internal_revenue_service national_office technical_advice_memorandum date number release date index uil no case-mis no ----------------- appeals team case leader ap atcl stp tam-109116-07 taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference -------------------------- ---------------------- ---------------------------------- ---------------------------------------------- ---------------- ----------------------------------- ------------------ legend corporation a x y z investment banker year year newco abc securities exchange c issue -------------------------- --------------------------------------------------------------------- -------------------------------------------- --------------------------------------------------------------------------------- ----------------------------------------- ---------------------------- ------- ------- -------------------------- -------------------------------- --------- the issue presented in this memorandum is whether corporation a and its subsidiaries taxpayers obtained audit protection by filing a form_3115 requesting consent to tam-109116-07 change their methods_of_accounting to comply with sec_1_263_a_-5 of the income_tax regulations audit protection is not defined in the code or regulations but is described as follows in revproc_2002_9 dollar_figure and in revproc_97_27 dollar_figure in substantially_similar terms except as provided in sections or dollar_figure or in the appendix of this revenue_procedure when a taxpayer timely files a copy of the application with the national_office in compliance with all the applicable provisions of this revenue_procedure the service will not require the taxpayer to change its method_of_accounting for the same item for a taxable_year prior to the year_of_change accordingly if taxpayers obtained audit protection as a result of filing their form_3115 the service would ordinarily be precluded from requiring taxpayers to change their methods_of_accounting for the items covered by the form_3115 for any taxable_year prior to the year_of_change although this protection would be subject_to certain exceptions conclusion s taxpayers did not obtain audit protection as a result of filing their form_3115 facts corporation a and its subsidiaries are primarily engaged in the business of providing x to y located in the united_states prior to corporation a and its subsidiaries also operated lesser business divisions which provided z the value of the corporation a’s common_stock had remained stagnant for several years in response to this lack of growth corporation a engaged investment banker to provide advice regarding strategic alternatives for increasing shareholder value investment banker identified three alternatives for consideration maintenance of the status quo recapitalization which would result in either a leveraged recapitalization or a full recapitalization with a spin off of the lesser business divisions and divestiture of the lesser business divisions by means of either targeted stock an initial_public_offering ipo carve out a split off or a spin off in january of year the board_of directors of corporation a approved a plan_of_reorganization which called for the division of corporation a and its subsidiaries into two independent companies under the plan certain lesser business divisions would be combined into a separate independent publicly traded company called newco the remaining business_assets and activities would remain with corporation a and its subsidiaries tam-109116-07 in march of year corporation a contributed various subsidiaries assets and liabilities to newco in may of year corporation a finalized its decision to divest itself of the ownership of newco through a mechanism involving a ipo and a split off an ipo of less than percent of the common_stock of newco was completed in june of year on the abc securities exchange thereafter the outstanding_stock of newco was owned in part by corporation a and in part by unrelated public shareholders corporation a also took steps to perform the split off in which certain shareholders of stock in corporation a would exchange their stock in taxpayer for stock in newco however in october of year corporation a abandoned the split off when it became apparent that a split off of newco would not maximize shareholder value instead corporation a ultimately determined that the traditional spin off was the best mechanism to maximize shareholder value the board_of directors of corporation a approved the spin off transaction in november of year the spin off was effected by the distribution of c share of newco common_stock for each one share of stock of corporation a the spin off was completed and newco became a wholly separate and independent company from corporation a in december of year in july of year the service issued a form_5701 notice of proposed_adjustment with respect to newco corporation proposing to capitalize certain ipo transaction costs on the same date the service issued a form_5701 with respect to corporation a proposing to capitalize certain spin-off transaction costs in september of year taxpayers filed a form_3115 application_for change in accounting_method under revproc_2004_23 for the calendar_year to request an accounting_method change in the handling of transaction costs under sec_1_263_a_-5 law and analysis sec_446 of the internal_revenue_code provides that taxable_income is to be computed under the method_of_accounting on the basis of which the taxpayer regularly computes his income keeping his books see also sec_1_446-1 clear_reflection_of_income sec_446 provides that if no method_of_accounting has been regularly used by the taxpayer or if the method used does not clearly reflect income the computation of taxable_income shall be made under such method as in the opinion of the secretary does clearly reflect income see also sec_1_446-1 the commissioner has broad discretion in determining whether a taxpayer’s method_of_accounting clearly reflects income and the commissioner’s determination must be upheld unless it is clearly unlawful see thor power tool co v commissioner tam-109116-07 u s 664_f2d_881 2nd cir cert_denied 457_us_1133 service-imposed accounting_method changes using professional judgment in accordance with auditing standards an examining agent will make findings_of_fact and apply service position on issues of law to determine whether an issue is an accounting_method_issue and whether the taxpayer's method_of_accounting is permissible for this purpose the term accounting_method_issue means an issue regarding whether the taxpayer's accounting treatment of an item is proper but only if changing the taxpayer's treatment of such item could constitute a change in method_of_accounting see revproc_2002_18 2002_1_cb_678 dollar_figure and an examining agent who determines that a taxpayer's method_of_accounting is impermissible may propose an adjustment with respect to that method only by changing the taxpayer's method_of_accounting except as provided in dollar_figure of revproc_2002_18 relating to previous accounting_method changes made by a taxpayer without obtaining the requisite consent under sec_446 an examining agent changing a taxpayer's method_of_accounting will select a new method_of_accounting by properly applying the law to the facts determined by the agent the method selected must be a proper method_of_accounting and will not be a method contrived to reflect the hazards_of_litigation see revproc_2002_18 dollar_figure and once the commissioner has determined that the taxpayer’s method_of_accounting does not clearly reflect income the commissioner has broad discretion in selecting a method_of_accounting that the commissioner believes properly reflects the income of a taxpayer the commissioner’s selection may be challenged only upon showing an abuse_of_discretion by the commissioner see 420_f2d_352 1st cir 430_f2d_679 9th cir 190_f2d_330 10th cir cert_denied 342_us_860 an examining agent changing a taxpayer's method_of_accounting will make the change in a year under examination ordinarily the change will be made in the earliest taxable_year under examination or if later the first taxable_year the method is considered to be impermissible although an examining agent may defer the year_of_change to a later taxable_year in appropriate circumstances an examining agent will not defer the year_of_change in order to reflect the hazards_of_litigation moreover an examining agent will not defer the year_of_change to later than the most recent year under examination on the date of the agreement finalizing the change see revproc_2002_18 sec_5 tam-109116-07 an examining agent changing a taxpayer's method_of_accounting ordinarily will impose a sec_481 adjustment subject_to a computation of tax under sec_481 if applicable the sec_481 adjustment whether positive or negative will be taken into account entirely in the year_of_change see sec_1_448-1 revproc_2002_18 sec_5 taxpayer-initiated accounting_method changes sec_446 provides that except as otherwise provided a taxpayer who changes the method_of_accounting on the basis of which he regularly computes his income in keeping his books shall before computing his taxable_income under the new method secure the consent of the commissioner such consent must be secured whether or not the taxpayer’s existing method is proper or is permitted under the internal_revenue_code or the regulations thereunder see sec_1 e i sec_1_446-1 provides in part that except as otherwise provided under the authority of sec_1_446-1 to secure the commissioner's consent to a taxpayer's change in method_of_accounting the taxpayer must file an application on form_3115 with the commissioner during the taxable_year in which the taxpayer desires to make the change in method_of_accounting to the extent applicable the taxpayer must furnish all information requested on the form_3115 the commissioner may require such other information as may be necessary to determine whether the proposed change will be permitted permission to change a taxpayer's method_of_accounting will not be granted unless the taxpayer agrees to the commissioner's prescribed terms and conditions for effecting the change including the taxable_year or years in which any adjustment necessary to prevent amounts from being duplicated or omitted is to be taken into account sec_1_446-1 provides that notwithstanding the provisions of sec_1 e i the commissioner may prescribe administrative procedures under which taxpayers will be permitted to change their method_of_accounting the administrative procedures shall prescribe those terms and conditions necessary to obtain the commissioner's consent to effect the change and to prevent amounts from being duplicated or omitted the terms and conditions that may be prescribed by the commissioner may include terms and conditions that require the change in method_of_accounting to be effected on a cut-off basis or by an adjustment under sec_481 to be taken into account in the taxable_year or years prescribed by the commissioner revproc_97_27 1997_1_cb_680 as modified and amplified by revproc_2002_19 2002_1_cb_696 and amplified and clarified by revproc_2002_54 c b provides the general procedures under sec_446 and sec_1_446-1 for obtaining the consent of the commissioner of internal revenue to change a method_of_accounting for federal_income_tax purposes tam-109116-07 section dollar_figure of revproc_97_27 provides that revproc_97_27 applies to all taxpayers requesting the commissioner's consent