internal_revenue_service te_ge technical_advice_memorandum release number date release date uil area manager - taxpayer’s name taxpayer’s address taxpayer’s identification_number years involved conference held legend t u v w x issues whether funds derived by t a state-chartered credit_union described in sec_501 of the internal_revenue_code from the following activities should be treated as unrelated_business_taxable_income under sec_511 of the internal_revenue_code sale of accidental death and dismemberment ad d insurance sale of members financial management services formerly plan america sale of car warranties sale of guaranteed auto protection gap insurance sale of credit life and credit disability insurance a b c d e sale of group life health and cancer insurance and stand alone cancer insurance sale of checks f g facts originally chartered in t is a state-chartered credit_union which is recognized as exempt from federal_income_tax under sec_501 of the internal_revenue_code code as an organization described in sec_501 t's board_of directors supervisory committee and loan committee are comprised entirely of elected members of the credit_union who serve on a voluntary basis without compensation membership in t is limited to employees and family members of u t’s purposes as stated in its articles of incorporation are to promote thrift and provide low cost credit for its members t’s activities include accepting deposits from and maintaining the accounts and savings o f its members these deposit accounts include savings or share accounts on which members earn periodic dividends credited to the accounts and share draft accounts which are transaction accounts similar to bank checking accounts t represents that its day-to-day business operations differ from conventional banking institutions in several ways t states that it conducts its business to reflect its non-profit mutual structure t makes loans to its members and states that many borrowers have low incomes and might not otherwise qualify for credit from conventional for-profit banks t also represents that it regularly issues loans for very small amounts such as loans for auto repairs which are typically not made by for-profit banks t indicates that it serves smaller communities than those served by for-profit banks t also indicates that because of its mutual non-profit operation all members not just those maintaining high minimum balances are able to earn competitive rates on their deposits and pay low banking fees t represents that in order to maintain its financial viability and continue to satisfy its stated purposes of promoting thrift and providing a source of low cost credit it has endeavored to become a full service financial_institution consequently t offers more than just demand deposits and loans currently t provides group life health and cancer insurance and stand alone cancer insurance members financial services and car warranties available to members t also makes available to its members ad d insurance gap cpi and credit life and credit disability insurance in connection with several loan programs the different types of insurance are described in more detail below t also sells checks to its members all of these products are underwritten or otherwise provided by third-party insurance_companies or other third-party vendors in each case t makes its members aware of the purpose and availability of these products answers members’ questions about the products or refers the member to the vendor for additional information and with respect to some of the products obtains and submits applications for coverage premium payments and claims during the years at issue t made the following types of loans personal mortgage vehicle and other secured and unsecured loans the majority of the loans were personal mortgage and vehicle based on the number of loans in were collateralized and in were collateralized the default rate on these loans as a percentage of total loans was and for years and respectively t filed form 990-t unrelated_business_income_tax return for both years sale of ad d insurance t offers ad d insurance to its members t states that providing this however the amounts derived from the sale of the products discussed herein were not included as income derived from unrelated_trade_or_business a insurance is an activity that is beyond the scope of services directly associated with members’ monetary deposits and loans made to members rather the provision of ad d insurance is a financial security activity that is offered to members under the terms of the ad d policy if the member has an accident that triggers a claim meeting the terms of the policy then the member or the member’s beneficiary receive specified insurance payments under the policy in the case of accidental death the member’s beneficiary would receive payments in the case of dismemberment the member would receive payments t markets and sells ad d insurance to its members under a policy issued by v t has offered the program since t makes its members aware of the purpose and availability of ad d insurance answers members’ questions about the product refers the member to v for additional information if it is needed and obtains and submits applications for coverage premium payment and claims t receives an administrative allowance for ad d insurance based on services provided by t the maximum reimbursement i sec_30 of gross premiums collected t has been unable to provide any information concerning the number of policies sold the number of claims nor percentage of member-borrowers that opted for such ad d coverage during and t has represented that it does not maintain records on this data and this information is not provided by the insurance_company b sale of members financial services program mfs program the mfs program is a financial services program that provides services sale of car warranties that t does not offer the mfs program is v’s direct response marketing program the mfs program authorizes v to offer insurance products to its members through a local representative product offers include mutual funds variable annuities fixed annuities variable universal life long term care insurance and term and whole_life_insurance v has a representative located at t and t supplies office space furniture equipment phone lines and marketing support pursuant to the agreement t made with v v pays a percentage of the new business_expense allowance dollars on all products offered by the mfs program the percentage varies based on the calendar year-to-date accumulated expense allowance for new business_expense allowance t is paid on the first dollar_figure on the next dollar_figure on the next dollar_figure and on excess over dollar_figure t is paid of the renewal expense allowance dollars the mfs program has been in existence since c t entered into an agreement with w the agreement provides that t would allow w to make its car warranty program a vailable to t’s members along with creating and disseminating marketing materials for w t provides w with office space on t’s premises to make the marketing materials and applications available to t’s membership during the new and used car loan process t’s employees offer w car warranties to members t’s employees explain to the member the benefits of purchasing a car warranty they explain the terms of the warranty they provide the member with brochures which assist in selling the warranty they compute the loan payment with and without warranty coverage finally they receive and forward warranty applications to w and assist members in obtaining warranty refunds sold approx mately of automobile loans during and of automobile loans during no loans were denied based on a member’s failure to purchase a car warranty d sale of gap insurance under the agreement w pays t for each warranty sold in t auto warranties and for sold warranties this equates to t makes gap insurance available to members who take out auto loans from the credit_union gap insurance covers any shortfall between the borrower’s regular auto insurance coverage and the balance of the loan on their automobile in the event of destruction of the vehicle serving as collateral for the loan the premium cost of the insurance coverage for the vehicle in question is charged to the member as part of the loan balance a loan officer informs each borrower of the availability of the gap insurance coverage when the members obtain their loans and credit_union personnel provide assistance with member claims obtaining the gap insurance coverage is not a condition of the member’s receiving the loan t receives payments from the insurance_company with respect to each borrower who elects gap insurance coverage based on the amount of premiums_paid by the borrower t’s reimbursement on gap insurance policies is per policy gap sale of credit life and credit disability insurance t offers its member borrowers the opportunity to purchase credit life and insurance has been offered since there were gap insurance policies sold in and sold in t was not able to provide information regarding number of claims made on these policies during the years at issue no member was ever denied a loan for failing to obtain gap insurance e credit disability insurance on certain loans t is a party to and beneficiary under standard group credit disability policies with a third party insurance_company under these policies a member-borrower who obtains a loan mortgages and other loans secured_by real_estate are often excluded may if he or she chooses obtain credit disability insurance which pays the loan installments during the period of physical disability which impacts the borrower’s employment a loan officer informs each member-borrower of the availability of credit life and credit disability insurance coverage and if the member-borrower elects to obtain the coverage the premium charge is added to the borrower’s loan balance obtaining the credit disability insurance coverage is never a condition of the member’s receiving the loan credit disability coverage is standard coverage that provides that the insurer will repay the balance of a member's loan up to a dollar_figure policy limit the maximum loan duration covered i sec_120 months and only credit_union members are eligible t does not offer credit disability insurance in connection with overdraft protection home equity loans and real_estate loans expenses in connection with its performance of the prescribed duties as the as reflected in the group credit insurance_policy and letter agreements the under the terms of the policy t is also reimbursed for its administrative policyholder t’s employees perform the following duties with respect to the credit disability insurance program during the loan process and as part of the loan transaction itself explain the insurance program to member-borrowers process insurance applications collect and forward the premiums to the insurance_company receive and forward claims claims can be filed directly by the member- borrower to the insurance_company and answer member-borrowers’ questions t's staff may recommend that the member opt to obtain coverage in situations where coverage appears beneficial based on the level of personal and family resources available for loan repayment in the event of disability the credit disability insurance coverage requires monthly premium payments the charges are calculated by t and added to the member's loan balance t remits the premiums it has collected less its expenses as noted above to the insurance_company t's commission for its role in coverage issuance and policy administration i sec_26 to percent of the premiums written for credit disability insurance this percentage is based on an agreement between t and the insurance_company