t c memo united_states tax_court jeffrey k and kristine k bergmann petitioners v commissioner of internal revenue respondent docket no filed date ronald b schrotenboer and brad bauer for petitioners gerald a thorpe for respondent memorandum opinion kroupa judge this matter is before the court on petitioners’ motion for summary_judgment filed pursuant to rule respondent determined deficiencies in petitioners’ federal income taxes and accuracy-related_penalties under sec_6662 for and this motion solely concerns the return for with respect to which respondent determined a dollar_figure deficiency and a dollar_figure gross_valuation_misstatement penalty under sec_6662 petitioners ask this court to grant them summary_judgment on two issues the first is whether as a matter of law petitioners filed a qualified_amended_return for and are therefore not liable for a valuation_misstatement_penalty under sec_6662 the second issue is whether petitioners are not liable for the valuation_misstatement_penalty as a matter of law on the ground that they may have conceded the deficiency we will deny petitioners’ summary_judgment motion for both issues as we do not have enough facts to make a proper determination background the following facts have been assumed solely for resolving the pending motion petitioner jeffrey k bergmann a partner at kpmg engaged in a series of currency options transactions commonly known as son of boss tax_shelter transaction sec_2 in 1all rule references are to the tax_court rules_of_practice and procedure and all section references are to the internal_revenue_code in effect for the year at issue unless otherwise indicated 2son of boss transactions purport to allow a taxpayer to reduce or eliminate capital_gains by creating artificial losses through the transfer of assets laden with significant liabilities continued and petitioners claimed dollar_figure of ordinary losses and dollar_figure of capital losses attributable to these transactions on their return for original return respondent began investigating kpmg to determine whether the firm promoted tax_shelters to its private clients and partners during the tax_year at issue respondent served summonses on kpmg in requesting documents and testimony relevant to determining kpmg’s liability for penalties for promoting_abusive_tax_shelters under sec_6700 the summonses issued to kpmg covered son of boss transactions but respondent did not then contact petitioners about their claimed losses petitioners subsequently filed an amended federal tax_return for in date amended_return petitioners removed the losses attributable to the son of boss transactions on the amended_return and reported dollar_figure of additional tax petitioners specifically stated in the amended_return however that they are not conceding the correctness of the positions asserted in notice_2000_44 2000_2_cb_255 and notice_2002_21 2002_1_cb_7303 or foreclosing the possibility that they might file another amended_return reflecting a different filing continued to a partnership see 128_tc_192 3these notices alert taxpayers that losses generated from certain transactions that lack actual economic consequences are not allowable for federal tax purposes position respondent credited the additional tax payment to petitioners’ account respondent sent petitioners a letter a year after receiving the amended_return informing petitioners that their return for was being examined respondent thereafter issued the deficiency_notice for determining the deficiency and the gross_valuation_misstatement penalty under sec_6662 with respect to the son of boss transactions they had claimed on their original return respondent did not consider the amended_return when determining the penalty amount petitioners timely filed a petition and thereafter filed the motion for summary_judgment at issue discussion we are asked to decide whether summary_judgment is appropriate summary_judgment is intended to expedite litigation and avoid unnecessary and expensive trials see eg 116_tc_73 a motion for summary_judgment will be granted if the pleadings answers to interrogatories depositions admissions and other acceptable materials together with the affidavits if any show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law see rule b 118_tc_226 the moving party has the burden of proving that no genuine issue of material fact exists and that it is entitled to judgment as a matter of law see eg 119_tc_157 we grant summary_judgment cautiously and sparingly and only after carefully ascertaining that the moving party has met all requirements for summary adjudication see 326_us_1 underpayment_of_tax penalty under sec_6662 petitioners move for summary_judgment on the issue that they are not liable for an accuracy-related_penalty under sec_6662 for having an underpayment a taxpayer may correct an earlier underpayment by filing a qualified_amended_return which may have the effect of preventing or reducing liability for the accuracy-related_penalty by substituting the tax shown on the amended_return for the tax_shown_on_the_return as originally filed sec_1_6664-2 income_tax regs accordingly if the amended_return for is a qualified_amended_return then there would be no underpayment of petitioners’ tax to which the penalty would apply respondent argues that the amended_return does not qualify as a qualified_amended_return a qualified_amended_return is an amended_return filed after the due_date of the return for the taxable_year and before 4an underpayment is the difference between i the correct_tax and ii the tax_shown_on_the_return plus any amount not so shown that was previously assessed less any rebates sec_6664 the earlier of certain events see sec_1_6664-2 income_tax regs at issue here is whether petitioners filed the amended_return before respondent contacted any person described in sec_6700 concerning examination of a sec_6700 activity from which petitioners directly or indirectly claimed a benefit on the original return see sec_1_6664-2 income_tax regs if respondent contacted such a person concerning such an activity before petitioners submitted the amended_return then the return would not be a qualified_amended_return and the accuracy-related_penalty may still apply the parties disagree whether kpmg is a person described in sec_6700 we now turn to that issue person described in sec_6700 respondent claims to have contacted a person described in sec_6700 by serving summonses on kpmg petitioners urge this court to find that kpmg is not a person under this section and thus the summonses sent to kpmg would not bar their amended_return from being a qualified_amended_return a person for sec_6700 purposes is one who is involved in promoting tax_shelters or similar investment plans or 5respondent also argues that even if this court finds that kpmg is not a person it could be proven at trial that mr bergmann and david greenberg a former kpmg partner were constructively contacted when respondent served summonses on kpmg thereby satisfying the person described in sec_6700 requirement arrangements and who in connection with such promotions knowingly makes or furnishes or causes others to make or furnish false or fraudulent statements as to the potential tax benefits or a gross_valuation_overstatement see sec_6700 and b the flush language of sec_6700 provides that such a person must pay a dollar_figure penalty for each described activity petitioners urge this court to find that kpmg is not a person described in sec_6700 because respondent failed to produce evidence that a penalty was assessed against kpmg with respect to petitioners’ son of boss transactions respondent asserts that we should not make a negative inference from his inability to provide evidence on whether kpmg is a person described in sec_6700 respondent is unable to confirm whether kpmg was assessed a penalty because that information constitutes kpmg’s return_information which respondent is prohibited from disclosing under sec_6103 nor have petitioners requested this court to issue an order compelling such information to be disclosed which is a limited exception to the non-disclosure rule we have carefully considered the materials the parties submitted in connection with petitioners’ motion for summary 6we further find that petitioners not respondent have the burden to show that no penalty has been assessed against kpmg for the type of transaction petitioners claimed on the original return judgment we are unable to conclude on the facts presented to the court at this juncture whether kpmg qualifies as a person under sec_6700 and thus whether petitioners’ amended_return is a qualified_amended_return we find genuine issues of material fact remain concerning this issue see 552_fsupp2d_1167 d colo the relevant inquiry is whether the third party was contacted regarding the taxpayers’ particular transactions these material facts include those respondent noted in his response to petitioners’ reply memorandum specifically factual disputes exist whether kpmg is a person described in sec_6700 and if it is whether and when respondent first contacted kpmg concerning promotion of tax_shelter transactions with respect to which petitioners directly or indirectly claimed tax benefits on the original return these material facts need to be further developed before the court can determine whether the amended_return is a qualified_amended_return accordingly petitioners are not entitled to summary_judgment on this issue 7petitioners also argue that they did not take a false or fraudulent position on their return to support their claim of filing a qualified_amended_return we find however a trial is necessary to fully consider whether petitioners filed a qualified_amended_return we therefore need not address this issue at this time the valuation_misstatement_penalty of sec_6662 petitioners also move for a summary_judgment that no valuation_misstatement_penalty applies to them as a matter of law a taxpayer is liable for an accuracy-related_penalty in the amount of percent of any part of an underpayment attributable to a substantial_valuation_misstatement see sec_6662 and b the commissioner may increase the penalty to percent where the tax underpayment is attributable to one or more gross_valuation_misstatements petitioners argue they are entitled to summary_judgment and that respondent may not impose the valuation_misstatement_penalty when the deductions giving rise to the penalty are disallowed in toto see 556_f3d_1056 9th cir dollar_figure petitioners claim that they have conceded the deductions which are the basis of respondent’s determination of a penalty by filing the amended_return this court has 8a substantial_valuation_misstatement occurs if among other things the reported value or adjusted_basis of property is percent or more of its correct value or adjusted_basis sec_6662 9a gross_valuation_misstatement occurs if the reported value or adjusted_basis of property is percent or more of its correct value or adjusted_basis sec_6662 10petitioners were residents of california we therefore follow precedent from the court_of_appeals for the ninth circuit to the extent such precedent is on point see sec_7482 54_tc_742 affd 445_f2d_985 10th cir determined that it will not conduct a trial solely to address the valuation misstatement issue where the taxpayer has conceded the deficiency on other grounds see 92_tc_827 schachter v commissioner tcmemo_1994_273 accordingly petitioners assert that a valuation_misstatement_penalty may not be imposed and that this court should dispose_of the issue on summary_judgment respondent counters that petitioners have yet to concede that they are not entitled to the loss deductions attributable to the son of boss transactions as noted above petitioners stated in the amended_return that they are not conceding the correctness of the positions taken in the amended_return we cannot find therefore that petitioners have conceded that the transactions lacked economic_substance and that no deductions are allowable accordingly we find it premature to rule at this time that the valuation_misstatement_penalty under sec_6662 does not apply we have considered all arguments the parties made in reaching our holdings and to the extent not mentioned we find them irrelevant or without merit to reflect the foregoing an appropriate order will be issued