to change a method_of_accounting for federal_income_tax purposes except as specifically provided in other published guidance or in dollar_figure of revproc_97_27 sec_4 of revproc_97_27 provides that revproc_97_27 does not apply if the change in method_of_accounting is required to be made pursuant to a published automatic change procedure revproc_2002_9 2002_1_cb_327 as modified and clarified by announcement 2002_1_cb_561 modified and amplified by revproc_2002_19 2002_1_cb_696 and amplified clarified and modified by revproc_2002_54 c b provides the procedures by which a taxpayer may obtain automatic consent to change the methods_of_accounting described in its appendix a taxpayer complying with all the applicable provisions of revproc_2002_9 has obtained the consent of the commissioner to change its method_of_accounting under sec_446 see revproc_2002_9 sec_1 section dollar_figure of revproc_2002_9 provides that revproc_2002_9 applies to a taxpayer requesting the commissioner's consent to change to a method_of_accounting described in the appendix of revproc_2002_9 revproc_2002_9 is the exclusive procedure for a taxpayer within its scope to obtain the commissioner's consent sec_4 of revproc_2002_9 provides that except as otherwise provided in the appendix of revproc_2002_9 see for example section dollar_figure of the appendix revproc_2002_9 does not apply if on the date the taxpayer would otherwise file a copy of the application with the national_office the taxpayer is under examination as provided in dollar_figure of rev_proc except as provided in 90-day window 120-day window director consent changes lacking audit protection and issue pending of revproc_2002_9 section dollar_figure of revproc_2002_9 provides that pursuant to sec_1_446-1 the consent of the commissioner is granted to any taxpayer within the scope of revproc_2002_9 to change its method s of accounting as described in the appendix to revproc_2002_9 this consent is granted only for the change s of accounting_method and the affected_item s that are clearly and expressly identified in the taxpayer's application further this consent is granted only to the extent that the taxpayer complies with all the applicable provisions of revproc_2002_9 and implements the change in method_of_accounting for the requested year_of_change section of revproc_2002_9 provides that except as otherwise provided in the appendix of revproc_2002_9 see for example section dollar_figure of the appendix a taxpayer that is under examination may file an application to change a method of tam-109116-07 accounting under of revproc_2002_9 only if the taxpayer is within the provisions of 90-day window 120-day window director consent changes lacking audit protection or issue pending of revproc_2002_9 a taxpayer that files an application beyond the time periods provided in the day and 120-day windows is not eligible for the automatic_extension of time and will not be granted an extension of time to file under sec_301 except in unusual and compelling circumstances section a of revproc_2002_9 provides that a taxpayer that is under examination with respect to any income_tax issue may request to change a method_of_accounting if the method_of_accounting to be changed is an issue pending for any taxable_year under examination however the audit protection provisions of dollar_figure of revproc_2002_9 do not apply to a taxpayer changing its method_of_accounting under of revproc_2002_9 for this purpose an issue is pending for taxable years under examination if the service has given the taxpayer written notification indicating an adjustment is being made or will be proposed with respect to the taxpayer's method_of_accounting this notification normally will occur after the service has gathered information sufficient to determine that an adjustment is appropriate and justified although the exact amount of the adjustment may not yet be determined section dollar_figure of revproc_2002_9 provides that except as provided in or dollar_figure or in the appendix of revproc_2002_9 when a taxpayer timely files a copy of the application with the national_office in compliance with all the applicable provisions of revproc_2002_9 the service will not require the taxpayer to change its method_of_accounting for the same item for a taxable_year prior to the year_of_change sec_263 intangibles regulations on date the internal_revenue_service service and treasury_department published an advance notice of proposed rulemaking announcement c b announcing an intention to provide guidance on the extent to which sec_263 requires taxpayers to capitalize amounts paid to acquire create or enhance intangible assets on date the service and treasury_department published a notice of proposed rulemaking nprm c b proposing regulations under sec_263 relating to the capitalization requirement sec_167 relating to safe_harbor amortization and sec_446 relating to the allocation of debt issuance costs part ix of the preamble of the nprm provided that taxpayers could not change a method_of_accounting in reliance upon the rules contained in the nprm until the rules are published as final regulations in the federal_register the nprm further provided that upon publication of the final regulations taxpayers would be required to follow the applicable procedures for obtaining the commissioner's automatic consent to a change in accounting_method tam-109116-07 on date the service and treasury_department published final regulations the final regulations under sec_263 in t d 2004_1_cb_447 sec_1_263_a_-4 prescribes the extent to which taxpayers must capitalize amounts paid_or_incurred to acquire or create or to facilitate the acquisition or creation of intangibles sec_1_263_a_-5 prescribes the extent to which taxpayers must capitalize amounts paid_or_incurred to facilitate an acquisition of a trade_or_business a change in the capital structure of a business_entity and certain other transactions sec_1_167_a_-3 provides a safe_harbor useful_life for certain intangible assets the final regulations under sec_1_263_a_-4 and sec_1_263_a_-5 are effective for amounts paid_or_incurred on or after date the final regulations under sec_1_167_a_-3 are effective for intangible assets created on or after date sec_1_263_a_-5 provides that a taxpayer seeking to change a method_of_accounting to comply with sec_1_263_a_-5 must secure the consent of the commissioner in accordance with the requirements of sec_1_446-1 for the taxpayer's first taxable_year ending on or after date the regulation granted a taxpayer consent to change its methods_of_accounting to comply with sec_1_263_a_-5 provided the taxpayer followed the administrative procedures issued under sec_1_446-1 for obtaining the commissioner's automatic consent to a change in accounting_method in this regard the regulation referenced revproc_2002_9 sec_1_263_a_-5 provides that any limitations on obtaining the automatic consent of the commissioner do not apply to a taxpayer seeking to change to a method_of_accounting to comply with sec_1_263_a_-5 for its first taxable_year ending on or after date sec_1_263_a_-5 provides that the sec_481 adjustment for a change in method_of_accounting to comply with this section for a taxpayer's first taxable_year ending on or after date is determined by taking into account only amounts paid_or_incurred in taxable years ending on or after date revproc_2004_23 c b provides in sec_1 that revproc_2004_23 provides the exclusive administrative procedures under which a taxpayer described in sec_3 of revproc_2004_23 may obtain automatic consent for the taxpayer's first taxable_year ending on or after date to change to a method_of_accounting provided in sec_1_263_a_-4 sec_1_263_a_-5 and sec_1_167_a_-3 section dollar_figure of revproc_2004_23 provides that revproc_2004_23 applies to a taxpayer that seeks for the taxpayer's first taxable_year ending on or after date to change to a method_of_accounting provided in the final regulations tam-109116-07 section dollar_figure of revproc_2004_23 provides that a taxpayer within the scope of revproc_2004_23 is in accordance with dollar_figure of revproc_2002_9 granted the consent of the commissioner to change to a method_of_accounting provided in the final regulations provided that the taxpayer follows the automatic change in method_of_accounting provisions in revproc_2002_9 with the following modifications the scope limitations in dollar_figure of revproc_2002_9 do not apply the taxpayer must prepare and file form_3115 application_for change in accounting_method in accordance with section dollar_figure of revproc_2004_23 the copy of form_3115 must be sent to a specified address the taxpayer must compute any applicable sec_481 adjustment and take such adjustment into account in accordance with sec_5 of revproc_2004_23 and a taxpayer described in sec_4 of revproc_2004_23 procedure must file one or more amended federal_income_tax returns in accordance with sec_4 or as applicable of revproc_2004_23 section dollar_figure of revproc_2004_23 provides that revproc_2002_9 is modified and amplified to include the automatic changes set forth in revproc_2004_23 within sec_3 of the appendix of revproc_2002_9 analysis the issue presented in this memorandum is whether taxpayers obtained audit protection by filing their form_3115 requesting consent to change their methods_of_accounting to comply with sec_1_263_a_-5 audit protection and sec_446 audit protection is not expressly created by sec_446 and sec_481 and the regulations issued thereunder while sec_446 requires a taxpayer to obtain the consent of the commissioner before changing a method_of_accounting it does not address whether such a request restricts the authority of the commissioner to correct an improper accounting_method in a prior taxable_year if anything the code and regulations appear to oppose the notion of audit protection by stressing that the commissioner has the authority and arguably the duty to correct improper methods_of_accounting in particular sec_446 states that if a taxpayer’s existing method_of_accounting does not clearly reflect income the computation of income shall be made under a method_of_accounting that does clearly reflect income in the opinion of the commissioner tam-109116-07 the regulations under sec_446 do authorize the commissioner to prescribe administrative procedures under which taxpayers will be permitted to change their method_of_accounting the administrative procedures include the terms and conditions necessary to obtain the commissioner's consent to effect the change see sec_1_446-1 the general administrative procedures issued by the commissioner for voluntary accounting_method changes - revenue procedures and - both establish audit protection which is part of an overall system of incentives to encourage prompt and voluntary compliance with proper tax_accounting principles see revproc_97_27 sec_1 the audit protection created by rev procs and is subject_to limitations audit protection does not apply to certain changes in method_of_accounting for example automatic accounting_method changes from sale to lease treatment and vice verse are made without audit protection see revproc_2002_9 appendix sec_2 where audit protection does apply such protection is subject_to certain enumerated limitations see revproc_97_27 dollar_figure and revproc_2002_9 in sum sec_446 and sec_481 and their associated regulations do not grant audit protection to accounting_method changes the commissioner however has promulgated administrative procedures that extend audit protection to accounting_method changes subject_to enumerated exceptions and limitations accounting_method changes under revproc_2004_23 taxpayers filed a form_3115 requesting consent to change to methods_of_accounting for transactions costs provided in sec_1_263_a_-5 for their first taxable_year ending on or after date accordingly taxpayers are within the scope of revproc_2004_23 which provides the exclusive administrative procedures under which taxpayers may obtain consent for their desired accounting_method changes see revproc_2004_23 sec_1 a taxpayer seeking consent pursuant to revproc_2004_32 must comply with the automatic change in accounting_method provisions in revproc_2002_9 as modified by sec_4 to see revproc_2004_32 if the taxpayer complies with such provisions the taxpayer is in accordance with dollar_figure of revproc_2002_9 granted the consent of the commissioner to change its method_of_accounting see revproc_2004_32 sec_4 a taxpayer that is under examination with respect to any income_tax issue may request to change a method_of_accounting if the method_of_accounting to be changed is an issue pending for any taxable_year under examination but the audit protection provisions of dollar_figure of revproc_2002_9 will not apply to such change see a of revproc_2002_9 as modified and amplified by revproc_2002_19 sec_2 d this tam-109116-07 provision of revproc_2002_9 is not modified by sec_4 to of revproc_2004_23 in july of year the service issued a form_5701 with respect to corporation a proposing to capitalize certain spin-off transaction costs accordingly the methods_of_accounting to be changed in taxpayers’ form_3115 were issues pending for a taxable_year under examination when the form_3115 was subsequently filed in september of year under a therefore the audit protection provisions of dollar_figure of revproc_2002_9 do not apply to the accounting_method changes requested by taxpayers taxpayers argue that the denial of audit protection in a is waived by sec_1_263_a_-5 which provides that any limitations on obtaining the automatic consent of the commissioner do not apply to a taxpayer seeking to change to a method_of_accounting to comply with this section for its first taxable_year ending on or after date this argument is unpersuasive because of revproc_2002_9 is not a limitation on obtaining automatic consent if anything of revproc_2002_9 expands the availability of automatic consent by making the automatic consent procedures available to taxpayers that are under examination but have an issue pending further the denial of audit protection cannot be a limitation on obtaining automatic consent because audit protection and automatic consent are fundamentally separate concepts automatic consent may exist either with or without audit protection indeed the denial of audit protection for taxpayers with an issue pending in of revproc_2002_9 is coupled with the waiver of restrictions that would otherwise preclude such taxpayers from obtaining consent taxpayers assert that the words any limitations in sec_1_263_a_-5 encompasses terms and conditions of accounting_method changes and that ‘terms and conditions’ includes audit protection this reasoning is over broad the literal application of taxpayers’ approach would arguably waive audit protection altogether for all taxpayers including those otherwise entitled to audit protection under revproc_2002_9 further taxpayers’ reasoning would result in the waiver language of sec_1_263_a_-5 waiving other terms conditions or limitations such as the spreading of taxpayers’ positive net sec_481 adjustment over taxable years we view any detailed inquiry into the exact meaning of these terms if such could be determined to be unnecessary sec_1_263_a_-5 does not waive any limitations in isolation rather sec_1_263_a_-5 waives any limitations on obtaining the automatic consent of the commissioner this phrase applies to provisions that would prevent taxpayers from obtaining consent at all such as provisions that prevent certain taxpayers that are under examination before appeals or before a federal court from applying to change their methods_of_accounting see dollar_figure of revproc_2002_9 this phrase does not apply to matters such as audit protection and spread periods for sec_481 adjustments because matters such as audit protection and spread periods tam-109116-07 only become relevant after consent is obtained they cannot be impediments to obtaining consent the accounting_method change provisions of sec_1_263_a_-5 taxpayers further contend that the accounting_method change provisions in sec_1 a - n provide audit protection to taxpayers requesting consent to make an accounting_method change described within this provision the most obvious difficulty with this contention is that sec_1_263_a_-5 contains no language that expressly creates audit protection the only provisions that arguably implicate audit protection are i the general statement that taxpayers seeking to change their method_of_accounting to comply with sec_1_263_a_-5 must secure the consent of the commissioner in accordance with the requirements of sec_1_446-1 and ii the directive that a taxpayer making such an accounting_method change for its first taxable_year ending on or after date must follow the automatic consent provisions of revproc_2002_9 as discussed above however sec_446 and sec_481 and their associated regulations do not directly create or extend audit protection and revproc_2002_9 denies audit protection to taxpayers because they had issues pending when they filed their forms to request consent in support of their contention that sec_1_263_a_-5 provides audit protection taxpayers propose two alternative constructions of sec_1_263_a_-5 the first construction is that the omission of any explicit reference to audit protection means that no audit protection exists so that the inclusion of words denying audit protection in the regulation would have been unnecessary surplusage the second construction which taxpayers advocate is that the omission of any explicit denial of audit protection means that audit protection exists so that the inclusion of words denying audit protection is necessary to achieve such denial taxpayers’ reasoning fails to account for a third and more persuasive construction of sec_1_263_a_-5 namely that the absence of express provisions either extending or denying audit protection in sec_1_263_a_-5 means that the applicable administrative procedures promulgated by the commissioner under sec_1_446-1 in this situation rev_proc control the availability of audit protection specific provisions in a regulation regarding audit protection or other aspects of accounting_method changes do control_over administrative guidance such as revenue procedures in the absence of such provisions however administrative procedures govern accounting_method changes the operation of the second and third constructions of sec_1_263_a_-5 is illustrated by their differing interpretations of sec_1_263a-1 and sec_1_263a-2 these provisions cited by taxpayers contain accounting_method change provisions that are broadly parallel to sec_1_263_a_-5 but contain additional paragraphs providing that a taxpayer making the specified accounting_method change does not receive audit protection if its method of tam-109116-07 accounting for mixed service cost is an issue under consideration at the time the application is filed with the national_office see sec_1_263a-1 sec_1_263a-2 taxpayers contend that the express denials of audit protection in sec_1_263a-1 and sec_1_263a-2 are evidence that audit protection exists for taxpayers making these changes absent express provisions in the regulations to the contrary by analogy taxpayers argue audit protection should exist by default for taxpayers subject_to the sec_1_263_a_-5 which differs only in the lack of an express denial of audit protection this counterargument does not address the alternative view that the express denials of audit protection in sec_1_263a-1 and sec_1_263a-2 are evidence that treasury wished to modify the standard audit protection rules of revproc_2002_9 that would ordinarily apply to taxpayers making these changes in other words taxpayers urge that audit protection exists independently of the administrative procedures issued by the commissioner rev procs and and the rules and limitations contained therein in addition to the lack of any express provisions creating such independent audit protection noted above the position urged by taxpayers would raise serious practical difficulties if adopted for example it is unclear whether this independent audit protection would be subject_to exceptions such as those enumerated in revproc_97_27 dollar_figure or revproc_2002_9 further the existence of independent audit protection is inconsistent with the creation of audit protection within the general administrative procedures for accounting_method changes finally taxpayers’ position fails to explain why independent audit protection whose existence is not supported by any express legal authority would override the audit protection which is expressly created and carefully limited within the administrative procedures these difficulties argue against the interpretation advanced by taxpayers more generally the construction of sec_1_263_a_-5 sec_1_263a-1 and sec_1_263a-2 proposed by taxpayers poses imponderable difficulties with respect to other aspects of accounting_method changes none of these regulations for example contain provisions regarding the spread periods of sec_481 adjustments under the analysis suggested by taxpayer the silence in these regulations regarding spread periods would imply that spread periods are not available this follows from the default rule in sec_481 and its associated regulations that the entire sec_481 adjustment is taken into account in the year_of_change by contrast the third construction handles the silence regarding spread periods in sec_1_263_a_-5 sec_1_263a-1 and sec_1_263a-2 quite easily and reaches an intuitively pleasing result the silence simply implies that the rules regarding spread periods in the administrative procedures apply without modification to changes made under sec_1_263_a_-5 sec_1_263a-1 and sec_1_263a-2 this construction avoids allowing silence in one regulation from overriding the express grant of authority to the commissioner in tam-109116-07 another regulations sec_1_446-1 to set terms and conditions for accounting_method changes to summarize taxpayers’ assertion that treasury was ‘silent’ regarding audit protection in sec_1_263_a_-5 is not persuasive the treasury addressed accounting_method change issues in sec_1_263_a_-5 by expressly invoking the detailed administrative procedures issued by the commissioner under sec_1_446-1 and modifying those procedures to the extent that a different result was desired in other words the treasury was not silent on audit protection or sec_481 spread periods or any other provision of revproc_2002_9 not expressly modified in sec_1_263_a_-5 to the contrary treasury clearly albeit indirectly indicated that the administrative provisions would control unless a contrary intention was expressed fairness and sound tax_administration taxpayers also argue that general considerations of fairness and sound tax_administration support audit protection for their accounting_method changes in particular taxpayers point out that that the notice of proposed rulemaking issued on date stated that taxpayers may not change a method_of_accounting in reliance upon the rules contained in these proposed_regulations until the rules are published as final regulations in the federal_register taxpayers argue that this provision prevented them from filing their accounting_method changes prior to the commencement of their audit which ultimately resulted in the denial of audit protection for their accounting_method changes pursuant to of revproc_2002_9 as a result taxpayers contend they were placed in a worse position than taxpayers that disregarded the notice of proposed rulemaking and filed accounting_method change requests prior to the publication of the final regulations they assert that such a result would be unfair and would be contrary to the general policy of the service to give better terms and conditions to taxpayers that comply with proper tax_accounting principles on a prompt and voluntary basis this argument fails for the reasons discussed below the initial reason taxpayers’ argument fails is that taxpayers were free to make changes that did not rely upon the proposed_regulations the notice of proposed rulemaking issued on date only prohibits changes in method_of_accounting made in reliance upon the rules contained in the proposed_regulations moreover denying audit protection to taxpayers for their accounting_method change is not inconsistent with the voluntary compliance incentive system to the extent that taxpayers changed from an improper method_of_accounting and thus would benefit from audit protection taxpayers did not do so prior to the initiation of the examination which is the basic qualification for obtaining the favorable terms and conditions associated with voluntary accounting_method changes with certain exceptions taxpayers that do not request accounting_method changes prior to the initiation of tam-109116-07 examination are generally barred from requesting such changes and obtaining audit protection after the examination commences see generally revproc_2002_18 most significantly however taxpayers are incorrect when they assert that they have been treated less favorably than taxpayers that filed accounting_method change requests despite the provisions to the contrary in the notice of proposed rulemaking the preamble to t d states the preamble to the proposed_regulations provides that taxpayers may not change a method_of_accounting in reliance upon the rules contained in the proposed_regulations until the rules are published as final regulations nonetheless the irs has received numerous forms from taxpayers seeking the commissioner's consent to change their method_of_accounting for items addressed in the advance notice of proposed rulemaking or in the proposed_regulations the irs suspended processing of these requests pending publication of these final regulations upon publication of the final regulations the irs intends to process these requests in a manner consistent with the rules contained in the final regulations including the effective date rules and rules relating to the computation of the sec_481 adjustment for example if the change is requested for a taxable_year ending prior to the effective date of the final regulations and concerns a method_of_accounting that the commissioner does not recognize as permissible prior to the effective date of the final regulations the irs intends to reject the request similarly if the change is requested for a taxable_year ending on or after the effective date of the final regulations and concerns a method_of_accounting that is permissible under the final regulations the irs intends to return the request to the taxpayer and refund the user_fee and advise the taxpayer to utilize the automatic consent procedures as authorized by the final regulations c b pincite accordingly if taxpayers had pursued their hypothetical course and filed their accounting_method change requests contrary to the instructions of the notice of proposed rulemaking audit protection for their accounting_method changes under rev procs these requests would have been rejected and taxpayers would not have received audit protection contrary to their assertion therefore taxpayers have not received less favorable treatment for more compliant behavior summary taxpayers requested and obtained consent to change their methods_of_accounting for transaction costs pursuant to sec_1_263_a_-5 and revproc_2004_23 which incorporate with certain modifications the automatic accounting_method change procedures of revproc_2002_9 taxpayers did not receive audit protection for their accounting_method changes under rev procs and because taxpayers had issues tam-109116-07 pending at the time consent was requested sec_1_263_a_-5 does not confer audit protection by its own terms similarly audit protection does not arise independently from sec_446 and sec_481 and the regulations promulgated thereunder finally the extension of audit protection in this situation is not required by general considerations of fairness or proper tax_administration accordingly we conclude that no audit protection attaches to the changes made by taxpayers a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom p si - plr-108657-99 date date x a b ira firm d1 d2 d3 year dear this letter responds to your letter dated date submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code the information submitted states that in year x analyzed the benefits of being an s_corporation following its analysis x decided to elect to be an s_corporation for its taxable_year beginning on d1 in order to meet the qualifications required for an s_corporation x reduced its number of shareholders following this reduction in shareholders x believed that it was qualified to be an s_corporation in d2 while preparing its s_corporation_election x contacted firm to discuss the procedural requirements for obtaining shareholder consents to the s_corporation_election firm requested that x reconfirm that all of its shareholders were qualified to hold stock in an s_corporation in reviewing its shareholder list x discovered that ira an individual_retirement_account for the benefit of a held x stock x believed that an individual_retirement_account was a qualified_shareholder and asked firm to confirm this at that point firm advised x that an individual_retirement_account is not a qualified_shareholder of an s_corporation in order to correct the problem on d3 x acquired the shares held by ira subsequently x timely filed a form_2553 election by a small_business_corporation with an effective date of d1 b represents that with the exception of the ownership of x stock held by ira x qualified as a small_business_corporation under sec_1361 on d1 and that when x filed the form_2553 x met the qualifications of a small_business_corporation under sec_1361 b as x’s president represents that the circumstances resulting in the invalidity of x’s election to be an s_corporation were inadvertent as to ira’s holding of x stock x believed all shareholders were qualified to hold s_corporation stock and only realized ira was not a qualified_shareholder when x proceeded in preparing its shareholder list and was advised by firm additionally x and each person who was or is a shareholder of x at any time since d1 agree to make such adjustments consistent with the treatment of x as an s_corporation as may be required by the secretary with respect to such period sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation sec_1361 provides that the term s_corporation means with respect to any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year sec_1361 provides that a small_business_corporation cannot have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual revrul_92_73 1992_2_cb_224 holds that a_trust that qualifies as an individual_retirement_account under sec_408 of the code is not a permitted shareholder of an s_corporation under sec_1361 sec_1362 provides that if an election under sec_1362 by any corporation was not effective for the taxable_year for which made determined without regard to sec_1362 by reason of a failure to meet the requirements of sec_1361 or to obtain shareholder consents or was terminated under paragraph or of sec_1362 the secretary determines that the circumstances resulting in such ineffectiveness or termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness or termination steps were taken so that the corporation is a small_business_corporation or to acquire the required shareholder consents and the corporation and each person who was a shareholder in the corporation at any time during the period specified pursuant to sec_1362 agree to make such adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such ineffectiveness or termination the corporation will be treated as an s_corporation during the period specified by the secretary based solely on the facts submitted and the representations made we hold that x’s election to be an s_corporation effective d1 was ineffective because from d1 until d3 ira which was not a qualified_shareholder of an s_corporation held shares in x we hold also that the ineffectiveness of x’s s_corporation_election was inadvertent within the meaning of sec_1362 we further hold that under the provisions of sec_1362 x will be treated as an s_corporation effective d1 and thereafter provided x’s election to be an s_corporation was not otherwise invalid and provided that the election was not terminated under sec_1362 during the period from d1 to d3 a for whose benefit ira held x stock will be treated as the owner of the x stock held by ira accordingly this individual and x’s other shareholders must include their pro_rata share of the separately and non-separately computed items as provided in sec_1366 make adjustments to stock basis as provided in sec_1367 and take into account any distributions made by x as provided by sec_1368 if x ira a or any of x’s other shareholders fails to treat themselves as described above this ruling shall be null and void except as specifically ruled above we express no opinion concerning the federal tax consequences of the transactions described above under any other provision of the code this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we are forwarding a copy of this letter to x sincerely yours branch h grace kim assistant to the chief office of the assistant chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court charles mchan and martha mchan petitioners v commissioner of internal revenue respondent docket no filed date charles mchan pro_se r walton davis iii for petitioner martha mchan eric b jorgensen and gwendolyn c walker for respondent memorandum findings_of_fact and opinion swift judge pursuant to sec_7443a and rule sec_180 and sec_183 this case was assigned to and heard by special_trial_judge unless otherwise indicated all section references are to the internal_revenue_code as amended and in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure lewis r carluzzo his recommended findings_of_fact and conclusions of law were filed and served upon the parties on date subsequently the petitioners filed objections thereto and petitioner charles mchan moved for a new trial respondent filed no objection to the special trial judge’s recommended findings_of_fact and conclusions of law but respondent did file a reply to petitioners’ objections hereinafter references to petitioner in the singular are to petitioner charles mchan we are mindful that with regard to our review of special_trial_judge carluzzo’s recommended findings of facts new rule d provides due regard shall be given to the circumstance that the special_trial_judge had the opportunity to evaluate the credibility of witnesses and the findings_of_fact recommended by the special_trial_judge shall be presumed to be correct we have given appropriate deference to the special trial judge’s recommended factual findings and after consideration of the evidence and the record in this case we have made minor changes to his recommended findings and analysis we also have made a number of editorial changes to the special trial judge’s recommended findings_of_fact and conclusions of law in an effort to clarify certain matters after consideration of the record herein the briefs of the parties petitioners’ objections to the special trial judge’s recommended findings_of_fact and conclusions of law and respondent’s reply thereto we conclude that the recommended findings_of_fact and conclusions of law of special_trial_judge carluzzo which are hereinafter set forth as modified in a number of minor respects should be adopted as the report of the court in a notice_of_deficiency dated date respondent determined deficiencies in and additions to the federal income taxes of petitioner as follows additions to tax sec sec sec sec sec years deficiencie sec_6653 b a b b b dollar_figure dollar_figure ---- ---- of int dollar_figure due on dollar_figure big_number ---- dollar_figure of int ---- big_number due on dollar_figure in a separate notice_of_deficiency also dated date respondent determined deficiencies of dollar_figure and dollar_figure in martha mchan’s respective and federal income taxes which deficiencies are based solely on martha’s alleged joint liability under sec_6013 for the tax deficiencies determined against petitioner after settlement of some issues the primary issues for decision are whether petitioners on their and joint federal_income_tax returns underreported petitioner’s income from the sale of marijuana and whether petitioner is liable for the additions to tax for fraud under sec_6653 petitioners’ income is also considered in this proceeding in order to determine the correct amount of a net_operating_loss_carryback from to and see sec_6214 also raised as an issue herein is whether petitioner martha mchan is eligibile for relief from joint liability under sec_6015 that issue has been severed from the issues tried and addressed in this opinion findings_of_fact petitioners were married in and remained so as of the date of trial at the time the petition was filed in this case petitioners were residents of murphy north carolina petitioner’s drug trafficking activities in through petitioner participated in various transactions involving the illegal purchase and sale of marijuana generally petitioner purchased the marijuana with cash from sources in mexico and belize and sold the marijuana in north carolina for resale by others in florida and other states a number of individuals participated with petitioner in various aspects of the illegal drug transactions we focus as did respondent on specific transactions involving petitioner paul thomas posey posey and paul leroy cunningham cunningham in on a number of occasions petitioner accompanied by posey traveled to lajitas texas the texas source and purchased marijuana on average each purchase by petitioner from the texas source consisted of to pounds of marijuana for which petitioner paid approximately dollar_figure a pound with respect to each purchase petitioner also paid dollar_figure to an individual identified as the colonel who provided security and who helped transport the marijuana from mexico to lajitas texas after its purchase from the texas source generally the marijuana was transported to north carolina by posey and an associate the marijuana would be divided between petitioner and posey and petitioner would sell his portion of the marijuana to cunningham who in turn generally would resell the marijuana in florida during and petitioner and cunningham were involved in the purchase of marijuana in florida and texas and the resale of the marijuana in florida the florida transactions in connection with the and florida transactions petitioner lost dollar_figure and dollar_figure respectively in date as a result of his arrest for conspiracy to possess and to distribute marijuana posey agreed to cooperate with law enforcement officials to provide information about petitioner’s drug trafficking activities and to assist government agents in gathering evidence against petitioner on march and date posey secretly made tapes of conversations between himself and petitioner the tapes of these conversations were turned over to government agents investigating petitioner’s drug trafficking activities in date petitioner cunningham and several other individuals traveled to el paso texas to purchase marijuana on date after purchasing for dollar_figure pounds of marijuana from an undercover government agent petitioner and cunningham were arrested and charged under u s c sec_846 with conspiring to possess with the intent to distribute pounds of marijuana with regard to the date drug transaction petitioner pleaded guilty to the above federal criminal charge and petitioner was sentenced to a prison term of months and was fined dollar_figure see 920_f2d_244 4th cir in connection with the above prosecution under u s c sec_853 the government obtained an in rem criminal forfeiture of petitioner’s interests in a 35-acre parcel of real_estate and in two automobiles cunningham also pleaded guilty to the above criminal charge as part of his plea agreement cunningham testified against petitioner before a federal grand jury regarding various illegal drug transactions in which he and petitioner participated in and on date in an additional indictment filed in the federal district_court for the western district of north carolina petitioner was charged with counts of illegal_drug_trafficking filing false tax returns and engaging in a continuing criminal enterprise in connection with the illegal drug transactions that cunningham had testified about and that occurred beginning in the fall of in and and in early in july of petitioner pleaded guilty to some of the charges and petitioner was convicted on all charges submitted to the jury petitioner was sentenced to a prison term of months also the government obtained another criminal forfeiture against petitioner of dollar_figure the amount of the net_proceeds that the district_court determined petitioner received from the related drug transactions after deducting dollar_figure for petitioner’s estimated costs of purchasing and transporting the marijuana and after deducting dollar_figure for one-half of the net marijuana sales proceeds that petitioner purportedly shared with posey on appeal the united_states court_of_appeals for the fourth circuit affirmed petitioner’s above second conviction but the court_of_appeals reversed the district_court as to the proper amount subject_to criminal forfeiture and held that under u s c sec_853 the government’s criminal forfeiture against petitioner extended to the entire dollar_figure gross_proceeds that the district_court determined petitioner received from the illegal drug transactions and was not to be reduced by petitioner’s costs nor by amounts shared with co-conspirators 101_f3d_1027 4th cir as a result of petitioner’s criminal convictions petitioner has been incarcerated since petitioner martha mchan is not implicated in petitioner’s illegal drug transactions with assets petitioners acquired over the years petitioners apparently have fully satisfied both criminal forfeiture judgments for and petitioners’ joint federal_income_tax returns were prepared by a professional income_tax_return_preparer based on information provided to him by petitioners and were signed by petitioners and filed with respondent thereon the following adjusted_gross_income and loss figures for petitioners were reported year - - adjusted_gross_income or loss dollar_figure dollar_figure dollar_figure the above adjusted_gross_income and loss figures reported on petitioners’ joint federal_income_tax returns for and did not reflect any of the proceeds of petitioner’s illegal drug transactions petitioners did not provide any books_and_records or otherwise disclose to their tax_return_preparer any information relating to petitioner’s drug transactions and petitioners failed to provide to their tax_return_preparer and to respondent any books_and_records with respect to the illegal drug transactions in which petitioner participated respondent’s agent investigated petitioner for failing to report income from illegal drug transactions in and respondent’s agent and an agent of the north carolina state bureau of investigation interviewed posey and cunningham regarding their participation with petitioner in the illegal drug transactions during the years in issue on the basis of his investigation and his interviews with posey and cunningham respondent’s agent determined the amounts petitioner received on the sales of marijuana in which petitioner and posey and or cunningham were involved also based in part on the statements made by petitioner to posey on the undercover tapes respondent’s agent determined how much petitioner received on the sales of marijuana purchased from the texas source respondent’s agent used information from his investigation to reconstruct petitioner’s and income from illegal drug transactions respondent’s agent identified certain specific marijuana transactions in which petitioner posey and cunningham participated during and with respect to each such marijuana transaction respondent’s agent determined the number of pounds of marijuana purchased petitioner’s cost for the marijuana and the sales proceeds and gross_profit petitioner received for example respondent’s agent determined that petitioner paid on average dollar_figure per pound for the marijuana purchased from the texas source also to take into account amounts paid_by petitioner to the colonel on the purchase of marijuana from the texas source respondent’s agent added dollar_figure per pound allowing petitioner a total cost_of_goods_sold in the amount of dollar_figure per pound where petitioner purchased marijuana from a different source respondent’s agent used a cost for the marijuana according to information provided by posey and cunningham in calculating petitioner’s gross_profits for and from illegal drug transactions in which petitioner participated respondent’s agent disregarded petitioner’s losses in and on the florida transactions respondent’s agent prepared a schedule of omitted gross_receipts the schedule which specifically identifies the marijuana sales petitioner participated in with posey and cunningham for each of these transactions respondent’s special_agent calculated gross_receipts amount of marijuana purchased x sale price cost of marijuana sold amount of marijuana purchased x purchase_price and the gross_profit gross_receipts minus cost of marijuana sold respondent’s agent’s calculation of petitioner’s gross_receipts cost of marijuana sold and gross_profit for each year from the specific marijuana sales transactions in which petitioner participated is summarized below petitioner’s marijuana sales gross_receipts dollar_figure dollar_figure dollar_figure cost_of_goods_sold big_number big_number big_number gross_profit big_number big_number big_number on date respondent mailed to petitioner and to martha mchan a notice_of_deficiency for and based on the above-determined dollar_figure and dollar_figure in income ie gross_profit of petitioner from marijuana sales not reported on petitioners’ and federal_income_tax returns in addition based on his above calculation and determination that petitioner had dollar_figure in additional unreported income in from marijuana sales respondent disallowed the portions of petitioners’s claimed dollar_figure net_operating_loss_carryback that were claimed on petitioners’ and federal_income_tax returns for and respondent also determined that petitioner was liable for additions to tax for fraud and for substantially understating his federal_income_tax liability certain other adjustments made by respondent against petitioners in each notice_of_deficiency are no longer in dispute at trial respondent sought to significantly increase the illegal drug income to be charged to petitioner for each year as indicated the tax deficiencies reflected in respondent’s notice_of_deficiency to martha mchan were based solely on martha’s alleged joint liability under sec_6013 for the tax deficiencies determined against petitioner and no fraud or other additions to tax were determined against martha respondent’s calculations of petitioner’s income from the sale of marijuana were also used by the district_court in the second criminal forfeiture action against petitioner opinion according to petitioners the determinations made in respondent’s notices of deficiency are arbitrary and erroneous and therefore are not entitled to the normal presumption of correctness provided in our rules and by the caselaw see rule a 290_us_111 where a taxpayer establishes that a deficiency determination is arbitrary capricious or without reasonable foundation the normal presumption of correctness attached thereto may not be applicable 293_us_507 83_tc_269 79_tc_185 73_tc_394 petitioners maintain that petitioner did not realize any income during the years in issue from the marijuana transactions identified by respondent’s agent throughout the proceedings and in their briefs petitioners argue that petitioner was acting as a mere conduit or agent for the other co-conspirators and that petitioner did not have ownership in the funds or profits relating to the marijuana transactions further petitioners claim that respondent has failed to produce any predicate evidence to establish that petitioner received income from illegal drug sales we recognize the difficulty of proving a negative that is the nonreceipt of income and in cases involving allegations of unreported illegal income we may reject respondent’s deficiency determinations if they constitute naked assessments ie if they are not supported by the evidence see eg 999_f2d_760 4th cir affg tcmemo_1992_153 88_tc_435 dellacroce v commissioner supra pincite the present case however does not involve a naked assessment in this case there is substantial evidence linking petitioner to income from the illegal sale of marijuana during and that evidence consists not only of petitioner’s arrest and subsequent criminal convictions for engaging in the illegal sale of marijuana criminal forfeitures and the testimony of various co-conspirators but also petitioner’s own admission that he was involved in a conspiracy to possess and to sell marijuana in franklin v commissioner tcmemo_1993_184 we held that indictment guilty plea and conviction are sufficient to support an inference linking a taxpayer to illegal income-generating activity respondent’s tax_deficiency determinations herein against petitioners are entitled to the usual presumption of correctness as a general_rule gross_income includes all income from whatever source derived sec_61 this includes income obtained from illegal sources 366_us_213 browning v commissioner tcmemo_1991_93 sec_1_61-14 income_tax regs sec_6001 requires taxpayers to maintain records sufficient to determine their correct federal income taxes 92_tc_661 if taxpayers fail to maintain or do not produce adequate books_and_records respondent is authorized by sec_446 to reconstruct the taxpayers’ income sec_446 petzoldt v commissioner supra pincite 54_tc_1530 40_tc_30 bratulich v commissioner tcmemo_1990_600 for the years in issue petitioners failed to maintain and to produce records of petitioner’s illegal marijuana sales respondent reconstructed petitioners’ income for each year by using the specific item method of proof a method approved by this court on numerous occasions see eg 56_tc_297 pappas v commissioner tcmemo_2002_127 levine v commissioner tcmemo_1998_383 affd 229_f3d_1158 9th cir baker v commissioner tcmemo_1991_340 affd 9_f3d_1550 9th cir based on information respondent’s agent obtained from interviews with posey and cunningham and from undercover tapes respondent’s agent identified a number of specific marijuana sales transactions in which petitioner participated with posey and cunningham in and based on the information obtained respondent’s agent determined petitioner’s related gross_receipts cost_of_goods_sold and gross_profits petitioners do not dispute that petitioner participated in marijuana transactions with posey and cunningham and for the most part petitioners do not dispute certain facts relied on by respondent in calculating petitioner’s gross_receipts cost_of_goods_sold and gross_profit therefrom to the contrary at both his criminal trial and his trial herein petitioner generally admitted to his involvement in the marijuana transactions described by posey and by cunningham nevertheless petitioner claims that he did not receive any net_income or profit from the marijuana sales according to petitioner he was merely assisting friends in the purchase and sale of marijuana our view of petitioner’s claim however is stated in petzoldt v commissioner supra pincite there is nothing in the record which would indicate that petitioner sold marijuana for philanthropic reasons expecting no profit for his efforts common sense would dictate the conclusion that anyone who is in an illegal and dangerous business such as the dealing of drugs would demand a very large profit for his enormous risks the transcripts of petitioner’s date criminal trial were admitted into evidence herein the danger and risks to which petitioner exposed himself could not be more apparent petitioner was arrested tried convicted and sentenced to a lengthy period of incarceration in a federal penitentiary we reject petitioner’s testimony that he did not have an ownership_interest in the illegal drug transactions identified and used by respondent in his calculations of petitioners’ income for purposes of the tax deficiencies herein and based on petitioners’ burden_of_proof and with the two exceptions noted below we agree with respondent’s calculations of petitioners’ unreported income from marijuana sales as set forth in the notices of deficiency for and the first adjustment to be made to respondent’s calculations relates to a date transaction involving purported gross_receipts of dollar_figure and after dollar_figure in cost_of_goods_sold a purported gross_profit of dollar_figure respondent now concedes this transaction did not occur or should not be charged to petitioner the second adjustment to be made to respondent’s calculations involves the losses of dollar_figure and dollar_figure that petitioner realized in and respectively from the florida transactions respondent’s agent apparently overlooked or disregarded these loss transactions that are to be taken into account in the calculations of petitioners’ unreported income for and in addition to the transactions included in respondent’s notices of deficiency at trial respondent claims that in july of petitioner participated in an additional purchase and sale of marijuana not included in respondent’s calculations respondent submits that this transaction involved petitioner’s purchase of pounds of marijuana for dollar_figure per pound and petitioner’s sale of the marijuana for dollar_figure per pound the inclusion of this transaction would result in an increased deficiency for on which respondent would bear the burden_of_proof rule a 77_tc_881 williams v commissioner tcmemo_1992_153 affd 999_f2d_760 4th cir we find the evidence insufficient to satisfy respondent’s burden on this alleged sale of marijuana on brief respondent also takes the position that the dollar_figure per pound paid to the colonel by petitioner for security and for transporting the marijuana into the untied states should not have been added by respondent’s agent to petitioner’s cost_of_goods_sold for marijuana purchased from the texas source respondent contends that under sec_280e this amount is not properly treated as an item of petitioner’s cost_of_goods_sold generally we do not consider issues that are raised for the first time on brief and we decline to consider this untimely raised issue see eg 92_tc_376 affd 920_f2d_1196 5th cir 64_tc_989 see also 182_f3d_275 4th cir affg tcmemo_1996_452 rejecting respondent’s assertion of increased income for and adjusting respondent’s calculations to account for the and losses on the florida transactions mentioned above we conclude that petitioner’s sale of marijuana generated the following gross_receipts cost_of_goods_sold and gross_profit gross_receipts dollar_figure dollar_figure dollar_figure cost_of_goods_sold big_number big_number big_number gross_profit big_number big_number big_number as indicated under sec_6653 and for and under sec_6653 and b for respondent determined that petitioner is liable for additions to tax for fraud respondent also determined that for and petitioner is liable for additions to tax under sec_6661 for substantial understatements of tax no additions to tax were determined by respondent against martha mchan taking into account the and florida loss transactions also involved making certain other adjustments to petitioner’s gross_receipts and cost_of_goods_sold for and for sec_6653 imposes an addition_to_tax equal to percent of a tax underpayment if any portion of the underpayment is due to fraud and sec_6653 imposes another addition_to_tax equal to percent of the interest with respect to the portion of an underpayment attributable to fraud for sec_6653 imposes an addition_to_tax equal to percent of the tax underpayment attributable to fraud and sec_6653 imposes a separate addition_to_tax equal to percent of the interest payable under sec_6601 on the portion of an underpayment attributable to fraud further for if fraud is established with respect to any portion under sec_6653 the entire underpayment is to be treated as attributable to fraud except to the extent the taxpayer establishes that some portion of the underpayment is not attributable to fraud for purposes of sec_6653 fraud is defined as an intentional wrongdoing designed to evade tax believed to be owed 252_f2d_56 9th cir 118_f2d_308 5th cir revg 40_bta_424 petzoldt v commissioner t c pincite 69_tc_391 respondent bears the burden of proving each of the elements of fraud by clear_and_convincing evidence - an intent to evade tax and an underpayment_of_tax sec_7454 rule b 84_tc_405 56_tc_213 to meet this burden respondent must establish that an underpayment_of_tax exists and that petitioner intended to evade taxes known to be owing by conduct intended to conceal mislead or otherwise prevent the collection of such taxes grossman v commissioner supra pincite 398_f2d_1002 3d cir 94_tc_654 91_tc_874 castillo v commissioner supra pincite 80_tc_1111 26_tc_107 respondent need not establish that tax_evasion was petitioner’s primary motivation but must show that a ‘tax- evasion motive’ played a part in petitioner’s conduct including conduct designed to conceal another crime recklitis v commissioner supra pincite quoting 370_f2d_713 1st cir vacating t c memo the existence of fraud is a question of fact to be resolved upon consideration of the entire record castillo v commissioner supra pincite rowlee v commissioner supra pincite 67_tc_181 affd without published opinion 578_f2d_1383 8th cir fraud is never imputed or presumed it must be established by independent evidence recklitis v commissioner supra pincite castillo v commissioner supra 55_tc_85 because however direct proof of a taxpayer’s intent is often not available fraud may be proved by circumstantial evidence grossman v commissioner supra pincite 204_f2d_205 5th cir affg a memorandum opinion of this court castillo v commissioner supra 79_tc_995 affd 748_f2d_331 6th cir gajewski v commissioner supra pincite the taxpayer’s entire course of conduct may establish the requisite fraudulent intent 317_us_492 castillo v commissioner supra gajewski v commissioner supra stone v commissioner supra pincite over the years courts have developed a nonexclusive list of factors that demonstrate fraudulent intent these badges_of_fraud include understating income maintaining inadequate records failing to file tax returns implausible or inconsistent explanations of behavior concealment of income or assets failing to cooperate with tax authorities engaging in illegal activities an intent to mislead which may be inferred from a pattern of conduct lack of credibility of the taxpayer’s testimony filing false documents and dealing in cash spies v united_states supra pincite 899_f2d_164 2d cir 796_f2d_303 9th cir affg tcmemo_1984_601 recklitis v commissioner supra pincite often a combination of factors may provide persuasive evidence of fraud 732_f2d_1459 6th cir affg per curiam tcmemo_1982_603 a taxpayer’s intelligence education and tax expertise also may be relevant for purposes of determining fraudulent intent stephenson v commissioner supra pincite 19_tc_631 we acknowledge that the facts and evidence in the trial record in this case as to the precise amount of total costs incurred sales proceeds and profit petitioner realized in each year from his illegal drug sales are not established with a great deal of clarity respondent relies heavily on the testimony of convicted felons and on grand jury testimony admitted at petitioner’s criminal trial however to find civil tax_fraud the exact amount of income underreported by a taxpayer need not be established it is sufficient that respondent establish by clear_and_convincing evidence that petitioners failed to report substantial income for each year and did so intentionally at which point the burden_of_proof shifts to the taxpayer to prove the amount of any related expenses 377_f2d_469 1st cir franklin v commissioner tcmemo_1993_184 petitioner has not produced credible_evidence of additional expenses_incurred relating to his purchase and sale of marijuana in excess of those allowed by respondent accordingly respondent has established by clear_and_convincing evidence that in and petitioner herein had significant additional income and income taxes relating to petitioner’s illegal sale of marijuana that petitioner did not report on his and federal_income_tax returns petitioner was indicted and convicted on numerous charges relating to his purchase and sale of marijuana during and no income relating to petitioner’s sale of marijuana was reported on petitioners’ joint federal_income_tax return for the years in issue 286_f2d_139 4th cir p roof of consistent and substantial understatements of income over a period of years may constitute persuasive and convincing evidence of fraud affg tcmemo_1959_224 see also 799_f2d_166 5th cir affg tcmemo_1985_148 301_f2d_484 5th cir affg tcmemo_1959_172 petitioner dealt in large amounts of cash when buying and selling marijuana but petitioner failed to maintain or to produce books_and_records relating to the transactions see 89_tc_1280 gajewski v commissioner t c pincite and petitioner failed to inform his tax_return_preparer of his marijuana sales see 451_f2d_197 3d cir affg tcmemo_1970_37 taken as a whole the evidence establishes that petitioner acted with the requisite fraudulent intent and that petitioner underreported substantial income for and relating to marijuana sales with fraudulent intent we also note that special_trial_judge carluzzo observed petitioner’s testimony and rejected in his recommended findings_of_fact and conclusions of law petitioner’s testimony as to his limited participation in the marijuana sales transactions and concluded that petitioner had the requisite fraudulent intent in filing his and federal_income_tax returns without reporting thereon his marijuana sales transactions we sustain respondent’s determinations that petitioner is liable for the additions to tax for fraud prescribed under sec_6653 for and respondent also determined additions to tax under sec_6661 for and for tax returns due after date but before date sec_6661 provides for an addition_to_tax equal to percent of the amount of any_tax underpayment attributable to a substantial_understatement an understatement is substantial if it exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6661 the understatement is reduced to the extent that the taxpayer has adequately disclosed his or her position or has substantial_authority for the tax treatment of an item sec_6661 sec_1 a income_tax regs for and petitioner bears the burden_of_proof as to the issue of his liability for the addition_to_tax under sec_6661 rule a 107_tc_18 due to petitioners’ substantial unreported income for and petitioner’s income_tax deficiencies for the taxable years in issue trigger the substantial_understatement addition_to_tax under sec_6661 petitioner has presented no evidence to show that respondent erroneously determined the additions to tax under sec_6661 petitioner is liable for the additions to tax under sec_6661 for and for sec_6501 expressly provides that in the case of a false or fraudulent tax_return with the intent to evade tax the tax may be assessed at any time petitioners’ argument that the period of limitations on assessment with respect to their income taxes for and expired before respondent issued the notices of deficiency to petitioners is rejected because petitioners filed joint federal_income_tax returns for and the assessment_period of limitations under sec_6501 remains open as to martha mchan as well stone v commissioner t c pincite other arguments raised by petitioners and not discussed herein have been considered are without merit and are rejected to reflect the foregoing an appropriate order will be issued


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 b02 - plr-123161-05 date date ----------------------- ---------------------------- ein ---------------- ---------------------- ssn ----------------- x a d1 dear ------------------ requesting a ruling under sec_1362 of the internal_revenue_code facts president of x represents that the shareholders of x intended that x elect to be an s_corporation effective d1 however x inadvertently failed to timely file a form_2553 election by a small_business_corporation accordingly x requests a ruling that it will be treated as an s_corporation effective d1 law and analysis this letter responds to a letter dated date submitted on behalf of x the information submitted states that x was incorporated on d1 a the sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective sec_1362 provides that if an s election is made within the first two and one-half months of a corporation's taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made under sec_1362 however if an s election is made after the first two and one-half months of a plr-123161-05 corporation's taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is filed sec_1362 provides that if - a an election under sec_1362 is made for any taxable_year after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make such election the secretary may treat such an election as timely made for such taxable_year conclusion based solely on the facts and representations submitted we conclude that x has established reasonable_cause for failing to make a timely election to be an s_corporation effective d1 accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 effective d1 along with a copy of this letter with the appropriate service_center within days from the date of this letter then such election will be treated as timely made for d1 federal tax consequences of the facts described above under any other provision of the code include whether x was or is a small_business_corporation under sec_1361 provides that it may not be used or cited as precedent being sent to x’s authorized representative except as specifically set forth above no opinion is expressed concerning the pursuant to a power_of_attorney on file with this office a copy of this letter is this ruling is directed only to the taxpayer requesting it sec_6110 sincerely beverly katz senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures cc copy of this letter copy for sec_6110 purposes


t c summary opinion united_states tax_court yakuba g brown petitioner v commissioner of internal revenue respondent docket no 16142-03s filed date yakuba g brown pro_se hieu c nguyen for respondent panuthos chief special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated subsequent section references are to the internal_revenue_code as amended and all rule references are to the tax_court rules_of_practice and procedure this matter is before the court on respondent’s motion for summary_judgment filed pursuant to rule as explained in more detail below we shall grant such motion in part and deny the motion in part we shall also on the court’s own motion dismiss for lack of jurisdiction and strike as to the taxable years and background the record reflects and or the parties do not dispute the following facts on date respondent sent to petitioner a notice_of_intent_to_levy regarding unpaid income_tax liabilities for and petitioner did not request an appeals_office hearing with respect to this notice on date respondent sent to petitioner a notice_of_intent_to_levy regarding unpaid income_tax_liability for petitioner timely requested an appeals_office hearing with respect to the date notice during the period date through part of date representatives of the irs unsuccessfully attempted to contact petitioner by telephone and letter a date letter from the irs appeals_office advised petitioner that he was entitled to a hearing for the tax_year pursuant to sec_6330 the letter further advised that since a timely request for hearing was not made for and an equivalent_hearing would be permitted as to those years however the letter further advised that there was no right to dispute a decision by the appeals_office in july and date there were communications between petitioner and the irs on date the irs representative received by fax from petitioner a form 433-a collection information statement for wage earners and self-employed individuals containing financial information provided by petitioner the irs representative concluded that the information included in the statement was incomplete and inaccurate petitioner was advised of the above in a telephone conference on date respondent issued a notice_of_determination concerning collection