t c memo united_states tax_court gregory h and elizabeth a price petitioners v commissioner of internal revenue respondent docket no filed date henry w tom and rick kilfoy for petitioners richard a rappazzo for respondent memorandum findings_of_fact and opinion swift judge respondent determined deficiencies additions to tax and penalties with regard to petitioners' and federal_income_tax liabilities as follows accuracy-related fraud addition_to_tax penalty penalty year deficiency sec_6651 a sec_6662 a sec_6663 dollar_figure dollar_figure --- dollar_figure big_number big_number --- big_number big_number big_number dollar_figure --- unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure all references to petitioner in the singular are to gregory h price after concession of some issues the primary issues for decision are the amount of income that should be charged to petitioner with respect to bank_deposits whether funds received from landlords for improvements to leased property constitute taxable_income and whether petitioner is liable for fraud penalties additions to tax for late filing of income_tax returns and accuracy-related_penalty for convenience with respect to each of respondent’s contested adjustments to petitioners’ income and expenses we combine our findings_of_fact and opinion findings_of_fact and opinion some of the facts have been stipulated and are so found when the petition was filed petitioners resided in glendale arizona income with respect to bank_deposits during through in phoenix arizona petitioner either in equal partnership with michael talerico the partnership or alone owned and operated seven movie video rental stores hereinafter sometimes referred to as the store or the stores the partnership and petitioner also sold some of the stores the schedule below indicates for each store the owner of the store the month or year the store was purchased or opened and the month the store was sold month year purchased month name of store owner or opened sold store petitioner mid-1980's date store petitioner date date store partnership date date store partnership date -- store partnership date date store petitioner date -- store partnership --- petitioner was responsible for finances and managed funds of the partnership and of the stores payments for rental of the movie videos videos were made by customers with cash checks and credit cards inadequate books_and_records were maintained with regard to income and expenses of the partnership and of the stores some entries were made in what petitioner refers to as general ledgers reflecting funds received from rental of videos these so-called general ledgers however were retained by the partnership and by petitioner for only a short_period of time and were not available at the trial petitioner maintained what he refers to as monthly summary records with respect to funds received from rental of videos the summary records also were not available at the trial there was maintained for each store a separate bank account at valley national bank funds received from rental of videos were deposited every few days into the bank accounts maintained for the stores most of the funds deposited in the bank accounts represented cash received by the stores from the rental of videos funds deposited into the bank accounts also represented checks received by the stores from the rental of videos and funds received by the stores from credit card companies for video rentals which had been paid_by customers with credit cards store sec_1 and were sold either in or in the beginning of and there is no issue between the parties as to the income relating to store sec_1 and for and the partnership timely filed partnership federal_income_tax returns and reported gross_receipts and after expenses ordinary losses relating to store sec_4 and as follows partnership year gross_receipts dollar_figure dollar_figure ordinary losses big_number petitioners untimely filed their and joint federal_income_tax returns to which returns petitioners attached schedule e supplemental income and loss relating to petitioner's interest in the partnership that owned and operated store sec_4 and and reflecting petitioner's one-half interest in the partnership ordinary losses as claimed on the partnership returns on petitioners' and joint federal_income_tax returns petitioners attached schedule c profit or loss from business relating to store that petitioner owned individually and reporting gross_income relating to store of dollar_figure for and dollar_figure for on audit using the bank_deposits method of proof respondent treated the funds that were deposited into the bank accounts of the stores -- the source of which respondent regarded as unexplained -- as taxable_income to the partnership or to petitioners respondent also treated certain funds received for leasehold improvements discussed below as specific items of taxable_income and respondent treated certain other funds that were deposited into the bank accounts maintained for the stores as nontaxable deposits for and total unexplained deposits as determined by respondent made into the bank accounts the partnership maintained for store sec_4 and consist of the following amounts respondent's determination of partnership unexplained bank_deposits dollar_figure dollar_figure for unexplained deposits as determined by respondent made into the bank account petitioner maintained for store consist of dollar_figure where a taxpayer fails to maintain adequate books_and_records relating to taxable_income respondent may reconstruct a taxpayer's income by any reasonable method see sec_446 680_f2d_1268 9th cir affg per curiam an order of this court 94_tc_654 23_tc_879 the bank_deposits method for computing income is approved by the courts see 730_f2d_1292 for total deposits made into the partnership store and store bank accounts were consistent with the total funds from video rentals reported on the partnership’s information federal_income_tax return accordingly in his bank_deposits analysis for the partnership for respondent made no adjustments for unexplained bank_deposits 9th cir 96_tc_858 affd 959_f2d_16 2d cir further for the years in issue where respondent uses the bank_deposits method to reconstruct a taxpayer's income respondent's determination has a presumption of correctness and the taxpayer has the burden of proving that the deposits are not attributable to taxable_income see rule a 449_f2d_311 9th cir affg per curiam tcmemo_1969_48 399_f2d_744 4th cir affg tcmemo_1967_67 231_f2d_186 6th cir 87_tc_74 petitioners contend that the funds deposited into the partnership’s and into petitioners’ bank accounts that respondent treats as unexplained bank_deposits and therefore as additional taxable_income for the partnership --- dollar_figure and dollar_figure for and respectively for petitioners -- dollar_figure for are largely attributable to sales of videos that petitioner owned personally in which videos petitioner had a cost or tax basis in excess of the amount for which the videos were sold and petitioners therefore contend that the bank_deposits in question do not constitute taxable_income respondent argues that petitioner has not established the nontaxable source of the bank_deposits in question inadequate books_and_records were maintained relating to funds received by the stores for the rental of videos and relating to the partnership’s and to petitioners’ income from the stores most of the records that allegedly were maintained were retained only for a short_period of time and were not introduced into evidence no records appear to have been maintained relating to checks and credit card payments received for rental of the videos petitioners presented no receipts invoices photographs or other credible_evidence to establish and verify petitioner’s ownership and sale of and tax basis in personal videos that would explain the nature and source of the bank_deposits in guestion petitioners have failed to establish the nontaxable nature of the bank_deposits treated by respondent as unexplained and as taxable_income we sustain respondent’s adjustments to the partnership's and to petitioner's income based on the unexplained bank_deposits reimbursements for leasehold improvements on date the partnership leased from mc-peoria limited_partnership peoria a portion of a building for store under terms of the lease the partnership was obligated to make certain capital improvements to the building and peoria was obligated to transfer to the partnership up to dollar_figure to reimburse the partnership for costs of the improvements during the partnership received from peoria dollar_figure to make the improvements to store in november of petitioner leased for a period of years from the college park partnership college park a portion of a building for store under terms of the lease petitioner was obligated to make certain capital improvements to the building and college park was obligated to transfer to petitioner up to dollar_figure to reimburse petitioner for costs of the improvements during petitioner received dollar_figure from college park to make the improvements to store in store and in early store were opened and conducted business and it appears from the evidence that the required improvements to the buildings were made and that the above funds were received from peoria and from college park by the partnership and by petitioner as reimbursement for costs of the improvements during petitioner received dollar_figure from college park to make improvements to store on the partnership's and on petitioners' income_tax returns the dollar_figure the partnership received from peoria in to make improvements to store was not reflected as income of the partnership also on petitioners’ joint federal_income_tax -- - return for the dollar_figure that petitioner received from college park in to make improvements to store was not reflected as taxable_income similarly on petitioners’ joint federal_income_tax return for the dollar_figure that petitioner received from college park in to make improvements to store was not reflected as taxable_income on audit respondent treated the dollar_figure received by the partnership from peoria in dollar_figure of the dollar_figure received by petitioner from college park in and the dollar_figure received by petitioner from college park in as specific items of unreported taxable_income under sec_61 gross_income includes all income from whatever source derived see 348_us_426 respondent relies on this general proposition in treating as taxable_income the funds the partnership and petitioner received in and from peoria and college park generally however gross_income does not include funds received by a taxpayer in reimbursement for expenses paid on behalf of another see 10_tc_590 respondent treated dollar_figure of the funds received by petitioner from college park in as a nontaxable reimbursement for leasehold improvements revrul_67_407 1967_2_cb_59 mertens law of federal income_taxation sec_5 pincite rev the evidence is sufficiently clear that the funds received in and relating to leasehold improvements to buildings in which store sec_5 and operated under short-term leases were received by the partnership and by petitioner in reimbursement for capital expenditures made to the buildings owned by the landlords as such these funds do not constitute taxable_income to the partnership or to petitioner see suwalsky 47-5th t m real_estate leases and improvements a-22 to a-26 date depreciation_recapture income in june of the partnership opened store throughout the years in issue the partnership purchased videos that store owned and rented to customers on date for a stated sales_price of dollar_figure the partnership sold store and the videos associated with store the partnership's total cost_basis in the assets of store equaled dollar_figure the sale took the form of an installment_sale generally under sec_110 for leases entered into after date funds received by tenants in reimbursement from landlords for improvements to certain buildings leased under short-term leases are treated as nontaxable income to the tenants under which the purchaser paid the partnership a cash downpayment of dollar_figure and gave the partnership a dollar_figure promissory note on its and partnership federal_income_tax returns the partnership claimed accelerated_depreciation with respect to the partnership’s tax basis in store on its partnership federal_income_tax return the partnership did not reflect the sale of store rather the sale of store was reflected only on petitioners’ joint federal_income_tax return as an installment_sale with respect to which a capital_gain for of dollar_figure was reported on audit respondent determined that the partnership’s total dollar_figure gain on the sale of store and the associated videos’ was attributable to depreciation_recapture and was taxable to the partnership for as ordinary_income under sec_453 under the installment_sale provisions of sec_453 it is provided that on an installment_sale all income related thereto that would be treated as ordinary recapture_income under sec_1245 or sec_1250 if received in the year of the sale must be treated as ordinary_income as if received in the year of the sale see murry v commissioner tcmemo_1993_471 mertens respondent apparently computed the partnership’s dollar_figure gain on the sale of store as follows dollar_figure sales_price for store less partnership’s depreciated tax basis in store and in the associated videos of dollar_figure equals dollar_figure law of federal income_taxation sec_15 pincite pincite rev although petitioners object to this adjustment to the partnership’s income for petitioners provide no basis for their objection we sustain respondent’s adjustment rental income during the years in issue petitioners owned a number of rental properties on which they received rental income petitioners reported on their joint federal_income_tax return dollar_figure in rental income relating to these properties respondent determined that in petitioners received dollar_figure of rental income from these rental properties and that petitioners failed to report dollar_figure of such rental income under sec_61 funds received from rental of property are included in a taxpayer’s income although petitioners dispute respondent’s adjustment petitioners provided no testimony or evidence to disprove the adjustment we sustain this adjustment depreciation of videos as indicated during the years in issue videos were purchased by the partnership and by petitioner for rental to customers on the partnership’s and on petitioners’ federal_income_tax returns for the years in issue the costs of some of the videos purchased for rental to customers were expensed currently in the partnership's and on petitioners' income_tax returns depreciation expense deductions relating to the balance of the videos rented to customers were claimed using the modified accelerated_cost_recovery_system a 3-year life and the half- year convention on audit respondent disallowed the current expenses claimed for the cost of videos rented to customers respondent also determined that the proper method for computing depreciation on the videos was the straight-line method using a 2-year life anda dollar_figure per-tape-salvage value straight-line method for some years respondent’s adjustments to depreciation resulted ina decrease in the depreciation claimed and in other years respondent's adjustments to depreciation resulted in an increase in the depreciation to be allowed the schedule below sets forth respondent’s recomputation of the partnership’s and of petitioners' allowable_depreciation relating to videos rented to customers -- - respondent's recomputation of depreciation partnership depreciation claimed on return dollar_figure dollar_figure dollar_figure videos expensed on return big_number -- -- recomputed depreciation big_number big_number total decrease increase big_number big_number big_number petitioner's one-half share big_number big_number petitioners depreciation claimed on return big_number big_number videos expensed on return big_number recomputed depreciation big_number big_number total decrease sdollar_figure a reasonable depreciation deduction is allowed for the exhaustion and wear_and_tear of property used in a trade_or_business see sec_167 under sec_167 and sec_168 movie videos are to be depreciated for federal_income_tax purposes using a straight-line method see revrul_89_62 1989_1_cb_78 petitioner argues that for and respectively of the above adjustments made by respondent respondent incorrectly classified dollar_figure for the partnership and dollar_figure for petitioners as costs of videos as not currently deductible and as subject_to straight-line_depreciation petitioners claim that such funds related to the cost of supplies for the stores and were properly expensed by the partnership and by petitioners no evidence supports petitioners’ contention we sustain respondent’s adjustments to current expenses and to depreciation claimed relating to videos rented to customers repair and maintenance_expenses on their and joint federal_income_tax returns petitioners claimed current business_expenses of dollar_figure dollar_figure and dollar_figure respectively relating to repair and maintenance work on petitioners' rental properties on audit respondent disallowed dollar_figure dollar_figure and dollar_figure for and respectively of the claimed repair and maintenance_expenses petitioners presented no evidence to dispute respondent's adjustments for repair expenses we sustain respondent's adjustments for each year see rule a summary of adjustments based on the above findings and conclusions relating to disputed issues on petitioners’ concession of adjustments and certain mechanical adjustments we set forth below in schedule format the total adjustments that are to be made to petitioners’ reported income expenses and taxable_income partnership adjustments - contested by petitioners store sec_4 and unexplained bank_deposits depreciation_recapture on store depreciation of videos total adjustments to partnership income petitioner's one-half interest in total partnership adjustments individual adjustments contested by petitioners unexplained bank_deposits rental income depreciation of videos repair and maintenance_expenses conceded by petitioners or mechanical adjustments state tax_refund rental interest_paid rental depreciation capital_gains losses self-employment_tax deduction itemized_deductions exemption adjustment corrected individual adjustments before partnership adjustments total combined individual adjustments to taxable_income and to petitioner's one-half interest in total partnership income adjustments dollar_figure big_number dollar_figure dollar_figure_79 dollar_figure big_number big_number big_number dollar_figure dollar_figure_82 fraud and penalties accuracy- related penalty and additions to tax dollar_figure dollar_figure big_number big_number dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure big_number sdollar_figure big_number big_number big_number big_number big_number big_number big_number big_number dollar_figure big_number dollar_figure dollar_figure for and petitioners untimely filed their joint federal_income_tax returns petitioners reported on their and joint federal_income_tax returns the following taxable_income year --oq- dollar_figure reported taxable_income -q- for respondent determined that petitioner is liable for fraud and that the fraud is attributable to the taxable_income relating to the unexplained bank_deposits and the reimbursements for leasehold improvements for respondent determined that petitioner is liable for fraud and that the fraud is attributable to the taxable_income relating to the unexplained bank_deposits the reimbursements for leasehold improvements and the dollar_figure of claimed depreciation expense for the years in issue under sec_6663 a penalty of percent applies to the portion of an understatement_of_tax that is attributable to fraud to establish fraud respondent is required to prove that the understatement is due to fraudulent intent see sec_7454 rule b 959_f2d_16 2d cir affg 96_tc_858 respondent has the burden of proving fraud by clear_and_convincing evidence see sec_7454 rule b 102_tc_596 where allegations of fraud are intertwined with unreported and indirectly reconstructed income respondent is required to establish a likely taxable source for alleged unreported income or to disprove nontaxable sources alleged by the taxpayer see dilbeo v commissioner t c pincite 94_tc_654 indicia of fraud include understatements of income inadeguate books_and_records lack of cooperation with tax authorities and implausible or inconsistent explanations of behavior see 796_f2d_303 9th cir affg tcmemo_1984_601 102_tc_632 92_tc_661 91_tc_874 with regard to the fraud alleged by respondent for and the evidence establishes that petitioner failed to maintain adequate books_and_records with regard to income and expenses of the stores that petitioner received significant taxable_income not reported on petitioners’ joint federal_income_tax returns and that significant understatements of tax were made on petitioners’ federal_income_tax returns we conclude that for and respondent has established by clear_and_convincing evidence that petitioner fraudulently intended to evade his correct federal_income_tax liabilities for and we conclude that the increases to petitioner's taxable_income that we have sustained herein and that relate to unexplained bank_deposits are attributable to fraud for purposes of the fraud penalties none of the other adjustments that we sustain herein are attributable to fraud with regard to the sec_6662 20-percent accuracy-related_penalty that respondent determined for such penalty applies where and to the extent that understatements of tax are attributable to negligence respondent asserts that this penalty applies to the adjustments for depreciation_recapture and depreciation taxpayers are required to maintain adequate_records and failure to do so may constitute negligence and a disregard of rules or regulations see sec_6001 see also nehus v commissioner tcmemo_1994_631 affd without published opinion 108_f3d_338 9th cir 40_tc_30 bard v commissioner tcmemo_1990_431 taxpayers bear the burden_of_proof with regard to this issue see rule a for the failure of petitioner to maintain adequate_records constitutes negligence we sustain respondent's determination of the accuracy-related_penalty with respect to the adjustments for depreciation_recapture and depreciation for the years in issue sec_6651 provides for an addition_to_tax for failure to timely file federal_income_tax returns the addition_to_tax equal sec_5 percent of the amount_required_to_be_shown_as_tax on the return for every month the return has not been filed but not exceeding percent this addition_to_tax will not be imposed if it is established that the late filing was due to reasonable_cause and not due to willful neglect we sustain respondent's determination of the additions to tax for failure to timely file to reflect the foregoing decision will be entered under rule


