plr-109516-07 internal_revenue_service number release date index number ---------------------------- ------------------------ ------------------------------ -------------------------------------- --------------------------- department of the treasury washington dc person to contact ------------------ id no ------------- telephone number --------------------- refer reply to cc fip b03 plr-109516-07 date date ----------------------------------------------------------------- legend trust a ------------------------------------------------------------ ------------------------------ --------------------------------------------- company ------------------------------------------------------------ hotel partnership trust b holding --------------------------------------- ---------------------------------- --------------------------------------------- ------------ state x state y date date date date ------------ ------------------- ------------------ -------------------------- ---------------------- plr-109516-07 date date date date a ---------------------- ----------------------- ------------------------ ------------------------ ----- dear ------------------ this responds to a letter_ruling dated date submitted on behalf of trust a and company requesting an extension of time under sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations to make an election under sec_301_7701-3 to classify company as a corporation for federal tax purposes effective as of date and an election under sec_856 of the internal_revenue_code to treat company as a taxable_reit_subsidiary trs of trust a effective as of date facts trust a is a state x corporation that was formed on date trust a plans to elect to be treated as a real_estate_investment_trust reit beginning with its tax_year that ended date company is a limited_liability_company organized in state y trust a has owned all of the interests in company at all times since company issued interests trust a owns hotel and leases hotel to company trust a is primarily owned by partnership a state y limited_partnership classified as a partnership for u s federal tax purposes other than partnership trust a has a direct shareholders the interests in partnership are owned primarily by trust b a publicly traded reit and holding a limited_partnership an officer officer of both trust a and company was charged with the responsibility for filing all forms necessary for company to be treated as a trs of trust a on or about date an officer of trust b made an inquiry as to the status of the tax filings necessary to treat company as a trs of trust a this inquiry prompted officer to ask outside counsel for holding for assistance in preparing an entity plr-109516-07 classification election for company a paralegal for the outside counsel prepared a form_8832 entity classification election which was executed and filed on date the form_8832 indicated that company elected to be classified as a corporation in completing the form the paralegal mistakenly chose an effective date of date instead of date when signing the form_8832 officer failed to realize that the form listed an incorrect effective date moreover the outside counsel failed to recommend to officer to also file a form_8875 taxable_reit_subsidiary election with respect to company officer was unaware that a trs election also needed to be filed for company to be treated as a trs of trust a_trust b subsequently sent officer a primary certification relating to trust a’s status as a reit the certification included a statement as to the timely and proper filing of a trs election for each entity intended to qualify as a trs officer forwarded the certification to the outside counsel for holding the outside counsel returned the certification with minor comments but did not question the statement regarding the election of trs status officer subsequently executed and returned to trust b a reliance certification attesting to the accuracy of the statements made in the primary certification on or about date the accounting firm engaged to prepare the tax returns for the entities involved in the structure determined that a trs election had not been filed for company on date the accounting firm also became aware that the form_8832 filed on behalf of company mistakenly specified date instead of date as the effective date on date the accounting firm filed a form_8875 on behalf of trust a and company officer represents that at all times since trust a’s formation trust a has been organized and has intended to operate in a manner that would permit it to qualify as a reit officer further represents that it had been understood at all relevant times that company would qualify as a trs under sec_856 furthermore trust a and company jointly make the following additional representations the request for relief was filed by trust a and company before the failure to make the regulatory election was discovered by the service granting the relief will not result in trust a and or company having a lower tax_liability in the aggregate for all years to which the regulatory election applies than that taxpayer would have had if the election had been timely made taking into account the time_value_of_money plr-109516-07 trust a and company did not seek to alter a return position for which an accuracy-related_penalty has been or could have been imposed under sec_6662 of the code at the time trust a and company requested relief and the new position requires or permits a regulatory election for which relief is requested being fully informed of the required regulatory election and related tax consequences trust a and company did not choose to not file the election law and analysis sec_856 of the code provides that a reit and a corporation other than a reit may jointly elect to treat such corporation as a trs to be eligible for treatment as a taxable_reit_subsidiary sec_856 provides that the reit must directly or indirectly own stock in the corporation and the reit and the corporation must jointly elect such treatment the election is irrevocable once made unless both the reit and the subsidiary consent to its revocation in addition sec_856 specifically provides that the election and any revocation thereof may be made without the consent of the secretary in announcement i r b the service announced the availability of new form_8875 taxable_reit_subsidiary election according to the announcement this form is to be used for tax years beginning after for eligible entities to elect treatment as a trs the instructions to form_8875 provide that the subsidiary and the reit can make the election at any time during the tax_year however the effective date of the election depends upon when the form_8875 is filed the instructions further provide that the effective date on the form cannot be more than months and days prior to the date of filing the election or months after the date of filing the election if no date is specified on the form the election is effective on the date the form is filed with the service sec_301_9100-1 of the regulations provides that the commissioner has discretion to grant a reasonable extension of time to make a regulatory election defined in sec_301_9100-1 as an election whose due_date is prescribed by regulations or by a revenue_ruling a revenue_procedure a notice or an announcement published in the internal_revenue_bulletin or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-3 through c i sets forth rules that the internal_revenue_service generally will use to determine whether under the particular facts and circumstances of each situation the commissioner will grant an extension of time for plr-109516-07 regulatory elections that do not meet the requirements of sec_301_9100-2 sec_301_9100-3 provides that subject_to paragraphs b i through iii of sec_301_9100-3 when a taxpayer applies for relief under this section before the failure to make the regulatory election is discovered by the service the taxpayer will be deemed to have acted reasonably and in good_faith and sec_301_9100-3 provides that the interests of the government are prejudiced if granting relief would result in the taxpayer having a lower tax_liability in the aggregate for all years to which the regulatory election applies than the taxpayer would have had if the election had been timely made taking into account the time_value_of_money conclusions based on the information submitted and representations made we conclude that trust a and company have satisfied the requirements for granting a reasonable extension of time to elect under sec_301_7701-3 to classify company as a corporation for federal tax purposes effective as of date and elect under sec_856 to treat company as a taxable_reit_subsidiary of trust a effective as of date accordingly the form_8832 that was filed by company on date will be treated as if it had been timely filed to classify company as a corporation for federal tax purposes effective as of date and the form_8875 that was filed by trust a and company on date will be treated as if it had been timely filed to treat company as a taxable_reit_subsidiary of trust a effective as of date no opinion is expressed with regard to whether the tax_liability of either trust a or this ruling is limited to the timeliness of the filing of the form_8832 and form_8875 this ruling’s application is limited to the facts representations code sections and regulations cited herein no opinion is expressed with regard to whether trust a otherwise qualifies as a reit under subchapter_m of the code company is not lower in the aggregate for all years to which the election applies than such tax_liability would have been if the election had been timely made taking into account the time_value_of_money upon audit of the federal_income_tax returns involved the director’s office will determine such tax_liability for the years involved if the director’s office determines that such tax_liability is lower that office will determine the federal_income_tax effect plr-109516-07 this ruling is directed only to the taxpayer who requested it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely alice m bennett chief branch office of associate chief_counsel financial institutions products enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court naren chaganti petitioner v commissioner of internal revenue respondent docket no filed date naren chaganti pro_se jessica r nolen karen o myrick and stephen a haller for respondent memorandum findings_of_fact and opinion buch judge naren chaganti is an attorney with clients in both missouri and california mr chaganti deducted expenses associated with his legal services although mr chaganti filed an entry of appearance with the court to represent himself his status as an attorney does not change the fact that he is appearing pro_se which translates to for oneself business for and and a net_operating_loss