department of the treasury internal_revenue_service washington d c office_of_chief_counsel date number release date cc ita b7 uilc internal_revenue_service national_office legal advice memorandum for associate area_counsel lmsb from heather c maloy associate chief_counsel ita cc ita subject this chief_counsel_advice responds to your memorandum dated date in accordance with sec_6110 this chief_counsel_advice should not be cited as precedent legend partnership state a dollar_figurex dollar_figurey dollar_figurez year year association issue whether sec_265 applies to disallow deductions for interest_paid on partnership’s repurchase agreements conclusion the determination of whether sec_265 applies is a facts_and_circumstances_test the facts indicate that a portion of partnership’s interest_expenses may be subject_to disallowance under sec_265 facts partnership is a state a limited_partnership that claimed interest_expenses of dollar_figurex for year and dollar_figurey for year the service disallowed under sec_265 a portion of the claimed investment_interest expense in each year the disallowance for each year was determined by multiplying the partnership’s total investment_interest expense by the ratio of the average fair_market_value of the partnership’s tax- exempt obligation to the average fair_market_value of all the partnership’s income- producing assets the tax_matters_partner tmp of the partnership contested the disallowance during the years at issue the partnership traded in securities engaging in transactions in securities and derivatives thereof including swaps puts calls and options the partnership was not a completely passive investor holding securities for long-term appreciation the partnership’s investment strategy involved frequent transactions designed to take advantage of short-term market fluctuations the partnership was not a dealer_in_securities all of the partnership’s investments were made for its own account it did not take make or place any orders investments or positions for or on behalf of others nor did it hold any assets investments or positions for or on behalf of others none of the partnership’s assets were acquired or held as inventory or otherwise for sale to customers during the years at issue the partnership financed and carried substantial positions in treasuries and foreign government bonds taxable bonds with repurchase agreements repo transactions essentially the partnership’s repo transactions were secured loans of up to of the purchase_price of the taxable bonds in a typical repo transaction the partnership sold the taxable bonds to a bank or broker subject_to an agreement by the partnership to repurchase them at a future date at a specified price exceeding the partnership’s original sale price the difference between the sale price and the repurchase price representing the interest_expense typically the term of a repo transaction varied from one to sixty days but the partnership frequently continued the financing at the end of the term by entering into successive repo transactions the partnership’s investment objective in carrying these positions through repo transactions was to profit from short-term fluctuations in price of the taxable bonds the funds for repurchasing the bonds subject_to a repo transaction were obtained by selling the bonds on the market the proceeds of each repo transaction were traceable to the purchase of specific taxable bonds which constituted the primary collateral security for the partnership’s repurchase obligation the investment_interest expense claimed by the partnership included the interest_expense incurred in the partnership’s repo transactions the claimed investment_interest expense also included a relatively minor amount of interest_expense reported on the forms k-1 issued to the partnership as a limited_partner in second- tier_partnerships during the years at issue the partnership held substantial amounts of tax-exempt_bonds issued by local and state governments none of these bonds were acquired with the proceeds of the financing provided by the repo transactions nor were the bonds pledged or held as collateral to secure the financing provided by the repo transactions during the years at issue a significant part of the tmp’s investment strategy involved the use of privately negotiated notional_principal_contracts or swaps the partnership was a member of the association a trade_association representing leading participants in the privately negotiated derivatives industry a business which includes interest rate currency commodity credit and equity swaps as well as related products such as caps collars floors and swaptions the association offers its members a master agreement agreement and related documentation materials and instruments designed to reduce legal and credit risks in derivatives transactions an association agreement provides security for participants in these transactions by making their respective obligations mutually dependent during the years at issue the partnership had outstanding association agreements with a number of institutional counter parties with which the partnership engaged in one or more swap transactions in a security_agreement annexed to each association agreement the partnership agreed to provide one or more forms of additional security including letters of credit third-party guarantees pledges of swap assets or proceeds and required deposits with rights of offset typically an institutional counter party to an association required that the partnership deposit with the institution cash or high-grade fixed-income securities such as treasuries marked to market in an amount equal at any given time to the counter party’s exposure creating a right of offset exercisable by the institution if the partnership defaulted a schedule attached to the association agreement provided that the partnership’s failure to maintain a specified minimum level of capital typically in treasuries and or tax-exempt obligations constituted a default with respect to all outstanding transactions under the association agreement the agreement also provided that a default by one party gave the non-defaulting party the right to terminate outstanding transactions it also required the defaulting party to reimburse the non-defaulting party for any losses during the years at issue the partnership held approximately in tax- exempt bonds which the partnership used to meet the minimum capital 1we do not have enough facts to express an opinion on whether this interest_expense should be disallowed requirements imposed by the association agreement the partnership satisfied its minimum capital requirements under the association agreements with tax-exempt_bonds rather than taxable bonds because the tax-exempt_bonds had a better after- tax yield you think sec_265 should be applied to disallow interest in proportion to tax exempt obligations total assets even without direct tracing of proceeds of repo indebtedness to tax exempts according to your argument the partnership is not a dealer and therefore can not have a business reason for holding tax exempt obligations rather it is an investor and the tax exempt bonds are part of its portfolio you also think that in any event the partnership does not have a business reason for holding tax exempt bonds because liquidity requirements of third parties could have been satisfied by treasuries law and analysis sec_163 generally allows a deduction for all interest_paid or accrued on indebtedness within the taxable_year sec_265 however disallows interest deductions on indebtedness incurred or continued to purchase or carry tax- exempt obligations the statute has been interpreted to disallow interest deductions based on the purpose of the borrowing the statute is designed to prevent escape from taxation of income properly subject_to tax by the purchase of exempt securities with borrowed money denham v slayton 282_us_514 however it is not activated by the mere simultaneous existence of indebtedness and the holding of tax-exempt obligations 60_tc_497 aff’d 503_f2d_102 6th cir bradford v commissioner 60_tc_263 thus taxpayers need not automatically liquidate tax-exempt obligations before obtaining needed funds through borrowing indian trading post inc pincite 388_f2d_420 7th cir 54_tc_1200 nevertheless a taxpayer cannot insulate himself from the prohibition of sec_265 by merely juggling the use of his available assets so as to create a surface sanitation of the indebtedness from the acquisition or holding of tax-exempt obligations indian trading post inc pincite citing 375_f2d_1016 ct_cl 41_tc_154 aff’d 342_f2d_757 6th cir the purpose for incurring or continuing indebtedness is determined based on all the facts and circumstances and may be established either by direct or indirect evidence see 60_tc_497 aff’d 503_f2d_102 6th cir section dollar_figure of revproc_72_18 1972_1_cb_740 the taxpayer bears the burden of proving that no prohibited purpose existed sec_265 was previously designated sec_265 for purposes of this advice we will use the designation a indian trading post inc pincite 875_f2d_293 784_f2d_375 n fed cir direct evidence of a purpose to purchase tax-exempt obligations exists where the proceeds of indebtedness are used for and are directly traceable to the purchase of tax-exempt obligations 411_f2d_614 cert_denied 396_us_1008 section dollar_figure of revproc_72_18 except in the case of dealers in tax-exempt obligations direct evidence of a purpose to carry tax-exempt obligations exists where tax-exempt obligations are used as collateral for indebtedness wisconsin cheeseman inc pincite 784_f2d_375 fed cir section dollar_figure of revproc_72_18 in the absence of direct evidence sec_265 applies only if the totality of facts and circumstances support a reasonable inference that a purpose to purchase or carry tax-exempt obligations exists wisconsin cheeseman inc pincite section dollar_figure of revproc_72_18 revproc_72_18 one focus of your advice request is whether partnership qualifies as a being engaged in a trade_or_business for purposes of sec_4 of revproc_72_18 which provides guidelines for individuals and in this case partnerships and the extent if any to which partnership falls under the guideline in the revenue_procedure section dollar_figure of revproc_72_18 provides that absent direct evidence of the purpose to carry tax-exempt obligations the rule_of sec_4 will apply section dollar_figure outlines certain situations where sec_265 will not apply to a taxpayer who holds tax-exempt obligations and incurs interest on other indebtedness under sec_4 a taxpayer who holds tax-exempt obligations and incurs indebtedness of a personal nature that is for purchases for personal consumption and for a home mortgage may still deduct the interest on the indebtedness similarly section dollar_figure of revproc_72_18 provides guidelines for individuals and partnerships engaged in the active_conduct_of_a_trade_or_business it states that t he purpose to purchase or carry tax-exempt obligations generally does not exist with respect to indebtedness incurred or continued by an individual in connection with the active_conduct of trade_or_business other than a dealer in tax-exempt obligations unless it is determined that the borrowing was in excess of business needs emphasis added thus a partnership in the active_conduct_of_a_trade_or_business may under some circumstances in addition to those laid out in sec_3section guidelines for dealers in tax-exempt obligations and section procedures of revproc_72_18 discuss additional circumstances in which interest incurred by dealers in tax-exempt obligations will be disallowed these circumstances