AMERICAN GAS ASSOCIATION & INTERSTATE NATURAL GAS ASSOCIATION

1. AMERICAN GAS ASSOCIATION & INTERSTATE NATURAL GAS ASSOCIATION Update on Selected Cases and Rulings Sal Montalbano June 28, 2011

2. Update on Selected Cases and RulingsCapitalization under §263A IRS Actions in Response to Robinson Knife Case: Proposed regulations issued on Dec. 17, 2010 Sales-based royalties are production costs required to be capitalized under § 263A and allocated to inventory sold during the taxable year. AOD 2011-01 issued February 9, 2011 IRS announced its nonacquiescence with the Second Circuit’s decision in Robinson Knife. It stated it would not follow the Second Circuit’s holding except in cases appealable to the Second Circuit. Note: Robinson Knife Manufacturing Co., Inc. & Subs v. Commissioner, 105 AFTR 2d 2010-1467 (2nd Cir. 2010) had held that a manufacturer’s royalty payments were currently deductible and not subject to capitalization under §263A if they were (1) calculated as a percentage of sales revenue from inventory and (2) were incurred only upon the sale of that inventory. 2

3. Update on Selected Cases and RulingsLILO/SILO Cases • Wells Fargo & Co. v. United States, 107 A.F.T.R.2d 2011-1850 (Federal Circuit Court of Appeals, April 15, ,2011) • Affirmed: The Federal Circuit Court of Appeals affirmed the Court of Federal Claim’s holding that Wells Fargo was not entitled to a refund of $115 million in taxes it paid after the disallowance of deductions stemming from its participation in 26 SILO transactions. • Rationale: The lower court’s finding that tax-exempt entities were virtually certain to repurchase leased assets when the lease period expired was not clearly erroneous. Consequently, Wells Fargo, the purported owner of the assets for federal income tax purposes, did not have the benefits and burdens of ownership of the property at issue. The SILO transactions involved violated the substance-over-form doctrine and were therefore abusive tax shelters. • The appellate court noted that the finders of fact in the Consolidated Edison Case and in the case before it had drawn different conclusions as to the likelihood of the tax-exempt entity exercising its repurchase option.

4. Update on Selected Cases and RulingsEconomic Substance New Phoenix Sunrise Corp. v. Commissioner, 408 Fed. Appx. 908 (6th Cir. 2010) • Held: (1) The Basis Leveraged Investment Swap Spread (BLISS) transaction entered into by the taxpayer lacked economic substance. (2) The assessment of the penalty for valuation misstatements of more than 400% was proper. (3) A tax opinion in support of the transaction was subject to the attorney-client privilege, which privilege was waived by the taxpayer. • Rationale: (1) There was no error in the trial court crediting the government experts’ testimony that the probability of a profit was tiny on paper and non-existent in practice. (2) The tax opinion was issued by a law firm that the trial court found to be a promoter of the tax shelter and therefore could not be relied on to support a good faith defense. (3) By raising the reasonable cause defense, the taxpayer waived the attorney-client privilege.

5. Update on Selected Cases and RulingsEconomic Substance Historic Boardwalk Hall, LLC v. Commissioner, 136 T.C. No. 1 (2011) • Held: The transaction involved, a rehabilitation of a historic structure eligible for the historic rehabilitation credit under section 47 of the Code, was not a sham and did not lack economic substance • Rationale: As the case is appealable to the 3rd Circuit, the two-prong test utilized by that court was applied to determine whether the transaction had economic substance: • Whether the transaction has objective economic substance, and • Whether there was a subjective business motivation to the transaction. • This test was met because: • The legitimate business purpose was to allow Pitney Bowes to invest in the rehabilitation. • The investors involved faced potential liability in the transaction. • Both would receive economic benefits if the transaction was successful. • The court also concluded that Pitney Bowes did become a partner in the taxpayer, and that the taxpayer gained benefits and burdens of ownership of the property involved in the transaction.

