t c memo united_states tax_court walter and susan moore petitioners v commissioner of internal revenue respondent docket no filed date brian isaacson and duncan turner specially recognized for petitioners kirk m paxson and julie payne for respondent memorandum findings_of_fact and opinion laro judge petitioners petitioned the court to redetermine respondent’s determination of a dollar_figure deficiency in their federal_income_tax and a dollar_figure accuracy-related_penalty under sec_6662 we decide primarily whether susan moore petitioner realized income in when she exercised stock_options received from her employer cell therapeutics inc cti we hold she did we also decide whether petitioners are liable for the accuracy-related_penalty determined by respondent under sec_6662 we hold they are not findings_of_fact some facts were stipulated or contained in the exhibits submitted therewith we find the facts accordingly petitioners are husband and wife and they resided in hansville washington when their petition was filed a petitioner’s relationship with cti before date cti hired petitioner as a compensation consultant in date and she continued to work for cti as a full-time_employee through date before working for cti petitioner had earned a bachelor’s degree in business administration and she had worked for more than years in various capacities eg compensation manager director of human resources for various other employers petitioner is certified by the american compensation society as a professional in the field of compensation unless otherwise indicated section references are to the applicable versions of the internal_revenue_code two months after petitioner began working for cti cti promoted her to its office of vice president of human resources in cti promoted her further to its office of executive vice president of human resource development in cti expanded petitioner’s responsibilities as executive vice president to head cti’s corporate communications department in addition to its human resource department petitioner reported directly to cti’s chief_executive_officer ceo dr james bianco dr bianco and she served on cti’s strategic management team the strategic management team was the top level of cti and it consisted of the ceo and all of the executive vice presidents of cti’s major functional areas cti was a private corporation when petitioner first began working for it and it later became a public corporation while she was affiliated with it during each year that petitioner was affiliated with cti cti employed between and individuals stock_option grants as part of her compensation package cti gave petitioner options to purchase cti common_stock each option allowed petitioner to purchase a specified number of shares of cti common_stock at a specified price a first options petitioner was granted options to purchase big_number shares and big_number shares of cti common_stock at dollar_figure per share under the cti stock_option plan incentive_stock_option agreement entered into as of date the agreement pertaining to these options contained the following recital termination of option a vested option shall terminate to the extent not previously exercised upon the occurrence of one of the following events i ten years from the date of grant or ii the expiration of ninety days from the date of optionee’s termination of employment with the company for any reason other than death or disability as defined in the plan unless the exercise period is extended by the plan_administrator until a date not later than the expiration date of the option b second options petitioner was granted options to purchase big_number shares and big_number shares of cti common_stock at dollar_figure per share under the cti equity incentive plan incentive_stock_option agreements entered into as of date and date respectively the agreement pertaining to the grant of the option to purchase the big_number shares contained the following recital termination of option a vested option shall terminate to the extent not previously exercised upon the occurrence of one of the following events i ten years from the date of grant or ii the expiration of three months from the date of optionee’s termination of employment or service with the company for any reason other than death or because optionee becomes disabled within the meaning of sec_22 of the code unless the exercise period is extended by the committee until a date not later than the expiration date of the option the agreement pertaining to the grant of the option to purchase the big_number shares contained the following recital termination of option a vested option shall terminate to the extent not previously exercised upon the occurrence of one of the following events i ten years from the date of grant or ii the expiration of three months from the date of optionee’s termination of employment or service with the company for any reason other than death or because optionee becomes disabled within the meaning of sec_22 of the code unless the exercise period is extended by the committee until a date not later than the expiration date of the option c third option petitioner was granted an option to purchase big_number shares of cti common_stock at dollar_figure25 per share under the cti equity incentive plan incentive_stock_option agreement entered into as of date the agreement pertaining to this option contained the following recital termination of option a vested option shall terminate to the extent not previously exercised upon the occurrence of one of the following events i ten years from the date of grant or ii the expiration of three months from the date of optionee’s termination of employment with the company for any reason other than death or because optionee becomes disabled within the meaning of sec_22 of the code unless the exercise period is extended by the committee until a date not later than the expiration date of the option d fourth option petitioner was granted an option to purchase big_number shares of cti common_stock at dollar_figure9 per share under the cti equity incentive plan incentive_stock_option agreement entered into as of date the agreement pertaining to this option contained the following recital termination of option a vested option shall terminate to the extent not previously exercised upon the occurrence of one of the following events i ten years from the date of grant or date ii the expiration of three months from the date of optionee’s termination of employment with the company for any reason other than death or because optionee becomes disabled within the meaning of sec_22 of the code unless the exercise period is extended by the committee until a date not later than the expiration date of the option b petitioner’s relationship with cti after date board_of directors’ resolution in or about the end of petitioner advised dr bianco that she was going to terminate her employment with cti because she was having a personality conflict with a key member of the staff dr bianco asked petitioner to remain affiliated with cti for approximately year longer to establish a transition plan for cti petitioner agreed to do so agreeing with cti to enter into a consulting agreement under which she would work for cti in a nonemployee capacity in connection therewith cti’s board_of directors’ compensation committee adopted a resolution that stated that petitioner ceased to be employed by cti as of date that cti continued to need petitioner’s services and that petitioner and cti would enter into a consulting agreement to obtain petitioner’s services the resolution resolved cti shall enter into a consulting agreement with ms moore which incorporates at a minimum the following terms and conditions for a period of one-year ms moore may be called upon to perform corporate communications and human resource development duties and responsibilities as determined by the ceo it is expected ms moore will the resolution does not state the date of its making devote approximately one-half the number of hours of a full-time equivalent as compensation_for this agreement ms moore will receive a salary of dollar_figure company-paid health and welfare benefits as of date the date of termination ms moore held big_number vested options and big_number unvested options to purchase cti common_stock granted in accordance with the corporation’s employee stock_option plan the plan which vested options would have been exercisable for a period of up to three months after the date of her termination with the corporation as provided in the plan the compensation committee deems it appropriate and in the best interests of the corporation to continue vesting of the unvested options according to the current vesting schedule and whereas the remaining unvested options would vest on date and date and extend the exercise period for vested and unvested options to days after ms moore completes this consulting arrangement consulting agreement petitioner and cti entered into the referenced consulting agreement with an effective date of date and a termination_date of date unless terminated earlier or extended longer by agreement of the parties thereto the agreement stated that petitioner would report to dr bianco and would oversee and manage the corporate communications and human resource development departments attend senior management team meetings as mutually agreed upon by petitioner and dr bianco conduct staff meetings as needed for corporate communications and human resource development personnel prepare the annual report for cti including coordinating the annual shareholder meeting and activities related thereto manage and oversee cti’s internet and intranet websites provide weekly contact with public relations groups in the industry interview and hire additional staff for the corporate communications department and perform additional services as agreed upon by petitioner and cti the agreement specified that the parties hereto are acting as independent contractors consultant will be responsible for and will pay all taxes related to the receipt of payments hereunder and shall give reasonable proof and supporting documents if reasonably requested to verify the payment of such taxes the agreement stated that petitioner would be paid for her services at the rate of dollar_figure per hour and that she would work no more than big_number hours during the 1-year term of the agreement unless she and cti agreed otherwise the agreement also stated that cti would pay for petitioner’s participation in health and dental plans for the term of the agreement cti paid for that participation under a plan that covered former employees the agreement also stated that petitioner was entitled to receive reimbursement of her preapproved reasonable out-of-pocket business_expenses eg food lodging air and ground travel incurred in providing services to cti petitioner was required to submit to cti invoices for her hourly pay and she was required to submit with those invoices documentation supporting her claim to reimbursement for out-of-pocket expenses the consulting agreement shortened the vesting period of petitioner’s stock_options it stated options consultant and cti are parties to the option agreement option agreement and the cti equity incentive option plan option plan in which consultant vests in cti incentive stock_options in lieu of consultant vesting in cti incentive options according to the option agreement the parties agree that consultant shall vest in cti incentive options for the term of this agreement as provided hereunder and in the option plan type option option of old