internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc tege eoeg teb plr-145483-01 date date legend issuer company city state a b c d e f g h i j k l m plr-145483-01 date date date date date date date date year taxable bonds dear this responds to your request for rulings that the issuer is an instrumentality for purposes of sec_141 of the internal_revenue_code and the proposed bonds hereinafter defined will be treated as financing property used for governmental purposes under sec_103 and sec_141 facts and representations the issuer was organized for the purpose of obtaining economical reliable wholesale electric power supplies and transmission services for its members the members to fulfill this purpose the issuer purchases sells generates and transmits electricity for members provides technical services to members and serves as an information clearinghouse for members in addition the issuer also sells electricity steam and service water to certain industrial customers the non- members the issuer was formed by its members and is organized under the non-profit corporation laws of the state for the purpose of benefitting its members the issuer’s governing documents provide that membership in the issuer is limited to political subdivisions of the state or another state that own or operate a utility system electric natural_gas or communication the governing documents also provide that membership is not transferable or assignable and terminates on dissolution or other termination of a member or the member’s utility system there are currently a plr-145483-01 members of the issuer the issuer is controlled by a board_of trustees the board that is composed exclusively of representatives of the members members elect a particular member to serve on the board and the elected member chooses an individual to represent the member elections are held at regularly scheduled member meetings each trustee serves a 3-year term the issuer’s governing documents do not provide for removal of a trustee in the event that a vacancy occurs before a regularly scheduled election a member is selected to fill the vacancy the issuer’s income consists of annual member dues revenues from sales of electricity to members fees for technical services provided to members and revenues from sales of electricity steam and service water to non-members the issuer’s governing documents provide that the issuer shall at all times be operated on a not-for- profit basis for the benefit of its members the issuer’s governing documents provide that its annual budget is developed by a committee of the board and is approved by both the board and by the members the board establishes the amount of fees for sales of electric power steam and service water to members and non-members and for services provided to members the issuer is subject_to an annual audit performed by a certified_public_accountant selected by the board the results of the annual audit are provided to each member to the extent that the issuer’s annual revenues exceed expenses the excess revenues are applied to reduce the costs of services to members in subsequent years the excess revenues may alternatively be treated as increases to members’ patronage capital which would be distributed to members in the event of the issuer’s dissolution or liquidation in the event of the issuer’s dissolution or liquidation the issuer’s assets would be used in the following order to pay all debts of the issuer to pay members’ initial capital contributions to refund membership fees including dues paid_by members or former members in the order of receipt and to make distributions to members and former members on the basis of patronage while a member on date the internal_revenue_service determined that the issuer is exempt from federal_income_tax under sec_501 ruling letters issued on date and date determined that the issuer continued to qualify as a sec_501 corporation in addition according to a private_letter_ruling that the issuer received on date the issuer is empowered to issue tax-exempt_bonds under sec_103 on behalf of its members under revrul_57_187 1957_1_cb_65 on date which is before date the issuer and the company executed a preliminary agreement the preliminary agreement that provided for the issuer’s purchase of the b percent interest in a cogeneration plant owned by the company the plant the preliminary agreement specifically identified the b percent plr-145483-01 interest in the plant as the asset the issuer would purchase established the purchase_price for that interest provided general terms for plant refurbishment and provided additional details regarding the parties’ rights and obligations the preliminary agreement was a valid and enforceable contract under state law and as such neither the issuer nor the company had the unilateral right to cancel the contract notwithstanding the preliminary agreement permitted the company to negotiate with other potential purchasers during the period between execution of the preliminary agreement and completion of the sale of the b percent interest if the company located a different purchaser the preliminary agreement permitted the issuer to match that purchaser’s bona_fide negotiated offer within days to the extent that the preliminary agreement contained conditions within the control of the parties each party was obligated to use good_faith and best efforts to meet such conditions any attempt by the parties to use the conditions within their control to unilaterally terminate the contract by failing to use good_faith and best efforts to meet such conditions would constitute a breach of contract under state law given the parties’ intent to be bound by the preliminary agreement and the difficulty in properly ascertaining monetary damages to be awarded if either party breached its mutual obligations thereunder the preliminary agreement was subject_to the remedy of specific performance under state law in addition the preliminary agreement did not contain any dollar limit on damages the preliminary agreement was contingent on approval by the issuer’s and the company’s boards of trustees and each board approved the preliminary agreement prior to date on date which is after date the issuer and the company executed a subsequent agreement to finalize the issuer’s purchase of the b percent interest in the plant the final agreement the final agreement incorporated the terms and provisions set forth in the preliminary agreement provided additional details and set forth the parties specific rights and obligations regarding plant refurbishment and operation the issuer acquired the plant to provide economical reliable wholesale electricity to its members the issuer financed the purchase of the b percent interest with the proceeds of the taxable bonds which were issued after date on date the issuer purchased the company’s remaining c percent interest in the plant and financed this purchase with internal operating revenues currently the issuer owns percent of the plant and reasonably expects that it will continue to do so the issuer operates the plant the plant was designed and constructed as a single integrated facility to provide electricity and steam to an industrial complex the plant continues to produce steam which is sold to customers under arrangements that give rise to private_business_use and private payments under sec_141 and electricity which is primarily sold to certain members although certain plant components have a nameplate_capacity or an equivalent rating the plant does not have a capacity or equivalent rating as a single integrated facility plr-145483-01 generally the plant’s components are boilers stages of turbines generators and related equipment the plant operates as follows the boilers burn coal to produce steam the boilers are licensed by state to produce a maximum of d pounds of steam per hour the boiler-licensed maximum a portion of the boiler-licensed maximum produces up to e pounds of steam per hour which is immediately available for sale without input into the 21-stage turbine cycle the remaining portion of the boiler-licensed maximum up to f pounds of steam per hour is input into the first stage of the 21-stage turbine cycle the steam that is fed into the 21-stage turbine cycle produces up to g pounds of steam per hour at the end of the 8th turbine stage up to h kilowatts of electricity per hour at the end of the 21st turbine stage and very low pressure steam also at the end of the 21st turbine stage that is returned to the boilers up to g pounds of steam per hour is sold to non-members under arrangements that give rise to private_business_use and private payments under sec_141 the h kilowatt hours of electricity are sold to members pursuant to the contracts described below and are used to provide services to non-members due to plant design and certain other factors producing electricity by burning coal is less efficient than producing an equivalent british thermal unit btu value of steam as a result of these differences in efficiency one btu of coal input into the plant’s boilers will produce i btu of steam but one btu of coal input produces only j btu of electricity in order to take account of the differences in producing steam and electricity the issuer and the company have measured the use of the plant by reference to the relative btu value of coal input that is required to produce steam and electricity specifically the percentage of the actual costs of the plant including operation maintenance and capital costs that have been allocated to the production of a given quantity of steam or electricity is equal to the ratio of the btu value of coal to produce that quantity of steam or electricity over the btu value of total coal input required to produce all types of plant output moreover when the issuer purchased the b percent interest in the plant the issuer and the company agreed in arm’s-length negotiations that their respective entitlement to output of the plant would be determined according to the relative btu value of coal input used to produce the issuer’s and the company’s output eg the issuer was entitled to the output that could be produced with b percent of the btu value of coal input the issuer reasonably expects to continue to determine the actual costs of production and rates for sales of the plant’s output of steam and electricity based on the btu value of coal input the issuer represents that the btu is a standard unit for measuring the quantity of heat energy equal to the quantity of heat required to raise the temperature of one pound of water by one degree fahrenheit and the btu is the appropriate unit of measure for comparing steam and electricity the issuer represents that the btu value of the coal necessary to produce the boiler- licensed maximum is k btus per hour