division release number release date uil code org department of the treasury internal_revenue_service te_ge eo examinations ormsby station court suite a - stop louisville ky date taxpayer_identification_number form s tax_year s ended person to contact id number contact numbers telephone fax dear the purpose of this letter is to provide information that was discussed over the telephone on october 20xx we have enclosed a copy of our draft report of examination explaining why we believe an adjustment of you organization’s exempt status is necessary if you accept our findings please sign and return the enclosed form_6018 consent to proposed adverse action by october 20xx we will then send you a final letter modifying or revoking exempt status you will also be required to file forms for the periods listed above additional tax returns may also be required these returns can be filed at a later date if you do not agree with our position or have additional information to present please mail all information to the address in the heading of this letter so that we receive it by october 20xx if we do not hear from you by october 20xx we will issue a final report after we issue the report you will have days from the date the letter is mailed to file an appeal information on this process will be with the final report if required if you have any questions or would like to arrange a conference with my manager please call me at the telephone number listed under the contact information thank you for your cooperation sincerely jason jarvis internal revenue_agent enclosure draft report of examination form_6018 envelope form 886a name of taxpayer schedule no or exhibit year period ended explanation of items department of the treasury - internal_revenue_service 20xx - 20xx org legend org - organization name president - president companies issue xx - date state - state treasurer - treasurer co-1 co-2 - motto - motto whether org org continues to meet the requirements of internal_revenue_code irc sec_501 and therein continues to qualify for exemption from federal_income_tax facts org was incorporated as a non-profit corporation under the laws of state on august 19xx with the name of org the purposes of the corporation were to assist the local educational systems to implement curriculums that will be most informative of the to maintain a mobile heritage museum to be used at school and other functions to aid children in heritage and culture of indigenous people understanding classes for youth and adults so as to enrich their knowledge of culture and history to respect and advocate the educational resources of other organizations and programs in the community community events and provide the mobile org for educational to support traditional on september 19xx articles of correction were filed to change the name to org in october of 20xx org was granted exemption under sec_501 of the irc during our examination we requested documentation showing the amount of time devoted to your exempt_activities and to your motto activities for calandér years 20xx - 20xx org indicated that they did not have any documentation org provided the following information relating to exempt vs non-exempt activities org indicated that five board members usually devote approximately two hours per quarter for oo board meetings the board minutes were requested but org failed to produce any minutes org stated that the project coordinator conducts the charitable gaming operations and devotes about o eleven hours per week org stated that the secretary averages about fifteen to twenty five hours per week the duties q include taking care of the charitable gaming records work motto sessions contact schools libraries museums etc to schedule showings taking care of correspondence maintain the museum show the museum conduct educational programs organize benefit activities for the museum etc org has two motto sessions per week each session is staffed by pull-tabbers sell pull-tabs counter o workers sell motto paper and computers motto caller security guards and a janitor according to org pull-tabbers and the motto caller usually devote eight hours per week the counter ob workers usually devote eleven hours per week form 886-a rev department of the treasury - internal_revenue_service page -1- department of the treasury - internal_revenue_service form_8 a name of taxpayer explanation of items 20xx - 20xxk org schedule no or exhibit year period ended based off of motto session sign-in sheets it is estimated that six pull-tabbers two counter helpers and one caller were present at each session on may 20xx an interview was conducted with treasurer treasurer was the treasurer and stated he attended almost every session in 20xx treasurer stated that the pull-tabbers did receive tips from the players and org did not want to know about the practice gross exemption function income vs gross motto income the form_990 for 20xx reported dollar_figure from charitable gaming activities and dollar_figure of donations that were received at the motto sessions the form_990 for 20xx reported dollar_figure from charitable gaming activities and dollar_figure of donations that were received at the motto sessions the form_990 for 20xx reported dollar_figure from charitable gaming activities and dollar_figure of donations that were received at the motto sessions the quarterly gaming reported filed with the state office of charitable gaming ocg reported charitable expenditures in the following amounts o o qo 20xx 20xx 20xx dollar_figure dollar_figure dollar_figure in 20xx transfers from the gaming account to the general account were dollar_figure occurred of these funds approximately dollar_figure was used in the purchase of a truck the truck was used to haul a traveling museum the dollar_figure in expenditures made in 20xx consisted of a dollar_figure check to the co-1 and a dollar_figure check to the co-2 co-2 assuming that the expenditures contributions and expenditures on the truck were made for an exempt_purpose over the three-year period org used of the gross_receipts for a charitable purpose a review of the pull-tab inventory for the 4th quarter of 20xx noted that boxes were unaccounted for org stated that these boxes were returned to the suppliers org was unable to provide any documentation to prove that the boxes were returned to the suppliers the suppliers were contacted and stated that the boxes were not returned the sale of these boxes would have reported gross_income of dollar_figure and a net profit of dollar_figure these sales were never recorded the income was not deposited into the bank and the funds were not used for a charitable purpose in the state of state all workers at a motto session must be volunteers workers at the motto session pull-tabbers chairperson callers and counter help are not allowed to accept tips if issue goes unagreed additional information may be added law sec_501 of the internal_revenue_code exempts from taxation organizations described in subsection c or d under this subtitle unless such exemption is denied under sec_502 or sec_503 form 886-a crev department of the treasury - internal_revenue_service page -2- form_8 a department of the treasury - internal_revenue_service name of taxpayer 20xx - 20kx org explanation of items schedule no or exhibit year period ended sec_501of the code exempts from taxation corporations and any community chest fund or foundation organized and operated exclusively for religious charitable scientific testing for public safety literary or educational_purposes or to foster national or international amateur sports competition but only if no part of its activities involve the provision of athletic_facilities or equipment or for the prevention of cruelty to children or animals no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual no substantial part of the activities of which is carrying on propaganda or otherwise attempting to influence legislation except as otherwise provided in subsection h and which does not participate in or intervene in including the publishing or distributing of statements any political campaign on behalf of or in opposition to any candidate for public_office sec_501 of the code provides for the exemption from federal_income_tax of organizations organized and operated exclusively for charitable educational or scientific purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual sec_1 c - a provides in part that in order to be exempt as an organization described in sec_501 an organization must be both organized and operated exclusively for one or more purposes specified in such section if an organization fails to meet either the organizational_test or the operational_test it is not exempt sec_1_501_c_3_-1 of the income_tax regulations provides c operational test-- primary activities an organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in sec_501 an organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt_purpose sec_1_501_c_3_-1 of the income_tax regulations provides that an organization is not operated exclusively for one or more exempt purposes if its net_earnings inure in whole or in part to the benefit of private shareholders or individuals sec_1_501_c_3_-1gi provides that the burden_of_proof is on the organization to establish that it is not organized and operated for the benefit of private interests 71_tc_102 provides in part that the word exclusively does not mean solely or without exception an organization which engages in nonexempt activities can obtain and maintain exempt status so long as such activities are only incidental and insubstantial 81_tc_958 neither the internal_revenue_code the regulations nor the case law provide a general definition of insubstantial for purposes of c this is an issue of fact to be determined under the facts and circumstances of each particular case world family corp v commissioner supra pincite in 28_tc_1128 the court held that an organization engaged in fund- raising activities through operation of motto games and whose actual charitable_contributions consisted of contributions to charitable institutions of insubstantial amounts when compared to its gross_receipts from operation of motto games did not qualify for exemption under sec_501 of the code petitioner's fund-raising activities consisted of the operation of motto games at the lodge of the fraternal order of the eagles it also operated a soda bar and miscellaneous activities income from the soda bar and miscellaneous the gross_receipts from the activities was reported on the returns as dollar_figure fixed charge or donation for_the_use_of the motto cards were dollar_figure anddollar_figure for for for for19 anddollar_figure form 886-a rev department of the treasury - internal_revenue_service page -3- form_8 a name of taxpayer schedule no or exhibit year period ended explanation of items department of the treasury - internal_revenue_service 20xx - 20kxk org petitioner did not operate any charitable institutions and its actual charitable function consisted of contributions to various individual doctors and institutions these contributions totaled dollar_figure its principal activity was the profitable operation of motto games on a business or commercial basis the principal source of gross_receipts was from the fixed charge or donation assessed against each player for_the_use_of the motto cards and dollar_figure inl9 in therefore the court held that the petitioner failed to establish that it is entitled to a tax-exempt status in the taxable years in question in make a joyful noise inc v commissioner 56_tcm_1003 the court held that operating regularly scheduled motto games on behalf of other exempt_organizations was a trade_or_business unrelated to the organization's exempt purposes in that case the court concluded that the petitioner failed to carry its burden of proving that its participation in motto games was an insubstantial part of its activities in p l l scholarshi82_tc_196 