will not be discussed here since partnership was not a dealer purchase or carry tax-exempt obligations and also incur business-related indebtedness provided the borrowing does not exceed the business’s needs however section dollar_figure also notes case law establishing a rebuttable_presumption that a taxpayer has a purpose to carry tax-exempt obligations where the taxpayer could have reasonably foreseen the need to incur future indebtedness when it purchased the tax-exempt obligations section dollar_figure of the revenue_procedure limits the general guidelines of sec_4 section dollar_figure provides that a purpose to carry tax-exempt obligations will generally be inferred wherever the taxpayer has outstanding indebtedness which is not incurred or continued in connection with the active_conduct_of_a_trade_or_business and the taxpayer owns tax-exempt obligations the section further states that the p urchase and sale of securities shall not constitute the active_conduct_of_a_trade_or_business unless the taxpayer is a dealer_in_securities within the meaning of sec_1_471-5 of the income_tax regulations sec_5 of the revenue_procedure provides guidelines for dealers here all of the partnership’s investments were made for its own account thus it was not a dealer and therefore was not in a trade_or_business for purposes of section dollar_figure of the revenue_procedure if it was not in a trade_or_business for purposes section dollar_figure of the revenue_procedure a purpose to carry tax-exempt obligations will be inferred sec_4 of the revenue_procedure by its reference to wisconsin cheeseman is obviously intended to apply to taxpayers whose trade_or_business involves manufacturing or selling goods and services or the buying of tangible assets such as the taxpayers in wisconsin cheeseman illinois terminal railroad co v united_states supra or 61_tc_846 section dollar_figure excludes those in the trade_or_business of buying and selling securities from the guideline because such taxpayers are likely to carry tax-exempt obligations as part of their trade_or_business and are also likely to borrow funds in the regular course of their business allowing them to hold tax-exempts and deduct interest on their borrowing without further scrutiny on the theory that their borrowings are for the reasonable_needs_of_the_business would defeat the purpose of the revenue_procedure as well as the underlying statute and case law thus taxpayers in the trade_or_business of buying and selling securities are necessarily excluded from the favorable presumption in section dollar_figure of the revenue_procedure this fact is reinforced by section dollar_figure of the revenue_procedure which reads in pertinent part 4stated differently interest on partnership’s indebtedness will not qualify for deduction under the general guidelines of section dollar_figure for individuals engaged in an active trade_or_business therefore partnership may deduct the interest under the guidelines of the revenue_procedure only if qualifies for the relief granted under sec_4 which it does not generally a purpose to carry tax-exempt obligations will be inferred unless rebutted by other evidence whenever the taxpayer has outstanding indebtedness which is not directly connected with personal expenditures see sec_4 and is not incurred or continued in connection with the active_conduct_of_a_trade_or_business see sec_4 and the taxpayer owns tax-exempt obligations this inference will be made even though the indebtedness is ostensibly incurred or continued to purchase or carry other portfolio investments c b pincite the section goes on to say that portfolio investments for purposes of this revenue_procedure are transactions not connected with the active_conduct_of_a_trade_or_business and then makes the crucial for our purposes statement p urchase and sale of securities is not the active_conduct_of_a_trade_or_business the reference to portfolio investments in this context with the qualification they are not transactions connected with the active_conduct_of_a_trade_or_business for for purposes of this revenue_procedure is further support for the conclusion that the guidelines of the revenue_procedure were not intended to apply to taxpayers engaged in the trade_or_business of buying and selling securities along these lines section of the revenue_procedure provides guidelines for corporations that are not dealers in tax-exempt obligations section dollar_figure states that t he purpose to purchase or carry tax-exempt obligations will not be inferred with respect to indebtedness incurred or continued to provide funds for carrying on an active trade_or_business not involving the holding of tax-exempt obligations unless it is determined that the borrowing was in excess of business needs the fact that section dollar_figure excludes trades_or_businesses that involve the holding of tax- exempt obligations such as the trade_or_business of buying and selling securities is further evidence that the revenue_procedure is not intended to apply to such businesses unless they are dealers trade_or_business the prior analysis of revproc_72_18 assumes that partnership is engaged in the active_conduct_of_a_trade_or_business this has not been established therefore an inquiry into whether partnership was engaged in a trade_or_business under established case law regardless of the guidelines in the revenue_procedure is necessary for tax purposes individuals and entities which purchase and sell stock and securities are either dealers traders or investors both traders and dealers engage in the trade of business of buying and selling stocks and securities whereas the activities of an investor do not qualify as a trade_or_business unlike a dealer whose business involves the sale of stocks or securities to customers a trader does not have customers in his business traders occupy an unusual position under the tax law because they engage in a trade_or_business which produces capital_gains_and_losses paoli v c i r 62_tcm_275 citing 89_tc_445 the internal_revenue_code has never contained a definition of the phrase trade_or_business 480_us_23 the determination of whether a taxpayer’s trading activities rise to the level of carrying_on_a_trade_or_business turns on the facts and circumstances of each case 889_f2d_29 2d cir aff’g 92_tc_180 citing 312_us_212 in order to qualify as a trader engaged in a trade_or_business of buying and selling stocks and securities a taxpayer’s trading activities must be frequent regular and continuous see generally 480_us_23 mere management of one’s investments is not a trade_or_business regardless of how extensive or substantial the investment activities higgins v commissioner pincite 89_tc_445 steffler v commissioner tcmemo_1995_271 in deciding whether a taxpayer is in the trade_or_business of trading securities the courts generally look to three factors the taxpayer’s investment intent the nature of the income derived from the activity and the frequency extent and regularity of the taxpayer’s transactions 721_f2d_810 fed cir in this regard there is a two-part test to determine if a taxpayer who manages his own affairs is a trader or investor a taxpayer’s activity is considered that of a trader if the trading is substantial and the taxpayer seeks to profit from daily or short-term swings in the market mayer v commissioner tcmemo_1994_209 dougherty v commissioner tcmemo_1994_597 in other words a trader must show that he is engaged in purchasing and selling stock regularly frequently and in substantial volume and also that his objective is to profit from short-term market swings not long-term appreciation and income paoli v commissioner tcmemo_1991_351 in your facts you state that during the years at issue partnership engaged in transactions in securities and derivatives thereof including swaps puts calls and options you further state that partnership’s investment strategy involved frequent transactions designed to take advantage of short-term market fluctuations you also state that partnership’s investment objective in the repo transactions was to profit from short-term fluctuations in price of the taxable bonds 5however if a trader in securities makes the election under sec_475 of the code any gain_or_loss associated with the trader’s trade_or_business of trading stock_or_securities is treated as ordinary_income or loss nonetheless as noted above this is a facts_and_circumstances_test in paoli the taxpayer engaged in sales of stocks or options during the year at issue some percent of these transactions involved stocks held for less than days in holding that the taxpayer was not a trader the court noted that nearly percent of the transactions were made during a one-month period at the beginning of the year some percent of the sales occurred in january february march and may and approximately percent of the taxpayer’s total_proceeds for the year came from these sales as well as percent of the taxpayer’s total losses additionally in the last three months of the year there was only one sale the court held that the taxpayer’s pattern of buying and selling was not sufficiently regular and continuous during the year to constitute a business although the court conceded that his activity in the first month of the year resembled that of a trader it nonetheless ruled against him because this pattern did not continue throughout the year it should also be emphasized that mere volume of transactions is not enough to convert an investor to a trader in estate of yeager the decedent had over transactions in the two years at issue and pursued his security activities vigorously and extensively f 2d pincite nonetheless the court stated ‘ n o matter how large the estate or how continuous or extended the work required may be ’ the management of securities investments is not the trade_or_business of a trader id pincite citing higgins v commisioner u s pincite the court instead looked to the length of time yeager had held his securities and the fact that most of his profit came from holding undervalued stock until the market improved id pincite similarly in mayer v commissioner tcmemo_1994_209 the court held that a taxpayer’s trading was substantial in both number of trades and dollar amount because he had more than a thousand transactions in each of three years and his gains were in the millions of dollars for each of the years thus he met the first prong of the two-part test however because his average holding periods for the years were and days respectively the court held that his emphasis was on capital growth and profit from resale since he did not seek to profit from short-term market swings he did not meet the second prong of the test and therefore was not in a trade_or_business prohibited purpose whether or not partnership was engaged in a trade_or_business it still has as noted above the burden of proving that it did not incur the debt at issue for the prohibited purpose of carrying tax-exempt obligations as further noted above the determination is based on the totality of the facts and circumstances where there is direct evidence that the taxpayer incurred the debt for the purpose of purchasing or carrying tax-exempt obligations the interest on the debt is disallowed even though the taxpayer acquired the obligations for resale and not to earn tax-exempt_income 413_f2d_636 2d cir cert_denied 396_us_1007 section dollar_figure of revproc_72_18 states that d irect evidence of a purpose to purchase tax-exempt obligations exists where the proceeds of indebtedness are used for and are directly traceable to the purchase of tax-exempt obligations this principle is firmly established in case law 411_f2d_614 cert_denied 