internal_revenue_service number release date index number --------------------------------- ------------------------------------------------------------ ------------------------ --------------------------- --------------------------------- re --------------------------------------------- --------------------------------------------------------- ----------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------- id no ---------------- telephone number -------------------- refer reply to cc psi plr-115077-15 date date legend ----------------- --------------------- ---------------------------------------------------------------------- ------------------------------- ------------------------- ------------------------- -------------------------- -------------------------- -------------------------- -------------------------------------------------------------------------------- date grantor_trust agreement child child child child child child trust --------------------------------------------------------------------------------------------------- state side agreement ---------------------------------------------------------------------------------------------------------- ------------------------------------------------ date corporate trustee state individual state court date date grandchild grandchild grandchild child 2’s widow -------------------------- ------------------------------------------ ------------ ---------------- ------------------------------------------------ ------------------------- ----------------------- ------------------------- -------------------------- ------------------ -------------- -------- ----------------------------------------------------------------- plr-115077-15 child 4’s widow grandchild grandchild grandchild date date x y date citation -------------------------------------------- citation -------------- ------------------------ -------------------------- ------------------ ------------------------ --------------------- ---------- ---------- ----------------------- -------------------------------------------------------------------------------- --------------------------------------------------------------------------------- dear ---------------------------------- this letter responds to your authorized representative’s letter dated date requesting rulings concerning the generation-skipping_transfer gst tax consequences of a court-approved settlement agreement facts the facts submitted and representations made are as follows on date a date prior to date grantor established an irrevocable_trust agreement creating separate trusts for the benefit of grantor’s children section dollar_figure of trust agreement provides that the trustees shall divide the trust property into separate trusts equal in value one for each of the following children and stepdaughter of grantor child child child child child and child accordingly upon execution of the trust agreement the trust property was divided immediately into six separate trusts of equal value for the grantor’s children individually child trust this ruling_request pertains to the trust trust that was established for the benefit of child section dollar_figure further defines sons and daughters of the grantor as the above-named children together with any child hereinafter born to or adopted by grantor in determining whether any person is a child grandchild or descendant for purposes of trust agreement legal adoption single or successive shall be the equivalent of blood relationship sec_3 a provides in part that after a son or daughter of the grantor reaches the age of twenty-one the trustees shall pay all the net_income of his trust to him in convenient installments at least as often as quarter-annually however the plr-115077-15 trustees may in their discretion withhold from any son or daughter of the grantor so much of the income of his trust as the trustees determine not to be required for his support comfort education and welfare or for any other purpose the trustees believe to be to his best interest the trustees may in their discretion pay to one or more of the descendants of any son or daughter of the grantor so much of any income withheld from such son or daughter as the trustees determine to be required or desirable for his or their support comfort education and welfare or for any other purpose the trustees believe to be to his or their best interests whenever the trustees determine that the income of any son or daughter of the grantor from all sources known to the trustees together with any resources that might be made available by enforcement of any obligation of the grantor to support and educate him is not sufficient for his reasonable support comfort and education and that of his immediate_family the trustees may pay to him or use for his benefit so much of the principal of his trust as the trustees determine to be required for those purposes sec_3 b provides that upon the death of any son or daughter of the grantor the trustees shall distribute his trust to or in trust for the benefit of such person or persons among the spouse of such son or daughter and the grantor’s descendants as he appoints and directs by will however no greater interest may be appointed for the benefit of a spouse of such son or daughter than the net_income from such trust until such spouse’s death or remarriage to the extent that he does not effectively exercise his power_of_appointment the trustee shall divide hold and distribute his trust as follows the trustee shall first divide such trust into equal trusts one for each then living child of such son or daughter of grantor a grandchild of grantor and one for the then living descendants collectively of each then deceased grandchild of grantor the share established for the descendants collectively of each then deceased grandchild of grantor shall be divided and allocated into portions per stirpes for the benefit of such then living descendants of such deceased grandchild each share established for a grandchild of grantor and each portion established for a descendant of a deceased grandchild of grantor shall be held as a separate and independent trust designated by the name of such grandchild or descendant of a deceased grandchild individually descendant trust sec_3 b also provides terms of a descendant trust that are similar to the terms of a child trust however after any grandchild or descendant of a grandchild of grantor has attained the age of thirty years the trustees shall distribute to him the balance of his trust upon the death of any grandchild or descendant of a grandchild of grantor prior to becoming entitled to receive full distribution of his trust the trustees shall distribute his trust to or for the benefit of such person or persons among the spouse of such grandchild or descendant of a grandchild of grantor and grantor’s descendants as he appoints and directs by will however no greater interest may be appointed for the benefit of a spouse of such grandchild or descendant of a grandchild of grantor than the net_income from such trust until such spouse’s death or remarriage to the extent that he does not effectively exercise his power_of_appointment the trustee plr-115077-15 shall distribute his trust subject_to the provisions of section dollar_figure of trust agreement to his then living descendants if any per stirpes and if none to his then living brothers and sisters if any in equal shares the then living descendants of any deceased brother or sister to take such deceased brother’s or sister’s share per stirpes and if there are no then living brothers or sisters or descendants of a deceased brother or sister of said decedent then in equal shares among the living grandchildren of grantor the then living descendants of any deceased grandchild to take such deceased grandchild’s share per stirpes section dollar_figure provides that no trust created hereunder or by any power_of_appointment hereunder shall continue for more than twenty-one years after the death of the last survivor of the grantor and the grantor’s descendants and their spouses living on date at that time the trustees are to distribute each remaining portion of the trust property to the beneficiary or beneficiaries the current income and if there is more than one beneficiary in the proportions in which they are beneficiaries and if their interests are indefinite the trustees shall distribute the trust per stirpes to those beneficiaries as are descendants of the grantor or if no beneficiary is a descendant of the grantor to those beneficiaries in equal shares trust agreement does not include a provision regarding which state’s law will govern the validity construction or administration of trust trust agreement was executed and initially administered in state section dollar_figure provides whenever the trustees consider it advantageous to the beneficiaries of any trust the trustees may transfer the situs of any trust and in so doing may appoint as a successor trustee any person or corporation authorized under the laws of the united_states or of any state to administer trusts by a written instrument delivered to the successor a side agreement executed on or before date by child as the income_beneficiary and individual co-trustee of trust and corporate trustee provided among other things that the situs of trust is state and the laws governing the administration of trust shall be of state the current trustees of trust are individual and corporate trust collectively trustees by order of state court dated date state governs the administration of trust and state continues to govern matters pertaining to the validity and construction of trust agreement and trust child died on date without a surviving_spouse or living descendants child 1’s will provides that all of child 1’s assets are to be used for animal welfare and makes no specific_bequest or devise of her assets to any individual or trust child did not exercise her testamentary_power_of_appointment over the assets of trust in her will child and child predeceased child child was survived by one biological child grandchild and two adopted children grandchild and grandchild accordingly under the terms of trust agreement grandchild and grandchild are descendants of child it is represented that the terms of the adoptions qualify plr-115077-15 grandchild and grandchild as descendants of child in his will child exercised his testamentary_power_of_appointment to distribute the assets of child 2’s child trust to a_trust family_trust for the benefit of grandchild and child 2’s widow counsel to the trustees of the family_trust represent that the family_trust complies with the requirements of trust agreement including the limitations with respect to the interest of child 2’s widow in the family_trust grandchild and grandchild have living children child was survived by child 4’s widow grandchild grandchild and grandchild the terms of child 4’s will exercised his testamentary_power_of_appointment to distribute the assets of