department of the treasury washington dc person to contact --------------------- id no ------------ telephone number -------------------- refer reply to cc psi b04 - plr-116224-04 date november internal_revenue_service number release date index number ---------------------------------- ---------------------------------- ------------------------------------------------ --------------------------------- in re ---------------------------------------------------- --------------- ----------------------------------------- --------------------------------------------------- ------------------ --------------------------------- ----------------------- - legend legend date ------------------------- settlor ------------------------------------ trust ---------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------- son --------------------------------- trust agreement ----------------------------------------------------- --------------------------------------------------------------------- granddaughter -------------------------------------------------------------------------- -------------------------------------------- --------------------------------------------------------- charity ------------------------------------------------------ charity -------------------------------------------------------- ------------------------------------------------------------------- state -------------------- company ------------------------ individual ------------- charity ------------------------------------------------------------ this is in response to a letter dated date and other individual ---------------------------- charity -------------------------------------------------------------------------------------------- state statute ----------------------------------------------------------- s trust agreement --------------------------------------------------------------- s trust --------------------------------------------------- grandchild ------------------------- plr-116224-04 ----------------------------------------------------------------------------------------------------------- charity ---------------------------------------------------------- -------------------------------------------------------------------------- state -------- ------------------------------------------------------------- grandchild ------------------------------ ------------------------------------------------------------- grandchild ------------------------------ ------------------------------------------------------------- dear -------------------- correspondence requesting rulings regarding the income gift and generation-skipping_transfer gst tax consequences of a proposed merger of trusts facts executed trust agreement creating an irrevocable_trust under paragraph of trust agreement the irrevocable_trust was to be held for the benefit of settlor’s son during his lifetime under paragraph at son’s death the trustees were to divide and allocate the remaining trust assets per stirpes among son’s then living descendants each share of the trust assets so allocated to a descendant of settlor was to be retained in trust as a separate and independent trust fund designated by that descendant’s name settlor and son are both deceased son had one natural born child granddaughter thus under paragraph of trust agreement at son’s death the trustees placed the remaining trust assets in a single trust named for granddaughter and held for the benefit of granddaughter and her descendants trust under trust agreement since date no additions actual or constructive have been made to the irrevocable_trust held the facts submitted and representations made are as follows on date settlor paragraph of trust agreement provides as follows after the death of settlor’s said son the income and principal of the separate funds named for descendants of settlor created by paragraph plr-116224-04 or by the subsequent provisions of this paragraph shall be held and disposed of as follows a the trustees shall pay to each beneficiary for whom a fund held hereunder is named and his or her descendants or any one or more of them so much or all of the net_income and principal of such fund even though such payments may result in a complete termination of the trusts hereby created with respect to such fund at such time or times and in such proportions among them as the trustees in their sole discretion shall decide taking into consideration the character habits experience needs best interests and welfare of such beneficiary and his or her descendants in the order named and as a group including the desirability of augmenting their respective individual incomes or assets their respective abilities to conserve manage and control property and money usefully and prudently and all other circumstances and factors which the trustees consider pertinent any net_income from any such fund not so distributed shall be accumulated and from time to time added to the principal from which it was derived except that the trustees in any calendar_year if they consider that the payments contemplated above will not be jeopardized in their sole discretion may pay for such religious charitable scientific literary or educational purpose or purposes as the trustees may select such amounts from the net_income which otherwise would have been accumulated as the trustees shall deem advisable but payments pursuant to this sentence shall not exceed twenty per cent of the total net_income from such fund for such year b when each such beneficiary for whom a fund held hereunder is named other than a grandchild of settlor reaches the age of thirty years the trustees shall distribute to such beneficiary the remaining principal of such fund c upon the death of any such beneficiary for whom a fund held hereunder is named the trustees shall divide and allocate the principal of such fund together with all accrued or undistributed_income therefrom per stirpes among his or her then living descendants if any otherwise per stirpes among the then living descendants of the nearest lineal ancestor of such beneficiary who also was a descendant of settlor and of whom one or more descendants then are living or if none then per capita among such of settlor’s grandchildren as then are living the then living descendants of any grandchild of settlor who then is deceased being allocated per stirpes the share which would have been allocated to such deceased grandchild of settlor if then living each share so allocated to a descendant of settlor for whom a fund then held hereunder is named shall be added to such plr-116224-04 fund and each share so allocated to any other descendant of settlor shall be retained in trust hereunder as a separate and independent trust fund designated by his or her name and disposed of as provided in this instrument paragraph provides that no trust property administered under trust agreement will be retained in trust for more than years after the last to die of settlor’s descendants who were living at the execution of trust agreement and each fund still retained in trust at the end of that period will be immediately distributed to the person for whom the fund is named property or of any separate fund that is not effectively disposed of by any of the foregoing provisions will be distributed in equal shares to charity charity and charity paragraph provides that any interest in the income or principal of the trust paragraph provides that the trustees have the powers and rights enumerated in that paragraph in addition to those vested in them elsewhere in the instrument or by law paragraph provides that state is the situs of trust and that the laws of state apply under state statute a trustee has the power to consolidate or more trusts having substantially_similar terms into a single trust it is represented that no court or third party approval is required trust agreement contains no definition of the terms charity and charities and does not limit permissible charities to those described in sec_170 of the internal_revenue_code trust holds stock in company which is currently taxed as a c_corporation the shareholders of company want to elect s_corporation status for company all of company’s shareholders must be eligible to hold s_corporation stock as of the first day of the year in which the election will take effect individual and individual are currently serving as the trustees of trusts and are not beneficiaries of trusts the trustees want to make an electing_small_business_trust esbt election under sec_1361 for trust to qualify trust as an eligible s_corporation shareholder however the trustees believe that trust is not currently eligible to make this election because the discretionary power in the trustees under trust agreement to pay up to percent of trust’s annual income to one or more charities contains no limit on the number of charities and trust agreement does not limit permissible charities to those described in sec_170 individual in his individual capacity will create s trust named for granddaughter and held for the benefit of granddaughter and her descendants individual will execute a new s trust agreement which contains provisions substantially_similar to those of trust agreement to s trust agreement and provides plr-116224-04 that only one trust is currently held under its provisions s trust individual sec_1 and will be named as the trustees of s trust upon the creation of s trust individual will fund s trust with a nominal sum the substantive terms of s trust agreement will differ from those of trust agreement as follows paragraph a of s trust agreement provides a the trustees shall pay to each beneficiary for whom a fund held hereunder is named and his or her descendants or any one or more of them so much or all of the net_income and principal of such fund even though such payments may result in a complete termination of the trusts hereby created with respect to such fund at such time or times and in such proportions among them as the trustees in their sole discretion shall decide taking into consideration the character habits experience needs best interests and welfare of such beneficiary and his or her descendants in the order named and as a group including the desirability of augmenting their respective individual incomes or assets their respective abilities to conserve manage and control property and money usefully and prudently and all other circumstances and factors which the trustees consider pertinent any net_income from any such fund not so distributed shall be accumulated and from time to time added to the principal from which it was derived except that the trustees in any calendar_year if they consider that the payments contemplated above will not be jeopardized in their sole discretion may pay to such designated charities as the trustees may select such amounts from the net_income which otherwise would have been accumulated as the trustees shall deem advisable but payments pursuant to this sentence shall not exceed twenty per cent of the total net_income from such fund for such year the designated charities to receive any such payment or payments shall be either or both of charity or charity as selected by the trustees from time to time except that no payments may be made to any charity that is not a qualified charity at the time the payment is made and any payment made to charity must be made to a donor_advised_fund under such program with the trustees hereunder as the advisers as to such fund if any designated charity is not a qualified charity at any time a payment is to be made the trustees