Volume 145 — Tax Court Reports

SP is a purported welfare benefit plan consisting of the respective separate plans that each participating employer customizes to apply to its employees alone. SP pays death, medical, and disability benefits with respect to a participating employee to the extent that his or her participating employer selects. Each employer selects the general provisions, the participation requirements, and the vesting schedule applicable to its plan. Each employee designates to whom SP will pay the benefits with respect to him or her. The death benefit that SP agrees to pay as to a participating employee is the face amount of an insurance policy that SP purchases on the employee's life. The employer effectively pays the premiums on the insurance policy through its payments to SP, and the insurance policy usually has a cash value component that increases annually. SP's payment of any nondeath benefit as to an employee is generally limited to the cash value of the insurance policy related to that employee. An employer may terminate its participation in SP and cause each of its employees to be fully vested in his or her policy (including its cash value). A participating employee, upon retiring, may take his or her insurance policy in satisfaction of any postretirement death benefit payable as to the employee. O and N are C corporations, each wholly owned by a single individual; E is an S corporation owned equally by three other individuals; and each of those five individuals was employed by the corporation he owned. O and E each participated in SP and caused SP to purchase insurance on the lives of their shareholder/employees. N participated in SP but did not cause SP to purchase insurance on an employee's life. Held: The life insurance policies that were issued on the lives of the four shareholder/employees incident to their corporations' participation in SP were part of a split-dollar life insurance arrangement. Held, further, the economic benefit provisions of sec. 1.61-22(d)-(g), Income Tax Regs., are not invalid, and the four shareholder/employees with insurance on their lives realized income (compensation for O's shareholder and guaranteed payments for E's shareholders) as to the split-dollar life insurance arrangements in amounts as ascertained from those provisions. The economic benefit provisions are inapplicable to N and its owner because no life insurance was issued in those cases. On the basis of Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002), and its progeny, N's owner realized dividend income to the extent of the payments that N made to SP. Held, further, none of the corporate employers may deduct its payments to SP. Held, further, Ps are liable for the accuracy-related penalties that R determined under I.R.C. sec. 6662(a). Held, further, Ps are liable for the accuracy-related penalties that R determined under I.R.C. sec. 6662A, to the extent stated.

MEG was an affiliated group that filed consolidated returns. On Dec. 27, 1996, certain MEG member entities filed for bankruptcy under 11 U.S.C. ch. 11 and subsequently excluded cancellation of indebtedness (COD) income from their respective gross incomes under I.R.C. sec. 108(a)(1)(A) for MEG's short taxable year ending Oct. 1, 1998. Pursuant to I.R.C. sec. 108(b)(2)(A), MEG reduced each member entity's allocable share of consolidated net operating loss (CNOL) by each member entity's previously excluded COD income. MEG carried forward into its successor affiliated group a $47,424,026 CNOL and used this amount to offset income of the successor group for its taxable years ending Dec. 31, 2003 and 2004. R determined deficiencies for 2003 and 2004, arguing that I.R.C. sec. 108(b)(2)(A) required MEG's 1998 tax attribute reduction to occur at the consolidated level rather than at the individual entity level. P, the successor to MEG and as agent for the members of the affiliated group, timely filed a petition disputing R's determinations. Held: Where a member of a consolidated group has excluded COD income during a consolidated return year before the adoption of sec. 1.1502-28T, Temporary Income Tax Regs., 69 Fed. Reg. 12071 (Mar. 15, 2004), the NOL subject to reduction pursuant to I.R.C. sec. 108(b)(2)(A) is the entire CNOL of the consolidated group. See United Dominion Indus., Inc. v. United States, 532 U.S. 822, 121 S. Ct. 1934, 150 L. Ed. 2d 45 (2001).

In Xilinx Inc. v. Commissioner, 125 T.C. 37 (2005), aff'd, 598 F.3d 1191 (9th Cir. 2010), we held that, under the 1995 cost-sharing regulations, controlled entities entering into qualified cost-sharing agreements (QCSAs) need not share stock-based compensation (SBC) costs because parties operating at arm's length would not do so. In 2003 Treasury issued sec. 1.482-7(d)(2), Income Tax Regs. (final rule). The final rule requires controlled parties entering into QCSAs to share SBC costs. P is an affiliated group of corporations that filed consolidated returns for the years in issue. A-US, the parent company, is a Delaware corporation, and A-I, a subsidiary of A-US, is a Cayman Islands corporation. A-US and A-I entered into a QCSA. During its 2004-07 taxable years A-US granted SBC to its employees. A-US did not share the SBC costs with A-I. R determined deficiencies based on I.R.C. sec. 482 allocations R made pursuant to the final rule. P and R have filed cross-motions for partial summary judgment. P contends that the final rule is arbitrary and capricious under 5 U.S.C. sec. 706(2)(A) and Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto Ins. Co., 463 U.S. 29, 103 S. Ct. 2856, 77 L. Ed. 2d 443 (1983). R contends that the final rule is valid under Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 104 S. Ct. 2778, 81 L. Ed. 2d 694 (1984), or alternatively, under State Farm. Held: The final rule is a legislative rule--i.e., it is not an interpretive rule under 5 U.S.C. sec. 553(b)--because it has the force of law. See Am. Mining Cong. v. Mine Safety & Health Admin., 995 F.2d 1106, 1109, 302 U.S. App. D.C. 38 (D.C. Cir. 1993). The final rule has the force of law because in I.R.C. sec. 7805(a) "Congress has delegated legislative power to" Treasury, id., and Treasury "intended to exercise that power" when it issued the final rule, id. Held, further, whether State Farm or Chevron supplies the standard of review is immaterial because Chevron step 2 incorporates the reasoned decisionmaking standard of State Farm, see Judulang v. Holder, 565 U.S.    ,    , 132 S. Ct. 476, 483, 181 L. Ed. 2d 449 n.7 (2011), and we are being asked to decide whether Treasury reasonably concluded that the final rule is consistent with the arm's-length standard. Held, further, Treasury failed to support its belief that unrelated parties would share SBC costs with any evidence in the administrative record, see State Farm, 463 U.S. at 43; failed to articulate why all QCSAs should be treated identically, see id.; and failed to respond to significant comments, see Home Box Office, Inc. v. FCC, 567 F.2d 9, 35, 185 U.S. App. D.C. 142 (D.C. Cir. 1977). Additionally, Treasury's "explanation for its decision * * * runs counter to the evidence before" it. State Farm, 463 U.S. at 43. Held, further, the harmless error rule of 5 U.S.C. sec. 706 is inapplicable because it is not clear that Treasury would have adopted the final rule if it had been determined to be inconsistent with the arm's-length standard. Held, further, the final rule fails to satisfy State Farm's reasoned decisionmaking standard and is therefore invalid. See5 U.S.C. sec. 706(2)(A); State Farm, 463 U.S. at 43.

During his life decedent (D) established two irrevocable charitable remainder trusts. Each trust was designed so that one of D's sons would receive distributions during his life or a term of years with the remainder going to a charity. The trust instruments directed the trustees to distribute the lesser of each trust's annual income or a fixed percentage to one of the sons. If trust income exceeded the fixed percentage, the trustee was directed to make additional distributions to make up for previous years when the trust income did not yield enough to satisfy a distribution of the fixed percentage. The estate (E) claims it is entitled to a charitable contribution deduction for the values of the charitable remainder interests of the two irrevocable trusts D created. For E to be eligible for the deduction, the value of each remainder interest must be at least 10% of the net fair market value of the property contributed to the trust at the time of contribution. I.R.C. sec. 664(d)(2)(D). The parties disagree about the appropriate distribution amount to use in calculating the values of the charitable remainder interests. Held: Where the trust payout is the lesser of the trust income or a fixed percentage, the parties must use an annual distribution amount equal to the fixed percentage stated in the trust instrument to determine whether E is eligible for the charitable contribution deduction. I.R.C. sec. 664(e).

P--a farming corporation--deducted the cost of various field-packing materials for the year in which it bought them. R contends that under IRC section 464 and 26 CFR section 1.162-3 P may deduct the cost of those materials only for the year in which P uses them. Held: The class of items described under section 464 as "feed, seed, fertilizer, or other similar farm supplies," does not include packing materials as "similar farm supplies." Held, further, the "provided that" clause of section 1.162-3 for the years at issue means that the cost of materials and supplies must be deducted as the items are used or consumed, on the condition that they haven't been deducted for any prior year. P may therefore deduct the cost of field-packing materials for the year of purchase.

Ps, husband and wife, marketed and promoted a plan involving the use of entities known as corporations sole. Held: Pursuant to R's concession, Ps may contest in this Court the existence/amount of the underlying I.R.C. sec. 6700 penalties. Held, further, on the basis of the findings of the District Court, Ps are collaterally estopped from disputing that they engaged in activities in violation of the provisions of I.R.C. sec. 6700.

P entered into a binding gift agreement with her daughters under which P gave her daughters properties and in exchange the daughters agreed to assume and to pay, among other things, any estate tax… Held: The daughters' assumption of a potential I.R.C. sec. 2035(b) estate tax liability was a detriment to the daughters and a benefit to P such as would be considered by a willing buyer and willing seller in determining a sale price of the transferred property rights.

This is a so-called whistleblower case brought pursuant to I.R.C. sec. 7623(b)(4). Ps move to compel production of documents and responses to interrogatories (motions). R objects on the ground that the requested information is outside the administrative record compiled by R's Whistleblower Office and is, thus, not discoverable. 1. Held: Even were we to agree with R that the Court's scope of review is the administrative record, R cannot unilaterally decide what constitutes that record, and R's response indicates that the purported record is incomplete. 2. Held, further, we will issue an appropriate order granting the motions.

P sold contracts for which the company's name is an acronym--residual value insurance. The parties insured under these contracts included leasing companies, manufacturers, and financial institutions. Held: The risks insured by the policies P sold cover an insurance risk. 2. Held, further, the policies P sold constitute contracts of insurance for Federal income tax purposes.

R issued P a final adverse determination letter (First Revocation Letter), accompanied by an examination report, that revoked P's tax-exempt status under I.R.C. sec. 501(c)(3)… Held: The First Revocation Letter and accompanying examination report constitute a written determination that was properly issued to P. These documents must therefore be made available for public inspection under I.R.C. sec. 6110(a), subject to the deletions required by I.R.C. sec. 6110(c). 2.

R determined a gift tax deficiency against E, the estate of D, a deceased individual. D worked in a family business with his father and his brother. Held: D's transfer of stock was made in the ordinary course of business and for a full and adequate consideration in money or money's worth, namely, recognition by D's father and brother that he was the outright owner of 2/3 of the disputed shares. 2.

PF is a corporation exempt from income tax under I.R.C. sec. 501(c)(3) and classified as a private foundation under I.R.C. sec. 509(a). P is a foundation manager of PF as defined in I.R.C. sec. 4946(b). During its taxable years ended Nov. 30, 1997 through 2000, PF made cumulative expenditures of $639,073 to produce and broadcast 30- and 60-second radio messages. As a foundation manager, P agreed to the making of the expenditures. R determined that the foregoing expenditures were "attempts to influence legislation and/or the opinion of the general public" and therefore taxable expenditures, rendering PF and P liable for excise taxes under I.R.C. sec. 4945(a)(1) and (2), respectively. R further determined that because the taxable expenditures were not timely corrected, PF and P were also liable for excise taxes under I.R.C. sec. 4945(b)(1) and (2), respectively. Held: Pursuant to the regulations interpreting I.R.C. sec. 4945(e), a communication refers to a ballot measure if it either refers to the measure by name or, without naming it, employs terms widely used in connection with the measure or describes the content or effect of the measure. Held, further, PF's expenditures for the radio messages were taxable expenditures under I.R.C. sec. 4945(d)(1) or (5) to the extent redetermined herein; consequently PF is liable for excise taxes under I.R.C. sec. 4945(a)(1) to the extent redetermined herein. Held, further, P is liable for excise taxes under I.R.C. sec. 4945(a)(2) to the extent redetermined herein. Held, further, PF and P are liable for excise taxes under I.R.C. sec. 4945(b)(1) and (2), respectively, to the extent redetermined herein. Held, further, the application of I.R.C. sec. 4945 and the regulations thereunder to PF and P does not violate the First Amendment to the U.S. Constitution, and the regulations are not unconstitutionally vague.

During 2007 Ps, through a disregarded entity, donated a conservation easement to a Colorado trust. Held: R's determination of I.R.C. sec. 6662(h) penalties was proper because R's examination report, determining as an alternative position that Ps were liable for the penalties, was an initial determination as required by I.R.C. sec. 6751(b).

P, a citizen of Pakistan and a foreign medical school graduate, entered the United States in 2009 to participate in an internal medicine residency training program. During the three-year residency training program, for which P received an annual salary, P treated patients, with supervision; conducted and presented research; and supervised and trained third- and fourth-year medical students. P's supervising and training of medical students consisted of having the medical students observe him during "rounds", preparing the students for monthly examinations, and evaluating the students monthly. For taxable year 2010 P reported his wages from the residency training program as exempt from U.S. income tax under the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income, U.S.-Pak., art. XII, July 1, 1957, 10 U.S.T. 984 (entered into force May 21, 1959) (hereinafter treaty). Treaty art. XII exempts from U.S. income tax remuneration that a professor or teacher receives for teaching if the professor or teacher is a Pakistani resident who temporarily visits the United States "for the purpose of teaching for a period not exceeding two years at a university, college, school or other educational institution" in the United States. R subsequently issued P a notice of deficiency disallowing the claimed treaty exemption. P asserts that he is entitled to an exemption under treaty art. XII or, alternatively, that he is entitled to an exemption under treaty art. XIII(3). Treaty art. XIII(3) exempts from income tax compensation up to $10,000 if a Pakistani resident, temporarily present in the United States under arrangements with the United States or any agency or instrumentality thereof solely for the purpose of training, study, or orientation, receives such compensation for the rendition of services directly related to such training, study, or orientation. Held: P was not in the United States for "the purpose of teaching" in 2010 and therefore is not entitled to the exemption under treaty art. XII. Held, further, P is not entitled to the exemption under treaty art. XIII(3) because P has not proven that he was in the United States under arrangements with the United States or an agency or instrumentality thereof. Held, further, R's determination is sustained.