internal_revenue_service national_office technical_advice_memorandum index uil numbers mar control number tam-111325-98 district directors office taxpayer's name taxpayer's id number taxpayer's address tax_year ended date of conference legend x taxpayer year year year b issues when is a bank's liability for payment of its deposit insurance assessment relating to the first semiannual period of year fixed under the all_events_test of sec_461 of the internal_revenue_code b35 tam-111325-98 if the bank's liability for payment of its deposit insurance assessment was fixed on december year should the payments be currently deducted under sec_162 of the code or capitalized under sec_263 conclusions the bank's liability for payment of its deposit insurance assessment relating to the first semiannual period of year was not fixed until january year under the all_events_test of sec_461 of the code because of the answer reached in the first issue we need not address this second issue facts x is the parent company of a number of bank holding_companies which own all the stock of fourteen banks in various states x the bank holding_companies and the fourteen banks are all members of an affiliated_group_of_corporations that file consolidated federal_income_tax returns each of the fourteen banks hereinafter collectively referred to as taxpayer are insured depository institutions subject_to the requirements of the federal deposit insurance act fdia u s c et seq taxpayer uses an accrual_method of accounting and files its federal_income_tax return on a calendar_year basis the fdia requires banks to insure customer deposits through the bank insurance fund bif which is administered by the federal deposit insurance corporation fdic during the years at issue taxpayer was a member of the bif in order to maintain its status as an insured bank the fdic regulations in effect during year required each bank to compute and pay the amount of the semiannual assessment due for the current semiannual period as shown on its certified statement for such period c f_r payments for assessments covering the period january year through june year along with signed certified statements showing the actual computations were due on or before january year c f_r and the assessment amount was computed by multiplying a bank's average assessment base for the prior semiannual period by one-half the annual assessment rate c f_r the annual assessment rate applicable for the first semiannual period of year for each bank was determined by the fdic and communicated by december of year the average assessment base for the first semiannual period of year was the average of the deposits shown on a bank's quarterly reports of condition dated september year and december year aal tam-111325-98 a bank must give notice of its decision to terminate its insured status at least days before the effective date of the termination u s c a if a bank does terminate its insured status and its deposit liabilities are assumed by another insured bank the terminating bank must file a final certified statement and pay the normal assessment on its deposits unless the deposits are assumed by a newly insured bank in which case the terminating bank is not required to file certified statements or pay any assessment for the deposits assumed after the semiannual period in which the assumption occurs or the assuming bank agrees to fulfill the terminating bank’s obligation to file the certified statement and pay the assessment c f_r a if a bank terminates its insured status and its deposit liabilities are not assumed by another insured bank the terminating bank must continue to file certified statements and pay assessments for the period its deposits are insured the terminating institution is not required to file further certified statements or to pay further assessments after the bank has paid in full its deposit liabilities c f_r b new fdic regulations were issued in december of year and were effective for the period beginning on july year these new regulations generally changed the assessment payment dates and computation periods and provided that an institution could elect to prepay on december year its first quarterly payment for the semiannual period beginning january year taxpayer maintains that although not formally announced by the end of year the fdic had established a procedure in which it would accept from a bank in december payment of its estimated assessment due for the first half of year prior to the filing of the certified statement for institutions that paid prior to december year the fdic still required the institutions to complete and file the certified statement by january year calculating the assessment in the normal fashion by subtracting the estimated paid assessment from the total assessment due as shown on the certified statement by letter dated december year taxpayer received notification from the fdic of its assessment rate for the first semiannual period of year using a copy of a certified statement taxpayer estimated the amount of its insurance assessment that would be due in january of year on december year taxpayer prepaid approximately dollar_figureb million of deposit insurance to the fdic for insurance covering the period january year through june year even though the payment and related certified statement were not due until january year the signed certified statement which showed the computation of the actual liability of the taxpayer for the semiannual period was not submitted until january of year the total amount_paid in december was deducted from the total amount due on its year federal_income_tax return taxpayer deducted the dollar_figureb million prepayment for years prior to year taxpayer paid the assessment in january of the semiannual period to which the assessment related and deducted the payment in that same year for financial report aad tam-111325-98 purposes the assessment payments were capitalized to an account titled prepaid fdic insurance and amortized monthly to an fdic insurance expense account law and analysis sec_461 of the code provides generally that the amount of any deduction or credit shall be accounted for in the taxable_year which is the proper taxable_year under the method_of_accounting used in computing taxable_income sec_1_461-1 of the income_tax regulations provides in part that under an accrual_method of accounting a liability as defined in sec_1_446-1 is incurred and generally is taken into account for federal_income_tax purposes in the taxable_year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability applicable provisions of the code the income_tax regulations and other guidance published by the secretary prescribe the manner in which a liability that has been incurred is taken into account for example sec_162 provides that a deductible_liability is generally taken into account in the taxable_year incurred through a deduction from gross_income asa further example under sec_263 or sec_263a a asset having a useful_life extending substantially beyond the close of the taxable_year is taken into account in the taxable_year incurred through capitalization within the meaning of 263a-1t a and may later affect the computation of taxable_income through depreciation or otherwise over a period including subsequent taxable years in accordance with applicable code sections and guidance published by the secretary liability that relates to the creation of an sec_461 of the code provides that the all_events_test is met if all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy sec_461 of the code generally provides that in determining whether an amount has been incurred with respect to any item during any taxable_year the all_events_test shall not be treated as met any earlier than when economic_performance with respect to such item occurs sec_461 of the code provides that in the case of a liability not described in sec_461 b or c economic_performance occurs at the time determined under regulations prescribed by the secretary sec_1_461-4 of the regulations provides that in the case of liabilities described in paragraphs g through of this section economic_performance tam-111325-98 occurs when and to the extent that payment is made to the person to which the liability is owed sec_1_461-4 of the regulations provides in part that if the liability of a taxpayer arises out of the provision to the taxpayer of insurance economic_performance occurs as payment is made to the person to which the liability is owed sec_1_461-4 of the regulations generally provides that for payment liabilities for which payment is economic_performance under paragraph g of this section the requirement applies to liabilities that would be allowable as a deduction or otherwise incurred for taxable years beginning after date thus a liability is incurred and can be taken into account by taxpayers using an accrual_method of accounting in the taxable_year in which the following three requirements are met all events have occurred to establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability first two requirements are referred to as the all_events_test sec_1_461-1 the sec_461 the agent questions whether the first requirement of the all_events_test was met on december year or at some point in january of year the agent argues that the fact of liability was not fixed until january year which was the due_date for the payment and the signed certified statement the agent believes that the last events fixing the fact of liability are submission of the signed certified statement and the provision of insurance coverage by the fdic which does not begin until january of year the agent is not questioning whether economic_performance has occurred or whether reasonable accuracy the second requirement of the all_events_test was met the taxpayer basically argues that the fact of liability was fixed on december year under fdic law because it was in existence as an insured bank on that date and it had deposits at the end of the final two quarters of year the taxpayer argues that the only circumstances in which it would not have been liable on december year for the insurance assessment covering the first semiannual period for year would have been either if they had terminated by december year and paid all their deposit liabilities or had been merged into another insured institution because neither of those events occurred by december year taxpayer argues it was certain to be insured on january year and thus subject_to the insurance assessment for the first six months of year it is fundamental to the all_events_test that although expenses may be deductible before they have become due and payable liability must first be firmly established 481_us_239 taxpayers may not 22ag tam-11 deduct a liability that is contingent or an estimate of anticipated expenses if the estimate is based on events that have not occurred by the close of the taxable_year d to satisfy the all_events_test a liability must be final and definite in amount fixed and absolute and unconditional see 476_us_593 the issue in this case is what event fixes the taxpayer's liability for the insurance assessment which covers the first semiannual period of year in 481_us_239 an accrual_method taxpayer self-insured its liability for its employee medical_care plan the taxpayer established a reserve at the end of the year for its obligation to reimburse employees for medical_care already received by the employees from third parties but for which reimbursement claims had not yet been