the tax_court held that petitioner was not operated exclusively for exempt purposes under the provisions of sec_501 ilr c and sec_1 c - c incorne tax regs therefore it is not exempt from federal_income_tax petitioner was incorporated as a nonprofit corporation for the purpose of raising money to be used for providing college scholarships the money was raised from the operation of motto games on the premises of a commercial establishment the court stated that after careful consideration of the entire record this court finds that the petitioner has not carried its burden of showing that it was operated exclusively for an exempt_purpose under the required standards the court further stated that since the record in this case does not show that the petitioner was operated exclusively for exempt purposes but rather indicates that it benefited private interests exemption was properly denied in 75_tc_127 the court held that part of petitioner's net_earnings inured to the benefit of private shareholders or individuals and that petitioner was not exempt as an organization described in sec_501 of the internal_revenue_code of the court stated that the burden falls upon petitioner to establish the reasonableness of the compensation the court indicated that by basing compensation upon a percentage of petitioner's gross_receipts apparently subject_to no upper limit a portion of petitioner's earnings was being passed on to an individual the court stated that the statute specifically denies tax exemption where a portion of net_earnings is paid to private shareholders or individuals we hold here that paying over a portion of gross earnings to those vested with the control of a charitable_organization constitutes private_inurement as well all in all taking a slice off the top should be no less prohibited than a slice out of net revrul_64_182 part c b concluded that an organization qualified for exemption under sec_501 of the code where it used the proceeds from a business activity to conduct a charitable program commensurate in scope with its financial resources of making grants to other charitable organizations thus an organization whose principal activity is operating games of chance may nevertheless qualify for exemption provided it uses the proceeds of that business activity in a real and substantial charitable program such as charitable grant making commensurate in scope with its financial resources and other wise meets the requirements of exemption form 886-a rev department of the treasury - internal_revenue_service page -4- form_8 a department of the treasury - internal_revenue_service explanation of items name of taxpayer org schedule no or exhibit year period ended 20xx - 20k 470_f2d_849 held in part that tax exemption is a privilege a matter of grace rather than right government’s position based off of the information that you have furnished approximately of org time was devoted to charitable gaming activities on average there were six pull-tabs that worked eight hours per week big_number hours per year two counter person that worked eleven hours per week hours per week and one project coordinator that worked eleven hours per week all of the time devoted was related to the motto operation which does not serve any charitable purpose the secretary devoted approximately hours per year their duties included activities related to the motto operation and the museum an allocation of was used even if the five board members met and discussed exempt_purpose business a total of hours per year would be devoted to exempt_purpose activities gross_income from you exempt_function activities was dollar_figure of your gross_income came from your charitable gaming activities you are operated similar to the organizations described in make a joyful noise v commissioner help the children v commissioner and p l l scholarship fund v commissioner those cases involved organizations engaged primarily in fund raising activities through motto games the courts held that neither organization qualified for exemption under sec_501 of the internal_revenue_code because they were not operated exclusively for exempt purposes the examination revealed that you underreported pull-tab sales in 20xx by and failed to deposit he net_proceeds of dollar_figure since you were unable to substantiate that the funds were used for legitimate motto expenses and or sec_501 purposes they are considered to have been used for nonexempt purposes for the private benefit of your motto workers and motto managers such expenditures do not serve charitable or other purposes within the meaning of sec_501 of the internal_revenue_code because a substantial part of your activities is not in furtherance of an exempt_purpose we have determined that you are not operated exclusively for an exempt_purpose pursuant to sec_501 of the internal_revenue_code and sec_1_501_c_3_-1 of the income_tax regulations we have determined that a substantial amount of income from your motto operation inured to the private benefit of your motto workers and motto managers in addition by engaging in substantial activities that serve private rather than public interests you are not operated exclusively for one or more exempt purposes pursuant to sec_1_501_c_3_-1 of the income_tax regulations see church in boston v commissioner and world family corp v commissioner form 886-a crev department of the treasury - internal_revenue_service page -5- form_8 a name of taxpayer schedule no or exhibit year period ended explanation of items department of the treasury - internal_revenue_service 20xx - 20kx org the amount of income distributed from the motto account for charitable and other sec_501 purposes in the year ended 20xx was dollar_figure charitable_contribution and dollar_figure in truck payments respectively the percentage of gross motto income distributed for charitable purposes was approximately and approximately for the year ended 20xx year ended 20xx was dollar_figure and year ended 20xx was dollar_figure for the year ended 20xx for year ended 20xx dollar_figure listed as based on the amount of gross motto income that was distributed for charitable purposes we have concluded that the amount of the proceeds received from your motto activities to conduct charitable and educational programs is not commensurate in scope with the financial resources of your motto operation see revrul_64_182 part c b taxpayer’s position the taxpayer’s position is unknown at this time on a telephone call on october 20xx president indicated that they will have no choice but to agree ‘ conclusion based on the analysis of your activities and the sources and amounts of your gross_income and expenses we have determined that you no longer meet the requirements for exemption under sec_501 of the internal_revenue_code you are operated similar to the organizations described in make a joyful noise v commissioner help the children v commissioner and p l l scholarship fund v commissioner those cases involved organizations engaged primarily in fund raising activities through motto games the courts held that neither organization qualified for exemption under sec_501 of the internal_revenue_code because they were not operated exclusively for exempt purposes based on the amount of gross motto income that was distributed for charitable purposes we have concluded that the amount of the proceeds received from your motto activities to conduct charitable and educational programs is not commensurate in scope with the financial resources of your motto operation see revrul_64_182 part c b because a substantial part of your activities is not in furtherance of an exempt_purpose we have determined that you are not operated exclusively for an exempt_purpose pursuant to sec_501 of the internal_revenue_code and sec_1_501_c_3_-1 of the income_tax regulations we have determined that a substantial amount of income from your motto operation inured to the private benefit of your motto workers and motto managers we also determined that you failed to deposit approximately dollar_figure of gross pull-tab proceeds in the bank account for org for the year ended december 20xx since you were unable to substantiate that the funds were used for legitimate motto expenses and or sec_501 purposes they are considered to have been used for nonexempt purposes for the private benefit of your motto workers and motto managers form 886-a crev department of the treasury - internal_revenue_service page -6- form_8 r6 a name of taxpayer schedule no or exhibit year period ended explanation of items department of the treasury - internal_revenue_service 20xx - 20kx org by engaging in substantial activities that serve private rather than public interests you are not operated exclusively for one or more exempt purposes pursuant to sec_1_501_c_3_-1 of the income_tax regulations see church in boston v commissioner and world family corp v commissioner based on the facts law and conclusions cited above we have determined that you no longer qualify for exemption under sec_501 of the internal_revenue_code therefore your exemption under sec_501 of the internal_revenue_code is revoked effective january 20xx the first day of the year that we determined that you are not operated exclusively for exempt purposes contributions made to you after january 20xx are not deductible under sec_170 of the internal_revenue_code you are required to file forms and pay federal_income_tax for all years beginning after january 20xx you are also required to file forms 11-c for all required periods after january 20xx these forms can be filed at a later date and may be prepared by the internal_revenue_service alternative position in the event that org remain tax-exempt are the unaccounted for pull-tab sales considered unrelated_business_income ubi facts same as above law sec_511 of the code imposes a tax on the unrelated_business_taxable_income of organizations described in sec_501 which includes sec_501 sec_512 of the code provides that as a general_rule except as otherwise noted the term unrelated_business_taxable_income means the gross_income derived by any organization from any unrelated_trade_or_business as defined in sec_512 regularly carried on by it less certain allowable deductions and modifications sec_512 of the code provides that with certain exceptions one of the modifications referred to in sec_512 is that there shall be excluded from the term unrelated_business_taxable_income all rents from real and personal_property sec_513 of the code defines the term unrelated_trade_or_business as any trade_or_business the conduct of which is not substantially related aside from the need of such organization for income or funds or the use it makes of the profits derived to the exercise or performance by such organization of the charitable educational or other purpose or function constituting the basis for its exemption under sec_501 form 886-a rev department of the treasury - internal_revenue_service page -7- form_886 a name of taxpayer explanation of items schedule no or exhibit year period ended department of the treasury - internal_revenue_service org 20xx - 20xx sec_513 of the code provides that the term unrelated_trade_or_business does not include any trade_or_business in which substantially_all the work in carrying on such trade_or_business is performed for the organization without compensation sec_1_512_b_-1 of the regulations provides that in general rents from real and personal_property and the deductions directly connected therewith are excluded in computing unrelated_business_taxable_income sec_1_512_b_-1 of the regulations provides that for purposes of sec_1_512_b_-1 payments for the use or occupancy of rooms and other space where services are also rendered to the occupant such as for the use or occupancy of rooms or other quarters in hotels boarding houses or apartment houses furnishing hotel services or in tourist camps or tourist homes motor courts or motels or for the use or occupancy of space in parking lots warehouses or-storage garages does not constitute rent from real_property sec_1_513-1 of the regulations provides that gross_income of an exempt_organization subject_to tax imposed by sec_511 of the code is includible in the computation of unrelated_business_taxable_income if it is income from a trade_or_business such trade_or_business is regularly carried on by the organization and the conduct of such trade_or_business is not substantially related other than through the production of funds to the organization’s performance of its exempt functions sec_1_513-1 of the regulations provides that in general any activity of an exempt_organization which is carried on for the production_of_income and which otherwise possesses the characteristics required to constitute trade_or_business within the meaning of sec_162 of the code is a trade_or_business for purposes of sections further the term trade_or_business generally includes any activity carried on for the production_of_income from the sale_of_goods or performance of services sec_1_513-1 of the regulations provides that in determining whether gross_income from a trade_or_business is regularly carried on within the meaning of sec_512 of the code regard must be had to the frequency and continuity with which the activities productive of the income are conducted and the manner in which they are pursued sec_1_513-1 of the regulations provides that in general gross_income derives from unrelated_trade_or_business within the meaning of sec_513 of the code if the conduct of the trade_or_business which produces the income is not substantially related other than through the production of funds to the purposes for which exemption is granted the presence of this requirement necessitates an examination of the relationship between the business activities which generate the particular income in question-- the activities that is of producing or distributing the goods or performing the services involved--and the accomplishment of the organization’s exempt purposes sec_1_513-1 of the regulations provides that trade_or_business is related to exempt purposes in the relevant sense only where the conduct of the business activities has causal relationship to the achievement of exempt purposes and is substantially related for purposes of sec_513 of the code only if the causal relationship is a substantial one thus for the conduct of trade_or_business from which a particular amount of gross_income is derived to be substantially related to purposes for which exemption is granted the production or distribution of the goods or the performance of the services from which the gross_income is derived must contribute importantly to the accomplishment of those purposes where the production or distribution of the goods or the performance of the services does not contribute importantly to the accomplishment of the exempt purposes of an organization the income from the sale of the goods or the performance of the services does not derive from the conduct of related trade_or_business whether activities productive of gross_income contribute importantly to the accomplishment of any purpose for which an organization is granted exemption depends in each case upon the facts and circumstances involved form 886-a crev department of the treasury - internal_revenue_service page -8- form_8 a department of the treasury - internal_revenue_service explanation of items co name of taxpayer org schedule no or exhibit year petiod ended 20xx - 20xx sec_1_513-1 of the regulations refers to sec_513 of the code which specifically states that the term unrelated_trade_or_business does not include any trade_or_business in which substantially_all the work in carrying on such trade_or_business is performed for the organization without compensation final-reg tax-regs sec_1_513-5 certain motto games not unrelated_trade_or_business sec_1_513-5 certain motto games not unrelated_trade_or_business a in general -under sec_513 and subject_to the limitations in paragraph c of this section in the case of an organization subject_to the tax imposed by sec_511 the term unrelated_trade_or_business does not include any trade_or_business that consists of conducting motto games as defined in paragraph d of this section b exception -the provisions of this section shall not apply with respect to any motto game otherwise excluded from the term unrelated_trade_or_business by reason of sec_513 and sec_1_513-1 relating to trades_or_businesses in which substantially_all the work is performed without compensation c limitations motto games must be legal -paragraph a of this section shall not apply with respect to any motto game conducted in violation of state or local law no commercial competition -paragraph a of this section shall not apply with respect to any motto game conducted in a jurisdiction in which motto games are ordinarily carried out on a commercial basis motto games are ordinarily carried out on a commercial basis within a jurisdiction if they are regularly carried on within the meaning of sec_1_513-1 by for-profit organizations in any part of that jurisdiction normally the entire state will constitute the appropriate jurisdiction for determining whether motto games are ordinarily carried out on a commercial basis however if state law permits local jurisdictions to determine whether motto games may be conducted by for-profit organizations or if state law limits or confines the conduct of motto games by for-profit organizations to specific local jurisdictions then the local jurisdiction will constitute the appropriate jurisdiction for determining whether motto games are ordinarily carried out on a commercial basis d motto game defined -a motto game is a game of chance played with cards that ‘are generally printed with five rows of five squares each participants place markers over randomly called numbers on the cards in an attempt to form a preselected pattern such as a horizontal vertical or diagonal line or all four corners the first participant to form the preselected pattern wins the game as used in this section the term motto game means any game of motto of the type described above in which wagers are placed winners are determined and prizes or other_property is distributed in the presence of all persons placing wagers in that game the term motto game does not refer to any game of chance including but not limited to keno games dice games card games and lotteries other than the type of game described in this paragraph e effective date - sec_513 and this section apply to taxable years beginning after date government’s position a review of the pull-tab inventory of 20xx noted that boxes were unaccounted for org stated that these boxes were returned to the suppliers org was unable to provide any documentation to prove that the boxes were returned to the suppliers the suppliers were contacted and stated that the boxes were not returned the sale of these boxes would have reported gross_income of dollar_figure and a net profit of dollar_figure these sales were never recorded the income was not deposited into the bank and the funds were not used for a charitable purpose form 886-a rev department of the treasury - internal_revenue_service page -9- fo on a department of the treasury - internal_revenue_service explanation of items name of taxpayer org schedule no or exhibit year period ended 20xx - 20kx since you were unable to substantiate that the funds were used for legitimate motto expenses and or sec_501 purposes they are considered to have been used for nonexempt purposes for the private benefit of your motto workers and motto managers the net profit of dollar_figure is considered ubi in the event org remains tax-exempt taxpayer’s position the taxpayer’s position is unknown conclusion in the event that org remains tax-exempt the unaccounted for pull-tab sales of dollar_figure are considered ubi department of the treasury - internal_revenue_service form 886-a cev page -10-


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi plr-157596-02 date date legend x a b state d1 dear this letter responds to your letter dated date and subsequent correspondence written on behalf of x as x's authorized representative requesting a ruling under sec_1362 of the internal_revenue_code facts according to the information submitted x was incorporated under state law on d1 x's shareholders a and b intended that x would be an s_corporation effective on d1 a form ss-4 application_for employer_identification_number filed for x indicates that it was plr-157596-02 intended for x to be an s_corporation x relied upon its tax advisors to file its form_2553 election by a small_business_corporation however the form_2553 was not filed timely x represents that x and x's shareholders have filed all of their tax returns since d1 as if x were an s_corporation law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective generally if an s election is made within the first two and one-half months of a corporation's taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made sec_1362 provides that if an s election is made after the first two and one-half months of a corporation's taxable_year then the corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made sec_1362 provides that if an election under sec_1362 is made for any taxable_year after the date prescribed by sec_1362 for making the election for the taxable_year or no sec_1362 election is made for any taxable_year and the secretary determines that there was reasonable_cause for the failure to timely make the election then the secretary may treat the election as timely made for such taxable_year and sec_1362 shall not apply conclusion based on the facts submitted and representations made we conclude that x has established reasonable_cause for its failing to make a timely s election and that x is eligible for relief under sec_1362 accordingly if x makes an election to be an s_corporation by filing with the appropriate service_center a completed form_2553 containing an effective date of d1 within days following the date of this letter then such election will be treated as timely made a copy of this letter should be attached to the form_2553 filed with the service_center except as expressly provided herein we express or imply no opinion concerning the federal tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion concerning whether x is an s_corporation for federal tax purposes pursuant to a power_of_attorney on file with this office we are sending a copy of this letter to x plr-157596-02 this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent sincerely yours s james a quinn senior counsel branch office of the associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


