internal_revenue_service number release date index number --------------------- --------------------------------------------- ------------------------------------ ------------------------ -------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------------- id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-109923-05 date date ----------------------------------------------------------------------------------------------------- ----------------------- --------------- ------------------------- -------------------- ----------------------- -------------------------- ---------------------- ----------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------- ------------------------ ------------------------ ------------------------ ------------------------ - x a b c d1 d2 d3 trust trust trust trust a an officer of x represents that an election was made for x to be an s this letter responds to a letter dated date submitted on behalf of x plr-109923-05 dear -------------- by its authorized representative requesting relief under ' f of the internal_revenue_code corporation effective d1 the shareholders of x include trust sec_1 through collectively the trusts each of which is represented to be an electing_small_business_trust esbt within the meaning of sec_1361 and sec_1361 and which is not an eligible s_corporation shareholder under another provision of sec_1361 under the terms of each of the trusts b and b’s spouse are eligible to receive current distributions of trust property pursuant to a power_of_appointment held by the primary beneficiary of each trust b was not married at the time of the creation of the trusts on d2 which was in a taxable_year beginning on or before date b married c a nonresident_alien b and c have not filed an election under sec_6013 or h to treat c as a resident_of_the_united_states for any taxable_year as b’s spouse c became a potential_current_beneficiary of each of the trusts as a nonresident_alien c is not an eligible s_corporation shareholder therefore x’s s_corporation_election terminated on d2 when x discovered that the ability of c to receive distributions from the trusts terminated x’s s_corporation_election it contacted the beneficiaries of the trusts who each executed a substantially identical release represented as being valid under local law providing that the beneficiary irrevocably and permanently released the right to exercise the power_of_appointment during that beneficiary’s lifetime or upon that beneficiary’s death in favor of any i non-resident alien within the meaning of sec_1361 ii nonresident_alien who has made an election pursuant to sec_6013 or h to be treated as a resident_of_the_united_states or iii other person who if that person were a permissible appointee of the power_of_appointment would cause any s_corporation in which the trust owns stock to cease to be a small_business_corporation as defined in sec_1361 the last of the four releases was executed d3 which was in a taxable_year beginning on or before date by tax_avoidance or retroactive tax planning x and its shareholders have agreed to make any adjustments that the commissioner may require consistent with the treatment of x as an s_corporation a represents that the termination of x’s s_corporation_election was not motivated sec_1361 of the code provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under ' a is in effect for such year plr-109923-05 sec_1361 provides that the term small_business_corporation means a domestic_corporation which is not an ineligible_corporation and which does not have as a shareholder a person other than an estate a_trust described in ' c or an organization described in sec_1361 who is not an individual sec_1362 provides that in general an election to be treated as an s_corporation shall be terminated whenever at any time on or after the first day of the first taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1361 provides that for purposes of ' b b an esbt may be a shareholder of an s_corporation sec_1361 provides that in the case of an esbt each potential_current_beneficiary pcb of such trust shall be treated as a shareholder for purposes of ' b except that if for any period there is no pcb of such trust such trust shall be treated as the shareholder during such period sec_1361 defines an esbt sec_1361 prior to its modification by of the american_jobs_creation_act_of_2004 p l provided that for purposes of ' e the term apotential current beneficiary meant with respect to any period any person who at any time during such period is entitled to or at the discretion of any person may receive a distribution from the principal or income of the trust this definition applied to taxable years beginning on or before date sec_1_1361-1 of the income_tax regulations provides that if the holder of a power_of_appointment permanently releases the power in a manner that is valid under the applicable local law the persons that would be pcbs solely because of the power will not be pcbs after the effective date of the release sec_1362 provides that if an election under ' a by any corporation a was not effective for the taxable_year for which made determined without regard to ' b by reason of a failure to meet the requirements of ' b or to obtain shareholder consents or b was terminated under ' d or the secretary determines that the circumstances resulting in the ineffectiveness or termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in the ineffectiveness or termination steps were taken a so that the corporation is a small_business_corporation or b to acquire the shareholder consents and the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to ' f agrees to make such adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in the ineffectiveness or termination the corporation will be treated as an s_corporation during the period specified by the secretary plr-109923-05 a citizen or resident_of_the_united_states may be treated as a resident_of_the_united_states for purposes of chapter of subtitle a of title_26 if the nonresident_alien and spouse so elect sec_6013 and h provide in general that a nonresident_alien married to based solely on the facts submitted and the representations made we conclude that x’s s_corporation_election terminated on d2 when c became a pcb of the trusts we further conclude that the termination constituted an inadvertent termination within the meaning of sec_1362 we further hold that pursuant to the provisions of sec_1362 x will be treated as continuing to be an s_corporation from d2 to d3 and thereafter provided x’s s_corporation_election was otherwise valid and provided that the election was not otherwise terminated under sec_1361 the trusts will be treated as trusts described in sec_1361 and sec_1361 c will not be treated as a pcb of any of the trusts subsequent to the effective date of the releases executed by the trust beneficiaries unless and until c becomes a united_states citizen the shareholders of x must include their pro-rata share of the separately_stated and nonseparately computed items of x as provided in sec_1366 make any adjustments to basis as provided in sec_1367 and take into account any distributions made by x as provided in sec_1368 if x or its shareholders fail to treat themselves as described above this ruling is null and void we further rule that any election by b and c under sec_6013 or h or any subsequent termination of such election will not have any effect on the relief granted above no other opinion is expressed or implied concerning the effect or validity of any election under sec_6013 or h or subsequent termination of such election except as specifically ruled above we express no opinion concerning the federal tax consequences of the transactions described above under any other provisions of the code specifically no opinion is expressed whether x is otherwise eligible to be an s_corporation or whether the trusts are otherwise eligible to be esbts this ruling is directed only to the taxpayer that requested it sec_6110 provides that it may not be used or cited as precedent plr-109923-05 pursuant to a power_of_attorney on file a copy of this letter is being sent to x’s authorized representative sincerely j thomas hines chief branch office of the associate chief_counsel passthroughs special industries copy of this letter copy for sec_6110 purposes enclosures ------------------------------------------------------ ------------------------------------------------------------------------------------------------ ------------------------------------------------------- -------------------------------- -------------------------------------------- ------------------------ ---------------------------------------- ------------------------------------------


t c memo united_states tax_court william j broedel and joan c broedel petitioners v commissioner of internal revenue respondent docket no filed date william j broedel and joan c broedel pro sese anne d melzer edward d fickess and john d steele jr for respondent memorandum findings_of_fact and opinion ruwe judge respondent determined a deficiency of dollar_figure in petitioners’ joint federal_income_tax the issues for decision are whether dollar_figure received from the state university of new york institute of technology in is excludable from petitioners’ gross_income under section - - a and whether petitioners realized dollar_figure in income in from the new york state and local retirement_system findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts the supplemental stipulation of facts the second supplemental stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners mr broedel and mrs broedel resided in marcy new york at the time they filed their petition mr broedel served in new york state law enforcement for approximately years the last years as a lieutenant with the public safety department at the state university of new york institute of technology suny in rome new york in and suny issued several notices of discipline to mr broedel for alleged misconduct in september of suny proposed terminating mr broedel’s employment for disciplinary reasons on date mr broedel filed a formal complaint with the new york state division of human rights nysdhr charging suny with an unlawful discriminatory practice relating to employment in violation of article of the executive law of the state of new york human rights law because of age and ‘unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue disability the complaint alleged that during and suny had repeatedly harassed and discriminated against mr broedel and pressured him to retire the complaint alleged injuries of financial loss pain and mental anguish the complaint was later crossfiled with the equal employment opportunity commission eeoc a hearing was scheduled for date before william babiskin mr babiskin an impartial arbitrator regarding the notices of discipline issued to mr broedel on the day of the hearing mr broedel richard lesniak mr lesniak and robert patterson mr patterson met with richard hasselbach mr hasselbach the attorney representing suny’s interests and anthony panebianco mr panebianco the director of human resources for suny and authorizing official with respect to any settlement amount suny would pay to discuss the possibility of a settlement the parties agreed that mr broedel would retire immediately in exchange for an amount equal to one and one-half times mr broedel’s annual salary the parties then met with mr babiskin and the terms of the settlement agreement were written out by him and incorporated into a consent award the complaint alleged that harassment by suny caused mr broedel to be hospitalized for stress and high blood pressure 7richard lesniak was mr broedel’s union steward robert patterson was a union representative the consent award provided grievant william broedel will be paid back pay and all attendant benefits