internal_revenue_service number release date index number -------------------- ---------------------------------------- ------------------------------- legend trust 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 b07 plr-139967-06 date date --------------------------------------------------------------------------------------------------- ----------------------- -------- ------------------------------------------------ state grantor --------------------- date ---------------- court date ------------------ child -------------------------- date ----------------------- child --------------------------------- date ------------------ date ----------------------- date --------------------------- statute ------------------------------------------------------------------------------------- dear ----- correspondence requesting income gift and generation-skipping_transfer gst tax rulings with respect to the proposed conversion of trust to a total_return_trust under state law on date at the request of the trustees court divided the irrevocable_trust into four separate trusts on date trust is one of the four trusts created by the date court this letter responds to your letter dated date and subsequent the facts and representations are as follows grantor created an irrevocable_trust under the terms of the original trust agreement and the date court order after under the terms of the original trust agreement and the date court order trust plr-139967-06 order and is held for the benefit of child and his descendants at the request of the trustees court modified the trustee succession provisions with respect to trust on date date date and date are before date no additions actual or constructive have been made to trust since date trust is governed by state law child 1’s death child may direct the payment of up to one-third of the net_income in his last will and testament to his surviving_spouse the balance of the net_income or all of the net_income if none becomes payable to a surviving_spouse shall be paid to child 1’s issue from time to time surviving per stirpes child may by will change the proportion in which his issue shall share in the net_income by exercise of a limited_power_of_appointment if child dies without issue before the termination of trust the trust assets shall be added to the shares of the remaining children in the same proportion that such shares bear to each other shall continue until twenty years after the death of the last surviving of eight named individuals child was the last surviving named individual child died on date upon termination of trust the trust estate shall be paid to the person s then in receipt of the income if a spouse is currently receiving income a share of trust necessary to produce such income shall continue to be held in trust during the spouse’s life but the person s who would have received the income shall immediately have a vested interest in the principal withheld the trustees may choose to purchase an annuity for the spouse and make immediate distribution of the entire trust estate child exercised his right to change the percentage of net_income paid to his issue but did not direct payment of any net_income to a surviving_spouse trust income is currently distributed in accordance with the percentages set out in child 1’s will state statute permits a court to convert a_trust to a total_return_trust or unitrust if the court determines that the conversion will enable the trustee to better carry out the purposes of the trust and that the conversion is in the best interests of the beneficiaries statute provides that following conversion of a_trust to a total_return_trust income in the governing instrument means an annual amount equal to a percentage of the net fair_market_value of the total trust assets averaged over a three-year period finally statute provides that a court has the power to determine the percentage of the total value of the trust assets to be distributed from a total_return_trust trust to a total_return_trust under statute and that court approve a distribution the trustees have filed a complaint in court requesting that the court convert child died on date under article three of his will executed on date sec_2511 provides that the tax imposed by sec_2501 applies whether the sec_2501 of the internal_revenue_code imposes a tax on the transfer of plr-139967-06 percentage from trust after the conversion the complaint further requests the court declare that on termination the trust assets will be distributed to the persons then in receipt of a portion of the unitrust_amount in the same proportions as the unitrust_amount is then being paid after the conversion the unitrust_amount will be divided among the beneficiaries as directed in child 1’s will the trustees have requested rulings that the proposed conversion of trust to a total_return_trust will not cause trust to lose its status as exempt from the gst tax will not cause any beneficiary to have made a gift_for gift_tax purposes and will not cause trust or any beneficiary to realize capital_gain from an exchange of a_trust interest for income_tax purposes ruling sec_1 and property by gift by an individual transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible the date of the gift shall be considered the amount_of_the_gift distribution a taxable_termination and a direct_skip under b a of the tax_reform_act_of_1986 and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the generation-skipping_transfer_tax provisions do not apply to any generation-skipping_transfer under a_trust as defined in sec_2652 that was irrevocable on date however this exemption does not apply if additions actual or constructive are made to the trust after date regulations provides that any trust in existence on date will be considered an irrevocable_trust except as provided in sec_26_2601-1 or c which relate to property includible in a grantor’s gross_estate under sec_2038 and sec_2042 judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the generation-skipping_transfer_tax under sec_26_2601-1 or sec_2512 provides that if a gift is made in property the value thereof at sec_2611 defines the term generation-skipping_transfer as a taxable sec_26_2601-1 provides rules for determining when a modification sec_26_2601-1 of the generation-skipping_transfer_tax sec_2601 imposes a tax on every generation-skipping_transfer sec_26_2601-1 provides that a modification of the governing plr-139967-06 hereinafter referred to as an exempt trust will not cause the trust to lose its exempt status in general unless specifically provided otherwise the rules contained in sec_26_2601-1 are applicable only for purposes of determining whether an exempt trust retains its exempt status for generation-skipping_transfer_tax purposes unless specifically noted the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of gain for purposes of sec_1001 instrument of an exempt trust including a trustee distribution settlement or construction that does not satisfy sec_26_2601-1 b or c by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject_to the provisions of chapter if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a gst transfer or the creation of a new gst transfer to determine whether a modification of an irrevocable_trust will shift a beneficial_interest in a_trust to a beneficiary who occupies a lower generation the effect of the instrument on the date of the modification is measured against the effect of the instrument in existence immediately before the modification if the effect of the modification cannot be immediately determined it is deemed to shift a beneficial_interest in the trust to a beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification a modification that is administrative in nature that only indirectly increases the amount transferred for example by lowering administrative costs or income taxes will not be considered to shift a beneficial_interest in the trust in addition administration of a_trust in conformance with applicable local law that defines the term income as a unitrust_amount or permits a right to income to be satisfied by such an amount or that permits the trustee to adjust between principal and income to fulfill the trustee’s duty_of impartiality between income and principal beneficiaries will not be considered to shift a beneficial_interest in the trust if applicable local law provides for a reasonable apportionment between the income and remainder beneficiaries of the total return of the trust and meets the requirements of sec_1_643_b_-1 of the income_tax regulations that is otherwise exempt from the gst tax because it was irrevocable prior to sec_26_2601-1 example considers a situation where a_trust sec_26_2601-1 provides that for purposes of this section a the trustees represent that trust was irrevocable on date and the facts in this case are similar to those set forth in example of sec_26 plr-139967-06 date provides that trust income is payable to a for life and upon a’s death the remainder is to pass to a’s issue per stirpes state x the situs of the trust then amends its income and principal statute to define income as a unitrust_amount of of the fair_market_value of the trust assets valued annually the example concludes that the administration of the trust in accordance with the state statute defining income to be a unitrust_amount will not be considered to shift a beneficial_interest in the trust therefore the trust will not be subject_to the provisions of chapter further under the facts of the example no trust_beneficiary will be treated as having made a gift_for federal gift_tax purposes and neither the trust nor any trust_beneficiary will be treated as having made a taxable_exchange for federal_income_tax purposes that there were no additions to trust after date b i e which provides that the conversion of an income_interest to a unitrust_interest pursuant to state statute will not be considered to shift a beneficial_interest in a_trust for gst purposes example further concludes that no trust_beneficiary will be treated as having made a gift_for federal gift_tax purposes and neither the trust nor any trust_beneficiary will be treated as having made a taxable_exchange for