deduction for interest on an indebtedness incurred to finance the construction of timeshares aqua sun's gross_income would be reduced by the amount of the deduction before the passthrough to petitioner the interest which petitioners seek to deduct as a trade_or_business expense is not an item which passes through from aqua sun to petitioner since the tax on which the interest must be paid is not imposed on aqua sun but directly on petitioner sec_163 provides that in the case of a taxpayer other than a corporation no deduction is allowed for personal_interest among other things personal_interest is defined as any interest allowable as a deduction under chapter of the internal_revenue_code other than as we have said interest_paid or accrued on indebtedness allocable to a trade_or_business sec_163 a the quoted language was substituted for interest_paid or accrued on indebtedness incurred or continued in connection with the conduct_of_a_trade_or_business by the technical_and_miscellaneous_revenue_act_of_1988 publaw_100_647 sec c 102_stat_3342 petitioners argue that while the previous language may have referred to a trade_or_business of the taxpayer the new language broadens the scope of sec_163 h a to include any trade_or_business which in this case can include a trade_or_business of aqua sun petitioners attempt to distinguish true v united_states aftr 2d ustc par big_number d wyo affd without published opinion 35_f3d_574 10th cir relied upon by respondent on brief petitioners acknowledge true's holding that interest_paid by an individual shareholder of an s_corporation on a tax_deficiency attributable to the business of the s_corporation is not deductible by the shareholder under sec_62 as a trade_or_business expense which must be attributable to a trade_or_business of the taxpayer in true the district_court held that the interest was not an allowable trade_or_business deduction because the s corporation's business activities were not attributed to the shareholders for purposes of sec_62 petitioners argue that true v united_states supra dealt with tax years prior to the enactment of present sec_163 consequently petitioners say the holding in true has nothing to do with whether such interest_expense is properly allocable to a trade_or_business under sec_163 a unlike sec_62 which requires the trade_or_business to be conducted by the taxpayer petitioners contend that sec_163 h a merely requires that interest be properly allocable to a trade_or_business in order for it to constitute deductible business_interest in petitioners' view nothing in sec_163 h a requires the interest to be paid_by the taxpayer conducting the trade_or_business petitioners seek to bootstrap deductibility of their interest_expense by analogizing their interest_expense to interest on debt incurred to acquire or increase an interest ina passthrough_entity citing a temporary_regulation and several irs notices referring to rules for allocating interest_expense for purposes of applying sec_469 the passive loss limitation and d and h the nonbusiness interest limitations sec_1_163-8t temporary income_tax regs fed reg date provides manner of allocation in general interest_expense on a debt is allocated in the same manner as the debt to which such interest_expense relates is allocated debt is allocated by tracing disbursements of the debt proceeds to specific expenditures this section prescribes rules for tracing debt proceeds to specific expenditures however sec_1_163-8t of the same regulations cross-- refers to paragraph b for definitions paragraph b defines trade_or_business_expenditure as an expenditure in connection with the conduct of any trade_or_business other than the trade_or_business of performing services as an employee thus if debt proceeds are allocated by the passthrough_entity to a trade_or_business expense the interest on the debt is similarly allocated in the case before us however no proceeds of debt incurred by aqua sun have been allocated by aqua sun to its trade_or_business so allocation rules are not germane to petitioners' position here as a final argument petitioners seek to have us declare invalid sec_1_163-9t b temporary income_tax regs fed reg date this provision reads as follows interest relating to taxes--- i in general except as provided in paragraph b of this section personal_interest includes interest---- b paid under sec_453c b now sec_453 interest on deferred tax resulting from certain installment_sales and sec_1291 c interest on deferred tax attributable to passive foreign investment companies or petitioners’ challenge to the validity of this regulation is mooted by our holding that the interest_paid by petitioner pursuant to sec_453 1s not paid_or_incurred in a trade_or_business of petitioner so that regardless of the validity or invalidity of the regulation we need not consider the merits of petitioners’ argument in sum we hold that petitioners may not deduct the sec_453 a interest on the tax incurred by petitioners on installment_sales of timeshares by agua sun because the interest is not properly allocable to a trade_or_business of petitioner as required under sec_163 h a decisions will be entered for respondent


internal_revenue_service department of the treasury number release date index number attn washington dc person to contact telephone number refer reply to cc psi plr-129049-00 date october in re legend husband wife daughter son trust trust trust trustees date date - - - - - - - - - - dear this is in reference to your letter dated date and subsequent correspondence requesting rulings regarding the effect of the proposed judicial construction of the trust instrument for federal generation-skipping_transfer_tax purposes the facts submitted are as follows background on date husband and wife collectively the trustors created and funded trust an irrevocable_trust governed by the law of california primarily for the benefit of trustors and their issue trust had three trustees one of which was husband under the terms of trust during the joint lifetime of the trustors the net_income and principal would be accumulated or distributed in the discretion of the trustees during any time that husband was serving as trustee husband would have the sole discretion to make distributions trust provides that upon the death of the plr-129049-00 first trustor to die after payment of debts expenses taxes and any other charges the corpus of trust would be divided into two separate shares one share for the surviving trustor to be held in trust survivor’s trust and the other share for the remaining beneficiaries primary beneficiaries share trust further provides that the primary beneficiaries share be divided into two equal shares to be held in separate trusts trust and trust the terms of trust and trust are substantially_similar except that trust is to be held for the benefit of daughter and her issue and trust is to be held for the benefit of son and his issue article of trust provides that after the death of the first