internal_revenue_service department of the treasury number release date index number washington dc person to contact refer reply to cc psi b1-plr-137587-02 date aug legend x y country date dear this letter responds to a letter dated date submitted on behalf of x requesting a ruling that it be granted an extension of time pursuant to sec_301 of the procedure and administration regulations in which to elect to be treated as a disregarded_entity for federal tax purposes under sec_301_7701-3 facts according to the information submitted x was validly formed under country law on date y a domestic limited_liability_company has been the sole owner of x since date x and x's shareholder intended from inception to elect to classify x as a disregarded_entity for federal tax purposes however form_8832 entity classification election inadvertently was not timely filed law and analysis sec_301_7701-3 provides that unless a foreign eligible_entity elects 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 plr-137587-02 sec_301_7701-3 provides that for purposes of sec_301_7701-3 a member of a foreign eligible_entity has limited_liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member sec_301_7701-3 allows an entity to elect to change its classification by filing form_8832 with the service_center designated on that form sec_301 c iii provides that all such elections become effective on the date specified by the entity on form_8832 or on the date filed if no effective date is specified the specified effective date must not be earlier than days prior to the filing_date of form_8832 nor later than twelve months after that filing_date sec_301_9100-1 gives the commissioner discretion to grant reasonable extensions of time to make regulatory elections under the rules of sec_301_9100-2 and sec_301_9100-3 under sec_301_9100-1 a regulatory election includes an election whose due_date is prescribed by a regulation published in the federal_register sec_301_9100-3 sets forth the standards which the commissioner uses to determine whether to grant a discretionary time extension under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence proving to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusion based solely on the facts submitted and the representations made we conclude that x has satisfied the requirements of sec_301_9100-1 and sec_301_9100-3 as a result x is granted an extension of time for making the election to be classified as a disregarded_entity for federal tax purposes effective date until days following the date of this letter x should make the election by filing form_8832 with the appropriate service_center a copy of this letter should be attached to that form except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the internal_revenue_code provides that it may not be used or cited as precedent plr-137587-02 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer’s representative sincerely s william p o’shea william p o’shea acting associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


tcmemo_2010_48 united_states tax_court john f esther k chow petitioners v commissioner of internal revenue respondent docket no filed date john f and esther k chow pro sese sarah a herson for respondent memorandum findings_of_fact and opinion cohen judge respondent determined deficiencies of dollar_figure and dollar_figure in petitioners’ federal income taxes for and respectively for respondent determined an addition_to_tax of dollar_figure under sec_6651 and an amount to be determined under sec_6651 respondent also determined accuracy-related_penalties of dollar_figure and dollar_figure under sec_6662 for and respectively all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure after concessions the issues for decision are whether petitioners are entitled to reduce rental income and capital_gains by amounts not conceded by respondent whether petitioner esther k chow was a professional gambler entitling her to deduct fully her gambling_losses against gambling income on schedule c profit or loss from business as business_losses or whether those losses are deductible only on schedule a itemized_deductions as itemized_deductions whether petitioners are liable for additions to tax under sec_6651 for late filing of their federal_income_tax return and whether petitioners are liable for penalties under sec_6662 with respect to their and returns findings_of_fact some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference petitioners resided in san gabriel california at the time that they filed their petition petitioner john f chow dr chow is a retired physician petitioner esther k chow petitioner studied as a medical laboratory technician from through petitioners operated a medical practice they built a medical office and pharmacy on property on del mar avenue in rosemead california in and petitioners’ income consisted of rental income gains from sales of real_property and social_security_benefits petitioners’ rental property included residential property on lilac place in los angeles and before its sale in the del mar avenue property they incurred various expenses including legal expenses relating to the rental property during they incurred expenses of dollar_figure paid to the department of water and power and dollar_figure paid to the department of building and safety with respect to the lilac place property the del mar avenue property was sold in for dollar_figure at that time petitioners paid dollar_figure to secure release of a lien recorded against the property by their former attorney kenneth hopp hopp had represented petitioners in relation to a civil rights action against san bernardino county california the lien was filed after hopp secured a judgment against petitioners also at the time the del mar avenue property was sold petitioners paid dollar_figure to dr chow’s sister and her husband in repayment of a loan about petitioner began gambling after dr chow underwent surgery in petitioner began playing slot machines extensively and exclusively at the morongo casino in cabazon california she gambled on days in and days in in petitioner won jackpots of dollar_figure or more and in she won jackpots of dollar_figure or more in she won two dollar_figure jackpots two dollar_figure jackpots and single jackpots of dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure in all she had gambling winnings of dollar_figure and gambling_losses of dollar_figure in she had gambling winnings of dollar_figure and gambling_losses of dollar_figure in if the winnings and losses are calculated on a net_basis for each slot machine session in which she played over a period of time and did not take more than a 3-hour break she had total gambling income of dollar_figure and losses of dollar_figure in and income of dollar_figure and losses of dollar_figure in petitioners did not use a professional preparer to prepare their federal_income_tax returns the first form_1040 u s individual_income_tax_return for received by the internal_revenue_service irs was signed on date and received on date it was labeled amended_return but was not on a form 1040x amended u s individual_income_tax_return prescribed for amended returns on that return petitioners deducted on schedule a dollar_figure as gambling_losses which they included in the amount of itemized_deductions used to offset their adjusted_gross_income they reported no taxable_income and no tax due copies of forms w-2g certain gambling winnings were attached to the return on date petitioners signed and sent to the irs a form 1040x for they again included dollar_figure as gambling_losses on schedule a and deducted them against adjusted_gross_income they reported no taxable_income and no tax due on date petitioners signed and sent to the irs another form 1040x for on this form 1040x petitioner was identified as a professional gambler since on a schedule c petitioners reported gambling income of dollar_figure the amounts shown on the attached copies of forms w-2g and deducted cash capital used of dollar_figure showing a schedule c loss of dollar_figure although the manner of computation is unclear from this form 1040x the reported adjusted_gross_income was reduced by amounts that included the claimed gambling_losses petitioners reported no taxable_income and no tax due petitioners’ form_1040 for was signed by petitioners and sent to the irs on date both petitioners were shown as retired on that return they reported a dollar_figure gain from sale of the del mar avenue property they deducted from adjusted_gross_income dollar_figure as gambling_losses based on a detailed gambling statement for attached to the return but they did not include a schedule c among the deductions claimed on schedule a as miscellaneous deductions were loans reimbursements dollar_figure dollar_figure totaling dollar_figure again petitioners reported no taxable_income and no tax due on date petitioners signed and sent to the irs a form_1040 marked amended_return their occupations were shown as retired on schedule a petitioners claimed as miscellaneous deductions gambling_losses capital used dollar_figure wg forms dollar_figure and included dollar_figure in the total itemized_deductions claimed they also deducted dollar_figure from adjusted_gross_income on the first page of the form_1040 and reported no taxable_income and no tax due on date petitioners signed and sent to the irs a form 1040x for on this form 1040x petitioner was shown as a professional gambler since to present a schedule c was attached and reported a loss of dollar_figure which was claimed to reduce adjusted_gross_income petitioners reported dollar_figure as taxable_income and dollar_figure tax due sometime before the form sec_1040x were submitted to the irs in date petitioner met with an irs representative concerning the proper method of reporting petitioners’ income and losses the use of schedule c was commenced after discussions with the irs representative sometime before date the date of the statutory notice petitioners’ returns were examined by the irs during the course of the examination bank records including canceled checks were delivered to the examining agent the records were subsequently misplaced and were not available by the time of trial in date opinion unfortunately the parties have expended much effort during the process of this case disputing matters that have no effect on the decision to be entered petitioners have from the beginning and through their posttrial briefs chosen to make spurious attacks on respondent’s agents and counsel and to file motions and requests for relief that have no reasonable basis in fact or in law their claims range from deliberate destruction and falsification of records to elder abuse we will not detail or address those claims in this opinion because they have no colorable merit and do not affect the resolution of issues properly before the court notwithstanding the difficulties created by petitioners’ approach to this case the parties were able to settle substantial issues and to enter into stipulations of many of the controlling facts respondent has conceded charitable_contribution deductions and some rental expenses that had been disallowed in the statutory notice other claimed rental expenses and basis adjustments relating to petitioners’ sale of the del mar avenue property remain in dispute as personal expenses or are unsubstantiated the most significant issue is classification of petitioner’s gambling_losses as