plr-145483-01 plant electric output is sold primarily to a portion of the members and to the city collectively the purchasers pursuant to contracts the power sales contracts the power sales contracts are dated date which is shortly after the date execution of the final agreement for the issuer’s purchase of the b percent interest in the plant from the date execution date of the power sales contracts until the issuer’s date purchase of the remaining c percent interest in the plant other than short term sales of less than a one-year term percent of the electricity attributable to the b percent interest was sold to the purchasers the power sales contracts have identical terms other than each purchaser’s respective entitlement to plant electric output the contracts have 20-year terms and require the purchaser to make full payment in any month in which any or all of the purchaser’s commitment can be supplied from any resource available to the issuer in the event that output is not available from the plant the issuer is entitled to deliver electricity to the purchaser from sources other than the plant each purchaser’s payment obligation is based on the plant’s operating_expenses including debt service although the power sales contracts have a term of years and therefore expire in year the issuer reasonably expects to renew the power sales contracts on the same or substantially_similar terms based on the power sales contracts at least l percent of the available output of the plant based on maximum btu value of coal input is reserved for use by the purchasers while the proposed bonds are outstanding with respect to the l percent reserved for use by the purchasers the issuer reasonably expects that over the term of the proposed bonds no purchaser will resell plant output under an arrangement that gives rise to private_business_use under sec_141 as such the issuer reasonably expects that not more than m percent of the available output of the plant based on maximum btu value of coal input will be sold under contracts giving rise to private_business_use under sec_141 over the entire term of the proposed bonds the issuer intends to issue bonds the proposed bonds and to use the proceeds to currently refund the taxable bonds and to finance l percent of certain plant improvements plus any costs attributable to any permissible private_business_use under sec_141 the final maturity of the proposed bonds is expected to be after year law and analysis instrumentality under sec_1_141-1 of the income_tax regulations the term governmental person means a state_or_local_government as defined in sec_1_103-1 or any instrumentality thereof sec_1_103-1 provides in part that a state or local plr-145483-01 government includes any political_subdivision of a state revrul_57_128 1957_1_cb_311 sets forth the following factors to be considered in determining whether an entity is an instrumentality of one or more governmental units whether the organization is used for a governmental purpose and performs a governmental function whether performance of its function is on behalf of one or more states or political subdivisions whether there are any private interests involved or whether the states or political subdivisions involved have the powers and interests of an owner whether control and supervision of the organization is vested in a public authority or authorities whether express or implied statutory or other authority is necessary for the creation and or use of the instrumentality and whether this authority exists and the degree of financial autonomy of the entity and the source of its operating_expenses the issuer was formed by the members to obtain economic reliable supplies of electric power and transmission services on behalf of its members political subdivisions of certain states and to provide related technical services to its members by obtaining electric power and transmission services and providing related technical services the issuer performs the same or similar functions that each member would be required to perform individually if the issuer did not exist hence the issuer is used for the governmental purpose of its member utility systems and performs the governmental function on behalf of the members the members have the powers and interests of an owner all annual revenues in excess of expenses accrue to the benefit of the members in that they are either applied to reduce costs of services to members or are treated as increases to members’ patronage capital in the event of the issuer’s dissolution or liquidation members receive the assets of the issuer to the extent that any remain after payment of the issuer’s debts based on initial capital contributions refunds of membership fees and their patronage capital control and supervision of the issuer are vested in public authorities and not private interests because the members each of which is a political_subdivision control all aspects of the issuer’s operations through the board the board is composed exclusively of representatives of the members each of whom must be elected by the members in the event of an unscheduled vacancy any replacement board trustee would also be selected from among the members the financial affairs of the issuer are controlled by the members the members through the board establish the amount of all fees and energy charges and develop the issuer’s annual budget both the board and the members approve the issuer’s annual budget accordingly we conclude that the issuer is an instrumentality of its members for plr-145483-01 purposes of sec_141 private business tests sec_103 generally provides that gross_income does not include interest on any state_or_local_bond sec_103 provides that this exclusion does not apply to any private_activity_bond unless it is a qualified_bond as these terms are defined under sec_141 as material to this ruling_request under sec_141 a bond is a private_activity_bond if the bond satisfies the private_business_use_test and private_security_or_payment_test of sec_141 under sec_141 an issue meets the private business test if more than percent of the proceeds of the issue are to be used for any private_business_use under sec_141 an issue meets the private_security_or_payment_test if the payment of the principal of or the interest on more than percent of the proceeds of an issue is under the terms of such issue or any underlying arrangement directly or indirectly a secured_by any interest in i property used or to be used for a private_business_use or ii payments in respect of such property or b to be derived from payments whether or not to the issuer in respect of property or borrowed money used or to be used for a private_business_use under sec_141 private_business_use means use directly or indirectly in a trade_or_business carried on by any person other than a governmental_unit sec_1_141-7 sets forth rules to determine whether arrangements for purchases of output from an output_facility cause an issue of bonds to meet the private business tests sec_1_141-7 provides that the purchase pursuant to a contract by a nongovernmental person of available output of an output_facility financed with the proceeds of an issue is taken into account under the private business tests if the purchase has the effect of transferring the benefits of owning the facility and the burdens of paying the debt service on the bonds used directly or indirectly to finance the facility the benefits and burdens test under sec_1_141-7 the benefits and burdens test is met if a nongovernmental person agrees pursuant to a take contract or a take_or_pay_contract to purchase available output of a facility sec_1_141-7 provides the following definitions of a take contract and a take_or_pay_contract a take contract is an output contract under which a purchaser agrees to pay for the output under the contract if the output_facility is capable of providing the output a take_or_pay_contract is an output contract under which a purchaser agrees to pay for the output under the contract whether or not the output_facility is capable of providing the output plr-145483-01 for purposes of sec_1_141-7 output contracts available output for generating facilities is determined under sec_1_141-7 by reference to nameplate_capacity or the equivalent or lacking either its maximum capacity which is not reduced for reserves or other unutilized capacity however sec_1_141-7 provides that the available output of a cogeneration_facility is to be measured in a reasonable manner to reflect capacity sec_1_141-7 provides that an output contract for_the_use_of a facility is not taken into account under the private business tests if the average annual payments to be made under the contract do not exceed one percent of the average annual debt service on all outstanding tax-exempt_bonds issued to finance the facility determined as of the effective date of the contract sec_1_141-7 provides that an output contract with a nongovernmental person is not taken into account under the private business tests if i the term of the contract including all renewal options is not longer than three years ii the contract either is a negotiated arm’s-length arrangement that provides for compensation at fair_market_value or is based on generally applicable and uniformly applied rates and iii the output_facility is not financed for a principal purpose of providing that facility for use by that nongovernmental person on date the internal_revenue_service issued an advance notice of proposed rulemaking describing and illustrating rules that the internal_revenue_service and treasury_department expect to propose in a notice of proposed rulemaking the proposed_regulations as part of the guidance priority plan see announcement i r b issuers may rely on announcement with respect to any issue that is sold before the date the proposed_regulations are published in the federal_register or such later date as may be specified in the proposed_regulations or final regulations announcement provides that tax- exempt bonds may be issued to finance costs attributable to the government_use portion of a mixed-use output_facility plus any costs attributable to any permissible private_business_use under sec_141 without the bonds being characterized as private_activity_bonds for this purpose the term facility includes an undivided ownership_interest in a facility with respect to arrangements for the purchase of output the government_use portion of an output_facility is determined based on the percentage of the available output of the facility that is not used for a private_business_use as determined under sec_1_141-7 announcement further provides that in the case of a mixed-use output_facility output contracts that result in private_business_use including any payments thereunder are allocated first to the portion of the facility that is financed with equity for this purpose equity means any amount other than proceeds of a tax-exempt_bond including funds of the issuer that are not derived from a borrowing and proceeds of taxable bonds but does not include any amount allocable to a tax-exempt_bond that has been retired with respect to each issue of bonds the portion of the output_facility plr-145483-01 financed with equity is determined based on expenditures of equity that are made contemporaneously with expenditures of proceeds of the issue as part of the same plan of financing in order for an output contract to be allocated in whole or in part to the equity-financed portion of an output_facility as described in this paragraph it first must be allocable to the facility under the facts_and_circumstances_test contained in sec_1 h for example an output contract that is allocable to two output facilities under sec_1_141-7 may not be allocated in its entirety to the equity-financed portion of one of the facilities announcement example provides that the authority a governmental person owns and operates an electric transmission facility prior to authority incurred capital costs of dollar_figure million for the facility none of which were financed with tax-exempt_bonds in authority needs to make repairs upgrades and improvements to the facility in the amount of dollar_figure million in the authority issues dollar_figure million in tax-exempt_bonds and uses the proceeds to pay capital costs of the facility the issue as part of the same plan of financing authority also uses dollar_figure million of its own funds which are not derived from a borrowing to pay capital costs of the facility with respect to the issue percent of the available output as determined under sec_1_141-7 of the facility is sold under output contracts that result in private_business_use thus of the dollar_figure million of new_capital costs dollar_figure million percent are attributable to government_use and dollar_figure million percent are attributable to private_business_use because in general output contracts that result in private_business_use are allocated first to the portion of the facility that is financed with equity dollar_figure million of the dollar_figure million costs attributable to private_business_use are allocable to authority’s equity and dollar_figure million are allocable to the issue thus dollar_figure million percent of the proceeds of the issue are used for a government_use and the issue does not consist of private_activity_bonds under sec_141 bonds are private_activity_bonds if the proceeds of an issue that are to be used directly or indirectly for the acquisition by a governmental_unit of nongovernmental_output_property exceeds the lesser_of percent of such proceeds or dollar_figure under c of the omnibus budget reconciliation act of the act p l stat 1987_3_cb_102 sec_141 applies to bonds issued after date other than bonds issued to refund bonds issued before such date however sec_141 does not apply to bonds other than advance refunding bonds with respect to a facility acquired after date pursuant to a binding contract entered into on or before date the house report h_r rep no i pincite accompanying the act provides that t he rules governing binding contracts contained in title xiii of the tax_reform_act_of_1986 are to be used to determine whether such a contract exists the conference committee report the conference_report h_r conf_rep no pincite2 c b pincite accompanying the act provides that the conference agreement follows the house bill with a clarification that plr-145483-01 the term binding contract for purposes of the general transitional exception in the house bill does not include an option to purchase output property rather as provided under the general transitional exceptions in titles ii and xiii of the tax_reform_act_of_1986 a binding contract exists only if both parties to a transaction are bound to complete the sale purchase of specifically identified property the conference_report at ii-55 c b vol pincite explains title ii as follows the general binding contract rule applies only to contracts in which the construction reconstruction erection or acquisition of property is itself the subject matter of the contract a contract is binding only if it is enforceable under state law against the taxpayer and does not limit damages to a specified amount eg by use of a liquidated_damages provisions sic a contractual provision that limits damages to an amount equal to at least five percent of the total_contract_price is not treated as limiting damages for purpose of the general binding contract rule a contract under which the taxpayer is granted an option to acquire property is not to be treated as a binding contract to acquire the underlying property in contrast a contract under which the taxpayer grants an irrevocable put ie an option to sell to another taxpayer is treated as a binding contract as the grantor of such an option does not have the ability to unilaterally rescind the commitment in general a contract is binding even if subject_to a condition as long as the condition is not within the control of either party or a predecessor a contract that was binding as of date will not be considered binding at all times thereafter if it is substantially_modified after that date the conference_report at ii-694-695 c b vol pincite explains title xiii sec_1312 as follows whether or not an arrangement constitutes a contract is determined under the applicable local law a binding contract is not considered to have existed before date however unless the property to be acquired or services to be rendered were specifically identified or described before that date a binding contract exists only with respect to property or services for which the taxpayer is obligated to pay under the contract a contract may be considered binding on a person even though the contract contains conditions which are under the control of a person not a party to the contract or the person has the right under the contract to make minor modifications as to the details of the subject matter of the contract a contract that was binding on date will not be considered binding at all times thereafter if it is modified other than as described in above after that date in order to determine whether the proposed bonds will be treated as financing plr-145483-01 property used for governmental purposes under sec_103 and sec_141 we first consider whether the proposed bonds are subject_to sec_141 the issuer intends to use the proceeds of the proposed bonds to currently refund the taxable bonds hence the proceeds of the proposed bonds will be used for the same purpose as the proceeds of the taxable bonds ie to purchase the b percent interest in the plant an existing output_facility because the issuer acquired the plant after date and the taxable bonds were issued after date sec_141 will apply to the issuer’s proposed bonds unless the issuer acquired the plant pursuant to a binding contract entered into before date we conclude that the preliminary agreement constitutes a binding contract within the meaning of c of the act for the following reasons the b percent interest in the plant is specifically identified as the subject of the preliminary agreement including the purchase_price of the plant and a description of the issuer’s and the company’s rights and obligations with respect to various aspects of the subsequent joint_ownership of the plant the preliminary agreement is enforceable against the issuer under state law and thus neither the issuer nor the company had the unilateral right to terminate the preliminary agreement while the preliminary agreement provision permitted the company to seek other potential purchasers this is analogous to the irrevocable put described in the conference_report wherein the issuer granted the company an irrevocable right to sell the plant to the issuer at the stated contract_price if the company did not reach an agreement with another purchaser the issuer had no right to unilaterally rescind the preliminary agreement and therefore was obligated to complete the purchase at the stated contract_price the provision that granted the issuer the right to match the bona_fide offer of another purchaser provided additional assurance that the plant would be available to the issuer notwithstanding the bona_fide offer of another purchaser in addition while the preliminary agreement contains conditions within the control of the parties each party was obligated to use good_faith and best efforts to meet such conditions any attempt to use the conditions to unilaterally terminate the preliminary agreement would be a breach of contract subject_to the remedy of specific performance in the event damages were awarded the preliminary agreement contained no limitation on the amount of damages because the final agreement incorporated the provisions of the preliminary agreement and provided only additional details including details as to the parties’ rights and obligations regarding plant refurbishment and operation that were generally described in the preliminary agreement any final agreement modifications to the preliminary agreement were minor modifications as to the details of the subject matter of the preliminary agreement accordingly we conclude that sec_141 does not apply to the proposed bonds pursuant to announcement the proposed bonds may be issued to finance costs attributable to the government_use portion of the plant plus costs attributable to any permissible private_business_use under sec_141 without the proposed bonds being characterized as private_activity_bonds plr-145483-01 we determine the government_use portion of the plant based on the percentage of the available output of the plant that is not used for a private_business_use as determined under sec_1_141-7 because the plant is a cogeneration_facility we first consider the appropriate manner in which to measure the available output of the plant in order to then determine the government_use portion of the plant the issuer proposes to measure the available output and use of the plant according to the relative btus of coal input that are required to produce steam and electricity the issuer explains that this is the only reasonable manner to reflect the capacity of the plant for the reasons indicated below we agree the plant as a single integrated facility does not have a nameplate_capacity or equivalent although the capacity could simply be determined by combining the capacity of the plant components that produce steam with the capacity of components that produce electricity the issuer argues that this does not reasonably reflect the plant’s capacity as a single integrated facility rather the issuer explains that in order to reasonably measure the available output and use of the plant the fact that the plant produces two different types of output steam and electricity must be considered because producing steam and electricity do not require equal use of plant assets instead producing electricity requires use of more plant components than producing steam moreover in the process of producing electricity a portion of plant components will serve the dual purpose of producing steam for example producing electricity requires use of the boilers and all stages of the plant’s turbines but producing steam requires use of the boilers and only of the stages of the turbines the issuer further explains that the company and the issuer have accounted for the difference in use of plant assets to produce steam and electricity by relying on the relative btus of coal input that are required to produce steam and electricity because more btus of coal input are required to produce one btu of electricity than to produce one btu of steam the company and the issuer concluded that btus of coal input accurately reflected use of plant assets to produce each type of output hence the company and the issuer determined the cost of the specific quantities of steam or electric output allocable to various users based on the relative btu value of coal input into the boilers needed to produce a given quantity of steam or electricity the issuer reasonably expects to continue to determine production_costs and rates for sales of output based on btu value of coal input although capacity is typically measured by reference to the output of a facility we believe that the facts presented here support the use of input the plant produces different types of output that require use of different portions of the plant for production moreover the type of output that requires more components of the plant to be created ie electricity requires more btu value of coal input and thus the amount of input appears to be reasonably related to the portion of the plant being utilized to produce the output finally the method has been utilized for other than tax-exempt_bond purposes as it has historically been used to allocate costs at the plant as well as to determine the entitlement to output when the issuer purchased its b percent interest in plr-145483-01 the plant accordingly we conclude that measuring the available output and use of the plant by reference to the btu value of coal input into the boilers is a reasonable manner to reflect the capacity of the plant as a single integrated cogeneration_facility because state has licensed the boilers to produce d pounds of steam per hour and based on the issuer’s representation that the btu value of the coal necessary to produce d pounds of steam per hour is k btus per hour we further conclude that it is appropriate to base the available output of the plant on k btus per hour having determined the appropriate method to measure the available output and use of the plant we next consider the issuer’s arrangements for the purchase of plant output to determine the government_use portion of the plant at all times while the proposed bonds are outstanding the issuer expects that at least l percent of the plant’s available output based on maximum btu value of coal input will be reserved for use by the purchasers the issuer bases this expectation on the power sales contracts under those contracts each purchaser is required to take and pay for the portion of plant output specified in that purchaser’s contract if the output is available from the plant or if not available from sources other than the plant although the power sales contracts have a term of years and therefore expire in year before the proposed bonds mature the issuer reasonably expects to renew the power sales contracts on the same or substantially_similar terms with respect to the l percent reserved for use by the purchasers the issuer reasonably expects that over the term of the proposed bonds no purchaser will resell plant output under an arrangement that gives rise to private_business_use under sec_141 thus the issuer reasonably expects that not more than m percent of the available output of the plant based on maximum btu value of coal input will be sold under contracts giving rise to private_business_use under sec_141 over the entire term of the proposed bonds therefore we conclude that l percent of the plant is the government_use portion based on the percent of the available output of the plant based on maximum btu value of coal input that is not used for a private_business_use because the issuer has established that it reasonably expects that l percent of the output of the plant will be used for government_use over the entire term of the proposed bonds we conclude that under announcement use of the proceeds of the proposed bonds to finance the l percent of the costs of the plant improvements plus costs attributable to any permissible private_business_use under sec_141 will not cause the proposed bonds to satisfy the private business tests under sec_141 although announcement provides that bonds may be issued to finance costs attributable to the government_use portion of an output_facility plus costs attributable to any permissible private_business_use under sec_141 without the bonds being characterized as private_activity_bonds it does not specifically address how to analyze a refunding of bonds previously issued to acquire an interest in a facility in particular it does not directly address whether the portion of the proposed bonds used to refund the taxable bonds may be treated as financing the government_use portion of the plant plr-145483-01 the issuer issued the taxable bonds to acquire the b percent interest in the plant which gave it rights to b percent of the capacity of the plant the b interest in the plant was acquired to serve the purchasers and it has continued to serve such purchasers from the date execution date of the power sales contracts until the issuer’s date purchase of the remaining c percent interest in the plant other than short term sales of less than a one-year term to non-members percent of the output attributable to the b percent interest was sold to the purchasers each of which is a political_subdivision under the power sales contracts based on the power sales contracts the issuer reasonably expects that l percent of the available output of the plant will be used for government_use over the entire term of the proposed bonds this percentage is greater than the b percent interest originally acquired to serve the purchasers in these circumstances we believe it is appropriate to treat the taxable bonds and the proposed bonds that refund them as financing the government_use portion of the plant moreover on these facts and circumstances the issuer’s subsequent purchase of the remaining c percent of the plant with equity does not invoke the requirement in announcement that bond proceeds and equity be expended contemporaneously with respect to mixed use facilities and thereby prohibit the refunding of the taxable bonds accordingly we conclude that use of the proceeds of the proposed bonds to refund the outstanding taxable bonds will not cause the proposed bonds to satisfy the private business tests under sec_141 conclusion sec_1 the issuer will be treated as an instrumentality of its members for purposes of sec_141 and therefore the issuer’s use of the plant will constitute government_use the proposed bonds will not be treated as financing nongovernmental_output_property under sec_141 because the issuer entered into a binding contract to purchase the b percent interest in the plant prior to date use of the proceeds of the proposed bonds to finance l percent of the costs of the plant improvements plus costs attributable to any permissible private_business_use under sec_141 and to refund the outstanding taxable bonds will not cause the proposed bonds to satisfy the private business tests under sec_141 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of plr-145483-01 the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely yours assistant chief_counsel exempt_organizations employment_tax government entities by ______________________________ bruce m serchuk senior technician reviewer tax exempt bond branch


tcmemo_1997_113 united_states tax_court wallace r noel and robinette noel petitioners v commissioner of internal revenue respondent docket no filed date p owned stock in corp a corp a operated numerous restaurants under a franchise arrangement with corp b p sued both corp a and corp b alleging two contract claims and a tort claim corp b and p entered into a settlement agreement whereby corp b purchased p's stock in corp a and in return p released his claims against corp b p used some of the proceeds received as a result of the agreement with corp b to settle a loan made to p by bank x the loan balance consisted of both principal and accrued interest p also wrote off an investment in company y held dollar_figure of the proceeds p received from corp b is excludable under sec_104 held further except for dollar_figure of the fees that p paid to his lawyers p failed to substantiate his additions to basis in corp a stock held further p failed to substantiate a part of his basis in company y held further r's calculation of the interest portion on the loan from bank x is sustained held further p failed to substantiate dollar_figure of attorney's_fees held further p is not liable for the accuracy- related penalty under sec_6662 david m berrett for petitioners william r davis jr for respondent memorandum findings_of_fact and opinion fay judge respondent determined deficiencies in peti- tioners' federal income taxes and penalties as follows year deficiency dollar_figure big_number penalty sec dollar_figure prior to trial respondent conceded that no amounts were due to fraud in her answer to the petition respondent asserted an accuracy- related penalty against petitioners pursuant to sec_6662 all section references are to the internal_revenue_code in effect for the taxable years in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated a trial was held to resolve the following issues for decision whether any of the amount received from pepsico inc pepsico on the sale of petitioner' sec_1 stock in pizza manage- ment inc is excludable from petitioners' income under sec_104 we hold that dollar_figure is excludable whether legal fees and other expenses should have been included in the basis of petitioner's stock in pizza management inc sold in we hold that dollar_figure of the fees should have been so included whether petitioner substantiated amounts included in the basis of his failed investment in a t j cinnamons bakery franchise we hold that the amounts have not been substantiated whether petitioners are entitled to deduct the invest- ment interest_expense claimed on their federal_income_tax return related to loans from the united bank of fort collins the bank we hold that they are in the amounts set out herein whether deductions claimed for attorney's_fees have been substantiated by petitioners we hold that the fees have not been substantiated whether petitioners are subject_to the accuracy-related_penalty under sec_6662 in connection with the filing of their and federal_income_tax returns we hold that they are not 1all references to petitioner are to wallace r noel findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorpo- rated herein by this reference at the time the petition was filed petitioners resided in fort collins colorado at all times relevant petitioners used the cash_receipts_and_disbursements_method of accounting investment in pizza management inc in the 1960's and early 1970's petitioner owned a number of pizza hut inc pizza hut restaurants as a sole_proprietor under a franchise arrangement between petitioner and pizza hut in petitioner was approached by several other individual pizza hut franchisees who had formed a corporation called pizza management inc pmi petitioner transferred his restaurants to pmi in exchange for stock in the pmi corporation petitioner believed that pmi had a special contractual right to issue its shares to the public notwithstanding any terms or limitations of the pizza hut franchise agreements as a result of petitioner's transferring his restaurants to pmi petitioner received approxi- mately percent of the stock in pmi by the mid-1980's pmi was the franchisee of approximately pizza hut restaurants in the spring of pmi developed plans for a public offering of pmi stock pizza hut successfully prevented pmi from issuing shares in pmi to the public pizza hut asserted that a public offering of pmi stock would violate the terms of the fran- chise agreements between pizza hut and pmi pepsico's action sec_2 in preventing the public offering adversely affected the value of petitioner's pmi stock also petitioner suffered personal emotional distress as a consequence of pepsico's actions further the damages to petitioner's business reputation caused by pepsico resulted in petitioner's suffering personal financial setbacks in ventures unrelated to his investment in pmi in date petitioner as a shareholder of pmi and his children as shareholders of pmi brought a civil_action against pepsico pizza hut pmi and other pmi shareholders petitioner alleged that he suffered damages as a result of pizza hut's refusal to allow the public offering to go forward specifi- cally petitioner made three claims against pizza hut and pepsico first petitioner alleged that pmi and pepsico had entered into agreements after petitioner had transferred his sole_proprietorship restaurants to pmi which restricted pmi's right to go public and that the agreements between pepsico and pmi constituted a breach of obligations owed to petitioner as a third-party beneficiary under the original agreements between pizza hut and pmi second petitioner urged that pizza hut be 2by the spring of pepsico had purchased all of the stock of pizza hut and pizza hut became a wholly owned subsidiary of pepsico estopped from claiming that the pmi shareholders' rights had been modified by the later agreements between pmi and pepsico finally petitioner alleged that the conduct by pizza hut in preventing the public offering constituted a tortious interference with petitioner's contractual rights and prospective business advantages in petitioner and lawrence f dickie a representative of pepsico entered into settlement negotiations resulting in an agreement whereby pepsico would acquire all of petitioner's pmi stock and petitioner would release his claims against pepsico and pizza hut during these negotiations petitioner and mr dickie discussed the damages suffered by petitioner as a result of pepsico's actions including the damage to his rela- tionship with the bank and the harm to his business reputation through adverse publicity in the press on date in compliance with the settlement agreement petitioner transferred shares of pmi stock to pepsico on the same date peti- tioner signed documents releasing all claims against pepsico and pizza hut in consideration of the stock transfer and peti- tioner's release of claims pepsico paid petitioner dollar_figure 3petitioner owned big_number shares of pizza management inc pmi additionally petitioner controlled big_number shares that were beneficially owned by his wife and children the total of these two amounts constitutes the big_number shares transferred to pepsico inc pepsico of this amount petitioner paid dollar_figure to the attorneys handling the lawsuit against pepsico in preparing his federal_income_tax return petitioner allocated the dollar_figure payment between two amounts petitioner treated dollar_figure as the amount received for his shares of pmi and dollar_figure as the amount received in exchange for the release of his claims against pepsico and pizza hut petitioner's c p a wayne hoover advised petitioner in connection with the preparation of petitioner's federal_income_tax return that the dollar_figure was excludable from income under sec_104 as damages received on account of per- sonal injuries petitioner did not report this amount as income on his federal_income_tax return petitioner claimed on his return a basis of dollar_figure in his pmi stock consisting of the following original_basis miscellaneous expenses received from children travel_expenses misc legal fees legal fees paid contingent legal fees total dollar_figure big_number big_number big_number big_number big_number big_number big_number petitioner in his federal_income_tax return reduced his gain by dollar_figure which represents the amount received which is attributable to his wife's and children's stock respondent concedes that this amount is not taxable to petitioner 4petitioner's allocation comports to the dollar_figure per share book_value reflected in the financial statements of pmi 2in his federal_income_tax return petitioner included dollar_figure in contingent legal fees in the basis of his stock in the brief petitioners admit that this was in error and that the contingent portion of the fees amounted to only dollar_figure thus the dollar_figure actually paid_by petitioner was reported twice on his federal_income_tax return accordingly we will discuss this issue using the dollar_figure amount as conceded by petitioner the difference between dollar_figure amount received for shares of pmi stock and dollar_figure was reported in petitioner's federal_income_tax return as a long-term_capital_gain of dollar_figure respondent in her notice_of_deficiency determined that the dollar_figure received from pepsico was paid as consideration for petitioner's pmi stock and no amounts were excludable under sec_104 further respondent limited petitioner's basis in the pmi stock to the dollar_figure initially invested by petitioner investment_interest expense petitioner deducted dollar_figure as investment_interest expense in his federal_income_tax return and reported dollar_figure as an investment_interest expense carryforward these amounts related to petitioner's various loans from the bank petitioner borrowed money from the bank on various dates throughout the 1980's in return petitioner executed promissory notes in favor of the bank secured_by petitioner's pmi stock and the assets of several other business ventures controlled by him one of these entities operated a restaurant and was called out of bounds inc another entity was noel exploration inc a corporation engaged in the oil_and_gas business the bank used separate customer numbers for noel exploration inc cust no out of bounds inc cust no and petitioner cust no typically the loans from the bank were for terms of year at the end of the term petitioner typically rolled the outstanding principal and accrued interest into a new 1-year loan on date the bank lent petitioner dollar_figure from an unsecured line of credit loan no dollar_figure of which was used to pay off a prior unsecured line of credit for out of bounds inc and dollar_figure was used to pay off the accrued interest on date the bank lent petitioner dollar_figure loan no of this amount dollar_figure was used to purchase acres of land called the overland trail property and dollar_figure was used to satisfy the outstanding principal balance on loan no the record is silent with regard to the application of the remaining dollar_figure also on date a dollar_figure unsecured line of credit was established between the bank and petitioner with loan no 5the number preceding the slash identifies the customer and the number following the slash identifies the specific loan on date the bank lent petitioner dollar_figure loan no the bank applied dollar_figure to pay off loan no the balance owed on the unsecured line of credit dollar_figure principal and dollar_figure interest the bank applied dollar_figure to pay off loan no an outstanding loan to out of bounds inc the bank disbursed dollar_figure to petitioner and the bank charged petitioner dollar_figure in fees finally dollar_figure was applied to pay off loan no dollar_figure for principal and dollar_figure for interest the remaining available balance of the note was to be used as a reserve for future_interest accruals on date the bank renewed loan no in the amount of dollar_figure the increase of dollar_figure was desig- nated to satisfy accrued interest on date the bank renewed loan no in the amount of dollar_figure million with a maturity_date of date again the increase in the amount of the note represents accrued interest on the note the note was secured_by big_number shares of pmi stock by date the bank began demanding payment of the dollar_figure million note of date as of date the amount due on the note was dollar_figure inclusive of principal and interest on date petitioner and the bank entered into a settlement agreement pursuant to the agreement peti- tioner agreed to pay the bank dollar_figure in full satisfaction of principal and interest due on loan no no amount was separately designated for principal or interest as of date the principal portion of the note was as follows principal balance from loan no amount advanced for overland trail property payoff of loan no payoff of principal of loan no funds advanced to petitioner loan fees total big_number dollar_figure big_number big_number big_number big_number petitioner in his federal_income_tax return deducted investment_interest expense in the amount of dollar_figure respon- dent disallowed this deduction additionally respondent deter- mined that petitioner realized income of dollar_figure the difference between the outstanding balance of dollar_figure and the dollar_figure actually paid_by petitioner the t j cinnamons bakery franchise on date petitioner entered into an agreement to purchase the assets of a t j cinnamons bakery franchise located in san antonio texas t j cinnamons bakery is a company that specializes in bakery products petitioner paid dollar_figure to acquire the business and assumed a note in the amount of dollar_figure shortly after the transaction was consummated petitioner discovered that the seller had given him inaccurate financial 6the amount of the deduction was limited to petitioner's net_investment_income information and that the seller was unable to transfer certain business_assets to petitioner after petitioner initiated steps to rescind the transaction the seller filed for bankruptcy in the bankruptcy court discharged petitioner's claims against the seller as a result of the bankruptcy court's decision petitioner claimed a long-term_capital_loss of dollar_figure in his federal_income_tax return related to the t j cinnamons bakery franchise the items that constitute the dollar_figure were not separately identified in petitioner's federal_income_tax return respondent limited the loss to petitioner's original_basis of dollar_figure exclusions under sec_104 opinion petitioner did not report dollar_figure of the dollar_figure received from pepsico as income on his federal_income_tax return petitioner's c p a advised him that the amount was excludable pursuant to sec_104 as damages received on account of personal injuries respondent argues that petitioner has failed to establish that any portion of the amount received is excludable under sec_104 we disagree with respondent sec_61 provides that gross_income means all income from whatever source derived sec_61 unless the internal_revenue_code specifically provides otherwise all accessions to wealth must be included in gross_income 348_us_426 exclusions from gross_income have been narrowly construed 499_us_573 sec_104 provides an exclusion from income for the amount of any damages received on account of personal injuries or sickness the term damages in sec_104 encompasses amounts received pursuant to settlement agreements sec_1_104-1 income_tax regs to be excludable the under- lying claim must be based on tort type rights and the damages must be received on account of personal injuries o'gilvie v united_states u s __ 117_sct_459 commissioner v schleier u s __ 115_sct_2159 the tax consequences of a settlement agreement depend on the nature of the litigation and on the origin of the claim but not on the validity of those claims 397_us_572 where a settlement agreement lacks specific language the intent of the payor is the most important factor in determining the nature of the claim being settled 349_f2d_610 10th cir affg tcmemo_1964_33 in his federal_income_tax return petitioner allocated some of the proceeds received from pepsico to nontaxable amounts received in settlement of a lawsuit under sec_104 petitioner in connection with the transfer of pmi stock to pepsico signed a release which discharged his claims against pizza hut and pepsico release the release states in perti- nent part the undersigned wallace r noel does hereby release and forever discharge pizza hut inc pepsico inc and all of their subsidiaries divisions and related companies and all of their employees officers and agents from any and all claims actions and causes of action now existing or that may arise here- after known and unknown and including in particular but without limitation all claims that have been asserted or that could be asserted in that certain action pending in sedgwick county district_court sedgwick county kansas captioned wallace r noel larry d noel michael l noel and cathy r noel vs pizza hut inc a corpora- tion pepsico inc a corporation pizza manage- ment inc a corporation and arturo g torres case no c the undersigned agrees that as a part of this release the referenced action as it relates to pizza hut inc and pepsico inc shall be dismissed with prejudice forthwith and agrees further that he shall take whatever action is necessary to bring about such a dismissal the release lacks any language concerning the amount of money petitioner received if any as consideration for signing this release further the stock transfer agreement states upon delivery to me or my designee of i dollar_figure in immediately available funds and ii your release of claims against me i will transfer to pizza hut inc by delivery of the shares and the powers good valid and marketable title to all of the shares the stock transfer agreement does not specify what portion of the proceeds if any was paid to petitioner for his release of claims since the documents presented by petitioner lack any language concerning what if any portion of pepsico's payment represents consideration for petitioner's signing the release we will look to the intent of the payor pepsico to determine what portion was paid for petitioner's release of his claims at trial mr dickie pepsico's representative in the transaction testified that the amount_paid to petitioner was based solely on pepsico's valuation of the pmi corporation mr dickie testified that the amounts paid to petitioner related only to the value of the pmi stock and no amounts were paid for the release of claims obtained by pepsico mr dickie indicated that it was a normal business practice to obtain a general release from all sellers in these types of situations we cannot accept this testimony at face value the evidence before the court belies mr dickie's assertion that no amounts were paid for the settlement of claims first the release is not merely a general release of claims rather the release specifically identifies petitioner's claims asserted against pepsico and pizza hut in the action pending in sedgwick county district_court second it is evident from the documents presented at trial that pepsico would not have purchased peti- tioner's stock in pmi without also receiving his release of claims it is apparent that pepsico paid petitioner dollar_figure 7in his testimony mr dickie explained that a retail food franchise is usually valued based on either a percentage of sales income or a multiplier of income before depreciation and taxes according to mr dickie these methods were applied to pmi in order for pepsico to arrive at the dollar_figure per share price paid_by pepsico to petitioner both to purchase his stock and to settle his claims accord- ingly we must allocate the dollar_figure between the value of the stock in pmi and the value of settling petitioner's claims it would serve no purpose to delve into detailed discussions concerning the weight of specific testimony or the credibility of certain evidence we make this allocation based on the totality of the evidence before the court while allowing for a certain amount of overstatement or understatement in the assertions contained in the testimony before us see 59_tc_634 therefore based on the evidence we conclude that pepsico paid dollar_figure for the pmi stock or dollar_figure per share consequently we find that the remainder of the amount_paid to petitioner by pepsico an amount equal to dollar_figure was paid to settle petitioner's claims in contract and in tort to exclude under sec_104 the proceeds from the settlement of a claim the claim must be based on tortlike rights and must be on account of personal injuries com- missioner v schleier u s __ 115_sct_2159 petitioner's first two claims against pepsico constitute contract claims not covered by sec_104 petitioner's third claim is an action in tort see 593_fsupp_250 d kan turner v halliburton co p 2d kan further we are satisfied that petitioner suffered personal injuries the phrase on account of personal injuries includes both nonphysical and physical injuries 504_us_229 n 848_f2d_81 6th cir affg 87_tc_1294 sec_104 has been held to apply to several types of nonphysical personal injuries such as emotional distress united_states v burke supra mental pain and suffering 835_f2d_67 3d cir affg 87_tc_236 indignity humiliation inconvenience pain and distress of mind and prevention from attending usual pursuits threlkeld v commissioner supra pincite and injury to personal professional and credit reputation 80_tc_1104 the evidence before the court is that pepsico's actions caused petitioner to suffer emotional distress and resulted in damage to petitioner's business reputation petitioner discussed these damages with mr dickie during the settlement negotiations the payment made by pepsico was intended to settle both the contract claims and the tort claim thus we conclude that part of the settlement payment was excludable and part was not excludable under sec_104 if a settlement payment covers both contract claims and excludable tort claims then we may allocate amounts to each claim 98_tc_1 eisler v 8when contracts are interfered with in a tortious manner a litigant may recover damages for emotional distress mcloughlin v golf course superintendents association of am no 85-4499-r d kan date commissioner supra pincite the record does not contain a great deal of evidence to help this court in making an allocation as we stated in eisler v commissioner supra pincite under these circumstances the most that can be expected of us is the exercise of our best judgment based upon the entire record therefore we conclude that of the dollar_figure in settlement pro- ceeds apportionable to the release of petitioner's claims in contract and in tort one-third was paid to settle the tort claim accordingly one-third of the dollar_figure or dollar_figure is excludable under sec_104 basis of petitioner's pmi stock in his federal_income_tax return petitioner included the following amounts in the basis of his pmi stock dollar_figure of miscellaneous expenses dollar_figure in additional travel costs dollar_figure in miscellaneous legal fees and dollar_figure in legal costs related to the pepsico litigation dollar_figure actually paid and dollar_figure in contingent fees see supra p table note respondent in her notice_of_deficiency determined that none of these amounts should have been included in petitioner's pmi stock basis we will deal with each of these items in turn the commissioner's determinations are presumed correct rule a 290_us_111 peti- tioner has the burden of establishing the correct basis of his pmi stock 283_us_223 at trial petitioner and his c p a testified that the dollar_figure in miscellaneous expenses and the dollar_figure in travel_expenses were paid_by petitioner as a stockholder of pmi however petitioner did not produce any records at trial to substantiate these claimed expenses a determination of basis is a factual one for which the burden_of_proof rests with peti- tioner 410_f2d_937 8th cir affg tcmemo_1967_180 petitioner's self-serving testimony without any additional proof fails to meet this burden because petitioner failed to substantiate his expenses the miscellaneous and travel_expenses are not allowable items in computing peti- tioner's basis in his pmi stock petitioner argues on brief that dollar_figure in accounting fees should be included in the basis of his pmi stock petitioner has failed to demonstrate that the accounting firm did any work related to the pmi stock in her notice_of_deficiency respon- dent has allowed this dollar_figure in fees as miscellaneous deductions respondent's notice_of_deficiency is presumed correct welch v helvering supra pincite since petitioner failed to put on any evidence outside of his own testimony as to the nature of the accounting work we find for respondent 9petitioner reported dollar_figure of miscellaneous legal fees in the basis of his pmi stock respondent in her notice_of_deficiency allowed these expenses as miscellaneous_itemized_deductions petitioner in his reply brief agreed that these fees were properly accounted for in the notice_of_deficiency petitioner paid dollar_figure to his lawyers upon the settlement of claims against pepsico and increased the basis of his pmi stock again respondent in her notice_of_deficiency allowed petitioner these fees as a miscellaneous itemized_deduction for the reasons set out below we hold that dollar_figure of these fees is a proper addition to the basis of petitioner's stock dollar_figure of the fees is deductible as a miscellaneous itemized_deduction and dollar_figure of the fees is nondeductible sec_265 precludes a deduction for legal expenses attributable to a class of income that is exempt from taxation sec_1_265-1 income_tax regs provides as follows expenses and amounts otherwise allowable which are directly allocable to any class or classes of exempt_income shall be allocated thereto and expenses and amounts directly allocable to any class or classes of nonexempt_income shall be allocated thereto if an expense or amount otherwise allowable is indirectly allocable to both a class of nonexempt_income and a class of exempt_income a reasonable proportion thereof determined in the light of all the facts and circum- stances in each case shall be allocated to each ordinarily we allocate the legal expenses in the same proportion as the settlement payment see stocks v commis- sioner supra pincite 88_tc_834 affd 845_f2d_1013 3d cir church v commis- sioner supra pincite1 but see eisler v commissioner supra pincite based on the evidence a proportionate allocation is appropriate in this case we have held that percent of the settlement payment was paid for petitioner's stock percent was paid to settle petitioner's two contract claims and per- cent was paid to settle his tort claim we therefore conclude that percent of the legal expenses or dollar_figure is not deduct- ible also dollar_figure of the legal fees the amount related to petitioner's two contract claims is deductible as a miscel- laneous itemized_deduction next we must decide whether the legal fees allocated to the sale of petitioner's stock or dollar_figure were properly added to the basis in petitioner's stock as argued by petitioner or whether the fees are deductible as miscellaneous_itemized_deductions as respondent contends in litigation involving the acquisition or disposition of capital assets the origin and character of the claim control in deciding whether or not legal expenses should be capitalized 397_us_572 this court has applied the same rule to cases involving the defense or perfection of title to property see 59_tc_708 consideration must be given to the issues involved the nature and objectives of the litigation and the background and the facts surrounding the controversy id pincite petitioner transferred his pizza hut franchises in exchange for pmi stock because he was under the impression that pmi possessed the right to issue its stock in a public offering without restrictions from pizza hut when pepsico contested pmi's public offering petitioner instituted a lawsuit to enforce these rights the litigation involved the transferability of pmi's stock thereby implicating the perfection of title by petitioner and the litigation culminated in the sale of the stock to pepsico thus percent of the legal expenses or dollar_figure of the dollar_figure legal fees paid was properly included in the basis of petitioner's stock and treated as an offset against the sale price see 55_tc_32 legal expenditures to remove restrictions on the trans- ferability of a partnership_interest are capital in nature in addition to the dollar_figure of legal fees paid to the attorneys petitioner included dollar_figure in the basis of his pmi stock the dollar_figure related to a contingent note executed by petitioner payable to the law firm involved in the litigation payment on the note was contingent upon any future awards from the pmi litigation generally a contingent_liability may not be added to basis 40_tc_831 affd per curiam 333_f2d_653 2d cir petitioner however relies on roberts co v commissioner a memorandum opinion of this court dated date to support his claim of propriety of this addition to basis this reliance is misplaced the taxpayers in roberts capitalized contingent attorney's_fees paid for defense of claims against their father's estate the fees were paid out of the estate because the defense was successful thus the contingency had been met and the legal expenses paid prior to being capitalized into the basis of the property here the contingency had not been met and the fees had not been paid accordingly the contingent fees cannot be treated as an addition to basis in petitioner's stock in pmi deductions in connection with t j cinnamons bakery in his federal_income_tax return petitioner deducted dollar_figure as a long-term_capital_loss from his failed investment in a t j cinnamons bakery franchise on brief however peti- tioner argues that the basis of the franchise consisted of the following amounts cash paid_by petitioner note assumed by petitioner capitalized expenses dollar_figure big_number big_number total big_number 1petitioner's counsel in his trial brief admits that petitioner was not able to reconstruct the dollar_figure amount reported in the federal_income_tax return therefore our discussion will focus on the dollar_figure amount testified to by petitioner's accountant mr hoover respondent contends that the basis is limited to the amount allowed in the notice_of_deficiency dollar_figure representing the cash paid and the note assumed by petitioner thus the expenses of dollar_figure remain in dispute for the reasons set forth herein we conclude that the basis is dollar_figure petitioner included dollar_figure of expenses in the basis of his t j cinnamons bakery investment a taxpayer is responsible for maintaining sufficient records to substantiate the propriety of a deduction sec_1_6001-1 income_tax regs at trial no reliable evidence was produced by petitioner a photocopy of a handwritten note made by mr hoover listing various expenses was produced many of the items in the handwritten note were illegible the descriptions were ambiguous and no amounts were supported by documentation petitioner also produced a letter from his lawyers listing expenses_incurred by petitionerdollar_figure the letter does not assist petitioner in substantiating his expenses accordingly we find petitioner's evidence insufficient to substantiate his claimed expenses involving the t j cinnamons bakery franchise investment_interest expense deduction respondent in her notice_of_deficiency disallowed petitioner's claimed investment_interest expense deduction of dollar_figure and determined that petitioner realized dollar_figure of income from debt forgivenessdollar_figure on brief respondent abandoned 10the letter from petitioner's attorneys was sent to the sellers of the t j cinnamons bakery franchise it was written as part of petitioner's attempts to rescind the transaction and recover his money 11petitioner in his federal_income_tax return reported dollar_figure as investment_interest expense carry forward this amount was also disallowed by respondent in her notice_of_deficiency this disallowance affected the deficiency determined for petitioner concedes on brief that the federal_income_tax return inaccurately reported interest accrued in prior years because none of that interest was actually paid until accordingly the interest carried forward will consist continued this argument because she calculated that the principal balance of petitioner's borrowings was something less than the dollar_figure he ultimately paid to the bank respondent therefore concluded that the remaining balance of petitioner's payment represented interest accrued by the bank specifically respondent deter- mined that dollar_figure of petitioner's dollar_figure payment to the bank constituted payment of principal and dollar_figure related to interest respondent calculated the principal balance by tracing payments through the bank's loan commitment sheets to determine how the funds were actually disbursed this analysis was detailed credible and persuasive petitioner relies on interest_paid statements he received from the bank to support his contention that more than dollar_figure of the dollar_figure payment to the bank related to interest included in these statements was a dollar_figure amount of interest_paid for however a bank charge off authorization form indicates that the dollar_figure amount was actually written off by the bank therefore the court finds that the bank's interest_paid statements do not reflect interest actually paid_by petitioner petitioner failed to introduce any other evidence at trial concerning the principal balance on the notes or the interest_paid to the bank accordingly we sustain respondent' sec_11 continued only of the interest_expense the court determines has been paid in but not deducted by petitioner due to sec_163 limitations determination that petitioner paid dollar_figure in interest charges for legal expenses in her notice_of_deficiency respondent disallowed dollar_figure in legal expenses claimed as a deduction in since peti- tioner failed to address this issue either at trial or in his brief we treat this as a concession by petitioner and find for respondent penalties in her notice_of_deficiency respondent determined that petitioners were liable for penalties for fraud pursuant to sec_6663 prior to trial respondent conceded that no amounts were due for fraud in her answer to the petition respondent asserted an accuracy-related_penalty against peti- tioners pursuant to sec_6662 for their and federal_income_tax returns since the accuracy-related_penalty was first raised in her answer to the petition respondent has the burden_of_proof on this issue an accuracy-related_penalty equaling percent of the underpayment may be imposed for any one of five reasons sec_6662 one such reason exists where the taxpayer is negligent in completing his return sec_6662 negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code sec_6662 this court has defined negligence as the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances 85_tc_934 quoting marcello v commissioner 380_f2d_499 5th cir a taxpayer can avoid liability for the accuracy-related_penalty if he engages a competent professional to prepare his return and he reasonably relies on the advice of that professional 89_tc_849 affd 904_f2d_1011 5th cir affd 501_us_868 the taxpayer must show that he provided all relevant information to the professional 59_tc_473 petitioner engaged wayne hoover a c p a with over years of experience to prepare his and federal_income_tax returns petitioner was a longtime client of mr hoover's and heavily relied on mr hoover's advice after discussing the facts with petitioner mr hoover advised petitioner to exclude income under sec_104 and include the contingent legal fees in his pmi stock basis since the burden_of_proof is on respondent she must prove that petitioner failed to provide relevant information to mr hoover and that petitioner's reliance on mr hoover was improper respondent has failed to meet this burden the penalties for and are not sustained decision will be entered under rule


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-147673-08 date date legend legend x country d1 d2 dear ------------- --------------------------- ----------------------- ------------------------------------------------- ------------------- ------------------------------- this letter responds to the letter dated date and related correspondence written on behalf of x requesting an extension of time under sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations to file an entity classification election facts the information submitted states that x was formed under the laws of country on d1 on d2 x had a single owner x represents x was a foreign_entity eligible to elect to be classified as a disregarded_entity for federal tax purposes effective d2 the election however was not timely filed law and analysis plr-147673-08 sec_301_7701-3 provides 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 elections are necessary only when an eligible_entity does not want to be classified under the default classification or when an eligible_entity chooses to change its classification sec_301_7701-3 provides that except for certain existing entities described in sec_301_7701-3 unless a foreign eligible_entity elects otherwise the entity is a a partnership if it has two or more members and at least one member does not have limited_liability b an association if all members have limited_liability or c disregarded as an entity separate from its owner if it has a single member that does not have limited_liability sec_301_7701-3 provides that an eligible_entity may elect to be classified other than as provided under sec_301_7701-3 by filing form_8832 entity classification election with the appropriate service_center under sec_301 c iii this election will be effective on the date specified by the entity on form_8832 or on the date filed if no such date is specified the date specified on form_8832 cannot be more than days prior to the date on which the election is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except e g h and i sec_301_9100-1 defines the term regulatory election as including an election whose deadline is prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusion based solely on the facts submitted and representations made we conclude that x has satisfied the requirements of sec_301_9100-1 and sec_301_9100-3 and therefore it is granted an extension of time of sixty days from the date of this letter to file a form plr-147673-08 to elect to be treated as a disregarded_entity for federal tax purposes effective d2 a copy of this letter should be attached to the election a copy is enclosed for that purpose except as specifically set forth above we express no opinion concerning the federal tax consequences of the facts described above under any other provision of the code this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being mailed to your authorized representative sincerely curt g wilson curt g wilson associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ------------------- ---------------- --------------------------- department of the treasury washington dc person to contact ------------------------- telephone number --------------------- refer reply to cc psi b04 - plr-103884-09 date july re ---------------------------------------------- ---------------------------------------------- legend grantor ---------------------------------------------- spouse ------------------------------------------------ trust ------------------------------------------------------------------------------------- dollar_figurex ------------- accountant --------------------------- firm ------------------------ date ---------------------- year ------- year ------- year ------- year ------- dear ------------- this responds to your authorized representative’s letter dated date requesting an extension of time pursuant to sec_2642 of the internal_revenue_code and sec_301_9100-3 of the procedure and administration regulations to make an allocation of generation-skipping_transfer gst_exemption facts the facts and representations submitted are summarized as follows grantor and spouse created an irrevocable_trust trust on date1 for the benefit of their plr-103884-09 descendants grantor is the trustee of trust trust was funded in year with real_property with a fair_market_value of dollar_figurex grantor and spouse hired accountant to prepare all necessary federal and state forms and to properly calculate and report the gift and gst taxes arising from their gift in year accountant signed an affidavit stating that he was engaged to prepare the form sec_709 united_states gift and generation-skipping tax_return for grantor and spouse to report their gifts of one-half of the property to trust he further stated that he understood that the engagement included properly calculating any gst tax that arose from the gift and determining whether grantor or spouse needed to allocate their gst_exemption to trust he also stated that due to his lack of understanding of the gst tax he never provided grantor and spouse with any information regarding the gst_exemption allocation the error was discovered by grantor and spouse’s estate_planning attorney at firm while he was reviewing the trust and other estate_planning documents including the prior gift_tax returns from year to year distributions were made to grantor and spouse’s children in year one of those children died in year distributions were made to grandchildren who are the children of the deceased child a return reporting those year distributions has not yet been filed pending this ruling_request law and analysis sec_2601 imposes a tax on every generation-skipping_transfer gst made by a transferor to a skip_person a generation-skipping_transfer is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2631 as in effect for the tax_year at issue provided that for purposes of determining the gst tax every individual shall be allowed a gst_exemption of dollar_figure adjusted for inflation under sec_2631 which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_26_2632-1 of the generation-skipping_transfer_tax regulations provides that an allocation of gst_exemption to property transferred during the transferor’s lifetime is made on form_709 sec_2642 provides that except as provided in sec_2642 if the allocation of the gst_exemption to any transfers of property is made on a gift_tax_return filed on or before the date prescribed by sec_6075 for such transfer the value of such property for purposes of sec_2642 shall be its value as finally determined for purposes of chapter within the meaning of sec_2001 plr-103884-09 sec_2642 provides that the secretary shall by regulation prescribe such circumstances and procedures under which extensions of time will be granted to make an allocation of gst_exemption described in sec_2642 or and an election under sec_2632 or c such regulations shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of this paragraph sec_2642 provides that in determining whether to grant relief under sec_2642 the secretary shall take into account all relevant circumstances including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the secretary deems relevant for purposes of determining whether to grant relief the time for making the allocation or election shall be treated as if not expressly prescribed by statute notice_2001_50 2001_2_cb_189 provides that under sec_2642 the time for allocating the gst_exemption to lifetime transfers is to be treated as if not expressly prescribed by statute and taxpayers may seek an extension of time to make an allocation described in sec_2642 or b under the provisions of sec_301_9100-3 sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute in accordance with sec_2642 and notice_2001_50 taxpayers may seek an extension of time to make an allocation described in sec_2642 or b or an election described in sec_2632 or c under the provisions of sec_301_9100-3 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election based on the facts submitted and representations made we conclude that the requirements of sec_301_9100-3 are satisfied therefore grantor is granted an extension of time of days from the date of this letter to make an allocation of his available gst_exemption with respect to his transfer to trust in year the allocation will be effective as of the date of the transfer to trust and the value of the transfer to trust as determined for federal gift_tax purposes will be used in determining the inclusion_ratio with respect to trust plr-103884-09 this allocation should be made on a supplemental form_709 and filed with the internal_revenue_service cincinnati service_center at the following address internal_revenue_service cincinnati service center-stop cincinnati ohio a copy of this letter should be attached to the supplemental form_709 the rulings contained in this letter are based upon information and representations submitted by the taxpayers and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination except as specifically ruled herein we express no opinion on the federal tax consequences of the transaction under the cited provisions or under any other provisions of the code this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent sincerely curt g wilson associate chief_counsel passthroughs and special industries enclosure copy for sec_6110 purposes copy of this letter