t c memo united_states tax_court utah medical insurance association petitioner v commissioner of internal revenue respondent docket no filed date tracy d williams richard bromley glen h kanwit and michael r schlessinger for petitioner martha sullivan peter hochman alan summers david sorensen and nancy mccurley for respondent memorandum findings_of_fact and opinion colvin judge respondent determined that petitioner had deficiencies in income_tax of dollar_figure for and dollar_figure for the sole issue for decision is whether petitioner may deduct dollar_figure for its reserves for discounted_unpaid_losses and loss adjustment expenses for and dollar_figure for we hold that it may section references are to the internal_revenue_code unless otherwise indicated rule references are to the tax_court rules_of_practice and procedure i findings_of_fact a petitioner utah medical insurance association referred to as petitioner is a property and casualty insurance_company the principal_place_of_business of which is in salt lake city utah petitioner provides medical malpractice liability insurance for physicians in utah montana and idaho medical malpractice liability insurance indemnifies a physician against medical professional liability claims for damages brought as a result of the provision of or the failure to provide medical services petitioner is and during the years in issue was taxed as a property and casualty insurance_company under sections petitioner is managed by its board_of directors which is composed of of petitioner's policyholder-physicians b medical malpractice insurance in the 1960's medical malpractice liability insurance was generally provided by commercial insurance_companies beginning around commercial insurance_companies experienced large underwriting losses as a result of a rapid increase in medical malpractice claims and litigation as a result they raised rates eg percent in california from to to cover their losses when rate increases failed to keep pace with continued adverse loss experience many commercial insurers stopped issuing medical malpractice insurance as a result state medical societies formed physician-owned medical malpractice insurance_companies to offer medical malpractice insurance to their members in the early 1970's the utah medical association uma the leading professional association for doctors in utah endorsed aetna life and casualty insurance co aetna as the preferred malpractice carrier in utah aetna which wrote most of the medical malpractice insurance in utah during the 1970's increased rates several times in the late 1970's c formation of petitioner in response to aetna's rate increases about doctors who were members of uma formed petitioner as an unincorporated inter- insurance exchange1 or reciprocal company in date they executed subordinated loans which gave petitioner an initial capitalization of dollar_figure million shortly thereafter aetna withdrew from the insurance market in utah petitioner became the principal medical malpractice insurer in utah an inter-insurance exchange is a mutual_insurance_company in which the members of a group insure each other's risks from to petitioner wrote medical malpractice insurance only in utah in petitioner began issuing insurance policies to physicians practicing in montana and in to physicians practicing in idaho during the years in issue about percent of petitioner's insurance policies were issued to doctors practicing in utah during those years petitioner primarily wrote medical malpractice liability insurance and also wrote a small amount of general liability insurance for its covered physicians from to the number of doctors insured by petitioner increased as follows year number of insureds big_number big_number big_number big_number big_number big_number big_number big_number big_number d regulation of petitioner by the utah department of insurance petitioner is principally regulated by the utah department of insurance udi petitioner maintained its books_and_records in accordance with udi requirements and filed annual statements with udi petitioner prepared each annual_statement in the format prescribed by the national association of insurance commissioners naic a voluntary association of state insurance commissioners insurance_companies use statutory accounting principles to prepare their annual statements statutory accounting principles are conservative and focus on maintaining the solvency of an insurance_company to protect insurance consumers udi required that annual statements due after date be accompanied by an actuarial opinion concerning the reasonableness of the insurance company's reserves the actuarial firm of tillinghast towers perrin tillinghast certified to udi that petitioner's reserves for unpaid_losses shown on its and annual statements were computed in accordance with accepted loss reserving standards and were fairly stated in accordance with sound loss reserving principles were based on factors relevant to policy provisions met the requirements of the insurance laws of the state of utah and provided sufficiently for all of petitioner's unpaid loss and loss expense obligations e reserves for unpaid_losses on their annual statements property and casualty insurers are required to report estimates of amounts they expect to pay for losse sec_2 that have already occurred unpaid_losses and related loss adjustment expenses these estimates are known a sec_2 a loss is an injury sustained by a person who has a right to hold the insured liable for that injury a loss is incurred when the event insured against occurs 100_f2d_441 8th cir reserves for unpaid_losses a property and casualty company's loss reserve is the amount that is needed to make all future payments on claims that have already been incurred utah code ann sec_31a-17-402 requires insurers to report a liability for unpaid_losses equal to the estimated amount necessary to pay all its unpaid_losses and claims incurred on or prior to the date of statement whether reported or unreported together with the expense of adjustment or settlement of the loss or claim the reserve for unpaid losse sec_3 includes all incurred losses_incurred losses include insured events for which a claim has been filed reported losses and insured events for which no claim has been filed with the company ie incurred but not reported ibnr losses the first step in estimating loss_reserves is to estimate the total amount that will ultimately be paid for a coverage year for all claims existing on a given date ultimate losses ultimate losses equal paid losses plus an estimate of unpaid_losses at the end of the year unpaid_losses are generally estimated not later than the year in which the insured event giving rise to the loss occurred the accident_year in unless otherwise indicated we use the terms loss and unpaid loss to include both losses and loss adjustment expenses that is amounts paid to defend or settle claims unless otherwise indicated we use the term coverage continued estimating its ultimate losses each year petitioner adjusted its prior estimates of earlier years' ultimate losses to factor in its loss experience petitioner's president martin j oslowski oslowski recommended an amount to report as annual_statement unpaid_losses to the board_of directors oslowski was petitioner's claims manager before he became president in date petitioner wrote only one line of insurance and thus petitioner could not offset reserve deficiencies with surpluses in another line as multiline companies could do f occurrence basis and claims-made basis policies medical malpractice insurance may be written on an occurrence basis or on a claims-made basis an occurrence basis policy covers losses that occur within the policy period whenever reported a claims-made basis policy covers only losses from occurrences during the policy period or a previous policy period for which claims are made or which are otherwise reported during the period from to petitioner and most of the medical malpractice insurance industry offered only occurrence basis policies in petitioner's financial position was tenuous because its losses in the early 1980's were significantly larger than it sec_4 continued year instead of accident_year because this case involves both occurrence and claims-made coverage reserves petitioner believed that a switch from occurrence to claims-made basis policies would improve its financial condition in based on the recommendation of tillinghast petitioner began offering claims-made instead of occurrence basis policies to its physicians petitioner's claims-made policies had a year term and an anniversary date5 of january occurrence basis medical malpractice insurance policies are long-tailed because it can take years or more for claims to be received and resolved g petitioner's actuaries petitioner has hired outside actuaries to perform all of its actuarial services since it was formed milliman robertson from to the actuarial firm of milliman robertson m r provided actuarial services to petitioner to help it estimate its annual_statement unpaid_losses petitioner followed m r's recommendations however m r underestimated petitioner's unpaid_losses as this unfavorable trend emerged petitioner gradually increased its estimates of unpaid_losses each year to improve its financial condition in petitioner asked udi for permission to discount its loss_reserves for the the anniversary date is the date when insurance coverage begins 92_tc_1230 occurrence basis years udi approved petitioner's request however udi required petitioner to begin filing quarterly statements and to provide udi with loss and investment information udi in effect began to oversee petitioner's operations tillinghast in petitioner hired tillinghast to determine whether petitioner had sufficient assets and surplus to meet its liabilities tillinghast concluded that petitioner did not tillinghast's loss reserve reviews