tcmemo_2005_233 united_states tax_court karns prime fancy food ltd petitioner v commissioner of internal revenue respondent docket no filed date john d sheridan and steven j schiffman for petitioner gerald a thorpe for respondent memorandum findings_of_fact and opinion chiechi judge respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax tax for the taxable_year ended date year at issue the only issue for decision is whether the dollar_figure million dollar_figure million at issue that petitioner received from its princi- pal supplier during the year at issue constitutes a loan that is not includable in its gross_income we hold that it does not findings_of_fact some of the facts have been stipulated and are so found at the time of the filing of the petition in this case petitioner’s principal_place_of_business was in mechanicsburg pennsylvania during the year at issue petitioner a corporation orga- nized under the laws of pennsylvania operated several grocery stores in towns located around harrisburg pennsylvania during that year super rite foods inc super rite one of peti- tioner’s suppliers of grocery items since the 1970s was peti- tioner’s principal supplier in scott karns mr karns who at all relevant times was petitioner’s chief_executive_officer concluded that peti- tioner needed dollar_figure million for capital improvements in that year mr karns approached dale conklin mr conklin who was then president of super rite to discuss obtaining financial assistance from super rite for petitioner’s capital needs at certain times during the relevant time period certain of super rite’s customers approached it seeking some form of finan- cial assistance eg an advance of funds a lease guaranty a supply agreement commitment although super rite preferred that its customers obtain financial assistance from outside sources from time to time around to times a year it decided to provide some form of financial assistance to certain of its creditworthy and strategically important customers in order to help them meet their respective financial needs the amount of funds that super rite was willing to advance to a customer depended upon super rite’s estimate of its potential profit under the supply agreement that it required of such customer before super rite agreed to provide financial assistance to a customer it required each such customer to enter into a written supply agreement supply agreement that inter alia required the customer to purchase annually a minimum amount of products and that contemplated that super rite would pay an advance price rebate to such customer at the inception of such supply agreement and execute a promissory note note payable to super rite in the amount of any such advance rebate although super rite expected that the customer would satisfy the minimum annual purchase requirement set forth in the supply agreement super rite nonetheless required the customer to execute a note payable to it in order to facilitate repayment of all or a portion of such advanced funds in the event that the customer did not satisfy such minimum annual purchase requirement or otherwise materially breached the supply agreement super rite intended 1even in a situation where a customer of super rite did not seek an advance of funds from super rite super rite may have agreed to enter into a supply agreement with such customer that inter alia required the customer to purchase annually a minimum continued that the customer’s obligation to repay funds that it advanced would arise only if the customer materially breached the supply agreement while petitioner was negotiating with super rite with respect to the terms of the supply agreement and the correspond- ing note that super rite required as conditions to super rite’s advancing any funds to it petitioner requested and received permission from pnc bank petitioner’s primary bank to enter into such supply agreement and to execute such note that is because petitioner had outstanding indebtedness to pnc bank and the loan documents with respect to that indebtedness required pnc bank’s permission before petitioner entered into any transaction in which it received an advance of funds that it might have to repay and or with respect to which certain of petitioner’s assets were to serve as collateral in all events pnc bank was to retain a first security_interest in any assets of petitioner that served as collateral with respect to petitioner’s outstanding continued amount of products and that contemplated that super rite would pay an advance price rebate to such customer at the inception of such supply agreement before super rite entered into such a supply agreement it required the customer to execute a note payable to super rite in the amount of any such advance rebate in order to facilitate repayment of such advanced funds in the event that the customer did not satisfy the minimum annual purchase requirement set forth in the supply agreement or otherwise materially breached that agreement indebtedness to that bank as a result of negotiations between mr conklin and mr karns super rite agreed to advance dollar_figure million to petitioner and petitioner agreed to execute the supply agreement and the corresponding note required by super rite in agreeing to the dollar_figure million advance to petitioner and to the terms of the supply agreement and the corresponding note that super rite required of petitioner super rite had concluded inter alia that petitioner would be entitled to an estimated dollar_figure million rebate under such supply agreement if petitioner did not materially breach that agreement on date petitioner executed the supply agreement date supply agreement that super rite required of petitioner as a condition to super rite’s advancing dollar_figure million to it petitioner also executed the corresponding dollar_figure million 2the supply agreement between petitioner and super rite discussed below provided that pnc bank was to have a first security_interest in certain equipment that was described in that agreement as collateral with respect to petitioner’s obligations under the supply agreement 3prior to agreeing to enter into a supply agreement with super rite petitioner did not have a supply agreement with that supplier 4prior to agreeing to enter into a supply agreement with super rite petitioner did not receive any price rebates from super rite with respect to its purchase of products from that supplier note date note dated date and payable to super rite that super rite also required of petitioner as a condition to super rite’s advancing dollar_figure million to it pursuant to the date supply agreement petitioner agreed to purchase annually from super rite dollar_figure million in products over a six-year period the date supply agreement provided in pertinent part supply of requirements certification throughout the term of this agreement super rite will be the principal wholesaler for all products purchased by the retailer petitioner for sale in the retailer’s stores that are located within the geographic area served by super rite throughout the term of this agreement the retailer shall purchase at least dollar_figure of product from super rite each year of this agreement pricing and payment terms during the term of this agreement product pricing fees billing and payment terms returns and credits for products pur- chased and other terms and conditions governing the sale of products hereunder shall be governed by super rite’s general policies and practices in effect from time to time in addition retailer shall receive a private label incentive to be determined on the basis of exhibit a attached hereto and further retailer fees for grocery frozen and dairy shall be in accordance with exhibit b attached hereto the parties further agree that retailer’s payment terms shall be seven days failure by the retailer to make payment to super rite of amounts due for the delivery of goods hereunder 5by using the term date note we do not intend to suggest that for tax purposes there was a loan by super rite to petitioner that was evidenced by that document 6prior to the date supply agreement super rite did not provide petitioner with any incentives for private label purchases and charged petitioner fees higher than those set forth in exhibit b attached to that supply agreement in accordance with the payment terms governing any shipment of goods shall constitute a default hereunder and in addition to its rights under sec_5 of this agreement super rite may suspend shipments to the retailer for so long as such default remains uncured term this agreement shall remain in full force and effect until date thereafter this agreement shall automatically be renewed for successive periods of one year each unless either party gives written notice to the other party at least sixty days prior to the expiration of the initial term or any renewal term hereof that it desires to terminate this agreement at the end of such term delays in supply neither party hereto shall be liable for any default or delay in the performance of its obligations hereunder caused by any contingency beyond its control in the event of a delay that materially impairs super rite’s shipments to the re- tailer or the retailer’s purchases from super rite the other party’s obligations hereunder shall be reduced for the period including the delay in proportion to the impairment and in the case of a delay affecting super rite the retailer shall be expressly permitted to cover such reductions by purchases from other wholesal- ers it being expressly understood that super rite shall incur no liability to the retailer for any in- creased costs or expenses related thereto