6. Update on Selected Cases and RulingsSection 48 Energy Property PLR 201043023, October 29, 2010 Ruled: Taxpayer’s photovoltaic curtain wall (PV curtain), which was made up of components substantially all of which were directly involved in the production of electricity through the use of solar energy, qualified for the section 48 energy credit. Rationale: The PV curtain was installed on the outside of the high-rise building as a replacement to standard glass windows. It served a dual purpose, as it generated solar electricity and enclosed the building. Although Reg. section 1.48-1(e) generally prohibits structural components from qualifying for the credit under section 48, Rev. Rul. 79-183 provides an exception for a structural component that is so specifically engineered that it is part of the machinery or equipment with which it functions. The PV curtain, made up of components substantially all of which are directly involved in the production of electricity through the use of solar energy, meets the exception in Rev. Rul. 79-183 and for that reason constitutes energy property under Section 48. 6

7. Update on Selected Cases and RulingsSection 45 Credit – Refined Coal PLR 201105002, February 4, 2011, (same as PLR 201105006 & PLR 201105007) Ruled: Additive processes that mix certain chemicals or other additives with feedstock coal in order to achieve emission reductions may qualify for the production tax credit for refined coal. Rationale: The taxpayer’s technology added chemical additives to feedstock coal prior to its combustion in the furnace. The additives created chemical structures enabling the capture of pollutants. The technology was not a mining process that would have disqualified any emission reduction under section 45(c)(7). Therefore, provided the emission reduction standards of section 45(c)(7)(B) are met, the coal produced using the taxpayer’s technology will constitute “refined coal” within the meaning of Section 45(c)(7). 7

8. Update on Selected Cases and RulingsSection 45 Credit – Refined Coal PLR 201123016, June 13, 2011 Ruled: (1) Coal produced by the taxpayer’s process constitutes a “refined coal” under section 45(c)(7), provided the refined coal is (i) produced by the taxpayer from feedstock coal that is the same source or rank as the “tested coal” and (ii) satisfies qualified emission reduction tests; (2) taxpayer may establish a qualified emission reduction through testing at its combustion research facility or similar pilot-scale facility under Notice 2010-54, regardless of subsequent normal fluctuations in conditions at the plant; (3) provided feedstock coals during any determination period are from the same coal seams and of the same rank as tested coal, all feedstock coal that satisfies that criteria will be treated as feedstock coal of the same source or rank for purposes of section 6.04 of Notice 2010-54 regardless of the mine from which such feedstock coal was purchased; and (4) a facility placed in service prior to January 1, 2010, will not have a new placed-in-service date by reason of relocation or replacement of parts so long as the 20 percent test for used property is met. 8

9. Update on Selected Cases and RulingsInflation Adjustment Factors Notice 2011-40, 2011-22 IRB 806, May 26, 2010. • Publishes the 2011 inflation adjustment factors and reference prices under for the production tax credit (“PTC”) and other credits under Code section 45. • Because the reference prices did not exceed the relevant thresholds, the phase-out of the credits is not applicable. • With the inflation adjustment, the PTC is 2.2 cents per kilowatt hour for wind, closed-loop biomass, geothermal and solar energy. It is 1.1 cent per kilowatt hour for open-loop biomass and qualified hydro projects.

10. Update on Selected Cases and RulingsQualifying Advanced Coal and Gasification Project Credits Notice 2011-24, 2011-14 IRB 603, March 23, 2011 • Provides: The recapture rules under § 50(a) will apply for all events that trigger recapture of credits allowed under § 48A or § 48B. • Rationale: • The IRS recognized that prior guidance (referencing recapture for certain events occurring at any time in the recovery period under § 168(c)) provided a wide range of recovery periods that may apply to qualifying projects under sections 48A and 48B, which created confusion and difficulty for taxpayers and the IRS. • Therefore, the IRS revised the prior guidance to apply the recapture rules under §50(a) for all events that trigger recapture of credits allowed under § 48A or § 48B , including a failure to attain or maintain the separation and sequestration requirements of § 48A(e)(1)(G) or § 48B(d)(1)(B).

11. Update on Selected Cases and RulingsCarbon Dioxide Sequestration Credit Notice 2011-25, IRB 2011-14, March 24, 2011 • Clarifies: For purposes of the section 45Q credit, qualified carbon dioxide, as defined under § 45Q(b)(1), does not exclude carbon dioxide that is required to be capitalized and sequestered under § 48A or § 48B. • Rationale: Notice 2009-83 had excluded carbon dioxide that is required to be capitalized and sequestered under § 48A or § 48B from the definition of “qualified carbon dioxide” for purposes of the § 45Q credit. • Following the issuance of Notice 2009-83, commenters asserted to the IRS that the intent of § 45Q(b)(1) is not to exclude carbon dioxide that is captured and sequestered under § 48A or § 48B programs, but to ensure that the § 45Q credit is limited to carbon dioxide captured from an industrial source that, but for the physical act of capture, would otherwise be released into the atmosphere as an industrial emission of greenhouse gas.

12. Update on Selected Cases and RulingsCarbon Dioxide Sequestration Credit Notice 2011-50, IRB 2011-27, June 10, 2011 • Provides: • Inflation Adjustment Factor for section 45Q credit for 2011 is 1.0187. • The 45Q credit for calendar year 2011 is $20.37 per metric ton of qualified CO2 under section 45Q(a)(1). • The 45Q credit for calendar year 2011 is $10.19 per metric ton of qualified CO2 under section 45Q(a)(2).

13. Update on Selected Cases and RulingsGrants in Lieu Updated Guidance on Section 1603 Renewable Energy Grants-in-lieu of Tax Credits, Revised April, 2011 Updated guidance released by the IRS in April 2011 reflects the one-year extension in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 as well as the following additional guidance: Expansion of the definition of qualified property to include assets not located at site of electrical production (primarily conversion equipment). A safe harbor for conversion equipment related to biomass facilities if 75% or more of gas or liquid from the conversion asset is dedicated to the qualified facility. Provides that costs related to land and preliminary activities are eligible for 5% safe harbor for when construction begins. Clarifies that components dependent on other components for the generation of renewable energy should all have same placed in service date. Pre-2009 costs are included in a Section 45 facility, if the facility is placed in service or significantly modified after 2008. 13

14. Update on Selected Cases and RulingsSales of State Credits Tempel v. Commissioner, 136 T.C. No. 15, April 7, 2011 • Held: Transferable Colorado conservation easement income tax credits (received as a result of charitable contributions) that were sold by the taxpayer were capital assets. Taxpayers had no basis in the credits and did not meet the long-term holding period, and thus recognized short-term capital gains. • Rationale: The credits did not represent a right to income or a substitute for a tax refund. In addition, courts and the IRS have frequently treated government-granted rights as capital assets. • The taxpayer had no basis in the credits based on professional fees incurred in connection with establishing and donating the easements, and did not purchase the credits. • The holding period was calculated beginning when the credits were granted and when they were sold. The holding period of the land was not the same as the holding period of the credits. • Accord: McNeil v. Commissioner, TC Memo 2011-109, May 23, 2011

15. Update on Selected Cases and RulingsEnergy Efficient Commercial Building Deduction Generic Legal Advice – Sec. 179D - Energy Efficient Commercial Building Deduction, December 13, 2010. Advice: When a government entity allocates a section 179D deduction for energy-efficient commercial buildings to a partnership or S corporation “designer,” the partners or shareholders must reduce their adjusted bases in their partnership interests or S corporation stock and the benefit of the deduction is subject to the basis limitation rules for partnerships (section 704(d)) and S-corporations (section 1366(d)). Rationale:Sec. 179D is an entity level item that is used to calculate the entity’s income, gain, or loss and is, therefore, not considered to apply at the partner or shareholder level. As a result, a partner or shareholder’s distributive share of Sec. 179D deductions reduce the partner or shareholder’s adjusted basis in its interest or stock, and the partner’s or shareholder’s ability to claim any ordinary loss generated by the deduction is limited to its basis in its ownership interest under section 704(d) or 1366(d). 15

