t c memo united_states tax_court diamond claims investigation services inc petitioner v commissioner of internal revenue respondent docket no filed date merritt s yoelin and michael d walker for petitioner shirley m francis for respondent memorandum findings_of_fact and opinion chiechi judge respondent determined a deficiency of dollar_figure in petitioner's federal_income_tax for its taxable_year ended date the only issue remaining for decision is whether petitioner must include in its income for the year at issue all or only a portion of the amount awarded by the u s district_court for the district of oregon district_court to the plaintiffs in a law- suit in which petitioner and two individuals peter j diamond mr diamond and shirley diamond ms diamond were identified as the plaintiffs we hold that petitioner must include in its income only the portion stated herein findings_of_fact some of the facts have been stipulated and are so found petitioner diamond claims investigation services inc dci is an oregon corporation that was incorporated on date and that had its principal_place_of_business in coos bay oregon at the time the petition was filed during the years through mr diamond and ms diamond who were married each owned percent of the outstand- ing stock of dci they also were its only officers serving as president and secretary respectively mr diamond and ms diamond are sometimes referred to as the diamonds as of the time of the trial herein dci was not actively engaged in a trade_or_business was in existence in name only and was wholly owned by mr diamond who inherited ms diamond's stock in dci after she died on date throughout the years through dci's principal business activity was the investigation of insurance claims and other insurance-related matters during the years through dci derived approximately percent of its business from a group of related companies that were collectively known as farmers insurance group fig that business consisted princi- pally of investigating suspected criminal and fraudulent activities of fig's agents clients and third-party claimants and training fig personnel in the conduct of such investiga- tions so as to enable fig to establish an internal workforce with that investigative capability during the years at issue dci sent fig invoices for ser- vices rendered that were prepared in accordance with fig's specifications and that pertained to different types of services rendered including investigative services and office and cleri- cal services related to those investigative services pursuant to fig's specifications dci's invoices also billed fig for costs that fig agreed to reimburse eg meals_and_lodging evergreen typing service throughout all relevant periods dci required various secretarial and clerical support services in order to conduct its business operations during the years through dci first employed ms diamond and then headquarters inc to provide such services during the summer of dci formed its own secretarial and clerical support services business known as evergreen typing service ets for the principal purpose of providing such services to dci in connection with the work that dci provided its services to a division within the legal department of fig known as the criminal investigations division cid it was performing for fig and other customers during the early part of dci sold ets to the diamonds who thereafter owned and operated it as a sole_proprietorship during and all relevant periods thereafter ets was the exclusive provider to dci of secretarial and clerical support services such as typing photocopying transcribing and answer- ing the telephone with dci providing approximately to percent of ets' business during those periods ets also made its clerical staff available to dci for dci's investigative work and permitted dci's surveillance vans to be marked with ets' logo during and virtually all of the services that ets provided to dci were related to the work that dci was per- forming for fig and ets provided certain of those services such as the preparation of clerical reports in accordance with fig's specifications during and ets sent dci invoices for services rendered that identified inter alia the name of the case with respect to which it provided the service the type of service rendered eg typing or copying and the charge for such dci informed certain fig officials of its plans to form ets those officials who were concerned about the security of docu- ments containing confidential information relating to the inves- tigative work that dci was conducting for fig assisted dci in executing those plans at the time that dci transferred the ownership of ets to the diamonds mr diamond informed fig officials of that transfer service at no time during those years did ets submit invoices directly to fig for the services that it provided to dci in connection with dci's work for fig rather dci billed fig for those services charging fig the same amount that ets had charged it the diamonds reported the financial results of ets in schedule c of the federal_income_tax return return that they filed for each of the years and as follows gross_receipts less cost_of_goods_sold plus other income gross_income less expenses net profit dollar_figure big_number big_number big_number big_number big_number dollar_figure -- -- big_number big_number big_number dollar_figure -- -- big_number -- big_number the farmers lawsuit the parties and their claims in date dci and the diamonds who were repre- sented by the law firm of markowitz herbold markowitz herbold commenced a lawsuit farmers lawsuit against fig in the district_court the plaintiffs named in the farmers lawsuit were diamond claims investigation services inc an oregon corporation and peter j diamond and shirley diamond husband and wife plaintiffs the plaintiffs filed an initial com- the particular information that ets included in the invoices that it submitted to dci during the years and was based on certain requirements specified by fig in order to enable fig to identify the costs associated with the particular investiga- tive projects that it had assigned to dci plaint initial complaint an amended complaint amended com- plaint and a second amended complaint second amended com- plaint and the plaintiffs and fig submitted a pretrial order pretrial order in those submissions the plaintiffs raised claims against fig for breaches of contract indemnity and fraudulent misrepresentations and sought damages from fig with respect to those claims the district_court ruled that the pretrial order superseded the various complaints that the plaintiffs had filed in the farmers lawsuit and controlled the determination of any damages to be awarded to the plaintiffs in the pretrial order the plaintiffs alleged inter alia vi contentions of fact in december michael conn acting as director of cid and on behalf of all defendants and plaintiffs agreed as follows these promises are hereinafter jointly referred to as the agreement that cid would assign to plaintiffs all investigations which were assigned to outside investi- a in the initial complaint and in the amended complaint the plaintiffs alleged that the parties to the agreement at issue in the farmers lawsuit were fig and diamond claims and that as a result of fig's breaches of contract and fraudulent misrepresen- tations plaintiff diamond claims has suffered lost revenue from investigation consultation and clerical services lost profits all to plaintiff diamond claims' damage in the amount of dollar_figure and requested inter alia that the district_court enter a judgment against fig and in favor of diamond claims in the amount of dollar_figure million on account of its claims against fig for breaches of contract and fraudulent misrepresentations in the second amended complaint and in the pretrial order references to diamond claims in the foregoing allegations were changed to references to plaintiffs gators by cid on behalf of any defendant for a period of five years from december in oregon washing- ton idaho utah and montana c that plaintiffs would perform investiga- tions of suspected criminal and fraudulent activities among defendants' insureds employees agents and brokers in connection with cid's investigation and attempted prosecution of insurance fraud provide equipment necessary thereto and provide consulting services training and assistance necessary to enable cid to establish and develop internal units with per- sonnel capable of conducting such investigations on an in-house basis from plaintiffs performed investi- gations described in paragraph vi-2 c on behalf of defendants during to plaintiffs as- sisted in training cid's regional in-house criminal investigators plaintiffs built their own organization capable of handling the defendants' investigation needs plaintiffs peter and shirley diamond devoted substantial time effort and resources to their performance of their agreement with defendants in the summer of dci started a business called evergreen typing service hereinafter ets for the purpose of providing transcription services to defendants in connection with investigations owner- ship of the business was later transferred to peter and shirley diamond from time to time plaintiffs in- vested in new equipment for ets and hired employees for the purpose of dealing with cid's workload from to ets provided services to defendants plaintiffs' actions in performance of their agreement with defendants were done at the request of defendants and with their knowledge and were necessary to the performance of plaintiffs' agreement with defen- dants plaintiffs have performed all of their obliga- tions under their agreement with defendants sometime in or cid began using outside investigators other than plaintiffs in oregon washington idaho utah and montana for cases which should have been assigned to plaintiffs under the agreement this practice continued up to the present this practice was in breach of defendants' agreement with plaintiffs in may mr conn on behalf of all defendants promised plaintiffs that agreements between plaintiffs and defendants would be extended for a period of two years on date ronald burlison wrote a letter to plaintiffs stating that they should cease all work on defendants' files since that time defen- dants have assigned no cases to plaintiffs defendants breached their agreements with plaintiffs as follows a cid failed to assign to plaintiffs all of its investigations done by outside investigators in oregon washington utah montana and idaho from date to may plaintiffs were damaged by defendants' breaches as follows b they lost profits on investigations defendants assigned to other investigators from to may in the approximate amount of dollar_figure million defendants repeatedly made false misrepresen- tations to plaintiffs and concealed the true state of affairs from plaintiffs with the knowledge and intent that plaintiffs would rely on the representations to their detriment as follows a defendants repeatedly represented to plaintiffs that plaintiffs were receiving and would continue to receive all of cid's assignments to outside investigators in oregon washington idaho montana and utah when plaintiffs were not receiving all such assignments defendants had no intention of giving plaintiffs all such assignments and cid's policy expressed to its regional criminal investigators was that assignments would be made on a case-by-case basis d defendants repeatedly represented to