qwhuqdo cid 5hyhqxh cid 6huylfh department of the treasury index washington dc number release date person to contact telephone number refer reply to cc dom it a - plr-114197-98 date date legend taxpayer lessor company lessee company date date date cla sec_1 stock cla sec_2 stock a b dear sir or madam this responds to a letter of date submitted on your behalf by your authorized representatives requesting rulings that taxpayer’s receipt from lessee company of a warrant to purchase lessee company cla sec_2 stock was a closed transaction rather than an open_transaction and that taxpayer did not receive rental income at the time of its exercise of the warrant when the fair_market_value of the lessee company cla sec_2 stock acquired exceeded the price paid for the stock although the second ruling requested concerns the receipt of rental income we have expanded the scope of our reply by considering whether taxpayer recognized income of any kind as a result of its exercise of the warrant plr-114197-98 issues was taxpayer’s receipt from lessee company of a warrant to purchase lessee company cla sec_2 stock a closed transaction or an open_transaction did taxpayer recognize income when it exercised the warrant because the then fair_market_value of the lessee company cla sec_2 stock acquired on exercise exceeded the price paid for the stock conclusions taxpayer’s receipt from lessee company of a warrant to purchase lessee company cla sec_2 stock was a closed transaction taxpayer did not recognize income when it exercised the warrant even though the then fair_market_value of the acquired lessee company cla sec_2 stock exceeded the warrant’s exercise price facts taxpayer represents that it is a venture capital fund the primary purposes of which are to provide lease financing to and purchase equity interests in emerging growth companies taxpayer represents that lessor company assists taxpayer in these activities and that the transactions in which it and lessor company together participate are generally structured as follows lessor company enters into an agreement with a company the lessee that taxpayer and lessor company believe is an emerging growth company pursuant to the agreement lessor company becomes obligated to lease property having a specified value to the lessee lessor company’s obligations under the agreement are then assigned to and assumed by taxpayer taxpayer receives purportedly in exchange for a stated cash consideration a warrant from the lessee entitling it to purchase stock in the lessee taxpayer may also invest in subsequent private equity offerings by the lessee taxpayer represents that it engages in these activities in order to earn yields that exceed average lease yields taxpayer represents that lessor company and lessee company a company unrelated to either taxpayer or lessor company entered into a term sheet on date pursuant to which lessor company offered to provide to lessee company lease financing for tangible_personal_property having a value of up to dollar_figurea the term sheet also stated that as an incentive to lessor company to enter into the lease agreement plr-114197-98 lessee company would grant to lessor company a warrant to purchase a specified number of shares of lessee company’s cla sec_1 stock at its initial_offering_price the term sheet also provided that if the amount of financing provided to lessee company by lessor company exceeded a specified amount that was less than dollar_figurea the number of shares of cla sec_1 stock that could be purchased at that price under the warrant would increase proportionately up to a specified maximum amount approximately months later on date lessor company and lessee company entered into a master lease agreement pursuant to which lessor company committed to provide to lessee company lease financing at predetermined rentals based on the nature and cost of the property to be leased for tangible_personal_property having a value of up to dollar_figurea the master lease agreement provided that lessee acknowledges that it is lessor’s intention to assign this lease and the related tangible_personal_property to taxpayer and agrees that upon such assignment the sole liability for performance of lessor’s obligations hereunder shall fall upon taxpayer which shall assume such obligations and lessor shall be fully released from such liabilities thereafter lessor company assigned to taxpayer and taxpayer assumed lessor company’s obligations under the master lease agreement taxpayer represents that the master lease agreement provided for an arm’s length return also on date taxpayer and lessee company entered into a warrant purchase agreement which provided that taxpayer agreed to purchase from lessee company and lessee company agreed to sell to taxpayer the warrant described therein for an aggregate cash purchase_price of dollar_figureb the warrant so acquired by taxpayer from lessee company entitled taxpayer to purchase a specified number of shares of lessee company’s cla sec_2 stock at a specified price and further provided that if the amount of lease financing provided to lessee company under the master lease agreement exceeded a specified amount that was less than dollar_figurea the number of shares of cla sec_2 stock that could be purchased at that price under the warrant would increase proportionately up to a specified maximum amount taxpayer represents that lessee company requested that the warrant contain this contingency because lessee company did not want taxpayer to fully benefit from the warrant in the event lessee company determined not to fully use the lease financing available to it under the master lease agreement the warrant was exercisable by taxpayer until the earlier of a specified date or the fifth anniversary of the first if any initial_public_offering of lessee company’s common_stock yielding aggregate gross_proceeds in excess of a specified amount at the time of the warrant’s issuance the fair_market_value of a share of lessee company’s cla sec_2 stock was less than the warrant’s per share exercise price taxpayer represents that the warrant was not issued to it in connection with its performance of services within the meaning of sec_83 of the internal_revenue_code plr-114197-98 the amount of the lease financing made available by lessor company dollar_figurea to lessee company was approximately big_number times as large as the cash purchase_price dollar_figureb recited in the warrant purchase agreement taxpayer represents that pursuant to the master lease agreement lessee company leased property from taxpayer having an aggregate value of approximately of dollar_figurea taxpayer represents that lessee company and taxpayer considered this to fully satisfy the contingency contained in the warrant so that taxpayer became entitled to purchase the maximum number of shares permitted under the warrant on date soon after lessee company’s successful initial_public_offering of stock taxpayer fully exercised its right under the warrant to purchase lessee company cla sec_2 stock for the price specified in the warrant at the time of the warrant’s exercise the fair_market_value of a share of lessee company’s cla sec_2 stock greatly exceeded the warrant’s per share exercise price analysis taxpayer has not requested a ruling as to whether the transaction described above in which it purported to lease tangible_personal_property to lessee company was for federal tax purposes a true lease taxpayer has not requested a ruling as to the fair_market_value of the warrant as of its issuance to taxpayer taxpayer has also not requested a ruling as to whether it received the warrant from lessee company solely for dollar_figureb cash as stated in the warrant purchase agreement in part for dollar_figureb cash and in part as rent paid_by lessee company in the event the transaction is a true lease or in part for dollar_figureb cash and in part as something else such as additional purchase_price for the property sold to lessee company in the event the transaction is instead a sale rather taxpayer seeks rulings that its receipt of the warrant whether it was just in exchange for dollar_figureb or was part in exchange for dollar_figureb and in part for something else was a closed transaction as of the date of its receipt rather than an open_transaction and that it did not recognize additional income of any kind on date as a result of its exercise the warrant at a time when the fair_market_value of the lessee company cla sec_2 stock acquired greatly exceeded the price paid for it sec_1_1001-1 of the income_tax regulations and revrul_58_402 1958_2_cb_15 provide that a property’s fair_market_value is a question of fact and that only in rare and extraordinary cases will property be considered to have no fair_market_value taxpayer’s receipt of the warrant on date was a closed transaction because the warrant had an ascertainable fair_market_value at that time in accordance with revrul_77_250 1977_2_cb_309 and revrul_68_601 1968_2_cb_124 the warrant was an option to purchase the stock subject_to the warrant accordingly upon its receipt of the warrant taxpayer had a basis in the warrant equal to the amount deemed exchanged for the warrant revrul_58_234 1958_1_cb_279 the amount exchanged for the warrant may be either dollar_figureb if the warrant’s then fair_market_value plr-114197-98 did not exceed dollar_figureb so that taxpayer would be deemed to have received the warrant solely in exchange for dollar_figureb cash or the warrant’s then fair_market_value if it exceeded dollar_figureb so that taxpayer would be deemed to have received the warrant for something in addition to dollar_figureb cash further in accordance with 297_us_496 revrul_78_182 1978_1_cb_265 revrul_58_234 1958_1_cb_279 taxpayer was not required to recognize income as a result of its exercise of the warrant even though the fair_market_value of the lessee company cla sec_2 stock acquired greatly exceeded the exercise price under the warrant rather taxpayer’s basis for the shares acquired on exercise of the warrant equaled the sum of its basis for the warrant plus the price paid on exercise 425_f2d_713 9th cir revrul_84_121 1984_2_cb_168 that basis would be taken into account in determining the tax consequences of a subsequent transfer of the shares by taxpayer accordingly based on the facts submitted and the representations made we rule that taxpayer’s receipt from lessee company of the warrant was a closed transaction rather than an open_transaction and that taxpayer did not recognize income when it exercised the warrant even though the then fair_market_value of the acquired lessee company cla sec_2 stock exceeded the warrant’s exercise price except as expressly provided herein no opinion is expressed or implied concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter under any other provision of the code and no opinion is expressed or implied herein as to the fair_market_value of the warrant as of the time of its issuance to taxpayer the amount taxpayer exchanged for the warrant or as to whether the transaction between taxpayer and lessee company was a true lease for federal tax purposes this letter_ruling is directed only to taxpayer sec_6110 of the code provides that this letter_ruling may not be cited or used as precedent taxpayer must attach a copy of this letter to any of its income_tax returns to which it is relevant sincerely assistant chief_counsel income_tax accounting by christopher f kane assistant to the branch chief branch