16. Update on Selected Cases and RulingsEnergy Conservation Subsidies PLR 201046013, November 19, 2010 Ruled: Solar photovoltaic (“PV”) systems and related property provided by a utility to its customers constituted energy conservation measures under section 136 and, thus, the value of the property was not includible in the customers’ gross income. Accordingly, the payments were not subject to reporting requirements under Sec. 6041. Rationale: IRS determined that the properties provided to the customers qualified as an energy conservation measure under section 136, because they were primarily designed to reduce consumption or improve the management of energy demands with respect to dwelling units. Therefore, the properties provided to the Taxpayer’s customers were excluded from income. Because they did not constitute gross income to the Taxpayer’s customers, the Taxpayer was also exempt from the reporting requirements under Sec. 6041. 16

17. Update on Selected Cases and Rulings §118 Nonshareholder Contributions to Capital Rev. Proc. 2011-30, April 14, 2011 Provides a safe harbor under § 118 for certain awards regarding clean coal technology made by the National Energy Technology Laboratory (NETL), the Department of Energy to corporate taxpayers. Safe Harbor: IRS will not challenge treatment by corporate taxpayers receiving eligible awards from the DOE as nonshareholder contributions to capital under § 118 if the corporate taxpayer properly reduces the basis of its property under § 362(c)(2) and the regulations thereunder. The safe harbor applies only if the corporate taxpayer has the right to retain ownership of its inventions made under an award, either by statute or under a waiver of patent rights from DOE. 17

18. Update on Selected Cases and Rulings §118 Nonshareholder Contributions to Capital Appeals Technical Guidance Program, Settlement Guidelines, February 28, 2011. Addresses: Whether partnerships and other entities not classified as corporations for Federal tax purposes, may exclude from gross income amounts received from a non-owner under Code section 118(a) or any common law contribution to capital. Conclusion: Based on its evaluation of the relevant and judicial precedents, the government’s hazards of litigation are “de minimis” and the appropriate resolution is the taxpayer’s “full concession.” 18

19. Update on Selected Cases and Rulings §118 Nonshareholder Contributions to Capital Sprint Nextel Corporation v. United States, 107 A.F.T.R.2d 2011-1204 (U.S.D.C. Kansas, March 4, 2011) Held: Universal Service Fund (USF) payments from the FCC are taxable as gross income, not excludable under § 118 as non-shareholder contributions to capital. Rationale: In determining the “intent or motive” of the FCC in making the payments, the court considered 4 issues, determining: The purpose and structure of the payments was to subsidize revenue. The payments were calculated by taking into account multiple costs, including general operating expenses. The public benefit involved was determined not to control the analysis. Application of the five CB&Q factors did not dictate a result in the case. 19

20. Update on Selected Cases and Rulings Consolidated Tax Adjustments Oregon Repeals S.B. 408 with S.B. 967, May 24, 2011 S.B. 408 had required regulated gas and electric utilities to annually reconcile the amount of income tax collected in utility rates with the amount of income taxes actually paid and either refund any over-collection or collect a surcharge for any under-collection. The new law – S.B. 967 – allows the Oregon PUC to make rate adjustments as necessary on a case-by-case basis. The PUC as well as the ratepayer advocacy organization, Citizens’ Utilities Board, endorsed the new law. Under the old law, a number of utilities had collected surcharges. 20

21. Update on Selected Cases and Rulings Ratemaking on Partnership Tax Expense ARCO Products Company et al v. Santa Fe Pacific Pipeline, L.P. (CA PUC, May 26, 2011) Decided: Santa Fe Pacific Pipeline, L.P. (SFPP), had not justified by a preponderance of the evidence that an income tax allowance should be included in rates as an expense the utility is likely to pay. Rationale: As a partnership, SFPP had not demonstrated that it incurs a federal corporate tax liability and, therefore, there was no tax expense to include in retail rates as part of determining just and reasonable rates. The PUC found that SFPP would fail the current FERC test – that any pass-through entity seeking an income tax allowance in a specific rate proceeding must establish that its partners or members have an actual or potential income tax obligation on the entity’s public utility income. SFPP presented only testimony that supported a pro forma application of treating SFPP as a stand-along taxable corporation. SFPP says it will seek a rehearing and pursue other legal options. 21

