t c memo united_states tax_court laurel alterman and william a gibson petitioners v commissioner of internal revenue respondent docket no filed date henry g wykowski and matthew a williams for petitioners cameron w carr kaelyn j romey and luke d ortner for respondent memorandum findings_of_fact and opinion morrison judge the petitioners laurel alterman and william a gibson filed joint income-tax returns for and on date the respondent hereinafter the irs issued a notice_of_deficiency to alterman and gibson the notice_of_deficiency made adjustments to the income of a colorado medical-marijuana business owned by alterman income that was reported on schedules c profit or loss from business of both returns the irs determined the following income-tax deficiencies and accuracy-related_penalties under sec_6662 for tax_year sec_2010 and sec_2011 year deficiency penalty sec_6662 dollar_figure big_number dollar_figure big_number alterman and gibson filed a petition under sec_6213 for redetermination of the deficiencies for both years we have jurisdiction under sec_6214 after taking into account concessions by the parties described later in the opinion here are the issues remaining for decision what are the amounts of deductible business_expenses for alterman’s medical-marijuana business for tax_year sec_2010 and sec_2011 we hold that petitioners are not entitled to any business-expense deductions see infra part i 1unless otherwise indicated all references to sections are to the internal_revenue_code_of_1986 as amended and all references to rules are to the tax_court rules_of_practice and procedure all dollar amounts are rounded to the nearest dollar 2alterman and gibson resided in colorado when they timely filed the petition therefore any appeal of our decision in this case would go to the u s court_of_appeals for the tenth circuit unless the parties designate the court_of_appeals for another circuit see sec_7482 and are alterman and gibson entitled to cost-of-goods-sold allowances for the medical-marijuana business in excess of the amounts conceded by the irs in its briefs for tax_year sec_2010 and sec_2011 the conceded amounts are dollar_figure for and dollar_figure for we hold that they are not entitled to additional allowances see infra part ii are alterman and gibson liable for accuracy-related_penalties under sec_6662 for tax_year sec_2010 and sec_2011 we hold that they are liable see infra part iii findings_of_fact the parties stipulated some facts and those facts are incorporated by reference at all times during and alterman and gibson were married and resided in colorado they filed joint returns for these years setting up altermeds llc during the years at issue it was not illegal under colorado law for people to use marijuana medically and for a medical-marijuana business to sell marijuana see colo const art xviii sec however both activities were illegal under federal_law in date alterman incorporated altermeds llc she was it sec_3under federal_law marijuana is classified as a schedule i controlled substance under the controlled substances act pub_l_no sec_102 continued sole owner during and altermeds llc was a separate_entity under colorado law for federal tax purposes it is a disregarded_entity meaning that it is treated as a sole_proprietorship of alterman see sec_301 a proced admin regs operation of the medical-marijuana dispensary around date altermeds llc opened a retail store under the business name altermeds we refer to this retail store as the dispensary the dispensary was in louisville colorado which is near boulder colorado the dispensary had regular operating hours of monday through saturday from a m to p m and on sunday from p m to p m the dispensary sold smokable marijuana either as prerolled marijuana cigarettes ie joints or as dried marijuana buds it also sold marijuana in edible form such as brownies and cakes and orally-consumed tincture sec_5 we refer to continued stat pincite codified as amended pincite u s c secs 4before she started altermeds llc alterman worked as a real_estate agent she continued to work as a real_estate agent even while owning and working at altermeds llc 5a marijuana tincture is a liquid containing marijuana and is consumed orally for example by adding tincture drops to tea altermeds llc’s merchandise that contained marijuana in any of the types of products mentioned above as its marijuana merchandise during and the dispensary also sold products that contained no marijuana such as pipes papers and other items used to consume marijuana we refer to this type of merchandise as the non-marijuana merchandise in and altermeds llc acquired all of its non-marijuana merchandise from third-party sellers altermeds llc did not provide any services alterman shared the management responsibilities for the dispensary with her son jack alterman jack worked at the dispensary during the years at issue it was he who usually made the decisions concerning the purchase of marijuana and non-marijuana merchandise alterman was responsible for altermeds llc’s recordkeeping and finances such as making bank_deposits paying for merchandise and paying expenses 6jack did not work for altermeds llc continuously during the years at issue the record is not clear when jack was not working for altermeds llc and who handled merchandise purchases during his absence purchases and production of marijuana merchandise by altermeds llc during altermeds llc did not grow or produce any of its marijuana merchandise it bought all of its marijuana merchandise during that year exclusively from third parties during altermeds llc continued to acquire marijuana merchandise from third-party sellers effective date colorado required medical-marijuana businesses to grow at least of the marijuana they sold colo rev stat sec b anticipating this requirement altermeds llc began renting a warehouse in date to grow its own marijuana the warehouse which was in boulder was referred to as the grow site when altermeds llc first rented the warehouse the warehouse needed modifications before it could produce marijuana altermeds llc hired michael boughton and tiffany weaver in date to make the necessary modifications boughton was a person who had previously sold marijuana merchandise to altermeds llc in date altermeds llc also hired joseph ingoglia to assist with the grow site the only employees who worked at the grow site during were boughton weaver and ingoglia while the grow site was being modified boughton and weaver agreed to sell marijuana merchandise to altermeds llc on credit pursuant to an oral agreement with alterman in marijuana was grown in tents in the warehouse while the grow site was being modified the record is unclear as to whether the marijuana grown in the tents in was owned by boughton and weaver who then sold it to altermeds llc on credit or by altermeds llc it is also unclear whether any of the marijuana grown in the tents during was transferred to the dispensary in during altermeds llc made payments to boughton weaver and ingoglia the payments to ingoglia were treated as wage payments by altermeds llc the payments to boughton and weaver included payments treated by altermeds llc for federal tax purposes as wage payments and included payments not so treated in altermeds llc continued to purchase marijuana merchandise from third-party sellers it is unclear whether altermeds llc purchased marijuana from boughton and weaver during from january until date altermeds llc made payments to boughton and weaver all of these payments were treated as wage payments for federal tax purposes by altermeds llc although the record does not allow us to say how much of the payments were actually for boughton’s and weaver’s services as employees around date the colorado medical marijuana board certified that altermeds llc’s grow site met the structural and mechanical requirements for marijuana cultivation facilities altermeds llc fired boughton and weaver around the same time boughton and weaver credibly testified that when they were fired altermeds llc still owed them for marijuana that they had sold altermeds llc on credit the record does not allow us to calculate the exact amount owed ingoglia continued to work at the grow site for some time after date but ended his employment with altermeds llc before the end of after ingoglia stopped working for altermeds llc it is unclear which altermeds llc employees worked at the grow site employees of altermeds llc in and altermeds llc employed boughton weaver ingoglia and others the following table summarizes the forms w-2 wage and tax statement issued by altermeds llc for the years at issue employee jack alterman robert des plaines samuel feliciano nathan leake noelle sherman michael boughton tiffany weaver joseph ingoglia chad terry adam locy jessica cole laurel alterman total dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number the record confirms that altermeds llc made payments in these amounts to these persons the record does not allow us to say how much of these payments was actually for these persons’ services as employees the overall amounts reported on the forms w-2 as wages equal the wage deductions reported on altermeds llc’s schedules c dollar_figure in and dollar_figure in some employees worked at the dispensary some worked at the grow site and some worked at both employees at the dispensary sold marijuana merchandise and non-marijuana merchandise according to alterman employees at the dispensary also engaged in the trimming of marijuana trimming is the process of removing stems seeds and twigs from a marijuana plant to convert marijuana to final salable form alterman estimated that of the time spent by any particular employee at the dispensary of that time was occupied by trimming we do not believe that employees working at the dispensary spent substantial time trimming because no evidence other than alterman’s testimony supports the assertion that employees working at the dispensary trimmed marijuana and other witnesses credibly testified that no trimming took place at the dispensary neither altermeds llc employees nor alterman recorded the hours worked by particular employees at the grow site versus the dispensary given the lack of information in the record we cannot determine what part of the payments treated by altermeds llc as employee wages was paid for work performed at the grow site versus the dispensary records of altermeds llc during examination alterman provided the irs with receipts that corroborated some of the expenses paid_by altermeds llc and some of the purchases of merchandise made by altermeds llc none of these receipts are in the record 7the record does not reveal whether the receipts for purchases of merchandise given by alterman to the irs were receipts for non-marijuana merchandise or marijuana merchandise or both the record contains altermeds llc’s general ledger for and we first discuss the notations made in the general ledger for purchases of marijuana and non-marijuana merchandise we refer to these notations as purchase notations for each purchase of merchandise the general ledger recorded the date the dollar amount and the method of payment each purchase of merchandise was given one of four types of descriptions in the general ledger smokable for marijuana buds and pre-rolled joints edible for food items tinctures and other infused items non-marijuana for papers and other paraphernalia and a fourth grouping mysteriously labeled meds-c hereinafter the undefined merchandise the record is unclear as to whether the undefined merchandise contained marijuana sometimes the identity of the seller was noted in the purchase notation sometimes it was not the general ledger aggregated the total_amounts paid for merchandise purchases in a year in each of the four descriptive categories of merchandise the general ledger also aggregated the total_amounts paid for all merchandise purchases in a year the general ledger tracked the