cancellation by super rite super rite may cancel this agreement i upon the failure by the retailer to make payment to super rite in accordance with sec_2 hereof for goods delivered hereunder ii immediately upon the filing of a petition for relief by the retailer in a voluntary proceeding under applicable federal or state bankruptcy law or like laws for the protection of debtors or upon the application of the retailer to any court or administrative agency of competent jurisdiction for the appointment of a receiver or trustee for the administration of the retailer’s affairs iii upon the filing of a petition for relief with respect to the retailer in an involun- tary proceeding under applicable federal or state bankruptcy law or like laws for the protection of debtors or upon the application by a third party to any court or administrative agency of competent jurisdic- tion for the appointment of a receiver or trustee for the administration of the affairs of the retailer if an order for relief shall be entered and continued unstayed in effect for thirty days or such peti- tion or application shall continue undismissed for sixty days iv following the breach of any obligation of the retailer hereunder if such breach is not cured within thirty days following notice thereof to the breaching party v following the default by retailer in the performance of or compliance with any material contract instrument or agreement including without limitation any lease of real prop- erty any material lease of personal_property or any promissory note instrument or agreement evidencing or in respect of any indebtedness for borrowed money or any security therefor if such default is not cured within any applicable_period of grace or vi immedi- ately upon the occurrence of a material adverse change in the condition financial or otherwise business or prospects of the retailer or any guarantor of the retailer’s liabilities and obligations hereunder cancellation by the retailer the retailer may cancel this agreement i immediately upon the filing of a petition for relief by super rite in a voluntary proceeding under applicable federal or state bankruptcy law or like laws for the protection of debtors or upon the application of super rite to any court or administrative agency of competent jurisdic- tion for the appointment of a receiver or trustee for the administration of super rite’s affairs ii upon the filing of a petition for relief with respect to super rite in an involuntary proceeding under applica- ble federal or state bankruptcy law or like laws for the protection of debtors or upon the application by a third party or sic any court or administrative agency of competent jurisdiction for the appointment of a receiver or trustee for the administration of the affairs of super rite if an order for relief shall be entered and continued unstayed in effect for thirty days or such petition or application shall con- tinue undismissed for sixty days or iii follow- ing the breach of any obligation of super rite hereun- der if such breach is not cured within thirty days following notice thereof to super rite liquidated_damages the parties understand that super rite’s commitment to supply the specified requirements of the retailer will require an allocation of resources by super rite that would not be practical if the retailer were to purchase less than such speci- fied percentage requirements from super rite the parties agree that the retailer’s failure to perform its obligations hereunder will cause damage to super rite that will be difficult or impossible to prove accurately and therefore with the intention of pro- viding a fair and reasonable formula to calculate the amount of such damage the parties agree that upon super rite’s cancellation of this agreement pursuant to sec_2 or of this agreement the retailer will pay super rite as liquidated_damages an amount equal to of the product of i the retailer’s aggregate purchases from super rite during the preceding calendar_year multiplied by ii the number of years remaining in the term of this agreement the amount of the retailer’s aggregate purchases and super rite’s damages for periods of less than one year shall be calculated on a pro_rata basis pledge on assets as collateral security for the prompt and complete payment and performance when due of all of retailer’s liabilities and obligations to super rite hereunder retailer hereby mortgages pledges hypothecates and grants to super rite a lien and secu- rity interest in all right title and interest which retailer may now or hereafter have in to and under the following wherever located collectively the collat- eral i all inventory as such term is defined in section of the uniform commercial code the code ii all accounts as such term is defined in section of the code iii all equipment as such term is defined in sec- tion of the code and iv all pro- ceeds of the foregoing as such term is defined in section the code sic retailer cove- nants that during the term of this agreement it will not without super rite’s prior written consent cre- ate incur assume or suffer to come into existence any mortgage pledge lien or other encumbrance upon any of the collateral or the proceeds thereof wherever located now existing or hereafter acquired other than that granted to super rite hereunder retailer agrees to execute and deliver such documents and to take such action as super rite may request to perfect and con- tinue super rite’s lien on and security_interest in such collateral provided however super rite ac- knowledges that pnc bank has first place security_interest on retailer’s equipment located at its’ sic west shore plaza store financial statements retailer shall furnish to super rite no later than ninety days after the end of each fiscal quarter of retailer the internal statements of retailer and every six months the reviewed balance_sheet of retailer together with its statement of income retained earnings and cash_flow for the fiscal quarter each year upon retailer’s request super rite shall provide retailer with a letter confirming the forgiveness of debt in accordance with that promissory note of even date herewith by and between super rite and retailer coupon redemption service during the term of this agreement retailer agrees to use super rite’s coupon service for the redemption of all coupons re- ceived by retailer and to pay for such service at the rates established by super rite from time to time the date note provided in pertinent part for value received karns prime fancy foods ltd the borrower hereby promises to pay to the order of super rite foods inc the lender the principal sum of one million five hundred thousand no dollars dollar_figure the borrower hereby further promises to pay interest on the unpaid principal balance hereof at a rate per annum equal to the prime rate as hereinafter defined plu sec_1 interest shall accrue daily from the date 7the date supply agreement referred to the date note as a note of even date the record does not clarify the inconsistency between the date of that note to which the supply agreement referred ie date and the date of that note to which such note referred ie date what is clear from the record is that the date supply agreement and the date note were entered into around the same time and were interdependent see infra note 8prior to the date supply agreement petitioner was not entitled to super rite’s coupon redemption service hereof on the unpaid principal balance hereof and shall be computed on the basis of the actual number of days for which due the principal balance of this note shall be repaid in six annual payments of dollar_figure each com- mencing on date and continuing on the third friday of each april thereafter through and including date provided however that the payment of the annual payment shall be forgiven by the lender super rite if the lender determines that the borrower is in compliance with and shall not have materially breached or then be in uncured default under that certain supply and requirements agreement of even date herewith among the borrower and lender the entire unpaid and unforgiven principal balance hereof shall be due and payable if prior to date borrower ceases for any reason to use lender as its primary food supplier notwithstanding the foregoing the entire unpaid and unforgiven principal balance hereof and accrued interest thereon shall be due and payable on date even though execution of the date supply agreement and the corresponding date note occurred in mid-date it was not until around date that petitioner received the dollar_figure million at issuedollar_figure around that last date rich foods inc rich foods the then parent of super rite 9the date note referred to the date supply agreement as a supply agreement of even date the record does not clarify the inconsistency between the date of that supply agreement to which the note referred ie date and the date of that supply agreement to which such supply agreement referred ie date what is clear from the record is that the date note and the date supply agreement were entered into around the same time and were interdependent see supra note 10the record does not explain why petitioner did not receive until date the dollar_figure million to which the date supply agreement and the corresponding date note pertained gave petitioner a dollar_figure million check drawn on rich foods’ check- ing account during the year at issue in date supervalu inc supervalu acquired rich foods supervalu recorded the dollar_figure million advanced to petitioner in supervalu’s fixed asset ledger as a supply rebate that was to be amortized over six years in monthly installments of dollar_figure petitioner recorded the date note in its books_and_records as a long-term note payable petitioner expended dollar_figure of the dollar_figure million at issue on capital improvements and temporarily invested the balance in certificates of deposit cds petitioner pledged the cds as collateral for a dollar_figure loan from pnc bank petitioner used the dollar_figure in pnc bank loan proceeds for capital improvements during the latter part of the year at issue mr karns concluded that it would be desirable to relocate one of peti- tioner’s stores as a result he entered into negotiations to lease a new site for that store the prospective lessor of that site refused to lease it to petitioner without a guaranty of petitioner’s lease obligations at all relevant times supervalu agreed to act from time to time as a guarantor of a customer’s lease obligations where supervalu concluded that to do so would serve supervalu’s busi- ness interests around date supervalu guaranteed petitioner’s obligations under the lease petitioner’s lease of the new site for one of petitioner’s stores in return for supervalu’s guaranty of petitioner’s lease on date petitioner entered into several agreements with supervalu including an agreement that granted to supervalu a security_interest in certain of petitioner’s assets a first amend- ment to the date supply agreement that inter alia amended the term of that supply agreement12 but that did not alter petitioner’s annual purchase requirement under the date supply agreement a retailer’s agreement that a required supervalu to make its product lines available to petitioner at certain prices and to provide petitioner with certain services including field advisory warehousing and marketing services and b required petitioner to comply with supervalu’s payment accounting inventory and confidentiality 11around early date supervalu filed financing statements with cumberland county pa and the pennsylvania secretary of state in order to perfect the security_interest in certain of petitioner’s assets that petitioner granted to supervalu on date 12the first amendment to the date supply agreement provided in pertinent part the term of the date supply agreement is hereby amended such that retailer’s petitioner’s obligations under this agreement shall continue in effect for the longer of a five years from the execution date or b as long as any capital commit- ment ie any capital committed by supervalu for the benefit of petitioner remains outstanding requirements a mediation arbitration agreement that required petitioner and supervalu to resolve any controversy claim or dispute by mediation or arbitration and a reimbursement agreement that required petitioner to pay annually to supervalu percent of the petitioner’s lease value in addition as was customary for supervalu when it guaranteed one of its customer’s lease obligations supervalu required petitioner to enter into an option agreement with supervalu that gave supervalu the right to take over petitioner’s lease in the event that petitioner de- faulted under itdollar_figure on date petitioner’s officers who were also stockholders of petitioner executed an agreement in which they guaranteed various obligations that petitioner had to supervalu and or its subsidiaries such obligations included petitioner’s obligations under the date supply agreement and the corresponding date note petitioner satisfied the annual purchase requirement set forth in the date supply agreement for each of the periods ended date and date and otherwise complied with did not materially breach and was not in uncured 13it has been supervalu’s practice to take over customer leases that it guaranteed where its customers were in default under them default under that supply agreementdollar_figure as a result petitioner was not obligated to make on each of those dates the annual payment set forth in the date note in petitioner’s books_and_records for each of the years ended date and date petitioner reduced by dollar_figure the balance of its long-term notes payable in each of petitioner’s tax returns for those respective years petitioner reported dollar_figure as other income--reduction of supplier note agreement on date petitioner executed a document entitled commercial note date commercial note payable to supervalu in the amount of dollar_figure on or about the same date petitioner received a dollar_figure check drawn on an account of supervalu the date commercial note provided in perti- nent part for value received karns prime and fancy food ltd collectively the maker promise s to pay to supervalu lender the principal sum of three hundred thousand and no dollars dollar_figure plus interest all as set forth below 14instead of discussing whether petitioner complied with materially breached and or was in uncured default under the date supply agreement for convenience we shall discuss only whether petitioner was in material breach of or materially breached that supply agreement however our refer- ences to whether petitioner was in material breach of or materi- ally breached the date supply agreement are intended also to pertain to whether petitioner complied with and or was in uncured default under that supply agreement 15by using the term date commercial note we do not intend to suggest that for tax purposes there was a loan by supervalu to petitioner that was evidenced by that document interest upon all principal advanced under this note shall accrue from the date of its advance and until repaid at a rate of ten and seven tenths percent per annum principal and interest due lender under this note shall be payable as follows a a payment of ninety one thousand five hundred two and dollars dollar_figure including princi- pal and accrued and unpaid interest shall be due and payable on march a payment of ninety one thousand five hundred two and dollars dollar_figure including principal and ac- crued and unpaid interest shall be due and pay- able on march a payment of ninety one thousand five hundred two and dollars dollar_figure including principal and ac- crued and unpaid interest shall be due and pay- able on march a payment of ninety one thousand five hundred two and dollars dollar_figure including principal and ac- crued and unpaid interest shall be due and pay- able on march and b the entire remaining principal balance plus all accrued and unpaid interest shall be due and payable in full on date this note shall be in default and at lender’s option the total unpaid principal under this note all accrued interest thereon and all other_amounts owed by any maker to lender whether evidenced by this note or otherwise shall be immediately due and payable with- out notice protest or demand upon the occurrence of any one or more of the following events of default a the failure of any maker to pay any amount when due or to perform any other obligation as required under this note b the occurrence of any default by any maker or any future guarantor there presently being no guarantors of this note called a guarantor below under any other obligation to or agreement with lender or any supervalu entity as defined below including any default by any maker or any guarantor under any supply agreement in favor of any supervalu entity and any failure by any maker or any guarantor to pay any open account obligation to any supervalu entity if this note any payment required to be made under this note or any other obligation payable to lender or any supervalu entity is not paid on the due_date whether at original maturity or following accel- eration in addition to any other rights lender may have under this note any related agreement or under applicable law lender shall have the right to set off the indebtedness evidenced by this note against any indebtedness of lender or any supervalu entity to any maker or guarantor reproduced literally on date petitioner and supervalu also entered into a second amendment to the date supply agreement date supply agreement second amendment the date supply agreement second amendment provided in pertinent part purchase requirement effective as of the execution date and continuing throughout the term of the date supply agreement retailer petitioner shall purchase at least dollar_figure of product from wholesaler super rite each year of the agreement sales rebate as additional consideration for retailer’s enter- ing into this agreement and provided no retailer entity is in default under this agreement or under any capital commitment or other agreement with or obligation to any supervalu entity wholesaler shall rebate to retailer a rebate the rebate on the terms and conditions set forth below the purchases on which the rebate shall be based the aggregate purchases shall be the total purchases of product from whole- saler by retailer for all of the supermarkets in the aggregate up to a maximum total of aggregate purchases over the term of this agreement of dollar_figure the rebate shall be calculated annually based on the aggregate purchases for the twelve month period immediately preceding an anniversary of the execution date the an- nual period the aggregate purchases for the annual period shall be multiplied by four thousand three hundred sixty seven ten-thousandths percent and the product of such calculation shall be the amount of the rebate payable by wholesaler to retailer for such annual pe- riod the amount of the rebate shall be shown as a credit on the first statement sent by whole- saler to retailer following the end of the annual period notwithstanding anything to the contrary which may be contained in this sec_5 at such point if any that the aggregate purchases reach dollar_figure no further purchases