396_us_1008 section dollar_figure of revproc_72_18 provides that t he purpose to purchase or carry tax-exempt obligations generally does not exist with respect to indebtedness incurred or continued by an individual in connection with the active_conduct of trade_or_business unless it is determined that the borrowing was in excess of business needs thus an individual or in this case a partnership in the active_conduct_of_a_trade_or_business may under some circumstances purchase or carry tax-exempt obligations and also incur indebtedness provided the borrowing does not exceed the business’s needs nevertheless section dollar_figure also provides that that there is a rebuttable_presumption that the purpose to carry tax-exempt obligations exists where the taxpayer reasonably could have foreseen at the time of purchasing the tax-exempt obligations that indebtedness would have to be incurred to meet future economic needs of the business of an ordinary recurrent variety this principle is based on wisconsin cheeseman f 2d pincite there the seventh circuit held that collateralizing indebtedness with tax-exempt securities was direct evidence of the prohibited purpose id however no court has adopted the so-called cheeseman corollary which posits that if interest on loans collateralized with tax-exempt obligations is conclusively nondeductible then interest on loans collateralized with 6the fact that the indebtedness and interest deductions at issue arise as a result of repurchase transactions should not preclude the difference between the sales and repurchase prices as qualifying as interest under sec_265 although the tax_court in 74_tc_1342 held that the repurchase agreements at issue were not loans for purposes of sec_265 this conclusion was based partially on the fact that the repurchase agreements were ordinary bank_deposits and the form of the transaction is an ordinary and customary despository transaction t c pincite the court further noted this distinction between a bank’s indebtedness and other taxpayers’ indebtedness in mcdonough v commissioner tcmemo_1982_236 taxable obligations is conclusively deductible this theory was specifically rejected in dillon read co v united_states pincite thus the fact that the repos were collateralized with taxable obligations does not conclusively show that partnership did not have the prohibited purpose section dollar_figure creates a rebuttable_presumption of a purpose to carry tax-exempt obligations whenever a taxpayer owns tax-exempt obligations and has outstanding indebtedness which is not incurred or continued in connection with the active_conduct_of_a_trade_or_business even though such indebtedness is ostensibly incurred or continued to purchase or carry other portfolio investments if the court were to rule that partnership is a trade_or_business for purposes of the revenue_procedure a result which we do expect as discussed above it might also rule that section dollar_figure does not apply since the indebtedness was incurred or continued in connection with partnership’s business however this means that the rebuttable_presumption created by the revenue_procedure does not apply it does not necessarily mean that the court would ignore favorable case law furthermore the finding of the taxpayer’s purpose does not depend solely upon looking into his mind and learning what he was thinking although his intentions are relevant purpose may be inferred from his conduct and from the circumstances that confronted him 50_tc_11 rev’d on other grounds 413_f2d_636 2nd cir the inquiry is whether there is a sufficient purposive connection between the borrowing and the investment h enterprises international inc v commissioner tcmemo_1998_97 aff’d 183_f3d_907 8th cir in 811_f2d_581 fed cir the court held that the fact that the taxpayer may not have incurred the subordinated indebtedness specifically to purchase tax-exempts is not dispositive however where trading in tax-exempts and the incurring of long-term indebtedness both represent a regular continuous routine and substantial part of taxpayer’s daily business taxpayer’s decision to continue rather than retire its subordinated indebtedness undoubtably facilitates the ability to carry tax-exempts the appeals court noted a continued solid tie between the incurring of subordinated indebtedness and the purchase and maintenance of tax-exempts f 2d pincite similarly in commissioner v leslie supra involved brokerage firm that routinely borrowed on a day-day basis to finance its operations and held tax-exempt obligations it also commingled the proceeds of the loans with its other funds making direct tracing of the loan proceeds impossible in holding that sec_265 applied the court noted that since the taxpayer borrowed money for the purpose of conducting its business including the holding of some tax-exempt securities and since the use of the borrowed funds cannot be traced it is reasonable to allocate them to all the business purposes of the taxpayer f 2d pincite accordingly t here was a direct relationship between the continuance of the debt and the carrying of tax-exempt securities id pincite as the tax_court put it in bradford v commissioner leslie permits the proscribed purpose to be inferred from a continuous course of conduct involving borrowing and the acquisition of tax-exempt securities t c pincite here partnership appears to be routinely borrowing at the same time that it holds the tax-exempts therefore the logic of leslie may apply bradford v commissioner like leslie and e f hutton involved a brokerage firm that held tax-exempts and regularly borrowed on a daily basis for its business needs the court rejected as far too simplistic the taxpayer arguments that it borrowed simply to maintain bank balances necessary to carry on its business and that application of sec_265 to its situation would substitute a mechanical allocation for the ‘purpose’ test t c pincite this approach the court said would allow the taxpayer to escape sec_265 simply because it dealt in both taxable securities and tax-exempt_bonds id here partnership should not necessarily escape sec_265 simply because of the range of securities and instruments it holds here although partnership apparently holds the tax-exempts rather than trading them the indebtedness at issue that is the repo transactions seems to represent a regular continuous routine and substantial part of taxpayer’s daily business as in e f hutton the terms of the repo transactions varied from one to sixty days but the fact that partnership frequently continued the financing at the end of the term by entering into successive repo transactions may serve to characterize the repo transactions as long-term indebtedness furthermore as commissioner v leslie and bradford v commissioner demonstrate it is does not appear to be necessary to show that the actual instruments were long-term in any case this fact was not necessarily critical to the federal_circuit t he fact that e f hutton’s subordinated borrowings were made on a long-term basis rather than daily is irrelevant and does not compel a different result f 2d pincite we also see some similarity to a case involving an investor 41_tc_154 aff’d 342_f2d_757 6th cir there the taxpayer borrowed funds to purchase stocks and debentures which had taxable returns she subsequently sold the stocks and bought tax-exempts the court 7the fact that e f hutton leslie and bradford all involved brokerage houses should not make a difference in their application here as noted previously the tax_court held in bradford that sec_265 on its face makes no distinction between classes of taxpayers t c pincite concluded she continued the loan instead of repaying it with the proceeds of the sale of the non-tax-exempt securities so that she would have the funds to purchase and hold tax-exempt securities t c pincite here it can be argued that partnership continued the repo transactions so that it could have the funds to hold the tax-exempts additionally under wisconsin cheeseman interest deductions are generally disallowed to the extent the subject indebtedness is incurred to meet recurring expenses and that the taxpayer at the time it acquired the tax-exempt obligations could reasonably foresee that it would probably have to incur indebtedness to meet such expenses f 2d pincite the indebtedness at issue here is of a recurring nature and thus the need to incur it is foreseeable partnership should not be able to insulate itself from the prohibition of sec_265 by merely juggling the use of its available assets so as to create a surface sanitation of the indebtedness from the acquisition or holding of tax-exempt obligations indian trading post inc pincite finally regarding the partnership’s liquidity requirements there is nothing in the facts to indicate that those liquidity requirements could only be met by tax-exempts in new mexico bancorporation supra the court’s finding that sec_265 did not apply was based in part on the fact that the purchase of state and municipal_bonds was necessary to satisfy the taxpayer’s liquidity and pledge requirements as the tax_court subsequently stated i ndebtedness of a bank to its depositors is not treated as indebtedness incurred to purchase tax-exempt securities largely because such treatment would seriously interfere with the marketing of government securities that are mostly purchased by banks mcdonough v commissioner tcmemo_1982_236 43_tcm_1273 absent such a showing here partnership’s holding of the tax-exempt obligations in the face of its recurrent borrowing indicates the presence of the prohibited purpose case development hazards and other considerations this writing may contain privileged information any unauthorized disclosure of this writing may have an adverse effect on privileges such as the attorney client privilege if disclosure becomes necessary please contact this office for our views please call if you have any further questions by heather c maloy associate chief_counsel ita jeffery g mitchell senior technician reviewer cc ita b07


uniform issue list department of the treasury internal_revenue_service washington d c apr gtef hb ofs attn legend state a plan x statute d statute e resolution f regulation g dear this is in response to a ruling_request dated date as supplemented by additional correspondence dated date date date date date and date from your authorized representative concerning the pick up of certain employee contributions to plan x under sec_414 of the internal_revenue_code code the following facts and representations have been submitted plan x is a fund established to pay benefits to teachers and to supervisors of teachers in the public schools of state a and its political subdivisions plan x is a defined_benefit_plan which satisfies the requirements of code sec_401 and is governed by state a statutes in addition plan x is a governmental_plan within the meaning of code sec_414 plan x maintains two types of accounts an annuity savings account and a retirement allowance account under state a statutes plan x is further segregated into the pre-1996 account and the account member contributions made after date are credited to the annuity savings accounts within the account with respect to a member who was hired after date by an institution covered by plan x or a member who before date served in a position covered by plan x and after date was hired by another institution covered by plan x or rehired by a prior employer all other member contributions are credited to the annuity savings accounts within the pre-1996 account employer contributions made after date with respect to members described in and above are credited to the retirement allowance account within the account and employer contributions made after date with respect to all other members are credited to the retirement allowance account within the pre- account under plan x employer contributions are paid to the retirement allowance account from which a defined benefit is paid at retirement the retirement allowance account of the pre-1996 account consists of the pre-1996 account exclusive of the annuity savings account and the retirement allowance account of the account consists of the account exclusive of the annuity savings account for the account separate_accounts within the retirement allowance account are maintained for contributions made by state a by each school corporation and by each institution members’ contributions are paid to each member's separate annuity savings account which at distribution may be paid out as a lump sum or an annuity the board_of trustees of plan x maintains a guaranteed program and an alternative investment program for the investment of the members’ contributions in the guaranteed program a stated_interest rate is credited on each member's account on the other hand in the alternative investment program the gain_or_loss in market_value on the member's account is attributed to the member's account the member may direct the allocation of the member's annuity savings account among the guaranteed fund and any available alternative investment funds in increments contributions to plan x include amounts from employers and employees under statute d each member is required to contribute to plan x a percentage of compensation as a condition_of_employment pursuant to statute e the member's employer may pick up and pay the mandatory contribution for the member within the meaning of code sec_414 in the state a general assembly amended statute d to allow a member of plan x to make an additional employee contribution to the member's annuity savings account this contribution is in addition to the mandatory employee contribution the total amount of additional employee contributions that may be made to a member's annuity savings account with respect to a payroll_period _ may not exceed ten percent of the member's compensation_for that payroll_period in addition statute d provides that in compliance with the rules adopted by the board_of trustees of plan x a member's employer may pick up and pay the additional employee contributions under code sec_414 the employer shall reduce the member's compensation by an amount equal to the amount of the member's additional employee contributions that are picked up by the employer employers may elect to participate in the pick up of the additional employee contributions by adopting resolution f the resolution states that the additional employee contributions even though designated as employee contributions for state law purposes are being paid_by the employer in lieu of contributions by the employee the resolution also states that a participating employer shall pick up all of the additional employee contributions made by employees through a binding irrevocable payroll deduction authorization and shall comply with all the terms and conditions of regulation g and applicable provisions of the code members electing to make additional employee contributions to the member's annuity savings account in plan x do so by completing a binding payroll deduction authorization form the form states that the authorization is irrevocable and that the contributions are being picked up by the employer and the employee does not have the option of receiving the deducted amounts directly instead of having them paid_by the employer to plan x the irrevocable payroll deduction authorization may only be made during an election_period that period will begin on the september following the plan_year in which the employee completes five years of creditable service under plan x and ends two years later on august of the second calendar_year following the opening of the election_period the authorization provides that a dollar amount but not more than of compensation shall be deducted per pay_period beginning with the pay_period immediately after the employer receives the authorization and continuing until the employee’s termination of employment or death proposed regulation g under statute d provides that if a member terminates and then returns to covered employment with a different employer when the member has five or more years of creditable service credited or recredited under state a statutes the member shall be entitled to execute a new binding irrevocable payroll deduction authorization within a two year election_period beginning on the september following the plan_year in which the employee completes or is recredited with five years of creditable service and ending on the august of the second calendar_year following the opening of the election_period if a member terminates and then returns to covered employment with the same employer the member's binding irrevocable payroll deduction authorization if any shall be immediately effective upon rehire the following is a summarization of the provisions of proposed regulation g that deal with a member's election to make additional employee contributions through irrevocable payroll deductions once a member in active covered employment has executed a binding irrevocable payroll deduction authorization with respect to any additional employee contributions he or she shall not be entitled to any option of choosing to receive the contributed amounts directly instead of having them paid_by the employer to plan x the contributions shall be remitted to plan x in the same manner as all other contributions made by the employee and shall be credited to the member's annuity savings account the salary the employer shall use to calculate such contributions is the same as the salary the employer reports to the board_of trustees of plan x for purposes of determining a member’s mandatory_contributions and benefit calculation the additional employee contributions although designated as employee contributions will be paid_by the employer in lieu of contributions by the employee members in active covered employment may elect to pay all or part of any additional employee contributions through payroll deduction the amounts to be deducted and the duration of the deduction shall be specified on the authorization form and such amounts and duration shall be irrevocable and binding once the authorization is made prepayment of amounts covered by the authorization is not permitted however a member may pay any amounts not covered by the authorization with after-tax_dollars up to the statutory maximum the payroll deduction shall not begin unless and until the member in service executes the payroll deduction authorization after the treasurer or other disbursing officer of the employer receives the binding irrevocable payroll deduction authorization from the employee he or she shall add such contributions to the contributions deducted from the member’s regular compensation each pay day the employer shall continue to make the deductions for the duration specified on the form and shall treat these deductions as picked-up contributions all payroll deductions covered by the binding irrevocable payroll deduction authorization including the amounts and the duration specified therein shall be binding and irrevocable upon the member's execution of the authorization form the deductions covered by such authorization shall cease only upon either the member's death or the termination of the member’s employment distribution of the additional employee contributions shall be made in the same manner as distribution from the member's annuity savings account in no event shall the member receive a return of the payroll deductions made under the above rules except pursuant to the normal disbursement procedures under plan x members with at least five years of creditable service as of date may elect to make additional employee contributions to their annuity savings accounts through payroll deduction by executing the irrevocable payroll deduction authorization form between date and date based on the foregoing facts and representations you have requested the following rulings that the amounts deducted by employers from an employee’s compensation and paid to an employee’s annuity savings account in order to pay the additional employee contributions as provided by statute d qualify as contributions that are picked up by the employer under code sec_414 that these picked-up contributions will not be treated as annual_additions for purposes of code sec_415 regarding ruling_request one code sec_414 provides that contributions otherwise designated as employee contributions shall be treated as employer contributions if such contributions are made to a plan described in code sec_401 established by a state government or a thereof or any agency_or_instrumentality of any one of the foregoing and are picked up by the employing unit political_subdivision the federal_income_tax treatment to be accorded contributions which are picked up by the employer within the meaning of code sec_414 is specified in revrul_77_462 1977_2_cb_358 in that revenue_ruling the employer school district agreed to assume and pay the amounts employees were required by state law to contribute to a state pension_plan revrul_77_462 concluded that the school district's picked-up contributions to the plan are excluded from the employees’ gross_income until such time as they are distributed to the employees the revenue_ruling held further that under the provisions of code sec_3401 the school district's contributions to the plan are excluded from wages for purposes of the collection of income_tax at source on wages therefore no withholding for federal_income_tax purposes is required from the employees' salaries with respect to such picked-up contributions the issue of whether contributions have been picked up by an employer within the meaning of code sec_414 is addressed in revrul_81_35 1981_1_cb_255 and revrul_81_36 1981_1_cb_255 these revenue rulings established that the following two criteria must be met the employer must specify that the contributions although designated as employee contributions are being paid_by the employer in lieu of contributions by the employee and the employee must not be given the option of choosing to receive the contributed amounts directly instead of having them paid_by the employer to the pension_plan furthermore it is immaterial for purposes of the applicability of code sec_414 whether an employer picks up contributions through a reduction in salary an offset against future salary increases or a combination of both in revrul_87_10 1987_1_cb_136 the internal_revenue_service considered whether contributions designated as employee contributions to a governmental_plan are excludable from the gross_income of the employee the service concluded that to satisfy the criteria set forth in revenue rulings and with respect to particular contributions the required specification of designated employee contributions must be completed before the period to which such contributions relate in this case the one-time irrevocable election by employees who wish to make additional employee contributions to plan x does not violate revenue rulings and because the election does not result in such employees having sufficient control of the contributed amounts to preclude such amounts from being treated as employer contributions resolution f states that additional employee contributions even though designated as employee contributions for state law purposes are being paid_by the employer in lieu of contributions by the employee