dispensary’s daily receipts in the same four merchandise categories as the purchase notations the general ledger does not reflect the dollar amount of each particular transaction according to the gross_receipts in the general ledger altermeds llc derived of its gross receipts from smokable marijuana merchandise from edible marijuana merchandise from non-marijuana merchandise and from the undefined merchandise for the percentages are from smokable marijuana merchandise from edible marijuana merchandise from non-marijuana merchandise and from the undefined merchandise we now discuss the notations made in the general ledger with respect to expenses as distinguished from the purchase of merchandise for each payment of an expense the general ledger shows the date the dollar amount the type of expense eg utilities rent etc the payment method ie cash check credit card or electronic funds transfer and sometimes the identity of the payee altermeds llc paid its expenses and paid for its merchandise through various alternative methods checks from three checking accounts written directly to vendors checks from one of three checking accounts ie the dispensary account as described below to jack who then paid cash to the vendor electronic funds transfers from the three checking accounts a visa credit card cash paid out of the cash register at the dispensary or cash paid from an unknown source as discussed above checks were written from three checking accounts the first checking account was often used to pay the expenses of the dispensary and for merchandise purchases we refer to this checking account as the dispensary account checks were written from this account during both and the record contains check-register entries for the checks written during the record contains check-register entries for some but not all of the checks written during the information in each check-register entry included the date and the amount of the check for checks written for merchandise purchases the check-register entries also sometimes showed the payees for checks written for smokable marijuana the check-register entries also sometimes showed the strains and weights of marijuana purchased for checks written for edibles and non-marijuana merchandise the check-register entries also sometimes showed the quantities purchased for checks written to pay expenses as distinguished from the purchases of merchandise the check-register entries also showed the general purposes of the payments eg costco - supplies and sometimes showed the payees the second checking account was often used to pay the costs of the grow site and also for merchandise purchases we refer to this second checking account as the grow-site account although checks were written from this account in and there is no check register in the record for this account the third checking account was first used in date it was sometimes used to pay expenses and also for merchandise purchases no check register is in the record for this account in both years at issue some merchandise purchases and expenses were paid with electronic funds transfers made from all three checking accounts the record contains banks statements for all three checking accounts for the dispensary account the bank statements cover date to date for the grow-site account the bank statements cover the period from when the account was opened date until date for the third account the bank statements cover date which is when the account was first used the bank statements contain entries corresponding to all checks written from the three accounts during and the bank statements contain entries corresponding to all electronic funds transfers from all three accounts during and for electronic funds transfers the bank statements show the date of each transfer the amount of the transfer and the payee this set of information is not more detailed than the corresponding information in the general ledger for the identical electronic funds transfers a number of entries recorded in the general ledger as purchases of smokable marijuana merchandise were paid with electronic funds transfers for some of these entries the payees were home improvement stores such as home depot or lowe’s we find it improbable that these stores sold smokable marijuana to altermeds llc in both years at issue some merchandise purchases were made with cash taken from the dispensary’s register altermeds llc kept a daily sales record for its dispensary in addition to recording gross_receipts on a daily basis this daily sales record noted the amount of cash taken from the register for merchandise purchases and classified the purchased merchandise into one of the four merchandise categories occasionally additional details concerning the purchased merchandise were recorded on the daily sales record some edible marijuana merchandise was purchased during using cash the source of the cash is unclear some merchandise was purchased during by jack using cash that he acquired when alterman wrote a check to him merchandise was purchased in this way when the third-party seller did not wish to receive a check it appears 8the additional information for these merchandise purchases was no greater in detail than what alterman noted in the most detailed check-register entries for purchases of merchandise ie those check-register entries in which alterman noted the strains and weights for smokable marijuana merchandise and the unit quantities for edible marijuana and non-marijuana merchandise that the checks used in such an intermediary purchase were drawn from the dispensary account and were recorded in the check register in and altermeds llc used a visa credit card to pay some of its expenses and for merchandise purchases the credit card statements hereinafter the visa statements in the record were incomplete as pages were missing for both years alterman wrote on the visa statements descriptions of the categories of some of the expenses either alterman or mark pendleton altermeds llc’s bookkeeper went through the visa statements and aggregated certain expenses or merchandise purchases into single sums these sums were then transferred to the general ledger thus for these sums the general ledger entries are not specific to particular payments but rather a group of payments pendleton used alterman’s initial categorizations of visa card charges when he transferred the amounts to the expense or merchandise purchase categories in the general ledger as discussed above the dispensary used daily sales records that tracked its gross_receipts alterman gave the daily sales records to pendleton to enter into the general ledger pendleton used the daily sales records to prepare monthly statements but these monthly statements are not in the record to prepare the general ledger pendleton relied on documents that alterman provided to him including daily sales records visa statements and receipts it is unclear whether alterman provided pendleton with bank statements it appears that alterman did provide pendleton with some deposit slips ie records given to alterman by the bank when alterman made a particular deposit however no deposits slips are in the record alterman herself did not verify whether the gross_receipts in the general ledger were consistent with the amounts stated in the daily sales records tax reporting the income of altermeds llc was reported on schedules c attached to alterman and gibson’ sec_2010 and sec_2011 joint returns for the schedule c reported gross_receipts of dollar_figure the schedule c reduced gross_receipts by cost_of_goods_sold of dollar_figure the schedule c also reported business-expense deductions of dollar_figure for the schedule c reported gross_receipts of dollar_figure the schedule c reduced gross_receipts by cost_of_goods_sold of dollar_figure the schedule c also reported business-expense deductions of dollar_figure the schedules c reported that cost_of_goods_sold for each year at issue and was computed as follows inventory at beginning of year purchases less cost of items withdrawn for personal_use cost of labor materials_and_supplies inventory at end of year cost_of_goods_sold dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number the schedules c reported that altermeds llc’s income had been calculated using the cash_method_of_accounting for the tax_year the first year that altermeds llc was in business alterman and gibson’s tax_return was prepared by pendleton pendleton also served as altermeds llc’s bookkeeper during pendleton had been preparing returns for alterman and gibson in years before for the tax_year alterman decided instead to use the services of comiskey co hereinafter comiskey to prepare the returndollar_figure comiskey was recommended to alterman by jill lameroux another medical-marijuana business owner alterman reviewed the return before signing it 9pendleton attached a separate schedule c for tax_year to report the expenses and income of alterman’s real_estate agent business 10comiskey attached a separate schedule c for tax_year to report the expenses and income of alterman’s real_estate agent business for comiskey’s use in preparing the return alterman provided the firm with a profit and loss statement and a balance_sheet for altermeds llcdollar_figure she did not provide comiskey with other records such as the general ledger or receipts comiskey apparently used the profit and loss statement and the balance_sheet to report the various items of cost_of_goods_sold on the schedule c for dollar_figure in particular dollar_figure total cost_of_goods_sold for it appears that comiskey transferred the profit and loss statement entry total cost_of_goods_sold in the amount of dollar_figure to the schedule c line item for cost_of_goods_sold in the same amount the entry total cost_of_goods_sold in the profit and loss statement in the amount of dollar_figure was composed of four subtotals for each of the four merchandise categories used in the purchase notations in the general ledger the record does not reveal how the profit and loss statement computed the subtotals in each of the four merchandise categories 11the record does not reveal who prepared the profit and loss statement or the balance_sheet or what information was used to prepare these two documents 12the record includes the profit and loss statement and balance_sheet for tax_year no such documents appear in the record for tax years and and we believe there were no such documents for those years dollar_figure beginning_inventory for it is unclear how comiskey determined the dollar_figure value reported on the schedule c for beginning_inventory the balance_sheet for reflects only one inventory_amount total inventory which is presumably the ending inventory for as explained below this amount was composed of subtotals dollar_figure ending inventory for it appears that comiskey transferred the entry in the balance_sheet total inventory in the amount of dollar_figure to the schedule c line item for inventory at the end of the year in the same amount the entry total inventory in the balance_sheet in the amount of dollar_figure was composed of three subtotals for smokable marijuana dollar_figure edible marijuana dollar_figure and non-marijuana merchandise dollar_figure it further appears that the balance_sheet entry of dollar_figure for total inventory corresponds to the same named entry with the same dollar amount in the general ledger to which comiskey did not have access the general ledger entry total inventory was made up of five subtotals smokable marijuana of dollar_figure edible marijuana of dollar_figure non-marijuana merchandise of dollar_figure undefined merchandise of dollar_figure and another category inventory - other of dollar_figure we are unable to trace the documentary source for the dollar_figure amount or its subtotals found in both the general ledger and the balance_sheet it appears that these amounts ultimately came from an yearend inventory done by alterman