retroactive to date grievant shall be entitled to a lump sum cash payment equivalent to one and one-half times his present annual salary rate said payments shall be made in two equal installments the first payment shall be made on or before date the second payment shall be made on or after date grievant william broedel will retire effective date grievant will execute a general release to the state university of new york relieving the university its officers agents employees and students of any and all liability arising out of and or in connection with his employment with the state university of new york said release shall be executed forthwith grievant’s complaint before the human rights commission is deemed withdrawn with prejudice and the commission shall be notified in writing accordingly any and all notices of discipline issued against grievant are hereby withdrawn with prejudice the parties will draft a mutually acceptable letter of reference concerning grievant’s employment by suny the arbitrator will retain jurisdiction to monitor compliance with the terms and conditions of this award the consent award was signed by mr babiskin and dated date in accordance with the settlement agreement mr broedel withdrew his complaints against suny and retired under the terms of the settlement agreement the amount mr broedel was to receive was allocated between backpay and attendant benefits and an amount equal to one and one-half times his - - annual salary neither the united_states nor any of its individual agencies were contacted or made a part of the settlement process between mr broedel and suny in mr broedel received two equal payments of dollar_figure from suny as required by paragraph of the consent award the first payment was dated date and the second payment was dated date in february of mr broedel received a form 1099-misc miscellaneous income from the state of new york reflecting nonemployee compensation_for of dollar_figure a dispute arose over whether mr broedel was paid the proper amount under paragraph of the settlement agreement mr broedel argued that the amount was supposed to be tax free and that the state of new york had improperly coded one of the two payments required under the settlement agreement resulting in the issuance of a form 1099-misc to mr broedel on date mr babiskin issued a supplemental opinion and award no which addressed this dispute the relevant portions of the opinion provided the parties agree that the amount of dollar_figure represents one and one-half times mr broedel’s annual salary the form and taxability of the portion of the settlement award attributable to backpay and attendant benefits are not at issue on date mr babiskin issued a supplemental opinion and award addressing an issue not relevant to this proceeding the consent award was the complete agreement of the parties the claim that the payments were to be tax free is without merit it flies in the face of the clear language of the stipulated settlement that led to issuance of the consent award under the terms of the consent award grievant was entitled to two equal lump sum payments the payments in the appropriate amounts were made pursuant to the consent award furthermore the tax status of the payments must be determined by the internal_revenue_service and the department of taxation and finance i have no authority to issue exemptions to anyone let alone mr broedel it appears that mr broedel has received every dime he is entitled to if he has a tax_liability that is a matter to be worked out between grievant and the tax collectors tt is not my function to ignore the clear-cut language and interpret same as if it said something else by reason of the foregoing i issue the following the payments under the consent award were not intended to be tax free grievant has not been underpaid there are no additional monies owed to grievant before his retirement on date mr broedel took out a loan from the new york state and local retirement_system nyrs against his retirement_funds on date the nyrs sent mr broedel a letter indicating that he had an outstanding loan balance and that he had the option of repaying the balance before date if he did not repay the loan mr broedel’s annual pension would be reduced mr broedel did not repay the loan in the nyrs issued mr broedel a form 1099-r distributions from pensions annuities retirement or profit-sharing_plans iras insurance contracts etc indicating taxable pension income of dollar_figure the amount represented the outstanding loan balance as of mr broedel’s retirement date petitioners did not report the dollar_figure on their form_1040 u s individual_income_tax_return petitioners did not include the dollar_figure in payments received under paragraph of the settlement agreement in gross_income on their return however receipt of the two payments totaling dollar_figure was fully disclosed on an attached form_8275 disclosure statement signed by mr broedel in the form_8275 mr broedel claimed that the payments were intended to be a tax-free award and that the form 1099-misc from the state of new york was erroneously sent to him before trial the parties stipulated an affidavit made by mr babiskin in the affidavit mr babiskin stated that the settlement agreement constituted the complete agreement between the parties and the subject of mr broedel’s health and or physical condition was not discussed in mr babiskin’s presence opinion respondent argues that petitioners’ gross_income for must be increased by dollar_figure to reflect the amount received under paragraph of the settlement agreement and dollar_figure to reflect income from the satisfaction of mr broedel’s loan from the nyrs petitioners claim that the amount received under the settlement agreement is excludable from gross_income under sec_104 and was intended by the parties to the settlement agreement to be tax free and that petitioners did not realize income in when mr broedel’s loan from the nyrs was satisfied taxability of settlement proceeds respondent determined that petitioners’ gross_income should be increased by dollar_figure to account for the amount received under paragraph of the settlement agreement with suny petitioners argue this amount is excludable from income under sec_104 because it was paid to settle mr broedel’s claim against suny pursuant to the americans with disabilities act of ada publaw_101_336 104_stat_328 for infliction of emotional distress and to avoid litigation of the complaint petitioners claim that suny had repeatedly harassed mr broedel and damaged his reputation petitioners also contend --- - that the amount of the settlement was negotiated by the parties and was intended to be tax free gross_income does not include the amount of any damages received on account of personal injuries or sickness see sec_104 ’ the term ‘damages received whether by suit or agreement ’ means an amount received through prosecution of a legal suit or action based upon tort or tort type rights or through a settlement agreement entered into in lieu of such prosecution sec_1_104-1 income_tax regs in order for damages to be excludable from gross_income under sec_104 the taxpayer must demonstrate that the underlying cause of action is based upon tort or tort type rights and the damages were received on account of personal injuries or sickness see 515_us_323 where amounts are received pursuant to a settlement agreement the nature of the claim that was the actual basis for settlement and not its validity controls whether such amounts are excludable from gross_income under sec_104 see 58_tc_32 t he critical question ‘the small_business job protection act of publaw_104_ sec a 110_stat_1838 amended sec_104 to limit the exclusion inter alia to personal physical injuries or physical sickness the amendment does not apply to damages collected before the date of its enactment and has no bearing here -- - is in lieu of what was the settlement amount_paid 105_tc_396 affd 121_f3d_393 8th cir the settlement agreement allocated payments for backpay and attendant benefits and for an amount equal to one and one-half times mr broedel’s annual salary the form and taxability of the amount allocated to the backpay and attendant benefits are not at issue because the remaining portion of the settlement agreement dollar_figure is not allocated among petitioners’ various claims we will examine the nature of each claim in turn initially we address petitioners’ claim that mr broedel suffered injury to his reputation because of harassment by suny the consent award and the complaint do not refer to any claim by mr broedel alleging harm to his reputation as the result of harassment by suny nor is there an allocation to such a claim in the consent award petitioners have failed to present any evidence establishing that suny paid any portion of the settlement amount to compensate mr broedel for injury to his reputation mr broedel’s complaint for relief was based on both state and federal_law the complaint raised allegations under the age discrimination in employment act of adea publaw_90_202 81_stat_602 recovery under the adea is not based upon tort or tort type rights see commissioner v schleier supra pincite thus any portion of mr broedel’s claim allocated to violations under the adea would be taxable respondent concedes that mr broedel’s complaint with the nysdhr alleging that he was the victim of age and disability discrimination prohibited by new york state law is based upon tort or tort type rights however respondent argues that petitioners have failed to show that the settlement proceeds were received on the account of personal_injury_or_sickness petitioners claim that mr broedel had a bona_fide claim against suny under the ada for infliction of emotional distress although the complaint fails to indicate that a claim under the ada was being made it does allege discrimination because of disability to the extent a claim was made under the ada respondent concedes that such a claim sounds in tort see eg phillips v commissioner tcmemo_1997_336 finding that for purposes of the motion before the court the taxpayer had established that a claim for relief under the ada was based on a tort type cause of action in order to exclude any portion of the dollar_figure under sec_104 petitioners must show that the payments were received on account of personal injuries or sickness and they must establish what portion of the payments if any was paid on account of personal injuries or sickness arising from tort or tort type rights generally when a settlement agreement deals with different claims and does not allocate the proceeds to specific claims and there is no evidence that a specific claim was meant to be singled out the entire amount is considered taxable see 35_f3d_93 2d cir reisman v commissioner tcmemo_2000_173 affd without published opinion 248_f3d_1151 6th cir sherman v commissioner tcmemo_1999_202 morabito v commissioner tcmemo_1997_315 sodoma_ v commissioner tcmemo_1996_275 affd without published opinion 139_f3d_899 5th cir where a settlement agreement lacks express language stating that the payment was or was not made on account of personal injury the most important factor in determining the application of sec_104 is the intent of the payor in making the payment see 290_f2d_283 2d cir affg per curiam tcmemo_1960_21 88_tc_834 affd without published opinion 845_f2d_1013 3d cir on the day of the hearing regarding the notices of discipline mr broedel mr lesniak and mr patterson met with mr hasselbach and mr panebianco suny’s authorizing official for the settlement agreement to discuss the possibility of a settlement as a result of the meeting mr broedel agreed to retire immediately in exchange for an amount equal to one and one-half times his annual salary the parties then met with mr babiskin and the terms of the settlement agreement were written out by him and incorporated into a consent