vest new vest no date option shares price date date p000698 iso big_number p000698 iso big_number c000892 iso big_number c000892 iso big_number c000892 iso big_number c000892 iso big_number for avoidance of any doubt whatsoever consultant shall vest in each set of options provided this agreement is in effect as of the vesting date for that respective set of options as described above ie if consultant terminates this agreement on she would be entitled to big_number vested options she would not be entitled to the remaining big_number unvested options consultant would then have ninety days from the date of termination of this agreement to exercise the vested options petitioner read the consulting agreement thought she understood it signed it and did not ask any questions regarding it she believed that by entering into the agreement she would work less she understood that she would be responsible for filing her own tax returns and paying her related taxes and that cti would not pay or withhold any taxes for her benefit she knew her employment status with cti was changing on or about date petitioner informed cti’s sec_401 plan that she had terminated her employment with cti on date and was electing to roll over her balance in that plan to her individual_retirement_account at cibc oppenheimer after date petitioner was neither an officer director or 10-percent stockholder of cti she continued to provide cti with essentially the same types of services that she had provided to cti before date but she worked fewer hours after date than she did before and she was not paid a salary but was paid in accordance with the hours that she claimed on the invoices she submitted to cti after date petitioner continued to report to dr bianco but she was evaluated through verbal feedback and not as formally as before after date she also could hire or subcontract third parties to perform most of the services listed in the consultation agreement and she could have worked for companies other than cti after date petitioner no longer headed or was responsible for cti’s human resource department cti paid petitioner a bonus in for the work she had performed for cti while employed by it in petitioner did not receive a bonus in for the work she performed for cti in at or about the beginning of the parties to the consulting agreement agreed that the term of the agreement should be extended through date so that petitioner could review the performance of cti’s employees the consulting agreement was so extended and it terminated on date c exercise of stock_options on date petitioner exercised some of her options to buy cti common_stock on that date each of her purchased shares had a fair_market_value of dollar_figure as to one option petitioner paid an exercise price of dollar_figure to purchase at dollar_figure6 per share big_number shares of cti common_stock with a total fair_market_value of dollar_figure upon exercise of that option she also paid dollar_figure to cti so cti could withhold and pay federal income social_security and medicare taxes associated with the exercise as to another option petitioner paid an exercise price of dollar_figure to purchase at dollar_figure6 per share big_number shares of cti common_stock with a total fair_market_value of dollar_figure upon exercise of that option she also paid dollar_figure to cti so cti could withhold and pay federal income social_security and medicare taxes associated with the exercise as to another option petitioner paid an exercise price of dollar_figure to purchase at dollar_figure6 per share big_number shares of cti common_stock with a total fair_market_value of dollar_figure upon exercise of that option she also paid dollar_figure to cti so cti could withhold and pay federal income social_security and medicare taxes associated with the exercise as to another option petitioner paid an exercise price of dollar_figure to purchase at dollar_figure9 per share big_number shares of cti common_stock with a total fair_market_value of dollar_figure upon exercise of that option she also paid dollar_figure to cti so cti could withhold and pay federal income social_security and medicare taxes associated with the exercise as to another option petitioner paid an exercise price of dollar_figure to purchase at dollar_figure3 per share big_number shares of cti common_stock with a total fair_market_value of dollar_figure upon exercise of that option she also paid dollar_figure to cti so cti could withhold and pay federal income social_security and medicare taxes associated with the exercise after exercising her options petitioner had legal_title to was the beneficial_owner of had the right to receive dividends on and had the right to vote her purchased stock at no time in full petitioner paid dollar_figure to purchase big_number shares with a total fair_market_value of dollar_figure petitioner also paid cti dollar_figure with respect to the withholding taxes after exercising the options was she obligated to return any of that stock to cti during and thereafter petitioner did not sell any of the purchased shares those shares were in electronic form d petitioners’ agreement with cibc oppenheimer petitioners entered into a client agreement and an investment management agreement with their stockbroker cibc oppenheimer the client agreement stated i agree to pay on demand any balance owing with respect to any of my accounts including interest and commissions and any costs of collection including attorneys fees if incurred by you i understand that you may demand full payment of the balance due in my accounts plus any interest charges accrued thereon at your sole option at any time without cause and whether or not such demand is made for your protection in addition margin loans are not made for any specific term or duration but rather are due and payable at your discretion upon demand the investment management agreement stated that client represents that client is the beneficial_owner of any securities client may deliver to the custodian and that there are no restrictions on the transfer sale and or public distribution thereof the investment management agreement also stated that client understands and agrees that all transactions shall be for client’s account and risk and that neither cibc wm cibc world markets corp the program manager of the assets of petitioners’ account at cibc oppenheimer nor any portfolio manager is guaranteeing or otherwise making representations with respect to the performance of the account and that cibc wm shall not be liable for any losses in the account e payment of the exercise price and withholding taxes cti received payment in full for the exercise price and withholding taxes due upon petitioner’s exercise of her options petitioner borrowed dollar_figure from cibc oppenheimer to pay the total of the options’ exercise price dollar_figure and cti’s withholding obligation dollar_figure cibc oppenheimer wired the dollar_figure dollar_figure dollar_figure to cti and cibc oppenheimer treated the wired funds as a borrowing that petitioner had made on her margin_account at cibc oppenheimer petitioners were personally liable for the repayment of that borrowing and any interest that accrued with respect thereto on date petitioner repaid the principal of the borrowing after she received margin calls from cibc oppenheimer she obtained the funds for repayment by selling stocks and bonds using available cash borrowing money and selling her house on date the fair_market_value of petitioner’s cti stock big_number shares was dollar_figure5 per share or dollar_figure in total f cti’s insider trading policy and trading windows according to cti’s insider trading policy statement an insider or temporary insider is permitted to trade cti stock only during certain specified periods the trading window and only if the insider or temporary insider is not at the time in possession of material non-public information cti’s trading window will be opened only upon written notification from cti’s chief financial officer cfo in general the trading window opens ie trading is permissible on the third business_day after cti releases information to the financial community about the prior quarter results and closes ie trading is prohibited at the close of business on the fifteenth 15th day of the last month of a fiscal quarter if the fifteenth day of the month falls in a weekend the window shall close on the last business_day preceding the fifteenth day of the month the trading window was closed when petitioner exercised her options on date the trading window remained closed until the third business_day after date g petitioners’ federal_income_tax return petitioner received from cti a form_1099 in the amount of dollar_figure petitioner also received from cti a form_w-2 wage and tax statement that reported that petitioner had received dollar_figure as wages tips or other compensation the form_w-2 listed dollar_figure as the amount of federal_income_tax withheld the wages reported by cti on the form_w-2 included the spread between the strike prices and the fair_market_value of the stock received when petitioner exercised her stock_options on date on or about date petitioners filed their federal_income_tax return they reported the following relevant information on that return dollar_figure in wages salaries tips etc business income of dollar_figure dollar_figure in gross_receipts less dollar_figure in expenses consisting of travel dollar_figure and meals and entertainment dollar_figure total adjusted_gross_income of dollar_figure taxable_income of dollar_figure tax of dollar_figure and federal_income_tax withheld of dollar_figure they claimed on that return that they were entitled to a refund of overpaid federal_income_tax in the amount of dollar_figure dollar_figure - dollar_figure attached to the return was a form_4852 substitute for form_w-2 wage and tax statement or form 1099-r distributions from pensions annuities retirement or profit-sharing_plans iras insurance contracts etc on which petitioners reported that cti had paid petitioner dollar_figure in wages or compensation also attached to petitioners’ return were a form calculation prepared by the issacson law firm and a form disclosure statement memorandum of law prepared by petitioners’ tax_return_preparer and counsel herein brian isaacson isaacson the form calculation reported that petitioners had made a dollar_figure negative adjustment to petitioner’s wages as reported on the form_w-2 to calculate petitioner’s wages as dollar_figure dollar_figure - dollar_figure dollar_figure the memorandum of law memorandum of law stated as facts that petitioner was granted stock_options as part of taxpayer’s employment contract that taxpayer exercised employee stock_options using margin debt secured_by the stock exercised and that taxpayer has not risked taxpayer’s own capital in the transaction the memorandum of law concluded that under the facts_and_circumstances_test in sec_1 a sic it appears that the transfer to the taxpayer may be treated as similar to the grant of an option this is so the memorandum of law rationalizes without any coherent explanation because petitioner would not have to use her personal assets to pay the margin debt were her cti stock to be insufficient to satisfy the debt in full the memorandum of law stated that isaacson was trying to get cti to change the referenced form_w-2 to report the lower amount of wages but that it is anticipated that cell therapeutics inc will not correct the taxpayer’s form_w-2 absent a ruling from the internal_revenue_service a statutory framework for