and rate reviews tillinghast began preparing loss reserve reviews6 and rate reviews7 for petitioner at the end of sometimes actuaries estimate ultimate losses as a range with high and low bounds a bounded range instead of as a single number a point estimate actuarial standard of practice no states the uncertainty inherent in the estimation of required provisions for unpaid_losses or loss adjustment expenses implies that a range of reserves can be actuarially sound tillinghast estimated petitioner's ultimate losses within a bounded range beginning in james hurley hurley an actuary loss reserve reviews project an insurer's ultimate losses based on its loss data tillinghast analyzed petitioner's rates ie premiums to help petitioner decide how much to charge its insureds in the upcoming year employed by tillinghast prepared annual rate reviews and semiannual loss reserve reviews for petitioner in preparing his reserve reviews hurley received information from petitioner about its paid losses and case reserves petitioner's claims investigators generally established petitioner's case reserves based on their initial impression of each claim and revised them as they acquired more information the high end of tillinghast's estimate of petitioner's ultimate losses in and the high end reestimates of its ultimate losses in later years were as follows tillinghast's high end estimates of petitioner's ultimate net losses allocated loss adjustment expense sec_1 in thousands year dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -- big_number big_number big_number big_number big_number big_number big_number big_number -- -- big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number -- -- -- big_number big_number big_number big_number big_number -- -- -- -- -- -- big_number big_number big_number big_number -- -- -- big_number big_number big_number -- -- -- -- -- -- big_number big_number -- -- -- -- -- -- -- -- -- big_number -- -- -- -- -- -- ibnr big_number big_number big_number big_number big_number big_number big_number total big_number big_number big_number big_number big_number big_number big_number big_number big_number allocated loss adjustment expense is defined above at par i-e petitioner discounted the part of its reserves that related case reserves are estimates made by an insurer of the unpaid loss amounts expected to be paid in connection with specific known claims to occurrence-based policies during the years in issue in those years petitioner followed the same procedures in establishing its annual_statement unpaid_losses that it had used in prior years it gave data to tillinghast which tillinghast used to make development method9 and pure premium method10 projections in the property and casualty industry development is the actual experience both paid and unpaid regarding a loss estimate over time the number of petitioner's claims greatly increased in and remained at a higher level for and the severity ie the average cost per claim of petitioner's claims also increased in and tillinghast's and loss reserve reviews used a range bounded by a high and low end estimate of projected ultimate losses the bounds of tillinghast's range are the sums of the high and low end estimates of ultimate loss for each coverage year at the december valuation_date tillinghast's under the development method a series of loss development factors one for each age of coverage year eg coverage year is the current_year coverage year is the preceding year coverage year is the second preceding year are developed based on the past experience of a given coverage year's paid_or_incurred losses over time these factors are then multiplied by the paid_or_incurred losses as of the annual_statement date for the corresponding age of coverage year the pure premium method projects expected losses by multiplying historical average losses per exposure unit eg per doctor by the number of exposure units covered for the coverage year ranges were relatively large because in hurley's opinion medical malpractice losses are difficult to project accurately tillinghast projected that as of date petitioner had ultimate losses ranging from dollar_figure to dollar_figure before discounting and that reserves ranging from dollar_figure to dollar_figure before discounting for coverage years to would be reasonable as of date tillinghast projected that petitioner had ultimate losses ranging from dollar_figure to dollar_figure before discounting and that reserves ranging from dollar_figure to dollar_figure before discounting for the coverage years to would be reasonable tillinghast separated the projected ultimate losses by coverage year joseph perry petitioner's vice president of finance chief financial officer subtracted from these ultimate loss estimates petitioner's paid losses as of date and date to determine a range of unpaid_losses for all of the coverage years included in the and unpaid loss_reserves petitioner reported on its annual statements that it had undiscounted_unpaid_losses of dollar_figure for and dollar_figure for petitioner had a conservative reserve philosophy to ensure that it could pay future losses petitioner selected reserves below the low end of tillinghast's range for and at the high end of tillinghast's ranges for to udi examined petitioner's annual statements it did not adjust the amount of unpaid_losses and loss adjustment expenses that petitioner reported estimates of unpaid_losses by the medical malpractice insurance industry both physician-owned and commercial multiline carriers and petitioner were similar as shown below estimates of unpaid_losses for and earlier as of dec medical malpractice percentage insurance industry of original petitioner of original percentage dollar_figure big_number -- dollar_figure big_number -- h petitioner's financial condition a m best ratings a m best best rates the financial condition of property and casualty insurers each year from to best gave petitioner the following ratings a m best describes its ratings as follows a a excellent assigned to companies which in best's opinion have achieved excellent overall performance when compared to the norms of the property casualty insurance industry a rated insurers generally have shown a strong ability to meet their policyholder and other contractual obligations b b very good assigned to companies which in best's opinion have achieved very good overall performance when compared to the norms of the property casualty insurance industry b rated insurers generally have shown a very good ability to meet their policyholder and other contractual obligations c b good assigned to companies which in best's opinion have achieved good overall performance when compared continued rating b unknown na-7 na b b a- a- a- year surpluses petitioner reported on its to annual statements that it had the following surpluses year surplus reported dollar_figure big_number big_number big_number big_number big_number big_number big_number ultimate loss estimates petitioner reported the following initial estimates and reestimates of its ultimate losses on its annual statements from continued to the norms of the property casualty insurance industry b rated insurers generally have shown a good ability to meet their policyholder and other contractual obligations d na not assigned approximately or percent of the companies reported on in best's insurance reports are not eligible for a best's rating a to c companies with an na rating are assigned to one of classifications to identify why the company was not eligible for a best's rating e na-7 below minimum standards assigned to a company that meets best's minimum size and experience requirements but does not meet the minimum standards for a best's rating of c to ultimate net losses allocated loss adjustment expenses schedule p - part - summary of annual_statement in thousands year dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -- big_number big_number big_number big_number big_number big_number big_number big_number big_number dollar_figure -- -- big_number big_number big_number big_number big_number big_number big_number big_number big_number -- -- -- big_number big_number big_number big_number big_number big_number big_number big_number -- -- -- -- big_number big_number big_number big_number big_number big_number big_number -- -- -- -- -- big_number big_number big_number big_number big_number big_number -- -- -- -- -- -- big_number big_number big_number big_number big_number -- -- -- -- -- -- -- big_number big_number big_number big_number -- -- -- -- -- -- -- -- big_number big_number big_number -- -- -- -- -- -- -- -- -- big_number big_number -- -- -- -- -- -- -- -- -- -- big_number total big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1the initial estimate is the first entry for each year in the vertical axis the reestimates are shown on the horizontal axis 2the information was not individually available on the annual_statement in and medical malpractice loss experience was favorable for coverage years dividends petitioner declared and paid dividends to its policyholders from to as follows year premiums dividend amount dollar_figure big_number big_number big_number big_number the premiums petitioner charged for its medical malpractice insurance policies changed as follows year ending percentage change from preceding year or period -5 -3 -13 -7 i reinsurance during the years at issue petitioner bought reinsurance12 coverage for losses falling in a certain loss layer ie for losses and allocated loss adjustment expenses in excess of a certain minimum and below a certain maximum per loss petitioner's reinsurance treaty13 during the years at issue covered losses from dollar_figure plus an indexed amount to a maximum of dollar_figure million per loss the indexed amount equaled the product of a dollar_figure and b the number of december 31sts occurring reinsurance is an agreement between an insurer the ceding