department of the treasury internal_revenue_service p o box irs cincinnati oh number release date date date employer id number contact person id number contact telephone number form you must file tax years uil dear this letter is our final_determination that you don’t qualify for tax-exempt status under sec_501 of the internal_revenue_code the code recently we sent you a proposed adverse determination in response to your application the proposed adverse determination explained the facts law and basis for our conclusion and it gave you days to file a protest because we didn’t receive a protest within the required days the proposed determination is now final because you don’t qualify as a tax-exempt_organization under sec_501 of the code donors can’t deduct contributions to you under sec_170 of the code you must file federal_income_tax returns for the tax years listed at the top of this letter using the required form also listed at the top of this letter within days of this letter unless you request an extension of time to file we’ll make this final adverse determination_letter and the proposed adverse determination_letter available for public inspection as required under sec_6110 of the code after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions follow the instructions in the notice on how to notify us if you agree with our deletions you don’t need to take any further action we'll also notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed determination_letter under sec_6104 of the code you should contact your state officials if you have questions about how this determination will affect your state responsibilities and requirements letter rev catalog number 47632s if you have questions about this letter you can contact the person listed at the top of this letter if you have questions about your federal_income_tax status and responsibilities call our customer service number pincite-829-1040 tty for deaf or hard of hearing or customer service for businesses pincite-829-4933 sincerely stephen a martin director exempt_organizations rulings and agreements enclosures notice redacted letter proposed adverse determination under sec_501 redacted letter final adverse determination under sec_501 - no protest letter rev catalog number 47632s department of the treasury internal_revenue_service cincinnati oh legend date date employer id number contact person id number contact telephone number contact fax number uil state n date p q gallery r date s t v website w board members city area l l l i number of working members number of consignment members percent commission xx y zz dear we considered your application_for recognition of exemption from federal_income_tax under sec_501 of the internal_revenue_code the code based on the information provided we determined that you don’t qualify for exemption under sec_501 of the code this letter explains the basis for our conclusion please keep it for your records issue do you qualify for exemption under sec_501 of the code no for the reasons stated below facts you incorporated on date n in the state of p as a nonprofit corporation prior to this date you operated as a for- profit called q on date r q conveyed all of its assets and liabilities to you as the nonprofit corporation and filed articles of dissolution with the state of p according to your articles you are organized and operated exclusively for charitable education and scientific purposes including for such purposes the making of distributions to organizations that qualify as exempt letter rev catalog number 47630w organizations under sec_501 of the internal_revenue_code of or the corresponding provision of any future united_states internal revenue law your articles further state that you are an evolving collective of local creatives exhibiting and inspiring artistic expression for the aesthetic enrichment of s and our global community your purpose is to provide gallery space to member and consignment artists to display promote and sell their works fostering public exposure to the arts for s and the t region of southern p membership is open to all artists living within approximately miles of s who are actively engaged in creating and producing artwork your bylaws indicate you have two types of members working members and consignment members working membership is for practicing artists who are actively engaged in the management and operation of the gallery working members numbering x are expected to provide high quality original work for exhibition display in the gallery and shall be willing and able to tend the gallery as a shopkeeper for the number of days designated in the gallery’s policies and procedure sec_2 must be a member of at least one of the gallery’s committee sec_3 may display works in the gallery after a jurying process according to the gallery’s policies and procedure sec_4 may individually sell their works at the gallery under terms established in the policies and procedures paying to the gallery a uniform and reasonable sales commission determined annually by the board_of directors in order to support the nonprofit purposes and mission of the gallery shall have voting privileges at all gallery meetings with one vote per working member they shall participate in gallery shows and special events and in related activities of the gallery and shall be required to attend at least two quarterly membership meeting sec_5 consignment membership is for practicing artists or persons wishing to be affiliated with the gallery but who cannot or do not wish to meet the requirements of a working member consignment members of which there are y in number do not have voting privileges and may display their work after a jurying process but do not serve on committees or attend meeting sec_2 may individually sell their works at the gallery under terms established in the policies and procedures paying to the gallery a uniform and reasonable sales commission determined annually by the board_of directors in order to support the nonprofit purposes and mission of the gallery article vii sec_3 of your bylaws states your 7-member board_of directors shall be elected by your voting members at your annual meeting you provide a space where local artists and artisans show their work collaborate with each other and sell their creations to the general_public you state that