business_losses of a professional gambler or losses in an activity_not_engaged_in_for_profit if the former the losses may fully offset the gains reportable on schedule c if the losses are only reportable as itemized_deductions on schedule a the itemized_deductions other than the gambling_losses are subject_to reduction pursuant to sec_68 the addition_to_tax for late filing of petitioners’ return and the accuracy-related_penalty for both years also remain in dispute as a general_rule taxpayers have the burden of proving that they are entitled to the deductions that they claim rule a 292_us_435 512_f2d_882 9th cir affg tcmemo_1972_133 under sec_7491 the burden_of_proof shifts to respondent if petitioners complied with requirements to substantiate an item maintained all required records and presented credible_evidence as to a factual issue rental expenses petitioners claim expenses in and relating to their lilac place rental property beyond the amounts allowed in the statutory notice or conceded by respondent the disputed items for relate to lawsuits involving petitioners a real_estate broker and others although petitioners have presented partial documents from several lawsuits they have not presented credible_evidence or corroborating evidence that they paid in the amounts that they claim for that year they are not entitled to any additional rental deductions for for petitioners presented copies of two money orders for dollar_figure and dollar_figure dated in the money orders appear to be for public services relating to the lilac place property petitioners are entitled to an additional deduction of dollar_figure on schedule e supplemental income and loss del mar avenue property adjustments petitioners seek to reduce their taxable gain on the sale of the del mar avenue property in by the amounts used to pay off a judgment obtained by their former attorney and to pay back a loan from relatives petitioners originally reported these items as miscellaneous expenses on schedule a respondent contends that the origin of the judgment ie attorney’s fees incurred in civil rights litigation was personal petitioners contend that removal of the judgment lien was necessary to clear title to the del mar avenue property and that hopp’s fees were deductible attorney’s fees however respondent is correct that paying a judgment having a personal origin does not increase petitioners’ basis in the property sold and that attorney’s fees incurred in personal litigation are not otherwise deductible see generally 372_us_39 holding that the origin and character of the claim with respect to which the expense was incurred not its consequence to the taxpayer is controlling in the determination of whether the expense is business or personal the litigation with petitioners’ former attorney had no relationship to operating acquiring or defending title to the del mar avenue property payment of the judgment obtained by the attorney was a nondeductible personal_expense under sec_262 and did not increase petitioners’ basis in the del mar avenue property under sec_1016 see heger v commissioner tcmemo_1993_408 affd without published opinion 35_f3d_561 5th cir petitioners claim that they borrowed dollar_figure from relatives and repaid the loan at the time the del mar avenue property was sold on their original federal_income_tax return for they deducted this amount as loans reimbursements on schedule a it was not separately itemized on the schedules attached to the amended returns for petitioners have not presented credible_evidence that dollar_figure was spent on amounts properly added to the basis of the property they have failed to satisfy their burden_of_proof or to shift the burden_of_proof to respondent with respect to this item petitioner’s gambling activities the parties have stipulated petitioner’s winnings and losses as reflected in the records maintained by the morongo casino respondent has calculated the losses using a session-based analysis ie by netting wins and losses per slot machine session as described in laplante v commissioner tcmemo_2009_226 regardless of the methodology petitioner’s losses exceeded her winnings in each year she is not however entitled to deduct those losses against other income even if we conclude that she is a professional gambler see sec_165 762_f2d_1369 9th cir kochevar v commissioner tcmemo_1995_607 petitioners rely on 480_us_23 as similar to petitioner’s situation and the standard by which she should be determined to be a professional gambler in commissioner v groetzinger supra pincite the supreme court held that if one’s gambling activity is pursued full time in good_faith and with regularity to the production_of_income for a livelihood and is not a mere hobby it is a trade_or_business the supreme court did not hold as petitioners contend that all gamblers are in the trade_or_business of gambling and that classifying gamblers is improper discrimination respondent asserts that the facts of groetzinger are not similar to those of this case consistent with other cases using the groetzinger standard the parties analyze petitioner’s gambling activities with regard to regulations promulgated under sec_183 to identify activities not engaged in for profit see eg hastings v commissioner tcmemo_2009_69 merkin v commissioner tcmemo_2008_146 whether the taxpayer engages in an activity with the primary purpose of making a profit is a question of fact to be resolved based on all the facts and circumstances in a particular case 72_tc_411 affd without published opinion 647_f2d_170 9th cir sec_1_183-2 income_tax regs while the test for whether a taxpayer engaged in an activity with the intention of making a profit takes into account the subjective intention of the taxpayer greater weight is given to the objective facts than is given to the taxpayer’s mere statement of intent see sec_1_183-2 income_tax regs sec_1_183-2 income_tax regs provides a nonexclusive list of relevant factors to be weighed when considering whether a taxpayer is engaged in an activity for profit the relevant factors are the manner in which the taxpayer carried on the activity the expertise of the taxpayer or his advisers the time and effort expended by the taxpayer in carrying on the activity the expectation that the assets used in the activity may appreciate in value the success of the taxpayer in carrying on other activities for profit the taxpayer’s history of income or losses with respect to the activity the amount of occasional profits if any that are earned from the activity the financial status of the taxpayer and whether elements of personal pleasure or recreation are involved in the activity no one factor is determinative of whether an activity is engaged in for profit 722_f2d_695 11th cir affg 78_tc_471 golanty v commissioner supra pincite sec_1_183-2 income_tax regs some of the factors do not apply or are neutral here respondent asserts that petitioner had no business plan did not seek or follow expert advice and did not adhere to her alleged pattern of strategic times to gamble thus respondent argues that petitioner did not carry on her activities in a businesslike manner and did not use the skills involved in her prior successful activity of managing dr chow’s medical practice petitioner testified that she had on the job training as a professional gambler beginning in that she read a couple of books about slot machine strategy and that she had reasons for gambling on particular days and during particular hours the nature of gambling or other high-risk activities makes comparison to businesslike conduct of more traditional businesses difficult there seem to be no recognizable standards for a businesslike approach to slot machine gambling therefore these factors are not conclusive the record contains information about petitioner’s history of profits and losses only for the years in issue petitioner received substantial jackpots but she continued to play until the overall results whether on a session-by-session basis or an annual basis were substantial losses her gambling and her losses increased from to when the substantial proceeds of the sale of the del mar avenue property permitted her to increase the capital she claims to have invested in the gambling activity petitioners however were retired and the record suggests that sale of the del mar avenue property eliminated a substantial source of rental income petitioners’ other income would not permit petitioner to sustain such losses indefinitely in the future petitioners’ situation is distinguishable from cases respondent cites in which other sources of income allowed a taxpayer to pursue an activity as a hobby without expectation of profit the parties dispute whether petitioner maintained appropriate records of her gambling activities petitioners claim that respondent’s agents are responsible for loss of certain records and that therefore respondent cannot show that they did not maintain adequate_records petitioner did not maintain a logbook but the casino records of her activities allowed the parties to reconstruct the stipulated amounts of winnings and losses cf estate of espinoza v commissioner tcmemo_2005_239 the schedules and forms w-2g attached to petitioners’ returns were detailed as to dates and amounts while petitioners’ calculations of deductible losses were erroneous they appear to be attributable to a misunderstanding of the law rather than to insufficient records respondent acknowledges that petitioner engaged in gambling during and with continuity and regularity it is unclear from her testimony whether she derived pleasure from it but that factor is generally neutral see eg strickland v commissioner tcmemo_2000_309 petitioner strongly disputes a suggestion by respondent’s agent that her gambling was compulsive or addictive her activities appear similar to those in other cases not involving professional gamblers but there is no evidence from either party sufficient to draw a conclusion about psychological factors cf gagliardi v commissioner tcmemo_2008_10 bearing in mind that the expectation of profit is a matter of subjective intent and need not be reasonable see sec_1 a income_tax regs we believe that the preponderance_of_the_evidence favors petitioner’s claim that during and she pursued gambling with a profit objective this is a close case and petitioners would be prudent to abandon gambling as a potential source_of_income we conclude however that petitioner was a professional gambler during and and may deduct her gambling_losses to the extent of her gambling winnings on schedule c of course she may not deduct any excess losses from petitioners’ adjusted_gross_income from other sources late filing of return sec_6651 provides that in the case of failure_to_file a tax_return on the date prescribed for filing including any extension of time for filing there shall be added to the tax required to be shown on the return an amount equal to percent of that tax for each month or fraction thereof that the failure_to_file continues not exceeding percent in the aggregate unless it is shown that the failure_to_file timely is due to reasonable_cause and not due to willful neglect under sec_7491 respondent has the burden of production and has produced records showing that petitioners’ return was not received by the irs until date petitioners claim that they filed a form_1040 for on date and that they always filed their tax returns on time the document that petitioners claim was their timely form_1040 dated