filed the taxpayer deducted the amount of its estimated liability in this reserve_account at the end of the tax_year as an accrued expense the supreme court held that the last event necessary to fix liability was submission of a claim form by an employee not receipt of medical_care and thus the first prong of the all_events_test was not met because the last event necessary to fix that liability had not occurred by the end of that year the court noted that some individuals might not file a claim for reimbursement because of oversight procrastination confusion over the coverage provided or fear of disclosure to the employer of the extent or nature of the services received thus the court reasoned that the filing of a claim was not a mere technicality but a condition_precedent to liability on the part of the taxpayer in 476_us_593 the supreme court addressed whether the casino taxpayer could deduct an accrued liability for progressive jackpot amounts shown on payoff indicators on progressive slot machines at the end of its taxable_year pursuant to state law registered jackpot amounts as shown on the payoff indicators were recorded daily and could not be reduced until jackpot was paid the supreme court held that the last event fixing the casino’s liability was the last play of the slot machine before the end of the casino’s tax_year because that event fixed the jackpot amount irrevocably under state law thus the court held that the all_events_test was met and a casino could accrue the amount of the jackpot guaranteed for payment on progressive slot machines even though the winning pull had not occurred and the jackpot had not been won by the end of the tax_year the court noted that the identity of the eventual winner of a jackpot was irrelevant to the existence of the liability and the fact that there was an extremely remote and speculative possibility that the jackpot might never be won did not change the fact that as a matter of state law the taxpayer had a fixed liability there is always a possibility of course that a casino may go out of business or surrender or lose its pe tam-111325-98 license or go into bankruptcy with the result that the amounts shown on the jackpot indicators would never be won by playing patrons but this potential nonpayment of an incurred liability exists for every business that uses an accrual_method and it does not prevent accrual id pincite revrul_80_230 1980_2_cb_169 addresses the proper year in which a bank can accrue its liability for a semiannual assessment by the comptroller of the currency to pay the expenses of bank examinations the issue is whether the bank a taxpayer using an accrual_method for reporting its income on a calendar_year basis can accrue on date the semiannual assessment required to be paid to the comptroller of the currency for the first semiannual period beginning date the assessment was based on the total assets of the bank as shown on the bank's date report of condition and was due on or before date applicable comptroller of the currency regulations provided that each bank subject_to the jurisdiction of the comptroller of the currency on the date of the second or fourth condition reports is subject_to the full assessment for the next 6_month period without proration for any reason the semiannual assessment for the first semiannual period of based on the condition reports submitted for the fourth reporting_period ending date was sent to the comptroller of the currency with the required_payment on date under these facts the ruling holds that all the events that determine the fact of liability for the semiannual assessment occur as of date and not as of date the ruling notes that although the semiannual assessment is based on the date report of condition it is not payable until date and is for the 6-month period beginning date we believe the facts of the present case are indistinguishable from the facts of revrul_80_230 similar to revrul_80_230 the taxpayer is attempting to accrue a liability for a payment which is for insurance coverage to be provided in a future taxable_year with respect to deposits on hand in the future taxable_year the taxpayer has no obligation under the fdia or the fdic regulations to pay the insurance assessment unless it is in existence on january year and it has customer deposits on hand on that date that will be insured by the fdic the taxpayer's obligation is not fixed and absolute nor is it unconditional as of december of year see c f_r b which limits a terminating bank’s obligation to file certified statements and pay assessments only for the period its deposits are insured thus following the analysis of revrul_80_230 we do not believe that all events necessary to fix the liability for the insurance assessment relating to the first semiannual period of year have occurred until january year 2d tam-111325-98 the taxpayer argues that the conclusion in revrul_80_230 is erroneous because the comptroller of the currency regulations provided that each bank subject_to the jurisdiction of the comptroller of the currency on the date of the second or fourth condition reports is subject_to the full assessment for the next 6_month period without proration for any reason according to the taxpayer the bank in revrul_80_230 would be subject_to the jurisdiction of the comptroller of the currency on date unless the bank had converted to a state charter ceased to do business or merged with another institution thus the taxpayer argues that under applicable banking laws the liability for the examination fee relating to the first semiannual period of was fixed on date since none of these events occurred and thus the bank was subject_to the jurisdiction of the comptroller of the currency on that date despite the taxpayer's argument however the conclusion reached in revrul_80_230 is based on the fact that the event fixing the liability the required performance or other event occurs as of date the ruling indicates that the event fixing the liability for the assessment was the required performance of bank examinations covering the first semiannual period of and not the filing of the date report of condition or the payment_date of date thus the analysis of revrul_80_230 requires the conclusion that the taxpayer's liability for insurance assessments covering the first semiannual period of year is not fixed until january year as the last event fixing the liability-the existence of deposits owned by the taxpayer requiring insurance coverage-does not occur until that time in the ruling payment was not made until january the taxpayer the taxpayer also argues that because revrul_80_230 was issued before enactment of the economic_performance rules the analysis of the ruling is no longer relevant ’ argues that because it made the payment in december of year its facts are distinguishable from revrul_80_230 we do not believe application of the economic_performance rules changes the all events analysis of revrul_80_230 even if the bank in that ruling had made payment of the semiannual assessment the ruling’s conclusion that all events was not met until date would still stand because the payment was for future bank examinations covering the period beginning january generally the economic_performance test of sec_461 of the code is effective date the date of enactment of the deficit reduction act sec_1_461-4 of the regulations provides that the payment requirement for payment liabilities under sec_1_461-4 applies to liabilities that would otherwise be deductible or incurred for taxable years beginning after date tam-11 the regulations at sec_1_461-4 make clear the fact that payment constitutes economic_performance in the presence of a payment_liability however payment does not serve to fix the liability which must be established independently as a consequence of the all_events_test absent the existence of the liability therefore payment alone will not suffice to permit the taxpayer to accrue a deduction thus revrul_80_230 remains as a valid and pointed illustration of when the liability of the taxpayer for deposit insurance becomes fixed moreover the taxpayer argues that its liability is fixed pursuant to the fdia and the fdic regulations and thus its situation is similar to the casino's obligation in hughes properties the taxpayer argues that its liability is imposed under the fdic regulations on the basis of facts which could not change after the end of the year and the fact that it might cease operations before january of year is irrelevant for purposes of the all_events_test we do not think the state law fixing liability in the hughes properties case is analogous to the fdia or the fdic regulations in this case in hughes properties the last pull of the slot machine at the end of the casino’s taxable_year established the exact amount as shown on the payoff indicator that the casino would have to pay at a future date the last pull irrevocably fixed the casino’s liability at the end of the tax_year under state law and only the identity of the actual winner was unknown at that time in this case the event which corresponds to the last pull in the hughes properties case is the provision of insurance coverage by the fdic and the existence of deposit liability of the taxpayer as of january year in hughes properties the fact that the casino might go out of business in the in this case the fact next taxable_year did not defeat the existence of a fixed liability that the taxpayer might go out of business in the next taxable_year could cause taxpayer to not be liable for the first semiannual assessment of year for example assume that a bank had not paid its first semiannual assessment yet and on january the bank terminates its insured status the fdic regulations provide that if a bank terminates its insured status and its deposit liabilities are assumed by another insured bank the terminating bank does not have to file a final certified statement and pay the normal assessment on its deposits if the assuming bank agrees to fulfill the terminating bank’s obligation to file the certified statement and pay the assessment c f_r a thus in this situation the terminating bank's liability for the first semiannual assessment of the year would be assumed by the assuming bank the fdic is not necessarily concerned about which insured bank pays the assessment as long as an insured bank pays the assessment if there are customer deposits to be insured during the first semiannual period in essence the liability to pay an assessment is fixed with respect to the deposits but the deposits have to be the tam-111325-98 in order for that bank to be liable for deposit liabilities of a particular bank on january the insurance assessment moreover the fdic regulations provide that if a bank terminates and its deposit liabilities are not assumed by another insured bank there is it no liability to pay for deposit insurance after the bank pays off all its depositors or if continues in business and none of the deposits are insured in the next period c f_r b thus there are circumstances in which the fdic regulations clearly relieve the terminating bank of its obligation to file a certified statement and pay the applicable assessment there are circumstances in which the taxpayer could contest its liability for a semiannual assessment and the fdic would have to establish their right to payment from the taxpayer in that semiannual period the taxpayer argues that because it did not terminate by december of year or give notice to the fdic that it intended to terminate by that time and because its deposits were not assumed by another insured bank it was certain to be an insured bank on january of year a taxpayer cannot deduct an estimate of an anticipated expense however no matter it is based on events that have not occurred by the close of how statistically certain if the taxable_year see 481_us_239 thus we believe the analysis of revrul_80_230 requires the conclusion that the taxpayer's liability for payment of its deposit insurance assessment relating to the first semiannual period of year is not fixed under the all_events_test until january year the last event fixing liability is the existence of deposit liability of the taxpayer on january of year and the corresponding provision of insurance coverage by the fdic beginning on january caveat 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-