shall be consid- ered aggregate purchases and no rebate shall be due or payable with respect to any purchases which are not considered aggregate purchases whole- saler may offset against any rebate any amounts owed to any supervalu entity by any retailer en- tity and wholesaler shall discontinue paying the rebate altogether upon any default by any retailer entity under this agreement under any capital commitment or under any other agreement with or obligation to any supervalu entity wholesaler shall have no obligation whatsoever to pay any rebate in the event any retailer entity commences any proceeding under any bankruptcy reorganiza- tion or similar law or in the event a similar proceeding is filed against any retailer entity agreement continues except as specifically amended herein the agree- ment continues unmodified in full force and effect for the annual period ended date petitioner met the increase in petitioner’s annual purchase requirement under the date supply agreement second amendment ie an increase of dollar_figure million in required annual product purchases over the dollar_figure million in required annual product purchases set forth in the date supply agreement before its amendment by the date supply agreement second amendment we shall refer to such dollar_figure million increase as the dollar_figure million increase in peti- tioner’s annual purchase requirement as a result petitioner earned under the date supply agreement second amendment a sales rebate for the annual period ended date in an amount equal to the annual payment for that period set forth in the date commercial note and such rebate offset such annual payment for the annual period ended date petitioner did not meet the dollar_figure million increase in petitioner’s annual purchase requirement as a result petitioner earned under the date supply agreement second amendment a sales rebate of dollar_figure for the annual period ended date which was dollar_figure less than the annual payment for that period set forth in the date commercial note such rebate offset dollar_figure of such annual payment and petitioner paid the balance of such annual payment ie dollar_figure on date petitioner which used the accrual_method of accounting timely filed form_1120 u s_corporation income_tax return petitioner’s return for its taxable_year ended date in that return petitioner did not include the dollar_figure million at issue in gross_income respondent issued a notice_of_deficiency notice to peti- tioner with respect to the year at issue in the notice respon- dent determined that petitioner is required to include the dollar_figure million at issue in gross_income for that year opinion although respondent must have commenced respondent’s exami- nation of petitioner’s return for the year at issue after date the parties do not address sec_7491dollar_figure in any event we need not decide whether the burden_of_proof shifts to respondent under that section that is because resolution of the issue presented here does not depend on who has the burden_of_proof the parties’ sole dispute is whether the dollar_figure million at issue constitutes a loan that is includable in petitioner’s gross_income for the year at issue the determination of whether a transfer of funds constitutes a loan is a question of fact 52_tc_255 affd per curiam 422_f2d_198 5th cir in order for a transfer of funds to constitute a loan at the time the funds are transferred there must be an unconditional 16all section references are to the internal_revenue_code in effect for the year at issue obligation ie an obligation that is not subject_to a condi- tion precedent on the part of the transferee to repay and an unconditional intention on the part of the transferor to secure repayment of such funds 88_tc_604 affd without published opinion 855_f2d_855 8th cir see also 925_f2d_180 7th cir affg tcmemo_1989_393 18_tc_780 affd per curiam 205_f2d_353 2d cir whether a transfer of funds constitutes a loan may be inferred from objective characteristics surrounding the transfer including the presence or absence of a debt_instrument collat- eral securing the purported loan interest accruing on the purported loan repayments of the transferred funds and any attributes indicative of an enforceable obligation to repay the funds transferred see eg haag v commissioner supra pincite n in determining whether a transfer of funds constitutes a loan the substance and not the form of the transaction is controlling for tax purposes see eg 364_us_361 in support of its position that the dollar_figure million at issue constitutes a loan petitioner argues the advance from super rite on date created an unconditional obligation to repay those funds it was only a condition_subsequent ie ful- filling the obligations under the supply and require- ments agreement on an annual basis that gave rise to the forgiveness of the annual debt service payment in the instant case petitioner has demonstrated that all the indicia of a loan as well as a true creditor-debtor relationship existed a promissory note was signed the note called for interest on the unpaid balance at the rate of prime plu sec_1 the note was to be repaid in six annual payments of dollar_figure each commencing on date and continu- ing on the third friday of each april thereafter through and including date the peti- tioner granted super rite a security_interest in i all inventory ii all accounts iii all equip- ment including without limitation all machinery equipment furnishings and fixtures of any kind and nature and description and iv all proceeds of the foregoing petitioner recorded the dollar_figure million promissory note as a long term note payable at the time of the transaction petitioner considered the dollar_figure million as a loan there was no guarantee in april of that the petitioner would meet the purchase obligations or other obligations under the supply and requirements agree- ments for the ensuing six years accordingly there was no guarantee that the future debt service payments would be forgiven without any guarantee that peti- tioner would be allowed to keep the funds there is no income from the loan unless and until such time a debt service payment is forgiven in determining whether a taxpayer enjoys ‘complete dominion’ over a given sum the crucial point is not whether his use of the funds is unconstrained during some interim period the key is whether the taxpayer has some guarantee that he will be allowed to keep the money c i r v indianapolis power light 493_us_203 110_sct_589 if super rite had filed for bankruptcy the supply and requirements agreement could be canceled had super rite declared bankruptcy they petitioner would have been under default under the supply and requirements agreement and accordingly all amounts due under the note would have been immediately due and payable if the petitioner was unable to meet their payment obligations under the supply and require- ments agreement and such default remained uncured for a period of days super rite could cancel the agree- ment and as a result of such default amounts due under the note would immediately become due and pay- able reproduced literally we turn first to petitioner’s related arguments that the dollar_figure million advance by super rite to petitioner created an unconditional obligation on the part of petitioner to repay those funds and that only a condition_subsequent ie compliance by petitioner with the date supply agreement gave rise to the forgiveness of the annual payment set forth in the date note in advancing those arguments petitioner relies on erickson post acquisition inc v commissioner tcmemo_2003_218 and on the following language in the date note the principal balance of this note shall be repaid in six annual payments of dollar_figure each com- mencing on date and continuing on the third friday of each april thereafter through and including date provided however that the payment of the annual payment shall be forgiven by the lender super rite if the lender determines that the borrower petitioner is in compliance with and shall not have materially breached or then be in uncured default under that certain supply and requirements agreement date supply agreement of even date herewith among the borrower and lender if the form of the date note were to control such form would appear to support petitioner’s arguments however we are not bound by the form of the date note see knetsch v united_states supra the substance of the bargain between petitioner and super rite at the time the dollar_figure million at issue was transferred to petitioner governs our resolution of whether such transfer constitutes a loan see id based upon our examination of the entire record before us we find that the substance of the bargain between petitioner and super rite at the time of the transfer to petitioner of the dollar_figure million at issue17 was that petitioner’s obligation for a given annual period to make the annual payment set forth in the date note would not arise unless and until it materially breached the date supply agreement with respect to such period on that record we find that at the time of the transfer to petitioner of the dollar_figure million at issue petitioner did not have an unconditional obligation to make each of the annual payments set forth in the date notedollar_figure we further find 17although the date note is dated date it was not until around date that petitioner received the dollar_figure million at issue see supra note 18we have found based on the testimony of joseph della noce mr della noce an officer of rich foods the parent of super rite at the time of the transaction at issue that super rite