company and a second insurer the reinsurer under which the ceding company passes to the reinsurer some or all of the risks that the ceding company assumes through the direct underwriting of insurance policies see 106_tc_274 a reinsurance treaty is a contract between two insurers in which the reinsurer agrees to provide coverage of risks that the primary insurer has already assumed under an insurance_contract with another party see trans city life ins co v commissioner supra between the loss event and the time when petitioner first became obligated to make a payment in respect to the loss eventdollar_figure losses exceeding dollar_figure million were covered by a separate reinsurance treaty based on its pattern for paying significant claims petitioner's average retention by the time those claims would be paid was about dollar_figure to dollar_figure during the years in issue dollar_figure plus dollar_figure for each december that passed between the coverage year and the year of final payment of the claim j income_tax returns and notice_of_deficiency petitioner timely filed forms 1120-pc u s property and casualty insurance_company income_tax return for and petitioner had undiscounted_unpaid_losses of dollar_figure for and dollar_figure for petitioner reported on its federal_income_tax returns that it had discounted_unpaid_losses of dollar_figure for and dollar_figure for which it deducted as part of losses_incurred under sec_832 a issue for decision ii opinion the sole issue for decision is whether petitioner may deduct dollar_figure for its reserves for unpaid_losses and loss for example if in date petitioner paid dollar_figure to settle a covered loss event the treaty would provide reimbursement of dollar_figure that is dollar_figure minus the indexed amount of dollar_figure dollar_figure plus dollar_figure each for date date and date retention is the dollar level of risk up to which an insurance_company is self-insured ie is not reinsured see dockery v commissioner tcmemo_1998_114 adjustment expenses for and dollar_figure for on date respondent sent a notice_of_deficiency to petitioner in which respondent determined that petitioner overstated its discounted_unpaid_losses by dollar_figure for and dollar_figure for and that petitioner's discounted_unpaid_losses should have been dollar_figure dollar_figure - dollar_figure for and dollar_figure dollar_figure - dollar_figure and dollar_figure for respondent amended its answer after trial to assert that petitioner overstated its undiscounted_unpaid_losses by dollar_figure for and by dollar_figure for and that petitioner's undiscounted_unpaid_losses should have been dollar_figure for and dollar_figure for dollar_figure petitioner bears the burden of proving that respondent's determination in the notice_of_deficiency is erroneous 290_us_111 and respondent bears the burden of proving that petitioner's discounted_unpaid_losses should have been less than the amounts determined in the notice_of_deficiency for and rule a however our holding is not affected by who bears the burden_of_proof respondent redetermined petitioner's discounted_unpaid_losses in the notice_of_deficiency whereas respondent's adjustments in the amended answer were to petitioner's undiscounted_unpaid_losses the taxpayer is required to report discounted_unpaid_losses on its income_tax return sec_832 and sec_846 b background insurance_companies may deduct ordinary and necessary expenses and losses_incurred sec_832 dollar_figure losses_incurred are losses paid during the taxable_year reduced by salvage and reinsurance recovered during that year plus all unpaid_losses discounted for years after outstanding at the end of the taxable_year less all unpaid_losses outstanding at the end of the preceding_taxable_year plus estimated salvage and reinsurance recoverable at the end of the preceding_taxable_year less estimated salvage and reinsurance recoverable at the end of the taxable_year sec_832dollar_figure property and casualty insurance_companies have sec_832 provides in pertinent part as follows sec_832 deductions allowed --in computing the taxable_income of an insurance_company subject_to the tax imposed by sec_831 there shall be allowed as deductions all ordinary and necessary expenses_incurred as provided in sec_162 relating to trade_or_business_expenses losses_incurred as defined in subsection b of this section sec_832 provides as follows losses_incurred -- continued accounting reserves for unpaid_losses atlantic mut ins co v commissioner u s ___ 118_sct_1413 unpaid_losses are those that have been reported but not yet paid or those that have been incurred but not yet reported 65_f3d_90 8th cir affg 102_tc_338 unpaid_losses must include only actual unpaid_losses as nearly as it is possible to continued a in general --the term losses_incurred means losses_incurred during the taxable_year on insurance contracts computed as follows i to losses paid during the taxable_year deduct salvage and reinsurance recovered during the taxable_year ii to the result so obtained add all unpaid_losses on life_insurance contracts plus all discounted_unpaid_losses as defined in sec_846 outstanding at the end of the taxable_year and deduct all unpaid_losses on life_insurance contracts plus all discounted_unpaid_losses outstanding at the end of the preceding_taxable_year iii to the results so obtained add estimated salvage and reinsurance recoverable as of the end of the preceding_taxable_year and deduct estimated salvage and reinsurance recoverable as of the end of the taxable_year the amount of estimated salvage_recoverable shall be determined on a discounted basis in accordance with procedures established by the secretary ascertain them sec_1_832-4 b income_tax regsdollar_figure the estimate of unpaid_losses must be fair and reasonable based on the facts in each case and the company's experience with similar cases id the reserve for unpaid_losses is an estimate made at the close of a taxable_year of the insurer's liability for claims that it will be required to pay in future years 65_tc_897 affd on another issue 571_f2d_514 10th cir a fair and reasonable estimate of a taxpayer's unpaid_losses is essentially a valuation issue and a question of fact 69_tc_260 affd 598_f2d_1211 1st cir sec_1_832-4 income_tax regs provides as follows b losses_incurred every insurance_company to which this section applies must be prepared to establish to the satisfaction of the district_director that the part of the deduction for losses_incurred which represents unpaid_losses at the close of the taxable_year comprises only actual unpaid_losses see sec_846 for rules relating to the determination of discounted_unpaid_losses these losses must be stated in amounts which based upon the facts in each case and the company's experience with similar cases represent a fair and reasonable estimate of the amount the company will be required to pay amounts included in or added to the estimates of unpaid_losses which in the opinion of the district_director are in excess of a fair and reasonable estimate will be disallowed as a deduction the district_director may require any insurance_company to submit such detailed information with respect to its actual experience as is deemed necessary to establish the reasonableness of the deduction for losses_incurred c fair and reasonable estimate of petitioner's unpaid losse sec_1 expert testimony both parties called expert witnesses to give their opinions about the reasonableness of petitioner's reserves for unpaid_losses for and we may accept or reject expert testimony according to our own judgment and we may be selective in deciding what parts of an expert's opinion if any we will accept 304_us_282 there were six expert witnesses at the trial four were actuaries hurley an actuary for tillinghast and owen gleeson gleeson for petitioner and frederick kilbourne kilbourne and raymond nichols nichols for respondent james schacht schacht and lawrence smarr smarr also testified for petitioner hurley we find hurley's estimates of petitioner's reserves for unpaid_losses to be reasonable hurley was petitioner's actuary during the years in issue see hospital corp of am v commissioner tcmemo_1997_482 the opinion of an expert who was taxpayer's actuary during the years in issue is entitled to some deference hurley considered the facts that were unique to nichols did not do an actuarial reserve study of petitioner petitioner in estimating its reserves unlike respondent's expert kilbourne who was unfamiliar with petitioner's business and who merely prepared a report essentially critiquing hurley's actuarial analysis hurley's loss reserve reviews were specifically based on petitioner and its business because hurley prepared petitioner's rate reviews he knew that estimating excessive loss_reserves would result in higher insurance premiums for petitioner's insureds he recognized that petitioner had an incentive not to overstate its reserves hurley prepared semiannual loss reserve reviews and annual rate indication studies for petitioner he used consistent actuarial methods and standard actuarial loss development and pure premium methods to estimate petitioner's unpaid loss_reserves for and hurley used petitioner's and industry data in his projections over time he increased the weight he gave to petitioner's data relative to industry data because more of petitioner's data was available hurley estimated only actual unpaid_losses in establishing petitioner's annual_statement unpaid_losses he based his projections on petitioner's database containing information about its past loss payments and case reserves hurley's report for the and annual statements estimated unpaid_losses within an actuarially reasonable range each point in hurley's range was reasonable his reports met all relevant actuarial standards hurley applied one exposure ie pure premium and four development methods the development and exposure methods