department of the treasury internal_revenue_service washington d c jun tep pa tl tax_exempt_and_government_entities_division uniform issue list kek kkk aan legend taxpayer a ira y account z reit m reit n reit o reit p financial_institution c financial_institution d financial advisor g eke eke kek he kek kee kkk kak kkk eke page amount date year year year dear kkk kk ee ee this letter is in response to your request on date submitted by your authorized representative as supplemented by correspondence dated date and date in which you request a waiver of the 60-day rollover period contained in sec_408 of the internal_revenue_code the code the following facts and representations have been submitted under penalty of perjury in support of the ruling requested taxpayer a age represents that his failure to accomplish a rollover of amount from ira y within the 60-day period prescribed by sec_408 of the code was due to errors made by financial_institution c and financial_institution d taxpayer a asserts that amount has not been used for any purpose taxpayer a maintained ira y at financial_institution c financial_institution d held reit m and reit n as investments within ira y financial_institution c gave up custodianship of ira y due to dollar_figure in uncollected administrative fees on date financial_institution c distributed_amount from ira y to taxpayer a at this time financial_institution d immediately converted ira y into account z within account z financial_institution d converted reit m into reit o a non-qualified investment and converted reit n into reit p another non-qualified investment taxpayer a never had possession of amount during year and year financial_institution d sent taxpayer a correspondence and account statements that identified account z as an ira and identified reit o and reit p as tax-qualified investments in year financial_institution d sent taxpayer a an account z year-end statement for year that reflected that financial_institution d had reclassified reit o and reit p as non-qualified investments taxpayer a provided copies of the paperwork that he completed at the time that he opened ira y at financial_institution c it included notices that service fees for ira y would be charged to the account and that in the event that ira y was terminated financial_institution c would convert it into another ira further using the paperwork provided by financial_institution c taxpayer a designated financial advisor g as his page 2012370e7 representative to receive ira y account statements and correspondence after financial_institution c gave up custodianship of ira y financial_institution d listed financial advisor g as taxpayer a’s financial advisor in all account z correspondence and account statements taxpayer a further represents that he relied upon financial advisor g’s services and advice in making decisions regarding ira y taxpayer a asserts that throughout year he understood and viewed account z to be an jra and reit o and reit p to be qualified_investments taxpayer a asserts that he neither gave financial_institution d his permission nor his direction to convert ira y into account z convert reit m into reit o and convert reit n into reit p furthermore financial advisor g provided a sworn statement that neither financial_institution c nor financial_institution d provided her with correspondence and account statements for ira y and for account z based on the facts and representations taxpayer a requests a ruling that the internal_revenue_service waive the 60-day rollover requirement contained in sec_408 of the code with respect to the distribution of amount sec_408 of the code provides that except as otherwise provided in sec_408 any amount_paid or distributed out of an ira shall be included in gross_income by the payee or distributee as the case may be in the manner provided under sec_72 of the code sec_408 of the code defines and provides the rules applicable to ira_rollovers sec_408 of the code provides that sec_408 of the code does not apply to any amount_paid or distributed out of an ira to the individual for whose benefit the ira is maintained if-- i the entire amount received including money and any other_property is paid into an ira for the benefit of such individual not later than the 60th day after the day on which the individual receives the payment or distribution or ii the entire amount received including money and any other_property is paid into an eligible_retirement_plan other than an ira for the benefit of such individual not later than the 60th day after the date on which the payment or distribution is received except that the maximum amount which may be paid into such plan may not exceed the portion of the amount received which is includible in gross_income determined without regard to sec_408 sec_408 of the code provides that sec_408 does not apply to any amount described in sec_408 received by an individual from an ira if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in sec_408 from an ira which was not includible in gross_income because of the application of sec_408 page sec_408 of the code provides a similar 60-day rollover period for partial rollovers sec_408 of the code provides that the secretary may waive the 60-day requirement under sec_408 of the code where the failure to waive such requirement would be against equity or good conscience including casualty disaster or other events beyond the reasonable control of the individual subject_to such requirement only distributions that occurred after date are eligible for the waiver under sec_408 of the code revproc_2003_16 2003_4_irb_359 date provides that in determining whether to grant a waiver of the 60-day rollover requirement pursuant to sec_408 of the code the service will consider all relevant facts and circumstances including errors committed by a financial_institution inability to complete a rollover due to death disability hospitalization incarceration restrictions imposed by a foreign_country or postal error the use of the amount distributed for example in the case of payment by check whether the check was cashed and the time elapsed since the distribution occurred the information presented and submitted by the taxpayer including documentation from financial_institution c and from financial_institution d is consistent with the assertion that taxpayer a’s inability to complete a timely rollover was due to errors committed by these financial institutions therefore pursuant to sec_408 of the code the service hereby waives the 60-day rollover requirement with respect to the distribution of amount from ira y taxpayer a is granted a period of days from the issuance of this letter_ruling to contribute amount into a rollover ira provided all other requirements of sec_408 of the code except the 60-day requirement are met with respect to such contributions amount will be considered a rollover_contribution within the meaning of sec_408 of the code no opinion is expressed as to the tax treatment of the transaction described herein under the provisions of any other section of either the code or regulations which may be applicable thereto this letter is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent kke page if you wish to inquire about this ruling contact at - please address all correspondence to se t ep ra t2 sincerely yours dd _ lilo donzelllittlejohn manager employee_plans technical group ith a enclosures deleted copy of ruling letter notice of intention to disclosure cc eek ek wee


date internal_revenue_service number info release date uil conex the honorable ed bryant u s house of representatives washington d c dear mr bryant this letter is in response to your inquiry copy enclosed dated date on behalf of your constituent refers to a newspaper article about statutory stock_option profits he questions the fairness of an irs proposal to impose federal_insurance_contributions_act fica tax on unrealized statutory stock_option profits because he says taxpayers already pay an income_tax on realized profits i have read the newspaper article and believe it alludes to the statement we make in notice_2001_14 2001_6_irb_516 published date copy enclosed in that notice we simply clarify current law that employment_taxes apply to statutory_stock_options such as incentive stock_options described in sec_422 of the internal_revenue_code code and options granted under an employee_stock_purchase_plan described in sec_423 of the code the notice also provides relief to taxpayers regarding the application of these taxes we disagree with any interpretation that we are proposing a new position on employment_taxes rather as stated in the notice we are simply clarifying current law that employment_taxes including fica tax apply to statutory_stock_options fica tax on statutory_stock_options the fica tax is made up of social_security and medicare taxes on the wages paid to an employee the congress enacted the social_security act and the fica to provide for a federal system of old-age survivors disability and hospital insurance under this system the social_security_tax finances old-age survivors and disability insurance the medicare_tax finances hospital insurance the fica tax finances social_security retirement benefits and medicare coverage that are important in the lives of many taxpayers the fica tax is calculated as a percentage of an employee’s wages for fica tax purposes wages are defined generally as all remuneration for employment including the cash_value of all remuneration including benefits paid in any medium other than cash the internal_revenue_code provisions provide no exceptions from wages for remuneration paid in the form of stock nor are there any provisions that exclude from wages remuneration received from the exercise of a statutory stock_option accordingly fica tax applies to the payment of wages that arise when a statutory stock_option is exercised the wages paid being equal to the difference between the fair_market_value of the stock received and the price paid_by the employee for the stock notice_2001_14 provides generous relief on the application of employment_taxes to statutory_stock_options it provides that the irs will not assess fica tax or futa_tax on the exercise of a statutory option exercised before date the notice also provides some income_tax_withholding relief notice_2001_14 also includes a comment period that closed on date we are considering all of the comments we received under this notice they are important in developing any further guidance on applying employment_taxes to statutory_stock_options i hope this information is helpful please call me or elliot m rogers at if you have any questions sincerely michael a swim chief employment_tax branch office of the division counsel associate chief_counsel tax exempt and government entities enclosures