stock_options opinion sec_83 generally provides that when property is transferred to a person in_connection_with_the_performance_of_services the fair_market_value of the property at the first time the rights of the person having the beneficial_interest in the property are transferable or not subject_to a substantial_risk_of_forfeiture less the amount_paid for the property is includable in the gross_income of the person who performed the services see 117_tc_237 affd 65_fedappx_508 5th cir see also 469_f3d_1249 9th cir in general an employee who receives a nonstatutory stock_option without a readily_ascertainable_fair_market_value is taxed not on receipt of the option but at the time pursuant to the employee’s exercise of the option the shares have been transferred to and become substantially_vested in the employee see sec_83 e tanner v commissioner supra pincite sec_1_83-1 income_tax regs shares become substantially_vested in the employee when the shares are either transferable or not subject_to a substantial_risk_of_forfeiture see united_states v tuff supra pincite racine v commissioner tcmemo_2006_162 facq v commissioner tcmemo_2006_111 sec_1_83-3 income_tax regs sec_83 does not apply to a statutory stock_option ie an incentive_stock_option iso within the meaning of sec_422 that meets the requirements of sec_421 through as relevant herein sec_421 provides that if the requirements of sec_422 are met a taxpayer does not recognize income either upon the granting to the taxpayer of an iso or when the taxpayer receives stock upon the iso’s exercise recognition of income is deferred until disposition of the stock sec_421 sec_422 defines an iso as a stock_option granted to an individual for any reason connected to his or her employment if granted by a corporate employer or its parent or sec_422 requires in relevant part that the option holder be an employee of the company granting the option at all times from the granting of the option until months before the date of exercise subsidiary to purchase the stock of the employer or parent or subsidiary but only if the requirements of sec_422 through are met b whether petitioner’s stock_options were isos petitioners argue that petitioner’s stock_options were isos respondent argues that petitioner’s options were not isos in that they failed the requirements of sec_422 through respondent argues alternatively that the options do not qualify for iso treatment because petitioner was not an employee of cti during the months before their exercise as required by sec_422 we agree with respondent in both regards requirements of sec_422 sec_422 generally sets forth six requirements that must be met for a stock_option to qualify as an iso first the option must be granted pursuant to a plan sec_422 second the option must be granted within years from the date of the plan’s adoption sec_422 third the option by respondent argues primarily that the options failed the sec_422 requirements upon their issuance respondent also argues that petitioner’s consulting agreement with cti caused the options to be modified see sec_424 and that the options as modified failed those requirements as well while petitioners assert in their reply brief that the issue of whether the options as originally granted were isos is a new issue improperly raised on brief we disagree among other things we note that petitioners’ petition before amendment at trial alleged that the commissioner erred by failing to determine that the stock_options were classified as incentive stock_options by cell therapeutics inc its terms may not be exercisable more than years after the date the option is granted sec_422 fourth the option_price must not be less than the fair_market_value of the stock at the time the option is granted sec_422 fifth the option by its terms may not be transferable except by will or laws of descent and distribution and must be exercisable during the optionee’s lifetime only by the optionee sec_422 sixth when the option is granted the optionee cannot own stock possessing more than percent of the total combined voting power of all classes of stock of the employer or its parent or subsidiary we agree with respondent that all of the sec_422 requirements were not met as to the options as originally issued to this end we are unable to conclude that the options met the requirements of sec_422 through we are unable to find on the basis of the credible_evidence in the record that the options were issued pursuant to a specific plan that cti’s shareholders approved such a plan or the date on which a plan was adopted or approved nor are we able to find that the option_price was at or above the fair_market_value of the related stock at the time of the options’ issuance we also note that the consulting agreement allowed petitioner to exercise her options within days after the consulting agreement expired a date that could have been more than years after the grant_date we also agree with respondent that the options as originally issued were later modified and that the options as modified also failed the requirements of sec_422 sec_424 provides that if the terms of any option to purchase stock are modified extended or renewed such modification extension or renewal shall be considered as the granting of a new option in this context a modification denotes any change in the terms of the option which gives the employee additional benefits under the option except that the term does not include a change in the terms of an option in the case of an option not immediately exercisable in full to accelerate the time at which the option may be exercised sec_424 the consulting agreement modified the original options and caused petitioner to receive a grant of new options pursuant to sec_424 in this regard the consulting agreement set new vesting dates for petitioner’s options and gave her days from the date of termination of the agreement to exercise the vested options petitioner benefited from this change in that she was given the right to exercise her options even if she ceased to be an employee of cti for more than days under the original option agreements the options would have expired months or days depending upon the particular agreement from the date of her termination of employment with cti for any reason other than death or disability stated differently as a result of the modification petitioner could still exercise her options if she ceased to be an employee of cti for more than days as long as the consulting agreement had not been terminated for more than days the options as modified failed the requirements of sec_422 there is no plan in the record and the option prices on the dates of grant were not shown to be equal to or greater than the fair_market_value of the cti stock on those dates the options also failed the requirement of sec_422 in that the options could be exercised up to days after the termination of the consulting agreement the term of which could have been extended by agreement of the parties the effect of the modification was to give the options an indefinite term so that each option was not limited by its terms as required by sec_422 requirement of sec_422 respondent also argues that the options are not entitled to iso treatment because petitioner was not an employee of cti at all times during the period beginning on the date of the granting of the option and ending on the day months before the date she exercised her options as required by sec_422 we agree we apply the common_law rules of employment to decide whether petitioner ceased to be an employee of cti on date ie months before the exercise date of date see 503_us_318 weber v commissioner 103_tc_378 affd 60_f3d_1104 4th cir sec_1_421-1 income_tax regs see also sec_3401 our decision is a question of fact see 862_f2d_751 9th cir affg 89_tc_225 55_tc_142 and we are guided by certain factors none of which is dispositive in and of itself these factors are the degree of control exercised by the principal over the details of the work the taxpayer’s investment in the facilities used in the work the taxpayer’s opportunity for profit or loss the permanency of the relationship between the parties to a working relationship the principal’s right of discharge whether the work performed is an integral part of the principal’s business what relationship the parties to a working relationship believe they are creating and the provision of employee_benefits see nationwide mut ins co v darden supra nlrb v united ins co 390_us_254 profl executive leasing inc v commissioner supra 117_tc_263 weber v commissioner supra we analyze these factors seriatim a degree of control the degree of control or right to control test is the most important factor to consider in deciding the nature of a working relationship 92_tc_351 affd 907_f2d_1173 d c cir consideration is given not only to the control exercised by an alleged employer but also to the degree to which the alleged employer may intervene to impose control 135_f2d_715 2d cir weber v commissioner t c pincite before date petitioner was a member of cti’s strategic management team she was expected to work at the office full time and she was required to be readily available to work for cti beginning on date as a result of the consulting agreement petitioner was no longer required to work nor did she work as many hours as she did beforehand she no longer had to be available to cti at all times and she was allowed to conduct her work for cti at any location she pleased in addition in contrast with her work for cti before date petitioner afterwards did not receive written evaluations she had the right to work for other companies and she had the right to subcontract cti business to third parties although petitioner’s job was substantially_similar to the one she did before she began working for cti pursuant to the consulting agreement there were significant changes after the agreement that call into question the level of cti’s control_over petitioner this factor favors a nonemployee relationship b investment in facilities after petitioner entered into the consulting agreement with cti she continued to use her cti office she was able had she wanted to work anywhere she pleased after entering into the agreement this factor is neutral c opportunity for profit or loss beginning on date petitioner had more flexibility and time to seek other employment she also was able to subcontract the consulting work she did for cti this provided her more time to seek other opportunities this factor favors a nonemployment relationship d permanency of the relationship the consulting agreement contemplated that petitioner would provide services to cti for only one year and it permitted the parties to the agreement to terminate it with days’ written notice after entering into the agreement petitioner worked fewer hours than she had before and by date no longer had responsibility over cti’s human resource department this factor favors a nonemployee relationship e principal’s right of discharge petitioner’s consulting agreement was nonexclusive and either party could terminate the agreement with days’ written notice this factor favors a nonemployee relationship f work as an integral part of principal’s business after petitioner entered into the consulting agreement she was no longer as integral to cti’s business as she was beforehand she worked fewer hours for cti the agreement lasted only one year she could pursue other consulting opportunities and she gave up all responsibility for cti’s human resource department this factor favors a nonemployee relationship g relationship of the parties petitioner and cti entered into a nonexclusive consulting agreement that stated specifically that petitioner was an independent_contractor in addition cti calculated petitioner’s income from her exercise of the stock_options pursuant to sec_83 as if she was not a cti employee for the months before the date of that exercise further petitioner notified cti’s sec_401 plan that she had ceased working for cti as an employee on date this factor favors a nonemployee relationship h employee_benefits during the period covered by the consulting agreement cti paid petitioner’s health benefits pursuant to a plan for its former employees petitioner did not receive a bonus in for the work she performed in petitioner caused cti’s sec_401 plan to distribute her account balance to her broker as a direct_rollover into her individual_retirement_account this factor favors a nonemployee relationship i conclusion the factors listed above support a finding that petitioner worked for cti on and after date as an independent_contractor and we make such a finding on the basis of the record at hand accord humphrey v commissioner tcmemo_2006_242 we conclude that petitioner’s stock_options even if they were otherwise isos within the meaning of sec_422 did not qualify under sec_422 for iso treatment c whether petitioner received income on exercise of options we decide whether petitioner received income when she exercised her options in petitioners rely upon sec_1_83-3 income_tax regs and argue that no transfer occurred upon petitioner’s exercise of her options because they state she paid for the exercise using nonrecourse debt according to petitioners petitioner did not place any of her own capital at risk until date when she used petitioners’ resources to pay her borrowing from cibc we disagree with this argument which is the same argument that the court_of_appeals for the ninth circuit recently considered and labeled nonsense united_states v tuff f 3d pincite as was true in the case of the taxpayer there petitioner exercised her options and purchased her cti stock with cash while the cash may not have come directly from her assets but was borrowed from cibc oppenheimer she was personally liable to cibc for repayment of that borrowing we also note that she owned her cti stock after the exercise and had all of the rights of ownership related thereto apparently seeing the illogic of their just-rejected argument petitioners in their petition and in their briefs expand their position as set forth in the memorandum of law by arguing that the shares obtained through the exercise of the stock_options were subject_to a substantial_risk_of_forfeiture or were nontransferable due to cti’s insider trading policy most specifically petitioners argue petitioner exercised her options during the corporate blackout period thus they conclude the shares were subject_to a substantial_risk_of_forfeiture and were nontransferable until date the day the restricted windows under the corporate insider trading policy ended we disagree with this argument this argument has been previously considered and rejected by this court and others see facq v commissioner tcmemo_2006_111 hilen v commissioner tcmemo_2005_226 see also 70_fedclaims_87 affd 475_f3d_1380 fed cir 363_fsupp2d_1288 w d wash 345_fsupp2d_1046 n d cal affd 209_fedappx_690 9th cir as was true in the case of petitioners’ previous argument this argument was considered and rejected by the court_of_appeals for the ninth circuit in united_states v tuff supra pincite- we do likewise here a taxpayer’s rights in property generally are subject_to a substantial_risk_of_forfeiture if the taxpayer’s rights to full enjoyment of the property are conditioned upon the future performance or refraining from performance of substantial services sec_1_83-3 income_tax regs a taxpayer’s rights in property are transferable only if the rights in such property of any transferee are not subject_to a substantial_risk_of_forfeiture sec_83 petitioners make no claim that petitioner’s rights to retain her cti stock were conditioned upon the future performance or nonperformance of any services or the occurrence of any condition related to a purpose of the transfer in fact petitioner’s consulting agreement had terminated when she exercised the options so her rights to retain the shares were not conditioned on the future performance or nonperformance of services nor do petitioners argue that petitioner was subject_to any risk substantial or otherwise that she would have to return the stock to cti at any time after she exercised her options on date to the contrary petitioners stipulated that at no time after exercising her cti stock_options was petitioner under any obligation to return the stock to cti and that during and thereafter petitioner did not sell any shares of cti she obtained through the date exercise of stock_options see merlo v commissioner tcmemo_2005_178 while petitioner might have violated cti’s insider trading policy had she sold her cti stock to a third party upon receiving it the possibility of such a violation does not create a substantial_risk_of_forfeiture within the meaning of sec_83 see united_states v tuff supra pincite6 d accuracy-related_penalty respondent determined that petitioners are liable for an accuracy-related_penalty under sec_6662 and b for a substantial_understatement_of_income_tax in part sec_6662 and b imposes a 20-percent accuracy-related_penalty for any portion of an underpayment that is attributable to a substantial_understatement_of_income_tax an understatement is the excess of the amount of tax required to be shown on the return for the taxable_year over the amount of tax imposed that is shown on the return reduced by any rebate sec_6662 a substantial_understatement_of_income_tax exists for any taxable_year for purposes of sec_6662 if the amount of the understatement for the taxable_year exceeds the greater of percent of the tax required to be shown on the return for the taxable_year or in the case of an individual dollar_figure sec_6662 respondent concedes that he bears the burden of production under sec_7491 and must come forward with sufficient evidence indicating that it is appropriate to impose an accuracy-related_penalty on account of a substantial_understatement_of_income_tax see 116_tc_438 in that we discern from the record that petitioners’ understatement is in excess of dollar_figure and of percent of the amount required to be shown on the return we conclude that respondent has met this burden of production petitioners bear the burden of proving that the accuracy-related_penalty does not apply because of reasonable_cause substantial_authority or the like id in an attempt to meet their burden_of_proof petitioners argue in brief that they are not liable for the accuracy-related_penalty because they acted reasonably and in good_faith by relying on their tax adviser to prepare their federal_income_tax return correctly petitioners also try to prove that they acted reasonably and in good_faith by noting that the taxpayer in facq v commissioner tcmemo_2006_111 was in a similar setting there the court declined to sustain respondent’s determination of an accuracy-related_penalty for among other reasons substantial_understatement_of_income_tax stating that the issue was novel as of the time that the taxpayers filed their tax_return for the year at issue there we agree with petitioners that they are not liable for the accuracy-related_penalty at issue such an accuracy-related_penalty is not imposed upon any portion of an underpayment as to which a taxpayer acted with reasonable_cause and in good_faith sec_6664 whether the taxpayer satisfies those tests is a factual determination where the taxpayer’s effort to assess the taxpayer’s proper tax_liability is a very important consideration sec_1_6664-4 income_tax regs reliance on the advice of a tax professional may constitute reasonable_cause and good_faith if under all facts and circumstances the reliance is reasonable and the taxpayer acted in good_faith see 115_tc_43 petitioners also argue at length that respondent’s determination of the accuracy-related_penalty is null and void this is so petitioners assert because the notice_of_deficiency neither shows specifically that respondent considered the reasonable_cause exception of sec_6664 nor explains why that exception was determined not to be applicable to this case as petitioners see it such a showing and explanation in the notice_of_deficiency is required by the omnibus budget reconciliation act of obra publaw_101_239 103_stat_2106 as discerned from the legislative_history thereunder specifically h rept pincite we disagree with this argument we read nothing in obra that requires that the inclusion of an accuracy-related_penalty in a notice_of_deficiency to be valid must be accompanied by a specific showing that respondent considered the reasonable_cause exception of sec_6664 and an explanation as to why that exception was determined to be inapplicable see also facq v commissioner tcmemo_2006_111 affd 299_f3d_221 3d cir sec_1_6664-4 income_tax regs see also 240_f3d_842 9th cir affg tcmemo_1998_447 reasonable_cause and good_faith also may be found where a position taken on a return involves an issue that is novel as of the time that the return was filed see 123_tc_144 mitchell v commissioner tcmemo_2000_145 cf 251_f3d_862 9th cir where a case is one ‘of first impression with no clear authority to guide the decision makers as to the major and complex issues ’ a negligence_penalty is inappropriate quoting 756_f2d_1430 9th cir affg in part and vacating as to an addition_to_tax for negligence 80_tc_34 we find reasonable_cause on the basis of the fact that the issue at hand was novel at the time petitioners filed their tax_return to be sure while the court_of_appeals for the ninth circuit in united_states v tuff f 3d pincite rejected the taxpayer’s margin debt argument as nonsense the court stated that the issue was a question of first impression in this circuit id pincite given this statement and the absence when petitioners filed their federal_income_tax return of any clear authority to guide the decision makers as to the major and complex issues foster v commissioner supra pincite we decline to sustain respondent’s determination that petitioners are liable for an accuracy-related_penalty for substantial_understatement_of_income_tax accord 127_tc_43 racine v commissioner tcmemo_2006_ facq v commissioner tcmemo_2006_111 e holdings we hold that petitioner realized income in when she exercised her stock_options received from cti we also hold that petitioners are not liable for the accuracy-related_penalty determined by respondent under sec_6662 and b we have considered all arguments made by petitioners for a contrary holding as to the deficiency and we have considered all arguments made by respondent for a contrary holding as to the accuracy-related_penalty as to the arguments that we have considered but not discussed herein we have rejected those arguments as without merit decision will be entered for respondent as to the deficiency decision will be entered for petitioners as to the accuracy-related_penalty


t c summary opinion united_states tax_court michael i bross and sharon g bross petitioners v commissioner of internal revenue respondent docket no 11959-10s filed date christian d posada for petitioners tracey b leibowitz for respondent summary opinion carluzzo special_trial_judge this case was heard pursuant to the provisions of section of the internal_revenue_code in effect when the 1unless otherwise indicated section references are to the internal_revenue_code_of_1986 as amended in effect for the relevant period and rule references are to the tax_court rules_of_practice and procedure petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case in a notice_of_deficiency dated date notice respondent determined a dollar_figure deficiency in petitioners’ federal_income_tax and imposed a sec_6651 addition_to_tax the issue for decision is whether petitioners realized and must recognize income as a result of the discharge of certain credit card debt background some of the facts have been stipulated and are so found michael i bross petitioner an attorney licensed to practice in florida and sharon g bross a licensed real_estate agent in florida are and were at all times relevant here married to each other they resided in florida at the time the petition was filed before the year in issue petitioners intended to take advantage of a deferred interest financing_arrangement offered by a credit card company in connection with the purchase of furniture from a certain furniture store financing_arrangement in effect the financing_arrangement allowed for no interest to accrue on certain furniture purchases financed through charges to a credit card 2respondent now concedes the addition_to_tax issued to petitioner by a certain credit card company if the charges were completely paid_by certain specified dates if the charges were not completely paid_by the specified dates then interest would be charged to the credit card account in an amount computed from the date of purchase petitioners misinterpreted the terms of the financing_arrangement and petitioner was charged interest that petitioners believed he did not owe petitioners unsuccessfully attempted to resolve the dispute with the credit card company over an extended period during which additional interest and late payment penalties added to the amount the credit card company claimed that petitioner owed all of the interest and late payment penalties charged to the credit card account were consistent with the terms of the credit card agreement entered into between petitioner and the credit card company pursuant to the financing_arrangement as it turned out during petitioner reached an agreement with the credit card company as part of that agreement and in return for a partial payment the credit card company canceled the unpaid balance of the credit card account in due course the credit card company issued to petitioner a form 1099-c cancellation of debt showing dollar_figure as the amount of debt canceled petitioners did not include the dollar_figure in the income reported on their timely filed joint federal_income_tax return according to the notice they should have discussion generally the commissioner’s determinations are presumed correct and the taxpayer bears the burden of proving that those determinations are erroneous rule a see 503_us_79 290_us_111 according to respondent the discharged portion of the debt including principal interest and related amounts incurred through the financing_arrangement resulted in income to petitioner in general the term income as used in the internal_revenue_code includes income from any source including any accession to the taxpayer’s wealth see 348_us_426 a taxpayer who has incurred a debt all or a portion of which is later discharged or forgiven generally has realized an accession to wealth see united_states v kirby lumber co 3other adjustments made in the notice are computational and need not be discussed 4petitioners do not claim that the provisions of sec_7491 are applicable and we proceed as though they are not u s accordingly when a taxpayer’s obligation to repay a debt is settled for less than the amount of the face value of the debt the taxpayer ordinarily realizes income from the discharge_of_indebtedness sec_61 see 110_tc_279 citing 790_f2d_1409 9th cir aff’g in part rev’g in part t c memo discharge_of_indebtedness income results not only from the discharge of principal but from the discharge of interest accrued on that principal as well see payne v commissioner tcmemo_2008_66 aff’d 357_fedappx_734 8th cir see also sec_1_6050p-1 income_tax regs according to petitioners petitioner did not realize discharge_of_indebtedness income upon the discharge of a portion of the debt owed to the credit card company because petitioner was not liable for the amount discharged rather the discharge resulted from the settlement of a contested liability sec_108 allows the discharged portion of the debt to be treated not as income but as an adjustment reduction to the purchase_price basis of the furniture purchased through the financing_arrangement and petitioner did not receive a form 1099-c from the credit card company with respect to the discharged portion of the debt was there a valid dispute with respect to the discharged debt if the debt or portion thereof that is discharged arises from a contested liability then the amount discharged does not give rise to discharge_of_indebtedness income of course the contest or dispute with respect to the debt must be in good_faith see 167_f3d_1323 10th cir citing 916_f2d_110 3d cir rev’g tcmemo_1996_543 see also melvin v commissioner tcmemo_2009_199 citing eg rood v commissioner tcmemo_1996_248 aff’d without published opinion 122_f3d_1078 11th cir according to petitioners the discharged portion of the debt resulted from the settlement of a contested liability and no income was realized from the event respondent disagrees and for the following reasons so do we we begin by noting that petitioners’ claim that the credit card company misrepresented the terms of the financing_arrangement is not supported by the record petitioner agreed to the terms of the financing_arrangement at the time of the furniture purchases furthermore the terms of the financing_arrangement were also included in the monthly credit card statements generated by the credit card company at most petitioners although both highly educated professionals misunderstood those terms as best we can determine from what has been submitted the debt that was discharged consisted of interest and penalties on petitioner’s credit card account the interest and penalties ultimately discharged accrued in a manner consistent with the terms of the financing_arrangement petitioners do not claim otherwise instead they complain that petitioner was not liable for the discharged interest and or penalties because the credit card company did not respond to their many requests for a pay off amount with respect to the credit card account we are unable to follow their reasoning in this regard after all the pay off or an amount close to it with respect to petitioner’s outstanding liability on the credit card account was shown on the many monthly credit card statements issued during the period of negotiations between petitioners and the credit card company that ultimately resulted in the settlement giving rise to the discharge_of_indebtedness income here under consideration under the circumstances petitioner’s claim that he was not liable for the portion of the credit card debt ultimately discharged did not render that debt a contested liability within the meaning of the above-referenced authorities was the discharged debt a purchase-money debt_discharge of indebtedness does not always result in the realization of income one exception to the general_rule is found in sec_108 in a situation involving a solvent debtor that section allows the discharge of purchase-money indebtedness to be treated as a purchase_price_adjustment rather than discharge_of_indebtedness income petitioners’ reliance on that section however is misplaced although nothing in the records suggests that petitioner was insolvent at the relevant time it is clear that the debt discharged was not purchase-money indebtedness because it was not a debt between a seller and a purchaser but rather a purchaser and the credit card company that financed the purchase see sec_108 cf 82_tc_638 what is the significance of the form 1099-c according to petitioners petitioner never received the form 1099-c reflecting the discharge of the credit card debt whether he did is of no consequence here neither the failure to issue nor the failure to receive a form 1099-c evidencing one form of income or another converts a taxable item such as the discharge_of_indebtedness into a nontaxable item see vaughn v commissioner tcmemo_1992_317 aff’d without published opinion 15_f3d_1095 9th cir accordingly the discharge of dollar_figure of credit card debt during is includable in petitioners’ income for that year to reflect the foregoing decision will be entered for respondent with respect to the deficiency and for petitioners with respect to the addition_to_tax


internal_revenue_service number release date index number ------------------------------------ -------------------------------- ---------------------------------------------- ------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no ------------- telephone number --------------------- refer reply to cc psi b03 plr-133862-07 date date legend -------------------------------------- -------------------------- ------------------- ----------------------- ---------------------- ---------------------- company ----------------------------------------------------------- date1 date2 date3 date4 date5 date6 date7 year1 year2 year3 year4 year5 year6 ---------------------- ------- ------- ------- ------- ------- ------- -------------------------- ---------------------- --------------------------- ----------------------------- plr-133862-07 a ------------------------ ------------------------------------------------------------- b ----------------------- ------------------------------------------------------------- c ------------------------------------------------------------- d ------------------------------------------------------------- e ------------------------------------------------------------- f ------------------------ ------------------------------------------------------------- ira1 ira2 ira3 ------------------------------------------------------------------------------- ira4 ------------------------------------------ ------------------------------------------------------------------------------- ira5 ----------------------------------- ----------------------------------------------------------------------- ira6 ----------------------------------------------------------------------- shareholders ------------------------ ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ---------------------------------------- ------------------------------------ ----------------------------------- ---------------------------------- ----------------------------- ------------------------------------------------- ----------------------------------------------------- ------------------------------------------------------ --------------------------------------------------- -------------------------------- --------------------------- -------------------------- ------------------------ ------------------------ plr-133862-07 ------------------------------------------------------------- shareholders cont ------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------ ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------ ------------------------------------------------------------- -------------------- --------------- ----------------------------- ----------------------------------------- ------------------------------------------------------- -------------------------------------------------------------------- -------------------------- --------------------------- ------------------------- -------------------- plr-133862-07 ------------------------------------------------------------- shareholders cont ------------------------------------------------------------- ------------------------------------------------------------- ----------------------- ------------------------------------------------------------- ------------------------------------------------------------- ------------------------------------------------------------- dear --------------- ------------------ --------------------------- --------------------------- this letter responds to your letter dated date submitted on behalf of company requesting a ruling under sec_1362 of the internal_revenue_code facts company was incorporated on date1 and elected under sec_1362 to be an s_corporation effective date1 on date2 company issued stock to shareholders on date3 a transferred a portion of his her company stock to ira1 on date4 b transferred a portion of his her company stock to ira2 these shareholders and their respective iras continued to own company stock throughout year1 year2 year3 and year4 on date5 c d e and f transferred all of their company stock to ira3 ira4 ira5 and ira6 respectively these iras continued to own such stock through year3 and year4 in year5 company learned that the iras were ineligible shareholders in company on date6 company redeemed all of the shares of company stock held by ira1 and ira2 and redeemed a portion of the shares held by ira3 ira4 ira5 and plr-133862-07 ira6 the balance of the company stock held by ira3 ira4 ira5 and ira6 was distributed to c d e and f respectively as of date7 no company stock was held by ira1 ira2 ira3 ira4 ira5 or ira6 in year6 company learned that its s_corporation_election may have terminated due to an ineligible shareholder owning company stock accordingly company seeks relief pursuant to sec_1362 law and analysis sec_1361 provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year sec_1361 provides that the term small_business_corporation means a domestic_corporation which is not an ineligible_corporation and which does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than class of stock sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation sec_1362 provides that an election under sec_1362 shall be terminated whenever at any time on or after the 1st day of the 1st taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1362 provides that any termination under sec_1362 shall be effective on and after the date of cessation sec_1362 provides in part that if an election under sec_1362 by any corporation was terminated under sec_1362 the secretary determines that the circumstances resulting in such termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such termination steps were taken so that the corporation for which the termination occurred is a small_business_corporation and the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to sec_1362 agrees to make the adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such termination the plr-133862-07 corporation shall be treated as an s_corporation during the period specified by the secretary sec_1_1362-4 of the income_tax regulations provides that the commissioner may require any adjustments that are appropriate in general the adjustments should be consistent with the treatment of the corporation as an s_corporation during the period specified by the commissioner in the case of a transfer of stock to an ineligible shareholder that causes an inadvertent termination under sec_1362 the commissioner may require the ineligible shareholder to be treated as a shareholder of an s_corporation during the period the ineligible shareholder actually held stock in the corporation moreover the commissioner may require protective adjustments that prevent any loss of revenue due to a transfer of stock to an ineligible shareholder eg a transfer to a nonresident_alien conclusion based solely on the facts submitted and the representations made we conclude that the termination of company’s s_corporation_election due to the transfer of company stock to ira1 ira2 ira3 ira4 ira5 and ira6 was inadvertent within the meaning of sec_1362 therefore under the provisions of sec_1362 company will continue to be treated as an s_corporation for the period from date3 to date7 and thereafter provided that company’s s_corporation_election is valid and not otherwise terminated under sec_1362 accordingly for the time that ira1 ira2 ira3 ira4 ira5 and ira6 held company stock the shareholders a b c d e and f must include their pro_rata shares of the separately and nonseparately computed items attributable to these shares in their income as provided in sec_1366 make adjustments to the stock basis of those shares as provided in sec_1367 and take into account any distributions with respect to those shares as provided in sec_1368 except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion concerning company’s eligibility to be an s_corporation further we express or imply no opinion concerning whether the shareholders are eligible shareholders for purposes of sec_1361 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 a power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative plr-133862-07 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 s leslie h finlow senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


number release date id office uilc cca_2009101308595637 ---------- from ------------------- sent tuesday date am to ------------------- cc ----------- subject re whoever the agents think they are addressing but technically only the partners are parties to a tefra proceeding which is analogous to a class action proceeding for the partners but agents frequently refer to the partnership as the taxpayer since that is the return they are focused on and are adjusting


internal_revenue_service number release date index number ---------------- ----------------------------------- --------------------------- --------- - department of the treasury washington dc person to contact ---------------------- id no ------------- telephone number --------------------- refer reply to cc psi - plr-106390-06 date date ---------------------------- -------------------------------- ------------------------------------------ ------------------------------------------- legend holding ----------------------------------------------------------- trust partnership ----------------------------------------------------------- llc -------------------------------------------------------------------------------- ----------------------------------------------------------- de1 ----------------------------------------------------------- de2 --------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------- a ---------------------------------------------------------------- b ------------------------------ ---------------------------------------------------------------- c ---------------------------------------------------------------- d ------------------------------------------- -------------------------------------- ---------------------------------------- ------------------------------------- -------------------------------------------------------------------------------- ---------------- ------------------- ----------------------- ----------------------- --------------------------- --------------------------------------- ------------- --------- plr-106390-06 ---------------------------------------------------------------- e ---------------------------------------------------------------- country country state a b c d e f g h dear -------------- correspondence submitted on behalf of e requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election to be classified as a disregarded_entity for federal tax purposes facts formed partnership also on that date partnership acquired de1 a country entity which in turn acquired de2 also a country entity de1 and de2 are both disregarded entities on b partnership acquired a a country entity from llc llc owned in part by the trust had acquired a on c partnership then sold a to de2 on d on e de1 acquired b a country entity which acquired c a country entity on f on g the information submitted discloses that on a the trust and another entity this letter responds to a letter dated date and subsequent ------------------- ------------------- ---------------- ---------------- sec_301_7701-3 provides that unless a foreign eligible_entity elects sec_301_7701-3 provides that a business_entity that is not classified as a plr-106390-06 de1 formed d a country entity which acquired e a country entity on h also on h holding acquired the trust’s interest in partnership the trust is a majority owner of holding the respective owners of a b c d and e intended them to be disregarded entities for federal tax purposes effective on their respective dates of acquisition or formation however each of a b c d and e inadvertently failed to timely file form_8832 entity classification election law and analysis corporation under sec_301 b or an eligible_entity may elect its classification for federal tax purposes an eligible_entity with a single owner can elect to be classified as an association and thus a corporation under sec_301 b or a disregarded_entity separate from its owner otherwise the entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owners if it has a single owner that does not have limited_liability for purposes of this provision sec_301_7701-3 provides that a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member be classified other than as provided under sec_301_7701-3 by filing form_8832 entity classification election with the applicable service_center c i will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified on the election form the effective date specified on form_8832 cannot be more than days prior to the date on which the election is filed and cannot be more than months after the date on which the election is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or an announcement published in the internal_revenue_bulletin commissioner will use to determine whether to grant an extension of time to make an sec_301_7701-3 provides in general that an eligible_entity may elect to sec_301_7701-3 provides that an election made under sec_301 sec_301_9100-1 through provide the standards the sec_301_9100-3 provides that requests for relief under sec_301_9100-3 will be based on the facts and representations submitted e has established that the plr-106390-06 election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusions requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied consequently e is granted an extension of time of days from the date of this letter for electing under sec_301_7701-3 to be treated as a disregarded_entity effective h e must file form_8832 within the extension period with the appropriate service_center with a copy of this letter attached except for the specific ruling above we express or imply no opinion concerning the federal tax consequences of the facts of this case under any other provision of the code sec_301_9100-1 provides that the granting of an extension of time for making an election is not a determination that the taxpayer is otherwise eligible to make the election sec_6110 of the internal_revenue_code this ruling may not be used or cited as precedent being forwarded to taxpayer’s authorized representatives pursuant to a power_of_attorney on file with this office a copy of this letter is this ruling is directed only to the taxpayer requesting it according to sincerely s william p o’shea associate chief_counsel passthroughs special industries enclosures copies of this letter copy for sec_6110 purposes


internal_revenue_service index no number release date cc dom p si - plr-110930-99 date x y state date dear this letter responds to your letter dated date requesting a ruling that waives the five-year waiting_period imposed by sec_1361 of the internal_revenue_code in order to permit x to make an s election under sec_1362 the information submitted states that x a corporation organized under the laws of state is a wholly-owned subsidiary of y y is an s_corporation as defined in sec_1361 of the code y filed an election under sec_1361 to treat x as a qualified_subchapter_s_subsidiary qsssub effective on date y’s shareholders intend to sell all of the outstanding shares of y pursuant to the sale certain assets unrelated to y’s core business will be excluded from the sale and distributed to the shareholders prior to the closing of the sale such assets consist of the x stock and certain real_property y intends to effectuate the distribution of the x stock and the real_property by contributing the real_property to x and then distributing the x stock to y’s shareholders in partial_redemption of their y stock as a result of this transaction y’s election to treat x as a qsssub will terminate sec_1361 of the code provides that except as provided in regulations prescribed by the secretary for purposes of the code i a corporation which is a qsssub shall not be treated as a separate corporation and ii all assets liabilities and items of income deduction and credit of a qsssub shall be treated as assets liabilities and such items as the case may be of the s_corporation sec_1361 of the code defines the term qualified_subchapter_s_subsidiary as a domestic_corporation that is not an ineligible_corporation if percent of the stock of the corporation is owned by the s_corporation and the s_corporation elects to treat the corporation as a qsssub the statutory provision does not however provide guidance on the manner in which the qsssub election is made or the effective date of the election sec_1361 of the code provides that if a corporation’s status as a qsssub terminates such corporation and any successor_corporation shall not be eligible to make i an election under subparagraph b ii to be treated as a qsssub or ii an election under sec_1362 to be treated as an s_corporation before the 5th taxable_year for which the termination was effective unless the secretary consents to the election in explaining sec_1361 the joint_committee on taxation states as follows it is expected that the secretary will provides waivers of the five year rule in appropriate instances for example if the stock of the qsssub is distributed to the individual shareholders of the subsidiary’s parent the subsidiary will no longer be a qsssub and would be subject_to the five-year rule if the parent_corporation retains its subchapter_s_election and the secretary determines that the distribution was not made for tax_avoidance it would seem appropriate for the secretary to waive the five-year rule joint_committee on taxation general explanation of tax legislation enacted in 104th congress jcs-12-96 rep no 104th cong 2d sess based solely on the foregoing facts and law the service waives the five-year waiting_period imposed by sec_1361 and consents to x’s election under sec_1362 to be an s_corporation effective for its first taxable_year beginning on the date of its deemed formation resulting from the termination of its qsssub election temporary or final regulations pertaining to one or more issues addressed in this ruling have not yet been adopted therefore this ruling will be modified or revoked if the adopted temporary or final regulations are inconsistent with any conclusion in the ruling see section dollar_figure of revproc_99_1 1999_1_irb_6 however when the criteria in section dollar_figure of revproc_99_1 are satisfied a ruling is not revoked or modified retroactively except in rare or unusual circumstances this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file with this office a copy of this letter is being sent to x sincerely yours j thomas hines acting branch chief branch office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ------------------------ ------------------ ---------------------------------- in re --------------------------------------- ------------------------ department of the treasury washington dc person to contact ----------------- id no ------------- telephone number --------------------- refer reply to cc psi plr-124092-07 date june legend decedent --------------------------- date -------------------------- spouse -------------------------- daughter ---------------------------------- daughter ------------------------ daughter ------------------------ daughter ------------------- stepchild ------------------------------- stepchild ------------------------------ grandchild ---------------------------------- grandchild ------------------------------- grandchild ----------------------- grandchild ---------------------------------------- grandchild ----------------------------- grandchild -------------------- grandchild -------------------- grandchild ------------------------------ grandchild ------------------------------ grandchild ------------------------ will -------------------------------------------------------------------- -------------------------------------------- a --------- account ------------------------------------------------------- -------------------------------------------------------------------------------------------- plr-124092-07 county ------------------------------------ x --------- individual ------------------ bank ----------------------------------------------------------------- --------------------------------------------------- court ---------------------------------------------------- ------------------------------------------------------------ petition ---------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------ individual ---------------------- date ------------------ date -------------------- date ------------------- date ---------------- state ------------ state statute --------------------------------------------------- state statute -------------------------------------------- state statute -------------------------------------------- state statute ------------------------------------------------------------------- date -------------------------- law firm ------------------------------ date --------------------- date ------------------- order ------------------------------------------------------------- --------------------------------------------------------------- dear ------------ this is in response to your letter dated date and subsequent submissions in which you request rulings regarding federal gift and estate_tax consequences of proposed disclaimers facts the facts submitted and representations made are as follows decedent died on date survived by the following family members spouse decedent’s four adult daughters daughter daughter daughter and daughter decedent’s stepchildren stepchild and stepchild and decedent’s grandchildren grandchild grandchild grandchild grandchild grandchild grandchild and grandchild grandchild grandchild and grandchild plr-124092-07 decedent’s will provides for the payment from account of costs expenses debts and taxes and for dollar_figurea in cash to each of daughter sec_1 and and stepchildren and will further provides that any cash remaining in account will be paid to spouse all of decedent’s real and personal_property in county pass to daughter sec_1 and article seventh of will provides for the establishment of a_trust to be funded with all of the stocks and bonds in account at decedent’s death trust is to be divided into equal shares one share to be held for the benefit of each of decedent’s grandchildren living at her death trust provides that the trustee will distribute specified portions of each grandchild’s share of principal and income when the grandchild reaches age sec_25 and sec_30 and the remaining portion when the grandchild reaches age article sixth names bank as trustee under article eighth decedent’s residuary_estate passes to spouse residuary clause under article ninth if spouse predeceases decedent or dies simultaneously dollar_figurex of decedent’s residuary_estate passes to each of stepchildren and the remaining residuary_estate will be divided equally among any of stepchildren and and daughter sec_1 and living at decedent’s death will contains no provisions regarding the consequences if any beneficiary disclaims an interest provided under will individual was named as and is currently serving as personal representative under will from date to date in response to a request from personal representative court issued orders appointing individual as guardian ad litem for grandchild grandchild grandchild grandchild grandchild grandchild and grandchild referred to herein as minor grandchildren on date court also issued orders appointing each of daughter sec_1 and to be the conservator of the estates of her respective children among the minor grandchildren and of any of her unborn children on date daughter sec_1 and as conservators of their respective minor children who are minor grandchildren filed a petition with court the petition states that each daughter proposes to execute a disclaimer on behalf of each of her respective wards the petition further states that each of the proposed disclaimers made by a daughter as conservator on behalf of each minor grandchild who is her ward will relate back to the date of decedent’s death and will disclaim a fraction of the minor grandchild’s beneficial_interest in the grandchild’s separate share of trust the numerator will be the amount equal to the value of the share of trust held for the benefit of the grandchild as finally determined for federal estate_tax purposes reduced by one- tenth of decedent’s generation-skipping_transfer gst tax exemption available on her date of death the denominator will be the value of the grandchild’s share of trust as finally determined for federal estate_tax purposes a copy of a proposed disclaimer was attached to the petition this copy states that the daughter as conservator in addition plr-124092-07 to disclaiming the respective minor grandchild’s fractional interest in trust also disclaims any and all rights and interests in the disclaimed interest which might constitute a gift bequest or devise to her as conservator the petition states that each proposed disclaimer will be irrevocable in writing will be delivered to bank within nine months of the later of decedent’s death or the date on which each disclaiming minor grandchild reaches age and that none of the minor grandchildren have accepted any benefits from the disclaimed property further the petition provides reasons why the proposed disclaimers are in the best interests of the minor grandchildren it has been represented that grandchild grandchild and grandchild will also disclaim their interests in trust in a manner consistent with the formula described above they are not part of this ruling_request the petition requests an order that conditioned and effective upon the receipt of a favorable letter_ruling from the internal_revenue_service the proposed disclaimers are valid under state law and that the disclaimed interests will pass to spouse under the residuary clause of will state statute provides that a disclaimed interest passes under the residuary clause of the transferor's will if the transferor died prior to the disclaimer under state statute to qualify as a disclaimer a refusal to accept an interest in property must be written irrevocable and unqualified must be received by the legal_representative of the transferor or the holder of legal_title to the property within months after the later of the day on which the transfer creating the interest in the disclaimant is made or the day on which the disclaimant reaches age the disclaimant must not have accepted the interest or any of its benefits and as a result of the refusal the disclaimed interest passes without any direction by the disclaimant either to the spouse of the decedent or to a person other than the disclaimant state statute provides that a duly appointed qualified and acting guardian of the property of a person under the age of years may make a disclaimer on behalf of his ward upon a showing satisfactory to the court having jurisdiction over the guardianship that the disclaimer is in the best interests of the ward a guardian of the property may be appointed by the court for the sole purpose of filing with the court an application_for approval of a disclaimer state statute defines a conservator as a person appointed by the court to have the custody and control of the property of a ward on date court held a hearing on the conservators’ petition on date the conservators filed a motion with court asking that personal representative be authorized to engage law firm as tax counsel on behalf of decedent’s estate and on behalf of the conservators who would be making the disclaimers subsequently the motion was approved on date the guardian ad litem filed a recommendation to court that the conservators execute disclaimers on behalf of the minor grandchildren the recommendation was conditioned on the following a that there be no disclaimer of plr-124092-07 the aggregate amount of decedent’s available gst_exemption b that the internal_revenue_service issues a ruling that the disclaimers are qualified disclaimers under sec_2518 of the internal_revenue_code and that all disclaimed property_passing_to_spouse qualifies for the federal estate_tax_marital_deduction under sec_2056 and c that court issues an order determining that the disclaimers are in the best interests of the grandchildren and that all of the disclaimed interests of the grandchildren will pass to spouse under the residuary clause on date court issued an order that the disclaimers the conservators proposed to execute on behalf of the minor grandchildren would be in the best interests of the minor grandchildren conditioned on personal representative’s receipt of a favorable letter_ruling from the internal_revenue_service it is represented that none of the assets of decedent’s estate have been distributed to trust it is further represented that spouse has not offered and will not provide any consideration in exchange for the proposed disclaimers spouse represents that there is no agreement express or implied that he will distribute the disclaimed assets to the minor grandchildren during his lifetime or at his death nor does he have a set plan to make lifetime gifts of disclaimed assets to the minor grandchildren if they execute the proposed disclaimers you have requested the following rulings the proposed disclaimers to be executed on behalf of the minor grandchildren will be qualified disclaimers under sec_2518 of the internal_revenue_code all disclaimed interests passing_to_spouse as a result of the proposed disclaimers will qualify for the estate_tax_marital_deduction under sec_2056 law and analysis ruling_request sec_2046 provides that disclaimers of property interests passing upon death are treated as provided under sec_2518 sec_2518 provides that if a person makes a qualified_disclaimer with respect to any interest in property the disclaimed interest is treated as if it had never been transferred to the person making the qualified_disclaimer for purposes of the federal estate gift and generation-skipping_transfer_tax provisions under sec_2518 the term qualified_disclaimer means an irrevocable and unqualified refusal by a person to accept an interest in property but only if -- the refusal is in writing plr-124092-07 the writing is received by the transferor of the interest or his legal_representative no later than months after the date on which the transfer creating the interest in the person making the disclaimer is made or the date on which the person making the disclaimer attains age the person making the disclaimer has not accepted the interest or any of its benefits and as a result of the refusal the interest passes without any direction on the part of the person making the disclaimer and passes either to the decedent's spouse or to a person other than the person making the disclaimer under sec_25_2518-2 of the gift_tax regulations a qualified_disclaimer of property cannot be made with respect to an interest in property if the disclaimant has accepted the interest or any of its benefits expressly or impliedly prior to making the disclaimer the acceptance of any consideration in return for making a disclaimer is an acceptance of the benefits of the entire_interest disclaimed sec_25_2518-2 provides that a disclaimer is not a qualified_disclaimer unless the disclaimed interest passes without any direction on the part of the disclaimant to a person other than the disclaimant except as provided in sec_25 e pertaining to the disclaimer by a surviving_spouse if there is an express or implied agreement that the disclaimed interest in property is to be given or bequeathed to a person specified by the disclaimant the disclaimant shall be treated as directing the transfer of the property interest the requirements of a qualified_disclaimer under sec_2518 are not satisfied if -- i the disclaimant either alone or in conjunction with another directs the redistribution or transfer of the property or interest in property to another person or has the power to direct the redistribution or transfer of the property or interest in property to another person unless such power is limited by an ascertainable_standard or ii the disclaimed property or interest in property passes to or for the benefit of the disclaimant as a result of the disclaimer except as provided in sec_25_2518-2 under sec_25_2518-3 the disclaimer of an undivided portion of an interest in a_trust may be a qualified_disclaimer under sec_25_2518-3 a disclaimer of an undivided portion of a separate interest in property which meets the other requirements of a qualified_disclaimer under sec_2518 and the corresponding regulations is a qualified_disclaimer an undivided portion of a disclaimant’s separate interest in property must consist of a fraction or percentage of each and every substantial interest or right owned by the disclaimant in such property and must extend over the entire term of the disclaimant’s interest in such property and in other_property into which such property is converted a disclaimer of some specific rights while retaining other rights with respect to an interest in the property is not a qualified_disclaimer of an undivided portion of the disclaimant’s interest in the property thus for example a disclaimer made by the plr-124092-07 devisee of a fee simple interest in blackacre is not a qualified_disclaimer if the disclaimant disclaims a remainder_interest in blackacre but retains a life_estate to satisfy the requirements of sec_2518 a disclaimer must be valid under applicable local law 872_f2d_84 4th cir that is because state law determines whether a property interest passes from one to another the disclaimer must constitute an effective renunciation under state law estate of bennett v commissioner 100_tc_67 under state law a duly appointed qualified and acting conservator of a person under the age of years may make a disclaimer on behalf of his ward upon a satisfactory showing to the court with jurisdiction over the conservatorship that the disclaimer is in the ward’s best interests the court may appoint a conservator for the sole purpose of filing an application with the court for approval of a disclaimer on behalf of a person under age if the transferor of the disclaimed interest dies before the disclaimer is executed the disclaimed interest passes under the residuary clause of the transferor's will in the present case the conservators appointed by court for minor grandchildren have obtained court’s approval of the proposed disclaimers conditioned upon the receipt of a favorable letter_ruling from the internal_revenue_service through his or her respective conservator each minor grandchild will disclaim a fractional share of the grandchild’s separate share of trust will is silent regarding the effect of a disclaimer by any beneficiary it is represented that the disclaimers will be irrevocable in writing delivered to bank as trustee of trust within nine months of the later of decedent’s death or the date on which each disclaiming minor grandchild reaches age and that none of the minor grandchildren have accepted any benefits from the disclaimed property further each minor grandchild's disclaimer of a fractional interest of trust will satisfy the requirements of sec_25_2518-3 however to be qualified disclaimers for purposes of sec_2518 the proposed disclaimers must be valid under applicable local law in this regard based on the facts submitted and the representations made we express no opinion as to whether the proposed disclaimers by minor grandchildren will be valid under applicable local law however provided the disclaimers are valid under state law the disclaimers will be qualified disclaimers under sec_2518 see estate of goree v commissioner t c memo ruling_request sec_2056 provides that for purposes of the tax imposed by sec_2001 the value of the taxable_estate except as limited by sec_2056 is determined by deducting from the value of the gross_estate an amount equal to the value of any interest in property which passes or has passed_from_the_decedent to the decedent's surviving plr-124092-07 spouse but only to the extent that such interest is included in determining the value of the gross_estate section d - b provides that if an interest in property passes from the decedent to a person other than the surviving_spouse in a transfer made after date and the person to whom the property passes makes a qualified_disclaimer with respect to the property and the surviving_spouse is entitled to such interest as a result of the disclaimer then the disclaimed interest is treated as passing directly from the decedent to the surviving_spouse in the present case if the proposed disclaimers qualify as disclaimers under state statute then under state statute as a result of the disclaimers the disclaimed property will pass outright to spouse under the residuary clause based on the facts submitted and the representations made we conclude that provided the proposed disclaimers on behalf of minor grandchildren are valid and effective under state law and are therefore qualified disclaimers for purposes of sec_2518 the disclaimed property passing outright to spouse under the residuary clause will be treated for federal estate_tax purposes as passing directly from decedent to spouse except as specifically ruled herein we express no opinion on the federal tax consequences of the proposed disclaimers under the cited provisions or under any other provisions of the code the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent enclosure copy for sec_6110 purposes sincerely yours _________________________ james hogan senior technician reviewer branch office of associate chief_counsel passthroughs and special industries