at the time the insurance was purchased t pays bonuses to employees based on an amount per policy sold t does not maintain records regarding the percentage of members that opted for credit insurance during a given time period however at the end of there were credit disability policies and credit policies the total number of loans during this period was at the end of there were credit disability policies and credit life policies the total number of loans during this period was f insurance sale of group life health and cancer insurance and stand alone cancer t markets and sells life health and cancer insurance to its membership t collects and remits the premiums to an insurance_company life and health insurance commissions are of new premiums and of renewals for cancer insurance the commission is dollar_figure per policy the commission for the stand alone cancer insurance which is offered by a different insurance_company is of the gross premiums collected the group life health and cancer insurance has been offered since the 1950’s and the stand alone cancer insurance has been offered since t states that records are not available for the number of group life health and cancer insurance policies and stand alone cancer insurance policies actually sold during the years at issue these products are offered to the entire membership and have no direct relationship with the lending area g sale of checks t has an agreement with x whereby t agrees to market and or sell x’s checks to its members pursuant to the contract t agrees to use its best efforts to place orders for all of its members’ requirements for checks and check-related products x provides the base price of member’s checks and t debits members’ accounts for the cost of the checks t receives a commission of approximately dollar_figure per order t provides its membership with brochures and order forms and answers questions regarding x’s products t informs members that they can order checks directly from other vendors if a member inquires about purchasing checks from another company t states that it is an option available to the member a member can purchase checks directly from other vendors by mail phone or over the internet the commissions received by t for selling checks constituted less than one percent of t’s total gross_income check sales have been offered since law sec_501 of the internal_revenue_code code provides in part that organizations described in sec_501 are exempt from federal_income_tax sec_501 of the code specifically exempts from federal_income_tax credit unions without capital stock organized and operated for mutual purposes and without profit sec_1_501_c_14_-1 of the income_tax regulations regulations provides in part that credit unions other than federal credit unions described in sec_501 of the code without capital stock organized and operated for mutual purposes and without profit are exempt from tax under sec_501 state-chartered credit unions were first acknowledged as exempt from federal_income_tax in a opinion of the attorney_general the attorney_general considered credit unions organized under the laws of the commonwealth of massachusetts the attorney general’s opinion described the purposes of credit unions existing at that time i t is apparent that the purpose of these financial associations is to help people save and to assist those in need of financial help whose credit may not be established at the larger banks in reality they are fundamentally similar and supplemental to the existing agencies for promoting thrift namely the savings banks and cooperative banks except on a much smaller scale the attorney general’s opinion also described some of the operations of credit unions--making loans in appropriate amounts to members on which a low rate of interest is charged and that p rompt payment of obligations is a fundamental requirement the opinion described in detail the procedures by which members’ savings were held by the credit_union and how the members earned interest on their deposits the opinion also pointed to the democratic character of the governance of these early credit unions by their members at the annual meeting of the association each member shareholder and depositor has but one vote credit unions the attorney general’s opinion held that state-chartered credit unions would be exempt from federal_income_tax see u s op atty gen after review of the features and operations of these early massachusetts the legal analysis of the attorney general’s opinion was adopted in treasury regulations issued in and this remained the official basis for the tax exempt status of state -chartered credit unions until the revenue act of granted express statutory tax-exempt status to state -chartered credit unions however the revenue act of removed tax exemption from savings and loan associations cooperative banks and mutual_savings_banks the legislative_history of the act suggests that the reason these entities lost their exemption was because of their increasing similarity to commercial banks and the resulting loss of their original characteristic of mutuality specifically referring to the early days of these institutions the legislative_history states the fact that the members were both the borrowers and the lenders was the essence of the mutuality of these organizations see generally s rep no date reprinted in u s code cong ad svc present-day sec_501 - as enacted in - incorporates the requirements of mutuality and non-profit operation which formed the basis for the attorney general’s recognition of credit unions’ tax-exempt status in accordingly the basic purposes of the credit_union tax exemption remain essentially the same today as they were in based on the attorney general’s opinion the basis for exemption is the provision of savings accounts and loans to members who may not be served by banks in a non-profit and mutual manner sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations otherwise exempt from federal_income_tax under sec_501 sec_512 of the code provides that the term unrelated_business_taxable_income means with certain modifications the gross_income derived by an organization from any unrelated_trade_or_business regularly carried on by it less allowable deductions sec_513 of the code defines the term unrelated_trade_or_business in the case of any organization subject_to tax imposed by sec_511 as any trade_or_business the conduct of which is not substantially related aside from the need of such organization for the income or funds or the use it makes of the profits derived to the exercise or performance by such organization of its exempt_function sec_1_513-1 of the regulations provides that gross_income of an exempt_organization subject_to the tax imposed by sec_511 of the code is with certain exceptions includable in the computation of unrelated_business_taxable_income if it is income from trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization's performance of its exempt functions sec_1_513-1 of the regulations provides that the term trade_or_business has the same meaning it has in sec_162 of the code and generally includes any activity carried on for the production_of_income from the sale_of_goods or the performance of services sec_1_513-1 of the regulations states that in determining whether a trade_or_business is regularly carried on within the meaning of sec_512 of the code regard must be had to the frequency and continuity with which the activities are conducted and the manner in which they are pursued hence for example specific business activities will ordinarily be deemed regularly carried on if they manifest a frequency and continuity and are pursued in a manner generally similar to comparable commercial activities of nonexempt organizations sec_1_513-1 of the regulations provides that gross_income is derived from unrelated_trade_or_business within the meaning of sec_513 of the code if the conduct of the trade or b usiness which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities that generate the particular income in question - the activities that is of producing or distributing the goods or performing the services involved - and the accomplishment of the organization's exempt purposes sec_1_513-1 of the regulations provides that a trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has a causal relationship to the achievement of exempt purposes other than through the production_of_income and it is substantially related for purposes of sec_513 only if the causal relationship is a strong one thus for the conduct_of_a_trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those exempt purposes whether activities contribute importantly to an organization’s exempt purposes depends in each case upon the facts and circumstances involved in 693_f2d_525 5th cir a business league described in sec_501 of the code engaged in several activities including the endorsement of insurance to its members the court analyzed whether these activities were substantially related to the business league's exempt_purpose under sec_501 of advancing the credit_union movement in order to determine whether income generated from those activities resulted in unrelated_business_income to the business league in its analysis the court stated that the 'substantial relationship' determination is necessarily a fact- based inquiry id pincite the court also noted that the regulations under sec_513 require a case-by-case identification of the exempt_purpose an analysis of how the activity contributes to that purpose and an examination of the scale on which the activity is conduc ted the league promoted the purchase of insurance policies from a particular carrier providing the carrier with convenient services in the marketing and administration of its programs the court stated that the league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue the court also discussed at length the distinction between group and individual benefit the court said the distinction between inherently group benefits and individual benefits is analogous to the aggregate entity concept familiar in partnership_taxation just as a member of a partnership may enjoy benefits in his separate capacities as partner and non-partner so may a member of the league may enjoy benefits both as a league member and as an individual credit_union only those activities that benefit the credit unions in their capacities as league members can be considered substantially related to the league’s exempt_function this group benefit standard also accords with the requirement that a business league seek to improve the conditions of an entire line_of_business rather than perform discrete services for individuals see sec_1_501_c_6_-1 when the activities of a business league are directed toward the achievement of the common business_interest of its members the benefits that accrue to its members are inherently group benefits id pincite the court continued its analysis by stating that insurance endorsement and administration is not the sort of unique activity that satisfies the substantial relationship_test nor is its benefits group-related id pincite rather than merely advising members of the availability and desirability of insurance coverage to credit unions generally the league promoted the purchase of polices from a particular carrier the court affirmed the district court’s rationale that the league’s insurance activities did little more than generate revenue because the league’s endorsement was basically a fundraising activity it was by definition unrelated business activity under sec_513 id pincite therefore the court concluded that the league’s insurance activities were not substantially related to its tax-exempt purpose of advancing the credit_union movement