internal_revenue_service p o box cincinnati oh number release date department of the treasury employer_identification_number contact person - id number date date contact telephone number legend uil x employer name y number z number dear you asked for advance approval of your employer-related scholarship grant procedures under internal_revenue_code sec_4945 this approval is required because you are a private_foundation that is exempt from federal_income_tax you requested approval of your scholarship program to fund the education of certain qualifying students our determination we approved your procedures for awarding employer-related scholarships based on the information you submitted and assuming you will conduct your program as proposed we determined that your procedures for awarding employer-related scholarships meet the requirements of code sec_4945 as a result expenditures you make under these procedures won't be taxable also awards made under these procedures are scholarship or fellowship grants and are not taxable to the recipients if they use them for qualified_tuition_and_related_expenses subject_to the limitations provided in code sec_117 description of your request your letter indicates you will operate an employer-related scholarship program you plan to provide educational scholarships to i the children of x income housing projects in your vocational and life-skills training programs and iii other individuals who meet the eligibility and qualifying requirements ii individuals from low- the purpose of your program is to enable scholarship recipients to obtain an education in their individual capacities for their personal benefit you will publicize the program in announcements to employees of x to individuals who participate in your life skills training programs and to the public through the intranet newsletters and email blasts such letter catalog number 58264e announcements will provide information on the availability of the scholarship grants solicit applicants provide information about the application process and announce the names of grant recipients these communications will clearly identify you as the grantor of the awards each applicant must be i the child of a current officer_or_employee of x with at least three years_of_service ii the child of a former officer_or_employee of x who died while so employed regardless of the length of service iii an individual participating in your life skills training programs or iv an otherwise deserving and qualifying_individual who is selected based on nondiscriminatory factors and who is not related to you or x in addition each applicant must be a full-time undergraduate or graduate student at an accredited college or university located in the united_states which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on or ii provide a copy of a letter of acceptance from such an institution at which the applicant intends to matriculate as a full-time_student with respect to an upcoming academic semester or year moreover an applicant is not eligible for a scholarship grant if he or she cannot reasonably be expected to attend the required educational_institution even if he or she satisfies the minimum eligibility requirements at the time of application furthermore eligibility shall not be related to any other employment-related factors such as the employee’s position or duties except to the extent if any that such duties with respect to you may affect the applicant’s status as a disqualified_person all applicants must complete sign and return to you by an established deadline an application including all supporting reports transcripts or other required documents such as letters of recommendation specified on the application the applications will be reviewed and evaluated by your scholarship selection committee and will consist entirely of individuals totally independent and separate from x you and those persons who run or help to run your training programming the scholarship selection committee will be composed of in the range of y individuals that you select annually at least z members will be individuals knowledgeable in the field of education to ensure they have the background and knowledge to properly evaluate and select the applicants no member of the scholarship selection committee may be a current or former officer or director of x a current or former officer or director of x or any other person who may have such a substantial personal or financial connection with either x you other than as a member of the committee or the vocational training program provided by you as would reasonably call into question the ability of that person to make independent objective and nondiscriminatory decisions relating to the selection of scholarship recipients the scholarship selection committee will select recipients solely using objective criteria completely unrelated to the employment by x of the applicant’s parent or parents and to letter catalog number 58264e any of your activities furthermore no recipient may be related to any current member of the scholarship selection committee and shall not otherwise be a disqualified_person with respect to you as defined by sec_4946 of the code such criteria will include but not be limited to the following i ii prior academic performance using the applicant’s transcript for the preceding academic year or such other period specified or by the receipt of academic awards or prizes performance on tests designed to measure ability and aptitude for higher education iii written recommendations from instructors or other individuals not related to iv v the applicant financial need as evidenced by a student financial aid report a proposed budget showing both educational expenses and all sources of income and the family circumstances of the applicant eg number of siblings then enrolled or expected to be enrolled at an accredited college or university in the united_states during the forthcoming academic year and conclusions drawn from personal interviews personal essays written by the applicant or other sources regarding the applicant's motivation character and potential as evidenced by the applicant's career plans and goals extracurricular activities community service or involvement ability to overcome personal or family adversity and similar factors in those cases where the scholarship selection committee has identified two or more potential recipients of a grant who are equally qualified for the grant based on the relevant selection criteria the grant will be awarded in the following descending order of preference i ii an applicant who is the child of an officer_or_employee of x who died while acting in the course of his or her employment an applicant who is the child of an officer_or_employee who died while employed by x iii an applicant whose parent or parents have died iv an applicant who has not previously received a grant the scholarship selection committee will recommend to you the amount of each scholarship using the annual budget for scholarships based on your current_assets and income provided by you subject_to your board_of directors’ power to authorize the grant amounts and to verify the eligibility requirements and selection criteria used by the scholarship selection committee in making its selections only the scholarship selection committee may vary the amounts of the grants awarded after receiving the scholarship the recipient must continue to be enrolled at an educational_institution as specified and his or her standing at such educational_institution must be consistent with the purposes and conditions of the grant if a grant is awarded for a period of more than one semester the grantee must remain in good academic standing letter catalog number 58264e to receive a grant for a subsequent semester and the scholarship selection committee may require the grantee to pledge that he she will maintain a minimum grade point average specified at the time of the grant award you will contact and confirm no earlier than five days prior to the disbursement of funds to the recipient's educational_institution that the recipient is enrolled and in good standing at the college or university no scholarship funds will be disbursed unless a current certified copy of the recipient's most recent transcript is provided and the recipient's status as a student enrolled and in good standing with the college or university is confirmed if a grant is awarded for either one semester or academic year and the recipient must reapply for a grant to continue studies for a subsequent semester or academic year the recipient shall not be considered ineligible for a further grant solely because the recipient’s parent is no longer employed by x or because the individual is no longer a participant in your training programs all standards for renewal of grants awarded to children of employees of shall be based solely upon non-employment-related factors such as need and maintenance of scholastic standards you will pay all scholarship grants directly to the educational_institution attended by or to be attended by the grant recipient under no circumstances will a grant be paid directly to a grant recipient or to an account controlled by the recipient the educational_institution to which a grant is paid on behalf of a recipient shall agree in writing to use the grant funds to defray the recipient’s expenses or to pay the funds or a portion thereof to the recipient only if the recipient is enrolled at such educational_institution and his or her standing at such educational_institution is consistent with the purposes and conditions of the grant furthermore the educational_institution will agree in writing that in the event the recipient fails to satisfy the criteria with respect to enrollment and standing the institution shall return to you any portion of the grant not yet expended on behalf of or paid to the recipient by the institution if the recipient fails to enroll in the college or university or withdraws from the college or university during the time where a reimbursement of tuition and fees is available any funds paid_by you shall be returned to you your program will comply with the seven conditions and either the percentage tests or the facts_and_circumstances_test for scholarships to attend an educational_institution as set forth in revproc_76_47 1976_2_cb_670 and 1980_2_cb_722 no grant shall include any commitments understandings or obligations conditional or unconditional suggesting that the studies are undertaken by the recipients for the benefit you or x or have as their objective the accomplishment of any purpose of yours or x other than enabling the recipients to obtain an education in their individual capacities and solely for their personal benefit the program will also satisfy one of the two alternative percentage tests as provided in rev procs and to determine who can be shown to be eligible for grants without submitting an application you will require the employees of x whose children may be eligible to complete an annual questionnaire letter cataiog number 58264e all records pertaining to the review of applications for and award of your scholarships will be maintained for no less than six years each year you will review all materials maintained in these records and complete an annual certification that all scholarship recipients have provided