department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc corp br fsa-n-153362-01 uilc internal_revenue_service national_office field_service_advice memorandum for chief counsel’s office special trial attorney from subject jasper l cummings assistant chief_counsel cc corp the use of sec_269 and sec_482 to prevent duplication of loss this advice is a supplement to a field_service_advice issued by deborah butler on date in accordance with sec_6110 this chief_counsel_advice should not be cited as precedent legend a b c d e date1 date2 date3 date4 date5 year1 year2 year3 a fsa-n-153362-01 b c d e f g h i a b c issue sec_1 whether sec_269 can be applied to disallow any loss by d on the sale or disposition of worthless properties whether upon d’s abandonments of worthless c-contributed properties sec_482 permits the service to make appropriate primary and correlative allocations to d and c respectively and conforming adjustments to the basis of c’s d aps to prevent the replication of losses that had effectively been sustained as of the time of the sec_351 transfer conclusion sec_1 since e was not a shareholder of d immediately before c’s transfer of the properties to d sec_269 can be applied to disallow any loss by d on the sale or disposition of worthless properties the service believes such allocations and adjustments fall within the broad mandate of sec_482 to prevent evasion of taxes and to clearly reflect income and would in fact be necessary to prevent the replication of losses that had effectively been sustained as of the time of the sec_351 transfer facts d was formed on or about date1 by e e did not receive any stock of d upon d’s formation the only shareholder of d at the time of d’s formation was an individual incorporator holding one share of d stock on or about date2 c an indirect subsidiary of e acquired a shares of d aps in a purported sec_351 transaction in exchange for a b and c properties with a combined tax basis of b and a fair_market_value of about c at the same time a fsa-n-153362-01 and b sister companies of c contributed income-producing properties in exchange for d common_stock and non-voting preferred_stock concurrently with the purported sec_351 transaction an additional d shares of aps were privately sold to institutional investors for e per share the service in a previous fsa dated date concluded that the above mentioned transaction met the requirements of sec_351 in date c sold f shares of its aps to outside investors for g and reported a loss of h in year1 d began to sell or abandon certain high basis low value c- contributed properties and take corresponding loss deductions as of date3 d’s remaining c-contributed properties were all non-producing and had a total basis of less than i d files a separate tax_return from that of the e consolidated_group which includes e c a and b the e consolidated group’s taxable years ending date4 year1 and year2 are at issue in this case the sec_482 regulations t d 1968_1_cb_218 effective for taxable years beginning on or before date are applicable with respect to the taxable_year year1 abandonments we understand there were no abandonments in the preceding_taxable_year the temporary sec_482 regulations t d 1993_1_cb_90 effective for taxable years beginning after date but before date are applicable with respect to the taxable year2 abandonments see temp sec_1_482-1t the final sec_482 regulations t d 1994_2_cb_93 are generally effective for taxable years beginning after date see sec_1_482-1 pursuant to sec_1_482-1 a taxpayer may elect to apply retroactively the sec_482 regulations but we understand that no such election has been made in this case thus the final sec_482 regulations are applicable with respect to abandonments in taxable years subsequent to the taxable years at issue in this case law and analysi sec_1 sec_269 sec_269 provides a in general -if- any corporation acquires or acquired on or after date directly or indirectly property of another corporation not controlled directly or indirectly immediately before such acquisition by such acquiring_corporation or its shareholders the basis of which property in the hands of the acquiring_corporation is determined by reference to the basis in the hands of the transferor_corporation and the principal purpose for which such fsa-n-153362-01 acquisition was made is evasion or avoidance of federal_income_tax by securing the benefit of a deduction credit or other allowance which such corporation would not otherwise enjoy then the secretary may disallow such deduction credit or other allowance for purposes of this section control means the ownership of stock possessing at least percent of the total combined voting power of all classes of stock entitled to vote or at least percent of the total value of shares of all classes of stock entitled to vote under sec_1_269-3 if a corporation acquires property having in its hands an aggregate carryover_basis which is materially greater than its aggregate fair_market_value at the time of such acquisition and utilizes the property to create tax reducing losses then it is assumed that in absence of evidence to the contrary the principal purpose for acquiring such property was evasion or avoidance of federal_income_tax however in order for this assumption to apply the additional requirements of sec_269 must be met in the instant case the requirements of lack of common_control of the transferor and transferee must be met in order for the statute to apply in the instant case these requirements were met because e was not a shareholder of d immediately before the transfer of property from c to d common_control sec_269 does not apply to asset acquisitions where the transferee and the transferor were under common_control immediately before the transaction boris l bitker james s eustice federal taxation of corporations and shareholders dollar_figure d 7th ed it is clear that e owned percent of the voting power and value of c the transferor immediately before the date2 transfer the existence of common_control then turns on whether e owned any stock of d prior to the transfer although the facts recite that e formed d on date1 e did not receive any stock of d upon d’s formation the only shareholder of d at the time of d’s formation was an individual incorporator holding one share of d stock since e did not receive any stock in exchange for any contribution it made in forming d e was not a shareholder of d immediately before the transfer of property from c to d therefore common_control would not exist for purposes of a because neither d nor its shareholders controlled c immediately before the transfer principal purpose in order for sec_269 to apply the principal purpose of the acquisition must be to evade or avoid federal_income_tax under sec_1_269-3 if a corporation acquires property having in its hands an aggregate carryover_basis which is materially greater than its aggregate fair_market_value at the time of such acquisition and utilizes the property to create tax reducing losses then it is fsa-n-153362-01 assumed that in absence of evidence to the contrary the principal purpose for acquiring such property was evasion or avoidance of federal_income_tax in the instant case d acquired property with a basis materially in excess of its fair_market_value and this property was used to create a double deduction ie a loss on preferred_stock and worthless assets therefore the principal purpose of d’s acquisition of the worthless properties from c was to avoid or evade income_tax in the instant case there was no substantial purpose for the transfer of worthless properties from c to d other than tax_avoidance the taxpayer’s stated business_purpose for this transfer was to raise cash through the sale of these properties the business_purpose of raising cash did not require the incorporation of d in addition the properties that were worthless at the time of the date transfer did not produce any cash however the sale of the aps stock by c as well the sale of the value properties by d did produce cash securing the benefit in order for a to apply the acquisition must secure the benefit of a deduction credit or other allowance that such person or corporation would not otherwise enjoy in the instant case when d acquired the worthless built in loss property from c it secured the benefit of the use of a loss it otherwise would not enjoy absent the transfer the built in loss would have been recognized by c on the abandonment of the property the taxpayer may argue that this transaction was a tax planning method used to effect a business motivated acquisition and that courts have refused to apply sec_269 to transactions of this type arwood corp v commissioner t c memo however there was no business_purpose for the transfer of the worthless properties therefore it appears d did secure the benefit of a deduction it otherwise would not enjoy carryover_basis in order for sec_269 to apply the acquiring corporation’s basis in the property must be determined by reference to transferor’s basis in that property in the instant case d acquired property from c as a part of a sec_351 transaction therefore d’s basis in the property it acquired from c was determined by reference to c’s basis in the property therefore the carryover_basis requirement of sec_269 is met summary fsa-n-153362-01 because the available information indicates that e was not a shareholder of d immediately before the transfer of property from c to d the service should go forward with the argument that sec_269 can be applied to disallow any loss by d on the sale or disposition of worthless properties a - sec_482 allocations in the context of nonrecognition transactions law and analysis the commissioner’s broad authority to make allocations under sec_482 in the context of nonrecognition transactions such as sec_351 exchanges has long been recognized by the courts such allocations have been upheld when the nonrecognition_transaction was entered into for tax purposes or the nonrecognition_transaction does not clearly reflect the income of the parties to the transaction the seminal case in which a court applied sec_482 in holding that a nonrecognition_transaction did not clearly reflect the income of the parties to the transaction is 137_f2d_600 3d cir cert_denied 320_us_794 in national securities a parent_corporation held big_number shares of standard gas and electric company sg e stock that had declined in value from approximately dollar_figure when purchased in to dollar_figure in in the sg e stock was transferred in a sec_112 a predecessor to sec_351 exchange to the taxpayer a wholly-owned subsidiary of the parent for shares of the subsidiary’s stock in the same taxable_year as the nonrecognition transfer the subsidiary sold the transferred sg e stock for dollar_figure and claimed a loss on its tax_return equal to the difference between this amount and its basis ie dollar_figure which the subsidiary had carried over from its parent under sec_113 a predecessor to sec_362 the commissioner determined that the loss should be reallocated to the parent_corporation which was unable to use it in order to clearly reflect income this determination was upheld by the third circuit_court of appeals which stated it seems most reasonable to treat the loss as one which had in fact been sustained by the parent rather than by the subsidiary the shifting of the loss to the subsidiary gives an artificial picture of its true income and one which it was unnecessary for the commissioner to accept the commissioner was justified in finding that the the taxpayer was however entitled to that part of the loss deduction which represented the difference between the fair_market_value of the shares when acquired by the taxpayer dollar_figure and the amount for which the taxpayer sold them dollar_figure see f 2d pincite fsa-n-153362-01 taxpayer’s income was not clearly reflected by its return for since the return included a loss which was in fact incurred by the parent f 2d pincite the effect of the loss reallocation on the parent’s basis in the shares of stock in the subsidiary obtained in the nonrecognition transfer ie a conforming_adjustment was not addressed in the third circuit opinion nor in the earlier board_of_tax_appeals opinion 46_bta_562 b discussion of sec_482 theories in order to develop the strongest case possible for the application of sec_482 we would recommend the field develop the following facts on an asset by asset basis showing a to what extent the losses associated with the abandoned properties had economically accrued to c at the time of the date2 sec_351 transfer and b to what extent the nonrecognition_transaction clearly reflects the income of the parties involved in the transaction and c whether the transfer of property involved a tax_avoidance purpose see 137_f2d_600 3d cir cert_denied 320_us_794 compare 84_tc_996 where the tax_court seemed to view transactions like that present in national securities and in the instant case ie built in gains or losses on transferred property as requiring reallocation when the sole purpose of the transfer of such properties was to achieve tax consequences on the disposition of the property by the transferee that were more favorable than the tax consequences of a disposition by the transferor when such factual development occurs national securities and its progeny appear to support the proposed primary and correlative allocations under the theory that the inclusion of worthless properties in the sec_351 transaction resulted in a distortion of true_taxable_income because losses sustained on the properties were built in before their transfer and hence were losses generated by c therefore those losses should be allocated from d to c we also believe that if such facts are developed the proposed sec_482 allocations may be made even though the abandonments occur in taxable years subsequent to the taxable_year of the sec_351 transaction we note that this is arguably a novel approach in that the national securities line of cases do not directly address a conforming_adjustment to basis when sec_482 is applied in the context of a sec_351 transaction we believe however that the authorities discussed above generally support the conforming adjustments to basis which logically and analytically follow from the primary and correlative allocations and are necessary to prevent the inappropriate replication of losses that had effectively fsa-n-153362-01 been sustained at the time of the sec_351 transaction such loss replication is not eliminated solely through the proposed primary and correlative sec_482 allocations because when only these allocations are made c’s basis in its remaining d aps would continue to reflect in part the abandoned properties’ built- in losses adjustments to the basis of c’s aps are thus required to conform c’s accounts to reflect the primary and correlative sec_482 allocations see sec_1_482-1 appropriate adjustments must be made to conform a taxpayer’s accounts to reflect allocations made under sec_482 the national securities theory underlying the primary and correlative sec_482 allocations reallocates abandonment losses to c to the extent these losses had economically accrued to c at the time of the sec_351 transaction under these circumstances it is not appropriate for the basis of c’s aps to continue to replicate reallocated losses under national securities d would be entitled to abandonment losses to the extent of any decrease in an abandoned property’s value subsequent to the date2 sec_351 transaction see f 2d pincite as a corollary c would be entitled to losses attributable to a post-contribution decrease in the value of its d aps which would reflect the value of d’s assets the analysis used in the example set forth below accordingly assumes that post-contribution decreases in an abandoned property’s value may properly be replicated we note that the application of sec_482 in the context of a nonrecognition transfer also requires a consideration of 84_tc_996 aff’d in part and rev’d in part 856_f2d_855 7th cir in eli lilly co the commissioner sought to reallocate to a united_states_corporation income earned through the use of intangibles in the manufacture and sale of products in and claiming that the sec_351 transaction transferring the intangibles in to a wholly-owned puerto rican subsidiary should be disregarded to prevent a distortion_of_income resulting from a mismatching of expenses and income the tax_court however finding that the transaction had a bona_fide business reason ie to qualify for the tax benefits of sec_931 and that its form and substance comported with economic reality held that there was no tax_avoidance and that no mismatching had occurred as a result the commissioner could not invoke either the tax_avoidance standard or the clear_reflection_of_income standard of sec_482 and the tax_court instead looked to whether a fair value was paid for the transfer of the intangibles these findings were upheld by the seventh circuit_court of appeals the tax_court in eli lilly co stated that sec_482 could be applied to override nonrecognition transactions in certain situations where the transaction was entered into solely for tax purposes or where the nonrecognition_transaction does not clearly fsa-n-153362-01 reflect the income of the parties to the transaction however the tax_court in eli lilly co found that the nonrecognition_transaction in that case had a bona_fide business reason and that its form and substance comported with economic reality as a result the transaction was not solely entered into for tax purposes and the transaction did clearly reflect the income of the parties to the transaction therefore the above mentioned situations were not applicable in applying sec_482 to override the eli lilly co nonrecognition_transaction there is moreover other case authority for the broad application of sec_482 in the non-recognition context based solely on the clear_reflection_of_income prong finally we note that the national securities line of cases involves the transferee’s complete disposition within a short time frame of all property received in a nonrecognition transfer in the present case in contrast it must be considered that d held on to the majority of the c-contributed properties through year3 if not later the time lag between the date2 sec_351 transaction and d’s abandonments of c-contributed properties may complicate the application of sec_482 in the instant case the sec_482 theory we have developed begins by making primary and correlative allocations to reduce d’s losses and to increase c’s losses from the abandonment of c-contributed properties deemed worthless at the time of the sec_351 transaction the example set forth below illustrates one application of the sec_482 theory example the tax_court in eli lilly stated that sec_482 could override sec_351 where there was a tax_avoidance motive for the transaction or there was an absence of a clear_reflection_of_income that court seemed to view transactions like that present in national securities and in the instant case ie built in gains or losses on transferred property as requiring reallocation as a tax_avoidance case rather than as a clear reflection case despite the fact that the tax_court and the court_of_appeals in national securities treated such a transaction as a clear reflection situation and did not require a showing of tax_avoidance see national securitie sec_46 bta pincite see eg 88_tc_252 in which the tax_court noted that an independent business_purpose is not in and of itself a complete defense to a sec_482 reallocation if such an allocation is appropriate to clearly reflect income we assume that the tax years in question with respect to d are open therefore the service can make a primary_adjustment to d’s income with respect to the tax years in question fsa-n-153362-01 the sec_482 theory developed below starts from the premise that the loss reported by c upon its date5 sale of d shares must be entirely recaptured before abandonment losses reallocated to c through primary sec_482 allocations are permitted to affect c’s taxable_income a primary allocation reduces d’s losses and a correlative allocation increases c’s losses in year as noted the primary allocation to d disallows the abandonment_loss to d in the taxable_year of the abandonment to the extent such loss exceeds the fair_market_value of the property as of the date of the sec_351 transfer an additional sec_482 allocation is necessary to clearly reflect c’s income in the taxable_year of the abandonment to the extent the abandonment_loss has already been reflected in the loss reported by c upon its sale of d aps - ie the additional sec_482 allocations will prevent the reallocated abandonment losses from having an effect on c’s taxable_income until the amount of the reallocated abandonment losses exceeds c’s aps sale loss conforming adjustments would then be made to c’s basis in its d aps to reflect the sec_482 allocations the application of this theory is illustrated in the following example assume a year sec_351 transaction in which c contributes the following properties to d in exchange for shares of d year1- sec_351 transaction adjusted_basis fair_market_value built-in_loss_property a property b total assume property a and property b are d’s only assets in year c sell sec_50 d shares for their fair_market_value of taking a loss of thereafter c holds d shares with a fair_market_value of and an adjusted_basis of the effects of the year d share sale can be illustrated as follows year - sell shares c’s remaining d shares adjusted_basis fair_market_value loss on sale adjusted_basis fair_market_value built-in lo sec_24 fsa-n-153362-01 in year d abandons property a under national securities d is allowed a loss of - ie d is entitled to the abandonment_loss to the extent of any decrease in property a’s value subsequent to the year sec_351 transaction the primary allocation denies d of the abandonment_loss increasing d’s year income by property a’s adjusted_basis less property a’s fair_market_value at the time of the sec_351 transaction the service makes a correlative allocation reallocating to c of the abandonment_loss an additional sec_482 allocation is then necessary to clearly reflect income because under the sec_482 theory developed in this example c is considered to have already taken a portion of the reallocated year abandonment_loss upon its year sale of d shares the amount of the additional sec_482 allocation i sec_44 - ie the amount of c’s year loss on its sale of d shares the effects of the year allocations to c may be illustrated as follows year - sec_482 allocations to c reallocate abandonment_loss - additional sec_482 allocation to recapture_year loss on d shares net effect on c’s year income an initial conforming_adjustment of reflects the reallocated abandonment_loss followed by a further conforming_adjustment of to reflect the recapture of the year stock sale loss the net effect of the conforming adjustments is to decrease c’s basis in its d shares by to with a built-in_loss of ie adjusted_basis less fair_market_value the effects of the year conforming adjustments may be illustrated as follows under the sec_482 theory developed in this example when the amount of the first abandonment_loss is greater than the stock sale loss the additional sec_482 allocation will equal the year stock sale loss no further additional sec_482 allocations will be necessary because the stock sale loss will have been completely consumed ie the inappropriate loss replication will have been eliminated when however the amount of the first abandonment_loss is less than the stock sale loss the first additional sec_482 allocation will be equal to the abandonment_loss in no case will the additional sec_482 allocation exceed the amount of the abandonment_loss subsequent abandonments will trigger further additional sec_482 allocations never exceeding the amount of the abandonment_loss until the total amount of the additional sec_482 allocations is equal to the year stock sale loss fsa-n-153362-01 year - conforming adjustments to basis reflect reallocated abandonment_loss reflect year loss on share sale c’s remaining d shares as of end of year adjusted_basis fair_market_value x net effect on c’s basis in shares built-in_loss in year d abandons property b under national securities d is allowed a loss of the primary allocation denies d of the abandonment_loss increasing d’s year income by property b’ sec_150 adjusted_basis less property b’s fair_market_value at the time of the sec_351 transaction the service makes a correlative allocation reallocating to c of the abandonment_loss a conforming_adjustment of reflects the reallocated abandonment_loss reducing c’s basis in its d shares to with a built-in_loss of ie adjusted_basis less zero fair_market_value the effects of the year sec_482 allocations may be illustrated as follows year - sec_482 allocations primary allocation to d correlative allocation to c conforming_adjustment to c’s c’s remaining d shares as of end of year adjusted_basis fair_market_value d has no assets basis built-in_loss applying the above example’s sec_482 theory in this factual scenario and assuming a write-off of c’s zero fair_market_value d shares c has been allowed total losses of as follows fsa-n-153362-01 total c losses as of end of year loss on year sale of d shares - net effect of year allocations net effect of year allocations write-off of zero fair_market_value d shares total this amount is equal to the total built-in_loss of as of the year sec_351 transaction plus the real loss of in c’s remaining d shares d has been allowed total losses of an amount equal to the decrease in the c-contributed properties’ values subsequent to the year sec_351 transaction loss replication has thus been eliminated except to the extent of the built-in_loss in c’s d shares which have a zero fair_market_value following the abandonment of property b as explained above the replication of losses attributable to a post- contribution decrease in the value of the abandoned properties is consistent with national securities summary although national securities and its progeny do not discuss the specific sec_482 primary and correlative allocations and conforming adjustments proposed in the present case we believe such allocations and adjustments fall within the broad mandate of sec_482 we have set forth above a sec_482 theory to prevent the replication of losses economically sustained at the time of the sec_351 transaction as noted above the national securities line of cases do not directly provide for a conforming_adjustment to basis when sec_482 is applied in the context of a sec_351 transaction moreover the time lag between the date5 sec_351 transaction and d’s abandonments of worthless c-contributed properties presents a complicating factor in the use of sec_482 in this case given that the national securities line of cases involves the transferee’s complete disposition within a short time of all property received in a nonrecognition transfer this writing may contain privileged information any unauthorized disclosure of this writing may have an adverse effect on privileges such as the attorney client privilege if disclosure becomes necessary please contact this office for our views fsa-n-153362-01 please call if you have any further questions by jasper l cummings assistant chief_counsel alfred c bishop jr branch chief corporate office of assistant chief_counsel corporate branch


t c memo united_states tax_court james h leste and stacy leste et al petitioners v commissioner of internal revenue respondent docket nos filed date sebastian d'amico for petitioners james j posedel and gordon l gidlund for respondent memorandum findings_of_fact and opinion jacobs judge in these consolidated cases respondent determined deficiencies in an addition to and penalties on petitioners' federal income taxes as follows cases of the following petitioners are consolidated herewith richard w moore and katherine j moore docket no james h leste docket no and first associates mortgage corp docket no james h and stacy leste docket no year deficiency dollar_figure sec_6662 dollar_figure accuracy-related_penalty richard w and katherine j moore docket no year deficiency dollar_figure big_number big_number james h leste docket no year deficiency dollar_figure big_number accuracy-related_penalty sec_6662 dollar_figure big_number big_number accuracy-related_penalty sec_6662 dollar_figure big_number first associates mortgage corp docket no year ended addition_to_tax accuracy-related_penalty deficiency sec_6651 dollar_figure big_number big_number -- -- dollar_figure sec_6662 dollar_figure big_number big_number unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure after concessions the issues for decision are whether payments made by corporate petitioner first associates mortgage corp famc to valentine silbernagel silbernagel pursuant to a consulting and noncompetition agreement represent compensation deductible under sec_162 as petitioners contend or additional consideration to valentine associates ltd corp for james h leste's and richard w moore's purchase of famc's stock and thus nondeductible by famc and taxable as constructive dividends to the individual petitioners as respondent contends whether all petitioners are liable for the accuracy- related penalty under sec_6662 pertaining to the above issue whether the lestes and the moores are liable for the accuracy-related_penalty under sec_6662 for failing to properly report bonus income received from famc on their individual income_tax returns and whether famc is liable for the accuracy-related_penalty under sec_6662 for overstating its cost_of_goods_sold by dollar_figure for its fiscal_year ended date findings_of_fact some of the facts have been stipulated and are found accordingly the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time of the filing of the petitions the lestes and the moores resided and famc's principal_place_of_business was located in california famc was incorporated on date it was a wholly owned subsidiary of valentine associates limited corp valc valc was incorporated in and was engaged in the business of providing collection and accounting services to mortgage lenders loan servicing at all relevant times silbernagel owned all the stock of valc and was its president from until the time valc was incorporated silbernagel had been the president of a large mobile home loan servicing company prior thereto he had worked for about to years for an automobile loan servicing company in his prior employment silbernagel procured loans and marketed them for sale in bulk to banks and savings and loan associations silbernagel had developed contacts pincite to banks and savings and loan associations with which he had worked utilizing his experience and contacts in the loan servicing industry silbernagel organized valc and began providing loan procurement and marketing services as well as collection and foreclosure services primarily to mobile home mortgage lenders on date valc's mobile home mortgage servicing business which at that time represented about to percent of the company's operations was sold to wesav financial corp wesav for approximately dollar_figure the sale contract between wesav and valc included a covenant_not_to_compete pursuant to which valc agreed to refrain from owning or operating a mobile home loan servicing business for a period of months in addition silbernagel personally executed a consulting and noncompetition agreement with wesav that agreement noted silbernagel's substantial knowledge and expertise in the operation management business contacts and research_and_development activities of the business and required him to refrain from aiding any competitor or potential competitor for a period of months as compensation_for services to be rendered and for his covenant_not_to_compete silbernagel was to receive dollar_figure per month during the term of the agreement despite valc's and silbernagel's noncompetition agreement with wesav valc entered into a mortgage servicing agreement with imperial savings association imperial on date pursuant to that agreement valc agreed to service loans purchased by imperial in bulk from other lenders the agreement was prospective only and no loans were being serviced at the time the agreement was entered the agreement required valc to obtain all necessary business licenses a fidelity bond protecting against losses caused by improper employee acts and various insurance policies naming imperial as the beneficiary in response to concerns raised by wesav regarding valc's covenant_not_to_compete with wesav the servicing rights and obligations under the imperial agreement were assigned to famc on date at that time famc was not an active business_entity and had been a dormant subsidiary of valc since it was incorporated in shortly after the assignment of the imperial contract to famc and to further alleviate concerns over his covenant_not_to_compete with wesav silbernagel approached petitioners james leste leste and richard moore moore to determine whether they would be interested in buying the stock of famc and operating the company as an independent loan servicing organization leste and moore joined valc in and held the positions of vice president of finance and senior vice president in charge of lending respectively both men were aware that valc's servicing agreement with imperial was causing silbernagel to receive a lot of flack from wesav they knew that famc had not yet begun servicing loans and they understood that famc would have to secure the appropriate business licenses a fidelity bond and various insurance policies prior to commencing loan service for imperial leste and moore agreed to acquire the stock of famc and they executed an agreement with valc on date pursuant to this agreement leste and moore each paid dollar_figure to acquire all the outstanding_stock of famc and thereafter they became equal percent shareholders of famc in addition to the amounts paid for famc's stock leste and moore each contributed dollar_figure to famc's working_capital to be used in acquiring office furniture and for other expenses associated with getting the business started after purchasing the stock of famc leste and moore served as the company's chief financial officer and president respectively at the time leste and moore purchased the stock of famc the company had not yet obtained the fidelity bond and insurance policies required pursuant to the imperial loan servicing agreement although famc began servicing some large loan pools for imperial in date famc's failure to obtain the fidelity bond and insurance policies resulted in a somewhat precarious relationship with imperial in date stephen m wright wright imperial's senior vice president wrote to moore requesting that the fidelity bond and insurance requirements be satisfied within days or i will have no choice but to consider pulling the servicing from your company famc complied with wright's request in date shortly after purchasing the stock of famc leste and moore entered into discussions with a consultant donald g shirk shirk who offered to assist famc in contacting banks and other mortgage lenders and in acting as a broker in the buying and selling of mobile home loan pools in a letter to moore dated date shirk stated that his services could assist famc in developing large profitable servicing portfolios in his letter shirk proposed a fee for his services of dollar_figure per day plus office rental expenses and reimbursement for other reasonable and verifiable expenses an oral agreement was reached pursuant to which shirk was hired as a consultant to famc on substantially the same terms as outlined in his letter to moore thereafter shirk submitted billing statements to famc pursuant to the agreed per_diem consulting fee and expense reimbursement arrangement the record does not indicate whether shirk entered into a covenant_not_to_compete with famc shirk provided consulting services to famc through date when it was determined that he was not generating an appropriate level of new business to replace famc's declining loan pool balances effective date shirk's compensation under the consulting agreement with famc was changed to a commission-only arrangement whereunder shirk was paid only when he brought in new business in the final months of the original per_diem consulting arrangement famc paid shirk a total of dollar_figure in consulting fees and expense reimbursements there is no evidence in the record as to the payment of any fees to shirk under the commission-based consulting agreement and it appears that his consulting services to famc were essentially discontinued by date at about that time leste and moore entered into discussions with silbernagel who had previously offered to provide consulting services to famc as the founder of valc and ultimately famc itself and with his numerous contacts in the loan servicing industry it was anticipated that silbernagel would add some muscle to famc's marketing effort and help restore the company's declining loan pool balances on date silbernagel entered into a consulting and noncompetition agreement with famc under that agreement silbernagel's primary duty was to attract new business through direct sales and other marketing efforts designed to promote famc's loan servicing business silbernagel was required to refer all loan servicing opportunities made known to him to famc and he agreed not to compete with famc by directly or indirectly assisting famc's competitors the consulting and noncompetition agreement with silbernagel was incorporated into a multiyear contract commencing on date and extending to date during the first years of the agreement silbernagel was to be paid the lesser_of dollar_figure per year or percent of famc's after-tax profits in conjunction therewith famc a consulting agreement with silbernagel was previously proposed but not executed in date at that time leste and moore decided to give shirk a little more time to see how much new business he could bring in was to advance to silbernagel a fully earned draw of dollar_figure per month against annual compensation thereafter the compensation limits and monthly draw amounts were to be reduced by percent for the remaining years of the contract during the years in issue silbernagel contacted between and banks and other mortgage lenders many of which he had worked with previously in an effort to generate loan servicing business for famc approximately percent or more of those contacts involved personal meetings with representatives of the mortgage lenders additionally moore and silbernagel spoke over the phone approximately times per month although silbernagel did not submit billing statements to famc through their regular phone conversations moore was kept apprised of silbernagel's activities including any leads that silbernagel had developed and whether any business was expected to come in despite silbernagel's efforts famc did not receive the anticipated increase in loan servicing business and it became increasingly difficult to support silbernagel's consulting fees in date famc reduced its payments to silbernagel to dollar_figure per month in date the payments were further reduced to dollar_figure per month silbernagel was aware of famc's financial difficulties and agreed to the reductions in his consulting fees in date leste wrote to silbernagel to inform him that his consulting agreement was to be terminated effective date silbernagel disagreed with the termination of the consulting agreement and in a letter to leste dated date silbernagel stated i must insist that you continue with the reduced consulting fees as called for in our agreement or i will be required to take the necessary action to enforce the agreement despite the comments in his letter to leste silbernagel did not pursue legal action to enforce the consulting agreement nor did he receive any additional consulting fees from famc famc issued forms to silbernagel for the calendar years and in the respective amounts of dollar_figure dollar_figure and dollar_figure silbernagel indicated at trial that he reported these amounts as ordinary_income from consulting services on his federal_income_tax returns for the respective years on its federal_income_tax returns for its fiscal years ended date and famc claimed deductions of dollar_figure dollar_figure and dollar_figure respectively for consulting fees paid to silbernagel respondent disallowed these deductions contending silbernagel performed few or no consulting services for famc and that the payments to silbernagel were in fact additional payments with regard to leste's and moore's purchase of famc's stock from valc further as a result of famc's payments to silbernagel respondent determined that leste and moore each had silbernagel's tax returns were not introduced into evidence however respondent did not challenge silbernagel's assertion that the consulting fees were reported as ordinary_income received constructive dividends from famc in the amounts of dollar_figure dollar_figure and dollar_figure for the calendar years and respectively during and leste received bonuses from famc in the amounts of dollar_figure and dollar_figure respectively the entire amount of the bonus and one-half of the bonus were incorrectly reported as self-employment_income on leste's individual income_tax returns for the respective years leste concedes that this error resulted in the overstatement of deductions for contributions to his pension_plan and that he is liable for excise_taxes on the overstated amounts during and moore received bonuses from famc in the amounts of dollar_figure and dollar_figure respectively one-half of the bonus and the entire amount of the bonus were not reported on moore's original income_tax returns for the respective years after respondent's examination of famc's returns had commenced moore filed an amended income_tax return for reporting the additional dollar_figure in bonus income for that year moore also has conceded that he is liable for the bonus income he failed to report on his return on its income_tax return for the fiscal_year ending date famc claimed dollar_figure for cost_of_goods_sold respondent disallowed this amount in full and famc concedes the disallowance opinion sec_162 permits a corporation to deduct a reasonable allowance for salaries or other compensation_for_personal_services actually rendered as an ordinary and necessary business_expense compensation payments are deductible under sec_162 if they are reasonable and paid purely for services rendered to the business sec_1_162-7 income_tax regs petitioners contend that the payments to silbernagel represent compensation_for services rendered and for his agreement not to compete with famc respondent claims that the payments were in substance additional payments by leste and moore for the stock in famc respondent contends that famc is not entitled to deduct the payments under sec_162 because silbernagel performed few or no consulting services for famc and that such payments constitute constructive dividends to leste and moore to the extent of famc's earnings_and_profits 421_f2d_910 6th cir 70_tc_651 petitioners provided little documentation of the work performed by silbernagel on behalf of famc we are mindful however that the consulting and noncompetition agreement entered between famc and silbernagel provided for fixed monthly payments to the parties agree that famc had sufficient earnings_and_profits in all relevant years such that all of the payments to silbernagel would be eligible for treatment as constructive dividends silbernagel regardless of the number of days worked and the agreement did not require silbernagel to submit billing statements or other summaries of his consulting activities in determining the nature of famc's payments to silbernagel we consider silbernagel's testimony which we found highly credible we are convinced that silbernagel indeed performed consulting services for famc which included utilizing his contacts in the mortgage lending industry in an attempt to generate business for famc and regularly discussing his activities in that regard with moore further silbernagel testified that he reported the payments received from famc as ordinary_income because he considered them to be compensation_for consulting services rendered and for his covenant_not_to_compete silbernagel was hired as a consultant to famc at a time when the company's loan servicing business was declining leste and moore whom we also regard as credible witnesses indicated that they expected silbernagel's expertise and contacts in the mortgage lending industry to add muscle to famc's marketing effort and generate new loan servicing business as well as smooth out famc's somewhat precarious relationship with imperial it is reasonable that leste and moore considered it worthwhile to pursue silbernagel's offer to provide consulting services to famc and in as noted above famc's prior consulting agreement with shirk was a per_diem and expense reimbursement arrangement whereunder shirk was required to submit monthly billing statements in order to get paid conjunction therewith famc secured from him a covenant_not_to_compete the dollar_figure valc received from leste and moore for the stock of famc was not unduly low and in our opinion none of the consulting fees paid to silbernagel was for the famc stock at the time leste and moore considered purchasing the stock of famc they were aware of the speculative value of the imperial loan servicing agreement assigned by valc to famc it was not clear at that time how much loan servicing business would be generated by the imperial agreement nevertheless leste and moore agreed to pay and valc accepted dollar_figure for all of famc's stock absent a showing that this was not an arm's-length agreement or a reasonable price to pay for the risky business opportunity famc provided we will not disturb their judgment we do not find as respondent contends that the consulting and noncompetition agreement between famc and silbernagel more than months after leste and moore purchased famc's stock was intended to provide additional consideration to silbernagel in connection with that purchase we also consider the amounts paid silbernagel pursuant to his consulting and noncompetition agreement with famc to be reasonable in light of his expertise and contacts in the mortgage lending industry famc paid shirk a total of dollar_figure during the final months of his per_diem and expense reimbursement consulting agreement or on average approximately dollar_figure per month shirk's consulting agreement apparently did not contain a covenant_not_to_compete with famc silbernagel's agreement with famc however contained both a consulting services component and a covenant_not_to_compete while the covenant_not_to_compete did not have a separately_stated consideration it did represent an additional commitment on silbernagel's part supplemental to the consulting commitment and it was an added value for the consideration famc was to pay silbernagel monthly silbernagel had previously been paid dollar_figure per month for a covenant_not_to_compete with wesav for a period of months following wesav's purchase of valc's mobile home mortgage servicing business we believe the dollar_figure monthly fee paid to silbernagel constitutes reasonable_compensation for both the consulting services component and the covenant_not_to_compete in the agreement between silbernagel and famc consequently we hold that famc is entitled to deduct all of the payments made to silbernagel pursuant to the consulting and noncompetition agreement entered between those parties there although the agreement with wesav also required silbernagel to assist in effecting a smooth transfer of the business we find that the payments under the agreement were primarily designed to compensate him for his covenant_not_to_compete with wesav for a period of months following the sale in determining that the dollar_figure monthly fee was reasonable we recognize that there were subsequent reductions of the monthly payment to dollar_figure in date and to dollar_figure in date those reductions were the result of arm's-length negotiations precipitated by the decline in famc's loan servicing business and the company's resulting financial difficulties respondent suggests on brief that the payments under the consulting and noncompetition agreement between silbernagel and famc were limited to the lesser_of dollar_figure per year or percent of famc's after-tax profits and therefore famc's deduction should likewise be limited to this amount moore testified at trial however that the monthly payments to continued are no constructive dividends to the individual petitioners and the accuracy-related_penalties under sec_6662 relating to this issue are not applicable the remaining issues for decision are whether the lestes and the moores are liable for accuracy-related_penalties under sec_6662 for their failure to properly report bonus income received from famc and whether famc is liable for the sec_6662 accuracy-related_penalty for claiming cost_of_goods_sold of dollar_figure which the parties have agreed was improper sec_6662 imposes a penalty on any portion of an underpayment that is attributable to negligence or disregard of rules and regulations in the instant case petitioners have conceded that they are liable for the underlying deficiencies resulting from the improperly reported bonus income and cost_of_goods_sold amounts a taxpayer must establish error in the commissioner's determination that he or she is liable for the penalty provided by sec_6662 rule a 104_tc_352 petitioners offered no evidence at trial concerning the negligence penalties and failed to address the issue continued silbernagel under the consulting and noncompetition agreement were his fully earned draw and that he could earn more but not less than the agreed dollar_figure per month floor as noted previously respondent did not challenge silbernagel's assertion that he reported all of the consulting fees received from famc as ordinary_income on his individual income_tax returns nor is there any evidence that silbernagel returned any of the payments to famc on brief accordingly to the extent that respondent has prevailed on the underlying issues her corresponding determination of the applicable penalties is sustained to reflect the foregoing and the concessions of the parties decisions will be entered under rule petitioners did however attach a document to their posttrial reply brief purporting to be an audit notification letter sent from an internal_revenue_service agent to moore on date presumably petitioners intend this document to exculpate moore from the negligence_penalty for by establishing that moore filed his amended return reporting the additional dollar_figure in bonus income prior to being informed by respondent that his return was under audit the document attached to petitioner's posttrial reply brief however was not introduced at trial and therefore is not part of the record in this case rule b additionally we note that the parties have stipulated that moore filed his amended return after respondent's examination of famc's returns had commenced based on our review of the record in this case and petitioners' failure to address the negligence issue at trial or on brief we conclude that petitioners have not carried their burden_of_proof and accordingly are liable for the accuracy-related_penalties under sec_6662 pertaining to the conceded deficiencies


internal_revenue_service number release date index number ----------------------------- -------------------------- ------------------------------------------------ ------------------------------- ---------------------------- in re private_letter_ruling request on normalization department of the treasury washington dc person to contact ---------------- id no ------------- telephone number --------------------- refer reply to cc psi b06 - plr-101933-03 date date taxpayer --------------------------------------------------------------------------------------------- ------------------------ ------------ ------------------- ------------------------- --------------------- ------------------ ------------------ --------------- ------------- commission ---------------------------------------- department --------------------------------------------------- state x date date date date date dollar_figureb dollar_figurec dear -------------------- ruling under the normalization requirements of former sec_167 and sec_168 of the internal_revenue_code with respect to the accumulated deferred federal_income_tax adfit reserve attributable to property that is removed from taxpayer’s regulated books of account consolidated federal_income_tax return on a calendar_year basis using the accrual_method of accounting taxpayer is a regulated_public_utility engaged in among other things the generation transmission distribution and sale of electrical energy taxpayer is the parent company of an affiliated_group_of_corporations that files a this letter is in response to your letter dated date requesting a taxpayer represents that the facts are as follows the final audit reports one for transmission plant and one for distribution plant on date the commission ordered audits of both the electric transmission and in state x taxpayer provides electric distribution and transmission services and plr-101933-03 is regulated by the commission taxpayer’s rates in state x are established and approved by the commission on a rate of return basis electric distribution plant accounts of taxpayer in state x the purposes of the audit were to support and establish proper depreciation rates for future ratemaking and to identify and remove from regulated plant accounts any assets not in service not properly identified not verifiable or not properly includible as transmission and distribution assets issued on date and date respectively recommended adjustments in taxpayer’s regulated plant accounts based on the physical inventory and independent valuation conducted by the auditors the adjustments to these plant account balances resulted from taxpayer not properly maintaining its plant accounts following the issuance of the audit report taxpayer and the department among others entered into a settlement agreement the amount of dollar_figureb excluded_property will be removed from taxpayer’s regulated books of account however the accumulated depreciation associated with the excluded_property will not be removed from taxpayer’s regulated books of account electric division in its initial rate case filing taxpayer excluded from its computation of regulated rate base the excluded_property in accordance with the settlement referred to above as noted above the accumulated depreciation_reserve in rate base was not adjusted for the accumulated depreciation_reserve on the excluded_property taxpayer did not reflect regulatory depreciation associated with the excluded_property in either its regulated depreciation expense or in its computation of regulated tax expense additionally taxpayer removed the adfit reserve associated with the excluded_property in the amount of dollar_figurec from its computation of regulated rate base the department took the opposite position on the adfit reserve associated with the excluded_property and sought to have this adfit reserve maintained on taxpayer’s regulated books of account to serve as a reduction to rate base however in its final order dated date the commission adopted taxpayer’s position and agreed to the removal of the adfit reserve associated with the excluded_property but ordered taxpayer to submit a letter_ruling request to the internal_revenue_service for the purpose of determining whether adoption of the department’s proposed treatment of the pursuant to the settlement which is pending before the commission property in in date taxpayer initiated a rate case in state x with respect to its state x accordingly taxpayer seeks the following ruling sec_168 of the code provides in part that the term public_utility would the maintenance of the adfit reserve associated with the excluded plr-101933-03 adfit reserve associated with the excluded_property violates the normalization requirements ruling requested property on taxpayer’s regulated books of account and its reflection in the computation of regulated rate base constitute a violation of the normalization rules under former sec_167 and sec_168 of the code and sec_1_167_l_-1 and sec_1 a - b of the income_tax regulations law and analysis property means property used predominantly in the trade_or_business of the furnishing or sale of electrical energy if the rates for such furnishing or sale as the case may be have been established or approved by a state of political_subdivision thereof by any agency_or_instrumentality of the united_states or by a public service or public_utility commission or other similar body of any state or political_subdivision thereof property was contained in sec_167 of the code and sec_168 which defined public_utility_property by means of a cross reference to sec_167 the definition of public_utility_property is unchanged sec_1_167_l_-1 of the regulations provides that under sec_167 property is public_utility_property during any period in which it is used predominantly in a sec_167 public_utility activity the term sec_167 public_utility activity means in part the trade_or_business of the furnishing or sale of electrical energy if the rates for such furnishing or sale have been established or approved by a regulatory body described in sec_167 the term regulatory body described in sec_167 means a state including the district of columbia or political_subdivision thereof any agency_or_instrumentality of the united_states or a public service or public_utility commission or other body of any state or political_subdivision thereof similar to such a commission the term established or approved includes the filing of a schedule of rates with a regulatory body that has the power to approve such rates though such body has taken no action on the filed schedule or generally leaves undisturbed rates filed by the taxpayer determined under sec_168 shall not apply to any public_utility_property within the prior to the revenue reconciliation act of the definition of public_utility sec_168 of the code provides that the depreciation deduction sec_168 of the code provides that one way in which the in order to use a normalization method_of_accounting sec_168 of plr-101933-03 meaning of sec_168 if the taxpayer does not use a normalization method_of_accounting the code requires the taxpayer in computing its tax expense for purposes of establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account to use a method_of_depreciation with respect to public_utility_property that is the same as and a depreciation period for such property that is no shorter than the method and period used to compute its depreciation for such purposes under sec_168 if the amount allowable as a deduction under sec_168 with respect to public_utility_property differs from the amount that would be allowable as a deduction under sec_167 using the method period first and last year convention and salvage_value used to compute regulated tax expense under sec_168 the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference requirements of sec_168 are not met is if the taxpayer for ratemaking purposes uses a procedure or adjustment that is inconsistent with the requirements of sec_168 sec_168 provides that the procedures and adjustments that are to be treated as inconsistent for purposes of sec_168 shall include any procedure or adjustment for ratemaking purposes that uses an estimate or projection of the taxpayer’s tax expense depreciation expense or reserve for deferred taxes under sec_168 unless such estimate or projection is also used for ratemaking purposes with respect to the other two such items and with respect to the rate base entitled to use accelerated methods of depreciation if they use a normalization method_of_accounting a normalization method_of_accounting is defined in former sec_167 in a manner consistent with that found in sec_168 according to former sec_167 the consistency_requirements of sec_168 apply to former sec_167 sec_1_167_l_-1 of the regulations provides that the reserve established for public_utility_property should reflect the total amount of the deferral of federal_income_tax liability resulting from the taxpayer’s use of different depreciation methods for tax and ratemaking purposes sec_1_167_l_-1 of the regulations provides that the amount of federal_income_tax liability deferred as a result of the use of different depreciation methods for tax and ratemaking purposes is the excess computed without regard to credits of the former sec_167 of the code generally provides that public_utilities are in the present situation taxpayer’s rate base tax expense and depreciation plr-101933-03 amount the tax_liability would have been had the depreciation method for ratemaking purposes been used over the amount of the actual tax_liability this amount shall be taken into account for the taxable_year in which the different methods of depreciation are used sec_1_167_l_-1 of the regulations provides that the taxpayer must credit this amount of deferred taxes to a reserve for deferred taxes a depreciation_reserve or other reserve_account this regulation further provides that the aggregate amount allocable to deferred taxes may be reduced to reflect the amount for any taxable_year by which federal income taxes are greater by reason of the prior use of different methods of depreciation under sec_1_167_l_-1 or to reflect asset retirements or the expiration of the period for depreciation used for determining the allowance for depreciation under sec_167 sec_1_167_a_-11 of the regulations provides similar rules for public_utility_property subject_to depreciation under the class_life_asset_depreciation_range_system cladr expense for ratemaking purposes will be determined without the cost of the excluded_property if the adfit reserve associated with the excluded_property is not removed from taxpayer’s regulated books of account and is used to reduce taxpayer’s rate base the consistency_requirement of sec_168 will be violated because taxpayer will not include the cost of the excluded_property in its rate base or include the amount of related depreciation in its computation of tax expense and depreciation expense for ratemaking purposes ruling above we conclude that the maintenance of the adfit reserve associated with the excluded_property on taxpayer’s regulated books of account and its reflection in the computation of regulated rate base would constitute a violation of the normalization rules under former sec_167 and sec_168 of the code and sec_1_167_l_-1 and sec_1_167_a_-11 of the regulations federal_income_tax consequences of the above-described facts under any other provision of the code or regulations this letter_ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that this ruling may not be used or cited as precedent except as specifically set forth above no opinion is expressed concerning the based solely on taxpayer’s representations and the law and analysis as set forth in accordance with the power_of_attorney on file a copy of this letter is being sent sincerely yours kathleen reed kathleen reed senior technician reviewer office of the associate chief_counsel passthroughs and special industries plr-101933-03 to taxpayer’s authorized legal_representative enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court judith walthers petitioner v commissioner of internal revenue respondent docket no 16382-07l filed date judith walthers pro_se kaelyn j romey for respondent memorandum opinion dean special_trial_judge this case is before the court on petitioner’s motion to restrain assessment or collection petitioner’s motion and respondent’s motion to dismiss for lack of jurisdiction respondent’s motion all section references are to the internal_revenue_code_of_1986 as amended and all rule references are to the tax_court rules_of_practice and procedure background petitioner filed her petition with the court seeking review of respondent’s collection action for and and attaching copies of a notice_of_levy on wages salary and other income for and in the petition she alleges that she never received a final notice_of_intent_to_levy which would have given her notice of the opportunity to request a hearing under sec_6330 before collection action proceeded the court filed petitioner’s motion concurrently with the petition respondent objected to petitioner’s motion and moved to dismiss the petition for lack of jurisdiction on the ground that no notice_of_determination as authorized by sec_6320 or sec_6330 has been issued nor has respondent made any other determination for the years at issue that would confer jurisdiction on the court respondent argues that the court cannot acquire jurisdiction to review a proposed lien or levy action unless there is a determination by the office of appeals and the taxpayer seeks review of the determination within days thereafter respondent alleges that his computer transcripts copies of which he has produced show that a letter final notice notice_of_intent_to_levy and notice of your right to a hearing notice was sent to petitioner by certified mail on date relating to tax years and according to respondent’s records the notice was refused unclaimed respondent was unable to produce either a copy of the final notice_of_intent_to_levy or a certified mailing list for the notice jurisdiction discussion the tax_court is a court of limited jurisdiction and may exercise that jurisdiction only to the extent authorized by congress 85_tc_527 as respondent has pointed out the jurisdiction of the court under sec_6320 and sec_6330 depends upon the issuance of a valid notice_of_determination and the filing of a timely petition for review see 123_tc_1 affd 412_f3d_819 7th cir 117_tc_122 116_tc_263 114_tc_492 see also rule b therefore in the absence of a notice_of_determination this court lacks jurisdiction respondent did not issue a notice_of_determination in respect of petitioner’s outstanding tax_liabilities for and because petitioner did not request a hearing under sec_6330 the commissioner however must first issue a final notice_of_intent_to_levy and send it to the taxpayer at the taxpayer’s last_known_address before a hearing is held and the notice_of_determination is issued sec_6330 the court does not have jurisdiction to hear petitioner’s case and the only issue to be decided is the proper basis for dismissal respondent argues that the court lacks jurisdiction because petitioner failed to request a hearing under sec_6330 dismissal on this ground would allow respondent to levy upon petitioner’s property to satisfy her federal tax_liabilities petitioner argues that she never received a valid final notice_of_intent_to_levy dismissal on that ground would in effect invalidate the notice_of_levy see 116_tc_255 buffano v commissioner tcmemo_2007_ sec_6331 provides that if any person liable to pay any_tax neglects or refuses to pay such tax within days after notice_and_demand for payment the secretary is authorized to collect such tax by way of a levy upon the person’s property sec_6331 requires the secretary at least days before proceeding with enforced collection by way of a levy on a person’s property to provide the person with a final notice_of_intent_to_levy including notice of the administrative appeals available see sec_6330 115_tc_35 114_tc_176 the notice_of_intent_to_levy must be given in person left at the person’s dwelling or usual place of business or sent by certified or registered mail to the person’s last_known_address sec_6330 sec_6331 sec_301_6330-1 q a-8 a proced admin regs the notice is valid if it is mailed to the taxpayer’s last_known_address even if it is not received or accepted by the taxpayer see 935_f2d_1066 9th cir affg tcmemo_1989_439 724_f2d_808 9th cir stein v commissioner tcmemo_2004_124 all that remains is for respondent to show that he mailed the notice to petitioner’s last_known_address the court has held that compliance with u s postal service form_3877 mailing procedures raises a presumption of official regularity in favor of the commissioner and is sufficient absent evidence to the contrary to establish that the notice was properly mailed 94_tc_82 see also united_states v zolla supra pincite however respondent was unsuccessful in his attempt to locate the u s p s form_3877 respondent instead offers as evidence of mailing copies of forms certificate of assessments payments and other specified matters for and that indicate the date of the mailing of the notice and that it was refused unclaimed respondent however must prove by direct evidence the date and fact of mailing the notice to the taxpayer coleman v commissioner supra pincite 89_tc_321 the commissioner’s presentation of a date- stamped copy of the notice and a file memorandum by an appeals officer noting that the notice was returned undeliverable has been held to be insufficient to prove statutory certified mailing requirements 658_fsupp_1 d alaska with the proper foundation computer records may be evidence of correspondence 485_f3d_1 1st cir 861_f2d_1225 10th cir as has been observed by another court however the form_4340 does not disclose the address to which the letter was sent or that it was sent by certified mail see 490_fsupp2d_852 n d ohio respondent has not shown that he mailed the notice to petitioner’s last_known_address by certified mail restraint of collection the authority of the court to restrain collection in a lien or levy action is found in the last sentence of sec_6330 the tax_court shall have no jurisdiction under this paragraph to enjoin any_action or proceeding unless a timely appeal has been filed under subsection d and then only in respect of the unpaid tax or proposed levy to which the determination being appealed relates sec_6330 is predicated upon the court’s having plenary jurisdiction in a lien or levy action before the court can enjoin any_action or proceeding and then only in respect of the unpaid tax or proposed levy to which the determination being appealed relates lacking any notice_of_determination the court is without jurisdiction to enjoin anything to reflect the foregoing an appropriate order of dismissal for lack of jurisdiction will be entered and petitioner’s motion will be denied


internal_revenue_service number release date index number --------------------------------------------- ----------------------------------------------- ------------------------- ------------------------------------- department of the treasury washington dc third party communication none person to contact ------------------------------------------------------ telephone number --------------------- refer reply to cc ita plr-145356-08 date date ty ------- legend taxpayer trust a child b_trust b child c trust c trustee x trustee y trustee z father mother farmland ---------------------------------------------------------- ------------------------ ---------------------- ---------------------------------------- ------------------------------- -------------------------------- ---------------------------------------- ---------------------------- --------------------------------- --------------------------------------- -------------------- ------------------ ---------------------------------------------------------------------- dear ---------------- - this is in response to your request for a private_letter_ruling dated date as amended by a supplemental submission dated date specifically you have requested a ruling that taxpayer and trust c are not related_persons for purposes of sec_1031 of the internal_revenue_code and that an exchange of property is not a transaction to which sec_1031 applies facts farmland was owned by father upon father’s death farmland was placed into two testamentary trusts with income payable to mother for life and remainder to taxpayer child b and child c upon the death of mother farmland was transferred to taxpayer child b and child c in equal shares as tenants in common the three children subsequently deeded each of their interests in farmland to three grantor trusts trust a plr-145356-08 trust b and trust c through trust a taxpayer holds its interest in farmland for use in a trade_or_business or for investment child c subsequently died pursuant to the terms of trust c child c’s interest in farmland is to remain in trust with trust income to be paid to her surviving_spouse for life and remainder to her children for federal_income_tax purposes the current owners of farmland are taxpayer through trust a child b through trust b and trust c in equal shares as tenants in common the co-trustees of trust c are trustee x the spouse of child c and trustees y and z the children of child c trust c now wishes to liquidate its ownership_interest in farmland taxpayer and child b wish to remain invested in farmland through trust a and trust b to facilitate each others’ wishes and to increase the marketability of the interest to be sold the trusts have agreed to exchange each of their undivided interest in farmland for percent fee simple interests in the same property this exchange will be based upon the division suggested in a recent survey and appraisal the division will split farmland into three parcels of equal value none of the trusts will assume any liabilities of the other trusts or receive money or other_property as a result of the exchange however as a result of the death of child c trust c will have a different and higher basis in its parcel than the other owners due to the step up in basis received when child c died after the exchange of the undivided interests for whole parcels trust c will sell its parcel to a third party taxpayer and child b will retain their respective parcels each a portion of farmland for use in a trade_or_business or for investment law and analysis sec_1031 of the code provides that no gain_or_loss shall be recognized on the exchange of property held for productive use in a trade_or_business or for investment if such property is exchanged solely for property of like_kind which is to be held either for productive use in a trade_or_business or for investment sec_1031 of the code generally provides that if -- a a taxpayer exchanges property with a related_person b there is nonrecognition_of_gain_or_loss to the taxpayer under this section with respect to the exchange and c before the date years after the date of the last transfer which was part of such exchange -- i ii the related_person disposes of such property or the taxpayer disposes of the property received in the exchange from the related_person which was of like_kind to the property transferred by the taxpayer plr-145356-08 there shall be no nonrecognition_of_gain_or_loss under this section to the taxpayer with respect to such exchange except that any gain_or_loss recognized by the taxpayer by reason of this subsection shall be taken into account as of the date on which such subsequent disposition occurs sec_1031 of the code provides that for purposes of sec_1031 the term related_person means any person bearing a relationship to the taxpayer described in sec_267 or sec_707 under sec_267 members_of_a_family as defined in sec_267 are considered related_persons sec_267 provides that the family of an individual includes only the individual’s brothers and sisters whether by the whole or half blood spouse ancestors and lineal_descendants the relationships described in sec_707 include a a partnership and a person owning directly or indirectly more than percent of the capital interest or the profits interest in such partnership and b two partnerships in which the same persons own directly or indirectly more than percent of the capital interests or profits interests revrul_73_476 1973_2_cb_300 holds that exchanges of undivided interests in multiple parcels of real_estate for percent ownership of one or more parcels of the same real_estate qualify as valid like-kind_exchanges the above-described exchange and subsequent sale by trust c of its fee simple interest in a portion of farmland is not a transaction to which sec_1031 applies in general a transaction is described in sec_1031 if related parties engage in an exchange and then one of the related parties disposes of their acquired property within two years of the acquisition in the present case taxpayer and child b are related_persons under sec_267 but neither intend to sell their respective property within years of the exchange further while trust c intends to sell its interest within years of the exchange taxpayer is not related to trust c or trustees x y and z within the meaning of sec_1031 accordingly with respect to taxpayer and trust c there is no exchange between related_persons for purposes of sec_1031 ruling taxpayer and trust c are not related_persons for purposes of sec_1031 consequently the application of sec_1031 to taxpayer is not affected by trust c’s sale of its interest including the interest it acquired from taxpayer in farmland within years of its acquisition by trust c caveats plr-145356-08 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 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 a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely michael j montemurro branch chief branch income_tax accounting enclosure


t c summary opinion united_states tax_court frederick t chambers and janice k chambers petitioners v commissioner of internal revenue respondent docket no 1093-10s filed date frederick t chambers and janice k chambers pro_se ashley d money for respondent summary opinion paris judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case in a notice_of_deficiency dated date respondent determined deficiencies in petitioners’ joint federal_income_tax of dollar_figure dollar_figure and dollar_figure for and respectively respondent also determined section accuracy-related_penalties of dollar_figure dollar_figure and dollar_figure for and respectively after concessions by the parties the issues for decision are whether petitioners may deduct losses from their rental_real_estate_activities under the passive_activity_loss rules in sec_469 and whether they are liable for accuracy-related_penalties under sec_6662 background some of the facts are stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners resided in tennessee when their petition was filed 1unless otherwise indicated section references are to the internal_revenue_code in effect for tax years at issue and rule references are to the tax_court rules_of_practice and procedure 2respondent concedes an error in the notice_of_deficiency the correct federal_income_tax deficiencies are dollar_figure dollar_figure and dollar_figure for and respectively and the correct amounts of penalties under sec_6662 are dollar_figure dollar_figure and dollar_figure for and respectively petitioners concede the inclusion of dollar_figure of cancellation_of_indebtedness_income and the disallowance of itemized_deductions of dollar_figure for adjustments to itemized_deductions for and are computational during and the tax years at issue mr chambers worked as a full-time civilian employee for the department of the navy navy the navy paid mr chambers for big_number hours of work which included hours of annual leave hours of sick leave and hours of holiday leave after reducing his big_number hours for annual sick and holiday leave mr chambers worked big_number hours each year at issue mrs chambers also worked as a full-time civilian employee for the navy during each year at issue in addition to her full-time employment she worked part time for dillard’s inc in and part time for macy’s inc in and petitioners’ properties during the years at issue petitioners owned a single-family rental property in san diego california petitioners were also responsible for the rental_real_estate_activities of cmb capital investments llc cmb capital a tennessee limited_liability_company llc in which mr chambers owned a interest cmb capital had three equal members cmb capital was organized as a member-managed llc with the purpose of investing in real_estate cmb capital owned four properties in tennessee during and eight during and only three of the properties were rented in and four were rented in and on their and federal_income_tax returns petitioners reported rental real_estate losses of dollar_figure dollar_figure and dollar_figure respectively the losses combined petitioners’ rental real_estate losses from the san diego property which were dollar_figure dollar_figure and dollar_figure for and respectively with mr chambers’ share of cmb capital passive_income and losses petitioners reported adjusted_gross_income agi of dollar_figure dollar_figure and dollar_figure for and respectively in a recomputation of petitioners’ federal_income_tax deficiencies see supra note respondent disallowed dollar_figure dollar_figure and dollar_figure of petitioners’ rental real_estate losses for and respectively respondent recalculated petitioners’ agi as follows dollar_figure for dollar_figure for and dollar_figure for petitioners’ real_estate logs petitioners submitted logs detailing the amount of time they purportedly spent on rental_real_estate_activities the logs which petitioners prepared in connection with the internal revenue service’s audit of their returns are based upon a review of rent receipt books bank statements spreadsheets for repairs maintenance logs and other activities associated with renting such as collecting rent collecting rent according to petitioners involved the following receiving notification that the rent was available traveling to pick up the rent or making arrangements with the renter to send a payment receiving the payment depositing the payment and issuing a receipt the logs record hours of real_estate activities for hours for and hours for the hours combine time spent on the san diego and cmb capital properties by petitioners subcontractors and another member of cmb capital who was a painter and carpenter included in the log entries are three to four hours per month per property for collecting rent hours in and hours in of viewing foreclosure properties and hours in of time spent at lowe’s and home depot the logs do not record petitioners’ prep time and phone calls related to their real_estate activities notice_of_deficiency on date respondent issued a notice_of_deficiency to petitioners for and petitioners timely filed a petition contesting the deficiencies and a trial was held in memphis tennessee on date despite receiving an extension of time to file their answering brief until date petitioners have failed to do so discussion i burden_of_proof generally the commissioner’s determination_of_a_deficiency is presumed correct and the taxpayer bears the burden of proving it incorrect see rule a 290_us_111 moreover deductions are a matter of legislative grace and the taxpayer bears the burden of proving his entitlement to any deductions claimed see 503_us_79 292_us_435 under sec_7491 the burden_of_proof may shift to the commissioner if the taxpayer produces credible_evidence with respect to any relevant factual issue and meets other requirements petitioners have not argued that sec_7491 applies and therefore the burden_of_proof remains on them ii passive_activity_losses sec_469 generally disallows passive_activity_losses for any taxable_year a passive_activity_loss is defined as the excess of the aggregate losses from all passive activities for a taxable_year over the aggregate income from all passive activities for that year sec_469 passive activities include any trade_or_business in which the taxpayer does not materially participate sec_469 or to the extent provided in regulations any activity with respect to which expenses are allowable as a deduction under sec_212 sec_469 rental_activity is generally treated as per se passive regardless of whether the taxpayer materially participates sec_469 there are however two exceptions for real_estate professionals under sec_469 and for passive_activity_losses up to dollar_figure under sec_469 a real_estate_professional under sec_469 rental activities of taxpayers in real_property trades_or_businesses are not per se passive but rather are treated as trades_or_businesses subject only to the material_participation requirements of sec_469 a taxpayer qualifies as a real_estate_professional if more than one-half of the personal services performed in trades_or_businesses by the taxpayer during such taxable_year are performed in real_property trades_or_businesses in which the taxpayer materially participates and the taxpayer performs more than hours of services during the taxable_year in real_property trades_or_businesses in which the taxpayer materially participates sec_469 a taxpayer must satisfy both requirements of sec_469 to qualify as a real_estate_professional for taxpayers filing a joint_return either spouse may separately satisfy the real_estate_professional requirements id the first part of the definition of a real_estate_professional under sec_469 requires that mr chambers have performed more than one-half of his personal services in trades_or_businesses during the years at issue in real_property trades_or_businesses in which he materially participated see 135_tc_365 personal services means any work performed by an individual in connection with a trade_or_business sec_1 b income_tax regs and a trade_or_business includes being an employee see fowler v commissioner tcmemo_2002_223 mr chambers was an employee of the navy and worked at least big_number hours during each year at issue in addition to working as an employee mr chambers claims that he managed the san diego and cmb capital rental properties for hours in hours in and hours in mr chambers’ total personal services working hours for the years at issue are big_number hours in big_number hours in and big_number hours in as a result to meet the first part of the real_estate_professional definition petitioners must show that mr chambers spent more than one-half of big_number hours in big_number hours in and big_number hours in working in real_property trades_or_businesses in which he materially participated before the court may address the number of hours mr chambers spent on real_property trades_or_businesses the court must determine whether he may include his time spent on real_estate activities for cmb capital sec_469 provides that except as provided in regulations no interest in a limited_partnership as a limited_partner shall be treated as an interest with respect to which a taxpayer materially participates therefore there is a presumption of passive_activity for taxpayers with interests in limited_partnerships as limited partners see 132_tc_368 general partners however are excepted see sec_1_469-5t temporary income_tax regs fed reg date 3petitioners acknowledge that mr chambers worked approximately big_number hours for the navy each year at issue nonetheless petitioners maintain that mr chambers satisfied the first part of the definition of a real_estate_professional because he spent hours in hours in and hours in on real_property trades_or_businesses because one-half of big_number is the court suspects that petitioners have misinterpreted sec_469 to require mr chambers to spend more than one-half of his hours with the navy on real_property trades_or_businesses as discussed above the real_estate_professional definition combines a taxpayer’s personal services for all trades_or_businesses eg his hours spent as an employee and on rental properties and requires more than one-half of the combined hours to be spent on real_property trades_or_businesses in garnett v commissioner t c pincite the court held that an interest in an iowa llc was not an interest in a limited_partnership as a limited_partner within the meaning of sec_469 or the regulations thereunder the court held that a member of an iowa llc unlike a limited_partner was not prohibited by state law from participating in the partnership’s business and consequently more closely resembled a general_partner id pincite accordingly the special rules of sec_469 did not apply to an interest in an iowa llc id pincite mr chambers was a member of cmb capital an llc that was organized in tennessee a member under tennessee law may participate in the management of the llc tenn code ann sec moreover according to its articles of organization cmb capital was member managed mr chambers was therefore not only allowed to participate in the management of cmb capital by tennessee law but also as a member manager was required to do so by the articles of organization furthermore mr chambers provided credible testimony that he managed the day-to-day operations of cmb capital which involved among other things overseeing cmb capital’s rental properties in tennessee mr chambers therefore functioned more like a general_partner of a limited_partnership and as a result he comes within the general_partner exception of sec_1_469-5t temporary income_tax regs supra the court concludes that the special rules of sec_469 do not apply to mr chambers consequently his time spent on real_estate activities for cmb capital is included in his calculation of hours performed in real_property trades_or_businesses for purposes of sec_469 a taxpayer may use any reasonable means to establish his hours of participation sec_1_469-5t temporary income_tax regs fed reg date reasonable means may include but are not limited to the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period based on appointment books calendars or narrative summaries id although contemporaneous daily time reports logs or similar documents are not required see id the court has held that the regulations concerning the records to be maintained by taxpayers by no means allow a postevent ‘ballpark guesstimate’ carlstedt v commissioner tcmemo_1997_331 citing speer v commissioner t c memo 4material participation pursuant to sec_469 has the same meaning as under sec_1_469-5t temporary income_tax regs fed reg date sec_1_469-9 income_tax regs petitioners stipulated that mr chambers spent at least big_number hours working for the navy during each year at issue thus in order to satisfy the requirements of sec_469 petitioners must show that mr chambers devoted more than big_number hours to his rental real_estate businesses see anyika v commissioner tcmemo_2011_69 as discussed above because cmb capital is a member-managed llc in which mr chambers performed managerial tasks his time spent on rental_real_estate_activities for cmb capital is included in his calculation of hours performed in real_property trades_or_businesses see eg garnett v commissioner t c pincite at trial petitioners submitted logs purportedly showing that jointly they spent hours performing rental_real_estate_activities during hours during and hours during some of the hours recorded do not qualify for purposes of sec_469 because the hours in part are 5see supra note 6time allocation for taxpayers with interests in more than one rental property is determined separately with respect to each property unless the taxpayer makes an election to treat all interests in rental real_estate as a single rental real_estate activity sec_469 sec_1_469-9 income_tax regs the record does not address whether petitioners made an election to treat the san diego and cmb capital properties as a single activity assuming petitioners made this election however the time mr chambers spent on all rental_real_estate_activities is less than the big_number hour threshold attributed to mrs chambers see sec_469 nonetheless even if all of the hours qualified the time recorded for real_estate activities is less than the big_number hours mr chambers spent working for the navy to wit mr chambers spent more than one-half of his personal services on trades_or_businesses ie as an employee of the navy that are not related to his rental real_estate businesses accordingly mr chambers failed to meet the hours required under sec_469 and the court need not address the 750-hour requirement in sec_469 mr chambers was therefore not a real_estate_professional under sec_469 during the years at issue and unless relief provided under sec_469 applies the real_estate losses sustained during those years are passive_activity_losses disallowed by sec_469 b offset for rental_real_estate_activities the second exception to the general_rule that rental_real_estate_activities are per se passive is found in sec_469 sec_469 provides that a taxpayer who actively participates in rental_real_estate_activities may deduct up to dollar_figure per year for related passive_activity_losses sec_469 and taxpayers may satisfy the active_participation requirement by participating in management 7mrs chambers’ ownership_interest was limited to the san diego property there was no evidence suggesting that she was an employee or independent_contractor of cmb capital decisions such as approving new tenants deciding rental terms and arranging services and repairs madler v commissioner tcmemo_1998_112 the dollar_figure amount begins to phase out when the taxpayer’s agi determined without regard to any passive_activity_loss exceeds dollar_figure and is phased out entirely when the taxpayer’s agi reaches dollar_figure sec_469 on each of their and federal_income_tax returns petitioners claimed that they actively participated in rental_real_estate_activities and deducted dollar_figure of passive_activity_losses respondent does not dispute that petitioners actively participated in rental_real_estate_activities and the record does not suggest otherwise instead respondent asserts that petitioners’ agi for each year at issue exceeds dollar_figure thereby making them ineligible for the dollar_figure deduction or any part thereof for and petitioners reported agi of dollar_figure dollar_figure and dollar_figure respectively after concessions by the parties see supra note petitioners’ agi is increased to include cancellation_of_indebtedness_income and disallowed itemized_deductions according to respondent’s concession on petitioners’ deficiencies their agi for purposes of the sec_469 phase out is dollar_figure dollar_figure and dollar_figure for and respectively because their agi for each year at issue exceeds dollar_figure petitioners are not entitled to deduct dollar_figure per year of passive_activity_losses under sec_469 iii accuracy-related_penalties respondent determined that petitioners are liable for sec_6662 accuracy- related penalties for the years at issue after concessions see supra note respondent determined accuracy-related_penalties of dollar_figure dollar_figure and dollar_figure for and respectively sec_6662 and b and provides an accuracy-related_penalty equal to of the underpayment attributable to any substantial_understatement_of_income_tax or to negligence or disregard of rules or regulations however no penalty will be imposed under sec_6662 if the taxpayer establishes that he acted with reasonable_cause and in good_faith sec_6664 circumstances that indicate reasonable_cause and good_faith include reliance on the advice of a tax professional or an honest misunderstanding of the law that is reasonable in the light of all the facts and circumstances sec_1_6664-4 income_tax regs see 116_tc_438 the taxpayer has the burden of proving that he acted with reasonable_cause and in good_faith rule a reilly v commissioner 53_tc_8 at trial mr chambers provided credible testimony that he devoted a significant amount of time to the rental activities of the san diego and cmb capital properties his rental_real_estate_activities included among other things renting properties collecting rents purchasing materials and scheduling repairs for the san diego property and the cmb capital properties which comprised three rented properties in and four in and what is more during the years at issue mr chambers was primarily responsible for making all management decisions including market research and negotiation of real_estate purchases on cmb capital’s behalf most of mr chambers’ rental_real_estate_activities were corroborated by documentary_evidence and recorded in petitioners’ real_estate logs petitioners however failed to account for real_estate activities that could not be documented such as prep time and phone calls and as a result did not meet their burden_of_proof moreover as discussed above the court surmises that petitioners misinterpreted the real_estate_professional requirements of sec_469 to require mr chambers to devote more than one-half of his big_number personal service hours as an employee of the navy to real_property trades_or_businesses see supra note the court is convinced that petitioners had reasonable_cause to believe that mr chambers qualified as a real_estate_professional and materially participated in their rental_real_estate_activities the court therefore declines to sustain the accuracy-related_penalties with respect to those portions of petitioners’ underpayments attributable to their rental real_estate loss deductions claimed for the years at issue the court has considered the parties’ arguments and to the extent not addressed herein concludes that they are moot irrelevant or without merit to reflect the foregoing decision will be entered under rule