membership is growing and the space has become a central hub letter rev catalog number 47630w for creative activity the shared space is run like an association or a cooperative with everything being done by volunteers with a part time bookkeeper being the only regularly paid person the gallery provides space a central networking hub and a facility in which your working and consignment members can exhibit and sell their artwork the gallery itself is owned by two individuals unrelated to you you do not purchase any artwork or art products but simply provide a holding place for them on behalf of your artist members and consignment members in addition to exhibition space you provide advertising shop- keeping services and gallery-based marketing and sales service to the collective group of working members and consignment members of the gallery activities at the gallery include featuring local musicians and poets at community and gallery-based events supporting k-12 artists through visiting artist programs in the local school district teacher trainings and mentoring hosting art-centered activities for holidays such as halloween and the 4th of july holding open house artist receptions at the gallery throughout the year and participating in activities sponsored by the s creative district commissions from art sales fund all activities you are preparing to more actively collaborate with s’s creative district to build your financial capacity to begin to pay for shop-keeping work by your members to eventually hire an executive director and to capitalize the long-awaited expansion of the gallery to accommodate your growing schedule of events and activities you intend to create more display space and more studio and workshop space with perhaps the development of a fine art gallery annex the gallery is staffed with volunteer working members who promote inform educate and otherwise encourage visitors to the gallery to purchase the artworks of its working members and consignment members these members are not only exhibiting artists but they may also be heads of committees directors on the board and or officers of the gallery the gallery’s policies and procedures and the contract it signs with exhibiting artists establish the terms between the gallery and its members ensuring that the jurying system the selling_price terms of the sale and the percentage of the commission paid to the gallery conform to the terms of the conflict of interest policy working members may individually sell their works at the gallery under terms established in the policies and procedures paying to the gallery a uniform and reasonable sales commission determined annually by the board_of directors in order to support the nonprofit purposes and mission of the gallery you provided a copy of your member contract which establishes the terms between the gallery cooperatively run by the participating artists and the artists whose works are displayed for sale to the public the contract provides that the gallery sets a z percent commission on all works for sale to be deducted from the original price set by the artist your website v provides links to various artists’ websites whose artwork is displayed at the gallery the artists whose work you promote include w members of your board_of directors according to your financial information you were exclusively funded by item sales and a small amount of investment_income in your first year of operations as a nonprofit corporation while you have budgeted grants and donations in future years a substantial amount of your revenue will continue to be derived from sales income letter rev catalog number 47630w law sec_501 of the code provides for exemption from federal_income_tax of organizations organized and operated exclusively for educational_purposes sec_1_501_c_3_-1 states that to be tax exempt an organization must be both organized and operated exclusively for one or more exempt purposes specified in sec_501 of the code if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1_501_c_3_-1 asserts an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 an organization will not be so regarded if more than an insubstantial part of its activities are not in furtherance of exempt purposes sec_1_501_c_3_-1 provides that an organization is not operated exclusively for exempt purposes if its net_earnings inure in whole or in part to the benefit of private shareholders or individuals sec_1_501_a_-1 defines a private_shareholder_or_individual as persons having a personal and private interest in the activities of an organization sec_1_501_c_3_-1 provides that an organization is not organized or operated exclusively for exempt purposes under sec_501 of the code unless it serves a public rather than a private interest thus it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals the creator or his family shareholders of the organization or persons controlled directly or indirectly by such private interests sec_1_501_c_3_-1 provides examples to illustrate the requirement of paragraph d 1i of this section that an organization serve a public rather than a private interest example states i o is an art museum o's principal activity is exhibiting art created by a group of unknown but promising local artists o's activity including organized tours of its art collection promotes the arts o is governed by a board_of trustees unrelated to the artists whose work o exhibits all of the art exhibited is offered for sale at prices set by the artist each artist whose work is exhibited has a consignment arrangement with o under this arrangement when art is sold the museum retains percent of the selling_price to cover the costs of operating the museum and gives the artist percent ii the artists in this situation directly benefit from the exhibition and sale of their art as a result the sole activity of o serves the private interests of these artists because o give sec_90 percent of the proceeds from its sole activity to the individual artists the direct benefits to the artists are substantial and o's provision of these benefits to the artists is more than incidental to its other purposes and activities this arrangement causes o to be operated for the benefit of private interests in violation of the restriction on private benefit in paragraph d ii of letter rev catalog number 47630w this section