expected that the customer would satisfy the minimum annual purchase requirement set forth in the supply agreement but that super rite nonetheless required the customer to execute a note payable to it in the amount of any advanced funds in order to facilitate repayment of all or a portion of such funds in the event that the customer did not satisfy such minimum annual purchase requirement or otherwise materially breached the supply agreement we have also found based on mr della noce’s testi- mony that super rite intended that the customer’s obligation to repay funds that it advanced to such customer would arise only if the customer did not satisfy the minimum annual purchase require- ment set forth in the supply agreement or otherwise materially breached that agreement petitioner’s reliance on erickson post acquisition inc v commissioner supra to be misplaced that case is materially distinguishable from the instant case in erickson post acquisi- tion inc the court found that at the time the taxpayer received the funds in question the taxpayer had an unconditional obligation to repay the full amount of such funds and that not only was the transaction in form a loan but under the circum- stances of this case that was also its substance erickson post acquisition inc v commissioner supra unlike the findings of the court with respect to the obligation of the taxpayer in erickson post acquisition inc we have found that at the time of the transaction at issue the substance of that transaction was that any obligation of petitioner under the date note did not arise unless and until there was a material breach by petitioner of the date supply agreement and that petitioner did not have an unconditional obligation to make each of the annual payments set forth in the date notedollar_figure 19on the record before us we reject petitioner’s argument that certain alleged loan transactions between it and supervalu that occurred after super rite advanced the dollar_figure million at issue to petitioner subsequent transactions support its position that the dollar_figure million at issue constitutes a loan assuming arguendo that we had found that the subsequent transactions constitute loans those subsequent transactions do not control whether at the time petitioner received the dollar_figure million at issue petitioner had an unconditional obligation to make each of the annual payments set forth in the date note see haag v continued we turn now to petitioner’s reliance on the statement in 493_us_203 that in determining whether a taxpayer enjoys ‘complete dominion’ over a given sum the key is whether the taxpayer has some guarantee that he will be allowed to keep the money according to petitioner there was no guarantee in april of that the petitioner would meet the purchase obligations or other obligations under the supply and requirements agree- ments for the ensuing six years accordingly there was no guarantee that future debt service payments would be forgiven even if one assumes that on the anniversary date the petitioner had met the purchase requirements under the supply and requirements agreement there was still no guarantee that the debt service payment would be forgiven because the note required that the borrower is in compliance with and shall not have materially breached or then be an uncured default under the supply agreement petitioner’s contentions in reliance on commissioner v indianapolis power light co supra miss the point that the supreme court established in that case the issue presented in indianapolis power light co was whether certain deposits that the taxpayer a power company received from its customers were income in resolving that issue the supreme court analyzed whether the taxpayer enjoyed complete dominion over such continued commissioner 88_tc_604 affd without published opinion 855_f2d_855 8th cir deposits the supreme court held that the taxpayer did not have complete dominion over the deposits in question because it did not have some guarantee that it would be allowed to keep them id according to the supreme court by making timely payments of their respective utility bills the customers and not the taxpayer controlled whether the taxpayer would be required to return the deposits that it received from such customers id pincite in contrast to the situation presented in indianapolis power light co super rite did not have control_over the events that petitioner asserts would have constituted a material breach by it of the date supply agreement and that would have required petitioner to repay a portion or all of the dollar_figure million at issue that it received from super ritedollar_figure see 20according to petitioner it would have materially breached the date supply agreement upon the occurrence of any of the following events set forth in paragraph of that supply agreement i upon the failure by the retailer to make payment to super rite in accordance with sec_2 hereof for goods delivered hereunder ii immediately upon the filing of a petition for relief by the retailer in a voluntary proceeding under applicable federal or state bankruptcy law or like laws for the protection of debtors or upon the application of the retailer to any court or administrative agency of competent jurisdic- tion for the appointment of a receiver or trustee for the administration of the retailer’s affairs iii upon the filing of a petition for relief with respect to the retailer in an involuntary proceeding under applicable federal or state bankruptcy law or like laws for the protection of debtors or upon the application by a third party to any court or adminis- continued id see also 106_tc_392 affd 129_f3d_788 5th cir on the record before us we find that petitioner had some guarantee that for each annual period covered by the date supply agreement and the corresponding date note it would be allowed to keep the amount of the annual payment set forth in that note as long as for each such period it lived up to its end of the bargain by not materially breaching the date supply agreementdollar_figure see commissioner v indianapolis power light co continued trative agency of competent jurisdiction for the ap- pointment of a receiver or trustee for the administra- tion of the affairs of the retailer if an order for relief shall be entered and continued unstayed in effect for thirty days or such petition or appli- cation shall continue undismissed for sixty days iv following the breach of any obligation of the retailer hereunder if such breach is not cured within thirty days following notice thereof to the breaching party v following the default by retailer in the performance of or compliance with any material contract instrument or agreement including without limitation any lease of real_property any material lease of personal_property or any promissory note instrument or agreement evidencing or in respect of any indebtedness for borrowed money or any security there- for if such default is not cured within any applicable_period of grace or vi immediately upon the occur- rence of a material adverse change in the condition financial or otherwise business or prospects of the retailer or any guarantor of the retailer’s liabilities and obligations hereunder 21on the record before us we reject petitioner’s contention that if super rite had commenced a bankruptcy proceeding peti- tioner would have been in default under the date supply agreement pursuant to the date supply agreement the continued u s pincite herbel v commissioner supra based upon our examination of the entire record before us we find that the dollar_figure million at issue does not constitute a loan on that record we further find that that amount is includable in petitioner’s gross_income for the year at issue we have considered all of the contentions and arguments of the parties that are not discussed herein and we find them to be without merit irrelevant and or moot to reflect the foregoing decision will be entered for respondent continued commencement of a bankruptcy proceeding by super rite merely would have granted petitioner the option of canceling the date supply agreement thus it was within the control of petitioner and not super rite to cancel that supply agreement in the event that super rite were to commence a bankruptcy proceeding


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 psi b04 plr-113724-07 date date ------------------ ------------------------ -------------------------------- ------------------ --------- ---------------------------- ------------------ ------------------------ ------------------------ date decedent trust date state spouse daughter daughter daughter marital trust one -------------------- family_trust marital trust two -------------------- trustee date a b c d date date executor date e f ---------------- -------------------------------------------------------------- ----------------------------------------- ----------- -------------- ----------- ----------- ----------------------------------------- ----------------------- ------------------------------------------------------------------ ----------------------------------- -------------- ----------- -------------- --------------------------------------------- ---------------------------------------------------------- plr-113724-07 g state statute state statute -------------------- this responds to your representative’s letter dated date requesting rulings under the applicable provisions of the internal_revenue_code facts the facts and representations submitted are summarized as follows on date decedent created trust a revocable_trust on date decedent died a resident of state whereupon trust became irrevocable decedent was survived by spouse daughter daughter daughter and grandchildren trust provides that after the death of decedent the trustee shall divide the trust estate into three trusts marital trust one to consist of certain real and personal_property family_trust to consist of the smallest amount necessary to reduce to zero the federal estate_tax payable as a result of the death of decedent after taking into account the state_death_tax_credit and marital trust two to consist of the balance of the trust estate article sections of trust contains the provisions of marital trust one relating to the distribution of income and principal to spouse during spouse’s lifetime article section provides that on the death of spouse the assets of marital trust one shall be added to or used to fund family_trust article sec_1 of trust contains the provisions of family_trust relating to the distribution of income to spouse during spouse’s lifetime article sec_2 provides that upon the death of spouse the trustee shall distribute the assets of family_trust including any amounts added thereto from marital trust one and marital trust two to such of decedent’s daughters as shall then be living except that the then living descendants of a deceased daughter shall take per stirpes the share that the daughter would have received if living each distribution is subject_to the postponement of possession until such beneficiary attains the age of article sections of trust contains the provisions of marital trust two relating to the distribution of income and principal to spouse during spouse’s lifetime article sec_3 provides that on the death of spouse the assets of marital trust two shall be added to or used to fund family_trust except to the extent the amount of estate and inheritance taxes is increased as a result of the inclusion of the assets of marital trust one and marital trust two in spouse’s estate plr-113724-07 article of trust provides that the law of state governs the validity and interpretation of trust trustee currently serves as the trustee of marital trust one family_trust and marital trust two it is represented that all of decedent’s generation-skipping_transfer gst tax exemption was available for allocation at her death form_706 the united_states estate and generation-skipping_transfer_tax return was timely filed with extensions on behalf of decedent’s estate on date form_706 reflects that marital trust one was funded with a total of dollar_figurea in assets marital trust two was funded with a total of dollar_figureb in assets and family_trust was funded with a total of dollar_figurec in assets an election was made on schedule m of decedent’s form_706 to treat the property of marital trust one and marital trust two as qualified terminal interest property qtip under sec_2056 of the internal_revenue_code code a reverse_qtip_election under sec_2652 of the code was made with respect to the property of marital trust two the executor of decedent’s estate allocated dollar_figurec of decedent’s gst tax exemption available under sec_2632 in effect at the time of the transfer to family_trust and dollar_figured of decedent’s gst_exemption to marital trust two on date daughter daughter and daughter disclaimed all of their interests in that portion of family_trust including that portion of marital trust one and marital trust two that may ultimately be added to family_trust that would not result in any gst tax due to any allocation of gst_exemption by decedent and spouse it is represented that all of the disclaimers are irrevocable and that the disclaimers were in a written instrument delivered to trustee of family_trust within months of decedent’s death it is also represented that none of the disclaimants have accepted or will accept any of the interests or benefits of the disclaimed interest spouse died on date a resident of state executor currently serves as the executor of spouse’s estate executor is neither a beneficiary nor a party related to a beneficiary of marital trust one marital trust two or family_trust executor timely filed with extensions spouse’s form_706 on date spouse’s form_706 reflected the inclusion in spouse’s gross_estate of the assets of marital trust one valued at dollar_figuree and marital trust two valued at dollar_figuref executor of spouse’s estate allocated spouse’s available gst_exemption in the amount of dollar_figureg to the assets of marital trust one trustee now seeks to sever marital trust one into gst exempt marital trust one and gst nonexempt marital trust one it is represented that upon severance gst exempt marital trust one and gst nonexempt marital trust one will be governed in accordance with the provisions governing marital trust one it is further represented that marital trust one will be severed on a fractional basis gst exempt marital trust one will be funded with a fraction of the original trust with the numerator equal to spouse’s unused gst_exemption and the denominator equal to the fair_market_value of plr-113724-07 the assets of marital trust one on the date of severance gst nonexempt marital trust one will be funded with a fraction of the original trust equal to one minus the fraction determined for gst exempt marital trust one it is further represented that gst exempt marital trust one and gst nonexempt marital trust one will be funded with the appropriate pro_rata portion of each asset held by marital trust one or if funded on a non pro_rata basis each trust will be funded by applying the appropriate fraction or percentage to the total fair_market_value of the assets of marital trust one as of the date of severance you have requested the following rulings after the severance of marital trust one gst exempt marital trust one and gst nonexempt marital trust two will be recognized as separate trusts for gst tax purposes the former having an inclusion_ratio of zero and the latter having an inclusion_ratio of one the disclaimers executed by daughter daughter and daughter will be considered qualified disclaimers under sec_2518 the distribution of the assets of gst exempt marital trust one will not result in a transfer subject_to gift_tax under sec_2501 ruling_request sec_2001 of the internal_revenue_code imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2056 provides that for purposes of the tax imposed by sec_2001 the value of the taxable_estate is to be determined by deducting from the value of the gross_estate an amount equal to the value of any interest in property that passes or has passed_from_the_decedent to the surviving_spouse sec_2056 provides in pertinent part that no deduction shall be allowed under sec_2056 where on the lapse of time on the occurrence of an event or contingency or on the failure of an event or contingency to occur an interest passing to the surviving_spouse will terminate or fail sec_2056 provides that in the case of qualified_terminable_interest_property the entire property shall be treated as passing to the surviving_spouse for purposes of sec_2056 and no part of such property shall be treated as passing to any person other than the surviving_spouse for purposes of sec_2056 sec_2056 defines the term qualified_terminable_interest_property as property i which passes from the decedent ii in which the surviving_spouse has a plr-113724-07 qualifying_income_interest_for_life and iii to which an election under sec_2056 applies sec_2056 provides that an election under sec_2056 with respect to any property shall be made by the executor on the return of tax imposed by sec_2001 and that such an election once made shall be irrevocable sec_2044 provides in relevant part that the value of the gross_estate shall include the value of any property in which the decedent had a qualifying_income_interest_for_life and for which a deduction was allowed under sec_2056 sec_2044 provides that for purposes of chapter and chapter property includible in the gross_estate of the decedent under sec_2044 shall be treated as property passing from the decedent sec_2601 imposes a tax on every gst under a of the tax_reform_act_of_1986 act the gst tax is generally applicable to gsts made after date however under b a of the act and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the tax does not apply to any gst from a_trust if the trust was irrevocable on date and no addition actual or constructive was made to the trust after that date sec_2611 provides that the term generation-skipping_transfer means a taxable_distribution a taxable_termination and a direct_skip sec_2602 provides that the amount of the gst tax is determined by multiplying the taxable_amount by the applicable_rate sec_2641 defines the term applicable_rate with respect to any gst as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer sec_2642 provides that generally the inclusion_ratio with respect to any property transferred in a gst is the excess of over the applicable_fraction with respect to a gst that is not a direct_skip sec_2642 provides that in general the applicable_fraction is a fraction the numerator of which is the amount of the gst_exemption under sec_2631 allocated to the trust and the denominator of which is the value of the property transferred to the trust sec_2631 provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption of dollar_figure adjusted for inflation under sec_2631 that may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that plr-113724-07 any allocation under sec_2631 once made shall be irrevocable sec_2632 provides that any allocation by an individual of his or her gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual's estate determined with regard to extensions regardless of whether such a return is required to be filed sec_2652 provides that for purposes of chapter the term transferor means a in the case of any property subject_to the tax imposed by chapter the decedent and b in the case of any property subject_to the tax imposed by chapter the donor an individual shall be treated as transferring any property with respect to which such individual is the transferor sec_2652 provides in pertinent part that in the case of any trust with respect to which a deduction is allowed to the decedent under sec_2056 by reason of sec_2056 the estate of the decedent may elect to treat all of the property in such trust for gst purposes as if the election to be treated as qualified_terminable_interest_property had not been made this election is referred to as a reverse_qtip_election and as provided in sec_26_2652-2 is made on the return on which the qtip_election was made sec_2654 provides that for gst tax purposes the portions of a_trust attributable to transfers from different transferors shall be treated as separate trusts sec_2642 provides that if a_trust is severed in a qualified_severance the trusts resulting from the severance shall be treated as separate trusts thereafter for gst purposes sec_2642 defines qualified_severance as the division of a single trust and the creation by any means available under the governing instrument or under local law of two or more trusts if i the single trust was divided on a fractional basis and ii the terms of the new trusts in the aggregate provide for the same succession of interests of beneficiaries as are provided in the original trust sec_2642 provides that if a_trust has an inclusion_ratio of greater than zero and less than a severance is a qualified_severance only if the single trust is divided into two trusts one of which receives a fractional share of the total value of all trust assets equal to the applicable_fraction of the single trust immediately before the severance in this case the trust receiving the fractional share shall have an inclusion_ratio of zero and the other trust shall have an inclusion_ratio of one sec_2642 provides that the term qualified_severance includes any other severance permitted under regulations prescribed by the secretary sec_2642 provides that a severance provided for in sec_2642 may be made at any time plr-113724-07 sec_26_2642-6 of the generation-skipping_transfer_tax regulations provides in relevant part that a qualified_severance must satisfy each of the following requirements the single trust must be severed pursuant to the terms of the governing instrument or pursuant to applicable local law the severance must be effective under local law the date of severance must be either the date selected by the trustee or the court-imposed date of funding in the case of an order of the local court with jurisdiction over the trust ordering the trustee to fund the resulting trusts on or as of a specific date for a date to satisfy the definition in the preceding sentence however the funding must be commenced immediately upon and funding must occur within a reasonable_time but in no event more than days after the selected valuation_date the single trust is severed on a fractional basis such that each new trust is funded with a fraction or percentage of the original trust and the sum of those fractions or percentages is one or one hundred percent respectively the severance of a_trust based on a pecuniary amount does not satisfy this requirement with respect to the particular assets to be distributed to each resulting trust each resulting trust may be funded with the appropriate fraction or percentage pro_rata portion of each asset held by the original trust alternatively the assets may be divided among the resulting trusts on a non pro_rata basis based on the fair_market_value of the assets on the date of severance however if funded on a non pro_rata basis each resulting trust must be funded by applying the appropriate fraction or percentage to the total fair_market_value of the trust assets as of the date of severance the terms of the resulting trusts must provide in the aggregate for the same succession of interests of beneficiaries as are provided in the original trust this requirement is satisfied if the beneficiaries of the separate resulting trusts and the interests of the beneficiaries with respect to the separate trusts when the separate trusts are viewed collectively are the same as the beneficiaries and their respective beneficial interests with respect to the original trust before severance in the case of a qualified_severance of a_trust with an inclusion_ratio as defined in sec_26_2642-1 of either one or zero each trust resulting from the severance will have an inclusion_ratio equal to the inclusion_ratio of the original trust in the case of a qualified_severance occurring after gst tax exemption has been allocated to the trust if the trust has an inclusion_ratio as defined in sec_26_2642-1 that is greater than zero and less than one then the trust must be severed initially into two trusts one resulting trust must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the applicable_fraction as defined in sec_26_2642-1 and c used to determine the inclusion_ratio of the original trust immediately plr-113724-07 before the severance the other resulting trust must receive that fractional share of the total value of the original trust as of the date of severance that is equal to the excess of one over the fractional share described in the preceding sentence the trust receiving the fractional share equal to the applicable_fraction shall have an inclusion_ratio of zero and the other trust shall have an inclusion_ratio of one sec_26_2642-6 provides that a qualified_severance may occur at any time prior to the termination of the trust thus provided that the separate resulting trusts continue in existence after the severance a qualified_severance may occur either before or after gst tax exemption has been allocated to the trust a taxable_event has occurred with respect to the trust or an addition has been made to the trust sec_2654 provides that for gst tax purposes the portions of a_trust attributable to transfers from different transferors shall be treated as separate trusts state statute provides in relevant part that a trustee has the power to sever any trust on a fractional basis into two or more separate and identical trusts for any reason unless expressly provided to the contrary in the trust instrument each separate trust must be held and administered upon the identical terms and conditions of the trust from which it was severed a separate trust created by severance must be treated as a separate trust for all purposes from the date on which the severance is effective in the instant case as a result of the qtip_election made on decedent’s form_706 with respect to marital trust one the property of marital trust one is includible in spouse’s gross_estate pursuant to sec_2044 spouse accordingly will be considered the transferor of the assets of marital trust one for gst tax purposes with respect to the assets of family_trust the property of family_trust was includible in decedent’s gross_estate and decedent is considered the transferor with respect to the assets of family_trust for gst tax purposes with respect to the assets of marital trust two as a result of the qtip_election and the reverse_qtip_election the property of marital trust two is includible in spouse’s gross_estate pursuant to sec_2044 but decedent is considered the transferor for gst tax purposes as provided above trust provides that upon the death of spouse the assets of marital trust one and marital trust two are to be added to family_trust however marital trust one is treated as a separate trust from family_trust for gst tax purposes because marital trust one has a different transferor than family_trust on spouse’s form_706 dollar_figureg of spouse’s gst tax exemption was allocated to the assets of marital trust one causing marital trust one to have an inclusion_ratio between one and zero trustee proposes to sever marital trust one into two trusts gst exempt marital trust one having an inclusion_ratio of zero and gst nonexempt marital trust one having an inclusion_ratio of one state statute authorizes a trustee to sever any trust on a fractional basis into two or more separate and identical trusts for any reason provided plr-113724-07 each separate trust is held and administered upon the identical terms and conditions of the trust from which it was severed trustee represents that marital trust one will be severed on a fractional basis with gst exempt marital trust one receiving that fractional share equal to the applicable_fraction and gst nonexempt marital trust one receiving that fractional share equal to one minus the applicable_fraction the provisions of gst exempt marital trust one and gst nonexempt marital trust one will provide for the same succession of interests of beneficiaries as is provided prior to severance provided the severance is effective under local law and the funding of the severed trusts occurs within a reasonable_time after the date of severance as selected by trustee we rule that the severance of marital trust one into gst exempt marital trust one and gst nonexempt marital trust one will be a qualified_severance under sec_2642 when gst exempt marital trust one receives a fractional share of the assets of marital trust one equal to the applicable_fraction as defined in sec_26_2642-1 and c used to determine the inclusion_ratio immediately before the severance gst exempt marital trust one will have an inclusion_ratio of zero and gst nonexempt marital trust one will have an inclusion_ratio of one the severance should be