shall designate irrevocably in a written instrument filed with the trust records a substitute qualified charity as a designated charity in its place from that point on qualified charity means a charity that is in existence and is described in sec_170 of the internal_revenue_code_of_1986 as amended or any successor provision charity can make distributions to a broad class of other charities and generally will follow the recommendations of the advisers paragraph of s trust agreement remains substantially_similar to paragraph plr-116224-04 of trust agreement and provides that no trust property administered under s trust agreement will be retained in trust for more than years after the last to die of settlor’s descendants who were living on date the date trust agreement was executed and each fund still retained in trust at the end of that period will be immediately distributed to the person for whom the fund is named of trust agreement but further provides that if charity charity or charity is not a qualified charity at the time of distribution under paragraph the trustees will distribute the remaining trust corpus and income to the remaining of said charities that is a qualified charity if none of them is then a qualified charity the trustees will choose one or more institutions that are then qualified charities of similar kind and distribute the remaining trust to them paragraph of s trust agreement remains substantially identical to paragraph paragraph of s trust agreement remains substantially identical to paragraph of trust agreement but further provides that each trust created under s trust agreement is governed by the laws of state as if s trust agreement were entered into on date shortly after s trust agreement is executed creating s trust the trustees of trust will merge trust into s trust the trustees will execute a memorandum of merger to effectuate the merger pursuant to their authority under state statute after the merger all of the assets of trust including trust’s stock in company will be owned by s trust and trust will cease to exist the trustees have requested the following rulings the current individual beneficiaries of trust are granddaughter and her three children grandchild grandchild and grandchild trust to gst tax under sec_2601 by forfeiting the effective date exempt status of those assets the merger of trust into s trust will not subject the assets of trust held by sec_2 the merger of trust into s trust will not result in a transfer by any of the no gain_or_loss under sec_1001 will be realized by trust s trust or any beneficiaries that is subject_to gift_tax under ' beneficiaries of either trust as a result of the merger of trust into s trust and the assets transferred from trust to s trust will have the same basis and holding periods under sec_1015 and sec_1223 before and after the merger plr-116224-04 immediately after the merger of trust into s trust s trust will qualify as an esbt within the meaning of sec_1361 and will not have as a potential_current_beneficiary any charity other than those named in s trust ruling_request transferor to a skip_person sec_2601 imposes a tax on each generation-skipping_transfer made by a under ' a of the tax_reform_act_of_1986 the generation-skipping_transfer_tax is generally applicable to generation-skipping transfers made after date however under ' b a of the tax reform act and ' b i of the generation-skipping_transfer_tax regulations the tax does not apply to a transfer from a_trust if the trust was irrevocable on date and no addition actual or constructive was made to the trust after that date under ' b ii any trust in existence on date will be considered irrevocable unless the settlor had a power that would have caused inclusion of the trust in his or her gross_estate under or if the settlor had died on date sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the generation-skipping_transfer_tax will not cause the trust to lose its exempt status the regulation provides that the rules contained in the paragraph are applicable only for purposes of determining whether an exempt trust retains its exempt status for generation-skipping_transfer_tax purposes the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of capital_gain for purposes of ' sec_26_2601-1 provides that a modification will not cause an exempt trust to be subject_to the provisions of chapter if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in ' than the person or persons who held the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a gst transfer or the creation of a new gst transfer a modification that is administrative in nature that only indirectly increases the amount transferred for example by lowering administrative costs or income taxes will not be considered to shift a beneficial_interest in the trust example contained in ' b i e considers a situation where in grantor established an irrevocable_trust for grantor's child and the child's issue plr-116224-04 in grantor's spouse also established a separate irrevocable_trust for the benefit of the same child and issue the terms of the spouse's trust and grantor's trust are identical in the appropriate local court approved the merger of the two trusts into one trust to save administrative costs and enhance the management of the investments the merger of the two trusts does not shift any beneficial_interest in the trust to a beneficiary who occupies a lower generation as defined in ' than the person or persons who held the beneficial_interest prior to the merger in addition the merger does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust therefore the trust that resulted from the merger will not be subject_to the provisions of chapter in the present case trust was irrevocable on date it is represented that no additions actual or constructive were made to trust after that date the merger of trust into s trust is substantially_similar to the situation described in example of ' b i e s trust agreement governing s trust contains substantially the same provisions as trust agreement governing trust except for limiting the definition of permissible charitable beneficiaries to those described in ' c and limiting the number and type of charitable beneficiaries the trustees of s trust will have the same discretion as they had over trust to pay or permanently set_aside for charities in any year up to percent of s trust’s income for the year s trust will terminate on the same date on which trust would have terminated all interests under s trust will vest on the same date as under trust thus the merger of trust into s trust will not result in a shift of any beneficial_interest in the trust assets to any beneficiary who occupies a generation lower than the persons holding the beneficial interests prior to the reorganization and will not extend the time for vesting of any beneficial_interest in s trust beyond the period provided for in trust accordingly based on the facts submitted and the representations made and assuming the transaction is carried out and is effective under state law we rule that the merger of trust into s trust will not subject the assets of trust held by s trust to gst tax under sec_2601 by forfeiting the effective date exempt status of those assets ruling_request sec_2501 imposes a tax on the transfer of property by gift by an individual sec_2511 provides that the tax imposed by ' applies whether the transfer is in trust or otherwise whether the gift is direct or indirect and whether the property is real or personal tangible or intangible sec_2512 provides that if a gift is made in property the value thereof at the date of the gift shall be considered the amount_of_the_gift sec_2512 provides that where property is transferred for less than an adequate_consideration in money or plr-116224-04 money s worth then the amount by which the value of the property exceeded the value of the consideration is deemed a gift in this case the terms of trust agreement governing trust and of s trust sec_1001 provides that the gain from the sale_or_other_disposition of sec_61 provides that gross_income includes gains derived from dealings sec_1001 states that the amount_realized from the sale_or_other_disposition agreement governing s trust are substantially identical except as noted above based on the facts submitted and the representations made and assuming the transaction is carried out and is effective under state law we conclude that the merger of trust into s trust will not result in a transfer by any of the beneficiaries that is subject_to federal gift_tax under ' ruling_request in property and under ' a from an interest in a_trust property shall be the excess of the amount_realized therefrom over the adjusted_basis provided in ' for determining gain and the loss shall be the excess of the adjusted_basis provided in ' for determining loss over the amount_realized of property shall be the sum of any money received plus the fair_market_value of the property other than money received under ' c except as otherwise provided in subtitle a the entire amount of gain_or_loss determined under ' on the sale_or_exchange of property shall be recognized sec_1_1001-1 of the income_tax regulations provides that the gain_or_loss realized from the conversion of property into cash or from the exchange of property for other_property differing materially either in_kind or in extent is treated as income or loss sustained a partition of jointly owned property is not a sale_or_other_disposition of property where the co-owners of the joint property sever their joint_interests but do not acquire a new or additional interest as a result of the transaction thus neither gain nor loss is realized on a partition see revrul_56_437 1956_2_cb_507 issue of when a sale_or_exchange has taken place that results in realization of gain_or_loss under sec_1001 in cottage savings a financial_institution exchanged its interests in one group of residential mortgage loans for another lender's interests in a different group of residential mortgage loans the two groups of mortgages were considered substantially identical by the agency that regulated the financial_institution 499_us_554 concerns the plr-116224-04 the supreme court of the united_states in cottage savings u s pincite concluded that sec_1_1001-1 reasonably interprets sec_1001 and stated that an exchange of property gives rise to a realization event under sec_1001 if the properties exchanged are materially different in defining what constitutes a material difference for purposes of sec_1001 the court stated that properties are different in the sense that is material to the code so long as their respective possessors enjoy legal entitlements that are different in_kind or extent cottage savings u s pincite the court held that mortgage loans made to different obligors and secured_by different homes did embody distinct legal entitlements and that the taxpayer realized losses when it exchanged interests in the loans cottage savings u s pincite having substantially_similar terms into a single trust see state statute the interests of the beneficiaries of the s trust will not differ materially from their interests in trust in the proposed transaction trust will be merged into s trust in accordance with state law except for the changes described above all other provisions of trust will remain unchanged accordingly the proposed transaction will not result in a material difference in_kind or extent of the legal entitlements enjoyed by the beneficiaries it is consistent with the supreme court's opinion in cottage savings to