trustor to die income of the survivor’s trust is to be paid to the surviving trustor at that trustor’s request the independent_trustee may make discretionary distributions of principal from the survivor’s trust trust and trust to the surviving trustor for that trustor’s reasonable care maintenance and support the surviving trustor has a limited power during life to appoint the principal and undistributed_income to that trustor’s living issue the spouse of any issue and any charity the surviving trustor also has a testamentary power to appoint the principal and undistributed_income to anyone including his or her estate article a of trust provides that after the death of the first trustor to die and during the life of the surviving trustor the independent_trustee may in its discretion pay the net_income of trust and trust to or for the benefit of the trustor’s living issue who are the beneficiaries of trust and of trust respectively for that beneficiary’s proper care maintenance support and education after taking into consideration other resources available to that beneficiary likewise article b provides that the independent_trustee may in its discretion make distributions of principal of trust and trust to or for the proper care maintenance support and education of the respective beneficiaries of trust and trust after the death of first trustor to die and during the life of the surviving trustor upon the death of the surviving trustor article a of trust provides that during the lifetime of the primary beneficiary daughter of trust the independent_trustee has the discretion to pay the net_income and principal of trust to daughter and her living issue for the proper care maintenance support and education of the daughter and her issue after taking into account the beneficiary’s other resources likewise during the lifetime of the primary beneficiary son of trust the independent_trustee has the discretion to pay the net_income and principal of trust to son and his living issue for the proper care maintenance support and education of the son and his issue after taking into account the beneficiary’s other resources article c of trust states that following the demise of surviving trustor each primary beneficiary who is legally competent to do so shall have the power to appoint the remaining principal and any undistributed_income of his or her child’s plr-129049-00 trust to such of trustors’ issue and or to the spouse of any one or more of trustors’ issue other than to such primary beneficiary’s own spouse during such primary beneficiary’s lifetime in such amount or amounts as such primary beneficiary shall appoint from time to time during his or her lifetime by an instrument or at his or her death by his or her last will or codicil thereto meeting the requirements of a will or codicil in force in the state of execution thereof at the date such will or codicil is executed in which instrument will or codicil specific reference to such power_of_appointment and the specific intention to exercise said power is expressed article provides that upon the last to occur of the death of the surviving trustor the death of the primary beneficiary and the death or remarriage of the primary beneficiary’s spouse the principal and undistributed_income of trust and trust respectively except as appointed by the primary beneficiary as described in article c above shall be distributed outright to or held for the benefit of the then living issue of the primary beneficiary of each respective trust appendix b of trust defines an independent_trustee as each institution and each individual other than husband and wife and other than a person who is or may become entitled to the distribution of income or principal from any trust created hereunder who serves as trustee of a_trust created herein subsequent to the execution of trust the attorneys who drafted the trust contacted husband to inform him of a possible error in the trust instrument as set forth above article c of trust provides that after the death of the surviving trustor wife the primary beneficiary of trust son shall have the power to appoint the remaining principal and any undistributed_income of that trust to such of trustors’ issue and or to the spouse of any one or more of trustors’ issue other than to such primary beneficiary’s own spouse during such primary beneficiary’s lifetime as drafted this provision indicates that upon wife’s death son would have the power to appoint the principal of trust to himself as an issue of husband and wife as such this power would constitute a general_power_of_appointment held by son husband and wife planned to make other changes to trust and they decided to amend article c during discussions of the changes husband stated that he did not intend to give son a general_power_of_appointment husband however was in poor health and died on date before amending trust to incorporate the change husband was survived by wife daughter and son wife as surviving trustor subsequently exercised her general_power_of_appointment over the survivor’s trust pursuant to article of trust wife is now deceased trustees which consist of son another individual and an independent corporation are the current trustees of trust trustees believe that the language in trust with respect to the powers held by son to appoint the principal and plr-129049-00 undistributed_income of trust as set forth in article c of trust is a result of scrivener error trustees have submitted extensive documentation detailing discussions between trustors and their attorneys concerning the execution of trust that documentation shows that when husband and wife established trust they intended that son have a limited power to appoint the trust property during his life and after his death to rectify the effect of the scrivener’s error the trustees propose to file a petition in the appropriate local court the petition will request that the court conclude that the trustors intended that under the terms of trust daughter and son have only a limited lifetime power and a limited testamentary power to appoint their respective trusts trust and trust to his or her spouse his or her issue or the spouses of his or her issue in addition the petition will request that the court reform the provisions of article c of trust effective ab initio to read as follows following the demise of surviving trustor each primary beneficiary who is legally competent to do so shall have the power to appoint the remaining principal and any undistributed_income of his or her child’s trust to such of such primary beneficiary’s spouse issue and or spouses of such issue other than to such primary beneficiary’s own spouse during such primary beneficiary’s lifetime in such amount or amounts as such primary beneficiary shall appoint from time to time during his or her lifetime by an instrument or at his or her death by his or her last will or codicil thereto meeting the requirements of a will or codicil in force in the state of execution thereof at the date such will or codicil is executed in which instrument will or codicil specific reference to such power_of_appointment and the specific intention to exercise said power is expressed no primary beneficiary shall have the power to appoint any portion of his or her child’s trust to himself or herself to his or her estate to his or her creditors or to the creditors of his or her estate trustees have represented that no additions actual or constructive have been made to trust after date rulings requested you have requested the following rulings as a result of the proposed judicial reformation son does not possess and never has possessed a general_power_of_appointment with respect to trust that would cause the corpus of trust to be includible in son’s gross_estate for federal estate_tax purposes as a result of the proposed judicial reformation son will not be treated as having released a general_power_of_appointment for federal gift and estate_tax purposes plr-129049-00 under sec_2514 and sec_2041 respectively as a result of the proposed judicial reformation the exempt status of trust for generation-skipping_transfer_tax purposes will not be affected and the judicial reformation will not result in a transfer of property that will subject trust or distributions thereunder to the generation-skipping_transfer_tax imposed under sec_2601 rulings and law and analysis sec_2041 of the internal_revenue_code provides that for federal estate_tax purposes the value of the gross_estate shall include the value of all property to the extent of any property with respect to which the decedent has at the time of death a general_power_of_appointment created after date or with respect to which the decedent has at any time exercised or released such a power_of_appointment sec_2041 defines the term general_power_of_appointment as a power that is exercisable in favor of the decedent the decedent’s estate the decedent’s creditors or the creditors of the decedent’s estate sec_2041 provides that the lapse of a power_of_appointment created after date during the life of the person possessing the power shall be considered the release of such power likewise for gift_tax purposes sec_2514 provides that the exercise or release of a general_power_of_appointment created after date is deemed a transfer of property by the individual possessing the power sec_2514 provides that the lapse of a power_of_appointment created after date during the life of the person possessing the power is considered a release of the power for gift_tax purposes a general_power_of_appointment is defined in sec_2514 as a power that is exercisable in favor of the individual possessing the power his estate his creditors or the creditors of his estate section of the probate code of california provides in part that a except as provided for in section pertaining to revocable trusts a trustee or beneficiary of a_trust may petition the court under this chapter concerning the internal affairs of the trust or to determine the existence of the trust b proceedings concerning the internal affairs of a_trust include but are not limited to proceedings for any of the following purposes determining questions of construction of a_trust plr-129049-00 instrument determining the existence or nonexistence of any immunity power privilege duty or right cal prob code west further the california civil code in addressing the revision of contracts provides at when through fraud or a mutual mistake of the parties or a mistake of one party which the other at the time knew or suspected a written contract does not truly express the intention of the parties it may be revised on the application of a party aggrieved so as to express that intention so far as it can be done without prejudice to rights acquired by third persons in good_faith and for value cal civ code west under california law t he paramount rule in the construction of wills to which all other rules must yield is that a will is to be construed according to the intention of the testator as expressed therein and this intention must be given effect as far as possible in re estate of russell cal rptr cal adams v cook cal 2d the primary duty_of the court in construing all documents is to give effect to the intention of the maker and that duty applies to inter_vivos instruments as well as testamentary instruments wells fargo bank national ass’n v huse cal rptr cal ct app extrinsic evidence may be admitted in order to give effect to the intent of the maker see ike v doolittle cal rptr 2d cal ct app estate of anderson cal rptr 2d cal ct app burch v george cal rptr 2d cal ct app wells fargo bank v marshall cal app 4th extrinsic evidence may also be admitted to reform the dispositive provisions of a_trust in order to correct errors made in drafting the instrument when such reformation will conform to the intent of the settlor lissauer v union bank trust co cal app 2d further under california law the rules set forth under of the california civil code regarding revision of a contract where due to fraud or mistake the instrument does not express the intent of the parties also apply to the reformation of a_trust instrument in getty v getty cal rptr cal app the court in applying the rules under to the reformation of a_trust stated that t he sole purpose of the reformation doctrine is to correct a written instrument in order to effectuate a common intention of the parties which was incorrectly reduced to writing the court stated that california civil code codifies the equitable action for reformation the purpose of which is to permit a court in equity to do equity reformation of the instrument to conform to the intent of the parties at the execution of plr-129049-00 the instrument relates back to the date that it was executed bank of america national trust and savings ass’n v craig cal rptr cal ct app in this case the documentation submitted by the trustees strongly indicates that husband and wife intended to provide son with only the authority to appoint the principal of trust to family members other than himself furthermore terms in article c of trust which allowed son to appoint the property to himself because he is the issue of the trustors were the result of a scrivener’s error consequently we conclude that the reformation by the court as proposed based on scrivener’s error is consistent with applicable california law that would be applied by the highest court of that state further we conclude that if the court determines as set forth in the proposed petition that trustors intended that article c of trust confer upon son a limited nongeneral_power_of_appointment over the assets of trust son has never had a general_power_of_appointment over the assets of trust that would be included under sec_2041 in son’s gross_estate for federal estate_tax purposes and that there was no lapse of a general_power_of_appointment held by the son under article c of trust that would be considered a release of the power under sec_2514 ruling sec_2601 imposes a tax on every generation-skipping_transfer gst made after date a generation-skipping_transfer is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2612 provides that the term taxable_termination means a termination by death lapse of time release of a power or otherwise of an interest_in_property_held_in_trust where the property passes to a skip_person with respect to the transferor of the property sec_2612 provides that the term taxable_distribution means any distribution from a_trust to a skip_person other than a taxable_termination or a direct_skip under sec_2612 a direct_skip is a transfer subject_to federal estate or gift_tax made by a transferor to a skip_person under b of the tax_reform_act_of_1986 and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the gst tax does not apply to any generation-skipping_transfer under a_trust that was irrevocable on date however this exemption does not apply to additions actual or constructive that are made to the trust after date sec_26_2601-1 states that if an addition is made after date to a_trust which was irrevocable on date a pro_rata portion of subsequent distributions from and terminations of interests in property held in the trust plr-129049-00 is subject_to the gst tax provisions if an addition is made the trust is thereafter deemed to consist of two portions a portion not subject_to the gst tax and a portion subject_to the gst tax sec_26_2601-1 provides that the release exercise or lapse of a power_of_appointment other than a general power is not treated as an addition to a_trust if the power was created in an irrevocable_trust that is not subject_to the gst tax because it was irrevocable on date and in the case of an exercise the power was not exercised in such a way that may postpone or suspend the vesting absolute ownership or power of alienation of an interest in property for a period beyond the rule_against_perpetuities measured from the creation of the trust sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the generation-skipping_transfer_tax will not cause the trust to lose its exempt status sec_26_2601-1 provides that a judicial construction of a governing instrument to resolve an ambiguity in the terms of the instrument or to correct scrivener’s error will not cause an exempt trust to lose its exempt status provided the judicial action involves a bona_fide issue and the construction is consistent with applicable state law that would be applied by the highest court of the state in the present case trust was irrevocable on date trustee has represented that no additions actual or constructive have been made to the trust after that date in this case assuming that pursuant to the petition the court concludes that the trustors never intended that son hold a general_power_of_appointment the power to appoint the assets of trust to himself his estate his creditors or the creditors of his estate and the court reforms article c of trust as set forth in the proposed petition we conclude that the court’s construction and reformation of trust would be consistent with applicable state law that would be applied by the highest court of the state accordingly based on the facts submitted and the representations made the judicial reformation of trust as proposed will not affect the exempt status of trust for generation-skipping_transfer_tax purposes and will not result in a transfer of property that will subject trust or distributions thereunder to the generation- skipping transfer_tax imposed under sec_2601 a copy of this letter should be attached to any gift estate or generation-skipping_transfer_tax returns that you may file relating to these matters the rulings contained in this letter are based upon information and plr-129049-00 representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by the 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 except as specifically ruled above no opinion is expressed as to the federal tax consequences of the facts described above under the cited provisions or any other provisions of the code or regulations this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely yours james hogan senior technician reviewer branch associate chief_counsel passthroughs and special industries enclosure copy for sec_6110 purposes


t c memo united_states tax_court raymond and cynthia turner-simmons petitioners v commissioner of internal revenue respondent docket no 3151-03l filed date raymond and cynthia turner-simmons pro sese john w sheffield iii for respondent memorandum findings_of_fact and opinion halpern judge this case is before the court to review a determination made by respondent’s appeals_office appeals that respondent may proceed to collect by levy unpaid taxes with respect to petitioners’ tax_year we review that determination pursuant to sec_6330 unless otherwise indicated all section references are to the internal_revenue_code_of_1986 as amended and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact the parties have filed a stipulation of facts which with accompanying exhibits except for 2-r and 4-j1 is incorporated herein by this reference petitioners resided in atlanta georgia at the time the petition was filed petitioners filed a joint federal_income_tax return for the return showing a balance due of dollar_figure respondent examined the return and determined a deficiency in tax of dollar_figure the deficiency the examination concluded with petitioners signing an internal_revenue_service irs form 4549-cg income_tax examination changes the form 4549-cg the form 4549-cg recites only computational changes based on reported self-employment_income and a reported pension distribution by signing the form 4549-cg petitioners agreed to immediate_assessment and collection of the deficiency and interest due to date and waived their appeal rights with the irs and their right to contest the deficiency in the tax_court exhibit 2-r was admitted into evidence independent of the stipulation of facts exhibit 4-j was objected to by petitioner and not admitted at trial on brief respondent states that he no longer relies on exhibit 4-j therefore we shall not receive it into evidence petitioner wife wrote the following on the signature page of the form 4549-cg upon receipt of this letter i spoke with mrs dillard on january illegible she explained and was very helpful in pointing out the additional taxes we do not dispute the amount and are presently in an installment_agreement with the irs and will continue to make monthly payments to pay off the amount in full thank you respondent computes that petitioners have a remaining unpaid income_tax_liability for of dollar_figure the remaining liability on date respondent issued to petitioners a notice_of_intent_to_levy and of petitioners’ right to a hearing under sec_6330 petitioners requested a hearing under sec_6330 and pursuant to the request petitioner wife met with appeals officer murphy on january and the sec_6330 hearing at the sec_6330 hearing petitioners did not that amount is respondent’s computation of the remaining liability as of approximately the time of trial respondent computes that amount as follows return liability payment dollar_figure return as filed withholding estimated_tax penalty failure to pay penalty interest form 4549-cg payments -- dollar_figure dollar_figure dollar_figure dollar_figure -- dollar_figure remaining liability dollar_figure -- dollar_figure -- -- -- -- dollar_figure dollar_figure -- raise as an issue or dispute the adjustments in the form 4549-cg the only issue raised by petitioners at the sec_6330 hearing was that they claimed that they had already paid their income_tax_liability petitioners presented no evidence beyond petitioner wife’s statements that they had paid that liability on date appeals mailed to petitioners a notice_of_determination concerning collection action s under sec_6320 and or the determination the determination addresses the issues raised by petitioners in protesting the levy states that the levy is necessary to ensure efficient collection_of_taxes and confirms that respondent has met the requirements of the applicable laws and administrative procedures opinion i sec_6330 and sec_6331 sec_6331 authorizes the secretary to levy against property and property rights where a taxpayer liable for taxes fails to pay those taxes within days after notice_and_demand for payment is made sec_6331 requires the secretary to send written notice of an intent to levy to the taxpayer and sec_6330 requires the secretary to send a written notice to the taxpayer of his right to a sec_6330 hearing at least days before any levy is begun if a sec_6330 hearing is requested the hearing is to be conducted by appeals and at the hearing the appeals officer conducting it must verify that the requirements of any applicable law or administrative procedure have been met sec_6330 c the taxpayer may raise at the hearing any relevant issue relating to the unpaid tax or the proposed levy sec_6330 the taxpayer may contest the existence or amount of the underlying tax_liability at a hearing if the taxpayer did not receive a statutory_notice_of_deficiency with respect to the underlying tax_liability or did not otherwise have an opportunity to dispute that liability sec_6330 at the conclusion of the hearing the appeals officer must determine whether and how to proceed with collection taking into account among other things collection alternatives proposed by the taxpayer and whether any proposed collection action balances the need for the efficient collection_of_taxes with the legitimate concern of the taxpayer that the collection action be no more intrusive than necessary see sec_6330 a taxpayer receiving a notice_of_federal_tax_lien has hearing rights similar to the hearing rights accorded a taxpayer receiving a notice_of_intent_to_levy see sec_6320 we have jurisdiction to review the appeals officer’s determination where we have jurisdiction over the type of tax involved in the case sec_6330 see 122_tc_287 generally we may consider only those issues that the taxpayer raised during the sec_6330 hearing see sec_301_6330-1 q a-f5 proced admin regs see also 118_tc_488 where the underlying tax_liability is properly at issue we review the determination de novo e g 114_tc_176 where the underlying tax_liability is not at issue we review the determination for abuse_of_discretion id pincite whether an abuse_of_discretion has occurred depends upon whether the exercise of discretion is without sound basis in fact or law see 104_tc_367 ii arguments of the parties petitioners dispute the adjustments on the form 4549-cg the adjustments they also argue that none of their income_tax_liability remains unpaid respondent argues that petitioners failed to raise the adjustments during the sec_6330 hearing and that they did not either during that hearing or at trial provide any evidence showing any payments in excess of those credited to their account by respondent iii discussion while petitioners claim that they raised the adjustments at the sec_6330 hearing respondent’s record of what occurred at the hearing states that the only issue petitioners raised was the amount petitioners had paid petitioners have failed to convince us that they raised the adjustments during the sec_6330 hearing also they have failed to convince us that as they claimed at trial they were coerced into signing the form 4549-cg at trial if a taxpayer signs a form 4549-cg under duress or coercion the waivers contained therein of the taxpayer’s rights to contest the deficiency are invalid zapara v commissioner t c __ __ slip op pincite in zapara we held a taxpayer who has signed a form 4549-cg waiving his right to challenge the proposed assessments should be deemed to have had an opportunity to dispute his tax_liabilities and is thereby precluded from challenging those liabilities id previously in 117_tc_324 we held that by signing a form 4549-cg the taxpayers expressly waived the opportunity to obtain prepayment judicial review of their tax_liability for those years as reported above sec_6330 provides that the taxpayer may contest the existence or amount of the underlying tax_liability at a sec_6330 hearing if the taxpayer did not receive a statutory_notice_of_deficiency with respect to the underlying tax_liability or did not otherwise have an opportunity to dispute that liability it is unclear from the two cases whether a taxpayer who signs a form 4549-cg following an examination of his return loses his right to raise the underlying tax_liability in a subsequent sec_6330 hearing because he waived his right to administrative or judicial consideration of the underlying liability by choosing not to receive a statutory_notice_of_deficiency or the examination preceding execution of the form 4549-cg constituted continued petitioners produced no evidence that would show any error in the adjustments they produced no evidence showing that respondent has made any error in crediting their account for all payments received from them with respect to their income_tax_liability nor did they establish that the remaining liability is any less than respondent claims it to be whatever standard of review we apply to appeals’ determination to proceed with collection by levy of the continued an opportunity to dispute the tax_liability recited on the form the former interpretation is suggested by aquirre in which we supported our holding by citing 114_tc_604 for the proposition that a taxpayer who deliberately refuses to accept delivery of a notice_of_deficiency repudiates his opportunity to contest the notice at appeals or in tax_court the distinction could be important in a case with facts different from those before us today consider for example a taxpayer who disagrees with an examiner’s proposed increase in his tax_liability and exercises his right to appeal within the irs by protesting the proposed increase to appeals suppose that appeals rejects his protest and the commissioner sends to the taxpayer’s last_known_address a notice_of_deficiency that conforms to the requirements of sec_6212 suppose further that the notice goes astray and is never delivered and therefore the taxpayer loses his opportunity to petition the tax_court for a redetermination of the deficiency see sec_6213 is the taxpayer precluded from raising the underlying tax_liability in a sec_6330 hearing and if necessary before the tax_court because he already had an opportunity to dispute the tax_liability or is he not precluded from raising the liability because he signed no form 4549-cg and waived no rights to any administrative or judicial consideration if he can raise the underlying tax_liability in a sec_6330 hearing and if dissatisfied with the resolution of the hearing before the tax_court then in effect the actual receipt rule_of sec_6330 replaces the last-known-address-is-adequate rule_of sec_6212 as a trigger for tax_court jurisdiction at least to the extent the taxpayer wishes to dispute the underlying tax_liability remaining liability--and even assuming that petitioners raised the issue of the adjustments in the form 4549-cg at the sec_6330 hearing--petitioners have failed to prove that appeals erred in determining to proceed with collection of that liability iv conclusion we sustain the determination to reflect the foregoing decision will be entered for respondent


department of the treasury int ernal revenue service washington d c date o f f i c e o f c h i e f c o u n s e l number release date cc ita wta-n-109939-01 uilc internal_revenue_service national_office field_service_advice memorandum for attorney lmsb from heather c maloy associate chief_counsel cc ita subject this field_service_advice responds to your memorandum date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent disclosure statement field_service_advice is chief_counsel_advice and is open to public inspection pursuant to the provisions of sec_6110 the provisions of sec_6110 require the service to remove taxpayer identifying information and provide the taxpayer with notice of intention to disclose before it is made available for public inspection sec_6110 and i sec_6110 also authorizes the service to delete information from field_service_advice that is protected from disclosure under u s c sec_552 b and c before the document is provided to the taxpayer with notice of intention to disclose only the national_office function issuing the field_service_advice is authorized to make such deletions and to make the redacted document available for public inspection accordingly the examination appeals or counsel recipient of this document may not provide a copy of this unredacted document to the taxpayer or their representative the recipient of this document may share this unredacted document only with those persons whose official tax_administration duties with respect to the case and the issues discussed in the document require inspection or disclosure of the field_service_advice legend taxpayer country country a b c wta-n-109939-01 x y z date year year issues whether arms sales commission payments are not deductible pursuant to the provisions of sec_162 because such payments are considered to be essential elements of criminal offenses conclusions sec_162 does not disallow a deduction for arms sales commission payments facts the taxpayer is in the business of designing and selling defense systems and weapons during the course of its business the taxpayer made payments to a in country to procure and service country military contracts and to four agents in country to secure country military contracts taxpayer alleges that neither a nor the country agents were foreign government officials the taxpayer did not disclose the commission payments to the country country or u s governments and taxpayer falsely described in its books records and federal_income_tax returns the commission payments as either x y or z the commission payments became the focus of a grand jury investigation in which the united_states department of justice filed an information and plea agreement in the united_states district_court for the central district of b the taxpayer pled guilty to three counts which charged conspiracy to defraud the internal_revenue_service the defense contract audit agency and country u s c sec_371 making false statements u s c sec_1001 sec_2 and mail fraud u s c sec_1341 the taxpayer is audited pursuant to the coordinated_examination_program cep exam is currently auditing the year through year tax years the amount of commission expenditures is believed to be approximately c law and analysis sec_162 of the internal_revenue_code provides in general that there shall be allowed as a deduction all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business sec_162 provides in general that no deduction shall be allowed under subsection a for any payment made directly or indirectly to any person if the payment constitutes an illegal_bribe illegal kickback or other illegal payment under any wta-n-109939-01 law of the united_states or under any law of a state but only if such state law is generally enforced which subjects the payor to a criminal_penalty or the loss of license or privilege to engage in a trade_or_business for purposes of this paragraph kickback includes a payment in consideration of the referral of a client patient or customer exam argues that the case 41_fedclaims_134 provides a basis for not allowing the taxpayer to deduct the commission payments specifically exam points to the language in bilzerian which states that if a payment is the essential element of the crime the payment is itself illegal id pincite however the bilzerian court did not rely on this essential element argument and the court ruled that the taxpayer’s conviction for criminal activity did not make payments connected with that activity illegal the general principle is that a payment must be illegal in and of itself for it to be disallowed as a deduction under sec_162 bilzerian pincite the fact that the payment was connected to illegal activity does not suffice to disallow the deduction of the payment under sec_162 356_us_27 g_c_m date the taxpayers in commissioner v sullivan operated an illegal gambling operation and sought to deduct wages paid to workers who helped operate the gambling establishment and rent for_the_use_of the premises where the establishment was located the tax_court held that the amounts paid for wages and rent could not be deductible since those deductions were for expenditures made in connection with illegal acts however the supreme court reversed the tax_court and held that the payments for wages and rent were deductible as ordinary and necessary business_expenses in the present case the commission payments made by the taxpayer to foreign agents were not in and of themselves illegal the taxpayer was sanctioned for not disclosing and for concealing the payments not for the payments themselves while the taxpayer would not have been sanctioned if it had not made the payments we cannot find authority to apply the essential element theory to this case please call nicole e francis pincite-4950 if you have any further questions by heather c maloy associate chief_counsel robert m casey acting senior technician reviewer branch income_tax accounting


o f f i c e o f c h i e f c o u n se l department of the treasury i n t e r n a l r e v e n u e s e r v i c e washington d c date number release date uil the honorable tom price member u s house of representatives roswell road suite marietta ga attention ------------------- dear congressman price cc ita b4 ------------ conex-111737-11 i am responding to your enquiry dated date submitted on behalf of your constituent ------------------------ he asked why a non-custodial parent that pays one-half of the support for the year of a qualifying_child is not entitled to one-half of the dependency_exemption deduction for that child in general a child can be claimed as a dependent on only one tax_return for any taxable_year under sec_152 of the internal_revenue_code code if the child’s parents do not file a joint_return then the custodial_parent may take the dependency_exemption deduction for that child the custodial_parent is generally the parent with whom the child lived for the greater number of nights during the year and the non-custodial parent is the other parent if the child lived with each parent for an equal number of nights then the parent with the higher adjusted_gross_income may take the dependency_exemption deduction for that child under sec_152 of the code a non-custodial parent may claim a dependency_exemption deduction for a child if the custodial_parent signs a written declaration that he or she will not claim the exemption for the child and the noncustodial_parent attaches the written declaration to his or her tax_return for taxable years beginning after date the regulations under sec_152 provide that the written declaration must be on form_8332 release revocation of release of claim to exemption for child by custodial_parent or other single-purpose document containing essentially the same information as form_8332 a non-custodial parent may not except for certain decrees executed before the effective date of the regulations substantiate a custodial parent’s release of a claim to the dependency_exemption deduction for a child by attaching pages of a divorce decree the regulations reflect conex-111737-11 congress’ concern of substantiation problems for claiming a dependency_exemption deduction for a child for further information please see the enclosed copies of form_8332 and its instructions and pages through of publication exemptions standard_deduction and filing information i hope this information is helpful if you have any questions please contact ---------------- --------- or -----------------------------at --------------------- sincerely george j blaine associate chief_counsel income_tax and accounting enclosure


t c memo united_states tax_court michael e nestor petitioner v commissioner of internal revenue respondent docket no 5372-o0l filed date michael e nestor pro_se david c holtz for respondent supplemental memorandum findings_of_fact and opinion colvin judge petitioner filed the petition in this case under sec_6330 seeking our review of respondent’s determination that collection by levy was appropriate the sole issue for decision is whether respondent’s determination to this memorandum opinion supplements 118_tc_162 - - proceed with collection with respect to petitioner’s tax years was an abuse_of_discretion we hold that it was not section references are to the internal_revenue_code as amended findings_of_fact petitioner resided in california when he filed the petition in this case a petitioner’s tax returns and the notices of deficiency petitioner filed purported federal_income_tax returns for in date and he timely filed a purported return on each return he reported that he had no wages other income or tax_liability after petitioner filed those tax returns and before date when respondent issued the notice_of_intent_to_levy discussed at paragraph b below respondent assessed the frivolous_return penalty under sec_6702 for respondent issued notices of deficiency to petitioner for each of his tax years determining deficiencies and additions to tax as follows ' we will dismiss for lack of jurisdiction the portion of this case that relates to the frivolous_return penalties for tax years 115_tc_324 additions to tax_year deficiency sec_6651 a sec_6654 dollar_figure dollar_figure dollar_figure big_number dollar_figure dollar_figure big_number dollar_figure -0- big_number dollar_figure -0- big_number dollar_figure -0- big_number dollar_figure -0- big_number dollar_figure dollar_figure big_number dollar_figure -o- petitioner received the notices of deficiency for but not for or b the lien and levy proceeding on date respondent issued to petitioner a notice_of_intent_to_levy and notice of your right to a hearing relating to petitioner’s tax years on date petitioner filed a form request for a collection_due_process_hearing for tax years and contended that there was no valid assessment of taxes he did not receive the statutory notice_and_demand for payment of the taxes at issue he did not receive a valid notice_of_deficiency and the amount of the underlying tax_liability was incorrect cc the sec_6330 hearing and respondent’s notice_of_determination on date respondent’s appeals_office conducted a hearing in petitioner’s case for tax years the record is silent as to why petitioner requested a hearing with respect to tax_year because respondent’s notice_of_intent_to_levy did not include that year was not at issue at the hearing petitioner attended the hearing he was not given an opportunity to challenge his underlying tax_liability for at the hearing at the hearing petitioner did not challenge the appropriateness of the intended method of collection offer an alternative means of collection or raise a spousal defense to collection on date respondent sent petitioner a notice_of_determination concerning collection action s under sec_6320 and or the lien or levy determination in which respondent determined to proceed with collection of deficiencies in petitioner’s income_tax additions to tax interest and the frivolous_return penalty for on date petitioner filed a petition for lien or levy action under sec_6320 or sec_6330 d the prior proceedings and remand of petitioner’s tax years in 118_tc_162 we held that petitioner may not contest his underlying tax_liability for tax years because he received notices of deficiency for those years sec_6330 b and that respondent’s determination to proceed with collection with respect to petitioner’s tax years was not an abuse_of_discretion however because petitioner did not receive the notices of deficiency for or and was not given an opportunity to challenge his underlying tax_liability for those years at the appeals_office hearing we issued an order remanding petitioner’s tax years to the commissioner to provide an opportunity for a hearing pursuant to sec_6330 relating to petitioner’s federal_income_tax liability for in our order remanding petitioner’s tax years to respondent we stated petitioner’s litigation position so far in this case prompts us to question whether he will use the hearing ordered herein to raise bona_fide issues relating to his underlying tax_liability for and if he uses that hearing only to raise frivolous issues like those rejected in nestor v commissioner t c we will consider an appropriate dispositive motion made by respondent and imposition of a penalty of up to dollar_figure under sec_6673 we also ordered the parties to file a status report with the court concerning petitioner’s tax years eb the opportunity for a hearing relating to petitioner’s tax years on date respondent’s appeals_office sent petitioner a letter stating that the sec_6330 hearing relating to petitioner’s tax years was scheduled for date on date petitioner called respondent’s appeals officer and said he could not attend a hearing on date he asked that the hearing be rescheduled for date the appeals officer told petitioner that he would reschedule the hearing for a date on or before date the date the parties were due to file the status report ordered by the court petitioner stated that he would call the appeals_office on may - - he did not do so nor did he attend the hearing on date respondent filed a report with the court in which respondent reported that petitioner did not propose an alternate date for a hearing other than date nor did he otherwise correspond with the appeals officer we ordered petitioner to respond to respondent’s report and to show cause why the circumstances reported by respondent do not provide a sufficient basis to enter a decision for respondent petitioner’s response consisted of copies of the order to show cause sec_601_102 through statement of procedural rules and an index from the code_of_federal_regulations he affixed to the pages five self-sticking removable notes containing the following statements requested a postponement to later date and was denied michael nestor enclosed is material i would use at a hearing no substitute return was ever offered by irs surprise surprise still can’t find law that requires me to pay an income_tax and if you can find the law please mail it to me thank you opinion a background respondent made a determination under sec_6330 for tax years and petitioner filed a timely petition for review thus we have jurisdiction under sec_6330 a to review respondent’s determination to proceed with collection of income - tax and additions to tax for petitioner’s tax years 117_tc_204 117_tc_159 in nestor v commissioner supra petitioner was provided an appeals_office hearing relating to at which he raised only frivolous arguments we held that respondent’s determination to proceed with collection of the tax_liabilities assessed against petitioner for was not an abuse_of_discretion by order we remanded petitioner’s tax years because he did not receive notices of deficiency for and at the hearing did not have an opportunity to contest the underlying tax_liabilities for sec_6330 b b whether respondent’s determination to proceed with collection as to was an abuse_of_discretion petitioner previously made frivolous arguments in the proceedings conducted with respect to his years see nestor v commissioner supra pincite he did not challenge the appropriateness of respondent’s intended method of collection although respondent determined to proceed with collection as to petitioner’s tax years we consider here only petitioner’s tax years we addressed petitioner’s tax years in 118_tc_162 at the time of trial in this case it appeared that respondent’s failure to offer a hearing was a jurisdictional defect 115_tc_417 however after trial this court ruled that it would no longer follow meyer 117_tc_159 --- - offer an alternative means of collection or make any bona_fide claim that collection was not appropriate his conduct throughout those proceedings was designed to delay resolution of his tax years thus we warned petitioner in the order remanding his tax years that if he continued to raise frivolous issues in the hearing on the tax years we would consider imposition of a penalty under sec_6673 on remand petitioner was offered but did not attend a hearing relating to his tax years instead he tried to delay the hearing for months he made no attempt to challenge the existence or amount of the underlying tax deficiencies for and he did not otherwise contact respondent regarding his tax years his response to the order to show cause was nonresponsive and contained the same frivolous contentions he raised in nestor v commissioner supra it is clear that petitioner instituted and maintained this proceeding solely for delay and that he does not intend to properly prosecute his tax years petitioner has given no bona_fide basis for his objection to the collection action we conclude that respondent’s determination to proceed with collection of the tax_liabilities assessed against petitioner for was not an abuse_of_discretion --- - cc whether to impose a penalty under sec_6673 we consider on our own motion whether this court should impose a penalty against petitioner under sec_6673 the court may require the taxpayer to pay a penalty to the united_states of not more than dollar_figure if the taxpayer instituted or maintained proceedings primarily for delay if the taxpayer’s position is frivolous or groundless or if the taxpayer unreasonably failed to pursue administrative remedies sec_6673 in remanding petitioner’s years we warned him that if he used the hearing to raise only frivolous issues as he did in nestor v commissioner supra we would consider an appropriate dispositive motion and imposition of a penalty under sec_6673 despite this petitioner persisted in maintaining frivolous positions in his response to the order to show cause and he sought to delay a hearing relating to his tax years petitioner’s attempt to delay the hearing for months his failure to reschedule it and his continuing to make frivolous arguments show that petitioner maintained this proceeding primarily for delay his positions in this proceeding are frivolous and groundless and he unreasonably failed to pursue administrative remedies sec_6673 we do not countenance the use of this court and lien and levy procedures under sec_6330 by taxpayers to pursue frivolous arguments - and to delay their inevitable reckoning with respondent accordingly we award a penalty to the united_states under sec_6673 in the amount of dollar_figure see 118_tc_365 court imposed a dollar_figure penalty under sec_6673 on taxpayer who instituted or maintained action under sec_6330 primarily for delay davis v commissioner tcmemo_2001_87 court imposed a dollar_figure penalty under sec_6673 for frivolous and groundless arguments in lien and levy case accordingly an appropriate order and decision will be entered