22. Update on Selected Cases and RulingsLike-Kind Exchanges Crandall v. Commissioner, T.C. Summ. Op. 2011-14, February 15, 2011. Held: The sale of an Arizona investment property and purchase of a California investment property with the funds from the sale, did not qualify as a like-kind exchange under § 1031. Rationale: Under the § 1031 regulations, gain or loss on a transaction may be recognized if a taxpayer actually or constructively receives money that does not meet the qualifications of § 1031 before the taxpayer actually receives like-kind property. Following the sale of the California property, the proceeds were deposited in an escrow account. In order to qualify under § 1031 as a qualified escrow account, the account must expressly limit the taxpayer’s right to receive, pledge, borrow, or otherwise obtain benefit of the deposited amount. The escrow account in question did not do so, and thus the transaction did not qualify under § 1031. 22

23. Update on Selected Cases and RulingsSection 197 Intangibles CCA 20111101F, February 15, 2011 Advised: Under Section 197(f)(1), no deduction is allowed for worthless goodwill purchased as part of a larger transaction in which other amortizable section 197 intangibles are retained. Rationale: A manufacturer terminated an automobile dealership’s franchise rights to sell certain types of automobiles. The dealer then sought to deduct the goodwill associated with the terminated franchise rights as worthless.However, since the dealer still retained other amortizable section 197 intangibles purchased as part of the same transaction or series of transactions (i.e., rights to sell other types of automobiles), under section 197(f)(1), the worthless portion of the goodwill could not be deducted. Instead the worthless goodwill will be included in the basis of the remaining amortizable section 197 intangibles. 23

24. Update on Selected Cases and RulingsAccounting Methods Lattice Semiconductor Corporation v. Commissioner, T.C. Memo. 2011-100 (May 9, 2011) • Held: • The IRS did not abuse its discretion in denying the taxpayer’s request to change its method of accounting with respect to 12-month expenses for the 2002 tax year. • The taxpayer was not permitted to claim a prepaid expense deduction for 2002. • Rationale: • The IRS issued proposed regulations regarding 12-month prepaid expenses in December, 2002, which advised taxpayers not to change method of accounting in reliance on the regulations until the final regulations were issued. • Final regulations were published in January 2004, effective for amounts paid or incurred on or after December 31, 2003. • The court concluded it was within the IRS’ discretion to grant or deny the requested method change, and that the taxpayer was ineligible to deduct the prepaid expenses before the regulations became final. • The court stated that U.S. Freightways Corp. v. Commissioner, which adopted the 12-monbth rule for accrual method taxpayers, was not binding on the IRS, the Tax Court, or taxpayers outside the Seventh Circuit.

25. Update on Selected Cases and RulingsCompensation Gudmundsson v. United States, 634 F.3d 212 (2nd Cir. 2011) Held: Stock is recognized as income by an employee on the date it is received notwithstanding that under an employment agreement, the taxpayer could not sell the stock on that date. Rationale: Under § 83(a), property received as compensation is recognized as income as soon as The recipient’s rights are transferable, or The property is not subject to a substantial risk of forfeiture. Taxpayer was subject to an insider-trading policy that required waiting periods prior to trading the stock. Violation of the policy could result in termination. The 2nd Circuit held that the substantial risk of forfeiture standard applies to risk of forfeiture of the stock, not risk of forfeiture of employment. Further, Taxpayer could transfer the stock to certain permitted transferrees. Thus, the stock was taxable in the year received. 25

26. Update on Selected Cases and RulingsCAP Program News Release 2011-32, March 31, 2011 IRS announced expansion of the Compliance Assurance Program (“CAP”) The Program, which began as a pilot in 2005, was made permanent. Taxpayers with assets of $10 Million or more are eligible to participate. Under CAP, participating taxpayers resolve tax issues with an IRS team before the tax return is filed. Participation results in shorter/narrower post-filing IRS examination, A new pre-CAP program provides interested taxpayers with a roadmap of the steps required for gaining entry into CAP. Another new CAP maintenance program is intended for taxpayers who have been in CAP, have fewer complex issues, and have established a track record of working cooperatively and transparently with the IRS. 26

27. Update on Selected Cases and RulingsAlternative Tax NOL Carryback Limits Metro One Telecommunications Inc. v. Commissioner, 135 T.C. No. 28 (December 15, 2010) Held: A taxpayer may not deduct an alternative tax net operating loss (ATNOL) carryback from 2004 to 2002 that would fully offset AMTI. Rationale: Taxpayers are permitted to deduct an ATNOL in lieu of an NOL under section 172. Because the ATNOL deduction cannot be determined without reference to and reliance upon the NOL deduction of section 172, the court interpreted the term “carryover” for purposes of section 56(d)(1)(A)(ii)(I) by looking to its meaning as a result of the interplay of sections 172 and 56(d). Under this interpretation, a carryover of an ATNOL to a prior period was not allowed. Consequently, the ATNOL deduction was determined to be a carryback, not a carryover under section 56(d)(1)(A)(ii)(I). Accordingly, the ATNOL carryback was subject to the 90 percent limitation of section 56(d)(1)(A)(i)(II). 27

28. Update on Selected Cases and RulingsSuccess Based Fees Safe-Harbor Revenue Procedure 2011-29, April 8, 2011 IRS addressed allocation of success-based fees between facilitative and non- facilitative amounts in “covered transactions.” General treatment: Reg. Sec. 1.263(a)-5(f) presumes any success based fees are facilitative and require capitalization. Taxpayers can allocate to non-facilitative and deduct currently if supported by contemporaneous documentation. New Safe-Harbor Election for success based fees Taxpayer can elect to treat 70 percent of all success based fees as non-facilitative and 30 percent as facilitative. Requires statement attached to income tax return for the tax year in which success-based fees are paid which identifies transaction and amounts capitalized and deducted. Election is irrevocable. Taxpayers can forego election and gather appropriate documentation. 28

29. Update on Selected Cases and RulingsStandard of Review for Regulations Mayo Foundation for Medical Education and Research v. United States (S. Ct. 1/11/2011) Held: Tax regulations promulgated under Code section 7805(a)’s general grant of authority are entitled to Chevron standard of deference. Prior to Supreme Court ruling, there was significant debate whether such tax regulations received the highly deferential standard set in Chevron USA Inc. v. NRDC (S. Ct. 1984) or the less deferential standard set in National Muffler Dealers Association v. U.S. (S. Ct. 3/20/1970) Chevron standard: Two part framework for courts to analyze deference to agency rules. Determine whether Congress directly addressed precise issue in legislative history. If Congress did not address the issue, the regulations are given controlling weight unless they are arbitrary, capricious, or contrary to the statute. 29

30. Update on Selected Cases and RulingsBasis overstatement – Omission of Income December 17, 2010 – Reg. Sec. 301.6501(e)-1 became final. These Regulations make clear that an overstatement of basis causing an omission of income greater than 25% carries a 6-year statute of limitations for assessing tax. These Regulations are explicit that, in the case of amounts related to the disposition of property, gross income generally means “the excess of the amount realized from the disposition of the property over the unrecovered cost or other basis of the property.” Effective Date: 9/24/2009. Courts have been split on extended limitation. 30

31. Update on Selected Cases and RulingsBasis overstatement – Omission of Income Beard v. Comm., 107 AFTR 2d (7th Cir. 2011) Held: Court of Appeals for Seventh Circuit held that an overstatement of basis is an omission of gross income for 6-year statute of limitations purposes. Rationale: Court of Appeals reasoned that changes to Sec. 6501(e) since the Supreme Court ruling in Colony v. Comm. made that precedent non-controlling. The Colony decision stated that Sec. 6501(e)(1)(A) applies only to receipts and accruals. The Court of Appeals reasoned that with the addition of Sec. 6501(e)(1)(B)(i), which specifically deals with receipts and accruals, Congress clearly meant for Sec. 6501(e)(1)(A) to be broader than interpreted in Colony, thus encompassing overstatement of basis. 31