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 b02 plr-133854-10 date date x state a b a d1 d2 d3 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ -------- ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ----- ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ ----------------- dear -------------- this responds to a letter dated date and subsequent correspondence submitted on behalf of x by its authorized representative requesting a ruling under sec_1362 of the internal_revenue_code the information submitted states that x was incorporated in state on d1 and made an election to be treated as an s_corporation effective as of that date on d2 a acquired a shares of x stock a was not an eligible s_corporation shareholder as of the date of transfer and x’s s_corporation_election terminated on d2 upon discovering the plr-133854-10 existence of the ineligible shareholder b an eligible shareholder of x acquired a’s shares of x stock effective d3 x represents that the circumstances resulting in the termination of x’s s_corporation_election were inadvertent and were not motivated by tax_avoidance or retroactive tax planning x and its shareholders consent to make any adjustments consistent with the treatment of x as an s_corporation as may be required by the secretary sec_1362 provides that if an election under sec_1362 by any corporation a was not effective for the taxable_year for which made determined without regard to sec_1362 by reason of a failure to meet the requirements of sec_1361 or to obtain shareholder consents or b was terminated under sec_1362 or the secretary determines that the circumstances resulting in the ineffectiveness or termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination steps were taken a so that the corporation is a small_business_corporation or b to acquire the shareholder consents 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 such 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 the ineffectiveness or termination the corporation will be treated as an s_corporation during the period specified by the secretary based solely on the facts submitted and the representations made we conclude that the termination of x's s_corporation_election on d2 was inadvertent within the meaning of sec_1362 accordingly pursuant to the provisions of sec_1362 x will be treated as continuing to be an s_corporation from d2 and thereafter provided x’s s_corporation_election was valid and was not otherwise terminated under sec_1362 this ruling is conditioned upon the shareholders of x including in income their pro_rata share of the separately_stated and nonseparately computed items of x as provided in sec_1366 making any adjustments to basis as provided in sec_1367 and taking into account any distributions made by x as provided in sec_1368 if x or its shareholders fail to treat themselves as described above this letter_ruling shall be null and void except as specifically provided herein no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provisions of the code in particular no opinion is expressed as to whether x is otherwise eligible to be an s_corporation plr-133854-10 this ruling is directed only to the taxpayer that requested it sec_6110 provides that it may not be used or cited as precedent sincerely bradford r poston senior counsel branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court roblene inc petitioner v commissioner of internal revenue respondent docket no 21576-95r filed date paul m thielking for petitioner lawrence h ackerman judith m picken and gregory j stull for respondent memorandum opinion hamblen judge this is an action for a declaratory_judgment regarding the gualification of petitioner's employee_stock_ownership_plan and trust on date respondent issued a final revocation letter to petitioner stating that the roblene inc employee_stock_ownership_plan the esop failed to meet the requirements of sec_401 for the plan years beginning after date and that its related trust the trust was not tax exempt under sec_501 for trust years ending with or within the affected plan years respondent also revoked the prior determination_letter to petitioner dated date the issue for decision is whether the esop violated the gualification reguirements of sec_401 in operation preventing its related trust from being exempt from income_tax under sec_501 because amounts contributed to the trust and allocated to the accounts of the esop's participants exceeded the sec_415 limitations for the limitation years that ended date through date ‘unless otherwise indicated all section references are to the internal_revenue_code as in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure we note that petitioner alleged in its second amended petition that respondent issued the final revocation letter after the expiration of the applicable statute_of_limitations we further note that petitioner abandoned this claim as petitioner does not address this issue in its brief or in its reply brief moreover the present action now before this court is a declaratory_judgment action concerning the qualification of petitioner's esop this action does not involve the imposition or collection of tax there is no applicable statute_of_limitations with regard to the issuance of revocation of gualification letters as they do not involve the imposition of tax sec_6501 provides continued we hold that the commissions paid to robert and charlene peers as independent contractors are not includable in participant's_compensation for purposes of the sec_415 limitations furthermore we hold that the elective salary deferrals are employer contributions and as such are not included in participant's_compensation for sec_415 limitation purposes consequently we hold that the esop failed to meet the requirements of sec_401 for the plan years beginning after date and that the related trust is not a qualified_trust under sec_401 for the plan years beginning after date background petitioner is an iowa corporation with its principal_place_of_business located in des moines iowa at the time of the filing of the petition in this case it filed its federal tax returns for the years in issue with the internal_revenue_service center in kansas city missouri petitioner maintains its tax records on the accrual_method of accounting with a fiscal_year ending july as its taxable_year continued a general_rule ---except as otherwise provided in this section the amount of any_tax imposed by this title shall be assessed within years after the return was filed and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period petitioner was incorporated on date and its principal business activity is real_estate sales it is the employer and plan_administrator with respect to the esop a defined_contribution_plan petitioner established the esop and the trust as of date effective for plan years beginning on and after date the plan years and limitation years of the esop and the trust are the fiscal years ending july petitioner amended and restated the plan document on date effective date on date respondent issued a favorable determination_letter to petitioner stating that the esop as amended and restated was in form gualified under sec_401 and consequently the trust was entitled to tax exempt status under sec_501 this determination_letter applied to plan_year s beginning after date the esop contains a salary_reduction_cash_or_deferred_arrangement feature under which an esop participant is permitted to reduce his cash compensation or to forgo an increase in cash compensation conditioned upon the employer's making a pretax contribution in the same amount to the esop to the participant's account apart from the shares of petitioner's stock issued to robert and charlene peers on date the esop's trust is and has been the sole shareholder of petitioner since its incorporation on date petitioner issued shares of its stock to the trust in payment of the contributions to the trust robert and charlene peers were during the taxable years that ended date through and are the founders and sole officers of petitioner robert peers was and is its president and charlene peers was and is the trustee of the fsop's trust robert and charlene peers also have been the only participants in the esop petitioner reported the following deductions on its u s_corporation income_tax returns forms pension compensation salaries profit--sharing of officers and wages etc plans year line line line dollar_figure dollar_figure dollar_figure big_number big_number big_number the deductions for pension profit-sharing etc plans were reflected as contributions to the trust in the trust's forms 5500-c return report of employee_benefit_plan for each of such years in addition petitioner included the following commissions paid to nonemployees who were treated by petitioner as independent contractors on line other deductions year commissions dollar_figure big_number big_number big_number robert and charlene peers filed joint u s individual income_tax returns their returns reflect the following wages salaries business principal year tips etc income business form 1040-line schedule c schedule c so dollar_figure -- big_number real_estate sales dollar_figure dollar_figure real_estate sales big_number big_number realtor for we note that no w-2 is included in the record to determine the source of the dollar_figure of salaries and wages since petitioner paid dollar_figure in compensation to officers and dollar_figure in salaries and wages for and it would appear that this income is from another employer for a form_w-2 is attached to the tax_return of robert and charlene peers indicating that first realty ltd paid dollar_figure to robert and charlene peers discussion prior to discussing the respective arguments of the parties regarding the qualification of petitioner's esop as exempt from taxation a brief summary of the pertinent statutes is helpful sec_501 provides