find that under state law the trustee has the power to consolidate or more trusts sec_1015 provides that the basis in property acquired by a transfer in trust is the same as it would be in the hands of the grantor with adjustments for gain and loss recognized the basis in the assets of the s trust will be determined under sec_1015 based on the facts submitted and the representations made and assuming the sec_1223 provides that in determining the period for which the taxpayer has held property however acquired there shall be included the period for which the property was held by any other person if under chapter of the code such property has for the purposes of determining gain_or_loss from a sale_or_exchange the same basis in whole or in part in the taxpayer's hands as it would have in the hands of such other person transaction is carried out and is effective under state law we conclude that no gain_or_loss under sec_1001 will be realized by trust s trust or any beneficiaries as a result of the merger of trust into s trust and the assets transferred from trust to s trust will have the same basis and holding periods under sec_1015 and sec_1223 respectively before and after the mergers ruling_request sec_1362 provides that except as provided in sec_1362 a small_business sec_1361 defines an s_corporation as a small_business_corporation for plr-116224-04 corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation which an election under sec_1362 is in effect for the taxable_year sec_1361 provides that the term small_business_corporation means a domestic_corporation which 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 sec_1361 provides that for purposes of sec_1361 an esbt may be a shareholder of an s_corporation sec_1361 provides that in the case of an esbt each potential_current_beneficiary of such trust shall be treated as a shareholder for purposes of sec_1361 except that if for any period there is no potential_current_beneficiary of such trust such trust shall be treated as the shareholder during such period as a beneficiary any person other than i an individual ii an estate iii an organization described in paragraph or of sec_170 or iv an organization described in sec_170 which holds a contingent_interest in such trust and is not a potential_current_beneficiary ii no interest in such trust was acquired by purchase and iii an election under sec_1361 applies to such trust not include - i any qualified_subchapter_s_trust as defined in sec_1361 if an election under sec_1361 applies to any corporation the stock of which is held by such trust ii any trust exempt from tax under subtitle a of chapter and iii any charitable_remainder_annuity_trust or charitable_remainder_unitrust as defined in sec_664 sec_1361 provides that the term electing_small_business_trust shall sec_1361 defines a_trust as an esbt if i such trust does not have sec_1361 provides that for purposes of sec_1361 the term potential sec_1_1361-1 provides that in general for purposes of determining current beneficiary means with respect to any period any person who at any time during such period is entitled to or at the discretion of any person may receive a distribution from the principal or income of the trust whether a corporation is a small_business_corporation within the meaning of sec_1361 each potential_current_beneficiary of an esbt generally is treated as a shareholder of the corporation subject_to the provisions of sec_1_1361-1 a potential_current_beneficiary generally is with respect to any period any person who at any time during such period is entitled to or in the discretion of any person may receive plr-116224-04 a distribution from the principal or income of the trust a person is treated as a shareholder of the s_corporation at any moment in time when that person is entitled to or in the discretion of any person may receive a distribution of principal or income of the trust based on the facts submitted and the representations made and assuming the transaction is carried out and is effective under state law we conclude as follows immediately after the merger of trust into s trust if the trustees make a valid except as specifically ruled herein we express no opinion on the federal tax this ruling is directed only to the taxpayer who requested it sec_6110 esbt election for s trust then s trust will qualify as an esbt within the meaning of sec_1361 and will not have as a potential_current_beneficiary any charity other than those named in s trust consequences of the proposed merger under the cited provisions or under any other provisions of the code provides that it may not be used or cited as precedent senior counsel branch office of associate chief_counsel enclosure copy for sec_6110 purposes passthroughs and special industries lorraine e gardner _________________________ sincerely yours cc


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 plr-121375-17 date august legend x state date date a b_trust trust trust --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- ------------------------------- ---------- ---------------------------- ----------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- --------------------------- --------------------------- -------------------------- ---------------------------- ---------------------------- dear ------------ this responds to a letter dated date and subsequent correspondence submitted on behalf of x by x’s authorized representative requesting inadvertent termination relief under sec_1362 of the internal_revenue_code facts the information submitted states that x was incorporated under the laws of state on date x filed a timely election under sec_1362 to be treated as an s_corporation effective date on date a and b individual shareholders of x established trust plr-121375-17 trust and trust nongrantor trusts whose beneficiaries were all u s citizens on date a and b transferred shares of x stock to each of trust trust and trust x represents that trust trust and trust each qualified to elect to be treated as electing small_business trusts esbts under sec_1361 however the trustees for each of the trusts failed to make timely esbt elections within the meaning of sec_1361 thereby causing x’s s_corporation_election to terminate on date x represents that the circumstances resulting in the termination of x’s s_corporation_election were inadvertent and not motivated by tax_avoidance x further represents that x filed returns consistent with x’s status as an s_corporation x also represents that on date trust trust and trust each qualified to be an esbt and continue to qualify as an esbt x further represents that trust trust and trust each filed returns consistent with rules applicable to esbts x and its shareholders agree to make such adjustments consistent with the treatment of x as an s_corporation as may be required by the secretary 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 provides that for purposes of subchapter_s the term small_business_corporation means a domestic_corporation which is not an ineligible_corporation and which does not have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual sec_1361 provides that for the purposes of sec_1362 an esbt may be a shareholder sec_1361 provides that for purposes of sec_1361 except as provided in sec_1361 the term electing_small_business_trust means any trust if i such trust does not have as a beneficiary any person other than i an individual ii an estate iii an organization described in sec_170 or or iv an organization described in sec_170 which holds a contingent_interest in such trust and is not a potential_current_beneficiary ii no interest in such trust was acquired by purchase and iii an election under sec_1361 applies to such trust sec_1361 provides that an election under sec_1361 shall made by the trustee any such election shall apply to the taxable_year of the trust for which made and all subsequent taxable years of such trust unless revoked with the consent of the secretary plr-121375-17 sec_1_1361-1 of the income_tax regulations provides in part that the trustee of the trust must make the esbt election by signing and filing with the service_center where the s_corporation files its income_tax return a statement that meets the requirements of sec_1_1361-1 sec_1362 provides that an election under sec_1362 shall be terminated whenever at any time on or after the 1st day of the 1st taxable_year for which the corporation is an s_corporation such corporation ceases to be a small_business_corporation sec_1362 provides that if an election under sec_1362 by any corporation was terminated under sec_1362 or 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 such termination steps were taken so that the corporation for which the termination occurred is a small_business_corporation and the corporation for which the termination occurred and each person who was a shareholder in such corporation at any time during the period specified pursuant to f agrees to make such adjustments consistent with the treatment of such corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such termination such corporation shall be treated as an s_corporation during the period specified by the secretary sec_1_1362-4 provides in relevant part that for purposes of sec_1_1362-4 the determination of whether a termination was inadvertent is made by the commissioner the corporation has the burden of establishing that under the relevant facts and circumstances the commissioner should determine that the termination was inadvertent the fact that the terminating event was not reasonably within the control of the corporation and was not part of a plan to terminate the election or the fact that the terminating event or circumstance took place without the knowledge of the corporation notwithstanding its due diligence to safeguard itself against such an event or circumstance tends to establish that the termination was inadvertent sec_1_1362-4 provides in part that the commissioner may require any adjustments that are appropriate in general the adjustments should be consistent with the treatment of the corporation as an s_corporation during the period specified by the commissioner based solely on the facts submitted and representations made we conclude that x’s s_corporation_election terminated beginning on date because the trustees of trust trust and trust failed to timely file the required esbt elections under sec_1361 we further conclude that the termination was inadvertent within the meaning of sec_1362 and x will continue to be treated as an s_corporation for the period plr-121375-17 from date provided that x’s s_corporation_election was valid and was not otherwise terminated under sec_1362 this ruling is conditioned upon the trustees of trust trust and trust filing a esbt elections effective upon date the elections must be filed with the appropriate service_center within days of the date of this ruling a copy of this letter should be attached to the esbt elections except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion regarding whether x is otherwise eligible to be treated as an s_corporation or whether trust trust or trust is eligible to be treated as an esbt this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file a copy of this letter is being sent to x’s authorized representative sincerely laura c fields laura c fields senior technician reviewer branch passthroughs special industries enclosures copy of this letter copy for purposes cc


