internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc dom corp br4 plr-115939-98 date date parent sub sub sub sub sub sub sub plr-115939-98 sub sub sub sub sub sub sub sub sub sub sub plr-115939-98 sub sub sub sub sub sub sub sub sub sub sub plr-115939-98 sub sub sub sub sub sub sub sub sub sub sub plr-115939-98 sub sub sub llc llc sub fsub fpart fsub fsub fsub target plr-115939-98 country a country b country c country d country e state f date date date date business a business b asset a asset b asset c asset d asset e debt a debt b investment banker a plr-115939-98 b c d a b c d e f g h i j k l m n o dear this letter responds to your date request for rulings on certain federal_income_tax consequences of a proposed transaction the rulings contained in this letter are based on facts and representations plr-115939-98 submitted by the taxpayer and accompanied by a penalties of perjury statement executed by an appropriate party this office has not certified any of the materials submitted in support of the request for rulings verification of the information representations and other data may be required as part of the audit process summary of facts publicly traded parent is the common parent of an affiliated_group that files a consolidated federal_income_tax return the parent group parent conducts business a and business b both directly and through subsidiaries parent has outstanding common_stock the common_stock and as of date had outstanding convertible preferred_stock the preferred_stock associated with each share of common_stock is a purchase right not exercisable or transferable separately from the common_stock unless and until certain events generally involving changes in control of distributing occur cumulatively the shareholder rights plan to the best of management’s knowledge a and b are the only shareholders who beneficially own five percent or more of the common_stock and neither actively participates in the management or operations of parent on date to diversify its equity holdings and avoid potential exposure under c d sold its a percent ownership of common_stock in open market transactions on date parent called the preferred_stock for conversion into common_stock resulting in a b percent shift of ownership in the parent voting_stock on date parent’s board gfof directors renewed its grant of authority to management to repurchase up to c percent of the common_stock in open market transactions parent also has various stock_option plans each of which has anti-dilution provisions that will be activated by the proposed transaction described below parent wholly owns sub sub sub sub sub sub sub sub sub sub and sub parent also owns d percent of sub e percent of sub and f percent of sub sub wholly owns sub sub wholly owns sub and sub wholly owns sub sub and sub sub wholly owns sub and sub and sub wholly owns sub sub wholly owns sub sub sub sub sub sub sub sub and sub sub wholly owns sub sub sub and sub sub owns g percent of fsub sub owns all of fsub e percent of fpart h percent of fsub and i percent of fsub all entities described in this paragraph are domestic except for fsub country a fpart country b fsub country c fsub country d and fsub country e financial information has been submitted indicating that the businesses conducted by sub after its merger with sub and sub in steps vii and viii below sub after contribution in step ix below sub through its ownership of sub sub through its ownership of sub sub after the contribution in step xvii below sub after its merger with sub in step iii below sub through plr-115939-98 its ownership of sub and parent each meets the requirements of sec_355 of the internal_revenue_code business_purpose parent desires to acquire unrelated target which is engaged in business b investment banker has advised parent that this acquisition would be an inefficient use of parent’s equity_capital unless parent first separated its business a operations from its business b operations investment banker reached this conclusion after analyzing the relative costs of equity_capital for entities engaged in only business a entities engaged in only business b and entities such as parent engaged in both business a and business b proposed transaction in response to this advice parent proposes to separate the businesses through i sub will merge into parent so that sub becomes a first-tier subsidiary of the following steps parent ii sub will contribute its assets to newly formed and wholly owned sub contribution 3a iii sub will merge into sub iv sub will form wholly owned sub v to satisfy a requirement of country e law sub will contribute to newly formed sub its stock in sub sub and sub vi sub will contribute its e percent partnership_interest in fpart to newly formed and wholly owned sub vii sub will merge into sub viii sub will merge into sub ix sub will contribute to sub a management contracts for asset c asset d and asset e and b its stock in fsub fsub fsub and fsub contribution transferring the management contracts for asset c and asset d and the fsub stock collectively the regulated assets requires certain regulatory and third-party approvals although the taxpayer expects that the approvals will be granted this may not happen before the closing in which event sub would transfer plr-115939-98 the regulated assets to sub in two interrelated steps as follows x on the closing date sub would segregate its beneficial_interest in the regulated assets for the benefit of sub and y when sub receives the requisite approvals after the closing date it will immediately transfer legal_title and the segregated beneficial_interest in the regulated assets to sub x sub will distribute its sub stock to sub xi sub will distribute its sub stock to sub xii sub will distribute its sub stock to parent distribution xiii sub sub and sub will each successively merge into parent xiv sub will merge into sub xv sub will merge into sub a newly-formed subsidiary of sub xvi parent will contribute to sub its stock in sub and sub assets that relate to asset a and asset b and j percent of sub xvii sub will contribute to sub its assets that relate to business b apart from its sub stock and the assets it received from parent in step xvi above xviii sub will contribute to sub the business b assets received from sub in step xvii above contribution 3b xix sub will distribute its sub stock to sub distribution xx sub will distribute its sub stock to parent distribution xxi sub will sell its business b assets to sub for cash xxii parent will sell certain furniture fixtures equipment and other miscellaneous assets used in business b to sub in partial satisfaction of a preexisting liability of parent to sub xxiii parent will contribute its sub stock to sub contribution 5a xxiv parent will merge sub sub sub sub sub and sub into sub xxv the assets and liabilities formerly belonging to sub and sub will be combined and transferred to sub a newly formed subsidiary of sub the assets plr-115939-98 and liabilities formerly belonging to sub will be transferred to sub a second newly formed subsidiary of sub the assets and liabilities formerly belonging to sub will be transferred to sub a third newly formed subsidiary of sub xxvi sub will merge into llc and sub after having first merged into sub to reincorporate itself in state f will merge into llc each of these limited_liability companies will have sub as its sole member xxvii parent will contribute to sub its interests in sub sub sub sub sub and sub certain royalty-free licenses the licenses and its e and f percent interests in sub and sub respectively collectively contribution 5b concurrently with contribution 5b sub will assume and agree to pay percent of the amount of each payment of principal and interest required to be made currently by parent under the terms of the indentures governing a the k aggregate principal_amount of debt a and b the l aggregate principal_amount of debt b these payments will be made directly by sub to the paying agent under the indentures for these two debt issues parent is obligated to make payment to the debt holder only in the event that sub fails to make payments as agreed and if parent should be called upon to make such payments sub is obligated to pay parent the amount of any such payments made by parent to the holders of the debt together with interest at the rate specified in the parent debt plus m percent per annum xxviii sub will contribute its e percent interest in sub to sub xxix sub will contribute its ownership interests in sub sub sub sub sub and sub to sub xxx sub will contribute all its sub stock to sub xxxi parent will distribute the sub stock to its shareholders distribution sub intends to adopt a plan similar to the shareholder rights plan of parent the sub rights plan xxxii sub a newly-formed subsidiary of sub will merge into target the merger in the merger the shareholders of target will exchange their target stock solely for sub voting_stock in a transaction intended to qualify as a reorganization under sec_368 the merger is expected to result in an n percent change in the ownership of sub xxxiii in connection with distribution the outstanding options under the various stock_option plans of parent will be adjusted so that each optionee holds an adjusted option to purchase shares of common_stock of parent and a new option to purchase shares of sub this adjustment will preserve the value of the outstanding options under the existing plans by issuing each optionee an option to purchase a plr-115939-98 number of shares of sub equal to the number of shares of common_stock of parent subject_to the option immediately before distribution and by allocating the value of the spread ie the difference between the exercise price of each outstanding option and the fair_market_value of the common_stock subject_to the option immediately before distribution between the optionee’s parent stock_option as adjusted and the new sub stock_option based upon the relative fair market values of the common_stock of parent and the common_stock of sub after distribution recharacterization for federal_income_tax purposes the proposed transaction is recharacterized in the following respects i step v will be disregarded except for its reference to the formation of sub by sub ii the distribution by sub of the sub stock to sub described in step x will instead be treated as a distribution by sub of the sub stock to sub distribution and iii the distribution by sub of the sub stock to sub described in step xi will be disregarded and replaced by a contribution of the sub stock by sub to sub contribution contribution and distribution representations the taxpayer has made the following representations regarding contribution and distribution a no part of the consideration distributed by sub will be received by a sub shareholder as a creditor employee or in any capacity other than that of a shareholder of sub b the five years of financial information submitted on behalf of sub reflecting the operation of sub and sub represents its present operation and there have been no substantial operational changes since the date of the last submitted financial statements c the five years of financial information submitted on behalf of sub reflecting the assets transferred in contribution represents its present operation and there have been no