office_of_chief_counsel internal_revenue_service memorandum number release date cc pa cbs b01 rmferguson postf-146510-05 uilc date date to sb_se associate area_counsel long island cc sb li attn donald glasel from acting chief branch collection bankruptcy summonses cc pa cbs br1 subject effect of sec_6324a special_estate_tax_lien on sec_6324 estate_tax lien this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views issue whether the recording of the special_estate_tax_lien for deferred taxes pursuant to sec_6324a automatically divests all assets comprising the gross_estate from the sec_6324 estate_tax lien conclusion the recording of the sec_6324a lien divests the sec_6324 lien only with respect to the property designated on the sec_6324a lien agreement it does not divest the remainder of the gross_estate property from the sec_6324 lien facts you have provided the following hypothetical factual scenario postf-146510-05 the decedent died owning the following property principal_residence with fair_market_value of dollar_figure marketable_securities with fair_market_value of dollar_figure closely-held real_estate management_corporation with fair_market_value of dollar_figure the only clients are other closely-held corporations and three closely-held corporations each holding dollar_figure in real_estate equity with shares valued on the form_706 estate_tax_return at dollar_figure each the decedent’s sole heir is his son executor the estate_tax liability shown on the return is dollar_figure payment of dollar_figure of this amount is deferred pursuant to election under sec_6166 for purposes of the sec_6166 election the amount of deferred estate_tax plus four years of interest payments totals dollar_figure each of the underlying parcels of real_estate is encumbered by a mortgage which states that the mortgagor will be in default if a lien is filed on the aforementioned real_estate the estate cites that provision for its refusal to designate real_property as security for the sec_6324a lien required as a condition of granting the sec_6166 election and instead offers dollar_figure of shares from two of the closely-held companies as security if these shares meet the requirements of sec_6324a and are designated on the sec_6324a lien agreement as sec_6166 lien property you ask whether this extinguishes the sec_6324 lien on all of the property of the gross_estate described above or just divests the sec_6324 lien from the shares in other words in the event of a default on the sec_6324a lien agreement if the sec_6166 lien property value is insufficient to satisfy the amount of remaining deferred liability is the remaining gross_estate property still secured_by the sec_6324 general estate_tax lien law and analysis sec_6324 provides that unless the estate_tax imposed by chapter is paid in full or becomes unenforceable by reason of lapse of time it shall be a lien upon the gross_estate of the decedent for ten years from the date of death except for the part of such gross_estate used for the payment of charges against the estate and expenses of administration allowed by the court shall be divested of such lien sec_6324 provides generally for divestment of the sec_6324 lien from property included in the gross_estate pursuant to sec_2034 through commonly known as nonprobate property upon certain transfers of such property sec_6324 generally provides for the continuation of the sec_6324 lien even after discharge of the fiduciary under sec_2204 except with respect to certain parts of the gross_estate transferred to a purchaser or security_interest holder in other words the discharge of a fiduciary from personal liability does not in and of itself effect the existence of the sec_6324 lien these are the only provisions in sec_6324 which address divestment of the sec_6324 lien postf-146510-05 sec_6166 allows an estate to elect to defer payment of tax attributable to interests in a closely_held_business essentially estates entitled to elect deferral under sec_6166 can defer payment of tax for five years and pay the balance of interest and tax due in installments over the next ten years the service requires security as a prerequisite to granting a sec_6166 election see sec_6166 such security can take the form of a bond pursuant to sec_6165 in the alternative the estate can elect to subject property to a lien under sec_6324a sec_6324a provides generally that where an estate has made an election under sec_6166 and filed the agreement referred to in sec_6324a the deferred_amount plus any interest additional_amount addition_to_tax assessable penalty and costs attributable to that amount shall be a lien on the property designated in the lien agreement lien property sec_6324a defines sec_6166 lien property to include any interests in real or other_property that are designated in the lien agreement and are expected to survive the deferral_period sec_6324a provides that the maximum value the service can require for sec_6166 lien property is a value not greater than the sum of the deferred_amount and required_interest_amount there is no requirement that sec_6166 lien property be property included in the gross_estate and subject_to the sec_6324 lien sec_20_6324a-1 6324a-1 b sec_6324a requires a written_agreement signed by every person in being who has an interest in the sec_6166 lien property consenting to the lien’s creation sec_6324a provides that the sec_6324a lien arises at the earlier of the date the lien agreement is filed or when the executor is discharged from liability under sec_2204 sec_2204 provides that an executor upon payment of any nondeferred amount due and upon furnishing a bond for amounts deferred under sec_6166 is discharged from personal liability sec_2204 provides that a bond for this purpose includes a sec_6324a lien agreement with respect to the amount for which the time for payment has been extended under sec_6166 sec_6324a provides if there is a lien under this section on any property with respect to any estate there shall not be a lien under sec_6324 on such property with respect to the same estate emphasis added see also sec_20_6324a-1 6324a-1 e the quoted language is the focus of your inquiry as to what specific property is divested from the sec_6324 lien upon creation of a sec_6324a lien our position based upon the plain language of this provision is that the such property language refers to the property subject_to the sec_6324a lien in other words the sec_6324a lien displaces the sec_6324 lien only with respect to the sec_6166 postf-146510-05 lien property further support for this position is found in the legislative_history for the tax reform act of p l the joint_committee explanation states that the sec_6324a lien is in lieu of the regular estate_tax lien under sec_6324 as to the property subject_to the special lien emphasis added p l section this issue has never been directly addressed by any court in in re roth 301_br_451 bankr w d pa aff’d u s t c big_number w d pa we argued on appeal to the district_court that a sec_6324a lien on shares of stock displaced the sec_6324 lien only with respect to those shares of stock the court held that it need not reach this issue however as the other assets the service was seeking to collect were not assets of the gross_estate ever subject_to the sec_6324 lien see also noble v soler u s t c big_number s d ohio court does not reach issue of extent of displacement of sec_6324 lien because sec_6324a lien agreement was never filed in a bankruptcy case involving sec_6324b which makes the language of sec_6324a applicable pursuant to sec_6324b the court again does not directly address this issue but notes that m oreover any property against which a sec_6324b lien is filed is divested of the sec_6324 lien regardless of whether the property was sec_2034 to property 82_br_1013 bankr d neb as demonstrated by the facts of your hypothetical payment of the entire estate_tax imposed by sec_2001 is not necessarily deferred see sec_6166 thus a portion of the estate_tax may be immediately due and owing if the filing of the sec_6324a lien did entirely extinguish the sec_6324 lien cases would arise in which the deferred_amount would be fully secured_by the sec_6324a lien but the nondeferred amount already due would be unsecured it is unlikely that congress intended this result we also do not believe congress intended a construction of sec_6324a in which the extent the service’s interest is secured would differ significantly depending upon whether the property designated as sec_6166 lien property was property of the gross_estate subject_to the sec_6324 lien or was other_property as previously discussed nothing in sec_6324a requires property designated as sec_6166 lien the language of sec_2204 previously discussed pertaining to an executor’s discharge from personal liability is similarly circumscribed to provide a discharge only with respect to amounts deferred under sec_6166 not a general discharge with respect to the entire estate_tax liability even if the filing of a sec_6324a lien did have an effect of a general discharge under sec_2204 however the language of sec_6324 makes it clear that this would not in itself effect the sec_6324 lien postf-146510-05 property to be property of the gross_estate and the regulations specifically provide that sec_6166 lien property need not be property of the gross_estate if the filing of the sec_6324a lien did entirely extinguish the sec_6324 lien under the facts of your hypothetical the service’s security_interest would only extend to the shares designated a sec_6166 lien property if the estate had designated non-estate property of the same type and value a sec_6166 lien property however under the language of sec_6324a the service’s security_interest would also include a sec_6324 lien on all gross_estate property accordingly our position is that under the facts of your hypothetical in the event of a default on the sec_6324a lien agreement if the value of the shares designated as sec_6166 lien property becomes insufficient to fully satisfy the unpaid estate_tax liability collection action may be taken against the remaining gross_estate property which is still subject_to the sec_6324 lien please call if you have any further questions


t c memo united_states tax_court von euw l j nunes trucking inc petitioner v commissioner of internal revenue respondent docket no filed date lawrence t ullmann for petitioner peter c rock for respondent memorandum findings_of_fact and opinion vasquez judge respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax for the taxable_year ending date taxable_year the issue for decision is whether respondent abused his discretion by requiring petitioner to change its method_of_accounting from the cash - - receipts and disbursements method cash_method to the accrual_method findings_of_fact the parties submitted this case fully stipulated pursuant to rule the stipulation of facts and the attached exhibits are incorporated herein by reference at the time the petition was filed petitioner’s principal_place_of_business was in fremont california petitioner a california corporation acquires and transports sand and gravel for its customers various contractors and developers operating in northern and central california petitioner’s customers use the sand and gravel to construct foundations for streets houses and buildings construction projects most of petitioner’s customers depend on petitioner to both acguire and transport the sand and gravel from storage sites to the customers’ construction sites some of petitioner’s customers own or acquire the sand and gravel necessary to complete their construction projects without petitioner’s ' in the notice_of_deficiency respondent reduced petitioner’s depreciation truck and advertising promotion deductions by dollar_figure which petitioner does not contest in its petition all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure the phrase sand and gravel refers to both sand and gravel and sand or gravel assistance these customers hire petitioner only for its transportation services ’ usually a customer contacts petitioner to order sand and gravel measured by weight in tons day before the sand and gravel are needed at the construction site the order date on the order date petitioner informs the customer of petitioner’s total charge for acquiring and transporting the sand and gravel contract amount petitioner calculates the contract amount by multiplying petitioner’s charge for acquiring and transporting ton of sand and gravel times the number of tons of sand and gravel ordered by the customer petitioner’s charge for acquiring and transporting ton of sand and gravel consists of four amounts petitioner’s costs in acquiring the sand and gravel petitioner’s profit for acquiring the sand and gravel approximately to percent of petitioner’s costs in acquiring the sand and gravel petitioner’s costs in transporting the sand and gravel from the storage site to the construction site and petitioner’s related profit for transporting the sand and gravel and a sales_tax levied on amounts through petitioner however does not provide the customer an itemized description of the separate amounts constituting the the record does not reflect what revenues and expenses relate to customers using petitioner solely for transportation services - contract amount if a customer requests only that petitioner transport the sand and gravel petitioner charges the customer petitioner’s costs for transporting the sand and gravel and petitioner’s related profit for transporting the sand and gravel petitioner acquires the sand and gravel from various suppliers during petitioner’s taxable_year different entities suppliers provided petitioner with percent evaluated by weight in tons of its sand and gravel needs while the unimin corp unimin supplied petitioner with the remaining percent unimin processes and sells a high grade of sand used primarily in the production of wine bottles processing this high grade of sand produces a byproduct consisting of water anda lower grade of sand known as byron sand after the water is removed from the byproduct the byron sand can be used by petitioner’s customers because petitioner must provide and maintain all the equipment and personnel necessary to filter gather and remove the byron sand from unimin’s processing plant unimin charges petitioner a lower amount than what the suppliers charge for the same grade of sand when petitioner computes the cost to acquire ton of the byron sand petitioner includes its costs in filtering gathering and removing the byron sand from unimin’s processing plant as well as the amount that unimin charges petitioner for the byron sand petitioner owns hauling trucks which it uses to transport the sand and gravel if petitioner’s customers order amounts of sand and gravel exceeding petitioner’s transportation capabilities petitioner hires third parties to meet customer demand on the delivery date petitioner’s employees travel to the supplier’s storage site load the sand and gravel purchased onto petitioner’s trucks and transport the sand and gravel to the customer’s construction site as to the byron sand once petitioner’s employees load it onto petitioner’s trucks and unimin creates a weighmaster certificate unimin considers the byron sand to be petitioner’s property because petitioner acquires and delivers the sand and gravel to its customers during the same business_day petitioner does not possess any sand and gravel at the beginning or end of its business_day on petitioner’s federal corporate_income_tax return tax_return petitioner described its business activity as sales and its product as construction materials petitioner maintained its books_and_records on the accrual_method of accounting and reported its income for federal tax purposes on the cash_method on its tax_return petitioner reported gross_receipts of dollar_figure and cost_of_goods_sold of petitioner’s employees perform similar tasks for customers who only request petitioner to transport and not acquire sand and gravel - - dollar_figure in computing its cost_of_goods_sold petitioner reported dollar_figure of purchases dollar_figure of cost of labor and no beginning or ending inventories in addition to its cost_of_goods_sold petitioner separately deducted its expenses related to the filtering gathering and removing of the byron sand at the unimin processing plant as of date petitioner had accounts_receivable of dollar_figure and accounts_payable of dollar_figure in the notice_of_deficiency respondent determined that petitioner’s use of the cash_method_of_accounting did not clearly reflect income respondent therefore changed petitioner’s method_of_accounting to the accrual_method further with regard to the change in accounting_method and petitioner’s concessions respondent made a sec_481 adjustment and determined a deficiency of dollar_figure in petitioner’s tax_liability for its taxable_year opinion the principal issue for decision is whether respondent abused his discretion by requiring petitioner to change from the cash_method to the accrual_method of accounting subsumed in this issue is the question of whether petitioner should be required to use inventories for tax purposes - under sec_446 the commissioner has broad powers to determine whether an accounting_method used by a taxpayer clearly reflects income see 360_us_446 104_tc_367 courts do not interfere with the commissioner’s determination under sec_446 unless it is clearly unlawful see 439_us_522 586_f2d_747 9th cir affg 64_tc_1091 ansley-sheppard-burgess co supra pincite whether respondent abused his discretion is a question of sec_446 provides in pertinent part a general_rule ----taxable income shall be computed under the method_of_accounting on the basis of which the taxpayer regularly computes his income in keeping his books b exceptions --if no method_of_accounting has been regularly used by the taxpayer or if the method used does not clearly reflect income the computation of taxable_income shall be made under such method as in the opinion of the secretary does clearly reflect income c permissible methods ----subject to the provisions of subsections a and b a taxpayer may compute taxable_income under any of the following methods of accounting-- the cash_receipts_and_disbursements_method an accrual_method any other method permitted by this chapter or any combination of the foregoing methods permitted under regulations prescribed by the secretary --- - fact see ansley-sheppard-burgess co v commissioner supra pincite 102_tc_87 affd 71_f3d_209 6th cir the reviewing court's task is not to determine whether in its own opinion the taxpayer's method_of_accounting clearly reflects income but to determine whether there is an adequate basis in law for the commissioner's conclusion that it does not see ansley-sheppard-burgess co v commissioner supra pincite consequently to prevail a taxpayer must prove that the commissioner’s determination is arbitrary capricious or without sound basis in fact or law see ansley- sheppard-burgess co v commissioner supra pincite ford motor co supra pincite to resolve this dispute we consider sec_446 and sec_471 and the regulations thereunder under sec_446 a taxpayer computes taxable_income based on the method_of_accounting utilized by the taxpayer in keeping its books sec_446 describes the various accounting methods that a taxpayer may use in computing taxable_income including the cash and accrual methods sec_1_446-1 income_tax regs provides that a taxpayer who is required to use inventories must also use the accrual_method of accounting with regard to purchases and sales under sec_471 and sec_1_471-1 income_tax regs a taxpayer must account for inventories if the production purchase or sale of merchandise is an income-producing factor in --- - the taxpayer’s business and the taxpayer has acquired title to the merchandise we consider the facts and circumstances of each case in deciding whether material is merchandise that is an income- producing factor see honeywell inc v commissioner tcmemo_1992_453 affd without published opinion 27_f3d_571 8th cir wilkinson-beane inc v commissioner tcmemo_1969_79 affd 420_f2d_352 1st cir although not specifically defined in the internal_revenue_code or the regulations courts have ruled that merchandise as used in sec_1_471-1 income_tax regs is an item acquired and held_for_sale see eg wilkinson-beane inc v commissioner supra respondent contends that because the sand and gravel is merchandise which is an income-producing factor in petitioner’s business petitioner must account for inventories and report its taxable_income under the accrual_method of accounting petitioner broadly argues that it does not have to account for inventories under sec_471 and sec_1_471-1 income_tax regs because its business consists of procuring and delivering not acquiring and holding sand and gravel for sale to customers therefore the sand and gravel should not be considered merchandise and even if the sand and gravel is considered merchandise the procurement of the sand and gravel is -- - not an income-producing factor in petitioner’s business petitioner makes several arguments regarding why the sand and gravel should not be considered merchandise ie items acquired and held_for_sale on brief petitioner positions itself as a service provider rather than as a seller of goods petitioner argues that to perform its primary business activity of delivering sand and gravel petitioner merely accommodates its customers by also procuring sand and gravel further petitioner asserts that because it does not have any sand and gravel on hand at the beginning or end of the business_day due to the fact that on the same day it procures and delivers the exact amount of sand and gravel requested by its customers it does not hold the sand and gravel for sale petitioner also argues that it does not mark up the cost of the sand and gravel and that it makes the same profit whether it procures and delivers the requested sand and gravel or simply delivers the sand and gravel which the customer already owns or has purchased separately ’ we reject petitioner’s contentions when petitioner transports the sand and gravel that a customer already owns or has acquired petitioner does not realize the profit associated with acquiring sand and gravel for a customer based on the ’ petitioner argues that because it designates the profit it earns on the procurement of sand and gravel as a separate element of its charge for acquiring and transporting ton of sand and gravel petitioner does not mark up the sand and gravel record petitioner generates more profits if it both acquires and transports sand and gravel for its customer rather than solely acting as a transporter further although not labeled by petitioner as a markup in its business records petitioner’s profit for acquiring the sand and gravel is nevertheless a markup since in substance the profit is based on a percentage of the underlying cost of the sand and gravel furthermore petitioner on its tax_return listed its business activity as the selling of construction materials in racmp enters inc v commissioner t1t c we recently held that respondent abused his discretion in placing a construction contractor on the accrual_method for federal_income_tax purposes in that case we concluded that the material provided by the contractor to its customer pursuant to a construction_contract for concrete foundations driveways and walkways was not merchandise within the meaning of sec_1_471-1 income_tax regs see id in reaching that conclusion we viewed the construction_contract as a service_contract finding that the materials were indispensable to and inseparable from the provision of that service and that the materials lost their separate identity during the construction activity see id see also 113_tc_376 wherein drugs used as part of chemotherapy treatments were not considered merchandise because their use was an indispensable and inseparable part of the rendering of services this is not such a case petitioner primarily sells a product the sand and gravel and incidentally provides a service the transportation of the sand and gravel because petitioner can generate profits from solely transporting the sand and gravel we do not view the sand and gravel as indispensable to and inseparable from the provision of a service further because petitioner does not consume alter or add to the sand and gravel petitioner does not cause the sand and gravel to lose its separate identity as the evidence shows that petitioner is a seller of sand and gravel we conclude that the sand and gravel is merchandise petitioner additionally argues that even if we conclude that the sand and gravel is merchandise petitioner does not have to maintain inventories because the sand and gravel is not an income-producing factor in petitioner’s business in evaluating whether merchandise is an income-producing factor in a taxpayer’s business we must compare the cost of the merchandise to the taxpayer’s gross_receipts computed under the cash_method of sdollar_figurewith regard to revenues and expenses generated as a result of customers requesting only transportation services petitioner has not argued in the alternative that they should be placed on a hybrid method_of_accounting in any respect petitioner has not presented any evidence with regard to those revenues and expenses and therefore it cannot meet its burden_of_proof accounting see wilkinson-beane inc v commissioner supra in wilkinson-beane inc we held that merchandise the cost of which in different taxable years constituted percent and percent of the taxpayer’s gross_receipts was an income- producing factor in the taxpayer’s business see also 743_f2d_781 11th cir wherein newspapers the cost of which constituted percent of the taxpayer’s total revenues were considered an income-producing factor for its taxable_year petitioner reported cost_of_goods_sold in the amount of dollar_figure petitioner argues that dollar_figure of the dollar_figure amount relates to petitioner’s transportation activities thereby leaving dollar_figure for the cost associated with petitioner’s acquisition of the sand and gravel assuming arguendo that petitioner’s figures are correct because the cost of the sand and gravel constitutes at least percent of petitioner’s gross_receipts dollar_figure dollar_figure we conclude that the sand and gravel is an income-producing factor in petitioner’s business ’ on brief petitioner does not address whether it acquire sec_2 petitioner does not include in cost_of_goods_sold the costs involved in filtering gathering and removing the byron sand from unimin’s processing plant these costs would significantly increase the cost_of_goods_sold and the percentage that cost_of_goods_sold would constitute of petitioner’s gross_receipts title to the sand and gravel petitioner and respondent stipulate that after petitioner loads the byron sand onto its trucks for delivery and unimin creates a weighmaster certificate unimin considers the byron sand to be petitioner’s property we interpret that stipulation to mean that title to the byron sand passes from unimin to petitioner at that point in time the record does not reflect whether petitioner acquires title to the sand and gravel that petitioner purchases from the suppliers in addison distrib inc tcmemo_1998_289 we described a taxpayer as both a buyer pursuant to its contract with a vendor or subcontractor and as a seller pursuant to its contract with its customers citing california commercial code sec_2106 west which provides that a ‘sale’ consists in the passing of title from the seller to the buyer for a price we concluded that the taxpayer had acquired title to goods which were purchased from the vendor or subcontractor for eventual sale to the taxpayer’s customers see id in light of california commercial code sec_2106 our characterization of petitioner as a seller of sand and gravel and petitioner’s failure to dispute the transfer of title we see no reason to treat petitioner’s contractual and legal relationship with the suppliers differently from petitioner’s business dealings with unimin we therefore conclude that petitioner acquires title to the sand and gravel because we hold that the sand and gravel is merchandise which 1s an income-producing factor in petitioner’s business and that petitioner acquires title to the sand and gravel petitioner must maintain inventories pursuant to sec_1_446-1 income_tax regs petitioner would therefore have to report its taxable_income on the accrual_method of accounting unless an exception applies a taxpayer demonstrating a substantial identity of results between the taxpayer’s method_of_accounting and the method_of_accounting selected by the commissioner may compute taxable_income under its method_of_accounting see 420_f2d_352 lst cir affg tcmemo_1969_79 on brief petitioner concedes that it does not meet the substantial identity of results test we therefore hold that respondent did not abuse his discretion under sec_446 when respondent required petitioner to compute its taxable_income based on the accrual_method of accounting in reaching all our holdings herein we have considered all arguments made by the parties and to the extent not mentioned above we find them to be irrelevant or without merit to reflect the foregoing decision will be entered for respondent


internal_revenue_service department of the treasury number release date index numbers washington dc person to contact telephone number refer reply to cc te_ge eb hw-plr-117346-01 date key m n p q r date a date b date c x dollars y dollars dear this is in response to letters dated date and date requesting rulings concerning the transaction described below plr-117346-01 facts m is an organization described in sec_501 of the internal_revenue_code n is a wholly-owned subsidiary of m m’s membership includes businesses with employees and businesses without employees among other activities m sponsors trade shows and educational seminars for its members collects industry data and publishes survey results and provides assistance with government lobbying in addition through n m offers medical dental life_insurance and disability benefits coverage for purchase by m’s members p a business with one or more employees is a member of m participating in the health and life_insurance programs sponsored by m during the 1970's and 1980's m received payments of excess reserve funds from insurance_companies based on favorable claims experience with health and group term life_insurance the premiums to which the refunds related were premiums_paid over a number of years by all group members for the health and life coverage the experience rating for the refunds was on a group-wide basis on date a q was established by m to ensure that the excess reserve funds received and developed would be available for the benefit of the insured persons in m’s insurance programs and the members of m q is not exempt under sec_501 of the code q’s stated purpose is to provide group employee welfare_benefit programs that can benefit employees of members of m the trust document specifies that the trustee may use trust assets to fund the employee welfare_benefit programs for members of m through any one or a combination of the following insurance policies a wholly-owned insurance_company for the purpose of providing insurance for the benefit of the members a multiple_employer_welfare_arrangement or any other insurance or other arrangement authorized by state or federal_law which would benefit the members a member’s rights and interest in q terminate when the member doesn’t make the required contributions under the welfare_benefit programs or when it is no longer a member of m pursuant to the trust document no part of the q’s earnings may inure to the benefit of any member of m or any individual other than through payments to provide benefits q is administered by m acting through its board_of directors which includes members of various types and sizes as well as certain officers of m no particular employer is able to control q rather q is controlled by m for the benefit of those who are participating in m’s insurance programs q was initially funded with the excess reserve funds mentioned above as well as with an equity share distribution in connection with a life_insurance company’s conversion from a mutual company to a stock company the trust document contemplates that participating members will make contributions to q as provided under plr-117346-01 the employee welfare_benefit program maintained under q disbursements from q in the form of benefit or insurance premium payments and other expenses must be made only in accordance with the employee welfare_benefit program it is represented that neither post-retirement medical benefits nor post-retirement life_insurance benefits have been provided under any of q’s benefit programs and that all benefit obligations have been met it is further represented that neither m nor any of its members has ever contributed more than ten percent of the total contributions of all participating members under any of the benefit programs available to m’s members and at no time was coverage for any member experience-rated on an individual basis finally it is represented that q is and has always been part of a ten or more employer plan described in sec_419a of the code as of date b q had assets valued at approximately x dollars m as trustee of q has now authorized the transfer of y dollars from q to r it is represented that r is an organization described in sec_501 of the code rulings are requested that the transfer of funds from q to r will not result in the imposition of the excise_tax under sec_4976 of the code and the transfer will not result in taxable_income or unrelated_business_taxable_income to m to r or to p and other members of m you are not requesting a ruling on the issue of whether q satisfies the sec_419a exception for ten or more employer plans and we are not ruling on that issue rather in addressing the issue raised in request we are relying on the representation that q satisfies the sec_419a exception with respect to request your application indicates that you are not requesting a ruling on the issue of whether the transfer of funds from q to r will result in taxable_income to q and we are not ruling on that issue further as explained in a telephone conversation with your authorized representative we decline to rule on whether the transfer of funds from q to r will result in income to p and other members of m ruling sec_419 and sec_419a of the code provide rules with respect to the deductiblity of contributions paid_or_accrued by an employer to a welfare_benefit_fund sec_419 provides that for purposes of sec_419 the term welfare_benefit_fund means any fund that is part of a plan of an employer and through which the employer provides welfare benefits to employees or their beneficiaries the term welfare_benefit means any benefit other than a benefit with respect to which sec_83 sec_404 or sec_404a applies the term fund means any organization described in sec_501 or any trust corporation or other non- exempt_organization and to the extent provided in regulations any account held for an employer by any person plr-117346-01 sec_419a of the code provides that sec_419 and sec_419a shall not apply in the case of any welfare_benefit_fund which is part of a ten or more employer plan that does not maintain experience-rating arrangements with respect to individual employers the term ten or more employer plan means a plan to which more than one employer contributes and to which no employer normally contributes more than ten percent of the total contributions contributed under the plan by all employers sec_4976 of the code imposes an excise_tax on an employer equal to of any disqualified_benefit provided by an employer-maintained welfare_benefit_fund pursuant to sec_4976 and b the term disqualified_benefit includes certain post-retirement medical or life_insurance benefits sec_4976 provides that the term disqualified_benefit also includes any portion of a welfare_benefit_fund reverting to the benefit of the employer sec_4976 provides that paragraph c of sec_4976 shall not apply to any amount attributable to a contribution to a welfare_benefit_fund that is not allowable as a deduction under sec_419 for the taxable_year or any prior taxable_year we conclude that q is a fund that is part of a plan through which m’s employer- members provide welfare benefits to their employees accordingly q is a welfare_benefit_fund as that term is defined in sec_419 of the code additionally for purposes of sec_4976 we conclude that q is a welfare_benefit_fund maintained by p and the other participating employers because m maintains q on behalf of its member- employers sec_4976 of the code imposes a excise_tax on an employer if a disqualified_benefit is provided during the taxable_year sec_4976 through c describe disqualified_benefits the transfer of assets from q to r cannot be a disqualified_benefit under sec_4976 or b of the code since no post- retirement medical or life_insurance benefits are provided under q’s benefit programs further it is represented that q is part of a ten or more employer plan to which the exception provided by sec_419a applies based on that representation employer contributions to q were not allowable as a deduction under sec_419 for the taxable_year or any prior taxable_year within the meaning of sec_4976 thus pursuant to sec_4976 the transfer of funds is not a disqualified_benefit under sec_4976 accordingly we conclude that the transfer of funds from q to r is not a disqualified_benefit for purposes sec_4976 of the code and therefore will not result in the imposition of the excise_tax under that code section ruling sec_511 of the code generally imposes a tax on the unrelated_business_taxable_income of organizations described in sec_501 plr-117346-01 sec_512 of the code in general defines unrelated_business_taxable_income as the gross_income derived by an organization from any unrelated_trade_or_business regularly carried on by it less the allowable deductions directly connected with the carrying on of such trade_or_business sec_513 of the code in general defines unrelated_trade_or_business as any trade_or_business the conduct of which is not substantially related to the exercise or performance of the purpose or function constituting the basis for the organizations exemption we conclude that the transfer of funds from q to r is not income derived by m from any unrelated_trade_or_business regularly carried on by it we also conclude that the transfer of funds from q to r is not income derived by r from any unrelated_trade_or_business regularly carried on by it accordingly the transfer will not result in taxable_income to m or to r the rulings contained in this letter are based on 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 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 no opinion is expressed or implied herein concerning whether q is as represented a part of a ten-or-more employer plan that does not maintain experience rating arrangements with respect to individual employers additionally no opinion is expressed concerning the tax consequences to n or to q with respect to the proposed transaction or any past transactions further we express no opinion as to whether the proposed transaction will cause the status of r to be that of a private_foundation as defined in sec_509 of the code nor as to the tax consequences if any to any other parties if that is the result this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-117346-01 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely mark schwimmer senior technician reviewer division counsel associate chief_counsel tax exempt and government entities


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom p si - plr-107406-99 date date x a d1 year dear this letter responds to a letter dated date and subsequent correspondence submitted by x’s authorized representative on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code the information submitted states that x was incorporated on d1 a the president of x represents that x intended to be an s_corporation beginning from incorporation but x did not have any business operations or assets until year a also represents that x relied on its attorney to file a form_2553 election by a small_business_corporation the attorney failed to prepare or file a form_2553 and therefore no form_2553 was filed for x for year for year and all subsequent years x filed form_1120s u s income_tax return for an s_corporation and x’s shareholders filed form_1040 u s individual_income_tax_return consistent with the treatment of x as an s_corporation sec_1362 of the code provides that if -- a an election under sec_1362 is made for any taxable_year 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 b the secretary determines that there was reasonable_cause for the failure to timely make such election the secretary may treat such an election as timely made for such taxable_year based solely on the facts and the representations submitted we conclude that x has established reasonable_cause for failing to make a timely election to be an s_corporation for x’s year taxable_year accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 with the appropriate service_center effective for its year taxable_year within days following the date of this letter then such election will be treated as timely made for x’s year taxable_year a copy of this letter should be attached to the form_2553 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code including whether x was or is a small_business_corporation under sec_1361 of the code this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being forwarded to x’s authorized representative sincerely yours h grace kim assistant to the chief branch office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division number release date date date uil dear contact person identification_number contact number employer_identification_number form required to be filed tax years this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final since you do not qualify for exemption as an organization described in code sec_501 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions you should follow the instructions in notice if you agree with our deletions you do not need to take any further action letter cg catalog number 47632s in accordance with code sec_6104 we will notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter about your federal_income_tax status and responsibilities please contact irs customer service pincite-829-1040 or the irs customer service number for businesses the irs customer service number for people with hearing impairments is if you have any questions sincerely lois lerner director exempt_organizations enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter letter cg catalog number department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date date contact person identification_number contact number fax number employer_identification_number vil legend h business p state u date dear we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code code sec_501 based on the information provided we have concluded that you do not qualify for exemption under code sec_501 the basis for our conclusion is set forth below issue does your primary activity of operating an art gallery preclude you from exemption under sec_501 of the code yes for the reasons given below facts you are a corporation formed on date u pursuant to the laws of the state of p your articles of incorporation state that you shall be organized as a c and will operate for civic charitable and educational_purposes your articles also indicate that on dissolution assets will be distributed within the meaning of section c of the code you were formed when a group of local artists got together to form an organization to further education in the arts and to provide a venue for regional artists to display promote and sell their work you have four board members who are artists and sell their work through your gallery you provided a promotional brochure that advertises the following mission the h you is dedicated to furthering education in the arts and providing a venue for regional artists to display promote and sell their work the h you offers a supportive environment for regional p artists to share their ideas and philosophies as-well-as market their work as a cooperative gallery members share in the decision making and staffing of the gallery membership membership in the gallery is divided into three categories active associate and supporting members active and associate member artists display and sell their work at the gallery gallery during business hours patrons of the gallery show their support through the friends of the gallery program in addition active members volunteer their time to work in the services along with workshops and exhibitions the h you also offers custom framing and matting space within the gallery can be reserved for meetings and special events gallery hours thursday a m to p m friday a m to p m saturday a m to p m sunday a m to p m seasonal evening hours while your brochure describes three types of members in addition to your friends of supporters your bylaws differentiate three different members levels - artists representatives and supporting founding members are defined as any individual that joins prior to the gallery opening and pays a one-time membership fee of dollar_figure founding members have the jury process waived when displaying works artists are juried and can be either active associate on leave of absence inactive or suspended active members retain their status by fulfilling their contractual member agreement and volunteering to work at the gallery associate members are the same without the volunteering non voting members are your friends of supporters your bylaws initially outlined member dues and commissions as well as procedures for addressing guest artists and consignors you later revised your bylaws to remove these provisions your initial activity was to provide a gallery for artists to display and subsequently sell their work the gallery would have a featured artist on a monthly basis to showcase their work the displayed artworks were consigned to you for sale you performed all the sales activity and charged commission to active members and commission to non-members the sale price of artwork was set by the consignee and the commission was based on the sale price you also provided a custom framing and matting service to the public at market price which wa sec_5 of your activity free educational workshops consisted of of your total activity you submitted a member contract agreement that provided further details about the members' consignment operation some notables are as follows e you provide the artists with monthly statements that contain a description of the work sold date price and terms of sale the name of the purchasers commission paid to the gallery amount due to the artist e the artists do the set-up of the artworks and are given three days for the set up e the artist retains the right to conduct his her business in the usual manner but will not knowingly solicit business away from the gallery e the artists shall not knowingly solicit sales from clients on the gallery's mailing list e the gallery is due commission for a period of six months after customer first contacts an artist e you provide incentives to volunteer artists you also provided a non-member consignment agreement form when questioned abut the commercial nature of some activities you eliminated the commission and the custom framing and matting service in eliminating the commission you will allow of all sales proceeds to go to the artist commission you will ask for voluntary donations from the artists in lieu of imposing a you provided a new membership contract agreement which reflects your changes regarding commissions the new member agreement does not contain commission and consignment related items however it stipulates that an artist agree to pay a monthly donation of dollar_figure beginning the month the artist joins the gallery also artists who are contacted by patrons are encouraged to donate for a period of six months after that contact you had stated that there would just be contact information to get in touch with the artist displayed with their work and you would no longer be involved with managing money for the artists the member agreement states that you will take payment for any items and turn over to the artist as well as giving them a statement of account and taking payments you have indicated no changes to your gallery operations you proposed changes to your educational activities by adding more workshops and seminars you stated that these additional activities will not affect your budget since all instruction and workshop materials will be donated you do not have any fundraising activities currently you project revenue through donations from member artists and ‘friends of support as well as membership fees law sec_501 of the code provides for the exemption from federal_income_tax of corporations organized and operated exclusively for charitable or educational_purposes provided no part of the net_earnings inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations provides that in order to be exempt as an organization described in sec_501 an organization must be both organized and operated exclusively for one or more purposes specified in such section an organization fails to meet either the organizational_test or the operational_test it is not exempt if sec_1_501_c_3_-1 of the regulations states an organization may be exempt under c if it operates exclusively for educational_purposes sec_1_501_c_3_-1 of the regulations provides that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest to meet this requirement it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests revrul_71_395 1971_2_cb_228 found that a cooperative art gallery formed and operated by a group of artists for the purpose of exhibiting and selling their works does not qualify for exemption under sec_501 of the code because the organization served the private purposes of its members even though the exhibition and sale of painting may be an educational activity in other respects in revrul_76_152 1976_1_cb_151 the service found that a nonprofit organization formed by a group of art patrons to promote community understanding of modern art trends by selecting exhibiting and selling art works of local artists and which retained commission on sales less than customary commercial charges but insufficient to cover the cost of operating the gallery does not qualify for exemption under sec_501 of the code the ruling concluded that the direct benefits to artists cannot be dismissed as being merely incidental to other purpose and activities since ninety percent of all sales proceeds are turned over to the individual artists in 326_us_279 the supreme court held that the presence of a single non-exempt purpose if substantial in nature will destroy the exemption regardless of the number or importance of truly exempt purposes the court found that the trade_association had an underlying commercial motive that distinguished its educational program from that carried out by a university in 302_f2d_934 ct_cl the court considered an organization that provided analyses of securities and industries and of the economic climate in general it sold subscriptions to various periodicals and services providing advice for purchases of individual securities the court noted that education is a broad concept and assumed for the sake of argument that the organization had an educational purpose however the totality of the organization's activities which included the sale of many publications as well as the sale of advice for a fee to individuals was indicative of a business therefore the court held that the organization had a significant non-exempt commercial purpose that was not incidental to the educational purpose and was not entitled to be regarded as exempt in goldsboro art league inc petitioner v commissioner of internal revenue 75_tc_337 the court found that the corporation was entitled to exemption from federal taxation and entered a decision in its favor the corporation contended that it was operated exclusively for exempt purposes that the sale of artwork in its galleries was an incidental activity but one which helped it pursue its exempt purposes that it was not operated in furtherance of a substantial commercial purpose and that the primary purpose of its sales and other activities was to further the public's appreciation of art and not to serve private interests the commissioner argued that since the corporation's activities were indistinguishable from activities required in operating a commercial art gallery for profit the corporation was operated for a substantial commercial purpose and could not qualify for exemption under sec_501 of the code despite the presence of any number of truly exempt purposes the court found that the purpose of the corporation's art gallery and art market was primarily to foster community awareness and appreciation of contemporary artists and to provide a constant flow of art for students to study art and painting techniques the corporation's sales activities were incidental to its other activities and served the same overall objective of art education in salvation navy v commissioner tcmemo_2002_275 the tax_court found that one of the reasons why the organization did not qualify for exemption from federal_income_tax was because it could not prove that it was not organized to serve the private interests of its founder application of the law based on the information you provided in your application and supporting documentation we conclude that you are not operated for exempt purposes under sec_501 of the code you are organized for a substantial private purpose and to benefit your members through the sale of their artwork in addition you failed to provide an assurance that earnings will not inure to your members sec_1_501_c_3_-1 of the income_tax regulations provides that to be exempt an organization must be both organized and operated exclusively for purposes specified in such section you do not meet the organizational_test as your purposes are not limited to those allowable under c your articles of incorporation state that in part you are formed to operate for civic purposes civic is not an exclusive purpose under c further your dissolution clause is invalid as it indicates rather then is not a valid code _section you fail to meet the operational_test because you are not operated for an exclusive c purpose but for the private purpose of your members while promotion of the arts is an accepted exempt_purpose you were not formed solely for this reason even though you do conduct some classes and workshops the majority of your time is spent on the operation of the gallery you educational activities took only of your total time while you have added some more workshops your primary activity still remains that of operating the gallery you were formed for and engage in the substantial non-exempt activity of perpetuating sales of art works for your members sec_1_501_c_3_-1 of the regulations provide that an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest your member agreement clause eight indicates that the artist is responsible for the cost of show materials when they become a featured artist this featured artist segment which places exhibit details and invitation selection with the artist demonstrates private benefit rather then community art education in allowing an individual to openly promote and display and potentially sell works of their choice because you operate for the private interests of your members in providing a space and a means for artwork to be viewed and sold rather then promoting the arts in general you are not serving public purposes and do not qualify in better business bureau of washington d c inc v united_states the supreme court held that the presence of a single non-exempt purpose if substantial in nature will destroy the exemption regardless of the number or importance of truly exempt purposes you devote more than substantial amount of time and activities in supporting the sale of artworks displayed by your members and for this reason do not meet the qualifications under c sec_1_501_c_3_-1 of the regulations provide in part that the term educational relates to the instruction of the public on subjects useful to the individual and beneficial to the community the educational aspect of an art exhibition cannot overcome the commerciality of the exhibition and the private benefits to your members because your main purpose is to sell art works to benefit your members as a cooperative therefore the educational impact of the exhibitions is merely incidental to your non-exempt activity selling artworks for your members revrul_71_395 found that a cooperative art gallery formed and operated by a group of artists for the purpose of exhibiting and selling their works does not qualify for exemption under sec_501 in your brochure you advertise the h you offers a supportive environment for regional o artists to share their ideas and philosophies as-well-as market their work as a cooperative gallery members share in the decision making and staffing of the gallery you made a change that you will not charge commissions anymore however you will ask voluntary donations which are merely a different form of compensation you do not have any other fundraising activities to support the operation of the gallery - members will be responsible for sustaining your operations your operation directly competes with other commercial art galleries you are solely dependant on the member contributions and you are a cooperative that runs an artwork sale business for the benefit of the members you define yourself as a marketer and a cooperative of local artists thus you are operated for your members benefit not the general_public the court in american institute for economic research v united_states above applied an even more stringent interpretation the court held that an educational_organization was not entitled to the exemption because it conducted the sale of many publications as well as the sale of advice for a fee to individuals you are similar to this organization in terms of running a business and having an educational component in your activity in your case the products are artwork exhibitions and seminars your main purpose and operation is running a cooperative art gallery to benefit your artist members you are different from the organization in goldsboro art league inc unlike this organization the sale of artwork is a substantial portion of your activities in addition all artists that display and sell art works are your members finally your educational activities account for only a small component of your overall activities rather then serving an educational purpose through art appreciation you were established to aid in members selling art work whereas in goldsboro the sales activities were incidental to educational activities here the opposite is true your educational activities are incidental to your overall purpose of providing a venue for artists to display promote and sell work in revrul_76_152 a gallery that retained of sales and turned over the remainder to the artist was held to not be exempt direct benefits to artists in this case could not be dismissed as being merely incidental to any other qualifying purposes here you will turn of proceeds over to the artist the artist has control_over selecting works setting prices and even in the case of being a featured artist inviting patrons to and advertising for a select exhibit of their works any qualifying activities that may be conducted such as workshops and classes are incidental to your purpose of promoting and selling works_of_art for your member artists as these direct benefits cannot be overlooked much as in the ruling you do not qualify for exemption furthermore since the individuals who will be selling and retaining any proceeds are members they are also insiders as insiders any direct benefit derived through your operations is inurement as seen in salvation navy v commissioner when an organization is formed to benefit insiders it does not qualify for exemption conclusion based on the facts and information submitted you are not operated exclusively for exempt purposes you are indistinguishable from a commercial gallery that sells artworks to the public you serve the private interests of your members in more than an insubstantial degree in addition you have not established that your net_earnings will not inure to the benefit of private shareholders or individuals thus you do not qualify for exemption as an organization described in sec_501 of the code you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination if your statement does not provide a basis to reconsider our determination we will forward your case to our appeals_office you can find more information about the role of the appeals_office in publication exempt_organization appeal procedures for unagreed issues types of information that should be included in your appeal can be found on page of publication under the heading regional_office appeal’ must be accompanied by the following declaration the statement of facts item under penalties of perjury declare that have examined the statement of facts presented in this appeal and in any accompanying schedules and statements and to the best of my knowledge and belief they are true correct and complete the declaration must be signed by an officer or trustee of the organization who has personal knowledge of the facts your appeal will be considered incomplete without this statement if an organization’s representative submits the appeal a substitute declaration must be included stating that the representative prepared the appeal and accompanying documents and whether the representative knows personally that the statements of facts contained in the appeal and accompanying documents are true and correct an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you during the appeal process if you want representation during the appeal process you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not already done so you can find more information about representation in publication practice before the irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to appeal as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do not need to take any further action if we do not hear from you within days we will issue a final adverse determination_letter that letter will provide information about filing tax returns and other matters please send your protest statement form_2848 and any supporting documents to the applicable address mail to deliver to internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance main street room cincinnati oh you may fax your statement using the fax number shown in the heading of this letter you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely lois lerner director exempt_organizations enclosure publication