date has attached schedules c and e that are identical to those attached to the form 1040x sent to the irs in date they are not attached to the purported amended_return filed in date petitioners claim that the attachments were erroneous due to rushing to include the document as an exhibit to the stipulation after reviewing the entire history of petitioners’ filings and shifting positions we cannot accept the testimony concerning a timely filed return for because petitioners deny that the return was late they have not suggested any reasonable_cause therefore petitioners are liable for an addition_to_tax under sec_6651 on the recomputed deficiency for that year sec_6662 accuracy-related_penalty sec_6662 and b and imposes a 20-percent accuracy-related_penalty on any underpayment of federal_income_tax attributable to a taxpayer’s negligence or disregard of rules or regulations or substantial_understatement_of_income_tax sec_6662 defines negligence as including any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code and defines disregard as any careless reckless or intentional disregard disregard of rules or regulations is careless if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position that is contrary to the rule_or_regulation sec_1_6662-3 income_tax regs on each version of their form sec_1040 petitioners attempted to deduct wagering losses against other income directly contrary to sec_165 that issue alone justifies application of the penalty to the final recomputed deficiency for each year petitioners also claimed deductions that were contrary to sec_262 or were not substantiated they spoke to irs representatives but obviously rejected or misinterpreted the advice they received there is no indication that they ever sought independent professional tax_return preparation advice or otherwise exercised reasonable diligence to determine the correctness of their returns as in umstead v commissioner tcmemo_1982_573 petitioners were negligent in displaying an unwillingness to understand any explanation of the tax laws other than their own misguided notions their tendency to use self- help caused problems with their returns and with their conduct of this case and they are urged to consult competent tax professionals before filing their returns or engaging in litigation in this court in the future petitioners also claim that there are no penalties due because they owe no tax but they are wrong about that the sec_6662 penalty will apply to the recomputed deficiency for each year we have considered the other arguments of the parties they are irrelevant moot or without merit to reflect concessions and our conclusions stated above decision will be entered under rule


office_of_chief_counsel internal_revenue_service memorandum number release date cc tege eb ec posts-143306-14 uilc 409a 409a date date to mark l hulse area_counsel cc tegedc ne from john b richards senior technician reviewer cc tege eb ec subject tax matter this chief_counsel_advice responds to your request for assistance this advice may not be used or cited as precedent issue does the correction of a failure to comply with sec_409a of the internal_revenue_code code applicable only to compensation subject_to a substantial_risk_of_forfeiture avoid income inclusion under sec_409a if the correction is made before the compensation vests but during the service provider’s taxable_year in which it vests conclusion no sec_409a provides that if a nonqualified_deferred_compensation_plan fails to comply or fails to be operated in accordance with sec_409a and at any time during a taxable_year compensation deferred under the plan that is not subject_to a substantial_risk_of_forfeiture and that has not previously been included in income is includible in the service provider’s gross_income for the taxable_year deferred_compensation that is subject_to a substantial_risk_of_forfeiture is subject_to the requirements of sec_409a and at all times during a taxable_year though a deferred_amount is not includible in income under sec_409a if it is subject_to a substantial_risk_of_forfeiture at all times during the taxable_year in contrast if the amount is not subject_to a substantial_risk_of_forfeiture at all times during the taxable_year generally meaning the amount is vested as of the end of the taxable_year the amount is includible in income posts-143306-14 the correction of a failure to comply with sec_409a during a taxable_year indicates that a failure existed during the taxable_year in which the correction is made in accordance with sec_409a a failure applicable to deferred_compensation subject_to a substantial_risk_of_forfeiture that lapses during the taxable_year results in income inclusion of the deferred_amount under sec_409a regardless of whether the failure is corrected during the same taxable_year but before the substantial_risk_of_forfeiture lapses facts executive is an executive officer of xco a corporation organized under state law on october of year xco entered into a retention agreement with executive the retention agreement provided that if executive remained continuously employed until the third anniversary of the execution date of the retention agreement the vesting date executive would receive a retention bonus the retention agreement provided for payment of the retention bonus in equal installments on the first two anniversaries of the vesting date however the agreement also provided that xco in its sole discretion could pay the retention bonus as a lump sum payment on the first anniversary of the vesting date xco determined that the retention agreement failed to meet the time and form of payment requirements of sec_409a because it permitted xco to accelerate payment of the retention bonus to correct the failure xco amended the retention agreement on june of year to remove xco’s discretion to accelerate payment of the retention bonus executive continued providing services through october of year and the substantial_risk_of_forfeiture lapsed xco paid executive the retention bonus in equal installments on october of year and year xco asserts that the retention bonus should not be includible in the executive’s income under sec_409a for any taxable_year because the retention agreement was amended before the vesting date to provide for payment terms that complied with the time and form of payment requirements of sec_409a even though the amounts were no longer subject_to a substantial_risk_of_forfeiture as of the end of year law and analysis a background sec_409a defines a nonqualified_deferred_compensation_plan subject_to sec_409a as any agreement or arrangement covering one person that provides for the deferral of compensation other than certain enumerated exceptions sec_1_409a-1 provides that a plan provides for the deferral of compensation if a service provider has a legally binding right during a taxable_year to compensation that under the terms of the plan is or may be payable to or on behalf of the service posts-143306-14 provider in a later taxable_year sec_1_409a-1 further provides that a service provider does not have a legally binding right to compensation to the extent that the compensation may be reduced unilaterally or eliminated by the service_recipient or other person after the services creating the right to the compensation have been performed however compensation is not considered subject_to unilateral reduction or elimination merely because it may be reduced or eliminated by operation of the objective terms of the plan such as application of a nondiscretionary objective provision creating a substantial_risk_of_forfeiture therefore a legally binding right to an amount that is subject_to a substantial_risk_of_forfeiture generally provides for the deferral of compensation from the time that the legally binding right arises stated differently compensation that meets the general definition of deferred_compensation and does not qualify for an exception even if subject_to a substantial_risk_of_forfeiture nonvested deferred_compensation is subject_to the requirements of sec_409a regardless of the fact that it may never become vested and may never be paid sec_409a provides that the rights of a person to compensation are subject_to a substantial_risk_of_forfeiture if such person’s rights to the compensation are conditioned upon the future performance of substantial services by any person sec_1_409a-1 provides that compensation is subject_to a substantial_risk_of_forfeiture if entitlement to the compensation is conditioned on the performance of substantial future services by any person or the occurrence of a condition related to a purpose of the compensation and the possibility of forfeiture is substantial sec_409a and provides that certain form requirements apply to a nonqualified_deferred_compensation_plan sec_409a provides rules for when a plan may make a distribution to a service provider sec_409a provides that a plan may not permit the acceleration of the time or schedule of any payment to the service provider except as provided under the sec_409a regulations sec_409a provides rules for determining when a plan may permit a service provider to elect to defer compensation the requirements of sec_409a generally are applicable from the time that the legally binding right to deferred_compensation arises regardless of whether the compensation is nonvested for example sec_409a provides that a plan must provide that deferred_compensation may not be paid earlier than upon certain permitted payment events including a specified time or pursuant to a fixed schedule specified under the plan at the date of the deferral of such compensation sec_1_409a-2 provides that the initial deferral election made upon the deferral of an amount generally at the time the legally binding right to the amount arises must irrevocably designate the time and form of payment of the amount under sec_409a the initial deferral election for performance-based compensation based on services performed over a period of at least months must be made no later than months before the end of the period therefore the decision to defer compensation subject_to a performance or a vesting condition including designation of posts-143306-14 the time and form of payment must be irrevocably made with respect to a nonvested amount even though it is uncertain whether the amount will become payable or vested sec_409a provides if at any time during a taxable_year a nonqualified_deferred_compensation_plan i fails to meet the requirements of sec_409a and or ii is not operated in accordance with such requirements sec_409a failure all compensation deferred under the plan for the taxable_year and all preceding_taxable_years shall be includible in the service provider’s gross_income for the taxable_year to the extent not subject_to a substantial_risk_of_forfeiture and not previously included in gross_income emphasis added sec_409a explicitly fails to distinguish between amounts deferred during a taxable_year before or after a failure to comply with sec_409a or before or after a substantial_risk_of_forfeiture applicable to a deferred_amount lapses rather deferred_compensation that is subject_to a substantial_risk_of_forfeiture is subject_to the requirements of sec_409a and at all times during a taxable_year though a deferred_amount is not includible in income under sec_409a if it is subject_to a substantial_risk_of_forfeiture at all times during the taxable_year in contrast if the amount is not subject_to a substantial_risk_of_forfeiture at all times during the taxable_year generally meaning the amount is vested as of the end of the taxable_year the amount is includible in income the correction of a failure to comply with sec_409a during a taxable_year indicates that a failure existed during the taxable_year in which the correction is made in accordance with sec_409a a failure applicable to deferred_compensation subject_to a substantial_risk_of_forfeiture that lapses during the taxable_year results in income inclusion of the deferred_amount under sec_409a regardless of whether the failure is corrected during the same taxable_year but before the substantial_risk_of_forfeiture lapses b proposed_regulations this conclusion is consistent with the proposed sec_409a income inclusion regulations at prop sec_1_409a-4 fr date irb proposed_regulations accordingly even though taxpayers may rely upon the proposed_regulations they do not support the taxpayer’s position prop sec_1 409a- a ii provides consistent with the requirement of the first clause of sec_409a that an amount is includible in income under sec_409a for a taxable_year only if the plan fails to meet the requirements of sec_409a during such taxable_year therefore the proposed_regulations provide that deferred_compensation is subject_to income inclusion under sec_409a for any taxable_year during which a sec_409a failure arises or continues to occur under the plan at any time during the taxable_year posts-143306-14 following the second clause of sec_409a prop sec_1_409a-4 provides that the amount includible in income under sec_409a as the result of a sec_409a failure is the excess if any of the total amount deferred under the plan for the taxable_year including the amount of any payments of amounts deferred under the plan during the taxable_year over the portion of such amount if any that is subject_to a substantial_risk_of_forfeiture or has been previously included in income prop sec_1 409a- a i provides the following the portion of the total deferred_amount under a plan for a taxable_year that is subject_to a substantial_risk_of_forfeiture as defined in sec_1_409a-1 is determined as of the last day of the service provider’s taxable_year accordingly an amount may be includible in income under sec_409a for a taxable_year even if such amount is subject_to a substantial_risk_of_forfeiture during the taxable_year if the substantial_risk_of_forfeiture lapses during such taxable_year including if the substantial_risk_of_forfeiture lapses after the date the nonqualified_deferred_compensation_plan under which the amount is deferred first fails to meet the requirements of sec_409a this provision is followed by an example demonstrating that whether or not an operational failure occurs on or after the date a substantial_risk_of_forfeiture lapses has no consequence to the amount includible in income see prop sec_1_409a-4 although these provisions do not explicitly address a situation in which the failure was corrected during the taxable_year there is nothing in these provisions to support that such a correction would result in different consequences rather the statute and the regulations repeatedly provide that if a failure occurred at any time during the taxable_year regardless of whether corrected and regardless of whether operational or as part of the written plan terms there is an amount includible in income that is determined based on the amounts deferred at the end of the taxable_year reduced by the amounts subject_to a substantial_risk_of_forfeiture at the end of the taxable_year and the amounts previously included in income for a year before that taxable_year c application of law to facts executive acquired a legally binding right to the retention bonus on the date that xco and executive executed the retention agreement during year to receive the retention bonus executive was required to remain continuously employed by xco until the vesting date which was the third anniversary of the execution date of the retention agreement executive’s legally binding right to the retention bonus was subject_to a substantial_risk_of_forfeiture because executive’s right to receive the retention bonus was conditioned on executive’s performance of substantial future services the retention bonus arrangement did not meet the requirements of any exception from treatment as deferred_compensation under sec_409a the retention bonus did not meet the requirements of the short-term deferral exception under sec_1 409a- b i because the retention agreement specified that the retention bonus would be posts-143306-14 paid after the end of the applicable month period following the vesting date accordingly the retention bonus is deferred_compensation and the retention agreement is a nonqualified_deferred_compensation_plan subject_to the requirements of sec_409a beginning on the execution date of the retention agreement the retention agreement failed to meet the requirements of sec_409a and sec_409a requires that a plan designate a specified time for payment of a deferred_amount sec_1_409a-3 provides that the requirements of sec_409a are met if a plan designates that deferred amounts may be paid only at a time or pursuant to a fixed schedule specified under the plan sec_1_409a-3 provides that such a fixed schedule may be based on a payment event permitted under sec_1_409a-3 and sec_1_409a-3 provides that such a payment event may include the lapse of a substantial_risk_of_forfeiture therefore the retention agreement’s provision for payment of the retention bonus in equal installments on the first two anniversaries of the vesting date would have complied with sec_409a sec_1_409a-3 and sec_1_409a-3 except that the retention agreement also provided that xco in its sole discretion could pay the retention bonus in lump sum on the first anniversary of the vesting date the retention agreement’s provision for xco’s right to accelerate payment of the retention bonus also failed to meet the requirements of sec_409a which provide that a plan may not permit the acceleration of the time or schedule of any payment except as provided under regulations by the secretary none of the regulatory exceptions provided under sec_1_409a-3 apply to xco’s right to accelerate the second installment_payment moreover the retention agreement’s provision for xco’s right to accelerate payment of the retention bonus also failed to meet the requirements of sec_409a which provide that a plan may permit a subsequent change in the time of a payment specified to be made at a time or pursuant to a fixed schedule other than an acceleration permitted under sec_409a only if the change is made no less than months before the scheduled payment_date and results in an additional deferral of no less than five years on june of year xco amended the retention agreement to remove xco’s discretion to pay the retention bonus in lump sum on the first anniversary of the vesting date the amendment resulted in payment terms that meet the requirements of sec_409a however the failure to meet the form requirements of sec_409a began on the execution date of the retention agreement and continued through year year and through june of year the amount includible in income under sec_409a for year and year is reduced to zero because the entire deferred_amount was subject_to a substantial_risk_of_forfeiture at the end of year and year however the entire deferred_amount was vested no longer subject_to a substantial_risk_of_forfeiture at the end of year therefore the amount includible in income under sec_409a for year is not posts-143306-14 reduced by any nonvested amount and the entire deferred_amount is includible in executive’s income under sec_409a for year this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call -------------------- if you have any further questions by _____________________________ john b richards senior technician reviewer executive compensation branch employee_benefits tax exempt and government entities


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-113184-10 date date legend x a b -------------------------------------------- -------------------------------------------- ----------------------- -------------------------------------------- ------------------------ -------------------------------------------- ------------------------ state ---------- date ---------------------- date ---------------------- dear ---------------------- this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code facts according to the information submitted x was incorporated on date x attempted to elect to be treated as an s_corporation effective date however the required consents to x’s s_corporation_election were not obtained from shareholders a plr-113184-10 and b as a result the election was ineffective x seeks a ruling that x will be treated as an s_corporation effective date x and its shareholders agree to make any adjustments required by the secretary consistent with the treatment of x as an s_corporation 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_1362 provides that such an election shall be valid only if all persons who are shareholders in such corporation on the day on which such election is made consent to such election sec_1362 provides that if an election under sec_1362 by any corporation a was not effective for the taxable_year for which it was 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 such ineffectiveness or termination were inadvertent no later than a reasonable period of time after discovery of the event resulting in the ineffectiveness or termination steps were taken a so that the corporation is a small_business_corporation or b to acquire the required 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 such ineffectiveness or termination the corporation shall be treated as an s_corporation during the period specified by the secretary conclusion based solely on the information submitted and the representations made we conclude that x's election to be treated as an s_corporation was ineffective due to the failure of a and b to consent to the election we also conclude that the ineffective election constitutes an inadvertent ineffective election within the meaning of sec_1362 therefore x will be treated as an s_corporation from date provided that x's s_corporation_election is otherwise valid and is not otherwise terminated under sec_1362 as a condition of this ruling a consent to the s election signed by a and b must be filed with the appropriate service_center indicating that the consent is to be plr-113184-10 associated with the originally filed form_2553 within days of this letter a copy of this letter should be attached to the consent this letter_ruling will be null and void if these conditions are not satisfied except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in particular no opinion is expressed as to whether x is otherwise an s_corporation for federal tax purposes this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file with this office a copy of this letter will be sent to x's authorized representatives sincerely s tara p volungis acting branch chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


internal_revenue_service number release date index number -------------------------------- --------------------------- ------------------------------------------------ in re ------------------------------------- - legend department of the treasury washington dc person to contact --------------------- id no ------------- telephone number --------------------- refer reply to cc psi b04 - plr-163280-05 date date taxpayer ---------------------------------------------------- date ------------------- trust ------------------------------------------------------------ ----------------------------------------------------------------------------- date ------------------ attorney ----------------------------------------------------------------- law firm ------------------------------- son ----------------------------------- a --------- b --------- company ------------------------------------------------- year ------- accountant ---------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------ --- --------------------------- attorney --------------------------- year ------- attorney -------------------------------- year ------- date ----------------------- exempt trust ------------------------------------------------------------------------ ----------------------------------------------------------------------------------------- ---------------------------------------------- plr-163280-05 non-exempt trust ------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------- ---------------------------------------------- c --------------- date ------------------------- d ----------- date ------------------ dear ------------------ this is in response to a letter from your authorized representative dated date and subsequent submissions requesting an extension of time pursuant to sec_2642 of the internal_revenue_code and sec_301_9100-3 of the procedure and administration regulations to allocate taxpayer’s generation-skipping_transfer gst_exemption to transfers to trust the facts and representations submitted are summarized as follows in year on date taxpayer established an irrevocable_trust trust for the benefit of his lineal_descendants and transferred a to the trust the trust agreement was drafted by attorney a partner with law firm who advised taxpayer and his son with respect to estate_planning matters son was appointed trustee of trust in year on date taxpayer transferred to trust b shares of stock in company a subchapter_s_corporation son acting under a durable general power_of_attorney executed by taxpayer before year met with attorney attorney counsel for company and accountant and discussed the need to prepare and file form_709 united_states gift and generation-skipping_transfer_tax return for the year transfers to trust and the need to allocate a portion of taxpayer’s gst_exemption to those transfers however a form_709 was not filed and gst_exemption was not allocated to trust with respect to the year transfer subsequently in year attorney asked his partner attorney to assist in advising son and taxpayer regarding estate_planning in year attorney discovered that a gift_tax_return reporting the year transfers was not filed nor was any gst_exemption allocated with respect to the transfers accordingly the taxpayer took the following corrective action prior to date first on date son as trustee divided the trust into an exempt trust and a non-exempt trust on a pro_rata basis as authorized under the terms of trust a fraction of trust assets was allocated to exempt trust the numerator of the fraction was the lesser_of i d and ii taxpayer’s actual gst_exemption available on date and the denominator was the value of trust as of that date as finally determined for plr-163280-05 gst tax purposes the balance of the trust’s assets was allocated to the non-exempt trust next on date taxpayer filed a form_709 united_states gift and generation- skipping transfer_tax return reporting the year gift to trust and allocating taxpayer‘s gst_exemption to the exempt trust on a notice of allocation the return reported the value_of_the_gift of b shares of company stock on date as d taxpayer applied his unified_credit against the tax and reported no gift_tax due taxpayer died on date taxpayer’s estate first requests a ruling that the corrective action taxpayer undertook specifically the division of trust into exempt and non-exempt portions and the late allocation of gst_exemption is to be disregarded second the estate requests an extension of time under sec_2642 and sec_301_9100-1 and sec_301_9100-3 to allocate taxpayer’s gst_exemption to the year transfers to trust of a and of b shares of stock sec_2601 imposes a tax on every generation-skipping_transfer gst a gst is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2602 provides that the amount of the tax is the taxable_amount multiplied by the applicable_rate sec_2641 defines applicable_rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer under sec_2642 the inclusion_ratio with respect to any property transferred in a generation-skipping_transfer is generally defined as the excess of over the applicable_fraction the applicable_fraction as defined in sec_2642 is a fraction the numerator of which is the amount of gst_exemption under sec_2631 allocated to the trust or to property transferred in a direct_skip and the denominator of which is the value of the property transferred to the trust or involved in the direct_skip sec_2631 provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption of dollar_figure adjusted for inflation under sec_2631 which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_2632 provides that any allocation by an individual of his or her gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual’s estate determined with regard to extensions regardless of whether such a return is required to be filed plr-163280-05 sec_26_2632-1 of the generation-skipping_transfer_tax regulations provides that an allocation of gst_exemption to property transferred during the transferor’s lifetime other than in a direct_skip is made on form_709 sec_2642 provides in relevant part that if the allocation of the gst_exemption to any transfers of property is made on a timely filed gift_tax_return or is deemed to be made under sec_2632 or c the value of such property for purposes of determining the inclusion_ratio shall be its value as finally determined for gift_tax purposes and such allocation shall be effective on and after the date of such transfer sec_2642 provides that the secretary shall by regulation prescribe such circumstances and procedures under which extensions of time will be granted to make an allocation of gst_exemption described in sec_2642 such regulations shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of sec_2642 which was enacted into law on date sec_2642 provides that in determining whether to grant relief the secretary shall take into account all relevant circumstances including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the secretary deems relevant for purposes of determining whether to grant relief the time for making the allocation shall be treated as if not expressly prescribed by statute notice_2001_50 2001_2_cb_189 provides that under sec_2642 the time for allocating the gst_exemption to lifetime transfers is to be treated as if not expressly prescribed by statute the notice further provides that taxpayers may seek an extension of time to make an allocation described in sec_2642 under the provisions of sec_301_9100-3 sec_301_9100-1 provides that the commissioner has discretion to grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute under sec_301_9100-1 a regulatory election includes an election whose due_date is prescribed by a notice published in the internal_revenue_bulletin in accordance with sec_2642 and notice_2001_50 taxpayers may seek an extension of time to make an allocation described in sec_2642 under the provisions of sec_301_9100-3 plr-163280-05 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied accordingly taxpayer’s estate is granted an extension of time of days from the date of this letter to allocate taxpayer’s gst_exemption that was available at the time of the transfers in year the allocation will be effective as of the dates of the respective transfers and the value of the transfers for gift_tax purposes will be used in determining the amount of gst_exemption to be allocated with respect to each transfer the date severance of trust into exempt trust and non-exempt trust was valid and effective under state law the late allocation on date of taxpayer’s gst_exemption is treated as ineffective because assuming an allocation of taxpayer’s gst_exemption is made to trust pursuant to the relief granted above the allocation will be deemed timely thus assuming taxpayer had sufficient available gst_exemption and assuming sufficient available gst_exemption is allocated with respect to the year transfers to trust pursuant to the relief granted herein and assuming no additional transfers were made to trust then immediately prior to the date severance trust will be deemed to have a zero inclusion_ratio for gst tax purposes consequently immediately upon exempt and non-exempt trusts becoming separate trusts on date exempt trust and non-exempt trust will each have a zero inclusion_ratio for gst tax purposes the allocation should be made on a supplemental form_709 united_states gift and generation-skipping_transfer_tax return for year and filed with the internal_revenue_service center cincinnati ohio a copy of this letter should be attached to the supplemental form_709 a copy is enclosed for this purpose 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 plr-163280-05 except as specifically ruled herein we express or imply no opinion on the federal tax consequences of the transaction under the cited provisions or under any other provisions of the code 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 sincerely william p o'shea associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes copy of this letter cc


department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc intl br3 postf-102026-02 uilc internal_revenue_service national_office field_service_advice memorandum for area_counsel communications technology and media oakland cc lm ctm from senior technical reviewer cc intl br3 subject prejudgment_interest and temp sec_1_861-9t this chief_counsel_advice responds to your memorandum dated date and supplements the advice previously issued in this case on date in accordance with sec_6110 this chief_counsel_advice should not be cited as precedent legend corporation a corporation b corporation c x date date date year date date taxpayer taxpayer subsidiary dollar_figurek dollar_figurem postf-102026-02 dollar_figuren issue whether taxpayer properly characterized and sourced the prejudgment_interest portion of a settlement payment as damages rather than as interest or an interest equivalent under temp sec_1_861-9t conclusion taxpayer’s characterization and sourcing of the prejudgment_interest portion of the settlement payment as damages is correct the prejudgment_interest portion of the payment does not constitute interest or an interest equivalent under temp sec_1_861-9t facts on date corporation a a large multinational corporation entered into a merger agreement with corporation b another large multinational corporation in reliance on the merger agreement corporation b reacquired x shares of its stock held by another corporation subsequently on date corporation a unilaterally cancelled the merger agreement on date corporation b filed a lawsuit against corporation a in state court seeking damages for various claims including breach of contract corporation b sought damages equal to the amount it expended to reacquire its shares in anticipation of the merger in year taxpayer subsidiary a wholly owned subsidiary of taxpayer acquired all of the outstanding_stock of corporation a after which corporation a merged with and into taxpayer subsidiary on date a jury returned a verdict in favor of corporation b and awarded damages for breach of contract in the amount of dollar_figurek the court also awarded prejudgment_interest on the damages totaling dollar_figurem accruing from the date of the breach to the date of the judgment and postjudgment interest accruing from the date of judgment to the date of payment on date taxpayer subsidiary and corporation b’s successor1 entered into a settlement agreement pursuant to which taxpayer subsidiary paid corporation b’s successor dollar_figuren which was the amount of the actual damages plus prejudgment and postjudgment interest on its consolidated federal tax_return for the tax_year in which taxpayer subsidiary paid the settlement amount taxpayer deducted the postjudgment interest component of that payment as interest and apportioned that amount to both foreign and u s source income however taxpayer deducted the damages and after corporation b filed the lawsuit it merged with and into corporation c thereafter corporation c acted on behalf of the former corporation b in the litigation postf-102026-02 prejudgment_interest portions of the payment and allocated and apportioned such amounts separately as amounts other than interest law and analysis taxpayers determine their taxable_income attributable to gross_income from domestic and foreign sources by deducting the expenses losses and other deductions properly allocated or apportioned to that gross_income and a ratable part of any expenses losses and other deductions that cannot definitely be allocated to some item or class_of_gross_income code sec_861 sec_862 and sec_863 treasury regulations provide specific guidance regarding the allocation and apportionment of deductions based on the factual relationship between those deductions and gross_income sec_1_861-8 through in the case of interest_expense the regulations apply the factual relationship principle for both allocation and apportionment purposes in a manner that acknowledges the fungibility of money temp sec_1_861-9t the fungibility approach recognizes that interest_expense is attributable to all activities and property regardless of any specific purpose for incurring an obligation on which interest is paid there are several narrow exceptions to this general fungibility rule none of which apply in this case sec_864 of the code provides that all allocations and apportionments of interest_expense must be made on the basis of assets rather than gross_income temp sec_1_861-9t applies only to payments that are interest expenditures deductible under sec_163 or interest equivalent expenditures to the extent deductible that are incurred in a transaction or series of integrated or related transactions in which the taxpayer secures the use of funds for a period of time if such payment is substantially incurred in consideration of the time_value_of_money temp sec_1_861-9t and b temp sec_1_861-9t interest expenditures sec_163 of the code provides that t here shall be allowed as a deduction all interest_paid or accrued within the taxable_year on indebtedness accordingly in order to come under the sec_163 definition of deductible_interest the prejudgment_interest payment must meet a two-pronged test first the payment must consist of interest_paid or accrued and second the payment must be made with respect to indebtedness with respect to the predecessor provision to sec_163 the supreme court concluded that the taxpayer in 308_us_488 could not deduct as interest on indebtedness the cost incurred to borrow stock used to fund an employee compensation program rejecting the notion that the code could be read to authorize deductions of effective interest the court looked to the ordinary business meaning of the words interest on indebtedness the court stated in the business world 'interest on indebtedness' means compensation_for the use or forbearance of money id pincite in a footnote the court observed that this definition makes irrelevant lines of authority where interest in a different context postf-102026-02 has been used to describe damages or compensation_for the detention or use of money or of property id pincite n the different context that the court had in mind was interest awarded in the case of court judgments several courts have more directly ruled that prejudgment_interest or similar amounts do not constitute interest on indebtedness see eg 992_f2d_226 9th cir aff’g t c memo midkiff v commissioner 96_tc_724 60_tc_872 aff’d 514_f2d_1209 8th cir and joseph w bettendorf 3_bta_378 in jordan supra the taxpayer together with other promoters had organized a corporation in which they acquired subscription rights the taxpayer sold his subscription rights to a related corporation which exercised the rights and sold the stock to the public claiming to have been misled the public shareholders filed securities lawsuits against the corporation and taxpayer as one of the incorporators in response the taxpayer and other promoters agreed to refund the purchase_price paid for certain purchased shares and pay five percent interest from the date the shares had been purchased to the date of recission the taxpayer claimed that the five percent interest was deductible under sec_163 the court found that the taxpayer could not deduct the additional five percent denominated as interest because there was no preexisting indebtedness on which interest could accrue as required by sec_163 in finding that indebtedness requires an existing unconditional and legally enforceable obligation for the payment of money the court concluded that the amount denominated as interest in the offer of recission was merely a part of the purchase_price paid_by the taxpayer to acquire the stock and was not deductible_interest id pincite in bettendorf supra the taxpayer was sued for failing as a fiduciary to make full and complete disclosure of facts in purchasing stock of bettendorf axle company of which taxpayer was president the plaintiff was awarded a judgment against the taxpayer for damages the award as modified by the iowa supreme court included both prejudgment and postjudgment interest the service disallowed the taxpayer’s deduction of the interest the taxpayer argued that the prejudgment and postjudgment interest was deductible as interest even though the court had awarded the interest in the form of damages as to the prejudgment_interest the court disagreed though it assumed that the prejudgment_interest qualified as interest under the code the court opined that the interest was not deductible because it was not paid_or_accrued on indebtedness the court found that there was no debtor-creditor relationship between the taxpayer and plaintiff rather the court found that taxpayer was sued as a trustee and there was no debt that was due from the taxpayer to the plaintiff accordingly the prejudgment_interest portion of taxpayer subsidiary’s settlement payment does not constitute deductible_interest under sec_163 postf-102026-02 temp sec_1_861-9t interest equivalent expenditures as stated above the interest allocation and apportionment rules apply not only to actual interest payments but also to deductible_interest equivalent payments incurred in a transaction in which a taxpayer secures the use of funds for a period of time temp sec_1_861-9t the regulations do not explicitly define what constitutes securing the use of funds in a transaction however in all of the regulatory examples illustrating the rule the taxpayer has secured the use of additional funds not already belonging to the taxpayer in a transaction2 that involved either the actual borrowing of money from another party through a formally delineated loan or through the effective borrowing of money through use of a financial_instrument such as a cash and carry arrangement or a prepaid swap the examples are consistent with the clear language of temp sec_1 9t b which requires that a taxpayer secure the use of funds in a transaction for a period of time in order for an expense to be considered an interest equivalent in this case taxpayer subsidiary did not incur the prejudgment_interest expense in a transaction in which it secured the use of funds the prejudgment_interest paid to corporation c was paid to compensate corporation b for the loss of the use of money due to it as damages from the time its claim accrued until judgment was entered see 479_us_305 taxpayer subsidiary did not incur the prejudgment_interest expense in a transaction in which it obtained the use of funds belonging to another as required under temp sec_1 9t b i rather taxpayer subsidiary incurred the expense through the deferral of the payment of its own funds such deferral of payment does not constitute the securing of the use of funds within the meaning of temp sec_1 the funds used to pay the prejudgment_interest were not acquired in a transaction within the meaning of temp sec_1_861-9t while taxpayer subsidiary or its predecessor had use of the funds relating to the prejudgment_interest for the period prior to the judgment there was no obligation to make a payment until judgment was entered postf-102026-02 9t b i consequently the prejudgment_interest paid_by taxpayer subsidiary cannot be allocated and apportioned as an interest equivalent the prejudgment_interest is not characterized as interest under temp sec_1_861-9t since it was neither interest deductible under sec_163 nor was it an interest equivalent since it was not incurred in a transaction in which it obtained the use of funds for a period of time accordingly the prejudgment_interest is properly characterized and sourced along with the payment for breach of contract damages and the deduction must be allocated to all gross_income and ratably apportioned among the statutory and residual groupings therein under sec_1 b and c please call if you have any further questions anne o’connell devereaux senior technical reviewer cc intl br3 because taxpayer has not incurred the prejudgment_interest expense in a transaction in which it secured the use of funds it is unnecessary to discuss whether the expense was incurred substantially in consideration of the time_value_of_money


department of the treasury internal_revenue_service washington d c apr number release date uilc cc tege eoeg et1 - cor-103525-01 memorandum for from subject office of division counsel associate chief_counsel tax exempt and government entities cc tege eoeg et1 - cor-103525-01 railroad retirement act tax status in accordance with the coordination procedure established between the service and the railroad retirement board rrb the rrb has provided us with its opinion that the following business is not a common carrier under the railroad retirement act and the railroad unemployment insurance act we have reviewed the opinion of the rrb and based upon the information submitted to the rrb we also conclude that is not a common carrier under the railroad_retirement_tax_act please take the appropriate action regarding this business will e mcleod cc


internal_revenue_service department of the treasury number release date index nos washington dc person to contact telephone number refer reply to cc dom p si plr-112659-98 date date legend date grantor_trust spouse daughter date child child child individual individual individual individual individual individual court date state dear we received the date letter requesting rulings concerning the income estate gift and generation-skipping_transfer gst tax consequences of the proposed division of a_trust this letter responds to that request the facts and representations submitted are as follows on date grantor established trust for the benefit of spouse and daughter grantor died on date spouse is the primary beneficiary of trust and daughter is the secondary beneficiary it is represented that no additions actual or constructive have been made to trust since date daughter’s siblings child child and child are the trustees of trust article a of trust provides that any amount to be distributed at any time by the trustees to the secondary beneficiary is to be distributed by the trustees to the secondary beneficiary and the descendants if any of the secondary beneficiary shall be in such amounts and upon such divisions as in the discretion of the trustees are deemed wise to meet the needs and requirements of said beneficiaries from time to time article b of trust provides that during the life of grantor all income shall be payable to the secondary beneficiary article c of trust provides that upon grantor’s death one-half of the income shall be paid to the primary beneficiary the remaining one-half of the income shall be distributed between the primary beneficiary and the secondary beneficiary subject_to the provisions of article a in such amounts and upon such divisions as the trustees deem necessary article d of trust provides that upon the primary beneficiary’s death all income shall be paid to the secondary beneficiary and her descendants in accordance with article a article of trust provides that the term of trust shall be for the life of the survivor of the following named individuals grantor spouse daughter child child child individual individual individual individual individual and individual article a of trust provides that upon the death of the survivor of daughter child child and child all income from trust shall be divided equally between grantor’s surviving grandchildren with the descendants of a deceased grandchild taking per stirpes the portion of their deceased ancestor and any after-born grandchild en ciente at the time of the death of the survivor of the aforesaid grantor being included as a surviving grandchild article b of trust provides that upon the death of the survivor of those named in section the entire trust including both principal and accumulated income shall be distributed equally to the surviving grandchildren of grantor with the descendants of a deceased grandchild taking per stirpes the portion of their deceased ancestor it is represented that the parties desire to divide trust into two trusts trust and trust in order to pursue differing investment strategies in accordance with this plan one-half of the trust value shall be allocated to trust and the other half by value shall be allocated to trust under the terms of the proposed division the beneficiary of trust will be spouse and all income from trust is to be distributed to her for her lifetime the beneficiaries of trust shall be spouse daughter and daughter’s descendants the income of trust shall be distributed among spouse daughter and daughter’s descendants in such amounts and upon such divisions as the trustees may deem necessary the term of trust shall be for spouse’s life at her death trust shall be merged with trust the term of trust shall be the same as the term of trust and trust shall terminate under the same provisions as for the termination of trust the trustees of trust petitioned court for an order authorizing the division further the trustees sought an order construing paragraph sec_2 and a of trust to mean that in the event the four children of grantor predecease spouse all of the provisions and directions found in paragraph sec_2 through d of trust pertaining to the distribution of income to spouse shall take precedence over the provisions contained in paragraphs a and that if all four children of grantor predecease spouse none of the income from trust shall be distributed under the provisions of paragraph a until spouse’s death on date court issued a decree construing and interpreting certain trust provisions and authorizing division of trust and trust assets the decree in that decree court approved the division of trust and construed paragraph sec_2 and a to mean that in the event that the four children of grantor predecease spouse the provisions of paragraph a through d shall apply and take precedence over the provisions contained in paragraph a court further held that if all four children predecease spouse none of the income from trust is to be distributed under the provisions of paragraph a of trust until spouse’s death the following rulings are requested the proposed division of trust into trust and trust will not cause the interest of any beneficiary of trust trust or trust to be includible in such beneficiary’s gross_estate under sec_2033 the proposed division of trust into trust and trust will not cause the interest of any beneficiary of trust trust or trust to be includible in such beneficiary’s gross_estate under sec_2036 sec_2037 or sec_2038 the proposed division of trust into trust and trust will not cause any beneficiary of trust trust or trust to have made a taxable gift_for purposes of chapter after the proposed division trust trust and trust each will be treated as a_trust that was irrevocable on date for purposes of b a of the tax_reform_act_of_1986 and sec_26_2601-1 of the generation- skipping transfer_tax regulations as a_trust that remains exempt from the gst tax under sec_2601 and that no actual or constructive additions to such trusts will result from such proposed division transfers from trust to trust and trust pursuant to the proposed division of trust and distributions from trust and trust to their beneficiaries will not be generation-skipping transfers and will not be subject_to tax under sec_2601 the proposed division of trust into trust and trust will not cause trust trust or trust or any of their beneficiaries to recognize any gain_or_loss from the sale_or_other_disposition of property under sec_61 or sec_1001 pursuant to sec_1015 the tax basis of trust and trust in each property received from trust in the proposed division of trust into trust and trust will be the same as the tax basis of trust in such property and pursuant to sec_1223 the holding_period of the trust and trust in each property received from trust in the proposed division of trust will include the holding_period of trust in such property ruling_request sec_2033 provides that the value of the gross_estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death based on the facts submitted and the representations made after the proposed division of trust into separate trusts spouse will have an income_interest in trust further spouse daughter and daughter’s descendants will have an income_interest in trust during the term of trust and trust none of the beneficiaries will have an interest in the principal of trust until its termination at spouse’s death trust will terminate and be merged with trust at the end of the term of trust trust will terminate and the principal and accumulated income will be distributed to grantor’s surviving grandchildren accordingly we conclude that the proposed division of trust into trust and trust will not cause the interest of daughter child child or child to be includible in such beneficiary’s gross_estate under sec_2033 ruling_request sec_2036 provides that the value of the gross_estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer except in case of a bona_fide sale for an adequate_consideration in money or money’s worth by trust or otherwise under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death the possession or enjoyment of or the right to the income from the property or the right either alone or in conjunction with any person to designate the persons who shall possess or enjoy the property or the income therefrom sec_2037 provides that the value of the gross_estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time after date made a transfer except in case of a bona_fide sale for an adequate_and_full_consideration in money or money’s worth by trust or otherwise if possession or enjoyment of the property can through ownership of such interest be obtained only by surviving the decedent and the decedent has retained a reversionary_interest in the property but in the case of a transfer made before date only if such reversionary_interest arose by the express terms of the instrument of transfer and the value of such reversionary_interest immediately before the death of the decedent exceed sec_5 percent of the value of such property sec_2038 provides that the value of the gross_estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer except in the case of a bona_fide sale for an adequate_and_full_consideration in money or money’s worth by trust or otherwise where the enjoyment thereof was subject at his death to any change through the exercise of a power in whatever capacity exercisable by the decedent alone or by the decedent in conjunction with any other person without regard to when or from what source the decedent acquired such power to alter amend revoke or terminate or where any such power is relinquished during the 3-year period ending on the date of the decedent’s death in order for sec_2036 through to apply the decedent must have at any time made a transfer of property or any interest therein except in the case of a bona_fide sale for an adequate_and_full_consideration in money or money’s worth under which the decedent retained an interest in or a power over the income or corpus of the transferred property based on the facts submitted and the representations made the beneficiaries have a right to income from the property and no right to distributions of principal under the terms of trust further on division of the trust into trust and trust each beneficiary will retain the same right to income as that beneficiary had under trust accordingly we consider that the division of trust into trust and trust will not cause any beneficiary of trust to be considered to have made a transfer within the meaning of sec_2036 sec_2037 or sec_2038 because the beneficiaries of trust trust and trust are not making a transfer within the meaning of sec_2036 sec_2037 and sec_2038 the division of trust into trust and trust will not cause the interest of any beneficiary of trust trust and trust to be includible in such beneficiary’s gross_estate under sec_2036 through ruling_request sec_2501 imposes a tax for each calendar_year on the transfer of property by gift during such calendar_year by any individual resident or nonresident sec_2511 provides that subject_to certain limitations the gift_tax applies whether the transfer is in trust or otherwise direct or indirect and whether the property transferred is personal tangible or intangible upon division of trust into trust and trust each beneficiary will have the same right to income as the beneficiary had under trust because the beneficial interests rights and expectancies of the beneficiaries of trust are substantially the same both before and after the proposed transaction no transfer of property will be deemed to occur as a result of the proposed division based on the facts submitted and the representations made we conclude that the proposed transaction will not cause any beneficiary of trust trust or trust to have made a taxable gift_for purposes of the gift_tax ruling_request sec_4 and sec_2601 imposes a tax on every generation-skipping_transfer sec_26_2601-1 of the generation-skipping_transfer_tax regulations provides that the tax does not apply to any generation-skipping_transfer under a_trust as defined in sec_2652 that was irrevocable on date the rule_of the preceding sentence does not apply to a pro_rata portion of any generation-skipping_transfer under an irrevocable_trust if additions are made to the trust after date sec_26_2601-1 provides that except as provided in sec_26_2601-1 or c any trust in existence on date is considered an irrevocable_trust sec_2611 defines the term generation-skipping_transfer as a taxable_distribution a taxable_termination and a direct_skip sec_26_2611-1 provides that a generation-skipping_transfer is an event that is either a direct_skip a taxable_distribution or a taxable_termination the determination as to whether an event is a generation-skipping_transfer is made by reference to the most recent transfer subject_to the estate and gift_tax sec_2612 defines the term direct_skip to mean a transfer subject_to a tax imposed by chapter or of an interest in property to a skip_person sec_2613 defines the term skip_person to mean - - a natural_person assigned to a generation that is two or more generations below the generation assignment of the transferor or a_trust - - a if all interests in the trust are held by skip persons or b if - - i ii there is no person holding an interest in the trust and at no time after the transfer may a distribution including distributions on termination be made from the trust to a non-skip_person an amendment to an exempt trust that modifies or otherwise changes the quality value or timing of any of the powers or beneficial interests rights or expectancies originally provided under the terms of the trust will cause the trust to lose its exemption from the gst tax based on the facts submitted and the representations made the division of trust into trust and trust will not change the quality value or timing of any powers beneficial interests rights or expectancies of any beneficiary provided for under the terms of the original trust it is represented that no additions have been made to trust since date accordingly trust trust and trust will be treated as trusts that were irrevocable on date and as trusts that remain exempt from the generation-skipping_transfer_tax no constructive or actual additions will result from the proposed transaction transfers to trust and trust pursuant to the proposed transaction will not be generation-skipping transfers and will not be subject_to tax under sec_2601 ruling_request sec_61 provides that gross_income includes gains derived from dealings in property sec_1001 provides that the gain from the sale_or_other_disposition of property shall be the excess of the amount_realized therefrom over the adjusted_basis provided in sec_1011 for determining gain and the loss shall be the excess of the adjusted_basis provided in such section for determining loss over the amount_realized sec_1_1001-1 of the income_tax regulations provides that except as otherwise provided in subtitle a of the code the gain_or_loss realized from the exchange of property for other_property differing materially either in_kind or in extent is treated as income or as loss sustained a partition of jointly owned property is not a sale_or_other_disposition of property where the co-owners of the joint property sever their joint_interests but do not acquire a new or additional interest as a result thereof thus neither gain nor loss is realized on a partition see revrul_56_437 1956_2_cb_507 in revrul_69_486 1969_2_cb_159 distinguished by revrul_83_61 1983_1_cb_78 a non-pro rata distribution of trust property was made in_kind by the trustee although the trust instrument and local law did not convey authority to the trustee to make a non-pro rata distribution_of_property in_kind the distribution was effected as a result of a mutual agreement between the trustee and the beneficiaries because neither the trust instrument nor local law conveyed authority to the trustee to make a non-pro rata distribution revrul_69_486 held that the transaction was equivalent to a pro_rata distribution followed by an exchange between the beneficiaries and was subject_to the provisions of sec_1001 and sec_1002 of the code the present case is distinguishable from revrul_69_486 because it has been represented that state code would permit the trustees to divide the properties of trust between trust and trust in a non-pro rata manner thus trust and trust are not required to receive pro_rata distributions of each asset of trust accordingly the proposed transaction will not be treated as a pro_rata distribution followed by an exchange of assets among the beneficiaries of trust 499_us_554 concerns the issue of when a sale_or_exchange has taken place that results in realization of gain_or_loss under sec_1001 of the code in cottage savings a financial_institution exchanged its interests in one group of residential mortgage loans for another lender’s interests in a different group of residential mortgage loans the two groups of mortgages were considered substantially identical by the agency that regulated the financial_institution the supreme court in cottage savings u s pincite concluded that sec_1_1001-1 of the regulations reasonably interprets sec_1001 and stated that an exchange of property gives rise to a realization event under sec_1001 if the properties exchanged are materially different in defining what constitutes a material difference for purposes of sec_1001 the court stated that properties are different in the sense that is material to the code so long as their respective possessors enjoy legal entitlements that are different in_kind or extent cottage savings u s pincite in cottage savings u s pincite the court held that mortgage loans made to different obligors and secured_by different homes did embody distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans since grantor is now deceased under trust one-half of the income is distributed to the primary beneficiary and one-half of the income is distributed by the trustee among the primary beneficiary the secondary beneficiary and the descendants of the secondary beneficiary also under trust upon the death of the primary beneficiary all income will be paid to the secondary beneficiary and the descendants of the secondary beneficiary trust will terminate upon the death of the primary beneficiary and its assets will be merged into trust trust will terminate at the same time that trust would have terminated the termination of trust upon the death of the primary beneficiary is consistent with the terms of trust since the assets of trust upon the death of the primary beneficiary will be held by trust for the benefit of the same beneficiaries under the same terms that they would have been held upon the death of the primary beneficiary under trust it is consistent with the supreme court’s opinion in cottage savings to find that the interests of the beneficiaries of trust and trust will not differ materially from their interests in trust the proposed transaction will not change the interests of the beneficiaries instead the beneficiaries will be entitled to the same benefits after the proposed transaction as before the proposed transaction is similar to the kinds of transactions discussed in revrul_56_437 since trust is to be partitioned but all other provisions of the trusts will remain unchanged other than changes which reflect the fact that grantor is no longer living and changes which are necessary to ensure that the beneficiaries will be entitled to the same benefits under trust and trust that they would have been entitled to under trust thus the proposed transaction will not result in a material difference in the kind or extent of the legal entitlements enjoyed by the beneficiaries therefore the beneficiaries of trust trust and trust will not realize gain_or_loss under sec_1001 of the code as a result of the proposed transaction ruling_request sec_1015 of the code provides that if property was acquired by gift after date the basis shall be the same as it would be in the hands of the donor or the last preceding owner by whom it was not acquired by gift except that if such basis adjusted for the period before the date of the gift as provided in sec_1016 is greater than the fair_market_value of the property at the time of the gift then for the purpose of determining loss the basis shall be such fair_market_value sec_1015 provides that if property was acquired by a transfer in trust other than a transfer in trust by gift bequest or devise the basis shall be the same as it would be in the hands of the grantor increased in the amount of gain or decreased in the amount of loss recognized to the grantor on such transfer sec_7701 of the code provides that the term transferred_basis_property means property having a basis determined under any provision of subtitle a or under any corresponding provision of prior income_tax law providing that the basis shall be determined in whole or in part by reference to the basis in the hands of the donor grantor or other transferor based upon the information submitted and representations made we conclude that because sec_1001 will not apply to the proposed partition of trust under sec_1015 the basis of the assets in trust and in trust sec_1 and after the partition will be the same as the basis of those assets prior to the partition therefore we conclude that the partition of trust will not alter the status of the assets held in trust prior to the proposed partition as transferred_basis_property under sec_1015 and sec_7701 ruling_request sec_1223 provides that in determining the period for which the taxpayer has held property however acquired there shall be included the period for which the property was held by any other person if under chapter of the code such property has for the purposes of determining gain_or_loss from a sale_or_exchange the same basis in whole or in part in the taxpayer’s hands as it would have in the hands of such other person as ruled above the basis of trust and trust in each property received from trust in the proposed division of trust into trust and trust will be the same as the basis of trust in such property therefore we conclude that the holding_period of trust and trust in each property received from trust in the proposed division of trust into trust and trust will include the holding_period of trust in such property except as specifically ruled herein we express no opinion as to the consequences of this transaction under the cited provisions of the code or under any other provisions of the code this ruling is based on the facts and applicable law in effect on the date of this letter if there is a change in material law local or federal before the transactions considered in this ruling take effect the ruling will have no force or effect if the taxpayer is in doubt whether there has been a change in material fact or law a request for reconsideration of this ruling should be submitted to this office this ruling is directed only to the taxpayer that requested it sec_6110 of the code provides that it may not be used or cited as precedent sincerely christine e ellison chief branch associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes