Internal Revenue Bulletin 2002-23 (PDF rendition): IRS Announcements

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
T.D. 8994, page 1078.
Final regulations under sections 444, 641, 1361, 1362, and
1377 of the Code relate to the qualification and taxation of
electing small business trusts (ESBTs), and to the definition of
deferral entities for purposes of electing a taxable year other
than the required taxable year. Notices 97–12 and 97–49 and
Rev. Proc. 98–23 superseded.
T.D. 8995, page 1070.
Final regulations under section 460 of the Code provide rules
applicable when there is a mid-contract change in the taxpayer
accounting for a long-term contract that has been under a long-
term contract method of accounting.
Notice 2002–37, page 1095.
This notice announces that regulations will be issued address-
ing partnership transactions involving contracts accounted for
under a long-term contract method of accounting.
EMPLOYEE PLANS
Rev. Rul. 2002–32, page 1069.
Cafeteria plans. In an asset sale, transferred employees who
have elected to participate in health flexible spending arrange-
ments (FSAs) under the seller’s cafeteria plan may continue to
exclude salary reduction amounts and medical reimburse-
ments from gross income without interruption at the same level
of coverage after becoming employees of the buyer.
REG–105885–99, page 1103.
Proposed regulations under section 457 of the Code would
provide guidance on compensation deferred under eligible sec-
tion 457 deferred compensation plans of state and local gov-
ernmental employers and tax-exempt entities. The regulations
reflect changes made to section 457 by the Tax Reform Act of
1986, the Small Business Job Protection Act of 1996, the Eco-
nomic Growth and Tax Relief Reconciliation Act of 2001, and
other legislation. These regulations would also make various
technical changes and clarifications to the existing final regula-
tions. A public hearing is scheduled for August 28, 2002.
EMPLOYMENT TAX
Rev. Rul. 2002–35, page 1067.
Wages subject to federal employment tax. This ruling clari-
fies that payments to employees for equipment they are
required to provide as a condition of employment are wages for
federal employment tax purposes, unless paid under an
accountable plan. Rev. Rul. 68–624 revoked.
Rev. Proc. 2002–41, page 1098.
This procedure provides that employers in the pipeline con-
struction industry may use an optional expense substantiation
rule to provide reimbursements under an accountable plan to
employees who also furnish welding rigs or mechanics rigs as
a condition of employment and use those rigs in their perfor-
mance of services as employees.
(Continued on the next page)
Finding Lists begin on page ii.
Bulletin No. 2002–23
June 10, 2002

ADMINISTRATIVE
Rev. Proc. 2002–40, page 1096.
Net operating losses; 5-year carryback. This document
provides procedures that certain taxpayers with net operating
losses incurred in 2001 or 2002 must follow on or before
October 31, 2002, for applying or electing out of the new
5-year carryback period enacted by the Job Creation and
Worker Assistance Act of 2002.
Announcement 2002–55, page 1125.
This document contains corrections to final regulations (T.D.
8985, 2002–14 I.R.B. 707) relating to the character of gain or
loss from hedging transactions.
Announcement 2002–56, page 1126.
The Service announces that an updated edition of Publication
597,Information on the U.S. – Canada Income Tax
Treaty(revised May 2002), is now available.
Announcement 2002–57, page 1126.
The Service announces that an updated edition of Publication
1544,Reporting Cash Payments of Over $10,000(revised
March 2002), is now available. The Spanish version of this pub-
lication, Publication 1544SP,Informe de Pagos en Efectivo
en Exceso de $10,000(revised April 2002), is also available.
June 10, 20022002–23 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping
them understand and meet their tax responsibilities and by
applying the tax law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
Superintendent of Documents on a subscription basis. Bulletin
contents are consolidated semiannually into Cumulative Bulle-
tins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the Bul-
letin. All published rulings apply retroactively unless otherwise
indicated. Procedures relating solely to matters of internal
management are not published; however, statements of inter-
nal practices and procedures that affect the rights and duties
of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the rev-
enue ruling. In those based on positions taken in rulings to tax-
payers or technical advice to Service field offices, identifying
details and information of a confidential nature are deleted to
prevent unwarranted invasions of privacy and to comply with
statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions of
the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A, Tax
Conventions and Other Related Items, and Subpart B, Legisla-
tion and Related Committee Reports.
Part III.—Administrative, Procedural, and
Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Secre-
tary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index for
the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the first Bulletin of the succeeding semiannual
period, respectively.
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.
2002–23 I.R.B.June 10, 2002

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 62.—Adjusted Gross
Income Defined
(Also §§ 3121(a), 3306(b), 3401(a), 7805(b).)
26 CFR 1.62–2: Reimbursements and other expense
allowance arrangements.
(Also §§ 31.3121(a), 31.3306(b), 31.3401(a),
301.7805–1.)
Wages subject to federal employ-
ment tax. This ruling clarifies that pay-
ments to employees for equipment they
are required to provide as a condition of
employment are wages for federal
employment tax purposes, unless paid
under an accountable plan.
Rev. Rul. 2002–35
ISSUE
Whether amounts paid to employees
for employee-provided equipment,
including vehicles, that are used by the
employee to provide services as an
employee are wages subject to federal
employment taxes?
FACTS
Situation 1 — BusinessAis engaged
in pipeline construction and repair.A
hires welderBand heavy equipment
mechanicCto perform services as
employees in connection with the con-
struction of a pipeline. BusinessA
requiresBto provide and maintain a
welding rig forB’s use in providing weld-
ing services and requiresCto provide and
maintain a mechanics rig forC’s use in
performing repair and maintenance ser-
vices at the work site on the employer’s
heavy equipment.BandCare required to
provide rigs sufficient to perform the
required employee services. (Neither
employeeBnorCis an independent con-
tractor.)
A welding rig consists of a truck
equipped with a welding machine and
other specialized welding equipment
required to perform welding services.Bis
paid an hourly wage of $X for the perfor-
mance of services as an employee. In
addition,ApaysBan hourly amount of
$Y per hour for providing the welding
rig. This rig reimbursement is only paid
for those hours thatBperforms services
asA’s employee.
A mechanics rig consists of a heavy
truck equipped with a crane, welding
machine, and various other equipment
used in the repair of heavy construction
equipment.Cis paid an hourly wage of
$X for the performance of services as an
employee. In additionApaysCan addi-
tional $Y amount per day for providing
the mechanics rig. This rig reimburse-
ment is only paid for the days thatCper-
forms services asA’s employee.
BusinessArequiresBandCto each
execute a document specifying that the
employee owns the rig provided and will
insure and maintain the rig. EmployeesB
andCbear all expenses associated with
the operation and maintenance of their
respective rigs. The flat dollar amount
paid as rig reimbursement is not related to
the actual employee business expensesB
orCincurs while performing services as
an employee ofA. BusinessAdoes not
requireBorCto substantiate expenses
incurred related to the rig provided. Nor
doesArequireBorCto return any
amount paid as a rig reimbursement that
exceeds the actual employee business
expensesBorCincurs in connection with
providing a rig while performing services
as an employee ofA.
Situation 2 — BusinessAalso hires
laborerDto perform services as an
employee. EmployeeDusesD’s pickup
truck for transportation along the pipe-
line. EmployeeDis paid an hourly wage
of $X for the performance of services as
an employee and is also paid an addi-
tional amount of $Y per day for providing
the pickup truck. BusinessAdoes not
requireDto substantiate mileage or
actual employee business expenses
incurred while performing services as an
employee ofA. EmployeeDis not
required to return any of the daily
amounts paid for the pickup truck if the
amount paid exceeds the employee busi-
ness expensesDincurred in connection
with the pickup truck while performing
services as an employee ofA. (LaborerD
is not an independent contractor.)
LAW AND ANALYSIS
Section 3402(a) of the Internal Rev-
enue Code (Code) requires employers
paying wages to deduct and withhold
income tax on wages. For income tax
withholding purposes, § 3401(a) provides
that the term “wages,” with certain excep-
tions, means all remuneration for services
performed by an employee for an
employer. Under §§ 3111 and 3301, Fed-
eral Insurance Contributions Act (FICA)
tax and Federal Unemployment Tax Act
(FUTA) tax, respectively, excise taxes are
imposed on the employer in an amount
equal to a percentage of the wages paid
by that employer. Under § 3101, FICA
tax also is imposed on the employee.
Under §§ 3121(a) and 3306(b), the term
“wages” for FICA tax purposes and
FUTA tax purposes, respectively, means,
with certain exceptions, all remuneration
for employment. Under §§ 3121(b) and
3306(c), “employment” is defined as any
service, of whatever nature, performed by
an employee for the person employing
him.
Consistent with this definition, § 31.
3121(a)–1(c) of the Employment Tax
Regulations provides that the name by
which the remuneration for employment
is designated is immaterial. Section
31.3121(a)–1(d) further provides that
generally, the basis upon which remu-
neration is paid to an employee is imma-
terial in determining whether the remu-
neration constitutes wages under FICA.
No specific section of the Code or
regulations excepts from wages amounts
paid to employees for providing equip-
ment used in the performance of services
as an employee. However, amounts paid
to employees for certain employee busi-
ness expenses incurred in connection with
such equipment are excluded from wages
if paid under a reimbursement or other
expense allowance arrangement that
meets the requirements of § 62(c).
Under § 1.62–2(c)(1) of the Income
Tax Regulations, a reimbursement or
other expense allowance arrangement sat-
isfies the requirements of § 62(c) if it
meets the requirements set forth in para-
graphs (d), (e), and (f) of § 1.62–2 (busi-
ness connection, substantiation, and
return of excess). If an arrangement meets
2002–23 I.R.B.1067June 10, 2002

these requirements, all amounts paid
under the arrangement are treated as paid
under an accountable plan.§1.62–
2(c)(2)(i). Amounts paid under an
accountable plan are excluded from the
employee’s gross income, are not
required to be reported on the employee’s
Form W-2, and are exempt from the with-
holding and payment of employment
taxes.§§31.3121(a)–3, 31.3306(b)–2,
31.3401(a)–4, and 1.6041–3(h)(1).
If an arrangement does not satisfy one
or more of these requirements, all
amounts paid under the arrangement are
paid under a“nonaccountable plan.”
Amounts paid under a nonaccountable
plan are included in the employee’s gross
income for the taxable year, must be
reported to the employee on Form W-2,
and are subject to withholding and pay-
ment of employment taxes.§§1.62–2
(c)(5), 31.3121(a)–3(b)(2), 31.3306(b)–2
(b)(2), 31.3401(a)–4(b)(2), and§1.6041–
3(h)(1). Additionally,§1.62–2(k) pro-
vides that if a payor’s reimbursement or
other expense allowance arrangement evi-
dences a pattern of abuse of the rules of
§62(c) and the regulations thereunder, all
payments made under the arrangement
will be treated as made under a nonac-
countable plan.
Rev. Rul. 68–624, 1968–2 C.B. 424,
considered what portion of the total
amount paid by a corporation for the use
of a truck and the services of a driver was
allocable as wages of the driver for fed-
eral employment tax purposes. The driver
hauled stone from the corporation’s
quarry to its river loading dock at a fixed
amount per load. The corporation allo-
cated one-third of the amount paid to the
employee as wages and two-thirds as pay-
ment for the use of the truck. The ruling
held that an allocation of the amounts
paid to an individual when the payment is
for both personal services and the use of
equipment must be governed by the facts
in each case. If the contract of employ-
ment did not specify a reasonable division
of the total amount paid between wages
and equipment, a proper allocation could
have been arrived at by reference to the
prevailing wage scale in a particular
locality for similar services in operating
the same class of equipment or the fair
rental value of similar equipment.
Rev. Rul. 68–624 pre-dates the Tax
Reform Act of 1986 (TRA’86), Pub. L.
99–514, and the Family Support Act of
1988, Pub. L. 100–485, which limit the
deductions of employee business
expenses. Pursuant to section 132 of TRA
’86, which added§67 to the Code,
employee business expenses are allowed
only as miscellaneous itemized deduc-
tions, to the extent that the aggregate of
those deductions exceeds 2 percent of
adjusted gross income. Section 62(c),
which was enacted in the Family Support
Act of 1988, in part limits employee busi-
ness expense reimbursements that can be
excluded from adjusted gross income to
those paid under an accountable plan.
Further, Rev. Rul. 68–624 does not
address whether the truck driver was
engaged in the trade or business of truck
rental in addition to the trade or business
of being an employee.
An arrangement that merely allocates
compensation paid to an employee
between wages and a reimbursement for
business expenses will not meet the
requirements of§62(c). For example, in
Shotgun Delivery, Inc. v. United States,
269 F.3d 969 (9th Cir. 2001), the court
held that a courier company’s arrange-
ment that paid employee drivers 40 per-
cent of the delivery charge rate less an
hourly minimum wage payment did not
meet the business connection requirement
because the drivers were reimbursed
regardless of actual mileage driven or
expenses incurred. Accordingly, the
arrangement was not a valid accountable
plan under§62(c).
CONCLUSION
Under the facts specified in Situations
1 and 2, the amounts paid to employees
B,C, andDfor providing equipment,
including vehicles, used in performing
services for the employer as an employee
are not paid under an accountable plan.
Each arrangement fails the business con-
nection requirement because in each situ-
ation the employer pays an amount to the
employee regardless of whether the
employee incurs (or is reasonably
expected to incur) business expenses that
would be deductible under§§161
through 198. Each arrangement fails to
require the employee to substantiate
employee business expenses, as required
by§1.62–2(e). Finally, the arrangements
do not require the return of excess as
required under§1.62–2(f).
HOLDING
In Situations 1 and 2, because the
amounts paid to the employee for provid-
ing equipment, including vehicles, for use
in performing services as an employee are
not paid under an accountable plan, they
are wages subject to the withholding and
payment of income and employment
taxes.
This ruling is not intended to provide
guidance regarding the treatment of pay-
ment for equipment, including vehicles,
provided by independent contractors.
See Rev. Proc. 2002–41, published
elsewhere in this Internal Revenue Bulle-
tin, regarding a deemed substantiation
rule for use in implementing an account-
able plan in connection with reimburse-
ments to certain employees for costs asso-
ciated with providing welding rigs or
mechanics rigs.
EFFECT ON OTHER REVENUE
RULINGS
This ruling revokes Rev. Rul. 68–624.
EFFECTIVE DATE
This revenue ruling is effective for
payments to employees after October 13,
1988 (the date of enactment for§62(c),
as part of the Family Support Act of
1988).
Under the authority of§7805(b), a
taxpayer that actually paid amounts sepa-
rate from wages for the use of employee-
provided equipment (such as described in
Situation 1 and the truck described in
Rev. Rul. 68–624) and reported these
payments on timely issued Forms 1099
for calendar years beginning before Janu-
ary 1, 2002, may continue to report these
payments on Form 1099 for periods end-
ing on or before December 31, 2002.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Joe Spires of the Office of the
Division Counsel/Associate Chief Coun-
sel (Tax Exempt and Government Enti-
ties), IRS. However, other personnel from
the IRS and Treasury Department partici-
pated in its development. For further
information regarding this revenue ruling,
call Mr. Spires at (202) 622–6040 (not a
toll-free number).
June 10, 200210682002–23 I.R.B.

Section 125.—Cafeteria Plans
(Also sections 106, 4980B.)
Cafeteria Plans. In an asset sale,
transferred employees who have elected
to participate in health flexible spending
arrangements (FSAs) under the seller’s
cafeteria plan may continue to exclude
salary reduction amounts and medical
reimbursements from gross income with-
out interruption at the same level of cov-
erage after becoming employees of the
buyer.
Rev. Rul. 2002–32
ISSUE
In an asset sale, may transferred
employees who have elected to partici-
pate in health flexible spending arrange-
ments (FSAs) under seller’s I.R.C.§125
cafeteria plan continue that benefit with-
out interruption at the same level of cov-
erage after becoming employees of
buyer?
FACTS
Situation (1). Employer S maintains a
cafeteria plan under section 125. One of
the benefits available under the plan is a
health FSA that provides for the reim-
bursement of participating employees’
medical care expenses that are not cov-
ered by other insurance. To participate in
the health FSA, employees elect pre-tax
salary reduction for the right to receive
medical care expense reimbursements
during the plan year up to a maximum
amount equal to the amount of the reduc-
tion elected for the year. Employer B is
an unrelated business entity.
During a plan year, S and B enter into
an agreement under which B acquires a
portion of the assets of S and, as part of
the acquisition, employees of S who work
in connection with the acquired assets ter-
minate employment with S and are trans-
ferred to and become employees of B.
Employer B has, or agrees to create, a
cafeteria plan that offers a health FSA
through pre-tax salary reduction. It is the
objective of both S and B that the admin-
istration of the transferred employees’
health FSAs following the asset sale have
as little impact on the transferred employ-
ees as possible. Following the sale, S will
continue its business operations, includ-
ing its health FSA. S and B agree that the
transferred employees who have elected
to participate in S’s FSA will continue in
S’s FSA for the agreed upon period. S and
B also agree on the extent, if any, to
which the existing salary reduction elec-
tions made by the transferred employees
for the FSAs under S’s plan will continue
as if made under B’s plan.
Situation (2). Same facts as in Situa-
tion (1) except that, as part of the sale, B
agrees to cover the transferred employees
who have elected to participate in S’s
health FSA under B’s health FSA. Under
B’s health FSA, the transferred employ-
ees will have the same level of coverage
provided under S’s health FSA and will
be treated as if their participation had
been continuous from the beginning of
S’s plan year. The transferred employees’
existing salary reduction elections will be
taken into account for the remainder of
B’s plan year as if made under B’s health
FSA. To implement this arrangement, B
amends its plan documents to provide that
transferred employees who elected to par-
ticipate in S’s health FSA become partici-
pants in B’s health FSA as of the begin-
ning of S’s plan year and at the level of
coverage provided under S’s health FSA,
except that transferred employees who
continue participation in S’s health FSA
after the sale (e.g., by election of COBRA
continuation coverage) are not covered by
B’s health FSA for that year. In addition,
B’s health FSA is amended to provide for
reimbursement of medical care expenses
incurred by the transferred employees at
any time during S’s plan year (including
claims incurred before the sale), up to the
amount of the employees’election and
reduced by amounts previously reim-
bursed by S. Thus, medical care expenses
incurred prior to the closing date of the
sale but not previously reimbursed as well
as medical care expenses incurred after
the closing date of the sale are reimburs-
able under B’s health FSA. S amends its
plan documents to provide that the trans-
ferred employees cease to be eligible for
medical care expense reimbursements
from S as of the closing date, except to
the extent of any COBRA continuation
coverage election. S and B have deter-
mined that the agreements between them
are consistent with applicable law.
LAW AND ANALYSIS
In general, section 106(a) provides that
gross income of an employee does not
include employer-provided coverage
under an accident or health plan. Under
section 105(b), an employee may exclude
amounts received through employer-
provided accident or health insurance if
those amounts are paid to reimburse
expenses incurred by the employee dur-
ing the period of coverage for medical
care (of the employee, the employee’s
spouse, or the employee’s dependents) for
personal injuries or sickness.
Section 125(a) states that no amount
will be included in the gross income of a
participant in a cafeteria plan solely
because, under the plan, the participant
may choose among the benefits in the
plan.
Section 125(d) defines a cafeteria plan
as a written benefit plan under which all
participants are employees, and the par-
ticipants may choose among two or more
benefits consisting of cash and certain
qualified benefits.
Section 125(f) defines qualified ben-
efits as any benefit not includible in the
gross income of the employee by reason
of an express provision of Chapter 1 of
the Code other than certain specified ben-
efits that are not qualified benefits. A
qualified benefit includes employer-
provided accident or health coverage
under section 106(a) and reimbursements
for medical care expenses under section
105(b).
Section 1.125–4 of the Income Tax
Regulations provides the circumstances
under which an employer can permit a
cafeteria plan participant to change an
existing election during a period of cover-
age and make a new election for the
remaining portion of the period of cover-
age. Generally, cafeteria plan participants
are permitted to make election changes if
there has been a change in status event
and the election change satisfies the con-
sistency rule. An election change satisfies
the consistency rule with respect to acci-
dent or health coverage only if the elec-
tion change is on account of and corre-
sponds with a change in status that affects
eligibility for coverage under an employ-
er’s plan.
2002–23 I.R.B.1069June 10, 2002

Under the asset sale described in both
Situation (1), where transferred employ-
ees maintain their existing health FSAs
under S’s cafeteria plan, and in Situation
(2), where B agrees to cover the trans-
ferred employees who have elected to
participate in S’s health FSA, there is no
loss of eligibility for coverage under
§1.125–4. Therefore, transferred employ-
ees continue to be subject to their existing
FSA elections and may not change those
elections during the remainder of the plan
year of the asset sale (unless an event
occurs thereafter which permits an elec-
tion change under§1.125–4).
For COBRA purposes, transferred
employees in Situation (1) do not suffer a
loss of coverage under S’s FSA during the
plan year. Consequently, if S’s FSA satis-
fies the requirements of Q&A-8(c) in
§54.4980B–2, there is no obligation to
make COBRA continuation coverage
available to the transferred employees
with respect to their coverage under S’s
FSA. However, if S’s FSA does not sat-
isfy the requirements of Q&A-8(c) in
§54.4980B–2 and is otherwise subject to
COBRA, then it will be obligated to
make COBRA continuation coverage
available beginning on the first day of the
plan year after the current plan year. For
additional information, see§54.4980B–2,
Q&A-8 and§54.4980B–9. In Situation
(2), the obligation of S to extend to
COBRA qualified beneficiaries the right
to elect COBRA continuation coverage is
not affected by the coverage provided by
B.
HOLDING
In an asset sale, transferred employees
who have elected to participate in health
FSAs under seller’s cafeteria plan may
continue to exclude the salary reduction
amounts and medical expense reimburse-
ments from gross income without inter-
ruption and at the same level of coverage
after becoming employees of buyer either
when seller agrees to continue its existing
health FSAs for the transferred employ-
ees as described in Situation (1) or when
buyer agrees to adopt a continuation of
seller’s health FSAs for the transferred
employees as described in Situation (2).
EFFECT ON OTHER REVENUE
RULING(S)
None
DRAFTING INFORMATION
The principal author of this revenue
ruling is Shoshanna Chaiton of the Office
of Division Counsel/Associate Chief
Counsel (Tax Exempt and Government
Entities). For further information regard-
ing this revenue ruling, contact her at
(202) 622–6080 (not a toll-free call).
Section 172.—Net Operating
Loss Deduction
Procedures are provided that certain
taxpayers with net operating losses
incurred in 2001 or 2002 must follow on
or before October 31, 2002, if they wish
to apply, or elect out of, the new 5-year
carryback period enacted by section 102
of the Job Creation and Worker Assis-
tance Act of 2002. See Rev. Proc. 2002–
40, page 1096.
Section 460.—Special Rules
for Long-Term Contracts
26 CFR 1.460–4: Methods of accounting for long-
term contracts.
T.D. 8995
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Mid-Contract Change in
Taxpayer
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations concerning a mid-
contract change in taxpayer of a contract
accounted for under a long-term contract
method of accounting. A taxpayer that is
a party to such a contract will be affected
by these regulations.
DATES:Effective Date: These regula-
tions are effective May 15, 2002.
Applicability Date: These regulations
apply to transactions on or after May 15,
2002.
FOR FURTHER INFORMATION CON-
TACT: John Aramburu at (202) 622–4960
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545–1732.
The collection of information in these
final regulations is in§1.460–
6(g)(3)(ii)(D). This information is
required to enable taxpayers to make
look-back computations when the income
from a long-term contract has been previ-
ously reported by another taxpayer.
An agency may not conduct or spon-
sor, and a person is not required to
respond to, a collection of information
unless it displays a valid control number.
The estimated average annual disclo-
sure burden per respondent is 2 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS
ReportsClearanceOfficer,W:CAR:
MP:FP, Washington, DC 20224, and to
theOffice of Management and Budget,
Attn: Desk Officer for the Department of
the Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503.
Books or records relating to a collec-
tion of information must be retained as
long as their contents might become
material in the administration of any
internal revenue law. Generally, tax
returns and tax return information are
confidential, as required by 26 U.S.C.
6103.
Background
Section 460 generally requires that
long-term contracts be accounted for
June 10, 200210702002–23 I.R.B.

under the percentage-of-completion
method (PCM), under which a taxpayer
must recognize income according to the
estimated percentage of the contract that
is completed during each taxable year and
make a look-back computation of interest
to compensate the government (or the
taxpayer) for any underestimation (or
overestimation) of income from the con-
tract. However, home construction con-
tracts and certain contracts of smaller
construction contractors are exempt from
these requirements. Moreover, residential
builders are entitled to use the 70/30
percentage-of-completion/capitalized cost
method (PCCM), and certain shipbuilders
are entitled to use the 40/60 PCCM. A
long-term contract or a portion of a long-
term contract that is exempt from the
PCM may be accounted for under any
permissible method, including the com-
pleted contract method (CCM), under
which a taxpayer does not report income
until a contract is complete, even though
progress payments are received in years
prior to completion.
This document contains amendments
to 26 CFR part 1. On February 16, 2001,
a notice of proposed rulemaking (REG–
105946–00, 2001–1 C.B. 1069) relating
to a mid-contract change in taxpayer of a
contract accounted for under a long-term
contract method of accounting was pub-
lished in theFederal Register(66 FR
10643). Written comments were received
from the public in response to the notice
of proposed rulemaking. No public hear-
ing was requested or held. After consider-
ation of all comments, the proposed regu-
lations are adopted as amended by this
Treasury decision.
Explanation and Summary of
Comments
The proposed regulations divide the
rules regarding a mid-contract change in
taxpayer of a contract accounted for
under a long-term contract method of
accounting into two categories—
constructive completion transactions and
step-in-the-shoes transactions. Generally,
a constructive completion transaction
results in the taxpayer originally account-
ing for the long-term contract (old tax-
payer) recognizing income from the con-
tract based on a contract price that takes
into account any amounts realized from
the transaction or paid by the old taxpayer
to the taxpayer subsequently accounting
for the long-term contract (new taxpayer)
that are allocable to the contract. Simi-
larly, the new taxpayer in a constructive
completion transaction is treated as
though it entered into a new contract as of
the date of the transaction, with the con-
tract price taking into account the pur-
chase price and any amount paid by the
old taxpayer that is allocable to the con-
tract. In the case of a step-in-the-shoes
transaction, the old taxpayer’s obligation
to account for the contract terminates on
the date of the transaction and is assumed
by the new taxpayer. The new taxpayer
must assume the old taxpayer’s methods
of accounting for the contract, with both
the contract price and allocable contract
costs based on amounts taken into
account by both parties.
Commentators raised concerns regard-
ing the general application of step-in-the-
shoes treatment to contracts of S corpora-
tions accounted for using the CCM. For
example, these commentators were con-
cerned with the potential for income shift-
ing that can occur when the stock of an S
corporation that is accounting for a long-
term contract using the CCM is sold to a
party with a lower marginal tax rate or to
a tax indifferent shareholder. Similarly,
income from a CCM contract could be
shifted to a party with a lower tax rate or
a tax indifferent party by making an S
election or transferring the contract in a
section 351 transaction, followed by an S
election and a sale of stock. To prevent
such a shifting of income, these commen-
tators generally recommend that the
transferor be required to apply the PCM
to CCM contracts in progress as of the
transaction date.
While these commentators’concerns
and recommendations relate solely to
CCM contracts, the potential for such
income shifting also exists with PCM
contracts due to the fact that recognition
of income under both the PCM and the
CCM does not correspond to the receipt
of progress payments. In addition, many
of the commentators’concerns are not
unique to the section 460 regulations as
similar opportunities are presented when-
ever an S corporation or an electing S
corporation has assets with built-in gain
or loss. Moreover, adoption of the com-
mentators’recommendation would trigger
tax as of the transaction date and thus
would be inconsistent with the policy of
providing for tax-free reorganizations of
going concerns. Thus, the commentators’
proposals for addressing this potential
abuse were not adopted. However, as in
the proposed regulations, the final regula-
tions contain an anti-abuse rule that is
designed to prevent such income shifting.
Commentators suggested that for pur-
poses of the section 1374 built-in gain
rules applicable to S corporation elec-
tions, long-term contracts should be val-
ued at the amount of income reportable
under the PCM on the date of the elec-
tion. The section 1374 regulations cur-
rently measure recognized built-in gain
attributable to a long-term contract
accounted for using the CCM based on
the amount of income reportable under
the PCM on the date of the election. See
§1.1374–4(g). These final regulations,
however, do not provide a specific rule to
determine the value of a long-term con-
tract because the fair market value of a
long-term contract reflects a variety of
factors, including the amount earned by
the old taxpayer as compared to the
progress payments received and retained
by the old taxpayer, and the new taxpay-
er’s estimates of future revenues and
costs.
One commentator pointed out that
while the preamble indicates the treat-
ment of partnership transactions (i.e.,
transactions described in sections 721 and
731, and transfers of partnership interests)
have been reserved, the proposed regula-
tions, by default, place these transactions
in the taxable, constructive completion
category. This commentator suggested
that the regulations reserve the treatment
of partnership transactions and provide
only that taxpayers use reasonable meth-
ods.
The final regulations provide that a
contribution to a partnership in a transac-
tion described in section 721(a), a transfer
of a partnership interest, and a distribu-
tion by a partnership to which section 731
applies (other than a distribution of a con-
tract accounted for using a long-term con-
tract method of accounting) are step-in-
the-shoes transactions. The final
regulations, however, reserve on the spe-
cial rules that will apply to such transfers.
As described in Notice 2002–37, 2002–23
I.R.B. 1030, the IRS and Treasury
Department intend to publish regulations
2002–23 I.R.B.1071June 10, 2002

that will set forth the special rules that
will apply to such partnership transac-
tions in a separate project. These regula-
tions will be effective for contributions of
long-term contracts to partnerships and
transfers of interests in partnerships that
are engaged in long-term contracts on or
after May 15, 2002.
One commentator objected to the
required use of the simplified marginal
impact method of computing look back
interest in the case of a step-in-the-shoes
transaction. In response to this comment,
the final regulations give taxpayers the
option of using this method without
requiring it, except in those cases in
which the existing regulations require its
use. See§1.460–6(d)(4).
Questions have arisen as to whether
the implementation of these rules requires
a taxpayer to request a change in method
of accounting by filing a Form 3115,
“Application for Change in Accounting
Method.”In response to these questions,
the final regulations clarify that the appli-
cation of these rules to a transaction
occurring after the effective date is not a
change in method of accounting and,
therefore, does not require the filing of
Form 3115.
In addition to changes made in
response to the comments and questions
described above, the final regulations
clarify the application of the step-in-the-
shoes rules to certain transfers of con-
tracts that result in the old taxpayer rec-
ognizing income with respect to the
contract. Specifically, the final regula-
tions explain how the old taxpayer calcu-
lates the gain realized with respect to the
contract in these transactions, clarify the
operation of the basis adjustment rule in
certain cases of successive transfers of a
contract, and provide that the contract
price of a new taxpayer should be
reduced to the extent that the old taxpayer
recognizes income with respect to the
contract in connection with these transac-
tions. The final regulations also clarify
that a taxpayer is not entitled to a loss in
the amount of its basis in the contract
(including the uncompleted property, if
applicable) where that basis is determined
under section 362 or 334. In addition, to
the extent the basis of the contract
(including the uncompleted property, if
applicable) reflects the old taxpayer’s rec-
ognition of income attributable to the
contract in the step-in-the-shoes transac-
tion, such income recognition reduces the
total contract price. Accordingly, the new
taxpayer recovers this additional basis
over the time that it performs the con-
tract. To the extent the basis of the con-
tract (including the uncompleted property,
if applicable) reflects costs incurred by
the old taxpayer that have not yet been
deducted (i.e., in the case of a CCM con-
tract), such costs will give rise to a deduc-
tion upon completion of the contract.
Therefore, disallowing the new taxpayer a
loss for its basis in the contract (including
the uncompleted property, if applicable)
is necessary to prevent the new taxpayer
from benefitting twice from the same
item. Finally, the final regulations include
new examples to illustrate these rules.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required. It also has been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions. It is hereby certified that the collec-
tion of information in this Treasury deci-
sion will not have a significant economic
impact on a substantial number of small
entities. This certification is based on the
fact that the relevant information is
already maintained by taxpayers. There-
fore, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required. Pursu-
ant to section 7805(f) of the Code, the
proposed regulations preceding these
regulations were submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on their
impact on small business.
Drafting Information
The principal author of these regula-
tions is John Aramburu, Office of Associ-
ate Chief Counsel (Income Tax and
Accounting). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par.2.In§1.358–1, a sentence is
added at the end of paragraph (a) to read
as follows:
§1.358–1 Basis to distributees.
(a)***See§1.460–4(k)(3)(iv)(A)
for rules relating to stock basis adjust-
ments required where a contract
accounted for using a long-term contract
method of accounting is transferred in a
transaction described in section 351 or a
reorganization described in section
368(a)(1)(D) with respect to which the
requirements of section 355 (or so much
of section 356 as relates to section 355)
are met.
*****
Par.3.In§1.334–1, a sentence is
added at the end of paragraph (b) to read
as follows:
§1.334–1 Basis of property received in
liquidations.
*****
(b)***See§1.460–4(k)(3)(iv)(B)(2)
for rules relating to adjustments to the
basis of certain contracts accounted for
using a long-term contract method of
accounting that are acquired in certain
liquidations described in section 332.
*****
Par.4.In§1.362–1, a sentence is
added at the end of paragraph (a) to read
as follows:
§1.362–1 Basis to corporations.
(a) * * * See§1.460–4(k)(3)(iv)(B)(2)
for rules relating to adjustments to the
basis of certain contracts accounted for
using a long-term contract method of
accounting that are acquired in certain
transfers described in section 351 and cer-
tain reorganizations described in section
368(a).
*****
June 10, 200210722002–23 I.R.B.

Par.5.In§1.381(c)(4)–1, a sentence
is added at the end of paragraph (a)(2) to
read as follows:
§1.381(c)(4)–1 Method of accounting.
(a)***
(2) * * *See§1.460–4(k) for rules
relating to transfers of contracts
accounted for using a long-term contract
method of accounting in a transaction to
which section 381 applies.
*****
Par. 6. Section 1.460–0 is amended by:
1. Revising the entry for paragraph (k)
of§1.460–4.
2. Adding entries for paragraphs (k)(1)
through (k)(6) of§1.460–4.
3. Adding entries for paragraphs (g)
through (g)(4) of§1.460–6.
§1.460–0 Outline of regulations under
section 460.
*****
§1.460–4 Methods of accounting for
long-term contracts.
*****
(k) Mid-contract change in taxpayer.
(1) In general.
(2) Constructive completion transactions.
(i) Scope.
(ii) Old taxpayer.
(iii) New taxpayer.
(iv) Special rules relating to distributions
of certain contracts by a partnership.
[Reserved.]
(3) Step-in-the-shoes transactions.
(i) Scope.
(ii) Old taxpayer.
(A) In general.
(B) Gain realized on the transaction.
(iii) New taxpayer.
(A) Method of accounting.
(B) Contract price.
(C) Contract costs.
(iv) Special rules related to certain corpo-
rate transactions.
(A) Old taxpayer—basis adjustment.
(1) In general.
(2) Basis adjustment in excess of stock
basis.
(3) Subsequent dispositions of certain
contracts.
(B) New taxpayer.
(1) Contract price adjustment.
(2) Basis in contract.
(v) Special rules related to certain part-
nership transactions. [Reserved.]
(4) Anti-abuse rule.
(5) Examples.
(6) Effective date.
*****
§1.460–6 Look-back method.
*****
(g) Mid-contract change in taxpayer.
(1) In general.
(2) Constructive completion transactions.
(3) Step-in-the-shoes transactions.
(i) General rules.
(ii) Application of look-back method to
pre-transaction period.
(A) Contract Price
(B) Method.
(C) Interest accrual period.
(D) Information old taxpayer must pro-
vide.
(iii) Application of look-back method to
post-transaction years.
(iv) S corporation elections.
(4) Effective date.
*****
Par. 7. Section 1.460–4 is amended by:
1. Adding a sentence at the end of
paragraph (a).
2. Adding paragraph (k).
The additions read as follows:
§1.460–4 Methods of accounting for
long-term contracts.
(a)***Finally, paragraph (k) of this
section provides rules relating to a mid-
contract change in taxpayer of a contract
accounted for using a long-term contract
method of accounting.
*****
(k)Mid-contract change in taxpayer
—(1)In general. The rules in this para-
graph (k) apply if prior to the completion
of a long-term contract accounted for
using a long-term contract method by a
taxpayer (old taxpayer), there is a transac-
tion that makes another taxpayer (new
taxpayer) responsible for accounting for
income from the same contract. For pur-
poses of this paragraph (k) and§1.460–
6(g), an old taxpayer also includes any
old taxpayer(s) (e.g., predecessors) of the
old taxpayer. In addition, a change in sta-
tus from taxable to tax exempt or from
domestic to foreign, or vice versa, will be
considered a change in taxpayer. Finally,
a contract will be treated as the same con-
tract if the terms of the contract are not
substantially changed in connection with
the transaction, whether or not the cus-
tomer agrees to release the old taxpayer
from any or all of its obligations under
the contract. The rules governing con-
structive completion transactions are pro-
vided in paragraph (k)(2) of this section,
while the rules governing step-in-the-
shoes transactions are provided in para-
graph (k)(3) of this section. Special rules
related to the treatment of certain partner-
ship transactions are reserved under para-
graphs (k)(2)(iv) and (k)(3)(v) of this sec-
tion. For application of the look-back
method to mid-contract changes in tax-
payers for contracts accounted for using
the PCM, see§1.460–6(g).
(2)Constructive completion transac-
tions—(i)Scope. The constructive
completion rules in this paragraph (k)(2)
apply to transactions (constructive
completion transactions) that result in a
change in the taxpayer responsible for
reporting income from a contract and that
are not described in paragraph (k)(3)(i) of
this section. Constructive completion
transactions generally include, for
example, taxable sales under section 1001
and deemed asset sales under section 338.
(ii)Old taxpayer. The old taxpayer is
treated as completing the contract on the
date of the transaction. The total contract
price (or, gross contract price in the case
of a long-term contract accounted for
under the CCM) for the old taxpayer is
the sum of any amounts realized from the
transaction that are allocable to the con-
tract and any amounts the old taxpayer
has received or reasonably expects to
receive under the contract. Total contract
price (or gross contract price) is reduced
by any amount paid by the old taxpayer
to the new taxpayer, and by any transac-
tion costs, that are allocable to the con-
tract. Thus, the old taxpayer’s allocable
contract costs determined under para-
graph (b)(5) of this section do not include
any consideration paid, or costs incurred,
as a result of the transaction that are allo-
cable to the contract. In the case of a
2002–23 I.R.B.1073June 10, 2002

transaction subject to section 338 or
1060, the amount realized from the trans-
action allocable to the contract is deter-
mined by using the residual method under
§§1.338–6 and 1.338–7.
(iii)New taxpayer. The new taxpayer
is treated as entering into a new contract
on the date of the transaction. The new
taxpayer must evaluate whether the new
contract should be classified as a long-
term contract within the meaning of
§1.460–1(b) and account for the contract
under a permissible method of account-
ing. For a new taxpayer who accounts for
a contract using the PCM, the total con-
tract price is any amount the new tax-
payer reasonably expects to receive under
the contract consistent with paragraph
(b)(4) of this section. Total contract price
is reduced by the amount of any consid-
eration paid by the new taxpayer as a
result of the transaction, and by any trans-
action costs, that are allocable to the con-
tract and is increased by the amount of
any consideration received by the new
taxpayer as a result of the transaction that
is allocable to the contract. Similarly, the
gross contract price for a contract
accounted for using the CCM is all
amounts the new taxpayer is entitled by
law or contract to receive consistent with
paragraph (d)(3) of this section, adjusted
for any consideration paid (or received)
by the new taxpayer as a result of the
transaction, and for any transaction costs,
that are allocable to the contract. Thus,
the new taxpayer’s allocable contract
costs determined under paragraph (b)(5)
of this section do not include any consid-
eration paid, or costs incurred, as a result
of the transaction that are allocable to the
contract. In the case of a transaction sub-
ject to sections 338 or 1060, the amount
of consideration paid that is allocable to
the contract is determined by using the
residual method under§§1.338–6 and
1.338–7.
(iv)Special rules relating to distribu-
tions of certain contracts by a partner-
ship. [Reserved]
(3)Step-in-the-shoes transactions—
(i)Scope. The step-in-the-shoes rules in
this paragraph (k)(3) apply to the follow-
ing transactions that result in a change in
the taxpayer responsible for reporting
income from a contract accounted for
using a long-term contract method of
accounting (step-in-the-shoes transac-
tions)—
(A) Transfers to which section 361
applies if the transfer is in connection
with a reorganization described in section
368(a)(1)(A), (C) or (F);
(B) Transfers to which section 361
applies if the transfer is in connection
with a reorganization described in section
368(a)(1)(D) or (G), provided the require-
ments of section 354(b)(1)(A) and (B) are
met;
(C) Distributions to which section 332
applies, provided the contract is trans-
ferred to an 80-percent distributee;
(D) Transfers described in section 351;
(E) Transfers to which section 361
applies if the transfer is in connection
with a reorganization described in section
368(a)(1)(D) with respect to which the
requirements of section 355 (or so much
of section 356 as relates to section 355)
are met;
(F) Transfers (e.g., sales) of S corpora-
tion stock;
(G) Conversion to or from an S corpo-
ration;
(H) Members joining or leaving a con-
solidated group;
(I) Contributions to which section
721(a) applies;
(J) Transfers of partnership interests;
(K) Distributions to which section 731
applies (other than the distribution of the
contract); and
(L) Any other transaction designated in
the Internal Revenue Bulletin by the
Internal Revenue Service. See§601.601
(d)(2)(ii) of this chapter.
(ii)Old taxpayer—(A)In general.
The new taxpayer will“step into the
shoes”of the old taxpayer with respect to
the contract. Thus, the old taxpayer’s
obligation to account for the contract ter-
minates on the date of the transaction and
is assumed by the new taxpayer, as set
forth in paragraph (k)(3)(iii) of this sec-
tion. As a result, an old taxpayer using the
PCM is required to recognize income
from the contract based on the cumulative
allocable contract costs incurred as of the
date of the transaction. Similarly, an old
taxpayer using the CCM is not required to
recognize any revenue and may not
deduct allocable contract costs incurred
with respect to the contract.
(B)Gain realized on the transaction.
The amount of gain the old taxpayer real-
izes on the transfer of a contract in a step-
in-the-shoes transaction must be deter-
mined after application of paragraph
(k)(3)(ii)(A) of this section using the rules
of paragraph (k)(2) of this section that
apply to constructive completion transac-
tions. (The amount of gain realized on a
transfer of a contract is relevant, for
example, in determining the amount of
gain recognized with respect to the con-
tract in a section 351 transaction in which
the old taxpayer receives from the new
taxpayer money or property other than
stock of the transferee.)
(iii)New taxpayer—(A)Method of
accounting. Beginning on the date of the
transaction, the new taxpayer must
account for the long-term contract by
using the same method of accounting
used by the old taxpayer prior to the
transaction. The same method of account-
ing must be used for such contract regard-
less of whether the old taxpayer’s method
is the new taxpayer’s principal method of
accounting under§1.381(c)(4)–1(b)(3) or
whether the new taxpayer is otherwise
eligible to use the old taxpayer’s method.
Thus, if the old taxpayer uses the PCM to
account for the contract, the new taxpayer
steps into the shoes of the old taxpayer
with respect to its completion factor and
percentage of completion methods (such
as the 10-percent method), even if the
new taxpayer has not elected such meth-
ods for similarly classified contracts.
Similarly, if the old taxpayer uses the
CCM, the new taxpayer steps into the
shoes of the old taxpayer with respect to
the CCM, even if the new taxpayer is not
otherwise eligible to use the CCM. How-
ever, the new taxpayer is not necessarily
bound by the old taxpayer’s method for
similarly classified contracts entered into
by the new taxpayer subsequent to the
transaction and must apply general tax
principles, including section 381, to deter-
mine the appropriate method to account
for these subsequent contracts. To the
extent that general tax principles allow
the taxpayer to account for similarly clas-
sified contracts using a method other than
the old taxpayer’s method, the taxpayer is
June 10, 200210742002–23 I.R.B.

not required to obtain the consent of the
Commissioner to begin using such other
method.
(B)Contract price. In the case of a
long-term contract that has been
accounted for under PCM, the total con-
tract price for the new taxpayer is the sum
of any amounts the old taxpayer or the
new taxpayer has received or reasonably
expects to receive under the contract con-
sistent with paragraph (b)(4) of this sec-
tion. Similarly, the gross contract price in
the case of a long-term contract
accounted for under the CCM includes all
amounts the old taxpayer or the new tax-
payer is entitled by law or by contract to
receive consistent with paragraph (d)(3)
of this section.
(C)Contract costs. Total allocable
contract costs for the new taxpayer are
the allocable contract costs as defined
under paragraph (b)(5) of this section
incurred by either the old taxpayer prior
to, or the new taxpayer after, the transac-
tion. Thus, any payments between the old
taxpayer and the new taxpayer with
respect to the contract in connection with
the transaction are not treated as allocable
contract costs.
(iv)Special rules related to certain
corporate transactions—(A)Old tax-
payer—basis adjustment—(1)In general.
Exceptasprovidedinparagraph
(k)(3)(iv)(A)(2) of this section, in the
case of a transaction described in para-
graph (k)(3)(i)(D) or (E) of this section,
the old taxpayer must adjust its basis in
the stock of the new taxpayer by—
(i) Increasing such basis by the amount
of gross receipts the old taxpayer has rec-
ognized under the contract; and
(ii) Reducing such basis by the amount
of gross receipts the old taxpayer has
received or reasonably expects to receive
under the contract.
(2)Basis adjustment in excess of stock
basis. If the old and new taxpayer do not
join in the filing of a consolidated Federal
income tax return, the old taxpayer may
not adjust its basis in the stock of the new
taxpayer under paragraph (k)(3)(iv)(A)(1)
of this section below zero and the old tax-
payer must recognize ordinary income to
the extent the basis in the stock of the
new taxpayer otherwise would be
adjusted below zero. If the old and new
taxpayer join in the filing of a consoli-
dated Federal income tax return, the old
taxpayer must create an (or increase an
existing) excess loss account to the extent
the basis in the stock of the new taxpayer
otherwise would be adjusted below zero
under paragraph (k)(3)(iv)(A)(1) of this
section. See§§1.1502–19 and 1.1502–
32(a)(3)(ii).
(3)Subsequent dispositions of certain
contracts. If the old taxpayer disposes of
a contract in a transaction described in
paragraph (k)(3)(i)(D) or (E) of this sec-
tion that the old taxpayer acquired in a
transaction described in paragraph
(k)(3)(i)(D) or (E) of this section, the
basis adjustment rule of this paragraph
(k)(3)(iv)(A) is applied by treating the old
taxpayer as having recognized the amount
of gross receipts recognized by the previ-
ous old taxpayer under the contract and
any amount recognized by the previous
old taxpayer with respect to the contract
in connection with the transaction in
which the old taxpayer acquired the con-
tract. In addition, the old taxpayer is
treated as having received or as reason-
ably expecting to receive under the con-
tract any amount the previous old tax-
payer received or reasonably expects to
receive under the contract. Similar prin-
ciples will apply in the case of multiple
successive transfers described in para-
graph (k)(3)(i)(D) or (E) of this section
involving the contract.
(B)New Taxpayer—(1)Contract price
adjustment. Generally, payments between
the old taxpayer and the new taxpayer
with respect to the contract in connection
with the transaction do not affect the con-
tract price. Notwithstanding the preceding
sentence and paragraph (k)(3)(iii)(B) of
this section, however, in the case of trans-
actions described in paragraph
(k)(3)(i)(B), (D) or (E) of this section, the
total contract price (or gross contract
price) must be reduced to the extent of
any amount recognized by the old tax-
payer with respect to the contract in con-
nection with the transaction (e.g., any
amount recognized under section 351(b)
or 357 that is attributable to the contract
and any income recognized by the old
taxpayer pursuant to the basis adjustment
rule of paragraph (k)(3)(iv)(A)).
(2)Basis in Contract. The new taxpay-
er’s basis in a contract (including the
uncompleted property, if applicable)
acquired in a transaction described in
paragraphs (k)(3)(i)(A) through (E) of
this section will be computed under sec-
tion 362 or section 334, as applicable.
Upon a new taxpayer’s completion
(actual or constructive) of a CCM or a
PCM contract acquired in a transaction
described in paragraphs (k)(3)(i)(A)
through (E) of this section, the new tax-
payer’s basis in the contract (including
the uncompleted property, if applicable)
is reduced to zero. The new taxpayer is
not entitled to a deduction or loss in con-
nection with any basis reduction pursuant
to this paragraph (k)(3)(iv)(B)(2).
(v)Special rules related to certain
partnership transactions. [Reserved]
(4)Anti-abuse rule. Notwithstanding
this paragraph (k), in the case of a trans-
action entered into with a principal pur-
pose of shifting the tax consequences
associated with a long-term contract in a
manner that substantially reduces the
aggregate U.S. Federal income tax liabil-
ity of the parties with respect to that con-
tract, the Commissioner may allocate to
the old (or new) taxpayer the income
from that contract properly allocable to
the old (or new) taxpayer. For example,
the Commissioner may reallocate income
from a long-term contract in a transaction
in which a contract accounted for using
the CCM, or using the PCM where the
old taxpayer has received advance pay-
ments in excess of its contribution to the
contract, is transferred to a tax indifferent
party (e.g., a foreign person not subject to
U.S. Federal income tax).
(5)Examples. The following examples
illustrate the rules of this paragraph (k).
For purposes of these examples, it is
assumed that the contract is a long-term
construction contract accounted for using
the PCM prior to the transaction unless
stated otherwise and the contract is not
transferred with a principal purpose of
shifting the tax consequences associated
with a long-term contract in a manner that
substantially reduces the aggregate U.S.
Federal income tax liability of the parties
with respect to that contract. The
examples are as follows:
Example 1.Constructive completion—PCM—
(i)Facts. In Year 1, X enters into a contract. The
total contract price is $1,000,000 and the estimated
total allocable contract costs are $800,000. In Year
1, X incurs costs of $200,000. In Year 2, X incurs
additional costs of $400,000 before selling the con-
tract as part of a taxable sale of its business in Year
2 to Y, an unrelated party. At the time of sale, X has
received $650,000 in progress payments under the
contract. The consideration allocable to the contract
2002–23 I.R.B.1075June 10, 2002

under section 1060 is $150,000. Pursuant to the sale,
the new taxpayer Y immediately assumes X’s con-
tract obligations and rights. Y is required to account
for the contract using the PCM. In Year 2, Y incurs
additional allocable contract costs of $50,000. Y cor-
rectly estimates at the end of Year 2 that it will have
to incur an additional $75,000 of allocable contract
costs in Year 3 to complete the contract.
(ii)Old taxpayer. For Year 1, X reports receipts
of $250,000 (the completion factor multiplied by
total contract price ($200,000/$800,000 x
$1,000,000)) and costs of $200,000, for a profit of
$50,000. X is treated as completing the contract in
Year 2 because it sold the contract. For purposes of
applying the PCM in Year 2, the total contract price
is $800,000 (the sum of the amounts received under
the contract and the amount realized in the sale
($650,000 + $150,000)) and the total allocable con-
tract costs are $600,000 (the sum of the costs
incurred in Year 1 and Year 2 ($200,000 +
$400,000)). Thus, in Year 2, X reports receipts of
$550,000 (total contract price minus receipts already
reported ($800,000 - $250,000)) and costs incurred
in year 2 of $400,000, for a profit of $150,000.
(iii)New taxpayer. Y is treated as entering into
a new contract in Year 2. The total contract price is
$200,000 (the amount remaining to be paid under
the terms of the contract less the consideration paid
allocable to the contract ($1,000,000 - $650,000 -
$150,000)). The estimated total allocable contract
costs at the end of Year 2 are $125,000 (the allo-
cable contract costs that Y reasonably expects to
incur to complete the contract ($50,000 + $75,000)).
In Year 2, Y reports receipts of $80,000 (the comple-
tion factor multiplied by the total contract price
[($50,000/$125,000) x $200,000] and costs of
$50,000 (the costs incurred after the purchase), for a
profit of $30,000. For Year 3, Y reports receipts of
$120,000 (total contract price minus receipts already
reported ($200,000 - $80,000)) and costs of
$75,000, for a profit of $45,000.
Example 2.Constructive completion—CCM—
(i)Facts. The facts are the same as inExample 1,
except that X and Y properly account for the con-
tract under the CCM.
(ii)Old taxpayer. X does not report any income
or costs from the contract in Year 1. In Year 2, the
contract is deemed complete for X, and X reports its
gross contract price of $800,000 (the sum of the
amounts received under the contract and the amount
realized in the sale ($650,000 + $150,000)) and its
total allocable contract costs of $600,000 (the sum
of the costs incurred in Year 1 and Year 2 ($200,000
+ $400,000)) in that year, for a profit of $200,000.
(iii)New taxpayer. Y is treated as entering into
a new contract in Year 2. Under the CCM, Y reports
no gross receipts or costs in Year 2. Y reports its
gross contract price of $200,000 (the amount
remaining to be paid under the terms of the contract
less the consideration paid allocable to the contract
($1,000,000 - $650,000 - $150,000)) and its total
allocable contract costs of $125,000 (the allocable
contract costs that Y incurred to complete the con-
tract ($50,000 + $75,000)) in Year 3, the completion
year, for a profit of $75,000.
Example 3.Step-in-the-shoes—PCM—(i)
Facts. The facts are the same as inExample 1,
except that X transfers the contract (including the
uncompleted property) to Y in exchange for stock of
Y in a transaction that qualifies as a statutory merger
described in section 368(a)(1)(A) and does not
result in gain or loss to X under section 361(a).
(ii)Old taxpayer. For Year 1, X reports receipts
of $250,000 (the completion factor multiplied by
total contract price ($200,000/$800,000 x
$1,000,000)) and costs of $200,000, for a profit of
$50,000. Because the mid-contract change in tax-
payer results from a transaction described in para-
graph (k)(3)(i) of this section, X is not treated as
completing the contract in Year 2. In Year 2, X
reports receipts of $500,000 (the completion factor
multiplied by the total contract price and minus the
Year 1 gross receipts [($600,000/$800,000 x
$1,000,000) - $250,000]) and costs of $400,000, for
a profit of $100,000.
(iii)New taxpayer. Because the mid-contract
change in taxpayer results from a step-in-the-shoes
transaction, Y must account for the contract using
the same methods of accounting used by X prior to
the transaction. Total contract price is the sum of
any amounts that X and Y have received or reason-
ably expect to receive under the contract, and total
allocable contract costs are the allocable contract
costs of X and Y. Thus, the estimated total allocable
contract costs at the end of Year 2 are $725,000 (the
cumulative allocable contract costs of X and the
estimated total allocable contract costs of Y
($200,000 + $400,000 + $50,000 + $75,000)). In
Year 2, Y reports receipts of $146,552 (the comple-
tion factor multiplied by the total contract price
minus receipts reported by the old taxpayer
([($650,000/$725,000) x $1,000,000] - $750,000)
and costs of $50,000, for a profit of $96,552. For
Year 3, Y reports receipts of $103,448 (the total
contract price minus prior year receipts ($1,000,000
- $896,552)) and costs of $75,000, for a profit of
$28,448.
Example 4.Step-in-the-shoes—CCM—(i)
Facts. The facts are the same as inExample 3,
except that X properly accounts for the contract
under the CCM.
(ii)Old taxpayer. X reports no income or costs
from the contract in Years 1, 2 or 3.
(iii)New taxpayer. Because the mid-contract
change in taxpayer results from a step-in-the-shoes
transaction, Y must account for the contract using
the same method of accounting used by X prior to
the transaction. Thus, in Year 3, the completion year,
Y reports receipts of $1,000,000 and total contract
costs of $725,000, for a profit of $275,000.
Example 5.Step in the shoes—PCM—basis
adjustment. The facts are the same as inExample 3,
except that X transfers the contract (including the
uncompleted property) with a basis of $0 and
$125,000 of cash to a new corporation, Z, in
exchange for all of the stock of Z in a section 351
transaction. Thus, under section 358(a), X’s basis in
the Z stock is $125,000. Pursuant to paragraph
(k)(3)(iv)(A)(1) of this section, X must increase its
basis in the Z stock by the amount of gross receipts
X recognized under the contract, $750,000
($250,000 receipts in Year 1 + $500,000 receipts in
Year 2), and reduce its basis by the amount of gross
receipts X received under the contract, the $650,000
in progress payments. Accordingly, X’s basis in the
Z stock is $225,000. All other results are the same.
Example 6.Step in the shoes—CCM—basis
adjustment—(i)Facts. The facts are the same as in
Example 4, except that X receives progress pay-
ments of $800,000 (rather than $650,000) and trans-
fers the contract (including the uncompleted prop-
erty) with a basis of $600,000 and $125,000 of cash
to a new corporation, Z, in exchange for all of the
stock of Z in a section 351 transaction. X and Z do
not join in filing a consolidated Federal income tax
return.
(ii)Old taxpayer. X reports no income or costs
under the contract in Years 1, 2, or 3. Under section
358(a), X’s basis in Z is $725,000. Pursuant to para-
graph (k)(3)(iv)(A)(1), X must reduce its basis in
the stock of Z by $800,000, the progress payments
received by X. However, X may not reduce its basis
in the Z stock below zero pursuant paragraph
(k)(3)(iv)(A)(2) of this section. Accordingly, X’s
basis in the Z stock is reduced by $725,000 to zero
and X must recognize ordinary income of $75,000.
(iii)New taxpayer. Upon completion of the con-
tract in Year 3, Z reports gross receipts of $925,000
($1,000,000 original contract price - $75,000
income recognized by the old taxpayer pursuant to
the basis adjustment rule of paragraph (k)(3)(iv)(A))
and total contract costs of $725,000, for a profit of
$200,000.
Example 7.Step in the shoes—PCM—gain rec-
ognized in transaction—(i)Facts. The facts are the
same as inExample 3, except that X transfers the
contract (including the uncompleted property) with
a basis of $0 and an unrelated capital asset with a
value of $100,000 and a basis of $0 to a new corpo-
ration, Z, in exchange for stock of Z with a value of
$200,000 and $50,000 of cash in a section 351
transaction.
(ii)Old taxpayer. For year 1, X reports receipts
of $250,000 ($200,000/$800,000 x $1,000,000) and
costs of $200,000, for a profit of $50,000. X is not
treated as completing the contract in Year 2. In Year
2, X reports receipts of $500,000 (($600,000/
$800,000 x $1,000,000 = $750,000 cumulative gross
receipts) - $250,000 prior year cumulative gross
receipts) and costs of $400,000, for a profit of
$100,000. Under paragraph (k)(3)(ii)(B) of this sec-
tion, X determines that the gain realized on the
transfer of the contract to Z under the constructive
completion rules of paragraph (k)(2)(ii) of this sec-
tion is $50,000 (total contract price of $800,000
($150,000 value allocable to the contract +
$650,000 progress payments) - $750,000 previously
recognized cumulative gross receipts—$0 costs
incurred but not recognized). The gain realized on
the transfer of the unrelated capital asset to Z is
$100,000. The amount of gain X must recognize due
to the receipt of $50,000 cash in the exchange is
$50,000, of which $30,000 is allocated to the con-
tract ($150,000 value of contract/$250,000 total
value of property transferred to Z x $50,000) and is
treated as ordinary income, and $20,000 is allocated
to the unrelated capital asset ($100,000 value of
capital asset/$250,000 total value of property trans-
ferred to Z x $50,000). Under section 358(a), X’s
basis in the Z stock is $0. However, pursuant to
paragraph (k)(3)(iv)(A)(1) of this section, X must
increase its basis in the Z stock by $750,000, the
amount of gross receipts recognized under the con-
tract, and must reduce its basis in the Z stock by
$650,000, the amount of gross receipts X received
under the contract. Therefore, X’s basis in the Z
stock is $100,000.
(iii)New taxpayer. Z must account for the con-
tract using the same PCM method used by X prior
tothetransaction.Pursuanttoparagraph
June 10, 200210762002–23 I.R.B.

(k)(3)(iv)(B)(1) of this section, the total contract
price is $970,000 ($1,000,000 amount X and Z have
received or reasonably expect to receive under the
contract - $30,000 income recognized by X with
respect to the contract as a result of the receipt of
$50,000 cash in the transaction). In Year 2, Z reports
gross receipts of $119,655 ($650,000/$725,000 x
$970,000 = $869,655 current year cumulative gross
receipts - $750,000 cumulative gross receipts
reported by the old taxpayer) and costs of $50,000,
for a profit of $69,655. In Year 3, Z reports gross
receipts of $100,345 ($970,000-$869,655) and costs
of $75,000, for a profit of $25,345.
Example 8.Step in the shoes—CCM—gain rec-
ognized in transaction—(i)Facts. The facts are the
same as inExample 4, except that X transfers the
contract (including the uncompleted property) with
a basis of $600,000 and an unrelated capital asset
with a value of $125,000 and a basis of $0 to a new
corporation, Z, in exchange for all the stock of Z
with a value of $175,000 and $100,000 of cash in a
section 351 transaction. X and Z do not join in fil-
ing a consolidated Federal income tax return.
(ii)Old taxpayer. X reports no income or costs
under the contract in Years 1, 2, or 3. Under para-
graph (k)(3)(ii)(B), X determines that the gain real-
ized on the transfer of the contract to Z under the
constructive completion rules of paragraph (k)(2)(ii)
of this section is $200,000 ($800,000 total contract
price ($150,000 value allocable to the contract +
$650,000 progress payments) - $600,000 costs
incurred but not recognized). The gain realized on
the transfer of the unrelated capital asset to Z is
$125,000. The amount of gain X must recognize due
to the receipt of $100,000 of cash in the exchange is
$100,000, of which $54,545 is allocated to the con-
tract ($150,000 value of the contract/$275,000 total
value of property transferred to Z x $100,000) and
is treated as ordinary income, and $45,455 is allo-
cated to the unrelated capital asset ($125,000 value
of capital asset/$275,000 total value of property
transferred to Z x $100,000). Under section 358(a),
X’s basis in the Z stock is $600,000 ($600,000 basis
in the contract and unrelated capital asset transferred
- $100,000 cash received + $100,000 gain recog-
nized). Pursuant to paragraph (k)(3)(iv)(A)(1) of this
section, X must reduce its basis in the stock of Z by
$650,000, the progress payments received under the
contract. However, X may not reduce its basis in the
Zstockbelowzeropursuanttoparagraph
(k)(3)(iv)(A)(2) of this section. Accordingly, X’s
basis in the Z stock is reduced by $600,000 to zero
and X must recognize income of $50,000.
(iii)New taxpayer. Z must account for the con-
tract using the same CCM used by X prior to the
transaction. Pursuant to paragraph (k)(3)(iv)(B)(1)
of this section, the total contract price is $895,455
($1,000,000 original contract price - $54,545
income recognized by old taxpayer with respect to
the contract as a result of the receipt of cash in the
transaction - $50,000 income recognized by the old
taxpayer pursuant to the basis adjustment rule of
paragraph (k)(3)(iv)(A)). Accordingly, upon comple-
tion of the contract in Year 3, Z reports gross
receipts of $895,455 and total contract costs of
$725,000, for a profit of $170,455.
(6)Effective date. This paragraph (k)
is applicable for transactions on or after
May 15, 2002. Application of the rules of
this paragraph (k) to a transaction that
occurs on or after May 15, 2002, is not a
change in method of accounting.
Par.8.In§1.460–6, paragraph (g) is
revised to read as follows:
§1.460–6 Look-back method.
*****
(g)Mid-contract change in taxpayer
—(1)In general. The rules in this para-
graph (g) apply if, as described in
§1.460–4(k), prior to the completion of a
long-term contract accounted for using
the PCM or the PCCM by a taxpayer (old
taxpayer), there is a transaction that
makes another taxpayer (new taxpayer)
responsible for accounting for income
from the same contract. The rules govern-
ing constructive completion transactions
are provided in paragraph (g)(2) of this
section, while the rules governing step-in-
the-shoes transactions are provided in
paragraph (g)(3) of this section. For pur-
poses of this paragraph, pre-transaction
years are all taxable years of the old tax-
payer in which the old taxpayer
accounted for (or should have accounted
for) gross receipts from the contract, and
post-transaction years are all taxable
years of the new taxpayer in which the
new taxpayer accounted for (or should
have accounted for) gross receipts from
the contract.
(2)Constructive completion transac-
tions. In the case of a transaction
described in§1.460–4(k)(2)(i) (construc-
tive completion transaction), the look-
back method is applied by the old tax-
payer with respect to pre-transaction
years upon the date of the transaction
and, if the new taxpayer uses the PCM or
the PCCM to account for the contract, by
the new taxpayer with respect to post-
transaction years upon completion of the
contract. The contract price and allocable
contract costs to be taken into account by
the old taxpayer or the new taxpayer in
applying the look-back method are
described in§1.460–4(k)(2).
(3)Step-in-the-shoes transactions—
(i)General rules. In the case of a transac-
tion described in§1.460–4(k)(3)(i) (step-
in-the-shoes transaction), the look-back
method is not applied at the time of the
transaction, but is instead applied for the
first time when the contract is completed
by the new taxpayer. Upon completion of
the contract, the look-back method is
applied by the new taxpayer with respect
to both pre-transaction years and post-
transaction years, taking into account all
amounts reasonably expected to be
received by either the old or new taxpayer
and all allocable contract costs incurred
during both periods as described in
§1.460–4(k)(3). The new taxpayer is
liable for filing the Form 8697 and for
interest computed on hypothetical under-
payments of tax, and is entitled to receive
interest with respect to hypothetical over-
payments of tax, for both pre- and post-
transaction years. The old taxpayer will
be secondarily liable for any interest
required to be paid with respect to pre-
transaction years reduced by any interest
on pre-transaction overpayments.
(ii)Application of look-back method to
pre-transaction period—(A)Contract
price. The actual contract price for pre-
transaction taxable years must be deter-
mined by the new taxpayer without
regard to any contract price adjustment
described in paragraph (k)(3)(iv)(B)(1) of
this section.
(B)Method. The new taxpayer may
apply the look-back method to each pre-
transaction taxable year that is a redeter-
mination year using the simplified mar-
ginal impact method described in
paragraph (d) of this section (regardless
of whether or not the old taxpayer would
have actually used that method and with-
out regard to the tax liability ceiling). But
see paragraph (d)(4) of this section,
which requires use of the simplified mar-
ginal impact method by certain pass-
through entities.
(C)Interest accrual period.With
respect to any hypothetical underpayment
or overpayment of tax for a pre-
transaction taxable year, interest accrues
from the due date of the old taxpayer’s
tax return (not including extensions) for
the taxable year of the underpayment or
overpayment until the due date of the new
taxpayer’s return (not including exten-
sions) for the completion year or the year
of a post-completion adjustment, which-
ever is applicable.
(D)Information old taxpayer must
provide. In order to help the new taxpayer
to apply the look-back method with
respect to pre-transaction taxable years,
any old taxpayer that accounted for
income from a long-term contract under
the PCM or PCCM for either regular or
2002–23 I.R.B.1077June 10, 2002

alternative minimum tax purposes is
required to provide the information
described in this paragraph to the new
taxpayer by the due date (not including
extensions) of the old taxpayer’s income
tax return for the first taxable year ending
on or after a step-in-the-shoes transaction
described in§1.460–4(k)(3)(i). The
required information is as follows—
(1) The portion of the contract
reported by the old taxpayer under PCM
for regular and alternative minimum tax
purposes (i.e., whether the old taxpayer
used PCM, the 40/60 PCCM method, or
the 70/30 PCCM method);
(2) Any submethods used in the appli-
cation of PCM (e.g., the simplified cost-
to-cost method or the 10-percent
method);
(3) The amount of total contract price
reported by year;
(4) The numerator and the denomina-
tor of the completion factor by year;
(5) The due date (not including exten-
sions) of the old taxpayer’s income tax
returns for each taxable year in which
income was required to be reported;
(6) Whether the old taxpayer was a
corporate or a noncorporate taxpayer by
year; and
(7) Any other information required by
the Commissioner by administrative pro-
nouncement.
(iii)Application of look-back method
to post-transaction years. With respect to
post-transaction taxable years, the new
taxpayer must use the same look-back
method it uses for other contracts (i.e.,
the simplified marginal impact method or
the actual method) to determine the
amount of any hypothetical overpayment
or underpayment of tax and the time
period for computing interest on these
amounts.
(iv)S corporation elections. Following
the conversion of a C corporation into an
S corporation, the look-back method is
applied at the entity level with respect to
contracts entered into prior to the conver-
sion, notwithstanding section 460(b)(4)
(B)(i).
(4)Effective date. This paragraph (g)
is applicable for transactions on or after
May 15, 2002.
§ 1.1362–2 [Amended]
Par.9.In§1.1362–2, paragraph (c)(6)
Example 2, first sentence is amended by
removing the language“§1.451–3(b)”
and adding“§1.460–1(b)(1)”in its place,
and removing the language“§1.451–
3(c)(1)”and adding“§1.460–4(b)”in its
place.
§ 1.1374–4 [Amended]
Par. 10. In§1.1374–4, paragraph (g),
first sentence is amended by removing the
language“§1.451–3(d)”andadding
“§1.460–4(d)”in its place, and removing
the language“§1.451–3(c)”and adding
“§1.460–4(b)”in its place.
PART 602—OMB CONTROL NUM-
BERS UNDER THE PAPERWORK
REDUCTION ACT
Par. 11. The authority section for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805
Par. 12. In§602.101, paragraph (b) is
amended by revising the following entry
in numerical order to the table to read as
follows:
§602.101 OMB Control numbers.
*****
(b)***
CFR part or section where
identified and described
Current OMB
control No.
*****
1.460–6 ..................................................................................................................................................................... 1545–1031
1545–1572
1545–1732
*****
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved May 2, 2002.
Pamela F. Olson,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on May
14, 2002, 8:45 a.m., and published in the issue of
the Federal Register for May 15, 2002, 67 F.R.
34603)
Section 1361.—S Corporation
Defined
26 CFR 1.1361–1: S corporation defined.
T.D. 8994
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Electing Small Business Trust
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
SUMMARY: This document contains
final regulations relating to the qualifica-
tion and treatment of electing small busi-
ness trusts (ESBTs). The final regulations
interpret the rules added to the Internal
Revenue Code (Code) by section 1302 of
the Small Business Job Protection Act of
1996, section 1601 of the Taxpayer Relief
June 10, 200210782002–23 I.R.B.

Act of 1997, and section 316 of the Com-
munity Renewal Tax Relief Act of 2000.
In addition, the final regulations provide
that an ESBT, or a trust described in sec-
tion 401(a) of the Code or section
501(c)(3) of the Code and exempt from
taxation under section 501(a) of the Code,
is not treated as a deferral entity for pur-
poses of§1.444–2T. The final regula-
tions affect S corporations and certain
trusts that own S corporation stock.
DATES:Effective Date: These regula-
tions are effective May 14, 2002.
Dates of Applicability: The regulations
regarding ESBTs under§1.641(c)–1(d)
through (k), (l)Examples 2–5,§1.1361
–1(h)(1)(vi),(h)(3)(i)(F),(h)(3)(ii),
(j)(12), and (m),§1.1362–6(b)(2)(iv),
§1.1377–1(a)(2)(iii) and (c)Example 3
apply for taxable years beginning on and
after May 14, 2002. The regulations
regardingtaxationofESBTsunder
§1.641(c)–1(a), (b), (c), and (l)Example
1are applicable for taxable years of
ESBTs that end on and after December
29,2000.Theregulationsunder
§1.444–4 are applicable to taxable years
beginning on or after December 29, 2000.
FOR FURTHER INFORMATION CON-
TACT: Concerning the final regulations,
Bradford Poston or James A. Quinn,
(202) 622–3060; specifically concerning
§1.444–4, Michael F. Schmit, (202) 622–
4960 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information in these
final regulations have been reviewed and,
pending receipt and evaluation of public
comments, approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) and assigned control num-
ber 1545–1591.
The collections of information in these
final regulations are in§1.1361–1(j)(12),
§1.1361–1(m), and§1.444–4(c). The
information required by§1.1361–1(j)(12)
and§1.1361–1(m) is needed to allow
trusts to elect to be ESBTs and to allow
for the conversion of a qualified subchap-
ter S trust (QSST) to an ESBT and the
conversion of an ESBT to a QSST. The
likely respondents are trusts.
The information required by§1.444–4
(c) is needed to allow certain S corpora-
tions to reinstate their previous taxable
year that was terminated under§1.444–
2T. The likely respondents are businesses
and other for-profit institutions.
Comments on the collections of infor-
mation should be sent to theOffice of
Management and Budget, Attn.: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC 20503 with
copies to theInternal Revenue Service,
Attn.: IRS Reports Clearance Officer,
W:CAR:MP:FP:S, Washington, DC
20224. Comments on the collection of
information should be received by July
15, 2002. Comments are specifically
requested concerning:
Whether the collections of information
are necessary for the proper performance
of the functions of the Internal Revenue
Service, including whether the informa-
tion will have practical utility;
The accuracy of the estimated burden
associated with the collections of infor-
mation;
How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with the
collections of information may be mini-
mized, including through the application
of automated collection techniques or
other forms of information technology;
and
Estimates of capital or start-up costs of
operation, maintenance, and purchase of
service to provide information.
The burden contained in§1.444–4is
reflected in the burden of Form 8716.
Estimated total annual reporting bur-
den: 7,500 hours.
Estimated annual burden per respon-
dent: 1 hour.
Estimated number of respondents:
7,500.
Estimated annual frequency of
responses: On occasion.
An agency may not conduct or spon-
sor, and a person is not required to
respond to, a collection of information
unless it displays a valid control number
assigned by the Office of Management
and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On December 29, 2000, proposed
regulations (REG–251701–96, 2001–1
C.B. 396) were published in theFederal
Register(65 FR 82963) containing pro-
posed amendments to the Income Tax
Regulations (26 CFR Part 1) relating to S
corporations and electing small business
trusts (ESBTs). Section 1302 of the Small
Business Job Protection Act of 1996,
Public Law 104–188 (110 Stat. 1755)
(August 20, 1996) (the 1996 Act),
amended sections 641 and 1361 of the
Code to permit an ESBT to be an S cor-
poration shareholder. Further amend-
ments were made to section 1361(e) by
the Taxpayer Relief Act of 1997, Public
Law 105–34 (111 Stat. 1601(c)(1))
(August 5, 1997), and the Community
Renewal Tax Relief Act of 2000, Public
Law 106–554 (114 Stat. 2763) (Decem-
ber 21, 2000). Prior section 641(d) was
redesignated as section 641(c) by the
Internal Revenue Service Restructuring
and Reform Act of 1998, Public Law
105–206 (112 Stat. 6007(f)(2)) (July 22,
1998).
On December 29, 2000, proposed and
temporary regulations were also pub-
lished in theFederal Register(REG–
251701–96, 2001–1 C.B. 396 [65 FR
82963]) and (T.D. 8915, 2001–1 C.B. 359
[65 FR 82926]) containing amendments
to the Income Tax Regulations (26 CFR
Part 1) relating to the election of a taxable
year other than the required taxable year.
A public hearing was held on the pro-
posed and temporary regulations on April
25, 2001. Written comments were
received on the proposed and temporary
regulations. The proposed regulations,
with certain changes in response to the
comments, are adopted as final regula-
tions, and the temporary regulations are
removed.
Summary of Comments and
Explanation of Revisions
Beneficiaries and Potential Current
Beneficiaries
For a trust to qualify as an electing
small business trust (ESBT) and as a
2002–23 I.R.B.1079June 10, 2002

shareholder in a subchapter S corporation,
only certain types of persons are permit-
ted to be beneficiaries of the trust. Once a
trust makes the ESBT election, each
potential current beneficiary (PCB) of the
trust is treated as a shareholder of the S
corporation. Thus, the identity of the ben-
eficiaries affects whether a trust can be an
ESBT, while the identity and number of
PCBs affect whether the corporation can
be a S corporation. It is possible under
certain circumstances for a person to be a
PCB, as that term is defined in section
1361(e)(2) and the proposed regulations,
without being a beneficiary, as that term
is defined in the proposed regulations.
For example, a person who may receive a
distribution from an ESBT under a cur-
rently exercisable power of appointment
is a PCB but is not treated as a benefi-
ciary until the power is actually exer-
cised.
Some commentators expressed con-
cerns about the possible adverse effects of
the definition of PCBs, especially in situ-
ations involving potential recipients of a
currently exercisable power of appoint-
ment. Some commentators suggested that
a person should have to meet the defini-
tion of a beneficiary before the person
could be considered a PCB. Commenta-
tors also suggested that a person who may
receive a distribution under a currently
exercisable power of appointment should
not be treated as a PCB until exercise of
the power. Several commentators sug-
gested that a temporary waiver or release
of a broad power of appointment should
be sufficient to limit the number of PCBs
during a period of time.
The final regulations do not change the
basic definition of PCBs. While there is
no statutory definition of beneficiary in
section 1361(e), there is a statutory defi-
nition of PCB. Under section 1361(e)(2),
a PCB is,“with respect to any period, any
person who at any time during such
period is entitled to, or, at the discretion
of any person, may receive, a distribution
from the principal or income of the trust.”
The IRS and the Treasury Department
believe that it would be inconsistent with
this statutory definition not to treat a per-
son as a PCB until an actual distribution
is made to that person pursuant to the
exercise of a power of appointment. The
final regulations provide that an attempt
to temporarily waive, release, or limit a
power of appointment would not be effec-
tive to limit the PCBs because of uncer-
tainty as to the effectiveness of a tempo-
rary waiver, release, or limitation on the
power of appointment under state law and
the potential to manipulate a temporary
waiver, release, or limitation on a power
of appointment to avoid the S corporation
shareholder limitation rules. However, a
permanent release of a power of appoint-
ment that is effective under local law may
reduce the number of PCBs of an ESBT.
Another commentator suggested that
the separate share provisions of section
663(c) should apply so that beneficiaries
or PCBs of the share holding the assets
other than the S corporation stock would
not be counted as beneficiaries or PCBs
of the S portion. There is no authority to
ignore beneficiaries and PCBs of a por-
tion of a trust holding assets other than S
corporation stock. The statutory defini-
tions of an ESBT and of a PCB look to all
the persons who are beneficiaries or
PCBs of the trust, not just the S portion.
In addition, the separate share provisions
of section 663(c) are not applicable
because they generally apply only for
purposes of allocating distributable net
income under sections 661 and 662.
Two commentators requested guidance
on what period of time is considered in
determining who are PCBs in light of the
statutory definition. They suggested that
periodmeans any moment in time. Thus,
if an event occurs during a taxable year
that changes who the PCBs are, the PCBs
before and after the event would not be
counted cumulatively for purposes of the
75-shareholder limit. The shareholder
limitation in section 1361(b)(1)(A) means
that an S corporation may not have more
than 75 shareholders at any particular
time during the taxable year. See Rev.
Rul. 78–390, 1978–2 C.B. 220. The final
regulations clarify that a person is treated
as a shareholder of the S corporation at
any moment in time when that person is
entitled to, or in the discretion of any per-
son may, receive a distribution of princi-
pal or income of the trust. The final regu-
lations also provide that a person who,
after the exercise of a power of appoint-
ment, receives only a future interest in the
trust is not a PCB.
One commentator was concerned
about the statement in the proposed regu-
lations that if a person holds a general
lifetime power of appointment, the corpo-
ration will exceed the 75-shareholder
limit and thus the corporation’s S election
will terminate. The commentator pointed
out that a beneficiary’s power to with-
draw assets from a trust is considered a
general power of appointment but the
beneficiary is the only one who can
receive those assets. The final regulations
clarify that the potential recipients of cur-
rent distributions pursuant to an exercise
of the power are considered, not whether
the power is a general or special power of
appointment.
The proposed regulations provide that
a person with a future beneficial interest
is not a beneficiary of an ESBT if that
interest is so remote as to be negligible.
This provision permitted trusts to qualify
as ESBTs even though there was a remote
possibility that all the named beneficia-
ries would die and the trust assets would
escheat to the state, an impermissible
beneficiary of an ESBT. The Community
Renewal Tax Relief Act of 2000 elimi-
nated this potential problem by changing
the statutory definition of permissible
beneficiaries to include an organization
described in section 170(c)(1) that holds a
contingent interest in the trust and is not
a PCB. The final regulations, therefore,
remove the provision regarding remote
beneficiaries and the accompanying
example.
Interests in Trust Acquired by Purchase
Two commentators requested clarifica-
tion on whether a trust is eligible to be an
ESBT if it acquires property in a part-gift,
part-sale transaction, such as a gift of
encumbered property or a net gift, in
which the donor transfers property to a
trust provided the trust pays the resulting
gift tax. Section 1361(e)(1)(A)(ii) pro-
vides that a trust is eligible to be an
ESBT only if“no interest in the trust was
acquired by purchase.”Section
1361(e)(1)(C) definespurchaseas“any
acquisition if the basis of the property
acquired is determined under section
1012.”The proposed regulations provide
that if any portion of a beneficiary’s basis
in the beneficiary’s interest is determined
under section 1012, the beneficiary’s
interest was acquired by purchase. The
final regulations clarify that the prohibi-
tion on purchases applies to purchases of
a beneficiary’s interest in the trust, not to
June 10, 200210802002–23 I.R.B.

purchases of property by the trust. A net
gift of a beneficial interest in a trust,
where the donee pays the gift tax, would
be treated as a purchase of a beneficial
interest under these rules, while a net gift
to the trust itself, where the trustee of the
trust pays the gift tax, would not.
Grantor Trusts
Most commentators praised the posi-
tion in the proposed regulations that a
trust, all or a portion of which is treated
as owned by an individual (deemed
owner) under subpart E, part I, subchap-
ter J, chapter 1 of the Code (grantor
trust), may elect to be an ESBT. One
commentator, however, suggested that
grantor trusts should not be permitted to
make ESBT elections. The final regula-
tions continue to provide that a grantor
trust may elect to be an ESBT.
The proposed regulations provide that
if a grantor trust makes an ESBT election,
the trust consists of a grantor portion, an
S portion, and a non-S portion. The items
of income, deduction, and credit attribut-
able to the grantor portion are taxed to the
deemed owner of that portion. The S por-
tion is taxed under the special rules of
section 641(c), while the non-S portion is
subject to the normal trust taxation rules
of subparts A through D of subchapter J.
Commentators made several sugges-
tions regarding the taxation of a grantor
trust that elects to be an ESBT. Some sug-
gested that the taxation rules of section
641(c) should override the grantor trust
rules of section 671, and thus all tax items
attributable to the trust’s shares in the S
corporation should be taxed to the trust,
not the deemed owner. Some suggested
the grantor trust rules should not apply to
any tax items of a trust that makes an
ESBT election. According to these com-
mentators, this approach would eliminate
administrative complexity in determining
what portion of the trust is treated as
owned by the deemed owner. Others sug-
gested that the trustee should be permitted
to elect to have all items attributable to
the S corporation taxed to the trust, not to
the deemed owner. Others suggested that
none of the S items should be taxed to the
deemed owner but that ESBTs should be
subject to additional reporting require-
ments to ensure the collection of the
proper tax. Another suggested that the
deemed owner should be taxed on the
items from an ESBT only if the deemed
owner is treated as owning the entire
trust, not just a portion of the trust. Other
commentators agreed with the taxation
regime set forth in the proposed regula-
tions.
The IRS and the Treasury Department
believe that the qualification and taxation
of ESBTs are two separate issues and that
the proposed regulations take the correct
position regarding the taxation of grantor
trusts that make ESBT elections. Section
1361(e)(1) expands the permissible share-
holders of an S corporation to include
trusts that meet the definition of an ESBT.
Grantor trusts are not excluded from the
definition of an ESBT and, therefore, are
permitted to make ESBT elections. Mak-
ing an ESBT election, however, does not
alter the long established treatment of tax
items attributable to the portion of a trust
treated as owned by the grantor or
another. Section 671 requires that items
of income, deduction, and credit attribut-
able to the portion of the trust treated as
owned by a grantor or another must be
taken into account by that deemed owner.
Only remaining items of the trust are sub-
ject to the provisions of subparts A
through D of subchapter J. The special
taxation rules for ESBTs are contained in
subpart A and, therefore, only apply to
any portion of the trust that is not treated
as owned by the grantor or another under
subpart E.
As pointed out by one of the commen-
tators, the issue of determining what por-
tion, if any, of a trust is treated as owned
by the grantor or another has existed for
years in a much broader context than in
the application of the ESBT rules. The
special taxation rules of section 641(c)
would apply only to S items, while nor-
mal trust taxation rules clearly apply to
non-S items. As a result, taxing all the S
items to the trust would not eliminate the
need to determine what portion of the
trust is a grantor trust and the resulting
administrative difficulties with respect to
the non-S tax items of the trust.
Some commentators requested clarifi-
cation of the effect of an ESBT election
by a grantor trust. One commentator sug-
gested that if a wholly-owned grantor
trust makes an ESBT election, only the
deemed owner should be treated as the
shareholder of the S corporation. Another
commentator made a similar suggestion
where the grantor has retained the power
to amend or revoke the trust or to make
gifts from the trust. The IRS and the Trea-
sury Department believe that the defini-
tional and qualification requirements of
section 1361(e) apply to any trust that
makes an ESBT election irrespective of
whether it is a grantor trust. Therefore,
the final regulations continue to provide
that the deemed owner is treated as a
PCB along with others who meet the defi-
nition of a PCB.
Charitable Contributions
The proposed regulations provide that
if an otherwise allowable deduction of the
S portion is attributable to a charitable
contribution paid by the S corporation,
the contribution will be deemed to be
paid by the S portion pursuant to the
terms of the trust’s governing instrument
and will be deductible if the other
requirements of section 642(c)(1) are met.
Several commentators requested clarifica-
tion concerning the other requirements of
section 642(c)(1), the application of the
limitations under section 681, and the
election to treat charitable payments
made after the close of a taxable year as
made during the taxable year. One com-
mentator suggested that the S portion
should be entitled to a deduction for its
share of any charitable contribution made
by the S corporation because it is a sepa-
rately stated item under section 1366 that
the S portion takes into account under
section 641(c)(2)(C)(i).
Section 641(c)(2)(C) specifies the
items of income, loss, deduction, or credit
that the S portion is required to take into
account in determining its tax. These
items include items required to be taken
into account under section 1366, that is,
the trust’spro ratashare of the S corpo-
ration’s items passed through to it as a
shareholder. Both section 641(c)(2)(C)
and section 1366(a) reference items that
must be taken into account but do not
themselves provide the authority to
include in income, deduct from income,
or claim a credit with respect to those
items. That authority comes from other
Code sections. A charitable contribution
made by an S corporation is required to
be a separately stated item under section
1366 because whether the item is deduct-
ible depends on the identity of the share-
holder and the provisions of the Code
2002–23 I.R.B.1081June 10, 2002

applicable to charitable contributions
made by that type of shareholder. Thus,
for an individual shareholder, the contri-
bution is deductible only in accordance
with the provisions of section 170, while
for a trust or estate, the contribution is
deductible only in accordance with the
provisions of section 642(c).
The final regulations continue to pro-
vide that the S portion’s share of a chari-
table contribution made by the S corpora-
tion is deductible only if it meets the
requirements of section 642(c)(1). The
final regulations clarify how those
requirements apply to such a contribution.
If a contribution is paid from the S corpo-
ration’s gross income, the contribution
will be deemed to be paid by the S por-
tion pursuant to the terms of the trust’s
governing instrument. The limitations of
section 681, regarding unrelated business
income, apply to determine whether the
contribution is deductible by the S por-
tion. The final regulations also clarify that
the charitable contribution is deductible
by the S portion, if at all, only in the year
that it is an item required to be taken into
account by the trust under section 1366.
The trustee may not make the election to
treat a contribution made by the S corpo-
ration after the close of the taxable year
as made during the taxable year. This
election is available only for charitable
payments actually made by the trust, not
for the trust’s share of contributions made
by another entity.
One commentator suggested that if the
trust contributes S corporation stock to a
charitable organization, the S portion
should be entitled to a charitable deduc-
tion with respect to the contribution.
Deductions available to the S portion are
limited by section 641(c)(2)(C) to S cor-
poration items required to be taken into
account under section 1366 and the S por-
tion’s share of state and local income
taxes and administrative expenses. Chari-
table contributions by the trust are not
items included in the list of items that
may be taken into account by the S por-
tion under section 641(c)(2)(C). There-
fore, the final regulations do not change
the rule that no deduction is available to
either the S portion or the non-S portion
with respect to a contribution of S corpo-
ration stock to charity.
Interest Paid on Loans to Acquire S
Corporation Stock
The proposed regulations provide that
interest expense incurred by the trust to
purchase S corporation stock is allocated
to the S portion but is not an administra-
tive expense. Therefore, the interest is not
an allowable deduction of the S portion
under section 641(c)(2)(C)(iii). Several
commentators suggested that the interest
should be deductible. Some thought the
interest should be allocated to the non-S
portion and deducted under the invest-
ment interest limitations of section
163(d). Others thought the interest should
be allocated to the S portion but should
be considered a deductible administrative
expense. One commentator suggested that
if the shareholders are required to buy the
stock of a departing shareholder pursuant
to the terms of a stock purchase agree-
ment, any interest expense incurred as a
result of financing the stock purchase
with a loan should be deductible when
paid by an ESBT. Another commentator
suggested that if interest paid on a loan to
acquire S corporation stock is not deduct-
ible, it should be added to the basis of the
acquired stock.
Because the purchase of S corporation
stock increases the S portion, rather than
the non-S portion, of the trust, interest
expenses incurred in the purchase should
be allocated to the S portion. These inter-
est expenses would be deductible by the S
portion only if they are“administrative
expenses”under section 641(c)(2)(C)(iii).
The IRS and the Treasury Department
believe that, for purposes of section
641(c)(2)(C)(iii),“administrative
expenses”include the traditional
expenses necessary for the management
and preservation of trust assets, but do
not include expenses incurred to acquire
additional assets. The final regulations,
therefore, continue to provide that, in all
cases, interest incurred to purchase S cor-
poration stock is a nondeductible expense
allocable to the S portion. Because there
is no authority to permit nondeductible
interest expenses to increase the basis of
assets, the final regulations do not adopt
this suggestion.
Tax Credit Carryovers
Section 641(c)(4) and the proposed
regulations provide that if a trust is no
longer an ESBT, any loss carryover or
excess deductions of the S portion that
are referred to in section 642(h) are taken
into account by the entire trust or by the
beneficiaries if the entire trust terminates.
One commentator suggested that any tax
credit carryovers of the S portion should
receive similar treatment. Section
641(c)(4) permits the entire trust to take
into account only those items specified in
section 642(h), which does not include
tax credit carryovers. The S portion’s tax
credit carryovers and any other items not
listed in section 642(h) are forfeited once
the trust is no longer an ESBT, just as
they are upon the termination of a trust or
estate. The final regulations, therefore, do
not adopt the commentator’s suggestion.
Distributions From the ESBT
One commentator suggested that the
tax treatment of distributions to beneficia-
ries in the proposed regulations is incon-
sistent with section 641(c)(1)(A), which
provides that the portion of an ESBT con-
sisting of the S corporation stock is
treated as a separate trust. The proposed
regulations provide that distributions to
beneficiaries from the S portion or the
non-S portion, including distributions of
the S corporation stock, are, to the extent
of the distributable net income of the
non-S portion, deductible under section
651 or 661 in determining the taxable
income of the non-S portion, and are
includible in the gross income of the ben-
eficiaries under section 652 or 662. The
commentator recommended that, because
the S portion and the non-S portion are
treated as separate trusts, the source of
the distribution should determine its tax
treatment.
The final regulations do not adopt the
commentator’s suggestion because sec-
tion 641(c)(3) provides that section
641(c) does not affect the taxation of any
distribution from the trust except for the
exclusion of the S portion items from the
distributable net income of the entire
trust. Thus, the rules otherwise applicable
to trust distributions apply to ESBTs.
ESBT Election
The proposed regulations provide that
the ESBT election is filed with the ser-
vice center where the trust files its
income tax returns. The election to be a
June 10, 200210822002–23 I.R.B.

qualified subchapter S trust (QSST) is
filed with the service center where the S
corporation files its income tax returns.
The preamble to the proposed regulations
requested comments on whether the rules
for filing the QSST election should be
changed so the election is filed with the
service center where the trust files its
returns. One commentator suggested there
should be consistent filing locations for
QSST elections, ESBT elections, and
conversions from QSST to ESBT or
ESBT to QSST. The commentator, there-
fore, suggested that all these documents
be filed with the service center(s) where
the trust and the S corporation file their
returns.
The final regulations provide that the
ESBT election and the election to convert
from an ESBT to a QSST or from a
QSST to an ESBT are all filed with the
service center where the S corporation
files its income tax returns. Thus, the rule
in the final regulations will establish a
consistent filing location for QSST and
ESBT elections and conversions.
One commentator suggested that
grantor trusts should be permitted to
make protective ESBT elections in light
of the uncertain status of some trusts that
may be grantor trusts under section 674.
The IRS and the Treasury Department
continue to believe that a conditional
ESBT election that only becomes effec-
tive in the event the trust is not a wholly-
owned grantor trust should not be avail-
able. A conditional ESBT election should
not be allowed because the ESBT election
must have a fixed effective date. If, in the
absence of a conditional ESBT election,
the trust is an ineligible shareholder, relief
under section 1362(f) may be available
for an S corporation. In addition, a trust
that qualifies as an ESBT may make an
ESBT election notwithstanding that the
trust is a wholly-owned grantor trust.
Expedited Section 1362(f) Relief
In several contexts, commentators
requested some form of expedited relief if
an S corporation’s election is inadvert-
ently ineffective or is inadvertently termi-
nated. In all these situations, the S corpo-
ration may seek relief under section
1362(f). The facts and circumstances of a
particular situation are considered in
determining whether relief is available,
and the procedures for obtaining this
relief are well established.
Effect under Section 1377 of Change in
Status of a Trust
A commentator suggested that a trust’s
conversion to an ESBT should result in a
complete termination of the trust’s inter-
est in the S corporation for purposes of
section 1377(a)(2) because the incidence
of taxation with respect to S corporation
items will change as a result of the ESBT
election. The proposed regulations pro-
vide that the election would result in a
termination only if, prior to the election,
the trust was described in section
1361(c)(2)(A)(ii) or (iii). The commenta-
tor also recommended that the regulations
address the conversion from an ESBT to
another type of trust and the availability
of an election under§1.1368–1(g) to
treat the S corporation’s taxable year as
two separate years in the case of a quali-
fying disposition.
The final regulations do not adopt the
suggestion that all conversions of a trust
to an ESBT should be treated as a com-
plete termination of the trust’s interest in
the S corporation for purposes of section
1377(a)(2). The final regulations expand
on the rule in the proposed regulations to
cover all types of conversions. Under this
rule, conversion of a trust to an ESBT or
a QSST does not result in the prior trust
terminating its entire interest in the S cor-
poration, unless the prior trust was
described in section 1361(c)(2)(A)(ii) or
(iii). When a trust described in section
1361(c)(2)(A)(ii) or (iii) converts to an
ESBT or a QSST, the shareholders of the
S corporation under section 1361(c)(2)(B)
change from the estate of the deemed
owner or testator to the PCBs of the
ESBT, or the current income beneficiary
of the QSST. When a trust changes from
a wholly-owned grantor trust or QSST to
an ESBT or from an ESBT to a QSST, the
individuals who are shareholders of the S
corporation under section 1361(c)(2)(B)
remain the same. The election to termi-
nate the taxable year provided in section
1377(a)(2) applies to the termination of a
shareholder’sinterest in the S corpora-
tion. Accordingly, it is appropriate to treat
the conversion of a trust described in sec-
tion 1361(c)(2)(A)(ii) or (iii) to an ESBT
or QSST as a termination of the prior
trust’s interest in the S corporation, but
not to treat other conversions to an ESBT
or QSST as terminations. The election
under§1.1368–1(g) is also not available
because the conversion of the trust is not
a qualifying disposition.
Section 444 Elections
One commentator suggested that the
final regulations permit an S corporation
to retroactively reinstate a section 444
election that it had treated as terminated
by operation of§1.444–2T(a) (prior to
the issuance of the temporary regulations)
as a result of an ESBT or certain tax-
exempt trusts becoming a shareholder of
the corporation under the auspices of the
1996 Act. The commentator believes that
failure to provide such relief would result
in inequitable treatment of such S corpo-
rations because, under the rules of section
444, once their elections are terminated,
they are precluded from again making a
section 444 election.
The IRS and the Treasury Department
believe that it is appropriate to allow S
corporations under these circumstances to
request that the IRS disregard the termi-
nation and permit the S corporation to
continue to use the same fiscal year that it
used previously under section 444. How-
ever, for reasons of administrative conve-
nience, and in order to reduce the burden
on taxpayers of having to file amended
returns and make retroactive payments
under section 7519, the prior termination
will be disregarded only at the S corpora-
tion’s request, and on a prospective basis.
The final regulations provide a proce-
dure for such requests. To illustrate the
procedure, assume that, prior to 1997, an
S corporation had made a section 444
election to use a taxable year ending on
September 30
th
. On January 1, 1997, an
ESBT acquired a shareholder interest in
the S corporation. The S corporation
treated its 444 election as terminated
under§1.444–2T(a) as a result of the
ESBT’s shareholder interest. The S cor-
poration changed to its required taxable
year for the short period beginning Octo-
ber 1, 1996, and ending December 31,
1996, and filed Form 1120S,“U.S.
Income Tax Return for an S Corpora-
tion,”on the basis of a calendar year for
all subsequent taxable years.
Under the final regulations, the S cor-
poration may request that the IRS disre-
gard the prior termination by filing Form
2002–23 I.R.B.1083June 10, 2002

8716,Election to Have a Tax Year Other
Than a Required Tax Year,with the
appropriate Service Center by October
15, 2002, and by designating on the form
“CONTINUATION OF SECTION 444
ELECTION UNDER§1.444–4.”The
Form 8716 must indicate that under the S
corporation’s prior section 444 election, it
used a taxable year ending September
30
th
. The request will be effective for the
taxable year beginning January 1, 2002.
No amended returns, no retroactive pay-
ments under section 7519, and no returns
under§1.7519–2T(a) for previous years
in which the S corporation used its
required year are required as a result of
the request. Moreover, the S corporation
need not make a required payment under
section 7519 for its taxable year ending
September 30, 2002; its first required
payment for the taxable year beginning
October 1, 2002, is due on May 15, 2003.
The S corporation will be required to file
a return under§1.7519–2T for each tax-
able year beginning on or after January 1,
2002.
Effective Dates
The portion of the regulations involv-
ing the taxation of the grantor, S, and
non-S portions of an ESBT was proposed
to be applicable for taxable years of
ESBTs that end on or after December 29,
2000, the date that the proposed regula-
tions were published in theFederal Reg-
ister. The remainder of the regulations
involving ESBTs was proposed to be
applicable on or after the date that final
regulations are published in theFederal
Register. Several commentators
expressed concerns about the proposed
applicability with regard to the taxation of
the grantor portion of an ESBT. One com-
mentator suggested that the proposed
effective date discriminated against trusts
with a situs in Guam. Others suggested
that the rules regarding taxation of the
grantor portion should not be applicable
before the date the final regulations are
published. One commentator suggested
that these rules should only apply either
to trusts created after the final regulations
are published or after a substantial transi-
tion period.
The IRS and the Treasury Department
believe that the applicable date for the
rules concerning the taxation of an ESBT
with a grantor portion is reasonable and
appropriate. These rules do not discrimi-
nate against trusts with a particular situs
because they apply to all trusts wherever
situated. In the case of a grantor trust that
made an ESBT election, the tax treatment
of the grantor portion set forth in the pro-
posed regulations may be different from
the tax treatment that the trust and the
grantor had thought was available. The
proposed regulations, however, were pub-
lished before the end of the 2000 taxable
year and before income from that taxable
year was required to be included on any
person’s income tax return. Thus, prior to
the filing of income tax returns for 2000,
it was known that the income from the
grantor portion of the trust was to be
taken into account by the deemed owner,
not by the trust. In some situations, the
trust, rather than the deemed owner, may
have made estimated tax payments. Rec-
ognizing that the payment of estimated
tax by the trust might subject the deemed
owner to a penalty for underpayment of
estimated taxes, the IRS and the Treasury
Department provided relief by issuing
Notice 2001–25, 2001–1 C.B. 941. That
Notice provides procedures for a trust to
elect to have its estimated tax payments
credited to the account of the deemed
owner and provides that, for purposes of
calculating any underpayment of esti-
mated tax, income attributable to the S
corporation was to be taken into account
on the last day of the deemed owner’s
2000 taxable year.
Some commentators were concerned
that existing ESBTs with currently exer-
cisable, broad powers of appointments
have resulted in S corporations exceeding
the shareholder limit and have caused the
termination of the S corporations’elec-
tions. The regulations regarding the defi-
nition of PCBs are applicable only for
taxable years of ESBTs that begin on or
after May 14, 2002. Therefore, persons
who may receive a distribution from an
ESBT pursuant to a currently exercisable
power of appointment will not be consid-
ered PCBs of the ESBT until the first day
of the ESBT’s first taxable year that
begins on or after May 14, 2002, and the
S corporation’s election will not terminate
before that date. In addition, under sec-
tion 1361(e)(2) if the trust disposes of all
its stock in the S corporation within 60
days after that date, the persons, who
would first meet the definition of PCBs
on that date, will not be PCBs and the
corporation’s S status will not be affected.
One commentator was concerned by
the applicability date of the regulations
involving the deductibility of state and
local income taxes and administrative
expenses. Section 641(c)(2)(C)(iii) pro-
vides that the S portion may take into
account its allocable share of state and
local income taxes and administrative
expenses, but only to the extent provided
in the regulations. The commentator
noted that before final regulations are
issued there is no authority for an ESBT
to deduct any of these items. Therefore,
the commentator requested that trusts be
allowed to rely on the regulatory provi-
sions regarding these items for taxable
years beginning after December 31, 1996.
The effective date provisions have been
modified based on this suggestion.
Additional Provisions
The final regulations clarify that the
basis of S corporation stock in the S por-
tion must be adjusted in accordance with
section 1367 and the regulations thereun-
der. If the ESBT owns stock in more than
one S corporation, the adjustments to the
basis in the S corporation stock of each S
corporation must be determined sepa-
rately.
Effect on other documents
The following documents are super-
seded for taxable years of ESBTs begin-
ning on and after May 14, 2002.
Notice 97–12 (1997–1 C.B. 385).
Notice 97–49 (1997–2 C.B. 304).
Rev. Proc. 98–23 (1998–1 C.B. 662).
Special Analysis
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required. It has also been
determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions. It is hereby certified that the collec-
tions of information in the regulations
will not have a significant economic
impact on a substantial number of small
entities. This certification is based upon
the fact that (1) the estimated average
June 10, 200210842002–23 I.R.B.

burden per trust in complying with the
collections of information in§1.1361–
1(m) is 1 hour, and (2) the requirement
for S corporations to comply with
§1.444–4(c) will affect very few taxpay-
ers and the associated burden is minimal.
Therefore, a Regulatory Flexibility
Analysis under the Regulatory Flexibility
Act (5 U.S.C. chapter 6) is not required.
Pursuant to section 7805(f) of the Code,
the notice of proposed rulemaking pre-
ceding these regulations was submitted to
the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on the regulations’impact on small
business.
Drafting Information
The principal authors of these regula-
tions are Bradford Poston and James A.
Quinn of the Office of Associate Chief
Counsel (Passthroughs and Special Indus-
tries), IRS. However, other personnel
from the IRS and the Treasury Depart-
ment participated in their development.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PA RT I—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805.***
Section 1.444–4 is also issued under
26 U.S.C. 444(g).***
Par. 2. Section 1.444–4 is added to
read as follows:
§1.444–4 Tiered structure.
(a)Electing small business trusts. For
purposes of§1.444–2T, solely with
respect to an S corporation shareholder,
the termdeferral entitydoes not include a
trust that is treated as an electing small
business trust under section 1361(e). An S
corporation with an electing small busi-
ness trust as a shareholder may make an
election under section 444. This para-
graph is applicable to taxable years begin-
ning on and after December 29, 2000;
however, taxpayers may voluntarily apply
it to taxable years of S corporations
beginning after December 31, 1996.
(b)Certain tax-exempt trusts. For pur-
poses of§1.444–2T, solely with respect
to an S corporation shareholder, the term
deferral entitydoes not include a trust
that is described in section 401(a) or
501(c)(3), and is exempt from taxation
under section 501(a). An S corporation
with a trust as a shareholder that is
described in section 401(a) or section
501(c)(3), and is exempt from taxation
under section 501(a) may make an elec-
tion under section 444. This paragraph is
applicable to taxable years beginning on
and after December 29, 2000; however
taxpayers may voluntarily apply it to tax-
able years of S corporations beginning
after December 31, 1997.
(c)Certain terminations disregarded—
(1)In general. An S corporation that is
described in this paragraph (c)(1) may
request that a termination of its election
under section 444 be disregarded, and
that the S corporation be permitted to
resume use of the year it previously
elected under section 444, by following
the procedures of paragraph (c)(2) of this
section. An S corporation is described in
this paragraph if the S corporation is oth-
erwise qualified to make a section 444
election, and its previous election was ter-
minated under§1.444–2T(a) solely
because—
(i) In the case of a taxable year begin-
ning after December 31, 1996, a trust that
is treated as an electing small business
trust became a shareholder of such S cor-
poration; or
(ii) In the case of a taxable year begin-
ning after December 31, 1997, a trust that
is described in section 401(a) or
501(c)(3), and is exempt from taxation
under section 501(a) became a share-
holder of such S corporation.
(2)Procedure—(i)In general.AnS
corporation described in paragraph (c)(1)
of this section that wishes to make the
request described in paragraph (c)(1) of
this section must do so by filing Form
8716,Election To Have a Tax Year Other
Than a Required Tax Year,and typing or
printing legibly at the top of such form—
“CONTINUATION OF SECTION 444
ELECTION UNDER§1.444–4.”In
order to assist the Internal Revenue Ser-
vice in updating the S corporation’s
account, on Line 5 the Box“Changing
to”should be checked. Additionally, the
election month indicated must be the last
month of the S corporation’s previously
elected section 444 election year, and the
effective year indicated must end in 2002.
(ii)Time and place for filing Form
8716. Such form must be filed on or
before October 15, 2002, with the service
center where the S corporation’s returns
of tax (Forms 1120S) are filed. In addi-
tion, a copy of the Form 8716 should be
attached to the S corporation’s short
period Federal income tax return for the
first election year beginning on or after
January 1, 2002.
(3)Effect of request—(i)Taxable years
beginning on or after January 1, 2002.
An S corporation described in paragraph
(c)(1) of this section that requests, in
accordance with this paragraph, that a ter-
mination of its election under section 444
be disregarded will be permitted to
resume use of the year it previously
elected under section 444, commencing
with its first taxable year beginning on or
after January 1, 2002. Such S corporation
will be required to file a return under
§1.7519–2T for each taxable year begin-
ning on or after January 1, 2002. No pay-
ment under section 7519 will be due with
respect to the first taxable year beginning
on or after January 1, 2002. However, a
required payment will be due on or before
May 15, 2003, with respect to such S cor-
poration’s second continued section 444
election year that begins in calendar year
2002.
(ii)Taxable years beginning prior to
January 1, 2002. An S corporation
described in paragraph (c)(1) of this sec-
tion that requests, in accordance with this
paragraph, that a termination of its elec-
tion under section 444 be disregarded will
not be required to amend any prior Fed-
eral income tax returns, make any
required payments under section 7519, or
file any returns under§1.7519–2T, with
respect to taxable years beginning on or
after the date the termination of its sec-
tion 444 election was effective and prior
to January 1, 2002.
(iii)Section 7519: required payments
and returns. The Internal Revenue Ser-
vice waives any requirement for an S cor-
poration described in paragraph (c)(1) of
this section to file the federal tax returns
and make any required payments under
section 7519 for years prior to the taxable
2002–23 I.R.B.1085June 10, 2002

year of continuation as described in para-
graph (c)(3)(i) of this section, if for such
years the S corporation filed its Federal
income tax returns on the basis of its
required taxable year.
§1.444–4T [Removed]
Par. 3. Section 1.444–4T is removed.
Par. 4. Sections 1.641(c)–0 and
1.641(c)–1 are added to read as follows:
§1.641(c)–0 Table of contents.
This section lists the major captions
contained in§1.641(c)–1.
§1.641(c)–1 Electing small business
trust.
(a) In general.
(b) Definitions.
(1) Grantor portion.
(2) S portion.
(3) Non-S portion.
(c) Taxation of grantor portion.
(d) Taxation of S portion.
(1) In general.
(2) Section 1366 amounts.
(3) Gains and losses on disposition of S
stock.
(4) State and local income taxes and
administrative expenses.
(e) Tax rates and exemption of S portion.
(1) Income tax rate.
(2) Alternative minimum tax exemption.
(f) Adjustments to basis of stock in the S
portion under section 1367.
(g) Taxation of non-S portion.
(1) In general.
(2) Dividend income under section
1368(c)(2).
(3) Interest on installment obligations.
(4) Charitable deduction.
(h) Allocation of state and local income
taxes and administration expenses.
(i) Treatment of distributions from the
trust.
(j) Termination or revocation of ESBT
election.
(k) Effective date.
(l) Examples.
§1.641(c)–1 Electing small business
trust.
(a)In general. An electing small busi-
ness trust (ESBT) within the meaning of
section 1361(e) is treated as two separate
trusts for purposes of chapter 1 of the
Internal Revenue Code. The portion of an
ESBT that consists of stock in one or
more S corporations is treated as one
trust. The portion of an ESBT that con-
sists of all the other assets in the trust is
treated as a separate trust. The grantor or
another person may be treated as the
owner of all or a portion of either or both
such trusts under subpart E, part I, sub-
chapter J, chapter 1 of the Internal Rev-
enue Code. The ESBT is treated as a
single trust for administrative purposes,
such as having one taxpayer identification
number and filing one tax return. See
§1.1361–1(m).
(b)Definitions—(1)Grantor portion.
The grantor portion of an ESBT is the
portion of the trust that is treated as
owned by the grantor or another person
under subpart E.
(2)S portion. The S portion of an
ESBT is the portion of the trust that con-
sists of S corporation stock and that is not
treated as owned by the grantor or
another person under subpart E.
(3)Non-S portion. The non-S portion
of an ESBT is the portion of the trust that
consists of all assets other than S corpo-
ration stock and that is not treated as
owned by the grantor or another person
under subpart E.
(c)Taxation of grantor portion. The
grantor or another person who is treated
as the owner of a portion of the ESBT
includes in computing taxable income
items of income, deductions, and credits
against tax attributable to that portion of
the ESBT under section 671.
(d)Taxation of S portion—(1)In gen-
eral. The taxable income of the S portion
is determined by taking into account only
the items of income, loss, deduction, or
credit specified in paragraphs (d)(2), (3),
and (4) of this section, to the extent not
attributable to the grantor portion.
(2)Section 1366 amounts—(i)In gen-
eral. The S portion takes into account the
items of income, loss, deduction, or credit
that are taken into account by an S corpo-
ration shareholder pursuant to section
1366 and the regulations thereunder.
Rules otherwise applicable to trusts apply
in determining the extent to which any
loss, deduction, or credit may be taken
into account in determining the taxable
income of the S portion. See§1.1361–
1(m)(3)(iv) for allocation of those items
in the taxable year of the S corporation in
which the trust is an ESBT for part of the
year and an eligible shareholder under
section 1361(a)(2)(A)(i) through (iv) for
the rest of the year.
(ii)Special rule for charitable contri-
butions. If a deduction described in para-
graph (d)(2)(i) of this section is attribut-
able to an amount of the S corporation’s
gross income that is paid by the S corpo-
ration for a charitable purpose specified
in section 170(c) (without regard to sec-
tion 170(c)(2)(A)), the contribution will
be deemed to be paid by the S portion
pursuant to the terms of the trust’govern-
ing instrument within the meaning of sec-
tion 642(c)(1) . The limitations of section
681, regarding unrelated business income,
apply in determining whether the contri-
bution is deductible in computing the tax-
able income of the S portion.
(iii)Multiple S corporations.Ifan
ESBT owns stock in more than one S cor-
poration, items of income, loss, deduc-
tion, or credit from all the S corporations
are aggregated for purposes of determin-
ing the S portion’s taxable income.
(3)Gains and losses on disposition of
S stock—(i)In general. The S portion
takes into account any gain or loss from
the disposition of S corporation stock. No
deduction is allowed under section
1211(b)(1) and (2) for capital losses that
exceed capital gains.
(ii)Installment method. If income
from the sale or disposition of stock in an
S corporation is reported by the trust on
the installment method, the income recog-
nized under this method is taken into
account by the S portion. See paragraph
(g)(3) of this section for the treatment of
interest on the installment obligation. See
§1.1361–1(m)(5)(ii) regarding treatment
of a trust as an ESBT upon the sale of all
S corporation stock using the installment
method.
(iii)Distributions in excess of basis.
Gain recognized under section 1368(b)(2)
from distributions in excess of the
ESBT’s basis in its S corporation stock is
taken into account by the S portion.
(4)State and local income taxes and
administrative expenses—(i)In general.
State and local income taxes and admin-
istrative expenses directly related to the S
portion and those allocated to that portion
in accordance with paragraph (h) are
taken into account by the S portion.
June 10, 200210862002–23 I.R.B.

(ii)Special rule for certain interest.
Interest paid by the trust on money bor-
rowed by the trust to purchase stock in an
S corporation is allocated to the S portion
but is not a deductible administrative
expense for purposes of determining the
taxable income of the S portion.
(e)Tax rates and exemption of S
portion—(1)Income tax rate. Except for
capital gains, the highest marginal trust
rate provided in section 1(e) is applied to
the taxable income of the S portion. See
section 1(h) for the rates that apply to the
S portion’s net capital gain.
(2)Alternative minimum tax exemp-
tion. The exemption amount of the S por-
tion under section 55(d) is zero.
(f)Adjustments to basis of stock in the
S portion under section 1367. The basis
of S corporation stock in the S portion
must be adjusted in accordance with sec-
tion 1367 and the regulations thereunder.
If the ESBT owns stock in more than one
S corporation, the adjustments to the
basis in the S corporation stock of each S
corporation must be determined sepa-
rately with respect to each S corporation.
Accordingly, items of income, loss,
deduction, or credit of an S corporation
that are taken into account by the ESBT
under section 1366 can only result in an
adjustment to the basis of the stock of
that S corporation and cannot affect the
basis in the stock of the other S corpora-
tions held by the ESBT.
(g)Taxation of non-S portion—(1)In
general. The taxable income of the non-S
portion is determined by taking into
account all items of income, deduction,
and credit to the extent not taken into
account by either the grantor portion or
the S portion. The items attributable to
the non-S portion are taxed under sub-
parts A through D of part I, subchapter J,
chapter 1 of the Internal Revenue Code.
The non-S portion may consist of more
than one share pursuant to section 663(c).
(2)Dividend income under section
1368(c)(2). Any dividend income within
the meaning of section 1368(c)(2) is
includible in the gross income of the
non-S portion.
(3)Interest on installment obligations.
If income from the sale or disposition of
stock in an S corporation is reported by
the trust on the installment method, the
interest on the installment obligation is
includible in the gross income of the
non-S portion. See paragraph (d)(3)(ii) of
this section for the treatment of income
from such a sale or disposition.
(4)Charitable deduction. For purposes
of applying section 642(c)(1) to payments
made by the trust for a charitable pur-
pose, the amount of gross income of the
trust is limited to the gross income of the
non-S portion. See paragraph (d)(2)(ii) of
this section for special rules concerning
charitable contributions paid by the S cor-
poration that are deemed to be paid by the
S portion.
(h)Allocation of state and local
income taxes and administration ex-
penses. Whenever state and local income
taxes or administration expenses relate to
more than one portion of an ESBT, they
must be allocated between or among the
portions to which they relate. These items
may be allocated in any manner that is
reasonable in light of all the circum-
stances, including the terms of the gov-
erning instrument, applicable local law,
and the practice of the trustee with
respect to the trust if it is reasonable and
consistent. The taxes and expenses appor-
tioned to each portion of the ESBT are
taken into account by that portion.
(i)Treatment of distributions from the
trust. Distributions to beneficiaries from
the S portion or the non-S portion, includ-
ing distributions of the S corporation
stock, are deductible under section 651 or
661 in determining the taxable income of
the non-S portion, and are includible in
the gross income of the beneficiaries
under section 652 or 662. However, the
amount of the deduction or inclusion can-
not exceed the amount of the distributable
net income of the non-S portion. Items of
income, loss, deduction, or credit taken
into account by the grantor portion or the
S portion are excluded for purposes of
determining the distributable net income
of the non-S portion of the trust.
(j)Termination or revocation of ESBT
election. If the ESBT election of the trust
terminates pursuant to§1.1361–1(m)(5)
or the ESBT election is revoked pursuant
to§1.1361–1(m)(6), the rules contained
in this section are thereafter not appli-
cable to the trust. If, upon termination or
revocation, the S portion has a net operat-
ing loss under section 172; a capital loss
carryover under section 1212; or deduc-
tions in excess of gross income; then any
such loss, carryover, or excess deductions
shall be allowed as a deduction, in accor-
dance with the regulations under section
642(h), to the trust, or to the beneficiaries
succeeding to the property of the trust if
the entire trust terminates.
(k)Effective date. This section gener-
ally is applicable for taxable years of
ESBTs beginning on and after May 14,
2002. However, paragraphs (a), (b), (c),
and (l)Example 1of this section are
applicable for taxable years of ESBTs that
end on and after December 29, 2000.
ESBTs may apply paragraphs (d)(4) and
(h) of this section for taxable years of
ESBTs beginning after December 31,
1996.
(l)Examples. The following examples
illustrate the rules of this section:
Example 1.Comprehensive example. (i) Trust
has a valid ESBT election in effect. Under section
678,Bis treated as the owner of a portion of Trust
consisting of a 10% undivided fractional interest in
Trust. No other person is treated as the owner of any
other portion of Trust under subpart E. Trust owns
stock inX, an S corporation, and inY, a C corpora-
tion. During 2000, Trust receives a distribution from
Xof $5,100, of which $5,000 is applied against
Trust’s adjusted basis in theXstock in accordance
with section 1368(c)(1) and $100 is a dividend
under section 1368(c)(2). Trust makes no distribu-
tions to its beneficiaries during the year.
(ii) For 2000, Trust has the following items of income and deduction:
Ordinary income attributable toXunder section 1366Y ..............................................................................................................................................................$5,000
Dividend income fromY...................................................................................................................................................................................................................$900
Dividend fromXrepresenting C corporation earnings and profits..................................................................................................................................................$100
Total trust income .......................................................................................................................................................................................................................$6,000
Charitable contributions attributable toXunder section 1366.........................................................................................................................................................$300
Trustee fees ........................................................................................................................................................................................................................................$200
State and local income taxes .............................................................................................................................................................................................................$100
2002–23 I.R.B.1087June 10, 2002

(iii) Trust’s items of income and deduction are divided into a grantor portion, an S portion, and a non-S portion for purposes of determining the taxation of those
items. Income is allocated to each portion as follows:
Bmust take into account the items of income attributable to the grantor portion, that is, 10% of each item, as follows:
Ordinary income fromX....................................................................................................................................................................................................................$500
Dividend income fromY.....................................................................................................................................................................................................................$90
Dividend income fromX.....................................................................................................................................................................................................................$10
Total grantor portion income .............................................................................................................................................................................................................$600
The total income of the S portion is $4,500, determined as follows:
Ordinary income fromX.................................................................................................................................................................................................................$5,000
Less: Grantor portion ......................................................................................................................................................................................................................($500)
Total S portion income ...................................................................................................................................................................................................................$4,500
The total income of the non-S portion is $900 determined as follows:
Dividend income fromY(less grantor portion)................................................................................................................................................................................$810
Dividend income fromX(less grantor portion) .................................................................................................................................................................................$90
Total non-S portion income ...............................................................................................................................................................................................................$900
(iv) The administrative expenses and the state and local income taxes relate to all three portions and under state law would be allocated ratably to the$6,000
of trust income. Thus, these items would be allocated 10% (600/6000) to the grantor portion, 75% (4500/6000) to the S portion and 15% (900/6000) to the non-S
portion.
(v)Bmust take into account the following deductions attributable to the grantor portion of the trust:
Charitable contributions fromX..........................................................................................................................................................................................................$30
Trustee fees ..........................................................................................................................................................................................................................................$20
State and local income taxes ...............................................................................................................................................................................................................$10
(vi) The taxable income of the S portion is $4,005, determined as follows:
Ordinary income fromX.................................................................................................................................................................................................................$4,500
Less: Charitable contributions from X (less grantor portion) .......................................................................................................................................................($270)
75% of trustee fees......................................................................................................................................................................................................................($150)
75% of state and local income taxes ............................................................................................................................................................................................($75)
Taxable income of S portion ..........................................................................................................................................................................................................$4,005
(vii) The taxable income of the non-S portion is $755, determined as follows:
Dividend income fromY...................................................................................................................................................................................................................$810
Dividend income fromX.....................................................................................................................................................................................................................$90
Total non-S portion income ...........................................................................................................................................................................................................$900
Less: 15% of trustee fees ..................................................................................................................................................................................................................($30)
15% state and local income taxes ..................................................................................................................................................................................................$15)
Personal exemption .....................................................................................................................................................................................................................($100)
Taxable income of non-S portion ......................................................................................................................................................................................................$755
Example 2.Sale of S stock. Trust has a valid
ESBT election in effect and owns stock inX,anS
corporation. No person is treated as the owner of
any portion of Trust under subpart E. In 2003, Trust
sells all of its stock inXto a person who is unrelated
to Trust and its beneficiaries and realizes a capital
gain of $5,000. This gain is taken into account by
the S portion and is taxed using the appropriate
capital gain rate found in section 1(h).
Example 3. (i)Sale of S stock for an installment
note. Assume the same facts as inExample 2, except
that Trust sells its stock inXfor a $400,000 install-
ment note payable with stated interest over ten
years. After the sale, Trust does not own any S cor-
poration stock.
(ii)Loss on installment sale. Assume Trust’s
basis in itsXstock was $500,000. Therefore, Trust
sustains a capital loss of $100,000 on the sale. Upon
the sale, the S portion terminates and the excess
loss, after being netted against the other items taken
into account by the S portion, is made available to
the entire trust as provided in section 641(c)(4).
(iii)Gain on installment sale. Assume Trust’s
basis in itsXstock was $300,000 and that the
$100,000 gain will be recognized under the install-
ment method of section 453. Interest income will be
recognized annually as part of the installment pay-
ments. The portion of the $100,000 gain recognized
annually is taken into account by the S portion.
However, the annual interest income is includible in
the gross income of the non-S portion.
Example 4.Charitable lead annuity trust. Trust
is a charitable lead annuity trust which is not treated
as owned by the grantor or another person under
subpart E. Trust acquires stock inX, an S corpora-
tion, and elects to be an ESBT. During the taxable
year, pursuant to its terms, Trust pays $10,000 to a
charitable organization described in section
170(c)(2). The non-S portion of Trust receives an
income tax deduction for the charitable contribution
under section 642(c) only to the extent the amount
is paid out of the gross income of the non-S portion.
To the extent the amount is paid from the S portion
by distributing S corporation stock, no charitable
deduction is available to the S portion.
Example 5.ESBT distributions. (i) As of January
1, 2002, Trust owns stock inX, a C corporation. No
portion of Trust is treated as owned by the grantor
or another person under subpart E.Xelects to be an
S corporation effective January 1, 2003, and Trust
elects to be an ESBT effective January 1, 2003. On
February 1, 2003,Xmakes an $8,000 distribution to
Trust, of which $3,000 is treated as a dividend from
accumulated earnings and profits under section
1368(c)(2) and the remainder is applied against
Trust’s basis in theXstock under section 1368(b).
The trustee of Trust makes a distribution of $4,000
to Beneficiary during 2003. For 2003, Trust’s share
ofX’s section 1366 items is $5,000 of ordinary
income. For the year, Trust has no other income and
no expenses or state or local taxes.
(ii) For 2003, Trust has $5,000 of taxable
income in the S portion. This income is taxed to
Trust at the maximum rate provided in section 1(e).
Trust also has $3,000 of distributable net income
(DNI) in the non-S portion. The non-S portion of
Trust receives a distribution deduction under section
661(a) of $3,000, which represents the amount dis-
tributed to Beneficiary during the year ($4,000), not
to exceed the amount of DNI ($3,000). Beneficiary
must include this amount in gross income under sec-
tion 662(a). As a result, the non-S portion has no
taxable income.
Par. 5. Section 1.1361–0 is amended
by adding entries for§1.1361–1(j)(12)
and (m) to read as follows:
§1.1361–0 Table of contents.
*****
§1.1361–1 S corporation defined.
June 10, 200210882002–23 I.R.B.

*****
(j)***
(12) Converting a QSST to an ESBT.
*****
(m) Electing small business trust (ESBT).
(1) Definition.
(2) ESBT election.
(3) Effect of ESBT election.
(4) Potential current beneficiaries.
(5) ESBT terminations.
(6) Revocation of ESBT election.
(7) Converting an ESBT to a QSST.
(8) Examples.
(9) Effective date.
*****
Par. 6. Section 1.1361–1 is amended
by:
1. Adding paragraphs (h)(1)(vi) and
(h)(3)(i)(F).
2. Adding a sentence to the beginning
of paragraph (h)(3)(ii) introductory
text.
3. Adding paragraph (j)(12).
4. Adding a sentence to the end of
paragraph (k)(2)(i).
5. Adding paragraph (m).
The additions read as follows:
§1.1361–1 S corporation defined.
*****
(h)***(1)***
(vi)Electing small business trusts.An
electing small business trust (ESBT)
under section 1361(e). See paragraph (m)
of this section for rules concerning
ESBTs including the manner of making
the election to be an ESBT under section
1361(e)(3).
*****
(3)***(i)***
(F) If S corporation stock is held by an
ESBT, each potential current beneficiary
is treated as a shareholder. However, if
for any period there is no potential cur-
rent beneficiary of the ESBT, the ESBT is
treated as the shareholder during such
period. See paragraph (m)(4) of this sec-
tion for the definition of potential current
beneficiary.
(ii)***See§1.641(c)–1 for the rules
for the taxation of an ESBT.***
*****
(j)***
(12)Converting a QSST to an ESBT.
For a trust that seeks to convert from a
QSST to an ESBT, the consent of the
Commissioner is hereby granted to
revoke the QSST election as of the effec-
tive date of the ESBT election, if all the
following requirements are met:
(i) The trust meets all of the require-
ments to be an ESBT under paragraph
(m)(1) of this section except for the
requirementunderparagraph(m)(1)
(iv)(A) of this section that the trust not
have a QSST election in effect.
(ii) The trustee and the current income
beneficiary of the trust sign the ESBT
election. The ESBT election must be filed
with the service center where the S corpo-
ration files its income tax return. This
ESBT election must state at the top of the
document“ATTENTION ENTITY
CONTROL—CONVERSION OF A
QSST TO AN ESBT PURSUANT TO
SECTION 1.1361–1(j)”and include all
information otherwise required for an
ESBT election under paragraph (m)(2) of
this section. A separate election must be
made with respect to the stock of each S
corporation held by the trust.
(iii) The trust has not converted from
an ESBT to a QSST within the 36-month
period preceding the effective date of the
new ESBT election.
(iv) The date on which the ESBT elec-
tion is to be effective cannot be more than
15 days and two months prior to the date
on which the election is filed and cannot
be more than 12 months after the date on
which the election is filed. If an election
specifies an effective date more than 15
days and two months prior to the date on
which the election is filed, it will be
effective on the day that is 15 days and
two months prior to the date on which it
is filed. If an election specifies an effec-
tive date more than 12 months after the
date on which the election is filed, it will
be effective on the day that is 12 months
after the date it is filed.
(k)***
(2)***(i)***Paragraphs
(h)(1)(vi), (h)(3)(i)(F), (h)(3)(ii), and
(j)(12) of this section are applicable for
taxable years beginning on and after May
14, 2002.
*****
(m)Electing small business trust
(ESBT)—(1)Definition—(i)General
rule. An electing small business trust
(ESBT) means any trust if it meets the
following requirements: the trust does not
have as a beneficiary any person other
than an individual, an estate, an organiza-
tion described in section 170(c)(2)
through (5), or an organization described
in section 170(c)(1) that holds a contin-
gent interest in such trust and is not a
potential current beneficiary; no interest
in the trust has been acquired by pur-
chase; and the trustee of the trust makes a
timely ESBT election for the trust.
(ii)Qualified beneficiaries—(A)In
general. For purposes of this section, a
beneficiary includes a person who has a
present, remainder, or reversionary inter-
est in the trust.
(B)Distributee trusts. A distributee
trust is the beneficiary of the ESBT only
if the distributee trust is an organization
described in section 170(c)(2) or (3). In
all other situations, any person who has a
beneficial interest in a distributee trust is
a beneficiary of the ESBT. A distributee
trust is a trust that receives or may
receive a distribution from an ESBT,
whether the rights to receive the distribu-
tion are fixed or contingent, or immediate
or deferred.
(C)Powers of appointment. A person
in whose favor a power of appointment
could be exercised is not a beneficiary of
an ESBT until the holder of the power of
appointment actually exercises the power
in favor of such person.
(D)Nonresident aliens. A nonresident
alien as defined in section 7701(b)(1)(B)
is an eligible beneficiary of an ESBT.
However, see paragraph (m)(4)(i) and
(m)(5)(iii) of this section if the nonresi-
dent alien is a potential current benefi-
ciary of the ESBT (which would result in
an ineligible shareholder and termination
of the S corporation election).
(iii)Interests acquired by purchase.A
trust does not qualify as an ESBT if any
interest in the trust has been acquired by
purchase. Generally, if a person acquires
an interest in the trust and thereby
becomes a beneficiary of the trust as
defined in paragraph (m)(1)(ii)(A), and
any portion of the basis in the acquired
interest in the trust is determined under
section 1012, such interest has been
acquired by purchase. This includes a net
gift of a beneficial interest in the trust, in
which the person acquiring the beneficial
interest pays the gift tax. The trust itself
may acquire S corporation stock or other
2002–23 I.R.B.1089June 10, 2002

property by purchase or in a part-gift,
part-sale transaction.
(iv)Ineligible trusts. An ESBT does
not include—
(A) Any qualified subchapter S trust
(as defined in section 1361(d)(3)) if an
election under section 1361(d)(2) applies
with respect to any corporation the stock
of which is held by the trust;
(B) Any trust exempt from tax or not
subject to tax under subtitle A; or
(C) Any charitable remainder annuity
trust or charitable remainder unitrust (as
defined in section 664(d)).
(2)ESBT election—(i)In general. The
trustee of the trust must make the ESBT
election by signing and filing, with the
service center where the S corporation
files its income tax return, a statement
that meets the requirements of paragraph
(m)(2)(ii) of this section. If there is more
than one trustee, the trustee or trustees
with authority to legally bind the trust
must sign the election statement. If any
one of several trustees can legally bind
the trust, only one trustee needs to sign
the election statement. Generally, only
one ESBT election is made for the trust,
regardless of the number of S corpora-
tions whose stock is held by the ESBT.
However, if the ESBT holds stock in mul-
tiple S corporations that file in different
service centers, the ESBT election must
be filed with all the relevant service cen-
ters where the corporations file their
income tax returns. This requirement
applies only at the time of the initial
ESBT election; if the ESBT later acquires
stock in an S corporation which files its
income tax return at a different service
center, a new ESBT election is not
required.
(ii)Election statement. The election
statement must include—
(A) The name, address, and taxpayer
identification number of the trust, the
potential current beneficiaries, and the S
corporations in which the trust currently
owns stock;
(B) An identification of the election as
an ESBT election made under section
1361(e)(3);
(C) The first date on which the trust
owned stock in each S corporation;
(D) The date on which the election is
to become effective (not earlier than 15
days and two months before the date on
which the election is filed); and
(E) Representations signed by the
trustee stating that—
(1) The trust meets the definitional
requirements of section 1361(e)(1); and
(2) All potential current beneficiaries
of the trust meet the shareholder require-
ments of section 1361(b)(1).
(iii)Due date for ESBT election. The
ESBT election must be filed within the
time requirements prescribed in para-
graph (j)(6)(iii) of this section for filing a
qualified subchapter S trust (QSST) elec-
tion.
(iv)Election by a trust described in
section 1361(c)(2)(A)(ii) or (iii). A trust
that is a qualified S corporation share-
holder under section 1361(c)(2)(A)(ii) or
(iii) may elect ESBT treatment at any
time during the 2-year period described in
those sections or the 16-day-and-2-month
period beginning on the date after the end
of the 2-year period. If the trust makes an
ineffective ESBT election, the trust will
continue nevertheless to qualify as an eli-
gible S corporation shareholder for the
remainder of the period described in sec-
tion 1361(c)(2)(A)(ii) or (iii).
(v)No protective election. A trust can-
not make a conditional ESBT election
that would be effective only in the event
the trust fails to meet the requirements for
an eligible trust described in section
1361(c)(2)(A)(i) through (iv). If a trust
attempts to make such a conditional
ESBT election and it fails to qualify as an
eligible S corporation shareholder under
section 1361(c)(2)(A)(i) through (iv), the
S corporation election will be ineffective
or will terminate because the corporation
will have an ineligible shareholder. Relief
may be available under section 1362(f)
for an inadvertent ineffective S corpora-
tion election or an inadvertent S corpora-
tion election termination. In addition, a
trust that qualifies as an ESBT may make
an ESBT election notwithstanding that
the trust is a wholly-owned grantor trust.
(3)Effect of ESBT election—(i)Gen-
eral rule. If a trust makes a valid ESBT
election, the trust will be treated as an
ESBT for purposes of chapter 1 of the
Internal Revenue Code as of the effective
date of the ESBT election.
(ii)Employer Identification Number.
An ESBT has only one employer identifi-
cation number (EIN). If an existing trust
makes an ESBT election, the trust contin-
ues to use the EIN it currently uses.
(iii)Taxable year. If an ESBT election
is effective on a day other than the first
day of the trust’s taxable year, the ESBT
election does not cause the trust’s taxable
year to close. The termination of the
ESBT election (including a termination
caused by a conversion of the ESBT to a
QSST) other than on the last day of the
trust’s taxable year also does not cause
the trust’s taxable year to close. In either
case, the trust files one tax return for the
taxable year.
(iv)Allocation of S corporation items.
If, during the taxable year of an S corpo-
ration, a trust is an ESBT for part of the
year and an eligible shareholder under
section 1361(c)(2)(A)(i) through (iv) for
the rest of the year, the S corporation
items are allocated between the two types
of trusts under section 1377(a). See
§1.1377–1(a)(2)(iii).
(v)Estimated taxes. If an ESBT elec-
tion is effective on a day other than the
first day of the trust’s taxable year, the
trust is considered one trust for purposes
of estimated taxes under section 6654.
(4)Potential current beneficiaries—(i)
In general. For purposes of determining
whether a corporation is a small business
corporation within the meaning of section
1361(b)(1), each potential current benefi-
ciary of an ESBT generally is treated as a
shareholder of the corporation. Subject to
the provisions of this paragraph (m)(4), a
potential current beneficiary generally is,
with respect to any period, any person
who at any time during such period is
entitled to, or in the discretion of any per-
son may receive, a distribution from the
principal or income of the trust. A person
is treated as a shareholder of the S corpo-
ration at any moment in time when that
person is entitled to, or in the discretion
of any person may, receive a distribution
of principal or income of the trust. No
person is treated as a potential current
beneficiary solely because that person
holds any future interest in the trust.
(ii)Grantor trusts. If all or a portion of
an ESBT is treated as owned by a person
under subpart E, part I, subchapter J,
chapter 1 of the Internal Revenue Code,
such owner is a potential current benefi-
ciary in addition to persons described in
paragraph (m)(4)(i) of this section.
(iii)Special rule for dispositions of
stock. Notwithstanding the provisions of
paragraph (m)(4)(i) of this section, if a
June 10, 200210902002–23 I.R.B.

trust disposes of all of its S corporation
stock, any person who first met the defi-
nition of a potential current beneficiary
during the 60-day period ending on the
date of such disposition is not a potential
current beneficiary and thus is not a
shareholder of that corporation.
(iv)Distributee trusts—(A)In general.
This paragraph (m)(4)(iv) contains the
rules for determining who are the poten-
tial current beneficiaries of an ESBT if a
distributee trust becomes entitled to, or at
the discretion of any person, may receive
a distribution from principal or income of
an ESBT. A distributee trust does not
include a trust that is not currently in
existence. For this purpose, a trust is not
currently in existence if the trust has no
assets and no items of income, loss,
deduction, or credit. Thus, if a trust
instrument provides for a trust to be
funded at some future time, the future
trust is not currently a distributee trust.
(B) If the distributee trust is not a trust
described in section 1361(c)(2)(A), then
the distributee trust is the potential cur-
rent beneficiary of the ESBT and the cor-
poration’s S corporation election termi-
nates.
(C) If the distributee trust is a trust
described in section 1361(c)(2)(A), the
persons who would be its potential cur-
rent beneficiaries (as defined in para-
graphs (m)(4)(i) and (ii) of this section) if
the distributee trust were an ESBT are
treated as the potential current beneficia-
ries of the ESBT. Notwithstanding the
preceding sentence, however, if the dis-
tributee trust is a trust described in sec-
tion 1361(c)(2)(A)(ii) or (iii), the estate
described in section 1361(c)(2)(B)(ii) or
(iii) is treated as the potential current ben-
eficiary of the ESBT for the 2-year period
during which such trust would be permit-
ted as a shareholder.
(D) For the purposes of paragraph
(m)(4)(iv)(C) of this section, a trust will
be deemed to be described in section
1361(c)(2)(A) if such trust would qualify
for a QSST election under section
1361(d) or an ESBT election under sec-
tion 1361(e) if it owned S corporation
stock.
(v)Contingent distributions. A person
who is entitled to receive a distribution
only after a specified time or upon the
occurrence of a specified event (such as
the death of the holder of a power of
appointment) is not a potential current
beneficiary until such time or the occur-
rence of such event.
(vi)Currently exercisable powers of
appointment—(A)In general. A person to
whom a distribution is or may be made
during a period pursuant to a power of
appointment is a potential current benefi-
ciary. Thus, if any person has a lifetime
power of appointment that would permit
distributions from the trust to be made to
more than 75 persons, the corporation’sS
corporation election will terminate
because the number of potential current
beneficiarieswillexceedthe
75-shareholder limit of section
1361(b)(1)(A). Also, the S corporation
election will terminate if the currently
exercisable power of appointment allows
distributions to be made to an ineligible
shareholder as defined in section
1361(b)(1)(B) and (C).
(B)Waiver or release. If the holder of
a power of appointment permanently
releases the power in a manner that is
valid under applicable local law, the per-
sons that would be potential current ben-
eficiaries solely because of the power will
not be potential current beneficiaries after
the effective date of the release. An
attempt to temporarily waive, release, or
limit a currently exercisable power of
appointment will be ignored in determin-
ing who are potential current beneficia-
ries of the trust.
(vii)Number of shareholders. Each
potential current beneficiary of the ESBT,
as defined in paragraphs (m)(4)(i)
through (vi) of this section, is counted as
a shareholder of any S corporation whose
stock is owned by the ESBT. During any
period in which the ESBT has no poten-
tial current beneficiaries, the ESBT is
counted as the shareholder. A person is
counted as only one shareholder of an S
corporation even though that person may
be treated as a shareholder of the S cor-
poration by direct ownership and through
one or more eligible trusts described in
section 1361(c)(2)(A). Thus, for example,
if a person owns stock in an S corporation
and is a potential current beneficiary of
an ESBT that owns stock in the same S
corporation, that person is counted as one
shareholder of the S corporation. Simi-
larly, if a husband owns stock in an S
corporation and his wife is a potential
current beneficiary of an ESBT that owns
stock in the same S corporation, the hus-
band and wife will be counted as one
shareholder of the S corporation.
(viii)Miscellaneous. Payments made
by an ESBT to a third party on behalf of
a beneficiary are considered to be pay-
ments made directly to the beneficiary.
The right of a beneficiary to assign the
beneficiary’s interest to a third party does
not result in the third party being a poten-
tial current beneficiary until that interest
is actually assigned.
(5)ESBT terminations—(i)Ceasing to
meet ESBT requirements. A trust ceases to
be an ESBT on the first day the trust fails
to meet the definition of an ESBT under
section 1361(e). The last day the trust is
treated as an ESBT is the day before the
date on which the trust fails to meet the
definition of an ESBT.
(ii)Disposition of S stock. In general,
a trust ceases to be an ESBT on the first
day following the day the trust disposes
of all S corporation stock. However, if the
trust is using the installment method to
report income from the sale or disposition
of its stock in an S corporation, the trust
ceases to be an ESBT on the day follow-
ing the earlier of the day the last install-
ment payment is received by the trust or
the day the trust disposes of the install-
ment obligation.
(iii)Potential current beneficiaries
that are ineligible shareholders.Ifa
potential current beneficiary of an ESBT
is not an eligible shareholder of a small
business corporation within the meaning
of section 1361(b)(1), the S corporation
election terminates. For example, the S
corporation election will terminate if a
nonresident alien becomes a potential cur-
rent beneficiary of an ESBT. Such a
potential current beneficiary is treated as
an ineligible shareholder beginning on the
day such person becomes a potential cur-
rent beneficiary, and the S corporation
election terminates on that date. However,
see the special rule of paragraph
(m)(4)(iii) of this section. If the S corpo-
ration election terminates, relief may be
available under section 1362(f).
(6)Revocation of ESBT election.An
ESBT election may be revoked only with
the consent of the Commissioner. The
application for consent to revoke the elec-
tion must be submitted to the Internal
Revenue Service in the form of a letter
2002–23 I.R.B.1091June 10, 2002

ruling request under the appropriate rev-
enue procedure.
(7)Converting an ESBT to a QSST.
For a trust that seeks to convert from an
ESBT to a QSST, the consent of the
Commissioner is hereby granted to
revoke the ESBT election as of the effec-
tive date of the QSST election, if all the
following requirements are met:
(i) The trust meets all of the require-
ments to be a QSST under section
1361(d).
(ii) The trustee and the current income
beneficiary of the trust sign the QSST
election. The QSST election must be filed
with the service center where the S corpo-
ration files its income tax return. This
QSST election must state at the top of the
document“ATTENTION ENTITY
CONTROL—CONVERSION OF AN
ESBT TO A QSST PURSUANT TO
SECTION 1.1361–1(m)”and include all
information otherwise required for a
QSST election under§1.1361–1(j)(6). A
separate QSST election must be made
with respect to the stock of each S corpo-
ration held by the trust.
(iii) The trust has not converted from a
QSST to an ESBT within the 36-month
period preceding the effective date of the
new QSST election.
(iv) The date on which the QSST elec-
tion is to be effective cannot be more than
15 days and two months prior to the date
on which the election is filed and cannot
be more than 12 months after the date on
which the election is filed. If an election
specifies an effective date more than 15
days and two months prior to the date on
which the election is filed, it will be
effective on the day that is 15 days and
two months prior to the date on which it
is filed. If an election specifies an effec-
tive date more than 12 months after the
date on which the election is filed, it will
be effective on the day that is 12 months
after the date it is filed.
(8)Examples. The provisions of this
paragraph (m) are illustrated by the fol-
lowing examples in which it is assumed,
unless otherwise specified, that all non-
corporate persons are citizens or residents
of the United States:
Example 1. (i)ESBT election with section 663(c)
separate shares. On January 1, 2003,Mcontributes
S corporation stock to Trust for the benefit ofM’s
three childrenA,B, andC. Pursuant to section
663(c), each of Trust’s separate shares forA,B, and
Cwill be treated as separate trusts for purposes of
determining the amount of distributable net income
(DNI) in the application of sections 661 and 662.
On January 15, 2003, the trustee of Trust files a
valid ESBT election for Trust effective January 1,
2003. Trust will be treated as a single ESBT and
will have a single S portion taxable under section
641(c).
(ii)ESBT acquires stock of an additional S cor-
poration. On February 15, 2003, Trust acquires
stock of an additional S corporation. Because Trust
is already an ESBT, Trust does not need to make an
additional ESBT election.
(iii)Section 663(c) shares of ESBT convert to
separate QSSTs. Effective January 1, 2004,A,B,C,
and Trust’s trustee elect to convert each separate
share of Trust into a separate QSST pursuant to
paragraph (m)(7) of this section. For each separate
share, they file a separate election for each S corpo-
ration whose stock is held by Trust. Each separate
share will be treated as a separate QSST.
Example 2. (i)Invalid potential current benefi-
ciary. Effective January 1, 2003, Trust makes a
valid ESBT election. On January 1, 2004,A, a non-
resident alien, becomes a potential current benefi-
ciary of Trust. Trust does not dispose of all of its S
corporation stock within 60 days after January 1,
2004. As of January 1, 2004,Ais a potential current
beneficiary of Trust and therefore is treated as a
shareholder of the S corporation. BecauseAis not
an eligible shareholder of an S corporation under
section 1361(b)(1), the S corporation election of any
corporation in which Trust holds stock terminates
effective January 1, 2004. Relief may be available
under section 1362(f).
(ii)Invalid potential current beneficiary and dis-
position of S stock. Assume the same facts as in
Example 2(i) except that within 60 days after Janu-
ary 1, 2004, trustee of Trust disposes of all Trust’s
S corporation stock.Ais not considered a potential
current beneficiary of Trust and therefore is not
treated as a shareholder of any S corporation in
which Trust previously held stock.
Example 3.Subpart E trust.Mtransfers stock in
X, an S corporation, and other assets to Trust for the
benefit ofBandB’s siblings.Mretains no powers or
interest in Trust. Under section 678(a),Bis treated
as the owner of a portion of Trust that includes a
portion of theXstock. No beneficiary has acquired
any portion of his or her interest in Trust by pur-
chase, and Trust is not an ineligible trust under para-
graph (m)(1)(iv) of this section. Trust is eligible to
make an ESBT election.
Example 4.Subpart E trust continuing after
grantor’s death. On January 1, 2003,Mtransfers
stock inX, an S corporation, and other assets to
Trust. Under the terms of Trust, the trustee of Trust
has complete discretion to distribute the income or
principal toMduringM’s lifetime and toM’s chil-
dren uponM’s death. DuringM’s life,Mis treated
as the owner of Trust under section 677. The trustee
of Trust makes a valid election to treat Trust as an
ESBT effective January 1, 2003. On March 28,
2004,Mdies. Under applicable local law, Trust does
not terminate onM’s death. Trust continues to be an
ESBT afterM’s death, and no additional ESBT elec-
tion needs to be filed for Trust afterM’s death.
Example 5.Potential current beneficiaries and
distributee trust holding S corporation stock.
Trust-1 has a valid ESBT election in effect. The
trustee of Trust-1 has the power to make distribu-
tions toAdirectly or to any trust created for the
benefit ofA. On January 1, 2003,Mcreates Trust-2
for the benefit ofA. Also on January 1, 2003, the
trustee of Trust-1 distributes some S corporation
stock to Trust-2.A, as the current income benefi-
ciary of Trust-2, makes a timely and effective elec-
tion to treat Trust-2 as a QSST. Because Trust-2 is a
valid S corporation shareholder, the distribution to
Trust-2 does not terminate the ESBT election of
Trust-1. Trust-2 itself will not be counted toward the
75-shareholder limit of section 1361(b)(1)(A). Addi-
tionally, becauseAis already counted as an S cor-
poration shareholder because ofA’s status as a
potential current income beneficiary of Trust-1,Ais
not counted again by reason ofA’s status as the
deemed owner of Trust-2.
Example 6.Potential current beneficiaries and
distributee trust not holding S corporation stock. (i)
Distributee trust that would itself qualify as an
ESBT. Trust-1 holds stock inX, an S corporation,
and has a valid ESBT election in effect. Under the
terms of Trust-1, the trustee has discretion to make
distributions toA,B, and Trust-2, a trust for the
benefit ofC,D, andE. Trust-2 would qualify to be
an ESBT, but it owns no S corporation stock and has
made no ESBT election. Under paragraph (m)(4)(iv)
of this section, Trust-2’s potential current beneficia-
ries are treated as the potential current beneficiaries
of Trust-1 and are counted as shareholders for pur-
poses of section 1361(b)(1). Thus,A,B,C,D, andE
are potential current beneficiaries of Trust-1 and are
counted as shareholders for purposes of section
1361(b)(1). Trust-2 itself will not be counted as a
shareholder of Trust-1 for purposes of section
1361(b)(1).
(ii)Distributee trust that would not qualify as an
ESBT or a QSST. Assume the same facts as in para-
graph (i) of thisExample 6except thatDis a non-
resident alien. Trust-2 would not be eligible to make
an ESBT or QSST election if it owned S corporation
stock and therefore Trust-2 is a potential current
beneficiary of Trust-1. Since Trust-2 is not an eli-
gible shareholder,X’s S corporation election termi-
nates.
(iii)Distributee trust that is a section
1361(c)(2)(A)(ii) trust. Assume the same facts as in
paragraph (i) of thisExample 6except that Trust-2
is a trust treated as owned byAunder section 676
becauseAhas the power to revoke Trust-2 at any
time prior toA’s death. On January 1, 2003,Adies.
Because Trust-2 is a trust described in section
1361(c)(2)(A)(ii) during the 2-year period beginning
on the day ofA’s death, under paragraph
(m)(4)(iv)(C) of this section, Trust-2’s only potential
current beneficiary is the person listed in section
1361(c)(2)(B)(ii),A’s estate. Thus,BandA’s estate
are potential current beneficiaries of Trust-1 and are
counted as shareholders for purposes of section
1361(b)(1).
Example 7.Potential current beneficiaries and
powers of appointment.Mcreates Trust for the ben-
efit ofA.Aalso has a currently exercisable power to
appoint income or principal to anyone exceptA,A’s
creditors,A’s estate, and the creditors ofA’s estate.
The potential current beneficiaries of Trust will beA
and all other persons except forA’s creditors,A’s
estate, and the creditors ofA’s estate. This number
will exceed the 75-shareholder limit of section
1361(b)(1)(A). If Trust holds S corporation stock,
the corporation’s S election will terminate.
June 10, 200210922002–23 I.R.B.

(9)Effective date. This paragraph (m)
is applicable for taxable years of ESBTs
beginning on and after May 14, 2002.
Par. 7. Section 1.1362–6 is amended
by revising paragraph (b)(2)(iv) to read as
follows:
§1.1362–6 Election and consents.
*****
(b)***
(2)***
(iv)Trusts. In the case of a trust
described in section 1361(c)(2)(A)
(including a trust treated under section
1361(d)(1)(A) as a trust described in sec-
tion 1361(c)(2)(A)(i) and excepting an
electing small business trust described in
section 1361(c)(2)(A)(v) (ESBT)), only
the person treated as the shareholder for
purposes of section 1361(b)(1) must con-
sent to the election. When stock of the
corporation is held by a trust, both hus-
band and wife must consent to any elec-
tion if the husband and wife have a com-
munity interest in the trust property. See
paragraph (b)(2)(i) of this section for
rules concerning community interests in S
corporation stock. In the case of an
ESBT, the trustee and the owner of any
portion of the trust that consists of the
stock in one or more S corporations under
subpart E, part I, subchapter J, chapter 1
of the Internal Revenue Code must con-
sent to the S corporation election. If there
is more than one trustee, the trustee or
trustees with authority to legally bind the
trust must consent to the S corporation
election.
*****
Par. 8. Section 1.1362–7 is amended
by:
1. Revising the section heading.
2. Adding a sentence to the end of
paragraph (a).
The revision and addition read as fol-
lows:
§1.1362–7 Effective dates.
(a)***Section 1.1362–6(b)(2)(iv) is
applicable for taxable years beginning on
and after May 14, 2002.
*****
Par. 9. Section 1.1377–0 is amended
by adding an entry for§1.1377–
1(a)(2)(iii) to read as follows:
§1.1377–0 Table of contents.
*****
§1.1377–1 Pro rata share.
(a)***(2)***
(iii) Shareholder trust conversions.
*****
Par. 10. Section 1.1377–1 is amended
by:
1. Adding paragraph (a)(2)(iii).
2. AddingExample 3to paragraph (c).
The additions read as follows:
§1.1377–1 Pro rata share.
(a)***
(2)***
(iii)Shareholder trust conversions. If,
during the taxable year of an S corpora-
tion, a trust that is an eligible shareholder
of the S corporation converts from a trust
described in section 1361(c)(2)(A)(i), (ii),
(iii), or (v) for the first part of the year to
a trust described in a different subpart of
section 1361(c)(2)(A)(i), (ii), or (v) for
the remainder of the year, the trust’s share
of the S corporation items is allocated
between the two types of trusts. The first
day that a qualified subchapter S trust
(QSST) or an electing small business trust
(ESBT) is treated as an S corporation
shareholder is the effective date of the
QSST or ESBT election. Upon the con-
version, the trust is not treated as termi-
nating its entire interest in the S corpora-
tion for purposes of paragraph (b) of this
section, unless the trust was a trust
described in section 1361(c)(2)(A)(ii) or
(iii) before the conversion.
*****
(c)***
Example 3.Effect of conversion of a qualified
subchapter S trust (QSST) to an electing small busi-
ness trust (ESBT). (i) On January 1, 2003, Trust
receives stock of S corporation. Trust’s current
income beneficiary makes a timely QSST election
under section 1361(d)(2), effective January 1, 2003.
Subsequently, the trustee and current income benefi-
ciary of Trust elect, pursuant to§1.1361–1(j)(12),
to terminate the QSST election and convert to an
ESBT, effective July 1, 2004. The taxable year of S
corporation is the calendar year. In 2004, Trust’spro
ratashare of S corporation’s nonseparately com-
puted income is $100,000.
(ii) For purposes of computing the income allo-
cable to the QSST and to the ESBT, Trust is treated
as a QSST through June 30, 2004, and Trust is
treated as an ESBT beginning July 1, 2004. Pursu-
ant to section 1377(a)(1), thepro ratashare of S
corporation income allocated to the QSST is
$49,727 ($100,000 x 182 days/366 days), and the
pro ratashare of S corporation income allocated to
the ESBT is $50,273 ($100,000 x 184 days/366
days).
Par. 11. Section 1.1377–3 is revised to
read as follows:
§1.1377–3 Effective dates.
Section 1.1377–1 and 1.1377–2 apply
to taxable years of an S corporation
beginning after December 31, 1996,
except that§1.1377–1(a)(2)(iii), and (c)
Example 3are applicable for taxable
years beginning on and after May 14,
2002.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 12. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 13. In§602.101, paragraph (b) is
amended by adding an entry for 1.444–4
and revising the entry for 1.1361–1in
numerical order to the table to read as
follows:
§602.101 OMB Control numbers
*****
(b)***
CFR part or section where
identified and described
Current OMB
control No.
*****
1.444–4 ..................................................................................................................................................................... 1545–1591
*****
1.1361–1 ................................................................................................................................................................... 1545–0731
1545–1591
*****
2002–23 I.R.B.1093June 10, 2002

Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved May 3, 2002.
Pamela F. Olson,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on May
13, 2002, 8:45 a.m., and published in the issue of
the Federal Register for May 14, 2002, 67 F.R.
34388)
June 10, 200210942002–23 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous
Partnership Transactions
Involving Long-term Contracts
Notice 2002–37
The Internal Revenue Service (IRS)
and the Treasury Department (Treasury)
intend to publish regulations addressing
partnership transactions involving con-
tracts accounted for under a long-term
contract method of accounting.
BACKGROUND
Concurrently with this Notice, the IRS
and Treasury are issuing final regulations
under§460 of the Internal Revenue Code
to address a mid-contract change in tax-
payer engaged in completing a contract
accounted for under a long-term contract
method of accounting. In general, the
regulations divide the rules regarding a
mid-contract change in taxpayer engaged
in completing this type of contract into
two categories—constructive completion
transactions and step-in-the-shoes trans-
actions. The regulations provide that a
transfer described in§721(a) of a long-
term contract to a partnership and a trans-
fer of a partnership interest are step-in-
the-shoes transactions. The IRS and
Treasury intend to publish regulations
addressing these and other partnership
transactions involving contracts
accounted for under a long-term contract
method of accounting. This Notice
describes the special rules that will apply
to such transactions.
DESCRIPTION OF REGULATIONS
RELATING TO PARTNERSHIPS
The IRS and Treasury believe that
step-in-the-shoes treatment generally is
appropriate for contributions of contracts
to partnerships in transactions subject to
§721(a). Accordingly, the contribution of
a contract accounted for under a long-
term contract method of accounting to a
partnership in a transaction subject to
§721(a) is a step-in-the-shoes transac-
tion.
The regulations will require a partner
that contributes a contract accounted for
under a long-term contract method of
accounting to a partnership to increase the
basis of the partnership interest by the
amount of gross receipts that the partner
has recognized with respect to the con-
tract, and reduce the basis of the partner-
ship interest by the amount of gross
receipts the partner has received or rea-
sonably expects to receive under the con-
tract. However, the partner may not
reduce the basis of the partnership interest
below zero, but must recognize income to
the extent that the basis of the partnership
interest would be reduced below zero.
The regulations will provide that, in
applying a long-term contract method of
accounting to the contributed contract, the
partnership must reduce its total contract
price (or gross contract price) by the
amount of income recognized by the con-
tributing partner. These rules follow pro-
visions in the final mid-contract change in
taxpayer regulations regarding transfers
of long-term contracts in certain corpo-
rate transactions qualifying for step-in-
the-shoes treatment.
Section 704(c) generally provides that
income, gain, loss, or deduction attribut-
able to property that is contributed to a
partnership must be allocated to the con-
tributing partner. The purpose of§704(c)
is to prevent the shifting of tax conse-
quences among partners with respect to
precontribution gain or loss. The regula-
tions will apply§704(c) principles to
income or loss attributable to a contrib-
uted contract accounted for under a long-
term contract method of accounting. The
amount of income or loss subject to
§704(c) will be (i) the amount that would
be taken into account (under the construc-
tive completion rules) if, immediately
before the contribution of the contract to
the partnership, the partner disposed of
the contract for its fair market value in a
fully taxable transaction, reduced by (ii)
the amount of income, if any, that the
partner is required to recognize as a result
of the contribution. The regulations will
provide additional guidance on the man-
ner of applying§704(c) to income or loss
from a contributed contract. The regula-
tions will provide that for periods prior to
the date that the regulations are pub-
lished, taxpayers must apply§704(c) to
such income or loss in any manner that
reasonably accounts for the§704(c)
income or loss over the life of the con-
tract.
Section 741 provides that gain or loss
recognized on the sale or exchange of an
interest in a partnership shall be consid-
ered as gain or loss from a capital asset,
except as provided in§751. Section
751(a) provides that the amount of any
money, or the fair market value of any
property, received by a transferor partner
in exchange for all or any part of the part-
ner’s interest in the partnership attribut-
able to unrealized receivables (as defined
in§751(c)) or inventory items (as
defined in§751(d)) of the partnership
shall be considered as an amount realized
from the sale or exchange of property
other than a capital asset. In Rev. Rul.
79–51, 1979–1 C.B. 225, the IRS ruled
that where a partner sold the partner’s
entire interest in a partnership, amounts
received in exchange for the partner’s
interest attributable to the value at the
time of sale of the partnership’s partially
completed contracts, the income from
which was being accounted for on the
completed contract method, were taxed
under§751(a).
The transfer of an interest in a partner-
ship engaged in a contract accounted for
under a long-term contract method of
accounting is a step-in-the-shoes transac-
tion. The regulations will provide that
contracts accounted for under a long-term
contract method of accounting are unreal-
ized receivables within the meaning of
§751(c). The amount of ordinary income
or loss attributable to a contract under the
regulations will be the amount of income
or loss that the partnership would take
into account (under the constructive
completion rules) if, at the time of a
transfer of a partnership interest or a dis-
tribution to a partner (as the case may be),
the partnership disposed of the contract
for its fair market value in a fully taxable
transaction.
The IRS and the Treasury do not
believe that step-in-the-shoes treatment is
appropriate for distributions of long-term
contracts by a partnership to a partner in
a transaction subject to§731(a). In these
transactions, a step-in-the-shoes rule may
not produce appropriate results if the part-
ner’s basis in the contract (including the
2002–23 I.R.B.1095June 10, 2002

uncompleted property, if applicable) that
is distributed by a partnership is not equal
to the partnership’s basis in the contract
(including the uncompleted property, if
applicable). The regulations will provide
that a distribution of a contract accounted
for under a long-term contract method of
accounting by a partnership to a partner is
a constructive completion transaction. In
determining the partnership’s income on
the constructive completion transaction
under§1.460–4(k)(2), the fair market
value of the contract will be treated as the
amount paid for the contract.
Section 751(b)(1) provides that to the
extent a partner receives in a distribution
—(A) partnership property which is (i)
unrealized receivables or (ii) inventory
items which have appreciated substan-
tially in value, in exchange for all or a
part of the partner’s interest in other part-
nership property (including money), or
(B) partnership property (including
money) other than property described in
§751(b)(1)(A)(i) or (ii) in exchange for
all or part of the partner’s interest in part-
nership property described in§751
(b)(1)(A)(i) or (ii), the transaction shall
be considered a sale or exchange of the
property between the distributee partner
and the partnership. Because the distribu-
tion of a contract accounted for under a
long-term contract method of accounting
is treated as a constructive completion
transaction, a distribution of the contract
causes the partnership to recognize all of
the ordinary income or loss attributable to
the contract. Although no income or loss
remains in the contract after the construc-
tive completion, the partnership may hold
other assets that may cause§751(b) to
apply. Therefore, the regulations will
require a partnership that distributes a
contract accounted for under a long-term
contract method of accounting to apply
the constructive completion rules before
applying the rules of§751(b) to the dis-
tribution.
Where a partnership that holds a con-
tract accounted for under a long-term
contract method of accounting makes a
distribution to a partner that has the effect
of reducing that partner’s share of ordi-
nary income or loss from the contract, the
regulations generally will not require a
constructive completion of the entire con-
tract. However, consistent with the gen-
eralprinciplesofsubchapterK,
§751(b) may apply to such a transaction.
Section 732 determines the basis of
property (other than money) distributed
by a partnership to a partner. Section
734(b) provides for an adjustment to the
basis of partnership property as a result of
certain distributions from partnerships
that have a§754 election in effect. The
regulations will provide that if a contract
accounted for under a long-term contract
method of accounting is distributed to a
partner, then for purposes of determining
the partner’s basis in the contract (includ-
ing the uncompleted property, if appli-
cable) under§732, and the amount of
any basis adjustment under§734(b), the
partnership’s basis in the contract (includ-
ing the uncompleted property, if appli-
cable) immediately prior to the distribu-
tion will be the partnership’s allocable
contract costs (including transaction
costs), increased (or decreased) by the
amount of income (or loss) recognized by
the partnership on the contract through
the date of the distribution (including
amounts recognized as a result of the con-
structive completion), and decreased by
the amounts that the partnership has
received or reasonably expects to receive
under the contract.
In addition, the regulations will pro-
vide that if a contract accounted for under
a long-term contract method of account-
ing is distributed to a partner, then, in
computing the total contract price for the
new contract under§1.460–4(k)(2)(iii),
the partner’s basis in the contract (includ-
ing the uncompleted property, if appli-
cable) after the distribution (as deter-
mined under§732) will be deemed to be
the consideration paid by the partner for
the contract. Thus, the total contract price
of the new contract will be reduced by the
partner’s basis in the contract (including
the uncompleted property, if applicable)
immediately after the distribution.
EFFECTIVE DATES
The regulations will be effective for
contributions of long-term contracts to
partnerships, distributions by partnerships
engaged in long-term contracts, and trans-
fers of interests in partnerships that are
engaged in long-term contracts occurring
on or after May 15, 2002.
REQUEST FOR PUBLIC COMMENT
Comments are requested on the scope
and substance of the regulations. Direct
all written comments to Internal Revenue
Service, Attn: CC:ITA:RU (NT 2002–37),
Room 5226, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20044. In the
alternative, comments may be hand deliv-
ered Monday through Friday between the
hours of 8:00 a.m. and 5:00 p.m. to:
CC:ITA:RU (NT 2002–37), Courier’s
desk, Internal Revenue Service,1111
Constitution Avenue, NW, Washington,
DC,orsubmittedelectronicallyto:
Notice.Comments@m1.irs.counsel.treas.
gov. Please submit all comments by
August 12, 2002. All submissions will be
open to public inspection.
DRAFTING INFORMATION
The principal author of this Notice is
Richard T. Probst of the Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). However, other
personnel from Treasury and the IRS par-
ticipated in its development. For further
information regarding this Notice, contact
Mr. Probst at (202) 622–3060 (not a toll-
free call).
26 CFR 601.105: Examination of returns and claims
for refund, credit or abatement; determination of
correct tax liability.
(Also Part I,§172.)
Rev. Proc. 2002–40
SECTION 1. PURPOSE
.01 The Job Creation and Worker
Assistance Act of 2002 (the Act) added
§172(b)(1)(H) to the Internal Revenue
Code to provide a 5-year carryback
period for net operating losses (NOLs) for
any taxable year ending during 2001 and
2002. Pub. L. No. 107–147,§102(a), 116
Stat. 21 (March 9, 2002). Consistent with
the intent of Congress as reflected in cor-
respondence to the Treasury Department
subsequent to the Act’s enactment, this
revenue procedure provides qualifying
taxpayers who filed returns for a taxable
year ending during 2001 and 2002 with-
out taking advantage of the new 5-year
carryback with a limited opportunity to
June 10, 200210962002–23 I.R.B.

do so and to apply for a tentative carry-
back adjustment if they act on or before
October 31, 2002.
.02 Specifically, this revenue proce-
dure allows taxpayers that incurred an
NOL in a taxable year ending during
2001or2002andelectedunder
§172(b)(3) to forgo the NOL carryback
period to revoke their elections in order to
apply the 5-year carryback period. This
revenue procedure also allows such tax-
payers, as well as taxpayers who used a
2-year carryback period for an NOL in a
taxable year ending during 2001 or 2002,
to file an application for a tentative carry-
back adjustment under§6411(a) based
on a 5-year NOL carryback period even if
the 12-month period for filing such an
application has expired. A revocation
and/or application for tentative carryback
adjustment under this revenue procedure
must be made on or before October 31,
2002. Finally, this revenue procedure
allows taxpayers that filed returns for a
taxable year ending in 2001 or 2002, and
who neither elected to forgo the carry-
back period, nor used the 2-year carry-
back period, to elect to relinquish the
5-year carryback period (and thereby
retain the ability to use the 2-year carry-
back period) if they act on or before
October 31, 2002.
.03 In connection with these rules
allowing taxpayers to reevaluate options
regarding the carryback period, the Inter-
nal Revenue Service and Treasury
Department intend to provide relief for
consolidated groups that failed to waive
the portion of the carryback period for
consolidated net operating losses attribut-
able to certain acquired members for
which such members were members of
another group. The scope of such relief
will be announced shortly in separate
guidance.
SECTION 2. BACKGROUND
.01 Section 172(b)(1)(A)(i) generally
provides that an NOL for any taxable year
must be carried back to each of the 2
years preceding the taxable year of such
NOL. Section 172(b)(3) provides that any
taxpayer entitled to a carryback period
under§172(b)(1) may elect to relinquish
the carryback period with respect to an
NOL for any taxable year.
.02 Section 102 of the Act amended
§172 of the Code in two respects. First,
§172(b)(1)(H) was added to allow a
5-year carryback period for NOLs for any
taxable year ending during 2001 and
2002. Second,§172(j) was added to
allow any taxpayer entitled to the 5-year
carryback under§172(b)(1)(H) from any
loss year to elect to relinquish that carry-
back period with respect to an NOL for
any taxable year. A taxpayer making this
election generally must apply the 2-year
carrybackperiodsetforthin
§172(b)(1)(A)(i).
.03 An election to relinquish either the
NOL carryback period in general under
§172(b)(3), or just the 5-year carryback
period under§172(j), must be made by
the due date (including extensions) for fil-
ing the taxpayer’s return for the taxable
year of the NOL and in the manner pre-
scribed by the Secretary.
.04 Section 6411(a) provides that a
taxpayer may file an application for a ten-
tative carryback adjustment of the tax for
the prior taxable year affected by an NOL
carryback from any taxable year. Section
6411(a) also provides that the application
must be filed on or after the date of filing
for the return for the taxable year of the
NOL from which the carryback results
and within a period of 12 months after
such taxable year or, with respect to any
portion of a business credit carryback
attributable to an NOL from a subsequent
taxable year, within a period of 12
months from the end of such subsequent
taxable year. Section 6411(b) provides a
90-day period during which the Service
will make a limited examination of the
application to discover omissions and
errors of computation and determine the
amount of the decrease in tax attributable
to the carryback. The Service may disal-
low, without further action, any applica-
tion that contains errors of computation
that cannot be corrected within the 90-day
period or that contains material omis-
sions. The decrease in tax attributable to
the carryback will be applied against
unpaid amounts of tax. Any remainder of
the decrease will, within the 90-day
period, be credited or refunded.
.05 It has been brought to the attention
of the Service and Treasury Department
that some taxpayers that incurred an NOL
in a taxable year ending during 2001 filed
returns before the Act became law and
either elected under§172(b)(3) to relin-
quish the NOL carryback period in gen-
eral or applied the 2-year carryback
period. In some cases, these taxpayers
might have wished to take advantage of
the 5-year carryback period, had they
been aware of its availability, and apply
for a tentative carryback adjustment. The
Chairmen and Ranking Members of both
the House Ways and Means Committee
and the Senate Finance Committee have
advised the Treasury Department of their
intent that qualifying taxpayers be
allowed to take advantage of the 5-year
NOL carryback period to the maximum
extent possible, and that they intend to
pursue technical corrections legislation
that will clarify this intent. Specifically,
the technical corrections legislation will
allow the Service to issue guidance to
allow taxpayers to reconsider a previous
election under§172(b)(3) to relinquish
the NOL carryback period in general, and
to file an application for a tentative carry-
back adjustment under§6411(a), to take
advantage of the 5-year carryback period,
on or before October 31, 2002. When
enacted, this legislation will be effective
as if originally included in the Act. This
revenue procedure describes how the Ser-
vice is taking into account Congressional
intent in administering the provision.
SECTION 3. SCOPE
This revenue procedure applies to tax-
payers that incurred an NOL for any tax-
able year ending in 2001 or 2002.
SECTION 4. TAXPAYERS THAT
ELECTED TO FORGO THE
CARRYBACK PERIOD
.01 In order to give effect to the intent
of Congress to allow taxpayers a 5-year
NOL carryback period, any taxpayer that
previously elected under§172(b)(3) to
forgo the carryback period for an NOL
for any taxable year ending in 2001 or
2002 may revoke such election in order to
apply the 5-year carryback period by fol-
lowing the procedures of section 7 of this
revenue procedure on or before October
31, 2002. Any revocation of the election
to forgo the NOL carryback period will
also apply to a carryback of any alterna-
tive tax NOL for the same taxable year.
.02 If a taxpayer that previously
elected under§172(b)(3) to forgo the car-
ryback period for an NOL incurred in a
taxable year ending in 2001 or 2002 does
2002–23 I.R.B.1097June 10, 2002

not want to revoke that election in order
to use the 5-year carryback period pro-
vided by§172(b)(1)(H), the taxpayer
need not file any additional form or state-
ment. Unless the taxpayer follows the
procedures set forth in section 7 of this
revenue procedure, the taxpayer’s previ-
ous election applies as well to forgo the
5-year carryback period.
SECTION 5. TAXPAYERS THAT
APPLIED THE 2-YEAR CARRYBACK
PERIOD
.01 If a taxpayer that previously filed
an application for a tentative carryback
adjustment (whether or not the Service
has acted upon such application) or an
amended return using a 2-year carryback
period for an NOL incurred in a taxable
year ending in 2001 or 2002, and that did
not elect to forgo the 5-year carryback
period under§172(j), wants to use the
5-year carryback provided under§172
(b)(1)(H), the taxpayer may do so by fol-
lowing the procedures of section 7 of this
revenue procedure on or before October
31, 2002. Any amendment of a prior
refund claim will also apply to a carry-
back of any alternative tax NOL for the
same taxable year. In the case of an
amended application for a tentative carry-
back adjustment, the 90-day period
described in§6411(b) will begin on the
date the amended declaration is filed.
.02 If a taxpayer that previously filed
an application for a tentative carryback
adjustment or an amended return using a
2-year carryback period for an NOL
incurred in a taxable year ending in 2001
or 2002 prefers to apply the 2-year carry-
back period, rather than the 5-year carry-
back period provided under§172(b)
(1)(H), the taxpayer need not file any
form or statement in order to satisfy the
requirements for an election under§172
(j) to forgo the 5-year carryback period.
Unless the taxpayer follows the proce-
dures of section 7 of this revenue proce-
dure, the taxpayer will be considered to
havemadeanelectionunder
§172(j) to forgo the 5-year carryback
period in favor of the 2-year carryback
period.
SECTION 6. TAXPAYERS THAT
NEITHER ELECTED TO FORGO THE
CARRYBACK PERIOD NOR APPLIED
THE 2-YEAR CARRYBACK PERIOD
.01 Any taxpayer that:
(1) filed a federal income tax
return for a taxable year ending in 2001
or 2002;
(2) did not elect under§172(b)(3)
to forgo the carryback period in general
for an NOL incurred in such taxable year;
and
(3) did not previously file an
application for a tentative carryback
adjustment or an amended return using a
2-year carryback period for such NOL,
may apply the 2-year carryback period, in
lieu of the 5-year carryback period, by
following the procedures of section 7 of
this revenue procedure on or before Octo-
ber 31, 2002.
.02 For any taxpayer described in sec-
tion 6.01 of this revenue procedure that
does not follow the procedures of section
7 of this revenue procedure to apply the
2-year carryback period, the 5-year carry-
back period will apply by operation of
law. In that event, the period of limita-
tions provided in§6511 will apply in the
case of any claim for refund on an
amended return, and the period provided
in§6411(a) will apply in the case of any
tentative carryback adjustment, that is
based on the 5-year carryback period.
SECTION 7. PROCEDURES
.01What to File. A taxpayer described
in section 4 or 5 of this revenue proce-
dure that wants to use the 5-year carry-
back period must file the appropriate
form(s) using a 5-year carryback period.
A taxpayer described in section 6 of this
revenue procedure that wants to relin-
quish the 5-year carryback period (and
thus retain its ability to use the 2-year
carryback period) must file the appropri-
ate form(s) using a 2-year carryback
period, even if no refund or change in tax
liability is shown on the form(s). The
appropriate form(s) are:
(1) for corporations, a Form 1139,
Corporation Application for Tentative
Refund, or Form 1120X,Amended U.S.
Corporation Income Tax Return;
(2) for individuals, a Form 1045,
Application for Tentative Refund, or Form
1040X,Amended U.S. Individual Income
Tax Return; and
(3) for estates or trusts, a Form
1045, or amended Form 1041,U.S.
Income Tax Return for Estates and Trusts.
.02Labels. Taxpayers described in
section 4.01 of this revenue procedure
should type or print across the top of the
appropriate form“Revocation of NOL
carryback waiver pursuant to Rev. Proc.
2002–40.”Taxpayers described in section
5.01 of this revenue procedure should
type or print across the top of the appro-
priate form“Amended refund claim pur-
suant to Rev. Proc. 2002–40.”
.03When to File. Any form filed pur-
suant to this revenue procedure must be
filed on or before October 31, 2002.
SECTION 8. EFFECTIVE DATE
This revenue procedure is effective for
NOLs arising in taxable years ending
after December 31, 2000.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Martin Scully, Jr. of the
Office of Associate Chief Counsel
(Income Tax and Accounting). For further
information regarding this revenue proce-
dure, contact Mr. Scully at (202) 622–
4960 (not a toll-free call).
26 CFR 1.62–2: Reimbursements and other expense
allowance arrangements.
(Also Part I,§62.)
Rev. Proc. 2002–41
The purpose of this revenue procedure
is to provide an optional expense substan-
tiation rule so that businesses in the pipe-
line construction industry can provide
reimbursements under an accountable
plan to employees who also furnish weld-
ing rigs or mechanics rigs as part of their
performance of services as employees.
This revenue procedure is not intended to
suggest that all workers providing such
services and equipment are employees.
Rather, the method in this revenue proce-
dure may be applied when businesses
choose to use an accountable plan to
reimburse individuals who are employees
for rig-related expenses incurred as
employees.
June 10, 200210982002–23 I.R.B.

As part of the Industry Issue Resolu-
tion Pilot Program, announced in Notice
2000–65, representatives of the pipeline
construction industry requested clarifica-
tion of the proper treatment of amounts
paid to employee welders and heavy
equipment mechanics who provide heavy
equipment in connection with the perfor-
mance of services. At issue was whether
the amounts should be treated as pay-
ments of rent, payments of wages, or as
the reimbursement of expenses subject to
the accountable plan requirements.
Employers in the pipeline construction
industry encounter several challenges to
reimbursing under an accountable plan
the costs relating to employee-provided
welding rigs and mechanics rigs, particu-
larly in determining the proper amount of
the expense incurred. Rig welders and
heavy equipment mechanics work for
multiple companies for relatively short
periods. Therefore, the proper allocation
of fixed costs related to the equipment
among employers is unclear. Moreover,
although the rigs are mobile, the existing
mileage-based expense substantiation
provision does not accurately reflect rig-
related costs because rigs are used prima-
rily while stationary. Further, these
employees incur substantial expenses as
employees in providing these rigs as a
condition of employment. Due to these
unique features, reimbursing employees
for rig-related expenses under the existing
accountable plan requirements is unwork-
able for this industry. In order to enable
this industry to reimburse rig-related
expenses to employees under an account-
able plan, this revenue procedure pro-
vides an optional expense substantiation
rule under which rig-related expenses
may be treated as substantiated when
reimbursing these expenses under an
accountable plan.
Under this revenue procedure an
employer may pay certain welders and
heavy equipment mechanics an amount of
up to $13 per hour for rig-related
expenses that is deemed substantiated
under an accountable plan when paid in
accord with this revenue procedure (up to
$8 per hour if the employer provides fuel
or otherwise reimburses fuel expenses).
This revenue procedure provides for an
annual inflation adjustment to these
amounts after 2003, if necessary and is
effective for payments made on or after
January 1, 2003. The rules are provided
in Questions and Answers below.
The Service recognizes that employers
in other industries may similarly provide
payments to employees for the costs of
providing equipment as employees used
in the performance of services as employ-
ees. To the extent that the unique features
of other industries creates similar chal-
lenges to implementing accountable
plans, the Service welcomes comments
regarding the appropriateness and design
of similar relief. We specifically request
comments concerning other categories of
qualified nonpersonal use vehicles owned
by employees and used by the employees
in the course of providing services as
employees, especially where the nature of
an industry results in employees working
for multiple employers during each year,
for which a deemed substantiation rule
would be appropriate.
TABLE OF CONTENTS
SECTION 1. PURPOSE AND SCOPE
Q-1. Must an employer use this rev-
enue procedure to reimburse employees
for rig-related expenses?
Q-2. What is the tax treatment of
amounts deemed substantiated under this
revenue procedure?
Q-3. Which employers may use the
deemed substantiation rule provided in
this revenue procedure?
Q-4. For which vehicles and equip-
ment may eligible employers use the
deemed substantiation rule provided in
this revenue procedure?
SECTION 2. BACKGROUND
Q-5. What provisions of the tax law
apply when an employer reimburses an
employee for employee business ex-
penses?
Q-6. What are the tax consequences to
an employee when an employer reim-
burses expenses under a nonaccountable
plan?
Q-7. What are the tax consequences to
an employee when an employer reim-
burses expenses under an accountable
plan?
SECTION 3. DEEMED
SUBSTANTIATION FOR RIG-
RELATED EXPENSES
Q-8. What is the amount of rig-related
expenses that can be deemed substanti-
ated under this revenue procedure?
Q-9. For what types of vehicles may
rig-related expenses be deemed substanti-
ated?
Q-10. May expenses be deemed sub-
stantiated for pickup trucks under this
revenue procedure?
Q-11. Are welding rigs and mechanics
rigs qualified nonpersonal use vehicles?
Q-12. For which employees may an
eligible employer deem rig-related
expenses substantiated under this revenue
procedure?
Q-13. Under what circumstances may
an eligible employer anticipate that an
employee would incur rig-related
expenses while performing services as an
employee for an eligible employer under
the deemed substantiation rule?
Q-14. Will the amount deemed sub-
stantiated under this revenue procedure
be adjusted for inflation?
Q-15. May an independent contractor
determine deductible expenses under this
revenue procedure?
SECTION 4. EMPLOYEE
TREATMENT OF RIG-RELATED
EXPENSES
Q-16. May an employee exclude from
income amounts reimbursed and deemed
substantiated under this revenue proce-
dure?
Q-17. May an employee claim deduc-
tions for rig-related expenses that exceed
amounts reimbursed under an account-
able plan or deemed substantiated under
this revenue procedure?
Q-18. May an employee treat pay-
ments made under a nonaccountable plan
as if they were made under an account-
able plan by voluntarily substantiating
expenses and returning any excess to the
employer?
Q-19. May an employee deduct any
rig-related expenses that exceed those
reimbursed by an employer and deemed
substantiated under this revenue proce-
dure on Schedule C, Profit or Loss From
Business?
Q-20. May an employee deduct any
rig-related expenses that exceed those
2002–23 I.R.B.1099June 10, 2002

reimbursed by an employer and deemed
substantiated under this revenue proce-
dure on Schedule E, Supplemental
Income and Loss?
Q-21. May an employee deduct
expenses that an eligible employer has
already reimbursed under an accountable
plan?
SECTION 5. SPECIAL RULES FOR
EMPLOYERS
Q-22. May an eligible employer estab-
lish an accountable plan to reimburse rig
welders or heavy equipment mechanics
for non-rig-related business expenses?
Q-23. May an eligible employer sub-
stitute a rig-related reimbursement for a
portion of wages otherwise payable to an
employee?
Q-24. What are the tax consequences
if an employer that uses the deemed sub-
stantiation rule in this revenue procedure
provides an additional reimbursement of
rig-related expenses?
SECTION 6. EFFECTIVE DATE
SECTION 7. REQUEST FOR
COMMENTS
SECTION 8. DRAFTING
INFORMATION
SECTION 1. PURPOSE AND SCOPE
Q-1. Must an employer use this rev-
enue procedure to reimburse employees
for rig-related expenses?
A-1. No. Use of the rule described in
this revenue procedure is not mandatory,
and an employer may, outside the scope
of this revenue procedure, reimburse
actual expenses under an arrangement
that meets the accountable plan require-
ments of§62(c) of the Internal Revenue
Code (Code) and regulations thereunder.
Alternatively, an employer may reimburse
employee business expenses under a non-
accountable plan (defined in Answer 6),
or may choose not to reimburse employee
business expenses.
Q-2. What is the tax treatment of
amounts deemed substantiated under
this revenue procedure?
A-2. If the other requirements
described in Answer 5 are satisfied, the
amounts substantiated in accordance with
this revenue procedure are treated as paid
under an accountable plan. Thus, the
amounts are not reported as wages on
Form W–2 and are exempt from the with-
holding and payment of income and
employment taxes. Also, no return of
information (e.g., Form 1099) is required
for payments made under an accountable
plan.§1.6041–3(h)(1).
Q-3. Which employers may use the
deemed substantiation rule provided in
this revenue procedure?
A-3. This substantiation rule may be
used by any“eligible employer.”An eli-
gible employer is any employer that hires
employee rig welders or heavy equipment
mechanics and requires, as a condition of
employment, that the rig welders and
heavy equipment mechanics provide a
welding rig or mechanics rig and use the
rig in performing services as an employee
employed in the construction, repair, or
maintenance of transportation mainline
pipeline. The business of transportation
mainline pipeline construction or repair
includes the construction, maintenance, or
repair of transportation mainline pipeline
up to the first metering station or connec-
tion. This includes mainline pipeline
whether it transports coal, gas, water, or
other transportable materials, vapors, or
liquids. The first metering station or con-
nection means the point where a valve,
consumer connection, or town border sta-
tion divides mainline transmission lines
or higher pressure lateral and branch lines
from lower pressure distribution systems.
Q-4. For which vehicles and equip-
ment may eligible employers use the
deemed substantiation rule provided in
this revenue procedure?
A-4. Eligible employers may use the
deemed substantiation rule in this revenue
procedure only to reimburse employees
for expenses related to the use of welding
rigs and mechanics rigs described in
Answer 9.
SECTION 2. BACKGROUND
Q-5. What provisions of the tax law
apply when an employer reimburses an
employee for employee business
expenses?
A-5. The tax rules that apply when an
employer reimburses an employee for
employee business expenses depend upon
whether the reimbursement is made under
an accountable plan or nonaccountable
plan. An accountable plan is a reimburse-
ment or other expense allowance arrange-
ment that meets three requirements under
§1.62–2: business connection, substantia-
tion, and return of amounts in excess of
substantiated expenses. The business con-
nection requirement is satisfied if the
arrangement provides advances, allow-
ances or reimbursements only for busi-
ness expenses allowable as deductions
under§§161–198 that are paid or
incurred by an employee (or that the
employer reasonably expects the
employee to incur) in connection with the
performance of services as an employee.
The substantiation requirement is satis-
fied if the arrangement requires each
business expense to be substantiated to
the employer within a reasonable period
of time. The return of excess requirement
is satisfied if the arrangement requires the
employee to return to the payor within a
reasonable period of time any amount
paid under the arrangement in excess of
the expenses substantiated. A nonaccount-
able plan is a reimbursement or other
expenses allowance arrangement that
does not satisfy one or more of the three
requirements.
Q-6. What are the tax consequences
to an employee when an employer reim-
burses expenses under a nonaccountable
plan?
A-6. Generally,§162(a) allows a
deduction for all the ordinary and neces-
sary expenses paid or incurred during the
taxable year in carrying on any trade or
business, including the trade or business
of being an employee. Under§1.62–
2(c)(5), amounts treated as paid under a
nonaccountable plan are included in the
employee’s gross income, must be
reported as wages on the employee’s
Form W–2, and are subject to withhold-
ing and payment of income and employ-
ment taxes (Federal Insurance Contribu-
tions Act (FICA), Federal Unemployment
Tax Act (FUTA), and income tax with-
holding).See alsoEmployment Tax
Regulations§§31.3121(a)–3 (FICA);
31.3306(b)–2 (FUTA); 31.3401(a)–4
(income tax withholding); and Income
Tax Regulation§1.6041–3(h)(1) (return
of information exemption) (for exemption
from reporting requirements for payments
made under an accountable plan before
January 1, 2001, see§1.6041–3(i)(1)).
The employee may still deduct the
expenses. However, those deductions may
June 10, 200211002002–23 I.R.B.

only be claimed as miscellaneous item-
ized deductions, which are limited by
§67 to the amount exceeding 2 percent of
adjusted gross income.
Q-7. What are the tax consequences
to an employee when an employer reim-
burses expenses under an accountable
plan?
A-7. Section 1.62–2(c)(4) provides
that amounts treated as paid under an
accountable plan are excluded from the
employee’s gross income, are not
reported as wages or other compensation
on the employee’s Form W–2, and are
exempt from the withholding and pay-
ment of income and employment taxes.
SECTION 3. DEEMED
SUBSTANTIATION FOR RIG-
RELATED EXPENSES
Q-8. What is the amount of rig-
related expenses that can be deemed
substantiated under this revenue proce-
dure?
A-8. If an eligible employer either pro-
vides fuel or separately reimburses fuel
expenses, expenses of up to $8 per hour
for welding rigs or mechanics rigs may be
deemed substantiated if the other require-
ments in this revenue procedure are met.
If an eligible employer does not provide
fuel or separately reimburse fuel
expenses, rig-related expenses of up to
$13 per hour for welding or mechanics
rigs may be deemed substantiated if the
other requirements in this revenue proce-
dure are met.
Q-9. For what types of vehicles may
rig-related expenses be deemed substan-
tiated?
A-9. Under this revenue procedure,
rig-related expenses may be deemed sub-
stantiated only with respect to welding
rigs and mechanics rigs. For purposes of
this revenue procedure, welding rigs are
¾ton or heavier trucks equipped with a
welding machine and other necessary
equipment, such as tanks and generators.
For purposes of this revenue procedure,
mechanics rigs are heavy trucks equipped
with a permanently installed mechanics
bed and other necessary equipment that is
used to repair and maintain heavy
machinery on a job site. As explained in
Answer 11, mechanics rigs and welding
rigs are qualified nonpersonal use
vehicles. The rule in this revenue proce-
dure is not available for any other
vehicles.
Q-10. May expenses be deemed sub-
stantiated for pickup trucks under this
revenue procedure?
A-10. No. Expenses for pickup trucks
may not be deemed substantiated as rig-
related expenses under this revenue pro-
cedure unless the pickup truck is part of a
welding rig as described in Answer 9.
(See Rev. Proc. 2001–54 for rules under
which the amount of ordinary and neces-
sary expenses of local travel or transpor-
tation incurred by an employee will be
deemed substantiated under§1.274–5
when an employer provides a mileage
allowance under an accountable plan.)
Q-11. Are welding rigs and mechanics
rigs qualified nonpersonal use vehicles?
A-11. Under the authority of§1.274–
5T(k)(2)(ii)(S), the Commissioner, solely
for purposes of applying the deemed sub-
stantiation rule in this revenue procedure,
designates the welding rigs and mechan-
ics rigs as described in Answer 9 as quali-
fied nonpersonal use vehicles.
Q-12. For which employees may an
eligible employer deem rig-related
expenses substantiated under this rev-
enue procedure?
A-12. An eligible employer may deem
rig-related expenses substantiated only
for employee rig welders and heavy
equipment mechanics who are required,
as a condition of employment, to provide
a welding or mechanics rig for use in pro-
viding personal services as an employee.
Q-13. Under what circumstances may
an eligible employer anticipate that an
employee would incur rig-related
expenses while performing services as
an employee for an eligible employer
under the deemed substantiation rule?
A-13. An eligible employer’s reim-
bursement will meet the business connec-
tion requirement of§1.62–2(d) if the eli-
gible employer reasonably anticipates that
the employee will incur rig-related
expenses in connection with the perfor-
mance of services for the employer. It
would not be reasonable for an eligible
employer to anticipate that an employee
would incur rig-related expenses for
hours that it actually knew the employ-
ee’s rig was not used (such as during a
work stoppage for inclement weather).
Q-14. Will the amount deemed sub-
stantiated under this revenue procedure
be adjusted for inflation?
A-14. Yes. For calendar years after
2003, the hourly rate will be adjusted
annually for inflation under§1(f)(3),
except that the base year for such adjust-
ment will be calendar year 2002 and no
adjustment will be made unless the
increase is at least one dollar. Any adjust-
ment will be rounded to the nearest dol-
lar. Any adjustment to the rates provided
in this revenue procedure will be pub-
lished annually.
Q-15. May an independent contractor
determine deductible expenses under
this revenue procedure?
A-15. No. Independent contractors
engaged in the trade or business of pro-
viding welding services or services as
heavy equipment mechanics may not use
the deemed substantiation method in this
revenue procedure to determine deduct-
ible expenses in their trade or business.
SECTION 4. EMPLOYEE
TREATMENT OF RIG-RELATED
EXPENSES
Q-16. May an employee exclude from
income amounts reimbursed and deemed
substantiated under this revenue proce-
dure?
A-16. Yes. This is true even if the
amounts reimbursed and deemed substan-
tiated exceed the actual rig-related
expenses. For example, assume an
employee incurs $20,000 in rig-related
expenses, and the employer reimburses
$20,800 at the $13 per hour rate for weld-
ing rigs provided under this revenue pro-
cedure. Because the reimbursement was
paid under an accountable plan, the entire
reimbursement is excluded from the
employee’s income.
Q-17. May an employee claim deduc-
tions for rig-related expenses that exceed
amounts reimbursed under an account-
able plan or deemed substantiated under
this revenue procedure?
A-17. Yes. To the extent employee
business expenses exceed those reim-
bursed under an accountable plan, they
may be claimed as miscellaneous item-
ized deductions on Schedule A. To do
this, the employee must report all reim-
bursed amounts, including those deemed
substantiated, and must offset expenses
on Form 2106.
2002–23 I.R.B.1101June 10, 2002

Q-18. May an employee treat pay-
ments made under a nonaccountable
plan as if they were made under an
accountable plan by voluntarily substan-
tiating expenses and returning any
excess to the employer?
A-18. No. An employee cannot create
an accountable plan. Under§1.62–
2(c)(3), if an employer provides a nonac-
countable plan, an employee who
receives payments under the plan cannot
compel the employer to treat the pay-
ments as paid under an accountable plan
by voluntarily substantiating the expenses
or returning any excess to the employer.
Q-19. May an employee deduct any
rig-related expenses that exceed those
reimbursed by an employer and deemed
substantiated under this revenue proce-
dure on Schedule C, Profit or Loss
From Business?
A-19. No. Expenses incurred in con-
nection with the trade or business of
being an employee may not be deducted
on Schedule C.
Q-20. May an employee deduct any
rig-related expenses that exceed those
reimbursed by an employer and deemed
substantiated under this revenue proce-
dure on Schedule E, Supplemental
Income and Loss?
A-20. No. Expenses incurred in con-
nection with the trade or business of
being an employee may not be deducted
on Schedule E.
Q-21. May an employee deduct
expenses that an eligible employer has
already reimbursed under an account-
able plan?
A-21. No.
SECTION 5. SPECIAL RULES FOR
EMPLOYERS
Q-22. May an eligible employer estab-
lish an accountable plan to reimburse
rig welders or heavy equipment mechan-
ics for non-rig-related business ex-
penses?
A-22. Yes. An employer may establish
a separate accountable plan to reimburse
non-rig-related employee business
expenses incurred by rig welders or heavy
equipment mechanics in addition to the
arrangement provided under this revenue
procedure. For example, Rev. Proc.
2001–47 provides rules under which an
employer may establish an accountable
plan for which the amount of ordinary
and necessary business expenses of an
employee for lodging, meal, and inciden-
tal expenses or for meal and incidental
expenses incurred while traveling away
from home will be deemed substantiated
under§1.274–54.
Q-23. May an eligible employer sub-
stitute a rig-related reimbursement for a
portion of wages otherwise payable to an
employee?
A-23. This revenue procedure is not
intended to permit the recharacterization
of wages otherwise payable to an
employee. For example, if an employer
normally pays an employee $35 per hour
in wages and does not provide a rig reim-
bursement in the event of inclement
weather, the employer may not recharac-
terize a portion of the $35 hourly wage
into rig reimbursement during inclement
weather. If an employer’s reimbursement
or other expenses allowance arrangement
evidences a pattern of abuse of the
accountable plan rules, then all payments
made under the arrangement will be
treated as paid under a nonaccountable
plan.
Q-24. What are the tax consequences
if an employer that uses the deemed sub-
stantiation rule in this revenue proce-
dure provides an additional reimburse-
ment of rig-related expenses?
A-24. If an employer that uses the
deemed substantiation rule separately
reimburses an employee for any rig-
related expenses, the additional payment
is treated as paid under a nonaccountable
plan. Thus, the additional payment is
reported as wages or other compensation
of the employee’s Form W–2, and is sub-
ject to withholding and payment of
income and employment taxes.
For example, employeeAis reim-
bursed for rig-related expenses deemed
substantiated under this revenue proce-
dure, andAincurs expenses for cleaning
the rig and an oil change. The employer
pays employeeAan additional $25 per
week to cover cleaning and the oil
change. Because the employer also pays a
rig reimbursement under this revenue
procedure, the $25 paid by the employer
is treated as paid under a nonaccountable
plan. Thus, the additional payment is
reported as wages or other compensation
of the employee’s Form W–2, and is sub-
ject to withholding and payment of
income and employment taxes.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective for
payments made on or after January 1,
2003.
SECTION 7. REQUEST FOR
COMMENTS
We welcome comments regarding this
revenue procedure. We specifically
request comments concerning other cat-
egories of qualified nonpersonal use
vehicles owned by employees and used
by the employees in the course of provid-
ing services as employees, especially
where the nature of an industry results in
employees working for multiple employ-
ers during each year, for which a deemed
substantiation rule would be appropriate.
Comments regarding this revenue pro-
cedure should be sent by September 9,
2002 in writing, and should reference
Rev. Proc. 2002–41. Comments can be
addressed to:
CC:ITA:RU (Rev. Proc. 2002–41),
room 5226
Internal Revenue Service
POB 7604, Ben Franklin Station
Washington, DC 20044
Comments also may be hand delivered
between the hours of 8 a.m. and 5 p.m.
to:
CC:ITA:RU (Rev. Proc. 2002–41)
Courier’s Desk
Internal Revenue Service
1111Constitution Avenue, NW
Washington, DC.
Alternatively, taxpayers may transmit
comments electronically via the following
e-mail address:
Notice.Comments@irscounsel.treas.gov
SECTION 8. DRAFTING
INFORMATION
The principal author of this revenue
procedure is Joe Spires of the Office of
the Division Counsel/Associate Chief
Counsel (Tax Exempt and Government
Entities), IRS. However, other personnel
from the IRS and Treasury Department
participated in its development. For fur-
ther information regarding this revenue
procedure, call Mr. Spires at (202) 622–
6040 (not a toll-free number).
June 10, 200211022002–23 I.R.B.

Part IV. Items of General Interest
Notice of Proposed
Rulemaking and Notice of
Public Hearing
Compensation Deferred
Under Eligible Deferred
Compensation Plans
REG–105885–99
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
and notice of public hearing.
SUMMARY: This document contains
proposed regulations that would provide
guidance on compensation deferred under
eligible section 457(b) deferred compen-
sation plans of state and local governmen-
tal and tax-exempt entities. The regula-
tions reflect the changes made to section
457 by the Tax Reform Act of 1986, the
Small Business Job Protection Act of
1996, the Taxpayer Relief Act of 1997,
the Economic Growth and Tax Relief
Reconciliation Act of 2001, the Job Cre-
ation and Worker Assistance Act of 2002,
and other legislation. The regulations
would also make various technical
changes and clarifications to the existing
final regulations on many discrete issues.
These regulations provide the public with
guidance necessary to comply with the
law and will affect plan sponsors, admin-
istrators, participants, and beneficiaries.
The document also provides a notice of
public hearing on these proposed regula-
tions.
DATES: Written and electronic comments
must be received by August 7, 2002.
Requests to speak and outlines of topics
to be discussed at the public hearing
scheduled for August 28, 2002, must be
received no later than August 7, 2002.
ADDRESSES: Send submissions to
CC:ITA:RU (REG–105885–99), room
5226, Internal Revenue Service, POB
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand
delivered between the hours of 8 a.m. and
5 p.m. to CC:ITA:RU (REG–105885–99),
Courier’s Desk, Internal Revenue Ser-
vice,1111Constitution Avenue, NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically
directly to the IRS Internet site at
www.irs.gov/regs. The public hearing will
be held in the IRS Auditorium, Internal
Revenue Building,1111 Constitution
Avenue, NW, Washington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, please
contact Cheryl Press, (202) 622–6060
(not a toll-free number). To be placed on
the attendance list for the hearing, please
contact LaNita Van Dyke at (202) 622–
7180 (not a toll-free number.)
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information in this
notice of proposed rulemaking has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number
1545–1580.
An agency may not conduct or spon-
sor, and a person is not required to
respond to, a collection of information
unless it displays a valid control number
assigned by the Office of Management
and Budget.
Books or records relating to the collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On September 23, 1982, final regula-
tions (T.D. 7836, 1982–2 C.B. 91) under
section 457 of the Internal Revenue Code
of 1954 (Code) were published in the
Federal Register(47 FR 42335 ) (Sep-
tember 27, 1982) (final regulations). The
final regulations provide guidance for
complying with the changes to the appli-
cable tax law made by the Revenue Act
of 1978 (92 Stat. 2779) relating to
deferred compensation plans maintained
by state and local governments and rural
electric cooperatives. These proposed
regulations would amend the final regula-
tions to conform them to the many
amendments made to section 457 by sub-
sequent legislation, including section
1107 of the Tax Reform Act of 1986
(TRA’86) (100 Stat. 2494), section 1404
of the Small Business Job Protection Act
of 1996 (SBJPA) (110 Stat. 1755) (1996),
section 1071 of the Taxpayer Relief Act
of 1997 (TRA’97) (111 Stat. 788) (1997),
sections 615, 631, 632, 634, 635, 641,
647, 649, and other sections of the Eco-
nomic Growth and Tax Relief Reconcilia-
tion Act of 2001 (EGTRRA) (115 Stat.
38) (2001), and paragraphs (o)(8) and
(p)(5) of section 411 of the Job Creation
and Worker Assistance Act of 2002 (116
Stat. 21) (2002). These proposed regula-
tions would also amend the final regula-
tions to provide additional guidance on
section 457 issues raised since the final
regulations were published in 1982. This
document also incorporates the guidance
provided in Notice 98–8, 1998–1 C.B.
355, with respect to amendments made to
section 457 by the SBJPA and TRA’97,
including the section 457(g) trust require-
ment for eligible plans of state and local
governments (eligible governmental
plans).
Explanation of Provisions
Overview
The proposed regulations would pro-
vide broad guidance regarding the rules
applicable to eligible deferred compensa-
tion plans described in section 457(b)
(eligible plans) and, in particular, provide
clear standards for the administration and
operation of eligible plans. The proposed
regulations would amend the existing
final regulations to update them for
changes in the law, including the many
changes made by EGTRRA, and respond
to the comments and inquiries received
from state and local governments and tax-
exempt employers that sponsor eligible
plans, from participants and beneficiaries,
and from service providers and other
advisors.
The proposed regulations at§§1.
457–1 through 1.457–3 include a general
overview of section 457, as applicable to
2002–23 I.R.B.1103June 10, 2002

both eligible plans and ineligible plans
that are subject to section 457(f), and
general definitional provisions. Specific
rules applicable to eligible plans are con-
tained in proposed§§1.457–4 through
1.457–10, while rules applicable to those
deferred compensation plans that fail to
satisfy the requirements applicable to eli-
gible plans (ineligible plans) are con-
tained in proposed§1.457–11.
1.General provisions and establishment
of eligible plans
Section 457, as amended by TRA’86,
applies to tax-exempt employers as well
as to state and local governments. Eli-
gible employers may maintain eligible
plans, which must satisfy the require-
ments of section 457(b) in both form and
operation, or may maintain ineligible
plans. Benefits under eligible plans are
excludable from income of plan partici-
pants until paid, in the case of an eligible
governmental plan, or, in the case of an
eligible plan of a tax-exempt employer,
until paid or made available. Benefits
under ineligible plans are, under section
457(f), includible in income when
deferred or, if later, when rights to the
benefits are not subject to a substantial
risk of forfeiture. Certain types of plans
of state and local government and tax-
exempt entities are not subject to section
457. These types are listed in the defini-
tion ofplanin proposed§1.457–2.
The proposed regulations make clear
that the requirements of section 457(b)
for eligible plans apply to both elective
contributions and to other types of contri-
butions, such as mandatory contributions,
nonelective employer contributions, and
employer matching contributions. Thus,
for example, proposed§1.457–2(b)
definesannual deferralsto include both
elective salary reduction contributions
and nonelective employer contributions.
Annual deferrals also include compensa-
tion deferred under eligible plans that are
defined benefit plans.
An eligible plan must satisfy the
requirements of section 457(b) and
related provisions both in form and in
operation. Under the proposed regula-
tions, an eligible plan must be established
in writing, must include all of the mate-
rial terms for benefits under the plan, and
must be operated in compliance with the
requirements reflected in the regulations.
Of course, plan sponsors retain flexibility
in determining whether to provide certain
design options permitted under section
457. For example, although these pro-
posed regulations permit certain
in-service distributions of smaller account
balances in accordance with section
457(e)(9), an eligible plan is not required
to offer participants this distribution
option. However, any optional features
incorporated into an eligible plan must
meet the requirements of section 457 and
the regulations in both form and opera-
tion.
All amounts deferred under an eligible
governmental plan are required to be set
aside in a trust, custodial account, or
annuity contract for the exclusive benefit
of participants and their beneficiaries.
However, under section 457(b)(6), all
amounts deferred under an eligible plan
of a tax-exempt employer are required to
be unfunded. This requirement for an eli-
gible plan of a tax-exempt employer does
not alter any provision of Title I of the
Employee Retirement Income Security
Act of 1974 (ERISA). Accordingly, an
eligible plan of a tax-exempt employer
may be subject to certain of the require-
ments of Title I.. In the case of an eligible
plan of a tax-exempt employer that is
subject to Title I of ERISA, compliance
with the exclusive purpose, trust, funding,
and certain other rules will cause the plan
to fail to satisfy section 457(b)(6). See
Q&A-25 of Notice 87–13, 1987–1 C.B.
432.
The proposed regulations include cer-
tain basic rules regarding the taxation of
contributions and benefits under ineli-
gible plans, especially the relationship
between deferred compensation under an
ineligible plan and property transfers to
which section 83 applies, but are not
intended to provide complete or compre-
hensive guidance under section 457(f).
Similarly, the proposed regulations refer
to, but do not provide specific guidance
on, certain arrangements that are not
treated as plans providing deferred com-
pensation, such asbona fideseverance
pay plans described in section 457(e)(11).
2.Annual deferrals, deferral limitations,
and deferral agreements under eligible
plans
a. Annual Deferrals
Proposed§1.457–4 sets forth rules
regarding deferrals under eligible plans
under section 457(b). The proposed regu-
lations would expand the rules contained
in the final regulations. Examples have
been included in order to illustrate the
application of the rules to specific cir-
cumstances and to address common ques-
tions and situations encountered in the
administration of eligible plans.
The proposed regulations use the term
annual deferralsto describe all amounts
contributed or deferred under an eligible
plan, whether by voluntary salary reduc-
tion contribution or by other employer
contribution, and all earnings thereon. If,
as is typical, amounts contributed to the
eligible plan are fully vested, the total of
amounts contributed to the eligible plan
during a taxable year is the same as the
total of the annual deferrals for the tax-
able year.
The proposed regulations would also
clarify that the rules concerning agree-
ments for deferrals operate on a cash
basis. Thus, under proposed§1.457–4(b),
an agreement to defer compensation is
valid if it is made before the first day of
the month in which compensation is paid
or made available. In general, there is no
requirement that the agreement be entered
into prior to the time the services giving
rise to the compensation are performed.
However, compensation payable in the
first month of employment may be
deferred only if an agreement is entered
into prior to the time a participant per-
forms services for the employer. The pro-
posed regulations provide explicitly that
nonelective employer contributions are
treated as being made under a valid
agreement. In addition, Rev. Rul. 2000–
33, 2000–2 C.B. 142, provides guidance
concerning automatic enrollment under
eligible plans. Contributions made under
an automatic enrollment arrangement
described in that Revenue Ruling may be
treated as made under a valid agreement.
June 10, 200211042002–23 I.R.B.

b. Deferral Limitations
Theproposedregulationsunder
§1.457–4 explain the annual limits that
apply to annual deferrals under eligible
plans. These contribution limits are some-
times referred to as“plan ceilings.”Gen-
erally, the basic annual limit or plan ceil-
ing for a year cannot exceed a specified
dollar amount for the year or, if less, 100
percent of a participant’s“includible
compensation.”Under EGTRRA, the dol-
lar amount is $11,000 for 2002; $12,000
for 2003; $13,000 for 2004; $14,000 for
2005; and $15,000 for 2006 and thereaf-
ter. After 2006, the $15,000 amount is
adjusted for cost-of-living. As a result of
the enactment of the Job Creation and
Worker Assistance Act of 2002, Public
Law 107–147 (116 Stat. 21) on March 9,
2002, the calculation of includible com-
pensation is no longer reduced by the
exclusions from gross income under sec-
tions 402(g), 125, 132(f), and 457. Thus,
for years beginning after December 31,
2001, includible compensation is no
longer reduced by elective deferrals to an
eligible plan. If a participant’s includible
compensation is less than the applicable
dollar limit, the dollar amount equal to
100 percent of includible compensation is
the basic annual limit for the participant.
An eligible plan may also permit cer-
tain“catch-up”contributions. First, in
accordance with section 414(v) as added
to the Code by EGTRRA, a plan may
allow a participant who attains age 50 by
the end of the year to elect to have an
additional deferral for the year. The addi-
tional amount permitted under this age 50
catch-up is $1,000 for 2002, $2,000 for
2003, $3,000 for 2004, $4,000 for 2005,
and $5,000 for 2006. Proposed regula-
tions (REG–142499–01, 2001–45 I.R.B.
476) under section 414(v) were published
in theFederal Registeron October 23,
2001 (66 FR 53555) as§1.414(v)–1.
Second, an eligible plan may permit a
larger catch-up amount in the last three
years ending before the participant attains
normal retirement age. The amount of
this special section 457 catch-up is two
times the basic annual limit (e.g., an addi-
tional $15,000 for 2006), but only to the
extent the participant has not previously
deferred the maximum amount under an
eligible plan or similar tax-deferred
retirement plan (called the underutilized
amount or underutilized limitation in the
proposed regulations). Alternatively, the
age 50 catch-up is available in the last
three years ending before the participant
attains normal retirement age if the age
50 catch-up amount is larger than the spe-
cial section 457 catch-up amount. Under
the proposed regulations, a participant
may not elect to have the special section
457 catch-up apply more than once,
unless the participant is covered by a plan
of another employer. If a participant also
or later participates in an eligible plan of
a different employer and otherwise meets
the requirements for limited catch-up, the
participant may elect under the new plan
to have the special section 457 catch-up
apply.
For purposes of the special section 457
catch-up, the proposed regulations pro-
vide that the plan must designate a nor-
mal retirement age between the age at
which participants have the right to
receive immediate retirement benefits
under the basic pension plan of the state
or tax-exempt entity without actuarial or
similar reduction and age 70½. Alterna-
tively, a plan may provide that a partici-
pant is allowed to designate a normal
retirement age within these ages. The pro-
posed regulations provide a special rule
for defining normal retirement age in eli-
gible plans of qualified police or firefight-
ersasdefinedundersection
415(b)(2)(H)(ii)(I), taking into account
that these participants are often eligible
for retirement at a younger age than other
workers.
The proposed regulations require an
eligible plan to set forth the plan’s normal
retirement age. However, as discussed in
this preamble underProposed Effective
Date, plan amendments to reflect this
requirement are not required to be
adopted until guidance is issued address-
ing when plan amendments must be
adopted.
3.Individual limitation for combined
annual deferrals under eligible plans
Before enactment of EGTRRA, a coor-
dination limitation applied under which
the basic annual limitation and the special
section 457 catch-up limitation were
reduced by amounts excluded from a par-
ticipant’s income for any taxable year by
reason of a salary reduction or elective
contribution under a section 401(k) plan
or a section 403(b) contract. EGTRRA
eliminated coordination with section
401(k) plans and section 403(b) contracts
for 2002 and thereafter. However, coordi-
nation with these types of arrangements is
still taken into account for purposes of
determining the underutilized amount for
years before 2002, so that these rules con-
tinue to be reflected in the proposed regu-
lations for that sole purpose.
EGTRRA did not eliminate section
457(c) under which the maximum amount
excludable under all eligible plans,
including eligible governmental plans and
eligible plans of a tax-exempt entity, can-
not exceed applicable section 457 plan
limitations. Thus, these limitations,
including the basic limitation, the age 50
catch-up limitation, and the special sec-
tion 457 catch-up limitation, apply not
only on a plan basis, but also on an indi-
vidual basis for cases in which an indi-
vidual participates in more than one eli-
gible plan during a taxable year. The
proposed regulations include rules for
how the applicable section 457 limita-
tions apply on an individual basis. The
rules for applying catch-up limits on an
individual basis provide that the special
section 457 catch-up available in the last
three years prior to normal retirement age
is taken into account only to the extent
that an annual deferral is made for a par-
ticipant under an eligible plan as a result
of plan provisions permitted under the
special section 457 catch-up and, if the
applicable catch-up amount is not the
same for each such eligible plan, the indi-
vidual limit is applied using the catch-up
amount under whichever plan that has the
largest catch-up amount applicable to the
participant. However, as discussed above,
a participant may not elect to have the
special section 457 catch-up apply more
than once, unless the participant is cov-
ered by a plan of another employer.
The proposed regulations allow an eli-
gible governmental plan to pay out an
annual deferral to the extent the deferral
exceeds the individual limit or to correct
a deferral in excess of the plan’s limit.
4.Sick and vacation pay deferrals
The proposed regulations would per-
mit an eligible plan to provide that a par-
ticipant may elect to defer accumulated
sick pay, accumulated vacation pay, and
2002–23 I.R.B.1105June 10, 2002

back pay if certain conditions are satis-
fied. In accordance with section
457(b)(4), the plan must provide that
these amounts may be deferred for any
calendar month only if an agreement pro-
viding for the deferral is entered into
before the beginning of the month in
which the amounts would otherwise be
paid or made available to the participant.
Thus, a participant is not permitted to
elect to receive the value of accumulated
sick and vacation pay on or after the date
on which the employer makes that pay
available to the participant in cash. Any
deferrals under an eligible plan of sick
and vacation pay or back pay are subject
to the maximum deferral limitations of
section 457 in the year of deferral. Thus,
the total amount deferred for any year
cannot exceed the plan ceiling for the
year, taking into account the 100 percent
of includible compensation limit.
5.Excess deferrals
The proposed regulations address the
treatment of excess deferrals and the
effect of excess deferrals on plan eligibil-
ity under section 457(b). The proposed
regulations also provide that an eligible
governmental plan may self correct
excess deferrals and will not fail to satisfy
the applicable requirements of the pro-
posed regulations (including the distribu-
tion rules and the funding rules) solely by
reason of a distribution of excess defer-
rals.
Under the proposed regulations, if an
excess deferral arises under the maximum
deferral limits of section 457(b) for a plan
of a governmental employer, an eligible
governmental plan is required to correct
the failure by distributing the excess
deferral to the participant, with allocable
net income, as soon as administratively
practicable after the plan determines that
the amount would be an excess deferral.
If excess deferrals of this type are not dis-
tributed, the plan will be an ineligible
plan with respect to which benefits are
taxed according to the rules of section
457(f). If an excess deferral arises under
the maximum deferral limits of section
457(b) for a plan of a tax-exempt
employer, the plan is not an eligible plan.
For purposes of these rules, all plans
under which an individual participates by
virtue of his or her relationship with a
single employer are treated as a single
plan.
As stated previously, while EGTRRA
repealed the coordination limitation under
section 457(c), EGTRRA did not elimi-
nate the requirement that the maximum
amount excludable under all eligible
plans under section 457(c) as revised by
EGTRRA, including eligible governmen-
tal plans and eligible plans of a tax-
exempt entity, cannot exceed the appli-
cable section 457(b) limitations. Thus, an
excess deferral that results from the appli-
cation of the new individual limitation for
multiple eligible plans under section
457(c) may also be, but is not required to
be, distributed to the participant. How-
ever, consistent with the legislative his-
tory to section 457(c), the proposed regu-
lations make clear that a plan will not
lose its status as an eligible plan by fail-
ing to distribute those excess deferrals
that result from the application of this
requirement (although those amounts are
currently includible in the participant’s
income).
Comments are specifically requested
concerning record-keeping requirements
with respect to excess deferrals that are
not distributed and, in particular, concern-
ing the maintenance of records adequate
to keep track of any previously taxed
excess deferrals that remain in an eligible
plan. In addition, comments are also
requested as to the proper income and
payroll tax reporting of distributions of
excess deferrals.
6.Minimum distribution requirements
EGTRRA eliminated the special mini-
mum distribution rules that applied to eli-
gible plans. Thus, the proposed regula-
tions generally incorporate by reference
the requirements of section 401(a)(9) and
the regulations thereunder concerning
minimum distributions to participants and
beneficiaries. Final and temporary regula-
tions (T.D. 8987, 2002–19 I.R.B. 852)
under section 401(a)(9) were published in
theFederal Registeron April 17, 2002
(67 FR 18988). These regulations provide
rules for defined benefit plans and
defined contribution plans. Generally, the
rules for defined contribution plans apply
to eligible deferred compensation plans.
Beginning in 2003, a simple uniform
table generally applies to all employees to
determine the minimum distribution
required during their lifetime, including
employees covered by an eligible
deferred compensation plan.
1
The one
exception to this rule for lifetime distribu-
tions is for an employee with a spouse
designated as the employee’s sole benefi-
ciary and the spouse is more than 10
years younger than the employee. In that
case the employee can use the employee
and spouse’s joint and last survivor
expectancy to determine the minimum
distribution required during the employ-
ee’s lifetime.
7.Loans
Proposed§1.457–6(f) sets forth rules
governing loans from eligible plans. This
proposal responds to the numerous inquir-
ies received concerning the availability of
loans from eligible plans maintained by
state and local governments, the assets of
which are held in trust pursuant to section
457(g).
While section 457(g) does not directly
address the issue of whether, or under
what circumstances, loans may be made
available from trusteed eligible plans, the
legislative history to the SBJPA indicates
that the new statutory provisions should
be interpreted as permitting participant
loans from the eligible plan trust under
the rules applicable to loans from quali-
fied plans. H.R. Rep. 104–737, at 251.
Commentators, some citing this legisla-
tive history and some citing pre-ERISA
case law and rulings interpreting the
exclusive benefit requirement of section
401(a), have urged the IRS to issue for-
mal guidance concerning loans from eli-
gible plans. These comments take the
position that the availability of loans will
make savings through eligible plans more
attractive to participants and will decrease
the disparity between eligible plans and
the other tax-favored voluntary retirement
savings plans.
1
Employees may use these new final regulations for distributions for 2002 or may use regulations proposed in 1987 or 2001.
June 10, 200211062002–23 I.R.B.

The pre-ERISA requirements appli-
cable to loans from qualified plans
require a facts and circumstances analysis
of the availability of the loan feature to
all participants, the rate of return, the
overall prudence of the investment of the
trust corpus in the note of an individual
participant, and the pattern of repay-
ments. See,e.g.,Central Motor Co. v.
United States, 583 F.2d 470, 488–491
(10th Cir. 1978);Winger’s Department
Store v. Commissioner, 82 T.C. 869
(1982);Ma-Tran Corp. v. Commissioner,
70 T.C. 158 (1978); andFeroleto Steel
Co. v. Commissioner, 69 T.C. 97 (1977).
See also Rev. Rul. 67–258 (1967–2CB
68).
Under the proposed regulations, a loan
from an unfunded eligible plan of a tax-
exempt organization would be treated as
an impermissible distribution, in violation
of the requirements of section 457. How-
ever, for loans from an eligible govern-
mental plan, the proposed regulations
include a facts and circumstances general
standard. This general standard is
intended to apply to determine whether
the loan isbona fideand for the exclusive
purpose of benefitting participants and
beneficiaries under section 457(g), as was
required under pre-ERISA law for quali-
fied plans. Among the facts and circum-
stances are whether the loan has a fixed
repayment schedule and a reasonable
interest rate, and whether there are repay-
ment safeguards to which a prudent
lender would adhere.
2
The proposed regu-
lations require a loan to bear a reasonable
rate of interest in order to satisfy the
requirement that assets and income of an
eligible governmental plan be held for the
exclusive benefit of participants and their
beneficiaries. The proposed regulations
would also clarify that section 72(p)
applies with respect to loans made under
an eligible governmental plan. Regula-
tions interpreting section 72(p)(2) are at
§1.72(p)–1.
If the proposed regulations are final-
ized in their current form, it is anticipated
that the IRS will modify its current
no-rule position regarding the issuance of
private letter rulings to eligible plans that
provide for loans.
8.Distributions from eligible plans
a. Eligible Governmental Plans
EGTRRA substantially altered the
taxation of distributions from an eligible
governmental plan by providing that
amounts held under such an eligible plan
are not included in a participant’s or ben-
eficiary’s gross income until distributed.
The proposed regulations would interpret
this EGTRRA change as applying to all
participants in an eligible governmental
plan. Thus, an eligible governmental plan
may permit participants who are currently
entitled to be paid after 2001 to change
their previously irrevocable payment
elections.
Under EGTRRA, after 2001, the direct
rollover rules applicable to qualified
plans and section 403(b) contracts will
apply to distributions from an eligible
governmental plan. The direct rollover
rules for qualified plans and section
403(b) contracts are generally explained
at§§35.3405–1, 31.3405(c)–1,
1.401(a)(31)–1, 1.402(c)–2, and
1.402(f)–1. These direct rollover regula-
tions have not been updated since
EGTRRA to reflect that rollovers are per-
mitted for distributions from eligible gov-
ernmental plans (nor do those regulations
reflect that amounts may be rolled over to
eligible governmental plans after 2001).
b. Eligible Plans of Tax-Exempt Entities
Amounts deferred under an eligible
plan of a tax-exempt entity continue to be
taxable when paid or made available. The
proposed regulations explain these rules,
including the exceptions for amounts
available in the event of unforeseeable
emergency and distributions of smaller
accounts (not in excess of $5,000).
9.Plan terminations and plan-to-plan
transfers
The proposed regulations address the
topic of plan terminations and plan-to-
plan transfers. These topics have become
increasingly important in light of the
recent statutory changes that impose a
trust requirement on eligible governmen-
tal plans. In particular, questions have
been raised with respect to hospitals and
other entities that change from govern-
ment to private entities, whether or not
tax-exempt. The direct rollovers that will
be permitted by EGTRRA beginning in
2002 for eligible governmental plans pro-
vide participants affected by these types
of events the ability to retain their retire-
ment savings in a funded, tax-deferred
savings vehicle by rollover to IRAs,
qualified plan, or section 403(b) con-
tracts. The proposed regulations provide a
blueprint for the different plan termina-
tion and plan-to-plan transfer alternatives
available to sponsors of eligible plans in
these situations.
a. Plan Terminations
The proposed regulations would allow
a plan to have provisions permitting plan
termination whereupon amounts could be
distributed without violating the distribu-
tion requirements of section 457. Under
the proposed regulations, an eligible plan
is terminated only if all amounts deferred
under the plan are paid to participants as
soon as administratively practicable. If
the amounts deferred under the plan are
not distributed, the plan is treated as a
frozen plan and must continue to comply
with all of the applicable statutory
requirements necessary for plan eligibil-
ity. The proposed regulations generally
follow the approach of Rev. Rul. 89–87,
1982–2 C.B. 81, which provides guidance
on the termination of qualified plans. In
that revenue ruling, a qualified plan under
which benefit accruals have ceased is not
terminated if assets of the plan remain in
the plan’s related trust rather than being
distributed as soon as administratively
feasible.
The proposed regulations also high-
light the consequences to the plan in the
case of an employer that ceases to be an
eligible employer but fails to terminate
the plan or to transfer its assets under the
rules of the proposed regulations
described below.
2
See, for example, the standards in Rev. Rul. 69–494, 1969–2 C.B. 88, for determining when plan investments are primarily for the purpose of benefitting employees or their beneficiaries.
2002–23 I.R.B.1107June 10, 2002

b. Plan-to-plan Transfers
The proposed regulations would
clarify that transfers between certain
types of eligible plans do not violate the
requirements of section 457(b), including
the distribution requirements of section
457(d), if certain conditions are satisfied.
Thus, an eligible governmental plan may
transfer its assets to another eligible gov-
ernmental plan; likewise, an unfunded,
tax-exempt plan may transfer amounts
deferred to another unfunded, tax-exempt
plan. However, in the same manner that
rollovers are not permitted between
unfunded plans of tax-exempt employers
and funded governmental plans (and
because of potential violations of the
exclusive benefit rule applicable to eli-
gible governmental plans), amounts can-
not be transferred from an eligible plan of
a tax-exempt employer to an eligible gov-
ernmental plan or from an eligible gov-
ernmental plan to an eligible plan of a
tax-exempt employer.
Plan-to-plan transfers within similar
types of eligible plans are permitted in
two kinds of circumstances. First, it is
contemplated that transfers may occur
when a participant in the transferor plan
terminates employment with the transf-
eror employer and is employed by the
transferee employer. Transfers with
respect to individual participants are per-
mitted if both plans agree to the transfer,
the participant has terminated employ-
ment with the transferor, and the partici-
pant whose amounts deferred are being
transferred will have an amount deferred
immediately after the transfer at least
equal to the amount deferred immediately
before the transfer.
Second, the proposed regulations also
contemplate certain asset transfers of all
amounts deferred under the plan in the
event an activity of a state or local gov-
ernment is privatized or otherwise ceases
to be performed by a governmental entity.
Thus, as an alternative to plan termination
or a plan-to-plan transfer, the proposed
regulations provide that a government
employer that loses its eligible status may
transfer the eligible plan to another eli-
gible government employer within the
same state. For example, a county hospi-
tal that maintains an eligible plan and that
ceases to be a governmental entity could
transfer the plan to the county for contin-
ued administration.
The proposed regulations also address
transfers between eligible governmental
plans and qualified defined benefit plans
with respect to past service credit.
Because the proposed regulations specifi-
cally state that a transfer for past service
credit is not treated as a distribution for
purposes of section 457, such a transfer
could be made while the participant is
still working.
10.Qualified domestic relations orders
The proposed regulations address the
issue of qualified domestic relations
orders (QDROs). The administration of
QDROs has created difficulties for eli-
gible employers and section 457 plan
administrators and participants, and
numerous inquiries and private letter rul-
ing requests involving the application of
judicial domestic relations orders to par-
ticipants’accounts in eligible section
457(b) deferred compensation plans have
been received. The proposed regulations
provide that an eligible plan may honor
the terms of a QDRO without jeopardiz-
ing its eligible status.
Under the proposed regulations, as
provided under section 457 as amended
by EGTRRA, an eligible plan does not
become an ineligible plan described in
section 457(f) solely because its adminis-
trator or sponsor complies with a QDRO
described in section 414(p) (taking into
account the special rule section
414(p)(11) for governmental and church
plans), including a QDRO requiring the
distribution of the benefits of a participant
to an alternate payee in advance of the
general rules for eligible plan distribu-
tions under§1.457–6. In the case of an
eligible governmental plan, amounts paid
to the alternate payee who is the spouse
or former spouse of a participant under
the QDRO are taxable to the alternate
payee when they are paid.
In the case of an eligible plan of a tax-
exempt entity, amounts payable to the
alternate payee who is the spouse or
former spouse of a participant under the
QDRO are taxable to the alternate payee
when they are paid or made available to
the alternate payee. In addition, amounts
deferred under an eligible plan of a tax-
exempt entity that are attributable to the
alternate payee are treated as made avail-
able on the date the alternate payee is first
able to receive a distribution.
11.Rollovers to eligible plans
EGTRRA now allows rollovers contri-
butions to be accepted by an eligible gov-
ernmental plan, but only if the receiving
eligible governmental plan maintains the
rollover amount in a separate account.
The proposed regulations include such
rollovers as part of the amount deferred
under the receiving plan, but a rollover
contribution is not taken into account as
an annual deferral under the plan for pur-
poses of the plan ceiling limit on annual
deferrals. While EGTRRA does not
require a separate account for each type
of rollover contributions (e.g., an account
for rollovers from qualified plans which
is separate from rollovers from section
403(b) contracts), comments are
requested on whether there are any spe-
cial characteristics applicable to qualified
plans, section 403(b) contracts, or indi-
vidual retirement arrangements (IRAs)
under section 72(t) (imposing an addi-
tional income tax on early distributions
from such plans, contracts, or arrange-
ments) which could be lost if multiple
types of separate accounts are not main-
tained.
12.Correction program for section
457(b) eligible deferred compensation
plans
Employee Plans, within the Office of
the Commissioner, Tax Exempt and Gov-
ernment Entities (TE/GE), has compre-
hensive correction programs for sponsors
of retirement plans (qualified retirement
plans, 403(b) plans, and Simplified
Employee Pensions). These programs,
including the Employee Plans Compli-
ance Resolution System (EPCRS), Rev.
Proc. 2001–17, 2001–1 C.B. 589, permit
plan sponsors to correct plan defects and
thereby continue to provide their employ-
ees retirement benefits on a tax-favored
basis. Employee Plans intends to expand
the provisions of EPCRS to include
appropriate correction procedures for cer-
tain failures arising under eligible
deferred compensation plans. The public
is invited to submit comments to assist in
the development of these procedures.
Comments should be sent to:
June 10, 200211082002–23 I.R.B.

Internal Revenue Service
Attention: T:EP:RA:VC
1111Constitution Avenue, NW
Washington, D.C. 20224
Pending the update of EPCRS, sub-
missions related to section 457 (b) eli-
gible deferred compensation plan failures
will be accepted by Employee Plans on a
provisional basis outside of EPCRS.
13.Ineligible plans
The proposed regulations include
guidance regarding ineligible plans under
section 457(f). Section 457(f) was in sec-
tion 457 when it was added to the Code
in 1978 for governmental employees, and
extended to employees of tax-exempt
organizations (other than churches or cer-
tain church-controlled organizations) in
1986, because unfunded amounts held by
a tax-exempt entity compound tax free
like an eligible plan, a qualified plan, or a
section 403(b) contract. Section 457(f)
was viewed as essential in order to pro-
vide an incentive for employers that are
not subject to income taxes to adopt an
eligible plan, a qualified plan, or a section
403(b) contract.
3
Section 457(f) generally
provides that, in the case of an agreement
or arrangement for the deferral of com-
pensation, the deferred compensation is
included in gross income when deferred
or, if later, when the rights to payment of
the deferred compensation cease to be
subject to a substantial risk of forfeiture.
Section 457(f) does not apply to an eli-
gible plan, a qualified plan, a section
403(b) contract, a section 403(c) contract,
a transfer of property described in section
83, a trust to which section 402(b)
applies, or a qualified governmental
excess benefit arrangement described in
section 415(m).
The proposed regulations reflect the
statutory changes in section 457(f) that
have been made since 1982—which is
when the current outstanding regulations
were issued—and clarify the interaction
between sections 457(f) and 83 (relating
to the transfer of property in connection
with the performance of services). Under
the proposed regulations, section 457(f)
does not apply to a transfer of property if
section 83 applies to the transfer. Further,
section 457(f) does not apply if the date
on which there is no substantial risk of
forfeiture with respect to the compensa-
tion is on or after the date on which there
is a transfer of property to which section
83 applies. However, section 457(f)
applies if the date on which there is no
substantial risk of forfeiture with respect
to the compensation deferred precedes the
date on which there is a transfer of prop-
erty to which section 83 applies. The pro-
posed regulations include several
examples, including an example illustrat-
ing that section 457(f) does not fail to
apply merely because benefits are subse-
quently paid by a transfer of property.
Comments are requested on the coordina-
tion of section 457(f) and section 83
under these proposed regulations.
In 2000, the IRS issued Announcement
2000–1, 2000–1 C.B. 294, in which it
provided interim guidance on certain
broad-based, nonelective plans of a state
or local government that were in exist-
ence before 1999. Comments are
requested on whether similar guidance
should be included in the final regula-
tions, and, if so, how the guidance should
apply to arrangements, such as those
maintained by certain state or local gov-
ernmental educational institutions, under
which supplemental compensation is pay-
able as an incentive to terminate employ-
ment, or as an incentive to retain
retirement-eligible employees, to ensure
an appropriate workforce during periods
in which a temporary surplus or deficit in
workforce is anticipated.
Proposed Effective Date
It is proposed that these regulations
apply generally for taxable years begin-
ning after December 31, 2001. This is the
general applicability date of the changes
made in section 457 by EGTRRA. Spe-
cial effective date provisions apply to
provisions relating to coordination of sec-
tions 457(f) and 83 and for qualified
domestic relations orders. Plan amend-
ments to reflect EGTRRA, and any other
requirement under these regulations, are
not required to be adopted until the later
of when guidance is issued addressing
when plan amendments must be adopted
or the date final regulations are issued.
However, employers may rely on these
proposed regulations in taxable years
beginning after August 20, 1996 (which is
the earliest applicability date for require-
ments applicable to eligible plans under
the SBJPA). Comments are requested on
whether an applicability date later than
taxable years beginning after December
31, 2001, should apply when the regula-
tions are issued in final form.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
also has been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply to
these regulations, and because the regula-
tions do not impose a collection of infor-
mation on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Internal Revenue Code, these pro-
posed regulations will be submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written or electronic
comments (a signed original and eight (8)
copies) that are submitted timely to the
IRS. The IRS and Treasury specifically
request comments on the clarity of the
proposed regulations and how they may
be made easier to understand. All com-
ments will be available for public inspec-
tion and copying.
A public hearing has been scheduled
for August 28, 2002, beginning at 10 a.m.
in the IRS Auditorium of the Internal
Revenue Building,1111 Constitution
Avenue, NW, Washington, DC. All visi-
tors must present photo identification to
enter the building. Because of access
restrictions, visitors will not be admitted
3
See generally theReport to the Congress on the Tax Treatment of Deferred Compensation under Section 457, Department of the Treasury, January 1992 (available from the Office of Tax
Policy, Room 5315, Treasury Department, 1500 Pennsylvania Avenue, NW, Washington DC 20220).
2002–23 I.R.B.1109June 10, 2002

beyond the immediate entrance more than
30 minutes before the hearing starts. For
information about having your name
placed on the building access list to
attend the hearing, see the“FOR FUR-
THER INFORMATION CONTACT”
section of this preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish to
present oral comments at the hearing
must submit written comments and an
outline of the topics to be discussed and
the time to be devoted to each topic
(signed original and eight (8) copies) by
August 7, 2002. A period of 10 minutes
will be allotted to each person for making
comments. An agenda showing the sched-
ule of speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Cheryl Press, Office of Division
Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities), IRS.
However, other personnel from the IRS
and Treasury Department participated in
their development.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PA RT 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805***
Par. 2. Sections 1.457–1, 1.457–2,
1.457–3, and 1.457–4 are revised to read
as follows:
§1.457–1 General overview of section
457.
Section 457 provides rules for non-
qualified deferred compensation plans
established by eligible employers as
defined under§1.457–2(d). Eligible
employers can establish either deferred
compensation plans that are eligible plans
and that meet the requirements of section
457(b) and§§1.457–3 through 1.457–10,
or deferred compensation plans or
arrangements that do not meet the
requirements of section 457(b) and
§§1.457–3 through 1.457–10 and that are
subject to tax treatment under section
457(f) and§1.457–11.
§1.457–2 Definitions.
This section sets forth the definitions
that are used under§§1.457–1 through
1.457–11.
(a)Amount(s) deferred.Amount(s)
deferredmeans the total annual deferrals
under an eligible plan in the current and
prior years, adjusted for gain or loss.
Except as otherwise specifically indi-
cated,amount(s) deferredincludes any
rollover amount held by an eligible plan
as provided under§1.457–10(e).
(b)Annual deferral(s)—(1)Annual
deferral(s)means, with respect to a tax-
able year, the amount of compensation
deferred under an eligible plan, whether
by salary reduction or by nonelective
employer contribution. The amount of
compensation deferred under an eligible
plan is taken into account as an annual
deferral in the taxable year of the partici-
pant in which deferred, or, if later, the
year in which the amount of compensa-
tion deferred is no longer subject to a
substantial risk of forfeiture.
(2) If the amount of compensation
deferred under the plan during a taxable
year is not subject to a substantial risk of
forfeiture, the amount taken into account
as an annual deferral is not adjusted to
reflect gain or loss allocable to the com-
pensation deferred. If, however, the
amount of compensation deferred under
the plan during the taxable year is subject
to a substantial risk of forfeiture, the
amount of compensation deferred that is
taken into account as an annual deferral
in the taxable year in which the substan-
tial risk of forfeiture lapses must be
adjusted to reflect gain or loss allocable
to the compensation deferred until the
substantial risk of forfeiture lapses.
(3) If the eligible plan is a defined ben-
efit plan within the meaning of section
414(j), the annual deferral for a taxable
year is the present value of the increase
during the taxable year of the partici-
pant’s accrued benefit that is not subject
to a substantial risk of forfeiture (disre-
garding any such increase attributable to
prior annual deferrals). For this purpose,
present value must be determined using
actuarial assumptions and methods that
are reasonable (both individually and in
the aggregate), as determined by the
Commissioner.
(c)Beneficiary.Beneficiarymeans a
beneficiary of a participant, a partici-
pant’s estate, or any other person whose
interest in the plan is derived from the
participant, including an alternate payee
as described in§1.457–10(c).
(d)Catch-up.Catch-upamount or
catch-uplimitation for a participant for a
taxable year means the annual deferral
permitted under section 414(v) (as
described in§1.457–4(c)(2)) or section
457(b)(3) (as described in§1.457–
4(c)(3)) to the extent the amount of the
annual deferral for the participant for the
taxable year is permitted to exceed the
plan ceiling applicable under section
457(b)(2) (as described in§1.457–
4(c)(1)).
(e)Eligible employer.Eligible em-
ployermeans an entity that is a state as
defined in paragraph (l) of this section
that establishes a plan or a tax-exempt
entity as defined in paragraph (m) of this
section that establishes a plan. The perfor-
mance of services as an independent con-
tractor for a state or local government or
a tax-exempt entity is treated as the per-
formance of services for an eligible
employer. The termeligible employer
does not include a church as defined in
section 3121(w)(3)(A), a qualified
church-controlled organization as defined
in section 3121(w)(3)(B), or the Federal
government or any agency or instrumen-
tality thereof.
(f)Eligible plan.Aneligible planis a
plan that meets the requirements of
§§1.457–3 through 1.457–10 that is
established and maintained by an eligible
employer. Aneligible governmental plan
is an eligible plan that is established and
maintained by an eligible employer as
defined in paragraph (l) of this section.
An arrangement does not fail to constitute
a single eligible governmental plan
merely because the arrangement is funded
through more than one trustee, custodian,
or insurance carrier. Aneligible plan of a
tax-exempt entityis an eligible plan that is
established and maintained by an eligible
employer as defined in paragraph (m) of
this section.
June 10, 200211102002–23 I.R.B.

(g)Includible compensation.Includ-
ible compensationof a participant means,
with respect to a taxable year, the partici-
pant’s compensation, as defined in section
415(c)(3), for services performed for the
eligible employer. The amount of includ-
ible compensation is determined without
regard to any community property laws.
(h)Ineligible plan.Ineligible plan
means a plan established and maintained
by an eligible employer that is not main-
tained in accordance with§§1.457–3
through 1.457–10. A plan that is not
established by an eligible employer as
defined in paragraph (e) of this section is
neither an eligible nor an ineligible plan.
(i)Nonelective employer contribution.
Anonelective employer contributionis a
contribution made by an eligible
employer for the participant with respect
to which the participant does not have the
choice to receive the contribution in cash
or property. Solely for purposes of section
457 and§§1.457–2 through 1.457–11,
the termnonelective employer contribu-
tionincludes employer contributions that
would be described in section 401(m) if
they were contributions to a qualified
plan.
(j)Participant.Participantin an eli-
gible plan means an individual who is
currently deferring compensation, or who
has previously deferred compensation
under the plan by salary reduction or by
nonelective employer contribution and
who has not received a distribution of his
or her entire benefit under the eligible
plan. Only individuals who perform ser-
vices for the eligible employer, either as
an employee or as an independent con-
tractor, may defer compensation under the
eligible plan.
(k)Plan.Planincludes any agreement
or arrangement between an eligible
employer and a participant or participants
under which the payment of compensa-
tion is deferred (whether by salary reduc-
tion or by nonelective employer contribu-
tion). The following types of plan are not
treated as agreements or arrangement
under which compensation is deferred: a
bona fidevacation leave, sick leave, com-
pensatory time, severance pay, disability
pay, or death benefit plan described in
section 457(e)(11)(A)(i) and any plan
paying length of service awards tobona
fidevolunteers (and their beneficiaries)
on account of qualified services per-
formed by such volunteers as described in
section 457(e)(11)(A)(ii). Further, the
termplandoes not include any of the fol-
lowing (and section 457 and§§1.457–2
through 1.457–11 do not apply to any of
the following)—
(1) Any nonelective deferred compen-
sation under which all individuals (other
than those who have not satisfied any
applicable initial service requirement)
with the same relationship with the eli-
gible employer are covered under the
same plan with no individual variations or
options under the plan as described in
section 457(e)(12), but only to the extent
the compensation is attributable to ser-
vices performed as an independent con-
tractor;
(2) An agreement or arrangement
described in§1.457–11(b);
(3) Any plan satisfying the conditions
in section 1107(c)(4) of the Tax Reform
Act of 1986 (TRA’86) (relating to certain
plans for state judges); and
(4) Any of the following plans or
arrangements (to which specific transi-
tional statutory exclusions apply)—
(i) A plan or arrangement of a tax-
exempt entity in existence prior to Janu-
ary 1, 1987, if the conditions of section
1107(c)(3)(B) of the TRA’86, as
amended by section 1011(e)(6) of Techni-
cal and Miscellaneous Revenue Act of
1988 (TAMRA), are satisfied;
(ii) A collectively bargained nonelec-
tive deferred compensation plan in effect
on December 31, 1987, if the conditions
of section 6064(d)(2) of TAMRA are sat-
isfied;
(iii) Amounts described in section
6064(d)(3) of TAMRA (relating to certain
nonelective deferred compensation
arrangements in effect before 1989); and
(iv) Any plan satisfying the conditions
in section 1107(c)(4) or (5) of TRA’86
(relating to certain plans for certain indi-
viduals with respect to which the Service
issued guidance before 1977).
(l)State.Stateincludes the 50 States
of the United States, the District of
Columbia, a political subdivision of a
state or the District of Columbia, or any
agency or instrumentality of a state or the
District of Columbia.
(m)Tax-exempt entity.Tax-exempt
entityincludes any organization (other
than a governmental unit) exempt from
tax under subtitle A of the Internal Rev-
enue Code.
(n)Trust.Trustmeans a trust described
under section 457(g) and§1.457–8. Cus-
todial accounts and contracts described in
section 401(f) are treated as trusts under
the rules described in§1.457–8(a)(2).
§1.457–3 General introduction to
eligible plans.
(a)Compliance in form and operation.
An eligible plan is a written plan estab-
lished and maintained by an eligible
employer that is maintained, in both form
and operation, in accordance with the
requirements of§§1.457–4 through
1.457–10. An eligible plan must contain
all the material terms and conditions for
benefits under the plan. An eligible plan
may contain certain optional features not
required for plan eligibility under section
457(b), such as distributions for unfore-
seeable emergencies, loans, plan-to-plan
transfers, additional deferral elections,
acceptance of rollovers to the plan, and
distributions of smaller accounts to eli-
gible participants. However, except as
otherwisespecificallyprovidedin
§§1.457–4 through 1.457–10, if an eli-
gible plan contains any optional provi-
sions, the optional provisions must meet,
in both form and operation, the relevant
requirements under section 457 and
§§1.457–2 through 1.457–10.
(b)Treatment as single plan.Inany
case in which multiple plans are used to
avoid or evade the requirements of
§§1.457–4 through 1.457–10, the Com-
missioner may apply the rules under
§§1.457–4 through 1.457–10 as if the
plans were a single plan.
§1.457–4 Annual deferrals, deferral
limitations, and deferral agreements
under eligible plans.
(a)Taxation of annual deferrals.
Annual deferrals that satisfy the require-
ments of paragraphs (b) and (c) of this
section are excluded from the gross
income of a participant in the year
deferred or contributed and are not
includible in gross income until paid to
the participant in the case of an eligible
2002–23 I.R.B.1111June 10, 2002

governmental plan, or until paid or other-
wise made available to the participant in
the case of an eligible plan of a tax-
exempt entity. See§1.457–7.
(b)Agreement for deferral. In order to
be an eligible plan, the plan must provide
that compensation may be deferred for
any calendar month by salary reduction
only if an agreement providing for the
deferral has been entered into before the
first day of the month in which the com-
pensation is paid or made available. A
new employee may defer compensation
payable in the calendar month during
which the participant first becomes an
employee if an agreement providing for
the deferral is entered into on or before
the first day on which the participant per-
forms services for the eligible employer.
An eligible plan may provide that if a
participant enters into an agreement pro-
viding for deferral by salary reduction
under the plan, the agreement will remain
in effect until the participant revokes or
alters the terms of the agreement. Non-
elective employer contributions are
treated as being made under an agreement
entered into before the first day of the
calendar month.
(c)Maximum deferral limitations—(1)
Basic annual limitation. (i) Except as
described in paragraphs (c)(2) and (3) of
this section, in order to be an eligible
plan, the plan must provide that the
annual deferral amount for a taxable year
(the plan ceiling) may not exceed the
lesser of—
(A) The applicable annual dollar
amount specified in section 457(e)(15):
$11,000 for 2002; $12,000 for 2003;
$13,000 for 2004; $14,000 for 2005; and
$15,000 for 2006 and thereafter. After
2006, the $15,000 amount is adjusted for
cost-of-living in the manner described in
paragraph (c)(4) of this section; or
(B) 100 percent of the participant’s
includible compensation for the taxable
year.
(ii) The amount of annual deferrals
permitted by the 100 percent of includible
compensation limitation under paragraph
(c)(1)(i)(B) of this section is determined
under section 457(e)(5) and§1.457–2(g).
(iii) For purposes of determining the
plan ceiling under this paragraph (c), the
annual deferral amount does not include
any rollover amounts received by the eli-
gible plan under§1.457–10(e).
(iv) The provisions of this paragraph
(c)(1) are illustrated by the following
examples:
Example 1. (i)Facts. Participant A, who earns
$14,000 a year, enters into a salary reduction agree-
ment in 2006 with A’s eligible employer and elects
to defer $13,000 of A’s compensation for that year.
Participant A is not eligible for the catch-up
described in paragraph (c)(2) or (3) of this section,
participates in no other retirement plan, and has no
other income exclusions taken into account in com-
puting includible compensation.
(ii)Conclusion. The annual deferral limit for A
in 2006 is the lesser of $15,000 or 100 percent of
includible compensation, $14,000. A’s annual defer-
ral of $13,000 is permitted under the plan because it
is not in excess of $14,000 and thus does not exceed
100 percent of A’s includible compensation.
Example 2. (i)Facts. Assume the same facts as
inExample 1, except that A’s eligible employer pro-
vides an immediately vested, matching employer
contribution under the plan for participants who
make salary reduction deferrals under A’s eligible
plan. The matching contribution is equal to 100 per-
cent of elective contributions, but not in excess of
10 percent of compensation (in A’s case, $1,400).
(ii)Conclusion. Participant A’s annual deferral
exceeds the limitations of this paragraph (c)(1). A’s
maximum deferral limitation in 2006 is $14,000. A’s
salary reduction deferral of $13,000 combined with
A’s eligible employer’s nonelective employer contri-
bution of $1,400 exceeds the basic annual limitation
of this paragraph (c)(1) because A’s annual deferrals
total $14,400. A has an excess deferral for the tax-
able year of $400, the amount exceeding A’s permit-
ted annual deferral limitation. The $400 excess
deferral is treated as described in paragraph (e) of
this section.
Example 3. (i)Facts. Beginning in year 2002,
Eligible Employer X contributes $3,000 per year for
five years to Participant B’s eligible plan account.
B’s interest in the account vests in 2006. B has
annual compensation of $50,000 in each of the five
years 2002 through 2006. Participant B is 41 years
old. B is not eligible for the catch-up described in
paragraph (c)(2) or (3) of this section, participates in
no other retirement plan, and has no other income
exclusions taken into account in computing includ-
ible compensation. Adjusted for gain or loss, the
value of B’s benefit when B’s interest in the account
vests in 2006 is $17,000.
(ii)Conclusion. Under this vesting schedule,
$17,000 is taken into account as an annual deferral
in 2006. B’s annual deferrals under the plan are lim-
ited to a maximum of $15,000 in 2006. Thus, the
aggregate of the amounts deferred, $17,000, is in
excess of the B’s maximum deferral limitation by
$2,000. The $2,000 is treated as an excess deferral
described in paragraph (e) of this section.
(2)Age 50 catch-up—(i)In general.In
accordance with section 414(v) and the
regulations thereunder, an eligible gov-
ernmental plan may provide for catch-up
contributions for a participant who is age
50 by the end of the year, provided that
such age 50 catch-up contributions do not
exceed the catch-up limit under section
414(v)(2) for the taxable year. The maxi-
mum amount of age 50 catch-up contribu-
tions for a taxable year under section
414(v) is as follows: $1,000 for 2002;
$2,000 for 2003; $3,000 for 2004; $4,000
for 2005; and $5,000 for 2006 and there-
after. After 2006, the $5,000 amount is
adjusted for cost-of-living. For additional
guidance, see regulations under section
414(v).
(ii)Coordination with special section
457 catch-up. In accordance with sections
414(v)(6)(C) and 457(e)(18), the age 50
catch-up described in this paragraph
(c)(2) does not apply for any taxable year
for which a higher limitation applies
under the special section 457 catch-up
under paragraph (c)(3) of this section.
Thus, for purposes of this paragraph
(c)(2)(ii) and paragraph (c)(3) of this sec-
tion, the special section 457 catch-up
under paragraph (c)(3) of this section
applies for any taxable year if and only if
the plan ceiling taking into account para-
graph (c)(1) and (3) of this section (and
disregarding the age 50 catch-up
described in this paragraph (c)(2)) is
larger than the plan ceiling taking into
account paragraph (c)(1) of this section
and the age 50 catch-up described in this
paragraph (c)(2) (and disregarding para-
graph (c)(3) of this section). Thus, a par-
ticipant who is eligible for the age 50
catch-up for a year and for whom the year
is also one of the participant’s last three
taxable years ending before the partici-
pant attains normal retirement age is
entitled to the larger of—
(A) The plan ceiling under paragraph
(c)(1) of this section and the age 50
catch-up described in this paragraph
(c)(2) (and disregarding paragraph (c)(3)
of this section) or
(B) The plan ceiling under paragraphs
(c)(1) and (3) of this section (and disre-
garding the age 50 catch-up described in
this paragraph (c)(2)).
(iii)Examples. The provisions of this
paragraph (c)(2) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. Participant C, who is 55, is
eligible to participate in an eligible governmental
plan in 2006. The plan provides a normal retirement
age of 65. The plan provides limitations on annual
deferrals up to the maximum permitted under para-
graphs (c)(1) and (3) of this section and the age 50
catch-up described in this paragraph (c)(2). For
2006, C will receive compensation of $40,000 from
the eligible employer. C desires to defer the maxi-
mum amount possible in 2006. The applicable basic
dollar limit of paragraph (c)(1)(i)(A) of this section
June 10, 200211122002–23 I.R.B.

is $15,000 for 2006 and the additional dollar amount
permitted under the age 50 catch-up is $5,000 for
2006.
(ii)Conclusion. C is eligible for the age 50
catch-up in 2006 because C is 55 in 2006. However,
C is not eligible for the special section 457 catch-up
under paragraph (c)(3) of this section in 2006
because 2006 is not one of the last three taxable
years ending before C attains normal retirement age.
Accordingly, the maximum that C may defer for
2006 is $20,000.
Example 2. (i)Facts. The facts are the same as
inExample 1, except that, in 2006, C will attain age
62. The maximum amount that C can elect under the
special section 457 catch-up under paragraph (c)(3)
of this section is $2,000 for 2006.
(ii)Conclusion. The maximum that C may defer
for 2006 is $20,000. This is the sum of the basic
plan ceiling under paragraph (c)(1) of this section
equal to $15,000 and the age 50 catch-up equal to
$5,000. The special section 457 catch-up under
paragraph (c)(3) of this section is not applicable
since it provides a smaller plan ceiling.
Example 3. (i)Facts. The facts are the same as
inExample 2, except that the maximum additional
amount that C can elect under the special section
457 catch-up under paragraph (c)(3) of this section
is $7,000 for 2006.
(ii)Conclusion. The maximum that C may defer
for 2006 is $22,000. This is the sum of the basic
plan ceiling under paragraph (c)(1) of this section
equal to $15,000, plus the additional special section
457 catch-up under paragraph (c)(3) of this section
equal to $7,000. The additional dollar amount per-
mitted under the age 50 catch-up is not applicable to
C for 2006 because it provides a smaller plan ceil-
ing.
(3)Special section 457 catch-up—(i)
In general. Except as provided in para-
graph (c)(2)(ii) of this section, an eligible
plan may provide that, for one or more of
the participant’s last three taxable years
ending before the participant attains“nor-
mal retirement age,”the plan ceiling is an
amount not in excess of the lesser of—
(A) Twice the dollar amount in effect
under paragraph (c)(1)(i)(A) of this sec-
tion; or
(B) The underutilized limitation deter-
mined under paragraph (c)(3)(ii) of this
section.
(ii)Underutilized limitation. The
underutilized amount determined under
this paragraph (c)(3)(ii) is the sum of—
(A) The plan ceiling established under
paragraph (c)(1) of this section for the
taxable year; plus
(B) The plan ceiling established under
paragraph (c)(1) of this section (or under
section 457(b)(2) for any year before the
applicability date of this section) for any
prior taxable year or years, less the
amount of annual deferrals under the plan
for such prior taxable year or years (dis-
regarding any annual deferrals under the
plan permitted under the age 50 catch-up
under paragraph (c)(2) of this section).
(iii)Determining underutilized limita-
tion under paragraph (c)(3)(ii)(B) of this
section. In determining the includible
compensation of a participant under
§1.457–2(g) for purposes of calculating
the amount described in paragraph
(c)(3)(ii)(A) of this section, includible
compensation is not reduced by contribu-
tions of amounts described in paragraph
(c)(3)(ii)(B) of this section. In addition, a
prior taxable year is taken into account
under paragraph (c)(3)(ii)(B) of this sec-
tion only if it is a year beginning after
December 31, 1978, in which the partici-
pant was eligible to participate in the
plan, and in which compensation deferred
(if any) under the plan during the year
was subject to a plan ceiling established
under paragraph (c)(1) of this section.
(iv)Special rules concerning applica-
tion of the coordination limit for years
prior to 2002 for purposes of determining
the underutilized limitation—(A)General
rule. For purposes of determining the
underutilized limitation for years prior to
2002, participants remain subject to the
rules in effect prior to the repeal of the
coordination limitation under section
457(c)(2). Thus, the applicable basic
annual limitation under paragraph (c)(1)
of this section and the special section 457
catch-up under this paragraph (c)(3) for
years in effect prior to 2002 are reduced,
for purposes of determining a partici-
pant’s underutilized amount under a plan,
by amounts excluded from the partici-
pant’s income for any prior taxable year
by reason of a salary reduction or elective
contribution under any other eligible sec-
tion 457(b) plan, section 401(k) qualified
cash or deferred arrangement, section
402(h)(1)(B) simplified employee pen-
sion (SARSEP), section 403(b) annuity
contract, and section 408(p) simple retire-
ment account, or under any plan for
which a deduction is allowed because of
a contribution to an organization
described in section 501(c)(18) (pre–2002
coordination plans). Similarly, in apply-
ing the section 457(b)(2)(B) limitation for
includible compensation for years prior to
2002, the limitation is 33 1/3 percent of
the participant’s compensation includible
in gross income.
(B)Coordination limitation applied to
participant. For purposes of determining
the underutilized limitation for years prior
to 2002, the coordination limitation
applies to pre-2002 coordination plans of
all employers for whom a participant has
performed services, not only to those of
the eligible employer. Thus, for purposes
of determining the amount excluded from
a participant’s gross income in any prior
taxable year under paragraph (c)(3)(ii)(B)
of this section, the participant’s annual
deferral under an eligible plan, and salary
reduction or elective deferrals under all
other pre-2002 coordination plans, must
be determined on an aggregate basis. To
the extent that the combined deferral for
years prior to 2002 exceeded the maxi-
mum deferral limitations, the amount is
treated as an excess deferral under para-
graph (e) of this section for those prior
years.
(C)Special rule where no annual
deferrals under the eligible plan. A par-
ticipant who, although eligible, did not
defer any compensation under the eligible
plan in any given year before 2002 is not
subject to the coordinated deferral limit,
even though the participant may have
deferred compensation under one of the
other pre-2002 coordination plans. An
individual is treated as not having
deferred compensation under an eligible
plan for a prior taxable year if all annual
deferrals under the plan are distributed in
accordance with paragraph (e) of this sec-
tion. Thus, to the extent that a participant
participated solely in one or more of the
other pre-2002 coordination plans during
a prior taxable year (and not the eligible
plan), the participant is not subject to the
coordinated limitation for that prior tax-
able year. However, the participant is
treated as having deferred amounts in a
prior taxable year for purposes of deter-
mining the underutilized limitation for
that prior taxable year under this para-
graph (c)(3)(iv)(C), but only to the extent
that the participant’s salary reduction con-
tributions or elective deferrals under all
pre-2002 coordination plans have not
exceeded the maximum deferral limita-
tions in effect under section 457(b) for
that prior taxable year. To the extent an
employer did not offer an eligible plan to
an individual in a prior given year, no
underutilized limitation is available to the
individual for that prior year, even if the
2002–23 I.R.B.1113June 10, 2002

employee subsequently becomes eligible
to participate in an eligible plan of the
employer.
(D)Examples. The provisions of this
paragraph (c)(3)(iv) are illustrated by the
following examples:
Example 1. (i)Facts. In 2001 and in years prior
to 2001, Participant D earned $50,000 a year and
was eligible to participate in both an eligible plan
and a section 401(k) plan. However, D had always
participated only in the section 401(k) plan and had
always deferred the maximum amount possible. For
each year before 2002, the maximum amount per-
mitted under section 401(k) exceeded the limitation
of paragraph (c)(3)(i) of this section. In 2002, D is
in the 3-year period prior to D’s attainment of the
eligible plan’s normal retirement age of 65, and D
now wants to participate in the eligible plan and
make annual deferrals of up to $30,000 under the
plan’s special section 457 catch-up provisions.
(ii)Conclusion. Participant D is treated as hav-
ing no underutilized amount under paragraph
(c)(3)(ii)(B) of this section for 2002 for purposes of
the catch-up limitation under section 457(b)(3) and
paragraph (c)(3) of this section because, in each of
the years before 2002, D has deferred an amount in
excess of the limitation of paragraph (c)(3)(i) of this
section.
Example 2. (i)Facts. Assume the same facts as
inExample 1, except that D only deferred $2,500
per year under the section 401(k) plan for one year
before 2002.
(ii)Conclusion. D is treated as having an
underutilized amount under paragraph (c)(3)(ii)(B)
of this section for 2002 for purposes of the special
section 457 catch-up limitation. This is because D
has deferred an amount for prior years that is less
than the limitation of paragraph (c)(1)(i) of this sec-
tion.
Example 3. (i)Facts. Participant E, who earned
$15,000 for 2000, entered into a salary reduction
agreement in 2000 with E’s eligible employer and
elected to defer $3,000 for that year. For 2000, E’s
eligible employer provided an immediately vested,
matching employer contribution under the plan for
participants who make salary reduction deferrals
under E’s eligible plan. The matching contribution
was equal to 100 percent of elective contributions,
but not in excess of 10 percent of compensation
before salary reduction deferrals (in E’s case,
$1,500). For 2000, E was not eligible for any
catch-up contribution, participated in no other retire-
ment plan, and had no other income exclusions
taken into account in computing taxable compensa-
tion.
(ii)Conclusion. Participant E’s annual deferral
exceeded the limitations of section 457(b) for 2000.
E’s maximum deferral limitation in 2000 was
$4,000 because E’s includible compensation was
$12,000 ($15,000 minus the deferral of $3,000) and
the applicable limitation for 2000 was one-third of
the individual’s includible compensation (one-third
of $12,000 equals $4,000). E’s salary reduction
deferral of $3,000 combined with E’s eligible
employer’s matching contribution of $1,500
exceeded the limitation of section 457(b) for 2000
because E’s annual deferrals totaled $4,500. E had
an excess deferral for 2000 of $500, the amount
exceeding E’s permitted annual deferral limitation,
and E’s underutilized amount for 2000 is zero.
(v)Normal retirement age—(A)Gen-
eral rule. For purposes of the special sec-
tion 457 catch-up in this paragraph (c)(3),
a plan must specify the normal retirement
age under the plan. A plan may define
normal retirement age as any age that is
on or after the earlier of age 65 or the age
at which participants have the right to
retire and receive, under the basic defined
benefit pension plan of the state or tax-
exempt entity, immediate retirement ben-
efits without actuarial or similar reduction
because of retirement before some later
specified age, and that is not later than
age 70½. Alternatively, a plan may pro-
vide that a participant is allowed to desig-
nate a normal retirement age within these
ages. For purposes of the special section
457 catch-up in this paragraph (c)(3), an
entity sponsoring more than one eligible
plan may not permit a participant to have
more than one normal retirement age
under the eligible plans it sponsors.
(B)Special rule for eligible plans of
qualified police or firefighters. An eli-
gible plan with participants that include
qualified police or firefighters as defined
under section 415(b)(2)(H)(ii)(I) may
designate a normal retirement age for
such qualified police or firefighters that is
earlier than the earliest normal retirement
age designated under the general rule of
paragraph (c)(3)(i)(A) of this section, but
in no event may the normal retirement
age be earlier than age 40. Alternatively,
a plan may allow a qualified police or
firefighter participant to designate a nor-
mal retirement age that is between age 40
and age 70½.
(vi)Examples. The provisions of this
paragraph (c)(3) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. ParticipantF, who will
turn 61 on April 1, 2006, becomes eligible to partici-
pate in an eligible plan on January 1, 2006. The plan
provides a normal retirement age of 65. The plan
provides limitations on annual deferrals up to the
maximum permitted under paragraphs (c)(1)
through (3) of this section. For 2006, F will receive
compensation of $40,000 from the eligible
employer. F desires to defer the maximum amount
possible in 2006. The applicable basic dollar limit of
paragraph (c)(1)(i)(A) of this section is $15,000 for
2006 and the additional dollar amount permitted
under the age 50 catch-up in paragraph (c)(2) of this
section for an individual who is at least age 50 is
$5,000 for 2006.
(ii)Conclusion. F is not eligible for the special
section 457 catch-up under paragraph (c)(3) of this
section in 2006 because 2006 is not one of the last
three taxable years ending before F attains normal
retirement age. Accordingly, the maximum that F
may defer for 2006 is $20,000. See also paragraph
(c)(2)(iii)Example 1of this section.
Example 2. (i)Facts. The facts are the same as
inExample 1except that, in 2006, F elects to defer
only $2,000 under the plan (rather than the maxi-
mum permitted amount of $20,000). In addition,
assume that the applicable basic dollar limit of para-
graph (c)(1)(i)(A) of this section continues to be
$15,000 for 2007 and the additional dollar amount
permitted under the age 50 catch-up in paragraph
(c)(2) of this section for an individual who is at least
age 50 continues to be $5,000 for 2007. In F’s tax-
able year 2007, which is one of the last three taxable
years ending before F attains the plan’s normal
retirement age of 65, F again receives a salary of
$40,000 and elects to defer the maximum amount
permissible under the plan’s catch-up provisions
prescribed under paragraph (c) of this section.
(ii)Conclusion. For 2007, which is one of the
last three taxable years ending before F attains the
plan’s normal retirement age of 65, the applicable
limit on deferrals for F is the larger of the amount
under the special section 457 catch-up or $20,000,
which is the basic annual limitation ($15,000) and
the age 50 catch-up limit of section 414(v) ($5,000).
For 2007, F’s special section 457 catch-up amount is
the lesser of two times the basic annual limitation
($30,000) or the sum of the basic annual limitation
($15,000) plus the $13,000 underutilized limitation
under paragraph (c)(3)(ii) of this section (the
$15,000 plan ceiling in 2006, minus the $2,000 con-
tributed for F in 2006), or $28,000. Thus, the maxi-
mum amount that F may defer in 2007 is $28,000.
Example 3. (i)Facts. The facts are the same as
inExamples 1and2, except that F does not make
any contributions to the plan before 2010. In addi-
tion, assume that the applicable basic dollar limita-
tion of paragraph (c)(1)(i)(A) of this section contin-
ues to be $15,000 for 2010 and the additional dollar
amount permitted under the age 50 catch-up in para-
graph (c)(2) of this section for an individual who is
at least age 50 continues to be $5,000 for 2010. In
F’s taxable year 2010, the year in which F attains
age 65 (which is the normal retirement age under
the plan), F desires to defer the maximum amount
possible under the plan. F’s compensation for 2010
is again $40,000.
(ii)Conclusion. For 2010, the maximum amount
that F may defer is $20,000. The special section 457
catch-up provisions under paragraph (c)(3) of this
section are not applicable because 2010 is not a tax-
able year ending before the year in which F attains
normal retirement age.
(4)Cost-of-living adjustment. For
years beginning after December 31, 2006,
the $15,000 dollar limitation in paragraph
(c)(1)(i)(A) of this section will be
adjusted to take into account increases in
the cost-of-living. The adjustment in the
dollar limitation is made at the same time
and in the same manner as under section
415(d) (relating to qualified plans under
section 401(a)), except that the base
period is the calendar quarter beginning
July 1, 2005, and any increase which is
June 10, 200211142002–23 I.R.B.

not a multiple of $500 will be rounded to
the next lowest multiple of $500.
(d)Deferral of sick, vacation, and
back pay under an eligible plan—(1)In
general. An eligible plan may provide
that a participant may elect to defer accu-
mulated sick pay, accumulated vacation
pay, and back pay under an eligible plan
if certain conditions are satisfied. The
plan must provide, in accordance with
paragraph (b) of this section, that these
amounts may be deferred for any calendar
month only if an agreement providing for
the deferral is entered into before the
beginning of the month in which the
amounts would otherwise be paid or
made available and the participant is an
employee in that month. Any deferrals
made under this paragraph (d)(1) under
an eligible plan are subject to the maxi-
mum deferral limitations of paragraph (c)
of this section.
(2)Examples. The provisions of this
paragraph (d) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. Participant G, age 62, is a
participant in an eligible plan providing a normal
retirement age of 65. Under the terms of G’s
employer’s eligible plan and G’s sick leave plan, G
may, during November of 2003 (which is one of the
three years prior to normal retirement age), make a
one-time election to contribute amounts representing
accumulated sick pay to the eligible plan in Decem-
ber of 2003 (within the maximum deferral limita-
tions). Alternatively, such amounts may remain in
the“bank”under the sick leave plan. No cash out of
the sick pay is available at any time prior to termi-
nation of employment. The total value of G’s accu-
mulated sick pay (determined, in accordance with
the terms of the sick leave plan, by reference to G’s
current salary) is $4,000 in December of 2003.
(ii)Conclusion. Under the terms of the eligible
plan and sick leave plan, G may elect before
December of 2003 to defer the $4,000 value of
accumulated sick pay under the eligible plan, pro-
vided that G’s other annual deferrals to the eligible
plan for 2003, when added to the $4,000, do not
exceed G’s maximum deferral limitation for the
year.
Example 2. (i)Facts. Employer X maintains an
eligible plan and a vacation leave plan. Under the
terms of the vacation leave plan, employees gener-
ally accrue three weeks of vacation per year. Up to
one week’s unused vacation may be carried over
from one year to the next, so that in any single year
an employee may have a maximum of four weeks
vacation time. At the beginning of each calendar
year, under the terms of the eligible plan (which
constitutes an agreement providing for the deferral),
the value of any unused vacation time from the prior
year in excess of one week is automatically contrib-
uted to the eligible plan, to the extent of the employ-
ee’s maximum deferral limitations. Amounts in
excess of the maximum deferral limitations are for-
feited.
(ii)Conclusion. The value of the unused vaca-
tion pay contributed to X’s eligible plan pursuant to
the terms of the plan and the terms of the vacation
leave plan is treated as an annual deferral to the eli-
gible plan in the calendar year the contribution is
made. No amounts contributed to the eligible plan
will be considered made available to a participant in
X’s eligible plan.
(e)Excess deferrals under an eligible
plan—(1)In general. Any amount
deferred under an eligible plan for the
taxable year of a participant that exceeds
the maximum deferral limitations set
forth in paragraphs (c)(1) through (3) of
this section, and any amount that exceeds
the individual limitation under§1.457–5,
constitutes an excess deferral taxable in
accordance with§1.457–11 for that tax-
able year. Thus, an excess deferral is
includible in gross income in the taxable
year deferred or, if later, the first taxable
year in which there is no substantial risk
of forfeiture.
(2)Excess deferrals under an eligible
governmental plan other than as a result
of the individual limitation. In order to be
an eligible governmental plan, the plan
must provide that any excess deferrals
resulting from a failure of a plan to apply
the limitations of paragraphs (c)(1)
through (3) of this section to amounts
deferred under the eligible plan (com-
puted without regard to the individual
limitation under§1.457–5) will be dis-
tributed to the participant, with allocable
net income, as soon as administratively
practicable after the plan determines that
the amount is an excess deferral. For pur-
poses of determining whether there is an
excess deferral resulting from a failure of
a plan to apply the limitations of para-
graphs (c)(1) through (3) of this section,
all plans under which an individual par-
ticipates by virtue of his or her relation-
ship with a single employer are treated as
a single plan. An eligible governmental
plan does not fail to satisfy the require-
ments of paragraphs (a) through (d) of
this section or§§1.457–6 through
1.457–10 (including the distribution rules
under§1.457–6 and the funding rules
under§1.457–8) solely by reason of a
distribution made under this paragraph
(e)(2). If such excess deferrals are not
corrected by distribution under this para-
graph (e)(2), the plan will be an ineligible
plan under which benefits are taxable in
accordance with§1.457–11.
(3)Excess deferrals under an eligible
plan of a tax-exempt employer other than
as a result of the individual limitation.If
a plan of a tax-exempt employer fails to
comply with the limitations of paragraphs
(c)(1) through (3) of this section, the plan
will be an ineligible plan under which
benefits are taxable in accordance with
§1.457–11. For purposes of determining
whether there is an excess deferral result-
ing from a failure of a plan to apply the
limitations of paragraphs (c)(1) through
(3) of this section, all plans under which
an individual participates by virtue of his
or her relationship with a single employer
are treated as a single plan.
(4)Excess deferrals arising from
application of the individual limitation.
An eligible plan may provide that an
excess deferral as a result of a failure to
comply with the individual limitation
under§1.457–5 for a taxable year may
be distributed to the participant, with allo-
cable net income, as soon as administra-
tively practicable after the plan deter-
mines that the amount is an excess
deferral. An eligible plan does not fail to
satisfy the requirements of paragraphs (a)
through (d) of this section or§§1.457–6
through 1.457–10 (including the distribu-
tion rules under§1.457–6 and the fund-
ing rules under§1.457–8) solely by rea-
son of a distribution made under this
paragraph (e)(4). Although a plan will
still maintain eligible status if excess
deferrals are not distributed under this
paragraph (e)(4), a participant must
include the excess amounts in income as
provided in paragraph (e)(1) of this sec-
tion.
(5)Examples. The provisions of this
paragraph (e) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. In 2006, the eligible plan
of State Employer X in which Participant H partici-
pates permits a maximum deferral of the lesser of
$15,000 or 100 percent of includible compensation.
In 2006, H, who has compensation of $28,000, nev-
ertheless defers $16,000 under the eligible plan. Par-
ticipant H is age 45 and normal retirement age under
the plan is age 65. For 2006, the applicable dollar
limit under paragraph (c)(1)(i)(A) of this section is
$15,000.
(ii)Conclusion. Participant H has deferred
$1,000 in excess of the $15,000 limitation provided
for under the plan for 2006. The $1,000 excess must
be included by H into H’s income for 2006. In order
to correct the failure and still be an eligible plan, the
plan must distribute the excess deferral, with allo-
cable net income, as soon as administratively prac-
ticable after determining that the amount exceeds
the plan deferral limitations. If the excess deferral is
not distributed, the plan will be an ineligible plan
2002–23 I.R.B.1115June 10, 2002

with respect to which benefits are taxable in accor-
dance with§1.457–11.
Example 2. (i)Facts. The facts are the same as
inExample 1, except that H’s deferral under the eli-
gible plan is limited to $11,000 and H also makes a
salary reduction contribution of $5,000 to an annu-
ity contract under section 403(b) with the same
Employer X.
(ii)Conclusion.H’s deferrals are within the plan
deferral limitations of Employer X. Because of the
repeal of the application of the coordination limita-
tion under former paragraph (2) of section 457(c),
H’s salary reduction deferrals under the annuity con-
tract are no longer considered in determining H’s
applicable deferral limits under paragraphs (c)(1)
through (3) of this section.
Example 3. (i)Facts. The facts are the same as
inExample 1, except that H’s deferral under the eli-
gible governmental plan is limited to $14,000 and H
also makes a deferral of $4,000 to an eligible gov-
ernmental plan of a different employer. Participant
H is age 45 and normal retirement age under both
eligible plans is age 65.
(ii)Conclusion. Because of the application of
the individual limitation under§1.457–5, H has an
excess deferral of $3,000 (the sum of $14,000 plus
$4,000 equals $18,000, which is $3,000 in excess of
the dollar limitation of $15,000). The $3,000 excess
deferral, with allocable net income, may be distrib-
uted from either plan as soon as administratively
practicable after determining that the combined
amount exceeds the deferral limitations. If the
$3,000 excess deferral is not distributed to H, each
plan will continue to be an eligible plan, but the
$3,000 must be included by H into H’s income for
2006.
Example 4. (i)Facts. Assume the same facts as
inExample 3, except that H’s deferral under the eli-
gible governmental plan is limited to $14,000 and H
also makes a deferral of $4,000 to an eligible plan
of Employer Y, a tax-exempt entity.
(ii)Conclusion. The results are the same as in
Example 3,i.e., because of the application of the
individual limitation under§1.457–5, H has an
excess deferral of $3,000. If the $3,000 excess
deferral is not distributed to H, each plan will con-
tinue to be an eligible plan, but the $3,000 must be
included by H into H’s income for 2006.
Par. 3. Sections 1.457–5 through
1.457–12 are added to read as follows:
§1.457–5 Individual limitation for
combined annual deferrals under
multiple eligible plans
(a)General rule. The individual limi-
tation under section 457(c) and this sec-
tion equals the basic annual deferral limi-
tation under§1.457–4(c)(1)(i)(A), the
age 50 catch-up amount under§1.457–
4(c)(2), and the special section 457
catch-up amount under§1.457–4(c)(3),
applied by taking into account the com-
bined annual deferral for the participant
for any taxable year under all eligible
plans. While an eligible plan may include
provisions under which it will meet the
individual limitation under section 457(c)
and this section, annual deferrals by a
participant that exceed the individual
limit under section 457(c) and this section
will not cause a plan to lose its eligible
status. However, to the extent the com-
bined annual deferrals for a participant
for any taxable year exceed the individual
limitation under section 457(c) and this
section for that year, the amounts are
treated as excess deferrals as described in
§1.457–4(e).
(b)Limitation applied to participant.
The individual limitation in this section
applies to eligible plans of all employers
for whom a participant has performed ser-
vices, including both eligible governmen-
tal plans and eligible plans of a tax-
exempt entity and both eligible plans of
the employer and eligible plans of other
employers. Thus, for purposes of deter-
mining the amount excluded from a par-
ticipant’s gross income in any taxable
year (including the underutilized limita-
tion under§1.457–4(c)(3)(ii)(B)), the
participant’s annual deferral under an eli-
gible plan, and the participant’s annual
deferrals under all other eligible plans,
must be determined on an aggregate
basis. To the extent that the combined
annual deferral amount exceeds the maxi-
mum deferral limitation applicable under
§1.457–4(c)(1)(i)(A), (c)(2), or (c)(3),
the amount is treated as an excess defer-
ral under§1.457–4(e).
(c)Special rules for catch-up amounts
under multiple eligible plans. For pur-
poses of applying section 457(c) and this
section, the special section 457 catch-up
under§1.457–4(c)(3) is taken into
account only to the extent that an annual
deferral is made for a participant under an
eligible plan as a result of plan provisions
permitted under§1.457–4(c)(3). In addi-
tion, if a participant has annual deferrals
under more than one eligible plan and the
applicablecatch-upamountunder
§1.457–4(c)(2) or (3) is not the same for
each such eligible plan for the taxable
year, section 457(c) and this section are
applied using the catch-up amount under
whichever plan has the largest catch-up
amount applicable to the participant.
(d)Examples. The provisions of this
section are illustrated by the following
examples:
Example 1. (i)Facts. Participant F is age 62 in
2006 and participates in two eligible plans during
2006, Plans J and K, which are each eligible plans
of two different governmental entities. Each plan
includes provisions allowing the maximum annual
deferral permitted under§1.457–4(c)(1) through
(3). For 2006, the underutilized amount under
§1.457–4(c)(3)(ii)(B) is $20,000 under Plan J and is
$40,000 under Plan K. Normal retirement age is age
65 under both plans. Participant F defers $15,000
under each plan. Participant F’s includible compen-
sation is in each case in excess of the deferral. Nei-
ther plan designates the $15,000 contribution as a
catch-up permitted under each plan’s special section
457 catch-up provisions.
(ii)Conclusion. For purposes of applying this
section to Participant F for 2006, the maximum
exclusion is $20,000. This is equal to the sum of
$15,000 plus $5,000, which is the age 50 catch-up
amount. Thus, F has an excess amount of $10,000
which is treated as an excess deferral for Participant
F for 2006 under§1.457–4(e).
Example 2. (i)Facts. Participant E, who will
turn 63 on April 1, 2006, participates in four eligible
plans during 2006: Plan W which is an eligible gov-
ernmental plan; and Plans X, Y, and Z which are
each eligible plans of three different tax-exempt
entities. For 2006, the limitation under these plans
that apply to Participant E under all four plans under
§1.457–4(c)(1)(i)(A) is $15,000. For 2006, the
additional age 50 catch-up limitation that applies to
Participant E under Plan W under§1.457–4(c)(2) is
$5,000. Further, for 2006, different limitations under
§§1.457–4(c)(3) and (c)(3)(ii)(B) apply to Partici-
pant E under each of these plans, as follows: under
Plan W, the underutilized limitation under§1.457–4
(c)(3)(ii)(B) is$7,000; under Plan X, the underuti-
lized limitation under§1.457–4(c)(3)(ii)(B) is
$2,000; under Plan Y, the underutilized limitation
under§1.457–4(c)(3)(ii)(B) is$8,000; and under
Plan Z,§1.457–4(c)(3) is not applicable since nor-
mal retirement age is age 62 under Plan Z. Partici-
pant E’s includible compensation is in each case in
excess of any applicable deferral.
(ii)Conclusion. For purposes of applying this
section to Participant E for 2006, Participant E
could elect to defer $23,000 under Plan Y, which is
the maximum deferral limitation under§§1.457–4
(c)(1) through (3), and to defer no amount under
Plans W, X, and Z. The $23,000 maximum amount
is equal to the sum of $15,000 plus $8,000, which is
the catch-up amount applicable to Participant E
under Plan Y and which is the largest catch-up
amount applicable to Participant E under any of the
four plans for 2006. Alternatively, Participant E
could instead elect to defer the following combina-
tion of amounts: $5,000 to Plan W and an aggregate
total of $15,000 to Plans X, Y, and Z; $22,000 to
Plan W and none to any of the other three plans;
$17,000 to Plan X and none to any of the other three
plans; or $15,000 to Plan Z and none to any of the
other three plans.
(iii) If the underutilized amount under Plans W,
X, and Y for 2006 were in each case zero (because
E had always contributed the maximum amount or
E was a new participant) or an amount not in excess
of $5,000, the maximum exclusion under this sec-
tion would be $20,000 for Participant E for 2006
($15,000 plus the $5,000 age 50 catch-up amount),
which Participant E could contribute to Plan W.
June 10, 200211162002–23 I.R.B.

§1.457–6 Timing of distributions under
eligible plans.
(a)In general. Except as provided in
paragraph (c) of this section (relating to
distributions on account of an unforesee-
able emergency), paragraph (e) of this
section (relating to distributions of small
accounts),§1.457–10(a) (relating to plan
terminations), or§1.457–10(c) (relating
to domestic relations orders), amounts
deferred under an eligible governmental
plan may not be paid to a participant or
beneficiary before the participant has a
severance from employment with the eli-
gible employer. For rules relating to
loans, see paragraph (f) of this section.
(b)Severance from employment—(1)
Employees. An employee has a severance
from employment with the eligible
employer if the employee dies, retires, or
otherwise has a severance from employ-
ment with the eligible employer.
(2)Independent contractors—(i)In
general. An independent contractor is
considered to have a severance from
employment with the eligible employer
upon the expiration of the contract (or in
the case of more than one contract, all
contracts) under which services are per-
formed for the eligible employer, if the
expiration constitutes a good-faith and
complete termination of the contractual
relationship. An expiration does not con-
stitute a good faith and complete termina-
tion of the contractual relationship if the
eligible employer anticipates a renewal of
a contractual relationship or the indepen-
dent contractor becoming an employee.
For this purpose, an eligible employer is
considered to anticipate the renewal of
the contractual relationship with an inde-
pendent contractor if it intends to again
contract for the services provided under
the expired contract, and neither the eli-
gible employer nor the independent con-
tractor has eliminated the independent
contractor as a possible provider of ser-
vices under any such new contract. Fur-
ther, an eligible employer is considered to
intend to again contract for the services
provided under an expired contract if the
eligible employer’s doing so is condi-
tioned only upon incurring a need for the
services, the availability of funds, or both.
(ii)Special rule. Notwithstanding
paragraph (b)(2)(i) of this section, the
plan is considered to satisfy the require-
ment described in paragraph (a) of this
section that no amounts deferred under
the plan be paid or made available to the
participant before the participant has a
severance from employment with the eli-
gible employer, if, with respect to
amounts payable to a participant who is
an independent contractor, an eligible
plan provides that—
(A) No amount will be paid to the par-
ticipant before a date at least 12 months
after the day on which the contract
expires under which services are per-
formed for the eligible employer (or, in
the case of more than one contract, all
such contracts expire); and
(B) No amount payable to the partici-
pant on that date will be paid to the par-
ticipant if, after the expiration of the con-
tract (or contracts) and before that date,
the participant performs services for the
eligible employer as an independent con-
tractor or an employee.
(c)Rules applicable to distributions
for unforeseeable emergencies—(1)In
general. An eligible plan may permit a
distribution to a participant or beneficiary
faced with an unforeseeable emergency.
The distribution must satisfy the require-
ment of paragraph (c)(2) of this section.
(2)Requirements—(i)Unforeseeable
emergency defined. An unforeseeable
emergency must be defined in the plan as
a severe financial hardship of the partici-
pant or beneficiary resulting from an ill-
ness or accident of the participant or ben-
eficiary, the participant’s or beneficiary’s
spouse or the participant’s or beneficia-
ry’s dependent (as defined in section
152(a)); loss of the participant’s or ben-
eficiary’s property due to casualty; or
other similar extraordinary and unforesee-
able circumstances arising as a result of
events beyond the control of the partici-
pant or the beneficiary. For example, the
imminent foreclosure of or eviction from
the participant’s or beneficiary’s primary
residence may constitute an unforeseeable
emergency. In addition, the need to pay
for medical expenses, including non-
refundable deductibles, as well as for the
cost of prescription drug medication, may
constitute an unforeseeable emergency.
Finally, the need to pay for the funeral
expenses of a family member may also
constitute an unforeseeable emergency.
Except in extraordinary circumstances,
the purchase of a home and the payment
of college tuition are not unforeseeable
emergencies under this paragraph (c)(2).
(ii)Unforeseeable emergency distribu-
tion standard. Whether a participant or
beneficiary is faced with an unforeseeable
emergency permitting a distribution under
this paragraph (c) is to be determined
based on the relevant facts and circum-
stances of each case, but, in any case, a
distribution on account of unforeseeable
emergency may not be made to the extent
that such emergency is or may be relieved
through reimbursement or compensation
from insurance or otherwise; by liquida-
tion of the participant’s assets, to the
extent the liquidation of such assets
would not itself cause severe financial
hardship; or by cessation of deferrals
under the plan.
(iii)Distribution necessary to satisfy
emergency need. Distributions because of
an unforeseeable emergency must be lim-
ited to the amount reasonably necessary
to satisfy the emergency need (which may
include any amounts necessary to pay any
federal, state, or local income taxes or
penalties reasonably anticipated to result
from the distribution).
(d) Minimum required distributions for
eligible plans. In order to be an eligible
plan, a plan must meet the distribution
requirements of section 457(d)(1) and (2).
Under section 457(d)(2), a plan must
meet the minimum distribution require-
ments of section 401(a)(9). See section
401(a)(9) and the regulations thereunder
for these requirements. Section 401(a)(9)
requires that a plan begin lifetime distri-
butions to a participant no later than April
1 of the calendar year following the later
of the calendar year in which the partici-
pant attains age 70½or the calendar year
in which the participant retires.
(e)Distributions of smaller acc-
ounts—(1)In general. An eligible plan
may provide for a distribution of all or a
portion of a dollar amount which is not
attributable to rollover contributions (as
defined in section 411(a)(11)(D)). In
order to permit such a distribution, an eli-
gible plan must provide that the amount
of the distribution must not exceed the
dollar limit under section 411(a)(11)(A)
(which is $5,000 for 2002) and that the
distribution is made only if no amount
has been deferred under the plan by or for
the participant during the two-year period
ending on the date of the distribution and
2002–23 I.R.B.1117June 10, 2002

there has been no prior distribution under
the plan to the participant under this para-
graph (e). An eligible plan is not required
to permit distributions under this para-
graph (e).
(2)Alternative provisions possible.
Consistent with the provisions of para-
graph (e)(1) of this section, a plan may
provide that the total amount deferred for
a participant or beneficiary, if not in
excess of the applicable dollar limit of
section 411(a)(11)(A), will be distributed
automatically to the participant or benefi-
ciary if the requirements of paragraph
(e)(1) of this section are met. Alterna-
tively, the plan may provide for the total
amount deferred for a participant or ben-
eficiary, if not in excess of the applicable
dollar limit of section 411(a)(11)(A), to
be distributed to the participant or benefi-
ciary only if the participant or beneficiary
so elects. The plan is permitted to substi-
tute a specified dollar amount that is less
than the applicable dollar limit of section
411(a)(11)(A) under either of these alter-
natives. In addition, these two alternatives
can be combined; for example, a plan
could provide for automatic distributions
for account balances totaling an amount
not in excess of the applicable dollar limit
of section 411(a)(11)(A) but allow partici-
pants or beneficiary to elect a distribution
if the total account balance is above $500
but not above the applicable dollar limit
of section 411(a)(11)(A).
(f)Loans from eligible plans—(1)Eli-
gible plans of tax-exempt entities.Ifa
participant or beneficiary receives
(directly or indirectly) any amount
deferred as a loan from an eligible plan of
a tax-exempt entity, that amount will be
treated as having been paid or made
available to the individual as a distribu-
tion under the plan, in violation of the
distribution requirements of section
457(d).
(2)Eligible governmental plans. The
determination of whether the availability
of a loan, the making of a loan, or a fail-
ure to repay a loan made from a trustee
(or a person treated as a trustee under sec-
tion 457(g)) of an eligible governmental
plan to a participant or beneficiary is
treated as a distribution (directly or indi-
rectly) for purposes of this section, and
the determination of whether the avail-
ability of the loan, the making of the loan,
or a failure to repay the loan is in any
other respect a violation of the require-
ments of section 457(b) and the regula-
tions, depends on the facts and circum-
stances. Thus, for example, a loan must
bear a reasonable rate of interest in order
to satisfy the exclusive benefit require-
ment of section 457(g)(1) and§1.457–
8(a)(1). See also§1.457–7(b)(3) relating
to the application of section 72(p) with
respect to the taxation of a loan made
under an eligible governmental plan, and
§1.72(p)–1 relating to section 72(p)(2).
(3)Example. The provisions of para-
graph (f)(2) of this section are illustrated
by the following example:
Example. (i)Facts. Eligible Plan X of State Y is
funded through Trust Z. Plan X provides for an
employee’s account balance under Plan X to be paid
in 5 annual installments (of 1/5th the account bal-
ance the first year, 1/4th the account balance the
second year, etc.) beginning at severance from
employment with State Y. Plan X includes a loan
program under which any active employee with a
vested account balance may receive a loan from
Trust Z. Loans are made pursuant to plan provisions
regarding loans that are set forth in the plan under
which loans bear a reasonable rate of interest and
are secured by the employee’s account balance. In
order to avoid taxation under§1.457–7(b)(3) and
section 72(p)(1), the plan provisions limit the
amount of loans and require loans to be repaid in
level installments as required under section
72(p)(2). Participant J’s vested account balance
under Plan X is $50,000. J receives a loan from
Trust Z in the amount of $5,000 on December 1,
2003 to be repaid in level installments made quar-
terly over the 5-year period ending on November
30, 2008. Participant J makes the required repay-
ments until J has a severance from employment
from State Y in 2005 and subsequently fails to repay
the outstanding loan balance of $2,250. The $2,250
loan balance is offset against J’s $80,000 account
balance benefit under Plan X, and J is paid one fifth
of the remaining $77,750 in 2005.
(ii)Conclusion. The making of the loan to J will
not be treated as a violation of the requirements of
section 457(b) or the regulations. The cancellation
of the loan at severance from employment does not
cause Plan X to fail to satisfy the requirements for
plan eligibility under section 457. In addition,
because the loan satisfies the maximum amount and
repayment requirements of section 72(p)(2), J is not
required to include any amount in income as a result
of the loan until 2005, when J has income of $2,250
as a result of the offset (which is a permissible dis-
tribution under this section) and income of $15,550
(one fifth of $77,750) as a result of the first annual
installment payment.
§1.457–7 Taxation of distributions under
eligible plans.
(a)General rules for when amounts
are included in gross income. The rules
for determining when an amount deferred
under an eligible plan is includible in the
gross income of a participant or benefi-
ciary depend on whether the plan is an
eligible governmental plan or an eligible
plan of a tax-exempt entity. Paragraph (b)
of this section sets forth the rules for an
eligible governmental plan. Paragraph (c)
of this section sets forth the rules for an
eligible plan of a tax-exempt entity.
(b)Amounts included in gross income
under an eligible governmental plan—(1)
Amounts included in gross income in year
paid under an eligible governmental plan.
Except as provided in paragraphs (b)(2)
and (3) of this section (or in§1.457–
10(c) relating to payments to a spouse or
former spouse pursuant to a qualified
domestic relations order), amounts
deferred under an eligible governmental
plan are includible in the gross income of
a participant or beneficiary for the taxable
year in which paid to the participant or
beneficiary under the plan.
(2)Rollovers to individual retirement
arrangements and other eligible retire-
ment plans. A trustee-to-trustee transfer in
accordance with section 401(a)(31) (gen-
erally referred to as a direct rollover) is
not includible in gross income of a par-
ticipant or beneficiary in the year trans-
ferred. In addition, any payment made in
the form of an eligible rollover distribu-
tion (as defined in section 402(c)(4)) is
not includible in gross income in the year
paid to the extent the payment is trans-
ferred to an eligible retirement plan (as
defined in section 402(c)(8)(B)) within 60
days, including the transfer to the eligible
retirement plan of any property distrib-
uted from the eligible governmental plan.
For this purpose, the rules of section
402(c)(2) through (7) and (9) apply. Any
trustee-to-trustee transfer under this para-
graph (b)(2) is a distribution that is sub-
ject to the distribution requirements of
§1.457–6.
(3)Amounts taxable under section
72(p)(1). In accordance with section
72(p), the amount of any loan from an
eligible governmental plan to a partici-
pant or beneficiary (including any pledge
June 10, 200211182002–23 I.R.B.

or assignment treated as a loan under sec-
tion 72(p)(1)(B)) is treated as having been
received as a distribution from the plan
under section 72(p)(1), except to the
extent set forth in section 72(p)(2) (relat-
ing to loans that do not exceed a maxi-
mum amount and that are repayable in
accordance with certain terms) and
§1.72(p)–1. Thus, except to the extent a
loan satisfies section 72(p)(2), any
amount loaned from an eligible govern-
mental plan to a participant or beneficiary
(including any pledge or assignment
treated as a loan under section
72(p)(1)(B)) is includible in the gross
income of the participant or beneficiary
for the taxable year in which the loan is
made. See generally§1.72(p)–1.
(4)Examples. The provisions of this
paragraph (b) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. Eligible Plan G of a gov-
ernmental entity permits distribution of benefits in a
single sum or in installments of up to 20 years, with
such benefits to commence at any date that is after
severance from employment (but not later than the
plan’s normal retirement age of 65). Effective for
participants who have a severance from employment
after December 31, 2001, Plan X allows an
election—as to both the date on which payments are
to begin and the form in which payments are to be
made—to be made by the participant at any time
that is before the commencement date selected.
However, Plan X chooses to require elections to be
filed at least 30 days before the commencement date
selected in order for Plan X to have enough time to
be able to effectuate the election.
(ii)Conclusion. No amounts are included in
gross income before actual payments begin. If
installment payments begin (and the installment
payments are payable over at least 10 years so as
not to be eligible rollover distributions), the amount
included in gross income for any year is equal to the
amount of the installment payment paid during the
year.
Example 2. (i)Facts. Same facts as inExample
1, except that the same rules are extended to partici-
pants who had a severance from employment before
January 1, 2002.
(ii)Conclusion. For all participants (i.e., both
those who have a severance from employment after
December 31, 2001, and those who have a sever-
ance from employment before January 1, 2002
(including those whose benefit payments have com-
menced before January 1, 2002)), no amounts are
included in gross income before actual payments
begin. If installment payments begin (and the
installment payments are payable over at least 10
years so as not to be eligible rollover distributions),
the amount included in gross income for any year is
equal to the amount of the installment payment paid
during the year.
(c)Amounts included in gross income
under an eligible plan of a tax-exempt
entity—(1)Amounts included in gross
income in year paid or made available
under an eligible plan of a tax-exempt
entity. Amounts deferred under an eligible
plan of a tax-exempt entity are includible
in the gross income of a participant or
beneficiary for the taxable year in which
paid or otherwise made available to the
participant or beneficiary under the plan.
Thus, amounts deferred under an eligible
plan of a tax-exempt entity are includible
in the gross income of the participant or
beneficiary in the year the amounts are
first made available under the terms of
the plan, even if the plan has not distrib-
uted the amounts deferred. Amounts
deferred under an eligible plan of a tax-
exempt entity are not considered made
available to the participant or beneficiary
solely because the participant or benefi-
ciary is permitted to choose among vari-
ous investments under the plan.
(2)When amounts deferred are consid-
ered to be made available under an eli-
gible plan of a tax-exempt entity—(i)
General rule. Except as provided in para-
graphs (c)(2)(ii) through (iv) of this sec-
tion, amounts deferred under an eligible
plan of a tax-exempt entity are considered
made available (and, thus, are includible
in the gross income of the participant or
beneficiary under this paragraph (c)) at
the earliest date, on or after severance
from employment, on which the plan
allows distributions to commence, but in
no event later than the date on which dis-
tributions must commence pursuant to
section 401(a)(9). For example, in the
case of a plan that permits distribution to
commence on the date that is 60 days
after the close of the plan year in which
the participant has a severance from
employment with the eligible employer,
amounts deferred are considered to be
made available on that date. However,
distributions deferred in accordance with
paragraphs (c)(2)(ii) through (iv) of this
section are not considered made available
prior to the applicable date under para-
graphs (c)(2)(ii) through (iv) of this sec-
tion. In addition, no portion of a partici-
pant or beneficiary’s account is treated as
made available (and thus currently
includible in income) under an eligible
plan of a tax-exempt entity merely
because the participant or beneficiary
under the plan may elect to receive a dis-
tribution in any of the following circum-
stances:
(A) If the requirements of§1.457–
4(d) are met, a distribution of amounts
representing accumulated sick and vaca-
tion pay solely because a participant was
entitled to take paid sick or vacation leave
in lieu of regular compensation or
because the participant could have
deferred these amounts under an eligible
plan at an earlier date. However, to the
extent that the participant is able to
receive the value of accumulated sick and
vacation pay in cash (in addition to regu-
lar compensation) at the time of the elec-
tion to defer, these amounts are consid-
ered made available.
(B) If the requirements of§1.457–
6(c)(2) are met, a distribution in the event
of an unforeseeable emergency.
(C) If the requirements of§1.457–
6(e)(1) are met, a distribution not in
excess of the dollar limit under section
411(a)(11)(A) (which is $5,000 for 2002)
either before or after the participant has a
severance from employment with the
employer.
(ii)Initial election to defer commence-
ment of distributions—(A)In general.An
eligible plan of a tax-exempt entity may
provide a period for making an initial
election during which the participant or
beneficiary may elect, in accordance with
the terms of the plan, to defer the pay-
ment of some or all of the amounts
deferred to a fixed or determinable future
time. The period for making this initial
election must expire prior to the first time
that any such amounts would be consid-
ered made available under the plan under
paragraph (c)(2)(i) of this section.
(B)Failure to make initial election to
defer commencement of distributions.
Generally, if no initial election is made by
a participant or beneficiary under this
paragraph (c)(2)(ii), then the amounts
deferred under an eligible plan of a tax-
exempt entity are considered made avail-
able and taxable to the participant or ben-
eficiary in accordance with paragraph
(c)(2)(i) of this section at the earliest
time, on or after severance from employ-
ment ( but in no event later than the date
on which distributions must commence
pursuant to section 401(a)(9)), that distri-
bution is permitted to commence under
the terms of the plan. However, the plan
may provide for a default payment sched-
ule that applies if no election is made. If
the plan provides for a default payment
2002–23 I.R.B.1119June 10, 2002

schedule, the amounts deferred are
includible in the gross income of the par-
ticipant or beneficiary in the year the
amounts deferred are first made available
under the terms of the default payment
schedule.
(iii)Additional election to defer com-
mencement of distribution. An eligible
plan of a tax-exempt entity is permitted to
provide that a participant or beneficiary
who has made an initial election under
paragraph (c)(2)(ii)(A) of this section
may make one additional election to defer
(but not accelerate) commencement of
distributions under the plan before distri-
butions have commenced in accordance
with the initial deferral election under
paragraph (c)(2)(ii)(A) of this section.
Amounts payable to a participant or ben-
eficiary under an eligible plan of a tax-
exempt entity are not treated as made
available merely because the plan allows
the participant to make an additional elec-
tion under this paragraph (c)(2)(iii). A
participant or beneficiary is not precluded
from making an additional election to
defer commencement of distributions
merely because the participant or benefi-
ciary has previously received a distribu-
tion under§1.457–6(c) because of an
unforeseeable emergency, has received a
distribution of smaller amounts under
§1.457–6(e), has made (and revoked)
other deferral or method of payment elec-
tions within the initial election period, or
is subject to a default payment schedule
under which the commencement of ben-
efits is deferred (for example, until a par-
ticipant is age 65).
(iv)Election as to method of payment.
An eligible plan of a tax-exempt entity
may provide that the election as to the
method of payment under the plan may
be made at any time prior to the time the
amounts are distributed in accordance
with the participant or beneficiary’s initial
or additional election to defer commence-
ment of distributions under paragraph
(c)(2)(ii) or (iii) of this section. Where no
method of payment is elected, the entire
amount deferred will be includible in the
gross income of the participant or benefi-
ciary when the amounts first become
made available in accordance with a par-
ticipant’s initial or additional elections to
defer under paragraphs (c)(2)(ii) and (iii)
of this section, unless the eligible plan
provides for a default method of payment
(in which case amounts are considered
made available and taxable when paid
under the terms of the default payment
schedule).
(3)Examples. The provisions of this
paragraph (c) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. Eligible Plan X of a tax-
exempt entity provides that a participant’s total
account balance, representing all amounts deferred
under the plan, is payable to a participant in a single
sum 60 days after severance from employment
throughout these examples, unless, during a 30-day
period immediately following the severance, the
participant elects to receive the single sum payment
at a later date (that is not later than the plan’s nor-
mal retirement age of 65) or elects to receive distri-
bution in 10 annual installments to begin 60 days
after severance from employment (or at a later date,
if so elected, that is not later than the plan’s normal
retirement age of 65). On November 13, 2002, par-
ticipant K, a calendar year taxpayer, has a severance
from employment with the eligible employer. K
does not, within the 30-day window period, elect to
postpone distributions to a later date or to receive
payment in 10 fixed annual installments.
(ii)Conclusion. The single sum payment is pay-
able to K 60 days after the date K has a severance
from employment (January 12, 2003), and is includ-
ible in the gross income of K in 2003 under section
457(a).
Example 2. (i)Facts. The terms of eligible Plan
X are the same as described inExample 1. Partici-
pant L participates in eligible Plan X. On November
11, 2002, participant L has a severance from the
employment of the eligible employer. On November
24, 2002, L makes an initial deferral election not to
receive the single sum payment payable 60 days
after the severance, and instead elects to receive the
amounts in 10 annual installments to begin 60 days
after severance from employment.
(ii)Conclusion. No portion of L’s account is
considered made available in 2002 or 2003 before a
payment is made and no amount is includible in the
gross income of L until distributions commence.
The annual installment payable in 2003 will be
includible in L’s gross income in 2003.
Example 3. (i)Facts. The facts are the same as
inExample 1, except that eligible Plan X also pro-
vides that those participants who are receiving dis-
tributions in 10 annual installments may, at any time
and without restriction, elect to receive a cash out of
all remaining installments. Participant M elects to
receive a distribution in 10 annual installments com-
mencing in 2003.
(ii)Conclusion.M’s total account balance, rep-
resenting the total of the amounts deferred under the
plan, is considered made available in, and is includ-
ible in M’s gross income, in 2003.
Example 4. (i)Facts. The facts are the same as
inExample 3, except that, instead of providing for
an unrestricted cash out of remaining payments, the
plan provides that participants or beneficiaries who
are receiving distributions in 10 annual installments
may accelerate the payment of the amount remain-
ing payable to the participant upon the occurrence of
an unforeseeable emergency as described in
§1.457–6(c)(1) in an amount not exceeding that
described in§1.457–6(c)(2).
(ii)Conclusion. No amount is considered made
available to participant M on account of M’s right to
accelerate payments upon the occurrence of an
unforeseeable emergency.
Example 5. (i)Facts. Eligible Plan Y of a tax-
exempt entity provides that distributions will com-
mence 60 days after a participant’s severance from
employment unless the participant elects, within a
30-day window period following severance from
employment, to defer distributions to a later date
(but no later than the year following the calendar
year the participant attains age 70½). The plan pro-
vides that a participant who has elected to defer dis-
tributions to a later date may make an election as to
form of distribution at any time prior to the 30th day
before distributions are to commence.
(ii)Conclusion. No amount is considered made
available prior to the date distributions are to com-
mence by reason of a participant’s right to defer or
make an election as to the form of distribution.
Example 6. (i)Facts. The facts are the same as
inExample 1, except that the plan also permits par-
ticipants who have earlier made an election to defer
distribution to make one additional deferral election
at any time prior to the date distributions are sched-
uled to commence. Participant N has a severance
from employment at age 50. The next day, during
the 30-day period provided in the plan, N elects to
receive distribution in the form of 10 annual install-
ment payments beginning at age 55. Two weeks
later, within the 30-day window period, N makes a
new election permitted under the plan to receive 10
annual installment payments beginning at age 60
(instead of age 55). When N is age 59, N elects
under the additional deferral election provisions, to
defer distributions until age 65.
(ii)Conclusion. In this example, N’s election to
defer distributions until age 65 is a valid election.
The two elections N makes during the 30-day win-
dow period are not additional deferral elections
described in paragraph (c)(2)(iii) of this section
because they are made before the first permissible
payout date under the plan. Therefore, the plan is
not precluded from allowing N to make the addi-
tional deferral election. However, N can make no
further election to defer distributions beyond age 65
because this additional deferral election can only be
made once.
§1.457–8 Funding rules for eligible
plans.
(a)Eligible governmental plans—(1)
In general. In order to be an eligible gov-
ernmental plan, all amounts deferred
under the plan, all property and rights
purchased with such amounts, and all
income attributable to such amounts,
property, or rights, must be held in trust
for the exclusive benefit of participants
and their beneficiaries. A trust described
in this paragraph (a) that also meets the
requirements of§§1.457–3 through
1.457–10 is treated as an organization
exempt from tax under section 501(a),
and a participant’s or beneficiary’s inter-
est in amounts in the trust is includible in
June 10, 200211202002–23 I.R.B.

the gross income of the participants and
beneficiaries only to the extent, and at the
time, provided for in section 457(a) and
§§1.457–4 through 1.457–10.
(2)Trust requirement. (i) A trust
described in this paragraph (a) must be
established pursuant to a written agree-
ment that constitutes a valid trust under
state law. The terms of the trust must
make it impossible, prior to the satisfac-
tion of all liabilities with respect to par-
ticipants and their beneficiaries, for any
part of the assets and income of the trust
to be used for, or diverted to, purposes
other than for the exclusive benefit of
participants and their beneficiaries.
(ii) Amounts deferred under an eligible
governmental plan must be transferred to
a trust within a period that is not longer
than is reasonable for the proper adminis-
tration of the participant accounts (if
any). For purposes of this requirement,
the plan may provide for amounts
deferred for a participant under the plan
to be transferred to the trust within a
specified period after the date the
amounts would otherwise have been paid
to the participant. For example, the plan
could provide for amounts deferred under
the plan to be contributed to the trust
within 15 business days following the
month in which these amounts would oth-
erwise have been paid to the participant.
(3)Custodial accounts and annuity
contracts treated as trusts—(i)In gen-
eral. For purposes of the trust require-
ment of this paragraph (a), custodial
accounts and annuity contracts described
in section 401(f) that satisfy the require-
ments of this paragraph (a)(3) are treated
as trusts under rules similar to the rules of
section 401(f). Therefore, the provisions
of§1.401(f)–1(b) will generally apply to
determine whether a custodial account or
an annuity contract is treated as a trust.
The use of a custodial account or annuity
contract as part of an eligible governmen-
tal plan does not preclude the use of a
trust or another custodial account or
annuity contract as part of the same plan,
provided that all such vehicles satisfy the
requirements of section 457(g)(1) and (3)
and paragraphs (a)(1) and (2) of this sec-
tion and that all assets and income of the
plan are held in such vehicles.
(ii)Custodial accounts—(A)In gen-
eral. A custodial account is treated as a
trust, for purposes of section 457(g)(1)
and paragraph (a)(1) and (2) of this sec-
tion, if the custodian is a bank, as
described in section 408(n), or a person
who meets the nonbank trustee require-
ments of paragraph (a)(3)(ii)(B) of this
section, and the account meets the
requirements of paragraphs (a)(1) and (2)
of this section, other than the requirement
that it be a trust.
(B)Nonbank trustee status. The custo-
dian of a custodial account may be a per-
son other than a bank only if the person
demonstrates to the satisfaction of the
Commissioner that the manner in which
the person will administer the custodial
account will be consistent with the
requirements of section 457(g)(1) and (3).
To do so, the person must demonstrate
that the requirements of§1.408–2(e)(2)
through (6) (relating to nonbank trustees)
are met. The written application must be
sent to the address prescribed by the
Commissioner in the same manner as pre-
scribed under§1.408–2(e). To the extent
that a person has already demonstrated to
the satisfaction of the Commissioner that
the person satisfies the requirements of
§1.408–2(e) in connection with a quali-
fied trust (or custodial account or annuity
contract) under section 401(a), that per-
son is deemed to satisfy the requirements
of this paragraph (a)(3)(ii)(B).
(iii)Annuity contracts. An annuity
contract is treated as a trust for purposes
of section 457(g)(1) and paragraph (a)(1)
of this section if the contract is an annu-
ity contract, as defined in section 401(g),
that has been issued by an insurance com-
pany qualified to do business in the State,
and the contract meets the requirements
of paragraphs (a)(1) and (2) of this sec-
tion, other than the requirement that it be
a trust. An annuity contract does not
include a life, health or accident, prop-
erty, casualty, or liability insurance con-
tract.
(4)Combining assets. [Reserved]
(b)Eligible plans maintained by tax-
exempt entity—(1)General rule. In order
to be an eligible plan of a tax-exempt
entity, the plan must be unfunded and
plan assets must not be set aside for par-
ticipants or their beneficiaries. Under sec-
tion 457(b)(6) and this paragraph (b), an
eligible plan of a tax-exempt entity must
provide that all amounts deferred under
the plan, all property and rights to prop-
erty (including rights as a beneficiary of a
contract providing life insurance protec-
tion) purchased with such amounts, and
all income attributable to such amounts,
property, or rights, must remain (until
paid or made available to the participant
or beneficiary) solely the property and
rights of the eligible employer (without
being restricted to the provision of ben-
efits under the plan), subject only to the
claims of the eligible employer’s general
creditors.
(2)Additional requirements. For pur-
poses of paragraph (b)(1) of this section,
the plan must be unfunded regardless of
whether or not the amounts were deferred
pursuant to a salary reduction agreement
between the eligible employer and the
participant. Any funding arrangement
under an eligible plan of a tax-exempt
entity that sets aside assets for the exclu-
sive benefit of participants violates this
requirement, and amounts deferred are
generally immediately includible in the
gross income of plan participants and
beneficiaries. Nothing in this paragraph
(b) prohibits an eligible plan from permit-
ting participants and their beneficiaries to
make an election among different invest-
ment options available under the plan,
such as an election affecting the invest-
ment of the amounts described in para-
graph (b)(1) of this section.
§1.457–9 Effect on eligible govern-
mental plan when not administered in
accordance with eligibility requirements.
A plan of a state ceases to be an eli-
gible governmental plan on the first day
of the first plan year beginning more than
180 days after the date on which the
Commissioner notifies the state in writing
that the plan is being administered in a
manner that is inconsistent with one or
more of the requirements of§§1.457–3
through 1.457–8, or 1.457–10. However,
the plan may correct the plan inconsisten-
cies specified in the written notification
before the first day of that plan year and
continue to maintain plan eligibility. If a
plan ceases to be an eligible governmen-
tal plan, amounts subsequently deferred
by participants will be includible in
income when deferred, or, if later, when
the amounts deferred cease to be subject
to a substantial risk of forfeiture, as pro-
vided at§1.457–11. Amounts deferred
before the date on which the plan ceases
to be an eligible governmental plan, and
2002–23 I.R.B.1121June 10, 2002

any earnings thereon, will be treated as if
the plan continues to be an eligible gov-
ernmental plan and will not be includible
in participant’s or beneficiary’s gross
income until paid to the participant or
beneficiary.
§1.457–10 Miscellaneous provisions.
(a)Plan terminations and frozen
plans—(1)In general. An eligible
employer may amend its plan to eliminate
future deferrals for existing participants
or to limit participation to existing partici-
pants and employees. An eligible plan
may also contain provisions that permit
plan termination and permit amounts
deferred to be distributed on termination.
In order for a plan to be considered termi-
nated, amounts deferred under an eligible
plan must be distributed to all plan par-
ticipants and beneficiaries as soon as
administratively practicable after termina-
tion of the eligible plan. The mere provi-
sion for, and making of, distributions to
participants or beneficiaries upon a plan
termination will not cause an eligible plan
to cease to satisfy the requirements of
section 457(b) or the regulations.
(2)Employers that cease to be eligible
employers—(i)Plan not terminated.An
eligible employer that ceases to be an eli-
gible employer may no longer maintain
an eligible plan. If the employer was a
tax-exempt entity and the plan is not ter-
minated as permitted under paragraph
(a)(2)(ii) of this section, the tax conse-
quences to participants and beneficiaries
in the previously eligible (unfunded) plan
of an ineligible employer will be deter-
mined in accordance with either section
451 if the employer becomes an entity
other than a state or§1.457–11 if the
employer becomes a state. If the
employer was a state and the plan is nei-
ther terminated as permitted under para-
graph (a)(2)(ii) of this section nor trans-
ferred to another eligible plan of that state
as permitted under paragraph (b) of this
section, the tax consequences to partici-
pants in the previously eligible govern-
mental plan of an ineligible employer, the
assets of which are held in trust pursuant
to§1.457–8(a), will be determined in
accordance with section 402(b) (section
403(c) in the case of an annuity contract)
and the trust will no longer be treated as
a trust that is exempt from tax under sec-
tion 501(a).
(ii)Plan termination. As an alternative
to determining the tax consequences to
the plan and participants under paragraph
(a)(2)(i) of this section, the employer may
terminate the plan and distribute the
amounts deferred (and all plan assets) to
all plan participants as soon as adminis-
tratively practicable in accordance with
paragraph (a)(1) of this section. Such dis-
tribution may include eligible rollover
distributions in the case of a plan that was
an eligible governmental plan. In addi-
tion, if the employer is a state, another
alternative to determining the tax conse-
quences under paragraph (a)(2)(i) of this
section is to transfer the assets of the eli-
gible governmental plan to an eligible
governmental plan of another eligible
employer within the same state under the
plan-to-plan transfer rules of paragraph
(b) of this section.
(3)Examples. The provisions of this
paragraph (a) are illustrated by the fol-
lowing examples:
Example 1. (i)Facts. Employer Y, a corporation
that owns a state hospital, sponsors an eligible gov-
ernmental plan funded through a trust. Employer Y
is acquired by a for-profit hospital and Employer Y
ceases to be an eligible employer under section
457(e)(1) or§1.457–2(e). Employer Y terminates
the plan and, during the next 6 months, distributes to
participants and beneficiaries all amounts deferred
that were under the plan.
(ii)Conclusion. The termination and distribution
does not cause the plan to fail to be an eligible gov-
ernmental plan. Amounts that are distributed as eli-
gible rollover distributions may be rolled over to an
eligible retirement plan described in section
402(c)(8)(B).
Example 2. (i)Facts. The facts are the same as
inExample 1, except that Employer Y decides to
continue to maintain the plan.
(ii)Conclusion. If Employer Y continues to
maintains the plan, the tax consequences to partici-
pants and beneficiaries with respect to compensation
deferred thereafter will be determined in accordance
with either section 402(b) if the compensation
deferred is funded through a trust, section 403(c) if
the compensation deferred is funded through annu-
ity contracts, or§1.457–11 if the compensation
deferred is not funded through a trust or annuity
contract. In addition, if Employer Y continues to
maintain the plan, the trust (including amounts
deferred before the date on which the plan ceases to
be an eligible governmental plan and any earnings
thereon) will no longer be treated as exempt from
tax under section 501(a).
Example 3. (i)Facts. Employer Z, a corporation
that owns a tax-exempt hospital, sponsors an
unfunded eligible plan. Employer Z is acquired by a
for-profit hospital and is no longer an eligible
employer under section 457(e)(1) or§1.457–2(e).
Employer Z terminates the plan and distributes all
amounts deferred under the eligible plan to partici-
pants and beneficiaries within a one-year period.
(ii)Conclusion. Distributions under the plan are
treated as made under an eligible plan of a tax-
exempt entity and the distributions of the amounts
deferred are includible in the gross income of the
participant or beneficiary in the year distributed.
Example 4. (i)Facts. The facts are the same as
inExample 3, except that Employer Z decides to
maintain instead of terminate the plan.
(ii)Conclusion. If Employer Z maintains the
plan, the tax consequences to participants and ben-
eficiaries in the plan will thereafter be determined in
accordance with section 451.
(b)Plan-to-plan transfers—(1)Gen-
eral rule. An eligible governmental plan
may provide for the transfer of amounts
deferred by a participant or beneficiary to
another eligible governmental plan, and
an eligible plan of a tax-exempt entity
may provide for transfers of amounts
deferred by a participant to another eli-
gible plan of a tax-exempt entity, if the
conditions in paragraph (b)(2) of this sec-
tion are met. An eligible governmental
plan may accept transfers from another
eligible governmental plan as described
in the preceding sentence, and an eligible
plan of a tax-exempt entity may accept
transfers from another eligible plan of a
tax-exempt entity as described in the pre-
ceding sentence. However, a state may
not transfer the assets of its eligible gov-
ernmental plan to a tax-exempt entity’s
eligible plan and the plan of a tax-exempt
entity may not accept such a transfer.
Similarly, a tax-exempt entity may not
transfer the assets of its eligible plan to an
eligible governmental plan and an eligible
governmental plan may not accept such a
transfer. In addition, if the conditions in
paragraph (b)(4) of this section (relating
to permissive past service credit and
repayments under section 415) are met,
an eligible governmental plan of a state
may provide for the transfer of amounts
deferred by a participant or beneficiary to
a qualified plan (under section 401(a))
maintained by a state. However, a quali-
fied plan may not transfer assets to an
eligible governmental plan or to an eli-
gible plan of a tax-exempt entity, and an
eligible governmental plan or the plan of
a tax-exempt entity may not accept such a
transfer.
(2)Requirements for plan-to-plan
transfers among eligible plans. A transfer
under paragraph (b)(1) of this section
from an eligible governmental plan to
another eligible governmental plan is per-
mitted only if the following conditions
are met—
June 10, 200211222002–23 I.R.B.

(i) The transferor plan provides for
transfers;
(ii) The receiving plan provides for the
receipt of transfers;
(iii) The participant or beneficiary
whose amounts deferred are being trans-
ferred will have an amount deferred
immediately after the transfer at least
equal to the amount deferred with respect
to that participant or beneficiary immedi-
ately before the transfer; and
(iv) The participant or beneficiary
whose amounts deferred are being trans-
ferred has had a severance from employ-
ment with the transferring employer and
is performing services for the entity main-
taining the receiving plan. However, this
paragraph (b)(2)(iv) is not required to be
satisfied if—
(A) All of the assets held by the eli-
gible governmental plan are transferred;
(B) The transfer is to another eligible
governmental plan maintained by an eli-
gible employer that is a state entity within
the same state; and
(C) The participants whose deferred
amounts are being transferred are not eli-
gible for additional annual deferrals in the
receiving plan unless they are performing
services for the entity maintaining the
receiving plan.
(3)Examples. The provisions of para-
graphs (b)(1) and (2) of this section are
illustrated by the following examples:
Example 1. (i)Facts. Participant A, the president
of City X’s hospital, has accepted a position with
another hospital which is a tax-exempt entity. A par-
ticipates in the eligible governmental plan of City X.
A would like to transfer the amounts deferred under
City X’s eligible governmental plan to the eligible
plan of the tax-exempt hospital.
(ii)Conclusion. City X’s plan may not transfer
A’s amounts deferred to the tax-exempt employer’s
eligible plan. In addition, because the amounts
deferred would no longer be held in trust for the
exclusive benefit of participants and their beneficia-
ries, the transfer would violate the exclusive benefit
rule of section 457(g) and§1.457–8(a).
Example 2. (i)Facts. County M, located in State
S, operates several health clinics and maintains an
eligible governmental plan for employees of those
clinics. One of the clinics operated by County M is
being acquired by a hospital operated by State S,
and employees of that clinic will become employees
of State S. County M permits those employees to
transfer their balances under County M’s eligible
governmental plan to the eligible governmental plan
of State S.
(ii)Conclusion. If the eligible governmental
plans of County M and State S provide for the trans-
fer and acceptance of the transfer (and the other
requirements of paragraph (b)(1) of this section are
satisfied), the transfer will not cause either plan to
violate the requirements of section 457 or these
regulations.
Example 3. (i)Facts. City Employer Z, a hospi-
tal, sponsors an eligible governmental plan. City
Employer Z is located in State B. All of the assets
of City Employer Z are being acquired by a tax-
exempt hospital. City Employer Z, in accordance
with the plan-to-plan transfer rules of paragraph (b)
of this section, would like to transfer the total
amount of assets deferred under City Employer Z’s
eligible governmental plan to the acquiring tax-
exempt entity’s eligible plan.
(ii)Conclusion. City Employer Z may not per-
mit participants to transfer the amounts to the eli-
gible plan of the tax-exempt entity. In addition,
because the amounts deferred would no longer be
held in trust for the exclusive benefit of participants
and their beneficiaries, the transfer would violate the
exclusive benefit rule of section 457(g) and
§1.457–8(a).
Example 4. (i)Facts. The facts are the same as
inExample 3, except that City Employer Z, prior to
the transfer of all of its assets to the eligible plan of
the tax-exempt entity, decides to transfer all of the
amounts deferred under City Z’s eligible govern-
mental plan to the eligible governmental plan of the
related state government entity, State B.
(ii)Conclusion. If City Employer Z’s (transf-
eror) eligible governmental plan provides for such
transfer and the eligible governmental plan of the
State B permits the acceptance of such a transfer
(and the other requirements of paragraph (b)(1) of
this section are satisfied), City Employer Z may
transfer the total amounts deferred under its eligible
governmental plan, prior to termination of that plan,
to the eligible governmental plan maintained by
State B. However, the participants of City Employer
Z whose deferred amounts are being transferred are
not eligible to participate in the eligible governmen-
tal plan of State B, the receiving plan, unless they
are performing services for State B.
(4)Purchase of permissive past ser-
vice credit by plan-to-plan transfers from
an eligible governmental plan to a quali-
fied plan—(i)General rule. An eligible
governmental plan of a state may provide
for the transfer of amounts deferred by a
participant or beneficiary to a defined
benefit governmental plan (as defined in
section 414(d)) of that state, and no
amount shall be includible in gross
income by reason of the transfer, if the
conditions in paragraph (b)(4)(ii) of this
section are met. A transfer under this
paragraph (b)(4) is not treated as a distri-
bution for purposes of§1.457–6. There-
fore, such a transfer may be made before
severance from employment.
(ii)Conditions for plan-to-plan trans-
fers from an eligible governmental plan
to a qualified plan. A transfer may be
made under this paragraph (b)(4) only if
the transfer is either—
(A) For the purchase of permissive
past service credit (as defined in section
415(n)(3)(A)) under the receiving defined
benefit governmental plan; or
(B) A repayment to which section 415
does not apply by reason of section
415(k)(3).
(iii)Example. The provisions of this
paragraph (b)(4) are illustrated by the fol-
lowing example:
Example. (i)Facts. Plan X is an eligible govern-
mental plan maintained by County Y for its employ-
ees. Plan X provides for distributions only in the
event of death, an unforeseeable emergency, or sev-
erance from employment with Y (including retire-
ment from Y). Plan S is a qualified defined benefit
plan maintained by State T for its employees.
County Y is within State T. Employee A is an
employee of Y and is a participant in Plan X.
Employee A previously was an employee of T and
is still entitled to benefits under Plan S. Plan S
includes provisions allowing participants in certain
plans, including Plan X, to transfer assets to Plan S
for the purchase past service credit under Plan S not
in excess of the credit permitted under section
415(n) and does not permit the amount transferred
to exceed the amount necessary to fund the benefit
resulting from the past service credit. Although not
required to do so, Plan X allows A to transfer assets
to Plan T to provide a past service benefit under
Plan T.
(ii)Conclusion. Assuming that the special rules
at section 415(n)(3) are satisfied with respect to the
transfer, the transfer is permitted under this para-
graph (b)(4).
(c)Qualified domestic relations orders
under eligible plans—(1)General rule.
An eligible plan does not become an
ineligible plan described in section 457(f)
solely because its administrator or spon-
sor complies with a qualified domestic
relations order as defined in section
414(p), including an order requiring the
distribution of the benefits of a participant
to an alternate payee in advance of the
general rules for eligible plan distribu-
tions under§1.457–6. If a distribution or
payment is made from an eligible plan to
an alternate payee pursuant to a qualified
domestic relations order, rules similar to
the rules of section 402(e)(1)(A) shall
apply to the distribution or payment.
(2)Examples. The provisions of this
paragraph (c) are illustrated by the fol-
lowing examples:
Example 1.(i)Facts. Participant C and C’s
spouse D are divorcing. C is employed by State S
and is a participant in an eligible plan maintained by
S. C has an account valued at $100,000 under the
plan. Pursuant to the divorce, a court issues a quali-
fied domestic relations order on September 1, 2003,
that allocates 50 percent of C’s $100,000 plan
2002–23 I.R.B.1123June 10, 2002

account to D and specifically provides for an imme-
diate distribution to D of D’s share within 6 months
of the order. Payment is made to D in January of
2004.
(ii)Conclusion.S’s eligible plan does not
become an ineligible plan described in section
457(f) and§1.457–11 solely because its administra-
tor or sponsor complies with the qualified domestic
relations order requiring the immediate distribution
to D in advance of the general rules for eligible plan
distributions under§1.457–6. In accordance with
section 402(e)(1)(A), D (not C) must include the
distribution in gross income. The distribution is
includible in D’s gross income in 2004. If the quali-
fied domestic relations order were to provide for
distribution to D at a future date, amounts deferred
attributable to D’s share will be includible in D’s
gross income when paid to D.
Example 2. (i)Facts. The facts are the same as
inExample 1, except that S is a tax-exempt entity,
instead of a state.
(ii)Conclusion.S’s eligible plan does not
become an ineligible plan described in section
457(f) and§1.457–11 solely because its administra-
tor or sponsor complies with the qualified domestic
relations order requiring the immediate distribution
to D in advance of the general rules for eligible plan
distributions under§1.457–6. In accordance with
section 402(e)(1)(A), D (not C) must include the
distribution in gross income. The distribution is
includible in D’s gross income in 2004, assuming
that the plan did not make the distribution available
to D in 2003. If the qualified domestic relations
order were to provide for distribution to D at a
future date, amounts deferred attributable to D’s
share would be includible in D’s gross income when
paid or made available to D.
(d)Death benefits and life insurance
proceeds. A death benefit plan under sec-
tion 457(e)(11) is not an eligible plan. In
addition, no amount paid or made avail-
able under an eligible plan as death ben-
efits or life insurance proceeds is exclud-
able from gross income under section
101.
(e)Rollovers to eligible governmental
plans—(1)General rule. An eligible gov-
ernmental plan may accept contributions
that are eligible rollover distributions (as
defined in section 402(c)(4)) made from
another eligible retirement plan (as
defined in section 402(c)(8)(B)) if the
conditions in paragraph (e)(2) of this sec-
tion are met. Amounts contributed to an
eligible governmental plan as eligible
rollover distributions are not taken into
account for purposes of the annual limit
on annual deferrals by a participant in
§1.457–4(c) or§1.457–5, but are other-
wise treated in the same manner as
amounts deferred under section 457 for
purposes of§§1.457–3 through 1.457–9
and this section.
(2)Conditions for rollovers to an eli-
gible governmental plan. An eligible gov-
ernmental plan that permits eligible roll-
over distributions made from another
eligible retirement plan to be paid into the
eligible governmental plan is required
under this paragraph (e)(2) to provide that
it will separately account for any eligible
rollover distributions it receives.
(3)Example.The provisions of this
paragraph (e) are illustrated by the fol-
lowing example:
Example. (i)Facts. Plan T is an eligible govern-
mental plan that provides that employees who are
eligible to participate in Plan T may make rollover
contributions to Plan T from amounts distributed to
an employee from an eligible retirement plan. An
eligible retirement plan is defined in Plan T as
another eligible governmental plan, a qualified sec-
tion 401(a) or 403(a) plan, or a section 403(b) con-
tract, or an individual retirement arrangement (IRA)
that holds such amounts. Plan T requires rollover
contributions to be paid by the eligible retirement
plan directly to Plan T (a direct rollover) or to be
paid by the participant within 60 days after the date
on which the participant received the amount from
the other eligible retirement plan. Plan T does not
take rollover contributions into account for purposes
of the plan’s limits on amounts deferred that con-
form to§1.457–4(c). Rollover contributions paid to
Plan T are invested in the trust in the same manner
as amounts deferred under Plan T and rollover con-
tributions (and earnings thereon) are available for
distribution to the participant at the same time and
in the same manner as amounts deferred under Plan
T. In addition, Plan T provides that, for each partici-
pant who makes a rollover contribution to Plan T,
the Plan T recordkeeper is to establish a separate
account for the participant’s rollover contributions.
The recordkeeper calculates earnings and losses for
investments held in the rollover account separately
from earnings and losses on other amounts held
under the plan and calculates disbursements from
and payments made to the rollover account sepa-
rately from disbursements from and payments made
to other amounts held under the plan.
(ii)Conclusion. Plan T does not lose its status as
an eligible governmental plan as a result of the
receipt of rollover contributions.
(f)Deemed IRAs under eligible gov-
ernmental plans. [Reserved]
§1.457–11 Tax treatment of participants
if plan is not an eligible plan.
(a)In general. Under section 457(f), if
an eligible employer provides for a defer-
ral of compensation under any agreement
or arrangement that is an ineligible
plan—
(1) Compensation deferred under the
agreement or arrangement is includible in
the gross income of the participant or
beneficiary for the first taxable year in
which there is no substantial risk of for-
feiture (within the meaning of section
457(f)(3)(B)) of the rights to such com-
pensation;
(2) If the compensation deferred is
subject to a substantial risk of forfeiture,
the amount includible in gross income for
the first taxable year in which there is no
substantial risk of forfeiture includes
earnings thereon to the date on which
there is no substantial risk of forfeiture;
(3) Earnings credited on the compen-
sation deferred under the agreement or
arrangement that are not includible in
gross income under paragraph (a)(2) of
this section are includible in the gross
income of the participant or beneficiary
only when paid or made available to the
participant or beneficiary, provided that
the interest of the participant or benefi-
ciary in any assets (including amounts
deferred under the plan) of the entity
sponsoring the agreement or arrangement
is not senior to the entity’s general credi-
tors; and
(4) Amounts paid or made available to
a participant or beneficiary under the
agreement or arrangement are includible
in the gross income of the participant or
beneficiary under section 72, relating to
annuities.
(b)Exceptions. Paragraph (a) of this
section does not apply with respect to—
(1) A plan described in section 401(a)
which includes a trust exempt from tax
under section 501(a);
(2) An annuity plan or contract
described in section 403;
(3) That portion of any plan which
consists of a transfer of property
described in section 83;
(4) That portion of any plan which
consists of a trust to which section 402(b)
applies; or
(5) A qualified governmental excess
benefit arrangement described in section
415(m).
(c)Coordination of section 457(f) with
section 83—(1)Transfer of property
described in section 83. Under paragraph
(b)(3) of this section, section 457(f) and
paragraph (a) of this section do not apply
to that portion of any plan which consists
of a transfer of property described in sec-
tion 83. For this purpose, a transfer of
property described in section 83 means a
transfer of property to which section 83
applies. Section 457(f) and paragraph (a)
of this section do not apply if the date on
June 10, 200211242002–23 I.R.B.

which there is no substantial risk of for-
feiture with respect to compensation
deferred under an agreement or arrange-
ment that is not an eligible plan is on or
after the date on which there is a transfer
of property to which section 83 applies.
However, section 457(f) and paragraph
(a) of this section apply if the date on
which there is no substantial risk of for-
feiture with respect to compensation
deferred under an agreement or arrange-
ment that is not an eligible plan precedes
the date on which there is a transfer of
property to which section 83 applies. If
deferred compensation payable in prop-
erty is includible in gross income under
section 457(f), then, as provided in sec-
tion 72, the amount includible in gross
income when that property is later trans-
ferred or made available to the service
provider is the excess of the value of the
property at that time over the amount pre-
viously included in gross income under
section 457(f).
(2)Examples. The provisions of this
paragraph (c) are illustrated in the follow-
ing examples:
Example 1. (i)Facts. As part of an arrangement
for the deferral of compensation, an eligible
employer agrees on December 1, 2002, to pay an
individual rendering services for the eligible
employer a specified dollar amount on January 15,
2005. The arrangement provides for the payment to
be made in the form of property having a fair mar-
ket value equal to the specified dollar amount. The
individual’s rights to the payment are not subject to
a substantial risk of forfeiture (within the meaning
of section 457(f)(3)(B)).
(ii)Conclusion. In this example, because there is
no substantial risk of forfeiture with respect to the
agreement to transfer property in 2005, the present
value (as of December 1, 2002) of the payment is
includible in the individual’s gross income for 2002.
Under paragraph (a)(4) of this section, when the
payment is made on January 15, 2005, the amount
includible in the individual’s gross income is equal
to the excess of the fair market value of the property
when paid, over the amount that was includible in
gross income for 2002 (which is the basis allocable
to that payment).
Example 2. (i)Facts. As part of an arrangement
for the deferral of compensation, individuals A and
B rendering services for a tax-exempt entity each
receive in 2010 property that is subject to a substan-
tial risk of forfeiture (within the meaning of section
457(f)(3)(B) and within the meaning of section
83(c)(1)). Individual A makes an election to include
the fair market value of the property in gross income
under section 83(b) and individual B does not make
this election. The substantial risk of forfeiture for
the property transferred to individual A lapses in
2012 and the substantial risk of forfeiture for the
property transferred to individual B also lapses in
2012. Thus, the property transferred to individual A
is included in A’s gross income for 2010 when A
makes a section 83(b) election and the property
transferred to individual B is included in B’s gross
income for 2012 when the substantial risk of forfei-
ture for the property lapses.
(ii)Conclusion. In this example2, in each case,
the compensation deferred is not subject to section
457(f) or this section because section 83 applies to
the transfer of property on or before the date on
which there is no substantial risk of forfeiture with
respect to compensation deferred under the arrange-
ment.
Example 3. (i)Facts. In 2010, X, a tax-exempt
entity, agrees to pay deferred compensation to
employee C. The amount payable is $100,000 to be
paid 10 years later in 2020. The commitment to
make the $100,000 payment is not subject to a sub-
stantial risk of forfeiture. In 2010, the present value
of the $100,000 is $50,000. In 2018, X transfers to
C property having a fair market value (for purposes
of section 83) equal to $70,000. The transfer is in
partial settlement of the commitment made in 2010
and, at the time of the transfer in 2018, the present
value of the commitment is $80,000. In 2020, X
pays C the $12,500 that remains due.
(ii)Conclusion. In this example3, C has income
of $50,000 in 2010. In 2018, C has income of
$30,000, which is the amount transferred in 2018,
minus the allocable portion of the basis that results
from the $50,000 of income in 2010. (Under section
72(e)(2)(B), income is allocated first. The income is
equal to $30,000 ($80,000 minus the $50,000 basis),
with the result that the allocable portion of the basis
is equal to $40,000 ($70,000 minus the $30,000 of
income).) In 2020, C has income of $2,500 ($12,500
minus $10,000, which is the excess of the original
$50,000 basis over the $40,000 basis allocated to
the transfer made in 2018).
§1.457–12 Effective dates.
Sections 1.457–1 through 1.457–11
apply for taxable years beginning after
December 31, 2001, except that§1.457–
11(c) does not apply with respect to an
option without a readily ascertainable fair
market value (within the meaning of sec-
tion 83(e)(3)) that was granted on or
before May 8, 2002, and,§1.457–10(c)
(relating to qualified domestic relations
orders) applies for transfers, distributions,
and payments made after December 31,
2001.
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on May
7, 2002, 8:45 a.m., and published in the issue of the
Federal Register for May 8, 2002, 67 F.R. 30826)
Hedging Transactions;
Corrections
Announcement 2002–55
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correcting amendment.
SUMMARY: This document contains
corrections to final regulations (T.D.
8985, 2002–14 I.R.B. 707) that were pub-
lished in theFederal Registeron
Wednesday, March 20, 2002 (67 FR
12863), relating to the character of gain
or loss from hedging transactions.
DATES: This correction is effective
March 20, 2002.
FOR FURTHER INFORMATION CON-
TACT: Elizabeth Handler (202) 622–
3930 or Viva Hammer (202) 622–0869
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
The final regulations that are the sub-
ject of these corrections are under section
1221 of the Internal Revenue Code.
Need for Correction
As published, the final regulations
contain errors that may prove to be mis-
leading and are in need of clarification.
Correction of Publication
Accordingly, 26 CFR Part 1 is cor-
rected by making the following correcting
amendments:
PART 1—INCOME TAXES
1. The authority citation for part 1 con-
tinues to read in part as follows:
Authority: 26 U.S.C. 7805***
§1.446–4 [Corrected]
2. Section 1.446–4, paragraph (d)(3) is
amended by removing the language
“§1.1221–2(a)(4)(i)”from the last sen-
tence and adding the language“§1.1221–
2(a)(4)”in its place.
2002–23 I.R.B.1125June 10, 2002

§1.1256(e)–1 [Corrected]
3. Section 1.1256(e)–1, paragraph (c)
is amended by removing the language
“(f)(1)(ii)”from the second sentence and
adding the language“(g)(1)(ii)”in its
place.
New Revision of Publication
597,Information on the U.S.
– Canada Income Tax Treaty
Announcement 2002–56
Publication 597, revised May 2002, is
now available from the Internal Revenue
Service. It replaces the May 1998 revi-
sion.
This publication discusses a number of
the treaty provisions that often apply to
U.S. citizens or residents who may be
liable for Canadian tax.
You can get a copy of this publication
by calling 1–800–TAX-FORM (1–800–
829–3676). You can also write to the IRS
Forms Distribution Center nearest you.
Check your income tax package for the
address. The publication is also available
on the IRS web site atwww.irs.gov.
New Revision of Publication
1544,Reporting Cash
Payments of Over $10,000
(and Publication 1544SP,
Informe de Pagos en
Efectivo en Exceso de
$10,000)
Announcement 2002–57
Publication 1544, revised March 2002,
is now available from the Internal Rev-
enue Service. It replaces the August 1997
revision. The publication is also available
in Spanish as Publication 1544SP.
The publication explains why, when,
and how to report large cash payments. It
also discusses the substantial penalties for
not reporting them.
You can get either version of this pub-
lication by calling 1–800–TAX-FORM
(1–800–829–3676). You can also write to
the IRS Forms Distribution Center near-
est you. Check your income tax package
for the address. Both versions are also
available on the IRS web site at
www.irs.gov.
June 10, 200211262002–23 I.R.B.

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as“rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus, if
an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
withmodified, below).
Clarifiedis used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modifiedis used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it
applies to both A and B, the prior ruling
is modified because it corrects a pub-
lished position. (Compare withamplified
andclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revokeddescribes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Supersededdescribes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a
period of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example,modified
andsupersededdescribes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case,
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplementedis used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings in the series.
Suspendedis used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current
use and formerly used will appear in
material published in the Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Intemal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedural Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
2002–23 I.R.B.iJune 10, 2002

Numerical Finding List
1
Bulletins 2002–1 through 2002–22
Announcements:
2002–1, 2002–2 I.R.B.304
2002–2, 2002–2 I.R.B.304
2002–3, 2002–2 I.R.B.305
2002–4, 2002–2 I.R.B.306
2002–5, 2002–4 I.R.B.420
2002–6, 2002–5 I.R.B.458
2002–7, 2002–5 I.R.B.459
2002–8, 2002–6 I.R.B.494
2002–9, 2002–7 I.R.B.536
2002–10, 2002–7 I.R.B.539
2002–11, 2002–6 I.R.B.494
2002–12, 2002–8 I.R.B.553
2002–13, 2002–7 I.R.B.540
2002–14, 2002–7 I.R.B.540
2002–15, 2002–7 I.R.B.540
2002–16, 2002–7 I.R.B.541
2002–17, 2002–8 I.R.B.561
2002–18, 2002–10 I.R.B.621
2002–19, 2002–8 I.R.B.561
2002–20, 2002–8 I.R.B.561
2002–21, 2002–8 I.R.B.562
2002–22, 2002–8 I.R.B.562
2002–23, 2002–8 I.R.B.563
2002–24, 2002–9 I.R.B.606
2002–25, 2002–10 I.R.B.621
2002–26, 2002–11 I.R.B.629
2002–27, 2002–11 I.R.B.629
2002–28, 2002–11 I.R.B.630
2002–29, 2002–11 I.R.B.631
2002–30, 2002–11 I.R.B.632
2002–31, 2002–15 I.R.B.747
2002–32, 2002–12 I.R.B.664
2002–33, 2002–12 I.R.B.666
2002–34, 2002–13 I.R.B.702
2002–35, 2002–12 I.R.B.667
2002–36, 2002–13 I.R.B.703
2002–37, 2002–13 I.R.B.703
2002–38, 2002–14 I.R.B.738
2002–39, 2002–14 I.R.B.738
2002–40, 2002–15 I.R.B.747
2002–41, 2002–14 I.R.B.739
2002–42, 2002–14 I.R.B.739
2002–43, 2002–16 I.R.B.792
2002–44, 2002–17 I.R.B.809
2002–45, 2002–18 I.R.B.833
2002–46, 2002–18 I.R.B.834
2002–47, 2002–18 I.R.B.844
2002–48, 2002–17 I.R.B.809
2002–49, 2002–19 I.R.B.919
2002–50, 2002–18 I.R.B.845
2002–51, 2002–22 I.R.B.1063
2002–52, 2002–19 I.R.B.919
2002–53, 2002–22 I.R.B.1063
Court Decisions:
2073, 2002–14 I.R.B.718
2074, 2002–20 I.R.B.954
Notices:
2002–1, 2002–2 I.R.B.283
2002–2, 2002–2 I.R.B.285
2002–3, 2002–2 I.R.B.289
2002–4, 2002–2 I.R.B.298
2002–5, 2002–3 I.R.B.320
2002–6, 2002–3 I.R.B.326
2002–7, 2002–6 I.R.B.489
2002–8, 2002–4 I.R.B.398
2002–9, 2002–5 I.R.B.450
2002–10, 2002–6 I.R.B.490
2002–11, 2002–7 I.R.B.526
2002–12, 2002–7 I.R.B.526
2002–13, 2002–8 I.R.B.547
2002–14, 2002–8 I.R.B.548
2002–15, 2002–8 I.R.B.548
2002–16, 2002–9 I.R.B.567
2002–17, 2002–9 I.R.B.567
2002–18, 2002–12 I.R.B.644
2002–19, 2002–10 I.R.B.619
2002–20, 2002–17 I.R.B.796
2002–21, 2002–14 I.R.B.730
2002–22, 2002–14 I.R.B.731
2002–23, 2002–15 I.R.B.742
2002–24, 2002–16 I.R.B.785
2002–25, 2002–15 I.R.B.743
2002–26, 2002–15 I.R.B.743
2002–27, 2002–18 I.R.B.814
2002–28, 2002–16 I.R.B.785
2002–29, 2002–17 I.R.B.797
2002–30, 2002–17 I.R.B.797
2002–31, 2002–19 I.R.B.908
2002–32, 2002–21 I.R.B.989
2002–33, 2002–21 I.R.B.989
2002–34, 2002–21 I.R.B.990
2002–35, 2002–21 I.R.B.992
2002–36, 2002–22 I.R.B.1029
Proposed Regulations:
REG–209135–88, 2002–4 I.R.B.418
REG–209114–90, 2002–9 I.R.B.576
REG–104762–00, 2002–18 I.R.B.825
REG–105369–00, 2002–18 I.R.B.828
REG–107100–00, 2002–7 I.R.B.529
REG–107184–00, 2002–20 I.R.B.967
REG–107366–00, 2002–12 I.R.B.645
REG–118861–00, 2002–12 I.R.B.651
REG–105344–01, 2002–2 I.R.B.302
REG–112991–01, 2002–4 I.R.B.404
REG–115054–01, 2002–7 I.R.B.530
REG–119436–01, 2002–3 I.R.B.377
REG–120135–01, 2002–8 I.R.B.552
REG–125450–01, 2002–5 I.R.B.457
REG–125626–01, 2002–9 I.R.B.604
REG–136193–01, 2002–21 I.R.B.995
REG–142299–01, 2002–4 I.R.B.418
REG–154920–01, 2002–22 I.R.B.1060
Proposed Regulations:—Continued:
REG–159079–01, 2002–6 I.R.B.493
REG–161424–01, 2002–21 I.R.B.1010
REG–163892–01, 2002–20 I.R.B.968
REG–165706–01, 2002–16 I.R.B.787
REG–167648–01, 2002–16 I.R.B.790
REG–102740–02, 2002–13 I.R.B.701
REG–108697–02, 2002–19 I.R.B.918
Revenue Procedures:
2002–1, 2002–1 I.R.B.1
2002–2, 2002–1 I.R.B.82
2002–3, 2002–1 I.R.B.117
2002–4, 2002–1 I.R.B.127
2002–5, 2002–1 I.R.B.173
2002–6, 2002–1 I.R.B.203
2002–7, 2002–1 I.R.B.249
2002–8, 2002–1 I.R.B.252
2002–9, 2002–3 I.R.B.327
2002–10, 2002–4 I.R.B.401
2002–11, 2002–7 I.R.B.526
2002–12, 2002–3 I.R.B.374
2002–13, 2002–8 I.R.B.549
2002–14, 2002–5 I.R.B.450
2002–15, 2002–6 I.R.B.490
2002–16, 2002–9 I.R.B.572
2002–17, 2002–13 I.R.B.676
2002–18, 2002–13 I.R.B.678
2002–19, 2002–13 I.R.B.696
2002–20, 2002–14 I.R.B.732
2002–21, 2002–19 I.R.B.911
2002–22, 2002–14 I.R.B.733
2002–23, 2002–15 I.R.B.744
2002–24, 2002–17 I.R.B.798
2002–25, 2002–17 I.R.B.800
2002–26, 2002–15 I.R.B.746
2002–27, 2002–17 I.R.B.802
2002–28, 2002–18 I.R.B.815
2002–31, 2002–19 I.R.B.916
2002–32, 2002–20 I.R.B.959
2002–33, 2002–20 I.R.B.963
2002–36, 2002–21 I.R.B.993
2002–37, 2002–22 I.R.B.1030
2002–38, 2002–22 I.R.B.1037
2002–39, 2002–22 I.lR.B.;1046
Revenue Rulings:
2002–1, 2002–2 I.R.B.268
2002–2, 2002–2 I.R.B.271
2002–3, 2002–3 I.R.B.316
2002–4, 2002–4 I.R.B.389
2002–5, 2002–6 I.R.B.461
2002–6, 2002–6 I.R.B.460
2002–7, 2002–8 I.R.B.543
2002–8, 2002–9 I.R.B.564
2002–9, 2002–10 I.R.B.614
2002–10, 2002–10 I.R.B.616
2002–11, 2002–10 I.R.B.608
2002–12, 2002–11 I.R.B.624
2002–13, 2002–12 I.R.B.637
2002–14, 2002–12 I.R.B.636
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 2001–27 through 2001–53 is
in Internal Revenue Bulletin 2002–1, dated January 7, 2002.
June 10, 2002ii2002–23 I.R.B.

Revenue Rulings:—Continued:
2002–15, 2002–13 I.R.B.668
2002–16, 2002–15 I.R.B.740
2002–17, 2002–14 I.R.B.716
2002–18, 2002–16 I.R.B.779
2002–19, 2002–16 I.R.B.778
2002–20, 2002–17 I.R.B.794
2002–21, 2002–17 I.R.B.793
2002–22, 2002–19 I.R.B.849
2002–23, 2002–18 I.R.B.811
2002–24, 2002–19 I.R.B.848
2002–25, 2002–19 I.R.B.904
2002–26, 2002–19 I.R.B.906
2002–27, 2002–20 I.R.B.925
2002–28, 2002–20 I.R.B.941
2002–29, 2002–20 I.R.B.940
2002–30, 2002–21 I.R.B.971
2002–31, 2002–22 I.R.B.1023
Tax Conventions:
2002–14 I.R.B.725
Treasury Decisions:
8968, 2002–2 I.R.B.274
8969, 2002–2 I.R.B.276
8970, 2002–2 I.R.B.281
8971, 2002–3 I.R.B.308
8972, 2002–5 I.R.B.443
8973, 2002–4 I.R.B.391
8974, 2002–3 I.R.B.318
8975, 2002–4 I.R.B.379
8976, 2002–5 I.R.B.421
8977, 2002–6 I.R.B.463
8978, 2002–7 I.R.B.500
8979, 2002–6 I.R.B.466
8980, 2002–6 I.R.B.477
8981, 2002–7 I.R.B.496
8982, 2002–8 I.R.B.544
8983, 2002–9 I.R.B.565
8984, 2002–13 I.R.B.668
8985, 2002–14 I.R.B.707
8986, 2002–16 I.R.B.780
8987, 2002–19 I.R.B.852
8988, 2002–20 I.R.B.929
8989, 2002–20 I.R.B.920
8990, 2002–20 I.R.B.947
8991, 2002–21 I.R.B.972
8992, 2002–21 I.R.B.981
8993, 2002–22 I.R.B.1026
2002–23 I.R.B.iiiJune 10, 2002

Finding List of Current Actions
on Previously Published Items
2
Bulletins 2002–1 through 2002–22
Announcements:
2001–83
Modified by
Ann. 2002–36, 2002–13 I.R.B.703
2002–9
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
Ann. 2002–35, 2002–12 I.R.B.667
Notices:
90–24
Modified and superseded by
Notice 2002–24, 2002–16 I.R.B.785
98–31
Supplemented by
Ann. 2002–37, 2002–13 I.R.B.703
98–43
Modified and superseded by
Notice 2002–5, 2002–3 I.R.B.320
2000–11
Obsoleted by
Notice 2002–3, 2002–2 I.R.B.289
2001–10
Revoked by
Notice 2002–8, 2002–4 I.R.B.398
2001–61
Supplemented by
Notice 2002–15, 2002–8 I.R.B.548
2001–68
Supplemented by
Notice 2002–15, 2002–8 I.R.B.548
2002–14
Modified and superseded by
Rev. Proc. 2002–28, 2002–18 I.R.B.815
Proposed Regulations:
REG–209135–88
Corrected by
Ann. 2002–15, 2002–7 I.R.B.540
Ann. 2002–30, 2002–11 I.R.B.632
REG–251502–96
Withdrawn by
Ann. 2002–33, 2002–12 I.R.B.666
REG–105316–98
Withdrawn by
REG–161424–01, 2002–21 I.R.B.1010
REG–113526–98
Withdrawn by
REG–105369–00, 2002–18 I.R.B.828
Proposed Regulations:—Continued
REG–107100–00
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–107566–00
Withdrawn by
REG–163892–01, 2002–20 I.R.B.968
REG–105344–01
Corrected by
Ann. 2002–7, 2002–5 I.R.B.459
REG–112991–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
Ann. 2002–38, 2002–14 I.R.B.738
REG–115054–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–119436–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–120135–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–125450–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–125626–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–126485–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–137519–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–142299–01
Corrected by
Ann. 2002–15, 2002–7 I.R.B.540
Ann. 2002–30, 2002–11 I.R.B.632
REG–142686–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
REG–159079–01
Corrected by
Ann. 2002–30, 2002–11 I.R.B.632
Revenue Procedures:
74–33
Superseded by
Rev. Proc. 2002–39, 2002–22 I.R.B.1046
Revenue Procedures:—Continued
84–37
Modified by
Rev. Proc. 2002–1, 2002–1 I.R.B.1
84–57
Obsoleted by
T.D. 8976, 2002–5 I.R.B.421
85–16
Superseded by
Rev. Proc. 2002–39, 2002–22 I.R.B.1046
87–32
Clarified, modified, amplified, and superseded by
Rev. Proc. 2002–38, 2002–22 I.R.B.1037
87–50
Modified by
Rev. Proc. 2002–10, 2002–4 I.R.B.401
89–45
Superseded by
Rev. Proc. 2002–23, 2002–15 I.R.B.744
91–71
Clarified and superseded by
Rev. Proc. 2002–32, 2002–20 I.R.B.959
96–13
Modified by
Rev. Proc. 2002–1, 2002–1 I.R.B.1
97–27
Modified and amplified by
Rev. Proc. 2002–19, 2002–13 I.R.B.696
98–49
Obsoleted by
T.D. 8976, 2002–5 I.R.B.421
99–49
Modified and superseded by
Rev. Proc. 2002–9, 2002–3 I.R.B.327
2000–11
Modified, amplified, and superseded by
Rev. Proc. 2002–37, 2002–22 I.R.B.1030
2000–20
Modified by
Rev. Proc. 2002–6, 2002–1 I.R.B.203
2000–46
Superseded by
Rev. Proc. 2002–22, 2002–14 I.R.B.733
2001–1
Superseded by
Rev. Proc. 2002–1, 2002–1 I.R.B.1
2001–2
Superseded by
Rev. Proc. 2002–2, 2002–1 I.R.B.82
2
A cumulative list of current actions on previously published
items in Internal Revenue Bulletins 2001–27 through 2001–53 is
in Internal Revenue Bulletin 2002–1, dated January 7, 2002.
June 10, 2002iv2002–23 I.R.B.

Revenue Procedures:—Continued
2001–3
Superseded by
Rev. Proc. 2002–3, 2002–1 I.R.B.117
2001–4
Superseded by
Rev. Proc. 2002–4, 2002–1 I.R.B.127
2001–5
Superseded by
Rev. Proc. 2002–5, 2002–1 I.R.B.173
2001–6
Superseded by
Rev. Proc. 2002–6, 2002–1 I.R.B.203
2001–7
Superseded by
Rev. Proc. 2002–7, 2002–1 I.R.B.249
2001–8
Superseded by
Rev. Proc. 2002–8, 2002–1 I.R.B.252
2001–13
Corrected by
Ann. 2002–5, 2002–4 I.R.B.420
2001–16
Modified by
Ann. 2002–26, 2002–11 I.R.B.629
2001–27
Supplemented by
Rev. Proc. 2002–20, 2002–14 I.R.B.732
2001–35
Obsoleted, except as provided in section 5.02 by
Rev. Proc. 2002–24, 2002–17 I.R.B.798
2001–36
Superseded by
Rev. Proc. 2002–3, 2002–1 I.R.B.117
2001–41
Superseded by
Rev. Proc. 2002–2, 2002–1 I.R.B.82
2001–51
Superseded by
Rev. Proc. 2002–3, 2002–1 I.R.B.117
2002–3
Modified by
Rev. Proc. 2002–22, 2002–14 I.R.B.733
2002–6
Modified by
Notice 2002–1, 2002–2 I.R.B.283
Rev. Proc. 2002–21, 2002–19 I.R.B.911
2002–8
Modified by
Notice 2002–1, 2002–2 I.R.B.283
Revenue Procedures:—Continued
2002–9
Modified and clarified by
Ann. 2002–17, 2002–8 I.R.B.561
Modified and amplified by
Rev. Rul. 2002–9, 2002–10 I.R.B.614
Rev. Proc. 2002–17, 2002–13 I.R.B.676
Rev. Proc. 2002–19, 2002–13 I.R.B.696
Rev. Proc. 2002–27, 2002–17 I.R.B.802
Rev. Proc. 2002–28, 2002–18 I.R.B.815
Rev. Proc. 2002–33, 2002–20 I.R.B.963
Rev. Proc. 2002–36, 2002–21 I.R.B.993
2002–10
Modified by
Ann. 2002–49, 2002–19 I.R.B.919
Revenue Rulings:
55–261
Distinguished by
Rev. Rul. 2002–19, 2002–16 I.R.B.778
55–747
Revoked by
Notice 2002–8, 2002–4 I.R.B.398
61–146
Distinguished by
Rev. Rul. 2002–3, 2002–3 I.R.B.316
64–328
Modified by
Notice 2002–8, 2002–4 I.R.B.398
66–110
Modified by
Notice 2002–8, 2002–4 I.R.B.398
73–304
Superseded by
Rev. Proc. 2002–26, 2002–15 I.R.B.746
73–305
Superseded by
Rev. Proc. 2002–26, 2002–15 I.R.B.746
76–270
Amplified and superseded by
Rev. Rul. 2002–20, 2002–17 I.R.B.794
79–151
Distinguished by
Rev. Rul. 2002–19, 2002–16 I.R.B.778
79–284
Superseded by
Rev. Proc. 2002–26, 2002–15 I.R.B.746
80–218
Superseded by
Rev. Rul. 2002–23, 2002–18 I.R.B.811
87–112
Clarified by
Rev. Rul. 2002–22, 2002–19 I.R.B.849
Revenue Rulings:—Continued
89–29
Obsoleted by
T.D. 8976, 2002–5 I.R.B.421
92–19
Supplemented in part by
Rev. Rul. 2002–12, 2002–11 I.R.B.624
2002–7
Corrected by
Ann. 2002–13, 2002–7 I.R.B.540
Treasury Decisions:
8971
Corrected by
Ann. 2002–20, 2002–8 I.R.B.561
8972
Corrected by
Ann. 2002–23, 2002–8 I.R.B.563
8973
Corrected by
Ann. 2002–14, 2002–7 I.R.B.540
8975
Corrected by
Ann. 2002–21, 2002–8 I.R.B.562
8976
Corrected by
Ann. 2002–21, 2002–8 I.R.B.562
8978
Corrected by
Ann. 2002–39, 2002–14 I.R.B.738
2002–23 I.R.B.vJune 10, 2002