plaintiffs that plaintiffs would be indemnified and held harmless by defendants when defendants never intended to indemnify plaintiffs and never did indem- nify plaintiffs or reimburse plaintiffs for plaintiffs' legal fees costs and expenses as a result of defendants' fraudulent acts as described above plaintiffs were damaged as set out in connection with their claim for breaches of contract plaintiffs peter and shirley diamond suf- fered embarrassment humiliation emotional distress and mental pain and suffering to their damage in the amount of dollar_figure each plaintiff dci is entitled to punitive_damages of dollar_figure million and plaintiffs peter and shirley diamond are entitled to punitive_damages of dollar_figure million vii contentions of law all of the named defendants are liable to plaintiffs for the damages described above all defendants and all plaintiffs were par- ties to and are bound by the agreement and are enti- tled to the benefits thereof plaintiffs peter and shirley diamond are entitled to recover their lost income including loss of profits from ets and increased expenses arising from defendants' fraud and breach of their agreement with plaintiffs in the pretrial order fig denied all of the plaintiffs' allegations including the foregoing and alleged inter alia that the diamonds were not entitled to recover any damages on account of claims against fig that properly belonged to dci proceedings before and rulings by the district_court imposition of sanctions at the conclusion of the pretrial discovery period in the farmers lawsuit the plaintiffs filed a motion motion for sanctions in which they alleged that fig had committed various discovery abuses and requested that the district_court enter sanctions against fig by striking fig's amended answer and counterclaims entering a judgment in favor of the plaintiffs and awarding attorneys' fees and costs to the plaintiffs on date the district_court issued an order order granting the plaintiffs' motion for sanctions and indicating that it would enter a default judgment in favor of the plaintiffs following an evidentiary hearing damages hearing to determine the amount of damages that they suffered damages hearing on october and the district_court held a damages hearing at which the plaintiffs presented evidence with respect to their claims for damages for lost profits on account of fig's breaches of contract and fraudulent misrepresentations that evidence included the testimony of donald wharton mr wharton a certified_public_accountant whom the plaintiffs had retained for the purpose of determining the profits lost by dci and by the diamonds as a result of those actions of fig at the damages hearing mr wharton testified that in determining lost profits he took account of the profits lost by dci as well as the profits lost by ets and that he treated ets as a division of dci in this connection mr wharton testified that it was his understanding that ets was owned by the diamonds that it was formed sometime during and that it provided services almost exclusively for dci mr wharton further testified at the damages hearing that he and others working under his supervision had prepared several analyses of the profits lost by dci and by ets as a result of fig's breaches of contract and fraudulent misrepresentations and that in determining those profits he relied principally on one of those analyses referred to as analysi sec_1 analysi sec_1 that was entitled additional profits due to dci - measure number one - using historical hourly rates for investigators' services and historical markups on other revenues analysi sec_1 although the title of analysi sec_1 referred only to dci as stated above in reaching the conclusions shown in analysi sec_1 mr wharton aggregated the operations of dci and ets reflected the following conclusions of mr wharton about the lost revenue the direct costs the variable overhead costs and the lost profits of both dci and ets additional revenues service dollar_figure mileage big_number office big_number photo phone and reimbursable items big_number dollar_figure less direct costs service big_number mileage big_number office big_number photo phone and reimbursable items big_number less variable overhead costs big_number additional profits big_number big_number mr wharton explained at the damages hearing the approach that he used in preparing analysi sec_1 and in arriving at the conclusions set forth therein as follows mr wharton first determined that dci and ets lost the following amounts of additional revenue during the years indi- cated year amount dollar_figure big_number big_number big_number big_number total lost revenues big_number mr wharton made the foregoing determinations by examining certain invoices that private investigative agencies other than dci had submitted to fig during the period through for work that he determined should have been assigned to dci under the agreement at issue in the farmers lawsuit and by examining certain other records that were obtained from fig containing the charges for such work mr wharton next analyzed certain historical financial data of dci and ets that showed the categories and the amounts in each category of revenues received by dci and by ets during the years through based on that analysis mr wharton concluded there were the following four categories of revenues received by dci or ets during those years a service b mile- age c office and d photo phone and reimbursable items he allocated the total lost revenues of dollar_figure among those four categories in proportions that reflected the historical data relating to those years that he had analyzed mr wharton next analyzed certain historical financial data of dci and ets that indicated the relationship of costs to revenues within each of the four categories of revenues shown in analysi sec_1 based on that analysis mr wharton determined the direct costs that dci or ets would have incurred in generating the lost revenues within each of those categories mr wharton next conducted a study of the general administrative-type expenses to determine the additional vari- able overhead costs variable overhead that dci or ets would have incurred on an annual basis during through in generating the dollar_figure of total lost revenues for that period mr wharton next reduced the total lost revenues by the total direct costs and the variable overhead to arrive at the total profits that dci and ets lost during the period through which he labeled in analysi sec_1 as additional profit due dci with respect to the portion of the total lost profits reflected in analysi sec_1 that was attributable to ets mr wharton testified at the damages hearing that although he was unable to determine that portion precisely the bulk of what is in the office profitability would have been from evergreen in that regard mr wharton further testified with respect to analysi sec_1 that the lost revenues of dollar_figure that he allocated to the office category were lost revenues from clerical and secretarial services such as typing photocopying and transcribing the direct costs of dollar_figure that he allocated to the office category were costs that would have been associated with the lost revenues in that category including variable office costs such as hourly rates charged by typists and the variable overhead of dollar_figure included additional costs that would have been associ- ated with the lost revenues in the office category the district court's award of damages on date the district_court issued an opinion opinion in the farmers lawsuit in that opinion the district_court concluded that the effects of the entry of default in favor of the plaintiffs and against fig were to treat as estab- lished the plaintiffs' factual allegations in the pretrial order relating to their claims against fig for breaches of contract indemnity and fraudulent misrepresentations and to hold fig liable to the plaintiffs on each of those claims based on the plaintiffs' allegations in the pretrial order the district_court specifically found in its opinion inter alia that dci started a business during known as ets for the purpose of providing transcription services to fig and that dci later transferred ownership of that business to the diamonds in its opinion the district_court awarded the plaintiffs viz diamond claims investigation services inc and peter j diamond and shirley diamond the following types of damages in the amounts and for the claims indicated plaintiffs' claims breaches of contract indemnity fraudulent misrepresentations7 total type of amount of damages awarded damages awarded lost profits damages indemnity damages punitive_damages and reliance damages dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure on date the district_court entered a judgment district court's judgment that plaintiffs shall recover from defendants the sum of dollar_figure together with interest at the rate of dollar_figure percent from the date of entry of judgment with respect to the lost profits damages the district_court the district_court did not award the diamonds any damages for the emotional distress that they claimed they suffered as a result of fig's fraudulent misrepresentations hereinafter all dollar amounts are rounded relied on analysi sec_1 and mr wharton's testimony at the damages hearing finding that with a few minor exceptions mr wharton's determinations set forth in analysi sec_1 were reasonable the district_court made the following minor adjustments to mr wharton's determinations in analysi sec_1 in order to reflect certain additional evidence presented at the damages hearing it increased lost revenue for the period and by dollar_figure and the total lost revenues for the period through by that same amount it increased direct costs for the period and by dollar_figure to reflect the cost of generating that additional revenue and the total direct costs for the period through by that same amount and it increased variable overhead by dollar_figure of additional monthly rents that would have been incurred during an unspecified period of time during the period through to generate the total lost revenues reflected in analysi sec_1 during those years the district court's award of attorneys' fees and costs the plaintiffs sought dollar_figure in attorneys' fees and the district_court scheduled an evidentiary hearing on that request in date the district_court awarded the plaintiffs attor- neys' fees and costs in the total amount of dollar_figure fig's appeal of the district court's judgment fig appealed the district court's judgment to the u s court_of_appeals for the ninth circuit in date the court_of_appeals affirmed the imposition of sanctions and the award to the plaintiffs of lost profits damages indemnity damages and punitive_damages and reversed the award of reliance damages satisfaction of the district court's judgment in the farmers lawsuit on or about date the attorneys representing fig in the farmers lawsuit delivered to the plaintiffs' attorneys markowitz herbold a check issued by fig dated date fig check in the amount of dollar_figure proceeds of the farmers lawsuit and a letter attached thereto fig letter the fig check was made payable to the plaintiffs in the farmers lawsuit viz dci peter diamond and shirley diamond and to markowitz herbold the fig letter stated inter alia that the check represented full payment by fig of the plaintiffs' claims as follows amount of judgment interest on