child 4’s child trust to separate trusts for the benefit of child 4’s widow grandchild grandchild and grandchild grandchild and grandchild have living children child failed to exercise her testamentary_power_of_appointment over the assets of trust in her will trust agreement is silent as to the distribution provisions of trust upon the death of child with no surviving_spouse or descendants consequently the proper distribution of trust assets under trust agreement is in issue trustees of trust communicated with the representatives of the living descendants of grantor and trustees of the trusts that are potential beneficiaries under trust regarding distributions of the assets of trust the trustees entered into arm’s length negotiations with the potential beneficiaries as part of the negotiations the parties considered alternative constructions of trust agreement a distribution alternatives schedule containing several possible distribution alternatives was circulated among the parties to date there are twenty-nine individuals representing the possible descendants of grantor on date the trustees filed a petition with state court in order to preserve claims concerning the proper distribution of trust and to delineate the various issues and the possible distribution schemes that may result from the resolution of the issues all interested parties including the attorneys general of state and state received notice and service of process regarding the petition over the next two years the parties entered into extensive negotiations a settlement was consummated and the parties executed a settlement agreement and mutual release dated date settlement agreement the settlement agreement provides in relevant part the settlement agreement is contingent upon approval by state court the settlement agreement is contingent upon trustees receiving a favorable private_letter_ruling from the internal_revenue_service that the termination of trust and the distribution of the assets of trust pursuant to the terms of settlement agreement will not result in tax under the provisions of chapter grandchild and grandchild will each receive outright distributions from trust equal to dollar_figurex dollar_figurey in the aggregate the assets of trust after payment to grandchild and grandchild and net of costs will be distributed in five plr-115077-15 equal shares to the following i family_trust ii child 3’s child trust iii child 4’s children grandchild grandchild and grandchild further divided among them in equal shares iv child 5’s child trust and v child 6’s child trust and neither child 2’s widow nor child 3’s widow shall have any right or interest in any asset distributed from trust on date state court entered an order approving the settlement agreement it is represented that no additions actual or constructive have been made to trust since date you have requested a ruling that termination of trust and distributions of the assets of trust pursuant to the terms of the settlement agreement will not result in gst tax under the provisions of chapter of the code law and analysis 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 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 plr-115077-15 sec_26_2601-1 provides that a court-approved settlement of a bona_fide issue regarding the administration of the trust or the construction of terms of the governing instrument will not cause an exempt trust to be subject_to the provisions of chapter if the settlement is the product of arm’s length negotiations and the settlement is within the range of reasonable outcomes under the governing instrument and applicable state law addressing the issues resolved by the settlement a settlement that results in a compromise between the positions of the litigating parties and reflects the parties’ assessments of the relative strengths of their positions is a settlement that is within the range of reasonable outcomes the trustees represent that trust was irrevocable on date and that there were no additions to trust after date accordingly trust is exempt from gst tax under state law the construction of a will or trust is based on the intent of the testator or settlor see citation where a_trust is silent on a particular question in the sense that it contains no express answer to the question then a construction of the trust is necessary citation the parties were represented by separate counsel and the settlement agreement was signed by the individual party or on behalf of his or her minor and unborn descendants accordingly the settlement agreement is a product of arm’s length negotiations in this case the fact that trust did not contain a distribution provision in the event child died with no surviving_spouse or descendants created a bona_fide issue regarding the construction of trust the parties considered various constructions of trust in order to reach a compromise regarding the distribution of the terminating distributions of trust the terms of the settlement agreement are a compromise of the parties’ respective adverse economic interests in trust state court approved the settlement agreement we conclude that the settlement agreement and state court order represent a compromise between the positions of the litigating parties and reflects the parties’ assessments of the relative strengths of their positions and therefore is within the range of reasonable outcomes accordingly based upon the facts provided and representations made we conclude that the requirements of sec_26_2601-1 are satisfied and rule that termination of trust and distributions of the assets of trust pursuant to the terms of the settlement agreement will not result in gst tax under the provisions of chapter of the code plr-115077-15 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely lorraine e gardner senior counsel branch office of associate chief_counsel passthroughs special industries enclosures copy for sec_6110 purposes copy of this letter cc


office_of_chief_counsel internal_revenue_service memorandum number release date cc pa cbs b01 gl-142830-05 uilc date date to -area counsel cc sb la attn alan h cooper from walter ryan assistant to the branch chief br collection bankruptcy summonses subject levy on taxpayer's property and rights to property under trust this chief_counsel_advice responds to your request for assistance dated date this advice may not be used or cited as precedent issue sec_1 whether the service may levy against a spendthrift trust under which the taxpayer is a current income_beneficiary and is a vested beneficiary of a future_interest in established portions of the trust principal if the trustee knowingly distributes funds encumbered with the federal_tax_lien and the funds disappear into the stream of commerce under state law may the government sue the trustee for the tortious conversion of the federal_tax_lien conclusion sec_1 the service may levy on certain assets of the trust despite the existence of spendthrift provisions as the taxpayer possesses fixed and determinable property rights in the trust a levy will clearly seize the taxpayer’s fixed_right to trust income and the taxpayer’s fixed_right to obtain a future distribution from corpus when a trustee distributes funds that he knows are encumbered by the federal_tax_lien and those funds enter the stream of commerce and cannot be traced the trustee is liable for tortious conversion ie intentionally impairing a lienor’s security gl-142830-05 facts on ------------------ --------------------------- hereinafter settlor executed a_trust agreement referred to as the --------------------------------------------------------------------------------------------- ------------------------- hereinafter trust a certification of trust was filed with the state of california on the same date taxpayer ------------------------------------------------------------- -------- was named trustee for the trust the settlor died on ---------------------- the trust provides that after the administration of the probate_estate the trust estate shall be divided into as many equal shares as are necessary to establish one share for each of the settlor’s children and grandchildren taxpayer is a ------------ of the settlor and as such was allocated one share of the trust estate ----------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------- 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----------------------------------- gl-142830-05 taxpayer currently receives dollar_figure-------- every month from the trust taxpayer has tax_liabilities for taxable years ------- and ------- totaling dollar_figure----------------- law and analysis pursuant to sec_6321 the federal_tax_lien attaches to all property and rights to property of a delinquent taxpayer the question of whether a state law right constitutes property or rights to property under sec_6321 is a matter of federal_law 472_us_713 when congress broadly uses the term property as it does in sec_6321 and sec_6331 it aims to reach every species of right or interest protected by law and having an exchangeable value 528_us_49 according to the supreme court the code’s prescriptions are most sensibly read to look to state law for delineation of the taxpayer’s rights or interests in the property the government seeks to reach but to leave to federal_law the determination of whether those rights or interests constitute property or rights to property under sec_6321 id pincite after the federal_tax_lien attaches to a taxpayer’s property and rights to property the service gives notice_and_demand for payment and if the taxpayer neglects or refuses to pay the service may levy upon the taxpayer’s property and rights to property as sec_301_6331-1 explains the levy seizes the taxpayer’s property and rights to property as of the time of the levy although it does not accelerate a right to future payment except as provided in sec_301_6331-1 with regard to a levy on salary or wages a levy extends only to property possessed and obligations which exist at the time of the levy obligations exist when the liability of the obligor is fixed and determinable although the right to receive payment thereof may be deferred until a later date the word determinable has been held to mean that the amount of liability is capable of being determined reiling v united_states u s t c n d ind thus for tax levy purposes the precise sum of the obligation need only be capable of measurement at some time in the future see 51_f3d_883 9th cir construing sec_301_6331-1 if a taxpayer has a fixed and determinable right to a stream of payments the levy will seize not only the payments currently due but also the payments to be made in the future revrul_55_210 1955_1_cb_544 thus if a taxpayer has a fixed_right under a_trust to receive periodic_payments or a lump sum distribution from a_trust the levy seizes the rights to such payments or distributions spendthrift provisions gl-142830-05 spendthrift provisions which are state-created exemptions cannot defeat a federal_tax_lien see eg northwestern trust company v internal_revenue_service 622_f2d_387 8th cir 550_f2d_682 1st cir in leuschner v first western bank and trust the ninth circuit affirmed that a taxpayer’s interest in a_trust could be reached by the federal_tax_lien observing that t here is no doubt that the paramount right to collect taxes of the federal government overrides a state statute providing for exemptions 261_f2d_705 9th cir footnotes omitted thus the spendthrift provision at --------------- of the trust however effective against certain creditors’ claims is clearly ineffective at insulating assets of the trust from levy by the service provided that such assets are first found to constitute the property or right to property of the taxpayer current_distribution of trust income the taxpayer has at a minimum the right to all current income of the trust distribution of current income to the beneficiaries is mandatory and not subject_to the exercise of discretion on the part of the trustee it follows then that such mandatory distribution of current income is a property right of the taxpayer that may be levied by the service and collected as payable pursuant to revenue rule the levy will seize the entire stream of income payments namely the income payments currently due and all future income payments future distributions of principal the taxpayer possesses an additional right to property in the trust in the form of future distributions of a certain proportion of trust corpus the trust document establishes that the trustee shall distribute to the beneficiaries -------------of the trust’s corpus on approximately the ------ anniversary of the settlor’s death approximately -------------------- ------- and later shall distribute ----------- of the remaining corpus on the -------- anniversary of the settlor’s death approximately ---------------------- as with distributions of current income distribution of these proportions of principal are mandatory and not subject_to the discretion of the trustee furthermore the beneficiaries’ right to such distribution appears fully vested and not subject_to divestment as the only qualification of such right is as to the timing of the beneficiaries’ receipt of the distribution the right is fixed and capable of determination this payment is essentially the same addressed in revenue rule so the levy seizes the taxpayer’s present right to this future payment although the levy cannot accelerate the right to payment tortious conversion of the federal_tax_lien as an alternative or supplement to a suit to enforce a levy the federal government may sue the holder of the taxpayer’s property for tortious conversion of the federal_tax_lien 388_f3d_738 10th cir under california state law a ------------------------------------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------- gl-142830-05 lienor may sue a defendant who intentionally impairs a lienor’s security 328_fsupp_1281 e d cal imposing liability for the tortious conversion of the federal_tax_lien under california law in this situation if the trustee-taxpayer who is also the beneficiary-taxpayer draws a check payable to herself as a_trust distribution then the trustee-taxpayer will have impaired the federal_tax_lien if the government cannot recover the funds distributed in other words the trustee-taxpayer knew that the federal_tax_lien encumbered her property and rights to property and that funds distributed would disappear into the stream of commerce thereby damaging the federal_tax_lien case development hazards and other considerations --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------- conclusions we find that the taxpayer as a current income_beneficiary and as the vested beneficiary of a future_interest in established portions of the trust principal possesses property rights in the trust that may be levied upon as payable notwithstanding operation of the trust’s spendthrift provisions as an alternative to the levy the federal government may also sue the trustee-taxpayer if ----- intentionally makes distributions of funds encumbered with the federal_tax_lien and the funds disappear into the stream of commerce if you have any questions with regard to the foregoing analysis please call us at 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


internal_revenue_service number release date index number ------------------------------------- --------------------------------------------------- ----------------------------------------- ---------------------------------- -------------------------------------------- --------------------------------- in re --------------------------------- 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 psi b09 plr-155335-05 date date ------------------------- -------------------------- ----------------------- ---------------- ---------------- ------------------------- legend legend decedent spouse child possession state date dear executors this is in response to your letter dated date and subsequent correspondence requesting a ruling regarding the credit under sec_2014 of the internal_revenue_code for decedent’s estate decedent was a united_states citizen domiciled in state who owned assets in possession decedent died on date survived by spouse and children article second of decedent’s will provides that spouse is to receive decedent’s articles of tangible_personal_property article fourth provides that the residuary of decedent’s estate is to be held in trust for the benefit of spouse and child during spouse’s lifetime spouse is to receive all of the net_income of the trust at least quarterly income accrued but not distributed at spouse’s death is to be paid to spouse’s estate the trustees have the discretion to invade trust principal for spouse’s benefit finally spouse has an annual power to withdrawal from trust principal the greater of percent of the value of the trust calculated annually or dollar_figure upon spouse’s death the remainder of the trust is to be held in further trust for child plr-155335-05 on the schedule m of the form_706 united_states estate and generation-skipping_transfer_tax return filed for decedent’s estate a marital_deduction was claimed for assets passing_to_spouse under articles second and fourth of decedent’s will the executors have requested a ruling as to the method to be used to calculate the credit under sec_2014 for decedent’s estate law and analysis sec_2014 provides that in general the tax imposed by sec_2001 shall be credited with the amount of any estate inheritance legacy or succession taxes actually paid to any foreign_country in respect of any property situated within such foreign_country and included in the gross_estate not including any such taxes paid with respect to the estate of a person other than the decedent the determination of the country within which property is situated shall be made in accordance with the rules applicable under subchapter_b sec_2101 and following in determining whether property is situated within or without the united_states sec_2014 provides that the credit provided in this section with respect to such taxes paid to any foreign country-- shall not with respect to any such tax exceed an amount which bears the same ratio to the amount of such tax actually paid to such foreign_country as the value of property which is-- a situated within such foreign_country b subjected to such tax and c included in the gross_estate bears to the value of all property subjected to such tax and shall not with respect to all such taxes exceed an amount which bears the same ratio to the tax imposed by sec_2001 after deducting from such tax the credits provided by sec_2010 sec_2011 and sec_2012 as the value of property which is-- a situated within such foreign_country b subjected to the taxes of such foreign_country and c included in the gross_estate bears to the value of the entire_gross_estate reduced by the aggregate amount of the deductions allowed under sec_2055 and sec_2056 sec_2014 provides that the values referred to in the ratio stated in subsection b are the values determined for purposes of the tax imposed by such foreign_country sec_2014 provides that the values referred to in the ratio stated in subsection b are the values determined under this chapter but in applying such ratio the value of any property described in subparagraphs a b and c thereof shall be reduced by such amount as will properly reflect in accordance with regulations prescribed by the secretary the deductions allowed in respect of such property under sec_2055 and sec_2056 relating to charitable and marital deductions sec_2014 provides that for purposes of the credits authorized by this section each possession_of_the_united_states shall be deemed to be a foreign_country plr-155335-05 sec_20_2014-1 provides in part that a credit is allowed under sec_2014 against the federal estate_tax for any estate inheritance legacy or succession taxes actually paid to any foreign_country hereinafter referred to as foreign death taxes the credit is allowed only for foreign death taxes paid i with respect to property situated within the country to which the tax is paid ii with respect to property included in the decedent's gross_estate and iii with respect to the decedent's_estate the credit is allowable to the estate of a decedent who was a citizen_of_the_united_states at the time of his death the credit is allowable not only for death taxes paid to foreign countries which are states in the international sense but also for death taxes paid to possessions or political subdivisions of foreign states with respect to the estate of a decedent dying after date the term foreign_country as used in this section and sec_20_2014-2 to includes a possession_of_the_united_states no credit is allowable for interest or penalties paid in connection with foreign death taxes sec_20_2014-1 provides in part whether or not particular property of a decedent is situated in the foreign_country imposing the tax is determined in accordance with the same principles that would be applied in determining whether or not similar_property of a nonresident decedent not a citizen_of_the_united_states is situated within the united_states for federal estate_tax purposes see sec_20_2104-1 and sec_20_2105-1 sec_20_2014-1 provides that the credit_for_foreign_death_taxes is limited to the smaller of the following amounts the amount of a particular foreign death_tax attributable to property situated in the country imposing the tax and included in the decedent's gross_estate for federal estate_tax purposes computed as set forth in sec_20_2014-2 or the amount of the federal estate_tax attributable to particular property situated in a foreign_country subjected to foreign death_tax in that country and included in the decedent's gross_estate for federal estate_tax purposes computed as set forth in sec_20_2014-3 sec_20_2014-2 provides that the amount of a particular foreign death_tax attributable to property situated in the country imposing the tax and included in the decedent's gross_estate for federal estate_tax purposes is the first_limitation thus the credit for any foreign death_tax is limited to an amount a which bears the same ratio to b the amount of the foreign death_tax without allowance of credit if any for federal estate_tax as c the value of the property situated in the country imposing the foreign death_tax subjected to the foreign death_tax included in the gross_estate and for which a deduction is not allowed under sec_2053 bears to d the value of all property subjected to the foreign death_tax stated algebraically the first_limitation a equals b x ---- d c plr-155335-05 where b amount of foreign death_tax c value of property in foreign_country subjected to death_tax included in gross_estate and for which a deduction is not allowed under sec_2053 and d value of all property subjected to foreign death_tax the values used in this proportion are the values determined for the purpose of the foreign death_tax the amount of the foreign death_tax for which credit is allowable must be converted into united_states money sec_20_2014-3 provides that the amount of the federal estate_tax attributable to particular property situated in a foreign_country subjected to foreign death_tax in that country and included in the decedent's gross_estate for federal estate_tax purposes is the second_limitation thus the credit is limited to an amount e which bears the same ratio to f the gross federal estate_tax reduced by any credit_for_state_death_taxes under sec_2011 and by any credit for gift_tax under sec_2012 as g the adjusted_value of the property situated in the foreign_country subjected to foreign death_tax and included in the gross_estate computed as described in paragraph b of this section bears to h the value of the entire_gross_estate reduced by the total amount of the deductions allowed under sec_2055 charitable deduction and sec_2056 marital_deduction stated algebraically the second_limitation e equals f x ---- h where f gross federal estate_tax less credits for state_death_taxes and gift_tax g adjusted_value of the property situated in the foreign_country subjected to foreign death taxes and included in the gross_estate and g h value of entire_gross_estate less charitable and marital deductions the values used in this proportion are the values determined for the purpose of the federal estate_tax sec_20_2014-3 provides that adjustment is required to factor g of the ratio stated in paragraph a of this section if a deduction for foreign death taxes under sec_2053 a charitable deduction under sec_2055 or a marital_deduction under sec_2056 is allowed with respect to the foreign_property if a deduction for foreign death taxes is allowed the value of the property situated in the foreign_country subjected to foreign death_tax and included in the gross_estate does not include the value of any property in respect of which the deduction for foreign death taxes is allowed see sec_20_2014-7 if a charitable deduction or a marital_deduction is allowed the value of such foreign_property after exclusion of the value of any property in respect of which the deduction for foreign death taxes is allowed is reduced as follows plr-155335-05 if a charitable deduction or a marital_deduction is allowed to a decedent's_estate with respect to any part of the foreign_property except foreign_property in respect of which a deduction for foreign death taxes is allowed specifically bequeathed devised or otherwise specifically passing to a charitable_organization or to the decedent's spouse the value of the foreign_property is reduced by the amount of the charitable deduction or marital_deduction allowed with respect to such specific transfer see example of paragraph c of this section if a charitable deduction or a marital_deduction is allowed to a decedent's_estate with respect to a bequest devise or other transfer of an interest in a group_of_assets including both the foreign_property and other_property the value of the foreign_property is reduced by an amount i which bears the same ratio to j the amount of the charitable deduction or marital_deduction allowed with respect to such transfer of an interest in a group_of_assets as k the value of the foreign_property except foreign_property in respect of which a deduction for foreign death taxes is allowed included in the group_of_assets bears to l the value of the entire group_of_assets as used in this subparagraph the term group_of_assets has reference to those assets which under applicable law are chargeable with the charitable or marital transfer see example of paragraph c of this section stated algebraically the reduction to the value of the foreign_property is equal to i below k i j x ----- l where j amount of the charitable deduction or marital_deduction allowed with respect to such transfer of an interest in a group_of_assets k value of the foreign_property except foreign_property in respect of which a deduction for foreign death taxes is allowed included in the group_of_assets and l value of the entire group_of_assets any reduction described in sec_20_2014-3 or b on account of the marital_deduction must proportionately take into account if applicable the limitation on the aggregate amount of the marital_deduction contained in sec_20_2056_a_-1 see sec_20_2014-3 example sec_20_2014-3 example provides as follows i decedent a citizen and resident_of_the_united_states at the time of his death on date left a gross_estate of dollar_figure which includes the following shares of stock issued by a domestic_corporation valued at dollar_figure bonds issued in by the united_states and physically located in foreign_country x valued at dollar_figure and shares of stock issued plr-155335-05 by a country x corporation valued at dollar_figure with respect to which death taxes were paid to country x expenses indebtedness etc amounted to dollar_figure decedent specifically bequeathed dollar_figure of the stock issued by the country x corporation to a u s charity and left the residue of his estate in equal shares to his son and daughter the gross federal estate_tax is dollar_figure and the credit_for_state_death_taxes is dollar_figure under the situs rules referred to in paragraph a of sec_20_2014-1 the shares of stock issued by the country x corporation comprise the only property deemed to be situated in country x the bonds also would be deemed to have their situs in country x if the decedent had died before date ii for the second_limitation e on the credit_for_foreign_death_taxes e second_limitation f dollar_figure - dollar_figure dollar_figure g dollar_figure - dollar_figure dollar_figure and h dollar_figure - dollar_figure dollar_figure therefore dollar_figure e dollar_figure x ----------------- dollar_figure dollar_figure the lesser_of this amount and the amount of the first_limitation computed under sec_20_2014-2 is the credit_for_foreign_death_taxes sec_20_2014-3 example provides as follows i decedent a citizen and resident_of_the_united_states at the time of his death left a gross_estate of dollar_figure which includes shares of stock issued by a united_states_corporation valued at dollar_figure shares of stock issued by a country x corporation valued at dollar_figure and life_insurance in the amount of dollar_figure payable to a son expenses indebtedness etc amounted to dollar_figure the decedent made a specific_bequest of dollar_figure of the country x corporation stock to charity a and a general bequest of dollar_figure to charity b the residue of his estate was left to his daughter the gross federal estate_tax is dollar_figure and the credit_for_state_death_taxes is dollar_figure under these facts and applicable law neither the stock of the country x corporation specifically bequeathed to charity a nor the insurance payable to the son could be charged with satisfying the bequest to charity b therefore the group_of_assets which could be so charged is limited to stock of the country x corporation valued at dollar_figure and stock of the united_states_corporation valued at dollar_figure ii factor g of the ratio which is used in determining the second_limitation is computed as follows value of property situated in country x less dollar_figure dollar_figure plr-155335-05 reduction described in sec_20_2014-3 reduction i described in sec_20_2014-3 i reduction amount j dollar_figure k dollar_figure and l dollar_figure dollar_figure dollar_figure therefore i dollar_figure x ------------------------------- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure factor g of the ratio is iii in this case the second_limitation on the credit_for_foreign_death_taxes is computed as follows e second_limitation f dollar_figure - dollar_figure dollar_figure g dollar_figure and h dollar_figuredollar_figure - dollar_figure dollar_figure therefore dollar_figure e dollar_figure x ------------------- dollar_figure dollar_figure sec_20_2014-3 example provides as follows i decedent a citizen and resident_of_the_united_states at the time of his death left a gross_estate of dollar_figure which includes shares of stock issued by united_states corporations valued at dollar_figure real_estate located in the united_states valued at dollar_figure and shares of stock issued by country x corporations valued at dollar_figure expenses indebtedness etc amounted to dollar_figure decedent devised dollar_figure in real_estate to a united_states charity in addition he bequeathed to his wife dollar_figure in united_states stocks and dollar_figure in country x stocks the residue of his estate passed to his children the gross federal estate_tax is dollar_figure and the credit_for_state_death_taxes is dollar_figure ii decedent's adjusted_gross_estate is dollar_figure ie the dollar_figure gross_estate less dollar_figure expenses indebtedness etc assume that the limitation imposed by sec_2056 as in effect before is applicable so that the aggregate allowable marital_deduction is limited to one-half the adjusted_gross_estate or dollar_figure which i sec_50 percent of dollar_figure factor g of the ratio which is used in determining the second_limitation is computed as follows dollar_figure dollar_figure dollar_figure dollar_figure plr-155335-05 value of property situated in country x less reduction described in sec_20_2014-3 b determined as follows see also end of sec_20_2014-3 - total amount of bequests which qualify for the marital_deduction specific_bequest of country x stock specific_bequest of united_states stock limitation on aggregate marital_deduction under sec_2056 part of specific_bequest of country x stock with respect to which the marital_deduction is allowed dollar_figure x dollar_figure dollar_figure factor g of the ratio iii thus the second_limitation on the credit_for_foreign_death_taxes is computed as follows e second_limitation f dollar_figure - dollar_figure dollar_figure g dollar_figure h dollar_figure - dollar_figure - dollar_figure dollar_figure and so dollar_figure dollar_figure dollar_figure dollar_figure e dollar_figure x --------------- dollar_figure dollar_figure in this case the available credit under sec_2014 is the lesser_of the first_limitation calculated under sec_20_2014-2 and the second_limitation calculated under a assets that pass to spouse under the provisions of article second of decedent’s will are specifically bequeathed to spouse therefore to the extent that the situs of assets passing_to_spouse under article second for purposes of sec_20_2014-1 are in possession the adjustment set forth in sec_20_2014-3 is applicable in determining the available credit under sec_2014 assets that pass to spouse under the provisions of article fourth of decedent’s will constitute a general bequest to spouse therefore to the extent that the situs of assets passing_to_spouse under article fourth for purposes of sec_20_2014-1 are in possession the adjustment set forth in sec_20_2014-3 is applicable in determining the available credit under sec_2014 plr-155335-05 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely melissa liquerman melissa liquerman branch chief branch passthroughs special industries enclosures copy for ' purposes