that a_trust described in sec_401 a is generally exempt from taxation sec_401 discusses the requirements that a_trust must meet in order to constitute a qualified_trust and sets forth certain restrictions that preclude qualification of a_trust sec_401 sets forth the restriction in issue in the instant case sec_401 a provides a_trust shall not constitute a qualified_trust under this section if the plan of which such trust is a part provides for benefits or contributions which exceed the limitations of sec_415 sec_415 provides that a_trust which is part of a pension profit-sharing or stock_bonus_plan shall not constitute a qualified_trust under sec_401 if-- b in the case of a defined_contribution_plan contributions and other additions under the plan with respect to any participant for any taxable_year exceed the limitation of subsection c sec_415 provides in general --contributions and other additions with respect to a participant exceed the limitation of this subsection if when expressed as an annual_addition within the meaning of paragraph to the participant's account such annual_addition is greater than the lesser of-- a dollar_figure or b percent of the participant's_compensation sec_415 a was amended by the tax_reform_act_of_1986 tra publaw_99_514 sec a 100_stat_2420 effective for years beginning after date to read dollar_figure or if greater of the dollar limitation dollar_figure in effect under subsection b a it was further amended to eliminate the parenthetical language effective for years commencing after date see uruguay round agreements act publaw_103_465 108_stat_5005 sec_415 provides that annual_addition means the sum for any year of-- a employer contributions b the lesser of-- the amount of the employee contributions in excess of percent of his compensation or ii one-half of the employee contributions and c forfeitures the dispute in this case focuses on whether amounts contributed to the trust and allocated to the accounts of robert and charlene peers exceeded the sec_415 limitations the parties disagree as to what constitutes participant's_compensation for purposes of sec_415 and as to whether elective salary deferrals constitute employee or employer contributions petitioner asserts that the commissions it paid robert and charlene peers as independent contractors constitute participant's_compensation for purposes of sec_415 petitioner also asserts that the amounts of elective salary deferrals are employee contributions and should be included in participant's_compensation thus petitioner maintains that the limitations of sec_415 have not been exceeded with sec_415 b was amended by the tra sec e 100_stat_2424 for the years beginning after date to include the entire employee contribution in the computation of the annual_addition the result that the esop and trust were qualified during the years at issue petitioner asserts in its brief that the participant's_compensation contributions to the esop and annual_additions are as follows year participant's annual ended compensation contributions additions commissions dollar_figure elective_deferrals _big_number dollar_figure dollar_figure big_number big_number sec_415 limit excess commissions dollar_figure dollar_figure elective_deferrals big_number big_number dollar_figure big_number big_number big_number sec_415 limit excess commissions dollar_figure dollar_figure dollar_figure big_number sec_415 limit excess commissions dollar_figure dollar_figure dollar_figure big_number prior year excess big_number net annual_additions big_number sec_415 limit big_number excess we note that petitioner included only one-half of the elective_deferrals in annual_additions for the year ended date since petitioner asserts the elective_deferrals are employee contributions and not employer contributions we also note that petitioner computed the sec_415 limit for the year ended date based only on the commissions dollar_figure x percent for the year ended date however petitioner based the sec_415 limit on both the commissions and elective_deferrals dollar_figure x percent respondent contends that the commissions petitioner paid to robert and charlene peers did not constitute participant's_compensation for purposes of sec_415 furthermore respondent asserts that elective salary deferrals constitute employer not employee contributions and thus cannot be included in participant's_compensation for purposes of calculating sec_415 limitations consequently respondent contends that the limits of sec_415 were exceeded and the esop and trust were not qualified during the years at issue respondent asserts that the participant's_compensation contributions to the esop year participant's ended compensation contributions commissions charlene peers dollar_figure robert peers elective_deferrals charlene peers dollar_figure dollar_figure robert peers big_number big_number commissions charlene peers dollar_figure robert peers elective_deferrals charlene peers dollar_figure dollar_figure robert peers big_number big_number commissions charlene peers dollar_figure dollar_figure robert peers big_number big_number annual_additions dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number and annual_additions are as follows sec_415 limit bxceess sec_415 limit excess cum excess sec_415 limit excess cum excess commissions charlene peers dollar_figure dollar_figure dollar_figure robert peers big_number big_number big_number big_number sec_145 limit big_number excess big_number cum excess ' this represents the cumulative excess in the trust for both participants see supra note l see supra note we note that respondent included the full amount of elective_deferrals as annual_additions for the year ended date since respondent asserts the elective_deferrals are employer contributions and not employee contributions respondent contends that for the limitation years ended date and the sec_415 limitations were exceeded in the respective amounts of dollar_figure dollar_figure dollar_figure and dollar_figure for each participant i commissions petitioner seeks to include in participant's_compensation the amounts that petitioner paid robert and charlene peers as independent contractors for the years ended date through petitioner's corporate_income_tax returns forms for the years that ended date through indicate that the compensation paid to the officers for each year was zero dollars these returns also indicate that during the same period the salaries and wages paid to employees for each year was zero dollars with the exception of in which petitioner reported dollar_figure as salaries and wages thus petitioner reported that it did not pay either robert or charlene peers any compensation_for their services as officers of petitioner and that petitioner paid only dollar_figure as salaries and wages for the years at issue rather than treating the remuneration of robert and charlene peers as compensation paid to officers or as salaries and wages paid to employees petitioner treated payments to the peerses as commissions paid to independent contractors petitioner's corporate_income_tax returns forms for the years at issue indicate that the commissions paid to nonemployees who were treated by petitioner as independent contractors for each year were as follows year commissions dollar_figure big_number big_number big_number we note that petitioner alleged no facts in its petition its amended petition or its second amended petition to challenge the treatment of the amounts as payments to independent contractors which treatment was clearly described in respondent's final revocation letter sec_415 a defines participant's_compensation as the compensation of the participant from the employer for the year petitioner argues that robert and charlene peers' respective compensation was their earned_income as self-employed persons in advancing its argument that the self-employment_income which robert and charlene peers reported on their schedule c constitutes participant's_compensation for purposes of determining the sec_415 limitations of the esop petitioner cites a portion of a pre-erisa regulation in the following manner treatment of a self-employed_individual as an employee for purposes of sec_401 a self-employed_individual who receives earned_income from an employer during a taxable_year of such employer beginning after date shall be considered an employee of such employer for such taxable_year sec_1_401-10 income_tax regs petitioner is correct that for a self-employed_individual participant's_compensation is the participant's earned_income see sec_415 b what petitioner fails to recognize is that a sole_proprietor is considered to be his own employer see howard ef clendenen inc v commissioner tcmemo_1998_318 sec_401 provides that an individual who owns the entire_interest in an unincorporated trade_or_business shall be treated as his own employer furthermore the definition of -- - employer set forth in sec_1_401-10 income_tax regs provides e definition of employer for purposes of sec_401 a sole_proprietor is considered to be his own employer and the partnership is considered to be the employer of each of the partners the peerses received their remuneration as independent contractors petitioner reported the commissions paid to the peerses on its corporate_income_tax returns forms not as line compensation of officers or as line salaries and wages rather petitioner included the commissions on line other deductions likewise the peerses reported the commissions on their schedule c for each of the years at issue as independent contractors and enjoyed the ability to offset that income with deductions unreduced by the percent of adjusted_gross_income offset applicable to miscellaneous deductions on schedule a petitioner paid the peerses as independent contractors the direct consequence of structuring its affairs in this manner is that the remuneration which robert and charlene peers received from the petitioner as independent contractors which they reported on schedule c does not constitute participant's_compensation for purposes of computing the sec_415 limitations for each of the limitation years at issue il hlective deferrals petitioner argues that the amounts of the elective salary deferrals which the participant chose not to receive as cash but rather to have contributed to the esop are employee contributions and are includable in participant's_compensation robert and charlene peers elected salary deferrals for the and taxable years in the respective amounts of at least dollar_figure and dollar_figure sec_402 provides cash or deferred arrangements ---for purposes of this title contributions made by an employer on behalf of an employee to a_trust which is a part of a qualified_cash_or_deferred_arrangement as defined in sec_401 shall not be treated as distributed or made available to the employee nor as contributions made to the trust by the employee merely because the arrangement includes provisions under which the employee has an election whether the contribution will be made to the trust or received by the employee in cash in addition sec_1 d i ’ income_tax regs provides that compensation does not include we note that respondent contends that robert and charlene peers elected dollar_figure in elective salary deferrals for this difference is immaterial to the outcome sec_402 was amended by sec_521 of the unemployment_compensation amendments of publaw_102_318 106_stat_290 the above-qgquoted language is currently found in sec_402 e ‘this provision was renumbered as sec_1 d i income_tax regs effective for years after date see t d 1991_2_cb_310 contributions made by the employer to a plan of deferred_compensation to the extent that before the application of the sec_415 limitations to that plan the contributions are not includible in the gross_income of the employee for the taxable_year in which contributed furthermore sec_1_401_k_-1 income_tax regs provides treatment of elective contributions as employer contributions except as provided in paragraph f of this section dealing with the correction of excess_contributions elective contributions under a gualified cash_or_deferred_arrangement are treated as employer contributions thus for example elective contributions are treated as employer contributions for purposes of sec_401 and sec_401 sec_402 sec_404 sec_409 sec_411 sec_412 sec_415 sec_416 and sec_417 the issue in respect of elective_deferrals has been before this court under substantially identical circumstances see howard ef clendenen inc v commissioner tcmemo_1998_318 steel balls inc v commissioner tcmemo_1995_266 affd per curiam without published opinion 89_f3d_841 8th cir we rejected the same arguments presented herein and concluded that respondent's position was clearly supported by the statute sthe small_business job protection act of publaw_104_ sec a 110_stat_1807 added sec_415 d which includes certain deferrals in participant's_compensation effective for years beginning after date this amendment does not apply to the instant case we note however that the legislative_history makes clear that congress considered the provisions of the then-existing law as requiring the result reached herein and specifically intended to change the law for future years see h rept pincite 1996_3_cb_331 s rept pincite h conf rept pincite 1996_3_cb_741 and regulations we reach the same conclusion herein and hold that the elective_deferrals are employer contributions and not included in participant's_compensation since the elective_deferrals are employer contributions the full amounts of the elective_deferrals are included in annual_additions ’ see sec_415 tilt conclusion we now determine whether the annual_additions on behalf of robert and charlene peers exceed the sec_415 limitations we hold that the commissions paid to robert and charlene peers as independent contractors are not includable in participant's_compensation for purposes of the sec_415 limitations furthermore we hold that the elective salary deferrals are employer contributions and are not included in participant's_compensation for sec_415 limitation purposes the record is not clear as to the exact amounts of salaries and wages paid to robert and charlene peers for the year ended date we for the year ended date no more than one-half of the employee contribution would have been included see sec_415 b supra note the amount deducted by petitioner for salaries and wages dollar_figure for the taxable_year ending date does not match that reported by robert and charlene peers as wages salaries tips etc dollar_figure on their joint individual income_tax returns for their taxable_year ending date while this could be due to the different tax years involved year ending july versus dec respondent in the revocation letter and continued need not make any findings with respect to the exact figures however for regardless of which amount we use the annual_additions allocated to robert and charlene peers during each of the plan years that ended date through date clearly exceed the sec_415 limitations petitioner has not argued or established that any corrective measures were taken to reduce these additions see sec_1 b income_tax regs consequently we hold that the esop failed to meet the requirements of sec_401 for the plan years beginning after date and that the related trust is not a qualified_trust under sec_401 for the plan years beginning after date decision will be entered for respondent 1’ continued in his briefs uses the dollar_figure figure appearing on robert and charlene peers' individual return


t c memo united_states tax_court stevedoring services of america inc and subsidiaries petitioners v commissioner of internal revenue respondent docket no filed date p bruce wright george r abramowitz and diana e buckley for petitioners terri a merriam and keith g medleau for respondent memorandum opinion cohen chief_judge respondent determined a deficiency in petitioners' federal_income_tax of dollar_figure for the fiscal_year ended date the issue for decision is whether upon disaffiliation from hanseatic eastern insurance_company bermuda ltd hanseatic and eagle pacific insurance_company eagle petitioners are entitled to an insurance premium deduction in the fiscal_year ended date for payments made to hanseatic in the fiscal years ended through and to eagle in the fiscal years ended and in excess of deductions previously allowed for longshoremen's and harbor workers'_compensation act amendments of lhw act publaw_98_426 98_stat_1639 u s c sec_901 claims paid unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to tax_court rules_of_practice and procedure background the material facts have been stipulated and the stipulated facts are incorporated herein by this reference the parties have stipulated to the detail and characterization of various contracts entered into during years prior to the one in issue because those details are not disputed and do not affect our analysis of the issue for decision we have not burdened this opinion with them at the time the petition was filed the principal_place_of_business of stevedoring services of america inc stevedoring was seattle washington stevedoring and its wholly owned subsidiaries primarily engage in stevedoring operations stevedoring and its includable subsidiaries petitioners filed a consolidated federal_income_tax return for the tax_year that began date and ended date prior to date petitioners were wholly owned subsidiaries of services group of america inc services group services group and its subsidiaries filed consolidated federal_income_tax returns prior to date there were a number of restructurings within the services group corporate entities and renamings of various corporations in addition to stevedoring operations prior to date services group engaged in wholesale food distribution and the insurance_business through separate wholly owned subsidiaries on date the services group entities were divided in a tax-free transaction pursuant to sec_355 the splitup prior to the splitup services group was owned equally by two shareholders frs capital corporation frs and thomas stewart stewart in settlement of a shareholder dispute frs relinquished its 50-percent stock interest in services group in exchange for all of the stock of stevedoring petitioners carried on all of the stevedoring operations of the former services group entities petitioners' ownership affiliation with the food services and insurance operations of the former services group entities terminated on the effective date of the splitup as part of the splitup stewart received the insurance group and the wholesale food operations of the former services group entities in the splitup the stock and other consideration received by frs had a fair_market_value that was approximately equal to the fair_market_value of the services group stock surrendered by frs hanseatic was incorporated in bermuda on date as of date hanseatic was equally owned by seattle stevedore co a predecessor of services group and marukyo company ltd marukyo on date seattle stevedore co purchased all of marukyo's interest in hanseatic from through date services group's stevedoring affiliates contracted with martin re-insurance company and its successor manhattan re-insurance company martin will be used to refer to martin and or manhattan where appropriate concerning their lhw act risks the lhw act risks encompass an employer's liability under the lhw act to pay workers'_compensation benefits including medical income replacement death and survivors and employee rehabilitation benefits in respect of injured employees covered by the lhw act generally stevedores and longshoremen martin then contracted with hanseatic to pass on percent of the risks martin was a licensed u s insurance_company that was unrelated to services group from into hanseatic entered into various other insurance and reinsurance contracts with related and unrelated companies with respect to risks of services group's stevedoring affiliates hanseatic ceased accepting new risks of services group's stevedoring affiliates at the end of date hanseatic continued to be responsible for all risks that it assumed under contracts that it issued for prior years norwesco insurance_company limited norwesco was incorporated in bermuda on date on the date of incorporation norwesco was wholly owned by brady-hamilton stevedore company brady-hamilton a stevedoring company that was then unrelated by ownership to seattle stevedore co on date seattle stevedore co purchased a 50-percent interest in norwesco on date seattle stevedore co purchased brady-hamilton also on date norwesco merged its portfolio into hanseatic and shortly thereafter norwesco liquidated on date services group acquired crescent wharf and its subsidiaries crescent wharf had formed executive insurance_company executive in bermuda in crescent wharf contracted with insurance_company of north america ina a licensed u s insurance_company concerning crescent wharf's lhw act risks ina then contracted with executive to pass on percent of the risks effective date executive entered into a portfolio transfer agreement with hanseatic eagle was incorporated in the state of washington on date on date seattle stevedore co purchased a percent interest in eagle on date services group contributed all of hanseatic's stock to eagle during the years relevant to this case eagle held licenses to conduct the insurance_business in the states of washington and alaska beginning on date and through the subsequent years relevant to this case the stevedoring affiliates of services group insured their lhw act risks with eagle on a direct basis after the splitup eagle continued to insure all of petitioners' lhw act risks in the fiscal years ended date and date eagle received approximately percent and percent respectively of its premiums from unrelated insureds the transactions among services group and its subsidiaries and eagle that were not treated as insurance for tax purposes in through would have been treated as insurance transactions in those years if the transactions had been entered into with nonaffiliated parties audit history services group and its affiliates claimed deductions for payments directly or indirectly to hanseatic norwesco executive and eagle as insurance premiums under sec_162 in the years paid services group and its subsidiaries were audited for each of its fiscal years ended date through date except the fiscal_year ended date as a result of the audits respondent proposed to disallow insurance premium deductions for payments made in those years directly or indirectly to hanseatic norwesco executive and eagle services group filed a petition in this court for its fiscal years ended date date and date one of the contested issues was the deductibility of the hanseatic payments the case was resolved by a stipulation of settlement dated date the internal_revenue_service irs and services group resolved the proposed disallowance of premium deductions for the fiscal years ended date date date date and date on terms similar to the stipulation of settlement dated date the irs audited crescent wharf's income_tax return and disallowed claimed insurance premium deductions made to executive through ina the case was settled on terms similar to the hanseatic settlement the parties resolved the proposed disallowance of premium deductions for the fiscal years ended date and date by agreeing to treat percent of the arrangements with eagle as insurance for tax purposes and therefore to allow percent of the payments to eagle in each year as deductible insurance premiums in the year paid the remaining percent was disallowed insurance treatment the amounts disallowed as insurance deductions in years prior to the year ended date were treated as capital contributions to hanseatic and eagle respectively as a result of the splitup of the services group entities in date hanseatic and eagle became disaffiliated with petitioners although hanseatic and eagle each remained liable for losses under the terms of the contracts they previously entered and assumed that covered the lhw act losses of petitioners in its consolidated federal_income_tax return for its fiscal_year that began date and ended date stevedoring claimed a deduction in the amount of dollar_figure in respect of the portions of transactions that were not treated previously as insurance for tax purposes in connection with contracts entered or assumed by hanseatic respondent disallowed the deduction claimed except for dollar_figure that respondent allowed as a deduction with respect to lhw act losses_and_expenses accrued in petitioners' fiscal_year ended date in a claim_for_refund of income taxes that stevedoring made for the fiscal_year ended date stevedoring claimed a deduction in the amount of dollar_figure in respect of the portions of the transactions between services group and eagle that were not treated as insurance for tax purposes prior to disaffiliation from eagle and stevedoring sought a refund of income taxes in the amount of dollar_figure on date the irs appeals_office at seattle washington mailed to stevedoring a notice of partial_disallowance of the claim_for_refund the amount of refund that was disallowed was dollar_figure discussion petitioners bear the burden of proving their entitlement to the claimed deductions rule a 503_us_79 512_f2d_882 9th cir affg tcmemo_1972_133 a taxpayer seeking a deduction must be able to point to an applicable statute and show that the taxpayer comes within its terms 292_us_435 petitioners have advanced numerous arguments in support of their position that the splitup resulted in a deduction under sec_162 for insurance expenses they have cited no authority that supports their arguments they have ignored the language and fundamentals of sec_162 there shall be allowed as a deduction all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business emphasis added the disputed deduction claimed by petitioners does not include any payments that were made or expenses accrued in the year ended date the claimed deduction did not arise out of new contracts entered during the year ended date instead petitioners ask us to deem an insurance premium payment as a result of the sec_355 splitup with respect to every item of expense that is claimed as a deduction under sec_162 a taxpayer must establish that the expense was paid_or_incurred that it was paid_or_incurred during the taxable_year in issue that it was paid_or_incurred in carrying_on_a_trade_or_business and that the expense was ordinary and necessary sec_162 sec_1_162-1 income_tax regs petitioners did not pay or incur any additional insurance expenses in the year ended date all of the claimed amounts were paid in years prior to the year ended date with regard to insurance contracts entered into and in effect in those prior years see sec_461 petitioners made no economic outlay and incurred no liability in the year ended date that would give rise to a deduction therefore no deduction is allowed under sec_162 both parties have argued at length about whether or not certain of the transactions entered into by petitioners and hanseatic and eagle respectively were insurance for tax purposes we need not decide whether the transactions constituted insurance because nothing occurred in the year ended date that would entitle petitioners to a deduction even if the transactions were insurance petitioners have also argued that in order to portray the economic realities of the splitup a deduction must be allowed disallowance of the claimed deduction however reflects the following economic realities petitioners previously made payments to related insurance_companies for which deductions were denied at least in part the amounts disallowed were treated as capital contributions to the related insurance_companies and increased the equity value of the related insurance_companies petitioners and the related insurance_companies subsequently became disaffiliated in a reorganization involving services group stock the value of the services group stock reflected the value of eagle successor to hanseatic the stock and other consideration received by frs in the splitup had a fair_market_value that was approximately equal to the fair_market_value of the services group stock surrendered by frs petitioners contend that the consideration for the transfer of risks to hanseatic and eagle upon disaffiliation was as an economic matter separate from the stock exchanged in the arm's- length disaffiliation transaction no evidence has been presented by petitioners to support their contention and there is no basis for a negative allocation of consideration to transfer of risks we have considered petitioners' other arguments and have determined that they are also without merit to reflect the foregoing decision will be entered for respondent


t c memo united_states tax_court ricky schmidt and suzetta j schmidt petitioners v commissioner of internal revenue respondent hillside dairy inc petitioner v commissioner of internal revenue respondent docket nos filed date douglas bleeker for petitioners douglas polsky and charles berlau for respondent memorandum findings_of_fact and opinion jacobs judge these cases have been consolidated for trial briefing and opinion in separate notices of deficiency respondent determined deficiencies in petitioners’ federal_income_tax and accuracy-related_penalties under section for and as follows ricky suzetta schmidt docket no year deficiency dollar_figure big_number big_number penalty sec_6662 -- -- -- hillside dairy inc docket no year ended deficiency dollar_figure big_number big_number penalty sec_6662 dollar_figure dollar_figure dollar_figure the issues for decision are whether amounts paid_by hillside dairy inc hillside dairy or the corporation to provide medical_care food and lodging to its shareholders ricky schmidt mr schmidt and suzetta j schmidt mrs schmidt collectively the schmidts and their children are a constructive dividends as respondent maintains or b employee medical_care expenses and or reimbursed employee_expenses that are excluded from the schmidts’ gross_income and deductible by hillside dairy as ordinary and necessary business_expenses as petitioners maintain and 1all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure whether hillside dairy is liable for the accuracy- related penalty under sec_6662 for the taxable years ended date and findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference when the petitions were filed in these cases the residence of the schmidts as well as the principal_place_of_business of hillside dairy was in parker south dakota a the schmidts the schmidts are husband and wife they have two children in date the schmidts entered into a contract_for_deed to acquire acres the homestead the homestead includes a house the farmhouse where the schmidts have resided since between date and date the schmidts acquired additional acres adjoining the homestead the homestead and the acres are referred to collectively as the schmidt farm the schmidt farm consists of pasture farmland and cow lots a dairy barn machine sheds grain bins and feed grain bulk bins as well as the farmhouse are located on the schmidt farm 2the homestead was mr schmidt’s childhood home where he lived with his parents until he married mrs schmidt in the schmidts raise corn and operate a dairy on the schmidt farm in the dairy operation cows are milked twice daily in addition the cows are bred once a year usually in the winter when the cows are calving especially with first-time calving heifers they must be checked at least every hours usually on a 24-hour basis in addition to the schmidt farm mr schmidt individually own sec_80 additional acres which he acquired in the acres are farmed by mr schmidt as a sole_proprietor b hillside dairy on date hillside dairy was incorporated under the laws of the state of south dakota hillside dairy was organized primarily to raise grain and operate a dairy the schmidts have been the sole shareholders officers and directors of hillside dairy since its incorporation mr schmidt has been president treasurer and a director and mrs schmidt has been vice president secretary and a director of hillside dairy article iv section of the bylaws of hillside dairy provides section repayment of disallowed expenses any expense paid_by the corporation which is finally determined as a personal_expense of any officer_or_employee and disallowed as corporation expense shall be 3douglas bleeker counsel for petitioners prepared the articles of incorporation bylaws minutes of meetings and other corporate documents for hillside dairy repaid by the officer_or_employee to the corporation within twenty-four months of the final_determination by the internal_revenue_service with interest at three below the new york prime rate on the date of final_determination a similar repayment obligation was set forth in a resolution adopted by the board_of directors of hillside dairy at the directors’ first meeting held on date at that meeting the directors also adopted the following resolution resolved that the corporation sic officers and employees shall be required to live at the worksite of the corporation to ensure security for the corporation property and operations the officers and employees shall be required to live on the worksite to supervise the care and feeding of the livestock of the corporation the corporation shall supply said officers and employees all of their food and lodging while living at said worksite that all officers and employees shall be considered on duty when at the worksite and therefore entitled to such benefits in addition at their first meeting the directors adopted a medical reimbursement plan covering all employees and officers executing management responsibilities and their spouses and dependents the medical reimbursement plan provides for the payment of all medical_expenses deductible on form_1040 including expenses for drugs doctor hospital and eyeglasses to the extent not compensated by insurance or otherwise under the plan each participant is entitled to a maximum reimbursement of dollar_figure per year hillside dairy also paid the premiums on a health insurance_policy covering the schmidts and their children on date the schmidts conveyed to hillside dairy their interest in the schmidt farm including the farmhouse hillside dairy raises corn and maintains between and milking cows half owned by the corporation and the other half by mr schmidt individually on date mr schmidt acquired a one-fourth interest as a tenant in common in acres located approximately mile from the schmidt farm on date mr schmidt conveyed his interest in the acres to hillside dairy by warranty deed on the same date the other three tenants in common transferred their interests in the property to hillside dairy c farm lease hillside dairy leased the schmidt farm and the acres to mr schmidt under a written_agreement titled farm lease dated date the initial term of the lease wa sec_1 year to date the lease continued on a year-to-year basis until otherwise canceled during the years at issue hillside dairy leased a pasture to a neighbor of mr schmidt mr schmidt agreed to pay dollar_figure rent to hillside dairy for_the_use_of the building site and improvements in addition 4the schmidts held their interest in the homestead under a contract_for_deed until date in date the schmidts acquired title to the homestead in date the schmidts conveyed title of the homestead to hillside dairy hillside dairy was to receive all of the gross_proceeds from the sales of crops grown on the farm as well as all payments received under federal conservation programs or any other federal state or local governmental programs hillside dairy supplied all of the fertilizer chemicals and seed necessary to plant and treat the crops mr schmidt agreed to farm the land to protect the crops from injury and waste to till the land after harvesting the crops and to rotate the crops from year to year hillside dairy agreed to furnish all tools farm implements machinery and hired help necessary to cultivate and manage the farm hillside dairy agreed to furnish all necessary materials and the schmidts agreed to supply all necessary labor to maintain all fences and other improvements mr schmidt was permitted to use the corporation’s combine and tractor on the land he owned individually he also had use of one of the pastures d mr schmidt’s separate farming activity during the years at issue mr schmidt individually and not as an employee of hillside dairy farmed land that was not owned by hillside dairy he kept his personal grain separate from that 5although a contradictory provision required mr schmidt to provide all seed labor and other expenses of producing harvesting and marketing crops hillside dairy in fact paid all those expenses and deducted the costs in computing its income of the corporation in addition mr schmidt had a dairy operation separate from that of the corporation mr schmidt also did custom hire work for his brother on land approximately miles from the schmidt farm e compensation and payment of food lodging and medical_expenses mr schmidt was the sole employee of hillside dairy hillside dairy paid mr schmidt as an officer employee dollar_figure in and dollar_figure in and following the transfer of the schmidt farm to hillside dairy the schmidts continued to use the farmhouse as their residence hillside dairy paid for the food consumed by the schmidts and their children the utilities property_tax and insurance for the farmhouse and the cost of some of the meals consumed by the schmidts and their children away from the farmhouse dining-out expenses in addition hillside dairy paid all the medical_care expenses of the schmidts and their children hillside dairy did not pay dividends for fiscal years ended date and f income_tax returns mr schmidt was responsible for keeping the books and paying bills for hillside dairy mr bleeker petitioners’ counsel prepared the schmidts’ joint form sec_1040 u s individual_income_tax_return and hillside dairy’s forms u s_corporation income_tax return for the years at issue hillside dairy hillside dairy filed timely its forms for the taxable years ended date and on these returns hillside dairy reported total income and total deductions as follows total income dollar_figure dollar_figure dollar_figure total deductions big_number big_number big_number taxable_income lo sec_1 -0- big_number included in the total expenses deducted by hillside dairy were the following items for food lodging and medical_expenses provided to the schmidts amounts are rounded to the nearest dollar food lodging property tax--house insurance--house food for employees utilities--house depreciation--house meals entertainment1 food lodging_expenses medical medical insurance medical_expenses medical cost sec_11 dollar_figure -- big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number dollar_figure -- big_number dollar_figure big_number dollar_figure big_number big_number 1the meals and entertainment_expenses claimed by hillside dairy included a portion of the schmidt family’s dining-out expenses the schmidts the schmidts timely filed their joint income_tax returns for and on these returns the schmidts reported mr schmidt’s wages from hillside dairy they did not report any income attributable to their food lodging-related and medical_expenses paid_by hillside dairy they reported mr schmidt’s income from his separate farming activities as self-employment_income mr schmidt reported gross_income total expenses and net profit from his separate farming activities on schedule f profit or loss from farming for and as follows gross_income dollar_figure dollar_figure dollar_figure total expenses big_number big_number big_number net profit big_number big_number g notices of deficiency on date respondent timely mailed to the schmidts a statutory_notice_of_deficiency for and the schmidt notice_of_deficiency also on date respondent timely mailed to hillside dairy a statutory_notice_of_deficiency for its fiscal years ended date and the hillside dairy notice_of_deficiency in the hillside dairy notice_of_deficiency respondent disallowed the food lodging and medical_expenses deducted by hillside dairy totaling dollar_figure for dollar_figure for and dollar_figure for respondent determined that hillside dairy failed to establish that the food and lodging_expenses were ordinary and necessary business_expenses under sec_162 and those items were the schmidts’ personal expenses respondent further determined that hillside dairy was liable for the accuracy-related_penalty under sec_6662 in the schmidt notice_of_deficiency respondent determined that payments by hillside dairy of the schmidts’ food lodging and medical_expenses resulted in constructive dividends as follows food lodging1 medical total dividends dollar_figure big_number big_number dollar_figure big_number big_number dollar_figure big_number big_number 1the record does not explain why the amounts of dividends for food and lodging_expenses included in the schmidts’ income exceed the amounts disallowed as deductions to hillside dairy opinion issue expenses_incurred by hillside dairy to provide medical benefits food and housing to the schmidts in and a positions of the parties6 respondent disallowed deductions taken by hillside dairy for medical costs health insurance premiums and other medical_care expenses food lodging including property insurance property taxes and utilities for the farmhouse and depreciation of the farmhouse respondent asserts that the medical costs food and lodging_expenses are the schmidts’ personal family and living 6under certain circumstances sec_7491 places the burden_of_proof or production on the commissioner sec_7491 applies to court proceedings arising in connection with tax examinations beginning after date internal_revenue_service restructuring and reform act of publaw_105_206 sec a 112_stat_726 petitioners timely filed their returns for the years at issue hence all of the returns were filed on or before date the record does not disclose when the examination of petitioners’ tax returns began and it is possible that the examination began before date petitioners do not contend that sec_7491 applies in these cases and they have not otherwise asserted that respondent has the burden_of_proof or production with respect to any issue presented in these cases we therefore conclude that sec_7491 does not apply and petitioners have the burden_of_proof and production expenses and that payments of these expenses by hillside dairy constitute constructive dividends to the schmidts on the other hand petitioners assert that all the expenditures are reasonable and necessary business_expenses deductible by hillside dairy and excluded from the schmidts’ income petitioners contend that the medical costs are employee_benefits deductible by the employer and excludable from the employee’s income under sec_105 and or petitioners further maintain that hillside dairy provided food and lodging to mr schmidt in his capacity as an employee and that such was done for the convenience of hillside dairy consequently petitioners assert that the food and lodging_expenses are employer-provided meals_and_lodging the costs for which are excluded from the schmidts’ income under sec_119 and deductible by hillside dairy petitioners further assert that as owner and lessor of the farmhouse hillside dairy is entitled to deduct the expenditure for insurance on the farmhouse as a reasonable and necessary business_expense under sec_162 the property taxes under either sec_162 or sec_164 and the depreciation of the farmhouse under sec_167 petitioners posit that these latter expenses are not the schmidts’ personal expenses because they are not the owners of the property b medical_expenses we first shall decide whether the payments by hillside dairy of the medical_expenses are excludable from the schmidts’ gross_income under sec_105 and sec_106 and deductible by the corporation as ordinary and necessary business_expenses under sec_162 under sec_106 an employee’s gross_income does not include employer-provided coverage eg accident_and_health_insurance premiums under an accident_and_health_plan 100_tc_531 the employer may provide coverage under an accident_or_health_plan by paying the premium or a portion of the premium on an accident_or_health_insurance policy covering one or more employees or by contributing to a separate trust or fund sec_1_106-1 income_tax regs under the general_rule of sec_105 amounts received by an employee through accident_and_health_insurance for personal_injury_or_sickness to the extent attributable to nontaxed employer contributions are includable in the employee’s gross_income amounts received under an accident_or_health_plan for employees are treated as amounts received through accident_or_health_insurance sec_105 an exception to the general_rule allows an employee to exclude from gross_income amounts received to reimburse the employee for expenses_incurred by the employee for the medical_care as defined in sec_213 d of the employee and the employee’s spouse and dependents sec_105 for the reasons set forth below we agree with petitioners that pursuant to sec_105 and or payments by hillside dairy for medical expense reimbursements and health insurance premiums need not be included in the schmidts’ gross_income for and sec_105 requires first that the benefits be received under a plan and second that the plan be for employees rather than for some other class of persons such as shareholders and their relatives 48_tc_629 affd 394_f2d_494 1st cir after giving due consideration to the record before us we conclude that hillside dairy’s medical plan payment of health insurance premiums and medical expense reimbursements satisfies both the plan and for employees requirements of sec_105 sec_1_105-5 income_tax regs provides guidelines as to what constitutes an accident_or_health_plan a plan may cover one or more employees and different plans may be established for different employees or classes of employees id the regulations do not require that there be a written plan or that there be enforceable employee rights under the plan so long as sec_213 includes amounts paid for medical insurance in the definition of medical_care the participant has notice or knowledge of the plan wigutow v commissioner tcmemo_1983_620 in the instant case a plan as defined in sec_1_105-5 income_tax regs existed hillside dairy adopted a written medical reimbursement plan identifying who was eligible to participate what expenses would be reimbursed and how participants were to make claims for reimbursement the plan was adopted at the first meeting of the board_of directors mr schmidt had knowledge of the medical reimbursement plan as well as the health insurance_policy moreover there is no doubt that the medical reimbursements provided under the written plan were intended to complement benefits provided by health insurance thus the corporation’s medical plan included health insurance as well as the medical reimbursements and finally we are satisfied that the corporation’s medical plan was for mr schmidt as an employee of hillside dairy and not for his benefit as one of the corporation’s shareholders plans limited to employees who are also shareholders are not per se disqualified under sec_105 larkin v commissioner supra pincite n in this regard we have sustained plans for corporate officers who were also shareholders because those officers had central management roles in conducting the business of the corporation wigutow v commissioner supra epstein v commissioner tcmemo_1972_53 seidel v commissioner tcmemo_1971_238 smith v commissioner tcmemo_1970_243 bogene inc v commissioner tcmemo_1968_147 respondent has stipulated that during the years at issue mr schmidt was an employee of hillside dairy indeed mr schmidt was the corporation’s only employee and without mr schmidt’s involvement hillside dairy could not have raised its crops or conducted its dairy operations mr schmidt’s compensation_for services rendered to hillside dairy was his salary and employee_benefits respondent does not contend that mr schmidt received excessive_compensation indeed respondent contends that mr schmidt was undercompensated for his services although mrs schmidt did not work for hillside dairy payment of her medical_expenses was based on her status as mr schmidt’s spouse likewise payment of the medical_expenses for the schmidts’ children was based on their status as mr schmidt’s dependents the derivative participation of mr schmidt’s spouse and dependents is plainly contemplated both by the medical plan and by sec_105 on the basis of the record before us we conclude that medical payments for the benefit of the schmidts and their children were made under a plan for employees and not for shareholders accordingly during the years at issue the medical payments made by hillside dairy pursuant to its medical plan including the insurance premiums and other medical_care expenditures are excludable from the schmidts’ gross_income under sec_105 sec_162 permits a taxpayer to deduct all ordinary and necessary expenses_incurred during the taxable_year in carrying on the taxpayer’s trade_or_business an expense is ordinary if it is customary or usual within a particular trade business or industry or relates to a transaction of common or frequent occurrence in the type of business involved 308_us_488 an expense is necessary if it is appropriate and helpful for the development of the business see 320_us_467 when payments for medical_care are properly excludable from an employee’s income because they are made under a plan for employees they are deductible by the employer as ordinary and necessary business_expenses under sec_162 sec_1_162-10 income_tax regs consequently hillside dairy is entitled to deduct the insurance premiums and medical reimbursement payments under sec_162 c food utilities property insurance property taxes and depreciation sec_119 employer-provided meals_and_lodging we next decide whether the food food for employees and meals and entertainment and lodging-related expenses utilities property insurance property taxes and depreciation related to the farmhouse qualify as employer-provided meals_and_lodging expenses excludable from the schmidts’ income under sec_119 and deductible by hillside dairy under sec_162 meals_and_lodging furnished to an employee by his employer are excluded from the employee’s gross_income under sec_119 if the meals_and_lodging are provided for the convenience_of_the_employer on the premises of the employer in the case of lodging the employee must be required to accept the lodging on the business_premises of his employer as a condition_of_employment meals_and_lodging are furnished for the convenience_of_the_employer if there is a direct nexus between the meals_and_lodging furnished and the asserted business interests of the employer served thereby 66_tc_223 petitioners assert that mr schmidt as the corporation’s sole employee was required to be available for duty hours a day hillside dairy leased the schmidt farm to mr schmidt hillside dairy contracted with mr schmidt as a tenant not as its employee to perform all necessary work it is well settled that ordinarily taxpayers are bound by the form of the transaction they have chosen taxpayers may not in hindsight recast the transaction as one that they might have made in order to obtain tax advantages 118_tc_32 citing 875_f2d_420 4th cir affg 90_tc_206 and 248_f3d_572 7th cir affg t c memo here inasmuch as mr schmidt farmed the schmidt farm as a tenant and not as an employee of hillside dairy the food and lodging in question were not furnished to mr schmidt as a corporate employee for the convenience of his employer thus the food and lodging_expenses at issue are not sec_119 meals_and_lodging expenses deductibility of expenses related to the leasing of the schmidt farm during the years at issue hillside dairy’s business activities included leasing the schmidt farm it leased the farm including the farmhouse to the schmidts and received rent therefore we look to the terms of the farm lease to determine whether expenses for insurance utilities depreciation and taxes are the expenses of hillside dairy or the schmidts a property insurance hillside dairy deducted dollar_figure in and dollar_figure in for property insurance certain business-related insurance expenses unquestionably are deductible under sec_162 116_tc_211 citing sec_1_162-1 income_tax regs the farm lease does not require the schmidts to provide property insurance covering the farmhouse or other improvements on the property the property insurance is an ordinary and necessary business_expense of hillside dairy the owner of the property and not a personal family or living expense of the schmidts we hold therefore hillside dairy is entitled to deduct the insurance expenses as claimed in and b utilities hillside dairy deducted utilities expenses of dollar_figure in dollar_figure in and dollar_figure in utilities expenses may be deductible under sec_162 if the expenses_incurred are ordinary and necessary in carrying_on_a_trade_or_business 85_tc_731 sengpiehl v commissioner tcmemo_1998_23 green v commissioner tcmemo_1989_599 here the farm lease did not contain any provisions regarding the utilities for the farmhouse petitioners did not produce any utility bills canceled checks or testimony to identify that portion if any of the utilities expenses related to the corporation’s business we have no basis for making any allocation of the expenses thus petitioners have failed to establish that hillside dairy is entitled to any deduction for utilities expenses c depreciation hillside dairy deducted dollar_figure in and for depreciation of the farmhouse sec_167 allows a depreciation deduction from gross_income for property used in the taxpayer’s trade_or_business or held_for_the_production_of_income ordinarily depreciation or amortization is available to an owner of an asset with respect to the owner’s basis in the asset hillside dairy owned the schmidt farm including the farmhouse one of the business activities of hillside dairy was the leasing of the schmidt farm including the farmhouse thus the farmhouse is property used in the corporation’s trade_or_business we hold that hillside dairy is entitled to a deduction for depreciation of the farmhouse for each of the years at issue as claimed d taxes hillside dairy deducted property taxes of dollar_figure in dollar_figure in and dollar_figure in attributable to the farmhouse hillside dairy owned the schmidt farm sec_164 allows the owner of property a deduction for real_property_taxes we hold therefore that hillside dairy may deduct property taxes as claimed in the years at issue e summary of food and lodging_expenses to summarize hillside dairy may deduct the following expenses for the years at issue property tax--house property insurance--house depreciation--house total dollar_figure -- big_number big_number dollar_figure big_number big_number dollar_figure big_number big_number hillside dairy may not deduct the following food and lodging_expenses food for employees meals entertainment utilities--house total dollar_figure big_number big_number dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number inclusion of payments in the schmidts’ gross_income when a corporation makes an expenditure that primarily benefits the corporation’s shareholders the amount of the expenditure may be taxed to the shareholders as a constructive_dividend 115_tc_172 73_tc_980 am insulation corp v commissioner tcmemo_1985_436 we have found that expenses for food for employees meals and entertainment and utilities paid_by hillside dairy are the schmidts’ expenses petitioners contend that the payments are not constructive dividends because mr schmidt was required to repay any amounts that hillside dairy could not deduct for federal_income_tax purposes petitioners cite cepeda v commissioner tcmemo_1993_477 to support their position cepeda however is inapposite in that case the taxpayers claimed that advances made by the corporation were loans rather than employee compensation or constructive dividends petitioners do not contend that the corporate payments of mr schmidt’s expenses were loans for federal_income_tax purposes a transaction will be characterized as a loan if there was an unconditional obligation on the part of the transferee to repay the money and an unconditional intention on the part of the transferor to secure repayment 88_tc_604 affd without published opinion 855_f2d_855 8th cir in the instant case when the payments were made there was no unconditional obligation on the part of mr schmidt to repay a specific dollar amount to the corporation his obligation to repay any of the payments was in general terms the amount of repayment could not be determined when the payments were made any obligation to repay any amount could not arise before respondent disallowed the deduction for the expenses i e when the hillside dairy notice_of_deficiency was issued in date thus the payments were not loans since the payments when made by hillside dairy did not constitute business_expenses of the corporation or loans to the schmidts the conclusion is inescapable that the payments constituted distributions by hillside dairy to the schmidts in n am oil consol v burnett 286_us_417 the supreme court stated if a taxpayer receives earnings under a claim of right and without restriction as to its disposition he has received income which he is required to return even though it may still be claimed that he is not entitled to retain the money and even though he may still be adjudged liable to restore its equivalent it is clear therefore under the claim_of_right_doctrine the amounts paid_by hillside dairy in and were taxable to the schmidts in those years see 67_tc_286 if a taxpayer is required to repay income recognized under the claim_of_right_doctrine in an earlier tax_year sec_1341 permits the taxpayer in effect to elect to compute his taxes for the year of repayment in a manner that gives the taxpayer the equivalent of a refund without interest of tax for the earlier year specifically sec_1341 permits the tax for the year of repayment to be reduced by the amount of the tax paid for the year of receipt that was attributable to the inclusion of the repaid amount in that year’s gross_income 394_us_678 sec_1341 however requires actual repayment restoration or restitution 149_f3d_805 8th cir 437_f2d_1222 3d cir 110_tc_12 although the bylaws of hillside dairy require mr schmidt to repay amounts for which the corporation is disallowed a deduction mr schmidt does not claim that he has repaid the disallowed amounts indeed there is no evidence in the record to show that he did therefore sec_1341 does not apply we hold that hillside dairy’s payment of the schmidts’ food meals and entertainment and utilities expenses constitutes income to the schmidts petitioners argue that the expenses are meals_and_lodging expenses excludable under sec_119 we have found to the contrary thus the food meals and entertainment and utilities expenses are the schmidts’ personal living_expenses personal family or living_expenses are not deductible except as otherwise expressly permitted sec_262 a taxpayer’s expenses for his or her own meals_and_lodging are personal because they would have been incurred whether or not the taxpayer had engaged in any business activity 841_f2d_809 8th cir 80_tc_1073 affd 758_f2d_211 7th cir in order for personal living_expenses to qualify as a deductible business_expense under a the taxpayer must demonstrate that the expenses were different from or in excess of what he would have spent for personal purposes 21_tc_170 petitioners did not produce any bills canceled checks or testimony to substantiate any portion of the expenses that relates to mr schmidt’s separate farming_business thus petitioners have failed to establish that the schmidts are entitled to a deduction for any portion of the expenses under sec_162 rental value of residence the schmidts leased the schmidt farm including the farmhouse from hillside dairy for dollar_figure we are satisfied on the basis of the property taxes for the farmhouse that the fair rental value of the farmhouse for each year at issue did not exceed dollar_figure summary of adjustments to the schmidts’ income the following personal expenses paid_by hillside dairy are included in the schmidts’ income as constructive dividends for the years at issue 8except as otherwise provided an individual is not allowed a deduction with respect to the use of a dwelling_unit that is used by the individual as a residence sec_280a the individual however may deduct expenses allocable to portions of the dwelling that are exclusively used for business purposes sec_280a in the cases at bar the schmidts did not argue that the utility expenses are deductible under sec_280a therefore we do not address the question of whether any portion of the utility expenses may be deductible under that section we note however that the schmidts made no showing that the farmhouse or any portion thereof was used exclusively for business purposes food for employees meals entertainment utilities--house total dollar_figure big_number big_number dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number issue accuracy-related_penalty under sec_6662 respondent determined that hillside dairy is liable for the accuracy-related_penalty under sec_6662 as pertinent here sec_6662 imposes a 20-percent penalty on the portion of an underpayment attributable to negligence or disregard of rules or regulations sec_6662 negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code sec_6662 sec_1_6662-3 income_tax regs the penalty under sec_6662 does not apply to any portion of an understatement_of_tax if it is shown that there was reasonable_cause for the taxpayer’s position and that the taxpayer acted in good_faith with respect to that portion sec_6664 the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all the pertinent facts and circumstances sec_1_6664-4 income_tax regs the most important factor is the extent of the taxpayer’s effort to assess his her proper tax_liability for the year id the good_faith reliance on the advice of an independent competent professional as to the tax treatment of an item may meet this requirement sec_1_6664-4 income_tax regs despite the fact that petitioners have the burden_of_proof see supra note petitioners have made no showing that they made an attempt to comply with the tax rules and regulations with regard to those deductions taken by hillside dairy for the years at issue which have been disallowed hence with respect to those deductions petitioners have failed to show that hillside dairy was not negligent nor have petitioners showed that they acted in good_faith with respect to or that there was reasonable_cause for the position they took further petitioners do not claim that they relied on mr bleeker or any other professional as to the tax treatment of the expenses for food and lodging petitioners simply assert that the accuracy-related_penalty does not apply because hillside dairy properly claimed the deductions under sec_162 and 9before the trial in these cases respondent filed a motion to disqualify mr bleeker from his representation of petitioners respondent’s motion was based in part on the premise that if petitioners contend that they reasonably relied on mr bleeker’s advice with respect to the proper tax treatment of the payments at issue then mr bleeker would be required to testify as a witness in the trial of these cases the court held a telephone conference call with mr bleeker and counsel for respondent to discuss respondent’s motion during that call mr bleeker informed the court that petitioners did not intend to raise reasonable reliance on a tax professional as a defense to the accuracy-related_penalties the schmidts properly excluded the payments under sec_119 we have found to the contrary under these circumstances we are compelled to hold that hillside dairy is liable for the accuracy-related_penalty for the years at issue to reflect the foregoing decisions will be entered under rule