actions s with respect to the taxable_year informing petitioner of the opportunity to file a petition with this court and that the irs would proceed with collection action if no petition was filed also on date respondent issued petitioner a decision letter with respect to the taxable years and the letter advised petitioner of the irs’s intent to proceed with collection action and further that petitioner would not have an additional opportunity to dispute the decision since a request for hearing was not filed within the time provided under sec_6330 a petition was filed with the court on date at the time the petition was filed petitioner resided in moreno valley california the petition indicates that the dispute relates to the taxable years and as a basis for the relief requested the petition states i’m in the process of having my previous tax returns reviewed by another cpa i also would like a settlement on my account so that i can begin to move forward i have been laid off twice in the past years and have some financial hardship within the motion for summary_judgment respondent asks that we dismiss this case for lack of jurisdiction as to the taxable years and discussion sec_6331 provides that if any person liable to pay any_tax neglects or refuses to pay such tax within days after notice_and_demand for payment the secretary is authorized to collect such tax by way of levy upon the person’s property sec_6331 provides that at least days prior to proceeding with enforced collection by way of a levy on a person’s property the secretary is obliged to provide the person with a final notice_of_intent_to_levy including notice of the administrative appeals available to the person sec_6330 provides that the secretary shall notify a person in writing of his or her right to an appeals_office hearing regarding a notice_of_intent_to_levy sec_6330 provides that the prescribed notice shall be provided not less than days before the day of the first levy with respect to the amount of the unpaid tax for the taxable_period further sec_6330 provides that the prescribed notice shall explain that the person has the right to request an appeals_office hearing during the 30-day period under the paragraph sec_6330 prescribes the matters that may be raised by a taxpayer at an appeals_office hearing the section provides that a taxpayer may raise collection issues such as spousal defenses the appropriateness of the commissioner’s intended collection action and possible alternative means of collection such as an offer_in_compromise sec_6330 provides that the existence and amount of the underlying tax_liability can be contested at an appeals_office hearing only if the taxpayer did not receive a notice_of_deficiency for the taxes in question or did not otherwise have an earlier opportunity to dispute such tax_liability 114_tc_176 where the appeals_office issues a determination_letter to a taxpayer following an administrative hearing sec_6330 provides that the taxpayer will have days to file a petition for review with the tax_court or federal district_court 119_tc_252 116_tc_263 we have held that the court’s jurisdiction under sec_6320 and sec_6330 depends on the issuance of a valid determination_letter and the filing of a timely petition for review craig v commissioner supra pincite 117_tc_183 114_tc_492 taxable years and as indicated on date respondent issued petitioner a notice_of_intent_to_levy with respect to the taxable years and since a timely request for an appeals_office hearing was not made respondent offered petitioner an equivalent_hearing sec_301_6330-1 proced admin regs see craig v commissioner supra pincite in response to the appeals_office hearing respondent issued a decision letter on date the decision letter did not purport to be a determination pursuant to sec_6320 or sec_6330 116_tc_255 consistent with the foregoing we shall dismiss for lack of jurisdiction so much of the case that seeks review of the taxable years and on the ground that the appeals_office did not make a determination with respect to those taxable years in addition we shall strike all references in the petition to the taxable years and respondent did not attach copy s of notice s of intent to levy in his motion respondent referred to transcripts of account attached as exhibits respondent references the transcripts as evidence that the notice s of intent to levy were sent to petitioner petitioner does not appear to dispute that notice s of intent to levy was properly sent to petitioner’s last_known_address it would have been better practice for respondent to file continued taxable_year as indicated a timely petition was filed in response to the notice_of_determination as to the taxable_year petitioner does not appear to dispute the underlying tax_liability and accordingly we review the commissioner’s administrative determination for abuse_of_discretion lunsford v commissioner supra pincite goza v commissioner supra pincite- the appeals_office summary reflects that an offer_in_compromise was submitted by petitioner on date the offer_in_compromise was returned to petitioner on date for failure to provide required supporting financial data in his request for an appeals_office hearing form request for a collection_due_process_hearing dated date petitioner left blank the section of the form which states continued a motion to dismiss for lack of jurisdiction and to strike under these circumstances see rule sec_52 sec_53 and sec_54 however given that it is clear that we do not have jurisdiction and that we cannot ignore a jurisdictional issue simply because the parties have not filed an appropriate motion the court on its own motion will dismiss and strike as appropriate 114_tc_324 85_tc_527 it is not clear from this record whether the amount due for the taxable_year results from an underpayment or an understatement petitioner did not assert at the appeals_office level that he disputed the underlying tax_liability nor does he articulate any such dispute in this proceeding a copy of the offer_in_compromise was not made part of the record in this case notice_of_levy seizure explain why you don’t agree use extra sheets if necessary by fax transmitted date petitioner submitted a partially completed form 433-a to the irs the appeals officer concluded that information as to income received by petitioner’s wife was omitted from the financial statement the appeals officer conducted a telephone conference on date wherein petitioner was advised that the financial statement failed to include full financial information of the household petitioner advised the appeals officer that he would not be interested in an installment_agreement for an amount that exceeded dollar_figure per month on date the appeals officer issued the notice_of_determination advising that there were no collection alternatives available based on this record we conclude that respondent did not abuse his discretion respondent determined that petitioner did not submit complete or accurate information to respondent respondent gave petitioner an opportunity to correct and complete financial information yet petitioner failed to do so petitioner has failed to raise a spousal defense or make a valid challenge to the appropriateness of respondent’s intended collection action these issues are now deemed conceded see rule b accordingly we conclude that respondent’s determination was not an abuse_of_discretion reviewed and adopted as the report of the small_tax_case division to reflect the foregoing an appropriate order and order of decision will be entered


internal_revenue_service number release date index number ------------------------ ------------------------ ------------------------------- ------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------ id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-113395-11 date date legend x y ------------------------ --------------------------------- ------------------------ --------------------------------- year ------- dear ------------------------------ this responds to a letter dated date submitted on behalf of x and y by your authorized representative requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations for x and y to file an election under sec_469 of the internal_revenue_code and sec_1_469-9 of the income_tax regulations to treat all interests in rental real_estate as a single rental real_estate activity according to the information submitted x and y were married individuals who filed their tax returns jointly x and y represent that in year x was in a real_property business as defined by sec_469 and was qualified under sec_469 to make an election to treat all interests in rental real_estate as a single rental real_estate activity however x and y inadvertently filed their joint_return for year without the statement required under sec_1_469-9 under sec_469 the term passive_activity generally includes any rental_activity sec_469 provides a limited exception to this rule for taxpayers in a real_property_trade_or_business specifically sec_469 indicates that if a taxpayer plr-113395-11 meets the requirements of sec_469 the taxpayer's rental real_estate activity will no longer be presumptively passive by its terms the exception under sec_469 is to be applied as if each interest of the taxpayer in rental real_estate were a separate activity however a taxpayer may elect to treat all interests in rental real_estate as a single activity sec_1_469-9 provides that a qualifying taxpayer makes the election to treat all interests in rental real_estate as a single rental real_estate activity by filing a statement with the taxpayer's original income_tax return for the taxable_year sec_1_469-9 describes the information that must be contained in the statement under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election whose due_date is prescribed by a regulation published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides the rules governing automatic extensions of time for making certain elections sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time for regulatory elections that do not meet the requirements of sec_301_9100-2 sec_301_9100-3 provides that requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that the grant of relief will not prejudice the interests of the government sec_301_9100-3 provides that subject_to paragraphs b i through iii of sec_301_9100-3 when a taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election the taxpayer will be deemed to have acted reasonably and in good_faith based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x and y are granted an extension of time of days from the date of this letter to make an election under sec_469 to treat all their interests in rental real_estate as a single rental real_estate activity effective year the election must be in the form of the statement required by sec_1_469-9 and attached to an amended_return for year plr-113395-11 a copy of this letter should be attached to the election a copy is enclosed for that purpose except as specifically set forth above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed concerning whether x and y satisfy the requirements under sec_469 or whether x and y materially participated in any activity this ruling is directed only to the taxpayers requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel passthroughs special industries _______________________________ by bradford r poston senior counsel branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes