CCA 200901033: Assumed medical liabilities yield section 162 deductions, not capital losses

Plain-English summary

A company pointed to a 1984 private letter ruling issued on an arrangement in which it had taken on responsibility for a set of medical liabilities. That ruling rested on three things sitting in three different taxpayers: the medical liabilities themselves, an obligation to pay them, and an obligation to indemnify the payer. Later mergers, and the conversion of one entity into an entity disregarded for tax purposes, collapsed those roles into the same taxpayer.

Chief Counsel advised that the company may not claim net capital losses on the strength of the old ruling. A written determination binds the IRS only as to the taxpayer who received it, and only on the facts recited in it. Those facts had substantially changed.

The company is not left without a deduction. As it actually pays the medical liabilities, it may deduct the payments under section 162 as ordinary and necessary business expenses.

Ruling snapshot

• Question: After mergers and a disregarded-entity conversion left the
  payment and indemnity obligations in one taxpayer, may the company still claim net capital losses under a 1984 letter ruling, and may it deduct the medical liabilities under section 162 as it pays them?
• Outcome: No capital losses. Section 162 deductions allowed as the
  liabilities are paid.
• Key authorities: I.R.C. §§ 162, 6110(k)(3), 7701; Treas. Reg.
  §§ 301.7701-2(a), 301.7701-3(b)(1).

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
Memorandum
Number: 200901033
Release Date: 1/2/2009
CC:PSI:B01:SIKahng Third Party Communication: None
POSTU-146823-05 Date of Communication: Not Applicable

UILC: 162.00-00, 7701.00-00

date: September 05, 2008

to: David J. Mungo
Associate Area Counsel (Denver)
(Large & Mid-Size Business)

from: Dianna K. Miosi,
Chief, Branch 1
(Passthroughts & Special Industries)

subject: Trade or business expenses under § 162

This Chief Counsel Advice responds to your request for assistance. This advice may not be used or cited as precedent.

LEGEND

X = ---------------------------

Y = --------------------------------------------------

D1 = -------------

ISSUES

1. Whether X may claim net capital losses for the payments of certain liabilities
   described below.

2. Whether X is entitled to take deductions under § 162 with respect to its payments of
   certain medical liabilities.

CONCLUSIONS

1. X may not claim net capital losses for the payments of certain liabilities it assumed.
   POSTU-146823-05 2

2. X is entitled to take deductions under § 162 with respect to its payments of certain
   medical liabilities.

FACTS

Through a series of transactions, X acquired for federal tax purposes the medical liabilities, Payment Obligation, and Indemnity Obligation that were the subject of PLR 8429014. In PLR 8429014, an entity, identified as P in the PLR, sold all stock of a wholly owned subsidiary, identified as S, to another entity, identified as N. As part of the transaction, P agreed with N to make payments for S’s medical liabilities under S’s medical plan (“Payment Obligation”). P and N also entered into an indemnity agreement under which N would pay to P an amount equal to the value of S’s tax deduction for a medical liability paid by P (“Indemnity Obligation”).

The PLR concludes in part that P’s payments for Payment Obligation increase P’s basis in its S stock and N’s payments for Indemnity Obligation increase the price of the S stock, both relating back to the sale of S stock. The increase in P’s basis in S stock due to P’s payments for Payment Obligation is necessarily larger than the increase in the price of S stock due to N’s payments for Indemnity Obligation. Therefore, the arrangement under the PLR generates net capital losses for P.

Several years after the sale of S stock, N and S merged into X. As a result, X acquired S’s medical liabilities and Indemnity Obligation. In D1, Y, successor to Payment Obligation and a subsidiary of X, converted from a corporation into a limited liability company and became an entity disregarded as separate from its owner X. Thus, X is treated for federal tax purposes as owning Payment Obligation.

X asserts that, as successor in interest to the taxpayers to whom PLR 8429014 was issued, X may claim ordinary loss deductions and net capital losses as described in PLR 8429014.

LAW AND ANALYSIS

Section 162(a) provides in part that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 6110(k)(3) provides in part that unless the Secretary otherwise establishes by regulations, a written determination may not be used or cited as precedent. Further, A taxpayer may not rely on a letter ruling issued to another taxpayer under § 6110(k)(3)1.

Section 301.7701-2(a) provides in part that a business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.

1
Section 11.02, Rev. Proc. 2008-1, 2008-1 I.R.B. 50.
POSTU-146823-05 3

Section 301.7701-3(b)(1) provides that except provided in paragraph (b)(3) of this section, unless the entity elects otherwise, a domestic eligible entity is – (i) A partnership if it has two or more members; or (ii) Disregarded as an entity separate from its owner if it has a single owner.

The facts upon which PLR 8429014 was based have substantially changed. As a result of the series of transactions described above, the medical liabilities, Indemnity Obligation and Payment Obligation no longer belong to separate taxpayers producing the results described in PLR 8429014. Thus, X is not permitted to claim net capital losses as described in PLR 8429014. However, when S merged into X, S’s medical liabilities under its medical plan became X’s liabilities. Therefore, X is entitled to claim deductions under § 162 as it pays for the medical liabilities.

CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS

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This writing may contain privileged information. Any unauthorized disclosure of this writing may undermine our ability to protect the privileged information. If disclosure is determined to be necessary, please contact this office for our views.

Please call Sean Kahng at (202) 622-3050 if you have any further questions.

Dianna K. Miosi

_______
Dianna K. Miosi,
Chief, Branch 1
Office of Associate Chief Counsel
(Passthroughs and Special Industries)