judgment attorneys' fees dollar_figure big_number this amount consisted of all the damages that the district_court awarded to the plaintiffs except reliance damages although the district_court awarded the plaintiffs dollar_figure in attorneys' fees and costs the fig letter indicated that the proceeds of the farmers lawsuit included a total of dollar_figure in attorneys' fees and costs moreover although the district court's judgment awarding attorneys' fees and costs to the plaintiffs does not indicate that the plaintiffs were also awarded interest on those fees and costs the fig letter indi- cated that the proceeds of the farmers lawsuit included a total of dollar_figure in interest on those fees and costs the record does not explain the reasons for those discrepancies and the parties do not advance any argument about them despite the foregoing continued interest on attorneys' fees costs appeal costs per_diem interest total big_number big_number the fig check was endorsed by peter diamond as president of dci peter diamond as an individual shirley diamond as an individual and david markowitz and barrie herbold and was deposited into the client trust account of markowitz herbold minutes of certain dci meetings and certain correspondence of dci with respect to the farmers lawsuit the minutes of a special meeting of dci dated date date minutes and signed by the diamonds in their capacity as shareholders of dci made reference to the farmers lawsuit and stated in pertinent part as is already known the corporation is engaged in litigation against farmers insurance resulting ef- fects to the corporation are going to be a continued drain of its financial capability ever- green typing service peter diamond and shirley diamond will continue to provide the support services that formerly were given by evergreen typing service in light of this they have agreed to not bill for their services rendered during the course of the liti- gation if dci will assume the litigation expenses court costs attorneys sic fees etc continued discrepancies since the parties proceed on the assumption that the district_court awarded damages attorneys' fees and costs and interest to the plaintiffs in amounts stated in the fig letter we shall also proceed on that assumption see supra note see supra note additionally they have agreed that they will also be compensated for the loss of evergreen typing service profits as a result of the breach of contract in sic case giving rise to the farmers litigation engaged in by the corporation they will be deferring those profit dollars however until such time as the litiga- tion has been successful the diamonds have also agreed that they will not bring a separate lawsuit against the corporation dci for any breach of con- tract that the corporation would have been responsible for to evergreen typing service a letter on dci's stationery that was signed by mr diamond addressed to the diamonds and to ets and dated date date letter also made reference to the farmers lawsuit and stated in pertinent part this will confirm the corporation's agreement to extend any and all expenses with regard to the litigation engaged in by ourselves as against farmers insurance since this litigation is to our mutual benefit there is no need to reiterate its content as we are all parties however sic the purpose of this letter is to affirm that all litigation expenses attorneys sic fees trial costs etc will be paid for by the corpo- ration in exchange for your continued support services throughout the litigation and your refraining from bringing any separate sic litigation against the corporation for any liabilities owed to evergreen typing service or yourselves individually this will also aknowledge sic that our arrangement indicated above will have no effect on your company's recovery at time of settlement or judgement as against farmers insurance et al nor will the litigation expenses extended by dci have any offsetting effect as against any judgement due evergreen typing service or yourselves individually as proprietors the minutes of a meeting of dci dated date date minutes and signed by the diamonds in their capacity as shareholders of dci also made reference to the farmers lawsuit and to certain rental payments that dci owed the diamonds and stated in pertinent part the diamonds have agreed to forestall collection of rent until such time as judgement has been rendered in the litigation ongoing this is also in consideration of the risk that litigation may be unsuccessful and the diamonds would be out their rent due they are willing to extend this credit as further consideration to avoid personal litigation expenses in the ongoing suit allocation by dci and the diamonds of the proceeds of the farmers lawsuit on date the diamonds in their capacity as the officers and shareholders of dci and in their capacity as the owners of ets met with attorneys from markowitz herbold in order to discuss how the proceeds of the farmers lawsuit should be divided or allocated between dci and the diamonds as the owners of ets on that date markowitz herbold issued a check to dci in the amount of dollar_figure which contained a notation indicating that that check was in settlement of claims and which was endorsed by mr diamond as president of dci on that same date markowitz herbold also issued a check to mr diamond in the amount of dollar_figure which contained a notation indicating that that check was in settlement of personal claim was endorsed by mr diamond as an individual and represented the diamonds' share of the proceeds of the farmers lawsuit as the owners of ets the law firm of markowitz herbold retained dollar_figure of the proceeds of the farmers lawsuit as attorneys' fees and costs that were incurred in the farmers lawsuit attor- neys' fees and costs actually incurred in the farmers lawsuit dollar_figure sometime after the damages hearing dci and or the diamonds retained james donnelly mr donnelly a certified_public_accountant to analyze how the proceeds of the farmers lawsuit should be allocated between dci and ets mr donnelly made seven alternative analyses in making those various analyses he had access to and relied on inter alia the following that he received from mr diamond a copy of the district court's opinion and copies of certain evidence presented at the damages hearing including copies of analysi sec_1 and portions of the transcript containing mr wharton's testimony historical financial records of dci and ets and federal_income_tax returns filed by dci and by the diamonds mr donnelly recommended and the board_of directors of dci and the diamonds in their capacity as owners of ets approved the use of one of those analyses selected allocation analysis under the selected allocation analysis mr donnelly recom- mended that dollar_figure of the lost profits damages be allocated to ets that amount which was approximately dollar_figure percent of those damages selected allocation_ratio represented mr donnelly's estimate of the profits that ets would have earned during each of although the attorneys' fees and costs actually incurred in the farmers lawsuit were dollar_figure the district_court awarded the plaintiffs dollar_figure in attorneys' fees and costs and fig paid the plaintiffs dollar_figure in attorneys' fees and costs see supra note the years through if it had continued to operate as it had during the years and reduced by any profits that ets actually earned during each of the years through mr donnelly used the following approach to estimate what those profits would have been he calculated ets' average net profits for the years and viz dollar_figure he used a constant annual inflation rate of percent he concluded that if ets had continued to operate during the years and as it had during and it would have earned profits of dollar_figure dollar_figure dollar_figure and dollar_figure respectively he determined that ets actually earned profits of dollar_figure during and reduced the estimated profits figure of dollar_figure by that amount and he reduced the forego- ing estimated profits figures for the years through by dollar_figure to reflect certain rounding adjustments for all four years under the selected allocation analysis mr donnelly also recommended that his selected allocation_ratio of dollar_figure percent be applied to the punitive_damages the interest and the attorneys' fees and costs components of the proceeds of the farmers lawsuit and that the resulting amounts be allocated to ets he also recommended that his selected allocation_ratio of dollar_figure percent be applied to the attorneys' fees and costs actually incurred in the farmers lawsuit14 and that the resulting in applying his selected allocation_ratio to the attorneys' continued amount be allocated to ets and reduce the proceeds of the farmers lawsuit that he had otherwise allocated to ets under the selected allocation analysis under the selected allocation analysis mr donnelly recom- mended that the proceeds of the farmers lawsuit and the attor- neys' fees and costs actually incurred in the farmers lawsuit be allocated between dci and ets as follows item allocated total amount recommended recommended allocation of item allocation allocated to ets to dci lost profits damages dollar_figure dollar_figure dollar_figure punitive_damages big_number big_number big_number indemnity damages big_number -0- big_number interest big_number big_number big_number attorneys' fees and costs big_number big_number big_number total_proceeds of the farmers lawsuit big_number big_number big_number less attorneys' fees and costs actually incurred in the farmers lawsuit big_number big_number big_number amount allocated big_number big_number big_number sometime after date and prior to date in reliance on mr donnelly's recommendation under the selected allocation analysis an additional allocation of dollar_figure of the proceeds of the farmers lawsuit was made to the diamonds as the owners of ets thereby increasing the amount of the continued fees and costs actually incurred in the farmers lawsuit mr donnelly used dollar_figure as the amount of such fees and costs however the actual amount of such fees and costs was dollar_figure the record does not explain that discrepancy and the parties make no argument about it proceeds of the farmers lawsuit allocated to and received by the diamonds as the owners of ets from dollar_figure to dollar_figure tax_return treatment in the return that it filed for its taxable_year ended date and that mr donnelly signed as return preparer dci included in gross_income the entire amount of the proceeds of the farmers lawsuit viz dollar_figure dci claimed a dollar_figure deduction for contract services dci also claimed various other deductions including deductions for legal and accounting fees in the amounts of dollar_figure and dollar_figure respec- tively the diamonds filed a joint_return for that mr donnelly signed as return preparer in schedule c of that return the diamonds reported dollar_figure of gross_receipts dollar_figure of other income dollar_figure of expenses that included dollar_figure of legal and accounting fees and dollar_figure of net profits from the operations of ets notice_of_deficiency in the notice_of_deficiency notice respondent determined inter alia that dci's taxable_income for the taxable_year ended date must be increased by dollar_figure the notice stated in pertinent part it is determined that for the taxable_year ended your