based on these facts and circumstances o is not operated exclusively for exempt purposes and therefore is not described in sec_501 revrul_66_178 1966_1_cb_138 found that a nonprofit organization created to foster and develop the arts by sponsoring a public art exhibit was exempt under sec_501 of the code the organization's sole activity was sponsoring an annual public art exhibit at which works of unknown but promising artists were displayed artists eligible to have their works displayed were those who were not affiliated with art galleries and who had no medium for exhibiting their creations the works exhibited were selected by a panel of qualified art experts the organization did not charge the artists any fees for the privilege of having their works displayed nor did the organization sell or offer the displayed works for sale revrul_71_395 c b found that a cooperative art gallery formed and operated by a group of artists for the purpose of exhibiting and selling their works did not qualify for exemption under sec_501 of the code the gallery was formed and operated by a group of approximately artists for the purposes of exhibiting and selling their works additional artists were admitted to membership by approval of the existing members the gallery was open to the public six days a week no admission was charged works of the member artists were exhibited and offered for sale a panel chosen by the members selected those works for exhibition that in its opinion meet certain minimal artistic standards special showings by individual members were also held on a rotating basis all works could be purchased by the public and many could be rented the gallery retained a commission from sales and rental sufficient to cover the cost of operating the gallery the ruling found that the gallery was a vehicle for advancing the careers of the members and for promoting the sale of their work the organization served the private purposes of its members even though exhibiting and selling the paintings may be an educational activity revrul_76_152 1976_1_cb_151 found that a nonprofit organization formed by a group of art patrons to promote community understanding of modern art trends by selecting exhibiting and selling art works of local artists and which retained ten percent commission on sales less than customary commercial charges but insufficient to cover the cost of operating the gallery did not qualify for exemption under sec_501 of the code the ruling concluded that the direct benefits to artists could not be dismissed as being merely incidental to other purposes and activities since ninety percent of all sales proceeds were turned over to the individual artists in 326_us_279 the supreme court held that the presence of a single non-exempt purpose if substantial in nature will destroy an exemption regardless of the number or importance of truly exempt purposes the court found that the trade_association had an underlying commercial motive that distinguished its educational program from that carried out by a university in 75_tc_337 the court found that an organization operating an art gallery and art market was exempt under sec_501 of the code its purpose was primarily to foster community awareness encourage appreciation of contemporary artists and provide a constant flow of art for students to study art and painting techniques the organization conducted many charitable and educational activities apart from operating the art gallery and art market including the operation of an art center which sponsored art classes quarterly at a community college offered art courses to children sponsored various art demonstrations and film series gave a series of art lectures and workshops owned a permanent art collection which it displayed and offered tours of artwork displayed at the letter rev catalog number 47630w gallery market was selected by jury procedures none of the art was by anyone on the board or officer of the petitioner and only two of over artists whose art was displayed were members of the petitioner no other art museum gallery or similar facility was available in the county or any adjacent county the organization contended that the sale of artwork in its galleries was an incidental activity but one that helped to further its exempt purposes in salvation navy v commissioner tcmemo_2002_275 the tax_court found that one of the reasons why the organization did not qualify for exemption from federal_income_tax was because it could not prove that it was not organized to serve the private interests of its founder application of law you are not described in sec_501 of the code because you are not operated exclusively for an exempt_purpose or purposes sec_1_501_c_3_-1 and because your net_earnings inure to the benefit of your members sec_1 c - c you are not described in sec_1_501_c_3_-1 because you are operating for the private interest of your artist members whose artworks you sell you are also like the organization described in example of sec_1_501_c_3_-1 providing a display and retail_space for member artists and allowing each member artist to set the sales_price selecting the works for sale and receiving a commission promotes the private interests of the artist members any education of the public by display of the artwork is secondary to the promotion of the artists by operation of the cooperative sec_1_501_c_3_-1 states that to be tax exempt an organization must be both organized and operated exclusively for one or more exempt purposes specified in sec_501 of the code you are not like the organization in revrul_66_178 the organization in that ruling conducted an annual exhibit did not sell any artworks did not have any artists affiliated in any way to any gallery and did not charge any fees for exhibition in contrast you have a gallery that is open to the public on a regular basis you are a membership_organization consisting of artists who select and sell members’ artwork in a gallery operated by you your artist members also earn commissions on works that are sold thus you are operating for the private purposes of your members unlike the organization in the ruling you are not formed primarily to further charitable or educational_purposes but are formed instead for the benefit of your members you are similar to the organization described in revrul_71_395 because you were formed by a group of artists and are operating an art gallery open to the general_public which displayed and sold members’ artwork all of your artwork is for sale and you retain a commission of the original sales_price of artwork that is sold consequently like the organization in the revenue_ruling you are a vehicle for advancing members’ careers and are promoting the sale of members' artwork this serves the private purposes of your members even though the exhibition of art may be an educational activity in other respects your activities are analogous to the organization in revrul_76_152 where a gallery that retained of sales and turned over the remainder of revenue to the artist was held to not be exempt direct benefits to artists in this case could not be dismissed as being merely incidental to any other qualifying purposes you turn z percent of your proceeds over to the artist the artists have control_over selecting works setting prices and even in the case of being a featured artist promoting select exhibits of their works any qualifying activities that may be letter rev catalog number 47630w conducted such as workshops and classes are incidental to your purpose of promoting and selling works_of_art for your member artists you are different from the organization in goldsboro art league inc unlike goldsboro your operation of the gallery and sale of artwork by member artists is a substantial portion of your activities that display and sell art works are your members even with planned additional educational activities your educational and charitable activities do not constitute exclusive activity required for sec_501 of the code in addition all artists furthermore since the individuals who will be selling and retaining any proceeds are members including your directors they are considered insiders as insiders any direct or indirect benefits derived through your operations is inurement under sec_1_501_c_3_-1 akin to better business bureau of washington d c inc v united_states you devote more than an insubstantial amount of time and activities in supporting a non-exempt purpose the sale of artworks displayed by your members and for this reason do not meet the qualifications under sec_501 of the code similar to salvation navy you have not proven you were not organized and operated to serve the private interests of your members conclusion based on the information submitted you are not operating exclusively for one or more purposes described in sec_501 of the code you serve the private interests of your members and therefore are not operated exclusively for exempt purposes in addition the private interests you serve include members of your board_of directors resulting in inurement which is prohibited under sec_501 even though some of your activities are educational you are primarily operating to benefit your member artists and therefore you are not described in sec_501 if you don’t agree you have a right to file a protest if you don’t agree with our proposed adverse determination to do so you must send a statement to us within days of the date of this letter the statement must include e e e e e your name address employer_identification_number ein and a daytime phone number acopy of this letter highlighting the findings you disagree with anexplanation of why you disagree including any supporting documents the law or authority if any you are relying on the signature of an officer director trustee or other official who is authorized to sign for the organization or your authorized representative e one of the following declarations letter rev catalog number 47630w for an officer director trustee or other official who is authorized to sign for the organization under penalties of perjury i declare that i examined this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all relevant facts and such facts are true correct and complete for authorized representatives under penalties of perjury i declare that i prepared this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all relevant facts and such facts are true correct and complete your representative attorney certified_public_accountant or other individual enrolled to practice_before_the_irs must file a form_2848 power_of_attorney and declaration of representative with us if he or she hasn’t already done so you can find more information about representation in publication practice_before_the_irs and power_of_attorney we'll review your protest statement and decide if you provided a basis for us to reconsider our determination if so we’ll continue to process your case considering the information you provided if you haven’t provided a basis for reconsideration we’ll forward your case to the office of appeals and notify you you can find more information about the role of the appeals_office in publication how to appeal an irs decision on tax- exempt status if you don’t file a protest within days you can’t seek a declaratory_judgment in court at a later date because the law requires that you use the irs administrative process first sec_7428 of the code where to send your protest please send your protest statement form_2848 if needed and any supporting documents to the applicable address u s mail street address for delivery service internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance main street room cincinnati oh you can also fax your statement and supporting documents to the fax number listed at the top of this letter if you fax your statement please contact the person listed at the top of this letter to confirm that he or she received it if you agree if you agree with our proposed adverse determination you don’t need to do anything if we don’t hear from you within days we’ll issue a final adverse determination_letter that letter will provide information on your income_tax filing_requirements letter rev catalog number 47630w you can find all forms and publications mentioned in this letter on our website at www irs gov formspubs if you have questions you can contact the person listed at the top of this letter enclosure publication sincerely stephen a martin director exempt_organizations rulings and agreements letter rev catalog number 47630w


t c summary opinion united_states tax_court deforest and rose m dorroh petitioners v commissioner of internal revenue respondent docket no 3701-01s filed date deforest and rose m dorroh pro_se gerald l brantley for respondent couvillion special_trial_judge this case was heard pursuant to sec_7463 in effect when the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority respondent determined a deficiency of dollar_figure in unless otherwise indicated section references hereafter are to the internal_revenue_code in effect for the year at issue all rule references are to the tax_court rules_of_practice and procedure petitioners' federal_income_tax for and a penalty under sec_6662 in the amount of dollar_figure the issues for decision are whether dollar_figure of a dollar_figure payment received by rose m dorroh petitioner from her former employer during is excludable from gross_income under sec_104 and whether petitioners are liable for the penalty under sec_6662 some of the facts were stipulated those facts with the annexed exhibits are so found and are incorporated herein by reference at the time the petition was filed petitioners were legal residents of san antonio texas petitioner was an employee of the defense finance and accounting service dfas an agency in the u s department of defense at the time her employment with that agency was mutually terminated during petitioner had completed at trial respondent conceded that dollar_figure representing attorney's_fees paid_by petitioner in recovering the dollar_figure is excludable from gross_income pursuant to decisions of the court_of_appeals for the fifth circuit to which this case would be appealable were it not a small_tax_case 220_f3d_353 5th cir affg in part vacating and remanding in part tcmemo_1998_362 263_f2d_119 5th cir affg in part and revg in part 28_tc_947 54_tc_742 affd 445_f2d_985 10th cir additionally petitioners conceded unreported interest_income of dollar_figure petitioners are husband and wife and filed a joint federal_income_tax return for the principal issue the dollar_figure involves only mrs dorroh approximately years_of_service as a federal employee petitioner was a data transcriber or a voucher examiner for dfas at kelly air force base at san antonio texas in essence petitioner's duties were to examine vouchers or bills submitted by commissary vendors and approve them for payment petitioner's relations with her immediate supervisors at dfas were not good during a confrontation with one of her superiors on date petitioner sustained an injury on the job when she fell injuring her head neck and back the injury was disabling and petitioner came under the care of a doctor she was unable to work for intermittent periods and qualified for worker's compensation benefits under the federal worker's compensation act petitioner however continued her work with dfas and received worker's compensation benefits when she was unable to work after her employment with dfas was mutually terminated in petitioner continued receiving worker's compensation benefits at trial petitioner had a claim pending for total and permanent disability benefits during the course of her employment petitioner filed numerous complaints within and without the chain of command in dfas complaining of various workplace conditions apparently not satisfied with whatever actions if any that were taken by dfas to address these complaints petitioner contacted a counselor with the equal employment opportunity commission eeoc at least three times during complaining that dfas had discriminated against her based on her race gender and in reprisal for having successfully prevailed against dfas in an earlier proceeding the nature of which was not explained at trial petitioner complained that as a result dfas supervisors made adverse employee reviews of her increased her workload and did not provide her office accommodations equivalent to those of other coworkers petitioner engaged the services of an attorney and an informal complaint of discrimination was filed with eeoc in this informal complaint the relief petitioner sought was a finding of discrimination a job performance evaluation of exceptional with a cash performance award and compensatory_damages of dollar_figure for discrimination in violation of the civil rights act of publaw_102_166 sec 105_stat_1071 petitioner's informal complaint did not seek any relief for physical injury or sickness or any corrective relief relating to the date incident when petitioner injured her back at work the eeoc counselor was not able to resolve informally petitioner's complaint and advised that she could file a formal complaint with eeoc petitioner through her attorney thereafter filed two formal complaints with eeoc the first in and the second in in both formal complaints petitioner alleged approximately instances or occurrences in which she was discriminated against based on race color national origin sex and reprisal for prior complaint activity neither of petitioner's formal complaints involved allegations of personal physical injuries or physical sickness after an investigation by eeoc of the first formal complaint it was determined that petitioner had established a prima facie case that dfas had discriminated against petitioner on the basis of race and reprisal before an investigation by eeoc was concluded on the second formal complaint the parties dfas and petitioner agreed to submit the case to mediation an eeoc investigator was the mediator petitioner's attorney represented petitioner in the mediation proceedings in due course a settlement agreement was reached and signed by the parties on date in the agreement petitioner agreed to resign from her employment with dfas and not seek employment with any dfas activity world wide petitioner further agreed that she would not file any suit against dfas for any violation of the civil rights act of or under any other federal or state law in connection with any of the formal and informal complaints she had filed with the eeoc against dfas in consideration for petitioner's concessions dfas agreed to pay petitioner dollar_figure agreed to various corrections to petitioner's personnel records cancellation of any pending disciplinary actions against her and give only neutral references in any future employer inquiries of petitioner dfas paid petitioner the dollar_figure during the mediation agreement listed each of the formal and informal complaints petitioner had filed with the eeoc and the agreement by its terms was for the express settlement of these complaints the agreement concluded that it represented the sum total of the provisions made by the parties with each party having had the opportunity to read and raise questions about its meaning prior to signing petitioner and her attorney signed the agreement along with a representative of dfas and the mediator the agreement makes no references to settlement of any claims by petitioner for physical injuries or sickness or emotional pain and suffering nor does the agreement make reference to petitioner's worker's compensation case and the worker's compensation benefits she was receiving at that time the agreement however includes an attachment not referenced or identified in the agreement which is a standard form 50-b u s office of personnel management entitled notification of personnel action that form lists petitioner's resignation from dfas on date which was approved by dfas on date the remarks portion of the form states i am officially resigning from federal service for medical and mental and physical trauma please see my dr statement that will officially be a part of my sf for the year dfas issued to petitioner a form_1099 for nonemployee compensation in the amount of dollar_figure representing the amount_paid by dfas pursuant to the mediation agreement petitioners did not include this payment as income on their federal_income_tax return in the notice_of_deficiency respondent determined that the dollar_figure payment constituted gross_income and further determined petitioners failed to report dollar_figure in interest_income on their federal_income_tax return as noted earlier petitioners conceded the unreported interest_income adjustment and respondent conceded that dollar_figure of the dollar_figure payment was excludable from gross_income sec_104 excludes from gross_income the amount of any damages other than punitive_damages received whether by suit or agreement and whether as lump sums or as periodic_payments on account of personal physical injuries or physical sickness sec_1_104-1 income_tax regs defines damages received as an amount received other than workmen's_compensation through prosecution of a legal suit or action based upon tort or tort type rights or through a settlement agreement entered into in lieu of such prosecution amounts are excludable from gross_income only when the underlying cause of action giving rise to the recovery is based on tort or tort type rights and the damages were received on account of personal injuries or sickness 515_us_323 where amounts are received pursuant to a settlement agreement the nature of the claim that was the actual basis for settlement controls whether such amounts are excludable under sec_104 504_us_229 determination of the nature of the claim is a factual inquiry and is generally made by reference to the settlement agreement 102_tc_116 affd in part and revd in part 70_f3d_34 5th cir w here an amount is paid in settlement of a case the critical question is in lieu of what was the settlement amount_paid 105_tc_396 affd 121_f3d_393 8th cir an important factor in determining the validity of the agreement is the intent of the payor in making the payment 349_f2d_610 10th cir affg tcmemo_1964_33 if the payor's intent cannot be clearly discerned from the settlement agreement the intent of the payor must be determined from all the facts and circumstances of the case including the complaint filed and details surrounding the litigation robinson v commissioner supra pincite although the taxpayer must show that the damages were received on account of personal injuries or sickness under the second requirement of commissioner v schleier supra subsequent to that decision congress amended sec_104 a to provide that amounts are excludable only if received on account of personal physical injuries or physical sickness sec_104 emphasis added the flush language in sec_104 further provides that emotional distress shall not be treated as a physical injury or physical sickness under sec_104 as amended and in effect for the mediation agreement pursuant to which the dollar_figure was paid to petitioner clearly was not a settlement of personal physical injuries or physical sickness the agreement is very explicit to the effect that the payment was in consideration of the resignation of petitioner as an employee of dfas and petitioner's agreement not to file suit against dfas for violations of the civil rights act of petitioner however sustained a personal injury in in the course of her employment however that injury is not addressed in the mediation agreement and moreover petitioner was otherwise compensated for that injury through worker's compensation benefits she was receiving at the time of the agreement and even at the time of trial petitioners argue that because standard form_50 is attached to the mediation agreement the language in small_business job protection act of publaw_104_ sec 110_stat_1838 effective for amounts received after date sf is part and parcel of the mediation agreement and therefore establishes that the dollar_figure represented payment for personal physical injuries the court rejects that argument the mediation agreement carefully recites the various bases upon which settlement was reached petitioner's on-the-job injury is not listed in the mediation agreement indeed if petitioner's contention is correct and the work-related injury is deemed to have been part of the mediation agreement such a conclusion could seriously impair petitioner's entitlement to worker's compensation benefits because the agreement was intended to settle all differences between the parties petitioner however at the time of trial continued pursuing her worker's compensation case on this record the court is satisfied that the dollar_figure payment to petitioner by dfas did not include any amount for physical injuries or physical suffering respondent therefore is sustained on this issue the final issue is whether petitioners are liable for the accuracy-related_penalty under sec_6662 for a substantial_understatement in tax or for negligence or disregard of rules and regulations sec_6662 provides that if it is applicable to any portion of an underpayment in taxes there shall be added as noted earlier sf in the remarks portion stated that petitioner was resigning her employment