internal_revenue_service national_office technical_advice_memorandum date number release date index uil no s tam-101966-00 cc fip b3 case mis no taxpayer’s name taxpayer’s address taxpayer’s identification no tax years date of conference legend a b c d e tax_year f g issues are automobile dealers’ transfers of customer notes to taxpayer a sales of such customer notes or b pledges of such customer notes as security for loans made by taxpayer to the dealers and if the transfers described in issue were sales what is taxpayer’s basis in the customer notes that it has purchased did the customer notes purchased by taxpayer have market_discount within the meaning of sec_1278 of the internal_revenue_code under what circumstances would taxpayer be entitled to a deduction for wholly or partially worthless_debt under sec_166 for a customer note that it has purchased tam-101966-00 tam-101966-00 -2- are the customer notes that taxpayer purchased permitted to be marked to market under sec_475 conclusions automobile dealers’ transfers of customer notes to taxpayer are sales taxpayer’s basis in a customer note upon purchase equals the amount of the advance_payment on the customer note taxpayer receives additional basis in the customer note for distribution payments since final regulations under sec_483 do not apply to tax years taxpayer may use a reasonable method to determine when to attribute additional basis to the customer notes the facts provided indicate customer notes are subject_to the market_discount_rules of sec_1276 to of the code and are typically acquired with market_discount however it is possible that some customer notes are acquired without market_discount or with only de_minimis market_discount in addition customer notes with a term of no more than months are not subject_to sec_1276 to nevertheless taxpayer is required to treat discount earned on such notes as ordinary_income when a realization event occurs taxpayer is entitled to a deduction for wholly or partially worthless_debt on customer notes the time of such deduction depends on the pertinent facts and circumstances not including the performance of other customer notes originated by the same dealer taxpayer is not permitted to mark customer notes to market under sec_475 of the code during tax years facts taxpayer is a corporation that files on the basis of a calendar taxable_year using an overall accrual_method of accounting taxpayer is a financing company that provides financing and other services to related and unrelated automobile dealers a significant portion of taxpayer’s business including the transactions at issue pertains to sales by dealers of used automobiles to retail customers with poor credit histories in the transactions at issue taxpayer’s arrangement with automobile dealers was governed by a master servicing agreement entered into by taxpayer and the dealer the servicing agreement was based on a standard form originated by taxpayer although taxpayer and the individual dealer might negotiate amendments to the tam-101966-00 tam-101966-00 -3- standard agreement for the purposes of this memorandum it is assumed taxpayer and each dealer used the standard servicing agreement without amendment the servicing agreement contemplates that the dealer will sell automobiles to retail customers in return for a cash down payment or a trade-in and a retail installment_sales contract a customer note secured_by a lien on the financed vehicle customer notes typically have terms of to months and are issued without original isue discount oid the dealer would pay taxpayer a one-time nonrefundable enrollment fee upon entering into the agreement and had the right to periodically submit customer notes for servicing administration and collection if taxpayer accepted a customer note it made an advance_payment to the dealer and agreed to make distribution payments which were monthly payments conditioned on taxpayer’s collections on the customer notes the amount of the advance_payment depended upon the dealer’s history with the taxpayer the credit profile of the retail customer and the year make model and mileage of the financed vehicle but was usually equal to between c and d of the stated principal_amount the face_amount of the customer note a customer's default did not obligate the dealer to return the advance_payment or to repurchase either the customer note or the financed vehicle taxpayer determined the distribution payments by pooling the customer notes transferred by the dealer and by applying payments on the pool in the following order to pay taxpayer's collection costs all of taxpayer's out-of-pocket costs incurred in the administration servicing and collection of the customer notes to pay taxpayer's fee of percent of the total_payment net of any collection costs and to repay taxpayer for all advance_payments made to the dealer the remainder if any was payable to dealer as distribution payments although not required to do so by the servicing agreement taxpayer as a concession to a particular dealer might calculate the dealer’s right to distribution payments by reference only to the customer notes in a defined pool of typically e or more customer notes which would not be added to in theory creating these capped pools accelerated the dealer’s receipt of distribution payments because it limited the amount of costs fees and advances that must be recovered before distribution payments begin in practice the effect of using capped pools was limited by taxpayer’s practice of using money received on one capped pool that was theoretically eligible to be paid as distribution payments to instead reimburse itself for costs fees and advances on another capped pools not received due to defaults occurring in the latter pool although taxpayer made significant distribution payments they were substantially less than the amount that might have been paid absent defaults on the customer notes and were a relatively small fraction of the outstanding principal balance of the customer notes some dealers received no distribution payments at all once taxpayer agreed to service a customer note the dealer transferred to taxpayer the customer note all files relating to the customer note and dealer's security tam-101966-00 tam-101966-00 -4- interest in the financed vehicle taxpayer was entitled to endorse the dealer’s name on any payments made to dealer and any other instruments concerning the customer note and the financed vehicle taxpayer could require the dealer to ensure that the customer obtained and maintained adequate automobile insurance taxpayer in its discretion could waive any late payment charge or any other fee it was entitled to collect in the ordinary course of servicing the customer note taxpayer agreed to use reasonable efforts to collect all payments due under a customer note and to repossess and sell or otherwise liquidate the financed vehicle if a default on the customer note occurred the dealer agreed to indemnify taxpayer for any expenses and claims arising out of taxpayer’s administration servicing and collection on the customer notes other than such claims as might arise out of taxpayer’s gross negligence or willful misconduct taxpayer had the right to terminate the servicing agreement on days written notice to the dealer taxpayer could terminate immediately if for any two calendar quarters the dealer failed to place with taxpayer at least qualifying customer notes or upon the occurrence of certain events of default eg dealer failed to perform any covenant set forth within the servicing agreement dealer made certain misrepresentations or dealer declared bankruptcy the dealer also had the right to terminate the servicing agreement on days written notice if taxpayer terminated the servicing agreement because of the occurrence of an event of default or if the dealer terminated the servicing agreement the dealer was obligated to pay taxpayer its unreimbursed collection costs any outstanding advances and a termination fee equal to percent of the outstanding amounts of the customer notes if taxpayer terminated the agreement other than for the occurrence of an event of default taxpayer would continue servicing and administering the customer notes unless the dealer asked taxpayer to stop also although seemingly inconsistent with the substantial payments to be made by a dealer that terminates the agreement the servicing agreement provides that taxpayer will continue to service customer notes upon termination by a dealer absent the occurrence of an event of default unless the dealer asks taxpayer to stop the assignment without_recourse of a customer note to taxpayer was typically stated on the face of the customer note the retail customers were informed at the time that their customer note was transferred to taxpayer that future payments should be made to taxpayer the servicing agreement also placed certain obligations on the dealer the dealer could not assign its rights under the servicing agreement to third parties the dealer was obligated upon taxpayer’s request to ensure that the customer obtained adequate automobile insurance the dealer also made a variety of representations including that it had and would remain duly qualified to carry on its business that it had all necessary licenses and permits to carry on its business and that each customer note delivered to taxpayer was originated in the ordinary course of the dealer’s business was properly executed and contained customary and enforceable provisions tam-101966-00 tam-101966-00 -5- taxpayer treated the transfer of the customer notes as a pledge of the notes to secure a loan made to the dealer in the form of the advance_payment taxpayer did not recognize interest_income on the loan but treated the service fees as income when received in tax_year f taxpayer took a bad_debt deduction of dollar_figureg million with respect to unrecoverable advances on the customer notes taxpayer asserts that it did not sell customer notes or other_securities during the years in question and this assertion is accepted for the purposes of this memorandum taxpayer’s tax returns for the tax years did not reflect the application of the mark to market accounting_method of sec_475 overview during tax years certain automobile dealers sold used cars to retail customers in return for a cash payment and a customer note secured_by the financed vehicle taxpayer in turn purchased these customer notes pursuant to the terms of the servicing agreement final regulations governing the purchase of assets for a price that included deferred contingent payments do not apply to tax years if they applied taxpayer’s basis in a customer note upon purchase would be equal to the advance_payment on the customer note in the event that taxpayer later made a distribution payment on the customer note taxpayer would receive additional basis in the customer note the additional basis would equal the amount of the distribution payment characterized as principal in the absence of final regulations taxpayer may use any reasonable method including the method of the proposed_regulations which are generally similar to the method described above to determine when additional basis is attributed to the customer notes generally taxpayer’s advance_payment on a customer note equaled between c and d of the face_amount of the customer note this amount was significantly less than the stated redemption price of the customer note at maturity therefore customer notes were typically purchased with market_discount although customer notes with a term of months or less would not be subject_to the market_discount_rules of sec_1276 to taxpayer would be required to treat earned discount on such notes as ordinary_income since taxpayer purchased the customer notes taxpayer would be entitled to a deduction should a customer note become wholly or partially worthless the time of such deduction depended on the pertinent facts and circumstances including the value of the financed vehicle and the financial condition of the obligor however the performance of other customer notes originated by the same dealer would not be pertinent to such determination since during tax years taxpayer regularly purchased securities that is customer notes from customers that is automobile dealers in the ordinary course of a tam-101966-00 tam-101966-00 -6- trade_or_business taxpayer met the statutory definition of a dealer_in_securities for the purposes of sec_475 of the code sec_475 requires a dealer_in_securities to mark its securities subject_to certain exceptions to market however sec_1_475_c_-1 excludes a taxpayer from the definition of a dealer_in_securities if the taxpayer makes only negligible sales of securities unless the taxpayer takes certain steps to waive such exclusion taxpayer made only negligible sales of securities during tax years and took no steps to waive the exclusion afforded by sec_1_475_c_-1 therefore taxpayer was not a dealer_in_securities during tax years and could not mark securities such as customer notes to market issue law and analysis were automobile dealers’ transfers of customer notes to taxpayer a sales of such customer notes or b pledges of such customer notes as security for loans made by taxpayer to the dealers dealers transferred customer notes to taxpayer in exchange for advance_payments and contractual rights to distribution payments the question is whether the dealers sold the customer notes or whether the dealers borrowed the advance_payment from taxpayer using the customer notes as collateral if the transactions were sales then taxpayer must recognize income on the customer notes as the obligee alternatively if the transactions were secured borrowings it is the dealers rather than the taxpayers who are the obligees who must recognize income on the customer notes in general federal_income_tax consequences are governed by the substance of a transaction determined by the intentions of the parties to the transaction the underlying economics and all other relevant facts and circumstances 293_us_465 xiv-1 c b the label the parties affix to a transaction does not determine its character 308_us_252 1939_2_cb_208 556_f2d_1107 ct_cl the term sale is given its ordinary meaning and is generally defined as a transfer of the ownership of property for money or for a promise to pay money 380_us_563 1965_2_cb_282 whether a transaction is a sale or some other arrangement is a question of fact which must be ascertained from the intent of the parties as evidenced by the written agreements read in light of the surrounding facts and circumstances 24_tc_1124 aff'd 241_f2d_288 9th cir but see 279_f2d_701 2d cir t he parties' bona_fide intentions may be ignored if the relationship the parties have created does not coincide with their intentions tam-101966-00 tam-101966-00 -7- a transaction is a sale if the benefits_and_burdens_of_ownership have passed to the purported purchaser 106_tc_237 77_tc_1221 in cases involving transfers of debt instruments the courts have considered the following factors to be relevant in determining whether the benefits_and_burdens_of_ownership passed whether the transaction was treated as a sale see 54_tc_1215 acq 1971_2_cb_3 whether the obligors on the notes the transferor’s customers were notified of the transfer of the notes id which party serviced the notes id 51_tc_1049 acq c b xxv whether payments to the transferee corresponded to collections on the notes united surgical steel co t c pincite town country food co t c pincite whether the transferee imposed restrictions on the operations of the transferor that are consistent with a lender-borrower relationship united surgical steel co t c pincite 319_fsupp_441 n d ga which party had the power of disposition 421_f2d_442 5th cir cert_denied 400_us_819 revrul_82_144 1982_2_cb_34 which party bore the credit risk 426_f2d_115 6th cir cert_denied 400_us_827 65_f2d_568 2d cir aff’g 22_bta_224 revrul_82_144 and which party had the potential for gain united surgical steel co t c pincite town country food co t c pincite revrul_82_144 no one factor is dispositive of the issue of whether a sale has taken place the facts and circumstances determine the importance of each factor thus a factor-by-factor analysis is necessary to determine whether taxpayer sold the customer notes were the transfers treated as sales the form of the agreement between taxpayer and automobile dealers is that of a servicing agreement and not a sales contract further taxpayer treated the transfers of the customer notes as pledges of security rather than sales for tax purposes however in a letter sent by taxpayer to most if not all dealers taxpayer acknowledged that sale treatment was an available characterization of the transfers were automobile dealers’ customers notified of the transfer of the customer notes to taxpayer the assignment without_recourse of the customer note to taxpayer was typically reported on the note itself see eg united surgical steel co t c pincite customers' lack of notice of assignment was a factor supporting financing treatment which party handled collections and serviced the customer notes tam-101966-00 tam-101966-00 -8- taxpayer collected payments serviced the customer notes and repossessed the financed vehicle if a customer defaulted although the servicing agreement states that taxpayer is the automobile dealer’s nominee for administrating servicing and collecting on the customer notes in fact taxpayer does not act as the dealer’s agent the dealer did not exercise any control_over taxpayer aside from agreeing to use reasonable efforts taxpayer had sole discretion to determine whether a default had occurred and to elect to pursue remedies compare united surgical steel co t c pincite and town country food co t c pincite taxpayers collected payments and serviced installment notes with elmer f 2d pincite taxpayer did not collect payments on installment notes see also mapco f 2d pincite did payments to taxpayer correspond to collections on the customer notes the payments taxpayer received were the payments that taxpayer collected on the customer notes automobile dealers had no obligation to make payments to taxpayer taxpayer received payments only if and when it collected amounts on the customer notes compare united surgical steel co t c pincite and town country food co t c pincite lenders looked to taxpayers for repayment not payments on pledged installment notes with 51_tc_175 taxpayer’s payments to purported lender were exactly the same in amount and timing as payments on underlying installment notes furthermore an advance_payment was based on the face_amount of a customer note rather than the dealer’s creditworthiness this implies that the dealers sold the customer notes cf united surgical steel co t c pincite taxpayer did not borrow maximum amount allowable under agreement yancey bros co f_supp pincite taxpayer had access to additional funds without providing additional collateral did taxpayer impose restrictions on the operations of automobile dealers that are consistent with a lender-borrower relationship the relationship between taxpayer and dealers had none of the characteristics that are common in a lender-borrower relationship taxpayer imposed no restrictions on the operations of dealers for example taxpayer did not require dealers to maintain a specified ratio of assets to liabilities or current_assets to current liabilities taxpayer did not receive the right to review dealers’ books_and_records taxpayer received only the right to documents that were necessary for taxpayer to exercise its rights and duties concerning the transferred customer notes since taxpayer imposed no restrictions on dealers’ operations taxpayer is less like a lender and more like a purchaser of the customer notes see eg united surgical steel co t c pincite bank's imposition of restrictions on operations of taxpayer was a factor showing lender- borrower relationship that conclusion is further supported by taxpayer 's failure to require dealers to maintain a minimum amount of collateral see eg union planters nat'l bank of memphis f 2d pincite purported seller required to make margin_account payments yancey bros co f_supp pincite taxpayer obligated to maintain ratio of collateral to debt of not less than percent tam-101966-00 tam-101966-00 -9- which party had the power to dispose_of the customer notes the servicing agreement is silent about the power of disposition dealers could dispose_of the customer notes only by reacquiring all of them from taxpayer to reacquire the customer notes dealers had to terminate the servicing agreement and pay taxpayer its unreimbursed collection costs any outstanding advances and a termination fee equal to percent of the outstanding amounts of the customer notes if however taxpayer were a lender then it would be reasonable to expect dealers to have the ability to substitute collateral of equal value to secure the outstanding loan cf american nat’l bank of austin f 2d pincite purported seller could dispose_of the securities without prior approval from purported buyer at the same time taxpayer’s power to dispose_of the customer notes must have been restricted since dealers had the right to reacquire them which party bore the credit risk on the customer notes by transferring the customer notes to taxpayer dealers eliminated almost all of their exposure to credit risk on the customer notes unless a dealer canceled or permitted the occurrence of an event of default under the servicing agreement the dealer in the event of a customer’s default had no obligation to repurchase either the customer note or the financed vehicle or return the advance_payment further dealers fixed their economic loss in the customer notes after transferring a customer note a dealer’s only risk of loss was a diminution in value of its right to receive distribution payments taxpayer on the other hand was at risk for recouping the advance_payments it made to the dealer it may be argued that taxpayer’s risk of loss was insubstantial because it advanced the dealer no more than c to d of the face_amount of each customer note and the distribution payments were based on the entire pool of customer notes which meant that the dealer’s right to payments was subordinated to taxpayer’s right this argument assumes that the fair_market_value of the customer notes equaled their face amounts the evidence however is to the contrary between a customer’s down payment and the advance_payment from taxpayer a dealer generally profited on the sale of an automobile given the value of the automobiles sold the credit quality of the customers and statutory limits on interest charged in consumer credit sales it is reasonable to conclude that the face amounts of the customer notes exceeded their fair market values see eg 40_bta_999 taxpayer inflated sales_price to account for buyer’s uncertain credit status dealers transferred customer notes to taxpayer for cash payments of no more than d percent of their face amounts and permitted taxpayer to retain substantial fees on all collections dealers would not have agreed to these conditions unless the fair_market_value of the customer notes was less than their face amounts furthermore in tax_year f taxpayer had to take a bad_debt deduction of dollar_figureg million with respect to unrecoverable advances on the customer notes this further indicates that taxpayer’s risk of loss was anything but insubstantial tam-101966-00 tam-101966-00 -10- accordingly we are unwilling to conclude that taxpayer's risk of loss was insubstantial the potential for gain on the customer notes both taxpayer and dealers had potential for gain on the customer notes dealers had the right to distribution payments if there were sufficient payments on the customer notes to first make all the payments due to taxpayer taxpayer gave dealers cash namely the advance_payments when dealers transferred customer notes to taxpayer taxpayer's right to recover those advance_payments plus payment for its collection costs and fees was limited to its collections on the customer notes taxpayer's profits therefore depended on the timing and amount of the collections rather than on any interest charged to dealers while the advance_payments were outstanding consequently the greater the collections on the customer notes the greater taxpayer's rate of return on the advance_payments made to dealers in cases addressing transfers of debt instruments or other rights to future payments courts have pointed to a fixed rate of return on the loaned amount as evidence that the transactions were secured loans e g mapco f 2d pincite 1an example may help illustrate why taxpayer had the potential for a significant return on its investment the advance_payments provided that the default rate on the customer notes is not too high assume that a dealer transferred to taxpayer a customer note with a face_amount of dollar_figure a term of months an interest rate of percent per annum and monthly payments of approximately dollar_figure in return for an advance_payment equal to of face or dollar_figure also assume that taxpayer had no collection costs and that dealer transferred only the one customer note taxpayer would be entitled to receive its fee of percent of each payment approximately dollar_figure taxpayer would also be entitled to the remaining dollar_figure of any payment dollar_figure - dollar_figure fee until it recovered the advance_payment of dollar_figure thus taxpayer would be entitled to seventeen payments of dollar_figure one payment of dollar_figure and eighteen payments of dollar_figure the dealer would be entitled to receive starting in month eighteen one payment of dollar_figure and eighteen payments of dollar_figure taxpayer’s rate of return on the advance_payment made to the dealer increases as more payments are collected on the customer note if taxpayer were to collect all payments then taxpayer’s yield_to_maturity would be approximately percent per annum compounded annually if taxpayer were to collect enough payments for it to recoup its collection costs its percent fee and its advance_payment then taxpayer’s yield_to_maturity still would be approximately percent and of course the taxpayer also runs the risk of not being able to recoup its advance_payment and any collection costs as the example shows the more payments taxpayer collects the greater taxpayer’s rate of return on its advance_payment to the dealer indeed the taxpayer’s rate of return on its investment depended solely on the performance of the customer notes tam-101966-00 tam-101966-00 -11- union planters nat’l bank of memphis f 2d pincite american nat’l bank of austin f 2d pincite united surgical steel co t c pincite a debt_instrument can provide for a variable rate of return and even contingent payments e g sec_1_1275-4 and sec_1_1275-5 of the income_tax regulations revrul_83_51 1983_1_cb_48 nevertheless for there to be a secured loan there must be a debtor-creditor relationship between dealers and taxpayer since taxpayer's economic return was based solely on the performance of the customer notes rather than on its relationship with dealers taxpayer was more like an owner of the customer notes than a creditor of the dealers after transferring the customer notes dealers had little potential to realize gain on the customer notes only after taxpayer recouped its out-of-pocket costs its fees and all of the advance_payments would dealers receive any distribution payments in practice the amount of distribution payments made were only a small percentage of the outstanding principal balance of the customer notes transferred to taxpayer while dealers had the potential for some benefit if the pool of customer notes had a low default rate that potential benefit does not in itself make the dealers the owner of the customer notes see commissioner v brown 380_us_573 revrul_83_51 1983_1_cb_48 further the cost of reacquiring the customer notes from taxpayer effectively prevented dealers from profiting from any changes in market interest rates for the foregoing reasons we conclude that the transfers of customer notes to taxpayer are sales issue what is the taxpayer’s basis in the customer notes that it has purchased as a general matter a taxpayer’s basis in property is the cost of the property subject_to adjustments at the time and in the manner required by the code or regulations sec_1012 of the code in the instant case taxpayer purchases a customer note from a dealer in return for two types of payments an initial advance_payment that is not absent default or termination of the servicing agreement by the dealer refundable distribution payments that as developed above may or may not be paid depending on the performance of the customer notes purchased from that dealer the advance_payment made on a customer note is a cost of purchasing the customer note and should be included in taxpayer’s basis for such note the treatment of the distribution payments requires some discussion under the servicing agreement taxpayer's payment of distribution payments depended on its ability to collect on the customer notes and its cost of making those collections distribution payments were determined under a complex formula no amount or time of payment was specified in the servicing agreement for any particular tam-101966-00 tam-101966-00 -12- customer note or any group of customer notes payment if any was deferred until an indefinite time in the future moreover there was no provision for interest regardless of when taxpayer might make any distribution payments the deferred nature of the distribution payments and the absence of any stated_interest implicates sec_483 of the code sec_483 generally applies to payments under a contract for the sale of property if the contract provides for one or more payments due more than year after the date of sale and the contract does not provide for adequate_stated_interest for purposes of sec_483 a sale is any transaction treated as a sale for tax purposes such as dealers’ sales of the customer notes to taxpayer and property includes debt instruments such as the customer notes sec_1_483-1 of the regulations however sec_483 would not apply to any payments if it can be established that at the time of sale of a customer note total payments under the contract of sale cannot exceed dollar_figure sec_483 sec_483 of the code authorizes the secretary to issue regulations applying sec_483 to any contract for the sale_or_exchange of property under which the liability for or the amount or due_date of a payment cannot be determined at the time of the sale_or_exchange the distribution payments called for in the servicing agreement are contingent payments under sec_483 of the code at the time taxpayer bought a customer note its liability for and the amount and timing of any distribution payments could not be reasonably determined taxpayer's liability to make distribution payments depended on its ability to collect on the customer notes and its collection costs in this case these contingencies were neither remote nor incidental nor were they predictable at the time of a sale both taxpayer and the dealer understood that customers' defaults and taxpayer's collection costs would reduce the amounts left for distributions to the dealer as discussed above the face of the customer notes generally exceeded the value of the underlying collateral given that fact together with the generally high credit risk of the dealer's customers taxpayer would fail to collect the entire principal_amount of a significant but uncertain number of customer notes taxpayer would also have significant but uncertain collection costs thus reductions due to default and collection costs would be significant and because of the formula for determining the distribution payments could reasonably be expected to leave many dealers with minimal or no distribution payments for these reasons and in light of other unique circumstances taxpayer's liability for and the amount and timing of those payments to the dealer could not be determined at the time of the sale of the customer notes sec_1_483-4 of the regulations which was issued under the authority of sec_483 contains rules applying sec_483 in the case of a sales contract that calls for one or more contingent payments however sec_1_483-4 applies only to sales or exchanges that occur on or after date and thus would not apply to sales or exchanges occurring during tax years if the final regulations did apply taxpayer’s tax basis in the customer notes would be calculated as follows tam-101966-00 tam-101966-00 -13- in general sec_1_483-4 of the regulations establishes the treatment of contingent payments by reference to sec_1_1275-4 which was issued simultaneously with sec_1_483-4 and addresses the taxation of contingent payment debt instruments neither sec_1_483-4 nor sec_1_1275-4 define the term contingent payments nevertheless the statutory basis for the sec_1_483-4 regulations is sec_483 and sec_483 pertains to payments which the liability for or the amount or due_date of cannot be determined at the time of the sale_or_exchange payments are not contingent payments however merely because of a contingency that is remote or incidental at the time of the sale_or_exchange see sec_1_1275-4 as developed previously the distribution payments are contingent payments for the purposes of sec_483 and so should also be treated as contingent payments for the purposes of sec_1_483-4 and sec_1_1275-4 because the distribution payments are contingent payments under sec_1_483-4 of the regulations these payment must be accounted for using the rules of sec_1_483-4 and rules similar to those contained in sec_1_1275-4 generally sec_1_1275-4 provides that each contingent payment under the contract is characterized as principal and interest a contingent payment is characterized by sec_1_1275-4 as a payment of principal in an amount equal to the present_value of the payment determined by discounting the payment at the test rate from the date the payment is made to the issue_date the remainder of the contingent payment is characterized as a payment of interest the fact that a purchaser may make contingent payments in the future does not give the purchaser a corresponding increase in its basis in the asset at the time of sale rather the purchaser receives additional basis in the purchased asset at the time that the purchaser makes a contingent payment the additional basis equals the amount of the contingent payment characterized as principal sec_1_483-4 example iii thus if the final regulations were to apply taxpayer would receive basis in a customer note equal to the advance_payment for the customer note in addition the taxpayer would receive additional basis in the customer note at the time taxpayer made a distribution payment on the customer note the amount of the additional basis would equal the amount of the distribution payment characterized as principal under sec_1_1275-4 of the regulations however the final regulations do not apply the preamble to the final regulations provide that for a sale_or_exchange that occurred before date a taxpayer may use any reasonable method to account for the contingent payments the preamble specifically provides that a reasonable method would include the method that would have been required under the proposed_regulations when the sale_or_exchange tam-101966-00 tam-101966-00 -14- occurred see t d 1996_2_cb_84 the proposed_regulations generally give the same result as the final regulations the preamble to the final regulations does not give other guidance as to what might constitute a reasonable method for accounting for contingent payments however any method of tax_accounting is subject_to the general requirement that it clearly reflect income sec_1_446-1 of the regulations presumably issues of administrability may also be considered in determining what is reasonable although such a standard gives taxpayers some discretion revrul_82_224 1982_2_cb_5 provides some indication of what would be a reasonable method for taxpayer this revenue_ruling which relied in part on section addressed the issue of a purchaser’s basis in a purchased asset attributable to contingent payments for the purposes of determining depreciation and the amount of the allowable tax_credit in this revenue_ruling the taxpayer acquired property for cash plus a part recourse part non-recourse note the note was payable in full in years but prepayments were required in the amount of profits derived from the use of the property the revenue_ruling concluded that the taxpayer’s basis in the property was equal to the cash paid plus the present_value of the recourse portion of the note assuming that it was paid in years in other words the taxpayer was given basis in the property equal to cash paid plus the present_value of those payments on the contingent_payment_debt_instrument for which purchaser would be personally liable if not made the taxpayer was permitted an adjustment to basis for earlier or additional payments although the nature of the adjustment was not described applying the regulations for sec_483 were first proposed in lr-189-84 1986_1_cb_820 the proposed_regulations the proposed_regulations were amended in fi-189-84 1993_1_cb_734 the amendments the amendments among other things rescinded the portion of the proposed_regulations that dealt with contingent payments thus there were no proposed_regulations under sec_483 dealing with contingent payments during tax years until proposed_regulations under sec_483 dealing with contingent payments were published in fi-59-91 1995_1_cb_894 the proposed_regulations applying the or proposed_regulations gives a result similar to that of the final regulations and revrul_82_224 the purchaser receives no basis in the property purchased for a contingent payment the adjusted_basis in the purchased property is increased on the date a contingent payment becomes fixed by the portion of the payment which is treated as principal sec_1 b iv of the proposed_regulations sec_1_483-4 example iii of the proposed_regulations due to the fact that current sec_483 was added in as sec_483 at which time sec_483 was substantially amended this revenue_ruling cannot be considered dispositive see tax_reform_act_of_1984 sec_41 vol c b tam-101966-00 tam-101966-00 -15- reasoning of the revenue_ruling to the instant case taxpayer would receive a basis in a customer note equal to cash paid at purchase plus additional basis for any contingent purchase payments it is obligated to make since there are no such contingent payments taxpayer’s basis in a customer note upon purchase will be limited to the advance_payment however taxpayer will be permitted an adjustment for later distribution payments revrul_82_224 indicates that a method_of_accounting that treated various dealers’ transfers of customer notes to taxpayer as a pledge of collateral for a loan made by taxpayer to the dealers would probably not be a reasonable method issue did the customer notes purchased by taxpayer have market_discount within the meaning of sec_1278 of the internal_revenue_code sec_1276 to of the code govern the treatment of market_discount as a general matter accrued market_discount on a debt_instrument is treated as ordinary_income when sold or upon receipt of a partial principal payment sec_1276 a a market_discount_bond is a debt_instrument with market_discount defined as the excess if any of - i the stated redemption price of the bond at maturity over ii the basis of such bond immediately after its acquisition by the taxpayer sec_1278 a a notwithstanding the foregoing market_discount bonds are not obligations with terms of no more than year u s savings bonds or installment_obligations sec_1278 in addition the market_discount_rules are subject_to a de_minimis exception in general a debt_instrument is deemed to have no market_discount if the market_discount is less than of percent of the stated_redemption_price_at_maturity times the number of complete years remaining to maturity at the time of acquisition as developed previously the customer notes are debt instruments taxpayer’s basis in a customer note immediately after acquisition will be the amount of the advance_payment for the customer note in general the customer notes are not the type of debt_instrument excluded from the definition of market_discount_bond thus customer notes may generally be subject_to sec_1276 to of the code provided that they are acquired with more than de_minimis market_discount notwithstanding the foregoing customer notes that have a term of no more than months are not market_discount bonds sec_1278 of the code the treatment of such customer notes will be further discussed below for debt instruments issued with oid the stated_redemption_price_at_maturity is equal to revised_issue_price sec_1278 however customer notes like other retail installment_obligations are typically issued without oid tam-101966-00 tam-101966-00 -16- the phrase stated redemption price of the bond at maturity is not defined for the purposes of sec_1276 or the other sections dealing with market_discount in subpart v b of subchapter_p of the code a similar phrase stated_redemption_price_at_maturity is defined for the purposes of subpart v a sec_1271 to and is used to define original_issue_discount oid but such definition does not apply to subpart v b sec_1273 a nevertheless the legislative_history of subpart v b demonstrates that congress was aware that market_discount and oid are economically indistinguishable from the viewpoint of the obligee s rept no vol 98th cong 2d sess senate report accordingly the two phrases should be interpreted consistently sec_1273 of the code defines stated_redemption_price_at_maturity to mean the amount fixed by the most recent modification of the purchase agreement other than payments of interest that are payable unconditionally at fixed periodic intervals of year or less during the entire term of the debt_instrument this has been interpreted by regulation to mean all payments on a debt_instrument other than payments of qualified_stated_interest sec_1_1273-1 of the regulations qualified_stated_interest in turn is defined as all payments of stated_interest that are unconditionally payable at least annually at a single fixed rate or in the case of variable rate debt instruments calculated with respect to certain permitted types of indices sec_1_1273-1 e in the instant case the stated_redemption_price_at_maturity of the customer notes is equal at least to the face_amount assuming all interest payable on the customer note is qualified_stated_interest if not all interest is qualified_stated_interest the stated_redemption_price_at_maturity will be increased by the amount of interest on the customer note that is not qualified_stated_interest in any event as developed previously taxpayer’s basis in a customer note immediately after acquisition was equal to the amount of the advance_payment for the customer note which was usually between c and d of the face_amount therefore the stated_redemption_price_at_maturity typically significantly exceeded the basis of such bond immediately after its acquisition by taxpayer and the customer notes were acquired with market_discount it is possible that in some cases taxpayer may acquire a customer note with only de_minimis market_discount or no market_discount but that is a factual issue to be addressed with respect to particular customer notes as developed previously those customer notes that have a term of no more than months are not market_discount bonds debt instruments that have a term of months or less are short-term obligations sec_1283 of the code sec_1281 to provide rules for the treatment of discount on short-term obligations however for nongovernmental obligations such as the customer notes sec_1281 to of the code govern only the treatment of oid unless the taxpayer makes an election under sec_1283 sec_1283 to the best of our knowledge taxpayer has not made an election under c tam-101966-00 tam-101966-00 -17- although there is no statutory guidance on the treatment of discount other than oid on customer notes with a term of months or less it is well-established that the portion of the amount_realized as a result of a realization event on a debt_instrument that is attributable to earned discount is ordinary_income rather than capital_gain since it is economically equivalent to interest see 381_us_54 discussing treatment of oid on debt instruments sold in year of purchase although the supreme court’s opinion in midland-ross dealt with oid rather than market_discount the two types of discount are economically equivalent for an obligee see s rep no 98th cong 2d sess legislative_history of sec_1276 to of the code therefore midland-ross unless superseded by statute should apply to an obligee that holds a debt_instrument with market_discount thus it should apply to taxpayer in the instant case and the amount of principal payments received on a customer note that are attributable to earned market_discount should be treated as ordinary_income however the opinion in midland-ross does not address the issue of how to determine the amount of market_discount earned at a particular point in time a later tax_court case assumed that discount would accrue ratably over time 44_tc_245 accruing oid thus the market_discount could be treated as accruing in an equal amount on each day a customer note with a term of months or less is outstanding however other methods would also be acceptable provided they meet the general requirement applicable to any method_of_accounting that it clearly reflect income sec_1_446-1 issue under what circumstances would taxpayer be entitled to a deduction for wholly or partially worthless_debt under sec_166 of the code for a customer note that it has purchased sec_166 of the code provides that taxpayers are allowed a deduction for a debt which became worthless within the taxable_year sec_166 further authorizes the secretary_of_the_treasury to promulgate regulations permitting a partial deduction for debt that is determined to be recoverable only in part during the taxable_year sec_166 limits the applicability of sec_166 but does not apply to corporate taxpayers such as taxpayer in general in determining whether a debt is worthless in whole or in part all pertinent evidence including the value of any collateral and the financial condition of the obligor is considered sec_1_166-2 of the regulations thus deductions for worthlessness are determined with respect to specific debts see also sec_1_166-3 applying to partial worthlessness a deduction for partial worthlessness is permitted tam-101966-00 tam-101966-00 -18- only to the extent that the debt has been charged off by the obligee for financial_accounting purpose sec_5 sec_1_166-3 since taxpayer acquires the customer notes from various dealers taxpayer is permitted a deduction for wholly or partially worthless customer notes under sec_166 of the code the time at which such deduction is permitted will depend on the pertinent facts and circumstances including the value of the financed vehicle securing the customer note and the credit of the obligor in assessing the time at which a deduction is permitted on a particular customer note under sec_166 the performance of other customer notes originated by the same dealer should not be considered as developed above taxpayer’s obligation to make distribution payments is calculated by reference to a complicated formula that takes into account among other things the aggregate amount of the advance_payments made and the payments received on either all the customer notes purchased from a particular dealer or a capped pool of such customer notes nevertheless the customer notes cannot be considered to collateralize each other since the customer notes are owned by taxpayer they cannot have been pledged by a dealer to secure payments on the other customer notes the dealer sold to taxpayer issue were the customer notes that taxpayer purchased required to be marked to market under sec_475 a dealer_in_securities is required to mark its securities to market at the end of its taxable_year sec_475 for the purposes of sec_475 a taxpayer that regularly purchases securities from or sells securities to customers in the ordinary course of a trade_or_business is a dealer_in_securities and securities include debt instruments sec_475 c c notwithstanding the foregoing securities does not include debt instruments that are nonfinancial_customer_paper id at c nonfinancial_customer_paper means a receivable that arises out of the sale of non- financial goods or services by a person the principal activity of which is the selling or providing of non-financial goods and services provided such receivable continues to be held by such person or a person that bears a relationship to such person described in sec_267 or sec_707 sec_475 in addition a taxpayer that regularly purchases securities from customers but engages in no more than negligible sales of the securities so acquired is not a dealer_in_securities for the purposes of sec_475 sec_1_475_c_-1 of the regulations for the purposes of the regulation a taxpayer makes negligible sales of as a general matter a debt_instrument that has been pledged as security by the obligee for a loan may not be charged off by the obligee for financial_accounting purposes tam-101966-00 tam-101966-00 -19- debt instruments purchased from customers if in the taxable_year it sells fewer than debt instruments or sells debt instruments with an adjusted_basis of less than percent of its aggregate basis immediately after acquisition of all debt instruments acquired in the year id at -1 c a taxpayer may elect to waive the exemption afforded by sec_1_475_c_-1 by filing a federal tax_return reflecting the application of sec_475 and meeting certain other requirements that may be necessary to receive the commissioner’s consent to a change_of_accounting_method id at -1 c ii revproc_97_43 i r b a dealer_in_securities does not mark to market securities that are held for investment or as a hedge and are identified as such on the taxpayer’s records before the close of the day when acquired sec_475 b as developed previously taxpayer certainly purchases debt instruments the customer notes from its customers in the ordinary course of business the customer notes are generally not nonfinancial_customer_paper when held by taxpayer since taxpayer did not originate the customer notes and does not bear a relationship to the dealers that originated the customer notes that is described in sec_267 or sec_707 b these facts suggest taxpayer might be a dealer_in_securities for the purposes of sec_475 however taxpayer did not sell securities during the years in question consequently taxpayer would not be a dealer_in_securities subject_to sec_475 unless taxpayer waived the exemption afforded by sec_1_475_c_-1 by filing a federal tax_return reflecting the application of sec_475 and meeting any other requirements imposed by revproc_97_43 since taxpayer’s tax returns did not reflect the application of sec_475 during the applicable taxable years taxpayer was not a dealer_in_securities for the purposes of sec_475 and could not mark securities such as the customer notes to market a copy of this technical_advice_memorandum is to be given to taxpayer sec_6110 of the code provides that it may not be used or cited as precedent caveat - end - 6however customer notes would be nonfinancial_customer_paper if purchased from an automobile dealer whose relationship to taxpayer at all times since issue was described in sec_267 or sec_707 such customer notes could not be marked to market


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 b01 plr-143001-09 date date legend x ------------------------------------------- ---------------------------- d1 ------------------------------ dear ------------------ this responds to the letter dated date submitted on behalf of x requesting relief under ' b of the internal_revenue_code facts x was incorporated on d1 the shareholder of x intended that x be treated as an s_corporation effective on d1 but the election to be treated as an s_corporation was not timely filed accordingly x requests a ruling that it will be treated as an s_corporation effective d1 law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective sec_1362 provides in relevant part that if an s election is made within the first two and one-half months of a corporation's taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made under ' b however if an s election is made after the first two and one-half months of plr-143001-09 a corporation's taxable_year then that corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is filed sec_1362 provides that if no ' a election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make such election then the secretary may treat such an election as timely made for such taxable_year and ' b shall not apply x did not timely file an election to be treated as an s_corporation under ' a x has however established reasonable_cause for not making a timely s election and is entitled to relief under ' b conclusion based solely on the facts submitted and the representations made and provided that x otherwise qualifies as an s_corporation we conclude that x will be treated as an s_corporation effective d1 within days from the date of this letter x should submit a properly completed form_2553 with a copy of this letter attached to the appropriate service_center except as specifically set forth above no opinion is expressed or implied as to the federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed concerning whether x is in fact an s_corporation for federal tax purposes this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file with this office a copy of this letter will be sent to x’s authorized representative sincerely david r haglund david r haglund acting branch chief branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for ' purposes


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 b01 plr-153982-09 date date legend x --------------------------------------------------- --------------------------------------------------- state d1 d2 ------------- ------------------------- ---------------------- dear ---------------- this letter responds to a letter dated ------------------------- and subsequent correspondence written on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code facts according to the information submitted x was incorporated under state law on d1 x’s shareholders intended for x to be an s_corporation as of d2 however x’s form_2553 election by a small_business_corporation was not timely filed x requests a ruling that it will be recognized as an s_corporation effective d2 plr-153982-09 law and analysis sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation sec_1362 provides that an election under sec_1362 may be made by a small_business_corporation for any taxable_year at any time during the preceding_taxable_year or at any time during the taxable_year and on or before the 15th day of the third month of the taxable_year sec_1362 provides that if a a small_business_corporation makes an election under sec_1362 for any taxable_year and b such election is made after the 15th day of the third month of the taxable_year and on or before the 15th day of the third month of the following taxable_year then such election shall be treated as made for the following taxable_year sec_1362 provides that if a an election under sec_1362 is made for any taxable_year determined without regard to sec_1362 after the date prescribed by sec_1362 for making the election for the taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make the election the secretary may treat the election as timely made for the taxable_year and sec_1362 shall not apply x did not file a timely election to be treated as an s_corporation under sec_1362 effective d2 x has however established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and provided that x otherwise qualifies as a subchapter_s_corporation we conclude that x will be recognized as an s_corporation effective d2 within days from the date of this letter x must submit a properly completed form_2553 with a copy of this letter attached to the appropriate service_center except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion concerning whether x otherwise qualifies as an s_corporation for federal tax purposes plr-153982-09 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representative this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely s david r haglund chief branch office of the associate chief_counsel passthroughs special industries enclosures a copy of this letter a copy for sec_6110 purposes cc


internal_revenue_service number release date index numbers ------------------------------------------------------------ ------------------------------------------------------ ---------------------------- ----------------------------------- ---------------------------------- 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 b01 plr-137791-16 date date legend x ----------------------------------------------------- ---------------------------- date date date year state ---------------------- ------------------ ------------------------ ------- -------------- dear ------------------ this is in response to a letter dated date submitted on behalf of x by x’s authorized representative requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_754 of the internal_revenue_code facts according to the information submitted x was formed as a limited_liability_company under the laws of state on date x is treated as a partnership for federal tax purposes plr-137791-16 on date interests in x were transferred causing x to undergo a technical_termination under sec_708 x’s partnership return for year was timely filed and x’s partnership return for year did reflect adjustments to the basis of the partnership property as if a sec_754 election were in effect however x inadvertently failed to file a timely sec_754 election with the return for its taxable_year ending on date x represents that it relied upon a tax professional when preparing the tax_return for year x represents that its tax professional prepared a election but that it was not advised by its tax professional to sign the election x further represents that around date x became aware of the error with making the sec_754 election for its taxable_year ending date x further represents that it has acted reasonably and in good_faith that granting relief will not prejudice the interests of the government and that it is not using hindsight in making the election law and analysis sec_754 provides that a partnership may elect to adjust the basis of partnership property when there is a distribution_of_property or a transfer of a partnership_interest an election under sec_754 applies with respect to all distributions of property by the partnership and to all transfers of interests in the partnership during the taxable_year with respect to which the election was filed and all subsequent taxable years sec_1_754-1 of the income_tax regulations provides that an election under sec_754 to adjust the basis of partnership property under sec_734 and sec_743 with respect to a distribution_of_property to a partner or a transfer of an interest in a partnership must be made in a written_statement filed with the partnership return for the taxable_year during which the distribution or transfer occurs for the election to be valid the return must be filed not later than the time prescribed by sec_1 e including extensions for filing the return for such taxable_year under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i section b defines the term regulatory election as including an election whose due_date is prescribed by a regulation published in the federal_register sec_301_9100-1 through provide the standards that the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-1 sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides rules for requesting extensions of time for regulatory elections that do not meet the requirements of sec_301_9100-2 plr-137791-16 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government section a conclusion based solely on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied as a result x is granted an extension of time of one hundred-twenty days from the date of this letter to make a sec_754 election for year the election should be made in a written_statement filed with the applicable service_center for association with x’s tax_return a copy of this letter should be attached to the statement filed except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent pursuant to the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely donna young acting associate chief_counsel passthroughs special industries by david haglund david haglund branch chief branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes cc


department of the treasury person to contact employee id number tel fax refer reply to ap in re eo determination form required to be filed tax period s ended last day to file a petition with the united_states tax_court peals office internal_revenue_service alpha road suite mc 8000nwsat dallas tx date nov uil code legend o j certified mall dear this is a final adverse determination as to your exempt status under sec_501 cx3 of the internal_revenue_code irc it is determined that you do not qualify as exempt from federal_income_tax under sec_501x3 following reason s a substantial part of our adverse determination was made for the ment assistance to home buyers to your activities consists of providing down pay rs and other real-estate related finance the assistance you rely on home selle m these down payment assistance transactions businesses that stand to benefit fro home seller corresponds to the amount of the down your receipt of a payment from the payment assistance provided in substantially_all of your down payment assistance transactions the manner in which you operate demonstrates you are operated primarily to further your insiders’ business interests therefore you are operated for a substantial nonexempt purpose in addition your operations further the private interests of the persons that finance your activities accordingly you are not operated exclusively for exempt purposes described in sec_501 c contributions to your organization are not deductible under code sec_170 you you are required to file federal_income_tax retums on the form indicated above - should file these retums within days from the date of this letter unless a request for an extension of time is granted file the retums in accordance with their instructions and do not send them to this office processing of income_tax retums and assessment of any taxes due will not be delayed because you have filed a petition for declaratory_judgment under code sec_7428 if you decide to contest-this determination under the declaratory_judgment provisions of code sec_7428 a petition to the united_states tax_court the united_states court of claims or the district_court of the united_states for the district of columbia must be filed within days from the date this determination was mailed to you contact the clerk of the appropriate court for rules for filing petitions for declaratory_judgment to secure a petition form from the united_states tax_court write to the united_states tax_court second street n w washington d c we will notify the appropriate state officials of this action as required by code section '6104 c you should contact your state officials if you have any questions about how this determination may affect your state responsibilities and requirements if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter this letter supersedes our letter dated date s’ charles fisher team manager


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 b01 plr-115715-08 date date legend x --------------------------------------------------- -------------------------------------- state ---------- a ---------------------------------------------------- ------------------------------ d1 ----------------- dear ---------------------- this letter responds to a letter dated date and subsequent correspondence written on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code facts according to the information submitted x was incorporated under state law on d1 a x’s sole shareholder intended for x to be an s_corporation as of d1 however x’s form_2553 election by a small_business_corporation was not timely filed plr-115715-08 x requests a ruling that it will be recognized as an s_corporation effective d1 law and analysis sec_1362 provides that except as provided in sec_1362 a small_business_corporation may elect in accordance with the provisions of sec_1362 to be an s_corporation sec_1362 provides that an election under sec_1362 may be made by a small_business_corporation for any taxable_year at any time during the preceding_taxable_year or at any time during the taxable_year and on or before the 15th day of the third month of the taxable_year sec_1362 provides that if a a small_business_corporation makes an election under sec_1362 for any taxable_year and b such election is made after the 15th day of the third month of the taxable_year and on or before the 15th day of the third month of the following taxable_year then such election shall be treated as made for the following taxable_year sec_1362 provides that if a an election under sec_1362 is made for any taxable_year determined without regard to sec_1362 after the date prescribed by sec_1362 for making the election for the taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make the election the secretary may treat the election as timely made for the taxable_year and sec_1362 shall not apply x did not file a timely election to be treated as an s_corporation under sec_1362 effective d1 x has however established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and provided that x otherwise qualifies as a subchapter_s_corporation we conclude that x will be recognized as an s_corporation effective d1 within days from the date of this letter x must submit a properly completed form_2553 with a copy of this letter attached to the appropriate service_center except as expressly provided herein we express or imply no opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion concerning whether x otherwise qualifies as an s_corporation for federal tax purposes plr-115715-08 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representative this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely stuart d murray stuart d murray senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures a copy of this letter a copy for sec_6110 purposes cc


tax_exempt_and_government_entities_division release number release date uil code department of the treasury internal_revenue_service date date taxpayer_identification_number person to contact employee identification_number employee telephone number last date to file a petition in tax_court september 20xx certified mail - return receipt dear this is a final adverse determination regarding your exempt status under sec_501 of the internal_revenue_code the code our favorable determination_letter to you dated may 20xx is hereby revoked and you are no longer exempt under sec_501 of the code effective december 19xx the revocation of your exempt status was made for the following reason s organizations described in sec_501 and exempt under sec_501 must be both organized and operated exclusively for exempt purposes you did not operate exclusively for exempt purposes because your assets inured to and served the private interests of your creators the entire amount of your assets was loaned to your creator there was no indication that the loan was secured or the creator ever made any payments the loan was used to pay for the business and personal expenses of your creator the loan was made at a favorable rate and terms which served the financial interests of your creator he has operated you for his own personal benefit you were controlled by your creator and you were established and operated to enable your creator to engage in financial activities which are beneficial to him facts that show a charity’s investments are decided in part by the needs of private interests indicate the charity may not be operated exclusively for exempt purposes 73_tc_196 aff’d 631_f2d_736 cir contributions to your organization are no longer deductible under sec_170 after december 19xx you are required to file income_tax returns on form_1120 these returns should be filed with the appropriate service_center for the tax_year ending november 20xx and for all tax years thereafter in accordance with the instructions of the return processing of income_tax returns and assessments of any taxes due will not be delayed should a petition for declaratory_judgment be filed under sec_7428 of the internal_revenue_code if you decide to contest this determination under the declaratory_judgment provisions of sec_7428 of the code a petition to the united_states tax_court the united_states claims_court or the district_court of the united_states for the district of columbia must be filed before the day after the date this determination was mailed to you please contact the clerk of the appropriate court for rules regarding filing petitions for declaratory judgments by referring to the enclosed publication you may write to the united_states tax_court at the following address united_states tax_court second street nw washington dc you also have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at see the enclosed notice taxpayer_advocate_service - your voice at the irs for taxpayer_advocate telephone numbers and addresses we will notify the appropriate state officials of this action as required by code sec_6104 you should contact your state officials if you have any questions about how this final_determination may affect your state responsibilities and requirements if you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely sunita lough director eo examinations enclosures publication publication internal_revenue_service department of the treasury date november taxpayer_identification_number form tax_year s ended november 20xx and 20xx person to contact id number contact numbers telephone fax certified mail - return receipt requested dear we have enclosed a copy of our report of examination explaining why we believe revocation of your exempt status under sec_501 of the internal_revenue_code code is necessary if you accept our findings take no further action we will issue a final revocation letter if you do not agree with our proposed revocation you must submit to us a written request for appeals_office consideration within days from the date of this letter to protest our decision your protest should include a statement of the facts the applicable law and arguments in support of your position an appeals officer will review your case the appeals_office is independent of the director eo examinations the appeals_office resolves most disputes informally and promptly the enclosed publication the examination process and publication exempt_organizations appeal procedures for unagreed issues explain how to appeal an internal_revenue_service irs decision publication also includes information on your rights as a taxpayer and the irs collection process you may also request that we refer this matter for technical_advice as explained in publication if we issue a determination_letter to you based on technical_advice no further administrative appeal is available to you within the irs regarding the issue that was the subject of the technical_advice letter rev catalog number 34809f if we do not hear from you within days from the date of this letter we will process your case based on the recommendations shown in the report of examination if you do not protest this proposed determination within days from the date of this letter the irs will consider it to be a failure to exhaust your available administrative remedies sec_7428 of the code provides in part a declaratory_judgment or decree undef this section shall not be issued in any proceeding unless the tax_court the claims_court or the district_court of the united_states for the district of columbia determines that the organization involved has exhausted its administrative remedies within the internal_revenue_service we will then issue a final revocation letter we will also notify the appropriate state officials of the revocation in accordance with sec_6104 of the code you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please call the contact person at the telephone number shown in the heading of this letter if you write please provide a telephone number and the most convenient time to call if we need to contact you thank you for your cooperation sincerely vicki l hansen acting director exempt_organizations examinations enclosures publication publication report of examination letter rev catalog number 34809f name of organization fye form agent date 20xx wip index l-4 other exempt status the following is the revenue_agent report sent to the taxpayer via day letter on november 20xx the organization agreed to the retroactive revocation and submitted a signed form_6018 on 20xx issue whether the sec_501 tax exempt status of the should be revoked because it is not operated exclusively for tax exempt purposes facts trust instrument the declaration by the organization was created with a declaration of trust hereinafter collectively referred to as the donor and sometimes referred to as trustee on december 19xx the declaration provides that the organization was created for the purpose of establishing an organization which is described in sec_501 and sec_509 the declaration states that it shall be irrevocable and the donor hereby expressly waives the right and the power to alter amend revoke or terminate the trust or any of the terms of this declaration the declaration provides that the donor hereby renounces any power to determine or control by alteration amendment revocation termination or otherwise and the donor renounces any interest in either vested or contingent including any reversionary_interest or possibility of reverter the income or principle of the trust estate the declaration requires that each year the trustee shall distribute net_income of organization to is intended that the distributions to the primary charity it will help of the adjusted perform its functions and carry out its purposes in order to insure that this happens the board shall meet with the governing body of or a representative thereof to determine the use of such distributions it is intended that the distributions will be used in a similar fashion each year to fund a project or carry out a function any donation grant or distribution to shall obtain written confirmation that recognized as a tax exempt_organization under sec_501 of the code prior to making the organization is then currently in addition to the distribution to be made pursuant to the above regarding the required_distribution each year the trustee shall distribute a total of net_income of this trust to one or more of the organizations listed on this reference is made a part hereof or to board in writing signed by at least of the which by as is directed by the members of the board provided that each such k-4-1 name of organization fye form agent date 20xx wip index l-4 distribution shall be a distribution which can be made by an organization described in sec_509 of the code each such distribution shall be made on or before the end of the month immediately following the year in which the income was earned there are charity to the declaration including the primary charities listed on upon winding up and dissolution of this trust after paying or adequately providing for the debts and obligations of the trust the remaining assets shall be distributed to a non-profit fund foundation or corporation which is organized and operated exclusively for charitable educational religious and or scientific purposes and which has established its tax exempt status under sec_501 of the code in the event that the trust does not obtain exempt status under c and a of the code the assets of the trust shall go to the as defined as a contingent_remainder in the event the trustee determines in the trustee’s sole and complete discretion that the trust fund is too small to economically administer then in such event the trustee shall distribute the trust fund in its entirety outright to such organization or organizations as described in sec_170 of the code the declaration provides that the board shall be the governing body of the trust and that the members of the board shall consist of members and be determined as follows board member shall be appointed by board members shall be from the class consisting of and and each of their descendants the provided that there are then at least members of the who are willing and able to so act other remaining members of the board including any vacancies caused by not having at least shall be appointed by a majority vote by the remaining members of the board the initial remaining board members shall be members as designated from the governance is the organization’s trustee is a substantial_contributor and therefore a disqualified_person with respect to the organization the organization’s initial board_of directors was comprised of members as follows a disqualified_person because he is a substantial_contributor also a disqualified_person k-4-2 name of organization fye form agent date 20xx wip index l-4 all november 19xx on the 20xx through 20xx tax returns only board members were disclosed on the form_990 for the tax_year ended and were disclosed as board members no other board members were disclosed operations application_for recognition of exempt status by letter dated may 20xx the organization was recognized by the service as exempt from federal_income_tax under sec_501 as an organization described in sec_501 the service also determined that the organization met the requirements of sec_509 and classified it as a supporting_organization rather than a private_foundation the service's determination_letter was based on the organization's representations made in its application and supplemental materials during the application process the organization did not disclose that it would lend all of its assets to disqualified persons years before exam 19xx the organization provided a copy of the board meeting minutes for december 19xx these were the only meeting minutes provided by the organization the organization filed its initial tax_return on october 20xx for the year ended november 19xx initial contributions to the organization per form_990 for the year ended november 19xx cash stock_dividends from stock gain on sale of contributed stock total h w h m w f p f p r h p k-4-3 name of organization fye form agent date 20xx wip index l-4 on november 19xx the organization issued a loan’ to the trustee in the amount of this was the total amount of assets for the organization a copy of the note dated november 19xx provided by the organization indicated the following terms dollar_figure amount rate apr due upon demand the loan to trustee was disclosed on line november 19xx and on the was loan to page of the form_990 for the year ended the information disclosed on 20xx there was no income or expenditures reported on the form_990 for the year ended november 20xx filed by the organization the loan to trustee was disclosed in the same manner as described above for the year ended november 19xx 20xx there was no income or expenditures reported on the form_990 for the year ended november 20xx filed by the organization the loan was reported as a receivable from officers on the organization disclosed the name of the borrower and terms of the loan page of the tax_return on a statement attached to the tax_return 20xx the 20xx tax_return was filed identical to the 20xx return no income or expenditures disclosed and the loan was disclosed on a statement attached to the return there was no indication the organization made any grants to the primary charity or any other charity the returns do not indicate that any income was received or any expenditures were made ' through the course of the initial interview and the examination of the books_and_records there was no indication the trustee made any payments on the loan to the organization and the money received by the trustee was used to pay for his business and personal living_expenses k-4-4 ‘name of organization fye form years under exam 20xx and 20xx agent date 20xx wip index l-4 through the course of the initial interview and examination of the books_and_records there was no indication the organization made any grants or received any income the organization did file forms disclosing the receivable from the trustee tax_return information 20xx 20xx line total revenue line total expenses dollar_figure dollar_figure balance_sheet line receivables from officers directors trustees and key employees line total assets line total liabilities line paid in capital surplus line total liabilities and net assets law dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure sec_501 exempts from federal_income_tax corporations and any community chest fund or foundation organized and operated exclusively for religious charitable scientific testing for public safety literary or educational_purposes or for the prevention of cruelty to children or animals no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual no substantial part of the activities of which is carrying on propaganda or otherwise attempting to influence legislation and which does not participate in or intervene in including the publishing or distributing of statements any political campaign on behalf of any candidate for public_office k-4-5 name of organization fye form wip index l-4 agent date 20xx regulation sec_1_501_c_3_-1 provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose regulation sec_1_501_c_3_-1 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 the words private_shareholder_or_individual refer to persons having a personal and private interest in the activities of the organization regulation sec_1_501_c_3_-1 provides an organization is not organized or operated exclusively for one or more exempt purposes unless it serves a public rather than a private interest thus to meet the requirement of this subdivision it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as the creator or his family shareholders of the organization or persons controlled directly or indirectly by such private interests in 326_us_279 the united_states supreme court held that regardless of the number of truly exempt purposes the presence of a single substantial non-exempt purpose will preclude exemption under sec_501 in revrul_67_5 1967_1_cb_123 it was held that a foundation controlled by the creator’s family was operated to enable the creator and his family to engage in financial activities which were beneficial to them but detrimental to the foundation it was further held that the foundation was operated for a substantial non-exempt purpose and served the private interests of the creator and his family therefore the foundation was not entitled to exemption from federal_income_tax under sec_501 government’s position the organization the sec_501 tax exempt status of should be revoked because it is not operated exclusively for tax exempt purposes 19xx a loan was issued from the organization to the trustee in the amount of from december 19xx through november 19xx on november the organization was funded with in cash and stock by the trustee the entire amount of the organization’s assets there was no indication of any issue board approval the lack of a board approval process prior to the transactions demonstrate that donor had full control of the assets name of organization fye form agent date 20xx wip index l-4 there was no indication that the loan was secured or the trustee ever made any payments the organization provided documentation stating the loan was used to pay for the business and personal expenses of trustee was loaned back to him the donor and disqualified the entire contribution by person at a favorable rate and terms which served the financial interests of the trustee facts that show a charity's investments are decided in part by the needs of private interests indicate the charity may not be operated exclusively for exempt purposes 73_tc_196 aff'd 631_f2d_736 cir the facts show that the organization is not operated exclusively for a tax exempt charitable purpose rather personal benefit the facts of the case show that organization and claimed tax benefits in the form of charitable_contribution deductions under sec_170 has operated the organization for his own established the the organization which is controlled enable accordingly it is operated for a substantial non-exempt purpose see revrul_67_5 to engage in financial activities which are beneficial to him was established and operated to an organization is described in sec_501 only if no part of its net_earnings inures to the benefit of any private shareholder the inurement prohibition is designed to insure that charitable assets are dedicated to exclusively furthering public purposes an organization is not operated exclusively for exempt purposes if its net_earnings inure to the benefit of private shareholders or individuals a gift to a charitable_organization must be a voluntary transfer of money or property without the receipt of adequate_consideration made with charitable intent 490_us_680 to claim a deduction under sec_170 a donor must surrender dominion and control_over the gift 202_f3d_1093 gt cir transferred assets to the organization and claimed a deduction under sec_170 a charity’s assets are required to be irrevocably dedicated to charitable purposes sec_1 c - b the inurement prohibition serves to prevent the individuals who operate the charity from siphoning off any of a charity's income or assets for personal_use by transferring the assets back to a disqualified_person purportedly as a loan but as a distribution the organization breached the dedication requirement and its net_earnings have inured to the benefit of the disqualified_person whether a particular transaction actually constitutes a loan is determined upon consideration of all the facts 54_tc_905 fora payment to constitute a loan when the payments are received the recipient must intend to repay the amounts and the transferor must intend to enforce payment haag v name of organization fye form agent date 20xx wip index l-4 commissioner 88_tc_604 aff'd without published opinion 855_f2d_866 cir 55_tc_85 in greg r vinikoor v a commissioner t c memo the tax_court provided the following factors to determine whether a transfer was made with a real expectation of repayment and an intention to enforce the debt there was a promissory note or other evidence_of_indebtedness interest was charged there was security or collateral there was a fixed maturity_date a demand for repayment was made any actual repayment was made the transferee had the ability to repay any records maintained by the transferor and or the transferee reflected the transaction as a loan and the manner in which the transaction was reported for federal tax purposes is consistent with a loan there was no intent by the trustee to pay the loan back and no demand by the organization to demand payment the trustee made no payments on the loan which was issued in 19xx the note states due upon demand there was no interest charged or accrued no fixed maturity_date and no collateral the entire amount constitutes a distribution -although the inurement prohibition is stated in terms of net_earnings it applies to any of a charity's assets that serve the interests of its private shareholders 505_f2d_1068 cir the transfer of funds directly to the disqualified_person served the financial interests of the disqualified_person and or his business facts that show a charity’s investments are decided in part by the needs of private interests indicate the charity may not be operated exclusively for exempt purposes 73_tc_196 aff'd 631_f2d_736 cir conclusion accordingly the organization’s status as an organization described under sec_501 should be revoked because it did not operate exclusively for exempt purposes because its assets inured to and it served the private interests of its creators and other private persons k-4-8 name of organization fye form agent date 20xx wip index l-4 this determination is effective beginning december 19xx the organization did not disclose in its exemption application that it would be making a loan with all of its assets it failed to disclose that it would distribute monies to the trustee a disqualified_person thus retroactive revocation is applicable ‘ _ u s income_tax return for estates and trusts should be filed for tax years form ending november 20xx 20xx 20xx and 20xx subsequent returns are due no later than the day of the 4' month following the close of the trust’s accounting_period returns should be sent to the following mailing address internal_revenue_service for tax_year ending november 20xx form _ is due march 20xx should be sent to the following address internal_revenue_service retroactive date of revocation the effective date of revocation is retroactive because the organization did not disclose in its application_for exempt status that it would loan essentially all of its assets to the founder within a year of his contribution to the organization therefore retroactive revocation to the first taxable_year which begins december 19xx is appropriate memo to file a memo was created to memorialize the actions required by the organization to accept agreement it was later determined through conference call with and manager that the org was not required to substantiate repayment of the loan prior to agreeing to revocation the org submitted form_6018 on 20xx results of examination is disposal code agreed revocation refer to exhibit l-4-1 for copy of memo to file conclusion the result of the examination is proposed revocation based on inurement the founder donor and trustee and contributed about issued a loan to the founder for all of its assets to the organization a year later the organization created the organization in late 19xx did not make any and_- k-4-9 - name of organization fye form agent date 20xx wip index l-4 payments on the loan the statute_of_limitations for the sec_4958 issue had expired prior to the opening of the examination see workpaper j-8 for more more information on this issue the organization agreed to retroactive revocation to the first taxable_year of the organization which is december 19xx the organization submitted a signed form_6018 on 20xx retroactive revocation is applicable in this case as the organization did not disclose in its application_for exempt status that it would loan all of its assets to a disqualified_person the founder made no payments on the loan sec_501 sec_1_501_c_3_-1 -2 and c -1 d ii revrul_67_5 1967_1_cb_123 and 326_us_279 at favorable terms