who testified that she generally performed a physical inventory at the end of each year and documented her inventory count on paperdollar_figure the record does not reveal whether alterman assigned cost values to the unit quantities in the physical inventory even if she did so the record does not give us any information about the cost she assigned to any particular unit in inventory or how she assigned cost to any particular unit for any unit of purchased marijuana and non- marijuana merchandise or self-grown marijuana merchandise indeed the record does not have any physical inventory that alterman committed to paper dollar_figure purchase costs for the record is unclear as to how the dollar_figure amount on the schedule c for purchase costs of 13a physical inventory is a list of the types of products on hand and unit quantities of each type of product at a given time merchandise was computeddollar_figure we note that the aggregated sum of total inventory dollar_figure from the balance_sheet and total cost_of_goods_sold dollar_figure from the profit and loss statement equals the dollar amount for purchase costs of merchandise on the schedule c dollar_figure for the return alterman decided to have pendleton prepare the return instead of comiskeydollar_figure alterman’s decision to go back to pendleton was motivated by the fact that comiskey had charged alterman significantly more for preparing the return than pendleton had charged for the return also pendleton told alterman he had experience preparing returns for other medical- marijuana businesses after pendleton prepared the return alterman reviewed it during pendleton continued to work as altermeds llc’s bookkeeper as he had during even though he had not prepared the return as part of his bookkeeping duties for he continued to prepare monthly statements from documentation alterman provided to him he also 14the general ledger contains a line item total cost_of_goods_sold that appears analogous to the tax-return line item under which the dollar_figure amount appears however the general-ledger item is a different amount dollar_figure 15pendleton attached a separate schedule c for tax_year to report the expenses and income of alterman’s real_estate agent business created the general ledger the general ledger bizarrely recorded that total inventory was dollar_figure which was the same dollar amount recorded in the total inventory entry in the ledger the general ledger also showed five subtotals the general ledger’s description of each subtotal and the dollar amount of each subtotal were the same as in the general ledger we are uncertain why the schedule c reported dollar_figure as the beginning and ending inventories for that would mean implausibly that altermeds llc had no merchandise on hand at the beginning and end of as for the dollar_figure reported on the schedule c for purchase costs we are unsure where this amount came from the analogous entry in the general ledger recorded the amount as dollar_figure audit and statutory_notice_of_deficiency in the irs examined alterman and gibson’ sec_2010 and sec_2011 returns it focused exclusively on altermeds llc’s schedules c revenue_agent kelly tipton hereinafter ra tipton was the principal revenue_agent who examined the returns alterman provided ra tipton with documents such as receipts and daily sales records the notice_of_deficiency determined that altermeds llc underreported gross_receipts by dollar_figure and dollar_figure for and respectively the notice allowed costs of goods sold of dollar_figure and dollar_figure for tax_year sec_2010 and sec_2011 respectively furthermore the notice disallowed all of altermeds llc’s schedule c business-expense deductions for tax_year sec_2010 and sec_2011 on sec_280e grounds except for depreciation and sec_179 expenses in the amounts of dollar_figure and dollar_figure for tax_year sec_2010 and sec_2011 respectively the notice also determined accuracy-related_penalties under sec_6662 ra tipton made the initial determination to impose accuracy-related_penalties the determination was approved by ra tipton’s supervisor tommy d mcdonald both the initial determination and the approval of the initial determination were made before the notice_of_deficiency was mailed conceded issues in the petition gibson sought innocent-spouse relief from joint_and_several_liability for the deficiencies and penalties in the notice_of_deficiency at trial gibson conceded his claim for innocent-spouse relief for both years at issue at trial alterman and gibson conceded that altermeds llc underreported its gross_receipts in the amounts stated in the notice_of_deficiency in the irs’s brief the irs increased the amounts of cost_of_goods_sold it conceded for from dollar_figure in the notice_of_deficiency to dollar_figure and for from dollar_figure to dollar_figure the irs’s brief stated that for tax_year the amount conceded in excess of the cost-of-goods-sold allowance in the notice_of_deficiency was made up of the following dollar_figure for rent for the grow site dollar_figure for utilities at the grow site dollar_figure for depreciation and sec_179 expenses the same amount allowed as a deduction in the notice and dollar_figure for wagesdollar_figure the irs’s brief stated that for tax_year the amount conceded in excess of the cost-of-goods-sold allowance in the notice_of_deficiency was made up of the following dollar_figure for rent for the grow site dollar_figure for utilities at the grow site dollar_figure for depreciation and sec_179 expenses the same amount allowed as a deduction in the notice dollar_figure for wages dollar_figure for testing of marijuana and dollar_figure for purchases of merchandisedollar_figure opinion the taxpayer bears the burden of proving by a preponderance_of_the_evidence that the irs’s determinations in the notice_of_deficiency are incorrect see rule a 290_us_111 88_tc_38 this is the burden of persuasion alterman and gibson concede that they have the burden of persuasion with 16the sum of these amounts dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure is dollar_figure 17the sum of these amounts dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure is dollar_figure respect to certain issues involving liability for penalties the irs has the burden of production this is described in greater detail infra part iii i business-expense deductions sec_162 allows a deduction for the expenses of carrying on a business sec_167 and sec_179 allow deductions for depreciation of assets used in a business sec_280e however provides that no deduction is allowed for an amount_paid or incurred in carrying on a business if the business consists of trafficking in controlled substances although alterman and gibson concede that altermeds llc trafficked in controlled substances they contend that it had a separate business of selling non-marijuana merchandise and that the business- expense deductions of this separate business are not disallowed by sec_280e whether selling non-marijuana merchandise was a separate business from selling marijuana merchandise is an issue of fact that depends on among other things the degree of economic interrelationship between the two activities see 128_tc_173 under the circumstances we hold that selling non-marijuana merchandise was not separate from the business of selling marijuana merchandise first altermeds llc derived almost all of its revenue from marijuana merchandise second the types of non-marijuana products that it sold pipes and other marijuana paraphernalia complemented its efforts to sell marijuanadollar_figure altermeds llc had only one unitary_business selling marijuana see canna care inc v commissioner tcmemo_2015_206 at aff’d 694_fedappx_570 9th cir if however selling non-marijuana merchandise were considered a separate business then the expenses of that business would be deductible see champ t c pincite stating that caregiving services were a business separate from provision of marijuana expenses of providing caregiving services were deductible alterman and gibson argue that these deductible expense are dollar_figure in and dollar_figure in these amounts are equal to of a list of subtotals in a table in the brief filed by alterman and gibson after trial each subtotal bears a vague description for example non-cogs utilities 18besides marijuana paraphernalia alterman testified that the dispensary also sold hats and t-shirts with the name and business logo of altermeds llc magazines about marijuana and chicken soup no documentary_evidence corroborates the existence or extent of these sales on a preponderance of evidence we find that no such items were sold furthermore these types of products as described by alterman would generally complement the sales of marijuana by the dispensary for example the hats and t-shirts as described by alterman bore the name and business logo of altermeds llc thus even if altermeds llc sold such hats and t-shirts selling those items would have helped advertise medical marijuana however the brief fails to adequately explain why any portion of those subtotals is deductible in particular the brief fails to identify any specific payments that make up these subtotals provide record citations to support these subtotals and propose findings of facts regarding these subtotals alterman and gibson’s argument regarding the amounts of business-expense deductions attributable to a putative second business was not briefed properly see rule e brief must include proposed findings_of_fact with references to the record rule e brief must include arguments regarding any disputed questions of fact even if we thought that the sale of non-marijuana merchandise was a separate business alterman and gibson’s failure to properly brief the amount_of_deductions that would be attributable to this business would preclude us from allowing any deductions for the separate businessdollar_figure we now consider whether alterman and gibson are entitled to any business-expense deductions for altermeds llc apart from the amounts of 19although under the rule in 39_f2d_540 2d cir the court can estimate the amount of deductible expenses if there is a reasonable basis for making such an estimate alterman and gibson do not contend the court should employ the cohan_rule to estimate the business_expenses of the putative second business furthermore their brief fails to point to any evidence that would provide the reasonable basis required for the court to make an estimate under the cohan_rule business-expense deductions allegedly attributable to the putative second business because we consider altermeds llc’s business to consist of trafficking in controlled substances all such deductions are disallowed by sec_280e furthermore alterman and gibson having failed to properly brief their entitlement to deductions for business_expenses they claim relate to altermeds llc’s putative second business have also failed to properly brief their entitlement to deductions for any other business_expenses of altermeds llc they did not even allege the amounts of such deductions much less any specific payments provide record citations or propose findings_of_fact therefore we conclude alterman and gibson are not entitled to any business-expense deductions for altermeds llcdollar_figure 20this conclusion holds even for depreciation and sec_179 expenses alterman and gibson claimed deductions of dollar_figure for and dollar_figure for for depreciation and sec_179 expenses and as discussed above the notice_of_deficiency partially allowed deductions for depreciation and sec_179 expenses dollar_figure and dollar_figure for and respectively in their post-trial brief alterman and gibson argue that they are entitled to deduct business_expenses for a second business that did not consist of trafficking in controlled substances but they do not identify among these business_expenses any depreciation and sec_179 expenses furthermore they argue that the deductions they claimed for depreciation and sec_179 expenses on their schedules c for and should be recharacterized as allowances for cost_of_goods_sold of altermeds llc in its business of trafficking in controlled substances the irs argues in its post-trial brief that sec_280e disallows all business-expense deductions including depreciation and sec_179 expenses for altermeds llc furthermore it continued ii cost_of_goods_sold alterman and gibson argue they are entitled to cost-of-goods-sold allowances in excess of the amounts the irs conceded in its briefs the individual income_tax is computed on the basis of taxable_income sec_1 taxable_income is equal to gross_income minus deductions sec_63 cost_of_goods_sold is a reduction made in the course of computing gross_income sec_1_61-3 income_tax regs it is not a deduction see 69_tc_477 aff’d 630_f2d_670 9th cir and therefore it is not disallowed by sec_280e 139_tc_19 aff’d 792_f3d_1146 9th cir sec_1_162-1 income_tax regs as the taxpayers alterman and gibson must prove the amounts allowable as cost_of_goods_sold see rule a a taxpayer is required to maintain continued concedes that alterman and gibson are entitled to cost-of-goods-sold allowances in the amounts allowed in the notice_of_deficiency for depreciation and sec_179 expenses and that the amounts are additional to the allowances for cost_of_goods_sold allowed in the notice_of_deficiency because alterman and gibson failed to brief their entitlement to deductions for business_expenses related to altermeds llc including depreciation and sec_179 expenses and because they argue that the amounts of deductions they reported for depreciation and sec_179 expenses should be recharacterized as cost_of_goods_sold they have waived any argument that they are entitled to the deductions allowed by the notice_of_deficiency for depreciation and sec_179 expenses sufficient permanent records to substantiate income including cost_of_goods_sold see sec_6001 sec_1_6001-1 d income_tax regs however the court may estimate cost_of_goods_sold under a variation of the cohan_rule even when cost_of_goods_sold is not fully substantiated provided that there is a reasonable basis for making such an estimate 39_f2d_540 2d cir 85_tc_731 see olive v commissioner t c pincite properly computed cost_of_goods_sold equals the cost of merchandise on hand at the beginning of the taxable_year beginning_inventory sec_1_471-3 income_tax regs plus the cost of merchandise purchased since the beginning of the taxable_year purchase costs id para b plus the direct and indirect_cost of producing merchandise production_costs id para c sec_1_471-11 income_tax regs minus the cost of inventory on hand at the end of the tax_year ending inventory sec_1_471-1 income_tax regs inventories must be recorded in a legible manner properly computed and summarized and these inventory records must be preserved by the taxpayer sec_1_471-2 income_tax regsdollar_figure alterman and gibson contend that the cost-of-goods-sold allowances for and are cost of merchandise purchased during the year cost of merchandise produced during the year total cost_of_goods_sold dollar_figure big_number big_number dollar_figure big_number big_number 21for businesses for which production purchase or sale of merchandise is an income-producing factor inventories at the beginning and end of each taxable_year are necessary sec_1_471-1 income_tax regs altermeds llc was such a business and therefore was required to use beginning and ending inventories at one point during discovery alterman and gibson asserted that revproc_2000_22 2000_1_cb_1008 as modified and superseded by revproc_2001_10 2001_1_cb_272 relieved altermeds llc of the obligation to account for inventories in response the irs filed a memorandum taking the position that alterman and gibson misinterpreted revproc_2000_22 supra alterman and gibson did not rely on revproc_2000_22 supra after that for example they did not cite revproc_2000_22 supra in their briefs therefore they have waived any argument that revproc_2000_22 supra relieved altermeds llc of the obligation to account for inventories the schedules c for altermeds llc reported that its income was calculated using the cash_method_of_accounting in certain situations farmers may use the cash_method_of_accounting as an alternative to the inventory_method 89_tc_98 alterman and gibson have not contended that they are farmers for this purpose and therefore have waived any argument that they were entitled to use the cash_method_of_accounting as farmers by comparison the irs concedes that the cost-of-goods-sold allowances for and are total cost_of_goods_sold dollar_figure dollar_figure the irs makes a threshold argument that the method of computing cost_of_goods_sold urged by alterman and gibson is improper because it does not account for beginning and ending inventories that their method ignores beginning and ending inventories can be seen from the formula supra p cost_of_goods_sold equals beginning_inventory plus purchase costs plus production_costs minus ending inventory alterman and gibson’s argument for cost-of-goods-sold allowances relies entirely on purchase costs and production_costs it assumes that cost_of_goods_sold equals purchase costs plus production_costs thus their method leaves out beginning_inventory and ending inventory such a method is indeed improper see sec_1_471-1 income_tax regs as an alternative argument alterman and gibson contend that the court should estimate under cohan the relevant beginning and ending inventories for each year this task is impossible on this record to calculate cost_of_goods_sold for the relevant beginning_inventory is the inventory on hand at the 22for the calculation of these amounts see supra notes and beginning of which is by definition the ending inventory for 76_tc_708 bearing in mind that beginning_inventory for any given year is equal to the ending inventory for the prior year it is easy to see that an error in any year carries forward to every subsequent year to estimate ending inventory for we would first need to estimate the types of products and unit quantities on hand at the end of this is called a physical inventorydollar_figure there is no information in the record regarding the physical inventory on hand at the end of even if we had a physical inventory for the end of we would need to assign a cost to each unit ending inventory for is composed solely of merchandise purchased during because altermeds llc did not produce any marijuana in and because it began its operations in there is no information in the record regarding the cost of merchandise purchased by altermeds llc in dollar_figure alterman and 23a physical count requires a determination of how many types of products are in inventory see stephen f gertzman federal tax_accounting para a 2d ed although we generally understand that the dispensary sold products like buds joints and brownies and therefore probably had these products on hand at the end of we do not know enough to determine whether each of these should be considered a product type or whether each of these groups should be broken into different product types 24alterman and gibson attached a schedule c for altermeds llc to their return they reported dollar_figure as beginning_inventory which is the correct continued gibson have pointed to no evidence in the record to give us a reasonable basis for estimating the ending inventory for dollar_figure in conclusion there is no way for us to estimate the ending inventory for and therefore the beginning_inventory for it is also impossible to estimate the ending inventory for we would first need to estimate the physical inventory at the end of ie unit quantities by product type then using a cashflow assumption such as first-in-first-out we would assign a cost value to each unit of physical inventory at the end of by importing a cost value from a unit in the beginning_inventory for a unit purchased during or a unit produced during sec_1_471-1 sec_1_471-3 sec_1_471-11 income_tax regs see also stephen f gertzman federal tax_accounting paras and dollar_figure 2d ed as explained above continued amount because altermeds llc started operating in they reported no production_costs they reported purchase costs of dollar_figure but the record does not contain evidence to show how this dollar amount was calculated such as receipts for merchandise purchases a physical inventory or other documentation ending inventory for was reported as dollar_figure we find the ending inventory_amount unreliable if altermeds llc’s inventory was dollar_figure at the end of it would not have had any inventory on hand we find this unlikely alterman and gibson calculated cost_of_goods_sold using only purchase costs ignoring ending inventory this is incorrect 25they reported on altermeds llc’ sec_2010 schedule c the beginning_inventory as zero but they do not argue that this amount is correct however we do not have the cost values for units in the beginning_inventory for dollar_figure and for units purchased during at most we have aggregate cost data rather than the cost of any particular unit of merchandisedollar_figure and for units produced during we cannot even tell from the record whether any units of any type of marijuana merchandise were produced by altermeds llc during to estimate ending inventory for there are similar problems that are magnified by the lack of data from prior years furthermore by altermeds 26the following hypothetical illustrates the importance of knowing the cost of beginning_inventory suppose the following in altermeds llc buys three joints at different times during the year for dollar_figure dollar_figure and dollar_figure respectively in it sells none of these joints so all three joints are in the ending inventory in and therefore are in beginning_inventory for in altermeds llc sells two of the three joints if we use the first-in-first-out cashflow assumption then the two joints sold in were the dollar_figure and dollar_figure joints the dollar_figure joint remains in inventory in and it has an inventory cost of dollar_figure the dollar_figure amount is used to compute ending inventory for along with the cost of all other products in ending inventory thus we can compute ending inventory for only if we know beginning_inventory for 27the check-register entries contain the most detail in the record concerning merchandise purchases nevertheless we cannot determine unit quantities or assign unit costs as the entries are minimally informative and incomplete and cover only a fraction of the merchandise purchases llc was growing some of its own marijuana but the record does not include inventory documentation for self-grown marijuana it is improper in this case for the court to estimate beginning and ending inventories the court need not reach the question of the cost of purchasing merchandise or the cost_of_producing merchandise during the years at issue these amounts are relevant to cost_of_goods_sold only when they are used in combination with beginning and ending inventorydollar_figure we hold that the cost-of-goods-sold allowances for altermeds llc are dollar_figure for and dollar_figure for which are the amounts conceded by the irsdollar_figure 28as a further alternative alterman and gibson contend that the court should determine cost_of_goods_sold for each year by multiplying altermeds llc’s gross_receipts for each year by a ratio similar to the ratio used in 139_tc_19 aff’d 792_f3d_1146 9th cir in olive v commissioner t c pincite we estimated the costs of goods sold for a medical-marijuana business by multiplying its gross_receipts by a comparative ratio of gross_receipts to costs of goods sold we determined the comparative ratio of gross_receipts to costs of goods sold from the testimony of two expert witnesses henry levy and dale gieringer id alterman and gibson called levy as an expert witness however the court ruled that his testimony was inadmissible and excluded it from evidence unlike the record in olive the record in this case contains no evidence to support a ratio comparison with other medical- marijuana businesses 29it appears that the irs determined the amounts it conceded by adding production_costs to purchase costs however it does not concede that this is the continued iii sec_6662 penalties the irs takes the position that alterman and gibson are liable for accuracy-related_penalties under sec_6662 because the underpayments of tax for and are attributable to negligence or alternatively to substantial understatements of income_tax see sec_6662 and sec_6662 imposes a penalty equal to of an underpayment that is attributable to negligence or to a substantial_understatement_of_income_tax or to various other causes sec_6662 an understatement of income_tax is generally the difference between the correct_tax and the tax reported on the return sec_6662 an understatement is substantial if it exceeds the greater of i percent of the tax required to be shown on the return for the taxable_year or ii dollar_figure sec_6662 negligence includes any failure by the taxpayer to keep adequate books_and_records or to substantiate items properly sec_1 b income_tax regs the penalty is not imposed on any portion of an underpayment if there was a reasonable_cause for such portion and the taxpayer acted in good_faith with respect to that portion sec_6664 sec_6751 provides that certain penalties cannot be assessed unless the initial continued proper method of calculating cost_of_goods_sold determination of the assessment is personally approved in writing by the immediate supervisor of the individual making the determination the irs has the burden of producing evidence that it is appropriate to impose the penalty sec_7491 116_tc_438 if the irs has met its burden of production the taxpayer has the burden of persuading the court that it is inappropriate to impose the penalty for example because a portion of the underpayment was due to reasonable_cause and good_faith higbee v commissioner t c pincite the irs’s burden of producing evidence includes producing evidence that there was a substantial_understatement_of_income_tax avrahami v commissioner t c __ __ slip op pincite date the taxes reported on the returns are determinable because the returns are in the record whether substantial understatements of income_tax exist and if so in what amounts will depend upon the recalculation of alterman and gibson’ sec_2010 and sec_2011 tax_liabilities taking into account their concession regarding underreported gross_receipts and the holdings in this opinion we leave these calculations to the parties under rule regardless of whether the underpayments were due to substantial understatements of income_tax we hold that they were due to negligence alterman and gibson did not keep adequate_records to compute reliable beginning and ending inventories for altermeds llc alterman and gibson acted negligently by failing to keep adequate books_and_records see sec_1 b income_tax regs the irs has met its burden of producing evidence that the underpayments are due to negligence alterman and gibson have not persuaded us otherwise in a deficiency case the irs’s burden of production includes the burden of producing evidence that it complied with the supervisory-approval requirement of sec_6751 for certain penalties see graev v commissioner t c __ date supplementing and overruling in part 147_tc_460 the irs satisfied this burden it introduced a penalty approval form bearing ra tipton’s name and the signature of ra tipton’s supervisor demonstrating his approval the supervisor testified that ra tipton had initially determined the penalties and that the supervisor had approved the initial determination at trial alterman and gibson objected to the admissibility of the penalty approval form they argued that the penalty approval form contains ra tipton’s expert opinions and that these opinions could be presented only through expert testimony ra tipton testified at trial as a fact witness not an expert witness we overruled the objection and admitted the penalty approval form into the record in post-trial briefing alterman and gibson urge us to reconsider the admissibility of the penalty approval form on the same grounds they gave for their objection at trial their objection was meritless the irs offered the penalty approval form to show that ra tipton had initially determined that the penalties should be imposed and that his supervisor approved the initial determination not to show that the penalties are appropriate alterman and gibson argue that the irs did not comply with the supervisory-approval requirement because ra tipton did not allow petitioners enough time to fully present a reasonable-cause defense to the accuracy-related_penalty before he submitted their case to his supervisor but sec_6751 requires only that the penalty be personally approved in writing by the immediate supervisor it does not require the supervisor to follow any specific procedure in determining whether to approve the penalty alterman and gibson argue that there was reasonable_cause for their underpayments and that they acted in good_faith taxpayers can demonstrate reasonable_cause and good_faith if they reasonably relied on advice about the appropriate tax treatment of their business sec_1_6664-4 income_tax regs however alterman and gibson neither sought or received advice from comiskey and pendleton regarding appropriate inventory_accounting or the effect of section 280e sec_1_6664-4 income_tax regs furthermore alterman and gibson did not ask whether businesses that sell medical marijuana or violate federal drug trafficking laws are taxed differently from other businesses this lack of inquiry evinces their lack of interest in complying with the federal tax laws sec_1_6664-4 income_tax regs providing that the most important factor in determining whether a taxpayer acted with reasonable_cause and in good_faith is the extent of the taxpayer’s effort to assess his or her proper tax_liability for the year alterman and gibson did not act with reasonable_cause and in good_faith with respect to the and underpayments therefore we hold they are liable for the accuracy-related_penalty for each year in reaching our holdings we considered all arguments made and to the extent not mentioned we conclude that they are moot irrelevant or without merit to reflect the foregoing decision will be entered under rule


internal_revenue_service department of the treasury index no washington dg person to contact telephone number refer reply to cc dom fi p plr-114750-98 date nov legend agency bank parent bank state town a dear this letter is in response to your request on behalf of bank for a ruling that certain obligations may be treated as qualified tax-exempt obligations within the meaning of sec_265 b b of the internal_revenue_code the facts you make the following representations the bank is a bank formed under the laws of the state consolidated_return group the common parent_corporation of which is the parent bank established by the state buy and sell securities and to make loans to qualified entities a body corporate and politic to the agency's statutory mission is the agency is a member of the bank is a the agency in conjunction with the bank plans to establish anew program the program to assist local_government borrowers in the state the local governments in financing the acquisition of capital assets the financed assets under the plr-114750-98 the bank will provide the funds for the program the agency will become the nominal purchaser of the financed assets which assets will then be leased to the local governments pursuant to the terms of lease agreements the lease agreements acquisition of the financed assets by purchasing the agency's rights as lessor including the payment obligations imposed on the local governments however the agency is under no obligation to make purchases of financed assets under the lease agreements either the bank or the agency take physical possession of the financed assets stream payable under the lease agreements nor will it have any continuing rights or obligations with respect to any lease agreement following the sale to the bank income from each transaction will be received at the closing of each transaction the agency will have no interest in the payment until the bank provides such funds a one-time placement fee the agency's sole at no time will for federal_income_tax purposes the lease agreements are financing arrangements and the owners of the financed assets will be the local governments local governments and not the agency are responsible for executing a form 8038-g or form 8038-gc as applicable with respect to the lease agreements electing to treat the lease agreements as qualified tax-exempt obligations and taking such actions as are necessary under state law to issue the lease agreements under the lease agreements the the bank reasonably expects that all of the lease agreements sec_141 other will not be private_activity_bonds than bonds described in expects the principal_amount of the lease agreements that it will purchase under the program when added to the tax-exempt obligations issued by the agency other than obligations described in calendar_year c ii will exceed dollar_figure for the the bank reasonably sec_265 b ii sec_265 as defined in under state law the lease agreements entered into by the local governments will not be subject_to public bidding requirements because the initial lessor is the agency lease agreements were entered into directly between the bank and the local governments a public bidding process would be required primary reason for the involvement of the agency in the transactions avoiding the public bidding requirements is the if the under the program each lease agreement will be a separate transaction with its own terms including default and security arrangements neither the agency nor the bank is obligated to enter into any other lease agreement as a lease agreement with a particular local_government a result of entering into plr-114750-938 only the format and structural terms of the specifically the bank is free to reject any given lease agreement arrangement have been agreed upon each lease agreement stands on its own with its own interest rate and payment terms will perform a separate credit risk analysis for each lease the credit risks associated with agreement and local_government one transaction will not have an impact on the terms of any other the bank is purchasing the lease agreements for transaction investment purposes and reasonably expects to hold each lease agreement entered into under the program for a period of one year the bank at least the town is a local_government participating in the program through the program the town is financing the acquisition of fire truck with a lease agreement the town lease agreement in the amount of sa a the town is a qualified_small_issuer within the meaning of if the bank had purchased the town lease sec_265 c agreement directly from the town under the terms described above without any involvement of the agency the town lease agreement would be eligible to be designated as obligation a qualified tax-exempt ruling requested the bank has requested a ruling that the town lease agreement is the involvement of the agency under the program a qualified_tax-exempt_obligation notwithstanding law and analysis sec_265 provides that no deduction shall be allowed for interest on indebtedness incurred or continued to purchase or carry obligations the interest on which is wholly exempt from federal income taxes sec_265 provides generally that in the case of a financial_institution no deduction shall be allowed for that portion of the taxpayer's interest_expense which is allocable to tax-exempt_interest of the taxpayer's interest_expense which is allocable to tax- exempt_interest is interest_expense as within the meaning of after august all assets of the taxpayer an amount which bears the same ratio to such the taxpayer's average adjusted bases of tax-exempt obligations acquired b the average adjusted bases for sec_265 provides that the portion sec_1016 bears to a plr-114750-98 sec_265 a provides that any qualified tax-exempt if obligation acquired after august it were acquired on date provides that the term qualified_tax-exempt_obligation means a tax-exempt_obligation which i by a qualified_small_issuer as defined in sec_265 qualified_tax-exempt_obligation is not a private_activity_bond but excluding bonds described in is designated by the issuer as shall be treated as is issued after august sec_265 b b b ii and sec_141 iii ii a sec_265 b c i provides in general that the term qualified_small_issuer means with respect to obligations issued during any calendar_year any issuer if the reasonably anticipated amount of tax-exempt obligations other than obligations described in by the issuer during the calendar_year does not exceed dollar_figure c ii which will be issued sec_265 sec_265 b f provides that in the case of an obligation which is issued as part of composite issue such obligation shall not be treated as qualified_tax-exempt_obligation unless i sec_265 determined by treating such composite issue as and each separate lot of obligations which are part of the issue determined by treating each such separate lot as a separate issue are met with respect to such composite issue a direct or indirect a the requirements of sec_265 a single issue are met with respect to the requirements of ii the bank has requested a private_letter_ruling that the town lease agreement assigned by the agency to the bank under the program as described above exempt obligations under sec_265 will constitute a qualified_tax-exempt_obligation if town agreement for purposes of the dollar_figure limit imposed by b issued as part of if the town lease agreement is not a direct or indirect composite issue is the issuer of the town lease will constitute a qualified tax- and not the agency c i and the town lease agreement ii the i the agency is not acting in the capacity of an issuer in the absence of the actual issuance of some type of obligation or certificate whether an entity is acting in the capacity of issuer is based on the facts and circumstances in each case this case certificate backed by the town lease agreement and selling it the bank nominal purchaser of the fire truck which will then be leased to the town the bank will provide the funds for the acquisition of the fire truck by purchasing the agency's rights as lessor to rather under the program the agency will become the the agency is not issuing any obligation or an in plr-114750-98 including the payment obligations imposed on the town under the town lease agreement until the bank provides such funds however the agency is under no obligation to purchase the fire truck under the town lease agreement in this capacity the agency is simply acting as an intermediary by purchasing the town lease agreement and selling it continuing rights or obligations with respect to any lease agreement following the sale to the bank participating in the transaction solely to avoid a state law public bidding requirement the agency has no the agency is to the bank the town lease agreement is not issued as part of a direct a composite issue would exist where or indirect composite issue sales of lease agreements to the bank were made directly or indirectly on a pooled basis or where the bank purchases individual lease agreements with the expectation of selling them directly or indirectly on a pooled basis in this case each lease agreement sold by the agency to the bank stands on its own with its own default and security arrangements and its own interest rate and payment terms given lease agreement risk analysis for each lease agreement and local_government such that the credit risks associated with one transaction will not have an impact on the terms of any other transaction is purchasing the lease agreements for investment purposes and reasonably expects to hold each lease agreement for a period of at least one year participants the benefits of either a large issue or a large issuer the bank will perform a separate credit the bank is free to reject any the program does not afford the bank as such conclusion we therefore conclude that the town lease agreement is a qualified_tax-exempt_obligation within the meaning of sec_265 notwithstanding the involvement of the agency with the program no opinion is expressed as to the tax treatment of the transaction involved herein under provisions of any other section of the code and regulations that may be applicable thereto or the tax treatment of any condition existing at the time of or effect resulting from covered by the above ruling the transaction that is not specifically plr-114750-98 this letter is directed only to the taxpayer who requested sec_6110 provides that it may not be used or cited it as precedent sincerely yours assistant chief_counsel financial institutions products by m serchuk senior technician reviewer branch enclosure copy for sec_6110 purposes


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 fip b01 plr-113080-10 date date taxpayer ----------------------------------------------------------------------- ---------------- business state x type a type b type c type d type e a dear ---------- ---------------- ------------ ------------------------------- ----------------------------- ------------------------------- ------------ ------------------------------- -------------------------- this is in reply to a letter dated date and subsequent submissions requesting rulings on behalf of taxpayer you have requested rulings addressing whether an operator manager of business facilities leased by taxpayer and certain of its taxable reit subsidiaries trss will fail to qualify as an eligible_independent_contractor under sec_856 of the internal_revenue_code solely as a result of certain income earned by taxpayer or its trss from affiliates of manager including affiliates that are organized as partnerships and whether manager will fail to qualify as plr-113080-10 an eligible_independent_contractor solely as a result of income earned by a trs from manager or from affiliates of manager additionally you have requested a ruling addressing whether certain investments by a trs in manager or its affiliates or other operators of business facilities will disqualify trs as a taxable_reit_subsidiary within the meaning of sec_856 or manager as an eligible_independent_contractor within the meaning of sec_856 facts taxpayer is a publicly traded state x corporation that invests primarily in real_estate servicing the business industry in the united_states taxpayer conducts its business through a number of subsidiaries which are treated for federal_income_tax purposes as partnerships and disregarded entities and through a number of trss both taxpayer and its trss acquire develop lease and dispose_of business real_estate and provide mortgage and specialty financing to business providers the company and its trss’ portfolio includes investments in type a type b type c type d and type e properties taxpayer has elected to be taxed as a real_estate_investment_trust reit under sec_856 through commencing with the taxable_year ended a taxpayer represents that all dealings and transactions between and among taxpayer and each of its trss have been conducted at arm’s-length manager is a member_of_an_affiliated_group of corporations collectively with any partnership or disregarded entities owned by such corporations manager group with a common parent_corporation parent parent directly or indirectly owns all of the stock of manager in addition to the stock of manager parent owns directly or indirectly all of the stock of another domestic_corporation brother manager does not directly or indirectly own any of the stock of brother or parent ie neither parent nor brother are a direct or indirect subsidiary of manager manager keeps its own separate books_and_records and has its own separate employees and officers from parent and brother manager may however have overlapping officers employees and directors with other members of manager group parent is organized as a domestic_corporation parent directly or through other members of the manager group is engaged in the business of operating and managing business facilities for itself and for third parties parent does not operate or manage any business facilities for either the taxpayer or its trss parent keeps its own separate books_and_records and has its own separate employees and officers parent may however also have overlapping officers employees and directors with other members of manager group in addition neither plr-113080-10 taxpayer nor its trss own an interest in parent or any other member of manager group like parent brother is in the business of operating and managing business facilities for itself and others brother through a subsidiary that is a disregarded_entity currently leases business facilities from taxpayer pursuant to lease agreements with market terms other than through these leases brother does not operate or manage any business facilities for either taxpayer or its trss brother keeps its own separate books_and_records and has its own employees and officers brother may however also have overlapping officers employees and directors with other members of manager group neither taxpayer nor any of its trss has any management contracts with manager or any member of manager group historically taxpayer has leased its properties directly to third party operators and has not directly or through a subsidiary engaged a manager to operate its properties other than properties for which a foreclosure election under sec_856 has been made the economy however has had an adverse effect on the operation of business facilities the poor performance of these facilities has been especially harsh for lessees of business facilities many of the properties at issue have had a period of financial distress and a third party operator may not be willing to lease the properties on terms that are acceptable to taxpayer as a result of these adverse economic conditions taxpayer proposes to lease the properties which taxpayer has represented constitute qualified health care properties within the meaning of sec_856 to one or more trss these trss plan to hire manager to operate and manage these properties the management agreement between manager and a trs for the operation and management of these facilities will reflect market terms and manager will be paid a market rate fee for its services brother currently leases multiple properties from taxpayer taxpayer expects to acquire additional properties in the future and would prefer to lease these properties directly to third party operators the number of potential third party operators is finite and taxpayer would like to have the ability to lease some of these newly acquired properties to parent or brother similarly as certain existing leases of property expire taxpayer would like to lease some of these properties to parent or brother on terms that may include market rent that is substantially higher than the rent previously received by taxpayer with respect to such properties taxpayer may make loans to parent or brother at market interest rates or sell certain of its real_property to parent or brother causing taxpayer to derive income from parent or brother respectively plr-113080-10 taxpayer’s trss could derive income or gains from manager or other members of the manager group such income may be comprised of rent interest or gain from the sale of real_property such income may also be in the nature of fees or indemnity payments made by manager to the trs such as in connection with a management agreement one or more of taxpayer’s trss intends to purchase stock_or_securities of one or more members of manager group including manager another trs is also negotiating to purchase stock of a corporation unrelated to manager operator that operates and manages health care facilities as defined in sec_856 and may provide to other persons rights to a brand name under which such facilities are operated these investments would not cause the relevant trs to own directly or indirectly securities possessing more than percent of the total voting power or value of the outstanding securities of manager any other member of manager group or operator taxpayer has represented that while taxpayer’s trss may purchase up to percent by vote or value of the stock or other_securities of manager parent brother or operator taxpayer either i will not own directly or indirectly percent or more by vote or value of the stock of any such entity or ii if the acquisition described above causes taxpayer to acquire directly or indirectly percent or more by vote or value of the stock of manager parent brother or operator any rent received by taxpayer from such entity will not pursuant to sec_856 be treated as rents_from_real_property within the meaning of sec_856 for the year during which taxpayer owns directly or indirectly percent or more by vote or value of the stock of such entity law and analysis sec_856 provides that at least percent of a reit's gross_income must be derived from among other sources rents_from_real_property sec_856 provides that at least percent of a reit's gross_income must be derived from among other sources rents_from_real_property sec_856 provides that rents_from_real_property include subject_to exclusions provided in sec_856 a rents from interests_in_real_property b charges for services customarily furnished or rendered in connection with the rental of real_property whether or not such charges are separately_stated and c rent attributable to personal_property which is leased under or in connection with a lease of real_property but only if the rent attributable to such personal_property for the taxable plr-113080-10 year does not exceed percent of the total rent for the taxable_year attributable to both the real and personal_property leased under or in connection with such lease sec_856 provides in part that the term rents_from_real_property does not include any amount received or accrued directly or indirectly from any person if the reit owns directly or indirectly i in the case of any person which is a corporation stock of such person possessing percent or more of the total combined voting power of all classes of stock entitled to vote or percent or more of the total value of shares of all classes of stock of such person or ii in the case of any person which is not a corporation an interest of percent or more in the assets or net profits of such person sec_856 provides that any impermissible_tenant_service_income is excluded from the definition of rents_from_real_property sec_856 defines impermissible_tenant_service_income to mean with respect to any real or personal_property any amount received or accrued directly or indirectly by the reit for services furnished or rendered by the reit to tenants at the property or for managing or operating the property sec_856 provides certain exclusions from impermissible_tenant_service_income sec_856 provides that for purposes of sec_856 services furnished or rendered or management or operation provided through an independent_contractor from whom the reit does not derive or receive any income shall not be treated as furnished rendered or provided by the reit and there shall not be taken into account any amount which would be excluded from unrelated_business_taxable_income under sec_512 if received by an organization described in sec_511 sec_856 provides that amounts paid to a reit by a trs shall not be excluded from rents_from_real_property by reason of sec_856 when a reit leases a qualified_lodging_facility or qualified health_care_facility to a trs and the facility or property is operated on behalf of the trs by a person who is an eligible_independent_contractor sec_856 defines an independent_contractor as any person who does not own directly or indirectly more than percent of the reit's shares and if such person is a corporation not more than percent of the total combined voting power of whose stock or percent of the total shares of all classes of whose stock is owned directly or indirectly by one or more persons owning percent or more of the shares of the reit sec_856 provides that the term eligible_independent_contractor means with respect to any qualified_lodging_facility or qualified_health_care_property any independent_contractor if at the time such contractor enters into a management agreement or similar service_contract with the trs to operate the facility or property the plr-113080-10 contractor or any related_person is actively engaged in the trade_or_business of operating qualified lodging_facilities or qualified health care properties for any person who is not a related_person with respect to the reit or the trs sec_856 provides that solely for purposes of sec_856 a person shall not fail to be treated as an independent_contractor with respect to any qualified_lodging_facility or qualified_health_care_property as so defined because the reit receives income from such person with respect to another property that is attributable to a lease of such other_property to such person that was in effect as of the later of date or the earliest date that any trs of such reit entered into a management agreement or other similar service_contract with such person with respect to such qualified_lodging_facility or qualified_health_care_property sec_856 provides that a reit and a corporation other than a reit may jointly elect to treat such corporation as a trs to be eligible for treatment as a trs sec_856 provides that the reit must directly or indirectly own stock in the corporation and the reit and the corporation must jointly elect such treatment sec_856 provides that any corporation in which a trs owns directly or indirectly more than percent of the total voting power or value of the outstanding securities shall be treated as a trs sec_856 provides that a trs cannot directly or indirectly operate or manage a lodging_facility or a health_care_facility a healthcare facility is defined in sec_856 as a hospital nursing facility assisted living facility congregate care facility qualified_continuing_care_facility as defined in sec_7872 or other licensed facility which extends medical or nursing or ancillary services to patients and which was operated by a provider of such services that is eligible for participation in the medicare program under title xviii of the social_security act with respect to the facility revrul_75_136 1975_1_cb_195 concerns whether a wholly owned subsidiary of a reit's corporate investment adviser can serve as an independent_contractor to manage the reit's property as required under sec_856 in determining that the subsidiary may qualify as an independent_contractor the ruling states that it is the relationship of the entity or individual such as an employee or trustee to the trust itself that precludes the entity from qualifying as an independent_contractor for the management of the property a relationship between the entity or individual and the trustee or employee or investment adviser of the reit would not in itself disqualify the entity assuming the other requirements for qualification as an independent_contractor are met accordingly the ruling holds that the wholly owned subsidiary of the investment adviser is not precluded from qualifying as an independent_contractor if it operates as a separate_entity with its own separate officers and employees and keeps its own separate books_and_records that clearly reflect its activities in the management of the property plr-113080-10 in revrul_73_194 a reit entered into a partnership with x corporation to construct and hold apartment buildings for investment the partnership_agreement provided that the partners would engage a management company to manage an apartment building the management company was employed in an arm's length transaction and was paid a market rate for its services x corporation was a wholly- owned subsidiary of y corporation which owned a substantial percentage of the stock of the management company in concluding that the income received by the reit from the partnership will not be disqualified as rents_from_real_property due to the relationship between x y and the management company the ruling cites the legislative_history underlying sec_856 which states that the restrictions imposed by that section were intended to prevent income from active business operations from being included in a reit's income the legislative_history indicates that for this requirement to be satisfied the reit and the independent_contractor must have an arm's-length relationship see h_r no 86th cong 2d sess 1960_2_cb_819 in revrul_76_534 1976_2_cb_215 a reit’s property manager was a wholly- owned subsidiary of the reit’s investment_advisor while the management company was operated as a separate company with separate officers and employees an employee of the investment_advisor served as a director of both the investment_advisor and the management company the revenue_ruling concludes that the relationship of the director to both the investment_advisor and the management company does not preclude the property manager from qualifying as an independent_contractor revrul_77_23 1977_2_cb_197 involves a situation in which an individual was both a trustee and a salaried employee of a reit and was also the sole shareholder and a director of a corporation that served as the reit’s property manager the ruling holds that although the property management company is directly related to the individual that is a trustee and employee of the reit the property manager is not precluded from qualifying as an independent_contractor the ruling explains that the proper relationship to be examined to determine independent_contractor status is the relationship between the reit and the property manager and not the relationship between the property manager and the reit trustee in revrul_2003_86 c b a reit owned all of the stock of a trs that owned an interest in a partnership the partnership was an independent_contractor under sec_856 the partnership provided certain noncustomary services to the reit's tenants although the reit did not directly receive payments from the independent_contractor the reit indirectly held an equity_interest in the independent_contractor through its ownership of the trs the revenue_ruling states that sec_856 provides an exception for services furnished or rendered through a trs noting that the reit's only interest in the independent_contractor is through the trs the ruling states that the services provided by the independent_contractor are provided by the trs to the extent of the trs's interest in the independent_contractor plr-113080-10 accordingly the ruling concludes that the reit will not be treated as providing impermissible tenant services in the present case taxpayer may provide loans or lease or sell property to parent or brother a trs of taxpayer may provide loans or lease or sell property to manager a trs of taxpayer may also receive fees or indemnity payments made by manager in each situation the income received by taxpayer or its trs is not derived from or dependent upon its relationship with the company operating or managing any of the business facilities all of the agreements entered into by taxpayer or its trss for the management or operation of the business facilities are represented to be arm's length and reflecting market terms additionally while taxpayer may enter into new leases with parent or brother with respect to certain properties currently leased to parent or brother these leases are not with manager who acts as an eligible_independent_contractor with respect to business facilities owned by or leased to taxpayer’s trss thus these leases will not cause manager to fail to qualify as an eligible_independent_contractor pursuant to sec_856 accordingly based on the information received and representations made we conclude that manager will not fail to qualify as an eligible_independent_contractor solely because taxpayer derives income from parent or brother including a subsidiary of parent or brother that is organized as a partnership for federal_income_tax purposes manager will not fail to qualify as an eligible_independent_contractor solely because a trs derives income from manager a trs’s purchase of stock or other_securities of parent brother manager or any of their direct or indirect subsidiaries or of operator will not cause the trs to fail to qualify as a taxable_reit_subsidiary within the meaning of sec_856 or cause parent brother manager or any of their direct or indirect subsidiaries or operator to fail to qualify as an eligible_independent_contractor within the meaning of sec_856 provided trs does not directly or indirectly own more than percent by vote or value of the securities of any such corporation except as specifically ruled upon above no opinion is expressed concerning any federal_income_tax consequences relating to the facts herein under any other provision of the internal_revenue_code specifically we do not rule whether taxpayer otherwise qualifies as a reit under part ii of subchapter_m of chapter also no opinion is expressed concerning the treatment of payments between taxpayer's trss and taxpayer for purposes of sec_857 plr-113080-10 this ruling is directed only to the taxpayer requesting it taxpayer should attach a copy of this ruling to each tax_return to which it applies sec_6110 provides that this ruling may not be used or cited as precedent sincerely alice m bennett__________________________ alice m bennett branch chief branch office of associate chief_counsel financial institutions products


t c memo united_states tax_court rosie l moore petitioner v commissioner of internal revenue respondent docket no 21712-04l filed date rosie l moore pro_se beth a nunnink for respondent memorandum opinion chiechi judge this case is before the court on respon- dent’s motion for summary_judgment respondent’s motion we shall grant respondent’s motion background the record establishes and or the parties do not dispute the following petitioner resided in millington tennessee at the time she filed the petition in this case petitioner timely filed a federal_income_tax tax_return for her taxable_year return respondent conducted an examination of petitioner’s return on date respondent mailed a 30-day_letter respondent’s 30-day_letter to petitioner at the following address coach drive apartment memphis tennessee on date respondent re- ceived correspondence from petitioner thereafter on date respondent mailed to petitioner at the address to which respondent mailed respondent’s 30-day_letter a notice_of_deficiency with respect to petitioner’s taxable_year which she received petitioner did not file a petition in the court with respect to the notice_of_deficiency relating to her taxable_year on date respondent assessed petitioner’s tax as well as interest as provided by law for her taxable_year we shall refer to any such unpaid assessed amounts as well as interest as provided by law accrued after date as petitioner’s unpaid liability for respondent issued to petitioner a notice of balance due with respect to petitioner’s unpaid liability for as required by sec_6303 on date respondent issued to petitioner a final notice_of_intent_to_levy and notice of your right to a hearing notice_of_intent_to_levy with respect to her taxable_year on date in response to the notice_of_intent_to_levy petitioner filed form request for a collection_due_process_hearing form and requested a hearing with respondent’s appeals_office appeals_office petitioner indicated in her form that she did not agree with the filed notice_of_federal_tax_lien however respondent did not issue to peti- tioner a notice_of_federal_tax_lien filing with respect to her taxable_year on date respondent’s appeals officer appeals officer held a telephonic conference telephonic conference with petitioner during that telephonic conference petitioner attempted to challenge the underlying tax_liability for her taxable_year the appeals officer refused to consider any such challenge that was because petitioner did not file a petition with the court with respect to the notice_of_deficiency that she received from respondent with respect to her taxable_year except for her attempted challenge of the underlying tax_liability for her taxable_year petitioner raised no 1all section references are to the internal_revenue_code in effect at all relevant times all rule references are to the tax_court rules_of_practice and procedure other issues during the telephonic conference with the appeals officer on date the appeals_office issued to petitioner a notice_of_determination concerning collection action s under sec_6320 and or notice_of_determination in which the appeals_office sustained the issuance of the notice_of_intent_to_levy an attachment to the notice_of_determination stated in pertinent part brief background in the form you state that first i got a letter from irs saying i owed dollar_figure for the year of i had to send this information proving i was head of my household i sent it twice before they came to the conclusion that i was head_of_household i got that cleared up ok now they’re saying i wasn’t due the earned_income_credit for that year before they came up with this they asked me to send proof my de- pendents were in school i faxed that information i talked to mr brown he said it was not showing any- where that they received this information a review of a transcript of your account indicates the following the return was filed by the due_date the return reflected a tax_liability of dollar_figure withholding credits of dollar_figure and the earned_income_credit of dollar_figure were claimed a refund of dollar_figure was issued your return was subsequently audited additional tax of dollar_figure and interest of dollar_figure were assessed the earned_income_credit of dollar_figure was not allowed your overpayments of dollar_figure were ap- plied to the liability you have made no other_payments at your request the audit was reconsidered but the adjustments were not changed discussion and analysis applicable law and administrative procedures with the best information available the requirements of various applicable law or administrative procedures have been met sec_6331 requires that the service notify a tax- payer at least days before a notice_of_levy can be issued sec_6330 provides that no levy may be made unless the service notifies a taxpayer of the opportu- nity for a hearing with appeals a letter final notice--final notice_of_intent_to_levy and your right to a hearing was sent to you by certified mail a levy source was identified prior to issuance of the notice_of_intent_to_levy sec_6330 allows the taxpayer to raise any relevant issue relating to the unpaid tax or the pro- posed levy at the hearing you were provided the opportunity to raise any issue at the hearing sec_6330 provides that a taxpayer may only raise challenges to the existence or amount of the underlying tax_liability if the person did not receive a statutory_notice_of_deficiency for such tax liablity or did not otherwise have an opportunity to dispute the liability the appeals officer has had no prior involvement with respect to these liabilities as required by sec_6330 relevant issues presented by the taxpayer challenge to the amount of the liability you indicate in the form that you do not agree with the amount of the liability a statutory_notice_of_deficiency was issued on to rosie moore coach dr apt memphis tn the notice was not returned by the post office as undeliverable or unclaimed a copy of the notice is in the file when asked during the hearing whether you received the statutory notice you stated that you could not recall the information in the file shows that you requested and received reconsideration of your audit however the audit adjustments were unchanged the appeals officer explained that head_of_household filing_status and the earned_income_credit were not allowed since it was determined that you did not meet the definition of certain married individuals living apart found in sec_7703 since you were previously given the opportunity to contest the liability the liability issue cannot be considered in the collection_due_process_hearing challenges to the appropriateness of the collection action you raised no specific challenge to the appropriateness of the collection action other issues in a letter dated the appeals officer ad- vised you that to be considered for an installment_agreement or offer_in_compromise you must provide a completed collection information statement form a this information was to be submitted within days of the date of the letter but was never provided in the cdp hearing you refused to discuss payment alternatives to the levy you raised no other issues balancing efficient collection and intrusiveness the issuance of the notice_of_intent_to_levy was not unnecessarily intrusive you did not contact the service to make arrangements to pay or otherwise re- solve the liabilities the proposed collection action balances the need for the efficient collection_of_taxes with the legitimate concern that any collection action be no more intrusive than necesssary my evaluation since you were previously given the opportunity to contest the liability the liability issue cannot be considered in the cdp hearing the liability remains unpaid you have offered no payment alternative to the levy the notice_of_intent_to_levy issued for tax_year ending is sustained discussion the court may grant summary_judgment where there is no genuine issue of material fact and a decision may be rendered as a matter of law rule b sunstrand corp v commissioner 98_tc_518 affd 17_f3d_965 7th cir in petitioner’s response to respondent’s motion petitioner’s response petitioner agrees with the material facts set forth in respondent’s motion and the attachments thereto we conclude that there are no genuine issues of material fact regarding the questions raised in respondent’s motion the only issue raised in petitioner’s petition and in petitioner’s response is the underlying tax_liability for peti- tioner’s taxable_year in petitioner’s response petitioner states please allow petitioner to re-emphasize the overall issue in question raised by i r s audit was that of petitioner rosie l moore’s legal filing_status for calendar_year the question of legal filing_status for rosie l moore led to respondent’s presumption of said under- lying liability petitioner provided proper documentation in support of filing_status claimed by said petitioner in year petitioner received a notice_of_deficiency with respect to her taxable_year but she did not file a petition with respect to that notice on the instant record we find that petitioner may not challenge the existence or the amount of petitioner’s unpaid liability for see sec_6330 114_tc_604 114_tc_176 where as is the case here the validity of the underlying tax_liability is not properly placed at issue the court will review the determination of the commissioner of the internal revenue for abuse_of_discretion sego v commissioner supra pincite goza v commissioner supra pincite based upon our examination of the entire record before us we find that respondent did not abuse respondent’s discretion in determining to proceed with the collection action as determined in the notice_of_determination with respect to petitioner’s taxable_year on the record before us we shall grant respondent’s motion to reflect the foregoing an appropriate order granting respondent’s motion and decision will be entered for respondent