internal_revenue_service national_office technical_advice_memorandum august third party communication none date of communication not applicable number release date index uil no case-mis no tam-106440-07 taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference legend --------------------------- ------------------ ------------------------------- ---------------- --------------------------------------- --------------------------- -------------------------------- --------------------------- sh --------------------------------------------------- scorp -------------------------------------------------- qsub1 qsub2 y1 y2 ------- ------- -------------------------- ------------------------------ tam-106440-07 y3 city1 city2 ------- -------- ----------- issues whether the truck leasing activity conducted by qsub1 is a separate rental_activity under sec_469 of the internal_revenue_code if the truck leasing activity conducted by qsub1 is treated as a separate rental_activity whether it may be grouped with the non-rental activities conducted by the other qsubs of scorp under sec_1_469-4 of the income_tax regulations conclusion s the truck leasing activity conducted by qsub1 is a separate rental_activity under sec_469 the truck leasing activity conducted by qsub1 may be grouped with the non-rental activities conducted by the other qsubs of scorp under sec_1_469-4 facts for the years at issue y1 y2 and y3 sh owned of scorp an s_corporation scorp owned several qualified subchapter_s subsidiaries qsubs including qsub1 and qsub2 qsub2 and the qsubs other than qsub1 generally sell new and used heavy trucks and trailers and have locations in city1 and city2 qsub1 located in city1 primarily leases heavy trucks and trailers via leveraged net leases qsub1 and qsub2 are located in the same building qsub1 maintains its own set of accounting_records computer accounting programs and books_and_records the lease terms of qsub1 are typically to months qsub1 acquires the equipment it leases primarily from qsub2 such sales are made at retail value qsub1 also makes purchases from unrelated third parties if the customer wants a model that qsub2 does not carry qsub1 has a master lease agreement for motor vehicles and another master lease agreement for equipment leases the master lease agreements call for various items such as rent security deposits owner’s right of inspection equipment to remain in the u s lessee to maintain insurance no vehicle to be marked or permanently altered without owner’s permission lessee to pay for all repairs not under warranty and lessee to be responsible for maintenance and conforming leased property to federal state_or_local_government requirements lessee must also pay all personal_property excise sales and or use taxes upon termination of the lease tam-106440-07 lessees must generally return the property to the lessor some of the leases also contain terminal rental adjustment clauses trac which provide that upon termination of the lease the equipment will be sold and the proceeds distributed as follows reimburse lessor for cost of putting leased equipment in condition to be sold sales commissions and other expenses of sale balance to lessor up to a stated residual_value and any remaining amount to lessee as an adjustment to rent previously paid if the proceeds are less than the residual_value and expenses of sale lessee shall pay to lessor the deficiency as additional rent but in any event not more than the residual_value the amount_paid by lessee is classified as a terminal rent adjustment alternatively the lessee can sell the item to avoid having to pay sales commissions and other costs but qsub1 is paid the residual_value for the years at issue scorp has grouped all of the activities conducted by the qsubs into one activity for purposes of sec_469 and has consistently used this grouping through the years sh reported consistently with the grouping of activities shown on the k-1s issued by scorp the combined activities of scorp represent an appropriate economic unit under sec_1_469-4 law and analysis sec_469 disallows passive_activity_losses to individual taxpayers for the taxable_year sec_469 provides that the term passive_activity means any activity which involves the conduct_of_a_trade_or_business in which the taxpayer does not materially participation sec_469 provides that the term passive_activity includes any rental_activity sec_469 provides that sec_469 shall be applied without regard to whether or not the taxpayer materially participates in the activity sec_469 provides that the term passive_activity_loss means the amount by which the aggregate losses from all passive activities for the taxable_year exceed the aggregate income from all passive activities for such year sec_469 provides that the term rental_activity means any activity where payments are principally for_the_use_of tangible_property sec_1_469-1t provides that an activity is a rental_activity for a taxable_year if during such taxable_year tangible_property held in connection with the activity is used by customers or held for use by customers and the gross_income attributable to the conduct of the activity during such taxable_year represents amounts paid principally for_the_use_of such tangible_property without regard to whether the use of the property by customers is pursuant to a lease or pursuant to a service_contract or other arrangement that is not denominated a lease tam-106440-07 sec_1_469-4 provides that sec_1_469-4 sets forth the rules for grouping a taxpayer’s trade_or_business activities and rental activities for purposes of applying the passive_activity_loss and credit limitation rules of sec_469 a taxpayer’s activities include those conducted through c corporations that are subject_to sec_469 s_corporations and partnerships sec_1_469-4 generally provides that trade_or_business activities are activities other than rental activities that involve the conduct_of_a_trade_or_business within the meaning of sec_162 sec_1_469-4 provides that rental activites are activities that constitute rental activities within the meaning of sec_1_469-1t sec_1_469-4 provides that one or more trade_or_business activities or rental activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain_or_loss for purposes of sec_469 sec_1_469-4 provides that except as otherwise provided in sec_1_469-4 whether activities constitute an appropriate economic unit depends upon all the relevant facts and circumstances sec_1_469-4 provides that the grouping of activities is subject_to several limitations sec_1_469-4 provides that a rental_activity may not be grouped with a trade_or_business activity unless the activities being grouped together constitute an appropriate economic unit under sec_1_469-4 and a the rental_activity is insubstantial in relation to the trade_or_business activity b the trade_or_business activity is insubstantial in relation to the rental_activity or c each owner of the trade_or_business activity has the same proportionate ownership_interest in the rental_activity in which case the portion of the rental_activity that involves the rental of items of property for use in the trade_or_business activity may be grouped with the trade_or_business activity sec_1_469-4 generally provides that an s_corporation must group its activities under the rules of sec_1_469-4 once the s_corporation groups its activities a shareholder may group those activities with each other with activities conducted directly by the shareholder and with activities conducted through other entities in accordance with the rules of sec_1_469-4 a shareholder may not treat activities grouped together by an s_corporation as separate activities the temporary regulations under sec_1_469-4 contained a bright line test whereby an activity would be considered insubstantial if it earned less than percent of the gross_income of the combined activity the final regulations however removed this bright line test the preamble to the final regulations explain this removal as follows several commentators requested clarification of the rule that trade_or_business activities may be grouped together with rental activities only if one is insubstantial in relation to the other some comments tam-106440-07 suggested specifying the term insubstantial refers to factors other than gross_income other commentators suggested adopting a bright-line_test or safe_harbor gross revenue test because the regulations already adopt a facts_and_circumstances_test that looks at all of the pertinent factors it is not necessary to specify that the term insubstantial refers to factors other than gross_income in addition to avoid complex and mechanical rules the final regulations do not adopt a bright-line or safe_harbor or gross revenue test t d in addition the legislative_history to sec_469 provides that the determination of what constitutes a separate activity is to be made in a realistic economic sense see s rep no pincite issue sh and scorp argue that the activity of qsub1 is a trade_or_business activity and not a rental_activity first sh and scorp argue that the activity of qsub1 is a financing trade_or_business because qsub1 receives a guarantee from the lessee in order to minimize the risk associated with the condition and market_value of the property at the end of the lease_term the leases are treated under gaap as finance leases that is qsub1 is treated as having sold the asset to the lessee and simply retains an interest as a creditor generally the tax_accounting of this transaction would be the same as gaap treatment as disguised sale but because of sec_7701 and the insertion by scorp of a trac in the agreements the code allows scorp to treat a financial_lease as an operating_lease regardless of the underlying sale that has occurred for purposes of depreciation thus sh and scorp contend that the exception contained in sec_7701 should not change the substance of the transaction for purposes of sec_469 and qsub1 should be treated as engaged in a financing trade_or_business rather than a rental_activity however the fact that a lease may be treated as a finance_lease for book purposes does not control its tax treatment sec_7701 specifically states that a lease with a trac will be treated as a lease for all purposes of the code and that the lessor will be treated as the owner of the leased property accordingly the activity of qsub1 constitutes a rental_activity for purposes of sec_469 rather than a financing trade_or_business activity sh and scorp also rely upon case law that states that a trade_or_business activity exists for purposes of sec_162 if taxpayer enters into and carries on an activity with a good_faith intention to make a profit and the activity is engaged in with some regularity and continuity because the activity of qsub1 meets these requirements sh and scorp believe that the activity conducted by qsub1 is a trade_or_business activity rather than a rental_activity for purposes of sec_469 sec_1_469-4 provides that trade_or_business activities are activities other than rental activities that involve the conduct_of_a_trade_or_business within the meaning of sec_162 thus although qsub1’s activity may constitute a trade_or_business activity within the meaning of sec_162 and the tam-106440-07 judicial doctrine thereunder the definition of trade_or_business for purposes of sec_469 specifically excludes activities which are rental activities because the activity of qsub1 is one in which property is held for use by customers and the income earned represents amounts paid principally for_the_use_of such tangible_property the activity is a rental_activity for purposes of sec_469 regardless of whether it also satisfies the trade_or_business requirements of sec_162 finally sh and scorp argue that it is inappropriate to break out the truck leasing activity conducted by qsub1 as a separate activity as the car dealership activity should be viewed as one integrated activity that is sh and scorp believe that the activity conducted by qsub1 is a part of the overall trade_or_business of selling vehicles at the end of a lease the customer can either return the vehicle at which time the car dealership trade_or_business will sell the vehicle or the customer can purchase the vehicle thus sh and scorp argue that leases are merely an alternative way to sell a vehicle and they go hand in hand with a car dealership trade_or_business activity this argument also fails because of the structure of sec_1_469-4 which excludes rental activities from the definition of a trade_or_business activity that is given the definition of trade_or_business activity in sec_1_469-4 a trade_or_business activity cannot have as one of its components a rental_activity therefore the truck leasing activity conducted by qsub1 is a rental_activity for purposes of sec_469 and may be grouped with the non-rental activities conducted by the other qsubs of scorp only if the activities satisfy the requirements of sec_1_469-4 issue the truck leasing activity conducted by qsub1 may be grouped with the activities of the other qsubs under sec_1_469-4 it is conceded that the activities of qsub1 and the other qsubs constitute an appropriate economic unit under sec_1_469-4 in addition based upon all of the facts and circumstances the rental_activity of qsub1 is insubstantial in relation to the trade_or_business activities conducted by the other qsubs of scorp caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent no opinion is expressed herein as to any other issues raised in the technical_advice request or that may be raised based on the facts of this case


t c memo united_states tax_court dean l and cynthia d sanders petitioners v commissioner of internal revenue respondent docket no filed date p a wealthy businessman engaged in the activity of showing and selling cutting horses incurring substantial losses during the years in issue and during preceding and following years held losses disallowed the activity was not an activity engaged in for profit p undertook and carried on the activity primarily as a hobby held further ps are liable for sec_6662 accuracy-related_penalties thomas l overbey and d derrell davis for petitioners edith f moates for respondent memorandum findings_of_fact and opinion halpern judge by notice_of_deficiency dated date respondent determined deficiencies in petitioners' federal income taxes and accuracy-related_penalties as follows accuracy-related_penalty year deficiency sec_6662 a dollar_figure dollar_figure big_number big_number unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure the issues for decision are whether petitioner dean l sanders' schedule f activity constituted an activity_not_engaged_in_for_profit within the meaning of sec_183 and whether petitioners are liable for sec_6662 accuracy- related penalties on account of negligence or disregard of rules or regulations on brief petitioners also raise certain issues that depend on our finding that petitioner dean l sanders' schedule f activity was engaged in for profit since we do not make that finding we need not address those additional issues findings_of_fact introduction some facts have been stipulated and are so found the stipulation of facts with attached exhibits is incorporated herein by this reference petitioners are husband and wife who at the time the petition was filed resided in bentonville arkansas petitioners made joint returns of income for their taxable calendar years and the and returns respectively hereafter we shall use the term petitioner in the singular to refer only to petitioner dean l sanders during and petitioner’s principal source_of_income was from his employment as chief_executive_officer of the sam’s club division of wal-mart stores inc wal-mart on the and returns petitioners reported substantial income from petitioner’s employment by wal-mart and from other sources on those returns they also reported net farm_losses of dollar_figure and dollar_figure respectively those losses are detailed on schedules f profit or loss from farming attached to the and returns the and schedules f respectively on the and schedules f petitioners identify the principal activity as cattle horses we shall refer to the activity giving rise to the losses shown on the and schedules f as the schedule f activity petitioner began working for wal-mart while he was in college and he retired from wal-mart after years_of_service in schedule f results the and schedules f show the following items of income deductions farm income livestock produce grains and products raised other income gross_income farm expenses custom hire depreciation feed fertilizers gasoline insurance interest labor repairs supplies taxes utilities veterinary horse show expenses legal accounting sale expenses horse shoeing tenant house dues practice work travel meals ent total expenses net farm profit or loss and losses dollar_figure big_number big_number dollar_figure dollar_figure big_number big_number the item livestock produce grains and products raised of dollar_figure for is proceeds from the sale of one or more horses the item other income of dollar_figure and dollar_figure for and respectively is proceeds winnings from horse shows during petitioner sold another two horses not reported on the schedule f one at a gain of dollar_figure and one at a loss of dollar_figure during petitioner sold three horses not reported on the schedule f all at a gain for a total gain of dollar_figure schedules f attached to petitioners' joint returns for through show income deductions and losses as follows year income deductions loss 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 fach year’s income is composed of one or two categories sales of livestock produce grains and other products you raised or other income petitioners began claiming expenses for horse shows beginning in for through petitioner’s horse show expenses gross_income reported from horse shows and the excess except for and of horse show expenses over horse show income were follows year income expenses excess so 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 horse sales petitioner realized the following gains and losses from sales of horses from date through date number of gain year horses sold loss dollar_figure -- big_number big_number big_number big_number big_number history of the schedule f activity beginning in petitioner entered into an activity with a friend and co-worker tom coughlin coughlin petitioner and coughlin purchased or more acres in arkansas improved it named it the c s ranch the arkansas ranch and conducted a cow and calf operation thereon they also grew and sold fescue the parties have stipulated the displayed data they have also stipulated that petitioners reported an additional dollar_figure of proceeds from the sales of horses on the schedule f since we cannot determine whether those proceeds represent a gain ora loss we shall disregard them in our discussion of gains and losses realized from sales of horses seed and hay in they changed their operation to one involving horses on date petitioner purchased coughlin’s interest in the arkansas ranch for dollar_figure and subsequently changed the name of the ranch to the dean sanders ranch also during petitioner and coughlin sold the last horses that they jointly owned during and petitioner bought yearling horses trained them took them to various horse shows and sold them petitioner had begun purchasing horses on his own account in in late in connection with petitioner’s anticipated retirement from wal-mart petitioners decided to relocate to texas in petitioners purchased a 212-acre ranch the diamond spur ranch in anderson texas the texas ranch on date petitioners formed two limited_liability companies dean sanders cutting horse ranch llc which lists its principal business activity as horse breeding and training and dean and cindy sanders ranch llc which lists its principal business activity as real_estate at the time of trial february and the arkansas ranch was listed for sale for dollar_figure million quarter horses cutting horses a cutting horse is a quarter horse that is trained to work with cattle cutting horses and their riders compete in competitions for which prize money is awarded quarter horses may be bred and their offspring sold stallions may be stood and a stud fee charged fees may be charged for training guarter horses to be cutting horses petitioner bred no horses at the arkansas ranch from through petitioners reported no stud fees on their income_tax returns during and petitioner employed scott brewer brewer as a trainer petitioner assisted with the training and performed some manual labor on the arkansas ranch during petitioner allowed brewer to train outside horses on the arkansas ranch petitioner billed for that service but kept only dollar_figure out of dollar_figure billed the remainder going