t c memo united_states tax_court l ben smith carol smith petitioners v commissioner of internal revenue respondent docket no filed date steven t barta for petitioners jonathan j ono for respondent memorandum findings_of_fact and opinion chiechi judge respondent determined the following defi- ciencies in and accuracy-related_penalties under sec_6662 a on petitioners’ federal_income_tax tax 1unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years at issue all rule references are to the tax_court rules of prac- continued year deficiency dollar_figure big_number accuracy-related_penalty under sec_6662 dollar_figure dollar_figure the only issue remaining for decision is whether petitioners are liable for for the accuracy-related_penalty under sec_6662 we hold that they are findings_of_fact all of the facts in this case which the parties submitted under rule have been stipulated by the parties and are so found petitioners resided in hermiston oregon at the time they filed the petition in this case starting around date l ben smith mr smith began working for raytheon demilitarization company raytheon on johnston island around date shortly before mr smith’s employment with raytheon began mr smith attended an orientation session presented by raytheon raytheon’s orientation session during raytheon’s orientation session raytheon orally informed mr smith that johnston island was not tax exempt and that he was to be liable for tax on the compensation that he earned while working on johnston island around date after raytheon’s orientation session raytheon issued a so-called continued tice and procedure assignment letter to mr smith raytheon’s date assign- ment letter the receipt of which mr smith acknowledged by signing that letter raytheon’s date assignment letter inter alia described certain benefits that raytheon was to provide to mr smith as a result of mr smith’s working on johnston island that letter stated inter alia johnston island is not tax exempt therefore standard tax obligations apply raytheon included with raytheon’s date assign- ment letter certain documents raytheon’s enclosure to raytheon’s date assignment letter that set forth certain terms and conditions of mr smith’s employment with raytheon among the documents in raytheon’s enclosure to raytheon’s date assignment letter was a document entitled tax treatment of johnston island assignment expenses raytheon’s description of the tax treatment of johnston island assignment expenses which provided assignment expense tax classification travel in-transit relocation expense employee w-2 and tax withholding treatment subject_to w-2 reporting-not subject_to_withholding if deductible remote site differential compensation taxable subsistence and quarters business travel expense taxable off-island rotation personal travel emergency leave compensation taxable taxable note you should also consult your personal tax advisor for application to your particular tax considerations throughout and mr smith continued to work for raytheon on johnston island during and mr smith received wages from raytheon totaling dollar_figure and dollar_figure respectively around date raytheon issued another letter to mr smith raytheon’s date letter that included revisions to certain terms and conditions of his employment on johnston island raytheon’s date letter stated inter alia johnston island is not tax exempt therefore standard tax obligations apply raytheon included with raytheon’s date letter certain documents including a document that was identical to raytheon’s description of the tax treatment of johnston island assignment expenses on date the internal_revenue_service irs issued a news_release entitled johnston inland sic individuals may not claim income exclusion irs date news_release that news_release stated in pertinent part the internal_revenue_service reminds individuals in an unincorporated u_s_territory such as johnston island that they may not claim the exclusion for personal_service_income earned in a u s possession under sec_931 they also cannot exclude this income as foreign_earned_income under the exclusion provision in sec_911 at one time johnston island was listed as a u s pos- session for purposes of the possessions exclusion under 2throughout and mr smith worked on johnston island for washington group international formerly raytheon for convenience we shall hereinafter refer only to raytheon and not to washington group international the code however the law was changed under amendments enacted by the tax_reform_act_of_1986 johnston island is not a specified_possession for purposes of new sec_931 so income earned on the island is not subject_to exclusion the irs published publication tax guide for individuals with income from u s possessions for use in the preparation of individual tax returns for the taxable_year irs publication for irs publication for stated in pertinent part for the possession exclusion applies only to individuals who are bona_fide residents of american samoa individuals in the following u s possessions or territories are not eligible for the possession exclu- sion discussed here johnston island sometime prior to date an individual named brian jordan mr jordan sent a letter to president george w bush mr jordan’s letter to president bush that letter stated in pertinent part subject cfr vol part sec_1_908 to revised as of date dear sir i would like to know if the above mentioned subject is still current for johnston atoll island because i 3the record does not disclose who mr jordan is or his relationship if any to petitioners have been unable to obtain an answer from the i r s on date in response to mr jordan’s letter to president bush the irs center in philadelphia pennsylvania sent a letter to mr jordan irs date letter to mr jordan that was signed by david l medeck who was identified in that letter as field director accounts management the irs date letter to mr jordan stated in pertinent part i am responding to your letter to president george w bush you asked about the code_of_federal_regulations cfr as it pertains to johnston island i am enclosing sec_1_931-1 these regulations are current as of date attached to the irs date letter to mr jordan was a copy of sec_1_931-1 income_tax regs which the department of the treasury treasury promulgated under sec_931 prior to its amendment by sec_1272 of the tax_reform_act_of_1986 tra publaw_99_514 100_stat_2593 we shall refer to sec_931 prior to its amendment by the tra as old sec_931 on date and date respectively peti- tioner signed form_1040 u s individual_income_tax_return for each of their taxable years joint_return and 4see infra note joint_return thereafter they filed their joint_return and their joint_return in the joint_return petitioners reported wage income of dollar_figure and claimed an exclusion_from_gross_income of dollar_figure dollar_figure exclusion of wages in the joint_return petitioners reported wage income of dollar_figure and claimed an exclusion_from_gross_income of dollar_figure dollar_figure exclusion of wages on page line of the joint_return petitioners included the following nota- tion with respect to the dollar_figure exclusion of wages code sec_931 deduct-see attached petitioners attached to the joint_return a document entitled federal supplemental informa- tion petitioners’ attachment to their joint_return that document stated taxpayer worked on johnston island atoll during tax_year and subsequent to title_26 vol part sec_1_908 to 26cfr revision taxpayer is entitled to exclude earnings from reportable income reproduced literally respondent issued to petitioners a notice_of_deficiency notice with respect to their taxable years and in that notice respondent determined inter alia to disallow 5on date and date respectively leland rubesh signed the joint_return and the joint_return as return preparer 6the record does not disclose the respective dates on which petitioners filed their joint_return and their joint_return petitioners’ dollar_figure exclusion of wages and petitioners’ dollar_figure exclusion of wages respondent further determined in the notice that petitioners are liable for and for the accuracy-related_penalty under sec_6662 because of negligence or disregard of rules or regulations under sec_6662 or a substantial_understatement of tax in peti- tioners’ joint_return under sec_6662 opinion we must determine whether petitioners are liable for for the accuracy-related_penalty under sec_6662 because of negligence under sec_6662 or a substantial understate- ment of tax under sec_6662 sec_6662 imposes an accuracy-related_penalty equal to percent of the underpayment to which sec_6662 applies sec_6662 applies to the portion of any underpayment which is attributable to inter alia negligence sec_6662 or a substantial_understatement of tax sec_6662 the term negligence in sec_6662 includes any failure to make a reasonable attempt to comply with the code see sec_6662 negligence has also been defined as a failure to do what a reasonable person would do under the circumstances see 963_f2d_907 6th cir 7respondent concedes that petitioners are not liable for for the accuracy-related_penalty under sec_6662 affg tcmemo_1991_179 91_tc_686 affd 893_f2d_656 4th cir a return position that has a reasonable basis within the meaning of sec_1_6662-3 income_tax regs is not attributable to negligence sec_1_6662-3 income_tax regs the meaning of the term reasonable basis is set forth in sec_1 b income_tax regs as follows reasonable basis is a relatively high standard of tax reporting that is significantly higher than not frivolous or not patently improper the reasonable basis standard is not satisfied by a return position that is merely arguable or that is merely a colorable claim if a return position is reasonably based on one or more of the authorities set forth in sec_1 d iii taking into account the relevance and persuasiveness of the authorities and subsequent developments the return position will generally satisfy the reasonable basis standard even though it may not satisfy the substantial_authority standard as defined in sec_1_6662-4 see sec_1_6662-4 for rules with respect to relevance persuasiveness subsequent developments and use of a well-reasoned construction of an applicable statutory provision for purposes of the substantial_understatement_penalty in addition the reasonable_cause and good_faith excep- tion in sec_1_6664-4 may provide relief from the penalty for negligence or disregard of rules or regulations even if a return position does not satisfy the reason- able basis standard a return position that does not have a reasonable basis is attributable to negligence 251_f3d_862 9th cir for purposes of sec_6662 there is a substantial_understatement of tax for any taxable_year if the amount of the understatement for the taxable_year exceeds the greater of percent of the tax required to be shown in the return for the taxable_year or dollar_figure sec_6662 an understatement is equal to the excess of the amount of tax required to be shown in the tax_return over the amount of tax shown in such return see sec_6662 the amount of the understatement is to be reduced by that portion of the understatement which is attrib- utable to the tax treatment of any item by the taxpayer if there is or was substantial_authority for such treatment sub- stantial authority sec_6662 or any item if a the relevant facts affecting the item’s tax treatment