tax_exempt_and_government_entities_division number release date date date department of the treasury internal_revenue_service washington d c contact person identification_number contact number employer_identification_number form required to be filed tax years uil dear this is our final_determination that you do not qualify for exemption from federal_income_tax as an organization described in internal_revenue_code sec_501 recently we sent you a letter in response to your application that proposed an adverse determination the letter explained the facts law and rationale and gave you days to file a protest since we did not receive a protest within the requisite days the proposed adverse determination is now final since you do not qualify for exemption as an organization described in code sec_501 donors may not deduct contributions to you under code sec_170 you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions if you disagree with our proposed deletions you should follow the instructions in notice if you agree with our deletions you do not need to take any further action in accordance with code sec_6104 we will notify the appropriate state officials of our determination by sending them a copy of this final letter and the proposed adverse letter you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements letter cg catalog number if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service pincite-829-1040 or the irs customer service number for businesses the irs customer service number for people with hearing impairments is if you have any questions about your sincerely lois lerner director exempt_organizations enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter letter cg catalog number department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date date contact person identification_number contact number fax number employer_identification_number uil s dollar_figure dollar_figure dollar_figure ceo board member previous board member board member board member board member individual for-profit company for-profit company for-profit company city county state date number number number number number number a w l n o i m i m i o i t l i z z l o m o i d m i m i s e x i k o o o s we have considered your application_for recognition of exemption from federal_income_tax under sec_501 of the internal_revenue_code code based on the information provided we have concluded that you do not qualify for exemption under sec_501 of the code the basis for our conclusion is set forth below issue sec_1 are you organized exclusively for c purposes no for the reasons described below are you operated exclusively for c purposes no for the reasons described below have you established that your operations do not inure to the benefit of private individuals including the person who created you no for the reasons described below if you were organized and operated exclusively for c purposes would you meet the requirements of sec_501 of the code no for the reasons described below facts you were incorporated on date s as a non-profit corporation under the laws of state r your charter or articles of incorporation articles state in pertinent part that your purposes are to increase affordable housing to the special needs population increase the affordable homeownership and or housing to the special needs - n population who meet certain income criteria offer multiple housing options housing counsel service sec_5 connection with down payment assistance programs case management services that will improve health and human services referral services regarding your board_of directors b is also your chief_executive_officer ceo incorporator and registered agent c is unemployed d was re-placed by g during the application process e co-owns n e is a day-care operator g is a licensed mental health counselor your application_for exemption states that during the first five years you will focus on acquisition and rehabilitation of single family and multifamily homes during the first and third year you will focus on supportive housing-permanent and transitional the third year a new_construction group home is planned to house residents b hereinafter referred to as the ceo will provide supervisory duties and oversight of the acquisition and rehabilitation of facilities your case managers will help residents with referral services act as liaisons for residents provide documentation as the residents well being providing assessments helping with food and clothing if residents need referrals to health services some of your services will be contracted out to other organizations in year one you will purchase four to ten single family homes for those in need of less restrictive care in year two you will purchase three to four multi-family homes with at least units each after the second year you will continue to add group homes single family homes and multi-family homes in year six physically handicapped services will be offered and in year ten a skilled nursing home for the elderly joint ventures will help you achieve a goal of big_number units and group home beds within years your initial property will be leased from the ceo you plan to lease other properties from the ceo a copy of a development management transfer of property lease sales agreement between you and the ceo regarding the lease of the initial property was submitted with your application it indicated in part that the ceo will subject_to your approval serve as the primary agent in overseeing the project help you devise a development plan and budget receive a fee for her services prepare loan and grant applications and negotiate contracts or loans in her name or your name for the benefit of the project you will provide the ceo with full information and not unreasonably withhold approval of proposed contracts plans and actions that have been negotiated prepared or undertaken by the ceo other planned services include housing for the homeless helping other non-profits rehabilitate construct lease and operate housing and construction for people with physical handicaps you intend to apply for us housing and urban development hud sec_811 disabled housing elderly housing and 221d multi-family grants you plan to offer housing counseling your counseling will give individuals knowledge about the home buying process maintaining their home what to do if financial problems may prevent them from keeping their homes you will address th ese issues by providing guidance and establishing policies and procedures within state and federal guidelines to help people keep their homes you will act as an advocate or representative for the homebuyer and educat e the homebuyer about predatory lending you wiil also assist people with down payment assistance programs you plan to create a development division this division will advise other non-profits expand into rural areas help with overall funding and offer services to the for-profit housing sector however outside development consultants will initially be used to oversee construction projects you state that you will be a real_estate development_corporation that is specifically marketed to a low-income population and or people with special needs’ your definition of special needs includes women who are pregnant the elderly mentally or physically handicapped people with children etc the ceo oversees operations and will handle all day to day operations v v v v v v v v v v v v v v v govern essential staff control fundraising oversee financial aspects and provide financial reporting directly enter into contracts on your behalf develop policies and procedures hire and fire employees over see all supportive housing projects interview all housing clients serve as spokesperson appoint committees supervise the program director oversee all planning and goal-setting initially will supervise group home handle all legal matters handle consultation with developers and consultants in order to raise funds for operations you will hold an annual ball and a golf tournament sell movie tickets and gas store cards sell named bricks and catalog items and hold food socials raffles auctions and other fundraisers will be considered regarding the food socials which will be held monthly you will obtain appropriate food and liquor licenses through the state in which the event will be held these events will showcase local vendors in an effort to increase their business and our corporate supports w h ere applicable you will hire a development consultant to serve as lead project manager the project manager will assist the ceo with developing and coordinating projects h who has substantial construction experience is being considered for the position you will also hire a financing consultant to help with loans for-profit general contractors hired by the development consultant will actually construct build and or renovate the housing units you plan to conduct joint ventures you will maintain at least control and abide by irs guidelines joint ventures may include a development firm management company and maintenance company the joint ventures will offer services to your properties and to unrelated for-profit entities and private individuals you hope to qualify for low_income_housing tax_credits you stated that u pon the successful purchase of a property to be used by you through any director or board member the ownership will remain with the director or board member the director or board member would be the cosigner of all loans and will have the responsibility to pay all indebt ed ness on the property properties purchased from directors or board members must have a deed restriction clause for specific use by you covenants and restrictions will become part of the real_estate_transaction and will specify that you will have unlimited rights and use to the property a lease will be agreed upon between you and the specific director or board member who owns the property a one-time nonrefundable fee will be charged to a potential client to offset your cost of a criminal background and credit checks clients will be obtained from referrals from governmental and other agencies and advertising financial projections submitted for your first three years of operations shows contribution revenue of more than dollar_figure million investment_income of more than dollar_figure and gross_receipts from sales of more than dollar_figure your projected expenses are almost dollar_figure in fundraising expenses officer director compensation of more than dollar_figure other wages of about dollar_figure occupancy expense of over dollar_figure professional fees of approximately dollar_figure and other expenses totaling more than dollar_figure to clarify your initial application and subsequent sometimes conflicting responses we sent you four letters your responses indicated in part the following board related responses board members are unpaid at this time and work in an advisory capacity on an as needed basis and will help the ceo make sound decisions’ the ceo and d were removed from the board you will fill the three vacant board positions resulting in seven board members the ceo and or board will not sign in their personal capacities as previously indicated h is no longer being considered as a development consultant however she will help the board find a consultant you filed a form with r indicating you intended to transact business in r under the name of m you also filed an amendment to your charter although the ceo was removed from the board prior to the filings she filed both forms with r as your incorporator in fact the amendment stated that it was filed without member approval by the incorporator ceo as such member approval was not required the twenty five page amendment indicated in part the following the principal officer and incorporator is the ceo you will have a director that will also serve as the ceo this contradicts the alleged v v v v removal of the ceo from the board no changes were made to your purpose as stated in your original charter no employee except the ceo coo chief operating officer and certain board members can approve spending the ceo will be appointed by the incorporator in cases of emergency lines of succession can be modified and notice of a meeting of the board_of directors need be given only to those directors who in practicable manner’ can be contacted at least one director must be present at the meeting the board may deem to be directors as members for a meeting in order of rank and within the same rank in order of seniority as necessary to achieve a quorum all action taken during an emergency meeting binds the corporation you are a membership_organization you will establish conditions for admission to membership admit members and issue memberships’ v v v v v w v v v v v v w v w v v v v v members are chosen by the board you registration agent is the ceo only the incorporator can change your registration office board members are appointed by the chief officers if a board member resigns their resignation is forwarded to the incorporator who will officially announce the resignation at the next board meeting the board will approve ceo compensation and review and approve contracts over dollar_figure a quorum for the purpose of the corporation shall consist of four members of the board directors are prohibited from having any financial interest in any contract in connection with the rendition of services the provision of goods or supplies procurement of furnishings or equipment construction of the project procurement of the site or any other matters whatsoever except with respect to management or supportive_service contracts entered into by the owner with the sponsor or its nonprofit affiliate the incorporator or registered agent shall have final_decision for the change_of the charter bylaws can be amended in a special meeting by the board with approval from the incorporator any amendments may be changed by the executor or incorporator the ceo shall hold in his her possession the official and amended bylaws and charters sale of assets in the regular course of activities shall be approved by of the board sale of assets other than in the regular course of activities can only be approved through the incorporators and board_of directors we asked for a statement signed by each board member that they would be active in the operation and oversight of your organization in your response the ceo indicated that i have emailed the board members requesting the information in question but have not yet received any responses back from the four board members to date we have not received any statements from the current four board members a copy of an email from the ceo to the existing four board members included the following statements i believe it is time to take the organization further and start with fundraising and actually following through with the mission of providing housing after some research to determine w h ere housing for low income individuals with disabilities will head the goal of starting with the group home may have to be placed on a hiatus recent lawsuits are driving the housing market to supportive living and single room occupancy with a focus on increased services and more independent living lam still in need of additional board members will be working to fill at least two of the slots over the next month the board will need to schedule a meeting sometimes before the end of october to vote on several issues including the conflict of interest policy compensation packages fundraising amongst other issues if everyone can please email at least dates that are convenient will try to schedule something around those dates as always will be flexible if you have questions please do not hesitate to call’ no evidence exists in the file that any of the four board members have been involved in any decision or activity of the organization the ceo who is also the incorporator and registered agent did all of the following v v v v v v housing counseling related responses signed the initial and revised form_1023 signed and filed the articles signed and filed the amendment to the articles signed and filed the document regarding an assumed name signed all responses signed your hud application you will apply for approval as a housing counseling service through hud the ceo will hire a housing counselor or contract the service work to another agency the housing counselor will conduct the following activities you will not conduct housing counseling in your first two years at that time the board and ceo will hire someone to run the counseling program the new program coordinator and ceo will take numerous housing counseling courses provide direct client-counselor and counselor-group activities interview clients to obtain information about the client and their housing needs identify resources agency community etc to address the client's needs design a counseling plan not limited to debt management help the client save or attain a down payment or rental assistance help the client through the loan process monitor the client's progress housing selection fair housing laws qualifying for hud subsidies budgeting for mortgage and rent payment money management housing maintenance and care referrals to community resources pre-purchase issues pre-rental issues fees charged to counseling clients will be inline with hud housing counseling program handbook chapter housing topics to be covered include v v v v v v v v v v v v v v v v mortgage default rent delinquency an actual fee schedule was provided housing selection referrals pre-rental orientation if renting from you displacement and relocation consultation are at no charge home improvement and rehabilitation counseling are dollar_figuret per session homebuyers education pre post purchase and money management is dollar_figureu per session must complete three sessions mortgage and rent default and rent delinquency are dollar_figurev per session no evidence of a policy providing for the waiver of fees in certain situations was submitted with the fee schedule the revised form_1023 did indicate some clients would receive free services however no specific guidelines were submitted mortgage default counseling will include v v v determination of whether the mortgagor with the assistance of the counseling agency might bring the account current within a time period and payment plan acceptable to the mortgagee working out repayment plans with the mortgagor's other creditors follow up counseling if the mortgagee decides to foreclose determining if the mortgager is eligible for hud’s assignment program foreclosure alternatives to foreclosure sale deed-in-lieu etc mortgage rate reduction program home equity conversion mortgage program v v v v a one-page homebuyers education agenda was provided it indicated there is a three day twelve hour course no actual educational materials were provided you indicated that after course completion the client will demonstrate an understanding of homeownership preparation budgeting finances credit management home financing home selection home maintenance and avoiding delinquency and foreclosure once the twelve hours are completed a certification will be granted the revised form_1023 attachment summarized your housing counseling in part as follows the purpose of the housing counseling services offered through you is to provide education on proper home buying procedures for residents who believe when they are ready to buy a home housing counseling services will be offered to the general_public as well as residents of you housing counselors will be trained and certified through neighborhood works the housing counselor will also have the task of connecting individuals with down payment assistant programs for example through p or q or r city county and state agencies the criteria for housing counsel services will be set by the hud neighborhood works and the national industry standard for homeownership education and counseling the targeted market will be people who wish to buy a home the housing counselling staff will initiate contact with the service_recipient through referrals walk in or solicitations form real_estate agents mortgage brokers etc the service_recipient will have an intake with the housing counselor to determine needed services the housing counselor will then schedule the recipient for needed classes or follow up sessions a case file will be kept on all persons who seek services from you the file will include an application_for services and all necessary contact information housing counselors will educate client’s on pre and post home buying procedures money management foreclosure prevention maintaining and owning a home housing selection fair housing laws helping residents qualify for housing subsidies w h ere applicable and pre-rental orientation your residents only and displacement and relocation assistance this furthers the mission of the organization by keeping vacancy rates down and by increasing the number of homeowners within the community individuals participating in the housing counselling services will receive free or reduced housing counselling services based on a sliding fee scale once the organization begins housing counselling services with funds from hud housing counselling services pre and post purchasing counseling will be offered free all other services will be in accordance with previous submissions the housing counselor will build a network of vendors mortgage lenders real_estate agents loan originators appraisal companies etc to help individuals with obtaining loans the target audience is people who have special needs responses related to housing sales and rentals property sales will differ due to the requirements of various programs r hud etc your board will determine if you will use n which is co-owned by e to handle your real_estate deals all profit from home sales will be used for down payment assistance administration cost purchase and rehabilitation and other programs you will place restrictive covenants on properties including you must be informed if the house is placed on sale you will authorize the sale mortgagor etc the home must be affordable for at least years ifahome is sold during the first years of ownership a prorated amount plus a portion of the gains from the property will be paid to you we asked how women with children and pregnant women have special needs you stated that each client will be qualified based on income past violent relationships referrals hospitals treatment centers etc and danger of homelessness your initial project the group home will need financing assistance your ceo will be responsible for seeking the financing you will serve as primary borrower or secondary to the loan the ceo will receive a salary and no fees the ceo will enter into contracts loans and grant agreements in her name on behalf of you in order to move you along initially the ceo will be the group home manager hours per week and provide oversight of the acquisition and rehabilitation of facilities in year three the program director will he hired to relieve the ceo of some duties no housing unit has been leased or purchased at this time however you indicated that the initial group home would be leased from the ceo stating that the board has to approve the lease or purchase of the house from the ceo however she will not benefit and once you become financially stable the group home will be paid off and all interest of the ceo relinquished without any further liabilities’ any purchase or lease will be made at fair_market_value any capital improvements to the property will be made before a lease or purchase agreement is signed your initial lease will be one year with indefinite renewal rights a sample lease agreement between you as lessee and the ceo as lessor was submitted the lease contained no actual terms but did indicate that any leasehold improvements would unless provided for in a separate written_agreement become the property of the lessor however your last response contradicted your previous statements indicating that the ceo does not own a personal_property that is being considered for group home activities if funds are available you will offer down payment assistance regarding this possible assistance v your program will not be seller funded w v v v the applicant must be a first-time_homebuyer the home price cannot exceed dollar_figurew you will use hud and fha low-income standards the applicant must have the income and employment history to qualify for a mortgage the applicant must attend housing counseling a homebuyer can ask the seller to make a contribution to you after the sale but it is not a standard procedure homebuyers must live in the house for years if the home is sold before the year period ends a pro-rated amount of the down-payment is recaptured you will also connect clients to city state and county down-payment assistance programs v v v v v v you will acquire houses through foreclosure or donation which will provide housing to people with special needs you stated that the income criteria will be based on hud guidelines and that the maximum income for a one person household will be dollar_figurex and for a household of eight or more persons dollar_figurey per year you will also build housing units you will offer the units at below market rates to people with special needs you did not indicate what construction management company would be used to actually build the units regarding your home sales you will pay closing costs only if the buyer was your tenant attended your counseling classes meets your low-income criteria and contribute sec_1 of the closing costs and or down payment we asked for details regarding relationships with for-profit entities construction companies developers etc future joint ventures and individuals companies that would provide services to your organization you failed to provide any details indicating there are no for profit entities that are being considered at this time the board has not developed a entities regarding joint ventures and there are not individuals or entities that have provided or are projected to provide services to the organization’ list of the revised application you submitted indicated you will purchase goods and or services from directors and that someone else will develop your facilities however no details were provided responses related to possible future activities you stated it has not been decided whether you will provide debt management and liquidation services you will not in your initial two years offer elderly housing you have not selected a for-profit investor to participate in a joint_venture if you do enter into a joint_venture you provided an example a housing development agreement where you retain management rights and ownership in a housing development you will not operate a donor_advised_fund at this time you will inform the service when you begin debt management services liquidation services elderly housing donor advised funds and joint ventures your foreclosure mitigation activity was removed from the application responses related to financial information you provided more information regarding your fundraising your ongoing monthly fundraiser o will be conducted by the board and ceo tickets will be sold to the public for the event or vendors must pay for booth space the board_of directors and ceo will solicit local companies to participate in the fundraiser a space will be rented to hold the event the board will work with vendors to determine the services provided for each fundraiser for example the chocolate social may have vendors such as local or national chocolatiers and candy makers sellers they will pay a predetermined booth fee and sell their goods to participants you may also sell tickets and offer food services to the public the vendors will receive a pre-negotiated amount for services or letter acknowledging donated services’ new financial projections submitted with the revised application indicated for your first three years of operations contribution revenue of more than dollar_figure million gross receipt revenue over dollar_figure fundraising expenses of approximately dollar_figure no board officer compensation this contradicts previous financial information and numerous assertions regarding ceo compensation other wages in excess of dollar_figure occupancy expense of almost dollar_figure professional fees over dollar_figure and other expenses over dollar_figure law sec_501 of the code provides that corporations may be exempted from tax if they are organized and operated exclusively for charitable or educational_purposes and no part of their net_earnings inures to the benefit of any private_shareholder_or_individual sec_1_501_c_3_-1 of the income_tax regulations regulations provides that in order to be exempt as an organization described in sec_501 of the code an organization must be both organized and operated exclusively for one or more of the purposes specified in such section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1_501_c_3_-1 of the regulations provides that an organization is not operated exclusively for one or more exempt purposes if its net_earnings inure in whole or in part to the benefit of private shareholders or individuals sec_1_501_a_-1 of the regulations defines the words private_shareholder_or_individual in sec_501 of the code to refer to persons having a personal and private interest in the activities of the organization sec_1_501_c_3_-1 of the regulations states that an organization must establish that it is not organized or operated for the benefit of private interests such as designated individuals the creator or his family shareholders of the organization or persons controlled directly or indirectly by such private interests sec_1_501_c_3_-1 of the regulations provides that the term educational as used in sec_501 of the code relates to a the instruction or training of the individual for the purpose of improving or developing his capabilities or b the instruction of the public on subjects useful to the individual and beneficial to the community sec_501 of the code provides that organizations which provide credit_counseling_services as a substantial purpose shall not be exempt from taxation under sec_501 unless they are described in sec_501 or sec_501 and they are organized and operated in accordance with the following requirements a the organization-- i provides credit_counseling_services tailored to the specific needs and circumstances of consumers ii makes no loans to debtors other than loans with no fees or interest and does not negotiate the making of loans on behalf of debtors iii provides services for the purpose of improving a consumer's credit record credit history or credit rating only to the extent that such services are incidental to providing credit_counseling_services and iv does not charge any separately_stated fee for services for the purpose of improving any consumer's credit record credit history or credit rating b the organization does not refuse to provide credit_counseling_services to a consumer due to the inability of the consumer to pay the ineligibility of the consumer for debt management plan enrollment or the unwillingness of the consumer to enroll in a debt management plan i requires that any fees charged to a consumer for services are reasonable ii allows for the waiver of fees if the consumer is unable to pay and c the organization establishes and implements a fee policy which-- iii except to the extent allowed by state law prohibits charging any fee based in whole or in part on a percentage of the consumer's debt the consumer's payments to be made pursuant to a debt management plan or the projected or actual savings to the consumer resulting from enrolling in a debt management plan d at all times the organization has a board_of directors or other governing body-- i which is controlled by persons who represent the broad interests of the public such as public officials acting in their capacities as such persons having special knowledge or expertise in credit or financial education and community leaders i not more than percent of the voting power of which is vested in persons who are employed by the organization or who will benefit financially directly or indirectly from the organization's activities other than through the receipt of reasonable directors' fees or the repayment of consumer debt to creditors other than the credit_counseling_organization or its affiliates and iii not more than percent of the voting power of which is vested in persons who are employed by the organization or who will benefit financially directly or indirectly from the organization's activities other than through the receipt of reasonable directors’ fees sec_501 of the code defines for purposes of sec_501 the term credit_counseling_services to mean i the providing of educational information to the general_public on budgeting personal finance financial literacy saving and spending practices and the sound use of consumer credit ii the assisting of individuals and families with financial problems by providing them with counseling or iii a combination of the activities described above revproc_2010_9 irb states in part that exempt status may be recognized in advance of the organization's operations if the proposed activities are described in sufficient detail to permit a conclusion that the organization will clearly meet the particular requirements for exemption pursuant to the section of the internal_revenue_code under which exemption is claimed a mere restatement of exempt purposes or a statement that proposed activities will be in furtherance of such purposes will not satisfy this requirement the organization must fully describe all of the activities in which it expects to engage including the standards criteria procedures or other means adopted or planned for carrying out the activities the anticipated sources of receipts and the nature of contemplated expenditures where the organization cannot demonstrate to the satisfaction of the service that it qualifies for exemption pursuant to the section of the internal_revenue_code under which exemption is claimed the service will generally issue a proposed adverse determination_letter or ruling revrul_61_170 1961_2_cb_112 described an association composed of professional private duty nurses and practical nurses which supported and operated a nurses’ registry controlled by the members primarily to afford greater employment opportunities for its members public participation in the management and support of the organization was negligible due in part to the limited control of the organization it was not exempt under sec_501 of the code in 283_fsupp2d_58 d d c the court relied on the commerciality doctrine in applying the operational_test because of the commercial manner in which this organization conducted its activities the court found that it was operated for a nonexempt commercial purpose rather than for an exempt_purpose as the court stated among the major factors courts have considered in assessing commerciality are competition with for profit commercial entities extent and degree of below cost services provided pricing policies and reasonableness of financial reserves additional factors include inter alia whether the organization uses commercial promotional methods eg advertising and the extent to which the organization receives charitable donations in 326_us_279 the supreme court held that the presence of a single non-exempt purpose if substantial in nature will destroy a claim for exemption regardless of the number or importance of truly exempt purposes in 765_f2d_1387 cir affg tcmemo_1984_349 tax_court concluded that the extent of the integration between the operations of a non-profit entity and related for- profit entities controlled by the non-profit directors precluded exemption furthermore the tax_court found it unnecessary to consider the reasonableness of payments made by the applicant to a business owned by its officers the 9' circuit_court of appeals in affirming the tax court’s decision stated that the critical inquiry is not whether particular contractual payments to a related for-profit organization are reasonable or excessive but instead whether the entire enterprise is carried on in such a manner that the for-profit organization benefits substantially from the operation of the church’ in international postgraduate medical foundation v commissioner tcmemo_1989_36 the court held that an organization that had the substantial nonexempt purpose of benefiting a related for-profit travel agency from which it purchased travel services did not qualify for exemption under sec_501 operating for the benefit of private parties constitutes a substantial nonexempt purpose 477_f2d_340 4th cir cert_denied 413_us_910 in solution plus inc v commissioner tcmemo_2008_21 the tax_court held that a credit_counseling_organization was not exempt under sec_501 because it was not organized and operated exclusively for educational or charitable purposes and impermissibly served private interests the organization was formed by an individual with experience selling debt management plans dmps the founder and his spouse were the only members of the organization's board_of directors the organization did not have any meaningful educational program or materials to provide to people who contacted the organization and its financial education seminars for students constituted an insignificant part of the organization’s overall activities application of law you are not described in sec_501 of the code because you are not organized and operated exclusively for charitable or educational_purposes and your net_earnings inure to the benefit of b you are not in compliance with sec_1_501_c_3_-1 of the regulations because you fail both the organizational and operational tests in order to meet the organizational_test under this section an organization’s organizing document must properly limit its purposes to exclusively c purposes and it must state that all assets will be distributed for c purposes upon dissolution your purpose clause in your articles of incorporation is very broad and does not limit you exclusively to c purposes your dissolution clause is also inadequate in that it allows for the distribution of assets to a n estate of a person or per the r code annotated therefore you do not meet the organizational_test you also fail the operational_test because you have not proven that your activities are exclusively charitable or educational and you also operate in a commercial manner for the benefit of your ceo your application indicated you would provide housing counseling however when asked for specific details no details or examples of an actual substantial educational program were provided you did indicate the broad topics the counseling would cover and that no counseling would be conducted during your first two years of operations however you did not provide evidence of a substantial educational program for example a one-page homebuyers education agenda was provided it indicated a three day twelve hour course however no actual educational materials were provided you indicated that after course completion the client will demonstrate an understanding of homeownership preparation budgeting finances credit management home financing home selection home maintenance and avoiding delinquency and foreclosure and be granted certification no material regarding your course was submitted you have not shown a substantial educational purpose as defined in sec_1_501_c_3_-1 of the regulations like the organization in solution plus tcmemo_2008_21 you did not provide evidence that you help clients develop an understanding of the cause of their financial problems or a plan to address their financial problems you conduct many of your activities which are normally carried on by commercial enterprises for a profit in the same commercial manner and in direct competition with commercial businesses like the organization in 283_fsupp2d_58 d d c this is evidenced by the fact that you charge fees that are consistent with market rates for counseling you also plan to sell and rent homes at market rates these activities are indistinguishable from other commercial entities your ongoing monthly fundraiser o will include for-profit entities paying for booth space you may also sell tickets and offer food services to the public you did not provide evidence that the monthly fundraiser served a public interest and that the benefit to the for-profit entities was incidental these benefits to unrelated for-profit entities are a substantial non- exempt_purpose similar to the operations of the organizations in better business bureau of washington d c inc v united_states international postgraduate medical foundation v commissioner and old dominion box co v united_states even though you have four board members it is apparent that your organization is not controlled by the board but is controlled by your ceo no evidence exists in the file that any of the four board members have been involved in any decision or activity of the organization you stated that the four board members work in an advisory capacity on an as needed basis and will help the ceo make sound decisions this implies the ceo will make final decisions you filed an amendment to your articles of incorporation with r your ceo filed as your incorporator in fact the amendment stated that it was filed without member approval by the incorporator the ceo as such member approval was not required the amendment indicates control of your organization by the ceo in that the principal officer and incorporator is the ceo you will have a director that will also serve as the ceo this contradicts the alleged v m w w v v v w v v v v v removal of the ceo from the board the ceo will be appointed by the incorporator in cases of emergency not defined lines of succession can be modified and the ceo can make binding decisions by herself only the incorporator can change your registration office board members are appointed by the chief officers the only chief officer at this time is the ceo if a board member resigns their resignation is forwarded to the incorporator who will officially announce the resignation at the next board meeting the incorporator or registered agent shall have final_decision for the change_of the charter both offices are held by the ceo bylaws can be amended in a special meeting by the board with approval from the incorporator’ any amendments may be changed by the executor or incorporator the ceo shall hold in his her possession the official and amended bylaws and charters when we asked for a statement signed by each board member that they would be active in the operation and oversight of your organization our request was forwarded by the ceo to each board member none of the board members responded to our request a copy of an email from the ceo to the existing four board members confirms our assertion regarding the control of the ceo and includes the following statements from the ceo believe it is time to take the organization further and start with fundraising and actually following through with the mission of providing housing after some research to determine w h ere housing for low income individuals with disabilities will head the goal of starting with the group home may have to be placed on a hiatus l am still in need of additional board members will be working to fill at least two of the slots over the next month note that the ceo and not the board decided to begin fundraising and put the group home on hiatus and will select the new board members all of these facts are evidence that you are similar to the organization described in revrul_61_170 where the board served the private interests of its membership and not the general_public the form_1023 and responses indicated you would lease your first group home from the ceo in fact a sample lease agreement was submitted between you and the ceo your last response contradicted your previous statements indicating that the ceo does not own a personal_property that is being considered for group home activities however the last response also appeared to contradict itself page item 7a of the revised form_1023 indicated you will purchase goods and or services from directors no details were provided regardless looking at all of the facts it appears you will conduct business with the ceo in her personal capacity her control_over you presents an inherent conflict of interest this is not in compliance with sec_1_501_c_3_-1 of the regulations your relationship with the ceo in her personal capacity is a substantial non-exempt purpose similar to the operations of the organizations in better business bureau of washington d c inc v united_states international postgraduate medical foundation v commissioner and old dominion box co v united_states considering the overwhelming control related_party transactions and compensation to your ceo you have not substantiated that your net_earnings do not inure to the benefit of your ceo through compensation and purchased services this is not in compliance with sec_1_501_c_3_-1 of the regulations it is unnecessary for us to determine that you make payments to the ceo in her personal capacity or that such payments are unreasonable see church by mail your entire enterprise is carried on in such a manner as to substantially benefit the ceo in her personal capacity even if you did otherwise satisfy the requirements to be exempt under sec_501 of the code you still would not qualify for exemption because you fail the requirements of sec_501 of the code you are providing credit_counseling_services within the meaning of sec_501 of the code you stated that counseling fees charged to clients will be in line with hud guidelines an actual fee schedule was provided that shows you charge dollar_figure to dollar_figure per session you did not submit evidence to show that you have a policy providing for the waiver of fees in certain situations the revised form_1023 you submitted did indicate some clients would receive free services however no specific guidelines were submitted therefore you have not established that you have a fee waiver policy in accordance with sec_501 of the code you currently have four board members that include an unemployed individual the co-owner of a real_estate agency a day-care operator and a licensed mental health counselor none of these individuals are public officials have special knowledge regarding financial counseling or have been established as a community leader this is not in compliance with sec_501 of the code in effect since the four board members are not involved in the decision-making for the organization you have a one-person governing body consisting of the ceo your one person governing body is not in compliance with sec_501 the initial form_1023 and responses indicated the ceo will be compensated although your revised form_1023 states no officer or director compensation this contradicts numerous previous statements because your ceo controls you and is responsible for your day to day operations it is likely your ceo will be compensated as either an officer or any employee such an arrangement does not comply with sec_501 of the code _ some of the activities initially mentioned in your application were changed to possible activities you have not yet decided whether you will provide debt management services debt liquidation services elderly housing joint ventures donor advised funds foreclosure mitigation etc even the activities that you definitely plan to conduct have changed several times and you have submitted several contradictory statements you have not demonstrated to the satisfaction of the service that you are organized and operated exclusively for charitable or educational_purposes and that your net_earnings do not inure to the benefit of private individuals therefore you do not meet the requirements of revproc_2010_9 that indicates proposed activities must be described in sufficient detail to permit a conclusion that the organization will clearly meet the particular requirements for exemption applicant’s position you declined to submit any additional information to support your request for tax exempt status conclusion the facts and law show three separate reasons any one of which standing alone is cause for denial of exemption you fail the organization test because your purposes are broader than permitted and your assets are not dedicated exclusively to c purposes upon dissolution you fail the operational_test because you have failed to establish your operations are within the meaning of sec_501 your operations are only vaguely described but it is apparent you are conducting activities in a commercial manner as your prices are at market rate you are not exclusively educational or charitable even your fundraisers result in more than an insubstantial private benefit it is apparent you were formed specifically to further the interests of your ceo and not the general_public or the poor and distressed in fact your entire method of operating provides for substantial private benefit to your ceo since your ceo is an insider this constitutes inurement even if you did otherwise meet the requirements to be exempt under sec_501 you would not qualify for exemption because you do not meet the requirements of sec_501 this is because you are controlled by your ceo your ceo will likely be compensated either as an officer or as an employee and your counseling activities have not been substantiated as educational accordingly you do not qualify for exemption as an organization described in sec_501 of the code and you must file federal_income_tax returns contributions to you are not deductible under sec_170 appeal rights you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination your protest statement should be accompanied by the following declaration under penalties of perjury declare that have examined this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all the relevant facts and such facts are true correct and complete you also have a right to request a conference to discuss your protest this request should be made when you file your protest statement an attorney certified_public_accountant or an if you individual enrolled to practice before the internal_revenue_service may represent you want representation during the conference procedures you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not for more information about representation see publication practice already done so before the irs and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications if you do not file a protest within days you will not be able to file a suit for declaratory_judgment in court because the internal_revenue_service irs will consider the failure to protest as a failure to exhaust available administrative remedies code sec_7428 provides in part that a declaratory_judgment or decree shall not be issued in any proceeding unless the tax_court the united_states court of federal claims or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted all of the administrative remedies available to it within the irs if you do not intend to protest this determination you do not need to take any further action if we do not hear from you within days we will issue a final adverse determination_letter that letter will provide information about filing tax returns and other matters please send your protest statement form_2848 and any supporting documents to this address mail to deliver to internal_revenue_service eo determinations quality assurance room p o box cincinnati oh internal_revenue_service eo determinations quality assurance room main street cincinnati oh you may also fax your statement using the fax number shown in the heading of this letter you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely lois lerner director exempt_organizations enclosure publication


c h i e f c o u n s e l department of the treasury i n t e r n a l r e v e n u e s e r v i c e w a s h i n g t o n d c date number info release date conex-130503-09 uil ---------------------- ------------------------------ ----------------------------------- dear -------------- your letter dated date to irs commissioner douglas h shulman was forwarded to me for response you expressed concern with our position on the information reporting requirements for payments made to volunteer firefighters as explained in detail below the law has historically provided and continues to provide that the information reporting requirements for payments to a volunteer firefighter differ depending on the individual firefighter’s status as an employee or an independent_contractor our interpretation of these provisions is well established and has remained constant over many years we appreciate the critical role volunteers at our nation’s fire departments play in maintaining the public safety for this reason we have worked to educate firefighting organizations about their tax obligations through various outreach programs we remain committed to partnering with them to help them correctly understand and apply the tax and reporting requirements the tax laws generally apply to volunteer firefighters in the same way they do to other workers in most cases the information reporting requirements for payments made or benefits provided to a worker depend on the worker’s status as either a common_law_employee or an independent_contractor non-employee the fact that a firefighter may be called a volunteer does not determine his or her status as an employee or an independent_contractor neither does it determine the nature of required federal information reporting the regulations that provide the criteria for determining a worker’s status as an employee or an independent_contractor for the federal_insurance_contributions_act fica tax and for federal_income_tax withholding purposes are found in sec_31_3121_d_-1 and sec_31_3401_c_-1 of the employment_tax regulations these regulations conex-130503-09 provide rules frequently referred to as the common_law rules that state in general that if the worker provides services under the direction and control of the service_recipient the worker is considered an employee for employment_tax and related information reporting purposes the rules reflect common_law principles developed and affirmed over decades by the courts which govern irs policy in this area whether a worker is an employee or an independent_contractor for federal tax and related information reporting purposes is determined under the internal_revenue_code and the employment_tax regulations the fair labor standards act does not affect whether an individual is an employee for federal tax purposes thus a worker may be an employee for federal tax purposes and not an employee for fair labor standards act purposes the term wages for purposes of fica is all remuneration for employment with certain exceptions sec_3121 of the code the law provides a similar definition of wages for purposes of federal_income_tax withholding sec_3401 of the code an employer who pays wages to an employee must furnish the employee with a form_w-2 showing the_amount_of_wages paid sec_6051 of the code wages paid to workers who are independent contractors generally must be reported on a form misc sec_6041 of the code the law excepts from the definition of wages for fica tax purposes any benefit or payment that an employee can exclude from gross_income under code sec_139b sec_3121 of the code the mortgage forgiveness debt relief act of adopted sec_139b of the code to provide members of qualified volunteer emergency response organizations including firefighters an exclusion_from_gross_income for certain state_or_local_tax benefits or payments these benefits or payments may be in the form of reimbursement or otherwise but the exclusion is limited to dollar_figure a month the law provides a similar exception from wages for income_tax_withholding purposes sec_3401 of the code in short employers do not need to report on form_w-2 or form 1099-misc any payments made or benefits provided to volunteer firefighters that are excluded from income under sec_139b however employers must report on form_w-2 or form 1099-misc amounts that are not excludable under sec_139b or any other code provision depending on the status of the volunteer firefighter as an employee or independent_contractor conex-130503-09 i appreciate and share your interest in this subject and in the well-being of firefighting organizations if you have further questions please call me or -----------------at -------------- --------------------------------------------------------------------------------------------------------------------- ------- sincerely lynne camillo branch chief employment_tax branch exempt_organizations employment_tax government entities tax exempt government entities


department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc psi tl-n-5982-00 uilc internal_revenue_service national_office field_service_advice memorandum for associate area_counsel from associate chief_counsel passthroughs special industries cc psi subject lease-in_lease-out_transaction this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent disclosure statement field_service_advice is chief_counsel_advice and is open to public inspection pursuant to the provisions of sec_6110 the provisions of sec_6110 require the service to remove taxpayer identifying information and provide the taxpayer with notice of intention to disclose before it is made available for public inspection sec_6110 and i sec_6110 also authorizes the service to delete information from field_service_advice that is protected from disclosure under u s c sec_552 b and c before the document is provided to the taxpayer with notice of intention to disclose only the national_office function issuing the field_service_advice is authorized to make such deletions and to make the redacted document available for public inspection accordingly the examination appeals or counsel recipient of this document may not provide a copy of this unredacted document to the taxpayer or their representative the recipient of this document may share this unredacted document only with those persons whose official tax_administration duties with respect to the case and the issues discussed in the document require inspection or disclosure of the field_service_advice tl-n-5982-00 legend a b c d e f g h i j k x y trust state date date date date date date date date date date date dollar_figurea dollar_figureb dollar_figurec dollar_figured dollar_figuree dollar_figuref dollar_figureg dollar_figureh dollar_figurei dollar_figurej dollar_figurek dollar_figurel dollar_figurem tl-n-5982-00 dollar_figuren dollar_figureo dollar_figurep dollar_figureq dollar_figurer dollar_figures dollar_figuret a b c d e f g h i j k l issue sec_1 whether the lease-in lease-out lilo_transaction described below has economic_substance whether the lilo_transaction qualifies for nonrecognition treatment under sec_1031 of the internal_revenue_code whether a is required to include in income original_issue_discount whether a’s participation in the lilo_transaction subjects it to the accuracy-related_penalty for negligence and substantial_understatement pursuant to sec_6662 conclusion sec_1 the lilo_transaction described below lacks economic_substance and should not be respected for federal_income_tax purposes the lilo_transaction does not qualify for nonrecognition treatment under sec_1031 the replacement_property acquired by a appears to constitute a partnership_interest which under sec_1031 does not qualify for nonrecognition treatment even if the replacement_property does not constitute a tl-n-5982-00 partnership_interest sec_1031 nonrecognition treatment will be unavailable because the transaction lacks economic_substance a must include oid in income a is liable for the accuracy-related_penalty because of its participation in a transaction lacking in economic_substance fact sec_1 a’s sale of x on date a acting through an intermediary sold its ownership_interest in x a culm-fired cogeneration plant for dollar_figurea at the time of sale a held its interest in x with an adjusted_basis of dollar_figureb accordingly the sale of x caused a to realize a gain of dollar_figurec to defer the gain realized from the x sale a entered into a lilo_transaction with b a treated the transaction as a sale_and_leaseback and accounted for it as a purchase claiming like-kind_exchange treatment under sec_1031 of the internal_revenue_code lease terms on date all of the parties to the transaction described below entered into a participation_agreement generally describing the lilo_transaction through which a would lease y from b a created a grantor_trust trust to act on its behalf in the transaction c a delaware corporation was appointed as trustee and executed all of the lilo_transaction documents as trustee for a prior to the transaction b a tax-exempt_entity was a owner of y an electric generating facility located in state d an unrelated tax-exempt_entity owned the remaining b of the facility b agreed to lease a c undivided_interest in the facility to trust for a term of d years beginning date and ending on date head lease trust agreed to lease the same interest back to b for a term of e years beginning date and ending date operating_lease c and b agreed that b’s transfer of the undivided_interest in the facility would be treated as a sale of that interest by b and the rent received by b would be treated as the purchase_price trust owed rent of dollar_figurea to b under the head lease to fund this rental payment a invested dollar_figured and borrowed dollar_figuree in non-recourse loans from e the borrowed dollar_figuree was divided into a series a loan for dollar_figuref and a series b loan for dollar_figureg the series b loan was immediately sold to f a transferred the entire dollar_figurea to trust which prepaid the dollar_figurea rent to b in full payment of the head lease tl-n-5982-00 pursuant to an investment agreement b transferred the prepaid rent to three accounts first b deposited dollar_figureg with g the investment agreement required g to invest the money in u s treasury strips b pledged the deposit with g to trust for its obligations under the operating_lease trust in turn pledged this interest to f the lender of the series b loan as collateral for the series b loan b also purchased a surety bond from f for dollar_figureh guaranteeing the payments owed to trust under the operating_lease with an additional fee of dollar_figurei paid to f b agreed to reimburse f for any payments made pursuant to the surety bond second b deposited an amount equal to the series a loan with h the interest rate on the series a loan to a equaled the interest rate paid on the amount deposited with h and h is an affiliate of e the series a lender third b transferred approximately dollar_figurej to i this money was used to purchase u s treasury strips the maturity dates and amounts of the treasury strips would allow b to use the proceeds to fund the purchase option granted to b the remainder of the prepayment approximately dollar_figurek was retained by b as its fee for participating in the transaction pursuant to the operating_lease trust leased the undivided_interest in y back to b for a term beginning date and ending on date the rent due to trust under the operating_lease was paid from the three accounts described above and equaled the amounts due by a under the series a loan and series b loan trust used the rental payments to make payments on the series a loan and series b loan b holds the following options for the end of the operating_lease term first b can purchase y from trust for a fixed price of dollar_figurel this amount exceeds the estimated appraisal value of y at that point by dollar_figurem if b exercises this purchase option b must pay an immediate installment of dollar_figuren on date and four subsequent installments of dollar_figureo each on date date date and date if b fails to exercise the purchase option d will have the opportunity to purchase y from trust under the same conditions offered to b if neither b nor d exercises its respective purchase option then a can terminate the operating_lease and purchase y for dollar_figurep if a also chooses not to exercise its purchase option the operating_lease grants b the option of arranging for service contracts this option requires b to locate potential purchasers of power and to persuade those purchasers to enter into a power sales agreement with trust to fund either the purchase option or the service_contract option b would use its remaining deposits with g h and the matured treasury strips if b elects the purchase option trust would use the initial option payment to pay off the series a loan and series b loan the four installment payments would be transferred to a the lilo_transaction allows a to defer approximately dollar_figurec in capital_gains for a e year period tl-n-5982-00 law and analysis you have asked whether this lilo_transaction should be respected for federal tax purposes for the reasons discussed below we agree with your conclusion that the transaction lacks economic_substance economic_substance to be respected a transaction must have economic_substance separate and distinct from the economic benefit achieved solely by tax reduction if a taxpayer seeks to claim tax benefits which were not intended by congress by means of transactions that serve no economic purpose other than tax savings the doctrine_of economic_substance is applicable 31_f3d_117 3d cir 861_f2d_494 7th cir aff’g 87_tc_1087 364_f2d_734 2d cir aff’g 44_tc_284 31_tc_33 aff’d 270_f2d_294 3d cir acm partnership v commissioner tcmemo_1997_115 aff’d in part and rev’d in part 157_f3d_231 3d cir whether a transaction has economic_substance is a factual determination 338_us_451 this determination turns on whether the transaction is rationally related to a useful nontax purpose that is plausible in light of the taxpayer’s conduct and useful in light of the taxpayer’s economic situation and intentions the utility of the stated purpose and the rationality of the means chosen to effectuate it must be evaluated in accordance with commercial practices in the relevant industry 89_tc_986 acm partnership supra a rational relationship between purpose and means ordinarily will not be found unless there was a reasonable expectation that the nontax benefits would be at least commensurate with the transaction costs yosha supra acm partnership supra in determining whether a transaction has economic_substance so as to be respected for tax purposes both the objective economic_substance of the transaction and the subjective business motivation must be determined acm partnership f 3d pincite 968_f2d_1229 d c cir 909_f2d_1360 9th cir the two inquiries are not separate prongs but are interrelated factors used to analyze whether the transaction had sufficient substance apart from its tax consequences to be respected for tax purposes acm partnership f 3d pincite casebeer f 2d pincite courts have recognized that offsetting legal obligations or circular cash flows may effectively eliminate any real economic significance of the transaction 364_us_361 in knetsch the taxpayer repeatedly borrowed against increases in the cash_value of a bond thus the bond and the taxpayer’s tl-n-5982-00 borrowings constituted offsetting obligations as a result the taxpayer could never derive any significant benefit from the bond the supreme court found the transaction to be a sham as it produced no significant economic_effect and had been structured only to provide the taxpayer with interest deductions in 94_tc_738 the tax_court denied the taxpayer the tax benefits of a series of treasury bill sale-repurchase transactions because they lacked economic_substance in the transactions the taxpayer bought treasury bills that matured shortly after the end of the tax_year and funded the purchase by borrowing against the treasury bills the taxpayer accrued the majority of its interest_deduction on the borrowings in the first year while deferring the inclusion of its economically offsetting interest_income from the treasury bills until the second year the transactions lacked economic_substance because the economic consequence of holding the treasury bills was largely offset by the economic cost of the borrowings the taxpayer was denied the tax_benefit of the transactions because the real economic impact of the transactions was infinitesimally nominal and vastly insignificant when considered in comparison with the claimed deductions sheldon t c pincite in 157_f3d_231 3d cir the taxpayer entered into a near-simultaneous purchase and sale of debt instruments taken together the purchase and sale had only nominal incidental effects on the taxpayer’s net economic position acm partnership f 3d pincite the taxpayer claimed that despite the minimal net economic_effect the transaction had economic_substance the court held that transactions that do not appreciably affect a taxpayer’s beneficial_interest except to reduce tax are devoid of substance and are not respected for tax purposes acm partnership f 3d pincite the court denied the taxpayer the purported tax benefits of the transaction because the transaction lacked any significant economic consequences other than the creation of tax benefits in other leasing transactions leases have been respected as valid despite the presence of credit support for their payment such as third-party rent guarantees see 88_tc_702 88_tc_84 87_tc_1471 on the other hand a fully defeased lease arguably is not compelled or encouraged by business and regulatory realities as required by 435_us_561 moreover claims of pre-tax profit are not dispositive there is some precedent that economic_substance for a lease transaction will be satisfied if there is some modicum of economic_substance which may mean some modicum of pre-tax profit see 81_tc_184 ndollar_figure aff’d in part and rev’d in part on other grounds 752_f2d_89 4th cir tl-n-5982-00 see 84_tc_412 ndollar_figure in 912_f2d_736 4th cir the fourth circuit found that a leasing transaction was a sham in doing so it described a dollar_figure profit potential as minimal on an eight-year investment of dollar_figure the fourth circuit also found evidence of tax motivation in the offsetting obligations to pay rent and debt service the transaction also involved the use of related parties to avoid sec_465 under these facts the court found that the tax tail began to wag the dog hines f 2d pincite thus small profits on a lease transaction may be overlooked when tax considerations have taken over the transaction see also pacheco v commissioner tcmemo_1989_296 application to lilo_transaction it is the position of the internal_revenue_service that certain lilo transactions lack economic_substance revrul_99_14 1999_13_irb_3 when the form of a transaction lacks economic_substance the form is disregarded and consistent with the substance of the transaction the proper tax treatment is determined acm partnership supra compaq computer v commissioner 113_tc_17 a sale leaseback_transaction is distinct from a lilo_transaction a lilo involves a lease from one entity to another with a generally coextensive lease back to the first entity a sale leaseback involves a disposition for tax purposes revproc_75_21 1975_1_cb_715 provides safe harbors and ruling guidelines for determining whether a transaction is a lease or a sale because a sale leaseback is distinct from a lilo_transaction revproc_75_21 does not apply to lilo transactions similarly an analysis of the benefits and burdens factors as would be utilized in analyzing a sale leaseback would be inappropriate under the present facts viewed as a whole the objective facts of the above-described lilo_transaction indicate that the transaction lacks the potential for any significant economic consequences other than the creation of tax benefits therefore the transaction lacks economic_substance as in revrul_99_14 the cash flows in the lilo_transaction described above are completely circular in nature the proceeds of the series a loan are transferred to b through trust and are then immediately deposited with h an affiliate of the series a lender the deposit with h earns an interest rate equal to that paid on the series a loan h will use the deposit plus interest to pay b’s rent obligation under the operating_lease as well as a portion of b’s initial installment of the purchase option likewise the proceeds from the series b loan are transferred to b who immediately deposits them with g the interest rate paid on the series b loan to f is f compared with g paid on b’s deposit with g these funds were also used to pay tl-n-5982-00 b’s rent obligations under the operating_lease and a portion of the initial installment of the purchase option as described above all of the payments due under the operating_lease are fully defeased as of the closing date of the lilo_transaction documents obtained from b consistently refer to the transaction as fully defeased moreover with the exception of the minimal risk associated with the series b loan a has eliminated all potential risks which may result from the transaction in addition the various options at the end of the operating_lease term present insignificant if any economic risk to either b or a although a obtained an appraisal showing the fair_market_value of the property at the end of the sublease term to be far less than the purchase option amount such appraisal is unreliable because it assumes a major turbine failure in the final year of the operating_lease furthermore the appraiser concludes that b would have no incentive to exercise its purchase option at the close of the operating_lease term however this conclusion apparently ignores b’s interest in retaining ownership of y documents obtained from b show that ownership and control of y were of paramount concern to b and if b failed to exercise its purchase option either d or a could accede to b’s ownership_interest journal entries made by b on date reflect a debit to restricted investment - lease termination fund and a credit to lease termination obligation both in the amount of dollar_figureq the amount used for the purchase of the treasury strips and for funding the purchase option the notation to this journal entry reads to record the investment of the equity deposit received for the fixed option and the obligation to exercise this option terminate the lease in e years additionally although the appraisal evaluates the service_contract option it fails to recognize the remoteness of this option as it is only available if the purchase option is not exercised by either b or d and a does not exercise its preemptive election the above facts combined with the full prepayment of the purchase option_price at the start of the transaction indicate that exercise of the purchase option is the most likely choice for b the purchase option thus acts as an economic collar which when exercised completes the circular flow of funds in addition the net present_value of a’s equity_investment of dollar_figured equals approximately dollar_figurer absent any_tax benefits - an approximate h rate of annual return however when tax benefits are included the present_value of the investment for the same period increases to approximately dollar_figures - an approximate i rate of annual return tl-n-5982-00 based on the above the circular flow of funds the minimal risk associated with the lilo_transaction and b’s incentive to purchase the property as set forth above we believe the transaction lacks economic_substance and should be disregarded for federal_income_tax purposes accordingly a should be required to immediately recognize the gain it realized on the sale of x and should be denied any deductions associated with the transaction like-kind_exchange to defer gain recognition of dollar_figurec on the disposition of x a structured a deferred like- kind exchange under sec_1031 a acting through trust acquired a c interest in y through a lilo_transaction the term of the head lease from b in the lilo is d years and the term of the operating_lease back to b is e years the remaining useful_life of y is estimated to be j years sec_1031 provides that no gain_or_loss shall be recognized on the exchange of property held for productive use in a trade_or_business or for investment if such property is exchanged solely for property of like_kind which is to be held either for productive use in a trade_or_business or for investment sec_1_1031_a_-1 of the regulations includes as examples of a like_kind exchange that qualifies for deferral of gain under sec_1031 the exchange of city real_estate by a taxpayer who is not a dealer in real_estate for a ranch or farm or the exchange of a leasehold of a fee with years or more to run for real_estate or the exchange of improved real_estate for unimproved_real_estate sec_1031 provides that sec_1031 shall not apply to any exchange of interests in a partnership the flush language in that provision indicates that for purposes of sec_1031 an interest in a partnership which has in effect a valid election under sec_761 to be excluded from the application of all of subchapter_k shall be treated as an interest in each of the assets of the partnership and not as an interest in the partnership see also sec_1_1031_a_-1 which provides in part that sec_1031 does not apply to any exchange of interests in a partnership regardless of whether the interests exchanged are limited or general sec_761 provides that the term partnership includes a syndicate group pool joint_venture or other unincorporated organization through or by means of which any business financial operation or venture is carried on and is not a corporation or a_trust or estate sec_761 allows a qualifying joint_venture to elect out of subchapter_k if it is availed of for the joint production extraction or use of property but not for the purpose of selling services or property produced or extracted sec_1_761-2 sets forth the following three-prong test to determine whether a joint_venture will qualify to make a election tl-n-5982-00 the participants own the property as co-owners either in fee or under lease or other form of contract granting exclusive operating rights and the participants reserve the right separately to take in_kind or dispose_of their shares of any property produced extracted or used and the participants do not jointly sell services or the property produced or extracted although each separate participant may delegate authority to sell his share of the property produced or extracted for the time being for his account but not for a period of time in excess of the minimum needs of the industry and in no event for more than one year in this case certain documents characterize the relationship of b and d as joint venturers in the ownership and operation of y we note that the undivided_interest in y that a claims it acquired for purposes of effectuating the like_kind exchange was acquired from only one of the parties -- b it was not acquired by virtue of either a long term lease or sale of such interest from both parties as joint venturers as a joint_venture b’s and d’s ownership interests in y would be partnership interests for federal tax purposes unless the owners elected out of subchapter_k under sec_761 in applying the three-part test of sec_1_761-2 to y the owners appear to satisfy the first two prongs the y ownership agreement executed by b and d states that b and d own y as tenants in common and that each participant reserves the right to take in_kind or dispose_of their shares of power produced however the ownership agreement also states that excess power not needed by b or d shall be pooled and offered for sale with each owner credited a proportionate share of the revenue from the sale this provision likely violates the requirement under sec_1_761-2 that the co-owners do not jointly sell the property produced thus regardless of whether or not b and d actually elected out of subchapter_k it seems unlikely that they were eligible to do so assuming your office determines that the facts indicate that b and d own and operate y as a partnership and thus the property acquired by the a from b amounts to a partnership_interest sec_1031 of the code precludes a from using sec_1031 to defer its gain on the disposition of its interest in the culm-fired cogeneration plant in the event that the interest acquired by a does not constitute a partnership_interest then under the sec_1031 regulations y must be actually acquired by trust this acquisition can be accomplished either by purchase or through a lease with a term of at least years if the lilo_transaction lacks economic_substance and thus y was not actually acquired by trust the sec_1031 nonrecognition of gain is not available to a on the disposition of x tl-n-5982-00 original_issue_discount if the lilo_transaction lacks economic_substance then a can be imputed original_issue_discount oid income under two alternative arguments first the dollar_figured equity_investment by a could be characterized as a loan from a to b to the extent that the purchase option_price exceeds the equity_investment that amount should be included in a’s income as oid income in the alternative the transaction could be recharacterized as a’s purchase of dollar_figurej of treasury strips funds paid_by a to b were used to buy the treasury strips which are pledged to c and the payments upon maturity of the treasury strips are used to satisfy b’s obligations to a these facts indicate that a is the owner of the treasury strips and therefore the oid on the treasury strips must be included in a’s income penalties sec_6662 imposes an accuracy-related_penalty equal to twenty percent of the portion of the underpayment attributable to among other things negligence or disregard of rules or regulations and any substantial_understatement_of_income_tax sec_1_6662-2 provides that there is no stacking of the accuracy-related_penalty components and thus the maximum accuracy-related_penalty imposed on any portion of an underpayment is twenty percent the accuracy-related_penalty does not apply to any portion of an underpayment with respect to which it is shown that there was reasonable_cause and that the taxpayer acted in good_faith sec_6664 negligence pursuant to sec_6662 and sec_1_6662-3 negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal_revenue_code or to exercise ordinary and reasonable care in the preparation of the tax_return negligence has been defined as the failure to what a reasonably and ordinarily prudent person would do under the circumstances marcello v commissioner 380_f2d_499 5th cir 85_tc_934 sec_1_6662-3 provides that negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction credit or exclusion on a return that would seem to a reasonable person to be too good to be true under the circumstances in 113_tc_214 the service argued that compaq was liable for the accuracy-related_penalty because compaq disregarded the economic_substance of the transaction the tax_court agreed with the service’s position and upheld the service’s assertion of the negligence_penalty because compaq failed to investigate the details of the transaction the entity it was tl-n-5982-00 investing in the parties it was doing business with or the cash-flow implications of the transaction similarly in united parcel services of america inc v commissioner tcmemo_1999_268 reversed aftr2d 11th cir the tax_court sustained the service’s determination of the negligence_penalty against united parcel service ups because ups was a sophisticated taxpayer engaged in an ongoing sham_transaction devoid of economic_substance for the year at issue the tax_court likewise sustained the application of the negligence_penalty in 94_tc_738 stating that the taxpayer intentionally entered into loss-producing repurchase agreements to generate and claim tax benefits b substantial_understatement pursuant to sec_6662 a substantial_understatement_of_income_tax exists for a taxable_year if the amount of the understatement exceeds the greater of ten percent of the tax required to be shown on the return or dollar_figure dollar_figure in the case of corporations other than s_corporations or personal_holding_companies sec_6662 provides that understatements are generally reduced by the portion of the understatement attributable to the tax treatment of items for which there was substantial_authority for such treatment and any item if the relevant facts affecting the item’s tax treatment were adequately disclosed in the return or a statement attached to the return and there is a reasonable basis for the taxpayer’s tax treatment of the item these exceptions however do not apply to tax_shelter items of corporate taxpayers sec_6662 thus if a corporate taxpayer has a substantial_understatement attributable to a tax_shelter_item the accuracy-related_penalty applies to the understatement unless the reasonable_cause exception applies sec_1_6664-4 discussed below contains special rules relating to the definition of reasonable_cause in the case of a tax_shelter_item of a corporation however sec_6662 which is applicable to the years at issue defines a tax_shelter among other things as a plan or arrangement the principal purpose of which is tax_avoidance_or_evasion c reasonable_cause sec_1_6664-4 provides that the determination of whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis generally taking into account all pertinent facts and circumstances the most important factor is generally the extent of the taxpayer’s effort to assess its proper tax_liability reliance on professional advice may constitute reasonable_cause and good_faith if under all the circumstances such reliance was reasonable see 469_us_241 the advice must also be based upon all pertinent tl-n-5982-00 facts and circumstances and the law relating to those facts and circumstances for example the advice must take into account the taxpayer’s purpose and the relative weight of such purpose for entering into a transaction and for structuring a transaction in a particular manner with respect to reasonable_cause for the substantial_understatement_penalty attributable to a corporation’s tax_shelter items a corporation is deemed to have acted with reasonable_cause and in good_faith if the corporation had substantial_authority as that term is defined in sec_1_6662-4 for its treatment of the tax_shelter_item and if at the time of filing the return the corporation reasonably believed such treatment was more_likely_than_not the proper treatment more_likely_than_not standard sec_1_6664-4 the regulations provide that the more_likely_than_not standard can be met by the corporation’s good_faith and reasonable reliance upon the opinion of a tax advisor if the opinion is based on the advisor’s analysis of the pertinent facts and authorities in the manner described in sec_1_6662-4 and the opinion unambiguously states the advisor’s conclusion that there is a greater than fifty percent likelihood the tax treatment of the item will withstand a challenge by the service sec_1_6664-4 in this case it is likely a will claim it had reasonable_cause for the lilo_transaction because it had a valid business_purpose although a review of x’s operating_profit and net_income for the years date through date appears to give some merit to this claim a has provided nothing to show that y would be a better investment than x as with the taxpayers in compaq and united parcel service a is a sophisticated taxpayer who would not have blindly ventured into this investment yet nothing has been provided to date to show that a considered investing in any other power plants and if it did so how those power plants compared with y the information gathered by the internal_revenue_service shows b acting through j was in the market for an investor in its power plant j then apparently brought this to the attention of k and after considering several alternatives relating to the amount of the investment the transaction was consummated as a lilo in the amount of dollar_figurea none of the information gathered shows that a either performed an in-depth analysis of y or considered other investments as like property to exchange in addition when considering the present_value and internal_rate_of_return analysis mentioned above arguably no prudent business person would enter into the transaction absent the tax benefits the net present_value of a’s dollar_figured investment utilizing a rate of k weighted average of the rate paid on the series a and series b deposits produces a loss of approximately dollar_figuret similarly a’s investment without the tax benefits produces an internal_rate_of_return of approximately h a most tl-n-5982-00 conservative investment in the lowest rated t-bills would have yielded a return rate of at least l based on the circular cash flows the rate of return and the lack of a valid business_purpose it is evident that a’s involvement in the lilo_transaction was solely due or primarily motivated by the tax benefits and thus is totally devoid of economic_substance therefore based on the facts presented assertion of the sec_6662 accuracy-related_penalty is appropriate in this case case development hazards and other considerations tl-n-5982-00 please call craig gerson at if you have any further questions by associate chief_counsel passthroughs special industries dianna k miosi chief branch office of the associate chief_counsel passthroughs special industries


internal_revenue_service number release date index number -------------------------- ------------- -------------------------------- ----------------------- ------------------------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ------------- telephone number --------------------- refer reply to cc psi b02 plr-154317-04 date date legend x y a b c d trust state date date date year -------------------------------- ein ---------------- ------------- ein ---------------- -------------------------- ssn ----------------- -------------------- ----------------------- ------------------- ---------------------------------------- tin ---------------- ------------- ----------------------- -------------------------- ---------------------- ------- plr-154317-04 dear ----------------- this letter responds to your letter dated date together with subsequent correspondence submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code facts the information submitted states that x was incorporated on date x’s shareholders are a and trust trust is an irrevocable_trust that was established on date by a_trust qualifies as a grantor_trust under sec_678 trust also qualifies as a qualified_subchapter_s_trust qsst trust’s beneficiaries are b c and d x elected to be treated as an s_corporation effective date x timely filed form_8869 qualified_subchapter_s_subsidiary qsub election for its wholly owned subsidiary y to be effective on date however no election was made to treat trust as a qsst further in year the shareholders’ attorneys discovered that the trustee of trust and not b c and d the beneficiaries of trust signed the form_2553 election by a small_business_corporation and that consequently x’s s_corporation_election was ineffective a as president of x represents that for all taxable years x and x’s shareholders have filed their tax returns as if x was an s_corporation trust has passed through all s_corporation items to its beneficiaries b c and d via a k-1 for all taxable years x has filed its tax returns consistent with y being treated as a qsub a as president of x also represents that the circumstances resulting in the ineffectiveness of x’s election to be an s_corporation were inadvertent and that x and x’s shareholders did not intend to engage in tax_avoidance or retroactive tax planning x x’s shareholders b c and d have agreed to make any adjustments that the secretary may require consistent with the treatment of x as an s_corporation law and analysis sec_1361 defines an s_corporation as a small_business_corporation for which an election under sec_1362 is in effect for the taxable_year sec_1361 provides that the term small_business_corporation is a domestic_corporation which is not an ineligible_corporation and which does not have as a shareholder a person other than an estate and other than a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual sec_1362 provides that if an election under sec_1362 by any corporation was not effective for the taxable_year for which made determined without regard to sec_1362 by reason of a failure to meet the requirements of sec_1361 or plr-154317-04 to obtain shareholder consents the secretary determines that the circumstances resulting in such ineffectiveness were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness steps were taken a so that the corporation is a small_business_corporation or b to acquire the required shareholder consents and the corporation and each person who was a shareholder of the corporation at any time during the period specified pursuant to sec_1362 agrees to make such adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such ineffectiveness the corporation shall be treated as an s_corporation during the period specified by the secretary conclusion based solely on the facts and representations submitted we conclude that x’s s_corporation_election was ineffective for the taxable_year beginning on date because x failed to acquire the necessary consents at the time of the election we also conclude that the ineffectiveness of x’s s_corporation_election was inadvertent within the meaning of sec_1362 accordingly we hold that under the provisions of sec_1362 x will be treated as an s_corporation effective date and thereafter provided that x’s s election was not otherwise invalid or terminated under sec_1362 in addition we conclude that trust will be granted an extension of time to file a qsst election effective date and that y will be treated as a valid qsub effective date and thereafter this ruling is contingent on x and all of its shareholders treating x as having been an s_corporation for the period beginning date and thereafter accordingly all of the shareholders of x in determining their respective income_tax liabilities for the period beginning date and thereafter must include their pro_rata share of the separately_stated and non-separately computed items of x as provided in sec_1366 make any adjustments to basis provided in sec_1367 and take into account any distributions made by x as provided in sec_1368 if x or its shareholders fail to treat themselves as described above this ruling shall be null and void this ruling is also contingent on b c and d filing consents with the appropriate service_center indicating that the consents are to be associated with the originally filed form_2553 within days of this letter in addition the ruling is contingent on trust making a valid qsst election effective date with the appropriate service_center within days of this letter a copy of this letter should be attached to b c and d’s consents and trust’s qsst election copies of the letter have been provided for this purpose except as specifically ruled upon above we express no opinion concerning the federal tax consequences of the transactions described above under any other plr-154317-04 provisions of the code specifically no opinion is expressed on whether x is otherwise eligible to be treated as an s_corporation whether trust is eligible to elect to be treated as a qsst or whether y is otherwise eligible to be treated as a qsub the code provides that it may not be used or cited as precedent being sent to x’s authorized representative this ruling is directed only to the taxpayer requesting it sec_6110 of pursuant to a power_of_attorney on file with this office a copy of this letter is sincerely enclosures three copies of this letter a copy for purposes beverly katz senior technician reviewer branch office of the associate chief_counsel passthroughs and special industries