rather the connection between the furtherance of the credit_union movement and the selling of insurance was at best tangential in 78_tc_246 aff’d 726_f2d_1097 6th cir the court held that promotional and administrative fees and an experience rating reserve refund received by a business league described in sec_501 of the code for promoting group_insurance programs for its members constituted unrelated_business_taxable_income under sec_512 in holding that the business league’s activities were not substantially related the court considered whether the league’s insurance activities contributed importantly to the league’s exempt_purpose of advancing the common business interests of independent insurance agents the court stated the burden is on the taxpayer to show that the challenged activities contribute directly and importantly to the improvement of conditions in a particular line_of_business the court noted that the petitioner’s insurance activities did little more than generate revenue for the association and provided members with a convenient and economical service in the operation of their agencies as such they stood in sharp contrast to petitioner’s educational and legislative activities which served the broader purpose of improving the general business environment in which insurance agents operated thus the court found petitioner’s activity of promoting insurance was not substantially related to its exempt_purpose in la caisse popu563_f2d_505 1st cir the government unsuccessfully challenged the exempt status under sec_501 of the code of an organization chartered as a credit_union by the state of new hampshire the government maintained that the organization was not exempt because it offered a wide variety of services typically offered by nonexempt full service banks and was therefore not organized or operated as a credit_union among these services were checking accounts mortgage loans banking by mail safe deposit boxes and a night depository this case focused solely on the taxpayer’s exemption under sec_501 and did not address the provisions of sec_511 through in 646_fsupp_1199 n d ala a credit_union described in sec_501 of the code offered cancer and group_life_insurance to its individual members the issue was whethe r commissions the credit_union received from servicing these particular types of insurance policies constituted unrelated_business_income under sec_512 the court did not reach the issue for jurisdictional reasons however it stated in a footnote that the petitioner would have lost on the merits of this issue because the policies benefited the insured without any reference to the member’s loans or accounts with the credit_union that court stated in dicta that cancer and group_life_insurance offered by a credit_union to its members would result in unrelated business table income for the following reasons petitioner earned commissions for servicing cancer and group_life_insurance policies these policies were for the express benefit of the ins ured without any reference to the member’s loans or accounts with the credit_union petitioner derived no benefit from the policies other than commission on the sale of said policies earned from the insurance_companies which issued the policies the sale of the cancer and group_life_insurance policies referred to had no substantial causal relationship to petitioner’s exempt purposes and the sale of the policies bore no relationship to petitioner’s function as a credit_union id pincite n revrul_69_282 1969_1_cb_155 provides that an organization must be formed and operated under the state law governing the formation of credit unions to qualify for exemption under sec_501 of the code as a state- chartered credit_union revrul_72_37 1972_1_cb_152 provides that to qualify as a credit_union_exempt from income_tax under sec_501 a of the code an organization must in addition to being formed and operated under a state credit_union law operate without profit and for the mutual benefit of its members the revenue_ruling clarified revrul_69_282 stating that a state charter is a threshold requirement for exemption but not the sole requirement revrul_60_228 1960_1_cb_200 interprets the substantially related requirement of sec_513 an organization exempt from federal_income_tax as an agricultural_organization described in sec_501 of the code promoted wider insurance coverage among its members and other local farmers including life casualty and fire insurance the insurance programs are provided by several insurance_companies but the organization’s administrative and secretarial staff is assigned to the work the organization receives an overall fee from the insurance_company for office and other services rendered them in connection with the insurance programs the revenue_ruling provides that a trade_or_business is substantially related to an organization’s exempt_activities if the principal purpose of the trade_or_business fur thers these exempt purposes however in this case such activities are not usually associated with the functions of an agricultural_organization and normally would not be carried on by such an organization in furtherance of its exempt purposes therefore these activities are not substantially related to the organization’s exempt purposes thus the income resulting from these activities is subject_to tax under sec_511 analysis in determining whether an income-producing activity is an unrelated_trade_or_business it is necessary to show that there is a trade_or_business the trade_or_business is regularly carried on and the conduct of the trade_or_business is not substantially related to the organization's exempt_purpose or function see sec_1_513-1 a of the regulations t has agreed that the activities at issue are trades_or_businesses that are regularly carried on therefore the sole issue is whether each activity is substantially related to the organization’s achievement of its exempt purposes gross_income is derived from an unrelated_trade_or_business if the conduct of the trade_or_business is not substantially related other than through production of funds to the purposes for which exemption is granted sec_1_513-1 of the regulations determination of the substantial relationship issue requires an examination of the relationship between the business activities which generate the particular income in question and the accomplishment of the organization’s exempt purposes id the regulations further state that for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes sec_1_513-1 of the regulations see also prof’l ins agents of michigan supra insurance activity was not substantially related because activity did little more than generate revenue and provide members with a service and did not further taxpayer’s exempt_purpose of improving business conditions and louisiana credit_union league supra league's endorsement of group_insurance plans was principally motivated by a desire to raise revenue and at best was only tangentially related to the furtherance of the league’s exempt_purpose of improving business conditions of one or more lines of business the court found the requisite substantial relationship lacking for t’s activities to escape taxation as unrelated_business_income the activities must contribute directly and importantly to the accomplishment of one or more of t’s exempt purposes-promotion of thrift and providing low cost credit for its members through mutual and nonprofit operation sec_1_513-1 of the regulations see also prof’l ins agents of michigan supra we address each of the activities below ad d insurance t argues that making ad d insurance available to members is substantially related to the credit union’s exempt_purpose of promoting thrift by providing basic financial protection to members on a mutual basis t also argues that ad d insurance facilitates prompt repayment of loans on a mutual basis by protecting the individual member’s financial security the facts do not show how t’s sales of ad d insurance contribute directly and importantly to t’s exempt purposes t has not demonstrated that sales of ad d insurance encourage savings by members who purchase it t has also not provided information showing that the sale of ad d insurance aids a member in obtaining credit or reduces the cost of providing credit to members the facts do not demonstrate that the sale of ad d insurance to individual members advances t’s mutual operation ad d insurance provides a financial protection to an individual the individual’s purchase of the ad d insurance does not provide a benefit to the members as a whole the legislative_history of sec_501 of the code indicates that mutuality is tied to the same members being the borrowers and lenders in loan transactions rather than the general principles that t espouses s rep no date t has not stated how the sale of ad d insurance to an individual provides a mutual benefit to t members the facts also do not show how sale of ad d insurance benefits the members of the credit_union as a whole a member may purchase ad d insurance without obtaining credit or a loan from t if a member of t receives accidental dismemberment insurance payments the member may use the insurance payments as he or she wishes rather than saving them or paying off an obligation to t in the case of accidental death the member’s beneficiary may or may not be a member of t and also may use the payments as he or she desires in alabama central credit_union supra the court stated in dicta several factors cited above relevant to the substantially related inquiry in this case t earns commissions for servicing ad d insurance policies sells policies for the express benefit of the insured without any reference to the member’s loans or accounts with the credit_union derives no benefit from the policies other than commission on the sale of the policies earned from the insurance_companies which issued the policies the sale of the insurance policies referred to has no substantial causal relationship to t’s exempt purposes and the sale of the policies bears no relationship to t’s function as a credit_union based on all of the facts and circumstances t’s activities with respect to the sale of ad d insurance do not contribute importantly to accomplishing t’s exempt purposes the ad d insurance sold benefits an individual and t receives no benefit other than the production_of_income therefore the sale of ad d insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to unrelated_business_income_tax ubit mfs program t argues that because y’s direct response marketing program the mfs program furthers the mutual operations required of credit unions the income resulting therefrom is not subject_to ubit t argues that the provision of mfs program products contributes importantly to the credit union’s exempt_purpose of promoting thrift and providing basic financial protection to members on a mutual basis t also argues the products enhance the core repayment principal of the credit_union movement the facts do not show how sales pursuant to the mfs program contribute directly and importantly to t’s exempt_purpose t does not state how the sale of products pursuant to the mfs program provides a mutual benefit to t’s members t has not shown that sales of products pursuant to the mfs program encourage savings by members who purchase it the mfs program does not provide any incentive or support for saving nor does it aid a member in seeking and obtaining a loan there are no facts showing that the sale of products pursuant to the mfs program has reduced the cost of providing credit to all members or benefited the membership as a whole in any way again a member’s purchase of a product pursuant to the mfs program provides financial protection to an individual that does not benefit members as a whole other than through the production_of_income elements of the agreement by t and y are also indicative of the motivating goals of t for instance y obtained a covenant_not_to_compete clause e nsuring that no other company would offer the same type of products to t’s members if t was truly concerned with enhancing the core repayment principal of the credit_union it would offer insurance from all companies to its members so that its members would have the largest selection of benefits and costs applying the factors of alabama central credit_union supra t earns commissions for offering the mfs program sells policies for the express benefit of the insured without any reference to the member’s loans or accounts with the credit_union derives no benefit from the policies other tha n commission on the sale of the policies earned from the insurance_companies that issued the policies the sale of the insurance policies referred to has no substantial causal relationship to t’s exempt purposes and the sale of the policies bears no relationship to t’s function as a credit_union t did not provide information regarding number of products sold pursuant to the mfs program for either or based on all of the facts and circumstances t’s activities with respect to the sale of products pursuant to the mfs program do not contribute importantly to accomplishing t’s exempt purposes the facts do not show how the sale of such products contributes to t’s exempt purposes of promoting thrift and providing low cost credit the sale of products pursuant to the mfs program does little more than produce income for t therefore the sale of products pursuant to the mfs program is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit car warranties t argues that making car warranties available to members is substantially related to what it believes is the credit union’s tax-exempt purpose of providing basic financial protection to members on a mutual basis in addition t contends that in the case of warranties for automobiles serving as collateral for a credit_union loan the warranty protection contributes importantly to the underlying loan transaction and facilitates repayment the facts do not show how the sales of car warranties contribute directly and importantly to t’s exempt purposes t has not shown that car warranties encourage savings by members who have availed themselves of those programs there are no facts showing that the purchase of a car warranty has reduced the cost of providing credit to all members or benefited the membership as a whole in any way again the car warranties provide a financial benefit or financial protection to an individual that does not benefit the members as a whole other than through the production_of_income the car warranties do not provide any incentive or support for saving nor does it aid a member in seeking and obtaining a loan regarding prompt repayment of loans a car warranty is not tied to the individual’s loan it can be purchased with or without the extension of credit by t the facts provided by t show that the purchase of a car warranty from t in connection with a loan increases the amount of the loan payment for the individual purchaser even if a car warranty is purchased in connection with a loan from t the warranty merely pays for certain car repairs for an individual’s car it does nothing to further the credit union’s exempt_purpose of promoting thrift and providing access to credit applying the factors of alabama central credit_union supra t earns fees for selling car warranties the car warranties are for the express benefit of the individual car buyer or insurance without any reference to the member’s loans or accounts with the credit_union derives no benefit from the car warranties earned from the company that provided the car warranties the car warranties referred to have no substantial causal relationship to petitioner’s exempt purposes and the car warranties bear no relationship to t’s function as a credit_union the car warranties do not contribute importantly to t’s exempt purposes therefore the car warranties are not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit based on all of the facts and circumstances t’s activities with respect to gap insurance t argues that because gap insurance furthers the mutual operations required of exempt credit unions the income resulting therefrom is not subject_to tax under sec_511 of the code t further states the provision of gap insurance contributes importantly to the credit union’s exempt_purpose of extending credit to members fostering the savings of members and otherwise providing financial services to members in a mutual fashion t argues that gap insurance becomes an integral part of the loan transaction and eases the financial burden on the credit union’s members when the property covered by a loan requires repair or replacement t notes that this insurance protects the credit union’s savers as a whole by lessening the likelihood that a loan secured_by that property will go into default and have to be made good from the members’ accumulated savings the facts do not show how sales of gap insurance contribute directly and importantly to accomplishing t’s exempt purposes the facts do not show that availability of the gap insurance encourages savings or increases the availability of low cost credit the purchase of gap insurance is not required for approval of a car loan t already requires that a borrower member have basic insurance protection on a vehicle that is collateral for a car loan while gap insurance covers any shortfall between the borrower’s regular auto insurance coverage and the balance of the car loan in the event the vehicle is destroyed the member decides whether to purchase gap insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member t has not presented facts that show how its members benefit as a whole from the gap insurance sales other than through the production_of_income applying the factors of alabama central credit_union supra t earns commissions for providing gap insurance sells insurance for the express benefit of the insured albeit with reference to a member’s loan with the credit_union derives some benefit from the gap insurance but the primary benefit is the commission on the sale of the insurance earned from the company that provided the insurance the insurance referred to has no substantial causal relationship to t’s exempt purposes and the insurance bears no relationship to t’s function as a credit_union based on all of the facts and circumstances t’s activities with respect to the sale of gap insurance do not contribute importantly to t’s exempt purposes therefore the sale of gap insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit credit life and credit disability insurance t argues that the sale of credit life and credit disability insurance is directly related to the credit union’s specific exempt purposes of fostering thrift among the members including both the extension of credit to members on reasonable terms and encouraging savings among the members and providing services to members on a mutual basis t further maintains that credit insurance which is an integral part of a member loan transaction is a mechanism for assuring the prompt repayment of debts in situations where the financial resources of the borrower and the borrower’s family become strained as a result of disability the facts do not show how sales of credit life and credit disability insurance contribute directly and importantly to accomplishing t’s exempt purposes credit life and credit disability insurance are not required for the approval of a loan in fact credit life and credit disability insurance are not available to members on certain types of loans such as mortgage and other real_estate loans the member decides whether to purchase credit life and or disability insurance based on his or her own assessment of whether the insurance will provide a benefit to that individual member the individual member benefits in that the member need not worry about paying a loan to t in the event of disability while there is also a benefit to the credit_union as the beneficiary the facts do not show how the sale of credit life and credit disability insurance otherwise contributes importantly and directly to accomplishing t’s exempt purposes other than through the production_of_income availability of credit disability insurance does not encourage savings or assist t in offering low cost credit t does not take into consideration the need for this insurance by members t performs no studies to determine which members may need credit disability insurance and there is no required corresponding counseling to members who may have more need than others although t’s staff may recommend insurance based on the level of personal and family resources these recommendations are not mandatory in specific cases and coverage is not required in these cases additionally t’s arguments do not address the fact that bonuses are paid to employees based on the number of policies sold providing a profit-motive incentive to t’s employees rather than a membership benefit as a whole in addition t’s commissions are high ranging from to percent of premiums_paid applying the factors of alabama central credit_union supra t earns commissions for providing credit life and credit disability insurance sells policies for the express benefit of the insured albeit with reference to a member’s loan with the credit_union derives some benefit from the credit life and credit disability insurance but the primary benefit is production_of_income both through the commission on the sale of the insurance earned and the bonuses paid to t employees the insurance referred to has no substantial causal relationship to t’s exempt purposes and the insurance bears no relationship to t’s function as a credit_union looking at the facts with respect to credit life and credit disability insurance the sale of credit insurance is not substantially related to t’s exempt purposes the available information indicates that the sale of insurance is primarily for the purpose of generating income to t and some of its employees and for the benefit of the insured rather than for the benefit of t’s membership based on all of the facts and circumstances t’s activities with respect to the sale of credit life and credit disability insurance do not contribute importantly to accomplishing t’s exempt purposes therefore the sale of credit life and credit disability insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit group life health and cancer insurance and stand alone cancer insurance t argues that the sale of group life health and cancer insurance and stand alone cancer insurance to members is substantially related to its exempt_purpose of promoting thrift because it provides basic financial protection to members on a mutual basis t further argues that making cancer insurance available to protect t’s members against the potential financial and personal ravages associated with a life-threatening disease contributes importantly to the promotion of thrift and facilitation of prompt repayment of loans on a mutual basis by protecting members’ financial security the facts do not show how sales of group life health and cancer insurance and stand alone cancer insurance contribute directly and importantly to t’s exempt_purpose t does not state how the sale of group life health and cancer insurance and stand alone cancer insurance provides a mutual benefit to t’s members t has not shown that sales of group life health and cancer insurance and stand alone cancer insurance encourage savings by members who purchase it the insurance does not provide any incentive or support for saving nor does it aid a member in seeking and obtaining a loan there are no facts showing that sale of such insurance has reduced the cost of providing credit to all members or benefited the membership as a whole in any way again a member’s purchase of group life health and cancer insurance and stand alone cancer insurance provides financial protection to an individual that does not benefit members as a whole other than through the production_of_income regarding prompt repayment of loans the facts do not show how group life health and cancer insurance and stand alone cancer insurance contribute to the individual member’s repayment of loans a member who has group life health and cancer insurance and stand alone cancer insurance may not even have a loan through t if a member of t receives insurance payments the member may spend the insurance payments as he or she wishes rather than saving them or paying off an obligation to t in the case of a beneficiary the beneficiary may or may not be a member of t and is also free to spend the payments as he or she desires applying the factors of alabama central credit_union supra t earns commissions for servicing the group life health and cancer insurance and stand alone cancer insurance policies sells policies for the express benefit of the insured without any reference to the member’s loans or accounts with the credit_union derives no benefit from the policies other than commission on the sale of the policies earned from the insurance_companies that issued the policies the sale of the insurance policies referred to has no substantial causal relationship to t’s exempt purposes and the sale of the policies bears no relationship to t’s function as a credit_union based on all of the facts and circumstances t’s activities with respect to the sale of group life health and cancer insurance and stand alone cancer insurance do not contribute importantly to accomplishing t’s exempt purposes the facts do not show how the sale of group life health and cancer insurance and stand alone cancer insurance contributes to t’s exempt purposes of promoting thrift and providing low cost credit the sale of group life health and cancer insurance and stand alone cancer insurance does little more than produce income for t therefore the sale of group life health and cancer insurance and stand alone cancer insurance is not substantially related to t’s exempt purposes and amounts received therefrom are subject_to ubit check sales conclusion because the sale of checks furthers t’s exempt purposes the income resulting therefrom is not subject_to ubit checks allow members access to their funds held on deposit accepting member funds for deposit including allowing the members access to those funds is obviously a critical and central exempt_function of a credit_union therefore the sale of checks to t member- borrowers is substantially related to t’s exempt purposes for reasons set forth above we conclude that the income received by a sec_501 credit_union from the activities listed below are not substantially related to the furtherance of t’s exempt purposes and therefore are subject_to ubit a b c d e f sale of ad d insurance sale of members financial management services sale of car warranties sale of gap insurance sale of credit life and credit disability insurance sale of group life health and cancer insurance and stand alone cancer insurance we also conclude the sale of checks by t to its members is substantially related to the furtherance of t’s exempt purposes and therefore is not subject_to ubit taxpayer sec_6110 of the code provides that it may not be used or cited as precedent a copy of this technical_advice_memorandum is to be given to the - end -


t c memo united_states tax_court luis alejandro rey petitioner v commissioner of internal revenue respondent docket no date luis alejandro rey pro_se william j gregg and maria f di miceli for respondent memorandum findings_of_fact and opinion lauber judge with respect to petitioner’s federal_income_tax for the internal_revenue_service irs or respondent determined a tax_deficiency of dollar_figure a late-filing addition_to_tax of dollar_figure under sec_6651 and an accuracy-related_penalty of dollar_figure under sec_6662 after concessions the sole issue for decision is whether the irs properly determined omissions from petitioner’s gross_income by use of a bank_deposits analysis with certain exceptions noted below we will sustain respondent’s determinations findings_of_fact the parties submitted a stipulation of facts at trial we incorporate that stipulation and the attached exhibits by this reference petitioner resided in vir- ginia when he filed his petition during petitioner worked as a consultant for the inter-american de- velopment bank iadb performing computer-related services his work entailed some foreign_travel for example to iadb meetings overseas he maintained with the iadb credit_union several accounts which formed the basis for respondent’s bank_deposits analysis during petitioner also had a virginia real_estate license and received in connection with his real_estate activity income of dollar_figure which was reported by the payors on three forms 1099-misc miscellaneous income unless otherwise indicated all statutory references are to the internal_revenue_code as amended and in effect for the taxable_year in issue and all rule references are to the tax_court rules_of_practice and procedure we round all monetary amounts to the nearest dollar petitioner filed his form_1040 u s individual_income_tax_return as mar- ried filing separately he received an extension of time until date to file that return because that day was a saturday petitioner’s return was due for filing on monday october he filed the return on date one week late petitioner attached to his form_1040 a schedule c profit or loss from business reporting income and expenses from his consulting business he report- ed gross_receipts of dollar_figure and total expenses of dollar_figure thus showing a net profit of dollar_figure upon examination of that return the irs allowed deductions in the aggregate amount of dollar_figure for legal and professional fees taxes and licen- ses travel meals and home_office expense the irs disallowed for lack of sub- stantiation deductions in the aggregate amount of dollar_figure for returns and allow- ances office expense repairs and maintenance and supplies petitioner produced no substantiation for any of the latter expenses and conceded at trial that the irs had correctly disallowed schedule c expenses in the amount of dollar_figure the irs determined that petitioner had engaged in a separate schedule c-2 business as a real_estate_professional in which he had earned a net profit of dollar_figure the aggregate amount reported on the forms 1099-misc petitioner conceded at trial that he had earned_taxable_income in that amount from his real_estate activity during the irs determined that petitioner was liable for a late-filing addition_to_tax under sec_6651 and an accuracy-related_penalty under sec_6662 petitioner conceded at trial that he was liable for both the only subject of dispute at trial concerned unreported income from peti- tioner’s consulting business the notice_of_deficiency determined on the basis of the revenue agent’s bank_deposits analysis that petitioner had omitted dollar_figure of income from this business petitioner contended that certain of the deposits the agent treated as taxable should have been excluded as nontaxable at the close of trial the court ordered one round of seriatim briefs respon- dent timely filed his brief on date petitioner did not file a post-trial brief the revenue_agent determined omitted income of dollar_figure overall but because the agent allocated dollar_figure of this sum to petitioner’s schedule c-2 real_estate business the omitted income allocable to petitioner’s schedule c-1 con- sulting business was reduced to dollar_figure when a party fails to file a brief on issues that have been tried we may consider those issues waived or conceded see eg 117_tc_117 n 84_tc_693 aff’d without published opinion 789_f2d_917 4th cir we will exercise our discretion not to do so here opinion i burden_of_proof the irs’ determinations in a notice_of_deficiency are generally presumed correct rule a 290_us_111 the u s court_of_appeals for the fourth circuit the appellate venue here absent stipula- tion to the contrary has held that the usual presumption of correctness applies in omitted-income cases where the irs employs a reasonable method of determin- ing income such as the bank_deposits method 999_f2d_760 4th cir aff’g tcmemo_1992_153 other courts have required the commissioner in unreported income cases to establish a minimal evidentiary showing connecting the taxpayer with the income-producing activity 994_f2d_1542 11th cir aff’g tcmemo_1991_636 if that threshold showing were required here respondent met it by introducing bank records establishing that petitioner received as he concedes unreported income from his consulting business petitioner thus bears the burden of proving by a preponderance_of_the_evidence that respondent’s determinations are arbitrary or erroneous see williams f 2d pincite citing 293_us_507 87_tc_74 ii analysis sec_61 defines gross_income as all income from whatever source de- rived including income derived from business a taxpayer must maintain books_and_records establishing the amount of his or her gross_income see sec_6001 when a taxpayer does not keep accurate books of account the irs may determine his income under such method as in the opinion of the secretary does clearly reflect income sec_446 see 92_tc_661 and where the taxpayer has unexplained bank_deposits the irs may em- ploy the bank_deposits method to estimate his income estate of 132_f2d_775 2d cir aff’g 45_bta_104 64_tc_651 aff’d 566_f2d_2 6th cir the irs has great latitude in reconstructing a taxpayer’s income and the reconstruction need only be reasonable in light of all surrounding facts and cir- cumstances petzoldt t c pincite bank_deposits are prima facie evidence of income the bank_deposits meth- od starts with the presumption that all money deposited in a taxpayer’s bank ac- count during a given period constitutes taxable_income 335_f2d_671 5th cir this presumption is rebutted to the extent the deposits are shown to include nontaxable amounts and the government must take into account any non-taxable source of which it has knowledge ibid 96_tc_858 aff’d 959_f2d_16 2d cir after the irs reconstructs a taxpayer’s income and determines a deficiency the taxpayer bears the burden of proving that the irs’ implementation of the bank_deposits analysis was unfair or inaccurate see 102_tc_632 dileo t c pincite the taxpayer may do so by showing among other things that certain deposits came from nontaxable sources see clayton t c pincite nontaxable sources include funds attributable to inter-account bank transfers and returned checks as well as loans gifts inheri- tances or assets on hand at the beginning of the taxable_period 69_tc_729 ndollar_figure quoting troncelliti v commissioner t c memo the revenue_agent employed the bank_deposits method to reconstruct peti- tioner’s income he used petitioner’s account statements which are part of the record to prepare schedules listing all deposits after eliminating nontaxable receipts of which he had knowledge the revenue_agent prepared and provided to petitioner schedules that initially determined unreported income in excess of dollar_figure in response petitioner provided the revenue_agent with a spreadsheet listing dollar_figure of alleged nontaxable deposits this list which was included in the revenue agent’s report comprised inter-account transfers of dollar_figure a returned check of dollar_figure an alleged loan of dollar_figure from a coworker and an alleged loan of dollar_figure from new york life the revenue_agent agreed that all of these de- posits with the exception of the dollar_figure item should be treated as nontaxable and revised his bank_deposits analysis accordingly this reduced the unreported in- come from petitioner’s schedule c-1 consulting business to dollar_figure petitioner subsequently supplied the revenue_agent with a revised spread- sheet listing dollar_figure of alleged nontaxable deposits this list which was intro- duced into evidence at trial was substantially identical to the previous list except that it included two additional items a deposit of dollar_figure which petitioner alleged was a transfer from coworker account and a deposit of dollar_figure which petitioner alleged was per_diem paid_by iadb for overseas expenses the revenue_agent declined for lack of substantiation to treat either of these additional items as a nontaxable deposit at trial petitioner did not identify or provide any evidence concerning any other deposits that he alleged to be nontaxable respondent conceded during trial that petitioner had supplied enough documentation concerning the loan from new york life to treat this dollar_figure deposit as nontaxable and respondent con- ceded in his opening brief that petitioner’s unreported income should be reduced by dollar_figure because the deposit to which petitioner refers had been counted twice this leaves the proper treatment of the dollar_figure deposit as the only issue for this court to decide petitioner contends that this sum constituted reimbursement from iadb for expenses he incurred during overseas travel we agree with re- spondent that petitioner did not carry his burden_of_proof he produced no evi- dence concerning iadb’s reimbursement policy no evidence that the dollar_figure constituted reimbursement and no evidence substantiating that he incurred dollar_figure of expenses to which the alleged reimbursement corresponded we accordingly find that petitioner received during unreported income from his schedule c-1 consulting business of dollar_figure that is dollar_figure as deter- mined in the notice_of_deficiency minus dollar_figure dollar_figure on the basis of peti- tioner’s concessions we sustain respondent’s other adjustments to hi sec_2010 in- come and expenses and conclude that he is liable for a late-filing addition_to_tax and an accuracy-related_penalty in amounts to be determined to reflect the foregoing decision will be entered under rule


t c memo united_states tax_court andrea cipriano petitioner v commissioner of internal revenue respondent docket no filed date andrea cipriano pro_se leon st laurent for respondent memorandum findings_of_fact and opinion swift judge for and respondent determined deficiencies in petitioner’s federal income taxes and accuracy- related penalties as follows accuracy-related_penalty year deficiency sec_6662 a dollar_figure s big_number big_number - - after settlement of some issues the primary issue for decision is whether certain amounts petitioner received in connection with a division of marital property constitute taxable interest_income unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are so found at the time the petition was filed petitioner resided in basking ridge new jersey petitioner is well educated in petitioner received a bachelor of arts degree in teaching from william paterson college in petitioner received a masters degree in business administration from fairleigh dickenson university since petitioner has been employed as a revenue_agent for respondent petitioner also is a certified_public_accountant and teaches accounting and tax courses part time at ramapo college petitioner’s ex-spouse is an attorney and maintains a law practice in new jersey on date petitioner and her ex-spouse divorced and entered into a property settlement agreement the agreement under the terms of the agreement petitioner was entitled to receive dollar_figure representing the value of her share of the marital assets under the agreement of the total dollar_figure petitioner was to receive dollar_figure in cash immediately after the divorce and petitioner was to receive the remaining dollar_figure through a series of annual installments of dollar_figure plus interest of percent per year on the unpaid balance to secure payment of the installment payments that were due petitioner received a mortgage on real_estate owned by petitioner’s ex-spouse the language from the agreement relating to the mortgage stated as follows a mortgage in the amount of dollar_figure shall be recorded against the real_estate which mortgage shall bear interest at the rate of and shall be paid in annual installments of dollar_figure plus all accrued interest over a period of five years each payment falling due on the anniversary date of this agreement under the agreement petitioner’s ex-spouse was also liable for all attorney’s fees incurred by petitioner in enforcing payment of amounts due under the agreement as part of the property settlement agreement petitioner and her ex-spouse each agreed to relinquish any rights they then owned in property held by the other spouse q4e- in late march of shortly after the divorce petitioner received the dollar_figure cash payment that was due under the agreement in march of however petitioner did not receive the first dollar_figure installment_payment due from her ex-spouse petitioner then requested the superior court of new jersey chancery division of monmouth county to issue an order compelling petitioner’s ex-spouse to pay petitioner this delinguent dollar_figure installment_payment plus interest and attorney’s fees pursuant to a date court order petitioner received from her ex- spouse dollar_figure of which dollar_figure was denominated as principal dollar_figure was denominated as attorney’s fees and the remaining dollar_figure was denominated as accrued interest the dollar_figure installment payments due from petitioner’s ex- spouse in each of and plus amounts denominated as accrued interest were received by petitioner as due in summary petitioner received the following payments from her ex-spouse under the property settlement amounts denominated amounts denominated year as principal as interest dollar_figure s --0o- big_number big_number big_number big_number big_number not shown in the schedule is the dollar_figure that was denominated as attorney’s fees that petitioner received in - - the record does not reflect whether or when petitioner received the installment payments that were due from her ex-spouse under the agreement in and on her and timely filed federal_income_tax returns petitioner did not report as interest_income any of the above payments received from her ex-spouse by letter dated date respondent notified petitioner that respondent wished to examine petitioner’s and federal_income_tax returns in the letter respondent proposed a meeting for date between respondent’s audit representative and petitioner relating to petitioner’s and federal income taxes at petitioner’s request the meeting was held on date in parsippany new jersey the location of petitioner’s employment petitioner and respondent’s audit representative met again in august of to discuss petitioner’s and federal income taxes during that meeting petitioner and respondent’s representative failed to reach an agreement on various adjustments that had been raised after this meeting in august of or thereafter petitioner’s federal_income_tax return was opened for examination by respondent another meeting was scheduled for date between petitioner and respondent’s audit representative to discuss further petitioner’s and federal income taxes and to discuss petitioner’s - - federal_income_tax petitioner however failed to attend this meeting on date respondent mailed to petitioner a notice_of_deficiency regarding petitioner’s and federal income taxes in the notice_of_deficiency sent to petitioner for and respondent determined that petitioner failed to report as taxable_income on her respective federal_income_tax returns the above dollar_figure and dollar_figure payments that petitioner received from her ex-spouse in and that were denominated as interest in the petition filed with this court petitioner raised as a new issue a claimed ordinary deduction in the amount of dollar_figure for expenses relating to attorney accountant and appraiser fees allegedly incurred in connection with her divorce the division of marital property and the installment payments petitioner does not indicate whether the dollar_figure should be deducted in or in or how the expenses should be allocated between and the record does not explain the dollar_figure variance in amounts denominated as interest by the superior court of new jersey chancery division of monmouth county and by respondent in the notice_of_deficiency the record does not reflect whether respondent mailed to petitioner a statutory_notice_of_deficiency regarding petitioner’s federal_income_tax - jj - opinion generally the burden_of_proof is on the taxpayer see rule a in however congress enacted sec_7491 effective date under which the burden_of_proof will be placed on respondent if a taxpayer meets certain requirements see internal_revenue_service restructuring and reform act of rra publaw_105_206 sec 112_stat_685 under sec_7491 the burden_of_proof with regard to any fact issue will be placed on respondent if the taxpayer maintained adequate_records satisfied applicable substantiation requirements cooperated with respondent and introduced during the court_proceeding credible_evidence with regard to the fact issue the specific relevant language of sec_7491 provides as follows sec_7491 burden_of_proof a burden shifts where taxpayer produces credible_evidence --- general_rule --if in any court_proceeding a taxpayer introduces credible_evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any_tax imposed by subtitle a or b the secretary shall have the burden_of_proof with respect to such issue limitations ---paragraph shall apply with respect to an issue only if-- --- - a the taxpayer has complied with the requirements under this title to substantiate any item b the taxpayer has maintained all records required under this title and has cooperated with reasonable requests by the secretary for witnesses information documents meetings and interviews the legislative_history of sec_7491 makes it clear that before the burden_of_proof will be placed on respondent taxpayers have the burden of proving that they satisfied each of the above requirements of sec_7491 the legislative_history states as follows the taxpayer has the burden of proving that it meets each of these conditions because they are necessary preregquisites to establishing that the burden_of_proof is on the secretary h conf rept pincite 1998_3_cb_747 a shift in the burden_of_proof under sec_7491 is available only in court proceedings arising in connection with examinations by respondent that commenced after date the effective date of sec_7491 see rra sec c 112_stat_727 for because respondent’s examination of petitioner’s federal_income_tax commenced in august of or thereafter it is clear that sec_7491 generally applies to petitioner petitioner contends that for she has met the --- - requirements of sec_7491 and that the burden_of_proof is on respondent on the issue as to the treatment of the dollar_figure denominated as interest for respondent contends that petitioner did not meet the requirements of sec_7491 and therefore that the burden_of_proof remains with petitioner among other things respondent notes that during the examination petitioner failed to attend the scheduled date meeting the only scheduled meeting regarding petitioner’s federal_income_tax for petitioner contends that respondent’s date letter was inadequate and defective to commence on date respondent’s examination of petitioner’s tax petitioner therefore argues that respondent’s examination for did not commence before date the date of the actual meeting between petitioner and respondent’s representative petitioner also claims that respondent has not provided evidence to prove when respondent’s date letter was actually mailed to petitioner petitioner does not specifically claim to have received that letter after date the effective date of sec_7491 based on the above petitioner argues that respondent’s examination of petitioner for commenced after date that sec_7491 is therefore generally applicable and that -- - thereunder the burden_of_proof is on respondent as to the treatment of the dollar_figure denominated as interest respondent argues that the letter to petitioner dated date was mailed on that date that the letter effectively commenced on that date the examination of petitioner’s federal_income_tax days prior to the effective date of sec_7491 and therefore that for the burden_of_proof is on petitioner neither the code nor the regulations define when an examination will be regarded as having commenced for purposes of sec_7491 respondent points us to the legislative_history of sec_7491 and to revproc_97_27 1997_1_cb_680 the legislative_history explains the following with regard to what constitutes an examination for purposes of sec_7491 an audit is not the only event that would be considered an examination for purposes of this provision for example the matching of an information_return against amounts reported on a tax_return is intended to be an examination for purposes of this provision similarly the review of a claim_for_refund prior to issuing that refund is also intended to be an examination for purposes of this provision h conf rept supra pincite c b pincite in revproc_97_27 c b pincite for purposes of a change in accounting_method under sec_481 respondent takes the position that any contact by respondent to schedule an examination is sufficient to commence an examination revproc_97_27 supra states as follows an examination of a taxpayer with respect to a federal_income_tax return begins on the date the taxpayer is contacted in any manner by a representative of the service for the purpose of scheduling any type of examination of the return id emphasis added respondent argues that the above examples suggest that an examination may occur without a personal meeting between respondent’s representative and the taxpayer or the taxpayer’s representative focusing on the facts before us in this case we do not believe that the character of the amounts in dispute for both and need be resolved on the basis of the burden_of_proof in spite of the extensive arguments of the parties in their briefs regarding the burden_of_proof in this case for both and as set forth below we conclude that the evidence establishes that the amounts petitioner received that were denominated as interest in fact constituted interest_income for federal_income_tax purposes we so hold and we decline to resolve the parties’ many arguments regarding the commencement of respondent’s examination regarding the applicability of sec_7491 and regarding petitioner’s qualification under the various requirements of sec_7491 gross_income includes all income from whatever source derived see sec 6l1 a interest received is specifically included within the definition of gross_income see sec_61 generally any portion of a judgment that compensates taxpayers for delay in receipt of money constitutes interest_income and is taxable as such see 317_us_399 petitioner contends that the portions of the installment payments received from her ex-spouse in and that were denominated as interest namely dollar_figure and dollar_figure respectively represented postdivorce appreciation in the value of her ex-spouse’s law practice and that these amounts should be treated as nontaxable transfers under sec_1041 to the contrary it is clear that the above amounts compensated petitioner for delay in the receipt of the marital assets to which petitioner was entitled as of the day of the divorce the amounts received are consistent with the 5-percent interest rate specified in the agreement ’ the dollar_figure and the dollar_figure that petitioner received in and constitute interest_income ‘ assuming that the installment payments were paid on time each year the approximate interest to be received each year by petitioner on dollar_figure payable in annual installments of dollar_figure would be dollar_figure in year dollar_figure in year dollar_figure in year dollar_figure in year and dollar_figure in year we now turn to petitioner’s claim that she is entitled to an additional dollar_figure deduction or some part thereof for fees paid to attorneys accountants and appraisers the parties herein make no argument as to the placement of the burden_of_proof nor as to how sec_7491 applies if at all to a new issue in general attorney’s fees and other expenses relating to a divorce represent personal expenses and are nondeductible to either spouse see 372_us_39 a deduction under sec_212 however may be allowed for expenses_incurred for the production_or_collection_of_income such as expenses relating to the right to receive interest_income the evidence in support of the dollar_figure paid to attorneys accountants and appraisers does not indicate the date the fees were actually paid_by petitioner from the invoices provided by petitioner it appears that most of the bills were paid_by petitioner before the years in dispute furthermore the invoices that do relate to and fail to differentiate between amounts paid in connection with petitioner’s divorce and amounts paid if any to obtain the receipt of interest_income for and no part of the claimed dollar_figure is deductible by petitioner sec_6662 imposes a penalty of percent on the portion of an underpayment_of_tax attributable to negligence or to disregard of rules and regulations for purposes of sec_6662 negligence consists of a failure to make a reasonable attempt to comply with the code see sec_6662 accuracy-related_penalties under sec_6662 do not apply to any part of an underpayment if the taxpayer shows reasonable_cause and if the taxpayer acted in good_faith see sec_6664 whether a taxpayer acted with reasonable_cause and in good_faith is ascertained on a case-by-case basis taking into account all of the pertinent facts and circumstances see sec_1_6664-4 b income_tax regs circumstances that may establish reasonable_cause and good_faith include an honest misunderstanding of fact or law that is reasonable in light of the experience knowledge and education of the taxpayer see id with regard to the penalties under sec_6662 for and the parties make no argument regarding the burden_of_proof or the burden of production see sec_7491 because of petitioner’s education and professional experience and because the agreement adequately identified the payments in question as interest petitioner knew or should have known that the payments constituted interest_income and were includable in her federal_income_tax returns we conclude that petitioner is liable for the accuracy- related penalties to reflect the foregoing decision will be entered under rule


internal_revenue_service number info 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 genin-129753-05 date date dear -------------- this letter responds to your inquiry postmarked date regarding a late election under subchapter_s for the ------- taxable_year automatic relief for your election is unavailable pursuant to revproc_2003_43 because your -------- tax_return form_1120s was filed after six months of the due_date in order to apply for relief for a late s_corporation_election you must request a private_letter_ruling plr from the national_office the procedures for requesting a plr are set forth in revproc_2005_1 copy enclosed the standard user_fee for a plr request is dollar_figure however if your entity’s gross_income was less than dollar_figure million for the tax period you may pay the reduced user_fee in the amount of dollar_figure in order for the lower fee to be accepted your plr submission must include a brief statement verifying your entity’s gross_income for the taxable_year if you decide to submit a formal request for a plr please follow the sample format shown in appendix b of revproc_2005_1 your request must include the required procedural statements a user_fee check and documents that substantiate your intent to elect s_corporation status please refer your ruling_request to the following address attn cc pa t p o box ben franklin station washington dc direct to cc psi incidentally the irs has developed two compact discs to help educate small_business owners on their tax responsibilities publication introduction to federal taxes for small_business self-employed and publication small_business workshop genin-129753-05 these items are free and can be ordered by calling an online small_business classroom is also available at www irs gov businesses small this letter has called your attention to certain general principles of the law it is intended for informational purposes only and does not constitute a ruling please keep this letter with your tax records and feel free to provide a copy of it to your authorized representative we hope that the above information proves helpful if you have any additional questions please contact our office at ----- ------------- sincerely dianna k miosi chief branch office of associate chief_counsel passthroughs special industries enclosure


t c summary opinion united_states tax_court charles horton devers petitioner v commissioner of internal revenue respondent docket no 3227-05s filed date charles horton devers pro_se steven w labounty for respondent armen special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed the decision to be entered is not reviewable by any other court and this opinion should not be cited as authority unless otherwise indicated all subsequent section references are to the internal_revenue_code in effect for the taxable_year in issue respondent determined a deficiency in petitioner’s federal_income_tax for in the amount of dollar_figure after concessions by respondent the sole issue for decision is whether petitioner properly deducted attorney’s fees paid in as alimony under sec_71 we hold that he did not background some of the facts have been stipulated and they are so found we incorporate by reference the parties’ stipulation of facts and accompanying exhibits at the time the petition was filed charles h devers petitioner resided in st louis missouri petitioner and nadine f lundsgaard devers ms devers were married in date and separated in date ms devers filed a petition seeking a dissolution of her marriage to petitioner on date in the circuit_court of st louis county missouri family court cause no 01fc-7461 a judgment pending dissolution proceeding pdl sometimes referred to as an order pendente lite was filed on date and required petitioner to pay dollar_figure to aaron dubin mr dubin attorney for ms devers as and for attorney fees on account petitioner did not appeal the order the pdl did not specify whether petitioner’s obligation to pay the dollar_figure would terminate upon either spouse’s death in date petitioner paid the dollar_figure as ordered by the pdl the original dissolution proceeding cause no 01fc-7461 was dismissed in date for reasons not relevant to the instant action petitioner himself then sought a dissolution of the marriage in the circuit_court of st louis county missouri family court cause no 02fc-7407 filed date and an order dissolving the deverses' marriage was entered on date petitioner claimed a deduction of dollar_figure as alimony on hi sec_2002 tax_return a notice_of_deficiency was mailed to petitioner determining an income_tax deficiency of dollar_figure after further inquiry by respondent it became clear that the dollar_figure comprised dollar_figure of maintenance paid to ms devers and the dollar_figure paid to mr dubin before trial respondent conceded the deduction for the payments to ms devers and recalculated petitioner’s income_tax deficiency to be dollar_figure only the dollar_figure deficiency corresponding to the dollar_figure payment made to mr dubin remains at issue discussion3 sec_71 provides the general_rule that alimony payments are included in the gross_income of the payee spouse sec_215 provides the complementary general_rule that there is no disagreement that if the deduction were proper would be the appropriate tax_year the issue for decision is essentially legal in nature accordingly we decide it without regard to the burden_of_proof alimony payments are tax deductible by the payor spouse in an amount equal to the alimony or separate_maintenance payments paid during such individual’s taxable_year payments to a third party on behalf of a spouse and pursuant to the terms of a divorce decree may be alimony if those payments would otherwise qualify as such see sec_1_71-1t q a-6 temporary income_tax regs fed reg date the term alimony means any alimony as defined in sec_71 sec_71 provides sec_71 alimony or separate_maintenance payments defined --for purposes of this section- in general --the term alimony_or_separate_maintenance_payment means any payment in cash if- a such payment is received by or on behalf of a spouse under_a_divorce_or_separation_instrument b the divorce_or_separation_instrument does not designate such payment as a payment which is not includable in gross_income and not allowable as a deduction under sec_215 c in the case of an individual legally_separated from his spouse under a decree of divorce or of separate_maintenance the payee spouse and the payor spouse are not members of the same household at the time such payment is made and d there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment in cash or property as a substitute for such payments after the death of the payee spouse both parties agree that petitioner’s payment to mr dubin satisfies the requirements set out in sec_71 b and c payment was made in cash made pursuant to a divorce_or_separation_instrument as described in sec_71 and corresponding regulations see sec_1_71-1 income_tax regs and the payment was not ineligible for the sec_71 and sec_215 deduction inclusion scheme at the time of payment petitioner and ms devers were not members of the same household further petitioner appears to be in agreement that the obligation for someone to pay mr dubin his fees would have survived ms devers’ death when he writes on page of his memorandum brief aaron dubin would be required to collect any accrued legal fees from the estate of ms devers by operation of missouri statute the disagreement in this case is about whether petitioner’s dollar_figure payment satisfies sec_71 ie whether petitioner’s own liability to pay attorney’s fees as ordered by the pdl would have terminated in the event of ms devers’ death see sec_1_71-1t q a-10 temporary income_tax regs supra pincite6 of course an inquiry of this kind necessitates exploring the fictional question of whether or not an amount already paid would have remained an amount to be paid had ms devers predeceased satisfaction of the obligation ordered by the pdl issued in the first inchoate marital dissolution proceeding to find an answer we must decide whether petitioner’s payment to mr dubin was pursuant to an obligation that would have been extinguished by ms devers’ death under either the terms of the pdl itself or missouri law see altmann v united_states aftr 2d ustc par big_number at big_number e d mo given that the pdl is silent on the issue we turn to state law although federal_law controls in determining petitioner’s income_tax_liability state law is necessarily implicated in the inquiry inasmuch as the nature of petitioner’s liability for the payment was based in missouri law berry v commissioner tcmemo_2000_373 affd 36_fedappx_400 10th cir see also eg 81_tc_614 affd without published opinion 829_f2d_39 6th cir in 387_us_456 the supreme court addressed the means for determining state law in the context of a federal tax case and stated the state’s highest court is the best authority on its own law if there be no decision by that court then federal authorities must apply what they find to be the state law after giving proper regard to relevant rulings of other courts of the state in this respect it may be said to be in effect sitting as a state court with no state decision squarely on point the court must do its best to discern and apply what it believes to be missouri law 350_us_198 missouri family law in missouri an award for attorney’s fees does not arise out of the missouri alimony provision in the state enacted the dissolution of marriage act mo ann stat sec_452 west prior to that time there was no express statutory authority for awarding attorney’s fees and such awards were generally made under the auspices of the alimony provisions see eg rutlader v rutlader s w 2d mo ct app knebel v knebel s w 2d mo ct app in enacting the dissolution of marriage act the state instead provided for three separate and distinct awards in a marriage dissolution proceeding child_support maintenance formerly referred to as alimony and attorney’s fees see mo ann stat sec_452 west the separate treatment of maintenance and child_support as one type of an award and litigation costs and attorney fees as another type of award demonstrates a legislative intent not to continue the authority to award attorney fees as an incident to alimony or the present substitute for alimony which is designated as maintenance dyche v dyche s w 2d mo alimony unlike other types of awards is traditionally considered to be support-based and consequently would end upon the death of the payee spouse altmann v united_states aftr 2d pincite ustc par big_number at big_number in fact the obligation to provide maintenance specifically terminates upon the death of either party see mo ann stat sec_452 the obligation to pay child_support also is subject_to specific termination provisions see eg mo ann stat sec_452 west obligation to pay child_support terminates when child dies or marries etc in contrast there is no statutory termination rule for an award of attorney’s fees suggesting that such an award would not terminate upon the death of either spouse caselaw also suggests that attorney’s fee awards would not terminate upon the death of either spouse as such awards are enforceable directly by the attorney in minor v minor s w 2d mo ct app an attorney sought reversal of a lower court decision dismissing a contempt suit against a husband who did not pay attorney’s fees as ordered in a dissolution proceeding the missouri court_of_appeals held that a contempt action by the attorney against the nonpaying husband was entirely appropriate according to minor and similarly decided caselaw because the award of attorney’s fees is an independent judgment the attorney may bring a contempt proceeding if the judgment is not satisfied there is nothing in the missouri statutes or caselaw to suggest that this ability would terminate upon the death of the person for whom legal services had been rendered validity of the award petitioner argues that a final order of dissolution would have been required for the pdl to have any effect and that the dismissal of the first dissolution proceeding removed the court’s authority to order him to pay attorney’s fees we disagree it is true that a court loses jurisdiction over a dissolution action if one of the parties dies before the entry of a final order see eg bilgere v bilgere s w 3d mo ct app winters v cooper s w 2d mo ct app parkhurst v parkhurst s w 2d mo ct app but while a court may lose jurisdiction over the dissolution action collateral and other issues may remain properly before the court see eg fischer v seibel s w 2d mo ct app reiterating that the parties are entitled to have property rights decided even though one of the parties has died state ex rel weber v mclaughlin s w 2d mo ct app allowing the court to retain jurisdiction over an order to a third party to return property despite the fact that the although there is caselaw suggesting that the obligation to pay attorney’s fees not yet earned but awarded prospectively on account would be subject_to modification see eg muegler v muegler s w 2d mo ct app there are no facts in this case that would suggest the dollar_figure had not yet been earned by mr dubin at the time petitioner was ordered to pay him husband had died and the dissolution action had abated we believe a court would retain jurisdiction over an order to enforce an award of attorney’s fees even if ms devers had died prior to petitioner’s payment and the court in the first dissolution proceeding did not lose its authority to make the order simply because the case did not result in a final marital dissolution in johnson v johnson s w 2d mo ct app the court wrote that an order on a pdl is a final judgment disposing of the merits from which an appeal may be taken such orders are in no way dependent on the merits of the underlying dissolution suit though that case concerned a pdl award of maintenance the same court found in an earlier case that the principle applied to attorney’s fees see carlson v aubuchon s w 2d mo ct app in fact it is well established in missouri that orders on motions to allow suit costs pendente lite are judgments in independent proceedings they stand upon their own merits and are in no way dependent on the merits of the underlying dissolution suit dardick v dardick s w 2d mo ct app see also noll v noll s w 2d mo ct app whether or not the case giving rise to the pdl ordering the payment at issue ever culminated in an order of dissolution the award of attorney’s fees to mr dubin was made on its own merits and because petitioner did not appeal the award the order was enforceable in its own right an order to pay attorney’s fees is more than a judgement for money it is a personal order to the spouse minor v minor supra pincite because the order to pay mr dubin was a personal order to petitioner even if ms devers had predeceased payment the order would still have been valid petitioner’s obligation to pay dollar_figure would have survived and mr dubin would have had his own cause of action to collect directly from petitioner the fact that the case giving rise to the pdl in discussion did not result in a final dissolution of the marriage is irrelevant for the inquiry at hand conclusion although the supreme court of missouri has not addressed the narrow legal issue presented in the instant case the state’s statutory scheme of the child_support maintenance and attorney fee provisions as well as relevant caselaw suggests that petitioner’s obligation to mr dubin would not have terminated had ms devers died before satisfaction of the obligation whether or not the pdl was ever followed by a final order and decree of dissolution for that reason and after considering all of the facts and circumstances we hold that petitioner’s deduction of the dollar_figure paid to mr dubin was improper as it did not meet the definition of alimony under sec_71 reviewed and adopted as the report of the small_tax_case division to reflect our disposition of the disputed issue as well as respondent’s concessions decision will be entered for respondent in the amount of the reduced deficiency of dollar_figure