nol carryforward from prior years to offset his taxable_income for the commissioner determined that mr chaganti was not entitled to deductions for many of the expenses or to a foreign_tax_credit he claimed that he was not entitled to deduct the nol carryforward that he owed additional self-employment_tax and that he was liable for sec_6651 additions to tax and sec_6662 accuracy-related_penalties for those years mr chaganti did not keep adequate_records to substantiate many of the expenses he reported and he failed to prove that he had any nol to carry forward he also filed his tax returns late for the years in issue accordingly because of failure of proof neither is mr chaganti entitled to deductions for many of the expenses and to the claimed foreign_tax_credit nor is he entitled to deduct an nol carryforward he is also liable for the sec_6651 additions to tax for failure_to_file returns and the sec_6662 accuracy-related_penalties unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure all monetary amounts are rounded to the nearest dollar findings of fact3 mr chaganti is a self-employed attorney who practices in missouri and california during the years in issue of his docketed cases with activity were in st louis missouri was in kansas city kansas were in los angeles california and were in the san francisco bay area mr chaganti used two different addresses one in st louis missouri and one in los angeles california but had closer ties to st louis he maintained a missouri driver’s license and had family ties to st louis during the years in issue accordingly his principal_residence was in st louis missouri mr chaganti traveled from missouri to california mr chaganti provided southwest airlines confirmations for some of the flights that he took during the years in issue most of the southwest airlines confirmations show that he paid less than dollar_figure for each of the tickets mr chaganti explained that he purchased southwest airlines travel coupons or vouchers from southwest airlines patrons or we issued a previous opinion in this case chaganti v commissioner tcmemo_2013_285 we incorporate the findings_of_fact in that opinion by this reference we reserved ruling on exhibit 29-p that exhibit was offered by mr chaganti but he did not cite it in his proposed findings_of_fact in contrast the commissioner objected to exhibit 29-p but relied on it in his answering brief thus we will treat his objection as withdrawn and admit exhibit 29-p employees and used them to purchase round trip tickets for himself at a cost of approximately dollar_figure per round trip however mr chaganti did not provide any proof of payment i tax returns a prior years for tax_year mr chaganti filed his form_1040 u s individual_income_tax_return and reported dollar_figure in adjusted_gross_income for tax_year mr chaganti filed his form_1040 and reported negative adjusted_gross_income of dollar_figure he did not elect to forgo the nol_carryback requirement for that year he attached a schedule c profit or loss from business to his return for his legal services business reporting gross_receipts of dollar_figure and expenses of dollar_figure resulting in a net_loss of dollar_figure for tax_year mr chaganti filed his form_1040 reporting negative adjusted_gross_income of dollar_figure mr chaganti did not elect to forgo the nol neither party offered evidence into the record about mr chaganti’s tax reporting for tax years before mr chaganti reported a schedule c business loss of dollar_figure but erroneously reported this amount as a passive_activity_loss mr chaganti also reported negative adjusted_gross_income of dollar_figure which included a net_loss of dollar_figure from his schedule c on line of his form_1040 that he characterized as an nol his negative adjusted_gross_income of dollar_figure should continued carryback for that year the negative adjusted_gross_income of dollar_figure is attributable in part to mr chaganti’s schedule c legal services business on his schedule c he reported gross_receipts of dollar_figure and total expenses of dollar_figure which yields a net_loss of dollar_figure included in the total expenses were contract labor expenses of dollar_figure mr chaganti provided substantiation for approximately dollar_figure of these expenses dollar_figure of which is for contract labor for tax_year mr chaganti filed his form_1040 and reported negative adjusted_gross_income of dollar_figure mr chaganti did not elect to forgo the nol_carryback for that year the negative adjusted_gross_income of dollar_figure is attributable in part to mr chaganti’s schedule c legal services business on his schedule c he reported gross_receipts of dollar_figure and total expenses of dollar_figure which yields a net_loss of dollar_figure included in the total expenses were contract labor expenses of dollar_figure mr chaganti did not substantiate these expenses the only evidence mr chaganti offered to substantiate these expenses was continued not include the dollar_figure but should include the schedule c loss of dollar_figure this would result in a negative adjusted_gross_income of dollar_figure the commissioner disputes that mr chaganti has shown that certain of these expenses were business related statements that he requested per_diem reimbursements from his brother’s business b years in issue--2006 and mr chaganti filed his form_1040 for tax_year late and the commissioner received his return on date on his schedule c mr chaganti reported gross_receipts of dollar_figure travel_expenses of dollar_figure meals and entertainment_expenses of dollar_figure and other expenses of dollar_figure which he described as prior years travel and per_diem expense in addition to other expenses overall he reported a net business loss of dollar_figure he attached a form_8582 passive_activity_loss limitations to his return and listed a prior year’s unallowed passive loss of dollar_figure described as legal services mr chaganti filed his form_1040 for tax_year late and the commissioner received his return on date on his schedule c mr chaganti reported gross_receipts of dollar_figure travel_expenses of dollar_figure meals and entertainment_expenses of dollar_figure and other expenses of dollar_figure which comprised prior years travel and per_diem expense of dollar_figure court ordered payments of dollar_figure and filing f ees for appeals writs of dollar_figure in addition to the reimbursement statements that are dated show that mr chaganti requested dollar_figure however there are no underlying documents such as receipts or canceled checks to show that mr chaganti actually paid any expenses other expenses he attached a form_8582 to his return and listed a prior year’s unallowed passive loss of dollar_figure described as legal services and used dollar_figure of the loss to offset dollar_figure in legal services income from his schedule c business leaving an overall net business profit of zero he also claimed a foreign_tax_credit of dollar_figure ii notice_of_deficiency on date the commissioner issued a notice_of_deficiency determining the following deficiencies additions to tax and penalties with respect to mr chaganti’s federal_income_tax for years and year deficiency dollar_figure big_number addition_to_tax sec_6651 penalty sec_6662 dollar_figure big_number dollar_figure big_number the commissioner determined that mr chaganti was not entitled to deduct the travel_expenses meals and entertainment and other expenses that he reported for those years on his schedules c the commissioner determined that he was liable for additional self-employment_tax because of his increased net_earnings but could for the commissioner disallowed the entire dollar_figure mr chaganti deducted for other expenses on schedule c for the commissioner allowed dollar_figure of the dollar_figure total other expenses he deducted on schedule c take a corresponding deduction for the commissioner determined that mr chaganti could not deduct an nol carryforward of dollar_figure and that he was not entitled to a foreign_tax_credit of dollar_figure iii tax_court case while residing in missouri mr chaganti timely filed a petition for redetermination mr chaganti moved for partial summary_judgment on whether he could deduct business_expenses he had paid in previous years and the court- ordered payments of dollar_figure that he made in the commissioner filed a cross-motion for partial summary_judgment on the same issues on date the court issued an opinion on these motions chaganti v commissioner tcmemo_2013_285 with respect to the first issue the court found that mr chaganti had received dollar_figure and dollar_figure in and respectively from his brother’s business as reimbursement for expenses paid in through id at the court explained that mr chaganti was not entitled to deductions for tax years and for reimbursements related to business_expenses paid in prior years id at however the court did not determine the veracity of the expenses themselves id at n because mr chaganti had not shown whether he included those expenses in the nols he reported for and the court did not decide this issue id at with respect to the issue involving the deductibility of the court-ordered payments totaling dollar_figure the court decided that issue in part the court held that mr chaganti was barred under sec_162 from deducting the dollar_figure he paid in id at the court did not address the deductibility of the dollar_figure sanction that mr chaganti paid to opposing counsel as reimbursement for deposition fees id at however the commissioner later conceded that mr chaganti could deduct this amount finally although the court held that mr chaganti could not deduct the dollar_figure sanction imposed against him under u s c sec because it was not an ordinary and necessary business_expense under sec_162 the court left open the question of whether he could deduct this payment under a different theory id at later the court held trial on the remaining issues in st louis missouri at the close of trial we instructed mr chaganti to prepare a chart or table that tied his claimed travel_expenses to a trip we explained so for example if you say i was in los angeles on march 13th of and you can direct me to a docket sheet and you can direct me to a southwest voucher then what you can do in your brief maybe it’s a table maybe it’s a chart but you can include in your brief you know travel to l a southwest voucher this date duration of travel three days as part of his brief mr chaganti provided a table that purported to detail when he traveled during the years in issue mr chaganti prefaced the table with this disclaimer petitioner presents the following table with the number of days spent at each location based on his best information and recollection it is respectfully suggested that there may be slight discrepancies between this table and other records the table had the following information start date end date place and number of days the table did not include any citations of any documents in the record overall a myriad of issues remains for us to decide the commissioner conceded that a portion of mr chaganti’s travel was business related that he was entitled to deduct a portion of his reported travel_expenses and that he could deduct the dollar_figure sanction he paid to opposing counsel in after these concessions the remaining issues we must decide are whether the burden_of_proof shifts to the commissioner whether mr chaganti is entitled to deduct the remaining travel and meals and entertainment_expenses he reported the commissioner conceded dollar_figure in travel_expenses for and dollar_figure in travel_expenses for for various business-related trips the court finds that mr chaganti was away from his tax_home for a total of days in and days in whether mr chaganti can offset net business profit with an nol he carried forward from prior years whether mr chaganti can reduce the gross_receipts he reported whether mr chaganti can deduct the dollar_figure sanction he paid pursuant to a court order under u s c sec whether mr chaganti is entitled to a foreign_tax_credit of dollar_figure for whether mr chaganti is liable for additional self-employment_tax but entitled to a corresponding deduction whether mr chaganti is liable for sec_6651 failure_to_file additions to tax and whether mr chaganti is liable for sec_6662 accuracy-related_penalties we will take each issue in turn opinion i burden_of_proof the commissioner’s determinations in the notice_of_deficiency are generally presumed correct and taxpayers bear the burden of proving otherwise the burden with respect to a factual issue may shift to the commissioner under sec_7491 if the taxpayer has introduced credible_evidence regarding the issue has complied with the necessary substantiation requirements has maintained all records and has cooperated with reasonable requests by the commissioner for witnesses information documents meetings and interviews mr chaganti rule a 290_us_111 argues that the burden_of_proof should shift however he has not met the statutory requirements to shift the burden because he failed to substantiate many of the expenses he reported accordingly the burden_of_proof remains on him ii deductions the code allows a deduction for ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business taxpayers are not allowed a deduction for personal living or family_expenses except where specifically allowed in the code deductions are a matter of legislative grace and taxpayers must maintain sufficient records to establish their claimed deductions these records must be retained for as long as the contents may become material and must be kept available for inspectiondollar_figure a strict substantiation certain expenses are subject_to strict substantiation rules under sec_274 such expenses include those relating to travel meals and entertainment sec_162 sec_262 503_us_79 sec_6001 sec_1_6001-1 income_tax regs sec_1_6001-1 income_tax regs gifts and listed_property under sec_280f for the years in issue listed_property included passenger automobiles any other_property used as a means of transportation any property of a type generally used for purposes of entertainment recreation or amusement computers and cellular telephones to comply with the strict substantiation rules the taxpayer must have adequate_records or sufficient evidence corroborating the amount of the expense the time and the place the expense was incurred the business_purpose of the expense and the business relationship of the taxpayer to any others benefited by the expense to substantiate by adequate_records the taxpayer must maintain an account book a log a diary or a similar record and documentary_evidence to establish each element of an expendituredollar_figure in some instances the court may approximate the amount if the taxpayer can establish a deductible expense but cannot substantiate the precise amount sec_274 sec_280f sec_274 sec_1_274-5t temporary income_tax regs fed reg date 39_f2d_540 2d cir however the taxpayer must provide some basis for that estimate and the court is precluded from making estimates with regard to expenses that are subject_to the strict substantiation requirements under sec_274dollar_figure b per_diem expense deduction as discussed above sec_162 allows a deduction for the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business taxpayers are also allowed to deduct traveling expenses while away from home in the pursuit of a trade_or_business the term away from home is not defined in the code accordingly the commissioner adopted the sleep_or_rest_rule which was first articulated by the u s court_of_appeals for the fifth circuit in 286_f2d_333 5th cir if the nature of the taxpayer’s employment is such that when away from home during released time it is reasonable for him to need and to obtain sleep or rest in order to meet the exigencies of his employment or the business demands of his employment his expenditures including incidental_expenses such as tips for the 85_tc_731 73_tc_1081 sec_1_274-5t temporary income_tax regs fed reg date sec_162 see revrul_61_221 1961_2_cb_34 adopting the sleep_or_rest_rule purpose of obtaining sleep or rest are deductible traveling expenses under sec_162 of the code the supreme court has acknowledged this rule as achieving not only ease and certainty of application but also substantial fairness dollar_figure although traveling expenses may be deducted under sec_162 they are subject_to the strict substantiation requirements of sec_274 pursuant to sec_1_274-5 income_tax regs the commissioner may prescribe alternative methods of substantiating certain expenses including per_diem allowances accordingly the commissioner provides an optional method by which in certain circumstances employees and self-employed individuals who pay or incur business-related meal and incidental_expenses may use an amount computed at the federal meals and incidental_expenses rate for the locality of travel for each calendar day that the individual is away from home these expenses are deemed substantiated for purposes of sec_274 if the individual can substantiate the time place and business_purpose of the travel in accordance 389_us_299 revproc_2007_63 2007_2_cb_809 revproc_2006_41 2006_2_cb_777 revproc_2005_67 2005_2_cb_729 with the regulations again to substantiate an expense a taxpayer must offer sufficient evidence to corroborate the taxpayer’s statements or adequate_records and to substantiate by adequate_records the taxpayer must maintain an account book a log a diary or a similar record and documentary_evidence to establish each element of an expendituredollar_figure when determining a taxpayer’s tax_home we have previously held that as a general_rule a taxpayer’s tax_home is defined as the taxpayer’s principal_place_of_business conversely a n employee without a principal_place_of_business may treat a permanent place of residence at which he incurs substantial continuing living_expenses as his tax_home and if a taxpayer does not have a principal revproc_2007_63 sec_4 c b pincite revproc_2006_41 sec_4 c b pincite revproc_2005_67 sec_4 c b pincite sec_274 sec_1_274-5t temporary income_tax regs supra 72_tc_190 aff’d 662_f2d_253 4th cir 49_tc_557 85_tc_462 relying on 49_tc_636 aff’d 807_f2d_177 9th cir place of business or a permanent residence then the taxpayer’s home is wherever he happens to be taxpayers have the burden_of_proof to show that they had a tax_home and this inquiry is a factual question we have previously explained that w hile the subjective intent of the taxpayer is to be considered in determining whether he has a tax_home for purposes of sec_162 this court and others consistently have held that objective financial criteria bear a closer relationship to the underlying purpose of the deduction mr chaganti’s principal_place_of_business during the years in issue was st louis missouri twelve of his seventeen docketed cases during those years were in st louis mr chaganti argued that this breakdown did not provide the full picture because the california cases represented higher potential revenue however he did not offer records to show a closer connection between his 308_f2d_204 9th cir barone v commissioner t c pincite relying on 513_f2d_697 6th cir aff’g tcmemo_1974_160 and 438_f2d_905 2d cir 69_tc_920 barone v commissioner t c pincite business and california accordingly mr chaganti’s principal_place_of_business was st louis and his tax_home was st louis as previously explained travel_expenses are subject_to strict substantiation beyond the travel expense deductions that the commissioner conceded we hold that mr chaganti is entitled to deduct only per_diem_amounts for meal expenses for those trips that the commissioner conceded were business-related travel when mr chaganti was away from his tax_home of st louis missouri the exact per_diem_amounts for meals and incidental_expenses computed at the federal meals and incidental_expenses rate for the locality of travel for each calendar day that mr chaganti was away from home will be determined under rule dollar_figure although mr chaganti argued that he is entitled to use per_diem_amounts for lodging because he had a contract for reimbursement from his brother’s business he is mistaken self-employed individuals are not eligible to use per see revproc_2007_63 sec_4 c b pincite revproc_2006_41 sec_4 c b pincite revproc_2005_67 sec_4 c b pincite diem amounts for lodging further mr chaganti has not provided evidence to show he incurred actual lodging_expenses mr chaganti has not adequately substantiated the remaining meals and entertainment and travel_expenses he reported sec_274 requires taxpayers to establish the amount of the expense the time and the place the expense was incurred the business_purpose of the expense and the business relationship of the taxpayer to any others benefited by the expense the court provided mr chaganti the opportunity to identify records in evidence that would establish this he failed to do so the table mr chaganti provided did not refer to any exhibit or provide any information about a specific client matter to show the business_purpose of any of his trips further some of the dates and locations that mr chaganti listed on his table were contradicted by the parties’ stipulations accordingly because he did not meet his burden_of_proof mr chaganti may not deduct any meals and entertainment_expenses or travel_expenses beyond those that the commissioner see revproc_2007_63 sec_4 c b pincite revproc_2006_41 sec_4 c b pincite revproc_2005_67 sec_4 c b pincite compare sec_1_274-5 income_tax regs allowing a deduction for travel when employees provide substantiation to their employers with sec_1 j income_tax regs allowing a deduction for per_diem meals mileage and incidental_expenses under the optional method determined by the commissioner when a taxpayer is away from home conceded were business-related expenses and beyond the per_diem_amounts for meals and incidentals previously addressed iii net_operating_loss carryforward sec_172 describes when a taxpayer may deduct an nol an nol is the excess of the allowable deductions over gross_income subject_to specified modifications in the case of a taxpayer who has an nol arising in and an nol generally must first be carried back for years and if not completely absorbed it may be carried forward for up to years further a taxpayer must carry the nol back to the earliest year first under sec_172 a taxpayer may elect to waive the carryback period and carry the entire loss forward however the election must be made by the due_date including extensions of the return for the year in which the nol arose and for which the election is to be in effectdollar_figure generally the taxpayer bears the burden of establishing both the actual existence of an nol for another year and the amount of that nol that may be sec_172 and d sec_172 h sec_1_172-4 income_tax regs sec_172 sec_1_172-4 income_tax regs sec_172 carried to the years in issue a taxpayer’s return is merely a statement of the taxpayer’s position and cannot be used to substantiate a deduction we have jurisdiction to consider facts related to years other than the years in issue in order to redetermine the liability for the periods before usdollar_figure mr chaganti reported nols for and and used an nol carryforward to offset net_income from his schedule c legal business in mr chaganti did not elect to forgo the requirement to carry his nols back we will take each claimed nol in turn put simply for mr chaganti provided no evidence of any excess loss to carry forward even if we accept that mr chaganti had an nol for that year he would be required to first carry the nol back to and mr chaganti did not offer evidence about his income_tax for or and thus he failed to prove that the nol was not fully absorbed in or because of that failure of proof he has no nol to carry forward 115_tc_605 71_tc_633 sec_6214 see sec_172 h sec_1_172-4 income_tax regs for mr chaganti has not established that he actually had an nol mr chaganti’s nol was a function of the net schedule c business loss he reported on his return mr chaganti reported gross_receipts of dollar_figure and expenses of dollar_figure which equals a net_loss of dollar_figure his total expenses of dollar_figure included dollar_figure of contract labor expenses mr chaganti provided substantiation for only dollar_figure of the contract labor expenses and for approximately dollar_figure of the other expenses he reported although mr chaganti might be entitled to deduct some per_diem_amounts for meals for business travel for he has not proven that his business_expenses exceeded the gross_receipts he reported accordingly he has not established a net business loss and is not entitled to any nol deduction for likewise for mr chaganti has not established that he actually had an nol mr chaganti’s nol was a function of the net schedule c business loss he reported on his return mr chaganti reported gross_receipts of dollar_figure and expenses of dollar_figure which equals a net_loss of dollar_figure his total expenses of dollar_figure included dollar_figure of contract labor expenses mr chaganti did not substantiate any of his reported expenses for although the commissioner stipulated that mr chaganti made a few court appearances in california during mr chaganti did not submit any documents to show what expenses he incurred the only documents mr chaganti provided were bills he submitted to his brother’s business for reimbursement these documents do not show that mr chaganti actually incurred expenses accordingly he did not establish a net business loss and has not shown entitlement to any nol deduction for overall mr chaganti cannot use an nol to offset income for because he has not proven he had any nol left over to carry forward for and has not proven he actually had an nol for or iv gross_receipts mr chaganti argues that his gross_receipts for and should be reduced from the amounts he reported by dollar_figure and dollar_figure respectively because these amounts represented client reimbursements and should not be taxable he cites a case holding that if a lawyer has a contractual right to reimbursement for expenses the lawyer pays on behalf of a client then the lawyer must treat these amounts as advances under this approach the lawyer cannot mr chaganti cites humphrey farrington mcclain p c v commissioner tcmemo_2013_23 deduct the expenses he pays on behalf of the client and does not have gross_income when the client reimburses the lawyer for the expenses the lawyer paiddollar_figure mr chaganti’s argument has merit but he has failed to substantiate his position the court previously held that mr chaganti received dollar_figure and dollar_figure in and respectively from his brother’s business as reimbursement for expenses paid from to but the court did not make any determination as to the veracity of the expenses themselves mr chaganti cannot treat these expenses as client advances because he failed to substantiate them v payment pursuant to u s c sec in our prior opinion we held that mr chaganti could not deduct the dollar_figure sanction imposed by a court under u s c sec because it was not an ordinary and necessary business_expense under sec_162 but we left open the question of whether he could deduct this payment under a different theory mr see 36_tc_672 aff’d 309_f2d_431 9th cir 23_bta_202 chaganti v commissioner tcmemo_2013_285 at chaganti v commissioner at chaganti now argues that he should be able to deduct the payment under sec_165 under u s c sec if an attorney multiplies the proceedings in any case unreasonably and vexatiously then a court may require that attorney to pay the excess costs expenses and attorney’s fees of another party the u s court_of_appeals for the eighth circuit the court to which this case is appealable has explained that section is penal in nature further it has stated that t he imposition of sanctions is a serious matter and should be approached with circumspection it may be helpful to contrast the penal sanction imposed on mr chaganti pursuant to u s c sec with the taxation of costs under u s c sec taxation of costs is a routine part of litigation and costs are not imposed by courts for punitive reasons costs that are taxed include clerk fees transcript fees expenses for copies docket fees and compensation of court- 177_f3d_714 8th cir o’connell v champion int’l c812_f2d_393 8th cir appointed experts the supreme court has explained that the assessment of costs most often is merely a clerical matter that can be done by the court clerk mr chaganti argued that he should be allowed a deduction under sec_165 for the dollar_figure he paid sec_165 allows taxpayers to deduct a loss they sustained during the taxable_year if they were not compensated for that loss sec_165 limits the deductibility of losses for individuals to those losses incurred_in_a_trade_or_business incurred in any transaction entered into for profit and incurred because of fire storm shipwreck or other_casualty or from theft because the u s c sec sanction is penal it cannot give rise to a loss incurred_in_a_trade_or_business or a loss incurred in a transaction entered into for profit and clearly is not the type of circumstance contemplated in sec_165 indeed we have disallowed loss deductions if the allowance thereof u s c sec taniguchi v kan pacific saipan ltd u s __ __ 132_sct_1997 quoting 664_f2d_652 7th cir see 320_us_467 where a taxpayer has violated a federal or a state statute and incurred a fine or penalty he continued would frustrate sharply defined national or state policies proscribing particular types of conduct the supreme court explained that to allow a deduction in those circumstances would have directly and substantially diluted the actual punishment imposed thus because the sanction paid pursuant to u s c sec is penal it would be against public policy to allow it to give rise to a business loss or a loss in a transaction entered into for profit under sec_165 accordingly mr chaganti cannot deduct the dollar_figure he paid vi foreign_tax_credit sec_901 allows taxpayers a foreign_tax_credit for foreign_income_war_profits_and_excess_profits_taxes they have paid_or_accrued during the taxable continued has not been permitted a tax deduction for its payment lincoln v commissioner tcmemo_1985_300 50_tcm_185 see also 356_us_30 disallowing a deduction because the fine paid_by the taxpayer was punitive action and not a mere toll for use of the highways and explaining that allowing the deduction sought here would but encourage continued violations of state law by increasing the odds in favor of noncompliance 88_tc_677 courts have traditionally disallowed business_expense and casualty_loss deductions under sec_162 or sec_165 where national or state public policies would be frustrated by the consequences of allowing the deduction aff’d 867_f2d_605 1st cir 383_us_687 see also 213_f2d_102 10th cir aff’g 20_tc_308 year taxpayers claiming a foreign_tax_credit must prove that they have met all the conditions to be entitled to any credit because mr chaganti has not provided any evidence that he paid_or_accrued foreign tax he is not entitled to the foreign_tax_credit he claimed for vii self-employment_tax the code imposes in addition to other taxes a tax on the net_earnings_from_self-employment of individuals net_earnings_from_self-employment are defined as the gross_income derived by an individual from any trade_or_business carried on by such individual less the deductions allowed by this subtitle which are attributable to such trade_or_business and sec_164 allows a deduction from gross_income for one-half of a taxpayer’s self-employment_tax for the year mr chaganti has a legal services business and is liable for self-employment_tax on his net_earnings from that business the exact amount of self-employment_tax and any corresponding deduction will be based on rule_155_computations sec_901 and b sec_1_901-1 income_tax regs wilcox v commissioner tcmemo_2008_222 96_tcm_194 relying on 143_f2d_256 2d cir aff’g 1_tc_880 sec_1401 and b b sec_1402 viii failure_to_file additions to tax under sec_6651 the code requires individuals to file income_tax returns by april of the year following the calendar_year for which the return is being filed and imposes consequences on those who fail to timely file their tax returns one such consequence is found in sec_6651 which imposes an addition_to_tax for failure to timely file a federal_income_tax return unless the failure_to_file was for reasonable_cause and not due to willful neglect a taxpayer may have reasonable_cause if the taxpayer exercised ordinary business care and prudence but was not able to timely file willful neglect means a conscious intentional failure or reckless indifference mr chaganti filed his returns for and late he argues that his filing was late because his tax issues were complex he was extremely busy with his business and his mother was ill tax issues are often complex and return filing is time consuming but complexity and lack of time alone do not remove the see sec_6012 sec_6072 sec_6651 see sec_301_6651-1 proced admin regs 469_us_241 requirement to timely file one’s return because mr chaganti has not shown his tardy filing was due to reasonable_cause and not due to willful neglect he is liable for the sec_6651 additions to tax for and ix accuracy-related_penalties under sec_6662 sec_6662 and b and imposes a accuracy-related_penalty on any portion of an underpayment_of_tax required to be shown on a return if the underpayment is due to negligence disregard of rules or regulations or any substantial_understatement_of_income_tax the commissioner bears the burden of production as to penalties penalties will not apply to any portion of the underpayment for which a taxpayer establishes that he or she had reasonable_cause and acted in good faithdollar_figure as defined in the code negligence includes any failure to make a reasonable attempt to comply with the provisions of title_26 and the term disregard includes any careless reckless or intentional disregard negligence see eg ellwest stereo theatres of memphis inc v commissioner tcmemo_1995_610 70_tcm_1655 sec_7491 sec_6664 sec_6662 has been further defined as a lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances additionally a taxpayer is negligent if he or she fails to maintain sufficient records to substantiate the items in questiondollar_figure an understatement of income_tax is substantial if the understatement exceeds the greater of of the tax required to be shown on the return or dollar_figure however if the taxpayer has substantial_authority for the tax treatment of an item then the portion of the tax attributable to that item is not included in the understatement a taxpayer has substantial_authority only if the weight of authority supporting the tax treatment of the item outweighs the contrary authoritydollar_figure after taking into account the parties’ concessions mr chaganti’s understatements for both and are greater than big_number and exceed of 85_tc_934 quoting marcello v commissioner 380_f2d_499 5th cir aff’g in part remanding in part 43_tc_168 and t c memo 116_tc_438 sec_1_6662-3 income_tax regs sec_6662 sec_1_6662-4 income_tax regs sec_1_6662-4 income_tax regs the tax required to be shown on the respective returns accordingly the commissioner has met his burden of production for the accuracy-related_penalties because of substantial understatements of income_tax the commissioner has also satisfied his burden of production for the accuracy-related_penalties because of negligence taxpayers are required to maintain adequate_records and negligence includes a failure to keep adequate books_and_records or to substantiate items mr chaganti acted negligently because he failed to substantiate many of the expenses he reported mr chaganti did not prove he acted with reasonable_cause and in good_faith he argued that he was not a tax lawyer and didn’t know all the intricacies about tax law he explained that he did not keep good business records because of the chaotic nature of his legal services business also he explained that he had returned many of the client records to his clients and that some of his other records had been lost these explanations do not show that mr chaganti acted with reasonable_cause and in good_faith we have previously explained that r easonable cause requires that the taxpayer have exercised ordinary business sec_6001 sec_1_6662-3 income_tax regs care and prudence as to the disputed item mr chaganti did not accordingly he is liable for the sec_6662 accuracy-related_penalties for and x conclusion mr chaganti has failed to substantiate many of the expenses he reported for his legal services business he did not keep adequate_records to prove that he incurred nols to carry forward and he did not timely file his tax returns because of his failure of proof he was not entitled to deductions for many of the expenses or to the foreign_tax_credit he claimed he is liable for self-employment_tax on his earnings he is also liable for the additions to tax and accuracy-related_penalties for and to reflect the foregoing decision will be entered under rule 115_tc_43 aff’d 299_f3d_221 3d cir


department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division release number release date date date xxxxkx xxxkxkxx xxxxxx xxkxkx uil code contact person identification_number contact number employer_identification_number form required to be filed tax years dear this is our final_determination that you do not qualify for exemption from federal_income_tax under internal_revenue_code sec_501 as an organization described in code sec_501 we made this determination for the following reason s there is an insufficient number of insureds to provide for an adequate premium-pooling base in addition your risk is too heavily concentrated in one insured as a result your business lacks one of the principal elements of insurance risk_distribution thus because you do not qualify as an insurance_company you do not meet the statutory requirement for exemption under sec_501 of the code you must file federal_income_tax returns on the form and for the years listed above within days of this letter unless you request an extension of time to file with their instructions and do not send them to this office failure_to_file the returns timely may result in a penalty file the returns in accordance we will make this letter and our proposed adverse determination_letter available for public inspection under code sec_6110 after deleting certain identifying information please read the enclosed notice notice of intention to disclose and review the two attached letters that show our proposed deletions instructions in notice action if you agree with our deletions you do not need to take any further if you disagree with our proposed deletions follow the if you have any questions about this letter please contact the person whose name and telephone number are shown in the heading of this letter federal_income_tax status and responsibilities please contact irs customer service at if you have any questions about your or the irs customer service number for businesses the irs customer service number for people with hearing impairments is sincerely robert choi director exempt_organizations rulings agreements enclosure notice redacted proposed adverse determination_letter redacted final adverse determination_letter department of the treasury internal_revenue_service washington d c tax_exempt_and_government_entities_division date date contact person identification_number contact number xxxxxx xxxxxx xxxxxxk xxxxkxk employer_identification_number xxxxxx uniform issue list dear we have considered your application_for recognition of exemption from federal_income_tax under internal_revenue_code sec_501 based on the information provided we have xxxxxxxxxxxkxkxxxxx concluded that you do not qualify for exemption under sec_501 of the internal_revenue_code the basis for our conclusion is set forth below facts you were incorporated on date in f a foreign_country you are in the business of providing certain commercial casualty and property insurance-type services you also reinsure certain contracts as described below your main source_of_income is premiums from the above- described activities in addition you receive some investment_proceeds you are a calendar_year taxpayer for your year tax_year you filed a form 1120-pc u s property and casualty insurance_company income_tax return you are wholly owned by c and d you have only one class of stock-big_number of no par_value shares out of these big_number shares you issued big_number shares in equal amounts to c and d c and d also serve as your only corporate officers and directors c serves as your chairman of the board corporate executive officer ceo president treasurer and assistant secretary d serves as your vice president secretary and assistant treasurer neither c nor d holds financial interests in any other insurance_companies moreover neither c nor d has any agreement or relationship with any of the shareholders of the insurance_companies that you conduct business you are a controlled_foreign_corporation as c and d are both u s citizens you are not a member of a controlled_group_of_corporations pursuant to sec_953 of the code you are treated as a domestic u s_corporation for federal_income_tax purposes you have employed e as your manager for an annual compensation of dollar_figurea you operate primarily to provide casualty and property insurance coverage toa aisa u s_corporation a is also wholly owned by c and d c serves as a’s president d serves as a's vice president you and a operate independently of one another a provides g services ona contract basis to companies in the h business in year you wrote five direct-written insurance contracts to a titled special risk - expense reimbursement insurance_policy excess employment practices liability insurance_policy special risk - regulatory changes insurance_policy excess directors officers liability insurance_policy and special risk - tax_liability insurance_policy each of the above-named policies is described in detail below the special risk - expense reimbursement insurance_policy covers public relations expenses to mitigate adverse publicity to a under certain circumstances including actual or imminent incidents where a's potential liability amount is disputes government or regulatory litigation bankruptcy or other major financial crisis loss of intellectual_property rights unsolicited takeover bids terrorism or any other adverse incident expected to reduce a’s annual gross revenue by at least the policy also covers all defense expenses for a's defenses related to actual or alleged civil liability in excess of dollar_figureb product recalls layoffs and labor xxxxxxxxxxxxxxxxx the excess employment practices liability insurance_policy covers damages and defense expenses a becomes legally obligated to pay as a result of any claim made during the covered period for wrongful acts with respect to employees wrongful acts include wrongful dismissal termination harassment and discrimination invasion of privacy retaliation and breach of employment contract in addition the policy covers claims of a’s violation of an employee’s civil rights and violations of the family medical and leave act acts and claims against non-employees are also covered the policy also reimburses a for expenses related to the above-described acts for business interruptions psychological counseling for employees and other costs required in order to bring workplace productivity back to pre-wrongful act levels the coverage applies in excess of any workers compensation benefits the special risk - regulatory changes insurance_policy covers actual compliance expenses and business interruptions suffered as a result of any regulatory change having an adverse impact on a’s normal on-going business operations the policy does not cover adverse regulatory changes resulting from a’s substantial noncompliance with regulations or guidelines or those changes initiated in direct response to a’s negligent acts omissions or errors the excess directors officers liability insurance_policy provides indemnification subject_to certain limitations to a for a’s indemnification of its officers and directors for wrongful acts including errors omissions neglect misstatements and breach of duty the policy also covers similar acts in relation to mergers and acquisitions moreover the policy includes liability for pollution the policy also provides direct executive liability coverage for similar acts to a’s officers and directors the special risk - tax_liability insurance_policy provides a with indemnification up to of the amount of additional tax_liability a may incur on its coverage is provided for additions to tax civil penalties or criminal penalties defense expenses and interest on any outstanding tax_liability are also covered in the policy federal_income_tax return no with respect to each of the above-referenced contracts you and b entered into an agreement titled joint underwriting stop loss endorsement b is not related to you a c or d you represent that b is a regulated insurer responsible for payment of claims up to certain specified thresholds if the thresholds are met if the specified limits then b becomes liable for payment of claims up to certain specified limits for b’s payment of claims are exceeded then you again become liable it also appears that for each of the above-referenced contracts you receive of the total premiums b receives of the total premiums it is unclear whether a pays you and b directly or whether a pays you and you remit to b it appears that under this agreement you are during year you entered into two types of reinsurance arrangements in the first arrangement you assumed reinsurance contracts from b the primary issuers on these contracts are unaffiliated insurance_companies that underwrite credit-type policies credit property credit disability and or credit life and policies for vehicle service contracts for year you received dollar_figurec in premium income from this arrangement you refer to the second arrangement as a reinsurance risk pooling program in this arrangement you participate in a reinsurance risk_pool with several other unrelated insurance xxxxxxkxxxxxxxxxxkx companies pool participants the risk_pool is operated by b each pool participant has one or more affiliated operating entities for which it underwrites insurance coverage generally casualty type coverage b insures a portion of the direct insurance underwritten by the pool participants using a so-called stop loss endorsement b currently participates in over insurance policies with more than insureds b blends together its direct-written insurance and then reinsures the entire book on a quota-share basis with each of the pool participants during year you received dollar_figured in premiums with respect to this second arrangement while unclear from the facts provided it appears that b reinsures its risks associated with the five direct-written contracts to a via the reinsurance risk-pooling program described above and of which you are a member your gross_income totaled dollar_figuree of which dollar_figuref was from premium income dollar_figureg from investment_income and dollar_figurex from consulting fees and other revenue sources of your total premium income for year is from a assuming you receive of the contract premiums as previously discussed is from the first reinsurance arrangement and is from the reinsurance risk pooling program for year your assets totaled dollar_figurey and total capital equaled dollar_figure law sec_501 of the code provides that an organization described in subsection c or d or sec_401 shall be exempt from taxation under this subtitle unless such exemption is denied under sec_502 or sec_503 sec_501 of the code provides insurance_companies as defined in sec_816 other than life including inter-insurers and reciprocal underwriters can apply for tax exempt status if ll the gross_receipts for the taxable_year do not exceed dollar_figure and more than of such gross_receipts consist of premiums or inthe case of a mutual_insurance_company the gross_receipts of which for the taxable_year do not exceed dollar_figure and more than of such gross_receipts consist of premiums sec_816 of the code provides that the term ‘insurance company’ means any company more than half of the business of which during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies sec_1_801-3 of the income_tax regulations provides that the term_insurance company mean a company whose primary and predominant business activity during the taxable_year is the issuing of insurance or annuity_contracts or the reinsuring of risks underwritten by insurance_companies thus though its name charter powers and subjection to state insurance laws are xxxxxxxxxxxxkxxkkx significant in determining the business which a company is authorized and intends to carry on it is the character of the business actually done in the taxable_year which determines whether a company is taxable as an insurance_company under the code pursuant to 312_us_531 the united_states supreme court in defining the term_insurance contract held that in order for a contract to amount to an insurance_contract it must shift and distribute a risk of loss and that risk must be an insurance risk pursuant to epmeir v united_states 199_f2d_508 7th cir insurance is a contract whereby for adequate_consideration one party agrees to indemnify another against loss arising from certain specific contingencies or perils pursuant to 979_f2d_162 9th cir affig 96_tc_18 risk-shifting means one party shifts his risk of loss to another and risk- distributing means that the party assuming the risk distributes his potential liability in part among others an arrangement without the elements of risk-shifting and risk-distributing lacks the fundamentals inherent in a true contract of insurance pursuant to 572_f2d_1190 7th cir the common definition for insurance is an agreement to protect the insured against a direct or indirect economic loss arising from a defined contingency whereby the insurer undertakes no present duty_of performance but stands ready to assume the financial burden of any covered loss pursuant to 183_f2d_288 2d cir the risk must contemplate the fortuitous occurrence of a stated contingency pursuant to 797_f2d_920 10th cir historically and commonly insurance involves risk-shifting and risk-distributing risk-shifting means one party shifts his risk of loss to another and risk-distributing means that the party assuming the risk distributes his potential liability in part among others an arrangement without the elements of risk-shifting and risk-distributing lacks the fundamentals inherent in a true contract of insurance pursuant to 988_f2d_1135 fed cir for insurance purposes risk-shifting means one party shifts his risk of loss to another and risk-distributing means that the party assuming the risk distributes his potential liability in part among others pursuant to 811_f2d_1297 9th cir a true insurance agreement must remove the risk of loss from the insured party pursuant to 881_f2d_247 6th cir risk_distribution involves shifting to a group of individuals the identified risk of the insured the focus is broader and looks more to the insurer as to whether the risk insured against can be distributed over a larger group rather than the relationship between the insurer and any single insured pursuant to revrul_89_96 1989_2_cb_114 an insurance agreement or contract must involve xxxxxxxxxxxxxxxkx the requisite risk shifting necessary for insurance pursuant to revrul_2002_89 2002_2_cb_984 it is not insurance where a parent company formed a subsidiary insurance_company and of the subsidiary’s earned premium was paid_by the parent company the rev_rul further held that such arrangement between a parent and a subsidiary would constitute insurance if less than of the premium earned by the subsidiary is from the parent company pursuant to revrul_60_275 1960_2_cb_43 risk shifting not present where subscribers all subject_to the same flood risk agreed to coverage under a reciprocal flood insurance exchange pursuant to revrul_2002_90 2002_2_cb_985 a wholly owned subsidiary that insured subsidiaries of its parent constitute insurance for federal_income_tax purposes pursuant to revrul_2005_40 r b an arrangement that purported to be an insurance_contract but lacked the requisite risk_distribution was characterized as a deposit arrangement a loan a contribution_to_capital an indemnity arrangement that was not an insurance_contract pursuant to revrul_2007_47 2007_30_irb_127 an arrangement that provides for the reimbursement of inevitable future costs does not involve the requisite insurance risk analysis neither the code nor the regulations define the terms insurance or insurance_contract the standard for evaluating whether an arrangement constitutes insurance is 312_us_531 in which the court stated that historically and commonly insurance involves risk-shifting and risk-distributing in a transaction which involve s an actual ‘insurance risk’ at the time the transaction was executed insurance has been described as involv ing a contract whereby for adequate_consideration one party agrees to indemnify another against loss arising from certain specified contingencies or perils epmeir v united_states 199_f2d_508 7th cir insurance is contractual security against possible anticipated loss id cases analyzing captive insurance arrangements have distilled the concept of insurance for federal_income_tax purposes to three elements applied consistently with principles of federal income_taxation involvement of an insurance risk shifting and distribution of that risk and insurance in its commonly accepted sense see eg 979_f2d_162 9th cir affig 96_tc_18 the risk transferred must be risk of economic loss 572_f2d_1190 7th cir the risk must contemplate the fortuitous occurrence of a stated contingency 183_f2d_288 2d cir and must not be merely an investment or business risk legierse u s pincite revrul_89_96 risk shifting occurs if a person facing the possibility of an economic loss transfers some or all of the financial consequences of the potential loss to the insurer such that a loss by the insured does not affect the insured because the loss is offset by a payment from the insurer see rev xxxxxxxxxxxxxxxxx rul risk shifting not present where subscribers all subject_to the same flood risk agreed to coverage under a reciprocal flood insurance exchange risk_distribution incorporates the statistical phenomenon known as the law of large numbers the concept of risk_distribution emphasizes the pooling aspect of insurance that it is the nature of an insurance_contract to be part of a larger collection of coverages combined to distribute risks between insureds 96_tc_18 aff'd 979_f2d_162 9th cir in treganowan f 2d pincite the court quoting note the new york stock exchange gratuity fund insurance that isn’t insurance yale l j explained that b y diffusing the risks through a mass of separate risk shifting contracts the insurer casts his lot with the law of averages the process of risk_distribution therefore is the very essence of insurance see also 797_f2d_920 10th cir risk_distribution means that the party assuming the risk distributes his potential liability in part among others 988_f2d_1135 fed cir ‘ risk_distribution involves spreading the risk of loss among policyholders distributing risk allows the insurer to reduce the possibility that a single costly claim will exceed the amount taken in as premiums and set_aside for the payment of such a claim by assuming numerous relatively small independent risks that occur over time the insurer smoothes out losses to match more closely its receipt of premiums 811_f2d_1297 9th cir risk_distribution necessarily entails a pooling of premiums so that a potential insured is not in significant part paying for its own risks see 881_f2d_247 6th cir in situation of revrul_2002_89 s a wholly owned subsidiary of p a domestic parent_corporation entered into an annual arrangement with p whereby s provided coverage for p’s professional liability risks the liability coverage s provided to p accounted for of the total risks borne by s under the facts of situation the service concluded that insurance did not exist for federal_income_tax purposes on the other hand in situation of revrul_2002_89 the premiums that s received from the arrangement with p constituted less than of s’s total premiums for the year under the facts of situation the service reasoned that the premiums and risks of p were pooled with those of unrelated insureds and thus the requisite risk shifting and risk_distribution were present accordingly under situation the arrangement between p and s constituted insurance for federal_income_tax purposes in revrul_2002_90 s a wholly owned insurance subsidiary of p directly insured the professional liability risks of operating subsidiaries of its parent s was adequately capitalized and there were no related guarantees of any kind in favor of s most importantly s and the insured operating subsidiaries conducted themselves in a manner consistent with the standards applicable to an insurance arrangement between unrelated parties together the operating subsidiaries had a significant volume of independent homogeneous risks under the facts presented the ruling concludes the arrangement between s and each of the operating subsidiaries of s’s parent constitute insurance for federal_income_tax purposes situation of revrul_2005_40 describes a scenario where a domestic_corporation operated a large fleet of automotive vehicles in its courier transport business covering a large portion of the xxxxxxxxxxxxxxxxx for united_states this represented a significant volume of independent homogeneous risks valid non-tax business purposes the transport company entered into an insurance arrangement with an unrelated domestic_corporation whereby in exchange for an agreed amount of premiums the domestic carrier insured the transport company against the risk of loss arising out of the operation of its fleet in the conduct of its courier business the unrelated carrier received arm's length premiums was adequately capitalized received no guarantees from the courier transport company and was not involved in any loans of funds back to the transport company the transport company was the carrier’s only insured while the requisite risk- shifting was seemingly present the risks assumed by the carrier were not distributed among other insured’s or policyholders therefore the arrangement between the carrier and the transport company did not constitute insurance for federal_income_tax purposes the facts in situation of revrul_2005_40 mirror the facts of situation except that in addition to its arrangement with the transport company the carrier entered into a second arrangement with another unrelated domestic company in the second arrangement the carrier agreed that in exchange for premiums it would insure the second company against its risk of loss associated with the operation of its own transport fleet the amount that the carrier received from the second agreement constituted of the total_amounts it received during the tax_year on a gross and net_basis thus of the carrier's business remained with one insured the revenue_ruling concluded that the first arrangement still lacked the requisite risk_distribution to constitute insurance even though the scenario involved multiple insureds in situation of revrul_2005_40 llcs elected classification as associations each contributing between and of the insurer's total risks the service concluded that this transaction constituted insurance for federal_income_tax purposes the principal concern with regard to your activities is whether there is sufficient risk_distribution as discussed above the idea of risk_distribution involves some mathematical concepts for example risk_distribution is said to incorporate the statistical phenomenon known as the law of large numbers whereby distributing risks allows the insurer to reduce the possibility that a single costly claim will exceed the amount taken in as premiums the concept hinges on the assumption of numerous relatively small and independent risks that occur randomly over time 811_f2d_1297 pincite as discussed the service in revrul_2002_90 concluded that insurance existed where insureds each contributed between five and to the insured’s total risks situation of revrul_2005_40 the service concluded that insurance existed where llcs electing classification as associations each contributed between five and of the insurer's total risks moreover in situation of revrul_2002_89 supra the service concluded that insurance existed where a wholly owned subsidiary insured its parent but the arrangement represented less than of the insurer’s total risk for the year similarly in of rev your application and the facts therein are analogous to the analysis under situation rul supra and situation of revrul_2005_40 supra in situation of revrul_2002_89 supra the liability coverage provided to the parent_corporation by its wholly owned subsidiary accounted for of the total risks borne by the subsidiary similarly in situation of revrul_2005_40 supra a second insurer contributing of the insured’s risks was added xxxxxxxxxxxxxxxxx to the single-insured scenario of situation the service concluded in both of the above scenarios that insurance did not exist because there lacked a sufficient number of insureds to provide for an adequate premium pooling base with respect to your case we make no determinations as to whether all of the agreements between you and a qualify as insurable risks see revrul_2007_47 in part holding that an arrangement that provides for the reimbursement of believed-to-be inevitable future cost does not involve the requisite insurance risk for purposes of determining whether the assuming entity may account for the arrangement as an insurance_contract for purposes of subchapter_l of the internal_revenue_code furthermore it appears that the various risks insured are not homogeneous and thus must be separated from one another and analyzed separately as to whether there is risk_distribution as to that risk see revrul_2002_89 supra see also revrul_2005_40 assuming that all of the agreements do constitute insurable risks or that a significant majority of the contracts qualify as insurable risks over of your total risks for the year are with a likewise to situation of revrul_2002_89 supra and situation of revrul_2005_40 supra there exists an inadequate premium pooling base for insurance to exist the addition of the two other insurance arrangements does not change the conclusion that the agreement with a lacks risk_distribution therefore you do not qualify as an insurance_company in your response to our request for additional information you rely on 96_tc_45 to support your argument that you qualify as an insurance_company you argue that in harper group the court held that where a single- insured paid of the total premium risk_distribution was sufficient to qualify the arrangement as insurance you argue here that less than of your risk is from a and thus the arrangement should qualify as insurance under harper group you misunderstand the holding in harper group in harper group the of the total premium received by the insurer was not related to a single corporate policyholder rather the was the total percentage from all related policyholders including brother-sister_corporations moreover the risks in harper group were diverse and widespread-an extensive variety of cargo shipments throughout the world via a variety of means and vessels thus harper group supports our conclusion as discussed above conclusion because you do not qualify as an insurance_company for federal tax purposes you fail to meet the requirements of sec_501 of the code thus you do not qualify for recognition of exemption under sec_501 of the code as an organization described in sec_501 as a result you must file federal_income_tax returns you have the right to file a protest if you believe this determination is incorrect to protest you must submit a statement of your views and fully explain your reasoning you must submit the statement signed by one of your officers within days from the date of this letter we will consider your statement and decide if the information affects our determination xxxxxxxxxxxxxxxxx your protest statement should be accompanied by the following declaration under penalties of perjury declare that have examined this protest statement including accompanying documents and to the best of my knowledge and belief the statement contains all the relevant facts and such facts are true correct and complete you also have a right to request a conference to discuss your protest this request should be made when you file your protest statement an attorney certified_public_accountant or an individual enrolled to practice before the internal_revenue_service may represent you want representation during the conference procedures you must file a proper power_of_attorney form_2848 power_of_attorney and declaration of representative if you have not already done so and power_of_attorney all forms and publications mentioned in this letter can be found at www irs gov forms and publications for more information about representation see publication practice_before_the_irs if you if you do not intend to protest this determination you do not need to take any further action if we do not hear from you within days we will issue a final adverse determination_letter that letter will provide information about filing tax returns and other matters please send your protest statement and any supporting documents to this address internal_revenue_service constitution ave n w washington dc you may also fax your statement using the fax number shown in the heading of this letter you fax your statement please call the person identified in the heading of this letter to confirm that he or she received your fax if lf you have any questions please contact the person whose name and telephone number are shown in the heading of this letter sincerely robert choi director exempt_organizations rulings agreements


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc corp 2-plr-106805-00 date date legend target target state a state b business y z year year date dear this letter responds to your authorized representative’s letter dated date in which rulings were requested as to certain federal_income_tax consequences of a proposed transaction additional information was submitted in letters dated june october and date the information submitted indicates that target was incorporated in year as a state a corporation target is engaged in business and is a calender year taxpayer using the accrual_method of accounting on date target made an election in accordance with the provisions of sec_1362 of the internal_revenue_code to be taxable as a subchapter_s_corporation target is no longer subject_to the recognition_period for certain built-in gains provided under sec_1374 target was incorporated in year as a state b corporation since its inception target has been taxable as a subchapter_s_corporation target is engaged in business and is a calender year taxpayer using the accrual_method of accounting target and target are each closely held and there is significant overlap in their shareholders target and target each has outstanding two classes of voting common_stock consisting of y shares of class a voting common and z shares of class b voting common the only difference between the two classes of stock is with respect to voting rights the holders of the class a common elect three members of the board_of directors while holders of the class b common elect two members of the board for valid business reasons the following transaction is proposed i ii iii the shareholders of target and target will incorporate newco as a state a corporation newco will elect s_corporation status in accordance with the provisions of sec_1362 to be effective for its first taxable_year newco will have two classes of authorized stock class a voting common and class b voting common class a and class b voting common will have identical rights to distribution and liquidation proceeds and differ only as to voting rights sec_1_1361-1 immediately after the incorporation of newco described above the shareholders of target and target will contribute all of their respective stock in target and target to newco in exchange for stock of newco as a result target and target will become wholly owned subsidiaries of newco newco will elect to treat target and target as qualified subchapter_s subsidiaries the qsub elections as defined in sec_1361 in accordance with the procedures set forth in sec_1_1361-3 of the income_tax regulations the following representations with respect to the proposed transaction have been submitted under penalties of perjury a to the best of taxpayer’s knowledge and belief the transfer to newco by the target and target shareholders of all of their respective stock in target and target solely in exchange for shares of stock in newco will qualify under sec_351 of the code b on the date of adoption of the plan_of_liquidation and at all times until the final liquidating_distribution is completed newco will be the owner of percent of the total combined voting power of all classes of stock of target entitled to vote and the owner of percent of the total value of all classes of stock c on the date of adoption of the plan_of_liquidation and at all times until the final liquidating_distribution is completed newco will be the owner of percent of the total combined voting power of all classes of stock of target entitled to vote and the owner of percent of the total value of all classes of stock d no shares of target stock will have been redeemed during the three years preceding newco’s qsub election for target e no shares of target stock will have been redeemed during the three years preceding newco’s qsub election for target f target will not have acquired assets in any nontaxable_transaction at any time except for acquisitions occurring more than three years prior to the date that newco makes the qsub election for target g target will not have acquired assets in any nontaxable_transaction at any time except for acquisitions occurring more than three years prior to the date that newco makes the qsub election for target h no assets of target have been or will be disposed of by target or newco except for dispositions in the ordinary course of business and dispositions occurring more than three years prior to newco’s qsub election for target i no assets of target have been or will be disposed of by target or newco except for dispositions in the ordinary course of business and dispositions occurring more than three years prior to newco’s qsub election for target j the deemed liquidation of target will not be preceded by nor will it be followed by the reincorporation in or transfer or sale to a recipient corporation of any of the businesses or assets of target if persons holding directly or indirectly more than percent in value of the target stock also hold directly or indirectly more than percent in value of the stock in target recipient for purposes of this representation ownership is determined by application of the constructive_ownership rules of sec_318 as modified by sec_304 k the deemed liquidation of target will not be preceded by nor will it be followed by the reincorporation in or transfer or sale to a recipient corporation of any of the businesses or assets of target if persons holding directly or indirectly more than percent in value of the target stock also hold directly or indirectly more than percent in value of the stock in target recipient for purposes of this representation ownership is determined by application of the constructive_ownership rules of sec_318 as modified by sec_304 l prior to making the qsub election with respect to target no assets of target will have been distributed in_kind transferred or sold to newco except for i transactions occurring in the normal course of business and ii transactions occurring more than three years prior to making the qsub election with respect to target m prior to making the qsub election with respect to target no assets of target will have been distributed in_kind transferred or sold to newco except for i transactions occurring in the normal course of business and ii transactions occurring more than three years prior to making the qsub election with respect to target n the fair_market_value of the assets of target will exceed its liabilities both at the date the qsub election is made and immediately prior to the time the deemed liquidation of target takes place o the fair_market_value of the assets of target will exceed its liabilities both at the date the qsub election is made and immediately prior to the time the deemed liquidation of target takes place p there is no intercorporate debt existing between newco and target and none has been canceled forgiven or discounted q there is no intercorporate debt existing between newco and target and none has been canceled forgiven or discounted r newco is not an organization that is exempt from federal_income_tax under sec_501 or any other provision of the code the representations submitted form a material basis for the issuance of our rulings based solely on the information submitted and representations we rule as follows provided the qsub elections for target and target are effective as of the date the stock of target and target is acquired by newco and before date target and target will each be treated as though it liquidated into newco at the beginning of the day the termination of the s elections of target and target are effective in transactions described in sec_332 and sec_337 sec_1_1361-4 a and b ii no gain_or_loss will be recognized by newco in connection with the qsub elections for target and target sec_332 no gain_or_loss will be recognized by target or target in connection with the qsub elections sec_337 for federal_income_tax purposes target and target will not be treated as separate corporations and all assets liabilities and items of income deduction and credit of target and target will be treated as assets liabilities and such items as the case may be of newco as of the effective date of the respective qsub election sec_1361 sec_1_1361-4 newco will succeed to and take into account those attributes of target and target described in sec_381 subject_to the provisions and limitations specified in sec_381 sec_382 sec_383 and sec_384 if applicable and the regulations thereunder sec_381 and sec_1 a - newco will succeed to and take into account the subchapter_c_earnings_and_profits or deficit in earnings_and_profits and the accumulated_adjustments_account of target and target if any as of the dates of the respective qsub elections sec_381 sec_1_381_c_2_-1 and sec_1_1368-2 no opinion is expressed about the tax treatment of the proposed transactions under other provisions of the code and regulations or about the tax treatment of any conditions existing at the time of or effects resulting from the transactions that are not directly covered by the above rulings in particular no opinion is expressed under sec_351 or on whether newco is otherwise eligible to be an s_corporation or target and target are otherwise eligible to be qsubs this ruling is directed only to the taxpayers who requested it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter should be attached to the federal_income_tax returns of the taxpayers involved for the taxable_year in which the transactions covered by this ruling letter are consummated in accordance with a power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer’s authorized representative sincerely associate chief_counsel corporate by edward s cohen chief branch