significant index no internal_revenue_service department of inl q washington oc contact person telephone number in reference to op e ep a date re aug this letter constitutes notice that a conditional waiver of the minimum_funding_standard has been granted for the above-named defined benefit pension_plan for the plan_year ended date the waiver request was submitted by letter dated date the conditional waiver has been granted in accordance with sec_412 of the internal_revenue_code the code and sec_303 of the employee retirement income security act of erisa the amount for which the waiver has been granted is the contribution which would otherwise be required to reduce the balance in the funding_standard_account of the plan to zero as of the end of the plan_year for which the waiver has been granted the company is in the collection agency business the company suffered substantial financial hardship evidenced by negative net_income in and a sharp decline in total assets from to as a result of the sale of the company and subsequent lack of key administrative support when top management personnel left the company recovery is evidenced by a rise in total current_assets and accounts_receivable combined with a leveling in accounts_payable an increase in payments collected from recent prior years and a net fee revenue increase over prior levels during the period of financial hardship the company maintained level positive retained earnings the company resumed contributions to the plan in - according to the information received the company has paid the excise_tax under sec_4971 a of the code with respect to a funding deficiency for the plan_year ended december i the waiver has been granted subject_to the following condition which you have agreed to qt the minimum_funding requirement including the initial amortization payment of the waiver hereby granted will be satisfied for the plan_year ending date if the company fails to meet the condition above the waiver is retroactively null and void your attention is called to sec_412 of the code and sec_304 of erisa which describes the consequences which result in the event the plan is amended to increase benefits to change the rate in the accrual_of_benefits or to change the rate of vesting while any portion of the waived_funding_deficiency remains unamortized this ruling is directed only to the organization that requested it sec_6110 of the internal_revenue_code provides that it may not be used or cited by others as precedent when filing form_5500 for the plan_year ending date the date of this letter should be entered on the schedule b actuarial information we have sent a copy to the key district_director for the in sincerely yours martin l pippins acting chief actuarial branch


t c memo united_states tax_court churchill ltd employee_stock_ownership_plan trust petitioner v commissioner of internal revenue respondent docket no 25833-10r filed date paul f christoffers for petitioner matthew m johnson for respondent memorandum opinion gerber judge in this declaratory_judgment proceeding under sec_7476 petitioner challenges respondent’s date revocation letter determining that for its year and subsequent plan years the plan was not qualified under sec_401 and that the related trust is not exempt under sec_501 the broad question we consider is whether there was an abuse_of_discretion in respondent’s determination to decide that question we consider whether the plan met certain statutory requirements and or whether the plan was timely or properly amended and whether a qualified_appraiser was used for required valuations background2 churchill ltd is an iowa corporation with its principal_place_of_business in carlisle iowa at the time the petition was filed churchill ltd is the employer plan_sponsor and plan_administrator of the plan during all years under consideration keith churchill was the president of churchill ltd and a participant of the plan for relevant years the following individuals served as the plan trustee gerald ratigan july to date kathleen churchill date to date and mr churchill date to present 1all section references are to the internal_revenue_code in effect for the period under consideration rule references are to the tax court’s rules_of_practice and procedure 2the parties submitted this case fully stipulated under rule on the basis of the pleadings and administrative record in accord with rule a the plan became effective date and on date respondent issued a favorable determination_letter the plan was amended and restated on date plan effective for the fiscal_year beginning date the plan was amended on date and date on date the plan was amended and restated plan the plan and its amendments did not include a primary direction or control test in the definition of a leased_employee the plan did include a primary direction or control test in the definition of a leased_employee sec_414 requires a qualified_plan to include provisions concerning special rules for veterans’ reemployment_rights and for differential wage payments to members on active_duty under the uniformed_services employment and reemployment_rights act of pub_l_no 108_stat_3149 the plan and its amendments did not include provisions complying with sec_414 however the plan did by reference the plan requires that accrued_benefits be distributed or installment payments begin not later than april of the calendar_year following the calendar_year in which the employee attains age 70½ the plan and its amendment require that the accrued_benefits be distributed or installment payments begin not later than april of the calendar_year following the calendar_year when the employee attains age 70½ or when the employee retires the plan defines employer contributions for highly compensated employees as employee and employer matching_contributions and compensation to family members but the family attribution requirement does not apply to nonhighly compensated employees the family attribution approach in the plan was eliminated in the plan sec_24 of the plan defined compensation as follows compensation paid_by the employer to the participant during the taxable_year ending with or within the plan_year which is required to be reported as wages on the participant’s form_w-2 and shall include compensation which is not currently includible in the participant’s gross_income by reason of the application of sec_125 sec_402 sec_402 or sec_403 of the code but shall not exceed dollar_figure for any plan_year an amendment to the plan effective date defined compensation as including amounts contributed or deferred by the employer at the election of the employee under sec_125 and sec_147 sec_24 of the plan defined compensation as follows all w-2_wages paid to the participant by the employer for the plan_year and all earned_income paid to self-employed individuals who are considered to be employees under the provisions of the sec_401 compensation also includes any elective_deferral and any amount which is contributed or deferred by the employer under the provisions of sec_125 and sec_401 total compensation does not include any amounts paid to a participant in excess of dollar_figure plus any future cost of living or inflation increases permitted by the internal_revenue_service the plan definition was amended effective date reducing the dollar_figure limitation to amounts in excess of dollar_figure the plan also defined compensation to include any elective_deferral and amounts contributed or deferred by the employer under sec_125 and sec_401 a date amendment of the plan effective date set forth additional conditions concerning highly compensated employees including the condition that compensation as used in the plan is to be compensation as defined in sec_415 including elective or salary reduction contributions to a cafeteria_plan cash_or_deferred_arrangement or tax-sheltered annuity the plan provided for vesting of benefits before the employee’s being entitled to retire or the employee’s death no portion of the employee’s benefits vested before the employee had two years_of_service after two years_of_service of the employee’s benefits vested and an additional per year vested until the benefits were vested the plan also provided for vesting of benefits before the employee’s being entitled to retire or the employee’s death under the plan there was no vesting before three years_of_service and then the vesting percentage increased by or increments until the employee was fully vested after years_of_service no provision was made in the or plan for special vesting if the plan was considered top-heavy under sec_416 stephen thielking was chosen to appraise churchill ltd ’s common_stock mr thielking’s qualifications were not stated in the appraisals in addition to performing the appraisals thielking also prepared and drafted the plans’ documents and he prepared forms annual return report of employee_benefit_plan the plans’ summary plan descriptions and summary annual reports he also computed the coverage testings for the forms finally thielking prepared participant account statements and prepared and maintained the plans’ trust records discussion the underlying facts in this proceeding are derived from the administrative record which the parties submitted fully stipulated in this declaratory_judgment proceeding we review respondent’s determination that the plan was not qualified the standard for our review was set forth in 92_tc_641 as follows when reviewing discretionary administrative acts however this court may not substitute its judgment for that of the commissioner the exercise of discretionary power will not be disturbed unless the commissioner has abused his discretion ie his determination is unreasonable arbitrary or capricious whether the commissioner has abused his discretion is a question of fact and petitioner's burden_of_proof of abuse_of_discretion is greater than that of the usual preponderance_of_the_evidence 82_tc_989 73_tc_182 further i n order for a plan to be qualified both its terms and its operations must meet the statutory requirements id pincite respondent’s determination was based on several reasons that the parties have addressed on brief we consider each reason separately i whether the plan was timely or properly amended a in general respondent argues that petitioner failed to timely or properly amend the plan petitioner argues that employee benefit rights were restored to appropriate levels under the statutes and regulations to the extent that the plan was not timely amended petitioner argues that the commissioner normally allows retroactive amendments to comply with various statutory changes respondent counters that even if the amendments petitioner made could be considered timely the amendments did not adequately comport with the statutory changes requirements during the 1990s and into the year various legislation affected existing employee benefit plans those legislative enactments are sometimes commonly and collectively known as gust where the gust legislative changes placed plans in a position of noncompliance sec_401 permits a remedial period within which to make plan amendments to comply with new legislation the gust remedial_amendment_period for the type of plan under consideration here ended on the later of date or the last day of the first plan_year beginning on or after date see revproc_2001_55 2001_2_cb_552 modifying revproc_2000_27 c b because of the complexity and number of statutory changes to be considered in this case we individually address each aspect of the plan that respondent determined not to be in compliance 3gust is a collective acronym for the following legislation uruguay round agreements act pub_l_no 108_stat_4809 which implemented the uruguay round of general agreement on tariffs and trade uniformed_services employment and reemployment_rights act of pub_l_no 108_stat_3149 the small_business job protection act of pub_l_no 110_stat_1755 taxpayer_relief_act_of_1997 tra pub_l_no 111_stat_788 internal_revenue_service restructuring and reform act of pub_l_no 112_stat_685 and consolidated appropriations act pub_l_no app g stat pincitea-587 b sbjpa statutory changes that impacted the plan the small_business job protection act of sbjpa pub_l_no 110_stat_1755 as pertinent to this case changed plan requirements under sec_414 concerning the definition of employee_leasing sec_414 concerning special rules for veterans sec_401 concerning required minimum distributions sec_414 concerning family aggregation rules in connection with highly compensated employees and sec_415 concerning a participant’s_compensation employee_leasing sec_414 concerns circumstances where a leased_employee performs services for another person recipient and may be treated as the recipient’s employee for certain employee benefit provisions sbjpa sec_1492 sec_110 stat pincite amended sec_414 for years after with respect to the test to determine whether a leased_employee was to be considered the recipient’s employee the new test for whether a leased_employee became the recipient’s employee was based upon whether the services are performed under the primary direction or control by the recipient petitioner’s plan and amendments did not include the primary direction and control test petitioner’ sec_2001 plan added the primary direction and control test to the definition of leased_employee but the amendment to the plan became effective for years beginning date and did not apply to the intervening years from date through date on brief petitioner fails to directly address the fact that the plan was not retroactively amended to address statutory changes for the intervening years before date petitioner makes the broad argument that the commissioner announced in revrul_82_66 1982_1_cb_61 that retroactive amendments will be permitted under certain circumstances and that revproc_2007_44 sec 2007_2_cb_54 provides that the last day of the remedial_amendment_period was date and that all necessary corrections were made by that date petitioner’s argument misses the point that no correcting amendment was made for the intervening plan years accordingly petitioner has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary special rules for veterans sec_414 contains provisions to restore certain pension profit- sharing and similar benefits that would have accrued but for the employee’s absence because of qualified_military_service these provisions were effective for all plan years beginning after date here again the plan and its amendments did not incorporate the sec_414 provisions the plan was amended to reflect the provisions but only for years beginning date the plan for intervening years after date was not amended petitioner makes no better an argument as to the failure to address the sec_414 changes for years before date and accordingly has not shown that respondent’s reliance on this aspect of the determination as the basis for revocation was unreasonable or arbitrary required minimum distributions sec_401 provides for required minimum distributions and additionally that the entire_interest of each employee will be distributed not later than the required_beginning_date or beginning not later than the required_beginning_date over the employee’s or employee’s designated beneficiary’s life see sec_401 and ii sbjpa sec stat pincite changed the required_beginning_date for participants other than a 5-percent_owner to april of the year following the year in which the participant reaches age 70½ or if later the year in which the employee retires see sec_401 and ii this change was required for plan years beginning after date with respect to percent owners sbjpa sec required the beginning distribution date to be april of the calendar_year following the year in which the participant reaches age 70½ the plan including amendments did not restrict the required_distribution beginning date for 5-percent owners to april of the calendar_year following the year in which the participant reaches age 70½ petitioner argues that the plan stated that distributions from the plan will be made in accordance with the requirements of the regulations under sec_401 including the minimum distribution_requirements of sec_1_401_a_9_-5 of the regulations even if the plan contained the quoted statement it would be insufficient to apprise plan participants of the terms and conditions of the plan congress established the writing requirement so that employees by examining the plan document can determine exactly what their rights and obligations are under the plan see 514_us_73 h_r rept no pincite 1974_3_cb_415 a generic statement in a plan that indicates that it complies with the internal_revenue_code or even a specific section thereof does not adequately meet the congressional mandate accordingly petitioner has not shown that respondent’s reliance on the plan’s omission regarding 5-percent owners as part of the basis supporting the determination for revocation was unreasonable or arbitrary family aggregation rules sec_414 concerned family aggregation rules in connection with the determination of the amount of compensation paid to certain highly_compensated_employee s sbjpa sec b stat pincite repealed the family aggregation rules effective for plan years after date see id sec d the plan as amended did include the family aggregation rules the plan eliminated the family aggregation rules in accordance with the repeal however the plan was not effective until date the plan accordingly provided for_the_use_of an incorrect method of calculating compensation from the effective date of the repeal from date until date here again petitioner argues that the plan as it exists does not require aggregation in the computation and that respondent could allow retroactive application of the corrected plan petitioner’s argument misses the point in that no correcting amendment was made applicable for the intervening plan years and there is no indication that petitioner applied for retroactive application accordingly petitioner has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary participant compensation sec_415 concerning participant’s_compensation was added by sbjpa sec a stat pincite and was effective for plan years beginning after date in essence sec_415 required that certain deferrals be included in a participant’s_compensation sec_415 generally defines elective_deferrals as those defined in sec_402 and any amount deferred by an employer at the election of the employee that is not includible in gross_income the plan defined compensation as follows compensation paid_by the employer to the participant during the taxable_year ending with or within the plan_year which is required to be reported as wages on the participant’s form_w-2 and shall include compensation which is not currently includible in the participant’s gross_income by reason of the application of sec_125 sec_402 sec_402 or sec_403 of the code but shall not exceed dollar_figure for any plan_year in the second amendment to the plan the definition of compensation was amended to include any amount which is contributed or deferred by the employer at the election of the employee by reason of sec_125 and sec_147 of the code the second amendment to the plan addressed some of the changes to the plan’s definition of compensation by enactment of sec_415 but failed to include amounts which are contributed or deferred by the employer at the election of the employee and which are not includible in the gross_income of the employee within the meaning of sec_457 respondent contends that the plan was therefore not in compliance with the sbjpa as to this item petitioner made no argument on brief concerning this item and has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary c community renewal tax relief act of cra statutory changes that affected the plan the community renewal tax relief act of cra appendix g of the consolidated appropriations act pub_l_no stat pincitea- made two changes as pertinent to this case as follows first sec_415 was amended by cra sec e stat pincitea-643 to require that compensation include any amount contributed or deferred by an employer at the election of the employee and which is not includible in the gross_income of the employee by reason of sec_132 see christy swan profit sharing plan v commissioner tcmemo_2011_62 sec_132 provides no constructive receipt no amount shall be included in the gross_income of an employee solely because the employee may choose between any qualified_transportation_fringe other than a qualified_bicycle_commuting_reimbursement and compensation which would otherwise be includible in gross_income of such employee the plans under consideration as amended do not address the cra changes or reference sec_132 respondent contends that the failure to address those changes caused the plans’ definitions of compensation to fall short of the requirements of sec_415 and in turn the requirements of sec_401 for all limitation years beginning date throughout the period under consideration respondent contends that the plan was therefore not in compliance with the changes the cra made to the definition of compensation as to this item petitioner made no argument on brief concerning this item and has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary second sec_414 defines compensation as it is used in sec_415 with respect to whether a person is a highly_compensated_employee respondent contends that the plan fails to meet the requirements of sec_414 and in turn sec_415 and sec_401 for all limitation years beginning sometime in petitioner contends that the plan’s definition does meet the statutory mandate petitioner quotes the following definition of a highly_compensated_employee from the plan in support of its argument an employee who was a five_percent_owner at any time during the current plan_year or the preceding plan_year or for the preceding plan_year had compensation from the employer in excess of dollar_figure that blanket quote from the plan falls far short of the detailed definition of a highly_compensated_employee as set forth in sec_414 and sec_415 petitioner’s explanation does not show that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary 4respondent also notes that the changes required by tra sec c stat pincite have not been made d tax_reform_act_of_1986 changes that affected the plan the tax_reform_act_of_1986 tra pub_l_no 100_stat_2085 made two changes pertinent to this case as follows first sec_411 concerning the minimum vesting standard was changed by tra before the change effective date sec_411 provided several ways by which a plan could satisfy the minimum vesting provisions one method of vesting included the allowance of of the employee’s accrued_benefits derived from employer contributions to vest after years_of_service another method involved the vesting of benefits derived from employer contributions in accordance with a schedule providing for benefit levels during a period of to years_of_service tra sec a stat pincite amended sec_411 as pertinent to this case to provide that for a plan to qualify the employee’s rights under the plan would have to vest and the benefits from the employer contributions would have to be nonforfeitable when the employee completes five years_of_service or an employee becomes vested in accordance with a three- to seven-year vesting schedule these two means for meeting the vesting requirements were in effect before date the plan including amendments complied with the sec_411 minimum vesting requirements the plan however amended the plan’s vesting schedule to an 11-year graduated vesting schedule which provided that of benefits from employer contributions would become nonforfeitable upon the completion of years_of_service with benefit increments to reach after the completion of years_of_service respondent determined that the plan did not comply with sec_411 beginning date and for subsequent years and in part based the revocation upon that determination petitioner in response to respondent’s determination with respect to the year vesting schedule simply explains t he plan provides for to years vesting per code sec_411 respondent counters that in spite of petitioner’s statement the plan in section provides for an 11-year minimum vesting schedule petitioner has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary second sec_416 provides that a_trust shall not be a qualified sec_501 trust if its plan is top-heavy unless the plan meets the 3-year vesting or 6-year graded requirements of sec_416 as already noted before the plan became effective the plan including amendments complied with the requirements of sec_411 and sec_416 respondent’s determination in part was based on the fact that the plan contained an 11-year minimum vesting schedule which would not remedy a sec_416 loss of qualification of the trust if the plan became top-heavy respondent notes that if the plan becomes top-heavy a non-highly-compensated plan participant could not vest as rapidly as required under sec_416 petitioner makes the same argument for sec_416 as was made for sec_411 above here again petitioner has not shown that respondent’s reliance on this part of the determination as part of the basis for revocation was unreasonable or arbitrary ii whether petitioner failed to use an independent qualified_appraiser to perform valuations of the securities held by the trust sec_401 provides that all valuations of securities that are not readily_tradable on an established_securities_market must be performed by an independent_appraiser and that the standards for appraisers are similar to those set forth in the regulations promulgated under sec_170 without going into all of the standards that are set forth in the statutes and regulations we focus upon the specific aspects that respondent relied upon to determine that the appraiser was not independent and petitioner’s response to same respondent’s first point is that thielking the person chosen by petitioner to appraise its common_stock for failed to list or disclose his qualifications as required by sec_1_170a-13 and i b income_tax regs respondent points out that thielking did not set forth his background experience education and membership if any in professional appraisal associations as required by the above-cited regulations the only statement of thielking’s background or qualifications set forth in the plan is that thielking is an accountant who is familiar with the assets being appraised petitioner argues that there is no requirement that the appraiser’s qualifications be set forth or disclosed annually petitioner also contends that thielking was in all other respects a person who was independent as set forth in the statute regulations and respondent’s announcements on the subject thielking was the person selected to appraise common_stock of a company’s employee_stock_ownership_plan esop in another case before this court in that case involving similar taxable years this court addressed thielking’s failure to set forth his qualifications as follows petitioner asserts that thielking was a permissible appraiser of the esot's stock in petitioner we hold otherwise sec_401 provides that all employer_securities which are not readily_tradable on an established_securities_market must be valued by an independent_appraiser since petitioner’s stock is not traded on an established_securities_market an independent_appraiser had to value the esot’s holdings of that stock as relevant here an independent_appraiser means a qualified_appraiser as defined by sec_1_170a-13 income_tax regs the esop fails at least two requirements of that section first sec_1_170a-13 income_tax regs requires that the appraisal_summary contain a declaration that the individual holds himself out to the public as an appraiser the appraisal letters covering the through plan years state that the undersigned holds himself out to be an appraiser however there is no signature below that statement on any of the letters there is an unsigned line for a signature with the word appraiser typed below second sec_1_170a-13 and i b income_tax regs requires that the qualified_appraiser who signs the appraisal must list his or her background experience education and membership if any in professional appraisal associations the appraisal here is not signed and the appraisal_summary does not list the referenced information hollen v commissioner tcmemo_2011_2 slip op pincite aff’d 437_fedappx_525 8th cir thielking’s failure to set forth his qualifications was part of the basis for this court’s holding that the common_stock in that case was not appraised by a qualified_appraiser the circumstances in hollen were substantially_similar to the circumstances in this case thielking’s failure to set forth his qualifications with his appraisal and petitioner’s failure to show that he was qualified cause us to reach the same conclusion here--petitioner’s common_stock was not appraised by an independent_appraiser within the meaning of sec_401 in the administrative record it is mentioned that thielking stated to respondent’s agent that he has been preparing appraisals for petitioner and other companies for many years we note that the hollen case shows that thielking prepared an esop securities appraisal in at least one other instance even if thielking had performed numerous appraisals over the years there is no evidence in the administrative record in this case showing the type of business and the nature of the appraisals that he performed although petitioner contends that thielking has extensive experience as an appraiser there is no evidence showing that he was qualified to appraise the common_stock of petitioner finally petitioner raises the issue of substantial compliance by arguing that thielking was in other respects not disqualified by the statutory requirements in particular petitioner contends that thielking was not a party in donor transactions in the property being appraised a donee of the property or an employee of the donors or donees and that he performs most of his appraisals for entities other than petitioner in 100_tc_32 this court considered whether there was substantial compliance with respect to certain charitable_contributions under sec_170 in bond one of the shortcomings of the taxpayer’s claim to a contribution deduction was the failure to provide the appraiser’s qualifications along with the appraisal the taxpayer in bond however provided the appraiser’s qualifications at the beginning of the audit examination process this court held that there was substantial compliance because the failure to provide the appraiser’s qualifications was remedied and the qualification requirements are procedural or directory in that they are not of the essence of the thing to be done but are given with a view to the orderly conduct of business they may be fulfilled by substantial if not strict compliance id pincite in bond the essence of the statute was verification or substantiation that a contribution was made and the regulations under sec_170 were more procedural or directory sec_401 provides that any valuation of securities not readily_tradable on an established_securities_market must be performed by an independent_appraiser and that the standards for appraisers are similar to those set forth in the regulations promulgated under sec_170 accordingly the essence of the statute involved here is that the appraiser be independent which does not inherently subsume the requirement that the appraiser be qualified the qualifications required of an appraiser are in the sec_170 regulations and appear to be more procedural and directory as already decided in bond on the basis of the administrative record it appears that thielking was not independent as he was the author and preparer of most of the trust records and returns additionally we are not able to find on the administrative record that he is qualified and see that as another difference from the holding in the bond case a more important difference from bond however is that the question of thielking’s qualifications is only one of several bases and justifications underlying respondent’s determination that petitioner’s plan was not qualified and in turn that its trust was not exempt under those circumstances we continue in our analysis of whether respondent’s determination was an abuse_of_discretion to give weight to the fact that petitioner has not shown that thielking was qualified and that he failed to attach appropriate information to his appraisal conclusion in this case two types of statutory noncompliance with respect to amending the plan occurred some failures to comply before the plan were cured in that plan and others were not with respect to those that were cured the lapses of time when the plan was not in compliance extended from three to more than eight years failure to amend the plan for these periods does not show the exercise of reasonable diligence see pawlak v commissioner tcmemo_1995_7 slip op pincite petitioner contends that the plan was in most instances amended to comport with the statutes and that in essence no employee_benefits were affected during the period within which there was a failure to amend as observed earlier congress established the writing requirement so that employees by examining the plan document can determine exactly what their rights and obligations are under the plan additionally petitioner complains that the revocation is retroactive in effect we cannot substitute our judgment for respondent’s judgment with respect to these discretionary acts petitioner has not shown that respondent abused his discretion in retroactively revoking the plan therefore petitioner’s argument must fail the enactment of the various statutes necessitated the amendment of petitioner’s plans within the applicable compliance dates and petitioner’s failure to amend was not reasonable that coupled with the failure of the appraiser to state or petitioner to show that he was independent and or qualified causes us to hold that there has been no abuse_of_discretion in respondent’s determination that and subsequent plan years are not qualified under sec_401 and that the related trust is not exempt under sec_501 to reflect the foregoing decision will be entered for respondent


department of the treasury internal_revenue_service washington d c date uil number release date memorandum for from subject wta-n-109778-99 cc intl b2 mike picariello ifasp phyllis marcus cc intl br2 chief avoidance of subpart_f_income by electing to check the box as a disregarded_entity this technical assistance responds to your memorandum dated date technical assistance is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent facts this memorandum responds to your request about whether an upper-tier controlled_foreign_corporation fc1 may convert what otherwise would be subpart_f_income related to the sale of stock of a lower-tier controlled_foreign_corporation fc2 into non-subpart f income by either liquidating fc2 or treating fc2 as a disregarded_entity pursuant to the check the box election set forth in sec_301 specifically u s co is the shareholder of fc1 a holding_company that owns all of the stock of fc2 an operating entity that owns various assets until the date fc2 liquidated or elected to be treated as a disregarded_entity both fc1 and fc2 operated as two separate corporations the purpose for liquidating fc2 or making the disregarded_entity election was so fc1 could treat a transaction that would otherwise be a sale of fc2 stock as a sale of fc2's assets you request our views on this issue based on the following fact patterns conclusion fc2 elects to check the box or liquidates into fc1 immediately prior to the sale transaction fc2 elects to check the box or liquidates into fc1 at the time fc1 enters into a contract for sale but the actual sale transaction is not consummated for a period of time eg months or less pursuant to sec_1_954-2 and sec_1_954-2 the gain from the sale of an asset will be excluded from subpart_f_income only when the asset was used or held for use in a trade_or_business by the controlled_foreign_corporation for more than one-half of the time during which such corporation had the asset prior to the sale transaction in both fact patterns fc1 did not use or hold the assets for use in its trade_or_business fc1 had no expectation of continuing or engaging in activities related to a particular field of endeavor since it had entered into a commitment to sell fc2 or its assets on or before fc2 became a branch of fc1 law and analysis sec_951 requires the u s shareholder of a controlled_foreign_corporation to include in gross_income its pro_rata share of the corporation’s subpart_f_income for the taxable_year sec_952 defines subpart_f_income to include inter alia foreign_base_company_income as determined under sec_954 sec_954 defines five categories of foreign_base_company_income one of which is foreign personal holding income fphci as defined in sec_954 specifically sec_954 states in pertinent part that in general - for purposes of subsection a the term foreign_personal_holding_company_income means the portion of the gross_income which consists of a dividends etc - dividends interest royalties rents and annuities b certain property transactions - the excess of gains over losses from the sale_or_exchange of property - i which gives rise to income described in subparagraph ii which is an interest in a_trust partnership or remic a or iii which does not give rise to any income gains and losses from the sale_or_exchange of any property which in the hands of the controlled_foreign_corporation is property described in sec_1221 shall not be taken into account under this subparagraph therefore any gain recognized from property transactions enumerated in sec_954 i through iii is fphci in general gain recognized by fc1 on the sale of fc2 stock is treated as fphci under sec_954 because that sec_1221 prescribes the types of property that are not considered capital assets subsection provides that capital assets do not include property that is inventory or primarily held_for_sale to customers in the ordinary course of the taxpayer’s trade_or_business gain is derived from the sale_or_exchange of property which gives rise to certain prescribed income eg dividends see also sec_1_954-2 however with respect to the sale of assets such transaction is governed by sec_954 as a property transaction which does not give rise to income the tax consequences of the resulting gains depend on the character of the assets that are described in the regulations under sec_954 sec_1_954-2 describes the types of property whose gain is fphci and excludes from fphci gain from those assets that are used or held for use in a trade_or_business specifically sec_1_954-2 states in relevant part property that does not give rise to income except as otherwise provided in this paragraph e for purposes of this section the term property that does not give rise to income includes all rights and interest in property whether or not a capital_asset including for example forwards futures and options property that does not give rise to income shall not include - ii tangible_property other than real_property used or held for use in the controlled foreign corporation’s trade_or_business that is of a character that would be subject_to the allowance for depreciation under sec_167 or sec_168 and the regulations under those sections including tangible_property described in sec_1_167_a_-2 iii real_property that does not give rise to rental or similar income to the extent used or held for use in the controlled foreign corporation’s trade_or_business iv intangible_property as defined in sec_936 goodwill or going_concern_value to the extent used or held for use in the controlled foreign corporation’s trade_or_business to determine whether the property was used or held for use in a particular fashion by the controlled_foreign_corporation sec_1_954-2 sets forth a specific time frame for examining the manner in which the property was so used or held sec_1_954-2 states changes in the use or purpose for which property is held - i in general under paragraphs e f g and h of this section transactions in certain property give rise to gain_or_loss included in the for the property to be subject_to an allowance for depreciation under sec_167 or sec_168 the property must be used in a trade_or_business or held_for_the_production_of_income computation of foreign_personal_holding_company_income if the controlled_foreign_corporation holds that property for a particular use or purpose the use or purpose for which the property is held is that use or purpose for which it was held for more than one-half of the period during which the controlled_foreign_corporation held the property prior to the disposition based on the foregoing regulations the gain from the sale of an asset will be excluded from fphci and thus from subpart_f_income only if the asset was used or held for use in a trade_or_business by the controlled_foreign_corporation for more than one-half of the time during which such corporation held the asset prior to the sale transaction therefore the key issues for determination are whether fc1 was engaged in a trade_or_business and whether the assets are used or held for use in that trade_or_business for the requisite period the phrase ‘trade or business ’ as used in the federal tax laws has a ‘common and well-understood connotation as referring to the activity or activities in which a person engages for the purposes of earning a livelihood hamrick v commissioner tcmemo_1979_72 38_tcm_305 t he taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit keenan v commissioner t c memo quoting 480_us_23 t he lack of continuity and frequency of activity in a particular field of endeavor is a strong indicia that a taxpayer is not engaged in a trade_or_business in that field 615_f2d_226 5th cir a single transaction ordinarily will not constitute a trade_or_business when the taxpayer enters into the transaction with no expectation of continuing in the field of endeavor id for instance in reese supra the taxpayer recognized an ordinary_loss upon the disposition of a partially completed building and claimed that such loss was incurred in connection with his trade_or_business the taxpayer argued that in addition to being the financial investor for the project he also acted as the builder developer and general contractor prior to this project the taxpayer had never been involved in a trade_or_business as a builder developer or general contractor the taxpayer developed the property solely for the purpose of providing his corporation with a new manufacturing_facility the court_of_appeals determined that t he project was clearly an isolated non-recurring venture taxpayer cannot be considered to be engaged in the trade_or_business of ‘building developing and general contracting’ with respect to the venture because there was neither prior or subsequent activity on his part in this field of endeavor nor an intention to devote his time and effort in the future to activities in this field reese v commissioner f 2d pincite for property to be considered used in a trade_or_business the asset must also be devoted to a taxpayer’s business or acquired with a view to its future business use ouderkirk v commissioner tcmemo_1977_120 36_tcm_526 see also 94_tc_455 aff’d 931_f2d_314 5th cir in ouderkirk supra the taxpayer received a sawmill and big_number acres of timberland upon liquidation of a corporation the taxpayer contributed both properties to a partnership in exchange for a ownership_interest and operated the sawmill business for eight years during this period the partnership cut some of the timber that was scattered on the big_number acres the taxpayer sold the sawmill at a loss and treated the transaction as a sale of property used in a trade_or_business that is subject_to an ordinary_loss deduction under sec_1231 on this same transaction the taxpayer also sold the big_number acres of timberland at a gain and treated the timberland as a sale of capital_asset the taxpayer argued that the timberland was a disposition of property_held_for_investment purposes while the service claimed that the land and timber were business_assets held for use in taxpayer’s sawmill operations as such the timber and land constituted property used in a trade_or_business the court held that whether an asset is used in a trade_or_business or is instead an investment the taxpayer’s intent in acquiring the property his reason for holding the property the relationship of the property to the taxpayer’s trade_or_business and the extent of its use must be examined ouderkirk v commissioner t c m pincite at the time the taxpayer received the properties pursuant to the corporate_liquidation the sawmill business was obsolete and the taxpayer had no intention to operate the same business as such the taxpayer held the property with a view to its eventual resale hoping to get a good selling_price for the land id although the taxpayer re-established the sawmill-lumber business and removed some trees that were scattered on the big_number acres for processing through the sawmill such conduct does not automatically cause the entire big_number acres to be treated as an asset used in the sawmill business within sec_1231 the incidental_use of this big_number acre sec_1231 sets forth the rules for recognition of gains or losses resulting from sale_or_exchange of property used in a trade_or_business and involuntary_conversions of such property sec_1231 defines the term property_used_in_the_trade_or_business as an asset that is subject_to an allowance for depreciation under sec_167 while the disputed property in ouderkirk was adjudicated within the context of sec_1231 the tax court’s analysis therein is nevertheless applicable to our issue since sec_1_954-2 also defines tangible_property as an asset that would be subject_to a depreciation allowance under sec_167 as such both sec_1_954-2 and sec_1231 provide rules for depreciable_property used in a trade_or_business tract in connection with such cutting of scattered timber did not convert the tract from investment_property to real_property used in the sawmill business id therefore the tract of land at issue is not property used or held in the taxpayer’s trade_or_business prior to fc2's disregarded_entity election or liquidation both fc1 and fc2 operated as separate corporations fc2 was an operating company while fc1 was a holding_company when fc2 liquidated or elected to be treated as a disregarded_entity it effectively became a branch or division of its owner fc1 see sec_301_7701-2 as such fc1 is then deemed to have the assets owned by fc2 while fc1 is deemed to have the assets owned by fc2 fc1 must nevertheless use or hold for use such assets for the requisite period of time in fc1's trade_or_business before fc1 is allowed to exclude from fphci the gain from the sale of those assets the trade_or_business in which fc2 used or held for use the subject assets cannot be attributed to fc1's holding_period for said assets this conclusion is supported by the language in sec_1_954-2 and other case law under sec_1_954-2 gain_or_loss derived from certain property transactions is included in the computation of fphci if the controlled_foreign_corporation holds that property for a particular use or purpose thus the regulation requires that we look to the manner in which the controlled_foreign_corporation fc1 used or held for use the subject asset rather than the entity that previously held the property furthermore i t is also a well settled principle of law that a shareholder has a separate identity from the corporation and that the business of a corporation is not the business of its shareholders or officers mere participation in a corporation by owning stock does not place one in the business of the corporation even devoting one’s time and energies to the affairs of a corporation is not of itself without more the trade_or_business of the person so engaged hamrick v commissioner t c m pincite for a trade_or_business to exist there must be some continuity and frequency of activity in a particular field the elements of continuity and frequency of activity are lacking in both fact patterns since fc1 had no intention of continuing or devoting its resources to the future trade_or_business activities of its branch fc2 the manner in which fc2 became a branch of fc1 constitutes an isolated and single transaction that was not undertaken for purposes of engaging or establishing a trade_or_business by fc1 therefore it would be difficult for fc1 to show that it was engaged in the trade_or_business of its branch during the time it held fc2's assets for the asset to be considered trade_or_business property the asset must be devoted to a taxpayer’s present or future business use simply because a taxpayer holds property as part of his business such conduct does not automatically treat the property as a trade_or_business asset even in ouderkirk supra where the taxpayer harvested the timber that was scattered throughout his land for approximately eight years the tax_court nevertheless concluded that the timberland was not a trade_or_business asset the factors considered by the tax_court in reaching its decision in ouderkirk included the taxpayer’s intent for acquiring or holding the property the relationship of the property to the taxpayer’s trade_or_business and the extent of its use in fc1's case its intent for acquiring and holding the assets of fc2 was to sell those assets rather than employ such properties in fc1's trade_or_business as such the assets have no relationship to fc1's trade_or_business since fc1 is not continuing or engaging in present or future activities related to the particular field of endeavor even if fc1 uses the assets for one day or for three months such use is incidental to the reason fc1 is holding the assets which is to sell those assets therefore in both fact patterns fc1 did not use or hold for use the assets of fc2 in the manner required by sec_1_954-2 and for the requisite holding_period under sec_1_954-2 phyllis marcus chief branch office of associate chief_counsel international