to brewer petitioners reported no income from training for competitions during and brewer rode as a professional on petitioner’s horses at cutting horse competitions petitioner paid him percent of his winnings net of entry fees during those years petitioner rode in such competitions as an amateur or nonprofessional in those categories petitioner also could earn prize money petitioner has competed in all the major cutting horse competitions and claims to have been one of the top nonprofessionals petitioner’s plan petitioner had no written business plan for the schedule f activity petitioner intended to buy quarter horses train them to be cutting horses show them establish their reputations and sell them he intended to devote more time to the schedule f activity following his retirement from wal-mart record keeping during the years at issue petitioner prepared neither profit and loss statements nor written projections of income or loss for the schedule f activity he maintained no records of the expenses associated with or the winnings on account of particular horses petitioner maintained a separate checking account for the schedule f activity nevertheless petitioners often wrote checks on their personal account with respect to the schedule f activity petitioner wife received the bank statements with respect to the schedule f activity checking account she did not always open those statements nor did she always reconcile the statements with the check book advertising prior to and during the years in issue petitioner did no advertising with respect to the schedule f activity the horses -- - he sold were sold at auction following the appearance of a horse in a competition petitioner's participation in the schedule f activity during and petitioner worked an average of to hours a week for wal-mart he spent to hours a week in connection with the schedule f activity on weekends he also spent time on his houseboat petitioner went bird hunting to days a year petitioners’ residence petitioners resided on the arkansas ranch in a house of approximately big_number square feet containing four bedrooms and five bathrooms the house also had a pool and jacuzzi respondent’s adjustments respondent disallowed the total expenses dollar_figure and dollar_figure for and respectively claimed on the and schedules f respondent explained his disallowance on the ground that the schedule f activity was not engaged in for profit respondent made compensating adjustments to petitioners’ itemized_deductions to reflect the deductions allowable under sec_183 assuming we sustain respondent’s primary adjustments those compensating adjustments are not in question opinion i deficiencies a issue the issue we must address is whether the net farm_losses claimed by petitioners on their and federal_income_tax returns result from an activity_not_engaged_in_for_profit as that term is used in sec_183 b sec_183 for-profit requirement in pertinent part sec_183 provides in the case of an activity engaged in by an individual if such activity is not engaged in for profit no deduction attributable to such activity shall be allowed under this chapter except as provided in this section sec_183 provides for purposes of this section the term ‘activity not engaged in for profit’ means any activity other than one with respect to which deductions are allowable for the taxable_year under sec_162 or under paragraph or of sec_212 deductions are allowable under sec_162 for expenses of carrying on activities that constitute a trade_or_business of the taxpayer and under sec_212 for expenses_incurred in connection with activities engaged in for the production_or_collection_of_income or for the management_conservation_or_maintenance_of_property_held_for_the_production_of_income no deductions are allowable under sec_162 or sec_212 for the expenses of an activity that is carried on - primarily as a sport hobby or for recreation thus an activity carried on primarily for any such purpose is not an activity engaged in for profit see sec_1_183-2 income_tax regs c actual and honest profit objective an activity is engaged in for profit if the taxpayer has an actual and honest objective of making a profit 94_tc_41 quoting 78_tc_642 affd without opinion 702_f2d_1205 d c cir although the expectation of profit need not be reasonable a bona_fide profit objective must exist see keanini v commissioner supra dreicer v commissioner supra 72_tc_411 affd without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs profit in this context means economic profit independent of tax savings see 91_tc_686 affd 893_f2d_656 4th cir 91_tc_371 the regulations promulgated under sec_183 provide the following nonexclusive list of factors to be considered in determining whether an activity 1s engaged in for profit the manner in which the taxpayer carried on the activity the expertise of the taxpayer or his or her advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that the assets used in the activity may appreciate in value the success of the taxpayer in carrying on other similar or dissimilar activities the taxpayer's history of income or loss with respect to the activity the amount of occasional profits if any which are earned the financial status of the taxpayer and whether elements of personal pleasure or recreation are involved sec_1_183-2 income_tax regs no single factor is determinative see keanini v commissioner supra pincite 88_tc_464 sec_1_183-2 income_tax regs petitioner's objective is a question of fact to be determined from all the facts and circumstances keeping in mind that petitioners bear the burden_of_proof see rule a 908_f2d_369 8th cir revg tcmemo_1988_468 sec_1_183-2 income_tax regs d analysi sec_1 nature of the schedule f activity petitioner became a part owner of a ranch the arkansas ranch in he and another individual used the arkansas ranch to raise cattle horses and crops which they sold in petitioner purchased the other individual’s interest in the arkansas ranch and ended his relationship with that individual with respect to the ranch petitioner began purchasing horses -- for his own account in his plan was to buy quarter horses train them to be cutting horses show them establish their reputations and sell them the shows petitioner planned to enter were competitions for cash prizes petitioner entered his horses in such competitions from through petitioner sold horses from date through date petitioner made only dollar_figure from training other persons’ horses the nature of petitioner’s activity during the years in issue the schedule f activity was the showing of and sale of cutting horses not an activity engaged in for profit the schedule f activity resulted in substantial losses not only during the years in issue but also during preceding and following years during the years in issue petitioner sold five horses two in and three in and had a net_loss and a net gain of dollar_figure and dollar_figure respectively thus for the years in issue petitioner realized a net gain of dollar_figure from the sale of horses dollar_figure dollar_figure - dollar_figure his horse show expenses for and exceeded his horse show income for those years his net farm_losses for the years were dollar_figure and dollar_figure as reported on the and schedules f respectively for a total of dollar_figure thus for and petitioner incurred - - expenses of dollar_figure to generate a net gain from sales of horses of dollar_figure petitioners did not report any gains or losses from the sale of horses on their through federal_income_tax returns from date through date petitioner’s net gain from horse sales was dollar_figure the first year in which petitioners claimed a deduction for horse show expenses in calculating their schedule f net farm loss was from through petitioners reported schedule f net farm_losses of dollar_figure those losses included a net excess of horse show expenses over horse show income of dollar_figure thus for when petitioner’s horse show expenses commenced through petitioner incurred expenses of dollar_figure to generate a net gain from sales of horses of dollar_figure notwithstanding that the schedule f activity was not profitable for any year in which petitioner operated it on the arkansas ranch it is guite clear that if petitioner entered into it or continued it with the actual and honest objective of making a profit it would be an activity engaged in for profit within the meaning of sec_183 see dreicer v commissioner supra pincite sec_1_183-2 income_tax regs if on the other hand petitioner engaged in the schedule f activity primarily as a sport hobby or for recreation petitioner would -- - not have engaged in the activity for profit see sec_1 a income_tax regs petitioner is a wealthy successful businessman petitioner testified that he and his wife had long planned that he would leave wal-mart when he wa sec_45 years old petitioner began working for wal-mart when he was in college and retired after years in when we assume he was approximately years old in petitioner acquired an interest in the arkansas ranch in petitioner began what we have characterized as the schedule f activity in following his retirement from wal-mart petitioner moved to texas and formed a limited_liability_company to engage in the business of horse breeding and training the texas ranch was substantially bigger than the arkansas ranch we believe that during the years in issue petitioner undertook and carried on the schedule f activity primarily as a hobby we reach that conclusion taking into account petitioner’s statement of his intent but giving greater weight to the factors set forth in the regulations in light of the facts before us most prominently the schedule f activity failed to generate even occasional profits a factor to be taken account of under sec_1_183-2 income_tax regs which failure did not seem paramount to petitioner a wealthy businessman another factor to be taken into account under sec_1_183-2 income_tax regs in the following paragraphs we detail our analysis of the remaining factors found in the regulations which weigh in our conclusion history of losses although no one factor is determinative of the taxpayer's intention to make a profit a record of substantial losses over many years and the unlikelihood of achieving a profitable operation are important factors bearing on the taxpayer’s true intention golanty v commissioner t c pincite see also sec_1_183-2 income_tax regs as we have detailed petitioner incurred substantial losses in the schedule f activity for each of the years that it was carried on at the arkansas ranch when a taxpayer's losses occur during the startup_period of an activity the losses have been held not to indicate the absence of a profit_motive see 72_tc_659 unremitting losses were not an indication of lack of profit_motive where years in issue fell within startup_period of horse breeding activity petitioners reported schedule f losses in connection with the arkansas ranch beginning in they reported losses in