gross_income is understated in the amount of dollar_figure which represents a portion of the lawsuit income received from farmers insurance_company and improperly allocated to your sole shareholder this income is determined to be includible in your gross_income and it has not been established that such amount is anything other than income to you accordingly taxable_income is increased dollar_figure for the taxable_year ended on date respondent filed with the court an answer answer to the petition that dci had filed with the court in which respondent alleged inter alia that respondent mis- characterized the adjustment in the notice to dci's taxable_income as an adjustment to its gross_income rather than as a disallowance of a claimed deduction for contract services in the amount of dollar_figure and that dci is not entitled to that deduction because it constitutes a dividend or an attempted assignment_of_income to the diamonds opinion the district_court awarded the proceeds of the farmers lawsuit15 to the plaintiffs viz dci and the diamonds without the components of the proceeds of the farmers lawsuit were lost profits damages of dollar_figure indemnity damages of dollar_figure punitive_damages of dollar_figure attorneys' fees and costs of dollar_figure and interest of dollar_figure despite the district court's awarding indemnity damages of dollar_figure to all the plaintiffs viz dci and the diamonds dci does not contend that any portion of those indemnity damages is allocable to the diamonds and thus not includible in its income for the year at issue in contrast although a portion of the interest component of the proceeds of the farmers lawsuit was awarded with respect to indemnity damages neither petitioner nor respondent contends that that portion of such interest component is not at issue we conclude that the indemnity damages component of the proceeds of the farmers lawsuit is not at issue in this case but that all of the interest component of such proceeds is at issue accord- ingly the amount of the proceeds of the farmers lawsuit that remains at issue is dollar_figure hereinafter any reference to continued specifying how much of those proceeds it was awarding to each of those plaintiffs in its return for the year at issue dci included in its gross_income all the proceeds of the farmers lawsuit and deducted as contract services dollar_figure in their joint_return for the diamonds included that dollar_figure as gross_receipts dci contends that it is entitled to the full amount ie dollar_figure of the deduction that it claimed for contract ser- vices because the diamonds were the plaintiffs in the farmers lawsuit in their capacity as the owners of ets the proceeds of the farmers lawsuit included damages that the dis- trict court awarded to the diamonds in that capacity and the proceeds of the farmers lawsuit that were allocated to the diamonds represented their share of the total_proceeds of that lawsuit in the alternative dci contends that it is entitled to the full amount of the deduction in question because dci and the diamonds entered into an agreement under which the diamonds agreed inter alia to refrain from instituting a lawsuit against dci for breach of contract in return for dci's agreement to pay the diamonds their share of the proceeds of the farmers lawsuit respondent counters that dci is not entitled to dollar_figure of the deduction that dci claimed for contract services because continued the proceeds of the farmers lawsuit shall be to those proceeds that remain at issue dci paid that amount to the diamonds as a dividenddollar_figure the parties frame the central issue that we must resolve as necessarily implicating section dollar_figure we assume that that is because in its return for the year at issue dci included in its gross_income all the proceeds of the farmers lawsuit and deducted as contract services dollar_figure we disagree with the parties' framing of the main issue that we must resolve as necessarily implicating section dollar_figure as we see it the critical question that we must decide is the factual issue of whether the district_court awarded all or only a portion of the proceeds of the farmers lawsuit to dci if we were to find that the district_court awarded a portion and not all of the proceeds of the farmers lawsuit to dci only that portion would be includible in dci's gross_income for the year at issue the remaining portion although respondent does not offer any explanation as to why she conceded dollar_figure of the dollar_figure deduction that dci claimed in its return for the year at issue we shall not disturb that concession all section references are to the internal_revenue_code in effect for the year at issue all rule references are to the tax_court rules_of_practice and procedure nor are we bound by dci's treatment of the proceeds of the farmers lawsuit in its return for the year at issue although as respondent suggests dci's inclusion in that return of all of those proceeds might be construed as an admission by dci that the diamonds were not awarded any damages in the farmers lawsuit in their capacity as the owners of ets we do not take it as such this is because inter alia dci also claimed in that return a deduction of dollar_figure the portion of those proceeds received by the diamonds in their capacity as the owners of ets pursuant to mr donnelly's recommendation of such proceeds would not be includible in dci's gross_income but would be includible in the gross_income of the person to whom the district_court awarded such portion and dci would not be entitled to deduct any portion of the proceeds of the farmers lawsuit that is at issuedollar_figure if we were to find that the district_court awarded all of the proceeds of the farmers lawsuit to dci all of those proceeds would be includible in dci's gross_income for the year at issue in that event we would have to address dci's alternative contention that because of a purported agree- ment entered into between dci and the diamonds pursuant to which dci was to pay a portion of the proceeds of the farmers lawsuit to the diamonds it is entitled to the deduction that it claimed under sec_162 for the year at issue we turn first to whether the district_court awarded all or only a portion of the proceeds of the farmers lawsuit to dcidollar_figure in deciding that question we shall focus on the district court's opinions and judgments in the farmers lawsuit the pretrial order submitted in that lawsuit and certain evidence presented at the see supra note we acknowledge that for a given taxable_year including an item in gross_income and then deducting a portion of it will generally produce the same result reached by excluding that portion from gross_income and deducting no portion of the item in question however we must reach that result by following the path mandated by the facts that we have found and the applicable law although there was a dispute at trial as to whether respon- dent's answer raised a new_matter and altered the burden_of_proof our determinations are made on the record without regard to that question damages hearing on which the district_court expressly relied in awarding damages to the plaintiffs in that lawsuit cf 566_f2d_1115 9th cir affg tcmemo_1976_331 80_tc_1104 in date dci and the diamonds commenced the farmers lawsuit in the district_court by filing an initial complaint thereafter they filed an amended complaint and a second amended complaint and the plaintiffs and fig submitted a pretrial order in those submissions the plaintiffs raised claims against fig for breaches of contract indemnity and fraudulent misrepresentations and sought damages from fig with respect to those claims at the conclusion of the pretrial discovery period the plaintiffs filed a motion for sanctions against fig and on date the district_court issued an order granting that motion and indicating that it would enter a default judgment in favor of the plaintiffs following the damages hearing on date the district_court rendered an opinion in which it concluded that the pretrial order a superseded the various complaints that the plaintiffs had filed in the farmers lawsuit and b controlled the determination of any damages to be awarded to the plaintiffs and that the effects of the entry of default in favor of the plaintiffs and against fig were to treat as established the plaintiffs' factual allega- tions in the pretrial order relating to their claims against fig for breaches of contract indemnity and fraudulent misrepresen- tations in the pretrial order the diamonds as well as dci were identified as the plaintiffs in the farmers lawsuitdollar_figure in that order those plaintiffs raised claims against fig for inter alia breaches of contract and fraudulent misrepresentations and sought damages from fig with respect to those claimsdollar_figure with respect to the plaintiffs' claims against fig for breaches of contract the pretrial order alleged inter alia that the plaintiffs were parties to bound by and entitled to the benefits of the agreement at issue in the farmers lawsuit that dci had started ets during for the purpose of providing transcription services to fig in connection with the investigative work that it was performing for fig that dci had thereafter transferred ownership of ets to the diamonds respondent contends that ets was not identified as a plain- tiff in the farmers lawsuit that ets was not so identified does not preclude our finding that the diamonds were the plaintiffs in the farmers lawsuit in their capacity as the owners of ets or that they were awarded damages in that capacity we note that at an early stage in the farmers lawsuit the plaintiffs apparently recognized that the initial complaint and the amended complaint were deficient insofar as those complaints indicated that the allegations in support of their claims of breaches of contract and fraudulent misrepresentations and in support of the damages sought on account of those claims were made solely by dci and not by the diamonds and they corrected those deficiencies in the second amended complaint and in the pretrial order that dci and the diamonds periodically invested in new equip- ment for ets and hired employees for the purpose of providing services to fig that ets provided services to fig during the years through and that fig breached the agreement at issue in the farmers lawsuit with respect to the plaintiffs' claims against fig for fraudulent misrepresentations the pretrial order alleged inter alia that fig repeatedly made false misrepresentations to the plaintiffs and concealed the true state of affairs from the plaintiffs with the knowledge and intent that the plaintiffs would rely on such misrepresentations to their detriment with respect to the lost profits damages that the plaintiffs sought from fig for breaches of contract and for fraudulent mis- representations the pretrial order alleged inter alia that the plaintiffs suffered damages as a result of those actions of fig that the plaintiffs lost profits on the investigative work that fig assigned to investigative agencies other than dci and that plaintiffs peter and shirley diamond are entitled to recover their lost income including loss of profits from ets and increased expenses arising from defen- dants' fraud and breach of their agreement with plaintiffs with respect to the punitive_damages that the plaintiffs sought from fig for fraudulent misrepresentations the pretrial order alleged that the diamonds as well as dci were entitled to punitive_damages in the amount of dollar_figure million based on the plaintiffs' factual allegations in the pretrial order that the district_court treated as established that court held in its opinion that fig was liable to the plaintiffs for breaches of contract indemnity and fraudulent misrepresenta- tions the district_court then proceeded in its opinion to deter- mine the damages to be awarded to the plaintiffs as a result of fig's liability in making that determination the district_court relied on evidence that the plaintiffs presented at the damages hearing with respect to their claims for damages for lost profits due to fig's breaches of contract and fraudulent misrepresentations including analysi sec_1 and the testimony of mr wharton regarding that analysis mr wharton testified at the damages hearing that it was his understanding that ets was owned by the diamonds that it was formed sometime during that it provided services almost exclusively to dci that in determining lost profits he took account of the profits lost by dci as well as the profits lost by ets and that he treated ets as a division of dci that he and others working under his supervision prepared several analyses of the profits lost by dci and by ets as a result of fig's breaches of contract and fraudulent misrepresentations and that in determin- ing those profits he relied principally on analysi sec_1 that in reaching the conclusions shown in analysi sec_1 he aggregated the operations of dci and ets and that although he was unable to determine precisely the portion of the total lost profits reflected in analysi sec_1 that was attributable to ets the bulk of what is in the office profitability would have been from evergreen in that regard mr wharton further testified with respect to analysi sec_1 that the lost revenues of dollar_figure that he allocated to the office category in analysi sec_1 were lost revenues from clerical and secretarial services such as typing photocopying and transcribing the direct costs of dollar_figure that he allocated to the office category were costs that would have been associated with the lost revenues in that category including variable office costs such as hourly rates charged by typists and the variable overhead of dollar_figure included additional costs that would have been associated with the lost revenues in the office category based upon the pretrial order and evidence presented at the damages hearing in its opinion the district_court awarded to all the plaintiffs in the farmers lawsuit viz dci and the diamonds and not just to dci damages in the total amount of dollar_figure for fig's liability for breaches of contract indem- nity and fraudulent misrepresentations on date it entered a judgment reflecting that opinion in favor of all the plaintiffs and not just dci and for interest on those damages this amount included the district court's award to the plain- tiffs of reliance damages which was reversed by the u s court_of_appeals for the ninth circuit thereafter the plaintiffs sought attorneys' fees and the district_court awarded attorneys' fees and costs to all the plaintiffs in the farmers lawsuit and not just to dci respondent points to the following language in the district court's opinion to support her position that the district_court awarded all of the lost profits damages to dci and did not award any portion of those damages to the diamonds as the owners of ets deducting the above costs and overhead items of dollar_figure from the dollar_figure total additional revenue that diamond claims would have received if farmers had not breached their investigation services contract i find that diamond claims' lost profits for the period were dollar_figure we acknowledge that the foregoing language in the district court's opinion standing alone appears to lend support to respondent's position however that language does not stand alone and should not be read in a vacuum without regard to all the other relevant facts relating to the district court's award in the farmers lawsuit that we have found we believe that the reason that the district_court referred to the lost profits damages as diamond claims' lost profits is that it relied on and adopted mr wharton's approach that was reflected in his testimony at the damages hearing and in analysi sec_1 of treating ets as a division of dci for purposes of calculating the lost profits damages to be awarded to the plaintiffs in the farmers lawsuit mr wharton testified at that hearing that in deter- mining lost profits he took account of the profits lost by dci as well as the profits lost by ets that he treated ets as a division of dci and that although he was unable to determine precisely the portion of the total lost profits attributable to ets the bulk of what is in the office profitability would have been from evergreen the following actions taken by the parties to the farmers lawsuit subsequent to the district court's opinions and judgments are consistent with those opinions and judgments fig made the fig check in payment of the proceeds of the farmers lawsuit payable to all the plaintiffs in the farmers lawsuit viz dci peter diamond and shirley diamond as well as their attorneys markowitz herbold fig prepared the fig letter that accompanied the fig check in which it stated inter alia that that check represented full payment by fig of the plaintiffs' claims without drawing any distinction between dci and the diamonds and peter diamond as president of dci peter diamond as an individual shirley diamond as an individual and david markowitz and barrie herbold endorsed the fig checkdollar_figure we note that certain statements by dci and the diamonds in the date minutes the date letter and the date minutes also are consistent with the district court's opinions and judgments in the farmers lawsuit those documents all indicate that at an early stage in the farmers lawsuit dci and the diamonds recognized that the diamonds in their capacity as the owners of ets were parties to the farmers lawsuit and would be entitled to a portion of any amount that the district_court decided to award in that lawsuit based on our examination of the entire record in this case we find that the district_court awarded a portion of the proceeds of the farmers lawsuit to dci and a portion of those proceeds to the diamonds as the owners of etsdollar_figure consequently only the portion of such proceeds that the district_court awarded to dci is includible in its gross_income for the year at issuedollar_figure the remaining question that we must resolve which also is factual is what are the respective amounts of the proceeds of the farmers lawsuit that the district_court awarded to dci and to the diamonds as the owners of etsdollar_figure in resolving that question respondent contends that no portion of the proceeds of the farmers lawsuit was awarded to the diamonds as the owners of ets because there is no indication that there was a contractual relationship between fig and the diamonds as the owners of ets we reject that contention the pretrial order alleged that the plaintiffs were parties to the agreement at issue in the farmers lawsuit that the diamonds were entitled to lost profits from the operations of ets as a result of fig's breaches of contract and fraudulent misrepresentations and that the diamonds were enti- tled to punitive_damages as a result of fig's fraudulent misrep- resentations the district_court entered a default judgment in favor of and awarded damages to all the plaintiffs viz dci and the diamonds on account of their claims against fig for breaches of contract and fraudulent misrepresentations in light of our finding that the district_court awarded a portion of the proceeds of the farmers lawsuit to dci and a portion of such proceeds to the diamonds as the owners of ets we shall not address dci's alternative contention which we under- stand dci would advance only in the event that we had not made such a finding that it is entitled to deduct the dollar_figure of the proceeds of the farmers lawsuit that it claimed in its return for the year at issue because that is the amount that dci was obli- gated to pay the diamonds under an agreement entered into between them we disagree with petitioner's suggestion on brief that re- continued we shall address each of the following components of the proceeds of the farmers lawsuit lost profits damages of dollar_figure punitive_damages of dollar_figure attorneys' fees and costs of dollar_figure and interest of dollar_figure dci contends that dollar_figure should be allocated to dci and that dollar_figure should be allocated to the diamonds as the owners of ets to support that contention dci relies on the selected allocation analysis that was prepared by mr donnelly the certified_public_accountant who was retained to analyze how the proceeds of the farmers lawsuit should be divided between dci and the diamonds as the owners of ets and relied on by dci and the diamonds when they allocated dollar_figure of the proceeds of the farmers lawsuit to dci and dollar_figure of those proceeds to the diamonds as the owners of ets according to petitioner those amounts represent the respective shares of dci and the diamonds viz dollar_figure and dollar_figure respectively of the proceeds of the farmers lawsuit as determined by mr donnelly under the selected alloca- tion analysis reduced by their respective shares viz dollar_figure and dollar_figure respectively of the attorneys' fees and costs actually incurred in the farmers lawsuit as determined by mr continued spondent conceded that issue in fact respondent states on brief that she made no concession with respect to the disallowed contract services expense that amount includes the indemnity damages of dollar_figure that are not at issue in this case see supra note donnelly under that analysis we are unwilling to rely on mr donnelly's selected alloca- tion analysis because the district_court did not use that analy- sis or any of mr donnelly's other analyses in determining the amount of damages that it awarded to the plaintiffs in the farm- ers lawsuitdollar_figure instead we shall rely on the district court's order opinions and judgments in the farmers lawsuit and on certain evidence presented at the damages hearing on which the district_court expressly relied in awarding damages to the plaintiffs cf 406_f2d_1006 9th cir affg tcmemo_1965_237 520_fsupp_808 n d cal affd 710_f2d_1391 9th cir we turn first to the lost profits damages component of the proceeds of the farmers lawsuit in determining the respective portions of the lost profits damages awarded to dci and to the diamonds as the owners of ets we have examined the entire record in this case and have focused on the following the district court's order granting the plaintiffs' motion for sanctions and the district court's opinions and judgments awarding damages attorneys' fees and costs and interest to the plaintiffs we note that mr donnelly's selected allocation analysis was based on data different than those relied on by the district_court applied a methodology different than that applied by the district_court and focused on profits lost by ets for years that were not the same years for which lost profits damages were awarded by the district_court analysi sec_1 on which the district_court relied in awarding the lost profits damages mr wharton's testimony at the damages hearing regarding analysi sec_1 on which the district_court relied in awarding those damages other evidence presented at the damages hearing on which the district_court relied in making a few minor adjustments to mr wharton's determinations in analysi sec_1 those minor adjustments and the facts that dci formed ets in and operated it until sometime during the early part of at which time the diamonds acquired and operated ets as a sole_proprietorship we find on the record before us that of the total amount of lost profits damages viz dollar_figure that the district_court awarded to the plaintiffs in the farmers lawsuit dollar_figure was awarded to dci and dollar_figure was awarded to the diamonds as the owners of ets as for the remainder of the proceeds of the farmers lawsuit at issue viz punitive_damages of dollar_figure attorneys' fees and costs of dollar_figure and interest of dollar_figure we believe that it is reasonable to assume that each of the foregoing components of those proceeds that were awarded to dci and to the diamonds as the owners of ets were awarded in the same proportions as the lost profits damages were awarded ie dollar_figure percent to dci and dollar_figure percent to the diamonds accordingly we find that the district_court awarded each of the following components of the see supra note proceeds of the farmers lawsuit to dci and to the diamonds as the owners of ets item awarded amount awarded to dci amount awarded to the diamonds dollar_figure dollar_figure punitive_damages attorneys' fees and costs interest big_number big_number big_number big_number based on our review of the entire record in this case we find that of the proceeds of the farmers lawsuit that are at issue viz dollar_figure dollar_figure was awarded to dci and dollar_figure was awarded to the diamonds as the owners of ets accordingly only dollar_figure of those proceeds is includible in dci's gross_income for the year at issuedollar_figure to reflect the foregoing and the concessions of the parties decision will be entered under rule the remaining portion of such proceeds or dollar_figure is not includible in dci's gross_income for the year at issue and dci is not entitled to the deduction of dollar_figure on which the parties focus their arguments in this connection petitioner concedes on brief that by allowing petitioner to deduct dollar_figure of the total deduction claimed in its return for the year at issue with respect to the proceeds of the farmers lawsuit respondent did not include in petitioner's taxable_income for that year dollar_figure of those proceeds that are at issue and that the district_court awarded to the diamonds as the owners of ets consequently in the rule computation the parties shall take account of petitioner's concession so that the maximum amount of the pro- ceeds of the farmers lawsuit that are at issue and that are not includible in the taxable_income of dci is dollar_figure


internal_revenue_service number release date index number ------------------------------------------------------------ ---------------------------------------- ------------------------------------ ------------------------------ ------------------------------------ department of the treasury washington dc third party communication date of communication month dd yyyy person to contact --------------------- id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-135344-07 date date trust ---------------------------------------------------------------------------------------- --------------------------------- a ----------------------------------------- -------------------------------- x -- trustee -------------------- court ---------------------------------------- ------------------------------------------------------ ------------------------------ d1 -------------------------- d2 ------------------- dear ---------------- this letter responds to a letter dated date submitted by trust’s authorized representative on behalf of trust and trustee a requesting ruling under sec_664 of the internal_revenue_code on the qualification of trust as a net_income make- up charitable_remainder_unitrust nimcrut the information submitted states that on d1 trust was established by a with the intention that trust qualify as a nimcrut under sec_664 trustee is the trustee of trust the governing document for trust provides for an annual unitrust payment to be paid to a in quarterly installments the annual unitrust payment is equal to the lesser plr-135344-07 of i x of the net fair_market_value of the assets of trust valued annually the unitrust_amount or ii the trust income for the taxable_year as defined under sec_643 in addition if the trust income for any year exceeds the unitrust_amount the annual payment will include such excess net_income to the extent the aggregate amounts paid to a in prior years is less than x of the aggregate net fair_market_value of the trust assets for such years pursuant to section of the governing instrument of trust trustee has the power to amend trust’s governing instrument in any manner required for the sole purpose of ensuring that trust qualifies as a charitable_remainder_trust within the meaning of sec_664 and and the regulations thereunder on date after trust was established final regulations under sec_1_664-3 were issued see t d f_r 1991_1_cb_364 sec_1_664-3 of those final regulations provides in part that proceeds from the sale_or_exchange of any assets contributed to the trust must be allocated to principal and not to trust income at least to the extent of the fair_market_value of those assets on the date of their contribution additionally the preamble to those regulations indicates that taxpayers do not have to treat the make-up amount as a liability when valuing the assets of a nimcrut a make-up liability provision the governing instrument of trust complies with sec_1_664-3 as promulgated in those final regulations with respect to the property used to fund trust initially but will not comply with respect to additional contributions to trust the governing instrument of trust also includes a make-up liability provision because trustee was concerned that he could not accept additional contributions of property to trust without disqualifying trust as a nimcrut trustee petitioned court to reform trust on d2 court entered a judgment reforming trust by striking trust’s make-up liability provision the judgment also reforms trust by adding a paragraph requiring that the proceeds from the sale_or_exchange of any assets contributed to trust be allocated to principal and not to trust income to the extent of the fair_market_value of those assets on the date of their contribution to trust and requiring the proceeds from the sale_or_exchange of any assets purchased by trust to be allocated to principal and not to trust income to the extent of trust’s purchase_price of those assets otherwise per the judicial reformation all realized capital_gain of trust is to be allocated to trust income sec_664 provides that for purposes of sec_664 a charitable_remainder_unitrust is a_trust a from which a fixed percentage which is not less than percent nor more than percent of the net fair_market_value of its assets valued annually is to be paid not less often than annually to one or more persons at least one of which is not an organization described in sec_170 and in the case of individuals only to an individual who is living at the time of the creation of the trust for a term of years not in excess of years or for the life or lives of such individual or individuals b from which no amount other than the payments described in sec_664 and other qualified gratuitous transfers described in sec_664 may be paid to or for_the_use_of plr-135344-07 any person other than an organization described in sec_170 c following the termination of the payments described in sec_664 the remainder_interest in the trust is to be transferred to or for_the_use_of an organization described in sec_170 or is to be retained by the trust for such a use or to the extent the remainder_interest is in qualified_employee securities as defined in sec_664 all or part of such securities are to be transferred to an employee_stock_ownership_plan as defined in sec_4975 in a qualified_gratuitous_transfer as defined by sec_664 and d with respect to each contribution of property to the trust the value determined under sec_7520 of such remainder_interest in such property is at least percent of the net fair_market_value of such property as of the date such property is contributed to the trust sec_664 provides that notwithstanding the provisions of sec_664 and b the trust instrument may provide that the trustee shall pay the income_beneficiary for any year - a the amount of the trust income if such amount is less than the amount required to be distributed under sec_664 and b any amount of the trust income which is in excess of the amount required to be distributed under sec_664 to the extent that by reason of sec_664 the aggregate of the amounts paid in prior years was less than the aggregate of such required amounts sec_1_664-3 of the income_tax regulations provides in part that a charitable_remainder_trust may not be subject_to a power to invade alter amend or revoke for the beneficial use of a person other than an organization described in sec_170 based on the information submitted and representations made we conclude that the judicial reformation of trust described above will not cause trust to fail to qualify as a nimcrut under sec_664 except as specifically set forth above no opinion is expressed as to the federal tax consequences of the above facts under any other provisions of the code specifically we express no opinion as to whether trust was or is a charitable_remainder_unitrust under sec_664 this ruling is directed only to the taxpayer on whose behalf it was requested sec_6110 provides that it may not be used or cited as precedent plr-135344-07 pursuant to a power_of_attorney on file with this office a copy of this letter is being sent to trust's authorized representative sincerely melissa c liquerman senior technician reviewer branch associate chief_counsel passthroughs special industries enclosures copy of this letter copy for ' purposes cc


t c summary opinion united_states tax_court rockwood gewanna summerfield jr petitioner v commissioner of internal revenue respondent docket no 13856-09s filed date peter andrew lowy for petitioner benjamin j peeler for respondent armen special_trial_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 unless otherwise indicated all subsequent section references are to the internal_revenue_code in effect for the taxable_year in issue and all rule references are to the tax_court rules_of_practice and procedure other court and this opinion shall not be treated as precedent for any other case respondent determined a deficiency in petitioner’s federal_income_tax of dollar_figure all but one of the issues in this case have been resolved by the parties in a stipulation of settled issues the remaining issue is whether petitioner is entitled to a deduction for travel_expenses as claimed on his federal_income_tax return for the resolution of this issue requires that we decide whether in petitioner had a tax_home within the meaning of sec_162 if petitioner did not then he is not entitled to the deduction in issue but if petitioner did then we must also decide where his tax_home was and the amount of the deduction background many of the facts have been stipulated and they are so found we incorporate by reference the parties’ stipulation of facts and accompanying exhibits at the time that the petition was filed petitioner resided in the state of texas due to taking a temporary job with a company in houston texas so stipulated in the petition petitioner listed a mailing address in texas but specified florida as his state of legal residence see sec_7482 by profession petitioner is and has been for many years a plumber pipefitter as such petitioner is a member of the united association of journeymen and apprentices of the plumbing and pipe fitting industry of the united_states and canada ua throughout his professional career petitioner has been a member of ua local also known as plumbers local union ua local has geographical jurisdiction over the metropolitan washington d c area petitioner was initiated into ua local as an apprentice in date and achieved journeyman status in date petitioner has never undertaken to transfer his membership to another local union but has instead chosen to remain a member of ua local throughout his professional career because of his perception that except for a period in the late ‘80s and early the ua is a multicraft union with more than big_number members throughout the united_states and canada who engage in the fabrication installation and servicing of various piping systems united association http www ua org aboutua asp the ua includes pipefitters and plumbers as well as other related tradespersons such as welders sprinklerfitters and service technicians for heating ventilation air conditioning and refrigeration hvacr id pipefitters also known as steamfitters lay out fabricate assemble install maintain and repair piping systems that typically operate under high pressure and that transport all types of fluids slurries and gases in industrial commercial and residential contexts id plumbers install repair maintain and service piping and plumbing systems and equipment used for potable water distribution sanitary storm water systems and waste disposal plumbers also work on technical installations for medical gas and other health and safety systems id see http www local5plumbers org ‘90s washington d c always seems to have some kind of work even when the rest of the country doesn’t for most if not all of his career as a journeyman petitioner has specialized in industrial and commercial projects involving work on structures such as oil refineries power plants hospitals and schools petitioner is also certified to work on medical gas systems found in hospitals as a journeyman petitioner typically works in various locations on projects of limited duration the length of these projects generally ranges from a few days or a week to a couple of months generally speaking petitioner finds work by signing the out-of-work list referral book at the business office of ua local in washington d c and waiting for his name to come to the top of the list in order to remain on the out-of-work list and therefore be eligible for an assignment to a project petitioner is required to sign the referral book every days when he is without work and he must do this in person by returning to the business office of ua local in washington d c petitioner was formerly married and he and his then-wife lived in maryland in the couple separated and a pretty bitter divorce followed in in date petitioner went to florida at the request of his father who was retired and caring for petitioner’s seriously-ill mother who subsequently died in petitioner’s parents owned a house in ocala florida petitioner obtained a florida driver’s license and registered to vote in florida he also registered his vehicles in florida and paid applicable licensing and registration fees during petitioner worked for nine different employers on nine different projects for the following periods and at the following locations period location - metro washington d c - chalmette la exxon-mobil oil refinery - fort riley ks us army base - paducah ky - metro washington d c - metro washington d c - metro washington d c - mcpherson ks valero oil refinery - washington d c children’s hospital petitioner traveled to all of the foregoing jobsites in his chevy trailblazer he took with him worktools as well as a microwave oven coffeepot and other similar necessities of everyday life he sought out economical accommodations and negotiated for weekly rates on occasion he shared a room with another pipefitter or tradesman in order to minimize expenses petitioner received no reimbursement from either his union or any employer for travel_expenses when he was not working petitioner returned to florida petitioner did not maintain a separate abode but stayed with his father in ocala petitioner did not pay rent however he did contribute to household expenses but only during the time that he was actually staying with his father petitioner was unemployed for the last months of because of an injury sustained in a motorcycle mishap during that period he collected unemployment insurance benefits from the state of florida petitioner filed a form_1040 u s individual_income_tax_return for on his return petitioner itemized his deductions on schedule a itemized_deductions among those claimed was one for unreimbursed employee business_expenses petitioner did not claim any deduction for either mortgage interest or real_estate tax petitioner did maintain a storage unit in orlando fla for some of his personal effects at trial petitioner testified that he did not pay rent to his father the reason being because i’m running halfway around the country three-quarters nine-tenths of the year when i’m there i do contribute to the household i mean i’m running up his water because i’m taking showers extra electricity you know whatever the case discussion7 generally outlays for food and shelter are considered personal expenses and are not deductible sec_262 however sec_162 allows a taxpayer to deduct traveling expenses including amounts expended for meals_and_lodging that are paid_or_incurred while away from home in the pursuit of a trade_or_business 326_us_465 513_f2d_697 6th cir affg tcmemo_1974_160 67_tc_824 respondent contends that petitioner had no tax_home and was therefore not away from home when he incurred the expenses in issue in contrast petitioner contends that ocala florida was his tax_home and that he was therefore away from home when working at various projects in washington d c and elsewhere around the country as a general_rule a taxpayer’s principal place of employment is the taxpayer’s tax_home 49_tc_557 an employee without a principal_place_of_business may treat a permanent place of residence at which the employee incurs substantial continuing living_expenses as his or her tax_home 29_tc_16 where the taxpayer has neither a principal_place_of_business nor we decide this case without regard to the burden_of_proof a permanent residence he has no tax_home from which he can be away his home is wherever he happens to be 85_tc_462 affd without published opinion 807_f2d_177 9th cir see 629_f2d_1071 5th cir affg tcmemo_1977_345 was ocala florida petitioner’s tax_home if petitioner did not have a principal place of employment as both parties implicitly assume then resolution of the tax_home issue is simple and straightforward thus the law is clear that the purpose of the away from home requirement of sec_162 is to mitigate the burden of the taxpayer who because of the exigencies of his or her trade_or_business must maintain two places of abode and thereby incur additional and duplicate living_expenses 143_f3d_497 9th cir affg tcmemo_1995_559 438_f2d_905 2d cir 61_tc_855 kroll v commissioner supra pincite 47_tc_71 an obvious precondition to a taxpayer being away from home is that the taxpayer have a home see bochner v commissioner supra pincite this means that the taxpayer must have incurred substantial continuing living_expenses at a permanent place of residence and must also have paid the expenses_incurred in connection with his or her business while on the road see brandl v commissioner supra pincite 308_f2d_204 9th cir bochner v commissioner supra pincite in the instant case petitioner did have some ties to the state of florida but significantly and indeed determinatively petitioner bore no duplicate living_expenses petitioner did not maintain a separate abode but stayed with his father in ocala he did not make mortgage payments or pay rent and he contributed to household expenses only while he was actually staying with his father these contributions are not of the type considered to be costs of maintaining a home such that the expenses related to petitioner’s life on the road would be redundant in short ocala was not petitioner’s tax_home in was metro washington d c petitioner’s tax_home as previously indicated both parties implicitly assume that petitioner had no principal place of employment however the record belies such assumption thus we conclude based on the totality of the following six factors that the metropolitan at trial petitioner acknowledged that his father paid the mortgage on the house and that when his mother died in he ie petitioner did not inherit any interest in the house presumably petitioner’s father also paid the real_estate tax on the house because petitioner claimed no deduction for real_estate tax on schedule a of his return we reject any suggestion that payment of rent on a storage unit is equivalent to maintaining a household washington d c area was petitioner’s principal place of employment in first petitioner was a member of ua local in washington d c second petitioner was a member of ua local because as he testified at trial washington d c has work most of the time third petitioner generally found work by signing the referral book at the business office of ua local in washington d c and waiting for his name to come to the top of the out-of- work list fourth in order to remain on the out-of-work list and therefore be eligible for an assignment to a project petitioner was required to sign the referral book in person at the business office of ua local in washington d c every days when he was without work fifth more than one-half of the jobsites where petitioner worked in were in the metropolitan washington d c area sixth approximately one-half of petitioner’s workdays in were spent at jobsites in the metropolitan washington d c area because the metropolitan washington d c area was petitioner’s principal place of employment in we hold that metropolitan washington d c was petitioner’s tax_home for that year see kroll v commissioner t c pincite amount of deduction because petitioner had a tax_home in he is entitled to a deduction under sec_162 for traveling expenses those expenses include lodging meals and incidental_expenses and mileage while on business away from home ie away from petitioner’s tax_home in washington d c regarding lodging petitioner is entitled to deduct actual expenses as stipulated by the parties variously as lodging hotel and hotel lodging except that petitioner is not entitled to deduct either hotel costs incurred on or about august and in traveling between washington d c and ocala florida as those costs were personal in nature or rent paid in the metropolitan washington d c area as petitioner was not away from home when he was at his tax_home in addition petitioner is entitled to deduct the dollar_figure daily lodging cost he incurred in staying at the fema camp while he was working at the exxon-mobil oil refinery in chalmette louisiana regarding meals and incidental_expenses the parties appear to agree that petitioner is entitled to a per_diem_allowance based on revproc_2005_67 2005_2_cb_729 and revproc_2006_41 2006_2_cb_777 as applicable to the calendar_year dollar_figure naturally petitioner is not entitled to any per_diem the allowance for meals is of course subject_to the 50-percent limitation of sec_274 allowance for the times that he was working in the metropolitan washington d c area as he was not then away from home finally regarding mileage petitioner is entitled to an allowance based on dollar_figure5 per mile driven as stipulated by the parties see revproc_2005_78 sec_5 2005_2_cb_1177 except that petitioner is not entitled to any allowance for mileage between washington d c and ocala florida which mileage was personal in nature conclusion we have considered all of the arguments advanced by the parties and to the extent that we have not expressly addressed any we conclude that none supports an outcome contrary to that reached herein to give effect to our disposition of the disputed issue as well as the parties’ stipulation of settled issues decision will be entered under rule


e r r a c internal_revenue_service department of the treasury index number u ll no washington dc person to contact telephone number refer reply to cc dom p si plr-106084-99 date date legend company state é shareholder o i o i dear l t t l u this letter responds to a letter dated date requesting a ruling on behalf of company under sec_1362 of the internal_revenue_code the information submitted discloses that company was incorporated on a in state company’s principal_shareholder is shareholder t is represented that company has intended to be an s_corporation since its incorporation believing itself to be an s_corporation company has operated accordingly since a after the end of its taxable_year beginning on a however company discovered that its s election had not been timely filed company requests a ruling that its sec_1362 election will be treated as timely made for its taxable_year that begins on b sec_1362 provides that a small_business_corporation may elect to be an s_corporation plr-106084-99 sec_1362 explains when an s election will be effective generally if an s election is made within the first two and one half months of a corporation's taxable_year then that corporation will be treated as an s_corporation for the year in which the election is made sec_1362 provides that if an s election is made after the first two and one half months of a corporation's taxable_year then that corporation will not be treated as an s_corporation until the taxable_year following the year in which the s election is made sec_1362 provides that if no sec_1362 election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and sec_1362 shall not apply applying the relevant law to the facts submitted and representations made we tule that company's sec_1362 election will be treated as timely made for its taxable_year that begins on b however this ruling is contingent on company filing form_2553 election by a small_business_corporation with an effective date of b with the appropriate service_center within days from the date of this ruling a copy of this letter should be attached to the form_2553 except as specifically set forth above we express no opinion concerning the federal tax consequences of the foregoing facts specifically we express no opinion on whether company otherwise qualifies as an s_corporation this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent enclosure copy for sec_6110 purposes sincerely yours signed william pp u’bhea william p o'shea chief branch office of the assistant chief_counsel passthroughs and special industries abl


internal_revenue_service number release date index number -------------------- ------------------------ --------------------------- ----------------------------- - department of the treasury washington dc person to contact ---------------------- id no ------------- telephone number --------------------- refer reply to cc psi b07 - plr-163783-03 date date ------------------------ ------------- ------------------ ----- -- --------- -- -- legend corporation state date a b c d e dear ---- regarding the application of sec_216 of the internal_revenue_code to corporation this letter responds to that request the represented facts are as follows corporation was formed on date under the laws of state for the purposes of acquiring and operating_on_a_cooperative_basis an apartment building building building contains a residential units and b commercial units currently c shares of common_stock are issued and outstanding common_stock has been allocated to a residential units and d commercial units common_stock has been not been allocated to e commercial units commercial units commercial units currently are leased to a commercial tenant corporation proposes to convert commercial units to cooperative ownership by selling to a purchaser additional shares of stock attributable to each unit corporation represents that the shares to be issued with respect to each unit will be fully paid up in we received a letter from your authorized representative requesting rulings you have specifically requested two rulings the proprietary leases will entitle the purchaser of the additional shares corporation represents that the local zoning law and building regulations plr-163783-03 an amount bearing a reasonable relationship to the portion of the value of corporation’s equity in the building and land that is attributable to each unit attributable to commercial units to occupy the units either for retail purposes or as residential apartments the owner of commercial units will at all times have the right as against corporation to occupy the units for dwelling purposes currently permit modification of commercial units to residential use as a matter of right corporation submits facts and representations to show that it would be reasonable to convert commercial units to residential use the size and location of commercial units are such that with certain modifications they could be converted into residential apartments provided corporation satisfies the requirements of sec_216 c and d neither the issuance of stock by corporation to be allocated to commercial units nor the possible nonresidential use of the units will prevent corporation from qualifying as a cooperative_housing_corporation within the meaning of sec_216 will qualify as a tenant-stockholder for purposes of sec_216 provided such stock is fully paid up in an amount which bears a reasonable relationship to the portion of the value of corporation’s equity in the building and land which is attributable to the unit which the purchaser is entitled to occupy means a corporation - a having one and only one class of stock outstanding b each of the stockholders of which is entitled solely by reason of his ownership of stock in the corporation to occupy for dwelling purposes a house or an apartment in a building owned or leased by such corporation c no stockholder of which is entitled either conditionally or unconditionally to receive any distribution not out of earnings_and_profits of the corporation except on a complete or partial_liquidation of the corporation and d percent or more of the gross_income of which for the taxable_year in which the taxes and interest described in sec_216 are paid_or_incurred is derived from tenant- stockholders who is a stockholder in a cooperative_housing_corporation and whose stock is fully paid-up in an amount not less than an amount shown to the satisfaction of the secretary as bearing a reasonable relationship to the portion of the value of the corporation’s the purchaser of the stock of corporation attributable to commercial units sec_216 provides that the term tenant-stockholder means a person sec_216 provides that the term cooperative_housing_corporation sec_1_216-1 provides in relevant part that in order to qualify as a plr-163783-03 equity in the houses or apartment building and the land on which situated which is attributable to the house or apartment which such person is entitled to occupy cooperative_housing_corporation under sec_216 each stockholder of the corporation whether or not the stockholder qualifies as a tenant-stockholder under sec_216 and sec_1_216-1 must be entitled to occupy for dwelling purposes an apartment in a building or a unit in a housing development owned or leased by such corporation the stockholder is not required to occupy the premises the right as against the corporation to occupy the premises is sufficient such right must be conferred on each stockholder solely by reasons of his or her ownership of stock in the corporation that is the stock must entitle the owner thereof either to occupy the premises or to a lease of the premises the fact that the right to continue to occupy the premises is dependent upon the payment of charges to the corporation in the nature of rentals or assessments is immaterial revrul_74_241 1974_1_cb_68 provides that for purposes of sec_216 the term apartment in a building means an independent housekeeping unit consisting of one or more rooms containing facilities for cooking sleeping and sanitation normally found in a principal_residence that a unit presently contain all the facilities normally found in a principal_residence in order to constitute an apartment in a building for purposes of sec_216 a unit will be treated as meeting that definition if the stockholder is entitled to convert the unit to an apartment as defined in revrul_74_241 solely by reason of ownership of stock in the cooperative_housing_corporation the conversion of the unit would be reasonable under all the facts and circumstances including structural feasibility and cost and the applicable zoning building and fire codes permit both the conversion and residential use of the unit as a matter of right subject_to the limitation below we conclude that provided corporation satisfies the requirements of sec_216 c and d neither the issuance of stock by corporation to be allocated to commercial units nor the possible nonresidential use of the units will prevent corporation from qualifying as a cooperative_housing_corporation within the meaning of sec_216 commercial units will qualify as a tenant-stockholder for purposes of sec_216 provided such stock is fully paid up in an amount which bears a reasonable relationship to the portion of the value of corporation’s equity in the building and land which is attributable to the unit which the purchaser is entitled to occupy revrul_90_35 1990_1_cb_48 provides that revrul_74_241 does not require we also conclude that the purchaser of the stock of corporation attributable to applying the above standards to the facts and representations submitted and this ruling is directed only to the taxpayer requesting it sec_6110 plr-163783-03 except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion whether corporation otherwise meets the requirements of sec_216 provides that it may not be used or cited as precedent 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 copy of this letter to your authorized representative a copy of this ruling must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file with this office we are sending a the rulings contained in this letter are based upon information and sincerely brenda m stewart senior counsel branch office of associate chief_counsel passthroughs and special industries