this satisfies the first criterion set forth in revrul_81_35 and revrul_81_36 which requires that the contributions although designated as employee contributions be paid_by the employer in lieu of contributions by the employee the irrevocable payroll deduction authorization provides the additional employee contributions are being picked up by the employer and the employee does not have the option of receiving the deducted amounts directly instead of having them paid_by the employer to plan x which satisfy both criteria of revrul_81_35 and revrul_81_36 satisfies the criteria of the revenue rulings proposed regulation g as discussed above also for new current and terminated employees who return to service the various participation elections to make additional employee contributions to plan x are consistent with the criteria set forth in revenue rulings and the election_period for new and current employees of participating employers opens on the september following the plan_year in which the employee completes five years of creditable service under plan x and closes on the august that i sec_24 months after that september however current employees with at least five years of creditable service as of date may elect to make additional employee contributions to their annuity savings accounts under plan x by executing the irrevocable payroll deduction authorization during the 24-month period beginning date and ending date for terminated employees who return to covered employment with a different employer when the member has five or more years of creditable service credited or recredited under state a statutes the member shall be entitled to execute a new binding irrevocable payroll deduction authorization within a two year election_period beginning on the september following the plan_year in which the employee completes or is recredited with five years of creditable service and ending on the august that i sec_24 months after that september these employee elections regarding the making of additional employee contributions to plan x are consistent with authority for code sec_414 which requires that employee participation elections must be made within the later of months of the date of hire or months of the date that the employee is participate therefore with respect to ruling_request one we conclude that the amounts deducted by employers from an employee’s compensation and paid to an employee’s annuity savings account under plan x in order to pay the additional employee contributions as provided by statute d qualify as contributions that are picked up by the employer under code sec_414 first eligible to regarding ruling_request two sec_1 d of the income_tax - regulations states that where a defined_benefit_plan provides for mandatory employee contributions the annual_benefit attributable to such contributions is not taken into account for purposes of applying the limitations on benefits described in code sec_415 sec_1 d further provides that the mandatory employee contributions are considered a separate defined_contribution_plan maintained by the employer that is subject_to the limitations on contributions and other annual_additions described in code sec_415 employee contributions however that are picked up by participating employers pursuant to sec_414 are treated as employer contributions and as such are not annual_additions to a separate defined_contribution_plan for purposes of code sec_415 accordingly with respect to the pick up of additional employee contributions paid to plan x we conclude that these picked-up contributions will not be treated as annual_additions for purposes of code sec_415 the effective date for the commencement of any proposed pick up as specified in the resolution f cannot be any earlier than the later of the date the resolution is signed or put into effect or the date the irrevocable payroll deduction authorization is signed by both parties this ruling is conditioned on the adoption of proposed regulation g which governs the pick up of additional employee contributions to plan x as set forth in your authorized representative’s correspondence dated date and further modified by correspondence dated date this ruling is based on the assumption that plan x is qualified under code sec_401 at all relevant times no opinion is expressed as to whether the amounts in question are subject_to tax under the federal_insurance_contributions_act no opinion is expressed as to whether the amounts in question are paid pursuant to a salary reduction agreement’ within the meaning of code sec_3121 this ruling is directed only to the taxpayer that requested it code sec_6110 provides that it may not be used or cited by others as precedent a copy of this ruling has been sent to your authorized representative pursuant to a power_of_attorney on file in this office ep ra t1 id at if you have any questions please call sincerely yours htuareus- e zur bop manager employee_plans technical group enclosures deleted copy of the ruling notice cc


internal_revenue_service number release date index number ---------------------------- -------------------------------------------- ------------------ ------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------- id no ------------ telephone number -------------------- refer reply to cc psi b01 plr-133232-15 date date x state year year ------------------------------------------------------------------------------------------------ -------------------------------------------------- ---------- ------ ------ dear -------------- this responds to a letter dated date submitted on behalf of x by x’s authorized representative requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_754 of the internal_revenue_code code facts the information submitted states that x was formed as a limited_liability_company under the laws of state in year and is classified as a partnership for federal tax purposes in year an interest in x was transferred at that time however x’s tax advisor did not advise x of the availability of an election under sec_754 accordingly x inadvertently failed to timely file a sec_754 election for year law and analysis sec_754 provides that if a partnership files an election in accordance with the regulations prescribed by the secretary the basis of partnership property is adjusted in the case of a distribution_of_property in the manner provided in sec_734 and in the case of a transfer of a partnership_interest in the manner provided in sec_743 such an election shall apply with respect to all distributions of property by the partnership and to all plr-133232-15 transfers of interests in the partnership during the taxable_year with respect to which the election was filed and all subsequent taxable years sec_1_754-1 of the income_tax regulations provides that an election under sec_754 to adjust the basis of partnership property under sec_734 and sec_743 with respect to a distribution_of_property to a partner or a transfer of an interest in a partnership shall be made in a written_statement filed with the partnership return for the taxable_year during which the distribution or transfer occurs for the election to be valid the return must be filed not later than the time prescribed by sec_1 e including extensions thereof for filing the return for that taxable_year sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making regulatory elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and grant of relief will not prejudice the interests of the government conclusion based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to make an election under sec_754 effective for its year taxable_year and thereafter the election should be made in a written_statement filed with the appropriate service_center for association with x’s year tax_return a copy of this letter should be attached to the sec_754 election 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 internal_revenue_code and the regulations thereunder plr-133232-15 this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representative sincerely associate chief_counsel passthroughs special industries by joy c spies joy c spies senior counsel branch passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


internal_revenue_service number release date index number dollar_figure ------------------------------ ------------------------------------------------------------ ---------------------------------------- ---------------------------- --------------------- ------------------------------------ department of the treasury washington dc person to contact --------------------------- id no --------------- ----------------- telephone number ---------------------- refer reply to cc psi b03 - plr-149816-12 date date legend estate a ira x date state b c d dear ------------ ---------------------------------------------------------------------------------------------------------------- ------------ ---------------------------------------------------------------------------------------------------------------- --------------- ----------------------------------------- -------------------- -------------- ---------------------------------------------------------------------------------------------------------------- --------------- ---------------------------------------------------------------------------------------------------------------- --------------- ---------------------------------------------------------------------------------------------------------------- --------------- this letter responds to a letter dated date and subsequent correspondence submitted on behalf of estate by its authorized representative requesting a ruling under sec_691 and sec_401 of the internal_revenue_code plr-149816-12 facts the information submitted states that a maintained an individual_retirement_account ira ira x a died intestate on date at the age of a did not name any beneficiaries of ira x as a result the right to receive ira x passed by state’s intestacy law to b c and d estate's personal representative proposes to subdivide ira x into three sub-iras each sub-ira will be titled a deceased for the benefit of b c or d estate represents that the subdivision of ira x will be made by means of trustee to trustee transfers estate represents further that it will allocate all post-death investment gains and losses for the period prior to the establishment of the sub-iras on a pro_rata basis in a reasonable and consistent manner among the separate_accounts based on the above facts and representations estate requests the following rulings that the division of ira x and the establishment of the three sub-iras will not constitute a transfer within the meaning of sec_691 and b c and d will include in gross_income the amounts of income_in_respect_of_a_decedent ird from their respective sub-iras when the distributions are received by b c and d respectively under sec_691 and that the five-year rule_of sec_401 will continue to apply to each sub- ira law sec_691 provides that the amount of all items of gross_income in respect of a decedent which are not properly includible in respect of the taxable_period in which falls the date of his death or a prior period including the amount of all items of gross_income in respect of a prior decedent if the right to receive such amount was acquired by reason of the death of the prior decedent or by bequest devise or inheritance from the prior decedent shall be included in the gross_income for the taxable_year when received of a the estate of the decedent if the right to receive the amount is acquired by the decedent’s estate from the decedent b the person who by reason of the death of the decedent acquires the right to receive the amount if the right to receive the amount is not acquired by the decedent’s estate from the decedent or c the person who acquires from the decedent the right to receive the amount by bequest devise or inheritance if the amount is received after a distribution by the decedent’s estate of such right plr-149816-12 sec_691 provides that if a right described in sec_691 to receive an amount is transferred by the estate of the decedent or a person who received such right by reason of the death of the decedent or by bequest devise or inheritance from the decedent there shall be included in the gross_income of the estate or such person as the case may be for the taxable_period in which the transfer occurs the fair_market_value of such right at the time of such transfer plus the amount by which any consideration for the transfer exceeds such fair_market_value for purposes of this paragraph the term transfer includes sale exchange or other_disposition or the satisfaction of an installment_obligation at other than face value but does not include transmission at death to the estate of the decedent or a transfer to a person pursuant to the right of such person to receive such amount by reason of the death of the decedent or by bequest devise or inheritance from the decedent sec_1_691_a_-1 provides that the term income_in_respect_of_a_decedent ird refers to those amounts to which a decedent was entitled as gross_income but which were not properly includible in computing the decedent’s taxable_income for the taxable_year ending with the date of the decedent’s death or for a previous taxable_year under the method_of_accounting employed by the decedent sec_1_691_a_-1 provides that the term income_in_respect_of_a_decedent also includes the amount of all items of gross_income in respect of a prior decedent if the right to receive such amount was acquired by the decedent by reason of the death of the prior decedent or by bequest devise or inheritance from the prior decedent and if the amount of gross_income in respect of the prior decedent was not properly includible in computing the decedent’s taxable_income for the taxable_year ending with the date of his death or for a previous taxable_year sec_1_691_a_-4 provides that in general the transferor must include in his gross_income for the taxable_period in which the transfer occurs the amount of the consideration if any received for the right or the fair_market_value of the right at the time of the transfer whichever is greater sec_1_691_a_-4 provides that if the estate of a decedent or any person transmits the right to ird to another who would be required by sec_691 to include such income when received in his gross_income only the transferee will include such income when received in his gross_income sec_1_691_a_-4 provides that if a right to ird is transferred by an estate to a specific or residuary legatee only the specific or residuary legatee must include such income in gross_income when received plr-149816-12 revrul_92_47 1992_1_cb_198 holds that a distribution to the beneficiary of a decedent’s ira that equals the amount of the balance in the ira at the decedent’s death less any nondeductible_contributions is ird under sec_691 that is includable in the gross_income of the beneficiary for the taxable_year the distribution is received sec_408 provides under regulations prescribed by the secretary rules similar to the rules of sec_401 and the incidental death_benefit requirements of sec_401 shall apply to the distribution of the entire_interest of an individual for whose benefit an ira trust is maintained sec_1_408-8 q a a provides that iras are subject_to the regulations regarding required minimum distributions from defined contribution plans under sec_1_401_a_9_-1 through a -9 and a -6 sec_401 provides that if a participant dies before the distribution of his interest has begun in accordance with sec_401 his entire_interest in the plan must be distributed either a within years of the participant’s death under sec_409 or b over the life or over a period not extending beyond the life expectancy of a designated_beneficiary sec_1_401_a_9_-3 q a provides that in order to satisfy the 5-year rule contained in sec_401 the participant’s entire_interest must be distributed by the end of the calendar_year which contains the fifth anniversary of the participant’s death sec_401 provides in relevant part that for purposes of sec_401 the term required_beginning_date means april of the calendar_year following the calendar_year in which the ira owner attains age sec_1_401_a_9_-4 q a defines designated_beneficiary as any individual designated as a beneficiary under the plan sec_1_401_a_9_-4 q a-3 clarifies that only individuals may be designated beneficiaries a person that is not an individual such as a participant’s estate may not be a designated_beneficiary sec_1_401_a_9_-4 q a-1 further provides that a person who takes under a will or otherwise under applicable state law will not be a designated_beneficiary unless that individual also is designated as a beneficiary under the plan revrul_78_406 1978_2_cb_157 states that the direct transfer of funds from one ira trustee to another does not result in a payment or distribution of the funds for purposes of sec_408 revrul_78_406 further provides that such a transfer even if directed by the participant is not a rollover_contribution to the recipient ira for purposes plr-149816-12 of sec_408 because the funds are not within the direct control and use of the participant neither the code nor the income_tax regulations promulgated under sec_401 preclude the posthumous division of an ira into more than one ira analysis and conclusion in this case a the owner of ira x died before attaining his required_beginning_date as that term is defined in sec_401 in addition ira x had no designated_beneficiary accordingly the five-year rule_of sec_401 is applicable to distributions from ira x it is proposed that ira x be subdivided into three sub-iras one of which will benefit b one of which will benefit c and one of which will benefit d the subdivision will be made by means of trustee-to-trustee transfers pursuant to revrul_78_406 thus no distributions will be made from ira x to accomplish its sub-division based solely on the facts and representations submitted we conclude the following the division of ira x and establishment of the three sub-iras will not constitute a transfer within the meaning of sec_691 b c and d will each include in their respective gross_income the amounts of ird from their respective sub-iras when the distribution or distributions from the sub-iras are received by b c and d respectively under sec_691 the five-year rule_of sec_401 will apply to each of the sub-iras except as specifically ruled above we express no opinion concerning the federal tax consequences of the transactions described above under any of the provisions of the code or regulations this letter does assume however that ira x and the resultant sub-iras either satisfied satisfy or will satisfy the requirements of sec_408 at all times relevant thereto plr-149816-12 this ruling is directed only to the taxpayer that requested it sec_6110 provides that it may not be used or cited as precedent sincerely james a quinn senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


internal_revenue_service number release date index number ---------------------- ------------- ----------------------------------------- ------------------------------------- -------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ----------------- telephone number --------------------- refer reply to cc ita b05 plr-111681-09 date date legend taxpayer --------------------------------------------- -------------------------------------- year ------- year ------- date ---------- date ------------------ date dear -------------- this is in reference to a form_1128 application to adopt change or retain a tax_year submitted on behalf of the above-named taxpayer requesting permission to change its accounting_period for federal_income_tax purposes from a taxable_year ending date to a taxable_year ending date effective date year the taxpayer has requested that the form_1128 be considered timely filed under the authority contained in of the procedure and administration regulations the taxpayer’s form_1128 requesting a change in accounting_period to a tax_year ending date was due on or before date year but was not timely filed the information furnished indicates that the taxpayer intended to make the change in a timely manner but that due to error or misunderstanding the form was not timely filed the error was not due to any lack of due diligence or prompt action on the part of the taxpayer sec_301 a of the regulations provides that requests for extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 automatic extensions such as the instant case must be made under the rules of plr-111681-09 sec_301_9100-3 requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government based on the facts and information submitted and the representations made it is held that the taxpayer has acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government accordingly the requirements of the regulations for the granting of relief have been satisfied in this case and the taxpayer’s late-filed form_1128 requesting permission to change to a tax_year ending date effective for the tax_year ending date year will be considered timely filed a copy of this letter_ruling taxpayer’s form_1128 and other relevant documents are being forwarded to the service_center where the taxpayer files its federal_income_tax returns with instructions that the form_1128 be considered timely filed and processed in accordance with established procedures under revproc_2006_45 the ruling contained in this letter is based upon facts and representations furnished by the taxpayer and is limited to the filing of form_1128 except as specifically addressed herein no opinion is expressed as to whether the taxpayer qualified for the automatic consent procedure or regarding the tax treatment of the subject transaction under the provisions of any other section of the internal_revenue_code or income_tax regulations that may be applicable thereto this office has not verified any of the materials submitted in support of the requested ruling verification of factual information representations and other data is within the examination jurisdiction of the taxpayer’s irs industry director copies of this letter_ruling are being provided to the taxpayer’s authorized representative this ruling is directed only to the taxpayer that requested it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent sincerely yours s william a jackson william a jackson chief branch office of associate chief_counsel income_tax accounting enclosures copy for sec_6110 purposes copy of this letter_ruling


office_of_chief_counsel internal_revenue_service memorandum number release date cc pa apjp b02 postn-134648-05 uilc date date third party communication none date of communication not applicable to dianne adelberg partnership technical advisor large midsize business from blaise g dusenberry special counsel administrative provisions and judicial practice ---------------------------------------- subject this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent legend taxpayer partnership individual transferror partner holding trust holding corp redeemed partner business transferee partner purchaser state dollar_figurea dollar_figureb dollar_figurec dollar_figured dollar_figuree ---------------------------------------- ------------------- ------------------------------------------ --------------------------- --------------------------------------- ------------------------------------------------------------------ --------------- ------------------------------------ ---------------------------------------------------- ---------------------------------------- ------------------ ------------ ------------------ ----------- ------------------ postn-134648-05 dollar_figuref dollar_figureg dollar_figureh dollar_figurei dollar_figurej dollar_figurek dollar_figurel issues ----------------- --------------- ------------------ --------------- ------------------ ------------------ ------------ whether the sale of an asset which is used in a trade_or_business and which has an overstated basis can cause an omission of gross_income which may trigger the six year period of limitations on assessment under sec_6501 whether taxpayer partnership made an adequate_disclosure of the nature and amount of the omitted items of gross_income on its return conclusions yes the sale of an asset which is used in a trade_or_business as opposed to being a good sold or a service provided in the course of that trade_or_business and which has an overstated basis can cause an omission of gross_income which may trigger the six year period of limitations on assessment no taxpayer partnership did not made an adequate_disclosure of the nature and amount of the omitted items of gross_income on its return based on our review of the return facts the transaction at issue is the --------return of taxpayer partnership and the omission of gain thereon from its sale of assets used in business to an unrelated party purchaser taxpayer partnership was created to hold the assets of business taxpayer partnership started operations on ------------------ the assets had been held by redeemed partner previously the basis for those assets was inflated in several steps described below the parties involved in these steps include individual who operates and indirectly owns business individual is also the grantor beneficiary of the transferor partner holding trust transferor partner holding trust owns holding corp which in turn owned redeemed partner initially redeemed partner owned an interest taxpayer partnership and transferor partner holding trust owned the other interest transferor partner holding trust also owns transferee partner step taxpayer partnership is created subsequently a disparity between inside and outside_basis in taxpayer partnership is manufactured when postn-134648-05 taxpayer partnership redeems redeemed partner’s interest in taxpayer partnership by issuing a promissory note which is guaranteed by transferor partner holding trust transferor partner holding trust includes this redemption note in its outside_basis under sec_752 step transferor partner holding trust transfers its interest in taxpayer partnership to transferee partner and taxpayer partnership makes an sec_754 election with an sec_743 adjustment step taxpayer partnership sells business to purchaser for cash after adjusting the basis of the assets pursuant to the sec_743 adjustment as a result of these steps the gain on the sale of the appreciate assets of business is deferred until payments on the redemption note are made the reporting taxpayer partnership filed a final as well as the initial year return for the period ------------------ to -------------------------- taxpayer partnership reports gain of dollar_figurea from form_4797 which an attachment shows includes dollar_figureb from the sale of the assets of business to purchaser although the first page of the form_1065 is an irs form most of the rest of the return was filed on state forms state schedule d-1 sales of business property shows the dollar_figurea and under the part headed ordinary gains and losses shows the dollar_figureb gain with the notation see attached the attachment shows a sale of goodwill trademarks on ------------------ ------------ with a gross_sales price of dollar_figurec depreciation allowed of dollar_figured and a cost of dollar_figuree and the resulting gain of dollar_figureb a statement is attached to the return labeled adjustment to basis_of_property resulting from sec_754 election the statement indicates an sec_743 adjustment of dollar_figuref the statement provides a balance_sheet dated -----------------------in two columns one in terms of tax adjusted_basis and the other in terms of value under the balance_sheet category liabilities capital the line item capital is shown as dollar_figureg in the tax adjusted_basis column and dollar_figureh in the value column the statement also shows the computation of adjustment to transferee partner basis in property and computes the dollar_figuref sec_743 adjustment as the difference between the dollar_figureg and the dollar_figureh following transfer of partnership_interest - dollar_figurei capital contributed - dollar_figurej and cash distribution - negative dollar_figurek leaving withdrawals and distributions of negative dollar_figurel law an attachment for the reconciliation of transferee partner’s capital shows the the omitted gain was reportable on a partnership return and therefore the six postn-134648-05 year period in i r c c is at issue i r c c provides for a six year statute_of_limitations where a tefra partnership omits from the calculation of gross_income shown on an income_tax return an amount properly includible therein which is in excess of of the gross_income stated in the return i r c c sets forth a special rule to extend the period of limitations prescribed by sec_6501 and both the definition of gross_income and the adequate_disclosure provision of sec_6501 are encompassed in i r c c 114_tc_533 omission of gross_income issue gross_income means the total of the amounts received or accrued from the sale_of_goods or services if such amounts are required to be shown on the return prior to diminution by the cost of such sales or services exceed sec_25 with the exception of sec_6501 where the statute carves out a special definition for trade_or_business gross_income from the sale_of_goods or services gross_income for purposes of sec_6501 is defined by reference to sec_61 see 101_tc_294 at note under sec_61 gain from the sale of real or personal_property is included in gross_income not the sale proceeds sec_6501 provides that in the case of a trade_or_business the term the service has the burden to establish that omission from gross_income taxpayers may attempt to rely on the supreme court’s decision in 357_us_28 colony held that gross_income under sec_6501's predecessor i r c ' c of the code equaled gross_proceeds but i r c ' c is distinguishable in colony the taxpayer's principal business was the development and sale of lots in a subdivision the taxpayer disclosed the gross_proceeds from the sale but overstated its cost_basis sec_6501 s current language show that after colony s transaction congress clarified the meaning of agross income such that while colony’s holding would remain the same under the current code it is not dispositive of the facts of the subject case sec_275 made no attempt to define gross_income but sec_6501 does in colony the supreme court found the language omits_from_gross_income an amount properly includible therein critical but ambiguous and looked to the legislative sec_61 includes in its nonexclusive list of items that constitute gross_income is a g ains derived from dealings in property at sec_61 treasury regulations further define these property gains as athe excess of the amount_realized over the unrecovered cost or other basis for the property sold or exchanged treas reg dollar_figure a which is in accordance with sec_1001 see 26_tc_30 aff’d 244_f2d_75 6th cir rev’d 357_us_28 postn-134648-05 history where it determined that in enacting sec_275 c congress manifested no broader purpose than to give the commissioner an additional two years to investigate tax returns in cases where because of a taxpayer's omission to report some taxable item the commissioner is at a special disadvantage in detecting errors u s pincite while the purpose of the extended assessment statute may remain the same it is no longer relevant whether an overstated basis puts the commissioner at a special disadvantage because the ambiguity regarding whether an overstated basis can create an omission of gross_income has been eliminated by sec_6501 sec_6501 applies colony s gross_receipts_test only to trade_or_business income arising from the sale of a good or service this partial definition implies that congress did not intend the gross_receipts_test to apply to other types of income colony’s income was trade_or_business income from the sale of a good and therefore sec_6501’s gross_receipts_test would have applied adequate_disclosure issue sec_6501 provides the amount omitted for purposes of the omission test does not include any amount disclosed in the return or in a statement attached to the return in a manner adequate to apprise the secretary of the nature and amount of such item member are considered together with the taxpayer’s return to determine the amount omitted from gross_income if the taxpayer references such an entity on the taxpayer’s return 24_tc_755 accordingly information disclosed in a partnership return or the return of an s_corporation will be taken into consideration in determining whether an omitted item was adequately disclosed on the return of a partner or s_corporation shareholder for purposes of sec_6501 see 54_tc_1336 acq c b xxi aff'd per curiam 444_f2d_90 8th cir moreover if any first_tier_partnership or s_corporation properly references its interest in a partnership or s_corporation disclosures on the returns of those second tier entities are taken into the returns of partnerships_and_s_corporations of which the taxpayer is a see 273_f3d_402 n 1st cir whether colony's main holding carries over to sec_6501 is at least doubtful that section's first special rule adopts justice harlan's gross_receipts_test but only for sales of goods and services sec_6501 the arguable implication is that it does not apply under sec_6501 to other types of income but we need not resolve this issue the supreme court did not purport to explain how an interpretation under the code should incorporate its analysis apparently each party did look to the code for support but the court only comment and without doing more than noting the speculative debate between the parties as to whether congress manifested an intention to clarify or to change the code we observe that the conclusion we reach is in harmony with the unambiguous language of sec_6501 u s pincite the burden of going forward under sec_6501 shifts to the taxpayer postn-134648-05 account see 116_tc_31 concerning second tier_partnerships regarding adequate_disclosure hines v commissioner tcmemo_1989_17 aff’d without opinion 893_f2d_1330 3d cir citing 64_tc_460 acq 1976_2_cb_3 to prevail petitioner must prove that the income_tax return contained a statement adequate to apprise the commissioner of the nature and amount of the item omitted the tax_court has described the test of whether a taxpayer has adequately disclosed an omitted item as follows the proper application of the rule is whether an adjustment might be apparent from the face of the return to the elusive reasonable man hines presumably applying third circuit law see also university country club t c pincite the tax_court explains that the statement on the return providing the disclosure must be sufficiently detailed to apprise the respondent and his agents of the nature and amount of the transaction so that a decision as to whether to select the return for audit may be a reasonably informed one 98_tc_341 aff’d in part and rev’d in part on another issue 998_f2d_567 8th cir 88_tc_1020 university country club inc t c pincite as indicated by the first circuit in 273_f3d_402 1st cir the return must give the commissioner a reason to investigate further regarding the omitted income it is not enough that a taxpayer may string together a series of inferences that could have led to the discovery of omitted income in that case cc f western operations lp cc f was formed to sell interests in several partnerships cc f’s form_1065 omitted income arising from being relieved of a share of partnership liabilities upon the sale of several of the partnership interests cc f had attached the sch k-1 for the partnerships which showed its share of the liabilities of those partnerships the court however found that nothing in the form_1065 indicated the allocation of debt or other sales terms in rejecting the taxpayer’s contention that if the service had combined the amounts reported on the sch k-1s attached to the return the service would have been alerted to the omission because of the large discrepancy between the debt and the reported sales_price the court said in the end the safe_harbor provision of sec_6501 has to be read in light of its purpose namely to give the taxpayer the shorter limitations_period where the taxpayer omitted a particular income item from its calculations but disclosed it in substance the chain of inferences relied upon by western is simply too thin and doubtful to meet this requirement postn-134648-05 f 3d pincite analysis omission of gross_income but rather of an asset created by taxpayer partnership in the course of its trade_or_business that helps it sell goods or services accordingly taxpayer partnership has omitted gross_income adequate_disclosure the sale at issue in taxpayer partnership is not a sale of its goods or services the adequacy of disclosures depends on the nature of the omission we understand you have recommended two alternative grounds for disallowing the step-up_in_basis the alternatives are as follows any promissory notes given by the partnership to any of its purported partners did not constitute partnership liabilities for purposes of sec_752 as a result the purported assumptions of such obligations by the partners of the partnership did not result in an increase of the partners' bases in the partnership consequently the partnership may not increase the basis of the partnership property pursuant to sec_754 and sec_743 the increased basis may be disregarded for federal tax purposes under judicial doctrines including the economic_substance_doctrine and the step_transaction_doctrine in regard to the first ground taxpayer partnership’s return discloses that redeemed partner’s interest was redeemed the return does not disclose that the liability for the redemption note distributed to redeemed partner was assumed by transferor partner holding trust and that transferor partner holding trust increased its outside_basis by the amount of the note the disclosures regarding the sec_754 election and the sec_743 inside_basis adjustment do not provide any disclosures regarding the genesis of the outside_basis adjustment that generates the inside adjustment the disclosure of the sale of goodwill trademarks likewise discloses nothing about the outside_basis manufactured by the redemption note that ultimately inflated the disclosed cost_basis of the goodwill trademarks in regard to the second ground taxpayer partnership’s return lacks disclosures about the relation of the parties the return discloses that transferor partner holding trust transferred its interest to transferee partner the return does not disclose that transferor partner holding trust and transferee partner are ultimately owned by the same person moreover the return does not disclose that redeemed partner as well as transferor partner holding trust and transferee partner are ultimately owned by postn-134648-05 the same person in this regard we note the return of taxpayer partnership is at issue in a tefra proceeding and taxpayer partnership has no interest in another partnership or s_corporation and therefore no gross_income and with it disclosures to take into account under rose and harlan taxpayer partnership does not take into account the gross_income of its members and therefore any returns of the upper tiers and ultimate owner s are not taken into account large dollar amounts are disclosed for the sec_743 adjustment as well as for both the contributions to capital by transferee partner and the partnership_distributions to transferee partner however without a disclosure of the nature of the omission that relates to these amounts the disclosure is not adequate a large number on a return may suggest that the commissioner may wish to examine return we would agree that if the service performed an examination of taxpayer partnership’s return it would have uncovered the abusive transactions the fact that the service might decide to audit a return because of large dollar amounts does not satisfy the requirement that the taxpayer apprise the service of the nature and amount of the omitted item_of_gross_income sec_6501 requires that the disallowance be apparent on the return to a reasonable man to obtain the relief offered by sec_6501 the taxpayer must provide a disclosure that starts an investigation in the direction of the omitted item and not one that simply starts the service down a path without any notion of the item but that winds up at that item due to the examination efforts of the service common sense dispels any other approach the service cannot examine every return with large numbers if the taxpayer points to any disclosures in the subject case they should be of the latter type and the inferences expected from them should be too thin and doubtful to meet the requirements of sec_6501 see cc f western operations lp f 3d pincite case development hazards and other considerations --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------- 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 please call branch of administrative provisions and judicial practice at ------------------- ------- if you have any further questions


internal_revenue_service number release date index number --------------------- --------------------------- -------------------------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact ------------------ id no -------------- telephone number ---------------------- refer reply to cc intl b02 plr-133345-12 date date ty ------- legend taxpayer country x company a accounting firm b date year year dear -------------- ---------------- ------------------------- ----------------------- --------------- ---------------- ----------------- ------- ------- this is in response to a letter received in this office on date submitted on your behalf by your authorized representative requesting an extension of time under sec_301_9100-3 to elect the provisions of sec_911 of the internal_revenue_code code for taxpayer’s year taxable_year additional information was submitted on date the rulings contained in this letter are based upon information and representations submitted by 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 beginning date year taxpayer lived and worked in country x for company a company a engaged the services of accounting firm b to complete taxpayer’s u s and county x income_tax returns for year and year additionally accounting firm plr-133345-12 b worked with company a to collect the information necessary for it to issue forms w-2 and corrected forms w-2 for those years when preparing taxpayer’s year and year u s income_tax returns accounting firm b failed to advise taxpayer to make the election and failed to advise taxpayer of the consequences of not make the election taxpayer has submitted an affidavit signed under penalties of perjury describing the events that led to taxpayer’s failure to make the election in year taxpayer relied on the advice of accounting firm b taxpayer has also submitted affidavits of company a and accounting b corroborating the statements made by taxpayer sec_911 of the code allows qualified citizens and residents of the united_states living abroad to elect to exclude from gross_income the foreign_earned_income and housing cost amounts of such individuals treas reg ' a sets forth the procedural rules for making a valid sec_911 election the election must be made on form_2555 or on a comparable form and must be filed with the income_tax return or with an amended_return with respect to the timing of the election treas reg ' a i provides that a valid sec_911 election must be made a with an income_tax return that is timely filed including any extensions of time to file b with a later return filed within the period prescribed in sec_6511 amending a timely filed income_tax return c with an original return filed within one year after the due_date of the return determined without regard to any extension of time to file or d with an income_tax return filed after the period described in paragraphs a i a b or c of this section provided - the taxpayer owes no federal_income_tax after taking into account the exclusion and files form_1040 with form_2555 or a comparable form attached either before or after the internal_revenue_service discovers that the taxpayer failed to elect the exclusion or the taxpayer owes federal_income_tax after taking into account the exclusion and files form_1040 with form_2555 or a comparable form attached before the internal_revenue_service discovers that the taxpayer failed to elect the exclusion plr-133345-12 sec_301_9100-1 provides that the commissioner has discretion to grant a taxpayer a reasonable extension of time under the rules set forth in sec_301_9100-3 to make a regulatory election under all subtitles of the code except subtitles e g h and i sec_301_9100-1 provides that an election includes an application_for relief in respect of tax and defines a regulatory election as an election whose due_date is prescribed by a regulation a revenue_ruling revenue_procedure notice or announcement sec_301_9100-3 provides that requests for relief will be granted when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government sec_301_9100-3 provides that except as provided in paragraph b i through iii a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer i ii iii iv v requests relief under this section before the failure to make the regulatory election is discovered by the internal_revenue_service failed to make the election because of intervening events beyond the taxpayer's control failed to make the election because after exercising reasonable diligence taking into account the taxpayer's experience and the complexity of the return or issue the taxpayer was unaware of the necessity for the election reasonably relied on the written advice of the irs or reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election in this case sec_1_911-7 fixes the time to make the election under sec_911 therefore the commissioner has discretionary authority under sec_301_9100-1 to grant taxpayer an extension of time provided that taxpayer satisfies the standards set forth under sec_301_9100-3 plr-133345-12 based on the facts and circumstances of this case we conclude that taxpayer satisfies sec_301_9100-3 accordingly taxpayer is granted an extension of time until days from the date of this ruling letter to elect the foreign_earned_income_exclusion for taxpayer’s year taxable_year and subsequent taxable years taxpayer should attach a copy of this letter_ruling to his federal_income_tax return for the relevant year this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely jeffery g mitchell branch chief branch international