federal_income_tax purposes provided the proposed conversion meets the requirements of state statute and an order from state court approving the conversion is obtained we conclude that the conversion of the income_interest in trust to a unitrust_interest will not be considered to shift any beneficial_interest in trust and therefore will not cause trust to lose its status as exempt from the gst tax we further conclude that the proposed modification will not result in any beneficiary being treated as having made a taxable gift_for federal gift_tax purposes ruling whatever source derived including gains derived from dealings in property and income from an interest in an estate_or_trust shall be the excess of the amount_realized therefrom over the adjusted_basis provided in sec_1011 for determining gain and the loss shall be the excess of the adjusted_basis provided in such section for determining loss over the amount_realized under sec_1_1001-1 of the income_tax regulations the gain_or_loss realized from the conversion of property into cash or from the exchange of property for other_property differing materially in_kind or in extent is treated as income or loss sustained under sec_1001 of the code gain from the sale_or_other_disposition of property sec_61 and provides that gross_income means all income from sec_1001 provides that the amount_realized from the sale or other sec_1_1001-1 provides that a loss is not ordinarily sustained prior to the plr-139967-06 disposition of property shall be the sum of any money received plus the fair_market_value of the property other than money received under sec_1001 except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under sec_1001 on the sale_or_exchange of property shall be recognized sale_or_other_disposition of the property for the reason that until such sale_or_other_disposition occurs there remains the possibility that the taxpayer may recover or recoup some of the adjusted_basis of the property until some identifiable_event fixes the actual sustaining of a loss and the amount thereof the loss is not taken into account an exchange of property results in the realization of gain_or_loss under sec_1001 if the properties are materially different 499_us_554 properties exchanged are materially different if the properties embody legal entitlements different in_kind or extent or if the properties confer different rights and powers id pincite in cottage savings the supreme court held that mortgage loans made to different obligors and secured_by different homes embody distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans id in defining what constitutes a material difference for purposes of sec_1001 the court stated that properties are different in the sense that is material to the code so long as their respective possessors enjoy legal entitlements that are different in_kind or extent id pincite sec_1_643_b_-1 provides a comprehensive definition of income as that term applies to trusts_and_estates it provides in part that items such as dividends interest and rents are generally allocated to income and proceeds from the sale_or_exchange of trust assets are generally allocated to principal however an allocation of amounts between income and principal pursuant to applicable local law will be respected if local law provides for a reasonable apportionment between the income and remainder beneficiaries of the total return of the trust for the year including ordinary and tax- exempt_income capital_gains and appreciation for example a state statute providing that income is a unitrust_amount of no less than and no more than of the fair_market_value of the trust assets whether determined annually or averaged on a multiple year basis is a reasonable apportionment of the total return of the trust sec_1_643_b_-1 further provides that a switch between methods of determining trust income authorized by state statute will not constitute a recognition event for purposes of sec_1001 beneficiaries of the trust will have the same property interests and legal entitlements as a result of the proposed conversion under state statute a conversion to a total_return_trust may be made upon the court's determination that the conversion will enable the trustee to better carry out the purposes of the trust in addition and under the facts in the present case the preliminary question is whether the trustees and except as expressly provided herein no opinion is expressed or implied plr-139967-06 presented there is to be no material_change in property interests or legal entitlements for trust the trustees or the beneficiaries if the conversion to a total_return_trust does not result in a material_change in property interest or legal entitlements there is no occasion for realizing taxable gain_or_loss under sec_1001 therefore under the facts presented the conversion will not trigger realization of gain_or_loss for the taxpayers for federal_income_tax purposes concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter 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 provides that it may not be used or cited as precedent being sent to the taxpayer’s representatives pursuant to the power_of_attorney on file with this office a copy of this letter is this ruling is directed only to the taxpayer s requesting it sec_6110 the rulings contained in this letter are based upon information and sincerely melissa c liquerman melissa c liquerman senior technician reveiwer branch passthroughs special industries copy for sec_6110 purposes enclosure cc


t c memo united_states tax_court international capital holding corp and subsidiaries petitioners v commissioner of internal revenue respondent docket no filed date david d aughtry and charles ef hodges ii for petitioners donald w williamson jr carolyn l rountree and gary f walker for respondent memorandum findings_of_fact and opinion laro judge petitioners sought redetermination of deficiencies in federal income taxes and accuracy-related_penalties determined by respondent as follows -- - accuracy-related_penalty year deficiency sec_6662 dollar_figure dollar_figure big_number big_number after concessions by the parties we must decide whether amounts paid_by petitioners to a related corporation are deductible as compensation under sec_162 we hold they are findings_of_fact many facts were stipulated and we incorporate by this reference the parties’ stipulation of facts and the accompanying exhibits when the petition was filed petitioners’ principal places of business were in georgia petitioners petitioners are an affiliated_group_of_corporations which filed consolidated federal_income_tax returns for and using an accrual_method of accounting the group’s parent_corporation is international capital holding corporation ichc a holding_company from date through the affiliated_group included ichc and subsidiaries nc acquisition corporation ncac resort designs inc rdi and norcom inc ichc has owned a controlling_interest in ncac from the time of ncac’s formation on unless otherwise indicated section references are to the internal_revenue_code applicable to the subject years rule references are to the tax_court rules_of_practice and procedure date in date ncac purchased percent of the common_stock of norcom in a leveraged_buyout norcom is the only operating company in petitioners’ affiliated_group it manufactures and wholesales school supplies such as notebooks filler paper and binders from the time of its acquisition by ncac through the end of norcom has been a thinly capitalized and highly leveraged company petitioners’ owners during all time periods relevant to this case petitioners were controlled by h ross arnold mr arnold from date through date mr arnold owned dollar_figure percent of ichc from date through ichc was 100-percent owned by mr arnold mr arnold is a nonpracticing attorney who previously worked in investment banking mr arnold is in the business of purchasing small and medium-sized closely held companies through leveraged buyouts generally mr arnold does not involve himself in his individual capacity in the day-to-day operations of the companies he owns instead mr arnold uses another company he owns quest capital corp quest to provide the only other ownership interests in petitioners were held by paul f lombardi mr lombardi and mr arnold’s wife mr lombardi owned approximately percent of the common_stock of ncac from date through date from date through the end of mr arnold’s wife owned percent of ncac q4e- financial investment and strategic management services to his portfolio of companies quest quest is a private investment management company since its incorporation mr arnold has been quest’s sole shareholder and president mr arnold has been a member of quest’s board_of directors since date and its sole member since date quest is not a member of petitioners’ affiliated_group quest employs people who are specially trained in accounting finance management or law from through quest employed at least two attorneys numerous c p a s and many individuals with mba degrees quest’s primary purpose is to provide financial and investment advice to mr arnold and his portfolio of companies including norcom for example quest was actively involved in the equity and debt financing of the portfolio companies and annually reviewed to potential acquisitions for mr arnold or one of his controlled companies including norcom the acguisition of norcom when ncac acquired norcom in norcom had incurred numerous years of operating losses the leveraged acquisition of norcom was accomplished largely through an dollar_figure million line of prior to date quest operated as a sole_proprietorship owned by mr arnold - credit from bank south which provided funds to acquire norcom and a line of credit for working_capital mr arnold personally guaranteed the bank south loan additionally messrs arnold and lombardi each lent small amounts of cash to ichc to help ncac acquire norcom the loan agreement with bank south included numerous restrictions on norcom’s activities two of which are relevant to this case first the loan agreement prohibited norcom from declaring distributions without the bank’s approval second the aggregate amount of compensation norcom could pay to its officers and directors was restricted to percent of the prior year’s total in early norcom regquested and was granted a waiver of these restrictions for norcom’s fiscal_year that ended on date norcom requested a waiver of the restriction on distributions because it had declared a dollar_figure million dividend in date at least a portion of the dividend was requested by bank south so that another member of the affiliated_group rdi could pay off a loan from bank south which rdi did not have the ability to pay this was the only dividend norcom declared from through the end of in date lasalle national bank replaced bank south as norcom’s primary lender lasalle provided norcom with an extension of credit in the amount of dollar_figure million mr arnold personally guaranteed at least dollar_figure million of this debt like the -- - agreement with bank south the agreement with lasalle prohibited norcom from declaring distributions although the lasalle agreement did not expressly limit the amount of compensation norcom could pay to its officers directors or outside consultants a net_worth requirement in the agreement prevented norcom from paying major fees without consulting lasalle from date through date the lasalle line of credit was amended times services which quest provided to norcom at the heart of the factual dispute in this case is the extent to which quest provided consulting services to norcom petitioners claim that at least since the early 1990s norcom’s management team lacked anyone who carried out the duties of a chief financial officer cfo according to petitioners quest served as the cfo without being fully compensated respondent claims that norcom had a full management team and that quest was fully compensated for any services it provided a date to date from shortly after its acquisition in through date norcom had an essentially complete management team for a company of its size in relevant part norcom’s management team consisted of mr arnold mr lombardi joseph zelazny and vince ciccarello ’ mr arnold was the chairman and a member of the board_of directors of norcom since its acquisition ’ he also served as norcom’s secretary from date to date mr arnold did not keep an office at norcom’s facilities and was not actively involved in norcom’s day-to-day management norcom did not compensate mr arnold for his work until he began receiving a salary in norcom’s day-to-day management was largely handled by mr lombardi a cpa who possessed significant management experience he served as cho treasurer and assistant secretary of norcom from the time it was acquired in and in date also became president of norcom mr lombardi was responsible for all aspects of norcom’s operations including strategic planning budgeting negotiating with lenders manufacturing sales and marketing acquiring equipment and hiring personnel mr lombardi was compensated each year of his employment at norcom until he resigned in date mr ciccarello was the vice president of sales and marketing in date he was replaced by ted crews iii the sales and marketing responsibilities are not material to this case and are not discussed further mr arnold was the sole member of norcom’s board_of directors at the times norcom made the two disallowed payments --- - mr zelazny has been norcom’s controller since his responsibilities included among other things oversight of norcom’s day-to-day cash management preparation of monthly and annual financial statements and dealings with norcom’s accountants although mr zelazny was involved in dealings with norcom’s lenders for the most part he was not responsible for finding potential lenders negotiating agreements with the lenders finding additional sources of equity financing or fulfilling other functions typically assigned to a cfo quest’s involvement with norcom before mr lombardi’s resignation in date was limited quest employees were involved in acquiring norcom seeking additional equity financing obtaining debt financing renegotiating loan agreements including both the bank south and lasalle lines of credit and overseeing norcom’s operations including its real_estate and long-term growth plan these quest services were largely provided by mr arnold robert wright john mccoll and their support staffs when these services were provided by quest there was no written_agreement requiring norcom to compensate quest while only mr arnold testified as to the existence of an oral agreement between quest and norcom numerous quest employees testified that norcom was not paying quest because at that time payments were not permitted by norcom’s lenders in fact no --- - compensation was paid_by norcom to quest before date however minimal expenses quest incurred in were reimbursed by norcom b date through the relationship between quest and norcom changed significantly in date when mr lombardi resigned from norcom immediately after mr lombardi’s resignation mr mccoll assumed oversight of the day-to-day operations of norcom especially with respect to oversight of norcom’s finances mr mccoll moved his office to norcom and worked at norcom on a full- time basis in addition to oversight of norcom’s operations mr mccoll became a norcom officer ’ from date until date he served as norcom’s secretary and treasurer from date until date he also served as the executive vice president of norcom the record does not indicate that mr mccoll was ever compensated by norcom mr arnold at least nominally assumed some of mr lombardi’s responsibilities by temporarily taking the positions of president and ceo of norcom despite holding these offices the evidence does not indicate that mr arnold was actively involved in the management of norcom ’ petitioner claimed that mr mccoll was not an employee of norcom because respondent has not disputed this claim we have accepted it as a stipulated fact accordingly we have not considered whether mr mccoll was an employee of norcom for federal tax purposes and that any work he performed for norcom was under such employment and not on behalf of quest sec_3121 defining an employee of a corporation to include its officers -- - in addition to his oversight of norcom’s operations mr mccoll made two important hiring decisions at norcom first in date he hired richard cross iii to be norcom’s interim part-time president thereafter messrs mccoll and cross worked together as coleaders of norcom mr cross worked days per week while mr mccoll worked full time at norcom responsibility for operational sales and marketing issues fell primarily on mr cross while mr mccoll focused on the financial management of norcom mr cross continued to be norcom’s president until date at that time mr cross assumed the title of ceo which he held until december of norcom paid dollar_figure for months of work by mr cross in date mr mccoll hired hal rahn to replace mr cross as norcom’s president mr rahn continued to serve in that capacity through like mr cross mr rahn focused on operational sales and marketing issues at norcom high-level financial and investment issues continued to be handled by mr mccoll and others at quest norcom compensated mr rahn for his services in mr mccoll also elevated mr zelazny to vice president of finance although mr zelazny was given an additional title in his duties continued to be primarily that of a controller norcom has not employed any senior level officers with significant financial expertise or experience after mr lombardi resigned in instead norcom looked to quest to carry out the duties of a cfo since acquiring norcom in mr arnold has assigned a high-ranking quest employee with expertise in financial and investment issues to oversee the financial management of norcom initially robert wright provided such oversight on or about the time of mr lombardi’s resignation in mr mccoll served this role and quest substantially increased the services it provided to norcom in robert espy became the quest officer responsible for management of norcom’s finances during and mr espy and his staff were actively involved in norcom’s financial management the services quest provided to norcom from through were mostly financial and investment advice these included consulting on norcom’s bank loans financing of equipment leases acquisition and sale of real_property and development of business plans quest played a critical role in negotiating norcom’s consolidation of its operations from four facilities down to a single larger plant which was accompanied with a sale leaseback of the new plant quest personnel also reviewed norcom’s monthly and annual financial statements as would a cfo quest hired at least two high ranking norcom officers mr cross as president in and mr rahn as president in quest personnel typically were not involved in the day-to-day operations of norcom with the exception of mr mccoll’s work in payments from norcom to quest norcom did not make any payments to quest before for management services in date norcom paid quest dollar_figure to reimburse quest for expenses_incurred by mr mccoll ina meeting he conducted with lasalle regarding norcom’s loan this appears to be the only pre-1992 payment from norcom to quest that relates to consulting services provided by quest from july through date quest issued monthly invoices to norcom for dollar_figure for a consulting fee from date through the end of quest regularly issued invoices to norcom for reimbursement of expenses also in date norcom paid to quest dollar_figure for management services quest provided to norcom on date norcom and quest entered into a formal consulting agreement the consulting agreement the consulting agreement provided that quest would provide to norcom advice on financial strategic planning and operational issues in turn norcom was required to pay quest an annual consulting fee of dollar_figure payable in monthly installments of dollar_figure from the beginning of through the end of norcom paid quest the monthly consulting fees respondent did not challenge the deductibility of these compensation payments the consulting agreement had the following integration clause entire agreement amendments and modification this agreement supersedes in the entirety any and all prior agreements or arrangements between the parties with respect to the subject matter hereof and this agreement may not be amended or modified in any respect other than by a writing that references this agreement 1s signed by the party against whom the amendment or modification is sought to be enforced the agreement was later revised to include the following clause bob other fees from time to time additional compensation will be paid to quest based upon the extent of involvement in and services provided to norcom at the discretion of the board_of directors in date mr espy proposed to mr rahn that norcom make a payment to quest that would be in addition to the monthly consulting fee of dollar_figure messrs espy and rahn agreed that norcom would pay quest dollar_figure million for services quest had previously provided to norcom later messrs rahn and espy approached mr arnold to obtain his approval of the payment which he granted before the payment could be made norcom and quest had to ensure that any payment to quest would not violate any terms of its loan agreement with lasalle in the fall of messrs arnold and espy sought lasalle’s consent to the proposed payment lasalle granted its consent for norcom to make the payments to quest as compensation_for services provided by quest after securing lasalle's consent to the dollar_figure million payment messrs espy and rahn collaborated in the preparation of the following resolution for norcom’s board_of directors whereas certain employees of quest capital corp have conducted meetings with and given consultations to norcom's management provided advisory services in marketing strategic planning systems and technical operations advised the corporation's employees and negotiated on behalf of norcom in connection with numerous bank transactions reviewed and analyzed monthly financial statements and the annual operating budget for and acted as general consultant to norcom as to its productivity and profitability and whereas the president has proposed to the board that norcom pay a management fee to quest capital corp in the amount of dollar_figure in consideration for the aforementioned services therefore it is resolved that the president is authorized and directed by the board_of directors to pay the amount of dollar_figure to quest capital corp for the consulting services described herein on date mr arnold norcom's sole director at the time executed the resolution on date norcom paid dollar_figure million to quest as a management fee as part of its audit of norcom’s books norcom’s outside accountants advised petitioners that they should treat a portion of the payment as a dividend to obtain the benefits of certain tax_credits in response to this suggestion norcom and quest reiterated their intention that the entire payment was compensation_for services rendered and should be treated as such -- - effective date mr rahn as norcom's president and mr espy as quest's chief operating officer executed a second consulting agreement the consulting agreement in the consulting agreement norcom stated that it desired quest to provide management banking and marketing services in connection with the operation of norcom's business bank relationship vendor relationships and customer relationships the agreement provided that for years quest would provide the following services to norcom a reporting and financial planning services - assistance and review of all reports required pursuant to loan agreements and other financing arrangements to which norcom is a party review renegotiate and extend the lines of credit made abailable sic by its lending institution review of financial statements annual budgets projections insurance reports and other financial reports necessary for the operation of norcom's business b consulting services - consulting and advisory services in regard to international marketing strategic planning systems technical operations and such other matters as norcom deems reasonably necessary for the conduct of its business c equipment - assistance in determining lease versus buy decisions on new equipment negotiate bank financing on new equipment purchases and provide overall consultation as to the cost benefit relationship of acquiring said eguipment -- - under the agreement quest was to be compensated as follows a during the term of this agreement a yearly fee will be paid equal to approximately of the gross_profit of norcom based on internally prepared financial statements pursuant to the terms and conditions of norcom's loan agreement with lasalle national bank payments approximating of the total fee will be made on october 10th of each year with the remaining of the estimated fee paid during the last week of the fiscal_year of norcom no payment will be made under this agreement if it were to cause an event of default under any covenant in the lasalle national bank loan agreement in addition management of norcom and the board_of directors will decide each year what additional fees if any will be payable to quest based on the services rendered and the amount of time involved by quest personnel for the months of september through date quest also issued invoices at the monthly rate of dollar_figure norcom promptly paid the amounts invoiced respondent did not challenge the deductibility of these payments during the fall of messrs rahn and espy commenced discussions concerning the amount of compensation to be paid to quest during they relied on the same considerations underlying the payment mr espy with input from messrs arnold and rahn then drafted the following resolution for norcom’s board_of directors whereas certain employees of quest capital corp have conducted meetings with and given consultations to norcom's management provided advisory services in marketing strategic planning systems and technical operations advised the corporation's employees and negotiated on behalf of norcom in connection with numerous bank transactions renegotiated and extended the existing bank line with lasalle national bank reviewed and analyzed monthly financial statements and the annual operating budget for and acted as general consultant to norcom as to its productivity and profitability and whereas the president has proposed to the board that norcom pay a management fee to quest capital corp in the amount of dollar_figure in consideration for the aforementioned services this amount being consistent with the services agreement and the amounts paid in and which are hereby ratified as to amount and prior year's consistent practice and methodology therefore it is resolved that the president is authorized and directed by the board_of directors to pay the amount of dollar_figure to quest capital corp for the consulting services described herein in date norcom's board_of directors executed the resolution and dollar_figure was paid to quest as a management fee opinion we must decide whether the payments from norcom to quest are deductible under sec_162 sec_162 allows a sdollar_figurethat section provides sec_162 in general --there shall be allowed as a deduction all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business including-- continued -- - business to deduct a reasonable allowance for salaries and other compensation_for_personal_services actually rendered as an ordinary and necessary business_expense in this case deductibility regquires that the payment be purely for services rendered and reasonable in amount 679_f2d_205 11th cir 95_tc_525 affd 965_f2d_1038 llth cir 58_tc_1055 affd without published opinion 474_f2d_1345 5th cir law offices---richard ashare p c v commissioner tcmemo_1999_282 sec_1_162-7 eyefull inc v commissioner t c memo pulsar components intl inc v commissioner tcmemo_1996_129 income_tax regs it is well established that a payment is deductible as compensation only to the extent that it was actually intended as such 56_tc_1324 affd without published opinion 496_f2d_876 5th cir eyefull inc v commissioner supra whether such intent existed is a factual question to be decided on the basis of the facts and circumstances of the case paula constr co v commissioner supra pincite the burden_of_proof rests upon continued a reasonable allowance for salaries or other compensation_for_personal_services actually rendered petitioners to prove that they are entitled to deduct an amount greater than that determined by respondent ’ rule a paula constr co v commissioner supra pincite elec neon inc v commissioner supra pincite while compensation_for_personal_services is a deductible expense distributions of corporate earnings_and_profits constitute dividends and are not deductible therefore a corporation has an incentive to characterize as compensation payments which are actually distributions of profits sec_1_162-7 income_tax regs thus the court must closely scrutinize the alleged compensation paid to determine if it is a disguised distribution of profits pulsar components intl inc v commissioner supra mad auto wrecking inc v commissioner tcmemo_1995_153 the provision of services by one company to another company does not alone establish the existence of a business relationship consistent with the payment of compensation eyefull inc v commissioner supra citing paula constr co v commissioner supra pincite there must also be evidence that at the time pursuant to sec_7491 the burden_of_proof can be shifted to respondent if certain conditions are met including that the examination was commenced before date internal revenue restructuring reform act of publaw_105_206 sec c 112_stat_727 116_tc_438 the examination in this case commenced before the effective date accordingly sec_7491 is not applicable to this case - - the services were rendered the parties understood them to be part of a business transaction conducted for profit id petitioners allege that quest provided valuable investment financial and management consulting services to norcom over an extended period of time petitioners further allege that in and they paid reasonable_compensation to quest for these services respondent takes the position that norcom lacked the requisite compensatory intent and the payments do not constitute reasonable_compensation because petitioners failed to establish the extent of the services rendered we disagree with respondent intent to compensate the evidence strongly supports petitioners’ contention that they intended to compensate quest for services rendered when they made the dollar_figure million payment in and the dollar_figure payment in the court finds it especially significant that both payments were initially negotiated by officers of norcom and quest who did not hold any ownership_interest in either company specifically mr espy chief operating officer of quest approached mr rahn president of norcom with the suggestion that norcom compensate quest for services rendered whereupon messrs espy and rahn negotiated the amount of the payments the court sees no reason to second-guess payments that were negotiated by two disinterested members of the management teams --- - at quest and norcom law offices--richard ashare p c v commissioner supra declining to second-guess the wisdom of the board_of directors as to the amount of compensation paid to a principal of the taxpayer there was also uncontroverted testimony by disinterested parties that immediately before and after the payment was made norcom intended it to be compensation_for services rendered specifically prior to making the payment messrs arnold and espy approached lasalle to obtain the bank’s approval lloan officers at lasalle testified that they were informed that the payment was compensation_for services previously rendered by quest notably lasalle did not question whether quest had provided services to norcom or the amount of the payment shortly after the payment was made to quest petitioners’ tax adviser learned of the payment and was told by petitioners that the entire payment was compensation_for services rendered additionally the payments to quest were contemplated by the revised consulting agreement ’ that agreement provides petitioners alleged that the consulting agreement was revised but they were unable to locate a final signed version of the allegedly revised agreement petitioners did produce a draft of the revised agreement on brief respondent urged the court to find that the agreement included the additional clause that petitioner claimed was part of the revised agreement we interpret the parties’ proposed findings_of_fact continued -- - that norcom could make such compensation payments to quest based upon the extent of the services provided by quest ’ notably respondent has accepted the deductibility of other_payments made under the consulting agreement ’ it is also clear that for both the and payments norcom followed its normal procedure for determining officer compensation specifically norcom’s president mr rahn made a recommendation to norcom’s board_of directors of the amount the salary and bonuses to be paid to norcom’s officers for both the and payments mr rahn was involved in determining the amount of compensation to be paid and in making a recommendation to norcom’s board_of directors about such compensation petitioners’ claim that norcom’s payment of compensation to quest was deferred until because its financial condition and financing arrangements precluded such payments is strongly supported by the evidence prior to the change in ownership in continued as a stipulation that the agreement was revised as alleged by the petitioners although we are not bound by the parties’ stipulated facts the record is absent of facts indicating that the stipulation is clearly erroneous rule a 66_tc_312 ‘t similarly the consulting agreement provides for the application of a formula to determine the amount of additional compensation payments norcom would make to quest respondent has not alleged that these payments were contingent payments that are deductible only if they satisfy the test provided in sec_1_162-7 income_tax regs - - norcom had sustained years of operating losses although norcom was restored to profitability after the acquisition norcom’s ability to compensate quest was limited at all times it continued to be highly leveraged with millions of dollars of debt the lender bank south viewed norcom as financially unstable and required mr arnold to personally guarantee norcom’s loan although norcom was profitable in the years after the ownership_change its financial condition was depleted in by the payment of a dollar_figure million dividend which was requested by bank south norcom’s poor financial condition is further evidenced by the fact it did not begin to compensate all of its officers until the bank south loan agreement expressly restricted the amount of compensation norcom could pay to its officers and directors moreover both the bank south loan and the lasalle loan limited norcom’s ability to make payments to related parties as petitioners have alleged norcom’s financial condition and its financing arrangements severely limited its ability to compensate quest until norcom’s financial condition improved dramatically in it is also clear that norcom’s management team lacked high- level financial planning expertise at least after mr lombardi resigned in early instead of replacing mr lombardi with an officer with a finance background norcom looked to quest for -- - advice and counsel on financial and investment issues numerous persons at quest possessed relevant experience and training not found at norcom finally with respect to both payments norcom’s board_of directors executed resolutions detailing that the payments were being made to quest for valuable services quest had previously provided to norcom both resolutions are consistent with the parties’ conclusion that the agreement envisioned that norcom’s board could exercise its discretion and make additional compensation payments to quest we find unpersuassive respondent’s arguments that petitioners lacked the requisite compensatory intent respondent initially drew the court’s attention to the fact that only mr arnold testified as to knowledge of a pre-1993 oral agreement between norcom and quest respondent correctly notes that mr lombardi norcom’s ceo and president from through date testified that he had no knowledge of any oral agreement the court chooses not to rely upon his testimony we find that mr lombardi’s testimony was biased because mr lombardi had a we note that respondent’s briefs were not in accordance with rule e which governs proposed findings_of_fact and could have been rejected respondent’s proposed findings_of_fact were rarely concise statements of fact and often were not based upon evidence proposed findings_of_fact should not be based upon statements made in a request for admission unless the subject matter of the request has been admitted or deemed admitted - - dispute with mr arnold over their respective ownership interests in norcom as a result of which mr lombardi resigned from norcom and later sued mr arnold moreover the lack of additional testimony regarding a pre- agreement is neither surprising nor necessarily inconsistent with norcom’s having the requisite compensatory intent at the time the payments were made in and closely held corporations often act informally with decisions not being documented in writing 67_tc_694 hyefull inc v commissioner tcmemo_1996_238 additionally in determining whether norcom possessed the requisite intent the relevant time is when the purported compensation payment was made tool producers inc v commissioner tcmemo_1995_407 the court finds it notable that numerous witnesses testified that before quest was not paid_by norcom because norcom’s financial condition precluded it from compensating quest in any event the substantial written documentation between the parties and the parties’ actions demonstrate that norcom possessed the requisite intent when it made the payments unlike in eyefull inc v commissioner tcmemo_1996_238 respondent has not alleged that norcom and quest lacked the necessary business relationship such that quest did not provide services with a view toward being compensated - - respondent also alleges that numerous contracts limited norcom’s ability to compensate third parties specifically bank south loan agreement which fees estate contracts that prohibited commissions these contracts do intend to compensate quest the norcom were similar to that of a do not believe that compensation and investment banking fees including quest respondent calls the court’s attention to norcom’s prohibited commissions finder’s as well as norcom’s real payments of real_estate broker not suggest norcom did not services quest provided to and we chief financial officer for such services was prohibited by these agreements additionally respondent claims that norcom’s intent to compensate quest for services rendered before is capped at the dollar_figure annual fee provided for in the consulting agreement plus the amounts invoiced by quest before the consulting agreement became effective we do not find that norcom intended to limit the compensation of quest to these amounts the consulting agreement expressly provides that norcom will consider making compensation payments to quest that are in addition to the required_payment of dollar_figure the agreement provides that such additional compensation is to be reflective of quest’s involvement in and services provided to norcom moreover there is nothing in the agreement that would -- p7 - not permit norcom to compensate quest for services provided to norcom before we find that the circumstances underlying norcom’s payments to quest in and confirm that the payments were made to compensate quest for services rendered reasonableness of the compensation the second element of the compensation test is whether the payments are reasonable in amount trinity quarries inc v united_states f 2d pincite estate of wallace v commissioner t c pincite haffner’s serv stations inc v commissioner tcmemo_2002_38 respondent has conceded that the payments were reasonable if petitioners substantiate that the services were provided as claimed to determine whether petitioners satisfied this condition we must initially determine the extent of the services petitioners claimed to have received from quest in the petition petitioners made the following claims regarding the services provided by quest to norcom norcom hired quest in the early 1990s quest employed at least four senior level management advisers who worked with norcom and quest provided along with other services the following analyzing norcom’s financing needs hiring senior and key executives at norcom managing norcom’s facilities iv negotiating - - sales and leases on norcom’s behalf and v developing norcom’s business plans ’ petitioners established that quest began to provide services at least as early as when norcom began to reimburse quest’s expenses moreover quest’s services to norcom increased substantially in early after mr lombardi resigned the evidence established that numerous senior-level quest employees or consultants worked on norcom matters including messrs mccoll espy arnold wright and cross prior to his employment at norcom additionally numerous other quest employees provided valuable services to norcom in support of these individuals the evidence also establishes that quest provided all of the services identified in the petition plus many others we find that petitioners have established that services were provided as claimed in the petition throughout the 1990s quest worked on norcom’s financing needs this includes attempts to find new 's petitioners made essentially the same claims ina position paper provided to respondent during the audit conversely respondent argues that petitioner must establish that norcom was the largest client of quest and its predecessor and that the personnel of quest and its predecessor spent the majority of their time in performing services for norcom the court finds no indication in the record that petitioners made any such claims to this court at the time that respondent made his concession no such claims were made in the petition - - sources of equity financing and repeated work on norcom’s debt financing quest personnel were also very active in norcom’s eguipment financing quest also played a critical role in hiring the last two norcom presidents mr mccoll hired both mr cross and mr rahn additionally mr mccoll himself assumed numerous offices at norcom without being paid_by norcom quest played a very important role in negotiating norcom’s consolidation of its operations from four facilities down to a single larger facility quest assisted in negotiating the purchase sale_and_leaseback of norcom’s plant quest personnel played similarly important roles in equipment acquisitions quest participated in the development of norcom’s business plans particularly with respect to financing and investment issues quest reviewed numerous potential acquisitions for norcom which would have allowed norcom to expand and diversify its business additionally quest hired mr cross to provide a review of norcom’s operations after mr lombardi resigned we find that petitioners have established that services were provided as claimed in the petition and that respondent has conceded that the compensation was reasonable in amount accordingly petitioners’ payments of dollar_figure million in and dollar_figure in are deductible under sec_162 as ordinary and necessary expenses -- - we have considered all arguments made by respondent and to the extent not discussed above we find them to be without merit to reflect the foregoing decision will be entered for petitioners


internal_revenue_service department of the treasury number release date index number 280g washington dc person to contact telephone number refer reply to cc tege eb ec-plr-102698-02 date may taxpayer date date date dollar_figurea b c d e x y z dear this letter is in response to your letter requesting rulings under sec_280g of the internal_revenue_code specifically you requested a ruling that neither the approval confirmation nor implementation of taxpayer’s reorganization plan plan constitutes a change in the ownership or effective_control of taxpayer or in the ownership of a substantial portion of taxpayer’s assets within the meaning sec_280g and sec_4999 of the code this ruling affects the determination of whether any options severance payments and warrants are subject_to sec_280g and sec_4999 of the code the facts as represented by taxpayer are as follows plr-102698-02 on date taxpayer filed a voluntary petition for relief under chapter of the bankruptcy code with the united_states bankruptcy court a creditor’s committee was not appointed on date the bankruptcy court confirmed the plan the plan resulted from negotiations between taxpayer’s largest creditors comprised of institutions holding senior notes issued by taxpayer with an aggregate face_amount of dollar_figurea former senior note holders and x pursuant to plan taxpayer as reorganized issued a single class of common_stock to former senior note holders and x plan also provided for the issuance of common_stock to y and z executive management however through negotiations with the former senior note holders and x executive management received vested stock_options in lieu of common_stock pursuant to plan the former senior note holders were issued shares representing b of the total fair_market_value and total voting power of the common_stock of taxpayer one former senior note holder received greater than of the total fair_market_value and voting power of taxpayer’s common shares after the reorganization x receive shares representing c of the total fair_market_value and total voting power of the common_stock of taxpayer after the reorganization the shares of common_stock that each senior note holder and x received under plan were worth substantially less than the face_amount of their respective claims against taxpayer pre-reorganization common_stock preferred_stock and notes of taxpayer were cancelled under plan plan which was approved by a majority of taxpayer’s board_of directors the old board provided for all existing directors of taxpayer and each of taxpayer’s subsidiaries to resign as directors as of the effective date of plan plan further provided that the board_of directors of taxpayer after the reorganization the new board would consist of up to seven directors six of whom were nominated by the former senior note holders and one who was nominated by x executive management remain as co-chief executive officers of taxpayer the former senior note holders any transferee of a former senior note holder together stockholders taxpayer and x entered into a stockholders agreement as to the management of taxpayer and stockholders’ ownership of taxpayer’s common_stock the stockholder’s agreement provides voting agreements with respect to the election and removal of new board the modification of charter agreements and a corporate_liquidation or a change in voting power the taxpayer is aware of no other arrangements formal or informal under which the former senior note holders or x will act together as a group to control the management and policies of taxpayer pursuant to plan the management and retention bonus plan in effect before the reorganization was assumed by taxpayer and amended to clarify that the reorganization did not constitute a change in control as otherwise defined in the retention plan that would trigger benefits under the retention plan plan also provides for a warrant and an option plan the warrant agreement as adopted to provide a plr-102698-02 distribution of warrants to holders of taxpayer’s preferred_stock interests to induce such holders to vote in favor of plan each warrant may be exercised for one share of common_stock in taxpayer at a stated price subject_to adjustments as provided in the warrant agreement the warrants are exercisable beginning on the last day of the third month following the effective date of plan and ending on the fifth anniversary of such date both the warrants and any shares issued on exercise of a warrant are subject_to certain restrictions on transfer but are otherwise nonforfeitable the option plan provides for the granting of stock_options to senior management only executive management may not participate in the option plan pursuant to plan existing severance agreements with senior management and existing employment agreements with executive management were assumed and amended to provide certain limitations on the receipt of severance benefits amended employment agreements the amended employment agreements generally provide for the forfeiture of severance benefits if a member of executive management is terminated for cause or voluntarily terminates employment prior to date or prior to the earlier of the sale of all or substantially_all of taxpayer’s assets or stock however severance benefits are payable to a member of executive management on any voluntary or involuntary termination of employment except for cause disability or death occurring on or after date the severance benefits payable to executive management are comprised of months of salary continuation and months of continuation of insurance these provisions were intended to provide an incentive for executive management to remain with taxpayer through the effective date of the reorganization and for at least four months thereafter as the date date has passed executive management is currently entitled to receive severance on any subsequent termination of employment unless on account of death disability or for cause the amended employment agreements also provide for a grant of immediately vested stock_options options to executive management if exercised these options would represent approximately d of the total shares of taxpayer’s common_stock these options were granted in lieu of the issuance of shares of taxpayer’s common_stock as reflected in plan sec_280g of the code provides that no deduction will be allowed for any excess_parachute_payment sec_280g defines excess_parachute_payment as an amount equal to the excess of any parachute_payment over the portion of the base_amount allocated to such payment sec_280g of the code defines parachute_payment as any payment in the nature of compensation to or for the benefit of a disqualified_individual if i such payment is contingent on a change in the ownership or effective_control of the corporation or in the ownership of a substantial portion of the assets of the corporation and ii the aggregate present_value of the payments in the nature of compensation to or for the benefit of such individual which are contingent on such change equals of exceeds an amount equal to three times the base_amount plr-102698-02 sec_4999 of the code imposes on any person who receives an excess_parachute_payment a tax equal to percent of the amount of the payment sec_1_280g-1 of the proposed income_tax regulations published in the federal_register on date fed reg big_number the proposed_regulations provides guidance concerning parachute payments the proposed_regulations were amended and clarified on date with the publication of sec_1_280g-1 of the proposed income_tax regulations the proposed_regulations in the federal_register fed reg big_number q a-27 a of sec_1_280g-1 of the proposed_regulations provides that a change in the ownership or control of a corporation occurs on the date that any one person or more than one person acting as a group acquires ownership of stock of the corporation that together with stock held by such person or group possesses more than percent of the total fair_market_value or total voting power of the stock of such corporation q a-27 b provides that persons will not be considered to be acting as a group merely because they happen to purchase or own stock of the same corporation at the same time or as a result of the same public offering however persons will be considered to be acting as a group if they are owners of an entity that enters into a merger consolidation purchase or acquisition of stock or similar_business transaction with the corporation if a person including an entity shareholder owns stock in both entities that enter into a merger consolidation purchase or acquisition of stock or similar transaction such shareholder is considered to be acting as a group with other shareholders in an entity only to the extent of his ownership in that entity prior to the transaction giving rise to the change and not with respect to his ownership_interest in the other entity q a-27 c provides that sec_318 applies to determine stock ownership q a-28 a provides in part that a change_of effective_control of a corporation is presumed to occur on the date that either any one person or more than one person acting as a group acquires or has acquired during the 12-month_period ending on the date of the most recent acquisition by such person or persons ownership of stock of the corporation possessing percent or more of the total voting power of the stock of such corporation or a majority of the members of the corporation’s board_of directors is replaced during any 12-month_period by directors whose appointment or election is not endorsed by a majority of the members of the corporation’s board_of directors the presumption of q a-28 a and may be rebutted by establishing that the acquisition or acquisitions of the corporation’s stock or the replacement of the majority of the members of the corporation’s board_of directors does not transfer the power to control directly or indirectly the management and policies of the corporation from any one person or more than one person acting as a group to another person or group q a-28 d contains the same language as q a-27 b concerning when persons will be considered to be acting as a group q a-28 e contains the same language as q a-27 c concerning the application of sec_318 plr-102698-02 q a-29 provides that a change in the ownership of a substantial portion of a corporation’s assets occurs on the date that any one person or more than one person acting as a group acquires or has acquired during the 12-month_period ending on the date of the most recent acquisition by such person or persons assets from the corporation that have a total fair_market_value equal to or more than one third of the total fair_market_value of all of the assets of the corporation immediately prior to such acquisition or acquisitions for this purpose a transfer of assets by a corporation is not treated as a change in the ownership of the assets if the corporation transfers the assets to an entity in which immediately_after_the_transfer the shareholders of the corporation own a greater than percent interest by value or voting power see q a-29 b and example of q a-29 d q a-29 d contains that same language as q a-27 c concerning when persons will be considered to be acting as a group q a-29 e contains the same language as q a-27 c concerning the application of sec_318 the passive receipt of stock by a creditor under a bankruptcy plan_of_reorganization is essentially involuntary in that the creditors of the bankruptcy_estate typically would prefer that the debt be paid in cash rather than stock of the debtor the fact that plan_of_reorganization provides for the creditors to receive stock instead of cash is a function of the financial resources of the estate and is not indicative of any intention on the part of the creditors either singly or acting as a group to acquire control of the debtor pursuant to plan no person or persons acting as a group acquired ownership or more than percent of the total fair_market_value or total voting power of taxpayer although e one of the former senior note holders acquired more than of the total voting power of the stock of taxpayer the presumption of an effective change in control is rebutted by the facts of the reorganization the facts as submitted by taxpayer indicate that the reorganization will not transfer to e the power to control the management and policies of taxpayer and that e will not act to control the management and policies of taxpayer the facts also indicate that the composition of the board_of directors after the reorganization was agreed upon by old board pursuant to plan no change in ownership of a substantial portion of the assets of taxpayer occurred as a result of the reorganization of taxpayer based on the above described facts and representations we rule as follows neither the approval confirmation nor implementation of plan constitutes a change in the ownership or effective_control of taxpayer or in the ownership of a substantial portion of taxpayer’s assets within the meaning of sec_280g and sec_4999 of the code and the options granted to executive management the severance payable to plr-102698-02 executive management and the warrants are not subject_to the provisions of sec_280g and sec_4999 of the code except as specifically ruled on above on opinion is expressed or implied concerning the tax consequences of any aspect of the transaction or item discussed or referenced above 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 the taxpayer should attach a copy of this ruling to any_tax return to which it is relevant sincerely robert misner senior technical reviewer office of executive compensation branch office of the division counsel associate chief_counsel tax exempt and government entities enclosure copy for purposes


t c memo united_states tax_court richard john florance jr petitioner v commissioner of internal revenue respondent docket no filed date richard john florance jr pro_se adam l flick for respondent memorandum opinion vasquez judge this case is before the court on respondent’s motion for summary_judgment and motion to impose a penalty under sec_6673 unless otherwise indicated 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 background by notice_of_deficiency respondent determined a deficiency of dollar_figure and additions to tax of dollar_figure and dollar_figure pursuant to sec_6651 and sec_6654 respectively in petitioner’s federal_income_tax on date petitioner invoked the jurisdiction of this court by filing an improper petition on date the court ordered petitioner to file a proper amended petition on or before date on date petitioner filed a status report acknowledging receipt of the court’s date order and stating that the case could be resolved without an amended petition once regional or district_counsel was assigned on date petitioner filed an amended petition petitioner requested that this case be conducted under the small_tax_case procedure in the amended petition petitioner noted that in the notice_of_deficiency respondent made an adjustment for dollar_figure in wages he admitted he received in but failed to include an additional dollar_figure in wages petitioner received during on date petitioner filed a motion for judgment on the pleadings petitioner characterized the primary issue in his case as whether he was a taxpayer and asserted that he had challenged this issue the motion for judgment on the pleadings also contained other frivolous and groundless statements contentions and arguments on date the court denied petitioner’s motion for judgment on the pleadings by notice dated date the court set this case for trial at the court’s dallas texas session beginning date this notice specifically stated your failure to appear may result in dismissal of the case and entry of decision against you on date petitioner filed a motion for continuance on date the court denied petitioner’s motion for continuance the court also ordered that petitioner’s request for admissions be returned to petitioner unfiled and that petitioner and respondent meet as soon as practical for purposes of informal_discovery and to complete a stipulation of facts as required by rule march order in the march order we stated respondent further objects that petitioner’s request document ‘requests respondent to admit to matters that are irrelevant conclusions of law frivolous arguments and not properly discoverable ’ we do not disagree on date petitioner filed a motion to remove the small_tax_case designation and another document the court filed as petitioner’s pretrial memorandum the pretrial memorandum contained frivolous and groundless statements contentions and arguments on date the court granted petitioner’s motion to remove the small_tax_case designation and ordered respondent to file an answer to the amended petition on or before date on date petitioner filed a notice of nonacquiescence to the march order and a motion for continuance on date the court denied petitioner’s motion for continuance on date respondent filed an answer in the answer respondent affirmatively alleged that he received a proposed set of stipulations from petitioner petitioner attached a form_w-2 wage and tax statement for from enterprise network systems inc listing petitioner’s name and address and dollar_figure in wages paid to petitioner the form_w-2 has a typographical error in which the numerals in petitioner’s social_security_number have been transposed on the basis of petitioner’s admission of receipt of this income in his amended petition and the form_w-2 respondent proposed an increased deficiency for petitioner for and the total deficiency for is dollar_figure additionally upon the basis of the additional unreported income from enterprise network sys inc not contained in the notice_of_deficiency respondent also asserted that the total additions to tax pursuant to sec_6651 and sec_6654 are dollar_figure and dollar_figure respectively that same day petitioner filed a motion to shift the burden_of_proof to respondent pursuant to sec_7491 and a motion for interlocutory review of the march order on date petitioner filed a notice of refusal to stipulate on date the court denied petitioner’s motion for interlocutory review in order to give petitioner time to file a reply to the answer the court also ordered this case stricken from the court’s dallas texas session beginning date and continued it generally on date petitioner filed a motion for stay an objection regarding the docket sheet a second motion for judgment on the pleadings and a motion for interlocutory appeal in the objection petitioner objected to the capitalization of certain letters of his name and to the address listing petitioner as a resident of a state via the identifier of ‘tx ’ petitioner claimed he was not a resident of that state in his objection regarding the docket sheet beneath his signature petitioner listed his address as vassar drive richardson texas this is the same address that petitioner had listed in his imperfect petition in the motion for interlocutory review petitioner requested interlocutory review of all the orders of the court and stated this notice intends also to cover prospectively any such order as it becomes a decision of the tax_court on date the court denied petitioner’s motion for stay motion for judgment on the pleadings and motion for interlocutory appeal on date the court notified respondent that petitioner had filed on date a motion to shift the burden_of_proof and that if there was an objection a notice of objection had to be filed on or before date on date respondent filed an objection to petitioner’s motion to shift the burden_of_proof and pursuant to rule filed a motion for entry of order that undenied allegations in the answer to the amended petition be deemed admitted on date the court denied petitioner’s motion to shift the burden_of_proof the court also notified petitioner that respondent had filed on date a motion for an order that the specified affirmative allegations in the answer be deemed admitted that if petitioner filed a reply as required by rule on or before date respondent’s motion would be denied and that if petitioner did not file a reply the court would grant respondent’s motion and deem admitted for purposes of this case the affirmative allegations in the answer on date petitioner filed a reply in the reply petitioner admitted respondent received a proposed set of stipulations from petitioner petitioner attached the form_w-2 for from enterprise network sys inc listing petitioner’s name and address and petitioner admitted that the form_w-2 has a typographical error in which the numerals in petitioner’s social_security_number have been transposed petitioner denied that a deficiency exists or that any additions to tax are justified on date the court denied respondent’s motion for entry of order that undenied allegations in the answer to the amended petition be deemed admitted by notice dated date the court set this case for trial at the court’s dallas texas session beginning date this notice specifically stated your failure to appear may result in dismissal of the case and entry of decision against you attached to this notice was the court’s standing_pretrial_order on date the court lodged respondent’s objection to petitioner’s request for admissions respondent attached a copy of petitioner’s request for admissions to his objection on date pursuant to rule the court ordered petitioner to file his request for admissions petitioner failed to do so on date petitioner filed a status report the status report alleged criminal conduct by the court and contained disrespectful and vulgar statements directed to the court petitioner failed to appear at the call or recall of his case on date respondent filed a motion for summary_judgment and a motion to impose a penalty under sec_6673 petitioner filed no response to either motion discussion a motion for summary_judgment rule a provides that either party may move for summary_judgment upon all or any part of the legal issues in controversy full or partial summary_judgment may be granted only if it is demonstrated that no genuine issue exists as to any material fact and a decision may be rendered as a matter of law rule b 98_tc_518 affd 17_f3d_965 7th cir we note that petitioner’s requests included ‘taxpayer’ means fiduciary ‘united states’ is a federal_corporation and ‘united states of america’ is another federal_corporation we conclude that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law deficiency determined in the notice_of_deficiency petitioner did not appear at trial we previously ruled that the burden_of_proof did not shift to respondent pursuant to sec_7491 petitioner bears the burden_of_proof for the deficiency determined in the notice_of_deficiency see rule a petitioner failed to produce any evidence to rebut the deficiency determined by respondent in the notice_of_deficiency accordingly we sustain respondent’s deficiency determination contained in the notice_of_deficiency increased deficiency respondent bears the burden_of_proof on the increased deficiency see id the increased deficiency derives from dollar_figure in wages paid to petitioner by enterprise network sys inc this amount is income to petitioner see sec_61 petitioner as early as the amended petition admitted receiving this income and provided respondent a document to support this admission petitioner further admitted that this amount was not included in the notice_of_deficiency we note that in the alternative we could have dismissed this portion of the case pursuant to rule b cf white v commissioner tcmemo_1997_459 accordingly we conclude that petitioner is liable for the increased deficiency additions to tax a burden of production sec_7491 sec_7491 provides that the commissioner will bear the burden of production with respect to the liability of any individual for additions to tax and penalties the commissioner’s burden of production under sec_7491 is to produce evidence that it is appropriate to impose the relevant penalty addition_to_tax or additional_amount 118_tc_358 see also 116_tc_438 if a taxpayer files a petition alleging some error in the determination of an addition_to_tax or penalty the taxpayer’s challenge will succeed unless the commissioner produces evidence that the addition_to_tax or penalty is appropriate swain v commissioner supra pincite the commissioner however does not have the obligation to introduce evidence regarding reasonable_cause or substantial_authority higbee v commissioner supra pincite b sec_6651 respondent determined that petitioner is liable for an addition_to_tax pursuant to sec_6651 for sec_6651 imposes an addition_to_tax for failure_to_file a return on the date prescribed determined with regard to any extension of time for filing unless such failure is due to reasonable_cause and not due to willful neglect respondent submitted a certified transcript of petitioner’s account for the certified transcript states that petitioner did not file a return for accordingly respondent has met his burden of production for the sec_6651 addition_to_tax for petitioner has not established that his failure to timely file for was due to reasonable_cause see higbee v commissioner supra pincite accordingly petitioner is liable for the sec_6651 addition_to_tax for c sec_6654 sec_6654 imposes an addition_to_tax for failure to pay estimated income_tax respondent submitted petitioner’s form_w-2 for from enterprise network sys inc and a certified transcript of petitioner’s account for the forms indicate that petitioner did not have any federal_income_tax withheld and did not make any estimated income_tax payments for we conclude that respondent has satisfied his burden of production regarding this issue thus petitioner must come forward with evidence sufficient to persuade the court that respondent’s determination is incorrect see rule a 290_us_111 see higbee v commissioner supra pincite we find that petitioner had no income_tax withheld and paid no estimated income taxes for and that no exception pursuant to sec_6654 applies we hold that petitioner is liable for the addition_to_tax pursuant to sec_6654 sec_6673 sec_6673 authorizes this court to require a taxpayer to pay to the united_states a penalty not to exceed dollar_figure if the taxpayer took frivolous or groundless positions in the proceedings or instituted the proceedings primarily for delay a position maintained by the taxpayer is frivolous where it is contrary to established law and unsupported by a reasoned colorable argument for change in the law 791_f2d_68 7th cir see also 820_f2d_1464 9th cir sec_6673 penalty upheld because taxpayer should have known claim was frivolous petitioner filed numerous frivolous documents and motions with the court petitioner has advanced shopworn arguments characteristic of tax-protester rhetoric that has been universally rejected by this and other courts 848_f2d_1007 9th cir affg tcmemo_1987_225 784_f2d_1006 9th cir we will not painstakingly address petitioner’s assertions with somber reasoning and copious citation of precedent to do so might suggest that these arguments have some colorable merit 737_f2d_1417 5th cir we conclude petitioner’s position was frivolous and groundless and that petitioner instituted and maintained these proceedings primarily for delay accordingly pursuant to sec_6673 we hold petitioner is liable for a dollar_figure penalty to reflect the foregoing an appropriate order and decision will be entered