substantial operational changes since the date of the last submitted financial statements d following the proposed transaction sub and sub will each continue plr-115939-98 the active_conduct of its business independently and with its separate employees e distribution is carried out for the corporate business_purpose described above distribution is motivated in whole or substantial part by this and other corporate business purposes f other than pursuant to contribution there is no plan or intention by the shareholders or security holders of sub to sell exchange transfer by gift or otherwise dispose_of any of their stock in or securities of either sub or sub after the proposed transaction g there is no plan or intention by either sub or sub directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the proposed transaction other than through stock purchases meeting the requirements of sec_4 b of revproc_96_30 1996_1_cb_696 h there is no plan or intention to liquidate either sub or sub to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation after the proposed transaction except in the ordinary course of business i the total adjusted_basis and fair_market_value of the assets transferred to sub by sub will each equal or exceed the sum of the liabilities assumed by sub plus any liabilities to which the transferred assets are subject j the liabilities assumed in the proposed transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred k no intercorporate debt will exist between sub and sub at the time of or after distribution l payments made in any continuing transactions between sub and sub will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length m no two parties to distribution are investment companies as defined in sec_368 and iv contribution and distribution representations the taxpayer has made the following representations regarding contribution and distribution plr-115939-98 n no part of the consideration to be distributed by sub will be received by a sub stockholder as a creditor employee or in any capacity other than that of a stockholder of sub o the five years of financial information submitted on behalf of sub reflecting the assets transferred to sub in contribution represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements p the five years of financial information submitted on behalf of sub reflecting the operation of sub and sub represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements q immediately after distribution at least percent of the fair_market_value of the gross assets of sub will consist of stock and securities of controlled corporations that are engaged in the active_conduct_of_a_trade_or_business under sec_355 immediately after distribution at least percent of the fair_market_value of the gross assets of sub will consist of stock and securities of controlled corporations that are engaged in the active_conduct_of_a_trade_or_business under sec_355 r following the proposed transaction sub and sub each will continue the active_conduct of its business independently and with its separate employees s distribution is carried out for the corporate business_purpose described above distribution is motivated in whole or substantial part by this and other corporate business purposes t other than pursuant to distribution there is no plan or intention by the stockholders or security holders of sub to sell exchange transfer by gift or otherwise dispose_of any of their stock in or securities of either sub or sub after the proposed transaction u there is no plan or intention by either sub or sub directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the proposed transaction other than through stock purchases meeting the requirements of sec_4 b of revproc_96_30 v there is no plan or intention to liquidate either sub or sub to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation after the proposed transaction except in the ordinary course of business plr-115939-98 w the total adjusted_basis and fair_market_value of the assets transferred to sub by sub will each equal or exceed the sum of the liabilities assumed by sub plus any liabilities to which the transferred assets are subject x the liabilities assumed in the proposed transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred y no intercorporate debt will exist between sub and sub at the time of or after distribution z payments made in any continuing transactions between sub and sub will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length aa no two parties to distribution are investment companies under sec_368 and iv contribution 3a contribution 3b and distribution representations the taxpayer has made the following representations regarding contribution 3a contribution 3b and distribution bb no part of the consideration distributed by sub will be received by a sub shareholder as a creditor employee or in any capacity other than that of a shareholder of sub cc the five years of financial information submitted on behalf of sub reflecting assets contributed in step xvii represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements dd the five years of financial information submitted on behalf of sub reflecting the operations of sub represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements ee following the proposed transaction sub and sub each will continue the active_conduct of its business independently and with its separate employees ff distribution is carried out for the corporate business_purpose described above distribution is motivated in whole or substantial part by this and other corporate business purposes plr-115939-98 gg other than pursuant to distribution there is no plan or intention by the shareholders or security holders of sub to sell exchange transfer by gift or otherwise dispose_of any of their stock in or securities of either sub or sub after the proposed transaction hh there is no plan or intention by either sub or sub directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the proposed transaction other than through stock purchases meeting the requirements of sec_4 b of revproc_96_30 ii there is no plan or intention to liquidate either sub or sub to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation after the proposed transaction except in the ordinary course of business jj the total adjusted_basis and the fair_market_value of the assets transferred to sub by sub each equals or exceeds the sum of the liabilities assumed by sub plus any liabilities to which the transferred assets are subject kk the liabilities assumed in the proposed transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred ll no intercorporate debt will exist between sub and sub at the time of or after distribution mm payments made in any continuing transactions between sub and sub will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length nn no two parties to distribution are investment companies under sec_368 and iv distribution representations the taxpayer has made the following representations regarding distribution oo no part of the consideration to be distributed by sub will be received by a sub stockholder as a creditor employee or in any capacity other than that of a stockholder of sub pp the five years of financial information submitted on behalf of sub reflecting the assets contributed to sub in the step xvii contribution represents its plr-115939-98 present operations and there have been no substantial operational changes since the date of the last submitted financial statements qq the five years of financial information submitted on behalf of sub reflecting the operations of sub represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements rr immediately after distribution at least percent of the fair_market_value of the gross assets of sub will consist of stock and securities of controlled corporations that are engaged in the active_conduct_of_a_trade_or_business under sec_355 ss following the proposed transaction sub and sub each will continue the active_conduct of its business independently and with its separate employees tt distribution is carried out for the corporate business_purpose described above distribution is motivated in whole or substantial part by this and other corporate business purposes uu other than pursuant to contribution 5a there is no plan or intention by the stockholders or security holders of sub to sell exchange transfer by gift or otherwise dispose_of any of their stock in or securities of either sub or sub after the proposed transaction vv there is no plan or intention by either sub or sub directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the proposed transaction other than through stock purchases meeting the requirements of sec_4 b of revproc_96_30 ww there is no plan or intention to liquidate either sub or sub to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation after the proposed transaction except in the ordinary course of business xx no intercorporate debt will exist between sub and sub at the time of or after distribution yy payments made in any continuing transactions between sub and sub will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length zz no two parties to distribution are investment companies under sec_368 and iv plr-115939-98 contribution 5a contribution 5b and distribution representations the taxpayer has made the following representations regarding contribution 5a contribution 5b and distribution aaa no part of the consideration distributed by parent will be received by a parent stockholder as a creditor employee or in any capacity other than that of a stockholder of parent bbb the five years of financial information submitted on behalf of parent represents its present operations and there have been no substantial operational changes since the date of the last submitted financial statements ccc the five years of financial information submitted on behalf of sub reflecting the assets transferred to sub in contribution represents its present operation and there have been no substantial operational changes since the date of the last submitted financial statements ddd immediately after distribution at least percent of the fair_market_value of the gross assets of sub will consist of stock and securities of controlled corporations that are engaged in the active_conduct_of_a_trade_or_business under sec_355 eee following the proposed transaction parent and sub each will continue the active_conduct of its business independently and with its separate employees fff distribution is carried out for the corporate business_purpose described above distribution is motivated in whole or substantial part by this and other corporate business purposes ggg there is no plan or intention by a or b and the management of parent to its best knowledge is not aware of any plan or intention on the part of any other stockholder or security holder of parent to sell exchange transfer by gift or otherwise dispose_of any stock in or securities of either parent or sub after the proposed transaction hhh there is no plan or intention by either parent or sub directly or through any subsidiary_corporation to purchase any of its outstanding_stock after the proposed transaction other than through stock purchases meeting the requirements of sec_4 b of revproc_96_30 iii there is no plan or intention to liquidate either parent or sub to merge either corporation with any other corporation or to sell or otherwise dispose_of the assets of either corporation after the proposed transaction except in the ordinary course of business plr-115939-98 jjj the total adjusted_basis and fair_market_value of the assets transferred to sub by parent each equals or exceeds the sum of the liabilities assumed by sub plus any liabilities to which the transferred assets are subject kkk the liabilities assumed in the proposed transaction and the liabilities to which the transferred assets are subject were incurred in the ordinary course of business and are associated with the assets being transferred lll no intercorporate debt will exist between parent and sub at the time of or after distribution mmm immediately before distribution items of income gain loss deduction and credit will be taken into account as required by the applicable intercompany_transaction regulations see sec_1_1502-13 and sec_1 of the income_tax regulations as in effect before the publication of t d 1995_2_cb_147 and as currently in effect sec_1_1502-13 as published by t d further any excess_loss_account parent may have in the sub stock will be included in income immediately before distribution nnn payments made in any continuing transactions between parent and sub will be for fair_market_value based on terms and conditions arrived at by the parties bargaining at arm’s length ooo no two parties to distribution are investment companies under sec_368 and iv ppp distribution is not part of a plan or series of related transactions within the meaning of sec_355 pursuant to which one or more persons will acquire directly or indirectly stock possessing percent or more of the total combined voting power of all classes of stock of either parent or sub or stock possessing percent of more of the total value of all classes of stock of either parent or sub in this regard the sale by d represents a percent of parent stock by vote and value the open market stock repurchases by parent represent a maximum of c percent of parent stock by vote and value the conversion of parent’s preferred_stock has no impact on value but represents b percent of the total combined voting power of parent’s stock thus if the sale by d the open market stock purchases by parent and the conversion of parent’s preferred_stock were aggregated and treated as part of the distribution plan they would not by themselves result in a percent or greater acquisition of parent by vote or value in addition the merger will result in the issuance of n percent of the sub stock by vote and value and the options in sub being issued to current holders of parent options pursuant to the anti-dilution provisions set forth in existing parent stock_option plans would if exercised result in the issuance of o percent of sub stock by vote and value thus if the merger and the exercise of sub options under the anti- dilution provisions of parent’s existing stock_option plans were aggregated and treated plr-115939-98 as part of the distribution plan they would not by themselves result in a percent or greater acquisition of sub by vote or value international representation qqq no federal_income_tax consequences under sec_367 sec_367 sec_897 sec_951 sec_1248 sec_1291 or sec_1293 will result from steps i through xxxiii of the proposed transaction contribution and distribution rulings based solely on the information submitted and the representations set forth above we rule as follows regarding contribution and distribution contribution followed by distribution will be a reorganization under sec_368 sub and sub each will be a_party_to_a_reorganization under sec_368 no gain_or_loss will be recognized by sub on contribution sec_361 no gain_or_loss will be recognized by sub on contribution sec_1032 the basis of each asset received by sub in contribution will equal the basis of that asset in the hands of sub immediately before its transfer sec_362 the holding_period of each asset received by sub in contribution will include the period during which that asset was held by sub sec_1223 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of sub on its receipt of sub stock in distribution sec_355 the holding_period of sub stock received by sub will include the holding_period of the sub stock on which distribution is made provided the sub stock is held as a capital_asset by sub on the date of distribution sec_1223 no gain_or_loss will be recognized by sub on distribution sec_355 and sec_361 proper allocation of earnings_and_profits between sub and sub will be made in accordance with sec_1 312-l0 a sec_312 if the transfer of the regulated assets in contribution occurs in two steps plr-115939-98 then for federal tax purposes the second step will be considered to have occurred on the closing date and sub will be treated as if it had transferred the regulated assets to sub on that date contribution and distribution rulings based solely on the information submitted and the representations set forth above we rule as follows regarding contribution and distribution contribution followed by distribution will be a reorganization under sec_368 sub and sub each will be a_party_to_a_reorganization under sec_368 no gain_or_loss will be recognized by sub on contribution sec_361 no gain_or_loss will be recognized by sub on contribution sec_1032 the basis of the sub stock received by sub in contribution will equal the basis of that stock in the hands of sub immediately before contribution sec_362 the holding_period of each asset received by sub in contribution will include the period during which that asset was held by sub sec_1223 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of parent on its receipt of sub stock in distribution sec_355 the holding_period of the sub stock received by parent will include the holding_period of the sub stock on which distribution is made provided the sub stock is held as a capital_asset by parent on the date of distribution sec_1223 no gain_or_loss will be recognized by sub on distribution sec_355 and sec_361 proper allocation of earnings_and_profits between sub and sub will be made in accordance with sec_1_312-10 sec_312 contribution 3a contribution 3b and distribution rulings based solely on the information submitted and the representations set forth above we rule as follows regarding contribution 3a contribution 3b and distribution plr-115939-98 contribution 3a and contribution 3b followed by distribution will be a reorganization under sec_368 sub and sub each will be a_party_to_a_reorganization under sec_368 no gain_or_loss will be recognized by sub on contribution sec_3a and sec_3b sec_361 no gain_or_loss will be recognized by sub on contribution sec_3a and sec_3b sec_1032 the basis of each asset received by sub in contribution sec_3a and sec_3b will equal the basis of that asset in the hands of sub immediately before its transfer sec_362 the holding_period of each asset received by sub in contribution sec_3a and sec_3b will include the period during which that asset was held by sub sec_1223 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of sub on its receipt of sub stock in distribution sec_355 the holding_period of the sub stock received by sub will include the holding_period of the sub stock on which distribution is made provided the sub stock is held as a capital_asset by sub on the date of distribution sec_1223 no gain_or_loss will be recognized by sub on distribution sec_355 and sec_361 proper allocation of earnings_and_profits between sub and sub will be made in accordance with sec_1 312-l0 a sec_312 distribution rulings based solely on the information submitted and the representations set forth above we rule as follows regarding distribution no gain_or_loss will be recognized by and no amount will otherwise be included in the income of parent upon its receipt of sub stock in distribution sec_355 the holding_period of the sub stock received by parent will include the holding_period of the sub stock on which distribution is made provided the sub stock is held as a capital_asset by parent on the date of distribution sec_1223 plr-115939-98 no gain_or_loss will be recognized by sub on distribution sec_355 and sec_355 proper allocation of earnings_and_profits between sub and sub will be made in accordance with sec_1_312-10 sec_312 contribution 5a contribution 5b and distribution rulings based solely on the information submitted and the representations set forth above we will as follows regarding contribution 5a contribution 5b and distribution contribution 5a and contribution 5b followed by distribution will be a reorganization under sec_368 sub and parent will each be a_party_to_a_reorganization under sec_368 no gain_or_loss will be recognized by parent on contribution sec_5a and sec_5b sec_361 no gain_or_loss will be recognized by sub on contribution sec_5a and sec_5b sec_1032 the basis of each asset received by sub in contribution sec_5a and sec_5b will equal the basis of that asset in the hands of parent immediately before its transfer sec_362 the holding_period of each asset received by sub in contribution sec_5a and sec_5b will include the period during which that asset was held by parent sec_1223 no gain_or_loss will be recognized by and no amount will otherwise be included in the income of the stockholders of parent on receipt of the sub stock in distribution sec_355 sec_355 will not treat as other_property that part of the sub stock attributable to the fair_market_value of the licenses the aggregate basis of the stock of sub and parent in the hands of a parent stockholder after distribution will equal the aggregate basis of the stock of parent in the hands of the stockholder immediately before distribution this basis will be allocated between the sub stock and the parent stock in proportion to the fair_market_value of each in accordance with sec_1_358-2 sec_358 the holding_period of the sub stock received by a parent stockholder will include the holding_period of the parent stock on which distribution will be made provided the parent stock is held as a capital_asset by the stockholder on the date of distribution sec_1223 no gain_or_loss will be recognized by parent on distribution sec_355 plr-115939-98 and c proper allocation of earnings_and_profits between sub and parent will be made in accordance with sec_1 312-l0 a sec_312 caveats no opinion is expressed about the tax treatment of the proposed transaction under any other section of the code or regulations or the tax treatment of any conditions existing at the time of or effects resulting from the proposed transaction that are not specifically covered by the above rulings in particular no opinion is expressed concerning the tax effects of a the mergers described above in steps i iii vii including whether this merger causes a termination of fpart under sec_708 viii xiii xiv xv xxiv and xxvi b the formation of sub by sub described above in step iv c the contributions described above in steps vi xvi xvii xxv xxviii xxix and xxx d the sales described above in steps xxi and xxii e the merger described above in step xxxii including whether it will qualify as a reorganization under sec_368 f the transfer of licenses by parent to sub described above in step xxvii including whether the licenses are property see revrul_69_156 c b g the option adjustments described above in step xxxiii h the allocation of stock bases under sec_358 as a result of distribution distribution distribution and distribution i the sub rights plan and j the proposed transaction under sec_367 sec_367 sec_897 sec_951 sec_1248 sec_1291 or sec_1293 temporary or final regulations pertaining to one or more issues addressed in this ruling letter including regulations under sec_358 have yet to be adopted therefore this ruling letter may be revoked or modified if adopted temporary or final regulations are inconsistent with any conclusions reached herein see section dollar_figure of rev_proc plr-115939-98 1998_1_irb_7 which addresses in greater detail when a ruling will be revoked or modified however when the criteria in section dollar_figure of revproc_98_1 are satisfied a ruling is seldom revoked or modified retroactively except in rare or unusual circumstances procedural matters this ruling letter is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent a copy of this letter should be attached to the federal_income_tax return of each taxpayer involved for the taxable_year in which the proposed transaction is completed under a power_of_attorney on file in this office copies of this letter are being sent to your authorized representatives sincerely yours assistant chief_counsel corporate by wayne t murray senior technician reviewer branch


t c memo united_states tax_court robert e corrigan petitioner v commissioner of internal revenue respondent docket no filed date robert e corrigan pro_se margaret s rigg for respondent memorandum findings_of_fact and opinion gerber chief_judge petitioner seeks the redetermination of respondent’s determinations contained in two separate notices of deficiency unless otherwise indicated all section references are to the internal_revenue_code in effect for the taxable years at issue all rule references are to the tax_court rules_of_practice and procedure respondent determined the following income_tax deficiencies penalties and additions to tax for petitioner’s through taxable years year deficiency dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure additions to tax and penalties under secs a a a a a b b a b b b a big_number big_number big_number big_number big_number big_number --- --- --- --- --- big_number --- --- --- ---1 --- --- --- --- big_number --- --- --- --- --- big_number --- --- --- --- --- big_number big_number big_number ---2 --- --- --- --- --- --- big_number big_number big_number percent of interest due on dollar_figure percent of interest due on dollar_figure after concessions by the parties the issues remaining for our consideration are whether petitioner’s debt that was forgiven as part of a settlement agreement is includable in petitioner’s income whether petitioner’s stock and option trading activity was a trade_or_business entitling him to claim ordinary losses and or business deductions on a schedule c profit or loss from business whether petitioner’s capital_gains losses for and were correctly reported whether petitioner is entitled to deduct payments or respondent also determined substantial_understatement and negligence additions to tax under former sec_6661 and sec_6653 for and respectively and under sec_6662 for through as an alternative position if the fraud_penalty were not sustained under sec_6653 or sec_6663 as the case may be brokerage commission rebates claimed for and whether petitioner is entitled to defer gain realized from the sale of a residence under sec_1034 and if not the amount of gain to be recognized whether petitioner is entitled to deduct losses from a horse breeding activity for through whether petitioner has shown that respondent’s determination that petitioner failed to report certain items of income was in error whether petitioner is entitled to itemized_deductions for interest_expenses casualty losses and employee_expenses in excess of the amounts allowed by respondent whether petitioner is entitled to dependency deductions for his children and or a personal_exemption for his former wife whether petitioner is liable for additions to tax and accuracy-related_penalties for negligence for through and whether petitioner is liable for additions to tax and penalties for substantial understatements findings of fact2 petitioner resided in newport beach california at the time his petition was filed petitioner’s federal_income_tax returns for and were filed on date date date date and the parties’ stipulation of facts is incorporated by this reference date respectively petitioner and respondent entered into timely agreements extending the period for assessment for each tax_year in controversy petitioner married jo ann corrigan mrs corrigan during and they had four children petitioner holds a master’s degree in finance and in business administration and began working as a stockbroker in southern california during beginning in petitioner began working as a stockbroker in san francisco california although petitioner and mrs corrigan legally_separated during they moved to walnut creek california and lived together in a home with their children petitioner and mrs corrigan jointly purchased the home in walnut creek for dollar_figure they remodeled the walnut creek home and added a barn and horse stables to the property at a cost of approximately dollar_figure after the improvements mrs corrigan began boarding breeding and showing horses at the time of their separation petitioner and mrs corrigan entered into a property settlement agreement providing for child_support custody and alimony mrs corrigan was given physical and legal custody of the four children under the agreement on what purported to be joint returns for through petitioner claimed dependency_exemptions for his four children and a personal_exemption for mrs corrigan respondent conceded that petitioner is entitled to file the returns as head_of_household for through respondent also conceded that petitioner is entitled to dependency_exemptions for david in through erin in through robert in and and amy in after petitioner and mrs corrigan’s divorce became final during they continued to cohabit petitioner left his position in san francisco during and accepted a new position as a stockbroker with smith barney harris upham smith barney in southern california petitioner flew to the smith barney office in san francisco for business on fridays and spent most weekends with his family at his walnut creek home that he continued to maintain as his principal_residence petitioner and mrs corrigan purchased new residences and left the walnut creek home during the walnut creek home was sold for dollar_figure during on the federal_income_tax return petitioner reported the walnut creek home sale and attempted to defer the gain by attaching a form_2119 sale_or_exchange of principal_residence the form_2119 reflected that gain was realized from the walnut creek home sale and that the recognition of the gain was to be deferred pursuant to former sec_1034 during petitioner and mrs corrigan jointly purchased real_property in chino california for dollar_figure mrs corrigan operated the property as a ranch and her initials were used to name the ranch jac ranch although the mortgage on the ranch was in petitioner’s name alone the deed to the property reflected joint_ownership by petitioner and mrs corrigan mrs corrigan used jac ranch as her primary residence beginning in petitioner owned a home in newport beach california which he used as his primary residence beginning in although petitioner and mrs corrigan maintained separate residences during the years in issue they occasionally spent time together in the same household during petitioner accepted a position as an account executive at prudential-bache prudential at prudential the position of account executive was the equivalent of a senior stockbroker petitioner was not a licensed stockbroker or dealer_in_securities and no license was required to act as a senior stockbroker for prudential during prudential lent petitioner dollar_figure which was evidenced by petitioner’s promissory note to prudential under the terms of the loan petitioner was required to make six annual dollar_figure installments with the first installment due_date petitioner made one dollar_figure installment leaving an unpaid balance of dollar_figure petitioner resigned his position at prudential during date without repaying the outstanding dollar_figure loan balance prudential sought to collect the loan balance and submitted its dollar_figure claim to arbitration petitioner asserted several grounds that related to his employment as counterclaims against prudential including breach of contract breach of the covenant of good_faith and fair employment fraud negligent misrepresentation in petitioner’s hiring and punitive_damages during the arbitration proceeding was settled under the settlement prudential released petitioner from his obligation to repay the dollar_figure loan balance and petitioner agreed to drop his employment-related claims petitioner’s attorney wrote petitioner a letter stating that the dollar_figure would be reclassified by prudential as punitive_damages but the attorney did not provide any_tax advice regarding this item prudential in connection with the settlement and release of the loan obligation issued petitioner a form_1099 misc miscellaneous income for reflecting dollar_figure as nonemployee compensation to petitioner petitioner did not report the settlement as income during while petitioner’s dispute with prudential was ongoing he transferred his interests in the jac ranch and the newport beach residence to mrs corrigan mrs corrigan quit- claimed the deeds for both properties back to petitioner once the prudential matter was settled at all pertinent times petitioner was the sole mortgagee and the only person obligated to make mortgage payments with respect to the mortgage on the jac ranch property mrs corrigan intended to use the jac ranch for the breeding sale and showing of horses she had no source_of_income or capital other than what she received from petitioner she used these funds to pay the operating_expenses and mortgage payments for jac ranch mrs corrigan generally requested and petitioner advanced approximately dollar_figure per month for the payment of expenses for hay and grain breeding costs hired help and the purchase training and showing of horses during the time petitioner made these payments he and mrs corrigan were legally divorced petitioner and mrs corrigan did not enter into a joint_venture or profit and loss agreement with respect to the operation of the jac ranch petitioner and mrs corrigan were divorced when they filed what purported to be joint federal_income_tax returns and joint amended returns the purported joint returns included claimed losses with respect to the activities at the jac ranch petitioner and mrs corrigan were not entitled to file joint income_tax returns for the years under consideration attached to the purported joint returns were schedules c reflecting mrs corrigan as the operator and sole_proprietor of the ranch on separate schedules c petitioner alone was shown as the operator and sole_proprietor of an activity in which he claimed to be engaged in the trade_or_business of buying and selling options and commodities petitioner claimed and respondent disallowed a theft_loss of dollar_figure for petitioner’s claim was on the basis of a report he filed with the local police reflecting a dollar_figure theft of cash from his newport beach home there was no evidence of forced entry and petitioner’s claimed theft was not solved or verified by local authorities petitioner did not seek reimbursement of the claimed dollar_figure loss from his homeowner’s insurance_company during through petitioner was employed by smith barney as an account executive in newport beach california he earned commissions of dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure for and respectively on his through returns petitioner claimed and respondent disallowed expenses for work-related travel as itemized_deductions on the schedules a itemized_deductions attached to each return smith barney as a broker and petitioner as a smith barney employee dealt in syndicated stock offerings during and which differed from regular stock transactions in that the underwriting of the stock involved risk to the broker because of the increased risk the transaction commissions were substantially larger and on occasion reductions in the amount of commissions were negotiated during and jlb capital which was owned by jack bergman bergman was a smith barney customer which was serviced by petitioner petitioner was the account executive for three jlb capital accounts jlb capital was operated by bergman as a proprietorship during the years at issue in and jlb capital purchased syndicated stock offerings through petitioner who negotiated with bergman to rebate a portion of the commission petitioner received from smith barney for syndicated stock sales to jlb capital on his and tax returns petitioner claimed reductions in gross_income for rebates of dollar_figure and dollar_figure respectively the rebates were paid out of the commissions petitioner earned from smith barney petitioner issued forms to jlb capital with respect to the above- described payments petitioner managed a smith barney brokerage account in his name and a second account held jointly with mrs corrigan during for petitioner also claimed a reduction in income of dollar_figure for an amount claimed to be paid to an anitra kalagian petitioner concedes that this item is not proper to consider in computing his tax_liability for and petitioner was able to show by means of canceled checks that he had paid rebates of dollar_figure and dollar_figure respectively to jlb capital or bergman the forms issued to jlb capital and the canceled checks are the only support petitioner provided for the rebates reported on his returns through a third smith barney account was held in mrs corrigan’s name only during the same period petitioner was the account executive for each of these three accounts petitioner purchased and sold options and commodities through these accounts that resulted in both gains and losses petitioner used the account in his name account no 06k-153400 to buy and sell options and commodities during the years through and petitioner incurred the following net gains and losses from trading in the account solely in his name year net_income loss dollar_figure big_number big_number big_number petitioner bought and sold commodities and options through the joint account account no 06k-151106 with mrs corrigan during and petitioner’s share of gains and losses from the joint account were as follows year net_income loss dollar_figure big_number petitioner was the account executive for the third account account no 06k-127531 which was solely in mrs corrigan’s name the transactions in that account and the amount of gains and losses are not those of petitioner the number and frequency of the purchases and sales of commodities and options in the above-described accounts are as follows year petitioner’s joint mrs corrigan’s total sales account account account or purchase sec_23 petitioner claimed that his dealing in options and commodities constituted a trade_or_business opinion5 petitioner challenged numerous adjustments determined by respondent for through after trial petitioner requested and was permitted several extensions of time for the filing of his factual and or legal arguments with the court ultimately petitioner did not file a posttrial brief to assist the court in better understanding his position regarding the errors that he alleged exist with respect to respondent’s determinations i settlement and release of dollar_figure debt during petitioner borrowed dollar_figure from prudential petitioner repaid dollar_figure and continued to owe dollar_figure as of when he resigned his position with prudential prudential sec_7491 does not apply because the audits for through occurred before sought to collect petitioner’s dollar_figure obligation and petitioner asserted counterclaims for breach of contract breach of the covenant of good_faith and fair employment fraud negligent misrepresentation in petitioner’s hiring and punitive_damages during petitioner and prudential agreed to a mutual release of all claims between them according to the terms of the release in exchange for petitioner’s release of all claims prudential in turn released petitioner from all claims including without limitation as to any and all promissory notes by or indebtedness of corrigan to prudential-bache correspondingly petitioner released prudential from all of the asserted counterclaims petitioner contends that the settlement is to be excluded from income under sec_104 because it was for a tortlike personal injury and or that it was to settle a claim for punitive_damages respondent counters that petitioner has not shown that the settlement was for tortlike injuries and even if the settlement were for punitive_damages it would not be excludable under sec_104 sec_61 provides that all income from whatever source derived is gross_income unless otherwise excluded by statute the definition of gross_income includes income from the discharge_of_indebtedness sec_61 sec_1_61-12 income_tax regs accordingly receipt of funds by a taxpayer is presumed to be gross_income unless it can be demonstrated that the accession to wealth is specifically excluded by law see 348_us_426 petitioner was relieved of his obligation to pay the remaining dollar_figure due on his promissory note to prudential and therefore realized income from the forgiveness of debt unless petitioner can show that the income may be excluded petitioner contends that sec_104 should apply to exclude the dollar_figure from his income sec_104 provides sec_104 in general --except in the case of amounts attributable to and not in excess of deductions allowed under sec_213 relating to medical etc expenses for any prior taxable_year gross_income does not include-- the amount of any damages received whether by suit or agreement and whether as lump sums or as periodic_payments on account of personal injuries or sickness paragraph shall not apply to any punitive_damages in connection with a case not involving physical injury or physical sickness the term damages received as used in sec_104 is defined as an amount received through prosecution of a legal suit or action based upon tort or tort type rights or through a settlement agreement entered into in lieu of such prosecution the exclusions from gross_income set forth in sec_108 are not applicable in this case sec_1_104-1 income_tax regs in the context of a settlement agreement the nature of the claim that was the basis for a settlement controls as to the question of whether damages are excludable under sec_104 504_us_229 the determination of the nature of a claim is a question of fact 102_tc_116 affd in part revd in part and remanded on another issue 70_f3d_34 5th cir when a settlement agreement explicitly allocates settlement proceeds between damages for tort type personal injuries and other types of damages that allocation may be respected if a court finds that it was the product of arm’s- length adversarial and good_faith negotiations id pincite however where a taxpayer settles contract claims and tort claims for a lump-sum amount and neither the agreement nor other evidence provides a basis to allocate any portion to tort claims for personal injuries the courts have decided that they are not in a position to be able to make allocations on the parties’ behalf see 35_f3d_93 2d cir reisman v commissioner tcmemo_2000_173 affd 3_fedappx_374 6th cir under those circumstances the settlement proceeds have been held to be includable in a recipient’s income see eg morabito v commissioner tcmemo_1997_315 petitioner relies upon a letter received from his attorney stating that prudential was willing to reclassify the dollar_figure dollars sic given to you in as a loan to a punitive damage settlement award in your lawsuit the release however states that the settlement is for all claims that petitioner had asserted in connection with his employment and his termination the release is silent with respect to any allocation to a particular claim and or punitive_damages for the dollar_figure to be excluded under sec_104 petitioner must meet a two-prong test and demonstrate that the underlying cause of action giving rise to recovery is based upon tort or tort type rights and that the damages were received on account of personal injuries 515_us_323 unless both prongs are met the payment is not excludable from gross_income under sec_104 id in that regard petitioner has not shown that the underlying cause of action that gave rise to recovery was based upon tort or tort type rights most of petitioner’s claims appear to be on the basis of contractual rights a tort is defined as a ‘civil wrong other than breach of contract for which the court will provide a remedy in the form of an action for damages ’ united_states v burke supra pincite quoting keeton et al prosser keeton on the law of tort sec_2 5th ed in the absence of a general federal common_law of torts or controlling definitions in the internal_revenue_code we look to state law to determine the nature of the claim litigated 403_us_190 304_us_64 although petitioner’s claims for fraud and negligent misrepresentation may sound in tort such claims generally involve economic loss rather than personal injury in that regard petitioner testified that his claim against prudential arose from lost commissions he did not offer any alternate reasons for his dispute and counterclaims with prudential finally concerning petitioner’s claim that the settlement was for punitive_damages sec_104 as in effect for the year in issue specifically states that amounts received on account of personal injuries or sickness shall not apply to any punitive_damages in connection with a case not involving physical injury or physical sickness there is no indication that petitioner’s settlement was based on physical injury or physical see prosser law of tort sec_5 pincite 4th ed the amendment adding this provision is effective for amounts received after date unless received a under a written_agreement court decree or mediation award in effect or issued on or before date or b pursuant to any suit filed on or before date omnibus budget reconciliation act of publaw_101_239 103_stat_2379 because the discharge_of_indebtedness occurred after date and was pursuant to an arbitration claim rather than the filing of a suit the amendment applies to the discharge_of_indebtedness sickness even if it were for punitive_damages accordingly we hold that petitioner has not shown that he is entitled to exclude the dollar_figure settlement from his gross_income ii commodity and option trading activity during the years under consideration petitioner was a successful stockbroker earning annual commissions ranging from dollar_figure to in excess of dollar_figure million in addition during the years under consideration petitioner claimed to be in the trade_or_business of trading options and commodities substantially_all of the transactions reported from this activity consisted of option trading in three separate stock brokerage trading accounts the three accounts included one in petitioner’s name one held jointly with mrs corrigan and one in mrs corrigan’s name likewise the cost_of_goods_sold reflected on the schedules c was in substantial part the purchase_price of the options that had been sold in addition to the cost_of_goods_sold petitioner claimed deductions for various expenses the activity was reported on the schedules c under the name corrigan enterprises and losses were claimed for and of dollar_figure dollar_figure dollar_figure and dollar_figure respectively respondent determined that this activity produced capital rather than ordinary gains and losses in addition respondent allocated the gains and losses between petitioner and mrs corrigan in accord with their ownership of the accounts allocating to petitioner all the gains and losses from the account in his name only and one-half of the gains and losses from the joint account held with mrs corrigan respondent also determined that the gains and losses were short-term finally respondent determined that petitioner had not substantiated the deductions claimed on the schedules c a substantiation of schedule c deductions even if petitioner shows that he was engaged in a trade_or_business he is obligated to show that deductions of expenses in controversy are ordinary and necessary and were paid during the year of deduction petitioner did not introduce evidence showing that the expenses deducted were ordinary and necessary and or were paid during the year of deduction therefore petitioner is not entitled to the deductions for expenses claimed on the schedules c for corrigan enterprises b dealer trader or investor generally for federal tax purposes individuals who purchase and sell securities have been characterized into one of three categories dealers traders and investors see estate of yaeger v commissioner tcmemo_1988_264 affd on this issue 889_f2d_29 2d cir petitioner concedes that he is not a dealer so any gains and losses would be capital in nature not ordinary see sec_1221 the parties dispute whether petitioner is a trader or investor only because the expenses petitioner claimed for corrigan enterprises would not be trade_or_business_expenses if petitioner were an investor having found that petitioner is not entitled to the deductions he claimed for corrigan enterprises we need not determine whether petitioner is a trader or investor iii capital_gains_and_losses although petitioner attempted to file joint federal_income_tax returns he was not entitled to do so because he and mrs corrigan were divorced at the time he attempted to file had petitioner and mrs corrigan been entitled to file joint returns it would not matter that the gains and losses from the joint account and mrs corrigan’s account were netted with the gains and losses in petitioner’s account because petitioner and mrs corrigan were not entitled to file joint returns we must decide whether petitioner was entitled to report the gains or losses from each of the three accounts when transacted through a brokerage account gains and losses from the sale of stock and options are reportable by the owner of the account in the absence of any evidence demonstrating that another person is the true or equitable owner see ruth v commissioner 962_f2d_14 9th cir affg without published opinion tcmemo_1991_30 the gains and losses in the three brokerage accounts were allocated by respondent according to which person owned the account at trial petitioner testified that he was the sole owner of all three accounts and was entitled to all the claimed losses his testimony however was inconsistent with the allegations in his petition alleging a joint_venture with mrs corrigan on the accounts to some extent petitioner’s testimony on this point was inconsistent for example he contradicted himself as to whether the proceeds of sales in the account in mrs corrigan’s name were remitted to her petitioner did not provide any corroborating testimony or evidence supporting his claim that the account ownership in substance differed from the form accordingly we sustain respondent’s allocations of the capital_gains and or losses from the three accounts iv deduction of payments claimed as brokerage commission rebates while employed as a stockbroker during and petitioner was responsible for servicing smith barney customers including jlb capital a sole_proprietorship owned by bergman petitioner earned dollar_figure and dollar_figure in commissions from that activity during and respectively also for and petitioner claimed reductions in income for rebates to jlb capital of dollar_figure and dollar_figure respectively petitioner contends that he rebated the amounts to jlb capital to induce the purchases of certain syndicated stock offerings during and it was not unusual for brokerage firms that offered syndicated stock to accept reduced commissions that is on the basis of the fact that commissions for syndicated stock transactions were generally larger than those for other stock transactions petitioner reported the gross commission income received from smith barney for his sales of syndicated stock to jlb capital he reduced the amount reported as income by the rebates or payments made to jlb capital as an inducement to trade with him respondent contends that such payments are not deductible from petitioner’s gross_income and if allowable would at very most be unreimbursed employee_expenses that may or may not be deductible as itemized_deductions respondent also contends that these payments may be in violation of california securities law and that rebates of commissions may result in disciplinary action or suspension by the new york stock exchange respondent did not even though petitioner could not substantiate the entire amount reported on his tax returns petitioner was able to substantiate percent of the claimed amounts by means of canceled checks petitioner’s proffered evidence is sufficient to show that the amounts claimed were paid see 39_f2d_540 2d cir argue however that such payments would not be deductible as being illegal see sec_162 finally respondent argued that the payments are not deductible as a rebate or price reduction because jlb capital paid the commissions for its stock purchases to smith barney under their customer-broker business relationship the question we consider focuses upon whether petitioner is entitled to reduce the gross commission income received from smith barney or whether the payments he made to jlb capital are deductible as employee business itemized_deductions from adjusted_gross_income we agree with respondent that in these circumstances petitioner is not entitled to reduce gross_income by the payments made to jlb capital see 70_tc_322 affd 628_f2d_1222 9th cir see also 26_tc_707 in which such a reduction of income was permitted in a two-party transaction here petitioner is an agent or employee of smith barney with whom jlb capital and bergman have contractual relationships regarding stock trading and commissions the commissions received by petitioner in his role as a smith barney employee and the payments made to jlb capital are not reductions or rebates of the customer’s commission payments to smith barney therefore the payments are three cornered and petitioner is not entitled to a reduction from gross_income alex v commissioner supra pincite5 rebates may be allowable under sec_162 as business_expenses if they are ordinary and necessary the payments in alex v commissioner supra were not deductible because of the prohibition against illegal deduction in sec_162 the payments made by petitioner here were not illegal within the meaning of sec_162 and are ordinary and necessary expenses_incurred in petitioner’s trade_or_business of being an employee as to respondent’s argument that petitioner could have sought reimbursement for rebate-like payments to smith barney customers the record does not support a conclusion that the payments were reimbursable respondent’s arguments on this point are internally inconsistent respondent on one hand points out that the payment may have violated california law and or the rules of the new york stock exchange on the other respondent contends that these payments would be reimbursable the possible impropriety of the payments would seem to dictate that such amount would not be reimbursable further it is obvious from petitioner’s testimony and we find on the record before us that the payments were not reimbursable petitioner is entitled to deduct the amounts paid to jlb capital the deduction however is not from gross_income because sec_62 provides that such deductions being attributable to petitioner’s employment are allowable as itemized_deductions from adjusted_gross_income see sec_63 accordingly we find that subject_to certain limitations petitioner is entitled to deduct itemized employee deductions on schedules a of dollar_figure for and dollar_figure for v sale of residence under former sec_1034 which was in effect for petitioner’s tax_year taxpayers were able to defer gain realized from the sale of their principal_residence if they purchased a replacement residence and met certain other conditions sec_1034 in pertinent part provided sec_1034 nonrecognition of gain --if property in this section called old residence used by the taxpayer as his principal_residence is sold by him and within a period beginning years before the date of such sale and ending years after such date property in this section called new residence is purchased and used by the taxpayer as his principal_residence gain if any from such sale shall be recognized only to the extent that the taxpayer’s adjusted_sales_price as defined in subsection b of the old residence exceeds the taxpayer’s cost of purchasing the new residence respondent’s sole contention with regard to the sale of petitioner’s residence is that if petitioner abandoned the walnut creek residence and had a new principal_residence before the sec_1034 was repealed in connection with the taxpayer_relief_act_of_1997 publaw_105_34 and b 111_stat_836 time of the sale sec_1034 does not apply to defer any gain from sale respondent relies on 91_f3d_82 9th cir affg tcmemo_1994_247 accordingly the sole question we consider is whether the walnut creek residence was petitioner’s principal_residence for purposes of sec_1034 in the perry case the taxpayer had because of a divorce left the home in question approximately years before its sale in that case the court_of_appeals for the ninth circuit held that the home was not the taxpayer’s principal_residence because he had left it several years before it was placed for sale and sold in other words the taxpayer had ceased to physically occupy and live in the house long before it was intended to be sold id pincite on the basis of that reasoning in perry it appears that the taxpayer would not have met the 2-year before and after rule_of sec_1034 in this case petitioner and mrs corrigan used the walnut creek home as their principal_residence until some time in when they decided to sell it and each of them moved to new residences one of which was jointly purchased by petitioner and mrs corrigan unlike the taxpayer in perry petitioner did not cease using the walnut creek home as his principal_residence several years before and then decide to sell it and reinvest in another home petitioner and mrs corrigan moved to new residences and sold the walnut creek property within a relatively short time well within the 2-year requirement of sec_1034 thus petitioner did not have more than one principal_residence sec_1 c income_tax regs considering the above principles and the record in this case the walnut creek property was petitioner’s principal_residence respondent does not contend that any other requirement of sec_1034 was not satisfied accordingly petitioner was entitled to defer any gain realized on the sale of that property vi deduction of losses from horse breeding activity petitioner claimed losses for through of dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure respectively from the operation of the jac ranch the losses were claimed on what purported to be joint returns filed by petitioner and mrs corrigan because the horse breeding activity to which these claimed losses are attributable was operated by and in the name of mrs corrigan and because petitioner was not entitled to file a joint_return he now contends that he and mrs corrigan operated the activity as a joint_venture and that he is entitled to claim all of the losses reflected on the purported joint returns for through respondent disallowed the losses in their entirety and the parties’ dispute concerns the question of whether petitioner was entitled as a joint venturer to all of the losses for the horse breeding activity at the jac ranch the parties have not addressed the question of whether the losses are correct in amount or whether the activity was operated with the intent to make a profit respondent’s position that petitioner was not a joint venturer is based upon the record and certain other factors we agree with respondent that petitioner has failed to show that the horse breeding activity was a joint_venture between petitioner and mrs corrigan initially we note that the purported joint returns reflect that the horse breeding activity was operated by mrs corrigan as a sole_proprietorship her name alone was reflected on the schedules c by contrast petitioner’s name was the only one reflected with respect to his claimed option trading activity this is a potent indication that mrs corrigan was the sole operator and proprietor of the horse breeding activity respondent also points out that for a partnership or joint_venture to exist there should be an agreement to share profit and losses a community of interest in the undertaking and a right of control_over the activity see eg 177_f2d_867 9th cir similar federal statutory requirements exist affg a memorandum opinion of this court see also sec_7701 in that regard petitioner has not shown that he had a right to participate in management or to control the activities at the jac ranch although petitioner did provide funding to mrs corrigan for the operation of the activity there is no showing that the character of these advances was debt or equity even if the advances constituted an equity_interest that would not necessarily entitle petitioner to share in profits and losses petitioner has alleged that there was a written_agreement between him and mrs corrigan regarding the sharing of profits and losses etc no such agreement was produced and no corroborating evidence was provided in support of petitioner’s self-serving allegations in view of the foregoing we hold that petitioner has not shown that he is entitled to claim losses from the horse breeding activity vii unreported income respondent determined that petitioner failed to report various items of income including dividends interest state_income_tax refunds and royalties during the years in issue with the exception of a dollar_figure adjustment that respondent now concedes was in error petitioner has failed to present any evidence to show that respondent’s determination was in error the net amounts of unreported income for and are dollar_figure dollar_figure dollar_figure and dollar_figure respectively for respondent determined that petitioner overstated the various items of income by a net amount of dollar_figure generally petitioner is obligated to show that respondent’s determination is in error there are exceptions to that rule one of which may concern the determination that there is unreported income under the holdings of the court_of_appeals for the ninth circuit to which an appeal would normally lie for petitioner the commissioner is required to make a threshold evidentiary foundation to support a determination of unreported income see 596_f2d_358 9th cir revg 67_tc_672 respondent has made a sufficient showing to shift to petitioner the obligation to show that respondent’s determination is in error which petitioner has failed to do wherefore respondent’s determination of unreported or overstated miscellaneous income items is sustained viii itemized_deductions a mortgage interest respondent made determinations regarding petitioner’s itemized_deductions for mortgage interest for the years under consideration respondent has conceded that petitioner is entitled to mortgage interest deductions of dollar_figure dollar_figure dollar_figure and dollar_figure for and respectively petitioner appears to have contested the mortgage interest_deduction for the telegraph avenue property in that regard respondent conceded that petitioner is entitled to dollar_figure of mortgage interest attributable to the telegraph avenue property for the remaining mortgage interest deductions for is not conceded and petitioner has provided no evidence or argument to show entitlement to mortgage interest deductions in excess of those allowed or conceded by respondent accordingly petitioner is not entitled to mortgage interest deductions in excess of those allowed by respondent b casualty losses petitioner claimed casualty losses attributable to theft of dollar_figure and dollar_figure for and respectively sec_165 permits a deduction for losses not_compensated_for_by_insurance_or_otherwise the loss for a casualty however is subject_to limitations the loss may be allowable for to the extent that it exceeds dollar_figure sec_165 in addition the loss is deductible only to the extent that it also exceeds percent of a taxpayer’s adjusted_gross_income sec_165 applying those rules to petitioner’s dollar_figure claimed casualty_loss for the amount would not exceed the statutory thresholds or limitations first the claim is limited to dollar_figure dollar_figure less the dollar_figure threshold second because petitioner’s adjusted_gross_income was approximately dollar_figure the 10-percent limitation would preclude any deduction for a casualty_loss of less than dollar_figure accordingly petitioner is not entitled to an itemized casualty_loss deduction for with respect to petitioner’s dollar_figure casualty_loss that he claimed for he testified that this was mrs corrigan’s loss and that there was an insurance recovery accordingly petitioner is not entitled to any part of the dollar_figure casualty_loss that he claimed for c employee_expenses petitioner claimed deductions for each year at issue in connection with his employment the deductions concerned travel meals and other employee-type expenses a taxpayer may deduct ordinary and necessary business_expenses incurred in conducting a trade_or_business sec_162 the term trade_or_business includes the trade_or_business of being an employee 54_tc_374 sec_274 however limits deductions for entertainment and recreation that would otherwise be allowable unless it is established that the expenditures were directly related to or preceding a bona_fide business_discussion and were associated with the active_conduct of a taxpayer’s trade_or_business see sec_274 a deduction is allowed for meals only if such expenses are not lavish and the taxpayer is present when such meals are furnished sec_274 in addition sec_274 limits such deductions to those that can be substantiated by adequate_records or other evidence corroborating the amount of the expenditure the time and place of the travel entertainment etc the business_purpose and the business relationship of persons being entertained petitioner claimed to have logs and other documentary_evidence regarding these claimed expenses but he did not produce them or offer them into evidence because of the rigorous requirements for substantiation for expenses of this variety his uncorroborated testimony will not suffice and we accordingly sustain respondent’s determination disallowing petitioner’s travel entertainment and related expenses ix dependency and or personal exemptions on his through returns petitioner claimed dependency_exemptions for his four children and a personal_exemption for mrs corrigan respondent conceded that petitioner was entitled to file his returns as head_of_household for through and that petitioner was entitled to dependency_exemptions for david in through erin in through robert in and and amy in all other dependency_exemptions and the personal exemptions have not been conceded and were determined not allowable by respondent sec_151 provides for a deduction for each dependent as defined in sec_152 a dependent among others can be a son or daughter over half of whose support for the calendar_year in which the taxable_year of the taxpayer begins was received from the taxpayer or is treated under subsection c or e as received from the taxpayer sec_152 the circumstances of this case are such that petitioner provided all the support to his children and mrs corrigan who had no source_of_income and was dependent upon petitioner for the children’s expenses and those of her horse breeding activity during the years in question petitioner was divorced and mrs corrigan was awarded custody of the children who had not reached majority petitioner’s son robert was in resided with petitioner and attended school for at least months during each of the years in controversy amy was a minor and resided with mrs corrigan in addition mrs corrigan who had no other source_of_income subscribed to the joint returns in which dependency_exemptions were claimed for all of the children this act by mrs corrigan is tantamount to her consent in allowing petitioner to claim the exemptions these circumstances conform to the substance of form_8332 release of claim to exemption for child of divorced or separated parents and meet the requirements for a noncustodial_parent claiming dependency_exemptions under sec_1_152-4t a q a-3 temporary income_tax regs fed reg date cf 114_tc_184 affd on other grounds sub nom 293_f3d_1208 10th cir accordingly petitioner is entitled to claim dependency_exemptions for amy in through and for robert in all years including and the years denied by respondent with respect to mrs corrigan petitioner is not entitled to claim a personal or dependency_exemption because they were divorced and she did not reside in his household sec_151 sec_152 x negligence additions to tax and accuracy-related_penalties for and respondent determined that petitioner was liable for an addition_to_tax for negligence under sec_6653 equal to percent of the underpayment for respondent also determined that petitioner was liable under sec_6653 for an amount equal to percent of the interest payable on the portion of the underpayment attributable to negligence for through respondent determined that petitioner was liable for a 20-percent accuracy-related_penalty under sec_6662 due to negligence or intentional disregard of the rules or regulations the standards and principles regarding these penalties are substantially_similar and accordingly we combine our discussion of whether respondent’s determination should be sustained negligence has been defined as the lack of due care or the failure to do what a reasonable and prudent person would do under similar circumstances 925_f2d_348 9th cir affg 92_tc_1 731_f2d_1417 9th cir affg 79_tc_714 negligence includes the failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code and or to exercise ordinary and reasonable care in the preparation of a tax_return sec_6653 sec_6662 sec_1_6662-3 income_tax regs disregard includes any careless reckless or intentional disregard sec_6653 sec_6662 sec_1 b income_tax regs the accuracy-related_penalty under sec_6662 does not apply with respect to any portion of an underpayment for which there was reasonable_cause and the taxpayer acted in good_faith sec_6664 whether a taxpayer acted with reasonable_cause depends on the facts and circumstances sec_1_6664-4 income_tax regs the most important factor to be considered is the extent of the taxpayer’s efforts to determine the proper income_tax_liability id with respect to and sec_6653 provides that the 5-percent addition_to_tax applies to the entire underpayment if any part of the underpayment is due to negligence or disregard of rules or regulations respondent contends that petitioner’s failure to maintain adequate books_and_records and to provide them to respondent supports the determination that petitioner was negligent see sec_1_6662-3 income_tax regs we agree with respondent that petitioner failed to maintain and to provide respondent or the court adequate_records with respect to the claimed deductions in connection with his option trading travel entertainment and meals in addition respondent contends that petitioner was negligent in connection with the exclusion of the amount received in settlement of his relationship with prudential finally negligence has been asserted with respect to petitioner’s claiming ordinary losses in connection with his option trading with respect to the exclusion of the settlement petitioner contends that he relied on his attorney’s advice that the settlement was for punitive_damages the attorney’s letter however merely advised petitioner of the characterization of the settlement not of the tax consequences in addition the relevant law for the year in issue provided that punitive_damages were excludable from gross_income only if arising from physical injuries or physical sickness accordingly it was not reasonable for petitioner to exclude the settlement on the basis of his attorney’s characterization of the settlement as for punitive_damages with respect to the disallowed deductions the negligence_penalty or addition_to_tax applies and petitioner has not shown reasonable_cause his negligence is on the basis of his failure to maintain records and failure to comply with rules or regulations as to petitioner’s claim of ordinary_loss status for his option trading activity his business experience as a stockbroker and educational background placed petitioner in a position where he knew or should have known that his activity was not entitled to ordinary_loss treatment see eg walker v commissioner tcmemo_1990_609 xi substantial_understatement liabilitie sec_11 sec_6661 as applicable for and provides for a 25-percent addition_to_tax for substantial understatements of tax_liability see 90_tc_498 respondent had determined that the fraud_penalty applied for each of the taxable years as an alternative respondent determined that the substantial_understatement_penalty applied in each year respondent conceded that the fraud_penalty does not apply sec_6661 was repealed for years with return due dates after date and recodified in sec_6662 sec_6662 provides for a 20-percent addition_to_tax for tax years with return due dates after december dollar_figure petitioner bears the burden of showing that respondent’s imposition of these additions to tax is erroneous rule a 92_tc_501 sec_7491 is not applicable in this case because the audit of petitioner’s returns began before date an understatement is substantial if the amount of the understatement for the applicable_year exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6661 under sec_6661 an understatement is defined as the excess of the tax required to be shown on the return over the amount of tax that is shown on the return reduced by any rebate within the meaning of sec_6211 sec_6661 the amount of the understatement is reduced by the portion of the understatement attributable to the tax treatment of any item if there is or was substantial_authority for the treatment or if there was adequate_disclosure of the relevant facts because the sec_6662 penalty applies to negligence and substantial understatements and we have found that petitioner was negligent with respect to all improperly reported items we need not discuss sec_6662 any further affecting the treatment of the item in the return or a statement attached to it see sec_6661 sec_1 a income_tax regs t d 1985_1_cb_379 petitioner did not file a brief or provide at trial any authority substantial or otherwise regarding any of the adjustments by respondent for the taxable years under consideration accordingly we consider whether petitioner’s return contained adequate_disclosure with respect to any of the adjustments by respondent the adequate_disclosure requirement under the regulations applicable for and is that the disclosure must show inter alia the facts affecting the tax treatment of the item or group of similar items that reasonably may be expected to apprise the internal_revenue_service of the nature of the potential controversy concerning the tax treatment of the item or items sec_1 b iv income_tax regs t d c b dollar_figure concerning the claimed ordinary business deductions or losses from stock trading activity petitioner reported that he was in the trade_or_business of buying and selling options but we decide these items on an item-by-item basis and ultimately the parties’ rule computation will be necessary to finally decide whether the threshold for application of the substantial_understatement addition applies in any of the years under consideration he was not and he failed to disclose that he was a broker or dealer in options see eg little v commissioner tcmemo_1993_281 affd 106_f3d_1445 9th cir in conjunction with the option trading question we allocated between petitioner and mrs corrigan the capital_gains losses from three separate_accounts for and we note that of the three accounts in question one was in petitioner’s name one in mrs corrigan’s and one was jointly held between petitioner and mrs corrigan petitioner and mrs corrigan from whom he was divorced at all pertinent times attempted to file joint returns for through as a matter of law they were not entitled to do so accordingly we held that petitioner was not entitled to combine the gains and losses of the three accounts for reporting purposes there was however no disclosure made on the returns indicating that petitioner and mrs corrigan were divorced or that they were otherwise justified in filing a joint_return likewise it was not reasonable to claim joint filing_status at a time when petitioner knew he was divorced there was therefore no adequate_disclosure or reasonable_cause for the position reported by petitioner we accordingly hold that the substantial_understatement addition is applicable with respect to this adjustment for next we consider the brokerage commission rebates that petitioner failed to include in gross_income for and the question we consider with respect to those adjustments is whether there was adequate_disclosure of such reductions from gross_income petitioner disclosed on his returns that he was reducing his income by the amount of the rebates reflected on the forms he issued and thus adequately disclosed his position accordingly petitioner is not subject_to the substantial_understatement additions to tax for and with respect to the understatement attributable to the rebate determination the adjustment concerning petitioner’s claim that he is entitled to deduct all of the losses from the horse breeding activity at jac ranch for through is one that likewise was dependent as a threshold matter upon petitioner’s being able to file a joint_return with mrs corrigan as already explained there was no disclosure on the returns that petitioner and mrs corrigan were divorced and therefore not entitled to file a joint_return likewise it was not reasonable to claim joint filing_status at a time when petitioner knew he was divorced accordingly petitioner may be subject_to the substantial_understatement additions to tax for and as to the losses claimed from the jac ranch we have found that petitioner failed to report certain items of income including interest and tax refunds these amounts were not disclosed on the return and it was not reasonable for petitioner to fail to report these items especially in light of the fact that forms were issued with respect to them we therefore hold that the substantial_understatement addition_to_tax may be applicable with respect to these income adjustments for and petitioner claimed various itemized_deductions including mortgage interest employee_expenses and casualty losses respondent has agreed that petitioner is entitled to mortgage interest deductions in each year in amounts that are less than the amount claimed by petitioner respondent also disallowed casualty losses in years due to failure to exceed the statutory threshold and failure to substantiate finally respondent disallowed petitioner’s claimed employee business_expenses for travel entertainment and meals with respect to each category petitioner failed to substantiate amounts in excess of those allowed by respondent or failed to adequately substantiate any amount with respect to the employee business_expenses and the casualty losses petitioner has not shown a reasonable basis or adequate_disclosure for those items and accordingly to the extent that a substantial_understatement exists the addition_to_tax or penalty applies with respect to these items for and as to whether petitioner adequately disclosed or had a reasonable basis for claiming mrs corrigan’s personal_exemption it is clear that he did not and that the substantial_understatement_penalty may apply for this item for and to reflect the foregoing decision will be entered under rule