are adequately disclosed in the return or in a statement attached to the return adequate_disclosure sec_6662 and b there is a reasonable basis for the tax treatment of such item by the taxpayer reasonable basis sec_6662 the accuracy-related_penalty under sec_6662 does not apply to any portion of an underpayment if it is shown that there was reasonable_cause for and that the taxpayer acted in good_faith with respect to such portion sec_6664 the determination of whether the taxpayer acted with reasonable_cause and in good_faith depends on the pertinent facts and circum- stances including the taxpayer’s efforts to assess such tax- payer’s proper tax_liability the knowledge and experience of the taxpayer and the reliance on the advice of a professional such as an accountant sec_1_6664-4 income_tax regs before turning to petitioners’ position under sec_6662 we shall address sec_7491 although respondent must have commenced respondent’s examination of petitioners’ return for the year at issue after date the parties do not address sec_7491 respondent has the burden of production under that section with respect to the accuracy-related_penalty under sec_6662 to meet that burden respondent must come forward with sufficient evidence showing that it is appropriate to impose the accuracy-related_penalty 116_tc_438 although respondent bears the burden of production with respect to the accuracy-related_penalty that respondent determined for petitioners’ taxable_year respon- dent need not introduce evidence regarding reasonable_cause substantial_authority or similar provisions the taxpayer bears the burden_of_proof with regard to those issues id old sec_931 permitted citizens of the united_states to exclude income derived from sources within possessions of the united_states except puerto rico the u s virgin islands and guam if certain conditions were satisfied although old sec_931 did not define the term possession_of_the_united_states sec_1_931-1 income_tax regs promulgated under old sec_931 provided that the term possession_of_the_united_states included johnston island sec_1272 of the tra amended old sec_931 to exclude from income in the case of an individual who is a bona_fide_resident of a specified_possession during the entire taxable_year gross_income derived from sources within any such specified_possession sec_931 as amended by sec_1272 of the tra defines the term specified_possession to mean only guam american samoa and the northern mariana islands sec_931 around 6½ months before petitioners signed their joint_return we issued our opinion in specking v commissioner sec_1_931-1 income_tax regs promulgated under sec_931 prior to its amendment by the tra provided in pertinent part sec_1_931-1 citizens of the united_states and domestic corporations deriving income from sources within a possession_of_the_united_states a definitions as used in sec_931 and this section the term possession_of_the_united_states includes american samoa guam johnston island midway islands the panama canal zone puerto rico and wake island on date the treasury_department promulgated t d 2005_20_irb_1016 which revised sec_1_931-1 income_tax regs promulgated under old sec_931 subsequent to that revision sec_1_931-1 income_tax regs provides in pertinent part sec_1_931-1 exclusion of certain income from sources within guam american samoa or the northern mariana islands -- reserved 9although the record establishes the date on which petition- ers signed their joint_return the record does not disclose continued t c affd sub nom 68_fedappx_44 9th cir affd sub nom 357_f3d_1108 10th cir in specking we held inter alia johnston island does not constitute a specified_possession for purposes of sec_931 as amended by the tra and the amendment of old sec_931 by the tra became effective as to taxpayers who earned compensation while working on johnston island for taxable years that began after date id pincite in so holding we rejected as misplaced the reliance by the taxpayers in specking on sec_1_931-1 income_tax regs promulgated under old sec_931 id pincite we stated the regulatory language on which petitioners rely defines the term possession for purposes of old sec_931 as we have concluded above that provi- sion no longer applies to petitioners consequently the regulatory provision also has no application to them and is obsolete as to petitioners id pincite petitioners nonetheless claimed the dollar_figure exclusion of wages in their joint_return according to petitioners’ attachment to their joint_return they did so in reliance on sec_1_931-1 income_tax regs that the treasury promulgated under old sec_931 and that we found in specking was obsolete with respect to taxpayers who earned compensation while working continued the date on which petitioners filed that return on johnston island for taxable years that began after date on the record before us we find that respondent has satisfied respondent’s burden of production under sec_7491 with respect to the accuracy-related_penalty under sec_6662 and b that respondent determined for we turn now to petitioners’ position that they are not liable for for the accuracy-related_penalty under sec_6662 according to petitioners they are not liable for that penalty because there was substantial_authority for claiming the dollar_figure exclusion of wages in their joint_return there was adequate_disclosure of the relevant facts affecting such tax treatment of those wages and there was a reasonable basis for such tax treatment we shall address only whether petitioners had a reasonable basis in claiming the dollar_figure exclusion of wages in their joint_return if the record were to establish that peti- tioners did not have a reasonable basis in claiming that exclu- sion such return position of petitioners would be attributable to negligencedollar_figure van camp bennion v united_states f 3d pincite in support of petitioners’ position that they had a reason- 10a fortiori a return position that did not have a reason- able basis is not a position for which there was substantial_authority under sec_6662 and the regulations there- under able basis in claiming the dollar_figure exclusion of wages in their joint_return petitioners advance three arguments as follows it is petitioners’ position that there was a reasonable basis for questioning the effective date of the proposed amendments to sec_931 old sec_931 contained in the tax reform act tra it has never been established that the so called specific possessions have ever entered into the required agree- ments regarding tax_administration which the tax reform act included as a condition_precedent to the effective date of the proposed amendments this was the basis upon which the court’s decision in specking et al supra 117_tc_95 affd sub nom 68_fedappx_44 9th cir affd sub nom 357_f3d_1108 10th cir was appealed to the 9th and 10th circuit courts of appeal the decisions affirming to tax courts opinion not being issued until based upon the respondent’s contin- ued publication of sec_1_931-1 mr medeck’s response irs date letter to mr jordan to the presidential inquiry and the question posed in the appeal of the specking et al supra opinion there was a reasonable basis for the petitioners treat- ment of l ben smith’s johnston island income on the return filed for the year sufficient to relieve them from liability for the sec_6662 addi- tions to the tax reproduced literally we consider first petitioners’ arguments that they had a reasonable basis in claiming the dollar_figure exclusion of wages in their joint_return because the amendment by the tra 11on date when petitioners signed their joint_return no notice of appeal had been filed with respect to 117_tc_95 affd sub nom haessley v commissioner 68_fedappx_44 9th cir affd sub nom umbach v commissioner 57_f3d_1108 10th cir it was not until date that the taxpayers involved filed respective notices of appeal to the u s courts of appeals for the ninth circuit and the tenth circuit of old sec_931 was not effective for their taxable_year since certain implementing agreements were not entered into between the united_states and the specified possessions identi- fied in sec_931 after that amendment and after the amendment by the tra of old sec_931 the treasury did not amend or withdraw sec_1_931-1 income_tax regs promulgated under old sec_931 and therefore petitioners were entitled to rely on that regulation around 6½ months before petitioners signed their joint_return we rejected both of those arguments in 117_tc_95 as discussed above in specking we held that the amendment of old sec_931 by the tra became effective as to taxpayers who earned compensation while working on johnston island for taxable years that began after date id pincite in so holding we rejected the argument advanced by the taxpayers in specking and petitioners here that the existence of certain implementing agreements between the united_states and the speci- fied possessions identified in sec_931 after its amendment by the tra was a condition_precedent to the effective date of such amendment of old sec_931 id as also discussed above in specking we further rejected the argument of the taxpayers there and petitioners here that sec_1_931-1 income_tax regs promulgated under old sec_931 continued to apply after 12see supra note the tra amended old sec_931 because the treasury did not amend or withdraw that regulation id pincite in specking we held that old sec_931 no longer applied to the taxpayers there id and that consequently the regulatory provision also has no application to them and is obsolete as to petitioners in specking id pincite in so holding we stated we do not agree with petitioners that respondent’s failure to amend sec_1_931-1 income_tax regs supports petitioners’ position as the supreme court recently observed regarding another unamended regula- tion provision the treasury’s relaxed approach to amending its regulations to track code changes is well documented the absence of any amendment is more likely a reflection of the treasury’s inattention than any affirmative intention on its part to say anything at all united dominion indus inc v united_states u s iddollar_figure 13even before we issued our opinion in 117_tc_95 affd sub nom 68_fedappx_44 9th cir affd sub nom umbach v commissioner 57_f3d_1108 10th cir the united_states district_court for the district of hawaii u s district_court held that taxpayers who earned compensation during and while working on johnston island must include such compensation in gross_income for those years farrell v united_states aftr 2d ustc par big_number d haw affd 313_f3d_1214 9th cir in so holding the u s district_court rejected the arguments of the taxpayers in farrell and petitioners here that the amendment by the tra of old sec_931 was not effective because certain imple- menting agreements were not entered into between the united_states and the specified possessions identified in sec_931 after that amendment and that the taxpayers were entitled to rely on sec_1_931-1 income_tax regs promulgated under old sec_931 because that regulation was not amended or withdrawn by the treasury after the tra amended old sec_931 in reject- ing the argument of the taxpayers in farrell with respect to the continued we conclude that petitioners’ arguments relating to the effective date of the amendment by the tra of old sec_931 and the failure by the treasury to amend or withdraw sec_1_931-1 income_tax regs did not provide petitioners with a reasonable basis in claiming the dollar_figure exclusion of continued effective date of the amendment by tra of old sec_931 the u s district_court stated the outdated sec_931 was no longer in the internal_revenue_code in the to period had congress intended that the outdated sec_931 have continuing effect it would have stated so in the amended sec_931 farrell v united_states aftr 2d pincite1 n ustc par big_number at big_number n in rejecting the argument of the taxpayers in farrell that sec_1_931-1 income_tax regs promulgated under old sec_931 allowed them to exclude the income earned while working on johnston island the u s district_court stated although sec_931 was amended regulation was not amended to reflect the changes made to sec_931 see united_states tax reporter explanation of sec_931 caution the treasury has not yet amended reg sec_1_931-1 to reflect changes made by p l to read regula- tion as including johnston island as a speci- fied possession for purposes of sec_931 would be contrary to the plain intent of congress which is to allow income to be excluded from gross_income for only guam american samoa and the northern mariana islands accordingly this court does not give any deference to the treasury’s outdated interpretation of possession in regulation farrell v united_states aftr 2d pincite0 to ustc par big_number at big_number wages in their joint_return we consider now petitioners’ third argument in support of their position that they had a reasonable basis in claiming the dollar_figure exclusion of wages in their joint_return as we understand that argument petitioners maintain that in claim- ing that exclusion they relied on the irs date letter to mr jordan14 that the irs sent in response to mr jordan’s letter to president bushdollar_figure on the record before us we reject any such argument the record does not establish that petitioners were even aware of the irs date letter to mr jordan when they signed their joint_return in relying on old sec_931 and sec_1_931-1 income_tax regs promulgated under old sec_931 in claiming the dollar_figure exclusion of wages in their joint_return petitioners not only ignored 117_tc_95 and farrell v united_states aftr 2d 14as stated supra note the record does not disclose who mr jordan is or his relationship if any to petitioners 15the irs date letter to mr jordan stated in pertinent part i am responding to your letter to president george w bush you asked about the code_of_federal_regulations cfr as it pertains to johnston island i am enclosing sec_1_931-1 these regulations are current as of date ustc par big_number d haw affd 313_f3d_1214 9th cir they also disregarded admonitions from mr smith’s employer and from the irs that compensation earned while working on johnston island is taxable and may not be excluded from income in this regard before petitioners signed their joint_return mr smith received multiple warnings from his employer one a little less than months before petitioners signed that return that johnston island was not tax exempt and that therefore standard tax obligations apply and that certain so-called assignment expenses were to be treated as compensation that is taxable the irs date news_release was issued that inter alia stated johnston island is not a ‘specified possession’ for purposes of new sec_931 so income earned on the island is not subject_to exclusion and irs publication for was issued that provided inter alia that taxpayers who earned compensation while working on johnston island are not eligible for the possession exclusion discussed here in this publication under the circumstances extant when petitioners signed their joint_return petitioners at a minimum should have consulted a professional about whether to claim the dollar_figure exclusion of wages in that return and relied on such professional’s advice see 731_f2d_1417 9th cir affg 79_tc_714 petitioners do not contend that they did so and do not claim that they are not liable for for the accuracy-related_penalty under sec_6662 because they relied on the advice of a professional on the record before us we find that petitioners did not have a reasonable basis in claiming the dollar_figure exclusion of wages in their joint_return on that record we further find that petitioners’ return position in claiming the dollar_figure exclusion of wages was attributable to negligence see van camp bennion v united_states f 3d pincite on the record before us we further find that petitioners have failed to carry their burden of establishing that there was reasonable_cause for and that they acted in good_faith with respect to any portion of the underpayment for petitioners’ taxable_year see sec_6664 sec_1_6664-4 income_tax regs on that record we find that petitioners have failed to carry their burden of showing any circumstances that would enable us to find that they had reasonable_cause for and acted in good_faith in claiming the dollar_figure exclusion of wages in their joint returndollar_figure 16for example petitioners have failed to show that after we issued 117_tc_95 they consulted a professional who advised them to claim the dollar_figure exclusion of wages in their joint_return indeed petitioners have failed to show that after we issued specking they even made any efforts to consult a professional about whether to make such a claim see 731_f2d_1417 9th cir affg 79_tc_714 based upon our examination of the entire record before us we find that petitioners have failed to carry their burden of establishing that they are not liable for for the accuracy- related penalty under sec_6662 and b dollar_figure we have considered all of the contentions and arguments of the parties that are not discussed herein and we find them to be without merit irrelevant and or mootdollar_figure to reflect the foregoing and the concessions of the parties decision will be entered for respondent with respect to the deficiency for and the deficiency and the accuracy-related_penalty under sec_6662 for and for petitioners with respect to the accuracy-related_penalty under sec_6662 for 17in light of our finding that petitioners are liable for for the accuracy-related_penalty because of negligence under sec_6662 we shall not address respondent’s argument that petitioners are liable for that year for that penalty because of a substantial_understatement of tax under sec_6662 18we note that taibo v commissioner tcmemo_2004_196 is materially distinguishable from the instant case in taibo the taxpayer unlike petitioners in the instant case filed his return for the year in question ie prior to the issu- ance of specking v commissioner supra


internal_revenue_service number release date index number --------------------------------------------- -------------------------- ------------------------------------------- ----------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------- id no ------------- telephone number --------------------- refer reply to cc corp b06 plr-104711-11 date april legend parent ---------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------- -------------------------- date date date x --------------------------- -------------------------- --------------------------- -- company official ----------------------------------------------------- ------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------- tax professionals ---------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------ ----------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- dear ---------------- this letter responds to a letter dated date submitted on behalf of parent requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election in particular parent is requesting an extension of time to plr-104711-11 elect an extended carryback period the election for a consolidated_net_operating_loss cnol incurred in the taxable_year ending date the year cnol additional information was submitted in correspondence dated date the material information submitted for consideration is summarized below parent is the common parent of an affiliated_group_of_corporations that joined in filing a consolidated_return for u s federal_income_tax purposes the parent group parent seeks to carry back the year cnol x years to its taxable_year ending on date under sec_172 parent was required to file the election in order to carry back the year cnol to its taxable_year ending on date and to obtain the benefit of sec_56 the election was due on date but for various reasons a valid election was not filed after the due_date for the election it was discovered that the election had not been filed subsequently this request was submitted under sec_301_9100-3 for an extension of time to file the election the period of limitations on assessment under sec_6501 has not expired for the parent group’s consolidated_income_tax_return for the taxable_year in which the year cnol was incurred or any subsequent taxable_year sec_172 of the internal_revenue_code generally permits a taxpayer to carry back a net_operating_loss to each of the taxable years preceding the taxable_year of the nol sec_172 of the internal_revenue_code permits a taxpayer to elect to carry back an applicable net_operating_loss to each of the or taxable years preceding the taxable_year of the applicable nol in lieu of the 2-year period provided by sec_172 sec_172 provides that the term applicable net_operating_loss applicable nol means the taxpayer’s net_operating_loss for a taxable_year ending after date and beginning before date sec_172 provides that the election under sec_172 shall be made by the due_date including extension of time for filing the return for the taxpayer’s last taxable_year beginning in the election is irrevocable and in general may be made only with respect to one taxable_year sec_1502 provides that the secretary shall prescribe such regulations as he may deem necessary in order that the tax_liability of any affiliated_group_of_corporations making a consolidated_return and of each corporation in the group both during and after the period of affiliation may be returned determined computed assessed collected and adjusted in such manner as clearly to reflect the income-tax liability and the various factors necessary for the determination of such liability and in order to prevent avoidance of such tax_liability in carrying out the preceding sentence the secretary may prescribe rules that are different from the provisions of chapter that would apply if such corporations filed separate returns plr-104711-11 sec_1_1502-21 provides that losses taken into account in determining a cnol may be carried to other taxable years whether consolidated or separate only under paragraph b of sec_1_1502-21 sec_1_1502-21 provides that net_operating_loss_carryovers_and_carrybacks to a taxable_year are determined under the principles of sec_172 and sec_1_1502-21 sec_1_1502-21 provides that net_operating_loss_carryovers_and_carrybacks to a taxable_year are determined under the principles of sec_172 and sec_1_1502-21 sec_1_1502-21 provides that a consolidated_group can elect an extended carryback period pursuant to sec_172 with regard to a cnol arising in a taxable_year ending after date and beginning before date revproc_2009_52 2009_49_irb_744 provides when and how a taxpayer may make an election under sec_172 sec_4 of revproc_2009_52 provides that the common parent of a consolidated_group makes the election for the group sec_4 and of rev_proc permit the election to be made for consolidated taxpayers by attaching a statement to the original or amended consolidated_return for the taxable_year of the applicable cnol by attaching a statement to the taxpayer’s amended consolidated_return applying the applicable cnol to the carryback_year or by attaching a statement to a claim for a tentative_carryback_adjustment on form_1139 sec_4 b and b of revproc_2009_52 require the election regardless of the manner in which made to be filed no later than the due_date including extensions for filing the return for the taxpayer’s last taxable_year beginning in under sec_301_9100-1 the commissioner has discretion to grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make a regulatory election sec_301_9100-1 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 the election by a consolidated_group to extend the carryback period under sec_172 for a cnol is a regulatory election therefore the commissioner has discretionary authority under sec_301_9100-3 to grant an extension of time for parent to file the election provided parent establishes to the satisfaction of the commissioner plr-104711-11 that it acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the interests of the government information affidavits and representations submitted by parent company official and tax professionals explain the circumstances that resulted in the failure to timely file a valid election the information establishes that parent reasonably relied on a qualified_tax professional who failed to make or advise parent to make the election see sec_301_9100-3 based on the facts and information submitted including the affidavits submitted and the representations made we conclude that parent has shown it acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the interests of the government accordingly provided the parent group qualifies substantively to file the election we grant an extension of time under sec_301_9100-3 until sixty days from the date on this letter for parent to file the election parent should file the election under sec_172 to carry back the year cnol to its taxable_year ending on date on form 1120x amended u s_corporation income_tax return according to the procedures set forth in revproc_2009_52 a copy of this letter must be attached to the form 1120x if parent files form 1120x electronically parent may satisfy the requirement of attaching a copy of this letter by attaching a statement to the parent group’s amended_return that provides the date and control number plr-104711-11 of this letter_ruling the above extension of time is conditioned on the parent group’s tax_liability if any not being lower in the aggregate for all years to which the election applies than it would have been if the election had been timely made taking into account the time_value_of_money we express no opinion as to the parent group’s tax_liability for the years involved a determination thereof will be made by the director’s office upon audit of the income_tax returns involved except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any item discussed or referenced in this letter in particular we express no opinion with respect to whether parent qualifies substantially to make the election in addition we express no opinion as to the tax effects or consequences of filing the election late under the provisions of any other section of the internal_revenue_code or regulations or as to the tax treatment of any conditions existing at the time of or resulting from filing the election late that are not specifically set forth in this letter for purposes of granting relief under sec_301_9100-3 we relied on certain statements and representations made by the parent company official and tax professionals the director however should verify all essential facts in addition notwithstanding that an plr-104711-11 extension is granted under sec_301_9100-3 to file the election any penalties and interest that would otherwise be applicable continue to apply this letter is directed only to the taxpayer s who requested it sec_6110 provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representative sincerely -------------------------------------------------- ken cohen senior technician reviewer branch office of associate chief_counsel corporate


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom corp plr-110578-99 date date distributing controlled shareholder a shareholder b date e we respond to a letter from your authorized representative dated date requesting that we supplement our letter_ruling dated date plr-117406-97 the prior letter_ruling additional information was submitted in letters dated july july august august and date the information submitted for consideration is summarized below capitalized terms retain the meanings assigned to them in the prior letter_ruling controlled is an accrual basis foreign_corporation that was organized for purposes of the transaction ruled upon in the prior letter_ruling and initially was wholly owned by distributing in the prior letter_ruling the taxpayer established that controlled had a need to issue equity within_12_months of the distribution to finance its plr-110578-99 operations and make certain acquisitions we granted the rulings in the prior letter_ruling based primarily on the stock offering business_purpose although the fit and focus business_purpose was considered as well see revproc_96_30 appendix a on date e distributing and controlled completed the proposed restructuring and distribution transaction described in the prior letter_ruling in its request for a supplemental letter_ruling controlled describes its inability to issue equity within_12_months of the distribution as contemplated in the prior letter_ruling controlled now seeks a supplemental letter_ruling stating that its failure to issue stock does not adversely affect the prior letter_ruling since it also established the fit and focus business_purpose as an independent business_purpose which in no way relies on the issuance of equity for the transaction the taxpayer provided the following additional facts in connection with the original transaction a b prior to the distribution shareholder a and shareholder b each held more than five percent of the outstanding distributing common_stock and there were no other five percent shareholders at the time of the distribution shareholder a and shareholder b each have filed schedules 13g indicating they are passive investors in distributing controlled has provided additional letters from representatives of shareholder a and shareholder b indicating that their ownership of distributing stock was in the manner of passive investments and that the shares were not acquired to influence management decisions of distributing in any way controlled has represented that all of the other representations made in the prior ruling letter are still true and correct based upon the information and representations submitted with the original and supplemental ruling requests we hold that the failure to issue stock as contemplated in the original proposed transaction will not have an adverse effect on the rulings contained in the prior letter_ruling and we reaffirm the rulings set forth in the prior letter_ruling this supplemental ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter together with the prior letter_ruling should be attached to the federal_income_tax returns of the taxpayers involved for the taxable_year in which plr-110578-99 the transaction covered by these ruling letters is consummated pursuant to the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representative sincerely assistant chief_counsel corporate by filiz a serbes assistant to the chief branch


internal_revenue_service department of the treasury index number washington dc person to contact telephone number refer reply to cc dom p si plr-114853 -99 date date number release date legend x d1 dear this letter responds to a letter dated date written on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administrative regulations to file an election under sec_301_7701-3 facts according to the information submitted x is a foreign eligible_entity classified as an association under sec_301_7701-3 x intended to file an election under form_8832 entity classification election to change its classification to a partnership effective d1 however the form_8832 was not timely filed x requests a ruling that it will be recognized as a partnership effective d1 law and analysis sec_301_7701-3 provides that an eligible_entity may elect to be classified as other than its default classification in sec_301_7701-3 by filing form_8832 with the appropriate service_center sec_301_7701-3 provides that unless the entity elects otherwise a foreign eligible_entity is classified as an association if all its members have limited_liability under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue plr-114853-99 ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make a regulatory election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusions in the present situation good cause has been shown and the other requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied consequently x is granted an extension of time for making the sec_301_7701-3 election until days following the date of this letter the election should be made by following the procedure set forth in form_8832 a copy of this letter should be attached to the election one is enclosed for that purpose except as specifically set forth above no opinion is expressed or implied as to the federal tax consequences of the transaction described above under any other provision of the code specifically no opinion is expressed concerning whether x is in fact a partnership for federal tax purposes this ruling is directed only to the taxpayer on whose behalf it was requested sec_6110 provides that it may not be used or cited as precedent under a power_of_attorney on file with this office a copy of this letter will be sent to x sincerely yours paul f kugler assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


office_of_chief_counsel internal_revenue_service memorandum number release date cc psi b07 tmmelchiorre preno-129095-11 third party communication none date of communication not applicable uilc date to holly l mccann chief excise_tax program from frank boland chief branch office of the associate chief_counsel passthroughs special industries subject sec_4052 - imported leased vehicles this responds to your request for assistance as to who is the importer and whether the excise_tax under sec_4051 of the internal_revenue_code is imposed in the following scenarios this advice may not be used or cited as precedent scenario - united_states company and foreign company - united_states lease united_states_corporation a enters into an agreement with foreign_corporation b so that b will lease to a new and used foreign-made heavy vehicles of the type that are taxable under sec_4051 a does not regularly sell such vehicles in the united_states at retail in arm’s length transactions the lease agreement is executed in the united_states where a is located before the agreement the vehicles have never been sold or used in the united_states a is not a related_person of b within the meaning of sec_4052 and sec_145_4052-1 of the temporary excise_tax regulations under the highway revenue act of pub l the agreement provides that a will lease the vehicles from b for a period of time that satisfies the definition of a long-term_lease under sec_4052 and sec_145_4052-1 in addition a will be responsible for all vehicle maintenance and be responsible for registering the vehicles with the applicable state department of motor_vehicle and paying all registration fees b retains title to the vehicles and is required under the agreement to ensure that the vehicles satisfy all united_states federal highway safety standards prior to importation the vehicles are imported thru a border crossing at which time u s customs and border protection issue a form_7501 entry summary listing b as the importer of record and a as the ultimate consignee at the conclusion of the lease a returns the vehicles back to b in b’s country questions who is the importer who is liable for the tax imposed under sec_4051 how is the tax under sec_4051 calculated scenario - law and analysis - question - who is the importer sec_145 f applies the general definitions and attachment of tax provisions of sec_48_0-2 of the manufacturers and retailers excise_taxes regulations to the tax imposed by sec_4051 sec_48_0-2 defines importer of a taxable article as any person who brings a taxable article into the united_states from a source outside the united_states or who withdraws such an article from a customs bonded_warehouse for sale or use in the united_states if the nominal importer of a taxable article is not its beneficial_owner for example the nominal importer is a customs broker engaged by the beneficial_owner the beneficial_owner is the importer of the article the question of who is the importer has been the subject of numerous court decisions and revenue rulings generally the cases and rulings hold that the importer is the first purchaser resident in the united_states who arranges as principal and not as agent for or is the inducing and efficient cause of goods being brought into the united_states for sale or use by him in determining who is the importer and the nominal importer the substance of the transaction rather than the mere passing of title to the goods is material see 368_f2d_577 ct_cl terry haggerty tire co v united_states cl_ct aff'd 899_f2d_1199 fed cir and revrul_69_393 1969_2_cb_206 in this scenario a is the importer because a is the inducing and efficient cause of the vehicles being brought into the united_states for a’s use but for a’s agreement with b to lease the vehicles b would not have imported the vehicles into the united_states see import wholesalers corp v united_states terry haggerty tire co v united_states and revrul_69_393 scenario - law and analysis - question - who is liable for the tax imposed by sec_4051 sec_4051 imposes a excise_tax on the first_retail_sale of certain enumerated articles including bodies and chassis of highway truck trailers and semitrailers sec_4052 defines first_retail_sale as the first sale for a purpose other than for resale or leasing in a long-term_lease after production manufacture or importation sec_4052 defines long-term_lease as any lease with a term of one year or more the rules of sec_168 apply in determining the lease_term sec_145_4052-1 provides that first_retail_sale means a taxable sale described in sec_145_4052-1 sec_145_4052-1 generally provides that a sale is a taxable sale unless i the sale is a tax-free sale under sec_4221 ii the sale satisfies the requirements of sec_48_4052-1 for sales after date or iii there has been a prior taxable sale of the article sec_145_4052-1 generally provides that the leasing of an article on a long-term basis as defined in sec_145_4052-1 is deemed to be a sale of the article and is deemed to be a taxable sale sec_145_4052-1 defines long-term_lease as any lease with a term of one year or more in 319_f2d_776 5th cir the court held that used volkswagen automobiles manufactured in germany were subject_to the excise_tax imposed by sec_4061 a predecessor to sec_4051 when imported into the united_states and sold at retail as used cars because each sale was the first sale within the united_states central transport inc v united_states wl e d mich affirmed by 953_f2d_1051 6th cir involved a situation where domestically-manufactured trucks were exported tax free to canada for sale in canada the trucks were purchased by a leasing company that leased the trucks when the leases expired the leasing company imported the trucks back into the united_states and leased them to a united_states company the court held that the first_retail_sale of the trucks for purposes of sec_4052 was the lease of the trucks to the united_states company after the leasing company imported the trucks into the united_states the court concluded based on the legislative_history of sec_4052 that the tax imposed by sec_4051 applied to used vehicles and that first_retail_sale means whatever first_retail_sale occurred within the boundaries of the united_states the court reasoned that sec_4052's use of the language after manufacture production or importation signifies that the first_retail_sale is either the first_retail_sale after manufacture or the first_retail_sale after production or the first_retail_sale after importation whichever first occurs in the united_states the use of the conjunctive term or was intended to capture the first sale in the united_states of imported vehicles whether or not the vehicles had previously been sold at retail outside of the united_states in this scenario b is liable for the tax imposed by sec_4051 the lease agreement is executed in the united_states b is the lessor of the vehicles and a is the lessee the long-term_lease of the vehicles by a from b is a treated as a taxable sale under sec_145_4052-1 because none of the exceptions contained in sec_145_4052-1 applies it is not material whether the vehicles are new or used see smith v united_states and central transport inc v united_states scenario - law and analysis - question - how is the tax under sec_4051 calculated sec_4052 provides that in the case of any long-term_lease of an article that is treated as the first_retail_sale of such article the tax is to be computed on a price equal to i the sum of i the price determined under but without regard to sec_4052 at which such article was sold to the lessor and ii the cost of any parts and accessories installed by the lessor on such article before the first use by the lessee or leased in connection with such long-term_lease plus ii an amount equal to the presumed_markup_percentage of the sum described in clause i sec_145_4052-1 provides that if a lease is deemed to be a taxable sale then the liability for the entire tax arises at the time of the lease no portion of the tax is deferred by reason of the fact that the sales_price is paid in installments sec_145_4052-1 provides that when a person other than a manufacturer producer or importer is the lessor of an article on a long-term basis as defined in sec_145_4052-1 and such lease is deemed to be a taxable sale under sec_145_4052-1 the tax is computed on a presumptive retail sales_price as determined under sec_145_4052-1 such person is liable for the tax as if the person sold the article at retail sec_145_4052-1 provides that in the case of any long-term_lease of an article in which any person other than a manufacturer producer or importer or related_person as defined in sec_145_4052-1 is the lessor and the long-term_lease is deemed to be a taxable sale of such article under sec_145_4052-1 the tax imposed by sec_4051 is computed on a price equal to the sum of-- i the price as determined under sec_145_4052-1 at which such article was sold to the lessor plus the cost of any parts and accessories installed by the lessor or an agent of the lessor on such article before the first use by the lessee or leased in connection with such long-term_lease and ii the product of the sum described in sec_145_4052-1 and the presumed_markup_percentage as defined in sec_145_4052-1 in this scenario b’s tax_liability under sec_4051 is calculated pursuant to sec_145_4052-1 because b is not the manufacturer producer or importer see also example of sec_145_4052-1 pursuant to sec_145_4052-1 b’s liability for the tax arises when the agreement between a and b is executed scenario - united_states company and foreign company - foreign lease the facts are the same facts as in scenario except that the agreement is executed in the foreign_country where b is located scenario - law and analysis - question - who is the importer in this scenario a is the importer for the reasons set forth in question of scenario scenario - law and analysis - question - who is liable for the tax imposed by sec_4051 sec_4052 provides that if any person uses an article taxable under sec_4051 before the first_retail_sale of such article then such person shall be liable for tax under sec_4051 in the same manner as if such article were sold at retail by him sec_145_4052-1 provides that the use of an article will be deemed to be a sale of the article in this scenario a is liable for the tax imposed by sec_4051 because a uses the vehicles in the united_states before the first_retail_sale of the vehicles in the united_states it is not material whether the vehicles are new or used scenario - law and analysis - question - how is the tax under sec_4051 calculated sec_4052 provides that in the case of any person made liable for tax by sec_4052 relating to the taxable use of the article the tax shall be computed on the price at which similar articles are sold at retail in the ordinary course of trade as determined by the secretary sec_145_4052-1 provides that if the taxable sale of an article is a taxable use of such article under sec_145_4052-1 the tax shall be computed on the price as determined under sec_145_4052-1 sec_145_4052-1 provides that if the seller of an article regularly sells such articles at retail in arm's length transactions tax_liability on its use of any such article shall be computed on its lowest established retail price for such articles in effect at the time of the taxable use in establishing such price there shall be included and excluded as applicable the charges and readjustments specified in sec_4216 sec_4216 and sec_6416 as in effect at the time the tax_liability on the use of the article is incurred if the seller of an article does not regularly sell such articles at retail in arm's length transactions a constructive price on which the tax shall be computed will be determined by the commissioner this price will be established after considering the selling practices and price structures of sellers of similar articles in this scenario a’s tax_liability under sec_4051 is calculated pursuant to sec_145_4052-1 because a does not regularly sell in the united_states at retail in arm’s length transactions the types of vehicles that are the subject of the lease the commissioner will determine a constructive price on which the tax will be computed after considering the selling practices and price structures of sellers of similar vehicles scenario - united_states company and foreign company - related_person the facts are the same facts as in scenario except that a is a wholly-owned subsidiary of b scenario - law and analysis - question - who is the importer in 714_f2d_1194 3rd cir strick and cotgo were united_states corporations that had the same parent company strick manufactured truck chassis and trailers cotgo purchased truck chassis and trailers from strick for the purpose of leasing them cotgo had no separate employees sales force or business location strick’s officers and manager handled cotgo’s business operations most of strick’s directors were also cotgo’s directors strick argued that cotgo should be disregarded as a corporate entity and that strick should be regarded as the lessor of the trailers for purposes of the excise_tax liability under sec_4061 a predecessor of sec_4051 the court declined to disregard cotgo finding that strick and cotgo and their parent were all corporations that were recognized as separate taxable entities the court cited for support 319_us_436 sole shareholder of corporation holding_real_estate unable to treat gain realized by the corporation’s sale of real_estate as gain taxable to him as an individual in this scenario a is the importer for the reasons set forth in question of scenario a being wholly owned by b is immaterial see strick corporation v united_states scenario - law and analysis - question - who is liable for the tax imposed by sec_4051 b is liable for the tax imposed by sec_4051 for the reasons set forth in question of scenario a being wholly owned by b is immaterial see strick corporation v united_states see also sec_48_4101-1 relating to certain fuel tax registrations which provides that each business unit that has a separate employer_identification_number is treated as a separate person for sec_4101 purposes scenario - law and analysis - question - how is the tax under sec_4051 calculated for purposes of determining the tax_base when the tax is imposed on the manufacturer producer or importer or person related to the manufacturer producer or importer sec_4052 defines related_person as any person who is a member of the same controlled_group within the meaning of sec_5061 as the manufacturer producer or importer except as provided in sec_4052 relating to sales through a permanent retail establishment in the normal course of business sec_5061 provides that in the case of a controlled_group_of_corporations all corporations that are component members of such group shall be treated as one taxpayer for purposes of the preceding sentence controlled_group_of_corporations has the meaning given to such term by sec_1563 except that more than percent shall be substituted for at least percent each place it appears in such subsection sec_145_4052-1 provides that except as provided in sec_145 d ii b relating to sales through a permanent retail establishment in the normal course of business related_person means any person that is a member of the same controlled_group within the meaning of sec_5061 as the manufacturer producer or importer sec_145_4052-1 provides that in the case of any long-term_lease as defined in sec_145_4052-1 by a manufacturer producer importer or a related_person as defined in sec_145_4052-1 of an article that is deemed to be a taxable sale of such article under sec_145_4052-1 the tax imposed by sec_4051 is computed on a price equal to the sum of-- i a constructive sales_price established by the commissioner based on the price at which such article would be sold by a manufacturer producer or importer in a sale other than a taxable sale eg a sale to which the exceptions contained in sec_145_4052-1 applies on the date the lease is made and ii the product of the constructive sales_price referred to in sec_145 d i and the presumed_markup_percentage as defined in sec_145_4052-1 in this scenario because a is wholly-owned by b b is a related_person to a within the meaning of sec_4052 and sec_145_4052-1 as a result b’s liability for the tax imposed by sec_4051 is calculated pursuant to sec_145_4052-1 see also example of sec_145_4052-1 pursuant to sec_145_4052-1 b’s liability for the tax arises when the agreement between a and b is executed please call if you have any further questions


office_of_chief_counsel internal_revenue_service memorandum number release date cc fip b03 postf-140487-12 third party communication none date of communication not applicable uilc date date to area_counsel heavy manufacturing transportation large business international attn philip yarberough from associate chief_counsel financial institutions products subject sec_475 and basket transactions this chief_counsel_advice responds to your request for assistance dated date this advice may not be used or cited as precedent legend taxpayer ---------------------------------------------------- trading entity y --------------------------------------------------- entity z -------------------------------------- person ------------------- year ------ year ------ years 3-through -------------- year ------ year ------ bank --------------------- basket transactions -------------------------------------- date ------------------ date ------------------ x percent --- y percent --- postf-140487-12 idr response ------------------------------------------------------------------ cca ------------------------------------------------------------------ --------------------------------------------------------------------------------------------------------- amount ------------------- amount ------------------- amount ------------------------- amount ----------------------- amount ----------------------- amount ----------------------- amount ----------------------- amount ----------------------- issue sec_1 whether the basket transactions at issue were subject_to a mark-to-market method_of_accounting under sec_475 if so please address how sec_475 would apply under the following alternative arguments a please address this issue under the primary theory of this case in which the basket transactions are recharacterized and not treated as options but rather the taxpayer is treated as the beneficial_owner of the underlying securities in the baskets b in the alternative if for example a court were to find that the recharacterization of the option treatment is not appropriate please address how the options would be treated under sec_475 c also if a court were to find under the primary argument or the alternative argument that neither position resulted in a change in method_of_accounting can the character of the gains and losses reported by taxpayer under the open_transaction method be treated as ordinary under sec_475 and f d conclusion sec_1 as discussed in the previously issued cca the change for taxpayer under the recharacterized basket transactions going from option transactions to the underlying securities traded under the basket transaction agreement results in taxpayer going from an open_transaction method_of_accounting to a sec_475 method_of_accounting this is a change in method_of_accounting for taxpayer and a sec_481 adjustment is appropriate we also think that same rationale applies to the method change for the alternative argument raised in issue b taxpayer had a whole class of securities ie options that should have been marked under sec_475 and it did not mark any of these basket transactions under sec_475 this is a material_item not a correction_of_an_error and therefore a method change discussed postf-140487-12 below is the application of the sec_475 method_of_accounting to the various scenarios described in issue sec_1 a - c a taxpayer made a sec_475 election so it must report all of its securities described in sec_475 under the sec_475 mark-to-market method_of_accounting the recharacterized basket transactions have underlying securities that are subject_to sec_475 taxpayer has not established that the basket transactions or the recharacterized transactions were excepted from marking under sec_475 therefore sec_475 is the appropriate method_of_accounting to be used for the recharacterized basket transactions and all gains and losses are ordinary b we note that it is service position that these transactions are not options and should not be treated as such that said you have now asked what the results would be under sec_475 if the basket transactions were not recast the tax treatment would be the same under sec_475 for the recharacterized transactions or if these securities were treated as options because these options are securities under sec_475 they are required to be marked to market taxpayer has not established that these securities are not held in connection with its trading business therefore they are not excepted from marking under sec_475 c if a court rejects our change in method_of_accounting argument another alternative argument can be used to treat the reported long term capital_gains as ordinary because sec_475 is the appropriate method_of_accounting to be used for these transactions under sec_475 and sec_475 any gains or losses reported under the open_transaction method can be recharacterized as ordinary gains or losses however we cannot say for certain that the service will get all of the gains and losses that would have been reported under a mark-to-market calculation with a sec_481 adjustment therefore this position should only be used as an alternative to the other two positions discussed above facts taxpayer is a limited_liability_company treated as a partnership for tax purposes taxpayer conducts hedge fund activities taxpayer and other affiliated limited_liability companies were controlled by common members including person who is a member manager of taxpayer person holds its majority interest in taxpayer through entity z taxpayer through its wholly owned disregarded_entity trading entity y made a sec_475 election as a trader in securities this election was made with taxpayer’s year tax_return and effective for year and forward for the years at issue taxpayer conducted trading activity through trading entity y trading entity y generally purchases and sells positions in securities on a daily basis during year sec_3 through taxpayer entered into several different basket transactions with bank the basket transactions were styled as a call option on a postf-140487-12 basket of securities held in specified prime brokerage accounts with bank taxpayer controlled the basket of securities while the option was open the baskets were comprised of u s equity securities divided into long and short positions in a typical basket transaction taxpayer makes an upfront payment of x percent of the notional amount referenced in the basket transaction bank provides the remaining y percent the total amount which is used to acquire a basket of securities that is actively_traded and managed by entity z and other affiliates of taxpayer the contract between taxpayer and bank describes taxpayer’s upfront payment as a premium that gives taxpayer an option to receive a cash settlement amount from bank when the contract expires or is otherwise terminated the premium amount is determined by bank’s finance department rather than through option valuations formulas typically used when pricing standard options the cash settlement amount is determined by a formula that reflects i the increase or decrease in the value of the securities held and traded within the basket transactions ii expense and income payments made or received with respect to the securities and iii the interest and fees payable to bank for its services and capital for tax purposes taxpayer treated the basket transactions as options under sec_1234 as a result taxpayer did not recognize gains losses income or deductions as it held and traded the securities within the basket transaction instead it deferred recognition of any_tax consequences until the basket transaction expired or otherwise terminated when taxpayer recognized gain equaling the difference between the cash settlement amount and the upfront payment made on its year return taxpayer reported that basket was purchased on date and sold on date for amount taxpayer had a basis in basket of amount taxpayer had reported long term capital_gain in amount on its year return taxpayer reported a combined sales_price of amount for baskets these same transactions had a cost_basis of amount taxpayer reported a combined long term capital_gain in amount taxpayer’s federal tax returns for years and are currently under examination exam has determined that the basket transactions lack the requirements to be treated as options for tax purposes it has also been determined by exam that taxpayer has the benefits_and_burdens_of_ownership of the securities underlying the basket transactions and thus was the beneficial_ownership of these securities for tax purposes exam has challenged taxpayer’s deferral of gains and losses income or deductions associated with the basket transactions exam intends to place taxpayer on the correct method_of_accounting consistent with its ownership of securities it also intends to impose an adjustment under sec_481 in the first year of the tax examination the service addressed this issue in generic_legal_advice see am-2010-005 postf-140487-12 for book purposes taxpayer marked to market its securities including the basket transactions for tax purposes taxpayer did not account for any of its basket transactions under sec_475 but it did mark to market other trading securities held by trading entity y by not marking the basket transactions taxpayer left out a whole class of securities from its proper method_of_accounting for securities subject_to sec_475 taxpayer had stated in its idr response that it misread sec_475 which provides for separate elections for a trader in securities and a trader in commodities taxpayer claims that they originally thought they could make separate sec_475 elections for each line of trade_or_business it owns and that it had not made an election for the basket transactions taxpayer argues that if they cannot make separate elections that this is not a change in method_of_accounting but rather a correction_of_an_error the service’s position is that the treatment of the basket transactions is a material_item and as such any adjustment that conforms to the practice of taxpayer’s existing method_of_accounting is an accounting_method change rather than an error correction advice has previously been sought by lb_i as to whether this change from a deferral reporting open_transaction method to reporting the gains and losses currently is a change in taxpayer’s method_of_accounting and whether this change allows for a sec_481 adjustment chief_counsel_advice was issued stating that this is a change in method_of_accounting and that a sec_481 adjustment is appropriate see cca chief_counsel_advice was also sought on the effect of sec_734 basis adjustments as a result of a sec_754 election on the issue of whether this is a change in method_of_accounting the service determined that the basis adjustments do not change its conclusion that this is a change in method_of_accounting this chief_counsel_advice addresses sec_475 implications law and analysis whether the basket transactions are subject_to a mark-to-market method_of_accounting under sec_475 sec_475 provides that a person who is engaged in a trade_or_business as a trader in securities can elect to have the mark to market rules of sec_475 apply to such trade_or_business if the mark-to-market rules apply such person shall recognize gain_or_loss on any security held in connection with its trade_or_business at the close of any taxable_year as if such security were sold for its fair_market_value on the last business_day of such taxable_year any such gain_or_loss shall be taken into account for such taxable_year the general_rule that the character of the gains and losses under sec_475 are ordinary also applies to a trader in securities that has made an election under sec_475 see sec_475 and sec_475 see also proposed treas postf-140487-12 reg sec_1 f b sec_475 also applies to traders and provides exceptions to the automatically ordinary rule under sec_475 if a taxpayer can establish that it held securities as hedges or that the securities were not held in connection with its trading business or that a security is improperly identified as described in sec_475 then gains and losses are not automatically ordinary sec_475 ii and iii character must then be determined by other relevant code sections any securities held by the trader are subject_to marking unless they fall within the exception to marking under sec_475 in the case of traders there is only one exception to marking under that exception two requirements must be met first it must be established to the satisfaction of the secretary that the security has no connection to the activities of such person as a trader see sec_475 second any such security must be clearly identified in such person’s records as being described in sec_475 before the close of the day on which it was acquired originated or entered into or such other time as the secretary may by regulations prescribe see sec_475 an identification that a security is held for investment for financial reporting purposes is not sufficient for sec_475 purposes see revrul_97_39 1997_2_cb_62 issue this is even more so in the case of a trader who has to establish more than that a security is held for investment but that the security is not held in connection with it trading business in the case of traders the legislative_history makes it clear that congress was concerned about issues of taxpayer selectivity in making identifications out of marking it did not want a taxpayer to selectively mark to market some securities and then to selectively identify other_securities as exempt from the mark-to-market treatment congress especially did not want a taxpayer to be able to do that using hindsight to address this concern congress placed a higher burden_of_proof for electing securities traders to identify securities as not subject_to sec_475 than is applicable to securities dealers another concern is that it is more difficult for the service to distinguish trading securities from investment securities than it is to distinguish dealer_securities from investment securities see conf report 105th cong 1st sess date 1997_4_cb_1457 general explanation of tax legislation enacted in blue_book jcs date p 1997_3_cb_89 see also preamble to reg-104924-98 1999_10_irb_47 under the proposed_regulations a taxpayer must be able to demonstrate by clear_and_convincing evidence that a security bears no relation to its activities as a trader in order to be identified as not subject_to the mark-to-market rules of sec_475 see proposed reg sec_1 f -2 a the proposed regulation also provides a special rule for the situation where a taxpayer may identify securities as not held in connection with its trading business when the electing trader also trades the same or substantially_similar securities that it uses in its trade_or_business in this situation a taxpayer can only meet the requirements of sec_475 if the security is held in a separate non-trading account maintained by a third party see proposed reg sec_1 f -2 a postf-140487-12 under proposed reg sec_1 f -2 a if an electing trader holds a security that is not held in connection with its trading business and fails to identify the security in a manner that satisfies the requirements of sec_475 then sec_475 applies ie the security is marked to market and any losses realized with respect to the security prior to its disposition are recognized only to the extent of gain previously recognized with respect to that security and the character of the gain_or_loss is ordinary the election under sec_475 is made on an entity by entity basis not a separate trade_or_business basis only in the case of separate commodities and securities businesses can a taxpayer make separate elections sec_475 provides that separate elections must be made for a trader in securities election under f and a trader in commodities election under f a application of sec_475 if basket transactions not treated as options under lb i’s primary theory for this case the basket transactions contracts should be recharacterized such that they are not treated as options under sec_1234 but instead as though taxpayer directly owned each security in the baskets the result is that taxpayer is to be taken off the open_transaction method_of_accounting it was using and will be placed on a mark-to-market method_of_accounting for these securities taxpayer had previously made an election under sec_475 and that election applies to any trading conducted by itself and any trading conducted by its disregarded_entity trading entity y all securities subject_to sec_475 must be marked to market unless they fall within the exception to marking under sec_475 in this case there does not appear to be any question that a sec_475 election was made and that it applies to taxpayer in idr response taxpayer explains that it originally thought that under sec_475 it could make separate elections for different lines of trading businesses but even within that idr it acknowledges that is not what sec_475 provides in that same idr response it does not appear that taxpayer’s position is that these securities are not held in connection with their trading business rather taxpayer is asserting that since they were already on a mark-to-market method under sec_475 that this is not a change in a method_of_accounting but a correction_of_an_error as stated above cca addresses this issue thoroughly it remains our position that this treatment of the the primary theory in this case is therefore consistent with the conclusions reached in am this chief_counsel_advice cca does not address the correctness of this position to this taxpayer that issue has been previously addressed this cca assumes that position is correct this cca also does not address the change in accounting_method_issue and the appropriateness of the sec_481 adjustment in depth as that it has been thoroughly discussed in a cca this cca is addressing the application of sec_475 to the recharacterized transactions and the alternative arguments raised by your incoming request postf-140487-12 underlying basket of securities as subject_to sec_475 is a change in its method_of_accounting and a sec_481 adjustment is appropriate although it is not clear from your incoming request whether taxpayer is actually asserting that these securities meet the exception to marking under sec_475 we are assuming that you have asked us to address this issue in case taxpayer raises it later in the exam in the appeals process or in litigation as discussed above there are two requirements that must met to except any securities from marking under sec_475 taxpayer must establish securities are not held in connection with its trading business and there must be timely and specific sec_475 identification made in its books_and_records taxpayer has not asserted that the basket transactions contracts were not held in connection with its trading business in addition there have been no facts presented to us that suggest these contracts were not held in connection with taxpayer’s trading business the facts seem to support the conclusion that these securities were held in connection with its trading business the trading strategies used for taxpayer and the basket transactions were nearly identical to the trading strategies used for the individual securities traded through taxpayer’s disregarded_entity trading entity y in its other brokerage account with bank taxpayer conducted its non-basket transactions through trading entity y’s brokerage account both taxpayer’s basket transactions and its individual security positions owned by trading entity y were held in the accounts with bank gains from taxpayer’s basket transactions upon termination were used to pay the liabilities incurred in trading entity y’s trading account it is also our understanding that the sheer volume of securities trading that occurred in each basket on a daily basis makes it very difficult to find that these securities were not held in connection with its trading business taxpayer did record the basket transactions in their month-ending trial balances under the title investment in barrier option taxpayer also noted in its financial statements that the basket transaction securities cannot be offered or sold because of other arrangements restrictions or conditions applicable to the instruments or to the company taxpayer recorded the x premium payment on its balance_sheet on its financial statements it reported the fair value of the total cash settlement amount from the baskets the fact that taxpayer did record the basket transactions on its monthly ending trial balances as an investment in options does not necessarily support a finding that these securities were not held in connection with its trading business in addition taxpayer did not make any specific references to sec_475 identifications taxpayer didn’t make any same day identifications in its books_and_records regarding sec_475 identifications taxpayer’s only type of identification of the basket transactions appears on the month-end trial balances and balance_sheet and as stated above these notations are not specific to sec_475 and they do not occur on acquisition dates but are noted at month end postf-140487-12 taxpayer has not established by clear_and_convincing evidence that these basket transactions or the underlying securities in the basket transactions are not held in connection with its trading business and no timely or proper sec_475 identifications have been made therefore the recharacterized option transactions the underlying basket of securities are marked to market under sec_475 and all gains or losses are ordinary because this is a change in method_of_accounting going from the open_transaction method to a sec_475 mark-to-market method for these recharacterized basket transaction a sec_481 adjustment is appropriate as thoroughly discussed in cca a change in method_of_accounting occurs when taxpayer no longer treats certain securities transactions as options and stops deferring the gains losses income and deductions associated with those transactions the computation and recognition of an appropriate sec_481 adjustment is needed to eliminate any distortion duplication or omission_of_income or deductions caused by the accounting_method change taxpayer’s argument that this is not a method change but a correction_of_an_error is incorrect as also discussed in cca the fact that taxpayer was already on a sec_475 method_of_accounting for its securities does not preclude a change in method_of_accounting when taxpayer has left out a whole class of securities basket transaction securities from that method a taxpayer is generally required to apply the same accounting_method to all instances of a particular item in this case taxpayer is required to apply the same accounting_method for all securities subject_to sec_475 and not identified out of marking on occasion however a taxpayer purports or attempts to report an item using the accounting_method that it has adopted established or elected but fails to apply the accounting_method with perfect consistency as a result the taxpayer treats the item in two different ways part of the item is reported under the primary accounting_method while the remainder of the item is reported using a treatment that diverges from the primary accounting_method divergent treatment when the divergent treatment is discovered by the taxpayer or exam the issue arises whether adjustments to conform the divergent treatment to the primary accounting_method should be treated as the correction of errors in open tax years or as a change in accounting_method under sec_446 and sec_481 under current law we believe that the key to deciding whether an accounting_method change occurs is whether the divergent treatment is a timing practice that is used on a consistent basis if so then the divergent treatment is a material_item and conforming the divergent treatment to the primary accounting_method is a change in the treatment of a material_item that constitutes an accounting_method change see sec_1 e ii a in contrast if the divergent treatment is not a timing practice and or is not a consistent practice it will have a permanent impact on lifetime taxable_income and the divergent treatment is an error or series of errors in this case taxpayer’s treatment of the basket transactions is a material_item a timing practice that was employed by taxpayer consistently over many years therefore any adjustment that postf-140487-12 conforms the practice to its existing accounting_method would be an accounting_method change rather than an error correction b alternatively application of sec_475 if the service fails in challenging taxpayer’s treatment of the basket transactions as options the incoming request raises an alternative question as to how these transactions would be treated under sec_475 if the option form of these transactions were somehow not recharacterized as noted above the recharacterization of the basket transactions should be our primary argument we are addressing this alternative argument in case a court disagreed with our primary argument because a sec_475 election was made by this taxpayer all of its securities must be marked to market an option other than a sec_1256 contract is a sec_475 security the options in this case do not appear to be sec_1256 contracts the same analysis discussed above would apply for determining whether taxpayer meets the exception to marking under sec_475 based upon the facts we know to date we do not think taxpayer can establish that the basket transactions were not held in connection with taxpayer’s trading business securities taxpayer also did not make an identification specific to sec_475 as required by sec_475 therefore the sec_475 method_of_accounting applies and all gains or losses are ordinary the same analysis discussed above regarding a change in method_of_accounting and a sec_481 adjustment also applies under this argument taxpayer’s failure to mark the options when it was subject_to sec_475 is a material_item and a timing practice that was consistently done therefore any adjustment that conforms the practice to its sec_475 method would be an accounting_method change rather than an error correction a sec_481 adjustment would be appropriate in this case c alternative argument if a court were to find under the primary argument a or the alternative argument b that neither position resulted in a change in method_of_accounting can the character of the gains and losses reported by taxpayer under the open_transaction method be treated as ordinary under sec_475 and f d the incoming request also raises another alternative argument as to whether the character of the long term capital_gains can be treated as ordinary under sec_475 and f d assuming a court does not agree with our conclusion that this is a change in method_of_accounting with a sec_481 adjustment applying for example basket was sold on date for amount taxpayer had a cost_basis in basket of amount taxpayer treated the sale of basket as triggering a long term capital_gain in amount exam wants to assert that taxpayer has ordinary_income on basket in amount for baskets at year end for year taxpayer still owned the baskets and the collective cash settlement amount of baskets was reported on this includes an increase to the original premium that is attributable to sec_734 adjustments from gain recognized by partners on the liquidation of their partnership interests postf-140487-12 the basket performance reports generated by bank as amount as of the end of year taxpayer had an adjusted_basis in the baskets of amount exam wants to assert that for year taxpayer had ordinary gains in amount for year when taxpayer terminated baskets for the cash settlement amount of amount exam wants to assert that taxpayer has ordinary gains in amount only if we are unable to get a sec_481 adjustment for closed years do we think we should use this argument as an alternative argument in that case we agree that sec_475 and f d can be asserted to find the gains and losses are ordinary we note also that proposed sec_1 f -2 a b also provides that the character of securities subject_to marking under sec_475 is ordinary however we are not sure that under this argument the service would pick up all the income that should be recognized under a mark-to-market method with a sec_481 adjustment picking up the income that arose during the closed years because of the closed years involved and because different securities could be and were traded in and out of the baskets on a daily basis we are uncertain that this argument picks up the appropriate amount of gains and losses under sec_475 it is not clear that all the appropriate values for the sold securities are reflected in the basis of the basket or are all part of the deferred gains or losses realized upon termination of the basket because the basket transactions do not reference specific properties at a defined price using the gains or losses from the open_transaction method may not be sufficient before this type of argument could be applied it must be established that sec_475 applies to the securities at issue and that the automatic ordinary treatment under sec_475 and f d applies and that none of the exceptions to automatic ordinary treatment under sec_475 apply as discussed above in the primary argument and the first alternative argument sec_475 applies in this case because of the election made by the taxpayer based upon the facts that have been presented to us so far none of the exceptions to automatic ordinary treatment under sec_475 and f d apply in this case taxpayer is not using the basket transactions as hedges identified under sec_475 the basket transactions are held in connection with the taxpayer’s trading business or at least taxpayer has not established that they are not held in connection with its trading business and these basket transactions have not been improperly identified as described in sec_475 therefore sec_475 and f d would make any gains or losses ordinary case development hazards and other considerations postf-140487-12 postf-140487-12 this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views postf-140487-12 please call if you have any further questions helen hubbard associate chief_counsel financial institutions products by _____________________________ robert b williams senior counsel branch financial institutions products