t c memo united_states tax_court william cavallaro donor petitioner v commissioner of internal revenue respondent patricia a cavallaro donor petitioner v commissioner of internal revenue respondent docket nos filed date ps owned kt corp and their three sons owned cs corp ps and their sons merged the two in and cs corp was the surviving entity in valuing the two companies for purposes of the merger they incorrectly assumed that cs corp owned intangibles that instead kt corp owned ps therefore accepted a dispropor- tionately low number of shares in the new company and their sons received a disproportionately high number of shares ps thereby made disguised gifts to their sons consisting of portions of the value of kt corp this opinion supplements our previously filed opinion cavallaro v commissioner tcmemo_2014_189 aff’d in part rev’d in part and remanded 843_f3d_16 1st cir r issued notices of deficiency to ps determining for each a gift_tax liability in cavallaro v commissioner tcmemo_2014_189 we held that ps had failed to meet their burden to prove the respective values of kt corp and cs corp on the basis of that failure and by treating r’s valuation of cs corp as a concession compared to the zero value in the notice_of_deficiency we held that ps made gifts to their sons in totaling dollar_figure million ps appealed the court_of_appeals affirmed our factual findings and our holding that ps had the burden_of_proof but the court held that we erred in our statement of the content of ps’ burden_of_proof and concluded that we should have considered ps’ arguments rebutting r’s expert witness testimony on the subject of valuation in order to determine whether the resulting determination was arbitrary and excessive on remand we now consider ps’ arguments concerning r’s expert’s report held r’s valuation expert’s error caused him to overvalue the disguised gifts by dollar_figure million and rendered r’s valuation arbitrary and excessive held further after correcting for that error we determine that ps gave their sons gifts valued at a total of dollar_figure million matthew d lerner for petitioners carina j campobasso and derek w kelley for respondent supplemental memorandum findings_of_fact and opinion gustafson judge these cases are before us on remand from the court_of_appeals for the first circuit for reconsideration on the issue of valuation see 842_f3d_16 1st cir aff’g in part rev’g in part and remanding cavallaro v commissioner cavallaro ii tcmemo_2014_189 at the trial of these cases the commissioner presented the report of an expert witness to assert for purposes of sec_2501 and sec_2502 the proposed value of disguised gifts that william cavallaro and patricia cavallaro had made to their sons the question before us on this remand is whether the commissioner’s expert’s valuation is arbitrary and excessive if it is then we are tasked with determining the proper amounts of the cavallaros’ tax_liabilities findings_of_fact many of the relevant facts underlying these cases are set forth in cavallaro ii and cavallaro iii and we assume familiarity with those opinions we restate and summarize certain relevant facts below 1before petitioning this court for redetermination of their gift_tax deficiencies petitioners were involved in litigation related to the examination by the internal_revenue_service irs which resulted in 284_f3d_236 1st cir affirming the denial of petitioners’ motion to quash a third-party_recordkeeper summons 2unless otherwise indicated all section references are to the internal_revenue_code u s c as amended and in effect for the relevant year and all references to rules are to the tax_court rules_of_practice and procedure the cavallaro family knight and camelot and the merger in the cavallaros incorporated knight tool co inc knight a machine shop and contract manufacturer mrs cavallaro owned of knight’s stock and mr cavallaro owned the cavallaros’ three sons ken paul and james worked in the family business at various times mr cavallaro and his son ken worked with knight engineers and employees to develop a liquid-adhesive dispensing machine prototype which came to be known as the cam a lot machine ken paul and james incorporated camelot systems inc camelot knight manufactured the cam a lot machines and camelot sold them in the cavallaros’ accountants at ernst young e y reviewed the situations of the cavallaros knight and camelot e y accountant lawrence goodman signed a letter dated date recommending the merger of the two companies he projected that in such a merger the majority of the shares possibly as high a sec_85 will go to bill and patti e y valued the merged company as being worth between dollar_figure and dollar_figure million however attorneys pincitemr goodman’s letter of date is useful it was commissioned by the cavallaros and was written by their own accountant who was knowledgeable about their affairs and had no bias against them on the contrary he came to his conclusions while pursuing their interests he wrote his letter before becoming aware of the attempt described below by the cavallaros’ attorneys at hale dorr to concoct a transfer of intangibles and before the current controversy arose in these respects it is very good evidence hale dorr later advised the cavallaros to assume incorrectly that camelot not knight owned the significant intangible assets the accountants did not agree with that view and one of them wrote mr hamel a letter concerning errors he perceived in the affidavits that were prepared by hale dorr but mr hamel responded history does not formulate itself the historian has to give it form without being discouraged by having to squeeze a few embarrassing facts into the suitcase by force as a result the accountants acquiesced and e y eventually attributed to mr and mrs cavallaro considerably less than of the stock in the merged company see cavallaro ii at on date the cavallaros and their sons merged knight and camelot in that merger mrs cavallaro received shares of the new company mr cavallaro received shares and shares each were distributed to ken paul and james thus mr and mrs cavallaro received of the shares not the the majority of the shares possibly as high a sec_85 that e y had foreseen rather it was the cavallaros’ sons who received the majority of the shares of the new company--ie in the aggregate--which allegedly represented the pre- merger value of camelot examination and notices of deficiency the irs conducted a gift_tax examination relating to the cavallaros and on date the irs issued statutory notices of deficiency to mr cavallaro and mrs cavallaro for the tax_year determining that by means of the merger each of the parents had made a taxable gift of dollar_figure to their sons resulting in gift_tax liabilities the cavallaros timely petitioned this court for redetermination of their gift_tax deficiencies valuations in cavallaro ii during trial mr and mrs cavallaro entered into evidence two reports on the issue of valuation--the e y valuation performed by timothy maio in valuing the combined companies as of date on which the post- merger share distribution had been based and the valuation prepared for trial in cavallaro ii by john murphy of atlantic management co mr maio had valued the combined company at dollar_figure to dollar_figure million and mr murphy valued the combined company at dollar_figure million both assumed contrary to our factual findings in cavallaro ii that camelot had owned the cam a lot technology and that knight had been a contractor for camelot the commissioner retained marc bello of edelstein co to determine the fair market values of knight and camelot his report assumed correctly per our findings in cavallaro ii that knight had owned the significant intangible assets mr bello adjusted for the non-arm’s-length nature of the two companies and then valued the combined entities using a discounted cashflow dcf method mr bello concluded that the total value of the merged entity was dollar_figure million ie less than the value as reckoned by mr maio and mr murphy that knight’s value was dollar_figure million ie of the total and that camelot’s value was dollar_figure million ie of the total on the basis of mr bello’s analysis the commissioner argued that the date merger of knight and camelot and the disproportionate_distribution of shares resulted in a gift to the cavallaros’ sons totaling dollar_figure million the cavallaros cross-examined mr bello challenged his methodology and alleged that his valuation was flawed for a number of reasons holding in cavallaro ii in cavallaro ii we found that mr and mrs cavallaro’s corporation knight rather than their sons’ corporation camelot owned the technology that the merger transaction was notably lacking in arm’s length character that the merger of the two companies with the issuance of of the stock of the new combined entity to the sons reflected a presumption that camelot had owned the technology that the -19 allocation of the stock was therefore not in accord with the actual relative values of the two companies and that the transaction therefore resulted in disguised gifts to the sons see cavallaro ii at in cavallaro ii we held in favor of the commissioner on the basis of the cavallaros’ failure to meet their burden_of_proof they put on no evidence as to the relative values of the two corporations under the correct assumption that knight not camelot owned the intangibles consequently we did not rule on the merits of the cavallaros’ arguments concerning the bello valuation id at citing 82_tc_299 aff’d 770_f2d_381 3d cir we held that on date mr and mrs cavallaro made gifts to their sons totaling dollar_figure million4 ie the gift_tax liability that was based on the bello valuation id at the first circuit’s opinion in cavallaro iii the cavallaros appealed cavallaro ii to the u s court_of_appeals for the first circuit alleging that this court erred in three respects not shifting the burden_of_proof to the commissioner concluding knight owned the 4our prior opinion rounded down the valuation of dollar_figure to dollar_figure million however the closer rounded value is dollar_figure million which we employ in this opinion intangibles and misstating the cavallaros’ burden_of_proof and failing to consider flaws in the bello valuation see generally cavallaro iii the court_of_appeals held that we were correct in not shifting the burden_of_proof to the commissioner see cavallaro iii f 3d pincite and affirmed our findings concerning the property ownership issue id pincite the court_of_appeals then considered the cavallaros’ argument that we had erred in our statement that they had the burden_of_proof to show the proper amount of their tax_liability id pincite cavallaro ii at the cavallaros alleged that this ‘legal error’ led to another the court refused to consider their evidence that the bello valuation was ‘fatally flawed ’ cavallaro iii f 3d pincite on this issue the court_of_appeals agreed with the cavallaros and found that we misstated the content of their burden id pincite the court_of_appeals stated w e remand so that the tax_court can evaluate the cavallaros’ arguments that the bello valuation had methodological flaws that made it arbitrary and excessive if the tax_court determines that the commissioner’s assessment was arbitrary then it must determine the proper amount of tax_liability for itself the court is free to accept in whole or in part or reject entirely the expert opinions presented by the parties on the subject the extent of any further briefing hearings or evidence is left to the tax court’s sound discretion id pincite fn ref omitted the cavallaros’ arguments regarding the bello valuation in accordance with the directive of the court_of_appeals we ordered further briefing from the parties on whether the commissioner’s valuation was arbitrary and excessive and explained that only after resolving that issue would we order proceedings as to the second issue the proper amount of tax_liability the cavallaros took this remand as an occasion not only to renew arguments that we had not previously addressed but also to renew arguments that we had previously rejected and to raise new arguments that they had not previously made before this court opinion in accordance with the directive of the court_of_appeals we evaluate the cavallaros’ arguments that the bello valuation had methodological flaws that made it arbitrary and excessive id to do so we ask first whether the dollar_figure million value that the bello report ascribed to the disguised gift is arbitrary and excessive and we find that it is on account of one error described below in part ii b that being so the directive of the court_of_appeals is that we then must determine the proper amount of tax_liability and in making that determination we are free to accept in whole or in part or reject entirely the expert opinions presented by the parties on the subject id we find that after we correct the error mentioned above the bello report establishes that the value is dollar_figure million i burden_of_proof in general the irs’s notice_of_deficiency is presumed correct and the petitioner has the burden of proving it to be wrong 290_us_111 see also rule a the court_of_appeals held that this court did not misallocate the burden_of_proof in cavallaro ii but it held that we misstated the content of that burden cavallaro iii f 3d pincite accordingly on remand the burden_of_proof remains with the cavallaros to prove that the bello valuation had methodological flaws that made it arbitrary and excessive see 293_us_507 unquestionably the burden_of_proof is on the taxpayer to show that the commissioner’s determination is invalid if the cavallaros show the commissioner’s determination to be arbitrary and excessive then we cannot sustain that determination and we will determine the correct amounts of tax see id pincite cavallaro iii f 3d pincite we therefore turn to the details of the cavallaros’ critique the cavallaros allege that the bello valuation is arbitrary for a variety of reasons in reviewing their criticisms we divide the arguments into two groups arguments raised during the trial of cavallaro ii discussed below in part ii and arguments not raised during that trial discussed below in part iii ii arguments raised during the cavallaro ii trial in their briefs on remand the cavallaros renewed and expanded upon several arguments that they advanced during the trial in cavallaro ii the renewed arguments that they raised during trial can be subdivided according to whether they are consistent with our factual findings in cavallaro ii a arguments inconsistent with the court’s findings_of_fact some of the cavallaros’ arguments on remand are implicitly or explicitly contrary to our findings_of_fact in cavallaro ii for example on remand the cavallaros argue that the bello valuation erred by not taking into consideration the confirmatory bill of sale that attested to a transfer between knight and camelot which the cavallaros contend on remand is a cloud on the title and that the bello valuation therefore erred by not discounting the value of knight because a buyer considering the acquisition of knight without camelot would have to take into account the risk that camelot might claim rights to the ip this argument is based on premises that are explicitly contrary to our factual finding that the ‘confirmatory’ bill of sale confirmed a fiction and i f an unrelated party had purchased camelot before the merger and had then sued knight to confirm its supposed acquisition of the cam a lot technology without doubt that suit would fail cavallaro ii at emphasis added the court_of_appeals explicitly affirmed this finding stating that the cavallaros advanced no argument that would warrant overturning the tax court’s finding that knight owned all of the cam a lot technology at the time of the merger cavallaro iii f 3d pincite see also id ndollar_figure the record shows that the tax_court carefully considered the gravitas of the camelot name stamp and other proprietary claims from the viewpoint of an unrelated purchaser the consideration and affirmance of our findings on this issue by the court_of_appeals forecloses all such arguments under the law_of_the_case_doctrine the law_of_the_case_doctrine ‘posits that when a court decides upon a rule_of law that decision should continue to govern the same issues in subsequent stages in the same case ’ 393_f3d_1 1st cir quoting 460_us_605 see also 157_f3d_35 1st cir the law_of_the_case_doctrine is a prudential principle that ‘precludes relitigation of the legal issues presented in successive stages of a single case once those issues have been decided’ quoting 101_f3d_155 1st cir under the mandate rule a branch of the law of the case doctrine when the reviewing court prescribes in its mandate that a court shall proceed in accordance with the opinion of the reviewing court it incorporates its opinion into its mandate 41_f3d_764 1st cir when a case is appealed and remanded the decision of the appellate court establishes the law of the case and it must be followed by the trial_court on remand 931_f2d_148 1st cir quoting 1b j moore j lucas t currier moore’s federal practice para 2d ed in cavallaro iii the court_of_appeals did not disturb this court’s factual findings in cavallaro ii and it found we erred only in one respect we correct that error in this opinion accordingly on remand we will not allow the cavallaros to relitigate the ownership of the cam a lot technology by arguing that there was a cloud on the title nor will we undertake the chore of considering their other 5the law_of_the_case_doctrine is not completely inflexible and may tolerate a ‘modicum of residual flexibility’ in exceptional circumstances 988_f2d_247 1st cir quoting 931_f2d_148 1st cir however the cavallaros who would be the proponents of reopening these already decided matters do not argue any of the exceptions for doing so and even if they did none of the exceptions applies to this case see bell f 2d pincite rivera-martinez f 2d pincite 6if the cavallaros are arguing not that camelot owned the intangibles but that prospective buyers of knight might have supposed that camelot owned them continued similarly flawed arguments that are contrary to our undisturbed post-trial legal conclusions and undisturbed factual findings b arguments raised at trial that are not inconsistent with the findings_of_fact some of the arguments that the cavallaros advance on remand constitute arguments and variations of arguments that they raised at trial and that do not contradict our explicit findings we summarize those arguments here and find that only one discussed below in part ii b has merit mr bello’s supposed bias the cavallaros allege that mr bello impermissibly followed the commis- sioner’s instructions and that this bias caused him to fail to interview the principals of knight and camelot in his process of valuing them and caused him to fail to do a site visit the cavallaros suggest that these failures caused mr bello to misunderstand the nature of knight and camelot’s businesses which caused him to overvalue knight and undervalue camelot the cavallaros say that mr continued and that this supposition would have diminished knight’s fair_market_value then we reject that argument as well such a diminution would have been possible only if the cavallaros had publicized the fiction of camelot’s ownership of the intangibles there is no evidence that they did publicize that fiction and we do not think that a donor should be able to reduce his gift_tax liability by arguing the hypothetical possibility that the value of his gift was lower because he could have slandered his own title to the donated assets bello acted like a member of respondent’s trial team not an expert useful to this court in making technical determinations they argue that his bias is further shown by errors in his report we do not agree the determination of whether expert testimony is helpful to the trier of fact is a matter within our sound discretion see 92_tc_101 it is true that an expert is not helpful to the court and loses credibility when giving testimony tainted by overzealous advocacy transupport inc v commissioner tcmemo_2016_216 at collecting cases aff’d 882_f3d_274 1st cir an expert who is merely an advocate of a party’s position does not assist the trier of fact in understanding the evidence or in determining a fact in issue id at citing 118_tc_181 and 105_tc_16 aff’d 98_f3d_194 5th cir but mr bello’s opinion was not tainted by these flaws and we found his opinion helpful with respect to mr bello’s decisions not to not interview the cavallaros7 and not to visit knight and camelot he testified credibly that he had enough 7similarly mr maio did not rely on interviews with the cavallaros--but he still testified that his report was reliable using information that he received from financial statements and marketing materials and from meeting with management information to understand the companies so it was not necessary for him to interview the owners of the business nor to make a site visit many years after the merger at issue we conclude that any errors in his report were the result of mistake and not bias we are satisfied that mr bello considered the objective and relevant facts and we conclude that his valuation was not tainted by overzealous advocacy mr bello’s value for the two combined companies ie dollar_figure million was significantly lower than the corresponding values put forth in both of the valuations that the cavallaros relied upon ie dollar_figure-75 million and dollar_figure million and the proportion of that value that mr bello allocated to knight ie was well within and was not at the top of the range of values that the cavallaros’ accountant postulated in ie to see cavallaro ii at his valuation prompted the commissioner to make a substantial partial concession before trial ie his valuation caused the commissioner to change his position in 8in determining whether a site visit and interviews are necessary a determining factor is the degree to which the analyst was able to gather and interpret written material shannon p pratt alina v niculita valuing a business the analysis and appraisal of closely held companies 5th ed the need for the valuation analyst to visit the company facilities and have personal contact with the company personnel and other related people varies greatly from one valuation to another the extent of necessary fieldwork depends on many things id in this instance mr bello did not err in his decision more than a decade after the merger not to visit the companies’ facilities and have personal contact with their personnel and that decision was not indicative of any bias the cavallaros’ favor id we do not find any merit in the cavallaros’ arguments to the effect that mr bello was biased the profit reallocation calculation on remand the cavallaros renew their criticisms of the profit reallocation calculation that mr bello performed before valuing the two companies they argue that the profit reallocation was generally unnecessary and they also criticize various aspects of it ie his reasons for performing the reallocation the reallocation calculation’s methodology the industry classifications and the inputs that he used such as the robert morris associates rma data discussed below the cavallaros’ general argument that the profit reallocation was unnecessary is contrary to our finding that knight received less income than it should have as the manufacturer of the machines while camelot received more than it should have as the mere seller id at and to our finding that the allocation of stock in the merger was not done at arm’s length id at mr bello’s profit reallocation corrected for the distortions that we found according to an authority cited in both parties’ briefs such adjustments to the financial statements require both analytical judgment and an understanding of accounting principles and an analyst should be guided by common sense experience and understanding of the compan ies in determining what adjustments should be made to present the statements in the manner most appropriate for valuation purposes shannon p pratt alina v niculita valuing a business the analysis and appraisal of closely held companie sec_150 5th ed mr bello’s profit reallocation adjustment reflected such judgment and understanding--the correct view as adopted by this court that knight and camelot were not dealing with each other at arm’s length that knight was effectively subsidizing camelot’s operations and that knight rather than camelot owned the cam a lot technology we conclude not only that this part of the valuation was not arbitrary but also in light of our factual findings in cavallaro ii that this reallocation or another similar type of profit normalization between the two companies was entirely necessary to yield an accurate valuation of the two companies see cavallaro ii at as to the details of mr bello’s profit reallocation adjustment we are not persuaded by the cavallaros’ critique mr bello sufficiently described the logic and reasoning underlying the steps he performed in the profit reallocation his selection of the industry classification for the companies was well reasoned and it was based in part on the industries that the cavallaros had self-reported see id at his decision to use the rma data--a composite source of privately owned company data--is supported by the treatise cited by both parties which describes the rma data as the most popular source of composite company data including privately owned company data pratt niculita supra pincite thus we conclude that the individual steps undertaken by mr bello as part of the profit reallocation the selection of the comparable industries and the inputs he used in performing the profit reallocation were not arbitrary except for the calculation discussed below in part ii a the discounted cashflow calculation after performing the profit reallocation between knight and camelot mr bello then valued camelot and knight using the dcf method the cavallaros argue that even if the profit reallocation adjustment was justified and even if there were no errors in the profit reallocation mr bello’s use of the dcf method was arbitrary as with their arguments concerning the profit reallocation the cavallaros advance criticisms concerning mr bello’s use of the dcf method generally and also advance specific criticisms of the inputs underlying the dcf calculation eg the growth rate the risk premium and the discount rate with respect to their general arguments about the use of the dcf method to value knight and camelot--two closely held companies--this argument is not convincing because this court has used this methodology to value similar property see eg estate of magnin v commissioner tcmemo_2001_ 81_tcm_1126 supplementing tcmemo_1996_25 rev’d and remanded on other grounds 184_f3d_1074 9th cir mr bello explained why he considered and rejected alternative methodologies--the asset accumulation method going concern the market approach the guideline publicly traded company method the guideline transaction_method the prior sales_method and the dividend payout method--and in doing so he was appropriately guided by and considered a number of factors set forth in revrul_59_60 1959_1_cb_237 mr bello explained convincingly why the dcf methodology that he ultimately selected to determine knight’s and camelot’s values was the best valuation method for this case with respect to the cavallaros’ arguments concerning the details of mr bello’s inputs for his dcf analysis such as the risk premiums working_capital depreciation capital expenditures and growth rates we find that these arguments are also unpersuasive keeping in mind the fact that a determination of fair_market_value being a question of fact will depend upon the circumstances in each case and the fact that valuation is not an exact science revrul_59_60 sec_3 c b pincite we think that mr bello adequately explained his rationale behind his selection and use of inputs in his dcf model his explanations demonstrate that he used the elements of common sense informed judgment and reasonableness to value knight and camelot id see sec_25_2512-2 f gift_tax regs in summary the cavallaros’ criticisms of and arguments concerning the bello valuation generally lack merit mr bello’s valuation was not arbitrary and excessive except in the one respect to which we now turn the 90th percentile profit margin calculation when mr bello performed the profit reallocation to normalize the profits between knight and camelot he calculated the returns available to camelot based on the expected return from the rma data and added a premium to reflect the strategy of premium pricing and higher profitability totaling as of the valuation_date which would put camelot in the top for all distributors the result of this profit allocation calculation is that both camelot and knight were in the top 90th percentile with regards to profitability within their respective industries on remand however the cavallaros pointed out an error in mr bello’s attempt to calculate a profit margin that would place each company in the 90th 9the bello report purported to state this premium a sec_3 but that was a typographical error and the actual intended premium wa sec_3_4 thus the total for the return that he used in his calculation was percentile of its industry the cavallaros demonstrated and the commissioner acknowledged that t he rma data on which he purports to rely reflect that a profit margin of would place camelot in the 3rd percentile not the 90th the cavallaros and the commissioner subsequently corresponded about how mr bello had arrived at the value and it became clear that mr bello had attempted to extrapolate the 90th percentile through a method that was not statistically reliable mr bello apparently believed that the underlying data was unavailable so in his attempt to arrive at the 90th percentile he employed a method that was not statistically correct he knew only the mean profit margin from the rma data he assumed that the mean profit margin would not be that far off from the median or 50th percentile so he inferred that the theoretical 100th percentile would be and that the 90th percentile would be making the figure that he employed in the profit reallocation calculation greater than his inferred 90th percentile the cavallaros characterize this as mr bello’s deceptive and erroneous profit allocation adjustment and argue that the court should disregard mr bello’s expert report and testimonydollar_figure despite this error the commissioner defends 10we agree that the allocation was erroneous but we do not at all conclude that it was deceptive we reject the cavallaros’ contention that this error rendered continued mr bello’s profit margin on the grounds that he had intended only to make camelot a top performer not specifically in the 90th percentile and that even the 3rd percentile used in mr bello’s analysis which allocated of the overall value to camelot was generous but this defense falls flat at trial and in his report mr bello was very explicit about his intent to place camelot in the 90th percentile and even on remand the commissioner initially reiterated mr bello’s intention to place camelot in the 90th percentiledollar_figure but we now know and the commissioner admits that his method did not do so using a profit margin in the 3rd percentile versus the 90th percentile makes a substantial difference in the valuation and therefore a substantial difference in the value of the disguised gift using the correct percentage for the actual 90th percentile of net_income before tax--9 rather than the mr bello used--results in camelot’s having a value of dollar_figure million or of the total value of the combined entities rather than the dollar_figure million value that continued his entire valuation arbitrary and excessive or otherwise unreliable 11the commissioner’s brief on remand insisted the selection of the premium was not ‘randomly chosen’ as petitioners claim rather as mr bello explains in his report it was explicitly chosen to put camelot in the 90th percentile of its wholesaler category peers in terms of profitability giving it a net profit of emphasis added represented of the combined entities’ valuation as mr bello had computed and although the commissioner continues to insist that correction of this error is not necessary or appropriate he admits that if one does correct for this error the correction reduces the value of the disguised gift by dollar_figure milliondollar_figure we find that this one error in this subcalculation was arbitrary and we conclude that it did result in an excessive gift_tax determination which must be corrected iii arguments made on remand that were not raised at trial on remand the cavallaros advance a number of arguments that they did not make during trial in cavallaro ii we reject these arguments both a as untimely and b on their merits a the untimeliness of the new arguments on remand on appeal the cavallaros attempted to advance new arguments that they had not made before this court the court_of_appeals refused to consider those 12the parties agree that the substitution of the correct 90th percentile value for the incorrect value while simultaneously holding all other aspects of mr bello’s valuation constant results in a decrease in the gift’s value by dollar_figure in this and subsequent discussions we do not correct for the arithmetical discrepancies that result from rounding argumentsdollar_figure we see in the same light the cavallaros’ attempt now on remand to assail the bello valuation by fact-intensive arguments they did not raise at trial and we conclude that they waived those arguments the court_of_appeals for the first circuit has explained that whether a party has waived an argument by its failure to raise that argument during an earlier proceeding depends on whether the party had sufficient incentive to raise the issue 171_f3d_24 1st cir holding that in the criminal context a defendant may not raise a new argument on remand for resentencing if he or she had reason to raise it initially citing united_states v 13in particular the cavallaros attempted to contend on appeal that the tax_court should have ruled that camelot owned two crucial property rights at the time of the merger the trade secrets embodied in camelot’s mechanical drawings and the copyrighted cam a lot operating software cavallaro iii f 3d pincite but in the first circuit the law is crystalline a litigant’s failure to explicitly raise an issue before the district_court forecloses that party from raising the issue for the first time on appeal 97_f3d_1504 1st cir quoting bos beer co ltd p’ship v slesar bros brewing co 9_f3d_175 1st cir the court_of_appeals observed that at trial in cavallaro ii the tax_court suggested that assessing potentially discrete proprietary components of cam a lot might be a better approach and invited the parties to consider such an approach only insofar as it was helpful to framing the case s and clearly warned that such an approach might not ‘survive the expert testimony ’ cavallaro iii f 3d pincite but the cavallaros ignored our invitation and continued to press their views--only to later complain on appeal that the tax_court erroneously treated cam alot as a ‘monolithic property interest ’ rather than seeing it for its discrete proprietary components id pincite de la cruz-paulino 61_f3d_986 n 1st cir noting in the context of fed r crim p that government violations of rule d should excuse a defendant’s failure to move to suppress evidence prior to trial since defendants have no incentive to move to suppress evidence that the government will not be introducing in ticchiarelli f 3d pincite the court_of_appeals explained that t his approach requires a fact-intensive case-by-case analysis so we examine the facts of the instant case before and during trial in cavallaro ii the cavallaros had every reason and every opportunity to thoroughly analyze and criticize the bello valuation even though the commissioner’s case was based on the bello valuation the cavallaros did not advance several of the criticisms that they now allege on remand rather during their cross-examination of mr bello the cavallaros chose to focus almost exclusively on criticizing the foundational premise of the bello valuation that knight owned the intangible assets that is the cavallaros put all their chips on that factual issue but on that issue we found in favor of the commissioner see cavallaro iii f 3d pincite cavallaro ii at knight did own the intangible assets id now on remand the cavallaros are attempting to avoid the consequence of their litigation strategy by advancing new criticisms and arguments whether the cavallaros omitted certain arguments because they overlooked them or whether instead such omissions were the result of deliberate choices the outcome is the same the cavallaros had every opportunity and every incentive to advance all possible criticisms of the bello valuation during the trial in cavallaro ii we therefore treat the cavallaros as having waived all arguments that they advance now for the first time on remand however the outcome is the same--ie we do not sustain these arguments-- even if we consider them on their merits which we now do b the lack of merit of the new arguments on remand discounts the most significant of these new arguments that the cavallaros direct against the bello report are its failure to make three discounts ie-- failing to discount the value of knight because of the risk of losing its key man mr cavallaro14 ie failing to apply a key man discount valuing knight and camelot without applying a discount for lack of control and 14in cavallaro ii the cavallaros argued to the contrary in their post-trial opening brief in cavallaro ii they argued that knight did not have a key leader comparable to kenneth cavallaro and in their reply brief they argued that kenneth not william cavallaro was the key man in the success of the dispensing machines valuing knight and camelot without applying a discount for lack of marketability our caselaw does show that these three discounts are properly used in some instances but the cavallaros’ current argument fails for complete lack of evidence that those discounts would be necessary or even appropriate in this particular casedollar_figure on the contrary the only possible inference to be drawn from the record in this case is that those discounts would not be appropriate here because neither of the cavallaros’ own appraisers mr maio and mr murphy made a key man discount or discounts for lack of control or lack of marketability the cavallaros represented that their appraisers’ valuations were accurate and that they used legally prescribed and widely accepted methodology yet those valuations made the same omissions for which the cavallaros now criticize the bello report no expert in this case used those discounts and no expert testimony criticized the absence of those discounts consequently one can hardly say on this record that the omission of these discounts from the bello valuation was an error 15there are other discounts that appraisers sometimes apply--eg discounts for illiquidity trapped-in capital_gains taxes portfolio nonhomogeneous assets contingent liabilities voting versus non-voting stock and blockages see generally pratt niculita supra pincite--but we would not assume without evidence that the absence of any of them would necessarily invalidate a valuation the cavallaros’ general argument that prompted the court_of_appeals to remand this case for further consideration was that the tax_court refused to consider their evidence that the bello valuation was ‘fatally flawed ’ cavallaro iii f 3d pincite emphasis added of course the court_of_appeals did not insist that on remand the tax_court should sustain arguments about discounts for which there is no evidence the court_of_appeals did order that on remand we may take new evidence including a new expert valuation id pincite emphasis added but it stated that t he extent of any further briefing hearings or evidence is left to the tax court’s sound discretion id we will exercise that discretion not to conduct a new trial as we stated in our order directing proceedings on remand-- long before the time of the trial of this case petitioners had clear notice of the factual and valuation issues at stake including whether knight owned the technology and what the values of the companies were if it did by receipt of mr bello’s report six16 months before trial and the taking of his deposition one month before trial petitioners had every opportunity to develop their contention that mr bello’s conclusions were arbitrary and excessive at trial petitioners had every opportunity to put on evidence on all the valuation issues and on all the defects in mr bello’s 16our order incorrectly stated that the cavallaros received the bello report three months before trial but in fact they received it on date and the first day of trial in cavallaro ii was more than six months later on date conclusions this court’s legal error that the court_of_appeals identified the tax_court did not misallocate the burden_of_proof at trial but misstated the content of that burden ct app slip op pincite occurred after trial in the tax court’s opinion not in any ruling before or during trial that could have limited petitioners’ ability to put on evidence anything omitted at trial from petitioners’ critique of mr bello was the result of their own choices we therefore look to the evidence admitted at the trial already conducted to determine whether and to what extent the bello valuation erred by not making the discounts for key man lack of control or lack of marketability and we find that there is no evidence of any error in this regard transfer_pricing allocation another new argument on remand that the cavallaros direct against the bello report is that it reallocated profits between knight and camelot in a manner that was inconsistent with transfer_pricing regulations see sec_1 c h d income_tax regsdollar_figure but as with the discounts discussed above in part iii b neither of the cavallaros’ own appraisers mr maio and mr murphy made adjustments pursuant to the transfer_pricing regulations 17the cavallaros argue if a taxpayer presented the bello report as evidence to support its transfer_pricing the taxpayer would face penalties for improper transfer_pricing under sec_1_6662-6 mr maio made no adjustment at all to the allocation of profits between knight and camelot--a serious flaw already discussed in cavallaro ii at mr murphy’s valuation attempted a profit reallocation between the companies by postulating a royalty that camelot would owe to knight but in so doing he made no showing of compliance with the selection-of-pricing-method principles of sec_482 which the cavallaros belatedly allege is a standard that should be applied to valuations in this case in fact mr murphy’s valuation violated that standard since he argued that no adjustment was necessary but then performed such an adjustment anyway this approach contradicts the requirement that a taxpayer evaluate the potential applicability of specified methods in a manner consistent with the principles of the best_method_rule and reasonably conclude that the method employed is the most reliable see sec_1_6662-6 ii b and c income_tax regs sec_482 is an income_tax provision it gives the irs discretion to allocate income and deductions among taxpayers that are owned or controlled by the same interests for purposes of preventing the evasion of taxes or to clearly reflect income broadly speaking t he purpose of sec_482 is to prevent the artificial shifting of the net incomes of controlled taxpayers by placing controlled taxpayers on a parity with uncontrolled unrelated taxpayers 96_tc_226 sec_482 is expressly applicable when the issue in dispute is the income_tax of the subject companies not the gift_tax of their shareholders this generality does not mean that principles and authorities under sec_482 may never be considered in analogous contexts see 67_tc_1060 alluded to sec_482 principles in a gift_tax case involving an interest-free_loan aff’d 585_f2d_234 7th cir but neither is sec_482 the governing authority every time a gift_tax valuation requires allocating profits between two companies--and the cavallaros acknowledge that there is no legal requirement that one purporting to value a company must always apply transfer_pricing principles consequently we disagree with the cavallaros’ argument that bello must identify specific transactions that were conducted off-market and analyze and adjust them under sec_1_482-1 income_tax regs however even if we were to review mr bello’s adjustment under the sec_482 standard we would hold that it satisfies that standard in reviewing the reasonableness of the commissioner’s allocation under sec_482 we focus on the reasonableness of the result not the details of the methodology employed 92_tc_525 citing 372_f2d_990 ct_cl aff’d 933_f2d_1084 2d cir for the reasons set forth in this opinion and especially in the comparison below we find that mr bello’s result was reasonable by any standard iv determining the proper amounts of tax_liabilities as is noted above we explained to the parties after the court_of_appeals issued its remand that we would first determine whether the bello valuation was arbitrary and excessive and that thereafter we would order proceedings as to the second issue if appropriate --ie the issue of the correct amounts of the liabilities our proceedings to date have identified the sole error in the bello report ie the 90th percentile profit margin calculation and the parties agree on the effect of that error ie that the profit margin figure places camelot in the 3rd rather than the 90th percentile and they agree on the effect that the error had on the amount of the disguised gifts ie that using the correct 90th percentile profit margin of would in mr bello’s calculation reduce the gifts’ total value by dollar_figure we are therefore able to say now that further proceedings are not necessary because of that error the commissioner’s valuation was arbitrary and excessive under the remand we therefore may not let that valuation stand but must determine the proper amounts of the tax_liabilities see cavallaro iii f 3d pincite ndollar_figure citing 767_f3d_443 5th cir aff’g in part rev’g in part 140_tc_86 445_f2d_455 1st cir aff’g tcmemo_1966_29 and moss v commissioner tcmemo_1969_213 in making this determination we are free to accept in whole or in part or reject entirely the expert opinions presented by the parties on the subject see cavallaro iii f 3d pincite citing 304_us_282 and 538_f2d_927 2d cir aff’g t c memo this one error does not make us unable to use mr bello’s valuation and it does not require a new trial or necessitate receiving additional evidence rather we accept in part the expert opinion presented by the commissioner on the subject cavallaro iii f 3d pincite on the basis of the trial record the cavallaros’ identification of the error and proposal of a correction and the commissioner’s acceptance of the cavallaros’ calculation we are able to correct for this error and determine the proper amount of the cavallaros’ gift the parties agree that if mr bello had used the correct 90th percentile figure rather than the incorrect value the value of the disguised gifts would be reduced from approximately dollar_figure million to dollar_figure million a difference of about dollar_figure million we conclude that the dollar_figure million value is the correct value of the disguised gifts made by the cavallaros to their sons as a check on the reliability of the bello report as thus corrected we make the following simple comparison of the bello valuation to the valuations relied on by the cavallaros first any such valuation must begin with the value of the combined pre- merger companies and a higher value for the combined companies is disadvantageous to the cavallaros nonetheless mr bello’s combined value dollar_figure million is lower than the combined value as reckoned by mr maio in dollar_figure to dollar_figure million and by mr murphy in this litigation dollar_figure million see cavallaro ii at in comparison to the cavallaros’ valuations mr bello’s dollar_figure million valuation is not at all excessive but is more favorable to the cavallaros second the valuation must determine what portion of that combined value is attributable to knight mr bello’s conclusion that knight accounts for of the combined value is easily within the range that the cavallaros’ own accountant mr goodman from e y estimated in before the cavallaros’ lawyers postulated a fictitious transfer of the intangibles mr goodman said that in a merger the majority of the shares possibly as high a sec_85 will go to the owners of knight mr and mrs cavallaro mr bello’ sec_65 represents a fairly conservative valuation within mr goodman’s range of a majority ie greater than to possibly as high a sec_85 third numbers derived from the cavallaros’ personnel suggest a gift amount not too far off mr bello’s where a range of possible values is given we take for this purpose the value within that range that is most favorable to the cavallaros as follows first to value the combined companies we use the lower combined value dollar_figure million of mr maio’s range dollar_figure to dollar_figure million next for the proportion attributable to knight we use the lowest number--51 --from mr goodman’s range majority to since the owners of knight received not but only of that value in stock from the merger we determine that the cavallaros forfeited in favor of their son sec_32 ie minus of that combined value to which they were entitled we therefore conclude under this alternative approach that they made disguised gifts totaling of the dollar_figure million combined company or dollar_figure milliondollar_figure this amount is reasonably close to the dollar_figure amount of the disguised gifts as calculated after correcting 18thus if we were persuaded that the bello report was irreparably flawed we are not then we could well find on the basis of other evidence in the existing trial record ie mr maio and mr goodman’s valuations that the total value of the disguised gift was at least dollar_figure million mr bello’s computation for the one error that rendered its conclusion arbitrary and excessive as we explained above in part ii b the corrected dollar_figure million value of the disguised gift that is yielded by mr bello’s methodology is less than higher than the dollar_figure million amount suggested by our rough-and-ready use of the numbers derived from the cavallaros’ own personnel we think this further validates our conclusion conclusion we have considered all of the cavallaros’ criticisms of the bello valuation and except for their objection to mr bello’s flawed 90th percentile profit calculation we find that they are without merit for the reasons set forth above and argued by the commissioner we find now that aside from the one previously discussed exception which rendered the commissioner’s valuation arbitrary and excessive mr bello’s inputs and methodology were reasonable and we conclude that his valuation reasonably determined knight and camelot’s total combined fair_market_value after correcting for the one error in mr bello’s allocation of that total value between knight and camelot we conclude that mr and mrs cavallaro made gifts totaling dollar_figure million on date so that mr and mrs cavallaro’s separate gift_tax liabilities can be recomputed decisions will be entered under rule


o f f i c e o f t h e c h i e f c o u n s e l department of the treasury i n t e r n a l r e v e n u e s e r v i c e w a s h i n g t o n d c date number release date cc tege eb qp4 conex-138102-17 -------------- ------------------ uil the honorable scott perry member u s house of representative sec_2209 east market street york pa attention dear representative perry i am responding to your email dated date on behalf of your constituent -- ------------ who asked why he could not get a distribution from hi sec_401 plan to pay off his daughter’s college student loans sec_401 plans are employer-sponsored retirement plans that provide a means for employees to contribute part of their pay towards their retirement to help ensure funds in the plan are available at retirement sec_401 of the internal_revenue_code code prohibits early_withdrawals from the plan however sec_401 of the code permit sec_401 plans to make distributions to employees in cases of hardship regulations under sec_401 provide that a hardship_distribution can only be made if the employee has an immediate and heavy financial need and a distribution is necessary to satisfy that financial need under the regulations a 401_k_plan can make a hardship_distribution to an employee if it is for payment of tuition related educational fees and room and board expenses for up to the next months of post-secondary education in case paying off student loans would not qualify because it is not payment for the next months of post-secondary education while we cannot give individual tax_advice as an alternative to taking a distribution from a 401_k_plan a participant may be able to get a loan from the plan unlike a distribution a loan would be tax-free and a participant could have up to five years to repay it ------------- conex-138102-17 at ------------------ i hope this information is helpful if you have additional questions please call me or ----- --------------------- victoria a judson associate chief_counsel tax exempt and government entities sincerely


department of the treasury internal_revenue_service washington d c 2v1451068 tax exempt and government entities sep uniform issue list tep nato legend taxpayer a ira x ira y amount a amount b amount c financial_institution a individual a dear this is in response to your request dated date as supplemented by correspondence dated date in which you request a waiver of the day rollover requirement contained in sec_408 of the internal_revenue_code the code’ the following facts and representations have been submitted under penalty of perjury in support of the ruling requested taxpayer a represents that he received a distribution on date from ira x of amount a and a distribution on date from ira y of amount b taxpayer a asserts that his failure to accomplish rollovers of amount a and amount b within the 60-day periods prescribed by sec_408 of the code was due to an error committed by financial_institution a that was not discovered until after the 60-day period had expired taxpayer a represents that it has been his practice for more than10 years to move his ira funds to banks which offer the best interest rates financial_institution a offered a better interest rate than he was currently receiving so taxpayer a decided to move his ira funds to financial_institution a also he indicated he wished to consolidate his iras at one bank on date taxpayer a went to financial_institution a and indicated that his intent was to open a rollover ira using amount c amount a plus amount b less cash received by taxpayer a he was referred to individual a individual a took his information and set up what taxpayer a thought was a rollover ira holding a cd for an month term one of the checks deposited clearly indicated that it was a distribution to close an ira further after making the deposit taxpayer a received a receipt with the wording cd ira for amount c the amount deposited which indicated to taxpayer a that the money was going into a cd within an ira taxpayer a did not realize amount c was not placed in an ira until date when he received a 1099-int which indicated that the funds were not in an ira but in a taxable account taxpayer a further represents that amount c has not been used for any other purpose based on the facts and representations you request a ruling that the internal_revenue_service the service waive the day rollover requirement contained in sec_408 of the code with respect to the distribution of amount c sec_408 of the code provides that except as otherwise provided in sec_408 any amount_paid or distributed out of an ira shall be included in gross_income by the payee or distributee as the case may be in the manner provided under sec_72 of the code sec_408 of the code defines and provides the rules applicable to ira_rollovers sec_408 of the code provides that sec_408 of the code does not apply to any amount_paid or distributed out of an ira to the individual for whose benefit the ira is maintained if i the entire amount received including money and any other_property is paid into an ira for the benefit of such individual not later than the day after the day on which the individual receives the payment or distribution or ii the entire amount received including money and any other_property is paid into an eligible_retirement_plan other than an ira for the benefit of such individual not later than the day after the date on which the payment or distribution is received except that the maximum amount which may be paid into such plan may not exceed the portion of the amount received which is includible in gross_income determined without regard to sec_408 sec_408 of the code provides that sec_408 does not apply to any amount described in sec_408 received by an individual from an ira if at any time during the 1-year period ending on the day of such receipt such individual received any other amount described in sec_408 from an ira which was not includible in gross_income because of the application of sec_408 sec_408 of the code provides a similar 60-day rollover period for partial rollovers sec_408 of the code provides that the rollover provisions of sec_408 do not apply to any amount required to be distributed under sec_408 sec_408 of the code provides that the secretary may waive the 60-day requirement under sec_408 and sec_408 of the code where the failure to waive such requirement would be against equity or good conscience including casualty disaster or other events beyond the reasonable control of the individual subject_to such requirement revproc_2003_16 2003_4_irb_359 date provides that in determining whether to grant a waiver of the 60-day rollover requirement pursuant to sec_408 the service will consider all relevant facts and circumstances including errors committed by a financial_institution inability to complete a rollover due to death disability hospitalization incarceration restrictions imposed by a foreign_country or postal error the use of the amount distributed for example in the case of payment by check whether the check was cashed and the time elapsed since the distribution occurred the information presented and documentation submitted by taxpayer a is consistent with his assertion that his failure to accomplish a timely rollover was caused by an error committed by financial_institution a therefore pursuant to sec_408 of the code the service hereby waives the 60-day rollover requirement with respect to the distribution of amount c taxpayer a is granted a period of days from the issuance of this ruling letter to contribute amount c requirements of sec_408 of the code except the 60-day requirement are met with respect to such contribution amount c will be considered a rollover_contribution within the meaning of sec_408 of the code into a rollover ira provided all other this ruling does not authorize the rollover of amounts that are required to be distributed by sec_401 of the code no opinion is expressed as to the tax treatment of the transaction described herein under the provisions of any other section of either the code or regulations which may be applicable thereto this letter is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent if you wish to inquire about this ruling please contact please address all correspondence to se t ep ra t2 ine manager lans technical group enclosures deleted copy of ruling letter notice of intention to disclose


internal_revenue_service number release date index number -------------------- -------------------------- -------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------------- id no ------------- telephone number --------------------- refer reply to cc psi b01 plr-110138-11 date date legend x -------------------------------------------------- ------------------------------- country d --------- ------------------------- dear ------------ this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting that the service grant x an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_301_7701-3 to be treated as a disregarded_entity for federal tax purposes facts according to the information submitted x was formed under the laws of country on d x intended to elect be treated as a disregarded_entity for federal tax purposes effective d however x inadvertently failed to timely file form_8832 entity classification election to elect to be treated as a disregarded_entity for federal tax purposes law and analysis sec_301_7701-3 provides in part that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes an eligible_entity with at least two members can elect to be classified as either an association or a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner plr-110138-11 sec_301_7701-3 provides guidance on the classification of a foreign eligible_entity for federal tax purposes generally a foreign eligible_entity is treated as an association if all members have limited_liability unless the entity makes an election to be treated otherwise a foreign eligible_entity with a single member having limited_liability may elect to be treated as a disregarded_entity pursuant to the rules of sec_301_7701-3 sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to days prior to the date the form is filed or up to months after the date the form is filed sec_301_7701-3 provides that such an election must be signed by either a each member of the electing entity who is an owner at the time the election is filed or b any officer manager or member of the electing entity who is authorized under local law or the entity’s organization documents to make the election and who represents to having such authorization under penalties of perjury sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than 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 defines the term regulatory election as an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make the election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 under sec_301_9100-3 a request for relief will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and granting relief will not prejudice the interests of the government conclusion based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to file a form_8832 with the appropriate service_center to elect to be treated as a disregarded_entity for federal tax purposes effective d a copy of this letter should be attached to the form_8832 a copy is enclosed for that purpose plr-110138-11 this ruling is contingent on the owner of x filing within days of this letter all required returns for all open years consistent with the requested relief these returns may include but are not limited to the following forms i forms information_return of u s persons with respect to certain foreign_corporations ii forms return of u s persons with respect to certain foreign_partnerships and iii forms information_return of u s persons with respect to disregarded entities such that these forms reflect the consequences of the relief granted in this letter a copy of this letter should be attached to any such returns except as specifically set forth above 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 requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to x's authorized representative sincerely david r haglund david r haglund chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes 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 intl b05 plr-121796-14 date date ------------------- --------------------------------------------------------------- ------------------------------------------------- -------- -------------------------------------- a cfc country a ---------- parent x agency country b ---------- country c ------------- country d ------ country e --------- country f ------------------ country g ---------- country h ------------------------------------------------------------------------ month y ------------------- dear ---------------------- in a letter dated a you requested rulings allowing cfc to use certain foreign statement insurance reserves in computing its taxable_income on grounds that these insurance reserves are an appropriate means of measuring income within the meaning of sec_954 specifically you requested permission to use the underwriting reserves and loss_reserves for life and annuity_contracts reported by cfc on its country a annual return and the underwriting reserves and loss_reserves for noncancellable and guaranteed renewable accident and health contracts reported by cfc on its country a annual return plr-121796-14 - - the rulings given in this letter are based on facts and representations submitted by parent and cfc and accompanied by a statement executed under penalty of perjury by an appropriate party this office has not verified any of the materials submitted in support of the request for rulings verification of the information representations and other data may be required as part of the audit process facts parent is a publicly-traded domestic_corporation that is engaged through its subsidiaries in various lines of business which primarily include domestic and international reinsurance of life and annuity_contracts parent conducts certain foreign operations through a country a subsidiary cfc parent owns x of cfc cfc was formed under the laws of country a and is engaged in the business of reinsuring life_insurance contracts annuity_contracts and accident and health contracts through country a and several branch operations located in country b country c country d country e country f country g and country h cfc is a controlled_foreign_corporation as defined in sec_957 country a regulates any insurance_business conducted in country a through its insurance laws and regulations a government body the agency is responsible for enforcing insurance laws and regulations in country a an insurance_company must obtain a license from the agency to conduct an insurance_business in country a cfc is licensed by the agency to reinsure persons other than related_persons in country a cfc also reinsures risks through its various branches cfc and its branches do not carry on any business other than the reinsurance of life_insurance contracts annuities accident_and_health_insurance contracts and other similar and ancillary activities cfc and its branches derive more than percent of its aggregate net written premiums from the reinsurance of contracts covering the applicable_home_country_risks of the branches and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in sec_954 cfc does not carry on non-life insurance businesses except for certain activities which are incidental to the life_insurance business or which are otherwise immaterial to its insurance_business parent has represented that cfc would be subject_to tax under subchapter_l if it were a domestic_corporation each branch of cfc is a separate and clearly identified unit of the reinsurance business of cfc and maintains separate books_and_records each branch is authorized or licensed by the applicable_insurance_regulatory_body for its home_country to sell reinsurance to persons other than related_persons as defined in sec_954 each branch’s financial position is overseen by the agency plr-121796-14 - - the branches and the country a home_office of cfc reinsure contracts that are regulated as life_insurance and annuity_contracts by the agency the branches and the home_office also reinsure health and personal accident insurance contracts that are noncancellable or guaranteed renewable cancellable or are riders to a life_insurance_contract cfc holds reserves with respect to such noncancellable health and personal accident insurance contracts which cfc treats as life_insurance_reserves cfc does not receive premiums from any insurance_contract in connection with the life or health of a resident_of_the_united_states or from a related_party as defined under sec_953 each branch with the exception of the country c branch derived more than of its net written premiums from contracts that cover home_country risks with respect to which no policyholder insured annuitant or beneficiary is a related_person within the meaning of sec_953 each branch and the country a home_office conducts with respect to contracts which cover risks other than applicable_home_country_risks as defined in sec_953 substantially_all the activities necessary for the generation of income with respect to each branch’s reinsurance business including client relationship management negotiating terms of reinsurance contracts with clients providing underwriting and claims management services including technological solutions actuarial assistance and e-underwriting tools actuarial pricing for risk assessment account administration providing product development and advice on financial needs including funding and financial products and providing related_services to clients as required by country a’s insurance laws and regulations for insurers engaged in the reinsurance business cfc files an annual return and financial statements annual return with the agency the annual return of cfc is audited by an outside accounting auditor in addition to the company’s auditor the accounting_records of cfc that form the basis for preparing the annual return are subject_to inspection by the agency at any time the annual return of cfc is made available to the public cfc's annual return is used for financial purposes in addition to regulatory purposes such as for credit rating purposes month y is the official year-end for life_insurance_companies operating in country a cfc has appointed a qualified actuary to be involved in matters prescribed by the agency as actuarial matters including the method of calculating reserves the actuary must submit a written opinion to the agency indicating whether the reserves relating to the insurance contracts prescribed by the agency are established and maintained according to actuarial soundness cfc is also subject_to solvency requirements which require a risk-based level of regulatory capital targeting an optimal capital level over and above the prudent reserve estimate plr-121796-14 - - to comply with country a’s insurance laws and regulations for reinsurance companies cfc must establish and maintain certain reserves these reserves are underwriting reserves including reserves for variable_contracts and loss_reserves that the branches maintain on their books for life_insurance and annuity_contracts the rules for calculating these reserves are prescribed by insurance laws regulations and other agency guidance and are summarized below underwriting reserves must be held to secure the performance of future obligations arising in the future from insurance contracts the underwriting reserves consist of the present_value of future_benefits plus future expenses minus the present_value of future gross contract premiums under current interest mortality morbidity and lapse assumptions with provision for moderate adverse deviation this method is commonly referred to as the gross premium valuation method gpv the default basis for reporting financial information to the agency is country a generally_accepted_accounting_principles which do not prescribe a particular insurance reserve methodology parent represents that the gpv method is commonly used in country a the branches may also hold loss_reserves for outstanding claims including claims that may have been incurred but not reported from life_insurance and annuity_contracts reinsured by cfc cfc calculates loss_reserves using a combination of known reported claims plus estimates based on each branch’s individual loss experience and general local country industry experience cfc represents that neither cfc nor its branches carry on reinsurance business other than certain businesses which are incidental to the reinsurance of life_insurance contracts annuity_contracts and accident_and_health_insurance contracts any difference in the methods under country a law used to calculate the reserves related to an insurance_policy issued by the branches as compared to the methods used to calculate such reserves for the same insurance_policy under subchapter_l if the branches were u s insurance_companies would not cause a material difference in the measurement of cfc’s income during the life of such policy and the foreign reserve_method used to calculate the branches’ underwriting reserves and loss_reserves are not contrary to the rules and principles applicable to the calculation of reserves under subchapter_l as modified by sec_954 law in general a united_states_shareholder of a controlled_foreign_corporation cfc must include in gross_income its pro_rata share of the cfc’s subpart_f_income for each year sec_951 subpart_f_income includes among other types of income insurance_income under sec_953 and foreign_base_company_income under sec_954 sec_952 and sec_953 defines the term_insurance income to plr-121796-14 - - include any income which is attributable to issuing or reinsuring of an insurance_or_annuity_contract and which would be taxed under subchapter_l if such income were the income of a domestic insurance_company sec_953 provides that sec_953 insurance_income does not include exempt_insurance_income derived by a qualifying_insurance_company sec_953 provides that reserves for any insurance_or_annuity_contract shall be determined in the same manner as under sec_954 sec_954 defines the term foreign_base_company_income to include among other types of income foreign_personal_holding_company_income sec_954 sets forth the types of income eg interest and dividends that are considered to be foreign_personal_holding_company_income sec_954 provides that for purposes of sec_954 foreign_personal_holding_company_income does not include qualified_insurance_income of a qualifying_insurance_company in general sec_953 defines a qualifying_insurance_company as any controlled_foreign_corporation which a is subject_to regulation as an insurance_company by its home_country and is licensed authorized or regulated by the applicable_insurance_regulatory_body for its home_country to sell insurance or annuity_contracts to persons other than related_persons within the meaning of code sec_954 in such home_country b derives more than percent of its aggregate net written premiums from the issuance by such controlled_foreign_corporation of contracts covering applicable_home_country_risks of such corporation and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in code sec_954 and c is engaged in the insurance_business and would be subject_to tax under subchapter_l if it were a domestic_corporation sec_953 defines a qualified_insurance_company branch as a qualified_business_unit within the meaning of sec_989 of a controlled_foreign_corporation if a the unit is licensed authorized or regulated by the applicable_insurance_regulatory_body for its home_country to sell insurance reinsurance or annuity_contracts to persons other than related_persons in such home_country and b such cfc is a qualifying_insurance_company as defined in sec_953 as if such unit were a qualifying_insurance_company_branch plr-121796-14 - - sec_954 defines the term qualified_insurance_income to mean income of a qualifying_insurance_company falling into two categories first income received from unrelated persons and derived from investments made by a qualifying_insurance_company or qualifying_insurance_company_branch collectively referred to as a qic either of its reserves allocable to exempt contracts or of percent of its unearned premiums from exempt contracts as both are determined in accordance with sec_954 sec_954 second income received from unrelated persons and derived from investments made by a qic of an amount of its assets allocable to exempt contracts equal to in the case of property casualty or health insurance contracts one-third of the premiums earned on those contracts during such year and in the case of life_insurance or annuity_contracts percent of the reserves described in sec_954 for such contracts sec_954 exempt contracts are defined under sec_953 to include insurance or annuity_contracts issued by a qualifying_insurance_company in connection with the lives or health of residents of a country other than the u s but only if such company derives more than percent of its net written premiums from otherwise exempt contracts which cover applicable_home_country_risks and with respect to which no policyholder insured annuitant or beneficiary is a related_person within the meaning of sec_954 a contract issued by a qic or qic branch which covers risks other than applicable_home_country_risks is not treated as an exempt_contract unless such company or branch conducts substantial activity with respect to an insurance_business in its home_country and performs in its home_country substantially_all of the activities necessary to give rise to the income generated by such contract sec_953 sec_954 generally provides that in the case of life_insurance and annuity_contracts a qic’s reserves allocable to exempt contracts are equal to the greater of the net_surrender_value of the contract or the reserve determined under sec_954 sec_954 however provides the amount of the reserves under code sec_954 shall be the foreign statement reserve for the contract less any catastrophe deficiency equalization or similar reserves if pursuant to a ruling_request submitted by the taxpayer or as provided in published guidance the secretary determines that the factors taken into account in determining the foreign statement reserve provide an appropriate means of measuring income code sec_954 was enacted by sec_614 of the job creation and worker assistance act of the staff of the joint_committee on taxation explains this provision as follows plr-121796-14 - - the provision does however permit a taxpayer in certain circumstances subject_to approval by the irs through the ruling process or in published guidance to establish that the reserve for such contracts is the amount taken into account in determining the foreign statement reserve for the contract reduced by catastrophe equalization or deficiency reserve or any similar reserve irs approval is to be based on whether the method the interest rate the mortality and morbidity assumptions and any other factors taken into account in determining foreign statement reserves taken together or separately provide an appropriate means of measuring income for federal_income_tax purposes in seeking a ruling the taxpayer is required to provide the irs with necessary and appropriate information as to the method interest rate mortality and morbidity assumptions and other assumptions under the foreign reserve rules so that a comparison can be made to the reserve amount determined by applying the tax_reserve_method that would apply if the qualifying_insurance_company were subject_to tax under subchapter_l of the code with the modifications provided under present law for purposes of these exceptions the irs also may issue published guidance indicating its approval staff of the joint comm on taxation technical explanation of the job creation and worker assistance act of jcx-12-02 date sec_953 and sec_954 do not define the terms life_insurance or annuity_contract or property casualty or health contract sec_953 generally provides that for purposes of sec_953 and sec_954 the determination of whether a contract issued by a cfc is a life_insurance or annuity_contract shall be made without regard to sec_7702 if such contract is regulated as a life_insurance or annuity_contract by the corporation’s home_country and no policyholder insured annuitant or beneficiary with respect to the contract is a united_states_person sec_816 of the internal_revenue_code the code defines life_insurance_company as an insurance_company which is engaged in the business of issuing life_insurance and annuity_contracts or noncancellable contracts of health and accident insurance if- its life_insurance_reserves plus plr-121796-14 - - unearned premiums and unpaid_losses whether or not ascertained on noncancellable life accident or health policies not included in life_insurance_reserves comprise more than percent of its total_reserves sec_816 defines the term life_insurance_reserves for purposes of part i of subchapter_l of the code as amounts a which are computed on the basis of recognized mortality or morbidity tables and assumed rates of interest and b which are set_aside to mature or liquidate either by payment or reinsurance future unaccrued claims arising from life_insurance annuity and noncancellable accident_and_health_insurance contracts including life_insurance or annuity_contracts combined with noncancellable accident_and_health_insurance involving at the time with respect to which the reserve is computed life accident or health contingencies analysis cfc is subject_to regulation as a reinsurer of life_insurance annuities and noncancellable accident and health contracts by country a cfc is licensed authorized and regulated by the agency which is the insurance regulatory body for country a to sell life_insurance and annuity_contracts to persons other than related_persons within the meaning of code sec_954 in country a cfc has represented that it derives more than percent of its aggregate net written premiums from its issuance of life_insurance and annuity_contracts covering risks in connection with the lives or health of residents of country a and with respect to which no policyholder insured annuitant or beneficiary is a related_person as defined in code sec_954 each of the branches is a qualified_business_unit within the meaning of sec_989 of cfc each branch is authorized or licensed by the applicable_insurance_regulatory_body for its home_country to sell reinsurance to persons other than related_persons within the meaning of sec_954 in such home_country premiums received by the branches are treated as earned in its home_country for the purpose of each home country’s tax laws finally cfc is engaged in the life_insurance business and would be subject_to tax under subchapter_l if it was a domestic_corporation accordingly cfc is a qic and the branches are qualifying_insurance_company branches plr-121796-14 the branches primarily reinsure life_insurance and annuity_contracts in connection with the lives and health of residents of their countries and do not reinsure risks on the lives or health of residents of the united_states with the exception of the country c branch each branch derives more than of its net written premiums from contracts that cover home_country risks with respect to which no policyholder insured annuitant or beneficiary is a related_person within the meaning of sec_954 each branch performs in its home_country substantial insurance_business activity and with respect to contracts which cover risks other than applicable_home_country_risks as defined in sec_953 substantially_all the activities necessary to give rise to the income generated by such contract therefore life_insurance and annuity_contracts issued by cfc with the exception of contracts issued by the country c branch and the country a home_office are exempt contracts within the meaning of sec_953 cfc uses the gpv method to determine its underwriting and loss_reserves because this method is a reasonable method for computing reserves the foreign statement reserves are an appropriate means of measuring income within the meaning of sec_954 cfc issues noncancellable and guaranteed renewable contracts and riders to life_insurance contracts as part of its life_insurance business for country a tax and insurance regulatory purposes cfc computes the underwriting reserves and loss_reserves using a methodology similar to that used to compute life_insurance_reserves therefore the foreign statement underwriting reserves and loss_reserves are also an appropriate means of measuring income within the meaning of sec_954 based on the information submitted and the representations made we rule as follows ruling sec_1 the foreign statement underwriting reserves and loss_reserves which are required by the agency to be maintained for the reinsurance of life_insurance and annuity_contracts are an appropriate means of measuring income within the meaning of sec_954 the foreign statement underwriting reserves and loss_reserves for noncancellable and guaranteed renewable accident and health contracts reinsured by cfc as required to be reported on the country a annual return are an appropriate means of measuring income within the meaning of sec_954 caveats we express no opinion on any provisions of the code or regulations not specifically covered by the above ruling this ruling will be subject_to revocation if any of the following circumstances occurs a change in the material facts on which this plr-121796-14 ruling was based a material_change in the business circumstances of cfc which would impact its reserving method or a change in the applicable law or foreign rules relating to cfc’s current reserving method procedural statements this ruling is directed only to parent and cfc 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 parent should attach a copy of this ruling letter to its federal_income_tax return for the taxable years to which this letter applies in accordance with the power_of_attorney on file in this office a copy of this letter is being sent to your authorized representatives by sincerely steven musher associate chief_counsel international steven d jensen senior counsel branch international


internal_revenue_service p o box cincinnati oh number release date department of the treasury employer_identification_number contact person - id number date contact telephone number ull legend x name of program c quantity x dollars amount y dollars amount dear you asked for advance approval of your educational grant procedures under sec_4945 this approval is required because you are a private_foundation that is exempt from federal_income_tax our determination we approved your procedures for awarding educational grants based on the information you submitted and assuming you will conduct your program as proposed we determined that your procedures for awarding educational grants meet the requirements of code sec_4945 as a result expenditures you make under these procedures will not be taxable description of your request your letter indicates that you will operate an educational grant program called x your purpose is to highlight and help facilitate the power of photography influencing the world and to make photography better understood utilized seen created and saved the purpose of x is to improve or enhance the artistic literary scientific or teaching capacity skill or talent in one or more photo fields defined below or assist the grantee in completing an artistic literary scientific or educational project in one or more photo fields including but not limited to photography projects exhibits or theses all such projects shall be referred to herein as photo field projects photo fields shall mean the field of photography or another field or discipline that complements or is related to the field of photography and that draws upon or contributes to the field of photography or that uses photography or photos in its activities including by way of example but not limited to visual journalism and education you intend to award c grants per year ranging from x dollars to y dollars annually the number and amount of awards may vary from year to year depending on the size and quality of the applicant pool the number of grant cycles and your overall finances since this program is a small part of your overall activities you may have one or more grant cycles per year the goal or subject matter of the grants made during the cycle may vary from one cycle to another each grant cycle will be announced on your website the announcement will explain the project goals subject matter and the deadline for the specific grant cycle you will publicize x on your website and through a variety of other outlets such as universities photography schools print electronic media and notices in relevant magazines and newsletters in order to be eligible for a grant a candidate must be a photographer writer scientist or other professional whether emerging or established or a teacher or student in each case working practicing teaching or studying in one or more photo fields agree to use the grant in creating a photo field project for public presentation or attending conferences workshops seminars and similar events for the purpose of improving or enhancing the candidates artistic literary scientific or teaching capacity skill or talent in one or more photo fields not be an employee of yours or a disqualified_person submit a completed grant application including a personal statement describing the goals and proposed uses of the grant recipients will be determined by a selection committee and will consist of members as determined by your board no committee member shall derive directly or indirectly any private benefit as a result of any award of any grant any committee member who foresees a potential benefit shall immediately notify you and abstain from the selection process any committee member who fails to follow this protocol will be removed from the letter catalog number 58222y committee family members of committee members are not eligible for your grants the selection committee will screen all candidates candidates passing the screening process may be interviewed by your selection committee your selection committee will make its recommendations to your board_of directors and the board will select one or more grantees from among the applicants recommended 'by the selection committee using the following criteria the candidate's artistic literary scientific or teaching capacity skill or talent the candidates vision for the grant and ability to carry out the proposed photo field project including the quality and clarity of the applicant's proposed plans the appropriateness of the budget submitted for the proposed project and the completeness of the application package including all narratives work samples if any and support material and the potential impact of the proposed project including enhancing public knowledge understanding and appreciation of one or more photo fields and or the applicants skill as a photographer writer scientist other professional teacher or student and the potential to contribute work of artistic literary scientific or educational value to one or more photo fields all award decisions will be made on an objective and nondiscriminatory basis you will specify the terms and conditions of each grant in a letter sent to each grantee notifying him or her of the grant award you will not disburse grant proceeds until the grantee accepts your grant terms and conditions in writing these terms and conditions include the grant's specific purpose project duration the total grant amount the requirement for narrative reports and the due dates for such reports and the requirement for maintaining records of receipts and expenditures and for making such records available to you you will obtain from each grantee annual reports and a final report describing the use of the grant proceeds and the progress made by the grantee toward achieving the grants purpose grantees will prepare the required reports as of december 31st of the year which the grant or any portion thereof is received and all such subsequent years until the grant proceeds are expended in full or the grant is otherwise terminated the reports will be provided to you no later than january 31st of the following year letter catalog number 58222y you will monitor the progress of each grantee review each report submitted and investigate actual or apparent deviations from the grants terms and conditions the results of all investigations shall be documented and reported to your board where reports to you or other information including failure to submit reports when due indicate that all or part of the grant proceeds are not being used for the grants intended purpose you shall initiate an investigation while conducting the investigation you shall withhold any additional disbursements until a determination is made that no part of the grant is being used for improper purposes and or delinquent reports have been submitted if you determine that grant funds have been used for improper purposes you will request that the funds be returned to you you will document and maintain records of the result of such investigation you will retain the following records information evaluating the qualifications of grant applicants written records identifying all applicants and grantees by name the amount and purpose of each grant and all grantee reports and other follow-up data obtained in the awarding and administration of your grants basis for our determination the law imposes certain excise_taxes on the taxable_expenditures of private_foundations code sec_4945 a taxable_expenditure is any amount a private_foundation pays as a grant to an individual for travel study or other similar purposes however a grant that meets all of the following requirements of code sec_4945 is not a taxable_expenditure the foundation awards the grant on an objective and nondiscriminatory basis the irs approves in advance the procedure for awarding the grant the grant is - a scholarship or fellowship subject_to sec_117 and is to be used for study at an educational_organization described in sec_170 or - a prize or award subject_to the provisions of sec_74 if the recipient of the prize or award is selected from the general_public or - to achieve a specific objective produce a report or similar product or improve or enhance a literary artistic musical scientific teaching or other similar skill or talent of the recipient letter catalog number 58222y to receive approval of its educational grant procedures sec_53_4945-4 requires that a private_foundation show the grant procedure includes an objective and nondiscriminatory selection process the grant procedure results in the recipients performing the activities the grants were intended to finance the foundation plans to obtain reports to determine whether the recipients have performed the activities that the grants were intended to finance other conditions that apply to this determination this determination covers only the grant loan program described above this approval will apply to succeeding grant loan programs only if their standards and procedures don't differ significantly from those described in your original request this determination applies only to you it may not be cited as precedent you cannot rely on the conclusions in this letter if the facts you provided have changed substantially you must report any significant changes in your program to the cincinnati office of exempt_organizations at internal_revenue_service exempt_organizations determinations p o box cincinnati oh you cannot make grantslloans to your creators officers directors trustees foundation managers or members of selection committees or their relatives all funds distributed to individuals must be made on a charitable basis and must further the purposes of your organization you cannot award grants for a purpose that is inconsistent with code sec_170 b you should keep adequate_records and case histories so that you can substantiate your grant loan distributions with the irs if necessary we've sent a copy of this letter to your representative as indicated in your power_of_attorney letter catalog number 58222y please keep a copy of this letter in your records if you have any questions please contact the person listed at the top of this letter sincerely director exempt_organizations letter catalog number 58222y