t c memo united_states tax_court melton r boone and geraldine r boone petitioners v commissioner of internal revenue respondent docket no filed date melton r boone and geraldine r boone pro sese horace crump for respondent memorandum findings_of_fact and opinion scott judge respondent determined deficiencies in petitioners' federal income taxes and additions to tax for the taxable years through as follows - additions to tax_year deficiency sec_6651 dollar_figure dollar_figure big_number big_number big_number all issues but one have been settled or conceded by the parties the only issue remaining for decision is whether petitioners are liable for additions to tax under sec_6651 for failure_to_file timely federal_income_tax returns for the years through findings_of_fact some of the facts have been stipulated and are found accordingly the stipulation of facts and the exhibits attached thereto are incorporated herein by reference petitioners husband and wife were residents of crestview florida at the time they filed their petition in this case sometime between and the time of trial melton r boone petitioner experienced brain hemorrhaging as a result he could not safely drive and his son melton r boone jr drove with respect to whether petitioner's civil service retirement income is taxable the parties agreed to be bound by the veterans' administration's disability determination petitioners conceded that respondent's determination of their schedule c income for through is correct finally petitioners conceded at trial that they are liable for the addition_to_tax for failure_to_file a timely return under sec_6651 for all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated - him to and from his regular work as d p manager for the city of pembroke pines florida during each of the years in issue petitioners requested and respondent granted an extension of time for them to file their federal_income_tax return for each of the years through not having received returns from petitioners for through on date respondent prepared and filed substitute returns for them for each of these years on date the internal_revenue_service center in atlanta received purported copies of federal_income_tax returns from petitioners that had been prepared by petitioner for the years through the return was dated date the return was dated date and the return was dated date although each return claimed that petitioners were due a refund petitioner who was a part-time income_tax_return_preparer did not contact the internal_revenue_service irs to determine why the refunds were never received for the taxable years through in the notice_of_deficiency respondent determined that petitioners are liable for additions to tax under sec_6651 for failing to file a timely federal_income_tax return for each of the years through opinion sec_6651 imposes a 5-percent-per-month addition_to_tax not to exceed percent for failure_to_file a timely return unless the taxpayer establishes the failure did not - result from willful neglect and the failure was due to reasonable_cause willful neglect has been interpreted to mean a conscious intentional failure or reckless indifference 469_us_241 reasonable_cause requires the taxpayer to demonstrate that he exercised ordinary business care and prudence and was nonetheless unable to file a return within the prescribed time id pincite petitioners were granted automatic 4-month extensions of time within which to file their and federal_income_tax returns the returns were due on date date and date respectively sec_1_6081-4 income_tax regs purported copies of the returns were not received by the atlanta internal_revenue_service center until date petitioner testified that he mailed their and tax returns on date date and date respectively he contends that the returns were timely filed because they were deposited with proper postage in a mailbox outside the main post office in perrine florida each year within the extended filing periods allowed he then argues that once the returns were placed in the u s postal service mailbox petitioners' responsibility for their delivery ended as to what may have happened to the returns petitioner speculates that the mailbox was tampered with by vandals or thieves vandals unbolted the mailbox from its base and took the mail - postal employees stole the mail or the irs lost or misfiled the returns because of its ineptitude to say the least we regard such speculations as farfetched and unreliable moreover we think it is highly improbable that the returns allegedly deposited with the u s postal service in late may for successive years would not have been delivered to the irs or that each return was lost or misplaced by the irs petitioner also offered his son's testimony in an effort to corroborate his own to show that petitioners timely filed their returns for each year petitioner and his son testified that petitioners' federal_income_tax return for each of the years in issue was mailed during their drive home from work but the son later testified that the returns were mailed late at night when asked by the court to reconcile the two seemingly conflicting statements the son admitted that he did not remember the specific circumstances surrounding the mailing of petitioners' returns however the son testified that his returns for through which he thought were mailed at the same time petitioners' returns for these years were mailed were timely received by the irs respondent's position is that petitioners have failed to prove that their returns for the years in issue were timely filed we agree sec_7502 provides that the date of the u s postmark stamped on the cover in which a return is filed is deemed the - date the return was filed if the postmark date is within the period for filing the return and the return is delivered after the date it was required to be filed if no evidence establishes the postmark date of a return the date the return was delivered is the date the return was filed here petitioners provided no evidence of a u s postmark consequently sec_7502 is not applicable it has been held however that sec_7502 does not displace the common_law presumption of delivery the mailbox rule 966_f2d_487 9th cir cf 71_f3d_850 11th cir under the common_law mailbox rule the proper mailing of a return gives rise to a rebuttable_presumption of delivery anderson v united_states supra pincite when a taxpayer is unable to produce documentary_evidence that a return was mailed we have allowed indirect credible_evidence to prove the date of postmark see 92_tc_793 accepting testimony of a postmistress who affixed the postmark to the envelope containing the return affd 909_f2d_1155 8th cir by contrast petitioners in this case have not produced credible_evidence that their returns were timely mailed and postmarked we are not persuaded by petitioner's self-serving testimony we think it is significant that petitioner failed to inquire about the refunds claimed on the returns it seems improbable to us that if petitioners had - filed returns showing refunds due for through petitioner an income_tax_return_preparer would not have made certain that the refunds were received in addition we do not find the testimony of petitioners' son credible as to whether or when they mailed their returns for the years in issue his testimony was contradictory and uncertain it is unlikely that petitioners' returns were mailed at the same time as and along with their son's returns for through because their son's returns were apparently received by the irs accordingly we conclude that petitioners did not file any federal_income_tax returns for the years through other than the copies of the returns received by respondent on date they of course were untimely filed next we consider whether petitioners have shown that they had reasonable_cause for filing their and tax returns late continuous illness or incapacity may constitute reasonable_cause if the taxpayer establishes that he was so ill that he was unable to file a tax_return 16_tc_893 respondent contends that petitioner was not so ill during the years in issue that he could not have filed the returns on time at some point after petitioner experienced a brain hemorrhage and was unable to perform some of the tasks associated with daily living such as safely driving an automobile - however he presented no evidence suggesting that he was so ill during those years that he was unable to file a return to the contrary petitioner was regularly employed by the city of pembroke pines and worked as an income_tax_return_preparer during the years through he even stated at trial that he was physically able to file a return during those years in issue while we are sympathetic to petitioner's physical condition during the years through we are unable to find that he was so ill that he could not file a return consequently we hold that petitioners have not shown they had reasonable_cause for failing to file their federal_income_tax returns in a timely manner having found that petitioners did not file timely federal_income_tax returns for through and that there was no reasonable_cause for their failure to do so it follows that they are liable for the additions to tax under sec_6651 therefore it is not necessary to decide whether their failure was due to willful neglect united_states v boyle u s pincite to reflect the foregoing decision will be entered under rule


t c memo united_states tax_court lee r stevens petitioner v commissioner of internal revenue respondent docket no filed date lee r stevens pro_se charles m ruchelman for respondent memorandum findings_of_fact and opinion jacobs judge respondent determined the following deficiencies in and additions to petitioner’s federal income taxes additions to tax_year deficiency sec_6651 sec_6654 dollar_figure dollar_figure --- big_number dollar_figure dollar_figure respondent’s determinations were reflected in two notices of deficiency one for each of the years involved respondent now concedes the deficiencies and all additions to tax for both years involved petitioner seeks refunds for claimed overpayments of his and federal income taxes respondent contends the refunds sought are time-barred accordingly the issue for decision is whether petitioner is entitled to refunds for claimed overpayments of his and federal income taxes or whether the statutorily imposed time limitations of sec_6511 and sec_6512 preclude him from obtaining any portion of his overpayments resolution of this issue depends on whether petitioner filed his and federal_income_tax returns as of the date the notices of deficiency were mailed all section references are to the internal_revenue_code in effect for the years under consideration all rule references are to the tax_court rules_of_practice and procedure findings_of_fact some of the facts have been stipulated and are found accordingly the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time he filed his petition lee r stevens petitioner resided in falls church virginia petitioner has a bachelor of arts degree in political science and two masters of arts degrees one in public administration and the other in marine affairs during the years under consideration petitioner was a program manager with the joint oceanographic institutions inc in washington d c in petitioner earned dollar_figure in wages dollar_figure in taxable interest_income and dollar_figure in dividend income he paid dollar_figure in withholding_tax that year in petitioner earned dollar_figure in wages dollar_figure in taxable interest_income and dollar_figure in dividend income he paid dollar_figure in withholding_tax that year the withholding_tax payments constitute the sole payments received by respondent with regard to petitioner’s and tax years petitioner has no record that he filed his or tax returns he did not send the returns by certified or registered mail petitioner did not use a tax_return_preparer to prepare his or tax returns the internal revenue service’s irs tax module indicates that petitioner neither filed or tax returns nor claimed a credit or refund for a or overpayment the irs sent letters to petitioner requesting that he file and returns petitioner claims he never received any such letters the letters were not returned to the irs as undeliverable on date the irs under the authority of sec_6020 constructed and returns for petitioner from payor information documents the notices of deficiency which were mailed to petitioner’s last_known_address on date are based on these substitute returns and the deficiency tax computations are based upon the allowance of the standard_deduction and one personal_exemption as in effect for each year petitioner timely filed a petition in this court on date he filed an amended petition on date the amended petition not only contests the and deficiencies and additions to tax but contains a claim for tax refunds of dollar_figure and dollar_figure for and respectively petitioner stated in the amended petition that he is entitled to his itemized_deductions on date respondent filed an answer to the amended petition generally denying petitioner’s allegations on or about date petitioner mailed respondent copies of his and federal_income_tax returns which petitioner alleges were timely filed on date and date respectively on date respondent received these documents the returns reflect tax overpayments of dollar_figure and dollar_figure for and respectively and claimed corresponding refunds respondent accepted these returns as filed on date as stated respondent acknowledges that petitioner owes no tax deficiencies or additions to tax for or but contends that petitioner’s refund claims for such years are time-barred the amended petition does not specify how these figures were determined petitioner claimed a dollar_figure overpayment on the copy of his federal_income_tax return after respondent discovered a mathematical error respondent corrected the return to reflect a dollar_figure overpayment petitioner’s case was heard on date it was held in suspense pending a decision by the supreme court regarding the fourth circuit_court of appeals' opinion in 45_f3d_856 4th cir the supreme court handed down a decision in the lundy case on date see commissioner v lundy u s 116_sct_647 following a date conference call with the parties we ordered that the record be reopened for the limited purpose of allowing petitioner to file a second amended petition on or before date on date petitioner filed a second amended petition disputing the deficiencies and additions to tax requesting refunds for overpayments of dollar_figure and dollar_figure for and respectively and contending that his and returns were timely filed petitioner further asserted that he had understood the notices to address solely his disallowed deductions rather than contesting the timely filing of his returns as well on date respondent filed an answer to petitioner’s second amended petition denying petitioner’s allegations and asserting that this court lacks jurisdiction to award petitioner’s requested refunds for and an appeal of this case would be to the fourth circuit_court of appeals opinion filing of petitioner’s and returns preliminarily we must decide when petitioner filed his and tax returns generally calendar_year individual taxpayers must file a federal_income_tax return by april following the close of the calendar_year sec_6072 the ‘filing’ of a return or a claim_for_refund by a taxpayer is completed when the return or claim reaches the collector’s office 226_f2d_24 9th cir see also 269_f2d_911 3d cir revg on another issue 30_tc_1093 90_tc_947 73_tc_249 petitioner bears the burden of proving when he filed a return rule a petitioner has no documentary_evidence as to when or even that he did file his tax returns for and when a taxpayer cannot provide any documentary_evidence that he filed a tax_return and respondent’s records do not show receipt of the document in question we have accepted the credible testimony of witnesses to the preparation and mailing of the document see 92_tc_793 affd 909_f2d_1155 8th cir testimony of postmistress who affixed postmark 53_tc_235 testimony of corporation’s shareholders and its accountants petitioner testified that he personally prepared his and returns he further testified that he sent by regular mail his return on date and his return on date petitioner’s mother mary e stevens testified that she reviewed her son’s and returns prior to their proper filing dates witnessed her son sign the return and accompanied him to the post office when he mailed the return she did not accompany petitioner when he mailed his return petitioner argues that because he timely deposited his and federal_income_tax returns in the u s mail in properly addressed envelopes with the proper prepaid postage affixed there is a strong presumption that the returns were delivered to and received by the irs in due course respondent claims that petitioner’s and returns were not filed before date in this regard kyle outen a custodian of records with the irs philadelphia service_center testified that a diligent search of the irs’ files revealed no record of petitioner's filing his or returns prior to date sec_7502 provides that when a return is delivered by u s mail to the irs office to which such return is required to be filed after the date prescribed for its filing the date of the u s postmark stamped on the envelope in which the return is mailed is deemed to be the date the return is delivered to the irs although and are the only years before us mr outen testified that the internal_revenue_service has no record of petitioner's filing returns for or petitioner however cannot avail himself of this remedial provision because the record does not establish that the returns were delivered to the irs prior to date see sec_301_7502-1 proced admin regs sec_7502 provides that if a return is sent by u s registered or certified mail the registration or certification is prima facie evidence that the return was delivered to the irs office to which it was addressed see sec_301_7502-1 proced admin regs see also hiner v commissioner tcmemo_1993_608 petitioner did not mail his or returns by registered or certified mail thus he assumes the risk of non- delivery of the returns see walden v commissioner supra pincite it is difficult to believe that respondent could lose or misplace petitioner’s tax returns for both of the years in issue as well as for and based on the record before us we are unable to find that petitioner filed his and returns as of the date the notices of deficiency were mailed overpayments of and taxes petitioner contends that he is entitled to refunds for overpayments of his and federal income taxes respondent contends that the time limitations of sec_6511 and sec_6512 preclude petitioner from obtaining any portion of his overpayments pursuant to sec_6512 we have jurisdiction to determine the existence and amount of any overpayment_of_tax to be credited or refunded for years that are properly before us however if a taxpayer has not filed a return before the notice_of_deficiency was mailed our jurisdiction with regard to claimed refunds is limited to taxes paid during the 2-year period prior to the date the deficiency_notice was mailed see sec_6511 and b b commissioner v lundy u s sec_6511 generally provides that a claim for credit or refund of an overpayment_of_tax must be filed by the taxpayer within years from the time the return was filed or within years from the time the tax was paid whichever period expires later sec_6511 also expressly provides that if no return is filed the claim must be filed within years from the time the tax was paid sec_6511 provides limitations on the amount of any credit or refund as follows limit on amount of credit or refund -- a limit where claim filed within 3-year period -- if the claim was filed by the taxpayer during the 3-year period prescribed in subsection a the amount of the credit or refund shall not exceed the portion of the tax paid within the period immediately preceding the filing of the claim equal to years plus the period of any extension of time for filing the return if the tax was required to be paid_by means of a stamp the amount of the credit or refund shall not exceed the portion of the tax paid within the years immediately preceding the filing of the claim b limit where claim not filed within 3-year period --if the claim was not filed within such 3-year period the amount of the credit or refund shall not exceed the portion of the tax paid during the years immediately preceding the filing of the claim c limit if no claim filed --if no claim was filed the credit or refund shall not exceed the amount which would be allowable under subparagraph a or b as the case may be if claim was filed on the date the credit or refund is allowed sec_6512 limits the amount of the credit or refund as follows limit on amount of credit or refund --no such credit or continued s ct rossman v commissioner 46_f3d_1144 9th cir affg without published opinion tcmemo_1993_ 37_f3d_587 10th cir affg tcmemo_1993_102 allen v commissioner 23_f3d_406 6th cir affg without published opinion 99_tc_475 davison v commissioner 9_f3d_1538 2d cir affg without published opinion tcmemo_1992_709 5_f3d_195 7th cir affg 98_tc_661 patronik-holder continued refund shall be allowed or made of any portion of the tax unless the tax_court determines as part of its decision that such portion was paid-- a after the mailing of the notice_of_deficiency b within the period which would be applicable under sec_6511 c or d if on the date of the mailing of the notice_of_deficiency a claim had been filed whether or not filed stating the grounds upon which the tax_court finds that there is an overpayment or c within the period which would be applicable under sec_6511 c or d in respect of any claim_for_refund filed within the applicable_period specified in sec_6511 and before the date of the mailing of the notice of deficiency-- i which had not been disallowed before that date ii which had been disallowed before that date and in respect of which a timely suit_for_refund could have been commenced as of that date or iii in respect of which a suit_for_refund had been commenced before that date and within the period specified in sec_6532 v commissioner 100_tc_374 97_tc_339 little v commissioner tcmemo_1995_1 khinda v commissioner tcmemo_1994_617 courtney v commissioner tcmemo_1994_502 floyd v commissioner tcmemo_1994_379 phillips v commissioner tcmemo_1993_349 the notices of deficiency concerning petitioner’s and tax years were mailed on date and petitioner did not file his or returns by that date as a result petitioner’s claimed refunds are limited to the amount of and taxes he paid in the two years prior to the mailing of the notices of deficiency the only tax_payments petitioner made for these years were the withholding credits from his wages which are deemed to have been paid as of date and date for and respectively see sec_6513 because the withholding taxes were paid more than two years before the notices of deficiency were mailed petitioner is not entitled to a refund of any part of the petitioner is deemed to have filed his refund claims on date the date the notices of deficiency were mailed sec_6512 sec_6513 provides in pertinent part any_tax actually deducted and withheld at the source during any calendar_year shall be deemed to have been paid_by him on the 15th day of the fourth month following the close of his taxable_year with respect to which such tax is allowable as a credit under sec_31 or overpayments we therefore hold that the statutorily imposed time limitations of sec_6511 and sec_6512 bar us from determining that petitioner is entitled to refunds with respect to his and income taxes see commissioner v lundy supra to reflect the foregoing and respondent’s concessions decision will be entered for petitioner as to the deficiencies and additions to tax and for respondent as to the overpayments


internal_revenue_service number release date index number ------------------------- ------------------------------------------------------------ ---------- ---------------------------------- ------------------------------ ------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------------- id no ---------------- ----------------- telephone number ---------------------- refer reply to cc psi b06 plr-123443-17 date date legend parent holdco taxpayer state a state b state c state d state e state f state g commission date date date date date date date director dear ---------------- ----------------------------------------------------------- --------------------------- ---------------------------------------------------------------------------- -------------- --------- ------------- -------------- --------------- ---------------- --------------- --------------------------------------------------------------- ---------- -------------- -------------------- ---------------------- ----------------------- ----------------------- ---------------------------- ------------------------------------------------------------------------------------------ this letter responds to parent’s request dated date filed on behalf of taxpayer for a ruling on the application of the normalization rules of the internal_revenue_code to certain accounting and regulatory procedures as described below the representations set out in your letter follow taxpayer is wholly owned by holdco a state a limited_liability_company that is disregarded for federal_income_tax purposes holdco is wholly owned by parent a plr-123443-17 corporation organized under the laws of state b parent is the common parent of an affiliated_group_of_corporations that includes holdco and taxpayer parent files a consolidated federal_income_tax return on a calendar_year basis employing the accrual_method of accounting parent is currently under the audit jurisdiction of the large_business_and_international_division of the internal_revenue_service taxpayer is a regulated_public_utility engaged in the provision of natural_gas distribution services in state b state c state d state e state f and state g the businesses in these states are conducted through unincorporated divisions local distribution companies taxpayer’s state e local distribution company ldc is subject_to regulation as to rates and conditions of service by the commission taxpayer has claimed and continues to claim accelerated_depreciation on all of its public_utility_property to the full extent those deductions are available under the code taxpayer normalizes the federal income taxes deferred as a result of its claiming these deductions in accordance with the normalization rules as a consequence taxpayer has a substantial balance of accumulated deferred federal_income_tax adfit that is attributable to accelerated_depreciation reflected on its regulated books of account while state e law allows utilities to use either historical or forecasted test periods the ldc has chosen to file its past several general rate cases using a fully forecasted test period generally the ldc has filed in date with a test period running from date of that year through date of the following year state e law provides that the commission must issue its final_determination within ten months of the initial filing_date unless it has extended that time by up to ninety days due to its need to act on other pending rate cases after the issuance of a final order additional procedures ensue these procedures may include a request for reconsideration and will always include the submission by the subject utility of a compliance filing which is typically made within thirty days of the date of an order parties to the proceeding then have thirty days to submit comments on that filing the rates established in that final order are typically not put into effect prior to the end of the projected test period in ldc’s most recent general rate case final rates were not implemented until after the forecasted test period had ended as part of the general rate case process and consistent with state e law the ldc has also been allowed recovery_of interim rates interim rate recovery begins no later than sixty days from the initial filing meaning it generally coincides with the start of the forecasted test period date the commission sets interim rates through an interim rate order consequently interim rates are established before a full review of the utility’s proposed costs is completed and are based primarily on the data used to support the utility’s proposed final rate request with the following differences the rate of return on common equity used is equal to that authorized by the commission in the utility’s most recent general rate case the utility may include in interim rates only rate base or expense items that are the same in nature and kind as those allowed in plr-123443-17 that most recent general rate case and interim rates may not reflect any change in existing rate design each of these factors may differ from the ones incorporated into the rates established in the final order that results from the conduct of the current proceeding interim rates are subject_to refund plus interest if at the end of the contested case amounts collected under the interim rate schedule exceed the commission-approved final rates interim rate refund any interim rate refund occurs only with the effective date of the final rates which as indicated above typically occurs after the end of the projected test period even when there are no time extensions in a general rate proceeding when an interim rate refund is required the percentage difference between the final and the interim rates is calculated after the end of the test year a bill credit is then computed for each customer by applying that percentage to the amounts paid_by that customer while interim rates were in effect the credit is posted in full to each customer’s next bill as a result customers who receive gas service during the projected test period collectively pay the allowed revenue level established in the final order for that service regardless of when the final order is issued or when the rates established by that order go into effect in determining its revenue requirement for the projected test period including in determining the appropriate level of interim rate recovery the ldc calculates the net plant component of rate base using a simple average of the beginning of test period and end of the test period balances all other elements of rate base including adfit balances are calculated using a 13-month average rate base is reduced by the adfit balance so computed there is no conventional true-up procedure applicable to rates established in the ldc’s general rate cases hence there is no procedure by which rates established in its general rate case whether interim or final and based on a projected test period are trued-up to a revenue requirement for that period which is calculated by reference to the actual results of ldc’s activities during the test period rather the final order establishes final rates based on representative levels of costs and revenues for the test year the interim rate refund reconciles the differential between the interim rates and the final rates and is implemented only after the rate case is completed final rates remain in effect until the utility chooses to file its next general rate case proceeding and any interim rates that may be put into effect pursuant to that proceeding as a result the general rate case may be seen as comprised of three elements setting interim rates established by the interim rate order setting final rates established by the final order subsequent to the rate case proceeding and calculating an interim rate refund subsequent to the rate case proceeding based on the difference between the interim rates paid and the amount that would have been paid had final rates been in effect for the same period plr-123443-17 previously when the ldc has projected the changes in its adfit balances for purposes of estimating its revenue requirement for the projected test period whether for the establishment of interim or final rates it has not used the proration formula provided in sec_1_167_l_-1 proration methodology prior to and including its most recent general rate case this lack of the use of the proration methodology has not been challenged or even commented upon by the commission or any party in any of the ldc’s proceedings the ldc filed its most recent general rate case with the commission on date the test period in the case ran from date through date with interim rates going into effect on date in its general rate case filing the ldc did not utilize the proration methodology in its adfit calculation after filing taxpayer considered whether it would be possible to revise its pending rate request to incorporate the impact of the proration methodology and determined that state e law provides that in no event shall the rates approved by the commission exceed the level of rates requested by the public_utility since a revision to reflect the proration methodology after the ldc had filed its request would have increased the requested revenue requirement the ldc could not take corrective action at that time additionally taxpayer considered whether a normalization issue may arise in the ldc’s general rate case filing because adfit was averaged using a 13-month average while other components of rate base were averaged using a simple beginning and ending balance average both averages were over the same period of time both taxpayer and the commission have at all times endeavored to use a proper normalization method_of_accounting for the ldc’s public_utility_property notwithstanding this intent taxpayer is now concerned that its prior ldc general rate case filings may have been inconsistent with the normalization rules insofar as they did not employ the proration methodology further taxpayer believes that there may be an issue regarding the ldc’s practice of applying two different averaging conventions to different components of its rate base calculation taxpayer represents that if required the ldc will take all necessary corrective actions in its next general rate case taxpayer requests that we rule as follows in order to comply with the normalization rules whether in determining the maximum amount of adfit by which the ldc can reduce rate base in establishing the interim rates it must employ the proration methodology described in sec_1_167_l_-1 whether for purposes of the normalization rules the effective date of the differential between the interim rates and the final rates established for the interim rate refund process calculated at the end of the rate proceeding is the effective plr-123443-17 date for the interim rates established in the interim rate order or the effective date for final rates established by the final order if with respect to requested ruling the service rules that the effective date of the differential between the interim rates and the final rates established by the interim rate refund process calculated at the end of the rate proceeding is the effective date for final rates established by the final order whether the interim rate refund process uses an historical test period and therefore is not required to employ the proration methodology described in sec_1_167_l_-1 if with respect to requested ruling the service rules that the effective date of the differential between the interim rates and the final rates established by the interim rate refund process is the effective date for the interim rates that were established in the interim rate order whether the interim rate refund process uses a future test period and must therefore employ the proration methodology described in sec_1_167_l_-1 whether for purposes of the normalization rules the effective date of the final rates established by the final order and implemented subsequent to the rate case proceeding is the effective date for the interim rates that were established by an interim rate order or the effective date for the final rates established by the final order if with respect to requested ruling the service rules that the effective date of the final rates established by the final order and implemented subsequent to the rate case proceeding is the effective date of the final rates established by the final order whether the computation of these rates uses an historical test period and therefore is not required to employ the proration methodology described in sec_1_167_l_-1 if with respect to requested ruling the service rules that the effective date of the final rates established by the final order is the effective date for the interim rates established by the interim rate order whether the computation of the final rates implemented subsequent to the rate case proceeding uses a future test period and must therefore employ the proration methodology described in sec_1_167_l_-1 if the service rules in the affirmative with respect to requested ruling in computing the interim rate refund whether the proration requirement does not apply only to the difference between the adfit balance used to set interim rates and the adfit balance used in the final rates to establish the interim rate refund that is the proration requirement would continue to apply to the changes in adfit balances reflected in setting the interim rates plr-123443-17 if the service rules that the proration methodology applies to any of the three elements of taxpayer’s base rate process interim rates interim rate refund and final rates the consistency rule does not require that the ldc apply to its prorated adfit balance the regulatory averaging procedure it applies to its other components of rate base in the relevant computation the taxpayer’s use of a simple average for certain components of rate base in conjunction with its use of a 13-month average for adfit is not violative of the consistency rule_of sec_168 and in the event that the service concludes with respect to requested ruling sec_1 or that the ldc must use the proration methodology to comply with the normalization rules and or concludes with respect to requested ruling that the ldc’s use of differing averaging conventions is violative of the consistency rule taxpayer requests a ruling that in any year prior to its taking the necessary corrective action taxpayer’s relevant regulatory practice were not a violation of the normalization rules law and analysis requested ruling sec_1 - sec_1_167_l_-1 of the regulations sets forth normalization requirements with respect to public_utility_property under sec_1_167_l_-1 a taxpayer does not use a normalization method_of_accounting if for ratemaking purposes the amount of the reserve for deferred taxes excluded from the rate base or treated as cost-free capital exceeds the amount of the reserve for the period used in determining the taxpayer’s ratemaking tax expense sec_1_167_l_-1 also provides the procedure for determining the amount of the reserve for deferred taxes to be excluded from rate base or to be included as no-cost capital sec_1_167_l_-1 provides that for the purpose of determining the maximum amount of the reserve to be excluded from the rate base or to be included as no-cost capital under sec_1_167_l_-1 if solely an historical period is used to determine depreciation for federal_income_tax expense for ratemaking purposes then the amount of the reserve_account for the period is the amount of the reserve determined under sec_1_167_l_-1 at the end of the historical period sec_1_167_l_-1 provides that if solely a future period is used for such determination the amount of the reserve_account for the period is the amount of the reserve at the beginning of the period and a pro_rata portion of the amount of any projected increase to be credited or decrease to be charged to the account during such period sec_1_167_l_-1 provides if in determining depreciation for ratemaking tax expense a period the test period is used which is part historical and part future then plr-123443-17 the amount of the reserve_account for this period is the amount of the reserve at the end of the historical portion of the period and a pro_rata amount of any projected increase to be credited to the account during the future portion of the period the pro_rata amount of any increase during the future portion of the period is determined by multiplying the increase by a fraction the numerator of which is the number of days remaining in the period at the time the increase is to accrue and the denominator of which is the total number of days in the future portion of the period this is generally referred to as the proration formula or the proration methodology sec_1_167_l_-1 makes it clear that the reserve excluded from rate base must be determined by reference to the same period as is used in determining ratemaking tax expense a taxpayer may use either historical data or projected data in calculating these two amounts but it must be consistent as explained in sec_1_167_l_-1 the rules provided in sec_1_167_l_-1 are to insure that the same time period is used to determine the deferred tax reserve amount resulting from the use of an accelerated method_of_depreciation for cost of service purposes and the reserve amount that may be excluded from the rate base or included in no-cost capital in determining such cost of services if a taxpayer chooses to compute its ratemaking tax expense and rate base exclusion amount using projected data then it must use the formula provided in sec_1 l - h ii to calculate the amount of deferred taxes subject_to exclusion from the rate base this formula prorates the projected accruals to the reserve so as to account for the actual time these amounts are expected to be in the reserve as explained in sec_1_167_l_-1 the formula in sec_1_167_l_-1 provides a method to determine the period of time during which the taxpayer will be treated as having received amounts credited or charged to the reserve_account so that the disallowance of earnings with respect to such amounts through rate base exclusion or treatment as no-cost capital will take into account the factor of time for which such amounts are held by the taxpayer the purpose of the proration formula is the same as that of the requirement for consistent periods discussed above to prevent the immediate flow-through of the benefits of accelerated_depreciation to ratepayers the proration formula stops flow- through by limiting the deferred tax reserve accruals that may be excluded from rate base and thus the earnings on rate base that may be disallowed according to the length of time these accruals are actually in the reserve_account the effectiveness of sec_1_167_l_-1 in resolving the timing issue has been limited by its failure to define some key terms nowhere does this provision state what is meant by the terms historical and future in relation to the test period for determining depreciation for ratemaking tax expense how are these time periods to be measured one interpretation focuses on the type or quality of the data used in the ratemaking process according to this interpretation the historical period is that portion of the test period for which actual data is used while the portion of the period for which data is plr-123443-17 estimated is the future period the second interpretation focuses on when the utility rates become effective under this interpretation the historical period is that portion of the test period before rates go into effect while the portion of the test period after the effective date of the rate order is the future period the first interpretation which focuses on the quality of the ratemaking data is an attractive one it proposes a simple rule easy to follow and to enforce any portion of the reserve for deferred taxes based on estimated data must be prorated in determining the amount to be deducted from rate base the actual passage of time between the date ratemaking data is submitted and the date rates become effective is of no importance but this interpretation of the regulations achieves simplicity at the expense of precision in other words it is overbroad the proration of all estimated deferred tax data does serve to magnify the benefits of accelerated_depreciation to the utility but this is not the purpose of normalization congress was explicit normalization in no way diminishes whatever power the utility regulatory agency may have to require that the deferred taxes reserve be excluded from the base upon which the utility’s permitted rate of return is calculated h_r rep no 91st cong 1st sess in contrast the second interpretation of sec_1_167_l_-1 is consistent with the purpose of normalization which is to preserve for regulated utilities the benefits of accelerated_depreciation as a source of cost-free capital the availability of this capital is ensured by prohibiting flow-through but whether or not flow-through can even be accomplished by means of rate base exclusions depends primarily on whether at the time rates become effective the amounts originally projected to accrue to the deferred tax reserve have actually accrued if rates go into effect before the end of the test period and the rate base reduction is not prorated the utility commission may be denying a current return for accelerated_depreciation benefits the utility is only projected to have this procedure is a form of flow-through for current rates are reduced to reflect the capital cost savings of accelerated_depreciation deductions not yet claimed or accrued by the utility yet projected data is often necessary in determining rates since historical data by itself is rarely an accurate indication of future utility operating results thus the regulations provide that as long as the portion of the deferred tax reserve based on truly projected future estimated data is prorated according to the formula in sec_1_167_l_-1 a regulator may deduct this reserve from rate base in determining a utility’s allowable return in other words a utility regulator using projected data in computing ratemaking tax expense and rate base exclusion must account for the passage of time if it is to avoid flow-through but if rates go into effect after the end of the test period the opportunity to flow-through the benefits of future accelerated_depreciation to current ratepayers is gone and so too is the need to apply the proration formula in this situation the only question that is important for the purpose of rate base exclusion is the amount in the deferred tax plr-123443-17 reserve whether actual or estimated once the period over which accruals to the reserve were projected is completed and the final rates are in effect the question of when the amounts in the reserve accrued is no longer being estimated or projected at the time the new rate order takes effect the projected increases have accrued and the amounts to be excluded from rate base are no longer projected but historical even though based initially on estimates in the ldc’s general rate case the interim rates subject_to refund became effective date the interim rates were based on test year from date through date the net plant component of rate base is calculated by using a simple average of the beginning of test period and end of the test period balances all other elements of rate base including adfit balances are calculated using a 13-month average rate base is reduced by the adfit balance so computed the averages were each over the same period of time the future portion of a part-historical and part-future period for purposes of interim rates charged began on date for purposes of determining the total number of days in the future portion of the period under sec_1_167_l_-1 in response to requested ruling we conclude that the test period for ldc’s interim rates is a future test period subject_to the proration formula rules under sec_1 h therefore taxpayer is required to apply the proration formula rules as they apply to part-historical and part-future periods to calculate the amount of adfit by which ldc may reduce rate base in establishing interim rates in response to requested ruling we conclude that the effective date of the differential between the interim rates and the final rates established for the interim rate refund process calculated at the end of the rate proceeding is the effective date for the final rates established by the final order accordingly requested ruling above is moot in response to requested ruling we also conclude that because the interim rate refund process uses an historical test period it is not required to employ the proration methodology described in sec_1_167_l_-1 in response to requested ruling we conclude that the effective date of the final rates established by the final order and implemented subsequent to the rate case proceeding is the effective date for the final rates established by the final order accordingly requested ruling above is moot the ldc’s computation of adfit for purposes of the final rates occurs after the end of the test period on which those amounts are based thus the calculation is determined by reference to a purely historical period accordingly in response to requested ruling we conclude that the computation of adfit for purposes of final rates is not subject_to the proration formula rules under sec_1 h there is no need to follow the proration formula rules designed for future test periods or part-historical and part-future plr-123443-17 periods to calculate the differences between taxpayer’s projected adfit balance and the actual adfit balance during the period requested ruling we have concluded above that the interim rates charged during the pendency of the rate case until final rates are implemented because they are in effect before the end of the test period are considered calculated using a future test period once final rates are determined the interim rate refund is calculated based on the difference between the interim rates and the final rates as discussed above the interim rate refund is in effect after the conclusion of the test year and thus the interim rate refund is not considered calculated using a future test period requested ruling requires that we apply the proration formula rules of sec_1_167_l_-1 to these situations the proration formula stops flow-through by limiting the deferred tax reserve accruals that may be excluded from rate base and thus the earnings on rate base that may be disallowed according to the length of time these accruals are actually in the reserve_account specifically while interim rates are charged during the test year the projected test year adfit increases have accrued only as allowed using the proration formula once the test year has ended and the interim rate refund is calculated and is in effect the amounts to be excluded from rate base are no longer projected but historical even though based on estimates at this point the purpose of the proration formula has been accomplished and associated prevention of flow-through_accounting has been avoided by its application during the future test period to permit the effects of the proration formula on interim rates charged during the test year to be reversed in a subsequent phase of the ratemaking would be economically equivalent to not applying the proration formula in the first place in response to requested ruling we conclude that the proration requirement does not apply only to the difference between the adfit balance used to set the interim rates and the adfit balance used in the final rates to establish the interim rate refund the proration requirement continues to apply to the changes in adfit balances reflected in setting the interim rates requested rulings former sec_167 of the code generally provided that public_utilities were entitled to use accelerated methods for depreciation if they used a normalization method_of_accounting a normalization method_of_accounting was defined in former sec_167 in a manner consistent with that found in sec_168 sec_1 -1 a provides that the normalization requirements for public_utility_property pertain only to the deferral of federal_income_tax liability resulting from the use of an accelerated method_of_depreciation for computing the allowance for depreciation under sec_167 and the use of straight-line_depreciation for computing tax expense and depreciation expense for plr-123443-17 purposes of establishing cost of services and for reflecting operating results in regulated books of account these regulations do not pertain to other book-tax timing differences with respect to state income taxes f i c a taxes construction costs or any other taxes and items sec_168 provides that the depreciation deduction determined under sec_168 shall not apply to any public_utility_property within the meaning of sec_168 if the taxpayer does not use a normalization method_of_accounting in order to use a normalization method_of_accounting sec_168 requires that a taxpayer in computing its tax expense for establishing its cost of service for ratemaking purposes of establishing its cost of service for ratemaking purposes and reflecting operating results in its regulated books of account to use a method_of_depreciation with respect to public_utility_property that is the same as and a depreciation period for such property that is not shorter than the method and period used to compute its depreciation expense for such purposes under sec_168 if the amount allowable as a deduction under sec_168 differs from the amount that-would be allowable as a deduction under sec_167 using the method period first and last year convention and salvage_value used to compute regulated tax expense under sec_168 the taxpayer must make adjustments to a reserve to reflect the deferral of taxes resulting from such difference sec_168 provides that one way the requirements of sec_168 will not be satisfied is if the taxpayer for ratemaking purposes uses a procedure or adjustment which is inconsistent with such requirements under sec_168 such inconsistent procedures and adjustments include the use of an estimate or projection of the taxpayer's tax expense depreciation expense or reserve for deferred taxes under sec_168 unless such estimate or projection is also used for ratemaking purposes with respect to all three of these items and with respect to the rate base in order to satisfy the requirements of sec_168 there must be consistency in the treatment of costs for rate base regulated depreciation expense tax expense and deferred tax revenue purposes in this case adfit was averaged using a 13-month average while other components of rate base were averaged using a simple beginning and ending balance average but are all calculated in consistent fashion - all are averaged over the same period while there are minor differences in the convention used to average all elements of rate base including depreciation expense on the one hand and adfit on the other for purposes of sec_168 it is sufficient that both are determined by averaging and both are determined over the same period of time thus the calculation of average rate base and adfit as described above complies with the consistency_requirement of sec_168 accordingly in response to requested ruling we conclude that the consistency rule does not require that the ldc apply to its prorated adfit balance the precise plr-123443-17 regulatory averaging procedure it applies to its other components of rate base in the relevant computation similarly in response to requested ruling we conclude that the taxpayer’s use of a simple average for certain components of rate base in conjunction with its use of a month average for adfit is not violative of the consistency rule_of sec_168 requested ruling sec_168 provides that the depreciation deduction determined under sec_168 shall not apply to any public_utility_property within the meaning of sec_168 if the taxpayer does not use a normalization method_of_accounting however in the legislative_history to the enactment of the normalization requirements of the investment_tax_credit itc congress has stated that it hopes that sanctions will not have to be imposed and that disallowance of the tax_benefit there the itc should be imposed only after a regulatory body has required or insisted upon such treatment by a utility see senate report no 92nd cong 1st sess 1972_2_cb_559 because the service has ruled affirmatively with respect to requested ruling prospectively adhering to the service’s interpretation of sec_1 l - h ii may require adjustments to conform to this ruling any rates that have been calculated using procedures inconsistent with this ruling nonconforming rates which are or which have been in effect and which under applicable state or federal regulatory law can be adjusted or corrected to conform to the requirements of this ruling must be so adjusted or corrected where nonconforming rates cannot be adjusted or corrected to conform to the requirements of this ruling due to the operation of state or federal regulatory law then such correction must be made in the next regulatory filing or proceeding in which taxpayer’s rates are considered taxpayer’s failure to comply with the normalization rules in its general rate case was inadvertent it was not an inconsistency with the normalization rules that taxpayer any participant in any of the proceedings or the regulator in any of the proceedings recognized no potential proration-related normalization issue was ever identified thus there was clearly no required treatment that was inconsistent with the normalization rules therefore there was no determination made with respect to taxpayer’s calculation of its adfit balance by the commission because the commission as well as taxpayer at all times sought to comply and because the ldc will take corrective actions at the earliest available opportunity it is not appropriate to conclude that the failure to use the proration formula constituted a normalization violation and apply the sanction of denial of accelerated_depreciation to taxpayer accordingly in response to requested ruling we conclude that in any year prior to the ldc taking the necessary corrective action taxpayer’s relevant regulatory practices were not a violation of the normalization rules plr-123443-17 conclusion sec_1 in order to comply with the normalization rules the ldc must employ the proration methodology described in sec_1_167_l_-1 to determine the maximum amount of adfit by which the ldc can reduce rate base in establishing the interim rates for purposes of the normalization rules the effective date of the differential between the interim rates and the final rates established for the interim rate refund process calculated at the end of the rate proceeding is the effective date for the final rates established by the final order the interim rate refund process uses an historical test period and therefore is not required to employ the proration methodology described in sec_1 l - h i as a result of our conclusion for requested ruling the issue is moot for purposes of the normalization rules the effective date of the final rates established by the final order and implemented subsequent to the rate case proceeding is the effective date for the final rates established by the final order the computation of the final rates uses an historical test period and therefore is not required to employ the proration methodology described in sec_1_167_l_-1 as a result of our conclusion for requested ruling the issue is moot the proration requirement does not apply only to the difference between the adfit balance used to set the interim rates and the adfit balance used in the final rates to establish the interim rate refund the proration requirement continues to be reflected in the changes in adfit balances reflected in setting the interim rates the consistency rule does not require that the ldc apply to its prorated adfit balance the regulatory averaging procedure it applies to its other components of rate base in the relevant computation the taxpayer’s use of a simple average for certain components of rate base in conjunction with its use of a 13-month average for adfit is not violative of the consistency rule_of sec_168 in any year prior to taxpayer taking the necessary corrective action taxpayer’s plr-123443-17 relevant regulatory practices were not a violation of the normalization rules these rulings are based on the representations submitted by taxpayer and are only valid if those representations are accurate the accuracy of these representations is subject_to verification on audit except as specifically determined above no opinion is expressed or implied concerning the federal_income_tax consequences of the matters described above this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative we are also sending a copy of this letter_ruling to the director sincerely patrick s kirwan chief branch office_of_chief_counsel passthroughs special industries cc