award the consent award refers to mr broedel’s early retirement the withdrawal of disciplinary actions against mr broedel the withdrawal of mr broedel’s complaints and a general release to suny of any and all liability arising out of and or in connection with mr broedel’s employment with suny the consent award does not refer to any personal injuries or sickness suffered by mr broedel nor does it make any allocation of the settlement payments among mr broedel’s various claims mr panebianco testified that suny’s only concern in reaching a settlement with mr broedel was the payment of one and one-half times mr broedel’s annual salary for him to retire and withdraw his complaints mr lesniak mr broedel’s union steward admitted that the payments were made so that mr broedel would retire mr broedel testified that during the negotiations there was no allocation of the settlement amount among his different claims finally mr babiskin’s affidavit states that the settlement agreement constituted the complete agreement between the parties and that the subject of mr broedel’s health and or physical condition was not discussed in mr babiskin’s presence petitioners have failed to show that suny intended any portion of the payments to compensate mr broedel for personal injuries or sickness based upon tort or tort type rights petitioners’ main argument is that the payments to mr broedel were intended by the parties to be tax free mr broedel and mr lesniak both testified that it was their understanding that the amount received under paragraph of the settlement agreement was tax free petitioners also presented substantial evidence in the form of letters written by mr broedel and mr lesniak to several state and federal officials in which they maintain that the settlement agreement required mr broedel to receive tax free payments the consent award does not provide that the payments were intended to be tax free additionally the testimony of mr panebianco and the supplemental opinion and award no rendered by mr babiskin both indicate that the condition that the payments be tax free was not part of the settlement agreement petitioners also argue that the form 1099-misc in the amount of dollar_figure was issued as the result of improper coding and that if the payments had been intended to be taxable then petitioners would have received a second form 1099-misc reflecting the other payment however it is just as possible that a second form 1099-misc was not sent by the state of new york because error caused only one payment to be coded as taxable when both payments were intended to be coded as taxable we note that even if the parties intended the payments to be tax free this does not necessarily mean that they are excluded -- - from gross_income under sec_104 the relevant inquiry is whether the claim is based upon tort or tort type rights and the damages received are on account of personal injuries or sickness see commissioner v schleier u s pincite furthermore neither the internal_revenue_service nor any other agency of the united_states consented to a settlement agreement awarding mr broedel tax free payments the amount_paid to mr broedel under the settlement agreement was equal to one and one-half times his annual salary the evidence in the record indicates that suny’s intent in settling with mr broedel was to induce his retirement and effect the withdrawal of any and all complaints against suny as we stated earlier mr broedel’s complaint filed with the nysdhr included various claims not all of these claims were based upon tort or tort type rights the settlement agreement did not allocate the payments among his claims and petitioners have failed to establish what portion if any was paid on account of personal injuries or sickness arising from tort or tort type rights indeed the fact that the amount of dollar_figure was based on the amount mr broedel would have received had he continued working another year and a half points in the direction of payment for reasons other than personal_injury_or_sickness see eg bland v commissioner tcmemo_2000_98 morabito v commissioner supra sodoma v commissioner supra webb v - commissioner tcmemo_1996_50 accordingly we hold that the entire dollar_figure is includable in petitioners’ gross_income income from satisfaction of mr broedel’s loan against his retirement account respondent argues that petitioners received income in because of the satisfaction of mr broedel’s outstanding loan against his nyrs retirement account petitioners argue they did not realize income because the nyrs deducted the loan amount from mr broedel’s retirement account when it was not repaid at the time of his retirement mr broedel had an outstanding loan against his retirement_funds mr broedel was given the option of repaying the loan mr broedel chose not to repay the loan and the nyrs apparently satisfied the loan by deducting the loan balance from mr broedel’s retirement account balance the nyrs issued mr broedel a form 1099-r for reflecting a taxable_amount of dollar_figure representing the outstanding loan balance petitioners did not report this amount on their tax_return petitioners did not present testimony at trial on this issue and they did not argue this issue on brief petitioners addressed this issue only in their petition and trial memorandum in which they claim that the loan amount was repaid because the nyrs deducted the loan amount from mr broedel’s retirement account sec_61 defines gross_income as all income from whatever source derived petitioners offered no evidence or argument to support any claim that the use of funds from mr broedel’s nyrs retirement account to satisfy his loan was not taxable_income on the basis of the evidence before us we hold that petitioners realized dollar_figure decision will be entered for respondent


release number release date internal_revenue_service te_ge technical_advice_memorandum uil date area manager - taxpayer's name taxpayer’s address taxpayer's identification_number years involved conference held legend t issues whether funds derived by t a state-chartered credit_union described in sec_501 of the internal_revenue_code from the sale of credit life and credit disability insurance should be treated as unrelated_business_taxable_income under sec_511 of the internal_revenue_code facts established in t is a state-chartered credit_union which is recognized as exempt from federal_income_tax under sec_501 of the internal_revenue_code code as an organization described in sec_501 t's board_of directors supervisory committee and loan committee are comprised entirely of elected members of the credit_union who serve on a voluntary basis without compensation t’s purposes as stated in its articles of incorporation are to promote thrift and provide low cost credit for its members t’s activities include accepting deposits from and maintaining the accounts and savings of its members these deposit accounts include savings or share accounts on which members earn periodic dividends credited to the accounts and share draft accounts which are transaction accounts similar to bank checking accounts t represents that its day-to-day business operations differ from conventional banking institutions in several ways t states that it conducts its business to reflect its non-profit mutual structure t makes loans to its members and states that many borrowers have low incomes and might not otherwise qualify for credit from conventional for-profit banks t also represents that it regularly issues loans for very small amounts such as loans for auto repairs which are typically not made by for-profit banks t indicates that it serves smaller communities than those served by for-profit banks t also indicates that because of its mutual non-profit operation all members not just those maintaining high minimum balances are able to earn competitive rates on their deposits and pay low banking fees t represents that in order to maintain its financial viability and continue to satisfy its stated purposes of promoting thrift and providing a source of low cost credit it has endeavored to become a full service financial_institution consequently t offers more than just demand deposits and loans currently t makes credit life and credit disability insurance available to members the credit insurance is described in more detail below all of these insurance products are underwritten or otherwise provided by third-party insurance_companies or other third-party vendors in each case t makes its members aware of the purpose and availability of these products answers members’ questions about the products or refers the member to the vendor for additional information and with respect to some of the products obtains and submits applications for coverage premium payments and claims during the year at issue t made the following types of loans personal mortgage vehicle and other secured and unsecured loans the majority of the loans were personal mortgage and vehicle in a total of loans were made and approximately of these loans were collateralized the default ratio was in however no information was provided regarding the default rate on these loans as a percentage of total loans for the year at issue t filed form 990-t unrelated_business_income_tax return for the year at issue however the amounts derived from the sale of the products discussed herein were not included as income derived from unrelated_trade_or_business sale of credit life and credit disability insurance t offers its member borrowers the opportunity to purchase credit life and credit disability insurance on certain loans t is a party to and beneficiary under standard group credit life and credit disability policies with a third party insurance_company under these policies a member-borrower who obtains a loan mortgages and other loans secured_by real_estate are often excluded may if he or she chooses obtain credit life and credit disability insurance which pays the loan installments during the period of physical disability which impacts the borrower’s employment a loan officer informs each member-borrower of the availability of credit life and credit disability insurance coverage and if the member-borrower elects to obtain the coverage the premium charge is added to the borrower's loan balance obtaining the credit life and credit disability insurance coverage is never a condition of the member's receiving the loan as reflected in the group credit insurance_policy and letter agreements the credit disability coverage is standard coverage that provides that the insurer will repay the balance of a member's loan up to the policy limit the maximum loan duration covered wa sec_120 months and the maximum amount of loan insured was dollar_figure t does not offer credit life and credit disability insurance in connection with overdraft protection home equity loans and real_estate loans under the terms of the policy t is also reimbursed for its administrative expenses in connection with its performance of the prescribed duties as the policyholder t’s employees perform the following duties with respect to the credit disability insurance program e e e e during the loan process and as part of the loan transaction itself explain the insurance program to member-borrowers process insurance applications collect and forward the premiums to the insurance_company receive and forward claims claims can be filed directly by the member- borrower to the insurance_company and e answer member-borrowers’ questions t's staff may recommend that the member opt to obtain coverage in situations where coverage appears beneficial based on the level of personal and family resources available for loan repayment in the event of disability the credit disability insurance coverage requires monthly premium payments the charges are calculated by t and added to the member's loan balance t remits the premiums it has collected less its