because of medical mental and physical trauma to the tax an amount equal to percent of the portion of the underpayment to which sec_6662 applies under sec_6664 however no penalty shall be imposed under sec_6662 with respect to any portion of an underpayment if it is shown that there was a reasonable_cause for the portion and that the taxpayer acted in good_faith with respect to the portion of the underpayment under sec_6662 there is a substantial_understatement_of_income_tax if the amount of the understatement exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6662 for purposes of sec_6662 understatement is defined as the excess of tax required to be shown on the return over the amount of tax that is shown on the return reduced by any rebates sec_6662 sec_6662 provides that the amount of the understatement shall be reduced by that portion of the understatement that is attributable to the tax treatment of any item by the taxpayer if there is or was substantial_authority for the treatment or any item with respect to which the relevant facts affecting the item's tax treatment are adequately disclosed in the return or in a statement attached to the return and there is reasonable basis for such treatment the tax that was required to be shown on petitioners' return based on respondent's adjustments was dollar_figure petitioners' return showed a tax of dollar_figure petitioners understated their tax by dollar_figure which clearly exceeds the greater of dollar_figure or percent of the tax required to be shown on the return ie dollar_figure it follows that petitioners' understatement_of_tax was substantial for purposes of sec_6662 the determination of whether a taxpayer acted with reasonable_cause and in good_faith depends upon the facts and circumstances of each particular case sec_1_6664-4 income_tax regs relevant factors include the taxpayer's efforts to assess his or her proper tax_liability the knowledge and experience of the taxpayer and reliance on the advice of a professional such as an accountant drummond v commissioner tcmemo_1997_71 the most important factor is the extent of the taxpayer's effort to determine the taxpayer's proper tax_liability sec_1_6664-4 income_tax regs an honest misunderstanding of fact or law that is reasonable in light of the experience knowledge and education of the taxpayer may indicate reasonable_cause and good_faith remy v commissioner the court recognizes that because of respondent's concession that dollar_figure of the dollar_figure settlement is excludable from gross_income and petitioners' concession of dollar_figure in unreported interest_income the exact amount of the understatement will be determined in the rule computation tcmemo_1997_72 petitioners did not act with reasonable_cause and in good_faith in failing to include the dfas settlement as gross_income on their return prior to filing their return petitioners through their attorney contacted dfas about the form_1099 issued by dfas requesting that it be corrected petitioners were advised in two letters from the attorney for dfas that the payment to them was not for personal injuries and could not be excluded from gross_income under sec_104 there is no showing that petitioners contacted any other professional advisors on this question they simply chose to ignore the form_1099 and did not include the payment as income on their tax_return respondent therefore is sustained on this issue reviewed and adopted as the report of the small_tax_case division decision will be entered under rule


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc dom corp plr-142942-01 date date distributing state x shareholder a employee b employee c controlled main business l m n p equipment business dear this letter responds to your letter dated date requesting rulings concerning the federal_income_tax consequences of a proposed transaction the information submitted for consideration is summarized below distributing is an accrual basis state x corporation distributing is engaged in two businesses which are main business and equipment business distributing has a single class of common_stock outstanding all of which is held by shareholder a employee b is unrelated to shareholder a employee c is the son of shareholder a plr-142942-01 employees b and c each contribute significantly to the success of main business they each possess specific work experience that is essential to main business including over years of experience in the main business industry distributing would like to provide employee b and employee c with a significant equity_interest in main business these employees presently can not afford to purchase a significant interest in distributing and desire to to be shareholders of a stand-alone corporation that is engaged solely in main business in addition transferring main business to a subsidiary would be impractical because of certain licensing and other requirements accordingly the following transaction has been proposed and partially consummated distributing has formed controlled an accrual basis state x corporation controlled has a single class of common_stock outstanding distributing will transfer to controlled its equipment business_assets and liabilities in exchange for controlled stock distributing will distribute all the controlled stock to shareholder a the distribution as soon as is reasonably convenient after the distribution and in all events within one year of the distribution employee b will purchase from distributing a significant amount of stock constituting l percent of distributing’s outstanding_stock within the same time period employee c will also purchase l percent of distributing’s outstanding_stock employee b will pay for the stock with a 5-year dollar_figurem fully recourse promissory note and dollar_figuren of cash and employee c will pay for the stock with a dollar_figurep fully recourse promissory note employees b and c will each enter into multi-year senior-position employment agreements with distributing and become members of distributing’s board_of directors it is anticipated that employees b and c will subsequently each acquire an additional l percent interest in distributing depending in part on the bonuses they earn in the course of their employment and distributing’s gross_profits distributing has submitted financial and employee information indicating that both main business and equipment business have had gross_receipts and operating_expenses representative of the active_conduct_of_a_trade_or_business for each of the past years the following representations have been made in connection with the proposed transaction a distributing controlled shareholder a employee b and employee c will each pay their own expenses in connection with the transaction b the years of financial information submitted on behalf of distributing’s plr-142942-01 main business and equipment business is representative of the corporation’s present operations and with regard to of each of these two businesses there have been no substantial operational changes since the date of the last financial statements submitted c d following the transaction distributing and controlled will each continue the active_conduct of its business independently and with its separate employees the distribution is being carried out for the purpose of enabling employees b and c to receive a significant equity_interest in main business the distribution is motivated in whole or substantial part by this corporate business_purpose e distributing is not an s_corporation within the meaning of sec_1361 and there is no plan or intention by distributing or controlled to make an s_corporation_election pursuant to sec_1362 f there is no plan or intention by shareholder a to sell exchange transfer by gift or otherwise dispose_of any of his stock in either distributing or controlled after the transaction g there is no plan or intention by either distributing or controlled directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the transaction h there is no plan or intention to liquidate either distributing or controlled to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation except in the ordinary course of business x j k the total adjusted_basis and the fair_market_value of the assets transferred to controlled by distributing will each equal or exceed the sum of the liabilities assumed by controlled within the meaning of sec_357 the liabilities of distributing assumed by controlled within the meaning of sec_357 and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets transferred although investment tax_credits were claimed with respect to certain of the properties being transferred to controlled the recapture periods for such credits have expired except with respect to one property the income_tax_liability for the taxable_year in which such investment_credit_property is transferred will be adjusted in accordance with applicable law to reflect an early disposition of the property plr-142942-01 l time of or subsequent to the transaction no intercorporate debt will exist between distributing and controlled at the m payments made in connection with any continuing transactions between distributing and controlled will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length n neither distributing nor controlled is an investment companies as defined in sec_368 and iv a the distribution is not part of a plan or series of related transactions within the meaning of sec_355 pursuant to which one or more persons will acquire directly or indirectly stock possessing percent or more of the total combined voting power of all classes of stock of either distributing or controlled or stock possessing percent or more of the total value of all classes of stock of either distributing or controlled based solely on the information submitted and the representations set forth above we hold as follows the transfer in step above by distributing to controlled of equipment business_assets in exchange for all the stock in controlled and the assumption by controlled of associated liabilities followed by the distribution in step above of all the controlled stock to shareholder a constitutes a reorganization within the meaning of sec_368 and sec_355 distributing and controlled will each be party_to_a_reorganization within the meaning of sec_368 no gain_or_loss will be recognized by distributing on the transfer of assets to controlled in exchange for all the stock of controlled and the assumption_of_liabilities sec_361 and sec_357 no gain_or_loss will be recognized by controlled on its receipt of assets in exchange for controlled stock sec_1032 controlled’s basis in the assets received from distributing will equal the basis of such assets in the hands of distributing immediately prior to the transfer sec_362 controlled’s holding_period for the assets received from distributing will include the period during which distributing held such assets sec_1223 no gain_or_loss will be recognized by distributing upon the distribution sec_361 plr-142942-01 no gain_or_loss will be recognized by and no amount will be included in the income of shareholder a upon the receipt of controlled stock in the distribution sec_355 shareholder a’s total basis in the controlled stock and the distributing stock held after the distribution will be the same as the basis of this distributing stock immediately before the distribution allocated in proportion to the relative fair market values of the controlled stock and distributing stock in accordance with sec_1_358-2 the holding_period of the controlled stock received by shareholder a will include the period during which he held the distributing stock provided that the distributing stock is a capital_asset in the hands of shareholder a on the date the distribution is consummated sec_1223 as provided in sec_312 proper allocation of earnings_and_profits between distributing and controlled will be made in accordance with sec_1_312-10 no opinion is expressed about the tax treatment of the proposed transactions under other provisions of the code and regulations or about the tax treatment of any conditions existing at the time of or effects resulting from the transaction that are not specifically covered by the above rulings this ruling is directed only to the taxpayers who requested it sec_6110 of the code provides that it may not be used or cited as precedent it is important that a copy of this letter be attached to the federal_income_tax returns of the taxpayers involved for the taxable_year in which the transactions covered by this letter are consummated sincerely yours assistant chief_counsel corporate by michael j wilder senior technician reviewer branch