tax_exempt_and_government_entities_division department of the treasury ‘ washington d c may -ih he of legend taxpayer a individual i ira x ira y trust t state s county c this is in response to the date request for letter rulings under sec_401 of the internal_revenue_code submitted on your behalf by your authorized representative as supplemented by correspondence dated date and february and and date the request for letter rulings is based on the following facts and representations at the age taxpayer a was born on of at the time of his death taxpayer a was a resident of county c in state s at the time of his death taxpayer a was survived by only one child individual i the taxpayer requesting this ruling individual i was born on and died on trust t was created by taxpayer a as trustor and trustee on by the terms of trust t taxpayer a is the only person who had the power to terminate the trust trust t became irrevocable at the death of taxpayer a your authorized representative asserts that trust t is valid under the laws of state s the state of taxpayer page a’s residence and the state designated in section dollar_figure of trust t as the state whose laws shall govern tee at the time of his death taxpayer a maintained ira x and ira y on _ taxpayer a executed a beneficiary designation form for ira x naming trust t as the sole beneficiary on designation form for ira y naming trust t as the sole beneficiary taxpayer a was unmarried at the time that the beneficiary designation forms were executed and remained unmarried up through the time of his death taxpayer a executed a beneficiary section dollar_figure of trust t specifies the distributions to occur upon the death of the trustor and after disposing of various tangible_personal_property subsection b states upon the death of the trustor the trustee shall distribute the balance of the trust estate to the trustor’s child free of trust provided she survives the trustor individual i is taxpayer a’s only child under the law of state s the trustee will distribute one hundred percent of ira x and ira y in_kind to individual i free of trust section dollar_figure of trust t states on the death of the trustor the trustee in the trustee’s discretion may pay out of the trust estate debts of the trustor the estate and inheritance taxes including interest and penalties arising because of the trustor’s death the last illness and funeral_expenses of the trustor attorneys’ fees and other costs incurred in administering the trustor’s probate_estate notwithstanding the foregoing no such payments shall be made from funds received by the trustee from qualified employees’ benefit plans to the extent they qualify for exclusion from the taxable_estate for estate_tax purposes or from assets which are exempt from creditor’s claims under applicable federal and state law and such funds shall not be used to satisfy any other obligations of the trustor’s estate no assets of iras x and y have been used to pay any taxes expenses of last illness or funeral nor have they been used to pay any of the costs incurred in administering the taxpayer a’s probate_estate or the expenses of trust t under sec_704 e of the code of state s funds in an ira or private retirement_plan are exempt to the extent necessary to provide for the support of the judgment debtor and for the support of the spouse and dependents of the judgment debtor taking into account all resources that are likely to be available for the support of the judgment debtor when the judgment debtor retires l i page given the fact that taxpayer a had not reached retirement age individual i asks the service to assume that state s courts would have ruled that iras x and y- were exempt from creditor claims under the preceding state s code section for purposes of this ruling_request the service so assumes copies of trust t were provided to the administrator custodian of iras x and y prior to date individual i has taken a required_minimum_distribution from trust t for based on her life expectancy of the year single life table of sec_1_401_a_9_-9 of the income_tax regulations she has also taken a required_minimum_distribution from trust t for the year on her life expectancy of the required_minimum_distribution for the year as determined under the sased 1as not yet been taken on ira x and ira y were re-titled as follows taxpayer a decedent ira individual i beneficiary no distributions were made from the iras in connection with the re-titling based on the above facts and representations you through your authorized representative request letter rulings that trust t is a qualified_beneficiary within the meaning of sec_1_401_a_9_-4 question and answer of the income_tax regulations required minimum distributions from iras x and y received in and through trust t and required minimum distributions for and subsequent years that will be made directly from iras x and y to individual i may be calculated based on the life expectancy of individual i and the transfer of individual i’s interest in taxpayer a’s iras to the re-titled iras will not constitute a taxable_distribution within the meaning of sec_408 of the code to individual i and does not constitute a rollover as that term is used in sec_408 with respect to your ruling requests code sec_408 provides that under regulations prescribed by the secretary rules similar to the rules of sec_401 and the incidental death_benefit requirements of sec_401 shall apply to the distribution of the entire_interest of an individual for whose benefit an ira trust is maintained code sec_401 provides in general that a_trust will not be considered qualified unless the plan provides that the entire_interest of each employee- i will be distributed to such employee not later than the required_beginning_date or page i will be distributed beginning not later than the required_beginning_date over the life of such employee or over the lives of such employee and a designated_beneficiary or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated_beneficiary code sec_401 provides in general that if a plan participant tra holder dies before the distribution of his interest has begun in accordance with subparagraph a ii prior to his required_beginning_date then his entire_interest must be distributed within years of his death code sec_401 provides in general that if any portion of the interest of a deceased plan participant ira holder is payable to or for the benefit of a designated_beneficiary such portion will be distributed beginning not later than year after the date of the deceased’s death or a later date as prescribed by the secretary under regulations in accordance with regulations over the life of the designated_beneficiary or a period not extending beyond the life expectancy of the beneficiary code sec_401 provides in relevant part that for purposes of this paragraph the term required_beginning_date means april of the calendar_year following the calendar_year in which the employee attains age with respect to your ruling requests final income_tax regulations under code sec_401 and sec_408 were published in the federal_register pincite federal_register date and in the internal_revenue_bulletin pincite l r b date the preamble to the final regulations in relevant part provide that the regulations apply for determining required minimum distributions for calendar years beginning after date for determining required distributions for calendar_year taxpayers may rely on the proposed_regulations the proposed_regulations or the final regulations sec_1_401_a_9_-3 of the final regulations q a-3 a provides in general that with respect to the life expectancy exception to the 5-year rule described in code sec_401 iii and in a-1 distributions are required to begin to a non-spouse beneficiary on or before the end of the calendar_year immediately following the calendar yeat in which the employee died sec_1_401_a_9_-5 of the final regulations q a-5 b provides in general that if an employee dies before his required_beginning_date in order to satisfy the requirements of code sec_401 or iv and the life_expectancy_rule described in a-1 of sec_1_401_a_9_-3 the applicable distribution period for distribution calendar years after the distribution calendar_year containing the employee’s date of death is determined in accordance with paragraph c of this a-5 sec_1_401_a_9_-5 of the final regulations q a-5 c provides in general that with respect to a non-spouse beneficiary the applicable distribution period l i page v455019 measured by the beneficiary’s remaining life expectancy is determined using the beneficiary’s age as of the beneficiary’s birthday in the calendar_year immediately following the calendar_year of the employee’s death in subsequent calendar years the applicable distribution period is reduced by one for each calendar_year that has elapsed after the calendar_year immediately following the calendar_year of the employee’s death sec_1_401_a_9_-4 of the final regulations q a-1 provides in relevant part that a designated_beneficiary is an individual who is designated as a beneficiary under a plan either by the terms of the plan or by an affirmative election by the employee q a-1 further provides that a person who takes under a will or otherwise under applicable state law will not be a designated_beneficiary unless that individual also takes under a plan sec_1_401_a_9_-4 of the final regulations q a-4 provides in relevant part that in order to be a designated_beneficiary an individual must be a beneficiary as of the date of the employee’s death generally an employee’s designated_beneficiary will be determined based on the beneficiaries designated as of the date of death who remain beneficiaries as of september of the calendar_year following the calendar_year of death sec_1_401_a_9_-4 of the final regulations q a-3 provides that only individuals may be designated beneficiaries for purposes of sec_401 a person who is not an individual such as the employee's estate may not be a designated_beneficiary however q a-5 of sec_1_401_a_9_-4 provides that beneficiaries of a_trust with respect to the trust's interest in an employee's benefit may be treated as designated beneficiaries if the following requirements are met the trust is valid under state law or would be but for the fact that there is no corpus the trust is irrevocable or the trust contains language to the effect it becomes irrevocable upon the death of the employee the beneficiaries of the trust who are beneficiaries with respect to the trust's interest in the employee's benefit are identifiable within the meaning of a-1 of this section from the trust instrument the documentation described in a-6 of this section has been provided to the plan_administrator sec_1_401_a_9_-4 of the final regulations q a-6 b provides generally with respect to required minimum distributions after the death of the employee that documentation described therein must be provided by the trustee of the trust_beneficiary to the plan_administrator by october of the calendar_year following the calendar_year in which the employee died page v453019 sec_1_401_a_9_-9 of the final regulations sets down the life expectancy tables to be used to determine minimum required distributions q a-1 sets dowfi the single life table pursuant to the single life table the life expectancy of an individual aged i sec_40 years as previously noted taxpayers must compute minimum required distributions for calendar years beginning with calendar_year regulations referenced above distributions for calendar_year accordance with the final regulations in accordance with the final may also be made in in this case with respect to the first and second ruling requests although the provisions of trust t authorize the payment of funeral burial and administrative expenses associated with the death of taxpayer a the above referenced state s statute precludes ira assets from being used to pay said expenses thus trust t assets other than iras x and y by law had to be used to pay any taxes expenses of last illness or funeral costs incurred in administering taxpayer a’s probate_estate or the expenses of trust t after careful consideration of the facts in this case we believe that it is appropriate to treat said fact pattern as coming within sec_1_401_a_9_-4 of the final the only remaining beneficiary regulations q a-4 a because on of trust t was individual i only the life expectancy of individual i must be considered to determine which is the life expectancy that must be used to calculate minimum required distributions from ira’s x and y to trust t and the beneficiary thereof further in accordance with a -4 of the final regulations q a- sec_5 the following requirements are met trust t is valid under the law of state s trust t became irrevocable upon the death of taxpayer a individual i is identifiable as the beneficiary with respect to trust t’s interest in the iras x and y within the meaning of a-1 of a -4 of the final regulations copies of trust t were provided to the administrator custodian of iras x and y prior to date with further respect to your second ruling_request taxpayer a’s beneficiary designation s provided that his iras x and y were to be paid at his death to his trust t for the benefit of individual i the beneficiary thereof as beneficiary of trust t which is a see-through trust within the meaning of sec_1_401_a_9_-4 of the final regulations q a-s individual may receive distributions from iras x and y through trust t over her life expectancy the issue to be resolved is whether she may continue i page to do so after iras x and y were transferred to iras set up and maintained in the name of taxpayer a deceased to benefit individual i directly without regard to trust-f- with regard to this question we note that the provisions of taxpayer a’s trust t authorize payment of trust property including iras x and y directly to individual i without regard to trust t thus said payment conforms with taxpayer a’s intent we also note that prior to the date action s referenced above required distributions from iras x and y were being made over individual i’s life expectancy in accordance with the requirements of code sec_401 and sec_408 and the final regulations promulgated thereunder after the date action s required distributions will continue to be made using individual i’s life expectancy thus individual i’s ceasing to use trust t as a conduit for her payments from iras x and y will affect neither the amount nor the timing of required distributions therefrom thus with respect to your first and second ruling requests based on the specific facts and representations surrounding this ruling_request we conclude as follows trust t is a qualified_beneficiary within the meaning of sec_1_401_a_9_-4 question and answer of the income_tax regulations and required minimum distributions from iras x and y received in and through trust t and required minimum distributions for and subsequent years that will be made directly from iras x and y to individual i may be calculated based on the life expectancy of individual i and with respect to ruling_request three revrul_78_406 1978_2_cb_157 provides that the direct transfer of funds from one ira trustee to another ira trustee even if at the behest of the ira holder or beneficiary of a deceased ira holder does not constitute a payment or distribution to a participant payee or distribute as those terms are used in code sec_408 furthermore such a transfer does not constitute a rollover_distribution and contribution thus based on the facts and representations surrounding this ruling_request we conclude as follows the transfer of individual i’s interest in taxpayer a’s iras to the re-titled _ iras will not constitute a taxable_distribution within the meaning of sec_408 of the code to individual i and does not constitute a rollover as that term is used in sec_408 this ruling letter is based on the assumption that iras x and y either met or meet the requirements of code sec_408 at all times relevant thereto it also assumes that the retitled iras created on all times relevant thereto furthermore it assumes that the law of state s precludes creditor claims against iras x and y as represented finally it assumes that trust t is valid under the laws of state s as represented meet the requirements of code sec_408 at i t page pursuant to a power_of_attorney on file with this office the original of this letter_ruling is being sent to one of your authorized representatives and a copy of this letter_ruling is being sent to another of your authorized representatives this letter is directed only to the taxpayer that requested it and is based solely on the representations made with respect thereto sec_6110 of the code provides that it may not be used or cited as precedent the author of this letter is se t ep ra t3 who may be reached at sincerely yours ere tances v eee sloan employee_plans anager technical group enclosures deleted copy of ruling letter notice of intention to disclose


t c memo united_states tax_court richard d nelson petitioner v commissioner of internal revenue respondent docket no filed date stanley hagendorf and wayne hagendorf for petitioner william r mccants for respondent memorandum findings_of_fact and opinion gerber judge respondent determined deficiencies in petitioner’s federal_income_tax and accuracy-related_penalties under sec_6662' for the and taxable years as follows unless otherwise indicated section references are to the internal_revenue_code in effect for the taxable years under consideration rule references are to the tax court’s rules_of_practice and procedure penalty year deficiency sec_6662 dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure we consider the following issues whether petitioner has established a passthrough loss by showing his s corporation’s entitlement a to accrue and deduct a dollar_figure million legal fee for b to deduct dollar_figure monthly payments made in connection with a bingo business and c to deduct claimed supplies expenses for the and taxable years if petitioner establishes a passthrough loss whether petitioner had basis in his wholly owned s_corporation so as to allow passthrough losses for his individual taxable years and whether petitioner is liable for a negligence_penalty under sec_6662 for and or findings_of_fact at the time his petition was filed petitioner resided in florida petitioner’s wholly owned corporation november inc november was incorporated in virginia on date and for its through taxable years reported as an s_corporation income and deductions under the accrual_method of accounting in the late 1980’s petitioner became involved with respondent bears the burden of showing that petitioner did not have basis because respondent raised the question of basis in his trial memorandum and assumed the burden in accord with this court’s rules sherman and elaine lichty the lichtys and hilton enterprises inc hilton in connection with a bingo operation leonard morrison morrison and the lichtys established a successful bingo operation during the early 1980’s at a location on warwick boulevard in newport news virginia warwick location but they were prosecuted for fraud and they were required to divest their interest in the bingo operation as a requirement of probation initially the divestment was accomplished by interposing michael anderson anderson morrison’s son-in-law to serve the lichtys’ and morrison’s interests anderson due to personal problems did not effectively operate the bingo operation and late in the lichtys and morrison were referred to petitioner by mark gilbert gilbert a mutual friend gilbert placed petitioner into the bingo business opportunity as a straw for the lichtys in accord with a date purchase agreement it appeared that november had purchased the assets of hilton enterprises inc hilton in order to operate the bingo business at the warwick location a property leased by the lichtys gilbert also became involved in the bingo operation and received a salary in addition gilbert owned an adjacent parking lot used in conjunction with the bingo business operations petitioner was to receive a dollar_figure salary that was to be increased after year prior to his involvement q4e- in the bingo operation petitioner had reported annual earnings to respondent of about dollar_figure petitioner’s involvement in the bingo business however was expected to generate dollar_figure per year for petitioner petitioner and november jointly executed a dollar_figure promissory note dated date in favor of the lichtys and a sublease for the warwick property the note was secured_by petitioner’s stock in november and all of the assets used in the bingo business and called for dollar_figure monthly payments to the lichtys the transaction was in part structured to appear to be a sale and also to permit the monthly note payments to be reflected as rent so as to be deducted by november and or petitioner from the bingo-related income in substance petitioner was acting as a shill for the lichtys and morrison because of their probation requirements the note and lease were intended as a contrivance that permitted the lichtys and morrison to remain financially involved in the bingo business and to maintain some control_over petitioner’s involvement in that regard gilbert assisted the lichtys and morrison by overseeing petitioner’s involvement in the bingo operation the lichtys’ lease on the warwick property expired date and during they found a new bingo location owned by lockwood brothers inc on chestnut avenue the chestnut property - - the chestnut property had been used as a fish processing factory and november expended approximately dollar_figure to improve and make the chestnut property suitable for the bingo operations november expended dollar_figure dollar_figure and dollar_figure during and respectively to convert it into a bingo operation based on those expenditures november claimed depreciation on a 10-year basis equal to the term of the chestnut property lease in the respective amounts of dollar_figure dollar_figure and dollar_figure for the through tax years the lichtys and november during date jointly entered into a lease of the chestnut property the lichtys’ involvement was through their corporate entity edl properties inc edl under the terms of the lease the lichtys’ entity was obligated for a dollar_figure monthly rental payment for the chestnut property beginning date disagreements arose between petitioner november and the lichtys and gilbert concerning the bingo operation and the lichtys advised petitioner that it was not likely that he would be allowed to continue as the bingo operator on date petitioner and november filed suit against the lichtys and others treating the sublease of the property and note for dollar_figure as rightful and seeking specific performance anda temporary injunction petitioner sought exclusive use of the chestnut property for the bingo operation and to keep the lichtys -- - and others from interfering in date the suit was settled with petitioner and november emerging with the right to continue the operation of the bingo business under the settlement edl entered into a 10-year sublease of the chestnut property with november petitioner november had hired attorney william m krieger krieger on a contingent_fee basis to represent them in the above-described lawsuit as a result of the successful settlement of the suit it was determined that the value of the bingo business was approximately dollar_figure million and that krieger was entitled to a dollar_figure million fee november and petitioner during date executed a promissory note to krieger for dollar_figure million that was payable from bingo income and wholly dependent on the success of the bingo operations the note did not have a maturity_date and was payable in monthly amounts computed in accord with a separate agreement between the parties the agreement limited petitioner’s salary to an amount not exceeding dollar_figure until such time as krieger’s dollar_figure million note including interest was paid in full the note was non-negotiable and could not be discounted transferred assigned or owned by anyone other than krieger and his immediate heirs under the agreement and note november was obligated for and did pay to krieger one-third of the pretax profit which amounted to - dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure for the years and respectively as an accrual basis reporter november claimed a dollar_figure million deduction for krieger’s fee for its reporting_period but petitioner now claims the entire dollar_figure million november paid the dollar_figure rent for the chestnut property for date and paid amounts for rent and other items into the court during the pendency of the lawsuit after the lawsuit and pursuant to the settlement between november petitioner and the lichtys and others november made monthly payments of dollar_figure the equivalent of dollar_figure rent on the chestnut property plus dollar_figure to the lichtys’ entity for the and reporting periods november paid dollar_figure dollar_figure and dollar_figure consisting of the above-described payments respondent disallowed the dollar_figure million deduction that had been claimed for legal fees the deduction was disallowed on the alternative grounds that economic_performance had not occurred or that the fee was a capital nonamortizable expenditure respondent also determined that the improvements to the chestnut property were not currently deductible and that they should be capitalized and depreciated during a 5-year recovery_period under the modified accelerated_cost_recovery_system macrs under respondent’s determination november would be entitled to depreciation_deductions of dollar_figure dollar_figure and dollar_figure for - - and respectively respondent also disallowed about dollar_figure of the dollar_figure monthly payments that november had claimed as rent on the basis that those amounts were capital payments that were being paid to acquire the bingo business petitioner on his income_tax return claimed a dollar_figure flowthrough loss from november his s_corporation respondent due to his determination denying certain of november’s claimed deductions in turn disallowed petitioner’s claimed loss petitioner claimed a carryover of the loss to his and income_tax returns respondent did not make the determination in the deficiency_notice that petitioner had insufficient basis in his s_corporation november to claim the loss november’s capital stock was issued for dollar_figure and did not increase loans from shareholders at one time approached dollar_figure but decreased to zero by the time of the years under consideration petitioner recognized dollar_figure and dollar_figure of passthrough income from november as reflected on forms 1120s schedules k shareholders’ shares of income credits deductions etc form_1120s for the and tax years november’s balance sheets reflect dollar_figure in equity and the loans to shareholders on november’s balance sheets reflected dollar_figure as of date dollar_figure as of date dollar_figure as - - of date dollar_figure as of date and dollar_figure as of date opinion the parties agree that prior to his bringing suit against the lichtys petitioner was a shill for others and that his apparent ownership of the bingo operation was most likely a sham in addition petitioner asserts that the existence of his s_corporation should be disregarded and that he should be permitted to report the income or claim the losses directly instead of passing them through the entity as an alternative petitioner argues that he was not the beneficial_owner of the equity_interest in november or the bingo operations during the years in issue but was merely a ‘front man’ a ‘straw’ or ‘shill’ under the alternative argument petitioner asks us to hold that he was not entitled to any income from november finally petitioner counters respondent’s position by contending that the disputed adjustments to his s_corporation were in error and that he had basis to claim a passthrough loss petitioner’s argument that we disregard his wholly owned corporate entity november must fail petitioner first raised this argument on brief in a posttrial setting although we summarily dispense with petitioner’s argument that no income should be attributable to him because he received varying amounts of money and or benefits from and or through his s corporation’s bingo activities -- - respondent argues that petitioner did not have ownership in the bingo operation prior to the settlement of the lawsuit neither party prior to the submission of the briefs contended that november should be disregarded as an entity under these circumstances petitioner’s attempt for the first time on brief to disavow the existence of november would be most prejudicial to respondent and will not be permitted see eg 59_tc_551 even if petitioner had been permitted to pursue his contention that the corporate entity be disregarded on the record here he would have failed petitioner created this corporate entity caused it to file returns and reported passthrough losses from the entity on his individual return in addition the existence and form of the s_corporation had not been guestioned by respondent importantly the existence of november is in no way dependent upon whether it or petitioner had an ownership_interest in the bingo operation november was the financial conduit for petitioner’s involvement in the bingo business whether or not he or november had an ownership_interest in the bingo business additionally the deficiencies under a party seeking to disavow the form of its own transaction may be required to present strong_proof that the substance differs from the form 264_f2d_305 2d cir affg t cc 87_tc_178 affd without published opinion 833_f2d_303 3d cir consideration arose in great part after petitioner had settled the litigation and was entitled to continue operating the bingo business finally where there has been substantial business activity by a corporation it would be difficult to show that the corporation is a taxpayer’s alter ego or merely a nominee for purposes of federal taxation see 319_us_436 336_us_422 283_f2d_395 2d cir although petitioner was a shill or front for the lichtys and others november was an active and operating entity that in the course of conducting the bingo business received income and issued checks for bingo business expenditures moreover november was a named plaintiff in the legal proceeding with the lichtys november played too large and vital a role to be disregarded we proceed to consider whether petitioner has shown that respondent’s determination disallowing certain of november’s deductions was in error we first consider the legal fee that was incurred in connection with litigation involving the bingo operation november originally claimed a dollar_figure million deduction with respect to the dollar_figure million fee for which an agreement and note were executed with to attorney krieger petitioner contends that the entire dollar_figure million fee should be deductible by an accrual basis taxpayer because it was an ordinary and necessary business_expense conversely respondent contends that the legal fee was a capital_expenditure and accordingly not deductible alternatively respondent contends that if the attorney’s fee is not a capital_expenditure november would not be entitled to deduct the entire amount for failure to meet the all_events_test should the dollar_figure million legal fee be capitalized respondent relying on 503_us_79 argues that the dollar_figure million legal fee is a nonamortizable capital_expenditure petitioner however contends that under sec_162 the legal fee was an ordinary_and_necessary_expense that was incurred in carrying_on_a_trade_or_business respondent counters that sec_263 provides that no deduction is allowable for amounts paid for permanent improvements or betterments made to increase the value of any property or estate respondent in support of his determination contends that petitioner instituted suit for the purpose of asserting ownership over the bingo operation and ultimately he emerged as the owner subject_to his making certain payments to the lichtys and others including kreiger petitioner’s attorney petitioner also points out that respondent did not allow the amounts actually paid_by november to the attorney during and in that regard respondent’s determination that the expenditure should be capitalized would not depend on the method_of_accounting or when the amounts were actually paid the situation we consider is quite novel initially petitioner acted as a front for others who were constrained not to reveal their ownership interests under his agreement with the true owners petitioner was to receive a dollar_figure salary ten times more than he had reported as income in the past with the potential to make dollar_figure in exchange for acting as owner and for operating the bingo business it was not until the lichtys advised petitioner that they were going to remove him from that position that petitioner hired krieger and sought to protect his income stream under the agreement petitioner’s lawyer advised him to approach the litigation by attempting to perfect the ostensible ownership that he had been permitted by the true owners petitioner’s attorney believed that it was the lichtys’ inability to assert their ownership that was the main reason for petitioner’s success in arriving at a settlement under which he was able to continue receiving income from the bingo operation respondent’s position that the legal fees were not deductible in the ordinary course of business and constitute a capital_expenditure does not fit the unique factual circumstances here in substance petitioner was not seeking to perfect control and or ownership of the bingo operation instead he knew that he was merely a shill or front for others with a promise of income for acting in that capacity and managing the business in effect he was seeking to keep the true owners from removing him from his position and from stopping the flow of his earnings or income stream by seeking to enforce the ostensible terms with the true owners petitioner protected his income earning position and kept the true owners from asserting their authority in the future petitioner already owned the capital entity november that was permitted to continue the operation of the bingo business he did not perfect his ownership in november and he did not acquire the lease to either of the locations where the bingo business was operated accordingly respondent’s reliance on indopco inc v commissioner supra is in apropos petitioner had entered into an agreement with the lichtys et al for a position where he would receive dollar_figure to dollar_figure per annum in exchange for his services including serving as a shill or front for the lichtys under that agreement petitioner would also have been entitled to some equity at a future time when the lichtys attempted to default on their part of the agreement by attempting to remove petitioner from his position he sued accordingly petitioner did not incur the legal fee to produce a long-term benefit he incurred it to protect his existing right to an income stream such expenditures are ordinary and necessary business_expenses we note that petitioner’s situation after the settlement was substantially_similar to his situation before he operated a bingo business and paid the lichtys dollar_figure before and dollar_figure per month after the settlement in form and substance nothing else changed -- - within the meaning of sec_162 and we so hold see 320_us_467 respondent also argues that petitioner is not entitled to deduct the face_amount of the note to krieger on the ground that all of the events had not occurred which determine the fact of liability and because the value of the note could not have been determined with reasonable accuracy the all_events_test respondent also relies on sec_461 arguing that it would apply to limit the deductible amount even if the all_events_test is met to an amount for which economic_performance has been met ’ there is no dispute that petitioner and november were obligated to krieger on a note in the face_amount of dollar_figure million and that krieger had successfully prosecuted petitioner’s litigation to a conclusion settlement during the taxable_year there was no performance left on the part of krieger and petitioner and november were obligated to make payment petitioner and november however were not required to make payments on the note unless the bingo operation was profitable further the note did not have a fixed payment_date and could ’ in addition respondent argues that sec_1_461-1 income_tax regs prohibits the deduction of any expenditure which results in the creation of an asset having a useful_life extending beyond the close of the taxable_year because we have decided that the litigation did not result in the creation of an new asset we need not address the effect of the cited regulation - have remained unsatisfied for an indefinite period of time in accord with the note and the terms of an accompanying agreement krieger was paid dollar_figure during the first years after the settlement dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure for the years and respectively accordingly although it was agreed that krieger was entitled to dollar_figure million there was no assurance that the bingo operation would generate income sufficient to satisfy the note the conditional nature of the note and its indefinite term prevent the all_events_test from being satisfied see eg restore inc v commissioner tcmemo_1997_571 affd per curiam 174_f3d_203 11th cir even if these circumstances did facially comply with the all_events_test the allowance of a dollar_figure million deduction for november’s year when payments on the note are conditional and extend over an indefinite period of time would result in a distortion and fail to match november’s income and deductions cf 102_tc_87 affd 71_f3d_209 6th cir accordingly we hold that november was not entitled to deduct dollar_figure million for legal fees for its year but that it is entitled to deduct the payments to krieger in the year of each payment whether november is entitled to write off or depreciate over the 10-year term of the lease the improvements made to the chestnut property the chestnut property had been used for processing fish and needed substantial improvements before bingo operations could commence november expended dollar_figure dollar_figure and dollar_figure during and respectively to convert it into a bingo operation based on those expenditures november claimed depreciation on a 10-year basis equal to the 10-year term of the lease in the respective amounts of dollar_figure dollar_figure and dollar_figure for the through tax years respondent determined that petitioner was entitled to use a 5-year recovery_period under the macrs resulting in allowances of dollar_figure dollar_figure and dollar_figure respectively on brief petitioner also claimed that november would alternatively be entitled to deduct the entire expenditure about dollar_figure as lease acquisition_cost that would not be subject_to the macrs requirements petitioner had relied on sec_1_162-11 income_tax regs which held that lessees may be entitled to use the length of the lease as the recovery_period for leasehold improvements respondent correctly points out that sec_168 added by the tax_reform_act_of_1986 made the above-referenced regulation because bingo is a game of chance where the bingo operator is the only participant who always wins it might be said that the chestnut property was to continue being used for the processing of fish -- - obsolete and instead required that leasehold improvements be subject_to the macrs-prescribed recovery periods with respect to petitioner’s claim that the expenditures to convert the facility to a bingo operation were lease acquisition costs respondent contends that most of the expenditures were made subsequent to the time that the lease was in effect furthermore petitioner has not shown as he is required to that the expenditures were for lease acquisition costs as opposed to leasehold improvements as reported by november and determined by respondent accordingly we hold that respondent’s determination that petitioner is not entitled to a 10-year recovery_period is sustained further we hold that petitioner has failed to show that november is entitled to deduct any portion of the expenditure as a lease acquisition_cost is november entitled to deduct the dollar_figure portion of the dollar_figure monthly payment to the lichtys’ entity prior to and after the settlement of the lawsuit november and the lichtys’ entity were obligated to pay dollar_figure rent for use of the chestnut property the note executed from petitioner and or november to the lichtys also called for a dollar_figure monthly payment for a period of years after the settlement november was reguired to pay to the lichtys’ entity dollar_figure which amount was dollar_figure more than the dollar_figure rental payment november claimed the dollar_figure monthly payments as rent respondent allowed the portion attributable to the rental of the chestnut property but disallowed the dollar_figure portion respondent argues that the dollar_figure portion is a payment to the lichtys in exchange for their interest in the operation under the circumstances here the dollar_figure portion of the monthly payment is not deductible rent but it would be deductible under sec_162 as an expense incurred in the operation of the bingo business respondent contends that the dollar_figure monthly payments to the lichtys are merely a continuation of the dollar_figure monthly payments that were made on the note prior to the litigation and settlement again respondent’s argument rests on the premise that petitioner was acquiring capital assets under the settlement in these circumstances we are not convinced that the dollar_figure should be classified as capital in nature and nondeductible as discussed in detail above petitioner and or november was the owner of the bingo operations on paper prior to the litigation and settlement but had an underlying agreement with the lichtys to receive income for appearing as the owner and managing the business the terms of the settlement do not delineate whether the dollar_figure payment is in exchange for the lichtys’ capital interest or for the lichtys’ forbearance from interfering with petitioner’s operation of the bingo business the lichtys were prohibited from having an interest in the bingo operation and - - appeared at least on paper as not directly involved it is difficult to tell from the settlement the nature of the dollar_figure portion of the monthly payments at the very least and in essence petitioner had the right to earn income in connection with the bingo operation and he was successful in protecting that right from the interference of the lichtys and perhaps others the dollar_figure monthly payments were not in exchange for an equity_interest but instead were a cost of continuing the bingo business operation accordingly we hold that november is entitled to deduct the dollar_figure portion of the payments made to the lichtys through their corporate entity for the years under consideration has petitioner shown that dollar_figure dollar_figure and dollar_figure were incurred for supplies for the and tax years respectively respondent disallowed the above-listed amounts due to petitioner’s failure to substantiate that the amounts were expended for deductible business supplies petitioner did not offer any evidence at trial regarding these amounts accordingly respondent’s determination on these items is sustained --- - does petitioner have basis in his s_corporation so as to be entitled to deduct any of the passthrough losses that may be finally redetermined for the years under consideration we now turn to a critical’ question of whether petitioner has sufficient basis in november so as to be able to deduct any passthrough losses in accord with the form k-1 petitioner received from november he claimed a dollar_figure passthrough loss respondent determined that petitioner was not entitled to the claimed loss on the grounds that petitioner had a passthrough gain in each year due to the disallowance of various deductions claimed by november some of the disallowed deductions are the subject of this opinion and our holding with respect to them may result in a passthrough and or carryover loss for the taxable years under consideration respondent did not determine in the notice_of_deficiency that petitioner lacked sufficient basis to receive the benefit of any loss respondent has shown that november’s balance sheets reflect dollar_figure in equity and the loans to shareholders on november’s balance sheets reflected dollar_figure as of date dollar_figure as of date dollar_figure as of date dollar_figure as of date and dollar_figure as of date no loans from shareholders were reflected for if petitioner is without basis in his s_corporation his success with respect to november’s deduction items would to the extent that november’s expenses exceed its income be a pyrrhic victory -- - the years under consideration so there was a decidedly large flow of capital to petitioner from november rather than the opposite petitioner did however recognize dollar_figure and dollar_figure of passthrough income from november as reflected in forms 1120s for and tax years petitioner does not rely on contributions made directly to november to counter respondent’s argument petitioner contends that the dollar_figure million note to krieger on which both petitioner and november were shown as obligors made him personally liable and would therefore constitute basis in november respondent contends that petitioner is merely a guarantor and under the circumstances of this case should not be permitted s_corporation basis attributable to the note the note to attorney krieger cannot be fully understood without reference to the integral accompanying agreement between the parties in that agreement it is made clear that but for the success in settlement of the lawsuit petitioner and november would have been bankrupt significantly the note is only to be paid from income of november’s bingo business for example it was agreed if the laws change to prohibit bingo krieger would receive no payments on the note more particularly the payment on the note to krieger was dependent on november and the profitability of its bingo business and krieger did not look to petitioner individually for payment accordingly in this setting - - petitioner was a guarantor who had not pledged any individual assets and who but for november’s business was without means to pay the dollar_figure million note to krieger this court and several u s courts of appeals have held that absent an economic outlay by a taxpayer guaranties of loans do not increase basis in s_corporation stock see 90_tc_206 affd 875_f2d_420 4th cir and cases cited therein the court_of_appeals for the eleventh circuit held in particular circumstances that some guaranties may be sufficient to constitute basis where the facts show that in substance the shareholder has borrowed funds and subsequently advanced them to the corporation see 778_f2d_769 11th cir the key factor emphasized by the court_of_appeals was that the lender looked to the shareholder as the primary obligor id any appeal of our decision here will lie in the court_of_appeals for the eleventh circuit and accordingly we must decide whether selfe v united_states would compel our holding for petitioner on this issue ’ the selfe v united_states holding would permit a stepped-up_basis where the facts show under our holding in 54_tc_742 affd 445_f2d_985 10th cir we follow if it is directly on point a holding by the court_of_appeals to which our decision would be appealable - that in substance the shareholder has borrowed funds from a third party and subsequently advanced them to the corporation in particular the court_of_appeals emphasized that it would be relevant whether the creditor looked to the shareholder as the primary obligor in the circumstances of selfe v united_states supra the circumstances here are factually distinguishable from selfe see 110_tc_62 affd without published opinion 194_f3d_1324 11th cir petitioner had no individual assets and did not put up any security more significantly november’s bingo business income was the sole source available and one which had been specifically designated for payment of the debt to krieger accordingly we do not feel compelled to follow selfe in this instance and instead hold that petitioner is not entitled to increase his basis in his s_corporation with respect to any part of the dollar_figure million debt to krieger should respondent’ s determination of a negligence_penalty under section a be sustained for or respondent for each of the taxable years determined an accuracy-related_penalty based on negligence under sec_6662 that section imposes an addition_to_tax in the amount of percent of any portion of the underpayment attributable to ‘t the court leaves the parties to the task of computing petitioner’s correct basis in their rule computation s in accord with our findings and holdings - - negligence to avoid this penalty petitioner must show that his actions were reasonable and not careless reckless or made with intentional disregard of rules or regulations see 743_f2d_670 9th cir affg tcmemo_1982_666 respondent determined that petitioner was liable for the penalty on the entire underpayment in each of the years under consideration accordingly we must consider each adjustment to decide whether the portion of the underpayment attributable to it is due to negligence we recognize that petitioner had no particular business or tax expertise and became involved in the bingo operation merely as a front for others he relied on advisers accountants and lawyers for establishing business entities and for the preparation of his and his s corporation’s returns on the seminal return the one in which the s_corporation claimed the loss the deductions were taken in accord with petitioner’s advisers’ judgment petitioner was successful with respect to two significant items in this litigation---the legal fee and the dollar_figure monthly payments he was unsuccessful on the amortization and substantiation issues with respect to the amortization issue that involved a technical interpretation of regulations and petitioner’s tax_return_preparer and adviser counseled petitioner to amortize the property based on a 10-year life considering petitioner’s - - background and reliance we hold that his actions with respect to that item were reasonable and are not subject_to the sec_6662 penalty with respect to the substantiation items and any items conceded petitioner has failed to show that his actions were reasonable and not careless reckless or made with intentional disregard of rules or regulations even considering petitioner’s background his inability to substantiate claimed expenditures is not reasonable under these circumstances we hold that petitioner is liable in each of the taxable years for the accuracy-related_penalty under sec_6662 on the portion of any underpayment attributable to the substantiation issues decided and on the adjustment items that he conceded to reflect the foregoing and due to concessions decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc corp b06-plr-100360-01 date date legend parent first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub first-tier sub second-tier sub second-tier sub second-tier sub second-tier sub second-tier sub second-tier sub second-tier sub second-tier sub second-tier sub date date date company official this responds to a letter submitted on behalf of parent dated date requesting an extension of time under sec_301_9100-1 through of the procedure and administration regulations to file an election the extension is being requested for parent and first-tier sub sec_1 through hereinafter first-tier subs to make an election to restore value under sec_1_382-8 hereinafter referred to as the election effective for parent’s taxable_year ending on date we received additional information in a letter dated date the material information submitted for consideration is summarized below parent and first-tier sub sec_1 - are calendar_year corporations first-tier sub is the common parent of a consolidated_group which includes second-tier sub first- tier sub is the common parent of a consolidated_group which includes second-tier sub sec_2 and first-tier sub is the common parent of a consolidated_group which includes second-tier sub sec_4 through on date parent underwent an ownership_change as defined in sec_382 of the code parent and first-tier sub sec_1 - intended to file the election the election was due on date but for various reasons the election was not filed after the due_date for the election it was discovered that the election was not timely filed the statute_of_limitations on assessment under sec_6501 has not expired for parent's or first-tier subs’ taxable_year for which they want to make the election or for any taxable_year that would be affected by the election sec_382 provides that the amount of the taxable_income of any new_loss_corporation for any post-change_year which may be offset by pre-change losses shall not exceed the sec_382 limitation for such year under sec_382 the sec_382 limitation is determined by multiplying the value of the old_loss_corporation by the applicable long- term tax-exempt rate a special rule designed to prevent double counting by controlled groups is set forth in sec_1_382-8 sec_1_382-8 requires the value of the stock of each member of the controlled_group be reduced by the value of stock owned by that component_member in any other component_member after the value of the stock of each component_member is reduced under sec_1_382-8 component members of a controlled_group can elect the election under sec_1_382-8 to restore some or all of its value to another component_member the election to restore value is made following the procedures set forth in sec_1_382-8 since parent and first- and second- tier subs constitute a controlled_group under sec_1_382-8 they request an extension of time under sec_301_9100-1 through to file an election to restore value under sec_1_382-8 under sec_301_9100-1 the commissioner has discretion to grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make a regulatory election sec_301_9100-1 sec_301_9100-2 provides automatic extensions of time for making certain elections requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 in this case the time for filing the election is fixed by the regulations ie sec_1_382-8 therefore the commissioner has discretionary authority under sec_301_9100-1 to grant an extension of time for parent and first-tier subs to file the election provided parent and first-tier subs show they acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the interests of the government information affidavits and representations submitted by parent and company official explain the circumstances that resulted in the failure to timely file the election the information also establishes that company official who is a tax professional was responsible for the election and that parent and first-tier subs relied on him to timely make the election and that the government will not be prejudiced if relief is granted see sec_301_9100-3 based on the facts and information submitted including the representations made we conclude that parent and first-tier subs have shown they acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the interests of the government accordingly an extension of time is granted under sec_301_9100-1 until days from the date_of_issuance of this letter for parent and first-tier subs to file the election the above extension of time is conditioned on the taxpayers' parent's and the members of its controlled group’s tax_liability if any being not lower in the aggregate for all years to which the election applies than it would have been if the election had been timely made taking into account the time_value_of_money no opinion is expressed as to the taxpayers' tax_liability for the years involved a determination thereof will be made by the director's office upon audit of the federal_income_tax returns involved further no opinion is expressed as to the federal_income_tax effect if any if it is determined that the taxpayers' liability is lower sec_301_9100-3 we express no opinion with respect to whether an ownership_change occurred whether parent first-tier subs and second-tier subs are members of a controlled_group the amount of value if any that may be restored or as to values or amounts of nols in addition we express no opinion as to the tax effects or consequences of filing the return or the election late under the provisions of any other section of the code or regulations or as to the tax treatment of any conditions existing at the time of or effects resulting from filing the return or the election late that are not specifically set forth in the above ruling for purposes of granting relief under sec_301_9100-1 we relied on certain statements and representations made by parent parent's authorized representative and company official however the director should verify all essential facts moreover notwithstanding that the extension is granted under sec_301_9100-1 to file the election any penalties and interest that would otherwise be applicable still apply this letter is directed only to the taxpayer s who requested it sec_6110 provides that it may not be used or cited as precedent except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer and to the second-listed authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely associate chief_counsel corporate by ken cohen senior technician reviewer branch