produced ultimates which were weighted as coverage years aged against petitioner's loss experience reflected primarily in the development methods hurley's weighting of the two types of methods was similar to a bornhuetter-ferguson method which is widely used for long-tailed lines of insurance like medical malpractice estimates as of date of petitioner's ultimates for coverage years through were lower than estimates made previously for those years hurley reduced his estimate of petitioner's ultimates for and because his projected ultimates for prior coverage years were reduced hurley's range was large because a petitioner is a relatively modestly capitalized single-line insurer that serves a limited geographic area b it has relatively few claims but the average cost of a claim is high and c medical malpractice insurance is highly risky and longer-tailed these facts makes projecting losses difficult see hospital corp of america v commissioner supra the bornhuetter-ferguson method is an actuarial technique used to estimate the value of a company's reserves by subtracting its paid losses from its reserves gleeson and schacht each said that hurley's estimates of the reserves were reasonable we find their analysis to be credible kilbourne kilbourne analyzed hurley's loss reserve reviews and the reasonableness of petitioner's reserves for unpaid_losses as shown on its and annual statements kilbourne averaged the four and yearend point estimate results of hurley's development methods with hurley's pure premium range based on the facts existing at the end of and kilbourne noted that the results of the four development methods were clustered and that hurley's reports did not indicate that any method was preferable kilbourne concluded that reasonable best estimates of petitioner's unpaid_losses and loss adjustment expenses at the end of and could be made by averaging the four point estimate results of hurley's four development methods with his pure premium method range kilbourne analyzed hurley's loss reserve reviews as of the end of and he concluded that hurley's lookback approach for selecting an initial estimate of ultimate loss for the current_year was flawed he believed that hurley's approach essentially ignored the point estimate results and that hurley's ranges overstated petitioner's actuarially supported reserves for and he concluded that the best estimates of petitioner's ultimate losses were dollar_figure for and dollar_figure for d analysi sec_1 whether petitioner's reserves were fair and reasonable respondent contends that respondent's adjustments to the unpaid loss_reserves are needed to make the reserves fair and reasonable as required by sec_1_832-4 income_tax regs respondent argues that respondent's proposed reduction of petitioner's undiscounted_unpaid_losses for and is reasonable a taxpayer's reserve for unpaid_losses must be fair and reasonable based on the facts in each case and the company's experience with similar cases sec_1_832-4 income_tax regs petitioner could not offset reserve deficits with reserve surpluses in another line of insurance because it wrote a single relatively volatile line_of_business in a limited market the inability to offset deficits with surpluses makes petitioner's business more risky and reasonably led petitioner to establish higher reserves for the years in issue the medical malpractice industry overstated reserves to virtually the same extent as petitioner this suggests that petitioner's estimates were fair and reasonable udi made a triennial examination of petitioner's annual statements it did not adjust petitioner's reporting of unpaid_losses and loss adjustment expenses cf hanover ins co v commissioner t c pincite the commissioner's adjustments to the taxpayer's reserves for unpaid_losses were reasonable the taxpayer failed to adjust its loss_reserves after naic examiners found substantial overstatements hurley adjusted petitioner's loss_reserves each year to account for petitioner's actual_loss_experience this suggests petitioner's loss estimates were fair and reasonable see 40_tc_735 bad_debt_reserve 19_bta_762 same hurley and schacht testified that insurance_companies have an incentive not to overstate their unpaid_losses because overstating their losses may result in higher premiums may make them less competitive with other companies and could diminish their surplus to the point that they cannot write new policies petitioner's insureds would prefer to keep their medical malpractice insurance premiums low this tension between petitioner and its insureds suggests that petitioner's reserve for unpaid_losses was fair and reasonable whether petitioner's reserve estimates were within the range of hurley's estimates petitioner contends that its unpaid loss_reserves for years ended and fall within the range of estimates made by hurley and are fair and reasonable respondent erroneously contended that petitioner's reserves were above the high end of hurley's ranges because respondent considered the discounted total_reserves column rather than the undiscounted total_reserves column petitioner selected reserves from the undiscounted column as required by sec_846 and petitioner deducted paid losses from tillinghast's projected reserves to account for the difference between the paid losses in petitioner's records and the paid losses in tillinghast's records finally oslowski testified credibly that petitioner chose reserves from the high end but not above the high end of tillinghast's reserve estimates we find that petitioner's reserves were within the ranges of tillinghast's reserve estimates whether petitioner's selection of tillinghast's high end values for and was fair and reasonable respondent argues that because petitioner overstated its unpaid loss_reserves for to petitioner's establishment of reserves using amounts at the high end of tillinghast's range in and was not fair and reasonable respondent contends that the favorable development for was apparent when tillinghast made the unpaid loss estimates in question which meant petitioner's estimates were overstated we disagree petitioner properly considered the fact that the frequency and severity of its claims began to increase significantly in that fact along with petitioner's prior history of inadequate reserves in makes reasonable petitioner's estimates of reserves for and the fact that petitioner's loss estimates for proved with hindsight to be higher than actual payments does not make petitioner's choice of values unreasonable petitioner's reserves for unpaid_losses must be fair and reasonable but are not required to be accurate based on hindsight sec_1_832-4 income_tax regs whether only the midpoint of an actuarially sound range is the fair and reasonable estimate respondent argues that for tax purposes the midpoint of an actuarially sound range which respondent characterizes as tax equipoise is the only fair and reasonable estimate since it gives no tax advantage to either the taxpayer or to treasury we disagree respondent cites no authority for the proposition that tax equipoise equates with the fair and reasonable standard we have held in a different context that the high end of a range of reasonable values may be reasonable see 99_tc_9 for purposes of assessing the actuarial assumptions of a defined_benefit_plan court adopted as reasonable a retirement age assumption that was at high end of reasonableness range affd 7_f3d_1235 5th cir hurley testified that any loss reserve amount selected from within the actuarial range he gave petitioner would be reasonable whether petitioner's reserves must be probable to be fair and reasonable respondent argues that petitioner's reserves were not fair and reasonable because it is improbable that petitioner's losses will reach tillinghast's highest estimates for or consecutive years respondent contends that to be fair and reasonable the estimates of unpaid_losses selected by the taxpayer must be at least equally likely to occur as any other estimate of unpaid loss we disagree the regulations require that the taxpayer make a fair and reasonable estimate of losses based on the facts of each case and on the taxpayer's experience with similar cases sec_1_832-4 income_tax regs the regulations do not provide or even suggest that only one estimate is correct whether petitioner's lookback method was proper respondent argues that hurley's lookback method22 for estimating the high end of its range ignored the most recent actual loss data and included the preceding year's overstated initial estimate in the initial high end estimate for the next year for example respondent contends that hurley used his initial dollar_figure million high end estimate made at the end of rather than using the most recent estimate for dollar_figure million reestimated at the end of hurley looked back at prior years' losses to estimate current loss_reserves we disagree that hurley improperly reestimated the prior years' ultimate losses hurley reestimated the ultimate losses for each prior coverage year when he estimated reserves for and hurley adjusted his ranges for and based on petitioner's favorable experience from to respondent's contention that he merely included the prior year's initial estimates in the current year's high end estimate is mistaken instead he compared the results of the development methods for the current_year to the initial estimates for the prior year in calculating the ultimate loss estimates for and hurley used reestimated ultimate loss estimates for prior coverage years respondent contends that because hurley reestimated by gradually reducing the high end ultimate losses for the post-1985 coverage years as of the end of and he compounded petitioner's overstated reserves for those years by carrying the overstatements forward we disagree that hurley compounded petitioner's overstated reserves by his approach as petitioner's loss experience began to improve