expenses as noted above to the insurance_company t's commission for its role in coverage issuance and policy administration is of gross premiums collected for credit life and credit disability insurance this percentage is based on an agreement between t and the insurance_company at the time the insurance was purchased approximately of borrowers opted for credit insurance during the year at issue law sec_501 of the internal_revenue_code code provides in part that organizations described in sec_501 are exempt from federal_income_tax sec_501 of the code specifically exempts from federal_income_tax credit unions without capital stock organized and operated for mutual purposes and without profit sec_1_501_c_14_-1 of the income_tax regulations regulations provides in part that credit unions other than federal credit unions described in sec_501 of the code without capital stock organized and operated for mutual purposes and without profit are exempt from tax under sec_501 state-chartered credit unions were first acknowledged as exempt from federal_income_tax in a opinion of the attorney_general the attorney_general considered credit unions organized under the laws of the commonwealth of purposes of credit unions existing at that time the attorney general’s opinion described the i t is apparent that the purpose of these financial associations is to help people save and to assist those in need of financial help whose credit may not be established at the larger banks in reality they are fundamentally similar and supplemental to the existing agencies for promoting thrift namely the savings banks and cooperative banks except on a much smaller scale the attorney general’s opinion also described some of the operations of credit unions--making loans in appropriate amounts to members on which a low rate of interest is charged and that p jrompt payment of obligations is a fundamental requirement the opinion described in detail the procedures by which members’ savings were held by the credit_union and how the members earned interest on their deposits the opinion also pointed to the democratic character of the governance of these early credit unions by their members at the annual meeting of the association each member shareholder and depositor has but one vote after review of the features and operations of these early credit unions the attorney general’s opinion held that state-chartered credit unions would be exempt from federal_income_tax see u s op atty gen the legal analysis of the attorney general’s opinion was adopted in treasury regulations issued in and this remained the official basis for the tax exempt status of state-chartered credit unions until the revenue act of granted express statutory tax-exempt status to state-chartered credit unions however the revenue act of removed tax exemption from savings and loan associations cooperative banks and mutual_savings_banks the legislative_history of the act suggests that the reason these entities lost their exemption was because of their increasing similarity to commercial banks and the resulting loss of their original characteristic of mutuality specifically referring to the early days of these institutions the legislative_history states the fact that the members were both the borrowers and the lenders was the essence of the mutuality of these organizations see generally s rep no date reprinted in u s code cong ad svc present-day sec_501 - as enacted in - incorporates the requirements of mutuality and non-profit operation which formed the basis for the attorney general's recognition of credit unions’ tax-exempt status in accordingly the basic purposes of the credit_union tax exemption remain essentially the same today as they were in based on the attorney general’s opinion the basis for exemption is the provision of savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations otherwise exempt from federal_income_tax under sec_501 sec_512 of the code provides that the term unrelated_business_taxable_income means with certain modifications the gross_income derived by an organization from any unrelated_trade_or_business regularly carried on by it less allowable deductions sec_513 of the code defines the term unrelated_trade_or_business in the case of any organization subject_to tax imposed by sec_511 as any trade_or_business the conduct of which is not substantially related aside from the need of such organization for the income or funds or the use it makes of the profits derived to the exercise or performance by such organization of its exempt_function sec_1_513-1 of the regulations provides that gross_income of an exempt_organization subject_to the tax imposed by sec_511 of the code is with certain exceptions includable in the computation of unrelated_business_taxable_income if it is income from trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization's performance of its exempt functions sec_1_513-1 of the regulations provides that the term trade_or_business has the same meaning it has in sec_162 of the code and generally includes any activity carried on for the production_of_income from the sale_of_goods or the performance of services sec_1_513-1 of the regulations states that in determining whether a trade_or_business is regularly carried on within the meaning of sec_512 of the code regard must be had to the frequency and continuity with which the activities are conducted and the manner in which they are pursued hence for example specific business activities will ordinarily be deemed regularly carried on if they manifest a frequency and continuity and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations sec_1_513-1 of the regulations provides that gross_income is derived from unrelated_trade_or_business within the meaning of sec_513 a of the code if the conduct of the trade_or_business which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities that generate the particular income in question - the activities that is of producing or distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes sec_1_513-1 of the regulations provides that a trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes other than through the production_of_income and it is substantially related for purposes of sec_513 only if the causal relationship is a strong one thus for the conduct_of_a_trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those exempt purposes whether activities contribute importantly to an organization’s exempt purposes depends in each case upon the facts and circumstances involved in 693_f2d_525 5th cir a business league described in sec_501 of the code engaged in several activities including the endorsement of insurance to its members the court analyzed whether these activities were substantially related to the business league's exempt_purpose under sec_501 of advancing the credit_union movement in order to determine whether income generated from those activities resulted in unrelated_business_income to the business league in its analysis the court stated that the substantial relationship’ determination is necessarily a fact- based inquiry id pincite the court also noted that the regulations under sec_513 require a case-by-case identification of the exempt_purpose an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conducted the league promoted the purchase of insurance policies from a particular carrier providing the carrier with convenient services in the marketing and administration of its programs the court stated that the league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue the court also discussed at length the distinction between group and individual benefit the court said the distinction between inherently group benefits and individual benefits is analogous to the aggregate entity concept familiar in partnership_taxation as just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner so may a member of the league may enjoy benefits both a league member and as an individual credit_union only those activities that benefit the credit unions in their capacities as league members can be considered substantially related to the league’s exempt_function this group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line_of_business rather than perform discrete services for individuals see sec_1_501_c_6_-1 when the activities of a business league are directed toward the achievement of the common business_interest of its members the benefits that accrue to its members are inherently group benefits id pincite the court continued its analysis by stating that insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship_test nor are its benefits group-related id pincite rather than merely advising members of the availability and desirability of insurance coverage to credit unions generally the league promoted the purchase of polices from a particular carrier the court affirmed the district court’s rationale that the league’s insurance activities did little more than generate revenue because the league’s endorsement was basically a fundraising activity it was by definition unrelated business activity under sec_513 id pincite therefore the court concluded that the league’s insurance activities were not substantially related to its tax-exempt purpose of advancing the credit_union movement rather the connection between the furtherance of the credit_union movement and the selling of insurance was at best tangential in 78_tc_246 aff'd 726_f2d_1097 cir the court held that promotional and administrative fees and an experience rating reserve refund received by a business league described in sec_501 of the code for promoting group_insurance programs for its members constituted unrelated_business_taxable_income under sec_512 in holding that the business league’s activities were not substantially related the court considered whether the league’s insurance activities contributed importantly to the league’s exempt_purpose of advancing the common business interests of independent insurance agents the court stated the burden is on the taxpayer to show that the challenged activities contribute directly and importantly to the improvement of conditions in a particular line_of_business the court noted that the petitioner’s insurance activities did little more than generate revenue for the association and provided members with a convenient and economical service in the operation of their agencies as such they stood in sharp contrast to petitioner's educational and legislative activities which served the broader purpose of improving the general business environment in which insurance agents operated thus the court found petitioner’s activity of promoting insurance was not substantially related to its exempt_purpose in la caisse popu563_f2d_505 1st cir the government unsuccessfully challenged the exempt status under sec_501 of the code of an organization chartered as a credit_union by the state of new hampshire the government maintained that the organization was not exempt because it offered a wide variety of services typically offered by nonexempt full service banks and was therefore not organized or operated as a credit_union among these services were checking accounts mortgage loans banking by mail safe deposit boxes and a night depository this case focused solely on the taxpayer’s exemption under sec_501 and did not address the provisions of sec_511 through in 646_fsupp_1199 n d ala a credit_union described in sec_501 of the code offered cancer and group_life_insurance to its individual members the issue was whether commissions the credit_union received from servicing these particular types of insurance policies constituted unrelated_business_income under sec_512 the court did not reach the issue for jurisdictional reasons however it stated in a footnote that the petitioner would have lost on the merits of this issue because the policies benefited the insured without any reference to the member’s loans or accounts with the credit_union that court stated in dicta that cancer and group_life_insurance offered by a credit_union to its members would result in unrelated business table income for the following reasons petitioner earned commissions for servicing cancer and group_life_insurance policies these policies were for the express benefit of the insured without any reference to the member's loans or accounts with the credit_union petitioner derived no benefit from the policies other than commission on the sale of said policies earned from the insurance_companies which issued the policies the sale of the cancer and group_life_insurance policies referred to had no substantial causal relationship to petitioner's exempt purposes and the sale of the policies bore no relationship to petitioner’s function as a credit_union id pincite n revrul_69_282 1969_1_cb_155 provides that an organization must be formed and operated under the state law governing the formation of credit unions to qualify for exemption under sec_501 of the code as a state- chartered credit_union revrul_72_37 1972_1_cb_152 provides that to qualify as a credit_union_exempt from income_tax under sec_501 a of the code an organization must in addition to being formed and operated under a state credit_union law operate without profit and for the mutual benefit of its members the revenue_ruling clarified revrul_69_282 stating that a state charter is a threshold requirement for exemption but not the sole requirement revrul_60_228 1960_1_cb_200 interprets the substantially related requirement of sec_513 an organization exempt from federal_income_tax as an agricultural_organization described in sec_501 of the code promoted wider insurance coverage among its members and other local farmers including life casualty and fire insurance the insurance programs are provided by several insurance_companies but the organization’s administrative and secretarial staff is assigned to the work the organization receives an overall fee from the insurance_company for office and other services rendered them in connection with the insurance programs the revenue_ruling provides that a trade_or_business is substantially related to an organization’s exempt_activities if the principal purpose of the trade_or_business furthers these exempt purposes however in this case such activities are not usually associated with the functions of an agricultural_organization and normally would not be carried on by such an organization in furtherance of its exempt purposes therefore these activities are not substantially related to the organization’s exempt purposes thus the income resulting from these activities is subject_to tax under sec_511 analysis in determining whether an income-producing activity is an unrelated_trade_or_business it is necessary to show that there is a trade_or_business the trade_or_business is regularly carried on and the conduct of the trade_or_business is not substantially related to the organization's exempt_purpose or function see sec_1_513-1 a of the regulations t has agreed that the activities at issue are trades_or_businesses that are regularly carried on therefore the sole issue is whether each activity is substantially related to the organization's achievement of its exempt purposes gross_income is derived from an unrelated_trade_or_business if the conduct of the trade_or_business is not substantially related other than through production of funds to the purposes for which exemption is granted sec_1_513-1 of the regulations determination of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question and the accomplishment of the organization’s exempt purposes id the regulations further state that for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes sec_1_513-1 of the regulations see also prof'l ins agents of michigan supra insurance activity was not substantially related because activity did little more than generate revenue and provide members with a service and did not further taxpayer's exempt_purpose of improving business conditions and louisiana credit_union league supra league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue and at best was only tangentially related to the furtherance of the league’s exempt_purpose of improving business conditions of one or more lines of business the court found the requisite substantial relationship lacking for t’s activities to escape taxation as unrelated_business_income the activities must contribute directly and importantly to the accomplishment of one or more of t’s exempt purposes-promotion of thrift and providing low cost credit for its members through mutual and nonprofit operation sec_1_513-1 of the regulations see also prof ins agents of michigan supra we address each of the activities below credit life and credit disability t argues that the sale of credit disability insurance is directly related to the credit union’s specific exempt purposes of fostering thrift among the members including both the extension of credit to members on reasonable terms and encouraging savings among the members and providing services to members on a mutual basis t further maintains that credit insurance which is an integral part of a member loan transaction is a mechanism for assuring the prompt repayment of debts in situations where the financial resources of the borrower and the borrower's family become strained as a result of disability the facts do not show how sales of credit life and credit disability insurance contribute directly and importantly to accomplishing t’s exempt purposes credit life and credit disability insurance is not required for the approval of a loan in fact credit life and credit disability insurance is not available to members on certain types of loans such as mortgage and other real_estate loans the member decides whether to purchase credit life and credit disability insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member the individual member benefits in that the member need not worry about paying a loan to t in the event of death or disability while there is also a benefit to the credit_union as the beneficiary the facts do not show how the sale of credit life and credit disability insurance otherwise contributes importantly and directly to accomplishing t’s exempt purposes other than through the production_of_income availability of credit life and credit disability insurance does not encourage savings or assist t in offering low cost credit t does not take into consideration the need for this insurance by members t performs no studies to determine which members may need credit life and credit disability insurance and there is no required corresponding counseling to members who may have more need than others although t’s staff may recommend insurance based on the level of personal and family resources these recommendations are not mandatory in specific cases and coverage is not required in these cases additionally t’s receives commissions based on the amount of premiums_paid for credit life and credit disability because the insurance is voluntary and has no bearing on the approval of a loan the individual benefit-to the selling employee-is the primary benefit of offering the insurance applying the factors of alabama central credit_union supra t earns commissions for providing credit life and credit disability insurance sells policies for the express benefit of the insured albeit with reference to a member's loan with the credit_union derives some benefit from the credit life and credit disability insurance but the primary benefit is production_of_income both through the commission on the sale of the insurance earned the insurance referred to has no substantial causal relationship to t’s exempt purposes and the insurance bears no relationship to t’s function as a credit_union looking at the facts with respect to credit life and credit disability insurance the sale of credit insurance is not substantially related to t’s exempt purposes the available information indicates that the sale of insurance is primarily for the purpose of generating income to t and some of its employees and for the benefit of the insured rather than for the benefit of t’s membership based on all of the facts and circumstances t’s activities with respect to the sale of credit life and credit disability insurance do not contribute importantly to accomplishing t’s exempt purposes therefore the sale of credit life and credit disability insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit conclusion for reasons set forth above we conclude that the income received by a sec_501 credit_union from the sale of credit life and credit disability insurance are not substantially related to the furtherance of t’s exempt purposes and therefore are subject_to ubit a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 of the code provides that it may not be used or cited as precedent - end -


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc fip 4-plr-138655-02 date date legend the company state x date y company jurisdictions parent sub annuity separate_account annuity separate_account annuity separate_account life separate_account life separate_account plr-138655-02 annuity separate_account annuity separate_account affiliate dear this is in response to your submission dated date and subsequent submissions requesting rulings on behalf of the company concerning the treatment under sec_817 of the internal_revenue_code of direct investments in certain institutional mutual funds the non-public funds that are proposed to be made in connection with sec_457 eligible deferred_compensation plans sponsored by tax-exempt entities a the company facts the company is a life_insurance_company organized under the laws of state x until date it was named y company the company is licensed to conduct an insurance_business in jurisdictions the company is a wholly-owned subsidiary of parent the company is also registered as an investment adviser under the investment adviser act of and is registered as such with the securities_and_exchange_commission in this capacity the company acts as the investment adviser for certain of the non-public funds discussed herein the company represents that it is a life_insurance_company within the definition of sec_816 it joins with its subsidiary sub in the filing of a life life consolidated federal_income_tax return the company uses the accrual_method of accounting for federal_income_tax purposes and files its returns on a calendar_year basis b the contracts the company issues nonparticipating life_insurance and annuity_contracts the contracts which offer both fixed and variable investment options the variable_contracts as well as contracts offering solely fixed investment options the fixed contracts some of the contracts the qualified contracts are issued in connection with qualified_retirement_plans including group annuity_contracts issued to trustees of pension or profit sharing plans and trusts which qualify under sec_401 sec_401 contracts group annuity_contracts issued to trustees of qualified_plans established by self-employed individuals under sec_401 and c h_r contracts group annuity_contracts issued to state and local governments and to tax- exempt_organizations in connection with deferred_compensation plans under section plr-138655-02 sec_457 contracts group and individual annuity_contracts which qualify as individual retirement annuities within the meaning of sec_408 ira contracts and group and individual annuity_contracts which satisfy the requirements of sec_403 tsa contracts the company represents that the qualified contracts constitute annuity_contracts for federal_income_tax purposes except to the extent that sec_72 requires otherwise and are pension_plan_contracts within the meaning of sec_817 and sec_818 certain of the contracts are not issued in connection with a qualified_plan but rather are purchased with after-tax monies the non-qualified contracts the company represents that the non-qualified contracts are either annuity_contracts for federal_income_tax purposes except to the extent that sec_72 requires otherwise or life_insurance contracts within the meaning of sec_7702 the contracts are purchased with the payment of one or more premiums purchase payments for the fixed contracts each purchase payment is allocated to the fixed account maintained as part of the company’s general account for variable_contracts each purchase payment is allocated as directed by the policyholder among the contract's investment options the investment options available differ somewhat amongst the variable_contracts but all offer as investment options a fixed account option and one or more variable options the current value of a variable_contract at any time generally equals the sum of the amounts in the various investment options at any time before an annuity option is elected for those contracts that are annuity_contracts or before the death of an insured under a life_insurance_contract all or part of the current value may be transferred among the investment options subject_to certain limitations on the timing amount and frequency of such transfers the contracts that are annuity_contracts provide for payments under the applicable annuity options some of the variable_contracts provide annuity payments which are fixed variable or a combination of fixed and variable as the policyholder specifies and some of the contracts including all fixed contracts provide only fixed annuity payments the contracts that are annuities may also provide a death_benefit payable to the beneficiary upon the death of the annuitant c the separate_accounts amounts allocated to the variable options under the variable_contracts currently are invested in one of the following separate_accounts of the company plr-138655-02 amounts allocated to the variable options under some tsa contracts some ira contracts certain sec_457 contracts and under the non-qualified contracts that are annuities are held in annuity separate_account amounts allocated to the variable options under some tsa contracts some sec_401 contracts some ira contracts and most sec_457 contracts are held in annuity separate_account amounts allocated to the variable options under most sec_401 contracts and certain sec_457 contracts are held in annuity separate_account amounts allocated to the variable options under most of the company’s non-qualified contracts that are life_insurance contracts are held in life separate_account amounts allocated to the variable options under one of the company’s non-qualified contracts that is a life_insurance_contract issued to a state retirement_system are held in life separate_account amounts allocated to the variable options under certain sec_401 contracts and sec_457 contracts that invest in shares of certain publicly available mutual funds are held in annuity separate_account and amounts allocated to the variable options under a closed block of qualified contracts and non-qualified contracts that are annuities and that were assumed by the company pursuant to an assumption_reinsurance agreement are held in annuity separate_account the aforementioned separate_accounts were established pursuant to the insurance laws of state x for the purpose of segregating assets attributable to the variable portions of the contracts from other assets of the company annuity separate_account annuity separate_account annuity separate_account life separate_account and life separate_account are registered under the investment_company act of the act with the securities_and_exchange_commission as unit investment trusts pursuant to sec_3 a of the securities act of and sec_3 c of the act annuity separate_account and annuity separate_account are not registered with the securities_and_exchange_commission plr-138655-02 d the funds the assets of annuity separate_account sec_2 and and life separate_account sec_2 and currently may be invested in shares of several investment companies that are not available to the general_public the non-public funds each of the non- public funds is registered under the act with the securities_and_exchange_commission as an open-end investment_company ie each is a mutual_fund certain of the non-public funds are managed by the company or one of its affiliates while others are managed by unaffiliated entities the company represents that each of the non-public funds managed by the company or one of its affiliates qualifies as a regulated_investment_company within the meaning of sec_851 and is considered a segregated_asset_account within the meaning of sec_1_817-5 the company further represents to the best of its knowledge and belief that each of the non-public funds not managed by the company or one of its affiliates qualifies as a regulated_investment_company within the meaning of sec_851 and is considered a segregated_asset_account within the meaning of sec_1_817-5 pursuant to sec_1_817-5 all of the shares of the non-public funds are held either by segregated_asset accounts of insurance_companies or by interests otherwise allowed by sec_1_817-5 with the exception of those interests permitted under sec_1_817-5 public access to the non-public funds is available exclusively through the purchase of a variable_contract within the meaning of sec_817 and e also the company represents that the investments of the non-public funds managed by the company or one of its affiliates in which the non-qualified contracts can invest satisfy and will continue to satisfy the diversification requirements of sec_817 and the regulations thereunder further the company represents to the best of its knowledge and belief the investments in the non-public funds not managed by the company or one of its affiliates in which the non-qualified contracts can invest satisfy and will continue to satisfy the diversification requirements of sec_817 and the regulations thereunder assets held in annuity separate_account sec_3 and on behalf of certain sec_401 contracts tsa contracts and sec_457 contracts as well as the assets of annuity separate_account may be invested in shares of investment companies that are available to the general_public each of these funds is registered under the1940 act with the securities_and_exchange_commission as open-ended investment companies each qualifies as a regulated_investment_company and each is considered a segregated_asset_account under sec_1_817-5 plr-138655-02 e proposed arrangement for sec_457 non-governmental plans as a result of expanded deferral limits allowed by provisions of the economic_growth_and_tax_relief_reconciliation_act_of_2001 there has been increased interest in top hat deferred_compensation plans for tax-exempt organizations described in sec_457 in response to this interest the company has developed an arrangement the arrangement that combines administrative services in connection with such top hat plans along with a facility providing a variety of participant-directed investment options the arrangement consists of several agreements initially there is a plan services agreement under this agreement between the company and the plan_sponsor the company agrees to provide required participant record keeping and related_services in connection with the administration of the sec_457 plan as outlined in the plan services agreement these services may include plan installation services maintenance of individual_account records for each participant balancing and allocation of plan contributions to individual participant accounts monitoring contribution limits provision of quarterly statements for the plan_sponsor and participants processing of distributions and in-service withdrawals tax withholding and reporting providing toll-free phone and internet access to plan participants minimum_required_distribution processing and the calculating processing and distribution of lump sum and installment payments to participants consistent with the rules of sec_457 a variety of participant-directed fixed and variable investment options are offered under the arrangement a guaranteed fixed income investment option is offered to plan participants through a fixed deferred_annuity_contract the annuity_contract the annuity_contract is a group contract issued by the company to the plan_sponsor or to the trustee of a rabbi_trust discussed below separate record keeping accounts are maintained by the company with respect to amounts directed to the contract on behalf of each plan participant contributions to and distributions from the annuity_contract will be made at the direction of the plan_sponsor on behalf of plan participants in addition to the guaranteed investment option offered through the annuity_contract the arrangement offers direct investments in a variety of mutual funds administrative costs to plan sponsors may be lower through the direct investment in these funds rather than through indirect investment by the purchase of a variable_annuity contract investments on behalf of plan participants to these mutual_fund options will be made at the direction of the plan_sponsor by the trustee of a rabbi_trust established pursuant to a_trust agreement entered into between the plan_sponsor and a_trust institution the trustee the trustee will be the registered owner of the shares of the mutual funds generally affiliate an affiliate of the company will be the plr-138655-02 trustee under the arrangement although in some instances an unrelated trust institution may be utilized by the plan_sponsor where an alternate trustee is involved affiliate’s role will be that of a custodian to the trustee the trust has been established in order to provide a centralized facility for making direct mutual_fund investments with respect to the sec_457 plan and to offer additional security for plan participants the company represents to the best of its knowledge and belief that trust is a grantor_trust subject_to the provisions of sections of the code and the trust assets will remain subject_to the claims of the plan sponsor’s general creditors in the event of insolvency currently all of the funds offered under the arrangement are available for purchase by the general_public however subject_to the receipt of a favorable ruling the arrangement would also allow plan investments in institutional mutual funds that are not publicly available these options would include certain of the non-public funds that presently are available solely through the purchase of a variable_contract or through direct purchase by qualified_pension or retirement plans described in sec_1_817-5 and revrul_94_62 1994_2_cb_164 it is the proposed investment in the non-public funds under the arrangement that is the subject of this ruling_request subject_to certain limitations participants will be able to transfer investments between the fixed options under the annuity_contract and the mutual_fund investments made through the trust as well as among the various mutual_fund options at the time a participant retires or otherwise reaches a distributable event under the sec_457 plan amounts invested on behalf of the individual under the arrangement will be payable to the participant in a lump sum in installments or in the form of an annuity law and analysis for purposes of sec_457 of the code the term eligible_deferred_compensation_plan is defined in sec_457 as a plan established and maintained by an eligible_employer meeting certain requirements for purposes of sec_457 the term eligible_employer is defined in sec_457 as a a state political_subdivision of a state and any agency_or_instrumentality of a state or political_subdivision of a state and b any other organization other than a governmental_unit exempt from tax under this subtitle sec_817 of the code provides that for purposes of subchapter_l sec_72 relating to annuities and sec_7702 relating to the definition of life plr-138655-02 insurance_contract a variable_contract other than a pension_plan_contract which is otherwise described in sec_817 and which is based on a segregated_asset_account shall not be treated as an annuity endowment or life_insurance_contract for any period and any subsequent period for which the investments made by such account are not in accordance with regulations prescribed by the secretary adequately diversified sec_1_817-5 contains the diversification requirements for variable_contracts based on segregated_asset accounts sec_1_817-5 provides a look-through_rule for the application of the diversification requirements of sec_1_817-5 sec_1_817-5 provides that if the look-through_rule applies a beneficial_interest in a regulated_investment_company will not be treated as a single investment of a segregated_asset_account instead a pro_rata portion of each asset of the investment_company will be treated for purposes of sec_1_817-5 as an asset of the segregated_asset_account sec_1_817-5 provides that the look-through_rule of sec_1_817-5 shall apply to an investment_company if a all the beneficial interests in the investment_company other than those described in sec_1_817-5 are held by one or more segregated_asset accounts of one or more insurance_companies and b public access to such investment_company is available exclusively except as otherwise permitted under sec_1_817-5 through the purchase of a variable_contract solely for this purpose the status of the contract as a variable_contract will be determined without regard to sec_817 of the code and sec_1_817-5 of the regulations sec_1_817-5 provides that satisfaction of the requirements of sec_1_817-5 shall not be prevented by reason of beneficial interests in the investment_company that are iii held by the trustee of a qualified_pension or retirement_plan revrul_94_62 1994_2_cb_164 lists nine arrangements that qualify as a qualified_pension or retirement_plan for purposes of sec_1_817-5 specifically the list under revrul_94_62 includes a governmental_plan within the meaning of sec_414 or an eligible_deferred_compensation_plan within the meaning of sec_457 the company has represented that the retirement plans underlying the arrangement are nongovernmental eligible deferred_compensation plans within the meaning of sec_457 plr-138655-02 conclusion based on the facts presented and the representations made we hold satisfaction of the look-through_rule of sec_1_817-5 by taxpayer shall not be prevented by reason of beneficial interests in the non-public funds being held by an eligible_deferred_compensation_plan within the meaning of sec_457 under the arrangement offered by taxpayer 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 the code provides that it may not be used or cited as precedent this ruling is directed only to the taxpayer s requesting it sec_6110 of a copy of this letter must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely s donald j drees jr senior technician reviewer branch office of associate chief_counsel financial institutions products


t c memo united_states tax_court alessio azzari inc petitioner v commissioner of internal revenue respondent docket no 27532-08l filed date barry allen furman for petitioner carol-lynn e moran for respondent supplemental memorandum opinion wells judge this case is before the court on the parties’ cross-motions for summary_judgment pursuant to rule the issue we must decide is this opinion supplements 136_tc_178 1unless otherwise indicated section references are to the internal revenue continued whether on remand respondent’s appeals_office abused its discretion by rejecting petitioner’s offer-in-compromise because the appeals_office concluded that petitioner failed to include the assets of its successor_corporation or by failing to provide petitioner the opportunity to amend its offer-in-compromise background some of the facts are set forth in our prior opinion in 136_tc_178 prior opinion and are incorporated by reference additionally other facts discussed below are taken from the parties’ moving papers and attachments including the administrative record from the appeals_office petitioner is a new jersey corporation with its principal_place_of_business in new jersey petitioner failed to pay its employment_tax liabilities for the quarters ending september and date march june september and continued code of as amended and rule references are to the tax_court rules_of_practice and procedure 2the administrative record provided by respondent does not contain some of the correspondence between petitioner’s counsel and the appeals_office consequently petitioner has moved to supplement the administrative record with that correspondence those documents are referenced in the settlement officer’s case activity record and they should have been part of the administrative record submitted by respondent we will grant petitioner’s motion and treat those exhibits as part of the administrative record date collectively the periods in issue petitioner’s unpaid employment_tax liabilities for the periods in issue total dollar_figure plus interest respondent filed a notice_of_federal_tax_lien nftl with respect to those liabilities and petitioner requested a collection_due_process_hearing during the collection_due_process_hearing petitioner requested that respondent subordinate the tax_lien to a security_agreement with petitioner’s lender penn business_credit llc lender so that petitioner could continue to use a line of credit with the lender to obtain financing secured_by petitioner’s accounts_receivable respondent’s appeals_office erroneously determined that petitioner’s lender already had priority and that it therefore was unnecessary to subordinate the tax_lien to the lender’s security_interest in part because of the appeals office’s failure to subordinate the tax_lien and in part because of delays by the appeals_office petitioner fell behind on its employment_tax deposits the appeals_office subsequently rejected petitioner’s request to subordinate the tax_lien and enter into an installment_agreement in our prior opinion we concluded that respondent’s appeals_office abused its discretion because its rejection of petitioner’s request to subordinate the tax_lien was based upon an error of law ie the appeals office’s erroneous conclusion that subordination was unnecessary because the lender’s security interest already had priority because the appeals office’s refusal to subordinate the tax_lien contributed to petitioner’s failure to make its employment_tax deposits we held that it was also an abuse_of_discretion for the appeals_office to refuse to consider petitioner’s request for an installment_agreement on that basis consequently we remanded the instant case to the appeals_office on remand the appeals_office assigned the case to settlement officer robert richards mr richards contacted petitioner and scheduled a telephone conference with petitioner for date on date petitioner faxed mr richards a letter summarizing what had happened to petitioner’s business during the past year summary according to petitioner’s summary because respondent refused to subordinate the tax_lien to the lender’s security_interest the lender refused to lend to petitioner petitioner also stated that as a result it is hopelessly insolvent petitioner explained in the summary that it began to phase out its business during early and that from that time on petitioner did not assume any new business petitioner stated in its summary that the only new work petitioner has assumed since that time was work that it subcontracted to its brother-sister corporation artex construction co inc artex but petitioner is now no longer taking any new business at all in its summary petitioner explained that artex is a builder and contractor that has had a lending relationship with petitioner since during that time petitioner subcontracted work to artex and artex lent petitioner money petitioner explained in its summary that after the lender ceased lending to petitioner artex sought a line of credit with the lender which it received to increase artex’s collateral petitioner transferred some of its accounts_receivable to artex petitioner reduced its loan balance to artex to reflect the value of the accounts_receivable transferred to artex in the summary petitioner proposed that it would make an offer-in- compromise and would lease its construction equipment to artex to generate funds to settle its tax_liabilities during the telephone conference with mr richards on date petitioner did propose an offer-in-compromise mr richards asked petitioner to submit its offer-in-compromise in writing by date but gave petitioner an extension until date on date the appeals_office received petitioner’s offer-in-compromise petitioner’s offer-in-compromise proposed to settle petitioner’s outstanding tax_liabilities for dollar_figure the most valuable assets petitioner listed on its form 433-b collection information statement for businesses were equipment which petitioner valued at dollar_figure and vehicles which petitioner valued at dollar_figure those valuations represented quick sale values at substantial discounts from appraisals of petitioner’s trucks and other construction equipment which concluded that in total their retail value was dollar_figure petitioner did not list any accounts_receivable on its form 433-b in an attachment to its form_656 offer_in_compromise petitioner provided the following explanation of its method for estimating the value of the equipment the business of petitioner was building homes petitioner has a brother-sister corporation artex concrete construction co inc artex artex is also a builder and contractor petitioner owns trucks and equipment with retail values that have been appraised and attached to form 433-b petitioner’s president knows that the only way to dispose_of the trucks and equipment would be an orderly auction petitioner’s president is familiar with construction companies in the area which have gone out of business in the last year some have offered their equipment for sale to the petitioner the auction value is no greater than thirty percent of retail petitioner proposes to sell the equipment to artex and the installment_payment will fund this offer petitioner proposed to satisfy its offer-in-compromise by paying equal installments over the course of months mr richards asked petitioner several questions about its payment plan and petitioner responded with a fax on date in that date fax petitioner stated that it is owned and controlled by the same individuals who control artex it explained that artex had recently secured dollar_figure million in new business and had a line of credit with a lender that would permit it to purchase petitioner’s trucks and other construction equipment under an installment_agreement petitioner proposed to use those funds to settle its tax_liabilities petitioner has conceded that artex was using petitioner’s equipment pending its sale on the basis of petitioner’s close relationship with artex mr richards determined that artex was merely a successor_corporation to petitioner in his account activity record mr richards wrote it is clear a successor corp situation exist s the officers of artex inc are the same people shareholders that controlled aai and allowed more than dollar_figure million dollars in payroll_taxes to accrue artex inc is located in the same building and uses assets that are titled to aai if the ‘successor’ corp issues did not exist the rcp reasonable collection potential determined by appeals would be closer to dollar_figurek aai established artex inc different ein when aai lost their line of credit on date respondent issued a supplemental notice_of_determination in which mr richards wrote the offer_in_compromise is being funded by the sale of assets from alessio azzari inc aai to artex inc when aai efforts to secure a loan failed aai started subcontracting to artex inc aai began to phase out its business on or about date working to complete pending contracts but did not assume any new business other than subcontracting to artex inc artex inc is owned and controlled by the same officers and shareholders as aai artex inc was using aai equipment to fulfill its business obligations including the dollar_figure in new business artex generated respondent has determined that artex inc is a successor_corporation to aai and is therefore liable for aai employment_tax liabilities the offer_in_compromise is being rejected because both artex inc and aai’s assets would have to be considered in an offer_in_compromise in the alternative mr richards determined that petitioner took an excessive discount when it estimated the quick sale value of its assets mr richards concluded that rather than taking a discount petitioner was entitled only to a discount on the quick sale value of its equipment consequently mr richards rejected petitioner’s offer-in-compromise on date respondent filed a motion for summary_judgment based upon the supplemental notice_of_determination and on date petitioner filed a cross-motion for summary_judgment on date the parties filed responses discussion where the underlying tax_liability is not in issue we review the determination of the appeals_office for abuse_of_discretion see 114_tc_604 in reviewing for abuse_of_discretion we review the reasoning underlying the settlement officer’s determination to decide whether it was arbitrary capricious or without sound basis in fact or law see 125_tc_301 aff’d 469_f3d_27 1st cir petitioner does not dispute the underlying liabilities consequently we review the determination of the appeals_office for abuse_of_discretion summary_judgment is intended to expedite litigation and avoid unnecessary and expensive trials and may be granted where there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law rule a and b fla peach corp v commissioner 90_tc_678 the moving party bears the burden of proving that there is no genuine issue of material fact and factual inferences are viewed in the light most favorable to the nonmoving party 98_tc_518 aff’d 17_f3d_965 7th cir because the issue we must decide in the instant case is whether on the basis of the undisputed administrative record the appeals_office abused its discretion when it rejected petitioner’s offer-in-compromise we conclude that this case is ripe for summary_judgment we first consider petitioner’s contention that the appeals_office abused its discretion when it concluded that artex is merely a successor_corporation to petitioner the parties agree that new jersey state law applies the general_rule under new jersey law is that ‘where one company sells or otherwise transfers all its assets to another company the latter is not liable for the debts and liabilities of the transferor’ ramirez v amsted indus inc a 2d n j quoting 420_fsupp_128 d n j however new jersey courts recognize four exceptions to the general_rule of successor nonliability where the purchasing_corporation expressly or impliedly agrees to assume such debts and liabilities the transaction amounts to a consolidation or merger of the seller and purchaser the purchasing_corporation is merely a continuation of the selling corporation or the transaction is entered into fraudulently in order to escape responsibility for such debts and liabilities id because the second and third exceptions tend to overlap and much of the same evidence is relevant to each new jersey courts often treat them together woodrick v jack j burke real_estate inc a 2d n j super ct app div in determining whether a particular transaction is a de_facto consolidation or mere continuation courts consider four factors i continuity of management personnel physical location assets and general business operations ii a cessation of ordinary business and dissolution of the predecessor as soon as practically and legally possible iii assumption by the successor of the liabilities ordinarily necessary for the uninterrupted continuation of the business of the predecessor and iv continuity of ownership shareholders id see also 13_f3d_69 3d cir applying new jersey law all of the factors need not be present t he crucial inquiry is whether there was an ‘intent on the part of the contracting parties to effectuate a merger or consolidation rather than a sale of assets ’ luxliner f 3d pincite quoting mckee v harris-seybold co a 2d n j super ct law div ‘for liability to attach the purchasing_corporation must represent merely a ‘new hat’ for the seller ’ id pincite quoting mckee a 2d pincite we must decide whether respondent abused his discretion or acted unreasonably when he applied the facts to the foregoing new jersey authorities and determined that artex was petitioner’s successor with respect to the first factor set forth in luxliner and woodrick the record establishes that petitioner and artex share the same management operate out of the same address are engaged in very similar_business operations that artex is currently using all of petitioner’s assets to conduct its business and that petitioner transferred its accounts_receivable to artex with respect to the second factor petitioner is no longer actively doing any construction work although petitioner has not been dissolved that fact is not dispositive and in any case it would not yet have been practical to dissolve petitioner because of its ongoing litigation the record does not contain any facts relevant to the third factor as to the fourth factor petitioner and artex have the same shareholders accordingly three out of the four factors suggest that artex should be viewed as a mere continuation of petitioner moreover the record contains sufficient evidence to infer that petitioner intended for artex to be a mere continuation of its business under a different entity indeed petitioner stated that it transferred its accounts_receivable to artex so that artex could secure a sufficiently large credit line with the same lender petitioner had been using before the filing of respondent’s nftl when respondent’s failure to subordinate the tax_lien made it impossible for petitioner to maintain a sufficient cashflow to sustain its business petitioner appears to have successfully maintained its credit line by transferring some of its collateral from petitioner to artex additionally petitioner shifted business to artex during that time by subcontracting its work to artex petitioner contends that respondent’s determination that artex was a successor constituted an abuse_of_discretion because mr richards wrote in his case activity record that artex was founded only when petitioner lost its line of 3we note that petitioner’s course of action seems to have minimized the harm that petitioner otherwise might have suffered from respondent’s failure on the basis of an error of law to subordinate the tax_lien to the lender’s security_interest which we held in our prior opinion to be an abuse_of_discretion however when petitioner transferred its collateral and business to artex as a method to maintain its credit line it made no attempt to pay its tax_liabilities the collection of which is in issue in the instant case credit although petitioner is correct that mr richards’ notes contradict the facts about artex’s history in the record mr richards had sufficient other reasons upon which to base his determination that artex was petitioner’s successor the one small error to which petitioner points does not make unreasonable mr richards’ determination concerning whether artex was petitioner’s successor accordingly we reject petitioner’s argument on the basis of the foregoing we conclude that the appeals_office did not abuse its discretion or act unreasonably when it determined that artex was petitioner’s successor_corporation under new jersey law and therefore rejected petitioner’s offer-in-compromise on the basis that it failed to consider artex’s assets because we conclude that it was reasonable for the appeals_office to determine that artex was petitioner’s successor we need not consider the appeals office’s alternative ground for rejecting petitioner’s offer-in-compromise ie that petitioner excessively discounted the quick sale value of its assets as petitioner’s successor artex is liable for petitioner’s outstanding liabilities including its liabilities for federal taxes the collection of which is in issue in the instant case see 70_tc_86 aff’d 614_f2d_860 3d cir accordingly the appeals_office did not abuse its discretion or act unreasonably when it concluded that artex was liable for petitioner’s tax_liabilities and that artex’s assets should have been included on petitioner’s form 433-b so that the appeals_office could have considered those assets when it evaluated petitioner’s offer-in-compromise additionally petitioner contends that it was an abuse_of_discretion for the appeals_office to reject petitioner’s offer-in-compromise without giving petitioner an option to amend its offer respondent contends that the appeals_office was not required to permit petitioner to amend its offer-in-compromise before rejecting it because it was impossible for the appeals_office to determine petitioner’s reasonable collection potential without information regarding the value of artex’s assets upon due consideration we conclude that the instant case should be remanded to allow petitioner to include artex’s assets on its form 433-b and revise its offer-in-compromise to accurately reflect the value of those assets and to allow respondent’s appeals_office to fully evaluate petitioner’s offer we recognize the possibility that when the value of artex’s assets is included on petitioner’s form 433-b the appeals_office may conclude that petitioner is ineligible for an offer-in- compromise however at this point that is mere speculation the administrative record currently before us contains insufficient information about the value of artex’s assets the administrative record reveals no reason why petitioner should not have been afforded the opportunity to amend its offer-in- compromise although as discussed above respondent contends that petitioner’s transfer of assets to artex made it impossible to determine petitioner’s reasonable collection potential such a reason standing alone is insufficient if the appeals_office had provided petitioner the opportunity to amend its offer-in-compromise petitioner could have included artex’s assets on its form 433-b accordingly we will again remand the instant case to the appeals_office so that the appeals_office may provide petitioner the opportunity to amend its offer-in-compromise petitioner will need to supplement the record by submitting a new form 433-b that includes the value of artex’s assets on the basis of the foregoing we shall partially grant respondent’s motion for summary_judgment insofar as we hold that artex is a successor_corporation to petitioner and that its assets should be considered in determining petitioner’s reasonable collection potential and we shall partially deny respondent’s motion for summary_judgment because of the failure to give petitioner the opportunity to amend its offer-in-compromise similarly we shall deny petitioner’s motion for summary_judgment insofar as we hold that artex was its successor_corporation and we shall deny petitioner’s motion insofar as the appeals_office failed to provide petitioner the opportunity to amend its offer-in-compromise since we are remanding the instant case to respondent’s appeals_office to give petitioner the opportunity to do so and have it considered on the remand in reaching these holdings we have considered all the parties’ arguments and to the extent not addressed herein we conclude that they are moot irrelevant or without merit to reflect the foregoing an appropriate order will be issued