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 b01 plr-155814-07 date date legend trust ------------------------------------------- ----------------------------------------------------- ----------------------------------------------------------------------------------------------- trust a -------------------------------------------------------------------------------------------------------- ------------------------------------------- ----------------------------------------------------------------------------------------------- trust b ------------------------------------------------------------------------------------------------------------ ------------------------------------------- foundation ----------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- ------------------------------------------------------------------------- foundation a ----------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- foundation b --------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------- a --------------------------------------------- ------------------------------- b --------------------------------------------- ----------------------------------- plr-155814-07 d1 d2 ------------------ ------------------------ state ----------------------------------------------- judgment ------------------------------------------------------------------ agreement ----------------------------------------------------------------- a -- dear ------------ this letter responds to a letter dated date submitted on behalf of trust by trust’s authorized representatives requesting rulings concerning the division of trust into two separate trusts trust a and trust b according to the information submitted on d1 a established trust a charitable_remainder_unitrust described in sec_664 of the internal_revenue_code pursuant to the laws of state a and b were married at the time that trust was created trust provides for an amount equal to a percent of the net fair_market_value of the trust assets valued as of the first business_day of such taxable_year to be paid to a annually during a’s lifetime and after a’s death to b during her surviving lifetime the life time unitrust_interest of b will take effect following the death of a only if b furnishes the funds for payment of any federal_estate_taxes or state_death_taxes for which the trustee may be liable upon the death of a_trust further provides that upon the death of the survivor of a and b the trust shall terminate and its remaining principal shall be distributed to such one or more organizations described in sec_170 sec_2055 and sec_2522 qualified charities as a shall designate in writing during his lifetime and to the extent he does not effectively designate the distribution of all of the remaining trust principal it shall be distributed to the trustees of foundation if it is a qualified charity under the terms of trust otherwise to one or more qualified charities as the trustee of trust shall determine prior to d2 a irrevocably designated charitable_remainder beneficiaries on d2 a and b divorced under judgment which incorporated agreement an agreement for the division of assets and liabilities by the terms of judgment trust’s assets were divided in equal shares to trust a and trust b both of which were intended to qualify as charitable_remainder unitrusts under sec_664 a is the initial non-charitable beneficiary of trust a and b is the initial non-charitable beneficiary of trust b plr-155814-07 during his lifetime a will possess and retain the sole power to designate the charitable_remainder beneficiary or beneficiaries of trust a b is the successor non- charitable_beneficiary of trust a if she survives a and furnishes the funds for payment of any federal_estate_taxes and state_death_taxes for which the trustee may be liable upon the death of a if the funds are not furnished by b by the due_date for payment of such taxes the unitrust period shall terminate on the death of a notwithstanding any other provision in trust a during her lifetime b will possess and retain the sole power to designate the charitable_remainder beneficiary or beneficiaries of trust b a is the successor non- charitable_beneficiary of trust b if he survives b and furnishes the funds for payment of any federal_estate_taxes and state_death_taxes for which the trustee may be liable upon the death of b if the funds are not furnished by a by the due_date for payment of such taxes the unitrust period shall terminate on the death of b notwithstanding any other provision in trust b upon the death of the survivor of a and b the remainder of trust a shall be distributed to satisfy percent of the irrevocable designated charitable_remainder distributions that a designated prior to the severance of trust the balance of the remainder of trust a shall be distributed to one or more qualified charities as a shall designate to the extent this power_of_appointment is not effectively exercised the balance of the remainder of trust a shall be distributed and paid over to the trustee or trustees of foundation a if it shall then be a qualified charity or if it shall not be a qualified charity to such one or more qualified charities and in such proportions as the trustees shall select in their sole discretion upon the death of the survivor of a and b the remainder of trust b shall be distributed to satisfy percent of the irrevocable designated charitable_remainder distributions that a has so designated prior to the severance of trust the balance of the remainder of trust b shall be distributed to one or more qualified charities as b shall designate to the extent this power_of_appointment is not effectively exercised the balance of the remainder of trust b shall be distributed and paid over to the trustee or trustees of foundation b if it shall then be a qualified charity or if it shall not be a qualified charity to such one or more qualified charities and in such proportions as the trustees shall select in their sole discretion ruling sec_664 provides generally that a charitable_remainder_unitrust shall be exempt from federal_income_tax sec_664 provides that a charitable_remainder_unitrust is a_trust a from which a fixed percentage which is not less than percent nor more than percent of plr-155814-07 the net fair_market_value of its assets valued annually is to be paid not less often than annually to one or more persons at least one of which is not an organization described in sec_170 and in the case of individuals only to an individual who is living at the time of the creation of the trust for a term of years not in excess of years or for the life or lives of such individual or individuals b from which no amount other than the payments described in sec_664 and other than qualified gratuitous transfers described in sec_664 may be paid to or for_the_use_of any person other than an organization described in sec_170 c following the termination of the payments described in sec_664 the remainder_interest in the trust is to be transferred to or for_the_use_of an organization described in sec_170 or is to be retained by the trust for such a use or to the extent the remainder_interest is in qualified_employer_securities as defined in sec_664 all or part of such securities are to be transferred to an employee_stock_ownership_plan as defined in sec_4975 in a qualified_gratuitous_transfer as defined by sec_664 and d with respect to each contribution of property to the trust the value determined under sec_7520 of such remainder_interest in such property is at least percent of the net fair_market_value of such property as of the date such property is contributed to the trust therefore based solely on the facts and the representations submitted the division of trust into trust a and trust b did not cause trust trust a or trust b to fail to qualify as charitable_remainder trusts under sec_664 ruling sec_2 and 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 is the excess of the amount_realized over the adjusted_basis provided in sec_1011 for determining gain and the loss is the excess of the adjusted_basis provided in sec_1011 for determining loss over the amount_realized under sec_1001 the entire amount of gain_or_loss must be recognized except as otherwise provided 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 an exchange of property results in the realization of gain_or_loss under sec_1001 if the properties exchanged are materially different 499_us_554 properties exchanged are materially different if the properties embody legal entitlements different in_kind or extent or if the properties confer different rights and powers id pincite in cottage savings the court held that mortgage loans made to different obligors and secured_by different homes did embody plr-155814-07 distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans id pincite 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 id pincite in the present case prior to the divorce a owned the entire unitrust income_interest in trust and b had no present_interest in either the income or corpus of trust b had at most a future contingent_interest in the unitrust income of trust that is b would have a right to that interest only if a is the first to die after the division of trust b's interest became immediate and possessory to a percent unitrust_amount determined by reference to the fifty percent of the assets of trust deposited into trust b consequently because after the division of trust a’s interest has declined significantly and b's interest has increased significantly a and b enjoy legal entitlements that are materially different in_kind or extent from those enjoyed prior to the division of trust accordingly gain_or_loss would be realized and recognized to a and b under sec_1001 unless another section of the code provides for nonrecognition in such case see sec_1_1001-1 sec_1041 provides that no gain_or_loss will be recognized on a transfer of property from an individual to or in trust for the benefit of a spouse or former spouse if the transfer is incident to the divorce under sec_1041 for purposes of subtitle a the transferee is treated as having acquired the property by gift from the transferor with a carryover_basis from the transferor sec_1041 was added to the code by sec_421 of the tax_reform_act_of_1984 1984_act pub_l_no it provides a broad non-recognition rule for transfers of property between spouses and former spouses the house report accompanying the 1984_act expresses the intent of congress in enacting sec_1041 furthermore in divorce cases the government often gets whipsawed the transferor will not report any gain on the transfer while the recipient spouse when he or she sells is entitled under the 370_us_65 rule to compute gain_or_loss by reference to a basis equal to the fair_market_value of the property at the time received the committee believes that to correct these problems and make the tax laws as unintrusive as possible with respect to relations between spouses the tax laws governing transfers between spouses and between former spouses should be changed the bill provides that the transfer of property to a spouse incident to a divorce will be treated for income_tax purposes in the same manner as a gift gain including recapture_income or loss will not be recognized to the transferor and plr-155814-07 the transferee will receive the property at the transferor's basis thus uniform federal_income_tax consequences will apply to these transfers notwithstanding that the property may be subject_to differing state property laws h_r rep no 98th cong 2d sess part pincite house report with respect to divorce-related transfers of annuities and beneficial interests in trusts the above legislative_history states where an annuity is transferred or a beneficial_interest in a_trust is transferred or created incident_to_divorce_or_separation the transferee will be entitled to the usual annuity treatment including recovery_of the transferor's investment_in_the_contract under sec_72 or the usual treatment as the beneficiary of a_trust by reason of sec_682 id in our view this statement of congressional intent supports the application of the nonrecognition treatment of sec_1041 to the facts of this case here prior to divorce a received annual income from trust equal to a percent unitrust_amount b did not receive anything pursuant to agreement which constituted a divorce instrument trust was partitioned and divided into two equal trusts one for a and one for b a and b respectively each receive income equal to a percent unitrust_amount determined as of the first day of the year from the fifty percent of the assets deposited into their respective trusts while both are alive consequently a in essence transferred incident_to_divorce one-half of his former interest in trust to trust b consistent with the above legislative_history we conclude that sec_1041 applied to the transfer therefore for purposes of the income_tax no gain_or_loss was recognized by a on the transfer of one-half of his unitrust_interest in trust b received that interest as a gift with a carryover_basis from a pursuant to sec_1041 in addition the pro_rata division of trust into trust a and trust b did not result in the recognition of gain_or_loss to trust trust a or trust b for purposes of sec_1001 ruling 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 such property was held by any other person if under chapter of the code such property has for the purpose 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 under sec_1015 if property is acquired by gift 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 plr-155814-07 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 the property is acquired by a transfer in trust other than by a transfer in trust by a 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 the transfer therefore based on the information provided and the representations made trust a and trust b determine their basis in the assets by reference to the basis of the assets in the hands of trust under sec_1015 or b and the holding periods of the assets held by trust a and trust b include the period for which the assets were held by trust ruling sec_2501 imposes a gift_tax for each calendar_year on the transfer of property by gift during the year by an individual sec_2511 provides that the gift_tax shall apply whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2512 provides that where property is transferred for less than an adequate_and_full_consideration in money_or_money's_worth the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift sec_2516 provides that where husband and wife enter into a written_agreement relative to their marital and property rights and divorce occurs within the 3-year period beginning on the date year before such agreement is entered into whether or not such agreement is approved by the divorce decree any transfers of property or interests in property made pursuant to such agreement to either spouse in settlement of his or her marital or property rights or to provide a reasonable allowance for the support of issue of the marriage during minority shall be deemed to be transfers made for a full_and_adequate_consideration_in_money_or_money's_worth in this case a and b entered into agreement on d2 in addition a and b’s divorce became final on d2 within the three year period beginning on the date one year before d2 accordingly under sec_2516 the termination of trust and the transfer of property interests in trust to trust a and trust b pursuant to agreement will be deemed to be transfers made for full and adequate_consideration in money or money’s worth and therefore will not be subject_to gift_tax plr-155814-07 except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts of the transaction described above under any other provision of the code in particular sec_61 we express no opinion on whether trust otherwise qualified as a charitable_remainder_trust under sec_664 or whether trust a and trust b each otherwise qualify as charitable_remainder trusts under sec_664 this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to trust’s authorized representatives sincerely audrey w ellis audrey w ellis senior counsel branch office of associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service department of the treasury number release date index number 468a washington dc person to contact telephone number refer reply to cc psi 6-plr-117909-99 date date legend taxpayer parent company company company company plant plant plant plant plant district commission a commission b a b c plr-117909-99 this letter responds to your request dated date that we rule on certain tax consequences of the transfer of the plants from taxpayer to company as set forth below you have requested rulings regarding the tax consequences under sec_468a of the internal_revenue_code to the taxpayer and its qualified nuclear decommissioning fund as well as rulings regarding the tax treatment of the transfer of nonqualified funds on the transfer of the plants the taxpayer has represented the following facts and information relating to the ruling_request the taxpayer owns and operates electric generation plants and a distribution network to carry power to industrial and retail customers the taxpayer is under the regulatory jurisdiction of commission a and commission b the taxpayer owns interests in a nuclear generating plants and is a wholly-owned subsidiary of the parent pursuant to an order dated c from commission a the taxpayer is in the process of withdrawing from the electric power generation business and will transfer all of its generation assets and liabilities to affiliated companies pursuant to the order the taxpayer will collect a nonbypassable societal benefits charge sbc as a mechanism in part for recovering nuclear decommissioning costs pursuant to the order of commission a the taxpayer will reorganize its business as follows company will be a wholly owned subsidiary of parent that will own all of the shares of companie sec_2 and company will supply administrative services to its subsidiaries and will be responsible for financing their operations company will hold and operate the non-nuclear generating facilities formerly owned by the taxpayer and will sell all of its generation capacity to company company will hold and operate the nuclear plants formerly owned by the taxpayer and will sell all of its generation capacity to company company will market energy purchased from companie sec_2 and and other sources and engage in the wholesale marketing brokering and trading of energy until b company will sell capacity and energy to the taxpayer in order to support the taxpayer’s basic generation service obligation to its customers after b company may compete to sell capacity and energy to the taxpayer subject_to review by the commissions in connection with the reorganization company will assume all liabilities associated with the interests in the nuclear power plants it receives including the liabilities to decommission those interests in the plants the taxpayer will assign the licenses to operate the plants and will transfer to company the right to receive the proceeds from the sbc relating to decommissioning in connection with the transfer of the plants the taxpayer will transfer to company its qualified and nonqualified plr-117909-99 nuclear decommissioning funds requested ruling neither the taxpayer company nor the qualified nuclear decommissioning funds will recognize any gain_or_loss or otherwise take into account any income_or_deduction into account by reason of the transfer to company of the qualified nuclear decommissioning funds the qualified nuclear decommissioning funds will have a basis in the assets held equal to the basis of such assets prior to the transfer of the funds to company sec_468a provides that a taxpayer may elect to deduct payments made to a nuclear decommissioning reserve fund the qualified nuclear decommissioning fund sec_468a limits the annual deduction of the electing taxpayer to the lesser_of the ruling_amount or the amount of decommissioning costs included in the electing taxpayer’s cost of service for ratemaking purposes for the taxable_year sec_468a provides that the ruling_amount means the amount determined by the service to be necessary to a fund that portion of the nuclear decommissioning cost with respect to the nuclear power plant that bears the same ratio to the total nuclear decommissioning costs with respect to such nuclear power plant as the period for which the fund is in effect bears to the estimated_useful_life of the nuclear power plant and b prevent any excessive funding of such costs or the funding of such costs at a rate more rapid than level_funding sec_468a provides that the rate_of_tax on the income of a qualified nuclear decommissioning fund is percent sec_468a provides in pertinent part that the assets in a qualified nuclear decommissioning fund shall be used exclusively for satisfying the liability of any taxpayer contributing to the qualified nuclear decommissioning fund sec_1_468a-1 of the federal_income_tax regulations provides that an eligible_taxpayer is a taxpayer that possesses a qualifying interest in a nuclear power plant sec_1_468a-1 provides that a qualifying interest is a direct ownership_interest or a leasehold interest meeting certain additional requirements sec_1_468a-1 provides in part that a nuclear power plant is any nuclear power reactor that is used predominantly in the trade_or_business of the furnishing or sale of electric energy if the rates for such furnishing or sale have been established or approved by a public_utility commission sec_1_468a-5 sets out the qualification requirements for nuclear decommissioning funds it provides in part that a qualified nuclear decommissioning fund must be established and maintained pursuant to an arrangement that qualifies as a_trust under state law an electing taxpayer can establish and maintain only one qualified nuclear decommissioning fund for each nuclear power plant sec_1 468a- c i provides that if at any time during the taxable_year a nuclear plr-117909-99 decommissioning fund does not satisfy the requirements of sec_1_468a-5 the service may disqualify all or a portion of the fund as of the date that the fund does not satisfy the requirements sec_1_468a-5 provides that if a qualified nuclear decommissioning fund is disqualified the fair_market_value with certain adjustments of the assets in the fund is deemed to be distributed to the electing taxpayer and included in that taxpayer’s gross_income for the taxable_year sec_1_468a-6 generally provides rules for the transfer of an interest in a nuclear power plant and transfer of the qualified nuclear decommissioning fund where after the transfer the transferee is an eligible_taxpayer under sec_1_468a-6 the service may treat any disposition of an interest in a nuclear power plant occurring after date as satisfying the requirements of the regulations if the service determines that such treatment is necessary or appropriate to carry out the purposes of sec_468a under the specific facts herein the service will generally treat these transfers under sec_1_468a-6 as dispositions qualifying under the general provisions of sec_1_468a-6 this exercise of discretion will apply to the provisions of except those outlined in 468a-6 e with respect to the calculation of a schedule of ruling amounts subsequent to a sale thus under sec_1_468a-6 the taxpayer’s funds will not be disqualified upon the transfer of the plants and the funds to company but will also not be able to accept additional contributions from the taxpayer or company unless company were to request and receive a new schedule of ruling amounts under sec_468a sec_1_468a-6 provides that neither a transferor of an interest in a nuclear power plant nor the transferor’s fund will recognize gain_or_loss or otherwise take any income_or_deduction into account by reason of a sale accordingly neither the taxpayer nor its qualified funds will recognize gain_or_loss or otherwise take into account any income_or_deduction upon the transfer of the qualified nuclear decommissioning funds to company sec_1_468a-6 provides that transfers to which sec_1_468a-6 apply do not affect basis thus the qualified funds in the hands of company will have a basis in their assets equal to the basis in their assets prior to the transfer from the taxpayer requested ruling with respect to the taxpayer’s transfer of the plants and associated nonqualified funds to company in exchange for consideration and the assumption of the obligation to decommission the plants company will not recognize any gain or otherwise take any income into account by reason of the transfer of the nonqualified funds plr-117909-99 generally a taxpayer does not realize income upon its purchase of a business’ assets even where those assets include cash or marketable_securities and in connection with the purchase the taxpayer assumes liabilities of the seller see 194_f2d_190 2d cir revrul_55_675 1955_2_cb_567 in this case company cannot acquire the taxpayer’s interests in the plants without assuming the associated decommissioning liabilities which are inextricably associated with the ownership and operation of the plants and there is no indication that the transaction is other than a bona_fide purchase of taxpayer’s interests in the plants and the associated assets and liabilities the exception to the general_rule set forth in revrul_71_450 1971_2_cb_78 does not apply in revrul_71_450 unlike the present situation the purchaser agreed to assume the prepaid subscription liability in return for a separate cash payment and the liability was not reflected in the sales_price of the business accordingly company will not realize income from its acquisition of taxpayer’s interests in the plants and in the assets in the non-qualified funds except to the extent that under the rules of sec_1060 the amount of cash and other class_i_assets received by company not including the assets in the qualified funds surpasses the amount of consideration provided by company and taken into account in the year of the acquisition further to the extent that company is entitled to take into account other consideration paid company will make appropriate adjustments to reflect any income previously recognized by virtue of having acquired class_i_assets in excess of the consideration taken into account in the year of the acquisition see sec_1_1060-1t c 338-6t b and -7t b our conclusion above is conditioned on company including in basis only the cash paid to taxpayer and any liabilities that are otherwise incurred for federal_income_tax purposes and allocating this consideration pursuant to the residual_method under sec_1060 and the regulations thereunder pursuant to sec_461 and the regulations thereunder company will not be entitled to treat as a component of its cost_basis at the time of the closing any amount attributable to the future decommissioning liabilities assumed in the transactions finally sec_1060 provides that in the case of an applicable_asset_acquisition the consideration received shall be allocated among the acquired assets in the same manner as amounts are allocated to assets under sec_338 sec_1_1060-1t a provides that in the case of an applicable_asset_acquisition sellers and purchasers must allocate the consideration under the residual_method as described in sec_1_338-6t and sec_1_338-7t in order to determine respectively the amount_realized from and the basis in each of the transferred assets sec_1060 defines the term applicable_asset_acquisition as the transfer of assets constituting a trade_or_business if the acquirer’s basis is determined wholly by reference to the consideration paid for such assets plr-117909-99 sec_1_1060-1t c defines a seller’s consideration as the amount in the aggregate realized from selling the assets in the applicable_asset_acquisition under sec_1001 sec_1060 provides no independent basis for determining the amount a taxpayer realizes on the sale of assets or the time such amount may be taken into account the amount_realized and the time such amount is taken into account are determined solely under generally applicable tax_accounting principles see sec_1001 and sec_461 the residual_method is based on a division of assets into seven classes class i generally consisting of cash and general deposit accounts held in banks savings and loan associations and other depository institutions class ii generally consisting of actively_traded personal_property like u s government securities and publicly traded stock but also including certificates of deposit and foreign_currency even if they are not actively_traded personal_property class iii accounts_receivable mortgages and credit card receivables from customers which arise in the ordinary course of business class iv stock_in_trade of the taxpayer or other_property of a kind which would properly be included in the inventory of taxpayer if on hand at the close of the taxable_year or property held by the taxpayer primarily_for_sale_to_customers in the ordinary course of its trade_or_business class v all assets other than class i ii iii iv vi and vii assets class vi all sec_197 intangibles as defined in sec_197 except goodwill and going_concern_value and class vii goodwill and going_concern_value whether or not they qualify as sec_197 intangibles consideration is first reduced by the amount of class_i_assets transferred by the seller the remaining consideration is then allocated among the class_ii_assets pro_rata to the extent of their fair_market_value then among the class_iii_assets pro_rata to the extent of their fair_market_value then among the class_iv_assets pro_rata to the extent of their fair_market_value then among the class_v_assets pro_rata to the extent of their fair_market_value then among the class_vi_assets pro_rata to the extent of their fair_market_value and finally any remaining consideration is allocated among the class_vii_assets pro_rata according to their fair_market_value sec_1 1t c 338-6t b and 338-6t b the following example illustrates the operation of sec_1060 on date1 an applicable_asset_acquisition is made the assets sold consist of class_i_assets in the amount of dollar_figure class_ii_assets with a fair_market_value of dollar_figure and a basis in the hands of the seller of dollar_figure class_iii_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_iv_assets with a fair_market_value of dollar_figure and a basis of dollar_figure class_v_assets with fair_market_value of dollar_figure and a basis of dollar_figure and class_vi_assets with a fair_market_value of dollar_figure and a basis of dollar_figure the consideration consists of dollar_figure cash and an assumed liability of dollar_figure that under applicable tax_accounting principles is taken into account at the time of the applicable_asset_acquisition the consideration will be first reduced by dollar_figure the amount of class_i_assets plr-117909-99 the remaining consideration will be allocated as follows dollar_figure to class_ii_assets pro_rata according to fair_market_value resulting in a dollar_figure gain dollar_figure to the class_iii_assets pro_rata according to fair_market_value resulting in no gain_or_loss dollar_figure to the class_iv_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain dollar_figure to the class_v_assets pro_rata according to the fair_market_value resulting in no gain_or_loss dollar_figure to the class_vi_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain and the remaining dollar_figure to the class_vii_assets pro_rata according to the fair_market_value resulting in a dollar_figure gain the character of the amounts of gain_or_loss recognized by the seller as well as any applicable holding periods are determined by the nature of the underlying assets sec_1 1t a 1060-1t c and 338-6t if under general tax principles there is a subsequent adjustment to the consideration eg if it is later determined that the actual amount of the liability assumed differs from the value that the parties assigned to such liability on the date of the applicable_asset_acquisition that amount is allocated in a manner that produces the same allocation that would have been made at the time of the acquisition had such amount been paid_or_incurred on the acquisition_date sec_1_1060-1t a 1060-1t c and 338-7t with respect to the plant equipment operating_assets and nonqualified_fund assets these assets comprise a trade_or_business in taxpayer’s hands and the basis company takes in those assets will be determined wholly by reference to company 3’s consideration thus taxpayer’s transfer of plant equipment operating_assets and nonqualified_fund assets to company in exchange for cash and the assumption of the decommissioning liability except to the extent funded by the qualified_fund is an applicable_asset_acquisition as defined in sec_1060 as such its federal tax treatment is determined under sec_1060 and the regulations thereunder accordingly taxpayer must allocate the consideration to the applicable assets in accordance with the provisions of sec_1060 and the regulations thereunder specifically taxpayer will first reduce the consideration received by the amount of class_i_assets it transfers in the transaction including any class_i_assets held in the nonqualified_fund to the extent taxpayer’s consideration exceeds the class_i_assets it transfers such excess will be allocated to the class_ii_assets then to the class_iii_assets then to the class_iv_assets then to the class_v_assets then to the class_vi_assets and finally to the class_vii_assets allocating to each class of assets pro_rata according to the fair_market_value of those assets up to their total fair_market_value the character and other attributes of the amounts of gain and loss are determined by the character and other attributes of the underlying assets this letter_ruling is directed only to the taxpayer that requested it sec_6110 provides that this ruling may not be used or cited as precedent plr-117909-99 in accordance with the powers of attorney we are sending a copy of this ruling to your authorized representative we are also sending a copy of this letter_ruling to the district_director of district sincerely charles b ramsey chief branch office of associate chief_counsel passthroughs and special industries


t c memo united_states tax_court may t rakow petitioner v commissioner of internal revenue respondent docket no filed date glen t dobosz and marios n karayannis for petitioner karen p wright for respondent memorandum findings_of_fact and opinion gale judge respondent determined a deficiency in petitioner’s federal gift_tax for the taxable_year in the amount of dollar_figure the issue for decision is the fair_market_value of stock given by petitioner to her children and grandchildren unless otherwise indicated all section references are to the internal_revenue_code as in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated by this reference petitioner resided in elgin tllinois at the time the petition was filed tllinois hydraulic construction co ihc has been owned by the rakow family since during ihc had outstanding big_number shares of common_stock and no preferred_stock on date petitioner gave a total of big_number shares of ihc common_stock to her children and grandchildren petitioner reported the gifts of the big_number shares of ihc stock on a form united_states gift and generation-skipping_transfer_tax return petitioner’s gift_tax_return valued the big_number shares of ihc common_stock at dollar_figure or dollar_figure per share on a minority basis respondent determined the value of the big_number shares of ihc to be dollar_figure or dollar_figure per share ona minority basis thc is a general contractor engaged in the construction of industrial and commercial buildings sewage and water treatment plants and underground utilities primarily in northern tllinois ihc obtained its work through bids some requests for bids such as those for public or municipal jobs were advertised in contrast the utilities that is the power and telephone_companies would send invitations to bid to ihc and other preselected companies ihc performed most of its contracts alone without subcontracting significant portions of the work thc has done work for the utilities for about years two of its major clients were ameritech a telephone company and commonwealth edison a power company in the 5-year period spanning fiscal years ended date through these two major clients contributed from to percent of its revenues thomas rakow mr rakow petitioner’s son has been president of ihc since the early 1980’s petitioner also was a full-time officer of ihc ihc paid mr rakow and petitioner as follows year ended mr rakow petitioner date dollar_figure dollar_figure date big_number big_number date big_number big_number date big_number big_number date big_number big_number ihc’s income statement for its fiscal_year ended date prepared by independent auditors reports the following revenues dollar_figure cost of revenue big_number gross_profit from operations big_number operating_expenses big_number income from operations big_number interest_expense big_number other income net of other expense big_number income before taxes big_number provision for income taxes big_number net_income big_number thc’s fiscal revenues represent a 5-year compound growth of dollar_figure percent and a 3-year compound growth of percent ihc’s balance_sheet for date prepared by independent auditors reflects assets of dollar_figure and liabilities of dollar_figure for a net_worth of dollar_figure as of date ihc had doubtful receivables of dollar_figure this amount was excluded from the assets reported on the balance_sheet ihc had a line of credit with a bank but had no outstanding long-term debt an analysis of ihc’s income statements for its fiscal years ended date through reveals the following expressed in percentages of revenues discrepancies in arithmetic are due to rounding average average revenues -direct cost sec_88 _88 _89 _91 gross_profit -operating expenses _10 operating_profit -interest expense other income expense qo earnings before tax opinion the issue for decision is the fair_market_value of the ihc stock given by petitioner on date both parties rely upon their respective experts’ opinions in attempting to establish the correct fair_market_value fair_market_value is defined as ‘the price at which the property would change hands between a willing buyer and a willing seller neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts ’ 411_us_546 quoting sec_20_2031-1 estate_tax regs expert opinion sometimes aids the court in determining valuation other times it does not see 92_tc_101 we evaluate such opinions in light of the demonstrated gualifications of the expert and all other evidence of value in the record see 94_tc_193 we are not bound however by the opinion of any expert witness when that opinion contravenes our judgment see id we may accept the opinion of an expert in its entirety see 74_tc_441 or we may be selective in the use of any portion thereof see 86_tc_547 when valuing stock in the absence of arm’s-length sales the following factors are taken into consideration the company’s net_worth prospective earning power and dividend-paying capacity and other_relevant_factors see sec_25_2512-2 gift_tax regs the other_relevant_factors include the good will of the business the economic outlook in the particular industry the company’s position in the industry and its management the degree of control of the business represented by the block of stock to be valued and the values of securities of corporations engaged in the same or similar lines of business which are listed on a stock exchange however the weight to be accorded such comparisons or any other evidentiary factors considered in the determination of a value depends upon the facts of each case id petitioner’s expert petitioner presented the opinion of george h reddin of fmi corp a management consulting firm to the construction industry petitioner’s expert petitioner’s expert valued ihc on a minority interest basis at dollar_figure or dollar_figure per share petitioner’s expert first valued ihc according to the cost or asset approach beginning with the book_value of ihc on date of dollar_figure he made downward adjustments for taxes dollar_figure and a doubtful account receivable dollar_figure and an upward adjustment to bring the book_value of the depreciable assets to fair_market_value dollar_figure he also subtracted the cash_value of insurance dollar_figure to be valued as a nonoperating asset these adjustments resulted in an adjusted book_value of dollar_figure for the operating_assets in determining the adjustment to the depreciable assets petitioner’s expert used information on book values and estimated fair market values as of date given to him by ihc’s chief financial officer petitioner’s expert believes the estimated fair market values were based on quick sale auction values he concluded that ihc had no goodwill apart from its earnings capacity petitioner’s expert next valued ihc using a capitalization of earnings method he adjusted ihc’s pretax earnings upwards in some years and downwards in others to bring mr rakow’s salary in line with the industry average over the fiscal years through this adjustment averaged dollar_figure percent of revenues with a range of -0 to percent of revenues he then selected a capitalization rate using the market comparable approach a buildup approach and fmi’s experience for the market comparable approach petitioner’s expert chose publicly traded companies in construction or construction-related businesses and focused on their price earnings p e ratios he derived each company’s year range of p e ratios from standard poor’s stock reports ignoring those p e ratios over and those not calculable due to losses or zero profits which eliminated eight companies and truncated the range for one petitioner’s expert determined that the median of the midpoints of the companies’ ranges of p e ratios was a p e ratio of petitioner’s expert then considered the following factors and made adjustments of unspecified quantities in the directions indicated below for an end result of a pretax p e ratio in the range of to factor adjustment market diversification down product diversification none management depth down future earnings prospect none financial strength none access to capital markets down marketability down control up net effect down petitioner’s expert also calculated a capitalization rate using the buildup approach as follows risk-free rate equity risk premium average market return risk premium for size other risk factor sec_5 net cash-flow discount rate net_earnings discount--net cash-flow discount _0 net_earnings discount rate - average growth rate net_earnings cap rate for next year growth rate dollar_figure net_earnings cap rate for current_year petitioner’s expert started with the risk-free rate of return for the long-term treasury bond on date he consulted ibbotson associates stocks bonds bills and inflation yearbook to obtain the historical equity risk premium for stocks and the premium for small company stocks he determined an additional premium of percent was warranted when comparing ihc to the public companies petitioner’s expert considered ihc’s net_income and cash-flow to be the same because its capital expenditures approximated depreciation he assumed a growth rate of percent petitioner’s expert converted the after-tax capitalization rate of percent to pretax using a percent tax_rate he then concluded that the buildup approach yields a pretax earnings multiple of petitioner’s expert then stated that in fmi’s experience with actual transactions involving privately owned construction companies the pretax p e ratios ranged from to no data on these transactions appear in his report or elsewhere in the record ultimately p e ratio of is appropriate in this case petitioner’s expert concluded that a pretax as it implies a pretax investment return in the absence of growth of nearly percent a return allegedly consistent with fmi’s experience petitioner’s expert then applied this p e ratio of to various average and weighted average historic pretax earnings to current pretax earnings and to projected pretax earnings as estimated by ihc management as shown below the results of the earnings approach were lower than the value of the operation derived through the asset approach method book_value adjusted book_value capitalization capitalization capitalization capitalization capitalization of of of of of 5-yr 5-yr 3-yr 3-yr average adjusted earnings weighted avg adj earnings average adjusted earnings weighted avg adj earnings projected_earnings valuation dollar_figure big_number big_number big_number big_number big_number big_number it was petitioner’s expert’s opinion that the fair_market_value of ihc as an enterprise was dollar_figure nonoperating assets of dollar_figure for ihc on a majority basis of dollar_figure when added to the this resulted in a total value petitioner’s expert determined a minority discount by consulting market data using the median premiums_paid for control for each year from to according to mergerstat review petitioner’s expert calculated the corresponding implied minority interest discounts these discounts ranged in value from to the average control premium wa sec_35 the median premium wa sec_29 and the minority discount corresponding to the median premium wa sec_22 the figures were and respectively petitioner’s expert also looked at the houlihan lokey howard zukin control premium study that study reflected an average control premium of percent and a median control premium of percent for the third quarter of and average and median premiums of and percent respectively for the 12-month_period ended date the third quarter of included transactions and the 12-month_period ended date involved transactions petitioner’s expert converted the median premiums for these two periods to minority discounts of and percent respectively using the data from the two sources petitioner’s expert selected a minority discount of percent he applied this discount to the value of ihc obtained above leading to a value on a minority basis of dollar_figure or dollar_figure per share respondent’s expert respondent relies on the opinion of warren t jacobsen of horizon capital management respondent’s expert respondent’s expert valued the ihc stock at dollar_figure per share on a minority basis respondent’s expert first valued ihc using the market comparable approach he selected nine public companies on the basis of their products markets growth prospects and risks from the companies listed under standard industrial classification sic_codes general commercial contractors special trade contractors water sewer and utility contractors heavy construction and structural steel construction he determined the following market ratios for the nine companies price revenue price earnings before interest and taxes ebit price net and price book_value in a few cases the ratios could not be calculated because of deficit earnings respondent’s expert calculated an average of the comparable companies’ ratios for each type of ratio he then calculated another such average eliminating the companies with the highest and lowest values for each type ratio lastly he adjusted the latter averages to fit thc the adjustments mainly representing the difference in size between ihc and the comparable companies the resulting ratios were as follows p rev p ebit p net p book average dollar_figure dollar_figure dollar_figure dollar_figure average excl high low dollar_figure dollar_figure dollar_figure dollar_figure conclusion ihc dollar_figure dollar_figure dollar_figure dollar_figure respondent’s expert then calculated a value for ihc using these ratios weighting each of the four market comparison methods equally as shown minority weighted base multiple value weight value price revenue dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure price earnings dollar_figure big_number dollar_figure big_number price ebit dollar_figure big_number dollar_figure big_number price book big_number dollar_figure big_number dollar_figure big_number unadjusted value big_number because the market approach based on individual shares reflects a marketable minority value respondent’s expert applied a control premium of percent and then a marketability discount of percent for a result of dollar_figure which he rounded to dollar_figure respondent’s expert selected the 30-percent control premium on the basis of the average premiums of percent for all companies percent for contractors and engineering services and percent for construction companies respondent’s expert also valued ihc using the discounted cash-flow approach this approach is based upon estimates of future cash-flow discounted for the time_value_of_money and relative investment risks relying on ihc’s 5-year and 3-year averages and industry trends and forecasts respondent’s expert used the following growth rates year sec_1 through percent years through percent post-year percent he projected direct costs to be percent of revenues based on historical results industry averages and anticipated economic conditions on the basis of ihc’s operating_expenses exclusive of depreciation which averaged percent of revenues for the last years and percent for the last years respondent’s expert forecast operating_expenses pincite percent depreciation was forecast pincite percent of revenues he assumed a 40-percent tax_rate for combined federal and state income taxes for working_capital respondent’s expert selected percent of revenue the industry averages being to percent and ihc’s year average about percent after a review of historical results and discussion with management he projected capital expenditures to equal depreciation in the long term pincite percent of revenues respondent’s expert developed a discount rate using a weighted average cost of capital for a capital structure of percent equity and percent debt a structure intended to be reflective of the capital structures of companies in sic_codes and this resulted in a 13-percent discount rate the end result of the discounted cash-flow approach was a value for ihc of dollar_figure rounded respondent’s expert then averaged the results of the discounted cash-flow dollar_figure and the market comparable approach dollar_figure for a value of dollar_figure million or dollar_figure per share on a majority basis the 30-percent control premium previously selected by respondent’s expert translates toa minority discount of percent accordingly on a minority basis respondent’s expert concluded that a share of ihc stock is worth dollar_figure court’s analysis not unexpectedly each of the parties criticizes the opinion of the other’s expert we have considered each of the criticisms in our analysis petitioner has presented an asset-based value but with certain flaws in its methodology respondent’s expert has not presented us with a value based on the asset approach reasoning that because ihc is not a holding_or_investment_company the approach is not as appropriate as one based on income or market comparables also respondent’s expert opined that the asset approach is not as reliable for going concerns because of the difficulty of valuing intangibles the company’s net_worth is one of the factors to be considered see sec_25_2512-2 gift_tax regs and the asset-- based approach provides a value useful for comparison with the results of other approaches petitioner’s expert began with ithc’s date balance_sheet however there is little support for his dollar_figure downward adjustment for the purportedly uncollectible receivable also the adjustment for fair_market_value of the depreciable assets is based on the representation of ihc’s management and quick sale values rather than on independent appraisals of value in an orderly disposition -- - or as part of a going concern considering these weaknesses we believe that ihc’s value calculated on the basis of its assets is greater than the dollar_figure million postulated by petitioner’s expert dollar_figure million in operating_assets plus dollar_figure million cash_value of life_insurance the usefulness of the market approach is dependent on the comparables selected and the application of the variable chosen to the appropriate data we find that petitioner’s expert’s calculation of the p e and price book_value ratios is flawed in that it does not focus on the period of time close to the valuation_date but uses a median of the year ranges also he ignored all high values of these ratios he used dollar_figure as the median p e ratio of the comparables but the exhibit in his report gives the median as nm or not meaningful petitioner’s expert converted the after-tax p e ratio derived from the comparables’ p e ratios to a pretax ratio and then misapplied the adjusted p e ratio to various average and weighted average pretax earnings in a properly calculated market comparable approach the comparables’ p e ratios are to be calculated and the selected result to be applied to the subject company on the same type of earnings eg a p e ratio determined on the most recent year’s net_earnings is to be applied to the subject company’s most recent year’s net_earnings a p e ratio calculated on 5-year average earnings should be applied to the subject’s 5-year average earnings see zukin financial valuation businesses and business interests par pincite par pincite because we find the p e ratios and related computations employed by petitioner’s expert to be unreliable we disregard his conclusion that a p e ratio between and is appropriate for valuing ihc ’ petitioner’s expert also developed a capitalization rate based on the buildup method to the risk-free rate and equity premium he added a small size risk premium and then percent for other risk factors petitioner’s expert describes the other risks as those factors which differentiate ihc from the public companies he selected as comparables factors such as smaller geographical market lack of management depth and lesser access to capital markets with the exception of control and marketability most of the factors presented by petitioner’s expert are those which differentiate a small company from a large one and already were taken into consideration by the small company premium if we reduce petitioner’s expert’s capitalization rate accordingly and follow the remainder of his methodology the resulting values are in the range of roughly petitioner’s expert also asserted that a pretax p e ratio ranging from to was consistent with fmi’s experience with actual transactions but because no supporting data with respect to these transactions was provided in his report we accord little weight to the assertion -- - dollar_figure to dollar_figure million rather than dollar_figure to dollar_figure million though still substantially lower than the value of ihc’s assets petitioner attacks respondent’s expert’s use of a discounted cash-flow approach to value on the grounds that that approach or any method based on a projection of future earnings is not feasible in the construction industry because of risks inherent in the business such as poor estimates delays litigation over accidents defects and nonperformance and cyclical demand petitioner has not established that ihc suffers disproportionately from any of the risks mentioned earnings_of the company are a factor to be considered in valuing stock see sec_25_2512-2 gift_tax regs careful selection of the input into the cash-flow analysis takes into account industry risks moreover ihc’s earnings for the 5-year period ending in fiscal do not suggest volatility with the exception of a dip in fiscal ihc’s earnings exhibited steady growth consequently the projected growth rates used by respondent’s expert in his discounted cash-flow analysis are reasonable indeed conservative thus we believe that a discounted cash- flow analysis can be used appropriately to value ihc the weight to be given to an earnings approach as opposed to an asset approach depends in part on the degree to which the company is actively engaged in the sale_of_goods or services as opposed to being a holding_or_investment_company see 87_tc_78 estate of ford v commissioner tcmemo_1993_580 affd 53_f3d_924 8th cir ihc was clearly the former petitioner also attacks the methodology of respondent’s expert’s discounted cash-flow analysis specifically petitioner criticizes respondent’s expert’s assumption of a pretax profit margin of percent when ihc’s actual pretax profit margin averaged percent for the 5-year period challenged to explain the 1-percent discrepancy at trial respondent’s expert contended that the difference was attributable to the upward adjustment in earnings he made to account for excessive_compensation paid to mr rakow and petitioner during the period we believe respondent’s expert was mistaken in his testimony his report makes no mention of excessive_compensation a review of his report suggests that the 1-percent difference between the actual average pretax profit margin and the pretax profit margin assumed in the discounted cash-flow analysis is attributable to-- respondent’s expert’s selection of a direct_cost percentage of percent rather than the actual 5-year average of percent for a difference of percent plus respondent’s expert’s selection of a percentage for operating_expenses minus depreciation of percent rather than the actual 5-year average of percent for a difference of percent plus the fact that short-term interest_expense which actually averaged percent for the 5-year period is disregarded in a discounted cash-flow analysis for a difference of percent these three factors appear to account for the difference between the percent pretax profit margin assumed in respondent’s expert’s discounted cash-flow and ihc’s actual 5-year average pretax profit margin of percent thus the maximum adjustment that could have been attributable to excess compensation was percent ie the difference between the expert’s assumption regarding operating_expenses and the actual average which is within the range that petitioner’s own expert conceded that mr rakow may have been overcompensated this is not to suggest that we believe respondent’s expert’s use of a 1-percent assumption for pretax profit margins in the cash-flow analysis is appropriate to the contrary we believe petitioner’s expert’s estimates understate direct costs with the result that cash-flow and the indicated value based thereon are inflated as noted above respondent’s expert assumed direct costs pincite percent of revenues notwithstanding the fact that ihc’s year average wa sec_88 percent in his report respondent’s expert states that the 0-percent figure chosen was based upon historical results industry averages and anticipated economic conditions yet historical results averaged percent and the industry average according to the report wa sec_90 percent if the assumed direct costs percentage is affected by the industry average it should go up in ihc’s case not down we find that respondent’s expert’s own data support an assumption of a direct costs percentage higher than percent if one were to take the average of the most recent 3-year and 5-year average direct costs just as respondent’s expert did with respect to his operating_expenses assumption the result would be a direct costs assumption of rather than percent we believe the record in this case supports the use of a higher direct costs percentage which more closely approximates the historical averages experienced by ihc than the one employed by respondent’s expert if one substitutes a direct costs percentage of percent into respondent’s expert’s discounted cash-flow analysis the indicated value for ihc as a whole becomes approximately dollar_figure million rather than the dollar_figure million calculated by respondent’s expert as recalculated the dollar_figure million value indicated by a discounted cash-flow analysis calls into question the other valuation approach employed by respondent’s expert namely the market comparable approach that approach indicated a value of dollar_figure million for ihc respondent’s expert testified that a material difference in the results produced by the market comparable and discounted cash-flow approaches----which he defined as a difference of approximately to percent---would suggest that there was something inherently wrong that would cause him to review his assumptions the difference between the values indicated by the discounted cash-flow approach as herein adjusted and the market comparable approach is dollar_figure million or approximately percent respondent’s expert further testified that as between the two valuation methods he used the discounted cash-flow analysis was more significant than market comparables based on his personal experience and his review of industry literature in addition we note that respondent’s expert’s use of the market comparable approach required him to make numerous adjustments to the ratios derived from the publicly traded comparables in an effort to account for the substantially smaller size of ihc and certain generally_accepted_accounting_principles applied to the financial reports of public companies these adjustments appeared in the end somewhat arbitrary in any event respondent’s expert conceded that they were based on his subjective determinations in the court’s view the adjustments necessitated by the size difference between ihc and the publicly traded comparables render the market comparable approach inherently more prone to error on the basis of these considerations and respondent’s expert’s own stated preference for the discounted cash-flow analysis we accord considerably more weight to its results than to the results indicated by the market comparable approach on the basis of the foregoing we conclude that respondent’s expert’s discounted cash-flow analysis as adjusted to reflect more closely ihc’s actual experience provides the most reliable indication of value namely dollar_figure million this figure is sufficiently close to the adjusted book_value of ihc’s assets ie dollar_figure million plus that the two indications of value are reconcilable conversely we think the dollar_figure to dollar_figure million value indicated by petitioner’s expert’s capitalization of earnings method is so divergent from the asset-based value that the former should be disregarded we accordingly find that the value of ihc as a whole was dollar_figure million on the valuation_date we now consider the appropriate minority discount to apply in determining the value of petitioner’s shares of ihc stock the parties agree that the minority discount is the inverse of the control premium respondent’s expert reviewed control premium figures for the overall market percent general contractors percent and construction companies percent selected percent as the appropriate control premium for ihc and converted this to a minority discount of percent petitioner’s expert selected a minority discount rate of percent using overall market averages one based on a survey of market activity recent to the valuation_date and another being the highest median premium in the 12-year period including the valuation_date generally the average of all companies is not a good indicator of the subject company see 87_tc_349 although petitioner’s expert does not present industry-specific control premium data petitioner argues for using the control premium of construction companies percent which converts to a minority discount of percent as consistently reported in its audited financial statements ihc performed most of its jobs on a stand-alone basis thus it more closely resembles a construction company than a general contractor consequently we agree that the 45-percent control premium that respondent’s expert reports for construction companies is appropriately used for ihc accordingly an inverse 31-percent minority discount should be applied to petitioner’s thc stock ’ dividing the dollar_figure value for ihc as a whole by the big_number shares outstanding results in a value of dollar_figure per share although the use of a 45-percent control premium would affect the value computed by respondent’s expert under the market comparable approach we need not consider this because of our conclusion that the market comparable approach is not reliable in this case - - applying the 31l-percent minority discount rate to this share value results in a value of dollar_figure per share accordingly we hold that petitioner’s shares were worth dollar_figure each on the valuation_date in keeping with our holding decision will be entered under rule


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom p si 1-plr-118012-99 date date legend x state d1 this responds to your letter dated date submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code facts x began doing business under state law on d1 x’s shareholders intended that x be a subchapter_s_corporation effective d1 however an s_corporation_election to be treated as an s_corporation was not timely filed law and analysis sec_1362 provides that a small_business_corporation can elect to be treated as an s_corporation sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation’s taxable_year then that corporation will be treated as an s_corporation for the year in which the election was made if an s election is made after the first two and one-half months of a corporation’s taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made plr-118012-99 sec_1362 provides that if an election under sec_1362 is made for any taxable_year after the date prescribed for making such election for such taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make the election then the secretary can treat the election as timely made for such taxable_year x’s s_corporation_election was not filed timely for the election to be effective as of d1 nevertheless x has established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and assuming that x otherwise qualifies as a subchapter_s_corporation as of d1 we conclude that x will be recognized as an s_corporation effective as of d1 x should file a completed form_2553 with a copy of this ruling attached reflecting its election of subchapter_s_corporation status as of d1 with the applicable service_center within days of the date of this letter except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed concerning whether x otherwise satisfies the s_corporation eligibility requirements this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely signed david r haglund david r haglund senior technician reviewer branch office of assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number --------------------------------------------------- -------------------------- ----------------------------------- --------------------------------------------------- --------- --------------------------------------------------- ------------------------------------------------------------ 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 intl b06 plr-123879-17 date date ty -------- --------------------------------------------------- ------------------------------- --------------------------------- ----------------- --------------------------- ------- ---------------------- ------------------------- legend taxpayer accounting firm company date date year individual shareholder dear ------------ this responds to a letter dated date supplemented by a letter dated date submitted by your representatives requesting that the internal_revenue_service service grant taxpayer an extension of time under sec_301_9100-1 and sec_301_9100-3 to file form 4876-a election to be treated as an interest_charge_disc for year taxpayer’s first taxable_year the ruling contained in this letter is based upon information and representations submitted by taxpayer and accompanied by affidavits and penalty of perjury statements executed by appropriate parties this office has not verified any of the materials submitted in support of the request for a ruling it is subject_to verification on examination plr-123879-17 facts on date taxpayer was formed to serve as an interest charge domestic_international_sales_corporation ic-disc taxpayer is a domestic_corporation that is wholly owned by company company is a limited_liability_company owned by individual and shareholder taxpayer was formed in order to sell industrial products of company to international buyers on a commission basis in year taxpayer engaged accounting firm for assistance with arranging for taxpayer to qualify as an ic-disc accounting firm mistakenly believed that a third party had been tasked with the completion and filing of form 4876-a due to this miscommunication a form 4876-a was not submitted to the service in a timely fashion as a result the form 4876-a was not filed within days after date accounting firm was instructed to file taxpayer’s year tax_return for the short taxable_year starting date and ending date accounting firm assuming that form 4876-a had been timely filed filed form_1120 ic-disc for year with the service taxpayer subsequently learned that the service had no record of the filing of a form 4876-a taxpayer then instructed accounting firm to file a request for a ruling granting an extension of time to file form 4876-a for year its first taxable_year law and analysis sec_992 of the sec_1 provides that an election by a corporation to be treated as a disc2 shall be made by such corporation for a taxable_year at any time during the 90-day period immediately preceding the beginning of the taxable_year except that the secretary may give his consent to the making of an election at such other times as he may designate sec_992 provides that such election shall be made in such manner as the secretary shall prescribe and shall be valid only if all persons who are shareholders in such corporation on such first day of the first taxable_year for which such election is effective consent to such election temporary sec_1_921-1t provides in part that a corporation electing ic-disc status must file form 4876-a and that a corporation electing to be treated as an ic-disc for its first taxable_year shall make its election within days after the beginning of that year sec_301_9100-1 provides in part that the commissioner in exercising the commissioner’s discretion may grant a reasonable extension of time all section references are to the internal_revenue_code as used in this letter the terms ic-disc and disc have the same meaning plr-123879-17 under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election under all subtitles of the code except subtitles e g h and i sec_301_9100-1 provides that a regulatory election is an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin for this purpose an election includes an application_for relief in respect of tax sec_301_9100-3 provides that requests for extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 automatic extensions must be made under the rules of sec_301_9100-3 requests for relief subject_to sec_301_9100-3 will be granted when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that the grant of relief will not prejudice the interests of the government in the present situation the election described in temp sec_1_921-1t is a regulatory election as defined in sec_301_9100-1 therefore the commissioner has discretionary authority under sec_301_9100-1 to grant taxpayer an extension of time provided that taxpayer satisfies the standards for relief set forth in sec_301_9100-3 based on the facts and representations submitted with taxpayer’s ruling_request we conclude that taxpayer satisfies sec_301_9100-3 accordingly taxpayer is granted an extension of time of days from the date of this ruling letter to file form 4876-a such filing will be treated as a timely election to be treated as an ic-disc for taxpayer’s first taxable_year the granting of an extension in this ruling letter is not a determination that taxpayer is otherwise eligible to make the election or to claim ic-disc status or benefits see sec_301_9100-1 taxpayer should attach a copy of this ruling letter to its form 4876-a and federal_income_tax return for the taxable years to which this letter applies this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent 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 plr-123879-17 in accordance with the power_of_attorney on file with this office a copy of this ruling letter is being sent to your authorized representative sincerely _____________________________________ robert z kelley assistant to the branch chief branch office of associate chief_counsel international enclosures copy of this letter copy for sec_6110 purposes cc


department of the treasury internal_revenue_service washington d c contact person identification_number contact number employer_identification_number form required to be filed tax years all years tax_exempt_and_government_entities_division number release date date date vil dear this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final since you do not qualify for exemption as an organization described in code sec_501 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions you should follow the instructions in notice if you agree with our deletions you do not need to take any further action in accordance with code sec_6104 we will notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements letter cg catalog number if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service pincite-829-1040 or the irs customer service number for businesses the irs customer service number for people with hearing impairments is if you have any questions about your sincerely lois lerner director exempt_organizations letter cg catalog number 47632s department of the treasury internal_revenue_service washington d c tax exempt ano government entities division date date legend b president founder d related for-profit company e for-profit company m for-profit company x date y state z state dear contact person identification_number contact number fax number employer_identification_number vil dollar_figure dollar_figure we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code sec_501 based on the information provided we have concluded that you do not qualify for exemption under code sec_501 the basis for our conclusion is set forth below issues are you operated exclusively for purposes described in sec_501 no for the reasons set forth below facts your board_of directors consists of your founder b and a related individual b is also the founder and owner of d a for-profit business that engages in the sale of electrical materials aggregates supplies and rental equipment through the company d b began a process to obtain substantial grant funding by entering into a contract with e a for-profit grant company in the contract b agreed to pay e dollar_figure for their service and requested a grant of dollar_figure the contract in pertinent part stated letter cg catalog number 47630w the service provided by e with this agreement is for research letter writing and grant writing this service is for a consecutive twelve month period beginning on the date on this agreement or the date on the client’s check whichever date comes first if e does not generate a grant within twelve months for the above mentioned client e will provide a second consecutive twelve months of service at no additional_charge the total cost of this service is dollar_figure also referred as the retainer amount the total grant amount awarded must be a minimum of dollar_figure for the balance to be due you the client agree to all of the terms of this agreement in its entirety as for governing law both parties agree that this is a business transaction and that this agreement shall be construed and enforced according to the laws of the state of y and any dispute under this agreement must be brought in this venue and no other if the client requests supplementary services additional cost charges may apply the retainer fee is non-refundable due to the nature of the services provided by e during the contract period b was told by e that in order to receive the grant funding a non- e told b that after the profit organization would have to be formed to receive of the grant non-profit was formed a grant in the amount of dollar_figure would be released b then entered into a second agreement with e to form you and paid e an additional dollar_figure this agreement stated in pertinent part non-profit corporation we will prepare and file with the secretary of state articles of incorporation including the filing fee for the articles as well as we will serve as your resident agent for one year you will receive your corporate charter your filed articles a corporate minutes book that includes your by-laws some sample minutes the corporate seal and your corporate ein application form_1023 completion we will facilitate the completions of all necessary documents and forms the primary form is the and submit them on your behalf to the internal_revenue_service you will be responsible for any irs filing fees we will provide counseling guidance and support throughout the process and after filing with the irs will interact with them on your behalf answering any questions they pose we will also file with the state of y a how to use your non-profit cd will also be sent to you paralegal services we will provide consulting and guidance to show you how to operate your corporation of your corporation and keys to help you function within the corporate environment this includes documentation as well as a manual on how to maximize the benefits the agreement was also accompanied by the following statement hereby understand and agree that e cannot provide me with tax_advice further agree that am not applying for non-profit status for the purposes of a tax_shelter or tax_avoidance purposes understand and agree that these services am purchasing are not consumer purchases regulated under state federal consumer fraud statutes nor are these services a product service that can be returned for a refund therefore all sales are final also understand and agree that e is not responsible for any illegal acts misuse or abuse of the corporation to be formed on my behalf letter cg catalog number 47630w the agreement was signed by b as a result of the agreement you were incorporated under the laws of the state of y on x your articles of incorporation state that your purpose is to be a nonprofit public benefit entity that is not organized for the private gain of any person your operations will be conducted in the state of z your initial application_for exemption describes your purpose as being to strengthen communities focusing on families children and education you provide financial resources to non-profit organizations in the area and fund projects that enhance the community and small businesses you continued by stating you are located in a rural_area that does not have resources for community centers playgrounds and educational needs and you will provide funds to assist in the development of these types of programs and projects you have no plans to be involved with any other non-profit organization but you may consider giving donations to two organizations in your area in the future you also stated that you will only give funds to other c organizations your application showed anticipated revenue of dollar_figure annually from grants your projected expenses were substantially lower than anticipated revenue and showed that your main expenses were for compensation to officers and occupancy expense when you were asked for more information regarding these expenses you stated that the financial data was prepared by e that you had no intention of paying salaries and that you do not have a facility however you intend to use the non-profit funds you receive to reimburse b the dollar_figure that was spent in filing fees to create you you stated that you only applied for tax-exempt status under the instructions of e for the purpose of securing grant money for d according to you e said the irs want sec_5 of the grant money to go to non-profit organizations and this could not be accomplished unless you were created you made it clear during the application process that you were formed in order to enable d to receive grant funding d will receive of grants awarded and you will receive the other law sec_501 of the internal_revenue_code provides in part for the exemption from federal_income_tax of organizations organized and operated exclusively for charitable religious or educational_purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 a of the federal tax regulations provides that in order for an organization to be exempt under sec_501 of the code it must be both organized and operated exclusively for one or more of the purposes specified in such section organization fails to meet either the organizational or operational_test it is not exempt if an sec_1_501_c_3_-1 of the regulations provides an organization is not operated exclusively for one or more exempt purposes if its net_earnings inure in whole or in part to the benefit of private shareholders or individuals letter cg catalog number 47630w sec_1_501_c_3_-1 of the regulations provides an organization is not organized and operated exclusively for one or more exempt purposes unless it serves a public rather than private interests thus to meet the requirement it is necessary for an organization to establish that it is not organized and operated for the benefit of private interests such as designated individuals the creator or his family shareholders of the organization or persons controlled directly or indirectly by such private interests 326_us_279 the supreme court of the united_states interpreted the requirement in sec_501 that an organization be operated exclusively by indicating that an organization must be devoted to exempt purposes exclusively this plainly means that the presence of a single non-exempt purpose if substantial in nature will destroy the exemption regardless of the number and importance of truly exempt purposes 35_tc_490 held that inurement occurred when an organization entered a transaction to benefit the stockholders of a particular business corporation not to benefit the charity even though the corporation suffered no financial loss where an exempt_organization engages in a transaction with an insider and there is a purpose to benefit the insider rather than the organization inurement occurs even though the transaction ultimately proves profitable for the exempt_organization the fest is not ultimate profit or loss but whether at every stage of the transaction those controlling the organization guarded its interests and dealt with related parties at arm’s-length in international postgraduate medical foundation v commissioner tcmemo_1989_36 the tax_court considered the qualification for exemption under sec_501 of the code of a nonprofit corporation that conducted continuing medical education tours the petitioner had mr helin who was a shareholder and the president of h c tours a for profit three trustees travel agency mr regan an attorney and a third director who was ill and did not participate mr helin served as executive director the petitioner used h c tours exclusively for all travel arrangements the court found that a substantial purpose of the petitioner was benefiting the for-profit travel agency it concluded that there is no evidence that the petitioner ever sought a competitive bid when a for-profit organization benefits substantially from the manner in which the activities of a related_organization are carried on the latter organization is not operated exclusively for exempt purposes within the meaning of sec_501 even if it furthers other exempt purposes application of law you are not described in sec_501 of the code because you are not operated exclusively for religious charitable or other purposes specified in the statute and your net_earnings inure to the benefit of private individuals catalog number 47630w although you meet the organizational_test you do not satisfy the requirements of sec_1 c -1 a of the income_tax regulations because you do not meet the operational_test letter cg you are not operated exclusively for one or more exempt purposes as set forth in sec_1_501_c_3_-1 of the regulations because your net_earnings inure to the benefit of d and therefore d’s shareholders the facts show that your president and founder b is also the owner of d benefit in the form of of the grant funds intended for you increase revenue and grow its business thus as a result of d’s relationship with you d receives the benefit of increased revenue this situation leads to inurement of earnings accruing to b through d as aresult of your activities and grant funding d is receiving substantial private d will use these funds to you are not operating exclusively for exempt purposes as described in sec_1 c - d ii of the income_tax regulations because you serve private interests including benefiting the persons who created you as explained above the fact that of the grant funding intended for you will go to d clearly shows that your activities substantially serve private interests moreover since your founder is also the owner of d your activities directly benefit the person who created you you are similar to the organization in 326_us_279 in that you are not operated exclusively for exempt purposes although you do have some charitable activities in the form of providing funds to other c organizations you are substantially involved in furthering the private interests of your president and founder b through his for-profit company d available to be used for your charitable purposes because of grant funds will go directly to d for exemption under sec_501 of the code like the organization in the court case this single nonexempt purpose destroys your claim in fact only of grant funding will be you are like the organization in 35_tc_490 while it is true that receiving of the grant funding ultimately proves profitable to you it is obvious you have a purpose to benefit an insider b the fact that of grant money is forwarded on to the related for-profit company shows that you are not guarding your own interests at every stage of the transaction as described in the above court case all of this is substantiated by your statement that you were only formed to enable d to receive grant funding you are similar to the organization in international postgraduate medical foundation v commissioner tcmemo_1989_36 in that you have a substantial purpose of benefiting a related for-profit company because you were formed for the substantial purpose of enabling d to receive grant funding d benefits substantially from the manner in which your activities are carried on therefore you are not operated exclusively for exempt purposes as described in sec_501 applicant’s position you stated you filed everything under the direction of e and the actual form_1023 was completed by m your main purpose is to be a resource for people small businesses and communities you state you will provide financial resources to non-profit organizations in your area you will fund projects that enhance the community focusing on small businesses children families health and education you continued by stating your small businesses will benefit from your assistance by providing the support to grow and create jobs for individuals letter cg catalog number 47630w service response to applicant’s position even if a portion of your activities are deemed charitable you have a substantial non-exempt purpose of providing funding to a for-profit company substantially_all of your grant revenue will go directly to d which is owned by your founder b not only is this a substantial non-exempt activity but it also provides direct private benefit to d and therefore b since b is your founder and president this constitutes inurement therefore you are precluded from exemption under sec_501 of the code it is important to note that b established you with the sole intention of receiving grants earmarked for you and forwarding of those funds on to his for-profit company d conclusion your primary purpose and reason for existence is to obtain grants for d a for-profit organization owned and operated by your founder b this constitutes a substantial non-exempt activity and provides private benefit and inurement to d and b accordingly you are not operated exclusively for purposes described in sec_501 and you do not qualify for exemption you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination if your statement does not provide a basis to reconsider our determination we will forward your case to our appeals_office you can find more information about the role of the appeals_office in publication exempt_organization appeal procedures for unagreed issues types of information that should be included in your appeal can be found on page of publication under the heading regional_office appeal’ must be accompanied by the following declaration the statement of facts item under penalties of perjury declare that have examined the statement of facts presented in this appeal and in any accompanying schedules and statements and to the best of my knowledge and belief they are true correct and complete the declaration must be signed by an officer or trustee of the organization who has personal knowledge of the facts your appeal will be considered incomplete without this statement if an organization’s representative submits the appeal a substitute declaration must be included stating that the representative prepared the appeal and accompanying documents and whether the representative knows personally that the statements of facts contained in the appeal and accompanying documents are true and correct letter cg catalog number 47630w an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you during the appeal process if you want representation during the appeal process you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not already done so you can find more information about representation in publication practice_before_the_irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to appeal as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do not need to take any further action if we do not hear from you within days we will issue a final adverse determination_letter that letter will provide information about filing tax returns and other matters please send your protest statement form_2848 and any supporting documents to the applicable address mail to deliver to internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance main street room cincinnati oh you may fax your statement using the fax number shown in the heading of this letter if you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely robert s choi director exempt_organizations rulings agreements enclosure publication letter cg catalog number 47630w