reported by filing form 706-gs t generation-skipping_transfer_tax return for terminations the form should have qualified_severance written at the top of the form and a notice of qualified_severance notice should be attached to the return the return and attached notice should be filed by april 15th of the year immediately following the year during which the severance occurred or by the last day of the period covered by an extension of time if an extension of time is granted to file the form the notice should contain with respect to the original trust the name of the transferor the name and date of creation of the original trust the tax identification_number of the original trust and the inclusion_ratio before the severance the notice should contain with respect to each of the resulting trusts created by the severance the name and tax identification_number of the trust the date of severance the fraction of the total assets of the original trust received by the resulting trust other details explaining the basis for the funding of the resulting trust and the inclusion_ratio ruling_request and sec_2501 imposes a tax on the transfer of property by gift by an individual sec_2511 provides that the tax imposed by sec_2501 applies whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_25_2511-1 of the gift_tax regulations provides that the gift_tax applies to gifts indirectly made any transaction in which an interest in property is gratuitously passed or conferred upon another regardless of the means or device employed plr-113724-07 constitutes a gift subject_to tax however in the case of a transfer creating an interest in property made after date sec_25_2511-1 shall not apply to the donee if as a result of a qualified_disclaimer by the donee a completed_transfer of an interest in property is not effected sec_2518 sets forth the requirements that must be met for a disclaimer to be treated as a qualified_disclaimer for federal gift_tax purposes sec_2518 provides that if a person makes a qualified_disclaimer with respect to any interest in property then for purposes of the estate gift and generation-skipping_transfer taxes the interest will be treated as if it had never been transferred to the disclaimant sec_2518 defines the term qualified_disclaimer to mean an irrevocable and unqualified refusal by a person to accept an interest in property but only if such refusal is in writing such writing is received by the transferor of the interest the transferor's legal_representative or the holder of the legal_title to the property to which the interest relates not later than the date which is nine months after the later of the date on which the transfer creating the interest in such person is made or the day on which such person attains age such person has not accepted the interest or any of its benefits and as a result of such refusal the interest passes without any direction on the part of the person making the disclaimer and passes either to the spouse of the decedent or to a person other than the person making the disclaimer sec_25_2518-1 provides in part that if a person makes a qualified_disclaimer then for purposes of federal estate gift and generation-skipping_transfer_tax provisions the disclaimed interest in property is treated as if it had never been transferred to the person making the qualified_disclaimer instead it is considered as passing directly from the transferor of the property to the person entitled to receive the property as a result of the disclaimer accordingly a person making a qualified_disclaimer is not treated as making a gift sec_25_2518-2 provides in part that in the case of a remainder_interest in property that an executor elects to treat as qualified_terminable_interest_property under sec_2056 the remainderman must disclaim within months of the transfer creating the interest rather than months from the date such interest is subject_to tax under sec_2044 or sec_2519 sec_25_2518-3 provides that a disclaimer of an undivided portion of a separate interest in property that meets the other requirements of a qualified_disclaimer under plr-113724-07 sec_2518 and the corresponding regulations is a qualified_disclaimer an undivided portion of a disclaimant’s separate interest in property must consist of a fraction or percentage of each and every substantial interest or right owned by the disclaimant in such property and must extend over the entire term of the disclaimant’s interest in such property and in other_property into which such property is converted sec_25_2518-3 example provides that a bequeathed his residuary_estate to b b disclaims a fractional share of the residuary_estate any disclaimed property will pass to a’s surviving_spouse w the numerator of the fraction disclaimed is the smallest amount that will allow a’s estate to pass free of federal estate_tax and the denominator is the value of the residuary_estate b’s disclaimer is a qualified_disclaimer state statute provides in part that a beneficiary may disclaim his succession to any interest in property that unless disclaimed would pass to the beneficiary as beneficiary of a testamentary_trust to be effective a disclaimer must be in writing declare the writing as a disclaimer describe the interest or power disclaimed and be signed by the person making the disclaimer a disclaimer with respect to an interest in a testamentary_trust must be delivered to the trustee within nine months after the event giving rise to the right to disclaim unless otherwise provided in the instrument creating the disclaimed interest the disclaimed interest passes as if the disclaimant had died immediately before the interest was created in this case based upon the representations made and the information submitted we conclude that the four requirements under sec_2518 are satisfied the first requirement is satisfied because the disclaimers are in writing the second requirement is satisfied because the disclaimers were delivered to the trustee of family_trust not later than nine months after the death of decedent which was the transfer creating the interest to be disclaimed the third requirement is satisfied because daughter daughter and daughter have represented that they have not and will not accept any of the disclaimed interests or benefits the fourth requirement is satisfied because under state law the disclaimed property will pass to recipients other than daughter daughter and daughter and will not pass to any recipient at the direction of daughter daughter or daughter accordingly assuming the disclaimers are effective under state law we conclude that each of the disclaimers by daughter daughter and daughter will be considered qualified disclaimers under sec_2518 as a result of the disclaimers by daughter daughter and daughter the assets of gst exempt marital trust one will be distributable to the grandchildren of decedent pursuant to sec_25_2511-1 and sec_25_2518-1 we further conclude that the distribution of the assets of gst exempt marital trust one will not result in a transfer subject_to gift_tax this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-113724-07 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely james f hogan senior technician reviewer branch passthroughs special industries


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 psi plr-124348-09 date date legend x d1 state ---------------------- ----------------------- --------------------- --------- dear ------------------ this letter responds to a letter dated date submitted on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code facts x was incorporated under the laws of state on d1 x’s sole shareholder desired that x elect s_corporation treatment effective d1 however form_2553 election by a small_business_corporation was not filed timely x represents that x has acted consistently with x's intended status as an s_corporation x requests a ruling that it will be treated as an s_corporation effective for the taxable_year beginning d1 plr-124348-09 law analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides that an election under sec_1362 shall be effective for the current taxable_year if it is made during the preceding_taxable_year or before the 15th day of the third month of the current taxable_year sec_1362 provides that an election made after the 15th day of the third month of the current taxable_year shall be treated as having been made for the following taxable_year sec_1362 provides that if an election under sec_1362 is made for any taxable_year determined without regard to sec_1362 after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply conclusion based on the facts submitted and representations made we conclude that x has established reasonable_cause for failing to make a timely s_corporation_election effective d1 thus we conclude that x is eligible for relief under sec_1362 accordingly if x makes an election to be an s_corporation by filing with the appropriate service_center a completed form_2553 within days following the date of this letter containing an effective date of d1 the election shall be treated as timely made for x's taxable_year beginning d1 a copy of this letter should be attached to the form_2553 a copy is enclosed for that purpose except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion concerning whether x is otherwise eligible to be an s_corporation for federal tax purposes this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative plr-124348-09 the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for a ruling it is subject_to verification on examination sincerely s tara p volungis senior technician reviewer branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc