internal_revenue_service national_office technical_advice_memorandum date third party communication none date of communication not applicable number release date index uil no case-mis no -------------------------------------------------- ----------------------------------- tam-134113-05 cc fip b4 taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference ---------------------------------------------------- ----------------------------- ------------------------------ ---------------- ---------- -------------------------- legend ---------------------------------------------------------------------- ---------------------------------------------------------- ------------------------------------------------------- ------------------------- ---------------------- ------------------------------------------ taxpayer agreement xxx yyy aaa plan issue sec_1 whether taxpayer may apply the safe_harbor method for premium acquisition expenses provided in revproc_2002_46 2002_2_cb_105 to deduct the liability shown on its annual_statement with respect to a deferred_compensation plan for independent_contractor insurance agents prior to the taxable_year for which this compensation is deductible under sec_404 of the internal_revenue_code conclusion is to be applied without retroactive effect pursuant to sec_7805 if the conclusion with respect to issue is adverse to taxpayer whether this taxpayer is taxable under part ii of subchapter_l as a non-life insurance taxpayer cannot use the safe_harbor method_of_accounting for premium taxpayer’s request under sec_7805 to have the conclusion with respect to tam-134113-05 conclusions acquisition expenses provided in revproc_2002_46 to deduct the liability shown on its annual_statement with respect to a deferred_compensation plan for independent_contractor insurance agents sec_404 and sec_404 specifically preclude taxpayer from deducting the contributions or compensation allocable to this plan prior to the taxable_year in which such compensation is includible in the gross_income of the agents participating in the plan these deduction limitations apply regardless of whether the contributions or compensations would otherwise be deductible under any other code provisions issue applied without retroactive effect is denied facts company and is the parent_corporation of an affiliated_group_of_corporations that file a consolidated federal_income_tax return taxpayer and certain affiliated insurance_companies collectively referred to as taxpayer sell property and casualty insurance through independent_contractor agents located throughout the united_states each agent enters into a written_agreement with taxpayer styled agreement the agreement serves to govern all aspects of the business relationship between the parties and has been enforced by the courts the agreement requires the agent to act as taxpayer’s exclusive agent in the sale and servicing of insurance_business the agreement also provides that the agent will be treated as an independent_contractor for all purposes including the responsibility for paying all federal state and local income and self- employment_taxes under the agreement the agents are entitled to receive regular commissions based on the amount of premiums that they generate on both new and recurring insurance_business the agreement also contains a deferred_compensation arrangement called the plan under the plan taxpayer agrees to pay participating agents additional_amounts on their retirement or termination depending on the agent’s past business performance and whether certain other requirements are met all payments under the plan are based on the agent’s regular commissions for certain prior periods which in turn reflect the amount of premiums that the agent generated in such periods with respect to both recurring and new business taxpayer’s contractual liability to pay these additional_amounts is dependent upon there being a qualified cancellation of the agreement a qualified cancellation is generally any cancellation of the agreement unless the agent has induced or attempted to induce either directly or indirectly policyholders to lapse cancel or replace any of their policies with taxpayer the plan basically has two separate components the first payment component tam-134113-05 is styled as the agent’s xxx the amount of an agent’s xxx is based on the level of the agent’s regular commissions for the year to the extent that such regular commissions exceed certain dollar thresholds set forth in the plan if the agent generates an amount of regular commissions in excess of the plan’s minimum dollar threshold the agent earns an xxx equal to a percentage of the excess up to the next threshold taxpayer accumulates the xxx credited each year in a memorandum account that taxpayer maintains for each agent on the agent’s retirement or termination taxpayer will pay out the agent’s accumulated xxx in not less than nor more than annual installments provided there has been a qualified cancellation of the agreement and the agent has satisfied certain minimum age requirements if the agreement terminates as a result of the agent’s death or permanent disability taxpayer will also pay out the agent’s xxx either to the agent or to a designated_beneficiary provided that the agent has completed at least five years_of_service the second payment component under the plan is styled as the agent’s yyy this payment component entitles the agent to receive an amount equal to the last full calendar months renewal_commissions upon a qualified cancellation of the agreement as the liability with respect to yyy is not determinable prior to the agent’s retirement or termination taxpayer accrues a liability with respect to yyy only with respect to agents who have already retired or otherwise terminated their relationship with taxpayer and yyy payments to which an agent will ultimately be entitled for example if an agent retires before age the agent receives less than of the xxx using a sliding scale based on age in addition certain actions taken by the agent can cause taxpayer’s liability to make xxx and yyy payments to the agent to be extinguished completely in that regard if the actions of an agent involve soliciting taxpayer’s policyholders within a certain distance of the agent’s prior business location or inducing any of those policyholders to cancel or lapse any of their insurance policies with taxpayer taxpayer’s liability to make additional xxx or yyy payments to the agent ceases consolidated federal_income_tax return for the taxable_year ended december ------ requesting an automatic change to treat the net increase in the liability shown on its annual_statement with respect to the plan as premium acquisition expenses_incurred for the tax_year under the safe_harbor method provided by revproc_2002_46 taxpayer’s application indicated that as of the beginning of the ------ taxable_year the liability shown on taxpayer’s annual_statement with respect to the plan was aaa taxpayer treated this amount as the negative sec_481 adjustment resulting from the change in accounting_method which was taken into account as a reduction of taxpayer’s taxable_income for the ------- taxable_year taxpayer filed form_3115 application_for change in accounting_method with its the plan contains various payment provisions that may affect the amount of xxx tam-134113-05 on the form_3115 taxpayer stated that it was adopting the safe_harbor method_of_accounting because the plan meets the definition of a premium acquisition expense under rev_proc amounts relating to taxpayer’s plan meet the definition of a premium acquisition expense as stated above the amounts under the plan are additional compensation to the agent for the production of premiums similar to a commission the only difference is that payment to the agent is deferred thus these amounts are primarily related to the production of premiums in addition the amounts for both the xxx and yyy components of the plan are determined by formulas that are based on commissions since commissions are determined as a percentage of the premium the amounts under the plan vary directly with the amount of gross premiums on the underlying contracts taxpayer also stated on the form_3115 that although it had previously limited its deductions with respect to the plan to the amounts actually paid out to agents pursuant to sec_404 the safe_harbor method set forth in revproc_2002_46 allows insurance_companies to deduct the premium acquisition expenses shown on the annual_statement regardless of whether another code provision would preclude the deduction under the safe_harbor method taxpayer’s accrual in the annual_statement for amounts under the plan would fall within the unpaid premium acquisition expenses shown on the annual_statement referred to in section dollar_figure b of rev_proc therefore the change in the annual_statement accrual is deductible as a component of premium acquisition expenses for the tax_year the safe_harbor method applies to premium acquisition expense accruals shown on the annual_statement even though they may not meet the all_events_test or are otherwise subject_to other irc sections governing the timing of deductions pursuant to section of revproc_2002_9 2002_1_cb_327 the field reviewed the form_3115 filed by taxpayer to determine if the change in method_of_accounting was made in accordance with the applicable provisions of revproc_2002_46 as a result of this review the field has requested national_office technical_advice to determine whether taxpayer is entitled to use the safe_harbor method provided in revproc_2002_46 to deduct the liabilities related to the plan prior to the taxable_year for which this deferred_compensation would deductible under sec_404 and sec_404 accounting provided by revproc_2002_46 to accelerate the deduction of the liabilities relating to the plan for two reasons first the field contends that taxpayer’s agent deferred_compensation liabilities are not premium acquisition expenses as defined in revproc_2002_46 because the deferred benefits that agents receive under the plan the field has challenged taxpayer’s application of the safe_harbor method of taxpayer contends that because the liabilities shown on its annual_statement tam-134113-05 are based on factors other than the agents’ past regular commissions and thus do not directly vary with the acquisition of gross premiums written on new and renewal insurance contracts even if the liabilities relating to the plan fit the definition of premium acquisition expenses under revproc_2002_46 the field argues that taxpayer cannot apply the revenue procedure’s safe_harbor method because the deduction limitations of sec_404 and sec_404 specifically govern when this deferred_compensation must be taken into account with respect to the plan meet the definition of premium acquisition expenses under revproc_2002_46 it is entitled to treat those liabilities as part of its deductible premium acquisition expenses notwithstanding the deduction limitations of sec_404 taxpayer further contends that by issuing revproc_2002_46 the service invited insurance_companies to rely on annual_statement accounting when determining their deductible premium acquisition expenses since taxpayer contends that it complied with and in good_faith relied upon rev_proc 2002-46’s automatic change procedure taxpayer requests that in the event of adverse advice its use of the safe_harbor method be discontinued on a prospective basis pursuant to the commissioner’s authority under section sec_7805 for purposes of addressing this technical_advice the field and taxpayer agree that in the absence of revproc_2002_46 taxpayer’s liability with respect to the plan constitutes deferred_compensation subject_to the deduction limitations of sec_404 and sec_404 issue law every insurance_company other than a life_insurance_company sec_832 provides that the taxable_income of an insurance_company subject_to the tax imposed by sec_831 is the gross_income as defined in sec_832 less the deductions allowed by sec_832 sec_832 provides that the gross_income of an insurance_company subject_to tax under sec_831 includes the combined gross amount earned for the taxable_year from investment_income and underwriting_income as provided in sec_832 computed on the basis of the annual_statement approved by the national association of insurance commissioners under sec_832 underwriting_income consists of the premiums earned on insurance contracts during the taxable_year less losses_incurred and expenses_incurred sec_831 imposes a tax for each taxable_year on the taxable_income of sec_832 provides that the computation of premiums earned on sec_832 lists various categories of allowable deductions including all tam-134113-05 insurance contracts during the taxable_year is made by taking the gross premiums written on insurance contracts during the taxable_year reduced by return_premiums and premiums_paid for reinsurance subject_to certain exceptions not relevant here the amount so obtained is increased by percent of the unearned premiums on outstanding business at the end of the preceding_taxable_year and is reduced by percent of the unearned premiums on outstanding business at the end of the current taxable_year sec_832 provides that expenses_incurred means all expenses shown on the insurance company’s annual_statement expenses_incurred generally are calculated as the sum of the expenses paid during the taxable_year plus the increase in unpaid expenses during the year for this purpose expenses_incurred do not include any unpaid loss adjustment expenses shown on the annual_statement which are to be treated as part of the insurance company’s unpaid_losses to be included in expenses_incurred an expense listed on the annual_statement also must be an allowable deduction under sec_832 ordinary and necessary business_expenses incurred as provided under sec_162 taxes as provided under sec_164 and other deductions as provided in part vi of subchapter_b sec_161 and following relating to itemized_deductions for individuals and corporations and subchapter_d sec_401 and following relating to pension profit sharing stock_bonus_plans etc see sec_832 sec_832 and sec_832 sec_461 provides that for purposes of determining of whether an amount has been incurred with respect to any item during any taxable_year the all_events_test shall not be treated as met any earlier than the taxable_year in which economic_performance occurs with respect to that liability when the liability of a taxpayer arises out of that taxpayer’s receipt of services provided by another person generally economic_performance with respect to that liability occurs as the services are performed sec_461 the rules set forth in sec_461 do not apply to any item for which the code specifically provides for a deduction for a reserve for estimated expenses sec_461 accounting a liability is incurred and generally is taken into account for federal_income_tax purposes in the taxable_year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability internal revenue regulation revenue_procedure or revenue_ruling the economic_performance requirement of sec_461 and the regulations thereunder is satisfied to the sec_1_461-1 provides in general that under an accrual_method of sec_1_461-1 provides in part that except as provided in any sec_404 provides the general_rule that compensation paid under a sec_1_461-1 provides in part that if any provision of the code sec_404 provides that if compensation is paid_or_accrued on account of tam-134113-05 extent that any amount is otherwise deductible under sec_404 employer contributions to a plan of deferred_compensation requires a liability to be taken into account in a taxable_year later than the taxable_year provided in sec_1_461-2 the liability is taken into account as prescribed by that code provision any employee under a plan deferring the receipt of compensation the compensation is not deductible under chapter of subtitle a sec_1 through 1400l but if the compensation would otherwise be deductible it is deductible under sec_404 subject_to the limitations imposed by sec_404 as to the amounts deductible in any year nonqualified_plan contributions to which are deductible under sec_404 or of deferred_compensation is deductible in the taxable_year in which an amount attributable to the contribution is includible in the gross_income of employees participating in the plan arrangement that has the effect of a plan deferring the receipt of compensation sec_404 shall apply as if there were a plan paid to nonemployees by providing that if a plan would be covered by sec_404 as modified by sec_404 but for the fact that no employer-employee relationship exists the contributions or compensation if otherwise deductible under chapter of subtitle a shall be deductible for the taxable_year in which an amount attributable to the compensation is includible in the gross_income of the persons participating in the plan deduction of compensation paid_or_incurred with respect to plans or methods or arrangements however denominated that defer the receipt of any amount of compensation or benefit including fees and other_payments under sec_404 and b if otherwise deductible a contribution paid_or_incurred with respect to a nonqualified_plan or method or arrangement is deductible in the taxable_year of the employer in which or with which ends the taxable_year of the employee in which the amount attributable to the contribution is includible in the gross_income of the employee without regard to any applicable exclusions under chapter subtitle a compensation_for service providers with respect to which there is no employer- employee relationship sec_404 and b and the regulations thereunder apply as if the sec_1_404_b_-1t q a-1 provides in part that sec_404 and d govern the sec_404 extends the application of sec_404 to benefits or compensation sec_1_404_d_-1t provides in part that in the case of deferred benefits or sec_404 provides that if there is no plan but there is a method or sec_1_404_b_-1t q a-2 b provides that a plan or method or sec_1_404_b_-1t q a-2 a provides that a plan or method or arrangement under sec_1_404_b_-1t q a-2 b the taxpayer may rebut this presumption only tam-134113-05 person providing the services were the employee and the persons to whom the services are provided were the employer defers the receipt of compensation or benefits to the extent an employee receives compensation or benefits thereunder more than a brief period of time after the end of the employer’s taxable_year in which the services creating the right to such compensation or benefits are performed the determination whether a plan or method or arrangement defers the receipt of compensation or benefits is made separately with respect to each employee and each amount of compensation or benefit arrangement is presumed to be one that defers the receipt of compensation_for more than a brief period of time after the end of an employer’s taxable_year to the extent that compensation is received after the 15th day of the third month after the end of the employer’s taxable_year in which the services are rendered the month period by demonstrating that it was impracticable to avoid the deferral of the receipt by an employee of the amount of compensation or benefits beyond the applicable month period and that as of the end of the employer’s taxable_year such impracticability was unforeseeable revproc_2002_46 provides certain insurance_companies subject_to tax under sec_831 with a safe_harbor method_of_accounting for premium acquisition expenses and a procedure to obtain automatic consent to change to the safe_harbor method section dollar_figure of revproc_2002_46 describes this safe_harbor method as follows insurance_company is permitted to treat as premium acquisition expenses_incurred for the tax_year an amount equal to the sum of- the insurance company’s annual_statement for the tax_year and the unpaid premium expenses shown on the company’s annual_statement for the preceding tax_year and premium acquisition expenses at the end of the tax_year and the company’s pro forma premium acquisition expenses at the end of the preceding tax_year deductibility of certain pro forma expenses as follows c the difference between the amount of the insurance company’s pro forma b the difference between the unpaid premium acquisition expenses shown on a the amount of premium acquisition expenses paid during the tax_year sec_5 ii of revproc_2002_46 provides a limitation on the current i except as provided in sec_5 ii or this revenue_procedure an tam-134113-05 ii for purposes of calculating the premium acquisition expenses_incurred for the taxable yearn under sec_5 i of the revenue_procedure the amount taken into account as a net increase in pro forma premium acquisition expenses during the year under sec_5 i c cannot exceed the insurance company’s unearned_premium_reserve offset amount for that year if the amount taken into account as a net increase in pro forma premium acquisition expenses during the year under sec_5 i c is reduced as a result of this limitation the reduction amount is carried forward and increases the company’s pro forma premium acquisition expenses at the end of the succeeding taxable_year are subject_to the safe_harbor method section dollar_figure of revproc_2002_46 defines premium acquisition expenses that a premium acquisition expense is an expense that is primarily related to production of gross premiums written on an insurance_contract and directly varies with the amount of gross premiums on the underlying contract for example agent and broker commissions premium taxes and premium-based assessments generally qualify as premium acquisition expenses because these expenses vary with and are primarily related to the acquisition of gross premiums written on new and renewal insurance contracts an annual expense allowance payable by a reinsurer to assume all or a portion of the risk on insurance contracts of another company is treated as a premium acquisition expense to the extent that this expenses allowance reflects the reinsurer’s reimbursements of the premium acquisition expenses_incurred by the direct writing company however expenditures with respect to salaried personnel and general administrative costs typically will not qualify as premium acquisition expenses although a portion of these costs may be associated with activities relating to the issuance of insurance contracts these expenditures do not vary directly based on the amount of gross premiums for the associated contracts analysis the issue in this technical_advice request is twofold whether the liability for the plan shown on the taxpayer’s annual_statement meets rev_proc 2002-46’s definition of premium acquisition expenses and if so whether taxpayer may use the revenue procedure’s safe_harbor to deduct such liability without regard to the deduction limitations for deferred_compensation under sec_404 the definition of premium acquisition expenses set forth in revproc_2002_46 was intended to restrict the expenses eligible to be accounted for under the safe_harbor method to those expense categories for which there was a direct nexus between the expenses_incurred by the insurance_company and the amounts included by the company in gross premium written with respect to new and renewal insurance policies when determining premiums earned under sec_832 accordingly revproc_2002_46 refers to agent’s commissions premium taxes and premium-based assessments as arguably the liabilities relating to taxpayer’s plan do not bear a direct nexus to tam-134113-05 examples of premium acquisition expenses because these expenses are directly linked to the insurance company’s direct written premiums the amounts taken into account by taxpayer as gross premiums written on new and renewal insurance contracts because the deferred benefits that an agent receives under the plan may vary depending on the overall level of the agent’s business performance the agent’s age and years_of_service and other factors specified in the plan moreover unlike the items cited as examples of premium acquisition expenses in revproc_2002_46 which under annual_statement accounting conventions must be charged off against an insurance company’s underwriting_income for the year in the related gross premiums written are recorded taxpayer accounts for the plan liabilities through a reserve provision based on the actuarial present_value of the estimated future payments under the plan this method of measuring the liability implicitly treats the deferred_compensation as being funded by a combination of taxpayer’s current income and future investment earnings despite these differences the definition of premium acquisition expenses set forth in revproc_2002_46 does not specifically provide that such expenses must be based exclusively on the amount of gross premiums written on the underlying insurance policies in addition even in the case of the expense categories cited by revproc_2002_46 as examples of premium acquisition expenses the amount of the insurance company’s liability for the expense may be affected by factors other than the gross premiums written recorded on the insurance company’s annual_statement in light of the manner in which revproc_2002_46 defines premium acquisition expenses and because we believe that the more fundamental issue is whether the revenue procedure’s safe_harbor method overrides the deduction limitations of sec_404 and sec_404 we conclude that solely for purposes of this technical_advice request taxpayer’s deferred_compensation liabilities should be treated as meeting the definition of premium acquisition expenses under revproc_2002_46 in the tax_reform_act_of_1986 congress amended the provisions of sec_832 to provide that in computing premiums earned an insurance_company was allowed to deduct only percent of the net increase of unearned premiums during the taxable_year the legislative committee reports indicate that congress adopted the percent reduction of unearned premiums as a means of correcting the mismeasurement of income that resulted from the deferral of unearned premiums and the current deduction of premium acquisition expenses including premium acquisition expenses attributable to unearned premiums amount of unearned premiums on outstanding business at the end of the taxable_year when determining premium earned under sec_832 at the same time an insurance_company was allowed to deduct the related expenses in generating new and renewal insurance policies in the year incurred as provided by sec_832 and sec_832 prior to the act an insurance_company was allowed to exclude the full the act legislative committee reports suggest that in adopting the tam-134113-05 notwithstanding that such expenses might include amounts attributable to the unearned premiums rather than adopt a rule requiring the deferral of an insurance company’s deductions for premium acquisition expenses attributable to unearned premiums which would have involved difficult measurement issues congress chose instead to address the mismatching of income and deductions by providing that only percent of the net increase in unearned premiums during the taxable_year was excluded from the insurance company’s premiums earned the legislative committee reports of the act indicate that the percent reduction of unearned premiums was intended to represent the allocable portion of the company’s expenses_incurred in generating the unearned premiums and thus was equivalent to denying current deductibility for a portion of the insurance company’s premium acquisition expenses percent reduction of unearned premiums congress operated under the assumption that this adjustment was necessary to correct for the current deductibility of premium acquisition expenses allowed by sec_832 and sec_832 in 571_f2d_514 10th cir and the 875_f2d_377 the courts ruled that an insurance_company was not permitted to deduct unpaid commissions relating to deferred premium installments as incurred expenses under sec_832 and sec_832 even though the unpaid commissions were shown as incurred expenses on the company’s annual_statement in those cases the courts interpreted the reference to ordinary and necessary expenses in sec_832 as meaning that to be deductible such expenses must be paid_or_incurred within the meaning of sec_162 the years involved predated the enactment of sec_404 the courts also upheld the disallowance of the companies’ accrual of unpaid commissions based on the commissioner’s authority under sec_446 to disregard a taxpayer’s ordinary method_of_accounting to the extent that such method did not clearly reflect income the courts found that allowing the taxpayers to deduct the unpaid commissions based on annual_statement accounting conventions would not clearly reflect income because such commissions were taken into account as a current deduction whereas the deferred premium installments were allocable to the insurance company’s unearned_premium_reserve and thus were includible in taxable_income only when the insurance_company provided the future coverage funded by those installments the holdings in western casualty and home group applied to taxable years prior to the effective date of the act’s amendments to sec_832 on date the service and treasury issued final regulations under sec_1_832-4 through relating to the determination of underwriting_income by non-life insurance_companies the regulations address the manner in which non-life insurance_companies determine gross premiums written and the amount of unearned premiums which are subject_to the percent reduction provided by sec_832 the rules set forth in sec_1_832-4 apply regardless of the method that the insurance_company uses to record written premiums and unearned premiums on its annual_statement filed for state regulatory reporting purposes in some situations the revproc_2002_46 provides that under the safe_harbor method_of_accounting tam-134113-05 regulations may require an insurance_company to take into account the gross premiums written for an insurance_contract earlier in the calculation of premiums earned under sec_832 than the year for which those premiums are recorded on the company’s annual_statement in these situations the regulations may cause the insurance_company to accelerate the amount of premiums earned under sec_832 due to the effect of the percent reduction of unearned premiums for premium acquisition expenses an insurance_company is permitted to treat as premium acquisition expenses_incurred for the taxable_year the yearly net increase in unpaid premium acquisition expenses shown on the company’s annual_statement as well as the yearly net increase in certain pro forma premium acquisition expenses these expenses are deductible under sec_832 and sec_832 even if they would not otherwise be treated as incurred under the general accrual accounting rules cf western casualty and home group revproc_2002_46 indicates that the service allowed insurance_companies to use this safe_harbor method for premium acquisition expenses consistent with the intent underlying the percent reduction of unearned premiums required by sec_832 ie that such reduction was intended to correct the mismatching that results from the deferral of unearned_premium income and the current deduction of premium acquisition expenses there is nothing in rev_proc 2002-46’s description of the safe_harbor method that suggests this method would override the deduction limitations of sec_404 and sec_404 revproc_2002_46 makes no mention of the deduction limitations of sec_404 nor does the plain language used in the revenue_procedure to describe the safe_harbor method - ie that an insurance_company may use the safe_harbor method to determine the premium acquisition expenses_incurred for the taxable_year - imply that if an insurance_company were to treat a liability for deferred_compensation as a premium acquisition expense the company could use this method to deduct such deferred_compensation without regard to the deduction limitations of sec_404 that preclude a taxpayer from deducting deferred_compensation expenses that it has incurred until such compensation is includible in the income of the plan participant d it is evident that the deduction limitations of sec_404 must be satisfied independently of the revenue procedure’s safe_harbor for purposes of determining the year of deduction of taxpayer’s agents deferred_compensation liabilities sec_404 and sec_404 specifically provide that if an employer’s contributions or compensation with respect to a nonqualified_plan of deferred_compensation would otherwise be deductible such contributions or compensation shall not be deductible under the employer’s regular_method of accounting but shall be deductible under sec_404 for the taxable_year in which amounts with respect to such contributions or compensation are includible in the gross_income of the persons participating in the plan when revproc_2002_46 is placed alongside the provisions of sec_404 and even if taxpayer’s characterization of the service’s purpose and legal basis for taxpayer argues that the liabilities shown on its annual_statement with respect to tam-134113-05 the plan are deductible because the concept underlying the revenue procedure’s safe_harbor method is that in order to match the income generated by the percent reduction of unearned premiums with an insurance company’s deductions for premium- related expenses the company should be permitted to deduct all premium acquisition expenses for the taxable_year in which related premiums are recognized in determining premiums earned under sec_832 taxpayer contends that the service provided this special treatment of premium acquisition expenses pursuant to the commissioner’s authority under sec_446 recognizing that without this premium expense matching the percent reduction of unearned premiums under sec_832 would not operate to compensate for the current deduction of the insurance company’s premium acquisition expenses issuing revproc_2002_46 is correct we do not think such purpose and legal basis evidence an intent to override sec_404 sec_404 and sec_404 provide specific limitations on the deduction of employer’s contributions or compensation under a deferred_compensation plan allowing the deduction only as set forth in those provisions the concept underlying sec_404 and sec_404 is that in order to ensure that employers do not have a tax incentive to adopt deferred_compensation plans over qualified_pension plans the employer’s deduction of the contributions or compensation attributable to such deferred_compensation plans is allowed no earlier than the amounts are includible in the gross_income of the persons participating in such plan or arrangement accordingly the rules for nonqualified_deferred_compensation operate on a matching_rule that ensures that the employer is ordinarily not allowed a deduction with respect to contributions or compensation under the plan until such contributions or compensation are taxed to the employee the matching_rule applies specifically for the purposes of sec_404 and is fundamentally different than the income and expense matching concepts of sec_446 provided by revproc_2002_46 should be construed as overriding other deduction limitations in the code including sec_404 because this result is necessary to sustain the validity of the regulations under sec_1_832-4 taxpayer contends that the service issued revproc_2002_46 in order to avoid a protracted controversy with the insurance industry over the validity of the regulations under sec_1_832-4 in a number of situations the regulations require an insurance_company to include amounts in gross written premiums for purposes of determining the company’s premiums earned under sec_832 prior to the year in which those premiums are reported on the company’s annual_statement or to the year in which those premiums would be taken into account under general accrual accounting rules according to taxpayer in order to sustain the validity of these rules the service recognized that it was necessary to permit an insurance_company to accelerate the deduction of all related premium acquisition expenses including unpaid agents commissions regardless of whether the commissions are shown on the annual_statement taxpayer argues that rev_proc taxpayer’s other principal argument is that the safe_harbor method_of_accounting we will not address taxpayer’s arguments regarding the possible impact that tam-134113-05 2002-46’s allowance of a deduction for unpaid agents commissions necessarily implicates sec_404 since in many instances such commissions will not be paid to the agent within the ½ month period after the end of the taxable_year in which the agent’s services with respect to the sale of the insurance_policy were performed thus if the safe_harbor method were interpreted as precluding the deduction of premium acquisition expenses that are subject_to sec_404 taxpayer argues that this would render the relief provided to insurance_companies with respect to their unpaid agents commissions a dead letter applying the deduction limitations under sec_404 and sec_404 to an insurance company’s premium acquisition expenses could have on the validity of the regulations under sec_1_832-4 because these arguments are frankly irrelevant to the facts of this technical_advice request there is nothing in the stated facts that suggests that taxpayer was required under sec_1_832-4 to accelerate the reporting of gross premiums written with respect to its property and casualty insurance_business taxpayer’s final argument is that the limitation specified in sec_5 ii of revproc_2002_46 with respect to the current deductibility of pro forma premium acquisition expenses shows that the service did not intend that the treatment of premium acquisition expenses provided for in revproc_2002_46 would be overridden by other limitations in the code such as sec_404 to prove this point taxpayer posits a situation in which an insurance_company has pro forma premium acquisition expenses in excess of the limitation specified in sec_5 ii a portion of which would also be limited by sec_404 if the insurance_company reduces its pro forma premium acquisition expenses by the limitation in sec_5 ii and then makes a further reduction to the extent the remaining pro forma expenses are attributable to deferred_compensation subject_to sec_404 the limitation in sec_5 ii produces an inequitable result because it crowds out pro forma expenses that would have been otherwise deductible if the limitation in sec_404 were to be applied first we do not find this argument persuasive at most this argument shows that rev_proc 2002-46’s rules regarding the treatment of pro forma premium acquisition expenses did not clearly provide that the sec_5 ii limitation should be applied after the sec_404 limitation the argument does not demonstrate that the safe_harbor method_of_accounting provided by revproc_2002_46 overrides the deduction limitations of sec_404 and sec_404 issue law sec_601_201 of the statement of procedural regulations provides in part that a ruling except to the extent incorporated in a closing_agreement may be revoked or modified at any time in the wise administration of the taxing statutes if a ruling is revoked or modified the revocation or modification applies to all open years under the tam-134113-05 statutes unless the commissioner or_his_delegate exercises the discretionary authority under sec_7805 to limit the retroactive effect of the revocation or modification sec_601_201 provides in part that except in rare or unusual circumstances the revocation or modification of a ruling will not be applied retroactively with respect to the taxpayer to whom the ruling originally was issued or to a taxpayer whose tax_liability directly was involved in such ruling if i there has been no misstatement or omission of material facts ii the facts subsequently developed are not materially different from the facts on which the ruling was based iii there has been no change in the applicable law iv the ruling originally was issued with respect to a prospective or proposed transaction and v the taxpayer directly involved in the ruling acted in good_faith in reliance upon the ruling and the retroactive revocation would be to his detriment sec_7805 provides that the secretary may prescribe the extent if any to which any ruling including any judicial decision or ay administrative determination other than by regulation relating to the internal revenue laws shall be applied without retroactive effect sec_15 of revproc_2005_2 i r b big_number sets forth a defined set of circumstances in which the service may apply a technical_advice_memorandum tam that retroactively revokes an earlier tam or ruling that involves a particular taxpayer section of revproc_2005_2 2005_1_irb_86 provides that under sec_7805 an associate chief_counsel as the commissioner’s delegate may prescribe the extent if any to which a tam will be applied without retroactive effect it is the position of the service that it does not revoke a revenue_procedure taxpayer has requested that if the service sustains the field’s position that the through the issuance of a technical_advice_memorandum see cc-2003-014 date analysis technical_advice would be applied without retroactive effect pursuant to sec_7805 taxpayer also suggests that if the service believes that its application of the safe_harbor method was inappropriate the service should modify revproc_2002_46 to carve out the long-term compensation from the definition of premium acquisition expenses such modification should also apply on a prospective basis taxpayer contends that the service invited non-life insurance_company taxpayers to use revproc_2002_46 to deduct all premium acquisition expenses in the year in which the related gross written premiums are included under sec_832 taxpayer represents it relied upon this definition of premium acquisition expenses in changing its method_of_accounting taxpayer also contends that if the service sustains tam-134113-05 the field’s position that the safe_harbor method does not override sec_404 it will be to the taxpayer’s detriment because other non-life companies that filed under the revenue_procedure treated unpaid agents commissions as premium acquisition expenses_incurred for the taxable_year without regard to the deduction limitations for deferred_compensation under sec_404 the procedural and administrative regulations sec_601_201 and revproc_2005_2 apply to a particular taxpayer taxpayer may have met the standards of sec_601_201 in interpreting the definition of premium acquisition expenses under revproc_2002_46 however taxpayer does not meet the standards of sec_601_201 for the change in method_of_accounting because the safe_harbor method_of_accounting described in revproc_2002_46 does not override sec_404 and sec_404 accordingly taxpayer’s request for relief under sec_7805 is denied caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


date internal_revenue_service number info release date uil conex-127776-04 cc tege eoeg et1 the honorable debbie stabenow united_states senator west congress street suite detroit mi attention bridget johnson dear senator stabenow this letter is in response to your inquiry addressed to the taxpayer_advocate copy enclosed dated date on behalf of your constituent mr ken kolk mr kolk said that when he retired last spring from teaching he received a severance incentive payment for resigning and giving up his tenure rights he said this payment is not earnings and questioned why he has to pay federal_insurance_contributions_act fica_taxes on this retirement payment he referred to an unnamed recent federal_circuit court_of_appeals case that he believes supports his view although i do not have enough information to discuss mr kolk’s specific circumstances i can provide the following general information the tax law imposes fica_taxes on wages which includes all payments made as remuneration for employment unless specifically excluded from fica coverage employment for fica purposes means any service of whatever nature an employee performs for the person employing him in 327_us_358 the supreme court interpreted the term service broadly under the social_security act the benefits legislation corresponding to fica to mean not only work actually done but the entire employer-employee relationship for which compensation is paid to the employee by the employer the same words used in the fica and the social_security act are presumed to have consistent meanings provided that such consistency serves the distinct purposes of the statutes namely tax collection and provision of benefits the tax regulations provide that the name used to describe the remuneration is immaterial the tax regulations also generally provide that remuneration constitutes wages even though the relationship of employer and employee no longer exists at the time paid thus the fact that a payment is called a severance incentive payment or is made after termination of employment does not change its characterization as wages additionally the federal_circuit court case we believe mr kolk referred to is north dakota state university v united_states 22_f3d_599 8th cir the case involved in part payments to professors for relinquishing formal tenure rights the irs issued an action on decision aod on date to explain the irs’ position on university faculty early retirement payments in this aod the irs disagrees with the eighth circuit’s decision that early retirement payments made by a university to its tenured faculty members for the relinquishment of their tenure rights were not wages and therefore not subject_to fica_taxes the aod further states that the irs recognizes the precedent this decision establishes for cases appealable to the eighth circuit and therefore will follow the decision for cases that have the exact facts within that circuit however the aod also states that the irs will continue to litigate its position that the decision is erroneous in cases having different facts in the eighth circuit and in all cases in other circuits mr kolk indicates in the materials provided that he is not within the jurisdiction of the eighth circuit we have enclosed a copy of this aod that you can forward to him i hope this information is helpful please call elliot m rogers or me at if you have any questions sincerely janine cook branch chief employment_tax office of division counsel associate chief_counsel tax exempt and government entities enclosures


internal_revenue_service index no number release date cc dom p si plr-117604-99 in re legend taxpayer tpv seller dear this is in response to a request for private_letter_ruling dated date and subsequent correspondence made on behalf of taxpayer by its authorized representative requesting whether the appropriate constructive_sale price for articles that taxpayer manufactures is the price at which taxpayer purchases the same articles from a third party vendor taxpayer a distributor of taxable sport_fishing_equipment recently acquired the equipment inventory and building previously owned by seller a manufacturer of sport_fishing_equipment from whom taxpayer formerly bought products taxpayer now manufactures the same taxable equipment that it purchases from taxpayer sells the equipment to retailers for sale to end users to two-step stocking distributors and wagon jobbers wholesale distributors and to end users via catalogs and e-commerce sec_4161 of the internal_revenue_code imposes on the sale by the manufacturer producer or importer of articles of sport_fishing_equipment a tax equal to percent of the price for which the articles are sold generally the basis for computing the manufacturers excise_tax is the actual selling_price of the article if however an article is sold at retail on consignment or otherwise than in an arm’s-length transaction at less than fair_market_value the tax must be based on a constructive_sale price determined under sec_4216 sec_4216 provides that where an arm’s-length sale at retail is made by the manufacturer the manufacturers excise_tax is computed based on the lower_of the price for which the article is sold or the highest price for which the article is sold to wholesale distributors in the ordinary course of trade by manufacturers or producers as determined by the irs this paragraph shall not apply if paragraph applies sec_4216 provides a special rule under which the constructive_sale price for sales at retail or to retailers is computed when the conditions contained therein are met the section provides in part that if an article is sold at retail or to a retailer and if the manufacturer of the article regularly sells the articles at retail or to retailers and also regularly sells the articles to one or more wholesale distributors in arm’s-length transactions then the constructive_sale price will be the lower_of the price for which the articles are sold or the highest price for which the articles are sold by the manufacturer to wholesale distributors sec_48_4216_b_-1 of the manufacturers and retailers excise_tax regulations defines a retail_sale as a sale of an article to a purchaser who intends to use or lease the article rather than resell it sec_48_4216_b_-1 defines a retail dealer or retailer as a person engaged in the business of selling articles at retail sec_48_4216_b_-1 defines a wholesale_distributor as a person engaged in the business of selling articles to persons engaged in the business of reselling the articles revrul_81_226 1981_2_cb_213 modifying revrul_80_273 1980_2_cb_350 provides that the constructive_sale price for computing the manufacturers excise_tax imposed by sec_4161 when the articles are sold at retail by manufacturers who do not sell like articles to wholesale distributors is percent of the actual selling_price revrul_81_73 1981_1_cb_501 holds that in computing the tax on retail sales a manufacturer may use the highest price for which it sells similar articles to wholesale distributors provided it has an established bona_fide practice of selling the articles in substantial quantities to those distributors where it is not shown that a manufacturer has a bona_fide practice of selling articles in substantial quantities to wholesale distributors a constructive_sale price will be determined by the commissioner taxpayer may only establish the price upon which the tax is based after answering the following questions to whom is the item being sold the purchaser to whom if anyone is the purchaser selling does taxpayer regularly sell the articles at arm’s length at retail or to retailers does taxpayer regularly sell at arm’s length substantial quantities of the articles to wholesale distributors the taxable sale price of an article manufactured and sold by taxpayer at retail when taxpayer does not regularly sell the same article to wholesale distributors at arm’s length is percent of the actual sale price of the article if taxpayer does regularly sell the same article to wholesale distributors the sale price of the article sold at retail is the lower_of the price for which the item is sold or the highest price for which the article is sold to wholesale distributors the taxable sale price of an article manufactured and sold by taxpayer to a retail dealer when the same article is not regularly sold at arm’s length to wholesale distributors is the actual price for which the article is sold the taxable sale price of an article manufactured and sold by taxpayer to retail dealers when taxpayer regularly sells the same article to wholesale dealers is the lower_of the price for which the article is sold or the highest price of the same article sold to wholesale distributors the taxable sale price of an article manufactured and sold by taxpayer to a wholesale_distributor is the actual price for which the article is sold under any circumstance the actual price for which an article is sold must be determined in accordance with sec_4216 there is no provision of law that would allow taxpayer to construct a sale price on the sport_fishing_equipment that it manufactures in the way taxpayer has suggested accordingly the price at which taxpayer purchases the same articles from not the appropriate constructive_sale price for taxpayer to use this ruling is directed only to the taxpayer who requested it sec_6110 provides that it shall not be used or cited as precedent sincerely assistant chief_counsel passthroughs and special industries by richard kocak chief branch enclosures copy of this letter copy for sec_6110 purposes


department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date release number release date date 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 instructions in notice action if you agree with our deletions you do not need to take any further if you disagree with our proposed deletions follow the in accordance with code sec_6104 we will notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if 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 pincite-829-1040 or the irs customer service number for businesses the irs customer service number for people with hearing impairments is if you have any questions about your sincerely robert choi director exempt_organizations rulings agreements enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter department of the treasury internal_revenue_service washington d c contact person identification_number contact number fax number employer_identification_number tax_exempt_and_government_entities_division date date legend xx y state a dear we have considered your application_for recognition of exemption from federal_income_tax under sec_501 of the internal_revenue_code based on the information provided we have concluded that you do not qualify for exemption under sec_501 of the code the basis for our conclusion is set forth below facts you were formed in state a as a not-for-profit corporation and have requested classification as a tax exempt publicly_supported_organization under sec_501 and sec_509 of the internal_revenue_code your articles of incorporation state that you are organized for charitable purposes your bylaws describe you as a charitable business organized to provide food clothing and educational supplies to pantries churches schools and organizations that provide for the hungry and needy families and individuals promote awareness within the city and enforce all state non-profit laws and regulations to cooperate and assist in the development of communities to promote all means of increasing the level of professionalism and efficiency of local food pantries to create a better public understanding and appreciation of the need for family support and their importance to public health safety and welfare and to promote the development of uniform administrative ordinances inspection methods and enforcement procedures the narrative you submitted as part iv of your application describes your services as conducting a community food bank set up to support the pantries churches and other organizations that support and provide food or clothes to the individual while you refer to supporting other organizations you have not stated whether this support will consist of giving away food and other items or whether you will sell the items the only other activities you plan to conduct are various fundraisers you have not secured any property for use in your food bank activities nor have you described any specific plans for doing so in the future you have no agreements with the organizations you claim you will serve and have provided only a general description of how you will determine who to supply you have no draft brochures no letters and no website you have not described how you will acquire commodities for the food bank in addition despite requests you have not provided any estimates of the amount or sources of your revenues in contrast to your description of your proposed exempt_activities you submitted detailed descriptions of plans for fundraising activities including sponsoring golf tournaments and sending mailings in addition you plan to contract with three fundraising and management consultants in order to solicit financial support you have not provided any descriptions of these consultants’ activities or their compensation other than to indicate that they will each be compensated more than dollar_figure you have provided detailed lists of expenses including dollar_figure in salaries and wages for your officers attorneys secretaries accountants and others dollar_figure for occupancy dollar_figure provided no information on the amount of money devoted to your program services you categorized food distribution and purchase expenses as miscellaneous and stated budget for food distribution not yet known for conferences in contrast you have for supplies and dollar_figure for travel dollar_figure you were incorporated by x and y who are husband and wife your bylaws provide for four officers president ceo executive vp coo secretary and treasurer x serves as the president and ceo and is paid a salary of dollar_figure paid a salary of dollar_figure but that they will each be paid a salary of dollar_figure may hold any two or more offices y serves as the executive vp coo and is you state that your secretary and treasurer are unknown at present in addition you stated that the same person prior to creating your organization x made deliveries and stocked shelves at a food bank y previously provided administrative services to a food bank neither x nor y were compensated at previous food bank jobs they held you have not provided any other information about their qualifications or education you indicated that your officers x and y do not have a specific term and can serve until their resignation or removal when asked how officers can be removed you stated only that tujnless otherwise provided in the bylaws any officer or agent may be removed by irresponsible actions or resignation and did not provide any information regarding who removes an officer or what procedures must be followed your application contained a reference to a board_of trustees but your bylaws do not contain a description of the board_of trustees their powers or how either trustees or officers are selected and removed when asked what the powers of trustees were you responded only that t he management and affairs of the corporation shall be at all times under the direction of the executive officers and trustees whose operations in governing the corporation shall be defined by statute and by the corporation’s by-laws law sec_501 of the internal_revenue_code provides an exemption from taxation for organizations organized and operated exclusively for religious charitable scientific testing for public safety literary or educational_purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations provides that in order to be exempt as an organization described in sec_501 an organization must be both organized and operated exclusively for one or more of the purposes specified in such section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1_501_c_3_-1 of the regulations provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if 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 it engages primarily in 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 of the regulations defines private_shareholder_or_individual as a person having a personal and private interest in the activities of the organization sec_1_501_c_3_-1 of the regulations provides that an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest to meet the requirement of this subsection the burden_of_proof is on the organization to show that it is not organized or operated for the benefit of private interests such as designated individuals the creator or his family shareholders of the organization or persons controlled directly or indirectly by such private interests sec_1_501_c_3_-1 of the regulations provides that the term charitable is used in sec_501 of the code in its generally accepted legal sense and includes the relief of the poor and distressed or of the underprivileged as well as the advancement of education sec_1_501_c_3_-1 of the regulations provides that an organization may meet the requirements of sec_501 although it operates a trade_or_business as a substantial part of its activities if the operation of such trade_or_business is in furtherance of the organization’s exempt_purpose or purposes and if the organization is not organized or operated for the primary purposes of carrying on an unrelated_trade_or_business revrul_69_383 1969_2_cb_113 provides an example of a possible inurement situation that did not jeopardize an organization’s exempt status in the revenue_ruling a tax exempt hospital entered into a contract with a radiologist which provided that the radiologist would be compensated by receiving a percentage of the gross_receipts of the radiology department the contract was negotiated on an arm’s-length basis the radiologist did not control the hospital the amount received under the contract was reasonable in terms of the responsibilities and duties assumed and the amount received under the contract was not excessive when compared to the amounts received by other radiologists in comparable circumstances revrul_72_369 1972_2_cb_245 held that an organization formed to provide managerial and consulting services at cost to unrelated exempt_organizations did not qualify for exemption under sec_501 of the code providing managerial and consulting services on a regular basis for a fee is a trade_or_business ordinarily carried on for profit the fact that the services were provided at cost and solely for exempt_organizations was not sufficient to characterize the activity as charitable for purposes of sec_501 of the code furnishing the services at cost lacks the donative element necessary to establish this activity as charitable revproc_2008_9 2008_2_irb_258 provides that exempt status may be granted in advance of the organization's operations if the proposed activities are described in sufficient detail to permit a conclusion that the organization will clearly meet the particular requirements for exemption pursuant to the section of the code under which exemption is claimed the organization must fully describe all of the activities in which it expects to engage including the standards criteria procedures or other means adopted or planned for carrying out the activities the anticipated sources of receipts and the nature of contemplated expenditures a mere restatement of exempt purposes or a statement that proposed activities will be in furtherance of such purposes will not satisfy this requirement in 326_us_279 the supreme court held 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 the court found that the trade_association had an underlying commercial motive that distinguished its educational program from that carried out by a university in 203_f2d_872 5th cir the court acknowledged that payment of reasonable_compensation to officers is not inurement the court went on to say however that if the salaries paid are excessive and unreasonable then inurement of corporate net_income will result such inurement would not allow an organization to claim tax exemption in 302_f2d_934 ct_cl the court considered an organization that provided analyses of securities and industries and of the economic climate in general it sold subscriptions to various periodicals and also services providing advice for purchases of individual securities the court noted that education is a broad concept and assumed arguendo that the organization had an educational purpose however it held that it had a significant non-exempt commercial purpose that was not incidental to the educational purpose and therefore was not entitled to be regarded as exempt in 74_tc_531 the court considered an adverse_ruling by the internal_revenue_service on an application_for exempt status as a church the court noted that the only voting members and directors of the organization were a husband and wife and their son who had no affiliation with any denomination or ecclesiastical body or other outside influence the applicant had declined to furnish some information and made answers to other inquires that were vague and uninformative on the basis of the record the court held that the applicant had not shown that no part of its net_earnings inure to the benefit of the family or that petitioner was not operated for the private benefit of the family in 75_tc_127 the court found that part of an organization’s net_earnings inured to the benefit of private individuals because their compensation was based on a percentage of the organization’s gross_receipts with no upper limit the court held that the petitioner was not exempt as an organization described in sec_501 of the internal_revenue_code of the court stated that the burden falls upon the petitioner to establish the reasonableness of compensation paid to private individuals in 823_f2d_1310 9th cir the court upheld the commissioner’s revocation of exempt status and assessment of tax deficiencies because the organization allowed its assets to inure to the founder and his family the founder had unrestrained and unaccounted for access to some church funds and the church failed to prove that the funds were spent on behalf of the church in miller sons drywall inc v commissioner of internal revenue t c memo the court set out several factors that should be considered when determining whether compensation is reasonable these include the employee’s qualifications the nature extent and scope of the employee's work the size and complexity of the business prevailing general economic conditions the employee's compensation as a percentage of gross and net_income the employee’s compensation paid in prior years and prevailing rates of compensation_for comparable positions in comparable concerns 70_fedclaims_782 was an action for declaratory_judgment that the petitioner brought to challenge the denial of his application_for exempt status the court found that the actual purposes displayed in the administrative record supported the conclusion of the irs findings it should have submitted it as part of the administrative process it is well-accepted that in initial qualification cases such as this gaps in the administrative record are resolved against the applicant if the petitioner had evidence that contradicted these analysis exemption from federal income_taxation is not a right it is a matter of legislative grace that is strictly construed new dynamics supra the burden is on the applicant to prove that it is entitled to exempt status d an applicant must prove that it is organized and operated exclusively for exempt purposes and not for the private benefit of its creators designated individuals or organizations controlled by such private interests sec_1 c - d ii exclusively does not mean solely but no more than an insubstantial part of an organization's activities may further a non-exempt purpose better business bureau supra an applicant for exempt status must provide sufficient information for the service to make an informed decision the application must include details figures and documentation basic bible church supra exempt status may be granted in advance of an organization's operations but its activities must be described in sufficient detail to permit a conclusion that the organization will clearly meet the requirements for exemption revproc_2008_9 supra based on the information submitted you have failed to establish that you will conduct any activities in furtherance of an exempt_purpose that no part of your net_earnings will inure to private individuals and that you will be operated for a public rather than a private interest no activities in furtherance of an exempt_purpose in order to qualify for tax exemption an organization must show that it is operated exclusively for exempt purposes see sec_1_501_c_3_-1 you were established for the charitable purpose of providing food and other items for the needy the only activities you plan to conduct are distributions of food and clothing to food banks churches and similar organizations while donating these items to other organizations might further a charitable exempt_purpose merely providing commercial services such as sales of items to exempt_organizations does not revrul_72_369 supra such activities are merely commercial activities an organization is not eligible for exemption if purpose american institute for economic research supra in your application you did not indicate whether you will sell the food and clothing or whether you will exclusively donate it gaps in an application are resolved against the applicant new dynamics supra you have not demonstrated that your distribution activities will consist only of donations to organizations or individuals therefore we cannot conclude that your activities do not substantially further a commercial non-exempt purpose it operates for a substantial commercial even if you plan to donate items and not sell them you have not demonstrated that you will actually conduct those activities you have not secured any real or personal_property for use in your activities nor have you described how you plan to do so the financial information you provided gives detailed accounting of expenses such as dollar_figure conferences yet under food distributed in your expense sheet you state bjudget for food distribution not yet known you have not provided sufficient information for us to conclude that you will conduct any distributions of food or other items therefore you have not demonstrated that you are engaged in any activities that further an exempt_purpose for travel and dollar_figure for private_inurement an organization will be denied exemption if any of its net_earnings inure to the benefit of private individuals sec_1_501_c_3_-1 even a small amount of inurement will prevent a grant of exemption x and y are the incorporators of your organization they are its executive officers and they have control_over the operations of your organization they have a personal_interest in your activities thus x and y are both private individuals within the meaning of sec_1_501_a_-1 of the regulations if an organization pays unreasonable_compensation to private individuals this will constitute inurement mabee petroleum corp v united_states in order to determine when compensation is unreasonable several factors may be considered these include an employee’s qualifications the nature extent and scope of the employee's work the size and complexity of the business prevailing general economic conditions the employee's compensation as a percentage of gross and net_income the employee’s compensation paid in prior years and prevailing rates of compensation_for comparable positions in comparable concerns miller sons drywall inc v commissioner of internal revenue x held previous food bank jobs his duties included driving vehicles making deliveries and stocking shelves x was not compensated at either of these positions you have not provided any information on x's level of education or other qualifications despite this you intend to pay x a salary of dollar_figure previous experiences assigning menu options stocking shelves and other administrative duties you intend to pay y a salary of dollar_figure hold or more officer positions it is possible that x and y will also hold the secretary and treasurer offices adding dollar_figure the only qualifications you have provided for y are her in addition your bylaws allow individuals to to their compensation you provided salaries of just two other organizations in your application they do not reflect similarly situated organizations and therefore cannot be used to substantiate the salaries paid_by your organization you provided salary information from an organization with dollar_figure million in revenues and for an organization with dollar_figure million in revenues however you have not had any revenues in the past and have not established that you will have any significant revenues in the future despite requests for such information your organization is not currently operating and is neither large nor complex in addition you have not presented any facts similar to those of revrul_69_383 x and y control your organization and you have not shown that the salaries for x and y were negotiated on an arm’s length basis based upon these facts you have not demonstrated that the compensation paid to x and y is reasonable therefore you have not established that no part of the net_earnings of your organization inure to the benefit of private individuals as a result you do not meet the requirements for tax exemption private benefit sec_1_501_c_3_-1 of the regulations states that an organization cannot qualify for exemption if regulation provides that the organization must demonstrate that it is not operated for the benefit of private individuals such as its creator and his family it is operated for private rather than public purposes in addition the x and y control your organization through their positions as officers you state that your organization is governed in part by a board_of trustees yet despite requests you have provided no information about how this group takes action or whether their actions can be overruled by x and y furthermore you indicated that you will hire consultants and compensate them with significant amounts of money yet you have not described their activities or how you will ensure that such amounts are reasonable these factors indicate that your organization will be operated for the benefit of private individuals see national association of american churches supra bubbling well church of universal love supra church of scientology supra based upon the facts presented you have not established that your organization will not be operated for the benefit of x y and your consultants therefore you have not met your burden to prove that you will be operated for public rather than private purposes consequently you are not eligible for exemption under sec_501 of the code even if you did conduct activities in furtherance of an exempt_purpose conclusion you have not established that you will be conducting any activities in furtherance of an exempt_purpose described in sec_501 of the code you have not established that you are not operated primarily for non-exempt commercial purposes nor have you demonstrated that no part of your net profits will inure to the benefit of private individuals finally you have not established that you will operated for public instead of private purposes accordingly you do not qualify for exemption as an organization described in sec_501 of the code and you must file federal_income_tax returns 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 wee 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 already done so and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications for more information about representation see publication practice_before_the_irs 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 action letter that letter will provide information about filing tax returns and other matters if we do not hear from you within days we will issue a final adverse determination please send your protest statement form_2848 and any supporting documents to this address internal_revenue_service constitution ave n w washington dc you may also fax your statement using the fax number shown in the heading of this letter if you fax your statement please call the person identified in the heading of this letter to 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 robert choi director exempt_organizations rulings agreements


department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date uil no 468b cc pa apjp ekaye gl-808387-00 memorandum for m k mortensen associate area_counsel cc sb slc attn mark h howard from blaise g dusenberry acting senior technician reviewer cc pa apjp subject legend w j k a b z office year year date date x y this memorandum responds to your request for assistance dated date regarding a federal receivership established by judge in a criminal case entitled w specifically you have asked whether the receiver appointed in this case must file gl-808387-00 income_tax returns for closely held corporations that owned prior to k creating the receivership facts the z office initiated the criminal case in as a result of inquiries to the fbi and the sec from the x government a and b an x citizen claimed to operate a stock brokerage firm through several different entities however they were not complying with securities regulations and in year the z office handed down a criminal indictment against them and began forfeiture proceedings on date the court overseeing the proceedings ordered in accordance with a stipulation of the promoters that the seized property should be delivered to the investors as restitution under a plan to be set forth in a subsequent stipulation of the parties pending the distribution the court ordered y to retain possession of the property eventually the administration of the property by the z office became too burdensome accordingly the z office asked the court to appoint a receiver to manage the seized assets the ultimate goal being liquidation and restitution to the x investors on date the court ordered y to turn over all properties to the receiver the court subjected the property in the receivership to the jurisdiction of the court encumbered the property via judicial lien and ordered the receiver to prepare an accounting of the receivership the service’s position regarding the fund held by the z office and the receiver is that it is a qualified_settlement_fund qsf this classification became effective date the date the court established the receivership law sec_468b of the internal_revenue_code code provides that for the purposes of subtitle f a designated_settlement_fund shall be treated as a corporation and any_tax imposed by this subsection shall be treated as a tax imposed by sec_11 sec_468b-2 k of the income_tax regulations provides that a qsf must file an income_tax return with respect to the tax imposed under sec_468b of the code for each taxable_year that the fund is in existence whether or not the fund has gross_income for that taxable_year sec_468b-2 k provides that the income_tax return of the qsf must be filed on or before march of the year following the close of the taxable_year of the qsf unless the fund is granted an extension of time for filing under sec_6081 the return must be made by the administrator of the qsf gl-808387-00 sec_468b-2 k i provides that the administrator of a qsf is the person designated or approved by the governmental authority that ordered or approved the fund for purposes of sec_1_468b-1 analysis on date the court created the receivership in this case by ordering y to turn over all properties it held to the receiver the receivership according to the service is a qsf as of that date date because it meets the requirements of a qsf under sec_1_468b-1 of the regulations under the code and regulations a qsf must file an income_tax return for each taxable_year the fund is in existence whether or not the fund has gross_income for that taxable_year according to the facts the fund has been in existence since year as such the qsf must file an income_tax return beginning with the year taxable_year for each taxable_year the qsf remains in existence the person responsible for filing the income_tax return of the qsf according to the regulations is the administrator of the qsf here the administrator is the receiver appointed by the court accordingly the court-appointed receiver must file the income_tax returns for the qsf for each taxable_year the qsf remains in existence conclusion the qsf must file an income_tax return beginning with the year taxable_year for each taxable_year the qsf remains in existence the court-appointed receiver is the person who must file the income_tax returns for the qsf for each of these years should you have further questions regarding this matter please contact elizabeth kaye at