all materials required for the award of funds and that all scholarship recipients have been certified as eligible to receive scholarship funds you will designate and require the chair of your scholarship committee to keep and maintain all scholarship applications certifications records related to ongoing eligibility of recipients grade reports of applicants as well as any and all other materials arising from or related to your scholarship program in a secure and confidential manner accessible to your scholarship committee audit committee and available for examination upon lawful request basis for our determination the law imposes certain excise_taxes on the taxable_expenditures of private_foundations code sec_4945 a taxable_expenditure is any amount a private_foundation pays as a grant to an individual for travel study or other similar purposes however a grant that meets all of the following requirements of code sec_4945 is not a taxable_expenditure the foundation awards the grant on an objective and nondiscriminatory basis the irs approves in advance the procedure for awarding the grant the grant is a scholarship or fellowship subject_to code sec_117 the grant is to be used for study at an educational_organization described in code sec_170 revproc_76_47 1976_2_cb_670 provides guidelines to determine whether grants a private_foundation makes under an employer-related program to employees or children of employees are scholarship or fellowship grants subject_to the provisions of code sec_117 if the program satisfies the seven conditions in sections dollar_figure through dollar_figure of revproc_76_47 and meets the applicable_percentage tests described in section dollar_figure of revproc_76_47 we will assume the grants are subject_to the provisions of code sec_117 you represented that your grant program will meet the requirements of either the percent or percent percentage_test in revproc_76_47 these tests require that e e the number of grants awarded to employees’ children in any year won't exceed percent of the number of employees’ children who were eligible for grants were applicants for grants and were considered by the selection committee for grants or the number of grants awarded to employees’ children in any year won't exceed percent of the number of employees’ children who were eligible for grants whether or not they submitted an application or letter catalog number 58264e the number of grants awarded to employees in any year won't exceed percent of the number of employees who were eligible for grants were applicants for grants and were considered by the selection committee for grants you further represented that you will include only children who meet the eligibility standards described in revproc_85_51 1985_2_cb_717 when applying the percent test applicable to employees’ children in determining how many employee children are eligible for a scholarship under the percent test a private_foundation may include only those children who submit a written_statement or who meet your eligibility requirements they must also satisfy certain enrollment conditions you represented that your procedures for awarding grants under this program will meet the requirements of revproc_76_47 in particular an independent selection committee whose members are separate from you your creator and the employer will select individual grant recipients you will not use grants to recruit employees nor will you end a grant if the employee leaves the employer you will not limit the recipient to a course of study that would particularly benefit you or the employer other conditions that apply to this determination this determination only covers the grant program described above this approval will apply to succeeding grant programs only if their standards and procedures don’t differ significantly from those described in your original request this determination is in effect as long as your procedures comply with sections dollar_figure through dollar_figure of revproc_76_47 and with either of the percentage tests of sec_4 if you establish another program covering the same individuals that program must also meet the percentage_test this determination applies only to you it may not be cited as a precedent you cannot rely on the conclusions in this letter if the facts you provided have changed substantially you must report any significant changes to your program to the cincinnati office of exempt_organizations at internal_revenue_service exempt_organizations determinations p o box cincinnati oh you cannot award grants to your creators officers directors trustees foundation managers or members of selection committees or their relatives letter catalog number 58264e e e all funds distributed to individuals must be made on a charitable basis and further the purposes of your organization you cannot award grants for a purpose that is inconsistent with code sec_170 you should keep adequate_records and case histories so that you can substantiate your grant distributions with the irs if necessary please keep a copy of this letter in your records if you have questions please contact the person listed at the top of this letter sincerely jeffrey cooper director exempt_organizations rulings and agreements letter catalog number 58264e


internal_revenue_service number release date index number ----------------- ----------------------------------------- -------------------------- ----------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------------ id no ---------------- telephone number ---------------------- refer reply to cc psi b01 plr-107005-18 date date legend x ------------------------------------------------------------ ------------------- a ------------------------------------------------------------- ------------------------------ b ----------------------- ------------------------------------------------------------- c ------------------------ ------------------------------------------------------------- partnership ------------------------------------------------------------ --------------------------------- state date date date date date -------------- ----------------------- ---------------------- --------------------------- ----------------- ---------------------------- plr-107005-18 dear ---------------- this responds to a letter dated date and subsequent correspondence submitted on behalf of x by x's authorized representative requesting relief under sec_1362 of the internal_revenue_code the code facts according to the information submitted x was incorporated under the laws of state on date x elected to be treated as an s_corporation effective date on date all of the shares in x were transferred to partnership a partnership for federal tax purposes partnership as a partnership was an ineligible shareholder of an s_corporation on date x learned that the transfer of stock to partnership terminated x's s election on date x and its shareholders took remedial action by having partnership transfer all of its shares in x to eligible s_corporation shareholders a b and c after date all income and other items from the x shares were allocated to a b and c between date and date all the partners of partnership were eligible shareholders of an s_corporation x represents that it did not intend for its s_corporation_election to terminate and that the events that resulted in the termination were not motivated by tax_avoidance or retroactive tax planning x represents that all shareholders filed their returns consistent with x being an s_corporation further x and its shareholders agree to make any adjustments required by the secretary consistent with the treatment of x as an s_corporation law and analysis sec_1361 provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year sec_1361 defines a small_business_corporation as a domestic_corporation that is not an ineligible_corporation and that does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than one class of stock sec_1362 provides that an election under sec_1362 shall be terminated whenever the corporation ceases to be a small_business_corporation plr-107005-18 sec_1362 provides in relevant part that if an election under sec_1362 by any corporation was terminated under paragraph or of sec_1362 the secretary determines that the circumstances resulting in such termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in termination steps were taken so that the corporation is once more a small_business_corporation and the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to sec_1362 agrees to make any adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to the period then notwithstanding the circumstances resulting in the termination the corporation will be treated as continuing to be an s_corporation during the period specified by the secretary conclusion based solely on the information submitted and the representations made we conclude that x's s election terminated on date when all of the shares of x stock were transferred to partnership we further conclude that the termination was inadvertent within the meaning of sec_1362 accordingly under sec_1362 x will be treated as continuing to be an s_corporation on and after date provided that x's s_corporation_election was valid and not otherwise terminated under sec_1362 partnership will be treated as the shareholder of x from date until date at which point a b and c will be treated as the shareholders accordingly the shareholders of x must include in income their pro_rata share of the separately_stated and nonseparately computed items of x as provided in sec_1366 make an adjustments to basis as provided in sec_1367 and take into account any distributions made by x as provided in sec_1368 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 specifically no opinion is expressed concerning whether x is otherwise eligible to be treated as an s_corporation plr-107005-18 this ruling is directed only to the taxpayer who requested it according to sec_6110 this ruling may not be used or cited as precedent pursuant to the power_of_attorney on file with this office we are sending a copy of this letter to x's authorized representative sincerely laura c fields laura c fields senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


t c memo united_states tax_court stephen s wang jr petitioner v commissioner of internal revenue respondent docket no filed date mark d pastor and robert t leonard for petitioner ronald m rosen for respondent memorandum findings_of_fact and opinion gerber judge respondent determined a deficiency in petitioner’s federal_income_tax for of dollar_figure additions to tax for fraud under sec_6653 a and b of dollar_figure and percent of the interest due on dollar_figure respectively and an unless otherwise indicated all section references are to the internal_revenue_code for the year in issue and all rule references are to the tax_court rules_of_practice and procedure addition_to_tax for substantial_understatement of tax under sec_6661 of dollar_figure in the answer respondent asserted additions to tax for negligence under sec_6653 in the alternative to additions to tax for fraud at trial and on brief respondent sought an increased deficiency and increased additions to tax as a result of the parties’ stipulation that petitioner had unreported income of dollar_figure for taxable_year in addition to the dollar_figure unreported income determined by respondent in the deficiency_notice the issues for our consideration are whether petitioner is entitled to deduct legal fees or disgorgement payments as business_expenses under sec_162 or sec_165 whether petitioner’s deductions or losses resulted in a net_operating_loss nol if petitioner is not entitled to an nol whether he is entitled to the computational benefits of sec_1341 with respect to the disgorgement payment whether petitioner is liable in the alternative for additions to tax for fraud under sec_6653 and b or for negligence under sec_6653 and b and whether petitioner is liable for an addition_to_tax for a substantial_understatement under sec_6661 findings of fact2 at the time the petition was filed petitioner resided in irvine california from the fall of through the spring of petitioner attended the university of illinois at urbana- champaign majoring in finance petitioner left college after the spring semester only nine credits short of his bachelor's degree in date he completed the necessary credits and received a bachelor of science degree in finance with high honors petitioner left college in to work for morgan stanley co morgan stanley a new york investment banking firm for a 2-year internship as a junior analyst initially petitioner worked in the leveraged_buyout unit of morgan stanley’s merchant banking department he was transferred to the mergers and acquisitions department in date because of unsatisfactory work performance and remained in that department until date during the course of his employment at morgan stanley petitioner was privy to confidential business information some of the information was nonpublic or insider information regarding morgan stanley’s clients involved in actual and anticipated corporate combinations and other transactions such as mergers tender offers and leveraged buyouts petitioner was contractually and the stipulation of facts and the attached exhibits are incorporated herein by this reference statutorily obligated to keep the information confidential and not to use or disclose it for his personal benefit in late petitioner met mr fred lee who was then a client of morgan stanley mr lee a taiwanese national owned or had trading authority over a large number of securities and trading accounts with several domestic and foreign brokerage firms sometime in petitioner began selling insider information to mr lee that information had been obtained in the course of petitioner’s employment at morgan stanley mr lee used the insider information to buy and sell corporate securities earning an overall profit of approximately dollar_figure million from date through date mr lee paid petitioner at minimum dollar_figure and dollar_figure for the insider information during and respectively petitioner admitted that he and mr lee had discussed petitioner’s receiving an additional dollar_figure million in compensation petitioner received some cash payments directly from mr lee petitioner also received payments in the form of deposits to a bank account opened in fictitious or nominee names chosen by mr lee petitioner had a power_of_attorney over the bank account in mr lee paid petitioner at least dollar_figure in cash and dollar_figure that was deposited by mr lee into the bank account petitioner spent the dollar_figure within a year and did not deposit any of it into a bank account or keep any record of the money mr lee deposited an additional dollar_figure into the bank account in date in petitioner also sold insider information to mr jerome cronin a former university of illinois classmate in exchange for dollar_figure on date the securities_and_exchange_commission sec instituted a civil_action against petitioner and mr lee in the u s district_court for the southern district of new york for alleged violations of sections b and e of the securities exchange act of u s c sec_78j b and 78n e and sec rules 10b-5 and 14e-3 c f_r secs 10b-5 and 14e-3 promulgated thereunder sec v wang civ no ro s d n y the civil complaint contained allegations that mr lee purchased insider information from petitioner about companies and used that information to purchase securities the sec sought preliminary and permanent injunctions prohibiting petitioner and mr lee from participating in alleged securities law violations and from disposing of their assets the sec also sought to have petitioner and mr lee disgorge their profits derived from the insider information petitioner had sold to mr lee petitioner entered into a settlement of the civil_action with the sec and agreed to disgorge dollar_figure the amount remaining in the nominee bank account in the disgorgement was placed in a receivership fund to be used as restitution for investors who could show a loss due to petitioner’s and mr lee’s illegal actions the disgorgement was not a fine or penalty paid to the government within the meaning of sec_162 on date the federal government filed a three- count criminal information against petitioner in the u s district_court for the southern district of new york charging him with one count each of mail fraud u s c sec_1341 wire fraud u s c sec and securities fraud u s c sec_78j b and 78ff and c f_r sec 10b-5 united_states v wang docket no commissioner ktd s d n y it was alleged that petitioner had taken or stolen confidential business information from morgan stanley and its clients the information contained the names of companies about which petitioner provided insider information to mr lee and mr cronin and also contained charges that insider trading occurred with respect to at least companies petitioner waived indictment and pled guilty to each criminal count he was sentenced to years’ imprisonment and years’ probation petitioner served approximately months in a federal prison from date to date petitioner engaged two law firms to represent him in legal matters arising from his insider trading during and petitioner incurred legal fees and litigation costs that totaled dollar_figure petitioner’s father stephen s wang sr paid petitioner’s legal bills in the amounts of dollar_figure and dollar_figure during and respectively mr wang sr used savings borrowed money employer savings_plan withdrawals and vacation time converted to cash in order to pay his son’s legal expenses before petitioner’s incarceration mr wang sr made out the checks for the legal fees jointly to petitioner and the law firm and gave the checks to petitioner after petitioner’s incarceration mr wang sr issued his checks directly to the law firm and did not obtain petitioner’s endorsement although mr wang sr liquidated assets and incurred debt to pay about dollar_figure of his son’s legal expenses in he sold stock in a taiwanese company for over dollar_figure million in petitioner in connection with the legal expenses executed three promissory notes to his father totaling dollar_figure notes the first note was drafted by an attorney for mr wang sr and was used as a model for the two subsequent notes the notes were unsecured did not require monthly payments and did not begin to accrue interest until in date petitioner executed a note to replace the notes and extended the maturity_date for years providing for accrual of interest during the extended period as of the time of trial petitioner had not made any payments of interest or principal on the replacement note or the notes on his tax_return petitioner reported gross_income of dollar_figure consisting of wages from morgan stanley and dollar_figure of taxable interest_income he did not report his dollar_figure insider trading income dollar_figure of which was included in his gross_income by respondent on his tax_return petitioner reported gross_income of dollar_figure his wages from morgan stanley and he did not report the dollar_figure insider trading income included in his gross_income by respondent for respondent allowed petitioner a dollar_figure deduction for the disgorgement of his insider trading income which resulted in no tax_deficiency for that year respondent determined however that the disgorgement deduction was not in connection with a trade_or_business and accordingly did not generate a nol that could be carried back to under respondent’s determination most about dollar_figure of the dollar_figure disgorgement deduction remained effectively nondeductible on date petitioner executed a form_872 consent to extend the time to assess tax intended to extend the assessment_period to date the form_872 was executed after date after the normal 3-year period for assessment under sec_6501 had expired the form_872 was executed before date within the 6-year period for assessment under sec_6501 that section applies where substantial omissions from gross_income exist the form_872 however did not contain any explanation or indication of whether the period for assessment was then open or under which particular provision it may be open for the tax_year when he signed the form_872 petitioner was represented by an attorney who also signed the form subsequently on or about date and date the parties executed form sec_872 to extend the assessment_period to date and date respectively the notice_of_deficiency was mailed on date 1987--period for assessment opinion as a preliminary matter we consider petitioner’s contention that the assessment_period had expired before respondent mailed the notice_of_deficiency there was in excess of a percent omission of gross_income on petitioner’s tax_return and the 6-year period for assessment is applicable see sec_6501 petitioner executed a form_872 in date before the 6-year assessment_period expired petitioner contends that the form_872 is invalid or without effect because it did not specify that the 6-year assessment_period was applicable accordingly petitioner argues that the assessment_period expired before the notice_of_deficiency was mailed an agreement to extend the assessment_period must be executed before the expiration of the applicable statutory period for assessment or the period agreed upon by the taxpayer and the secretary in a prior agreement sec_6501 there is no requirement however that the parties’ consent or agreement contain a reference to the applicable statutory provision under which the assessment_period remains open additionally our holding that petitioner filed a fraudulent return would also permit the tax for that year to be assessed at any time see sec_6501 therefore the assessment_period had not expired at the time respondent mailed the notice_of_deficiency to petitioner was petitioner’s activity a trade_or_business petitioner has admitted that he had unreported income in the amounts of dollar_figure and dollar_figure for and respectively petitioner’s dollar_figure deduction claimed for the disgorgement was allowed but it only affected the dollar_figure of the insider information income earned for because respondent disallowed any carryback to the dollar_figure earned in petitioner also seeks to claim legal expenses of dollar_figure and dollar_figure paid during and respectively respondent disallowed those deductions on the grounds that they were not paid_by petitioner and or were not incurred_in_a_trade_or_business because of respondent’s allowing dollar_figure of the dollar_figure disgorgement deduction against the dollar_figure of unreported income no deficiency was determined for because respondent determined that petitioner was not in a trade_or_business no part of the dollar_figure difference that was not deductible in could be carried to other taxable years the parties advanced several arguments and the pivotal question for each is whether petitioner was in a trade_or_business although respondent determined that petitioner is entitled to a deduction for the disgorgement an nol was disallowed because of the determination that petitioner’s activity was not a trade_or_business a prerequisite here for a carryback in that context we must decide whether petitioner was in a separate trade and or business of selling insider information or whether the expenses were connected with petitioner’s status as an employee petitioner stipulated that he had unreported income of dollar_figure in from the sale of insider information petitioner contends that he is not liable for an income_tax deficiency for because he sustained nol’s for and that may be carried back to in particular petitioner argues that he is entitled to deduct legal expenses in and and the disgorgement of his insider trading profits in as business_expenses he contends that the legal fees and respondent did not argue or determine that the deduction for the disgorgement or the allowance of a net_operating_loss nol was against public policy in the deficiency_notice respondent determined unreported income of dollar_figure respondent did not seek to amend the answer but at trial and on brief sought an increased deficiency and additions to tax petitioner’s admission that he had unreported income of dollar_figure caused the issue to have been tried by consent of the parties see rule b disgorgement were related to his business activities in the securities industry and therefore are deductible business_expenses respondent maintains that petitioner’s expenditures are not business_expenses because his insider trading activity was not related to his employment at morgan stanley and petitioner was not in a separate trade_or_business of selling insider information respondent has permitted petitioner to deduct the disgorgement under sec_165 as a loss incurred in an activity entered into for profit that does not constitute a trade_or_business a sec_165 nonbusiness loss deduction cannot create an nol_carryback sec_172 respondent also argues that petitioner is not entitled to deduct the legal expenses under either sec_162 or sec_212 because the expenses were paid_by petitioner’s father the first issue for our consideration is whether petitioner’s selling of insider information constituted a trade_or_business petitioner asserts that the sale of insider information was in connection with his employment at morgan stanley and that his job provided him with the opportunity and means to engage in insider trading petitioner also argues that he made the disgorgement to protect his business reputation and future employment although petitioner obtained the insider information in the course of his position with morgan stanley his use and disclosure of the information for profit was not within the scope of his employment petitioner violated his confidentiality agreement with morgan stanley by disclosing and using for his personal gain confidential information that he acquired through his employment respondent attempts to analogize petitioner’s actions to those of an employee who embezzles money from his employer repayment of embezzled funds is not an ordinary and necessary business_expense of being an employee because an embezzler does not act in the course of his employment when taking the money see eg 67_tc_388 morrison v commissioner tcmemo_1981_617 whitler v commissioner tcmemo_1980_214 petitioner’s use and disclosure of the insider information was not in connection with or furtherance of his employment or for a business_purpose of his employer morgan stanley cf 91_tc_352 bribery charge against taxpayer related to his employment because bribe advanced purposes of employer although taxpayer's employer did not instruct him to offer bribe while petitioner’s sale of insider information was facilitated by his employment it was not directly or proximately related to his job at morgan stanley petitioner is not entitled to deduct the legal fees or disgorgement as business_expenses of being a financial analyst next we consider whether petitioner is entitled to deduct the disgorgement payment or the legal fees in connection with the separate trade_or_business of selling insider information to be a trade_or_business a taxpayer’s activity must be frequent regular and continuous 480_us_23 90_tc_1263 affd 877_f2d_1075 1st cir activities that are sporadic do not qualify as a trade_or_business see 91_tc_660 whether petitioner was engaged in a trade_or_business is a question of fact 312_us_212 it has not been established on this record that petitioner’s sales of insider information were continuous and occurred regularly he obtained insider information and sold it to others until his activities were discovered by the sec however his internship with morgan stanley was intended for a limited period after which petitioner intended to finish his college education the civil complaint filed by the sec contained accusations that petitioner sold insider information involving at least companies resulting in dollar_figure million in profits in connection with mr lee’s trading securities the criminal charges against petitioner identified five companies about which petitioner sold insider information to mr lee and mr cronin the criminal information also contained allegations that petitioner had sold insider information with respect to at least companies the five instances of selling insider information to mr lee and mr cronin as set forth in the criminal charges were separate and occurred over several months with respect to the other instances alleged in the civil and criminal documents there is insufficient detail to determine that petitioner's activity was frequent regular and continuous on the basis of this record we conclude and hold that petitioner’s sale of insider trading information was sporadic and represented a limited opportunistic transactional relationship with mr lee accordingly petitioner was not in a trade_or_business in connection with his insider trading activities petitioner contends that the legal expenses paid for his defense in civil and or criminal litigation that arose in connection with his sale of insider information are deductible under sec_162 respondent however argues that petitioner is not entitled to a deduction because the legal expenses were paid_by his father petitioner maintains that his father lent him money to pay his legal expenses and argues that he intended to repay his father as evidenced by promissory notes alternatively petitioner argues that he is entitled to deduct the legal fees because his father paid his legal expenses as a gift to petitioner because we have decided that petitioner was not engaged in a trade_or_business in connection with his sales of insider information it is unnecessary to decide whether he paid the legal expenses that is so because respondent has already allowed the deduction of the disgorgement under sec_165 consuming all of the income reportable for petitioner’s ability to deduct any portion of the or legal payments is governed by the sec_172 net_operating_loss provisions a taxpayer engaged in a trade_or_business may be entitled to carry a resulting nol deduction to other taxable years an nol is the excess of deductions over the taxpayer's gross_income subject_to certain modifications specified in sec_172 sec_172 nonbusiness expenses and losses are not included in nol’s and may not be carried back sec_172 77_tc_246 affd per curiam 682_f2d_207 9th cir the sec_165 loss not from a trade_or_business of the disgorgement would not create an nol for petitioner’s or tax_year that could be carried back to prior years including sec_172 likewise because petitioner is not in a trade_or_business in connection the disgorgement of petitioner’s profits is governed by sec_165 the distinction between losses_and_expenses is found primarily in the nature and occasion of the expenditure it is well settled that deductions for cash forfeitures and confiscations if allowed at all are normally allowed as loss deductions under sec_165 69_tc_75 affd per curiam 611_f2d_1160 5th cir with his sales of insider information an nol would not result from the payment of the legal expenses_incurred in or we hold that petitioner is not entitled to carry back an nol deduction from or to the year in controversy in this case does sec_1341 apply to petitioner’s disgorgement payment having decided that petitioner is not entitled to an nol_carryback to we consider his alternative argument that sec_1341 applies to the disgorgement payment in particular petitioner argues that he is entitled to a tax_credit under sec_1341 equal to the tax attributable to the inclusion of the dollar_figure disgorgement in his income sec_1341 permits a special computation method for the tax_liability of a taxpayer who has received income in excess of dollar_figure in year under a claim of right included the amount in income and in a subsequent taxable_year was required to make restoration of the income to another because it was established that the taxpayer did not have an unrestricted right to the income sec_1341 sec_1_1341-1 income_tax regs sec_1_1341-1 income_tax regs continues with the definition income included under a claim of right means an item included in gross_income because it appeared from all the facts available in the year of inclusion that the taxpayer had an unrestricted right to such item and restoration to another means a restoration resulting because it was established after the close of such prior taxable_year or years that the taxpayer did not have an unrestricted right to such item or portion thereof sec_1341 is titled claim of right but the statutory language used to describe that concept is that the income item must have been includable because it appeared that the taxpayer had an unrestricted right to it emphasis added the above- quoted regulations however again use the term claim of right in the process of defining the operative terms of sec_1341 the concept of claim of right accordingly must be part of our consideration of sec_1341 issues respondent contends that petitioner is not entitled to use sec_1341 because petitioner never included the proceeds of the illegal sale of insider information in his gross_income for petitioner did not have an unrestricted right to the income ie in cases usually involving embezzlement courts have held that the illegal income is not held under a claim of right and in general illegally obtained income does not per se give rise to a claim of right petitioner disagrees with respondent’s contentions and argues that 96_tc_713 a case involving a securities trader who was allowed sec_1341 relief is substantially_similar factually and should be followed sec_1341 was enacted in to address the type of situation that existed in 340_us_590 in that case the taxpayer repaid in a later year part of a bonus received erroneously in a prior year that was closed for tax purposes because of those circumstances the taxpayer lost the benefits of being able to calculate the reduction of income in the year of receipt of the bonus those benefits included interest from a refund of the tax paid earlier and differing tax_rates between the years of receipt and repayment although sec_1341 does not address the question of interest it does address other possible benefits that might have been available from the deduction or computation of the tax in the earlier year respondent contends that sec_1341 generally does not apply to circumstances where the income is obtained through illegal means the cases that have addressed this issue however generally involve embezzlement or a similar circumstance where the taxpayer was entrusted with another's cash or assets we could find only one sec_1341 illegal income case that did not involve embezzlement or similar circumstances on the basis one case involved the misappropriation of a lawyer’s clients’ trust funds which in all material respects is the same as embezzlement especially with respect to the question of whether a taxpayer has a claim of right appearance of an unrestricted right with respect to the item in question see o'hagan v commissioner tcmemo_1995_409 of the embezzlement cases the court in that case decided that the result in the embezzlement case s cannot be limited only to embezzlers instead the statute’s ‘unrestricted right’ language must be read to exclude from its coverage all those who receive earnings knowing themselves to have no legal right thereto 553_fsupp_558 m d fla in a memorandum opinion of this court the generalized holding of perez was relied upon in circumstances where a lawyer converted his client’s trust fund to his own use o’hagan v commissioner tcmemo_1995_409 factually however it is difficult to distinguish a lawyer’s conversion of a client’s funds entrusted to him from other forms of embezzlement in both instances the taxpayer did not have and knew he did not have a claim of right or appearance of unrestricted right to the funds any analysis of the claim of right concept in conjunction with embezzlement cases must focus on a line of cases surrounding 366_us_213 in james the supreme court reversed its holding in 327_us_404 that embezzled funds were not includable in gross_income wilcox was in part predicated on the embezzler’s lack of a claim of right to the alleged gain u s pincite in james v united_states supra pincite the court reasoned that when a taxpayer acquires earnings lawfully or unlawfully without the consensual recognition express or implied of an obligation to repay and without restriction as to their disposition he has received income which he is required to return even though it may still be claimed that he is not entitled to retain the money and even though he may still be adjudged liable to restore its equivalent citation omitted the requirement to report embezzled funds for tax purposes even though the embezzler taxpayer may not have had a claim of right to the funds was analyzed in 67_tc_388 in that case an embezzler failed to meet the first qualification of sec_1341 ie the embezzler did not have a claim of right to the embezzled funds id pincite we agree with respondent that with respect to embezzlement gains it is well established that sec_1341 is not available it does not necessarily follow however that taxpayers with illegal income per se are not entitled to use sec_1341 with respect to each taxpayer it would be necessary to decide whether his circumstances meet the requirements of sec_1341 embezzlers do not meet the claim of right requirement of sec_1341 because there was no claim of right not because the income or gain was illegally obtained sec_1341 applies only if the taxpayer appeared to have an unrestricted right to the income in the year of receipt sec_1341 sec_1_1341-1 income_tax regs here petitioner’s and mr lee’s activities were illegal in every respect petitioner’s act of obtaining the insider information his sale of insider information to others and the use of the information by others were all illegal acts although mr lee did not place any restrictions on use of the funds paid to petitioner under securities laws petitioner did not have a claim of right or the appearance of an unrestricted right to the money he had then knowingly committed a crime and he was subject_to criminal penalties and to the sec’s remedy of disgorgement in petitioner’s disgorged profits were placed in a receivership fund to be used as restitution for investors who could show a loss due to petitioner’s and or mr lee’s illegal actions under these circumstances we hold that petitioner does not pass the sec_1341 requirement and that he is not entitled to sec_1341 relief petitioner argued that his circumstances were similar to those of 96_tc_713 in that case the taxpayer a shareholder in a stock brokerage purchased stock_options on the basis of insider information and realized gain from the sale of the options although the taxpayer was not criminally prosecuted he was sued by the option brokers with whom he had made the trades and profit due to insider information in a year subsequent to the option transactions disgorgement is used as a deterrent and is intended to make the improper use of security information unprofitable 8_f3d_653 9th cir 991_f2d_1486 9th cir 944_f2d_80 2d cir the amount disgorged must be reasonable ie approximately equal to the violator’s profits hateley v sec supra pincite the taxpayer settled the civil suit by disgorging to the option brokers part of his profit from the sale of the options in barrett the taxpayer was allowed to use sec_1341 after the court found that the taxpayer did not have an unrestricted right to the profits or in other words that the taxpayer had a legal_obligation to restore the item id pincite although barrett is factually similar to the case under consideration the holding in that case concerned sec_1341 the court in barrett however did not consider whether there was a claim of right or the appearance of unrestricted right to income from option purchases the focus in barrett was whether the repayment was due to a restriction on the taxpayer ie whether the taxpayer had an obligation to pay the option brokers who had sued him because of our holding that petitioner did not meet the first prong of the sec_1341 requirements we need not consider whether petitioner met the other requirements of sec_1341 accordingly petitioner does not qualify for sec_1341 treatment with respect to the disgorgement payment additions to tax for fraud under sec_6653 the next issue for our consideration is whether petitioner is liable for additions to tax for fraud under sec_6653 and b or in the alternative for negligence under sec_6653 and b sec_6653 imposes an addition_to_tax equal to percent of the underpayment attributable to fraud additionally sec_6653 imposes an addition_to_tax equal to percent of the interest due on an underpayment attributable to fraud respondent has the burden of proving fraud by clear_and_convincing evidence rule b to satisfy this burden respondent must prove that petitioner intended to evade taxes by conduct intended to conceal mislead or otherwise prevent the collection_of_taxes 94_tc_654 80_tc_1111 respondent determined additions to tax for under sec_6653 and b the version of sec_6653 that applied to petitioner’s return see tax_reform_act_of_1986 tra publaw_99_514 100_stat_2085 in the answer respondent incorrectly alleged that the fraud additions for should have been asserted under sec_6653 and a prior version of sec_6653 similarly in the answer respondent asserted alternate additions to tax for negligence for under sec_6653 and a prior version of sec_6653 the version of sec_6653 applicable to taxable_year is sec_6653 and b tra sec_1503 with respect to the fraud additions to tax the deficiency_notice cited the version of sec_6653 applicable to the year in issue and properly informed petitioner of respondent’s determination respondent’s assertion in the answer of a prior version of sec_6653 and b for the additions is an error in form only and does not have a substantive effect on this case in any event citation of a prior version of sec_6653 and b is immaterial to the outcome of the case because respondent bears the burden on both the fraud and negligence additions to tax see rule the existence of fraud is a question of fact to be resolved upon consideration of the entire record 96_tc_858 affd 959_f2d_16 2d cir 69_tc_391 fraud is never presumed and must be established by affirmative evidence of fraudulent intent 829_f2d_828 9th cir affg tcmemo_1986_223 55_tc_85 fraud may be proven by circumstantial evidence because direct proof of the taxpayer’s intent is seldom available 317_us_492 rowlee v commissioner supra courts have developed a nonexclusive list of factors that establish fraudulent intent understatement of income inadequate records implausible or inconsistent explanations of behavior concealment of assets failure_to_file tax returns filing false documents failure to cooperate with tax authorities dealing in cash and engaging in illegal activity 796_f2d_303 9th cir affg tcmemo_1984_601 94_tc_316 91_tc_874 a taxpayer’s intelligence education and experience are relevant in determining fraudulent intent 99_tc_202 from the record in this case we hold that petitioner’s return was fraudulent he pled guilty to securities mail and wire fraud in connection with his acquisition and sale of insider information he failed to report any of the income he received from the sales in either or reporting the illegal income would have increased the risk that petitioner’s illegal activities would be detected reluctance to report illegal income because of the chances that the illegal source of the income will be discovered does not preclude a tax_evasion motive recklitis v commissioner supra pincite moreover participation in illegal activities is a badge of fraud bradford v commissioner supra in addition petitioner attempted to conceal his illegal activities and income by dealing in cash and using a bank account under fictitious names he did not maintain any records of the illegal income or how he used the money received from selling insider information petitioner argues that he did not have fraudulent intent because he did not consider whether or not to report the illegal income petitioner’s argument is unpersuasive he is a well- educated and knowledgeable taxpayer in college he took a number of business courses including a class on federal_income_tax accounting petitioner does not deny that he knew that illegal income was taxable and was aware of his reporting obligations in addition petitioner understood that he received cash he did not use his own name on the bank account to avoid detection of his illegal activity and income we are satisfied that respondent has proven by clear_and_convincing evidence that petitioner had a fraudulent intent petitioner is liable for the additions to tax for fraud under sec_6653 and b consequently we do not need to consider respondent’s alternate assertion that petitioner is liable for additions to tax for negligence addition_to_tax under sec_6661 the final issue for our consideration is whether petitioner is liable for a sec_6661 addition_to_tax sec_6661 imposes an addition_to_tax of percent of any underpayment attributable to a substantial_understatement of tax an understatement is the excess of the correct_tax over the tax reported on the return sec_6661 an understatement is substantial if it exceeds the greater of percent of the correct_tax or dollar_figure sec_6661 the understatement can be eliminated if substantial_authority existed for the taxpayer’s treatment of the item in dispute or if the taxpayer adequately disclosed relevant facts regarding treatment of the item on the return sec_6661 sec_1 a income_tax regs petitioner has the burden to show that he is not liable for the sec_6661 addition_to_tax rule a petitioner has not made any arguments or presented any evidence regarding the sec_6661 addition_to_tax accordingly we find that petitioner is liable for an addition_to_tax under sec_6661 for see 105_tc_324 decision will be entered under rule