hurley reduced the estimates for that coverage year kilbourne's criticism of petitioner's methods respondent argues that kilbourne's method is reasonable and points out that it is very similar to petitioner's actual experience as reflected in the development of petitioner's losses for coverage years through reestimated at the end of respondent's argument misses the mark although we agree that kilbourne's method is reasonable we need not decide whether his method is more reasonable than petitioner's method sec_1_832-4 income_tax regs requires that the taxpayer show that its unpaid_losses were actual unpaid_losses and that its estimate of loss_reserves be fair and reasonable petitioner has satisfied the requirements of the regulations and thus our inquiry ends cf 85_tc_485 78_tc_1029 the commissioner cannot require a taxpayer to change from an accounting_method which clearly reflects income to an alternate method merely because the commissioner concludes that the alternate method more clearly reflects the taxpayer's income whether gleeson confirmed that hurley's ranges were not actuarially sound respondent argues that gleeson confirmed kilbourne's conclusion that hurley's ranges were not actuarially sounddollar_figure we disagree gleeson applied a probability distribution test to kilbourne said that hurley's approach ignored the point estimate results of his four actuarial methods and that his ranges were skewed so that even the low ends of his ranges as of the end of and were higher than what in kilbourne's opinion were actuarially reasonable best estimates of petitioner's ultimate losses hurley's initial high end estimate of ultimate loss for gleeson testified that hurley's dollar_figure high end estimate was a reasonable estimate of petitioner's ultimate losses for as of the end of on cross-examination respondent asked gleeson to add coverage years to to his test respondent asked gleeson to review exhibit sec_86 sec_87 and sec_88 which purport to show that petitioner's net ultimate losses as reestimated for coverage years to fell increasingly to the right of the range moving back from to and fell outside the range for to gleeson testified that respondent's computations in exhibit sec_86 sec_87 and sec_88 were accurate respondent argues that gleeson agreed that petitioner's estimates for coverage years to taken together failed his test we disagree gleeson testified that respondent's probability distribution graphs did not change his conclusion that hurley's work was reasonable he pointed out that exhibit sec_86 sec_87 and sec_88 particularly exhibit used basic limits data that is data about claims that are paid or reserved at dollar_figure or less in gleeson's opinion basic limits data shows more rapid development than total limits data because the smaller and easier to settle claims are paid first he also pointed out that exhibit contains several probability distribution graphs showing factors for to exhibit is a report showing updated development factors that had been contained in an attachment to gleeson's report exhibit contains loss development factors these exhibits extended gleeson's probability distribution test back through the basic limits data contained in respondent's exhibits does not show claims that are paid or reserved at more than dollar_figure gleeson pointed out that petitioner's retention was about dollar_figure and that the basic limits data does not account for the development between the dollar_figure basic limits and petitioner's dollar_figure retention amountdollar_figure thus gleeson found hurley's ranges to be actuarially sound whether respondent's use of hindsight was proper respondent points out that hindsight may be used in deciding whether to sustain respondent's proposed adjustments hanover ins co v commissioner t c pincite the commissioner reasonably used hindsight to test the reasonableness of the taxpayer's reserves hospital corp of am v commissioner tcmemo_1997_482 the taxpayer did not prove that its reserves were reasonable because the commissioner's expert used hindsight to show that the taxpayer's reserves were overstated respondent relies on petitioner's annual_statement to support respondent's contention that the development of petitioner's actual losses shown in the reestimates of ultimate losses for coverage years to as of the end of confirms that respondent's proposed adjustments are reasonable we need not decide whether respondent's adjustments are reasonable since petitioner's loss_reserves were fair and reasonable compare gleeson testified that petitioner's retention was about dollar_figure we have found that it was dollar_figure-dollar_figure the difference in retention amounts does not affect gleeson's explanation hanover ins co v commissioner t c pincite e conclusion we conclude that petitioner's reserves for unpaid_losses and loss adjustment expenses for and were fair and reasonable estimates of petitioner’s actual unpaid_losses to reflect the foregoing decision will be entered under rule


internal_revenue_service number release date index numbers -------------------------------------- ------------------------------------------------------------ --------------------- ----------------------------------------------------------- ---------------------- ------------------------------------- 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 b03 plr-113614-17 date date legend ----------------------------------------- x --------------------------------------- y --------------------------------- -------------------------------- country -------- date ------------------- dear ------------ this letter responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_301_7701-3 to be classified as a disregarded_entity for federal tax purposes facts the information submitted discloses that x was formed on date under the laws of country x's owner y intended x to be classified as a disregarded_entity for federal tax purposes however x failed to timely file form_8832 entity classification election to be classified as a disregarded_entity for federal tax purposes effective date plr-113614-17 law and analysis sec_301_7701-3 provides in part that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes as provided in sec_301_7701-3 an eligible_entity with at least two members can elect to be classified as either an association and thus a corporation under sec_301_7701-2 or a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner sec_301_7701-3 provides that except as provided in sec_301_7701-3 unless the entity elects otherwise a foreign eligible_entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single owner that does not have limited_liability sec_301_7701-3 provides in part that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 provides in part that except as provided in sec_301 c iv and v an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 or to change its classification by filing form_8832 with the service_center designated on form_8832 sec_301_7701-3 provides in part that an election made under sec_301 c i will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified on the election form the effective date specified on form_8832 can not be more than days prior to the date on which the election is filed and can not be more than months after the date on which the election is filed under sec_301_9100-1 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 internal_revenue_code code except subtitles e g h and i sec_301_9100-1 provides that the term regulatory election includes an election whose due_date is prescribed by a regulation published in the federal_register 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 regulatory elections that do not meet the requirements of sec_301_9100-2 plr-113614-17 sec_301_9100-3 provides that requests for relief under sec_301_9100-3 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 conclusion based solely on the facts and representations submitted we conclude that x has satisfied the requirements of sec_301_9100-1 and sec_301_9100-3 consequently x is granted an extension of time of days from the date of this letter to elect under sec_301_7701-3 to be classified as a disregarded_entity effective date x must file form_8832 within the extension period with the appropriate service_center with a copy of this letter attached this ruling is contingent on x and its owner filing within days of the date of this letter all required federal_income_tax and information returns including amended returns for all open years consistent with the requested relief these returns must include but are not limited to form_8858 information_return of u s persons with respect to foreign disregarded entities such that these forms reflect the consequences of the relief granted in this letter a copy of this letter should be attached to any such returns we express no opinion concerning the assessment of any interest additions to tax additional_amounts or penalties for failure_to_file a timely income_tax or information_return with respect to any taxable_year that may be affected by this ruling for example we express no opinion as to whether a taxpayer is entitled to relief from any penalty on the basis that the taxpayer had reasonable_cause for failure_to_file timely any income_tax or information returns except for the specific ruling above we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the code in addition sec_301_9100-1 provides that the granting of an extension of time for making an election is not a determination that the taxpayer is otherwise eligible to make the election this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the ruling_request it is subject_to verification on examination plr-113614-17 in accordance with a power_of_attorney on file with this office we are sending a copy of this letter_ruling to your authorized representatives sincerely associate chief_counsel passthroughs special industries by _____________________________ mary beth carchia senior technician reviewer branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


internal_revenue_service number release date index number ------------------------------------------------------------ ------------------------------ ------------------------------------------------------------ ---------------------------------- --------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no ------------- telephone number --------------------- refer reply to cc psi b07 plr-137629-06 date date grantors trust trust trust trust ----------------------------------- -------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------- ----------------------- ----------------------- ----------------------- ----------------------- -------------------------------------------------------------------------------------------- ------------------ date grandchild ------------------------------------------- grandchild ------------------------------------------------ grandchild -------------------------------------------- grandchild ----------------------------- trust date date date date trustee trustee state trustee ----------------------- -------------------------- ------------------ ------------------------- ----------------------- ------------------------------------ -------------------------- ------------- -------------------- dear -------------------- plr-137629-06 this letter responds to your letter dated date requesting that the proposed modifications to trust will not cause certain trusts to lose their status as exempt from the generation-skipping_transfer gst tax grantors created trust trust trust and trust collectively the grandchildren’s trusts on date the grandchildren’s trusts have identical trust terms except for the identity of the primary beneficiary trust is for the benefit of grandchild and her lineal_descendants trust is for the benefit of grandchild and her lineal_descendants trust is for the benefit of grandchild and her lineal_descendants trust is for the benefit of grandchild and her lineal_descendants grantors created trust on date for the benefit of their great-grandchildren the provisions of the trusts governing trustee succession were modified by court order on date on date trust was reformed to conform with the grantors’ intentions regarding accumulation and distribution of income for the benefit of the trust beneficiaries on date the service ruled that the reformation of trust would not cause trust to lose its status as exempt from the gst tax the service further ruled that the reformation would not cause any party to be subject_to income or gift_tax date date and date are before date date and date are after date trustee and trustee currently serve as trustees of trust trust trust trust and trust the taxpayer represents that trust trust trust trust and trust were irrevocable on date and no additions actual or constructive have been made to any of the trusts after date the trustees propose to modify various administration provisions of the trusts paragraph of the each trust agreement as amended on date provides that there shall be at least two co-trustees either individual or corporate trustee and any co-trustee who is a lineal descendant of the grantors shall have the right to appoint his or her successor after reaching thirty-five years of age each grandchild has the right to become a co-trustee or appoint a co-trustee and successors if there are more than three co-trustees serving a majority may remove any co-trustee who is not a lineal descendant of the grantors trustee may remove any co-trustee other than a grandchild of the grantors or a co-trustee appointed by a grandchild of the grantors if there are not at least two co-trustees a successor co-trustee shall be named by a co- trustee who is a lineal descendant of the grantors if there is none a successor shall be named by the co-trustee and a majority of the then adult income beneficiaries and the guardians of any other income beneficiaries paragraph of each trust will be replaced with a new paragraph the new paragraph a will provide that the current co-trustees shall be trustee and trustee collectively current co-trustees if either current co-trustee becomes unwilling or plr-137629-06 unable to serve the remaining current co-trustee and the independent_trustee shall serve as co-trustees and thereafter there shall be an independent_trustee serving at all times if neither current co-trustee is willing and able to serve the successor co- trustees shall be the independent_trustee and those of the grantors’ grandchildren who are willing and able to serve and thereafter there shall be at least three co-trustees serving at all times one of whom shall be the independent_trustee and the rest of whom shall be referred to as other trustees the new paragraph b shall provide that at any time both current co-trustees are serving the eligible voters by a vote of at least of the eligible votes shall have the power to remove either acting current co-trustee at any time that only one current co-trustee is serving the eligible voters shall have the power to remove that acting current co-trustee with a vote of at least of the eligible votes the new paragraph c shall provide that each other trustee shall have the power to designate his or her immediate successor unless that other trustee is removed by the eligible voters pursuant to paragraph d except as otherwise provided in paragraph d if an other trustee becomes unwilling or unable to serve and no successor designated by that other trustee is willing and able to serve the remaining co-trustees may but are not required to appoint a successor other trustee to fill that vacancy if at least two other trustees are then serving or shall be required to appoint a successor other trustee if the vacancy would result in fewer than two other trustees serving in the event that fewer than two other trustees are serving and the vacancy is not filled as provided in the preceding provisions of paragraph c that vacancy may be filled by a successor other trustee appointed by the eligible voters by a vote of at least of the eligible votes in the event that fewer than two other trustees are serving and the vacancy is not filled as provided in the preceding provisions of paragraph c a successor other trustee shall be selected by a court of competent jurisdiction all trusts created under the trust agreements that hold interests in the same family business shall have the same other trustees the new paragraph d shall provide that the eligible voters by a vote of at least shall have the power to remove any acting other trustee if the removal would reduce the number of other trustees below two the eligible voters may not remove the other trustee unless they appoint a successor other trustee by a vote of at least of the eligible voters at any time that two or more other trustees are serving the eligible voters by a vote of at least may appoint one or more additional other trustees to serve with the co-trustees the new paragraph e shall provide that the original independent_trustee will be trustee if trustee or any successor independent_trustee is or becomes unwilling or unable to serve and if the remaining current co-trustee is serving the remaining current co-trustee shall select a successor independent_trustee except as otherwise provided each independent_trustee shall have the power to designate his or her immediate plr-137629-06 successor if an independent_trustee fails to name a successor the other trustees who are then serving shall appoint a successor independent_trustee if the other trustees fail to appoint a successor the eligible voters by a vote of at least may appoint a successor independent_trustee if the eligible voters fail to appoint a successor a court of competent jurisdiction shall appoint a successor independent_trustee no person who is a_related_or_subordinate_party as defined in sec_672 of the code with respect to any income_beneficiary of trust trust trust trust or trust shall be eligible to serve as an independent_trustee the new paragraph f shall provide that at any time that an independent_trustee other than trustee is serving with the remaining current co-trustee the remaining current co-trustee shall have the power to remove that independent_trustee and to appoint a successor independent_trustee at any time that trustee is serving as the independent_trustee with the remaining current co-trustee or at any time that neither current co-trustee is serving the eligible voters by a vote of at least shall have the power to remove the independent_trustee and to appoint a successor the new paragraph g shall provide that the eligible votes shall be determined in the following manner trustee and trustee shall each be entitled to three votes each living grandchild of the grantors shall be entitled to one vote the descendants of each grantors’ grandchild who is then deceased and survived by descendants collectively shall be entitled to one vote which shall be allocated among those descendants who shall be permitted to cast their votes independently and shall not be required to vote as a block by right of representation for purposes of the preceding provisions of this paragraph any person who has resigned as an eligible voter is incapacitated or is a minor shall be treated as if he or she were deceased the new paragraph n shall provide that except as otherwise provided if there are two co-trustees serving all decisions shall be unanimous and if more than two co- trustees are serving the decision of the majority shall control if a trustee is prohibited under the terms of the trust agreement from exercising any power authority or discretion that power authority or discretion shall be exercisable by any co-trustees who are not so prohibited or if there are none shall not be exercisable the new paragraph t shall provide that no trustee shall exercise any power authority or discretion otherwise granted to the trustees in the trust agreement if that power authority or discretion would cause that trustee to be treated as having a general_power_of_appointment under sec_2041 of the code any power authority or discretion that a trustee is prohibited from exercising pursuant to the provisions of this paragraph shall be exercisable by any acting trustees who are not so prohibited or if there are none shall not be exercisable the trusts’ assets consist of bank accounts and ownership_interest in a limited_liability_company that manages farming enterprises commercial real_estate and stock plr-137629-06 portfolios the trustees also propose to modify certain trust provisions relating to the trustees’ powers and duties in connection with managing the limited_liability_company the provisions allow trustees to serve in management positions in the limited_liability_company and protect against liability for management decisions except in the case of gross negligence bad faith or reckless indifference the proposed modifications further permit amendments to the trust agreements with respect to the provisions relating to the management of the limited_liability_company and the exculpation of the trustees by a vote of of the eligible voters the eligible voters are not authorized to change any other terms of the trusts or to retroactively increase a trustee’s liability sec_2601 imposes a tax on every generation-skipping_transfer sec_2611 defines the term generation-skipping_transfer as a taxable_distribution a taxable_termination and a direct_skip under b a of the tax_reform_act_of_1986 and sec_26_2601-1 of the generation-skipping_transfer_tax regulations the generation-skipping_transfer_tax provisions do not apply to any generation-skipping_transfer under a_trust as defined in sec_2652 that was irrevocable on date however this exemption does not apply if additions actual or constructive are made to the trust after date sec_26_2601-1 of the generation-skipping_transfer_tax regulations provides that any trust in existence on date will be considered an irrevocable_trust except as provided in sec_26_2601-1 or c which relate to property includible in a grantor’s gross_estate under sec_2038 and sec_2042 sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the generation-skipping_transfer_tax under sec_26_2601-1 or hereinafter referred to as an exempt trust will not cause the trust to lose its exempt status in general unless specifically provided otherwise the rules contained in sec_26_2601-1 are applicable only for purposes of determining whether an exempt trust retains its exempt status for generation-skipping_transfer_tax purposes unless specifically noted the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of gain for purposes of sec_1001 sec_26_2601-1 provides that a modification of the governing instrument of an exempt trust including a trustee distribution settlement or construction that does not satisfy sec_26_2601-1 b or c by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject_to the provisions of chapter if the modification plr-137629-06 does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust sec_26_2601-1 provides that for purposes of this section a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a gst transfer or the creation of a new gst transfer to determine whether a modification of an irrevocable_trust will shift a beneficial_interest in a_trust to a beneficiary who occupies a lower generation the effect of the instrument on the date of the modification is measured against the effect of the instrument in existence immediately before the modification if the effect of the modification cannot be immediately determined it is deemed to shift a beneficial_interest in the trust to a beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification a modification that is administrative in nature that only indirectly increases the amount transferred for example by lowering administrative costs or income taxes will not be considered to shift a beneficial_interest in the trust in addition administration of a_trust in conformance with applicable local law that defines the term income as a unitrust_amount or permits a right to income to be satisfied by such an amount or that permits the trustee to adjust between principal and income to fulfill the trustee’s duty_of impartiality between income and principal beneficiaries will not be considered to shift a beneficial_interest in the trust if applicable local law provides for a reasonable apportionment between the income and remainder beneficiaries of the total return of the trust and meets the requirements of sec_1_643_b_-1 of the income_tax regulations in the present case trust trust trust trust and trust are considered irrevocable because neither sec_2038 nor sec_2042 apply and each trust was irrevocable as of date in addition there have been no actual or constructive additions made to either trust since date accordingly trust trust trust trust and trust are exempt from gst tax the proposed modifications to trust trust trust trust and trust are administrative in nature and do not shift a beneficial_interest in any trust to any beneficiary who occupies a lower generation than the person or persons who hold the beneficial_interest prior to the modifications in addition the proposed modifications do not extend the time for vesting of any beneficial_interest beyond the period provided for in the original trust agreements thus the proposed modifications of trust trust trust trust and trust will not constitute an addition to any of the trusts will not cause any of the trusts to lose their exempt status under b a of the tax_reform_act_of_1986 and sec_26_2601-1 and will not subject distributions from any of the trusts to the gst tax plr-137629-06 except as expressly provided herein no opinion is expressed or implied concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this ruling is directed only to the taxpayer s requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer’s representatives sincerely melissa c liquerman melissa c liquerman senior technician reviewer branch passthroughs special industries cc


department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division number release date date date legend b individual c individual d individual e state f date g dollar amount h dollar amount j dollar amount dear contact person identification_number contact number fax number employer_identification_number uil we have considered your request for recognition of an unusual grant under income_tax regulations sec_1_170a-9 and related provisions based on the information provided we have concluded that the proposed grant does not constitute an unusual grant under sec_1_170a-9 and related provisions of the regulations the basis for our conclusion is set forth below facts you were formed as a nonprofit public benefit corporation in e on f you operate a low cost spay and neuter clinic for the public and provide educational materials regarding the health and care of dogs and cats you charge for these services including receiving insurance reimbursement and are also supported through donations and unrelated income you applied for and were recognized as exempt from federal_income_tax under internal_revenue_code sec_501 when your advance_ruling period ended you were classified as a private_foundation subsequently you requested termination of your private_foundation_status under b b we determined you were reasonably expected to terminate your private_foundation_status and are currently treated as a public charity described in sec_509 for an advance period of months you determined you could better fulfill your charitable purpose if you were to also operate an animal shelter accept stray dogs and cats and operate an adoption center to do so however you would need a significantly larger facility b is your incorporator initial agent for service of process a substantial_contributor pursuant to sec_507 and a disqualified_person pursuant to sec_4946 b has offered to contribute approximately g dollars per year for four years or until sufficient funds are raised to allow you to complete construction of an additional facility pursuant to appropriate design plans and construction bids the grant would pay for construction costs of a multi-purpose animal shelter adoption center over the past ten years b has given over j dollars to you in donations including funds allowing the purchase of your current facility you consider b to be a continual supporter and contributor you also provided copies of form 990pf which show b as a substantial_contributor to you for a continued period since your inception you have a governing body consisting of five directors and three officers the directors are unrelated to b however c your chairman and president is b’s spouse d your executive director a full time compensated employee is c’s daughter you have submitted documentation requesting recognition that the proposed grant from b be classified as an unusual grant under sec_1_170a-9 and related provisions of the regulations law sec_1_170a-9 and sec_1_509_a_-3 of the regulations set forth the criteria for an unusual grant sec_1_170a-9 of the regulations states that for purposes of applying the percent limitation described in subdivision i of this subparagraph to determine whether the percent-of-support test in subparagraph of this paragraph or the percent-of-support limitation in subparagraph i of this paragraph is satisfied one or more contributions may be excluded from both the numerator and the denominator of the applicable percent-of-support fraction if such contributions meet the requirements of subdivision iii of this subparagraph the exclusion provided by this subdivision is generally intended to apply to substantial contributions or bequests from disinterested parties which contributions or bequests are attracted by reason of the publicly supported nature of the organization a and b are unusual or unexpected with respect to the amount thereof and as normally being publicly supported for the applicable_period described in subparagraph or of this paragraph c would by reason of their size adversely affect the status of the organization sec_1_509_a_-3 of the regulations states that in determining whether a particular contribution may be excluded under subdivision ii of this subparagraph all pertinent facts and circumstances will be taken into consideration no single factor will necessarily be determinative such factors may include e whether the contribution was made by any person or persons standing in a relationship to such person which is described in internal_revenue_code sec_4946 through g who created the organization previously contributed a substantial part of its support or endowment or stood in a position of authority such as a foundation_manager within the meaning of sec_4946 with respect to the organization a contribution made by a person other than those persons described in this subdivision will ordinarily be given more favorable consideration than a contribution made by a person described in this subdivision e whether the contribution was a bequest or an inter_vivos transfer a bequest will ordinarily be given more favorable consideration than an inter_vivos transfer e whether the contribution was in the form of cash readily marketable_securities or assets which further the exempt purposes of the organization such as a gift of a painting to a museum e except in the case of a new organization whether prior to the receipt of the particular contribution the organization a has carried on an actual program of public solicitation and exempt_activities and b has been able to attract a significant amount of public support e whether the organization may reasonably be expected to attract a significant amount of public support subsequent to the particular contribution n this connection continued reliance on unusual grants to fund an organization's current operating_expenses as opposed to providing new endowment funds may be evidence that the organization cannot reasonably be expected to attract future support from the general_public whether prior to the year in which the particular contribution was received the organization met the one-third support_test described in subparagraph of this paragraph without the benefit of any exclusions of unusual grants pursuant to subparagraph of this paragraph such contributor which is described in sec_4946 through g continues directly or indirectly to exercise control_over the organization e whether neither the contributor nor any person standing in a relationship to e e whether the organization has a representative governing body as described in income_tax regulations sec_1_509_a_-3 and e whether material restrictions or conditions within the meaning of income_tax regulations sec_1_507-2 have been imposed by the transferor upon the transferee in connection with such transfer application of law we have determined the proposed grant from b does not constitute an unusual grant within the meaning of sec_1_170a-9 and related provisions of the regulations while the proposed grant may adversely affect your public charity status it is not attracted by reason of your publicly supported nature and is not unusual or unexpected with respect to the amount thereof the following factors are present e e e e e you received multiple grants totaling over j dollars from b from to date the purpose of the proposed grant is to support the construction of your animal shelter adoption center this is the same purpose as the initial contributions received from b to establish your animal clinic given the forms 990pf provided the overwhelming majority of your total support since inception will have come from b cis one of your officers she is also b’s spouse dis your executive director she is also c’s daughter the proposed grant is not attracted by reason of your publicly supported nature but rather by your historical relationship with b the contributions previously received from b detail this relationship and together they demonstrate a stream of funds from b to you furthermore the proposed h dollars grant is not unusual or unexpected with respect to the amount since you have previously received a series of contributions from b such as funding when you were initially formed and to aid in the establishment of your current animal clinic in addition after reviewing the factors detailed in sec_1_509_a_-3 of the regulations we have determined the proposed grant from does not constitute an unusual grant e the grant is being made by b a substantial_contributor throughout your existence and a disqualified_person pursuant to sec_4946 when determining unusual grant classification contributions received from those who have previously not contributed a substantial part of an organization’s support e e e e e e are given more favorable consideration than contributions from organizations who have previously substantially contributed the grant would be classified as an inter_vivos contribution the grant is in the form of cash which will be used to further your exempt purposes you received a determination_letter approving your sec_501 status on date review of your previously filed forms 990-pf shows that while you have received public support the majority of your funds since inception have been received from b in addition while you have been in existence you have not always attracted a significant amount of public support as evidenced by your private_foundation_status review of previously filed forms 990pf you submitted shows that you did not always met the one-third support_test without the benefit of any exclusions of unusual grants you are currently in a 60-month advance_ruling period to terminate your private_foundation_status under sec_507 of the code one of your officers is b’s spouse your executive director is b’s stepdaughter this illustrates a relationship between you and b the grant from b is contingent on two conditions first b has offered to contribute to your building fund until sufficient funds are raised to allow you to complete construction second the grant must be classified as an unusual grant so that your a status is not adversely affected to allow ba charitable_contribution_deduction to the extend of of his contribution_base with respect to such contributions applicant’s position you agreed b has been a substantial_contributor since inception you also agreed that his past contributions enabled you to become established and allowed you to acquire your current facility you believe that greater emphasis should be on the unusual nature of the gift and on your stability as a publically supported clinic over the past five years you contend that the grant is unusual because its purpose is to build a proposed new second facility in a new area not to support the operating budget of the current facility you contend that five years of a stable publically supported operation is sufficient to distinguish this grant from prior donations made by b you believe that there is some point in time at which a history of stable publically supported operations will separate a new donation from the prior operating history of reliance on a few donors including in particular b you stated five years is a sufficient period service’s response to applicant’s position while any initial grant could be considered unusual and or unexpected subsequent grants from the same individual are logically more usual and more expected b has shown a history of providing support in significant amounts to the point where the proposed grant of the given amount is not unusual the factor listed in sec_1_509_a_-3 of the regulations pertains to whether a contribution was made by any person who created the organization previously contributed a substantial part of its support or endowment or stood in a position of authority such as a foundation_manager with respect to the organization b has been a substantial_contributor to you throughout your existence and has a continuing relationship with you since inception the factor listed in sec_1_509_a_-3 of the regulations pertains to whether the organization has carried on an actual program of public solicitation and exempt_activities and has been able to attract a significant amount of public support since inception you have not always attracted significant amount of public support you are currently in a 60-month advance_ruling period to terminate your private_foundation_status under sec_507 of the code if you receive the proposed grant the overwhelming majority of your total support since inception will have come from b conclusion based on the facts described above we have determined that the proposed grant from b does not constitute an unusual grant within the meaning of sec_1_170a-9 and sec_1_509_a_-3 and of the regulations b is a disqualified_person a regular substantial_contributor and the grant would not be considered unusual or unexpected we have sent a copy of this letter to your representative as indicated in your power_of_attorney please keep a copy of this letter in your permanent records if you have any questions regarding this matter please contact the person whose name and telephone number appear in the heading of this letter sincerely lois g lerner director exempt_organizations


id office uilc cca_2008110513554337 ------------- number release date from -------------------- sent wednesday november pm to --------------------- cc -------------------------------------------------------------------------- subject re ---------- all of the aar's both by the tmp under sec_6227 and by the individual partners under sec_6227 may be treated as valid i would suggest denying the individual claims on the basis that the claimed adjustments will be considered exclusively in the context of the tmp aar