t c memo united_states tax_court interhotel company ltd torrey hotel enterprises inc matters partner petitioner v commissioner of internal revenue respondent docket no filed june m and thei were partners in ihcl a limited_partnership formed in to hold interests in landmark and gateway two limited_partnerships landmark and gateway were formed to construct own and manage separate hotel towers of a san diego resort complex landmark and gateway financed their hotel developments using nonrecourse debt the ihcl partnership_agreement provided that upon liquidation the proceeds would be distributed only to those partners having positive capital accounts the partnership_agreement did not require the partners to this memorandum opinion supplements our opinion in interhotel co ltd v commissioner tcmemo_1997_449 vacated and remanded without published opinion 221_f3d_1348 cir tax o01 9th -- - restore any deficits in their capital accounts upon liquidation of the partnership in d agreed to invest dollar_figure million in ihcl in exchange for a 15-percent interest in ihcl d received a non-pro rata special_allocation of percent of thcl’s income and losses upon d’s entry as a partner in thcl m withdrew as a partner and thei’s interest in thcl was reduced d encountered financial difficulties and defaulted on its contribution_payment obligation in the special_allocation of ihcl’s gains and losses to d was terminated thereafter the gains and losses of ihcl were allocated to thei and d pro_rata in accordance with their respective partnership interests under this new allocation percent of the losses went to thei creating a substantial deficit balance in thei’s partnership capital_account on date m purchased d’s interest in ihcl and thereafter succeeded to d’s then-positive dollar_figure million partnership capital_account at the time thei had a negative dollar_figure million partnership capital_account balance upon m’s reentry into ihcl the ihcl partnership_agreement was amended to provide that ihcl’s income would be allocated first to partners having negative capital_account balances and thereafter to the partners pro_rata ihcl’s information_return reported an allocation of percent of ihcl’s income to d through date and thereafter an allocation of percent of the income to thei respondent determined that percent of ihcl’s income after date should be allocated to m in our original opinion in this case we sustained respondent’s position on appeal the parties agreed that a minimum_gain_chargeback should be included in the court’s calculations for purposes of the comparative liguidation test of the partners’ interests under sec_1_704-1 b income_tax regs held in view of the parties’ agreement the special_allocation of percent of ihcl’s income earned after date to thei is in accordance with the partners’ interests in ihcl and is therefore respected see sec_704 kenneth w gideon for petitioner gretchen a kindel for respondent supplemental memorandum opinion jacobs judge this case is before us on remand from the court_of_appeals for the ninth circuit see interhotel co ltd v commissioner 221_f3d_1348 9th cir vacating and remanding without published opinion tcmemo_1997_449 torrey hotel enterprises inc thei 1s a california corporation organized and controlled by douglas f manchester mr manchester thei is the tax_matters_partner of interhotel company ltd ihcl a california limited_partnership mr manchester is the other partner in ihcl respondent issued a notice of final_partnership_administrative_adjustment fpaa on date in relevant part respondent t in addition to the amounts at issue respondent determined that interhotel co ltd the partnership whose earnings are at issue here had ordinary_income from its business activities in the amount of dollar_figure rather than dollar_figure as reported on its form_1065 u s partnership return of income for respondent further determined that the partnership was entitled to other deductions professional fees continued q4e- proposed increasing mr manchester’s reported distributive_share of thcl’s net_income for by dollar_figure as a consequence of this determination respondent determined that mr manchester should be subject_to adjustments for alternative_minimum_tax and tax preference items totaling dollar_figure the issue for decision on remand is whether the allocation of all of ihcl’s income to thei possessed economic_substance or was made in accordance with the partners’ interests in ihcl background we incorporate herein the findings_of_fact set forth in interhotel _co ltd vv commissioner tcmemo_1997_449 interhotel co i by this reference for convenience we shall summarize the relevant facts in interhotel co i we also incorporate herein the stipulations and exhibits in interhotel co i by this reference unless indicated otherwise all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure prior to mr manchester formed two limited_partnerships pacific landmark hotel ltd landmark and pacific gateway ltd gateway to construct own and manage two hotel facilities at the san diego convention center the two partnerships financed the ' continued in the amount of dollar_figure instead of dollar_figure as reported the parties resolved these issues prior to trial - construction of the hotels principally through the use of nonrecourse borrowing for tax purposes landmark and gateway utilized accelerated_depreciation methods these methods reduced the partnerships’ tax bases in the hotel properties to amounts that were less than the amount of debts the partnerships had incurred to construct those properties mr manchester formed ihcl to hold 354-percent limited_partnership interests in landmark and gateway under the agreement of limited_partnership of ihcl dated date the ihcl original agreement mr manchester held a 001-percent interest in thcl thei held a 999-percent interest both as a general and limited_partner in date dondi properties dondi which was then controlled by vernon savings and loan association vernon invested in ihcl dondi received a 15-percent limited_partnership_interest in ihcl in exchange for its agreement to contribute dollar_figure million to ihcl mr manchester then withdrew as a partner in thcl following this transaction thei held an 85-percent interest in ihcl an 84-percent limited_partnership_interest and a 1-percent interest as the general_partner dondi’s entry into ihcl was reflected in a restated and amended agreement of limited_partnership of ihcl dated date the ihcl restated agreement that agreement allocated percent of ihcl’s net losses to dondi and percent to thei as -- - the general_partner the ihcl restated agreement further provided that after approximately years the net losses were to be allocated to the partners on a pro_rata basis pursuant to the thcl restated agreement ihcl’s net_income was allocated to the partners in the same ratio as net losses until such time as the allocated amount of income equaled the amount of ihcl’s cumulative net losses thereafter ihcl’s income would be allocated to the partners pro_rata moreover as part of dondi’s entry into ihcl the limited_partnership agreements of landmark and gateway were amended to allocate dollar_figure percent of landmark’s and gateway’s net losses to ihcl thcl maintained capital accounts for each of its partners the partnership agreements of ihcl landmark and gateway all required that upon liguidation distributions to partners would be made in accordance with the partners’ positive capital_account balances by date dondi had contributed dollar_figure million of the reguired dollar_figure million to ihcl and agreed to pay the balance due dollar_figure million in subsequent quarterly installments dondi encountered financial difficulties and failed to make the installment_payment due_date by that time the federal deposit insurance corporation fdic had become the receiver for vernon as a result in date thei gave dondi - written notice under sec_4 d of the ihcl restated agreement that dondi’s 99-percent allocation of ihcl’s net losses was terminated pursuant to the ihcl restated agreement ihcl’s net losses were then allocated to the partners pro_rata in accordance with the ratio reflecting the two partners’ interests as a conseguence percent of the losses were allocated to dondi and percent of the losses were allocated to thei the special_allocation of ihcl’s net_income remained unchanged and ihcl’s restated agreement continued to allocate percent of its net_income to dondi in october of the marriott corp marriott obtained a 5-percent general_partnership interest in both landmark and gateway marriott also received an allocation of percent of landmark’s net losses and percent of gateway’s net losses these allocations reduced the amount of losses landmark and gateway previously allocated to ihcl by the end of thei’s capital_account in ihcl was a negative dollar_figure principally this was the result of the losses generated between dondi’s date default and the reallocation of losses to marriott months later in contrast by the end of dondi’s capital_account in ihcl grew to dollar_figure thcl’s balance_sheet as of the end of revealed the following cash dollar_figure unamortized organization costs big_number investment in pacific gateway big_number investment in pacific landmark big_number liabilities big_number subtotal big_number on date dondi transferred its 15-percent limited_partnership_interest in ihcl to the fdic as receiver for vernon the fdic transferred this interest in ihcl to mr manchester in exchange for his dollar_figure million payment as a result thei held a percent interest as general_partner and an 84-percent interest as a limited_partner mr manchester as dondi’s successor held the remaining 15-percent limited_partnership_interest and succeeded to dondi’s capital_account on date the parties executed a second amendment to the ihcl restated agreement the second amendment provided that thcl’s net_income would be allocated first to the partners who had negative capital_account balances and thereafter to the partners pro_rata at the end of the balance_sheet of ihcl set forth its book_value as follows cash dollar_figure unamortized organization costs big_number note receivable from thei big_number investment in pacific gateway big_number investment in pacific landmark big_number liabilities big_number subtotal big_number thcl filed a information_return partnership return of income reporting the allocation of percent of its net_income to --- - dondi through date the date dondi’s interest was transferred to mr manchester the return further reflected that after date percent of ihcl’s net_income was allocated to thei respondent challenged the allocation of percent of ihcl’s net_income to thet respondent determined that for the period after date mr manchester should be allocated a portion of thcl’s net_income specifically respondent determined that mr manchester’s distributive_share of ihcl’s net_income should be increased by dollar_figure and that his share of tax preference items should be increased by dollar_figure this reallocation of ihcl’s net_income reflects the pre-date allocation of income and losses to dondi percent to thei and percent to mr manchester as dondi’s successor the fpaa stated that the adjustments in the distributive shares are determined in accordance with the partners’ interest in the partnership as the partnership has not shown that the allocation per the return is an allowable allocation under the provisions of the internal_revenue_code in interhotel co i we held that the allocation of percent of ihcl’s net_income for to thei lacked substantial economic_effect and was inconsistent with the partners’ interests in the partnership accordingly we sustained respondent’s reallocation of the majority of that income to mr manchester on -- - appeal of our decision the court_of_appeals for the ninth circuit stated the internal_revenue_service concedes that it erred in convincing the tax_court to refrain from including a minimum_gain_chargeback in the court’s calculations for purposes of the comparative liquidation test because of this concession we vacate the tax court’s decision and remand for further proceedings findings and conclusions discussion sec_704 provides the framework for the determination of a partner’s distributive_share of partnership income gain loss deductions or credits of the partnership in general the partnership_agreement determines a partner’s distributive_share of these items see sec_704 however the partners’ ability to allocate partnership items on a basis other than in accordance with the partners’ interest in the partnership e non-pro rata basis is not unrestricted the allocation of partnership items on a non-pro rata basis hereinafter referred to as a special_allocation either must have substantial economic_effect as opposed to the mere avoidance of tax or if the allocation does not have substantial economic_effect then the partner’s distributive_share of partnership items shall be determined in accordance with the partner’s interest in the partnership determined by taking into account all facts and circumstances sec_704 the regulations under sec_704 describe in detail not only the circumstances in which a special_allocation will have substantial economic_effect but also the manner of determining a partner’s interest in the partnership substantial economic_effect the regulations provide that a special_allocation of partnership items is deemed to have substantial economic_effect if in the event there is an economic benefit or burden that corresponds to an allocation the partner to whom the special_allocation is made receives a corresponding benefit or bears a corresponding burden see sec_1_704-1 income_tax regs moreover the economic_effect of the special_allocation must be substantial this requires a reasonable possibility that the allocation or allocations will affect substantially the dollar amounts to be received by the partners from the partnership independent of tax consequences sec_1_704-1 a income_tax regs determinations of substantial economic_effect as well as determinations of a partner’s interest in the partnership depend upon an analysis of the partners’ capital accounts generally speaking a partner’s capital_account represents the partner’s equity_investment in the partnership the capital_account balance is determined by adding the amount of money that the partner contributes to the partnership the fair_market_value of property the partner contributes net of liabilities to which the property is subject or which are assumed by the partnership and any allocation of partnership income or gain a partner’s capital_account is decreased by the amount of partnership losses and deductions allocated to such partner the capital_account is further reduced by the fair_market_value of property distributed to the partner net of any liability that the partner assumes or to which the property is subject see sec_1_704-1 iv income_tax regs the regulations governing the economic_effect of special allocations contain three tests that essentially serve as safe harbors special allocations are deemed to have economic_effect if they meet the requirements of any one of these safe_harbor tests the basic test of ebconomic effect the basic test for economic_effect with respect to special allocations is set forth in sec_1_704-1 b income_tax regs the test provides in general that a special_allocation will have economic_effect if the partnership_agreement contains provisions that require the determination and maintenance of partners’ capital accounts be in accordance with the rules of sec_1_704-1 iv income_tax regs upon liguidation of the partnership the proceeds of liguidation be distributed in accordance with the partners’ positive capital_account balances and upon liquidation of the partnership all deficit capital accounts be restored to zero with regard to the matter before us the parties agree that the ihcl restated agreement complies with the first two requirements the agreement provides that the partners’ capital accounts will be properly maintained and that liquidation proceeds will be distributed to the partners in proportion to their positive capital_account balances however neither the ihcl restated agreement nor any of its amendments require partners having deficit capital_account balances to restore the deficits to zero upon liquidation of the partnership accordingly the special_allocation of percent of ihcl’s net_income for to thei did not meet all the requirements necessary to satisfy the basic test of substantial economic_effect alternative test of economic_effect limited_partnership agreements such as the ihcl original agreement usually provide specific limits upon the amount the limited partners are required to contribute to the partnership these limits on liability however are inconsistent with the requirement in the basic test that upon liguidation each partner must agree to repay the deficit balance in that partner’s capital_account consequently an alternative test for economic_effect has been developed to provide that special allocations of partnership items may have economic_effect even in the absence of an unlimited deficit restoration requirement the alternative test begins by incorporating the first two parts of the basic test as with the basic test the partnership_agreement must provide for properly maintained capital accounts it must also provide that the proceeds of liguidation are to be distributed in accordance with the partners’ positive capital_account balances however instead of a negative capital_account makeup requirement the alternative test mandates a hypothetical reduction of the partners’ capital accounts specifically the alternative test reguires that capital accounts be reduced for any distributions that as of the end of the year are reasonably expected to be made to the extent that such distributions exceed reasonably expected increases to the partners’ capital accounts see sec_1_704-1 d income_tax regs by requiring a prospective reduction of capital accounts the alternative test serves to preclude a limited_partner from timing the receipt of deductible partnership expenses in a way that permits a partner to accumulate a negative capital_account that the partner need not repay the alternative test also requires that the partnership_agreement provide for a qualified_income_offset qio a qio provision automatically allocates income including gross_income and gain to a limited_partner who has an unexpected negative capital_account either as a result of partnership operations or as a result of making the adjustment for reasonably expected -- - reductions the qio must operate in an amount and manner sufficient to eliminate such deficit balance as quickly as possible sec_1_704-1 d income_tax regs flush language in the present matter neither the ihcl original agreement nor the ihcl restated agreement contains a provision requiring capital_account adjustments for reasonably expected distributions or a qualified_income_offset although the second amendment to the thcl restated agreement does provide for a net_income allocation to pay off thei’s deficit capital_account the second amendment falls short of providing a qio rather the second amendment allocates only net_income not a pro_rata portion of each item of partnership income allocated in an amount and manner sufficient to eliminate such deficit balance as quickly as possible sec_1_704-1 b d income_tax regs consequently the ihcl special_allocation does not meet the alternative test of economic_effect economic equivalence test there is a third economic_effect safe_harbor referred to as the economic equivalence test sec_1_704-1 income_tax regs provides that in the event that an allocation would produce the economic equivalent of meeting the basic test for -- - economic_effect it will be deemed to have economic_effect even if it does not otherwise meet the formal requirements of the basic test in the present case neither party maintains that the special allocations in this complex multitiered partnership situation would have the equivalent economic_effect of meeting the basic test conclusion the special_allocation of percent of ihcl’s net_income for to thei does not have substantial economic_effect partners’ interests in the partnership the general_rule sec_704 provides that an allocation of partnership income gain loss deductions or credit or item thereof that does not meet the requirements for substantial economic_effect will be determined in accordance with the partner’s interest in the partnership this requirement although less specific than the test for economic_effect nevertheless requires that partnership_allocations be analyzed on the basis of their actual economic impact accordingly the regulations provide that an examination of a partner’s interest in the partnership shall be made by taking into account all facts and circumstances relating to the economic arrangement of the partners sec_1_704-1 income_tax regs the comparative liquidation test pursuant to sec_1_704-1 income_tax regs a partner’s interest in the partnership is determined by the comparative liquidation test when a partner’s special_allocation is consistent with the comparative liquidation test the special_allocation is deemed to be in accordance with the partners’ interests in the partnership this test applies only when a partnership’s special allocations lack economic_effect under the alternative test for economic_substance set forth in sec_1 b income_tax regs to satisfy the comparative liquidation test the partnership_agreement must meet the first two parts of the basic test for economic_effect that is the partnership_agreement must provide that capital accounts are to be properly maintained and liguidating distributions will be made only to partners with positive capital_account balances when both conditions are satisfied a partner’s interest is measured by comparing the amount the partner would receive in a hypothetical liquidation at the end of the current_year with the amount the partner would have received in a hypothetical liquidation at the end of the prior year specifically the partner’s interests in the partnership with respect to the portion of the allocation that lacks economic_effect will be determined by comparing the manner in which distributions and contributions would be made if all partnership property were sold at book_value and the partnership were liquidated immediately following the end -- - of the taxable_year to which the allocation relates with the manner in which distributions and contributions would be made if all partnership property were sold at book_value and the partnership were liguidated immediately following the end of the prior taxable_year x kk a determination made under this paragraph b will have no force if the economic_effect of valid allocations made in the same manner is insubstantial under paragraph b of this section sec_1_704-1 income_tax regs both parties rely on the comparative liquidation test to show their differing schemes respondent asserts that the comparative liguidation test of sec_1_704-1 income_tax regs supports the special_allocation of all partnership income to mr manchester as set forth in the fpaa first respondent contends that if all of thcl’s assets had been sold at the end of the net liquidation proceeds would have been dollar_figure respondent computes this amount using stipulated figures as follows assets cash dollar_figure investment in landmark big_number investment in gateway big_number unamortized organization costs total assets big_number liabilities accounts_payable big_number total liabilities big_number net_proceeds big_number respondent eliminated the unamortized organization costs thus respondent’s figures for total assets and net_proceeds are dollar_figure less than indicated above without passing on the correctness of this omission we have included these costs in order to make respondent’s and petitioner’s figures more easily comparable next respondent contends that if all of ihcl’s assets had been sold at the end of the proceeds therefrom would be dollar_figure this amount is computed as follows assets cash dollar_figure investment in landmark big_number investment in gateway big_number note receivable from thei big_number unamortized organization costs big_number total assets big_number liabilities accounts_payable big_number total liabilities big_number net_proceeds big_number respondent asserts that at the end of the first year all the liquidation proceeds would have gone to dondi which was the only partner to have a positive capital_account further respondent claims the amount available for distribution upon liquidation is dollar_figure less than the positive capital_account balance of dollar_figure for dondi at the end of the next year the year involved herein the net_book_value of ihcl’s assets was dollar_figure respondent contends that under the ihcl restated agreement all of the increase in book_value would have been distributed to mr - - manchester as successor to dondi’s interest in ihcl because mr manchester was the only partner with a positive capital_account at the end of respondent points out that the amount available for distribution is approximately dollar_figure million less than the positive balance in mr manchester’s capital_account respondent concludes that the application of the comparative liquidation test supports the determination made in the fpaa- -1 e that because at the end of mr manchester was the only partner having a positive capital_account in ihcl he would be the only partner eligible to receive thcl’s liguidation proceeds accordingly all the post-date income of ihcl must be allocated to him nonrecourse debt deductions petitioner disagrees with respondent’s conclusion petitioner contends that respondent erroneously failed to include in the deemed liquidation proceeds approximately dollar_figure million relating to deductions that were based upon nonrecourse debt for both and a brief discussion relating to tax principles involving the calculation of the basis_of_property acquired through nonrecourse debt financing and the calculation of gain required to be realized from the disposition of such property is deemed beneficial in understanding petitioner’s position in a nonrecourse debt financing situation the lender agrees that it will not maintain a collection action directly against the --- - debtor rather should the debtor default the lender’s only recourse is the institution of foreclosure proceedings with respect to the property securing the debt accordingly if the value of the property securing the debt falls below the amount of the debt it is the lender not the debtor who bears the risk of loss nevertheless it is well settled that for tax purposes nonrecourse debt incurred to acquire property constitutes a part of the debtor’s cost_basis in the property it has purchased see 331_us_1 accordingly the amount of debt even nonrecourse debt increases the amount the debtor taxpayer may claim for depreciation with respect to encumbered property however when the debtor disposes of the property the debtor must include in the amount_realized from the disposition of the property the amount of any remaining nonrecourse debt to which the property is subject thus if the debtor has taken deductions such as depreciation_deductions that have reduced its basis in the property to an amount less than the amount of the nonrecourse debt the debtor must recognize gain at least to the extent that its basis is exceeded by the amount of debt secured_by the property see 461_us_300 minimum gain and minimum gain chargebacks the aforementioned nonrecourse debt principles apply to partnerships if a partnership has acquired properties with -- - nonrecourse debt the partnership’s deduction of expenses associated with these properties---such as expenses for depreciation--may lead to a situation where the amount of nonrecourse debt exceeds the partnership’s basis in the properties securing that debt these deductions--called nonrecourse_deductions ---per se do not have economic_effect because the lender and not the partnership or its partners bears the economic risk of loss with respect to the nonrecourse_deductions as applicable to the taxable_year at issue temporary regulations exist that govern the allocation of deductions attributable to nonrecourse debt these provisions are set forth in sec_1_704-1t and temporary income_tax regs fed reg date and involve the concepts of minimum gain and minimum gain chargebacks these provisions represent the application of the tufts principle in a partnership context minimum gain is created when a partnership claims deductions that decrease the partnership’s basis in a given property to an amount less than the balance of the nonrecourse debt incurred in the acquisition of that property the event that triggers a minimum_gain_chargeback is one which causes a decrease in partnership_minimum_gain a triggering event therefore occurs when a partnership disposes of property in respect of which the partnership’s nonrecourse indebtedness exceeds - - the partnership’s basis it is this type of event that under tufts triggers the realization of gain by the partnership at least to the extent the amount of the partnership’s acquisition_indebtedness exceeds the partnership’s basis in that property to illustrate assume that a partnership owed dollar_figure million in nonrecourse debt that it used to acquire depreciable_property if the partnership claimed dollar_figure in depreciation_deductions which would lower its dollar_figure million basis in the property to dollar_figure the dollar_figure the amount by which the debt exceeds the partnership’s basis would be the minimum gain this dollar_figure is the potential gain sometimes called phantom_gain that the partnership would realize when it disposes of that property thus if the lender foreclosed upon the property the partnership would realize at least a minimum gain of dollar_figure even though the partnership received no gain in an economic sense the dollar_figure minimum_gain_chargeback is the minimum gain that is allocated to the partners who had claimed as pass throughs the nonrecourse_deductions these allocations of minimum see nadler v commissioner tcmemo_1992_383 quoting westin the tax lexicon affd without published opinion 993_f2d_1533 2d cir -- - gain increase the partners’ capital accounts as well as expose the partners to income_taxation on the amount of gain minimum gain and the comparative liquidation test petitioner maintains that the minimum_gain_chargeback provisions required ihcl to realize approximately dollar_figure million in minimum gain chargebacks with respect to the comparative liquidation test petitioner’s position is based on the following theory although ihcl owned no property subject_to nonrecourse debt it had ownership interests in landmark and gateway both of specifically sec_1_704-1t iv e temporary income_tax regs fed reg date provides e minimum gain chargeback--- in general if there is a net decrease in partnership_minimum_gain for a partnership taxable_year the partners must be allocated items of partnership income and gain in accordance with this paragraph b iv e minimum_gain_chargeback allocations required pursuant to minimum_gain_chargeback if a minimum_gain_chargeback is required for a partnership taxable_year then each partner must be allocated items of income and gain for such year and if necessary for subsequent years in proportion to and to the extent of an amount equal to the greater of-- the portion of such partner’s share of the net decrease in partnership_minimum_gain during such year that is allocable to the disposition of partnership property subject_to one or more nonrecourse liabilities of the partnership or the deficit balance in such partner’s capital_account at the end of such year - - which did own such properties thcl’s ownership of interests in these lower tier_partnerships is in effect a proportionate ownership_interest in the properties of those lower tier_partnerships as well in this regard petitioner points to the regulations governing allocation of nonrecourse_deductions which expressly provide a look-through_rule for situations involving tiered partnerships petitioner then posits that for purposes of the nonrecourse_deductions the look-through_rule is designed to produce the same consequences for the upper_tier_partnership here thcl that would have resulted had ihcl directly held its proportionate share of the properties owned by gateway and landmark petitioner concludes that under these regulations had landmark or gateway incurred minimum gains on the disposition of their property ihcl would be required to realize its proportionate share of those gains see sec_1_704-1t 1v temporary income_tax regs fed reg date continuing petitioner asserts that a deemed liquidation of thcl under the comparative liquidation test would imply a deemed liquidation of landmark and gateway as well and hence a sale of their hotel properties the result of the disposition of those properties would trigger minimum gain chargebacks to landmark and gateway and through them a proportionate share to ihcl petitioner’s application of the comparative liquidation test uses the same figures as respondent however petitioner augments - - those figures with substantial amounts of minimum gain chargebacks for both and as a first step petitioner contends that if all of ihcl’s assets had been liquidated at the end of 1990--the year prior to the taxable year--the net liguidation proceeds would have been dollar_figure this amount is computed as follows assets cash dollar_figure unamortized organization costs big_number investment in pacific gateway big_number investment in pacific landmark big_number liabilities big_number subtotal big_number minimum_gain_chargeback big_number distributable liquidation proceeds at book_value big_number petitioner contends that dollar_figure of the minimum_gain_chargeback would be used first to eliminate thei’s negative capital_account the dollar_figure balance of the minimum_gain_chargeback would then be allocated pursuant to the ihcl restated agreement as it was in effect during thus percent or dollar_figure would be allocated to thei and percent or dollar_figure would be allocated to dondi these allocations when added to the partners’ capital accounts yield a positive capital_account of dollar_figure for thei and dollar_figure for dondi together they reflect total partnership capital of dollar_figure--the amount of the previously identified liquidation proceeds o7 - as a second step petitioner maintains that a liquidation of all of ihcl’s assets at the end of 1991--the taxable year--would yield proceeds of dollar_figure this amount is computed as follows deemed liquidation cash dollar_figure organization costs big_number note receivable from thei big_number investment in pacific gateway big_number investment in pacific landmark big_number liabilities big_number subtotal big_number minimum_gain_chargeback big_number distributable liquidation proceeds at book_value big_number this dollar_figure amount is dollar_figure more than that for the prior year this increase consists of an additional dollar_figure in minimum gain chargebacks generated during plus partnership income for of dollar_figure the total minimum gain would first be used to eliminate thei’s negative capital_account of dollar_figure the balance of dollar_figure would be distributed in accordance with the partnership agreement---that is percent to dondi and percent to thei until date when percent would be allocated to thei respondent’s figures showing a comparison of the partners’ capital accounts that reflect minimum gain chargebacks are as follows dondi date thei manchester total dollar_figure dollar_figure dollar_figure minus big_number big_number big_number increase big_number big_number big_number ' these figures do not take into account a dispute over an adjustment in ihcl’s ordinary_income for of dollar_figure an issue which we address infra p respondent concludes that because a deemed liquidation would produce the above results its allocation of all the net_income to thei after date reflects the partners’ interests in the partnership the issue revisited the contrast between respondent’s and petitioner’s theories of the comparative liquidations arises from petitioner’s contention that a deemed liguidation of ihcl must also involve a deemed liguidation of landmark and gateway and the resulting minimum gain chargebacks in our initial examination of this issue we agreed with respondent in interhotel i we held that ihcl as a minority owner of landmark and gateway lacked the legal capacity to force landmark and gateway to dispose_of the property that generated the nonrecourse_deductions accordingly upon liquidation ihcl could only dispose_of its partnership interests in landmark and gateway those partnerships however would continue to own the hotel properties in the absence of some other event that triggered minimum gain chargebacks such as a repayment of the principal of - - the nonrecourse loans with new_capital or profits from operations we concluded that a liguidation of ihcl under the comparative liquidation test would not increase the partners’ capital accounts sufficiently to eliminate thei’s deficit account therefore because mr manchester would continue to have the only positive capital_account on liquidation we concluded that he alone would be entitled to the liquidation proceeds thus we sustained respondent’s determination that mr manchester was chargeable with all of ihcl’s income for under the comparative liquidation test petitioner revised its argument on appeal to maintain that there need not be a deemed sale of the hotel properties in order to trigger the minimum gain chargebacks on appeal petitioner argued that to generate such chargebacks it would suffice that ihcl a pass-through beneficiary of the nonrecourse_deductions had terminated its pass-through connection to the properties respondent having considered this revised argument agreed in view of respondent’s concession as to the minimum gain chargebacks the court_of_appeals vacated our earlier decision and remanded the case to us following the court of appeals’ remand of this case we instructed the parties either to submit an agreed decision document or to file written status reports advising how we should implement the court of appeals’ mandate the parties filed status reports -- - informing us that neither party desired an evidentiary hearing we then ordered the parties to file briefs addressing the issues on remand with appropriate computations in support of their respective positions it is apparent that respondent’s concession effectively removes the basis for our original decision namely that a deemed liquidation of ihcl would not trigger a minimum_gain_chargeback petitioner now asserts that respondent’s concession requires a determination in petitioner’s favor petitioner maintains that a comparative liquidation of ihcl in and in would produce minimum gain chargebacks to thei in both years which chargebacks would be sufficient to eliminate thei’s negative capital_account the result is that both partners would have positive capital accounts accordingly petitioner maintains the requirement that liquidation proceeds be paid in accordance with positive capital accounts shows that its allocations reflect the partners’ economic interests in the partnership respondent however contends that notwithstanding his concession our original decision was correct based upon alternative evidentiary and legal arguments initially in his brief on remand respondent maintains that petitioner has failed to substantiate the amounts of the partnership minimum gains at issue we disagree we reviewed this matter thoroughly during the trial of this case and see no reason to revisit this issue petitioner produced its accountant’s work - - papers which reflected how the amount of partnership_minimum_gain would be derived petitioner’s accountant substantiated these figures through his testimony we found the accountant’s work papers both accurate and internally consistent and the accountant’s testimony credible we are not persuaded otherwise by respondent’s assertion that petitioner’s work papers are inconsistent with schedule l of the subsidiary partnerships’ tax returns respondent correctly maintains that the amount of depreciation for landmark reflected on the work papers for exceeds the amount reflected on the balance sheets attached to form_1065 u s partnership return of income for the same year petitioner however has explained that the discrepancy results from utilizing highly accelerated forms of depreciation then available for real_estate on the accountant’s work papers while the balance sheets for landmark included on its returns were book balance sheets reflecting slower depreciation rates a schedule entitled tax depreciation in form_1065 substantiates the use of depreciation schedules which produced higher figures than those on the balance sheets reflected on schedule l of the same return moreover the amounts of claimed depreciation set forth in forms u s partnership return of income for and are identical to the figures utilized in the accountant’s work papers used to compute both landmark’s minimum gain and ihcl’s share of that minimum gain in - - the absence of further evidence we again accept petitioner’s figures as accurate next respondent contends that even if petitioner has proved the amount of ihcl’s partnership_minimum_gain petitioner improperly included this amount in the liquidation proceeds respondent argues that the minimum_gain_chargeback is only an allocation of income not income itself accordingly respondent concludes that absent evidence that a liquidation of ihcl would produce economic_income or gain it is improper to include minimum gain in the figures produced by a liquidation in our opinion respondent misperceives the function of the minimum_gain_chargeback sec_1_704-1t iv a temporary income_tax regs fed reg date states that when the amount of nonrecourse_liability exceeds the basis of the partnership’s property securing it a disposition of such property will generate gain in an amount that is at least egual to such excess emphasis supplied although this phantom_gain does not exist in the form of cash it nevertheless is taken into account for tax purposes the regulations explain the relation of this phantom_gain to nonrecourse_deductions as follows although an allocation of nonrecourse_deductions cannot have economic_effect the amount of nonrecourse_deductions allocated to any partner decreases such partner’s capital_account similarly although the allocation to a partner of partnership_minimum_gain that is attributable to nonrecourse_deductions claimed by the - - partnership increases the partner’s capital_account the allocation cannot have economic_effect because the minimum gain merely offsets mnonrecourse deductions previously claimed by the partnership and does not necessarily bear any relationship to the value of partnership property thus minimum gain that is attributable to nonrecourse_deductions claimed by the partnership must be allocated to the partners that were allocated such nonrecourse_deductions to prevent such gain from impairing the economic_effect of other partnership_allocations id the regulations thus implement the tufts doctrine that deductions based on nonrecourse_financing will later be offset by increased income even though that income is not realized in an economic sense here ihcl had passed through nonrecourse_deductions to its partners the regulations require that a subsequent deemed liquidation of ihcl generates gains albeit noncash to offset previously claimed deductions those gains increase the upper tier partners’ capital accounts pro tanto respondent’s insistence that a deemed liguidation must produce actual economic gains to offset nonrecourse_deductions is inconsistent with the logic of tufts other provisions of the regulations do not mandate a different result respondent refers to language of sec_1 1t b iv e temporary income_tax regs fed reg date to the effect that if there is a net decrease in partnership_minimum_gain then each partner must be allocated items of income and gain for such year and if necessary for subsequent years respondent argues the parenthetical language - -- refers to situations where the net decrease in partnership_minimum_gain in a taxable_year exceeds the income and gain of the partnership for that taxable_year in such cases respondent maintains the excess_amount of the decrease in minimum gain must be carried over and treated as a decrease in partnership_minimum_gain for the following years at least to the extent there is equivalent partnership income and gain in those years from this premise respondent argues that the regulations restrict any minimum_gain_chargeback to the amount of partnership income or gain realized ina given taxable_year accordingly respondent asserts before it can charge back any of the net decrease in partnership_minimum_gain to the partners petitioner must show that ihcl realized income or gain on the liquidation respondent then points to his earlier conclusion that ihcl would have a loss on liquidation and concludes that because there is not income or gain on the liquidation no minimum_gain_chargeback is allowed we are not persuaded by respondent’s argument we believe that the quoted language does not apply to situations such as that here where minimum gain chargebacks are generated by the disposition of property in which the partnership’s nonrecourse liabilities exceed its basis in the latter situation the regulations provide that sufficient gain will be generated automatically by operation of the tufts principle to equal the amount of the minimum_gain_chargeback as the regulations state -- - such dispositions of property will automatically generate gain in an amount that is at least equal to the minimum gain that must be charged back sec_1_704-1t iv a temporary income_tax regs supra there is thus no occasion to carry over any excess of a decrease in minimum gains ‘ respondent also attacks petitioner’s assumption that the allocation of minimum gain will suffice to offset ihcl’s negative capital_account respondent argues that even if thei properly included ihcl’s partnership_minimum_gain in the computation of the liquidation proceeds ihcl improperly allocated enough of its partnership_minimum_gain to thei to offset thei’s negative capital_account respondent maintains that ihcl has not computed each partner’s share of partnership_minimum_gain we disagree as noted above petitioner has demonstrated to our satisfaction that ihcl’s share of the minimum_gain_chargeback was dollar_figure at the end of and dollar_figure at the end of moreover the applicable regulations provide that each the regulations however do not provide that other types of decreases in partnership_minimum_gain will by themselves generate gain for example a partnership may choose to pay down the principal of its nonrecourse debt that payment would diminish the amount by which the partnership’s liability exceeds its basis in the property hence the payment would decrease minimum gain the parenthetical language in the regulation quoted by respondent apparently refers to that possibility in such cases where the net decrease in minimum gain exceeds annual income or gain that language appears to require allocations of minimum gain for subsegquent years that matter however is not presently before us - - partner must be allocated items of income and gain to the extent of the greater of the partner’s share of the decrease in minimum gain allocable to the disposition of partnership property subject_to nonrecourse liabilities or the deficit balance in such partner’s capital_account at the end of the year see sec_1 1t b iv e temporary income_tax regs supra here even according to respondent’s calculations thei’s share of the decrease in minimum gain allocable to the disposition of property is dollar_figure thei’s negative capital_account at the end of however was dollar_figure under the regulations thei is allocated the greater of these amounts that is dollar_figure under the comparative liquidation test allocation of the latter amount automatically is sufficient to eliminate thei’s negative capital_account nor are we persuaded by respondent’s related contention that before taking into account any minimum gain chargebacks thei’s negative capital_account of dollar_figure must be increased by a deemed obligation to restore dollar_figure as noted above this amount represents respondent’s computation of thei’s share of the decrease in minimum gain allocable to the disposition of property respondent contends that this restoration would provide a negative petitioner questions the accuracy of the dollar_figure figure because of our resolution of this issue we need not and do not make specific findings as to whether the figure is correct -- - capital_account of dollar_figure respondent then notes that sec_1_704-1t b iv e temporary income_tax regs requires that each partner must be allocated items of income and gain to the extent of the greater of the partner’s share of the decrease in minimum gain allocable to the disposition of partnership property subject_to nonrecourse liabilities or the deficit balance in such partner’s capital_account at the end of the year under respondent’s theory thei would be entitled to a minimum_gain_chargeback of only dollar_figure its share of the minimum_gain_chargeback because that amount would be greater than the recalculated deficit in its capital_account of dollar_figure respondent’s argument that thei must increase its capital_account is based upon an erroneous reading of the regulations the regulations state for purposes of sec_1_704-1 d the alternative test for economic_substance the amount of a partner’s share of partnership_minimum_gain shall be added to the limited dollar amount if any of the deficit balance in such partner’s capital_account that such partner is obligated to restore sec_1 1t b iv temporary income_tax regs fed reg date this provision of the regulations is specifically designed to provide a means for nonrecourse_deductions to meet the alternative test for economic_substance described supra the regulations do so by treating a partner’s share of a minimum_gain_chargeback as an amount the partner is required to restore to his or her capital_account in the present case however neither the ihcl original -- - agreement nor the ihcl restated agreement meets the alternative test for economic_substance because such agreements fail to provide a qio see supra pp accordingly there is no deemed obligation that thei restore to its capital_account its alleged dollar_figure share of the decrease in minimum gain allocable to the disposition of property even if thei had such an obligation that obligation would not operate to reduce the amount allocable to thei under the minimum_gain_chargeback the regulations provide that such a restoration obligation is performed only after taking into account any changes during such year in partnership_minimum_gain and in the minimum gain attributable to any partner_nonrecourse_debt sec_1_704-1t iv e temporary income_tax regs supra emphasis added in this case the antecedent changes in such minimum gain were their total elimination by operation of the tufts principle in the partnership regulations after such changes there was no minimum gain and no partner could have a share of minimum gain to restore to its capital accounts substantiality the comparative liquidation test of sec_1 b income_tax regs is ineffective if the economic_effect of the resulting allocations is insubstantial under sec_1_704-1 income_tax regs in general this requirement of substantiality requires a reasonable possibility -- -- that the allocation or allocations will affect substantially the dollar amounts to be received by the partners from the partnership independent of tax consequences id an allocation is not substantial under these regulations if the allocation enhances the after-tax economic position of at least one partner and it is likely that the after-tax consequences of none of the other partners will be diminished see sec_1_704-1 a income_tax regs the requirement of substantiality is another provision designed to ensure that allocations reflect economic reality here ihcl has allocated its annual income away from mr manchester who succeeded to dondi’s large capital_account to thei which had a substantial negative capital_account this special_allocation had an economic_effect because it operated first to eliminate thei’s negative capital_account and by creating a positive capital_account for thei then to increase thei’s share of thcl’s assets to be received on jligquidation the special_allocation also ended mr manchester’s claims to additional income the economic benefit to thei and economic detriment to mr manchester combined to prevent the reallocation from failing the requirement of the substantiality test accordingly not only is the special_allocation consistent with the partners’ interests in -- - the partnership it is also substantial within the meaning of sec_1_704-1 iii income_tax regs the facts and circumstances regulations both parties have made alternative arguments based upon the broad factors enumerated in the regulations as appropriate for consideration in resolving issues of partners’ interests the relevant regulations provide that the determination of a partner’s interest ina partnership shall be made by taking into account all facts and circumstances relating to the economic arrangement of the partners sec_1_704-1 income_tax regs because of our holding with respect to the comparable liquidation test there is no need to revisit the facts and circumstances issue deficiencies after remand respondent in his brief on remand presented an issue that is not directly related to inclusion of the minimum_gain_chargeback in the comparative liquidation test respondent maintains that the recalculated deficiencies should include a correction to the decision submitted by the parties as a basis for the earlier decision that correction concerns the treatment of an asserted the comparative liquidation test also requires that the result of the liquidations be adjusted for the items described in and of sec_1_704-1 d income_tax regs see sec_1_704-1 6b income_tax regs respondent asserts that these provisions described under the alternate_test of economic_substance supra are inapplicable here petitioner does not disagree - al --- constructive distribution of dollar_figure to ihcl petitioner argues that such correction cannot be made on remand we disagree the law_of_the_case_doctrine states that the decision of the appellate court must be respected on remand but the binding effect of this doctrine does not extend to issues the appellate court did not address 51_f3d_178 9th cir under the similar but broader rule_of mandate we may not entertain a proceeding inconsistent with the remand id neither doctrine precludes a technical correction to reflect an earlier agreement of the parties that was neither affirmed nor addressed by the court_of_appeals when it vacated and remanded our earlier decision the decision should reflect the correct_tax liability to reflect the foregoing and the parties’ concessions decision will be entered under rule


internal_revenue_service national_office technical_advice_memorandum date number release date index uil no case mis no cc dom corp b1 tam-120240-98 attention chief appeals_office taxpayer’s name taxpayer’s address taxpayer’s identification no years involved date of conference legend taxpayer state x year year year year tam-120240-98 date guaranty fund x y z m o p q r court a plan tam-120240-98 policyholder group issue whether the taxpayer’s distributions of surplus to certain of its policyholders as part of a state mandated plan in which taxpayer became the successor life_insurance_company to a number of insurance departments lids constitute deductible policyholder dividends under sec_808 or instead nondeductible expenditures in a capital_transaction in which the policyholders exchanged an ownership_interest in their respective lids for the distributions of surplus conclusion we conclude that the payments constitute expenditures in a capital_transaction and therefore are not deductible under sec_808 facts background in year state x authorized to sell life_insurance the was designed to provide low cost life_insurance for wage earners under the original each was authorized to establish its own lid the lid was liable for the payment and satisfaction of liabilities pertaining to the insurance_business only the could apportion its expenses between the lid and the other business but none of the surplus of the insurance_business could ever inure to the the principal benefit to the bank in establishing a lid was the ability to sell a popular financial product to its customers initially only were permitted to establish lids in year the state x legislature amended the law to permit with lids to by date the time of the transaction described below fewer than half of the which had lids were still while the lids were subject_to applicable provisions of the life_insurance laws those departments did not enjoy all the rights and privileges of commercial life_insurance_companies and were subject_to different licensing and operational requirements additionally the lids were subject_to extensive control by the state tam-120240-98 specifically the lids were subject_to control and oversight by two entities guaranty fund and the state x actuary guaranty fund was created for the purposes of intervening and protecting the policyholders in the event of an insolvent liquidation of a lid in practice however guaranty fund exercised broad powers of regulation for example if one of the lids suffered particularly poor claims experience with the result that its surplus dropped below certain specified levels guaranty fund had the authority to mandate another lid with more favorable experience to transfer its surplus to the lid with the lower surplus guaranty fund also appointed the state x actuary under state x law the lids were required to maintain a surplus the amount of that surplus was to remain between p percent and q percent of net reserves if the surplus increased above q percent of net reserves approval of the state x actuary was required the state x actuary however routinely approved of surplus levels of lids above q percent while state x law required the to distribute the net profits from the lids to their policyholders not accumulated to surplus nothing in state x law explicitly provided that either the policyholders or the banks would ever be entitled to any amount of the lid’s accumulated surplus the policyholders did not have voting rights in the lids and the state x law did not specifically provide for any liquidation rights until year state x law provided that in the event of a liquidation of a lid the policies were assumed by and the surplus was received by guaranty fund in year the law was amended to provide that when a lid liquidated the surplus along with the policies would be assumed either by a successor or by guaranty fund or by a commercial mutual_insurance_company that fit certain business criteria the taxpayer informs us however that the provision allowing a mutual insurer to receive the surplus and assume the policies was meaningless because no mutual insurer which operated in state x since the inception of the system has ever met the required business criteria state x law in effect at the time of the transaction described herein provided that if a converted to a its eligible account holders and supplemental eligible account holders were entitled to preemptive rights to acquire stock in the the sbli policyholders however did not have such rights the aggregation in year after considerable deliberation the state x legislature enacted legislation to restructure the system the restructuring was to be accomplished pursuant to a written plan the plan state x established taxpayer as a domestic stock_life_insurance_company authorized to issue insurance contracts and to assume tam-120240-98 the ownership and operation of the lids the taxpayer assumed all of the contracts and outstanding policies of the former lids of the each of the was issued one share of voting_stock in taxpayer and nonvoting_stock in taxpayer in proportion to the surplus they contributed to the insurance_company after the transaction the aggregation the continued to sell sbli but only as agent for a single insurer taxpayer the plan became effective on date as part of the plan the policyholders who held policies on date were to be entitled to a series of special distributions the plan for taxpayer’s formation provided for distributions to individual policyholders of an amount equal to the total aggregated surplus of all of the lids or dollar_figurex however the total aggregated surplus was to be paid over a y to z year period or perhaps longer with the payment of only one year of interest the plan indicated that providing for the payment over the extended period was designed to deliver m percent of the present_value of the combined surplus of the lids of the to the policyholders the addition of a single year of interest raised the total_payment on a present_value basis to approximately o percent of the present_value of the combined surplus of the lids in determining the amount of the surplus the plan used a formula that would apply in state x to a mutual company converting to a stock insurer in a demutualization under state x law the law provides that the surplus to be distributed is determined upon the insurer’s entire surplus as shown on their financial statements most recently filed with the state x commissioner of insurance intangible assets are not considered in the calculation the same methodology was used in determining the dollar_figurex of surplus available for the special distributions the plan provides that only policyholders on the date of the transaction ie date are eligible for the special distributions if a policyholder’s insurance lapses he becomes ineligible for the special distributions however if the policyholder dies prior to completion of the special distributions his beneficiary in addition to the death_benefit receives an additional payment equal to the present_value of all future special distributions further if taxpayer were liquidated prior to the completion of the payments the policyholders would receive an amount equal to the present_value of the difference between the surplus assumed by the taxpayer and the sum of previously distributed special distributions additionally payment of the special distributions is contingent upon future favorable experience if the surplus of taxpayer would ever fall below p percent of net reserves taxpayer would suspend payment of the special distributions until the surplus was again above p percent tam-120240-98 the plan noted that payment of the special distributions recognized the policyholder contributions to the growth and development of the system the plan also indicated the method of payment of special distributions was designed to assure that as special distributions were made taxpayer would not be left without adequate capital the financial projections portion of the plan indicated the special distributions were expected to be funded out of current earnings currently all new policies are issued by the taxpayer under state x law the policyholders have a right to participate in the profits of the taxpayer the taxpayer has had favorable experience and has paid the special distributions on a regular basis we have been informed that in fact the surplus of taxpayer has not been below q percent since date prior to the aggregation the did not include the value of the lids on their balance sheets after the aggregation the now include the value of their taxpayer stock on their financial statements as an asset of the bank however the stock held by the has restricted rights in the life_insurance statutes amended in connection with the aggregation policyholder group was created policyholder group must approve all payments of stockholder dividends since the aggregation the banks have received dividends of r percent each year under the aggregation legislation in the event of a solvent liquidation eligible policyholders would receive the unpaid portion of their special distributions all remaining surplus would be apportioned between the policyholders and the banks on an equitable basis the court a opinion prior to enactment of the plan the state x legislature certified to court a the highest court in state x certain questions concerning whether the proposed aggregation violated either the federal constitution or the state x constitution one question addressed whether the proposed aggregation deprived the policyholders of property without due process of law court a found that while the assets net profits and surplus of the lids are devoted exclusively to the benefit of the policyholders the proposed aggregation did not deprive the policyholders of property without due process of law the court indicated that it was unclear whether the policyholders had an interest in the lids although they did note longstanding precedent in state x indicating that a mutual policyholder had no right to demand a particular dividend in any case the court pointed out the policyholders were being paid the special distributions the court tam-120240-98 indicated that the payment of the special distributions made it more comfortable that the policyholders were not deprived of property without due process of law court a concluded that the transaction did not impair the policyholders’ contract or ownership rights in the lids since the policies had provisions for the assignment of the policies the court held the policyholders could not have any reasonable expectation that there would be no substitution of another entity for their particular the court found that the change from several lids to a single entity would not impair the prospects that the policyholders would receive what they were due under the contract law and analysis life_insurance_companies are subject_to tax under part i of subchapter_l of the internal_revenue_code additionally life_insurance_companies as corporations defined in sec_7701 are subject_to the general principles of subchapter_c of the code unless specifically overruled by the rules of subchapter_l sec_801 imposes a tax on life_insurance_companies based on life_insurance_company_taxable_income sec_801 defines life_insurance_company_taxable_income as life_insurance_gross_income minus life_insurance_deductions under sec_804 life_insurance_deductions include the general_deductions provided in sec_805 one such general deduction is the deduction for policyholder dividends sec_808 provides that for purposes of part i of subchapter_l the term policyholder_dividend means any dividend or similar distribution to policyholders in their capacity as such under sec_808 the term policyholder_dividend includes any amount_paid or credited where the amount is not fixed in the contract but depends on the experience of the company or the discretion of management the payments at issue in this case were not fixed in the contract but depended on the experience of the company the taxpayer’s payments were made pursuant to the plan and were not provided for in the policies it issued the plan also provided that the payment of the special distributions by taxpayer over a period of years was contingent on taxpayer’s surplus remaining at a level equal to at least p of reserves since the level of taxpayer’s surplus depends upon taxpayer’s own experience the amount and timing of the payments at issue depended on both the experience of the lids before the aggregation and the experience of taxpayer after the aggregation tam-120240-98 however we still must consider whether the policyholders had an ownership_interest in their respective lids and if so whether they exchanged that interest for the special distributions if they did the special distributions are not policyholder dividends the unum case in 130_f3d_501 1st cir cert_denied 119_sct_42 the first circuit held that distributions made by a mutual_life_insurance_company to its policyholders in connection with a demutualization are not deductible in unum a holding_company was formed to own all the stock of a new stock company on the date of the consummation of the transaction all policyholders of the mutual company transferred their mutual interests to the stock insurance_company in exchange for stock in the holding_company certain policyholders generally those with smaller mutual interests were eligible immediately to exchange their holding_company stock for cash other policyholders retained a stock interest in the holding_company unum pincite the company also created a participation fund account pfa also known as a closed block in connection with the reorganization the closed block consisted of assets set_aside exclusively for those policyholders prior to the conversion the purpose of the closed block was to ensure that the expectation of future policyholder dividends would not be impaired by the shareholders or management of the converted stock company id pincite the taxpayer claimed that the payments to the policyholders of cash and holding_company stock in connection with the demutualization were deductible as policyholder dividends under sec_808 the commissioner disallowed this claim and the district_court and first circuit upheld the commissioner’s determination the first circuit agreed with the service that the term policyholder dividends does not include a value-for-value exchange that occurs during a capital_transaction id pincite the courts found that the phrase in the policyholders’ capacity as such in sec_808 requires that the dividend distributions be based upon the contractual relationship between policyholder and insurer here the payment that the policyholders received was based not upon their contractual relationship but in exchange for the mutual holders’ equity_interest in the corporation id pincite the court decided that subchapter_l had no application to this capital_transaction and looked to general principles of subchapter_c to determine the tax consequences of the cash and stock payments the policyholders who received cash essentially redeemed the equity interests inherent in their mutual policies in exchange for cash thus in this classic redemption sec_311 applied to disallow any deduction on the payment by unum sec_311 generally holds that gain but not loss is recognized to tam-120240-98 a corporation on a distribution not in complete_liquidation with respect to its stock id pincite the court also held that sec_1032 applied to disallow any loss on the distribution of stock to the policyholders under this section a corporation may claim no gain_or_loss on the issuance of its own stock in exchange for property here unum had issued its stock to the policyholders in exchange for the equity held by the policyholders by virtue of their mutual policies id pincite the taxpayer’s arguments that unum is distinguishable from the instant case the taxpayer in the instant case argues that the holding in unum has no application to this case because the demutualization transaction in unum is very different from the aggregation transaction which formed taxpayer first the taxpayer argues the policyholders of the taxpayer did not have any ownership rights in the lids prior to the aggregation thus the special distributions cannot be in exchange for the ownership rights of the policyholders because the policyholder had no ownership rights to surrender secondly unlike unum where the policyholders unquestionably surrendered rights in the demutualization the taxpayer’s policyholders had no significant change in their economic rights before and after the transaction without this change in the relative economic rights of the policyholders before and after the aggregation the taxpayer concludes that the special distributions falls well within the definition of a policyholder_dividend the taxpayer argues that ownership in a mutual entity can only be measured by indicia of ownership to that end it examines three of the traditional indicia of ownership in a mutual company--voting control rights liquidation rights and rights to profits of the company voting rights control it is not disputed that policyholders who owned prior to the aggregation had no voting rights or equivalent type of control_over the lids rather the program was subject_to extensive regulation by the state x government through the guaranty fund and the state x actuary it was state x and its agencies and to a lesser degree the that made investment decisions and determined reserve levels dividend payout and the amount retained in surplus if the policyholders disagreed with the decisions of state x or the they were given no recourse to vote to change the policies of the lids in fact the taxpayer argues that after the aggregation the policyholders have more control of the taxpayer than they did of the lids the policyholder group which tam-120240-98 is largely comprising policyholders and is charged to act in the policyholders’ interest elects one of the board_of directors of the taxpayer and must approve major corporate decisions including the decision to pay shareholder dividends liquidation rights the taxpayer asserts the policyholders had no liquidation rights in the lids in fact it appears no statutory provision existed providing for the total elimination and liquidation of the program the state x law prior to the aggregation provides for who would be eligible to assume the policies in the event of the solvent or insolvent termination of an individual lid in the taxpayer’s view if the entire program had been eliminated state x would have decided how to distribute the surplus and may have decided to use the surplus for the benefit of the policyholders however there was no state x statute indicating that the policyholders had a right to the surplus although the court a opinion clearly indicates that the surplus was devoted exclusively to the benefit of the policyholders it would still have required an action by state x for the policyholders to receive the liquidation proceeds thus again it was the state and not the policyholders who exercised control_over the surplus the taxpayer argues that after the aggregation the policyholders have liquidation rights in taxpayer greater than they did in the lids if state x were to decide to liquidate taxpayer state x law now provides that state x would allocate the surplus between the policyholders and the banks rights to profit finally taxpayer claims a typical mutual policyholder has an exclusive right to the profits of the mutual entity by contrast the policyholders who owned had a participating life_insurance_policy prior to the aggregation and they have a participating policy after the aggregation by virtue of their having a participating policy taxpayer asserts they have a customer right to share in profits now just as they did before the aggregation this right however has never risen to the level of an ownership right according to taxpayer that this is the case is borne out by the fact that unlike unum there was no closed block set up during the aggregation to wall off assets specifically for benefit of the old policyholders the closed block is set up to protect those policyholders that lose rights here the policyholders have the same rights after the aggregation as before thus it would be unnecessary and even inappropriate to segregate assets dedicated to those policies written before the aggregation from the working assets of the company moreover since the policyholder group must still approve all shareholder dividends and major corporate decisions they can now in some tam-120240-98 manner participate in determining the amount distributed out of the earnings_of the taxpayer after the aggregation in sum the taxpayer concludes all indicia of ownership which resided with the policyholders of unum--rights to control the entity rights in liquidation and rights to profit did not reside with the policyholders prior to the aggregation in point of fact state x controlled the lids and the surplus held by them while state x regulated the lids for the benefit of the policyholders it was state x and its agencies and not the policyholders who possessed the requisite rights of ownership and should be considered the closest to the owners of the lids the taxpayer maintains that the special distributions were essentially unrelated to the aggregation rather the taxpayer argues the special distributions were the result of excessive conservatism of the state x actuary the taxpayer provided a report from an actuary which indicated that the aggregate surplus levels of all of the lids at the time of the aggregation were considerably higher than contemplated under the statute it has indicated that even in the absence of the aggregation the special distributions likely would have been made anyway to return the excessive surplus held by the taxpayer to the shareholders finally the taxpayer argues that the special distributions constitute a mere return of excess surplus is confirmed by two facts about the distributions policyholders whose policies lapse do not continue to receive the special distributions and payments of the special distributions do not continue to be made in the event the surplus falls below p percent the special distribution constitutes a part of a capital_transaction although taxpayer raises a strong argument why the facts of this case are different from that of the unum case ultimately we conclude that the special distributions were an integral part of a capital_transaction and therefore are not deductible policyholder dividends payment of the special distributions was made to policyholders only as of the date of the aggregation over a period of many years policyholders whose policies were written after the aggregation have no right to the payment this fact renders the taxpayer’s statement that the special distributions were unrelated to the aggregation less tenable and a mere return of excess surplus rather it leads to the conclusion that the aggregation and the payment of the special distributions are part of a single transaction the language contained in the plan for the aggregation casts doubt on the taxpayer’s argument that the special distributions were designed to disgorge the taxpayer of excess surplus created as a result of the conservatism of the state x actuary the plan never addresses the issue of return of excess surplus as the reason for the special distributions tam-120240-98 we have concluded that each lid in material respects may be characterized as the functional equivalent of a mutual_life_insurance_company by definition a mutual_life_insurance_company differs from a stock_life_insurance_company in that a mutual life company does not have stockholders see eg pan american life_insurance_company v united_states u s t c big_number e d la the lids did not have stockholders with a superior right of ownership in the underlying assets of the lids while the policyholders may have had limited rights under the old system no other party had a better claim to ownership of the lids than the policyholders further the aggregation and the special distributions resemble the payment that would be made in the standard demutualization of a mutual life company into a stock company the total_payment for the special distributions was determined by reference to the entire surplus of the lids the plan used a formula that would apply in state x to a mutual_insurance_company converting to a stock_life_insurance_company we do not dispute the taxpayer’s claim that the policyholders did not have voting rights nor do we dispute that state x and its agencies had significant control and discretion over the funds of the surplus however policyholders have been found to have an interest in an insurance_company because the corporate charter indicated that the surplus belonged to them despite their having no voting rights in the company no right to demand the surplus and no other right to control the insurance_company 274_f2d_771 6th cir cert_denied 363_us_828 in the instant case it is clear the policyholders had the strongest claim of any group on the assets of the lids particularly the surpluses of the lids the court a opinion confirms this point by stating that the assets of those insurance departments including the net profits generated and the accumulated surplus are devoted exclusively to the benefit of the policyholders the were specifically prohibited by statute from ever succeeding to the assets state x did exercise control_over the lids but it operated the lids exclusively for the benefit of the policyholders and not for its own benefit after the aggregation by contrast the assets of the taxpayer are no longer devoted exclusively to the benefit of the policyholders on the contrary the surplus accrues to the benefit of both the and the policyholders this result was reflected in the payment of shareholder dividends the now are paid a dividend out of the surplus of the taxpayer which would have been prohibited under the old system although the shareholder dividend is subject_to the approval of the policyholder group it nevertheless depletes the amount of surplus which is held for the policyholders regardless of whether or not the dividend predominantly reimburses the banks for their expenses or whether it has remained constant it still depletes the tam-120240-98 surplus of the taxpayer which could not happen under the old system this lack of exclusivity is also reflected in the statutory liquidation rights which call for an equitable distribution between policyholders and the most telling in confirming this point the now show the value of their stock in taxpayer as an asset of the bank on their financial statements while they never showed any of the value of the lids on their financial statements prior to the aggregation this fact strongly belies the notion that the did not acquire any ownership_interest in the taxpayer in the transaction moreover court a indicated that they felt more comfortable that the policyholders were not deprived of property in the aggregation without due process of law precisely because the policyholders were to receive the special distributions this point leads to the inevitable conclusion that when the received an interest in the assets of the lids they received it from the policyholders equally importantly the now have considerably more power to control the taxpayer than they did to control the lids the elect all but one of the members of the board_of directors most of the major decisions of the company are made by the board further since the are now a unified entity they appear to have more control and more leverage in negotiations with the agencies of state x that no closed block was created in connection with the aggregation does not persuade us that this case is different from unum state x created a policyholder group specifically for the purpose of safeguarding the rights of the policyholders from overreaching by the new stockholders of taxpayer ie the banks these special protections may have rendered the creation of a closed block unnecessary additionally the first circuit in unum specifically stated that their holding that the payments were not policyholder dividends would not have been different if unum had not created a closed block because the basic nature of the transaction as a value-for- value exchange would have remained unchanged unum pincite n taking into account all of the concomitant circumstances surrounding the aggregation transaction and the payment of the special distributions the policyholders in this case just as in unum surrendered ownership rights in the lids in connection with the aggregation moreover we believe that state x in providing for the special distributions compensated them in exchange for their rights therefore the payments cannot be viewed as policyholder dividends tam-120240-98 caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


number release date id office uilc cca_2009082010043138 ----------------------------- from ---------------------------- sent thursday date am to ------------------------ cc subject fw silf attachments revrul_2009_6 good morning got your voice mail----------------------is the ------------------in ------------------------who handles fringe benefit-related topics so i checked with her this morning about your question here and figure it would be easier to forward her comments i've also attached the latest sifl rates the rates for the second half of this year should be coming out next month please don't hesitate to call if you need more information i'm just being lazy -------- from sent thursday date am to subject re silf i would tell him that under these facts the employer has a choice to use either the general valuation rule the amount that the employee would have to pay in an arm's length transaction to charter the same or a comparable piloted aircraft for that period for the same or a comparable flight or the special valuation rule also known as sifl or the noncommercial flight valuation rule the fact that the entity is an exempt_organization and the fact that it paid a fixed charter cost does not change anything the employer can still use sifl if it chooses to do so the regulations pincite g allow the use of sifl for flights on employer-provided aircraft this encompasses aircraft that the employer owns and aircraft that the employer charters