connection with the schedule f activity beginning in when petitioners first claimed a deduction for horse show expenses and continuing through petitioner's move to the texas ranch in petitioner had no written plan for the schedule f activity and he has failed to -- - prove that the schedule f activity was within the anticipated startup phase of an activity conducted for profit as stated we think that the schedule f activity was in the nature of a hobby manner in which taxpayer carries on activity the fact that the taxpayer carries on the activity ina businesslike manner and maintains complete and accurate books_and_records may indicate that the activity is engaged in for profit sec_1_183-2 income_tax regs petitioner did not keep formal or accurate books_and_records for the schedule f activity petitioner’s only records consisted of canceled checks invoices for goods and services received and bills while a taxpayer need not maintain a sophisticated cost accounting system the taxpayer should keep records that enable the taxpayer to make informed business decisions see 809_f2d_355 7th cir affg tcmemo_1985_523 petitioner’s failure to maintain books of account reconcile his bank statement every month or even open the envelopes containing the statement and canceled checks or use checks only from the account dedicated to the schedule f activity evidences a lack of concern for cash-flow also petitioner did not keep records respecting the costs associated with individual horses see dodge v commissioner tcmemo_1998_89 without records according to individual horses taxpayers had no way of knowing which horses were more profitable or which training regimen was successful at increasing the value of the horses as in dodge it appears that petitioners retained what they thought were the minimum records necessary to prepare their tax returns petitioner’s bookkeeping practices were more consistent with the schedule f activity's being a hobby than a _ profit- motivated business petitioner lacked a written plan a business plan does not have to be a financial plan or a written budget it may be evidenced by a taxpayer's actions see phillips v commissioner tcmemo_1997_128 petitioner’s intent was to buy guarter horses train them to be cutting horses show them establish their reputation and sell them petitioner acted in accordance with that intent but that does not establish that he was engaged in a business for which he had a plan for success profitability given the substantial but expected costs associated with the schedule f activity we need more than petitioner’s representation that he could make money if he sold enough horses at high enough prices to conclude that petitioner had a plan to make a profit see ballard v commissioner tcmemo_1996_68 taxpayer testified as to his business plan yet did not conduct activity in businesslike manner prior to and during the years in issue petitioner did not advertise the arkansas ranch or his horses in trade magazines or publications while we recognize that horse shows may be one - - method of advertising horses for sale eg engdahl v commissioner supra pincite petitioner's failure to attempt to reach a larger customer base is not consistent with a profit_motive see dodge v commissioner supra a change_of operating methods adoption of new techniques or abandonment of unprofitable methods in a manner consistent with an intent to improve profitability may also indicate a profit_motive sec_1_183-2 income_tax regs petitioners argue that petitioner made changes in his operating methods that indicate a profit_motive there is no evidence that most of the changes petitioners refer to such as the cattle weight gain program taking on outside horses instituting a breeding program and maintaining the breeding rights to mares sold were implemented prior to or during the years in issue subseguent actions do not materially impact this aspect of our analysis under sec_183 for the years in issue see borsody v commissioner tcmemo_1993_534 affd per curiam 92_f3d_1176 4th cir while we agree that hiring a trainer and leasing cattle may have been more cost effective we are not persuaded that petitioner implemented methods to control his losses see dodge v commissioner supra ‘ while petitioner did take on outside horses at the arkansas ranch he did not actively pursue that aspect of his activity during and petitioner obtained only dollar_figure of net_income from outside horses --- - we find that petitioner did not carry on the activity ina businesslike manner expertise of taxpayer or his advisors preparation for the activity by extensive study of its accepted business economic and scientific practices or consultation with those who are expert therein may indicate that the taxpayer has a profit_motive where the taxpayer carries on the activity in accordance with such practices sec_1 b income_tax regs while petitioner received free and paid advice from individuals he considered experts in the cutting horse industry the advice did not focus on the economic aspects of the activity the advice which petitioner received on profitable bloodlines and which horses to sell is consistent with a hobbyist's motives taken as a whole we find this factor to be neutral time and effort the fact that the taxpayer devotes much of his personal time and effort to carrying on an activity particularly if the activity does not have substantial personal or recreational aspects may indicate an intention to derive a profit sec_1_183-2 b income_tax regs during and petitioner spent to hours a week in connection with the schedule f activity he employed a professional trainer but he testified that he also helped with training petitioner managed the -- - schedule f activity and he performed manual labor on the arkansas ranch he attended a number of competitions and testified i have competed in all the major events have been successful and have been one of the top non-pros in the united_states while we acknowledge petitioner’s substantial contribution of time to the schedule f activity during the years in issue we believe that petitioner’s success as a nonprofessional was a source of pride to him which although not inconsistent with an intent to make a profit serves to explain in part the time and money he poured into a then losing proposition expectation of appreciation the term ‘profit’ encompasses appreciation in the value of assets such as land used in the activity sec_1_183-2 income_tax regs that provision of the regulations also provides thus the taxpayer may intend to derive a profit from the operation of the activity and may also intend that even if no profit from current operations is derived an overall profit will result when appreciation in the value of land used in the activity is realized since income from the activity together with the appreciation of land will exceed expenses of operation id sec_1_183-1 income_tax regs however provides if the taxpayer engages in two or more separate activities deductions and income from each separate activity are not aggregated either in determining whether a particular activity is engaged in for profit or in applying sec_183 the farming and - - holding of the land will be considered a single activity only if the income derived from farming exceeds the deductions attributable to the farming activity which are not directly attributable to the holding of the land at the time of trial the arkansas ranch was on the market for dollar_figure million petitioners argue the unrealized_appreciation in the arkansas ranch should be taken into account in determining the profitability of the schedule f activity we disagree petitioner’s investment in the land encompassing the arkansas ranch was an activity separate from the schedule f activity the schedule f activity did not produce profits that reduced the net costs of carrying the land elements of personal pleasure or recreation the presence of personal motives in carrying on of an activity may indicate that the activity is not engaged in for profit especially where there are recreational or personal elements involved sec_1_183-2 income_tax regs clearly petitioner took pride in his competitive abilities and we assume enjoyed the competitions petitioner and his wife lived on the arkansas ranch in a big_number square foot house with a pool they moved there prior to his retirement from wal-mart depreciation schedules attached to schedules f for through show a substantial investment in physical improvements to the ranch depreciation is the largest expense item listed on petitioners’ schedules f for out of the years through -- - we believe that petitioners enjoyed the ranch lifestyle were wealthy enough to indulge that lifestyle without too much concern for costs remember they did not always open their bank statements and at least during their years on the arkansas ranch viewed the schedule f activity as an integral part of that lifestyle without regard to profitability success in similar activities petitioner did not demonstrate success in carrying on any similar activity see sec_1 b income_tax regs be conclusion during the years in issue the schedule f activity was not an activity engaged in for profit respondent’s determination_of_a_deficiency based on that determination is sustained il sec_6662 accuracy-related_penalties sec_6662 provides for an accuracy-related_penalty in the amount of percent of the portion of any underpayment attributable to among other things negligence or intentional disregard of rules or regulations hereafter simply negligence respondent determined sec_6662 penalties against petitioners for their negligence in deducting the farm_losses shown on the and schedules f negligence has been defined as the failure to exercise the due care of a reasonable and ordinarily prudent person under like circumstances see 85_tc_934 - - in the petition petitioners assign error to respondent’s determination of sec_6662 penalties however petitioners do not aver any specific facts in support of their assignment of error in their opening brief petitioners recognize that respondent determined sec_6662 penalties but they propose no findings_of_fact specifically relating to that issue nor do they make any argument with respect to the issue in response to respondent’s opening brief petitioners argue only that they maintained and produced adequate_records of the schedule f activity petitioners bear the burden of proving that they were not negligent or that they had reasonable_cause for the underpayment and that they acted in good_faith see sec_6664 rule a we assume that in defense to respondent’s determination of a penalty petitioners rely principally on the assumption that we shall determine no deficiency on account of our finding that the schedule f activity was engaged in for profit we have not made that finding and have sustained respondent’s adjustments with respect to the schedule f activity respondent’s determination of a sec_6662 penalty is therefore sustained decision will be entered for respondent