32. Update on Selected Cases and RulingsBasis overstatement – Omission of Income Home Concrete & Supply LLC v. United States, No. 09-2353 (4th Cir. 2011) Held: Fourth Circuit concluded that Colony decision was applicable to Sec. 6501(e)(1) and, as such, the extended limitation period did not apply to omission of income by way of overstatement of basis. Rationale: Court would not defer to final Reg. Sec. 301.6501(e)-1 since the Regulation was promulgated during litigation and the stated effective date did not apply to the tax year at issue. Therefore, the Court ruled that the precedent set in Colony applied. 32

33. Update on Selected Cases and RulingsBasis overstatement – Omission of Income Burks v. United States, No. 09-11061 (5th Cir. 2011) Held: Fifth Circuit Court of Appeals held that an overstatement of basis does not constitute an omission from gross income for purposes of extended tax assessment. Rationale: Court refused to give deference to the recent final Reg. Sec. 301.6501(e)-1. Court claimed regulation was “an unreasonable interpretation of settled law” and not applicable to Burks. The Court then applied the Supreme Court ruling in Colony which stated that Sec. 6501(e)(1)(A) was limited only to apply to receipts and accruals. 33

34. Update on Selected Cases and RulingsBasis overstatement – Omission of Income Carpenter Family Investments, LLC v Commissioner, 136 TC No. 17 (2011) Held: Tax Court held that a basis overstatement does not extend the general 3-year limitation period on assessments to the extended 6-year period. Rationale: The Court concluded the ruling in Colony applied even in light of contrary Regulations. The Tax Court explained that a “prior interpretation of a statute can override an agency’s contrary interpretation if the prior judicial construction follows from the unambiguous terms of that statute,” as was found in National Cable & Telecomm. Ass’n v. Brand X Internet Servs., (2005) 545 U.S. 967” In essence, the Tax Court determined that the Supreme Court’s interpretation of Sec. 6501(3) in Colony still applies even after the Reg. Sec. 301.6501(e)-1 became final. 34

35. Update on Selected Cases and RulingsBasis overstatement – Omission of Income Salman Ranch, Ltd., Frances Koenig Tax Matters Partner v. Commissioner, 2011-1 USTC Para. 50,450 (9th Cir. May 31, 2011) Held: IRS properly determined that an overstatement of basis is an omission of gross income for purposes of the 6-year statute of limitations. Rationale: Following the Mayo Foundation case, the court applied the Chevron standard of review. Based on the legislative history to Code section 6501(e)(1)(A) and its predecessor statute, the court could not conclude that Congress’ intent was unambiguous as to the treatment of overstatements of basis. The IRS’ construction of “omits from gross income” was a permissible construction of the statute. 35

36. Update on Selected Cases and RulingsInterest Capitalization Dominion Resources, Inc. v. U.S. , Fed. Cl., No. 080195T (February 25, 2011) Held: Regulations section 1.263A-11(e), which required Dominion to capitalize interest in respect of real property temporarily withdrawn from service in order to install or construct an improvement (the associated-property rule), was held to be within the discretion granted by Congress to the Treasury Department. Rationale: The court applied the Chevron standard of review. It found that the regulations passed the first Chevron test since the associated property rule does not contradict Sec. 263A(f)(2). As to the second Chevron test, although the court questioned the wisdom of including the basis of associated property in calculating interest to be capitalized for an improvement, it nonetheless concluded that it could not say that Treasury had overstepped the latitude granted by the statute to adopt regulations prescribing the calculation of interest to be capitalized in connection with an improvement to existing property. 36

37. Update on Selected Cases and RulingsInterest Netting CCA 201113001, December 17, 2010 Advised: The IRS may allow a claim for netting underpayment interest that the taxpayer owed and paid but which the IRS did not assess and was barred from assessing. The applicable date for the period of underpayment interest is the date the IRS received the interest payment. Rationale: Taxpayer filed an amended tax return along with payment of additional tax due and the interest due on that liability. However, the IRS did not process the return in a timely manner and did not assess any tax or interest prior to the expiration of the assessment period. Taxpayer filed an interest rate netting claim seeking to net underpayment interest associated with the amended return against overpayment interest in subsequent years.Interest netting under Sec. 6621(d) is not permitted for any period that interest is not allowable or payable. Although the assessment period had expired, the interest was still payable (albeit, uncollectable) and, therefore, the interest paid qualified under Section 6621(d) for interest netting. 37

38. Update on Selected Cases and RulingsHot Interest CCA 201120026, June 2, 2011 Advised: IRS believes that once the $100,000 threshold for hot interest (interest at a 5% rate on large corporate underpayments) is met, hot interest applies to all underpayments of tax after the applicable date, regardless of any payments made – including the satisfaction of a deficiency by the carryback of an NOL (which is considered payment). Rationale: Hot interest begins to run pursuant to section 6601(a) when a tax becomes both due and unpaid. Under Regulations section 301.6621-3(b)(2)(i) and (ii), the existence of a threshold underpayment of tax should be determined as of the due date of the return. Thus, an NOL carryback that arises after the due date of the return does not affect the existence of a threshold underpayment. 38

39. Update on Selected Cases and RulingsFiling Dates CCA 201052003, December 30, 2010 Facts: Taxpayer filed amended return indicating the taxpayer had additional tax liability resulting from one adjustment that increased income and two that decreased income. The amended return was mailed on last day of the statute of limitation and was received by the IRS after the statute had expired. Issues Addressed Issue 1: IRS concluded that Sec. 7502 -which allows a return filed before a due date but received by the IRS after that due date, to be treated as filed on date postmarked- did not apply to amended tax returns. IRS reasoned that Sec. 7502 only applies to returns “required to be filed.” An amended return is not required to be filed by any internal revenue laws. Issue 2: The IRS determined that because Sec. 7502 does not apply to amended returns, the 60 day extension of the period for assessment afforded by Sec. 6501(c)(7) the IRS to investigate amended returns filed at the end of the statute of limitation, also does not apply . Issue 3: IRS ruled that an amount received for tax due after the expiration of the period of limitations is an overpayment. That amount can be refunded or credited to another tax year. Issue 4: The IRS concluded that the various up and down adjustments to a tax assessment were part of the overall tax assessment and cannot be bifurcated. That is, the IRS cannot treat favorable adjustments as a claim for refund while disregarding the unfavorable adjustments as untimely filed. 39

40. Update on Selected Cases and RulingsStatute of Limitations Donnelley Corporation v. U.S., 2011-1 USTC Para. 50,313 (4th Cir. 2011) Held: The IRS is entitled to recalculate a corporation’s tax liability for a closed year in order to determine whether the corporation had excess tax credits that could be carried back to support its refund claim for earlier years. Rationale: Taxpayer filed refund claims by carrying back to 1991 and 1992 unused tax credits generated in 1994. After the statute of limitations had expired on the 1994 tax return, the IRS recalculated the taxpayer’s 1994 tax liability and determined that additional tax liability would have resulted in no unused tax credits available for carry back. Although the IRS did not have the right to assess and collect additional taxes for 1994, it did have the authority to retain payments already received as long as the amounts do not exceed the properly calculated tax liability. Therefore, the taxpayer was not assessed additional tax for 1994 but was denied its refund claim for 1991 and 1992. 40

41. Update on Selected Cases and RulingsNormalization PLR 201107002, February 18, 2011 Ruled: Disallowance or recapture of the taxpayer’s investment tax credit (ITC) not required notwithstanding taxpayer’s failure to extend the amortization period for the accumulated deferred ITC (“ADITC”) while extending the useful life of certain assets as a result of depreciation studies. Rationale: Taxpayer informed the regulating authorities upon discovering the erroneous treatment. These authorities accepted corrections to the ADITC. IRS determined that neither the taxpayer nor the regulators intended to violate the normalization rules and that the taxpayer’s actions were not inconsistent with the requirements of the ITC. Thus, no disallowance or recapture of ITC was required. In addition, none of the commissions specifically considered the ADITC calculation of the taxpayer in any rate case and therefore did not make a determination inconsistent with section 46(f)(2). 41

42. Update on Selected Cases and Rulings Q&A