Internal Revenue Bulletin 2004-6 (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.

Bulletin No. 200
4-6
February 9, 2004
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
Rev. Rul. 2004–9, page 428.
Federal rates; adjusted federal rates; adjusted federal
long-termrateandthelong-termexemptrate.For pur-
poses of sections 382, 642, 1274, 1288, and other sections
of the Code, tables set forth the rates for February 2004.
T.D. 9104,
page 406.
Final regu
lations under section 41 of the Code clarify the def-
inition of
qualified research contained in the credit for increas-
ing resear
ch activities. In addition, the regulations adopt the
recordke
eping requirements and the rules for excluded activi-
ties as se
t forth in the 2001 proposed regulations.
T.D. 9105, page 419.
REG–126459–03, page 437.
Final, temporary, and proposed regulations under sections
167, 446, and 1016 of the Code provide rules for changes
in determining depreciation or amortization. The regulations
also provide guidance as to whether certain changes in depre-
ciation or amortization are changes in methods of accounting.
The regulations apply to changes made for taxable years
ending on or after December 30, 2003. A public hearing on
the proposed regulations is scheduled for April 7, 2004.
T.D. 9108, page 429.
Final regulations under section 6011 of the Code modify and
clarify the rules relating to confidential transactions under reg-
ulations section 1.6011–4(b)(3), and make minor conforming
changes to the list maintenance rules under regulations section
301.6112–1.
Notice 2004–11, page 434.
This notice announces a pilot program that permits large
and mid-size business taxpayers to enter into research credit
recordkeeping agreements.
Announcement 2004–9, page 441.
This advance notice of proposed rulemaking
(REG–153656–03) under section 41 of the Code in-
vites comments relating to the definition of internal-use
software contained in the credit for increasing research
activities. In addition, the document provides guidance
for taxpayers regarding the interim effective dates of the
internal-use software rules.
EMPLOYEE PLANS
Rev. Rul. 2004–4, page 414.
Employee stock ownership plans; S corporations; listed
transactions.A finding of synthetic equity owned by a dis-
qualified person in a nonallocation year of an ESOP, as those
terms are defined in section 409(p) of the Code and regulations
section 1.409(p)–1T, takes place in three distinct situations.
In addition, the transactions described in this ruling, as well
as substantially similar transactions, are designated as “listed
transactions.”
Notice 2004–10, page 433.
Electronic delivery of Form 1099 and Form 5498 payee
statements.This notice permits the electronic delivery of
Form 1099–R, Form 1099–MSA, Form 1099–Q, Form 5498,
Form 5498–ESA, and Form 5498–MSA payee statements by
their respective due dates.
(Continued on the next page)
Announcements of Disbarments and Suspensions begin on page 439.
Fi
nding Lists begin on page ii.

EXEMPT ORGANIZATIONS
Notice 2004–10, page 433.
Electronic delivery of Form 1099 and Form 5498 payee
statements.This notice permits the electronic delivery of
Form 1099–R, Form 1099–MSA, Form 1099–Q, Form 5498,
Form 5498–ESA, and Form 5498–MSA payee statements by
their respective due dates.
ADMINISTRATIVE
T.D. 9108, page 429.
Final regulations under section 6011 of the Code modify and
clarify the rules relating to confidential transactions under reg-
ulations section 1.6011–4(b)(3), and make minor conforming
changes to the list maintenance rules under regulations section
301.6112–1.
Notice 2004–10, page 433.
Electronic delivery of Form 1099 and Form 5498 payee
statements.This notice permits the electronic delivery of
Form 1099–R, Form 1099–MSA, Form 1099–Q, Form 5498,
Form 5498–ESA, and Form 5498–MSA payee statements by
their respective due dates.
Announceme
nt 2004–8, page 441.
This announ
cement corrects the user fee in Appendix A of Rev.
Proc. 2004
–1 for a letter ruling request involving an extension
of time to f
ile Form 3115,Application for Change in Accounting
Method.Th
e correct user fee is $1,200, not $1,500.
February 9, 20042004-6 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. Bul-
letin contents are consolidated semiannually into Cumulative
Bulletins, 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, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
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 revenue
ruling. In those based on positions taken in rulings to taxpayers
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.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al 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, Leg-
islation 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 Sec-
retary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d suspension lists, and announcements.
The last 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 last Bulletin of each semiannual period.*
The c
ontents 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.
* Beginning with Internal Revenue Bulletin 2003–43, we are publishing the index at the end of the month, rather than at the beginning.
2004-6 I.R.B.February 9, 2004

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 41.—Credit for
Increasing Research
Activities
26 CFR 1.41–4: Qualified research for expenditures
paid or incurred in taxable years ending on or after
December 31, 2003.
T.D. 9104
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Credit for Increasing Research
Activities
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains fi-
nal regulations relating to the definition of
qualified research under section 41(d) for
the credit for increasing research activities.
These final regulations reflect changes to
section 41(d) made by the Tax Reform Act
of 1986.
DATES:Effective Dates: These regula-
tions are effective January 2, 2004.
Applicability Dates: For dates of appli-
cability of these regulations, see §1.41–4
(e) and Effective Dates under SUPPLE-
MENTARY INFORMATION.
FOR FURTHER INFORMATION
CONTACT: Nicole R. Cimino at (202)
622–3120 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On December 2, 1998, the Treasury De-
partment and the IRS published in theFed-
eral Registeranoticeofproposedrule-
making (REG–105170–97, 1998–2 C.B.
729 [63 FR 66503]) under section 41 (1998
proposed regulations) relating to the credit
for increasing research activities (research
credit). The 1998 proposed regulations ad-
dressed, in relevant part, (1) the definition
of qualified research under section 41(d),
(2) the application of the exclusions from
the definition of qualified research, and
(3) the application of the shrinking-back
rule. Comments responding to the 1998
proposed regulations were received and a
public hearing was held on April 29, 1999.
On January 3, 2001, the Treasury De-
partment and the IRS published in the
Federal Registerfinal regulations re-
lating, in relevant part, to the definition
of qualified research under section 41(d)
(T.D. 8930, 2001–1 C.B. 433 [66 FR
280]). In response to taxpayer concerns
regarding T.D. 8930, on January 31, 2001,
the Treasury Department and the IRS pub-
lished Notice 2001–19, 2001–1 C.B. 784,
announcing that the Treasury Department
and the IRS would review T.D. 8930 and
reconsider comments previously submit-
ted in connection with the finalization
of T.D. 8930. Notice 2001–19 also pro-
vided that, upon the completion of the
review, the Treasury Department and the
IRS would announce changes to the reg-
ulations, if any, in the form of proposed
regulations.
On December 26, 2001, the Treasury
Department and the IRS published in the
Federal Registera notice of proposed
rulemaking (REG–112991–01, 2002–1
C. B. 404 [66 FR 66362]) reflecting the
Treasury Department and the IRS’ review
of T.D. 8930 (2001 proposed regulations).
Comments responding to the 2001 pro-
posed regulations were received and a
public hearing was held on March 27,
2002. After considering the comments
received and the statements made at the
public hearing, portions of the 2001 pro-
posed regulations are adopted as revised
by this Treasury Decision.
Explanation of Provisions
This document amends 26 CFR part 1
to provide revised rules for the research
credit under section 41. These final regula-
tions generally retainthe provisions of the
2001 proposed regulations but clarify the
provisions relating to the requirement in
section 41(d)(1)(C) that qualified research
be research “substantially all of the ac-
tivities of which constitute elements of a
process of experimentation.” These final
regulations, however, do not contain final
rules for research with respect to computer
software “which is developed by (or for the
benefit of) the taxpayer primarily for in-
ternal use by the taxpayer” for purposes of
section 41(d)(4)(E).
Process of Experimentation—In General
The Tax Reform Act of 1986, Public
Law 99–514 (100 Stat. 2085) (the 1986
Act), which narrowed the definition of
the termqualified research, amended the
definition of qualified research by adding
a process of experimentation requirement.
Section 41(d)(1) provides that in order to
constitute qualified research, substantially
all of the activities of the research must
constitute elements of a process of exper-
imentation related to a new or improved
function, performance, or reliability or
quality. The legislative history to the 1986
Act explained that “[t]he determination
of whether research is undertaken for
the purpose of discovering information
that is technological in nature depends
on whether the process of experimenta-
tion utilized in the research fundamentally
relies on principles of the physical or bio-
logical sciences, engineering, or computer
science.” H.R. Conf. Rep. No. 99–841,
at II–71 (1986). The legislative history
further explained that the termprocess
of experimentationmeans, “a process
involving the evaluation of more than
one alternative designed to achieve a re-
sult where the means of achieving that
result is uncertain at the outset.”Id.,at
II–72. In addition, a process of experi-
mentation may involve developing one or
more hypotheses, testing and analyzing
those hypotheses (through, for example,
modeling or simulation), and refining or
discarding the hypotheses as part of a
sequential design process to develop the
overall component.Id.
The 1998 proposed regulations defined
a process of experimentation as “a process
to evaluate more than one alternative de-
signed to achieve a result where the means
of achieving that result are uncertain at the
2004-6 I.R.B.406February 9, 2004

outset.” Further, the 1998 proposed regu-
lations specified that a process of exper-
imentation is a four-step process requir-
ing that the taxpayer: (i) develop one or
more hypotheses designed to achieve the
intended result; (ii) design a scientific ex-
periment (that, where appropriate to the
particular field of research, is intended to
be replicable with an established experi-
mental control) to test and analyze those
hypotheses (through, for example, model-
ing, simulation, or a systematic trial and
error methodology); (iii) conduct the ex-
periment and record the results; and (iv)
refine or discard the hypotheses as part of
a sequential design process to develop or
improve the business component. Com-
mentators generally objected to this pre-
scribed four-step test arguing that it would
not be appropriate for evaluating the qual-
ification of certain commercial and indus-
trial research activities.
In response to these comments, the
Treasury Department and the IRS in
T.D. 8930 provided that taxpayers con-
ducting a process of experimentation may,
but were not required to, engage in the
four-step process described in the 1998
proposed regulations, but eliminated, for
this purpose, the specific recordation re-
quirement. (As an addition to the general
recordkeeping requirement under section
6001, T.D. 8930 instead included a con-
temporaneous documentation requirement
that was intended to be less burdensome
than the specific recordation requirement.
The contemporaneous documentation re-
quirement in T.D. 8930 was eliminated in
the 2001 proposed regulations.) Consis-
tent with the legislative history, however,
T.D. 8930 retained the underlying process
of experimentation requirement in the
1998 proposed regulations by providing
that a process of experimentation “is a
process to evaluate more than one alter-
native designed to achieve a result where
the capability or method of achieving that
result is uncertain at the outset.”
The 2001 proposed regulations further
clarified the definition of a process of ex-
perimentation and provided, in relevant
part, that “a process of experimentation is
a process designed to evaluate one or more
alternatives to achieve a result where the
capability or the method of achieving that
result, or the appropriate design of that re-
sult, is uncertain as of the beginning of
the taxpayer’s research activities.” More
specifically, however, the general require-
ment was modified in the 2001 proposed
regulations to provide, first, that “a process
of experimentation is a processdesigned
to evaluateone or morealternatives to
achieve a result.” (Emphasis added). The
2001 proposed regulations also provided
that a process of experimentation may ex-
ist if a taxpayer performs research to es-
tablish the appropriate design of a busi-
ness component even when the capabil-
ity and method for developing or improv-
ing the business component are not un-
certain. The 2001 proposed regulations
further stated that a taxpayer’s activities
do not constitute elements of a process of
experimentation where the capability and
method of achieving the desired new or
improved business component, and the ap-
propriate design of the desired new or im-
proved business component, are readily
discernible and applicable as of the be-
ginning of the taxpayer’s research activ-
ities so that true experimentation in the
scientific or laboratory sense would not
have to be undertaken to test, analyze,
and choose among viable alternatives. Fi-
nally, the 2001 proposed regulations em-
phasized that the determination of whether
a taxpayer has engaged in a process of ex-
perimentation was dependent on the facts
and circumstances of the taxpayer’s re-
search activities and, for this purpose, con-
tained three non-dispositive and non-ex-
clusive factors that tend to indicate that a
taxpayer has engaged in a process of ex-
perimentation.
In response to the 2001 proposed reg-
ulations, a number ofcommentators ex-
pressed concern with the rules for the
process of experimentation requirement,
and, in particular, stated that the rules and
terms used (includinguncertainty,appro-
priate design,andreadily discernible and
applicable) did not provide clear guidance
for the requirement. More specifically,
commentators stated that the termread-
ily discernible and applicablewas highly
subjective in nature, and thus arguably
could be construed as a variant of the dis-
covery test of T.D. 8930. In addition, one
commentator expressed concern regard-
ing the meaning and scope of the term
uncertainand suggested adding examples
illustrating the factors that tend to indicate
that a taxpayer has engaged in a process of
experimentation. Another commentator
also noted that the 2001 proposed regula-
tions appeared to allow the inclusion of all
design costs as qualified research expen-
ditures to the extent that the appropriate
design of the desired result is never certain
at the outset of the typical design process.
The Treasury Department and the IRS
continue to believe that the process of ex-
perimentation test requires an evaluation
of the facts and circumstances of a tax-
payer’s research activities. As reflected
by the changes made in the 2001 proposed
regulations, this requirement is not in-
tended to be inflexible or overly narrow.
Nevertheless, the Treasury Department
and the IRS continue to believe that the
requirement in the 2001 proposed regu-
lations that a process of experimentation
is “aprocessdesigned to evaluate one
or more alternativesto achieve a result”
(emphasis added) implies that research
activities must contain certain core el-
ements in order to constitute a process
of experimentation within the meaning
of section 41(d)(1)(C). These final reg-
ulations, therefore, make the following
clarifications relating to the process of
experimentation requirement in the 2001
proposed regulations.
Process of
Experimentation—Requirements
The final regulations retain, but further
clarify, the requirement in the 2001 pro-
posed regulations that “a process of exper-
imentation is a process designed to evalu-
ate one or more alternatives to achieve a
result where the capability or the method
of achieving that result, or the appropriate
design of that result, is uncertain as of the
beginning of the taxpayer’s research activ-
ities.” Further, the final regulations empha-
size that the taxpayer’s activities must be
directed at resolving uncertainty regarding
the taxpayer’s development or improve-
ment of a business component, and that
the process of experimentation must fun-
damentally rely on the principles of the
physical or biological sciences, engineer-
ing, or computer science in attempting to
resolve the uncertainty. Although these
concepts are stated explicitly in the 1986
legislative history and are implicit in the
statute, they may not have been given ap-
propriate or necessary weight in prior pro-
posed or final guidance on the process of
experimentation requirement.
February 9, 20044072004-6 I.R.B.

The final regulations, therefore, set out
what the Treasury Department and the
IRS have concluded to be the core ele-
ments of a process of experimentation for
purposes of the research credit. As noted
above and consistent with the statute’s
wording which requires purposeful activ-
ity (i.e., “undertaken for the purpose of
discovering information”), a taxpayer is
required to identify the uncertainty regard-
ing the development or improvement of
a business component that is the object
of the taxpayer’s research activities. A
taxpayer is also required to identify one
or more alternatives intended to eliminate
that uncertainty. Additionally, a taxpayer
is required to identify and to conduct a
process of evaluating the alternatives.
The final regulations provide that such a
process may involve, for example, model-
ing, simulation, or a systematic trial and
error methodology.
The final regulations further provide
that a process of experimentation “mustbe
an evaluative process and generallyshould
be capable of evaluating more than one
alternative.” (Emphasis added). Although
the identification and evaluation of more
than a single alternative is not required
to satisfy the process of experimentation
requirement, the Treasury Department and
the IRS believe that a taxpayer’s activities,
in order to qualify for the research credit,
generally should be capable of evaluat-
ing more than one alternative and, in any
event, must be designed to evaluate the
alternative, or alternatives, being consid-
ered.
The final regulations state that the mere
existence of uncertainty regarding the de-
velopment or improvement of a business
component does not indicate that all of a
taxpayer’s activitiesundertaken to achieve
that new or improved business component
constitute a process of experimentation,
even if the taxpayer, in fact, does achieve
the new or improved business component.
The Treasury Department and the IRS
believe that the inclusion of a separate
process of experimentation requirement
in the statute makes this proposition clear.
However, the Treasury Department and
the IRS have included this clarification in
the final regulations out of concern that
taxpayers have not been giving sufficient
weight to the requirement that a taxpayer
engage in a process designed to evaluate
one or more alternatives to achieve a re-
sult where the capability or the method of
achieving that result, or the appropriate
design of that result, is uncertain as of
the beginning of the taxpayer’s research
activities. In particular, this clarifica-
tion is intended to indicate that merely
demonstrating that uncertainty has been
eliminated (e.g., the achievement of the
appropriate design of a business compo-
nent when such design was uncertain as
of the beginning of a taxpayer’s activities)
is insufficient to satisfy the process of
experimentation requirement. A taxpayer
bears the burden of demonstrating that its
research activities additionally satisfy the
process of experimentation requirement.
As noted above, all of the facts and
circumstances of a taxpayer’s research
activities are taken into account to de-
termine whether the taxpayer identified
uncertainty concerning the development
or improvement of a business component,
identified one or more alternatives in-
tended to eliminate that uncertainty, and
identified and conducted a process of eval-
uating the alternatives. Although the final
regulations set out the core elements of
a process of experimentation, how a tax-
payer’s qualified research activities will
reflect these core elements will depend on
the facts and circumstances. These core
elements will not necessarily occur in a
strict, sequential order. A process of ex-
perimentation is an evaluative process, and
as such, often involves refining through-
out much of the process the taxpayer’s
understanding of the uncertainty the tax-
payer is trying to address, modifying the
alternatives being evaluated to eliminate
that uncertainty, or modifying the process
used to evaluate those alternatives.
Accordingly, the final regulations do
not provide detailed guidance as to how the
regulatory provisions are to be applied to a
given factual situation. Rather, the Trea-
sury Department and the IRS have con-
cluded that the application of these pro-
visions will depend on the specific activ-
ities being claimed by a taxpayer as quali-
fied research, the nature of the taxpayer’s
business and industry, and the uncertain-
ties being addressed by the taxpayer’s re-
search activities. The Treasury Depart-
ment and the IRS believe that additional,
industry-specific guidance may be appro-
priate and request comments on the form
of such guidance.
The final regulations do not include
the rule contained in the 2001 proposed
regulations that a taxpayer’s activities do
not constitute a process of experimentation
where the capability and method of achiev-
ing the desired new or improved business
component, and the appropriate design
of the desired new or improved business
component, are readily discernible and
applicable as of the beginning of the tax-
payer’s research activities. A number
of commentators expressed concern that
this rule was too vague and susceptible
to conflicting interpretations. In light of
the clarifications made in these final regu-
lations, the Treasury Department and the
IRS have concluded that this rule is no
longer necessary because such activities
do not constitute a process of experimen-
tation under the final regulations.
As noted above, the 2001 proposed reg-
ulations do not contain a specific record-
keeping requirement beyond the require-
ments set out in section 6001 and the reg-
ulations thereunder. No change regarding
recordkeeping is being made in these fi-
nal regulations. The clarifications being
made to the process of experimentation re-
quirement do not impose any recordkeep-
ing requirement on taxpayers beyond the
requirements set out in section 6001 and
the regulations thereunder.
Process of
Experimentation—Substantially
all Requirement
The 2001 proposed regulations retained
the rule in T.D. 8930 that the “substantially
all” requirement of section 41(d)(1)(C) is
satisfiedonlyif80percentormoreofthe
research activities, measured on a cost or
other consistently applied reasonable ba-
sis (and without regard to §1.41–2(d)(2)),
constitute elements of a process of exper-
imentation for a purpose described in sec-
tion 41(d)(3). This requirement is applied
separately to each business component.
The Treasury Department and the IRS
requested comments on the application of
the substantially all rule and, in partic-
ular, whether research expenses incurred
for non-qualified purposes (i.e., relating to
style, taste, cosmetic, or seasonal design
factors) are includible in the credit compu-
tation provided that substantially all of the
research activities constitute elements of a
process of experimentation for a qualified
2004-6 I.R.B.408February 9, 2004

purpose. After consideration of the com-
ments received, the Treasury Department
and the IRS have concluded that the sub-
stantially all requirement can be satisfied
even if some portion of a taxpayer’s activ-
ities are not for a qualified purpose.
Accordingly, these final regulations
clarify the substantially all rule and pro-
vide that the substantially all require-
ment is satisfied if 20 percent or less of
a taxpayer’s research activities do not
constitute elements of a process of ex-
perimentation for a purpose described in
section 41(d)(3), so long as these remain-
ing activities satisfy the requirements of
section 41(d)(1)(A) and are not otherwise
excluded under section 41(d)(4). Example
(6) of §1.41–4(a)(8) of the 2001 proposed
regulations has been modified to illustrate
the application of this rule, and appears as
example (4) in these final regulations.
Other Issues
Patent Safe Harbor
Section 1.41–4(a)(3)(iii) of the 2001
proposed regulations generally provided
that the issuance of certain patents is
conclusive evidence that a taxpayer has
discovered information that is technologi-
cal in nature that is intended to eliminate
uncertainty concerning the development
or improvement of a business compo-
nent. Some commentators requested that
this patent safe harbor be expanded to
cover all requirements contained in sec-
tions 41(d)(1) and (3). After consideration
of these comments, and in light of the
clarifications being made in these final
regulations to the provisions relating to
the process of experimentation require-
ment, the Treasury Department and the
IRS continue to believe that the patent
safe harbor is appropriately limited and,
therefore, have not changed the patent safe
harbor provision.
Shrinking-Back Rule
Some commentators expressed concern
that the language of the shrinking-back
rule in §1.41–4(b)(2) of the 2001 proposed
regulations implied that not all of a tax-
payer’s qualified research expenses would
be eligible for the research credit as a re-
sult of the application of the rule. This
provisionhasbeenrevisedinthesefinal
regulations to clarify that the rule is not
intended to exclude qualified research ex-
penses from the credit, but rather is in-
tended to ensure that expenses attributable
to qualified research activities are eligible
for the research credit for purposes of sec-
tion 41(d)(1).
Research After Commercial Production
Some commentators requested addi-
tional clarification regarding the scope of
the research after commercial production,
adaptation, and duplication exclusions
set out in section 41(d)(4)(A), (B) and
(C), and §1.41–4(c)(2), (3) and (4) of the
2001 proposed regulations. After consid-
eration of these comments, the Treasury
Department and the IRS believe that the
multitude of factual situations to which
these exclusions might apply make it im-
practical to provide additional clarification
that is both meaningful and of broad appli-
cation. The Treasury Department and the
IRS believe these three specific exclusions
do not cover research activities that other-
wise satisfy the requirements for qualified
research. Taxpayers, however, should
carefully review (including, as appropri-
ate, the application of the shrinking-back
rule) research activities that might other-
wise fall within these exclusions to ensure
that only eligible activities are being in-
cluded in their credit computations.
One commentator expressed concern
that the language of §1.41–4(c)(2)(iv), re-
lating to the clinical testing of pharmaceu-
tical products, could exclude from credit
eligibility clinical trials performed under
an arrangement where the Food and Drug
Administration has granted conditional
approval for a pharmaceutical product
contingent upon the results of additional
clinical trials. Another commentator ex-
pressed concern that the language would
exclude otherwise qualifying activities
because the research was not required to
be approved by the Food and Drug Ad-
ministration. Section 1.41–4(c)(2)(iv) is
not a rule of exclusion. As stated above,
the Treasury Department and the IRS be-
lieve that the research after commercial
production exclusion (as well as the adap-
tation and duplication exclusions) do not
cover research activities, including these
additional clinical trials, so long as such
trials satisfy the requirements for qualified
research.
Gross Receipts
These final regulations retain the broad
definition of gross receipts contained in
T.D. 8930. In response to Notice 2001–19,
a number of commentators reiterated ear-
lier comments that this definition was
overly broad. As stated in the preamble to
the 2001 proposed regulations, the Trea-
sury Department and the IRS continue
to believe that the definition of gross re-
ceipts should be construed broadly, and,
accordingly, no change has been made in
these final regulations to the definition
contained in T.D. 8930.
Examples
The examples in the regulations have
been changed to remove references to
“readily discernible and applicable.”
While the Treasury Department and the
IRS continue to believe that the activities
inExamples 4and5of §1.41–4(a)(8) of
the 2001 proposed regulations would not
qualify under the final regulations, these
examples were removed as the only pur-
pose of these examples was to illustrate
the “readily discernable and applicable”
standard. Minor changes to the facts in
Example 4of §1.41–4(a)(8) in the final
regulations (Example 6of §1.41–4(a)(8) of
the 2001 proposed regulations) were made
to illustrate more clearly the application
of the substantially all requirement of
§1.41–4(a)(6). These changes do not indi-
cate that the Treasury Department and the
IRS believe that the integration activities
removed from the example, as contained
in the 2001 proposed regulations, are or
are not qualified activities standing alone.
The determination of whether activities are
qualified research is based on the specific
facts and circumstances of those activities.
Additionally, minor changes were made
to the examples in §1.41–4(c)(10) to re-
move references to “readily discernable
and applicable” and to make some clarifi-
cations based on comments received.Ex-
ample 1of §1.41–4(c)(10) was modified to
remove the conclusion regarding qualifi-
cation of expenses under section 174. Al-
though the Treasury Department and the
IRS continue to believe that the conclu-
sion in the 2001 proposed regulations is
correct, the Treasury Department and the
IRS believe that the point illustrated in the
removed portion of the example would be
February 9, 20044092004-6 I.R.B.

more appropriately addressed in guidance
issued under section 174, rather than in
guidance under section 41.
Effective Date
Notice 2001–19 stated, in relevant part,
that the provisions of T.D. 8930, includ-
ing any changes to T.D. 8930, would be
effective no earlier than the date when the
completion of the Treasury Department
and the IRS’ review of T.D. 8930 was
announced. The 2001 proposed regula-
tions provided, in relevant part, that final
regulations would apply to taxable years
ending on or after December 26, 2001,
the date the proposed regulations were
published in theFederal Register.
Because these finalregulations only
clarify the provisions of the 2001 pro-
posed regulations, these final regulations
apply to taxable years ending on or af-
ter December 31, 2003. For taxable years
ending before December 31, 2003, the IRS
will not challenge return positions that are
consistent with these final regulations.
Special Analyses
It has been determined that these reg-
ulations are not a significant regulatory
action as defined in Executive Order
12866. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
these regulations do not impose a col-
lection of information on small entities,
the Regulatory Flexibility Act (5 U.S.C.
chapter 6) does not apply. Therefore, a
Regulatory Flexibility Act Analysis is not
required. Pursuant to section 7805(f), the
notice of proposed rulemaking preceding
these regulations was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal author of these regula-
tions is Nicole R. Cimino of the Office
of Associate Chief Counsel (Passthroughs
and Special Industries), IRS. However,
personnel from other offices of the IRS
and the Treasury Department participated
in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART I—INCOME TAXES
Paragraph 1. The authority for part 1
continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.41–0 is amended by
revising the entries for §1.41–4 to read as
follows:
The revisions and additions read as fol-
lows:
§1.41–0 Table of contents.
*****
§1.41–4 Qualified research for
expenditures paid or incurred in taxable
years ending on or after December 31,
2003.
(a) Qualified research.
(1) General rule.
(2) Requirements of section 41(d)(1).
(3) Undertaken for the purpose of discov-
ering information.
(i) In general.
(ii) Application of the discovering infor-
mation requirement.
(iii) Patent safe harbor.
(4) Technological in nature.
(5) Process of experimentation.
(i) In general.
(ii) Qualified purpose.
(6) Substantiallyall requirement.
(7) Use of computers and information
technology.
(8) Illustrations.
(b) Application of requirements for quali-
fied research.
(1) In general.
(2) Shrinking-back rule.
(3) Illustration.
(c) Excluded activities.
(1) In general.
(2) Research after commercial production.
(i) In general.
(ii) Certain additional activities related to
the business component.
(iii) Activities related to production
process or technique.
(iv) Clinical testing.
(3) Adaptation of existing business com-
ponents.
(4) Duplication of existing business com-
ponent.
(5) Surveys, studies, research relating to
management functions, etc.
(6) Internal use software for taxable years
beginning on or after December 31, 1985.
[Reserved].
(7) Activities outside the United States,
Puerto Rico, and other possessions.
(i) In general.
(ii) Apportionment of in-house research
expenses.
(iii) Apportionment of contract research
expenses.
(8) Research in the social sciences, etc.
(9) Research funded by any grant, contract,
or otherwise.
(10) Illustrations.
(d) Recordkeeping for the research credit.
(e) Effective dates.
*****
Par. 3. Section 1.41–4 is amended as
follows:
1. The section heading and paragraphs
(a)(2)(iii), (a)(3), (a)(4), (a)(5), (a)(6),
(a)(8), (b)(2), (b)(3), (c)(2)(iv), (c)(4),
(c)(7)(ii), (c)(10), (d), and (e) are revised.
2. The heading of paragraph (c)(6) is re-
vised and the text is removed and reserved.
The revisions read as follows:
§1.41–4 Qualified r
esearch for
expenditures paid o
r incurred in taxable
years ending on or a
fter December 31,
2003.
(a) * * *
(2) * * *
(iii) Substantially all of the activities of
which constitute elements of a process of
experimentation that relates to a qualified
purpose.
(3)Undertaken for the purpose of dis-
covering information—(i)In general.For
purposes of section 41(d) and this sec-
tion, research must be undertaken for the
purpose of discovering information that is
technological in nature. Research is under-
taken for the purpose of discovering infor-
mation if it is intended to eliminate uncer-
tainty concerning the development or im-
provement of a business component. Un-
certainty exists if the information available
to the taxpayer does not establish the capa-
bility or method for developing or improv-
ing the business component, or the appro-
priate design of the business component.
2004-6 I.R.B.410February 9, 2004

(ii)Application of the discovering in-
formation requirement. A determination
that research is undertaken for the purpose
of discovering information that is techno-
logical in nature doesnot require the tax-
payer be seeking to obtain information that
exceeds, expands or refines the common
knowledge of skilled professionals in the
particular field of science or engineering
in which the taxpayer is performing the re-
search. In addition, a determination that
research is undertaken for the purpose of
discovering information that is technolog-
ical in nature does not require that the tax-
payer succeed in developing a new or im-
proved business component.
(iii)Patent safe harbor. For purposes
of section 41(d) and paragraph (a)(3)(i) of
this section, the issuance of a patent by
the Patent and Trademark Office under the
provisions of 35 U.S.C. 151 (other than a
patent for design issued under the provi-
sions of 35 U.S.C. 171) is conclusive evi-
dence that a taxpayer has discovered infor-
mation that is technological in nature that
is intended to eliminate uncertainty con-
cerning the development or improvement
of a business component. However, the is-
suance of such a patent is not a precondi-
tion for credit availability.
(4)Technological in nature. For pur-
poses of section 41(d) and this section,
information is technological in nature if
the process of experimentation used to dis-
cover such information fundamentally re-
lies on principles of the physical or bio-
logical sciences, engineering, or computer
science. A taxpayer may employ exist-
ing technologies and may rely on existing
principles of the physical or biological sci-
ences, engineering, or computer science to
satisfy this requirement.
(5)Process of experimentation—(i)In
general. For purposes of section 41(d) and
this section, a process of experimentation
is a process designed to evaluate one or
more alternatives to achieve a result where
the capability or the method of achieving
that result, or the appropriate design of
that result, is uncertain as of the begin-
ning of the taxpayer’s research activities.
A process of experimentation must fun-
damentally rely on the principles of the
physical or biological sciences, engineer-
ing, or computer science and involves the
identification of uncertainty concerning
the development or improvement of a
business component, the identification of
one or more alternatives intended to elimi-
nate that uncertainty, and the identification
and the conduct of a process of evaluating
the alternatives (through, for example,
modeling, simulation, or a systematic trial
and error methodology). A process of
experimentation must be an evaluative
process and generally should be capable
of evaluating more than one alternative.
A taxpayer may undertake a process of
experimentation if there is no uncertainty
concerning the taxpayer’s capability or
method of achieving the desired result
so long as the appropriate design of the
desired result is uncertain as of the begin-
ning of the taxpayer’s research activities.
Uncertainty concerning the development
or improvement of the business compo-
nent (e.g., its appropriate design) does not
establish that all activities undertaken to
achieve that new or improved business
component constitute a process of experi-
mentation.
(ii)Qualified purpose. For purposes of
section 41(d) and this section, a process of
experimentation is undertaken for a qual-
ified purpose if it relates to a new or im-
proved function, performance, reliability
or quality of the business component. Re-
search will not be treated as conducted for
a qualified purpose if it relates to style,
taste, cosmetic, or seasonal design factors.
(6)Substantially all requirement.In
order for activities to constitute qualified
research under section 41(d)(1), substan-
tially all of the activities must constitute
elements of a process of experimentation
that relates to a qualified purpose. The
substantially all requirement of section
41(d)(1)(C) and paragraph (a)(2)(iii) of
this section is satisfied only if 80 percent
or more of a taxpayer’s research activities,
measured on a cost or other consistently
applied reasonablebasis (and without
regard to §1.41–2(d)(2)), constitute ele-
ments of a process of experimentation for
a purpose described in section 41(d)(3).
Accordingly, if 80 percent (or more) of a
taxpayer’s research activities with respect
to a business component constitute ele-
ments of a process of experimentation for
a purpose described in section 41(d)(3),
the substantially all requirement is satis-
fied even if the remaining 20 percent (or
less) of a taxpayer’s research activities
with respect to the business component
do not constitute elements of a process of
experimentation for a purpose described
in section 41(d)(3), so long as these re-
maining research activities satisfy the
requirements of section 41(d)(1)(A) and
are not otherwise excluded under section
41(d)(4). The substantially all requirement
is applied separately to each business com-
ponent.
*****
(8)Illustrations. The following exam-
ples illustrate the application of paragraph
(a)(5) of this section:
Example 1.(i)Facts. X is engaged in the business
of developing and manufacturing widgets. X wants
to change the color of its blue widget to green. X ob-
tains from various suppliers several different shades
of green paint. X paints several sample widgets, and
surveys X’s customers to determine which shade of
green X’s customers prefer.
(ii)Conclusion. X’s activities to change the color
of its blue widget to green are not qualified research
under section 41(d)(1) and paragraph (a)(5) of this
section because substantially all of X’s activities are
not undertaken for a qualified purpose. All of X’s
research activities are related to style, taste, cosmetic,
or seasonal design factors.
Example 2.(i)Facts. The facts are the same
as inExample 1, except that X chooses one of the
green paints. X obtains samples of the green paint
from a supplier and determines that X must modify
its painting process to accommodate the green paint
because the green paint has different characteristics
from other paints X has used. X obtains detailed data
on the green paint from X’s paint supplier. X also
consults with the manufacturer of X’s paint spraying
machines. The manufacturer informs X that X must
acquire a new nozzle that operates with the green
paint X wants to use. X tests the nozzles to ensure
that they work as specified by the manufacturer of the
paint spraying machines.
(ii)Conclusion. X’s activities to modify its paint-
ing process are a separate business component un-
der section 41(d)(2)(A). X’s activities to modify its
painting process to change the color of its blue wid-
get to green are not qualified research under section
41(d)(1) and paragraph (a)(5) of this section. X did
not conduct a process of evaluating alternatives in or-
der to eliminate uncertainty regarding the modifica-
tion of its painting process. Rather, the manufacturer
of the paint machines eliminated X’s uncertainty re-
garding the modification of its painting process. X’s
activities to test the nozzles to determine if the noz-
zles work as specified by the manufacturer of the
paint spraying machines are in the nature of routine
or ordinary testing or inspection for quality control.
Example 3.(i)Facts. X is engaged in the busi-
ness of manufacturing food products and currently
manufactures a large-shred version of a product. X
seeks to modify its current production line to per-
mit it to manufacture both alarge-shred version and
a fine-shred version of one of its food products. A
smaller, thinner shredding blade capable of produc-
ing a fine-shred version of the food product, how-
ever, is not commerciallyavailable. Thus, X must
develop a new shredding blade that can be fitted onto
its current production line. X is uncertain concerning
the design of the new shredding blade, because the
material used in its existing blade breaks when ma-
February 9, 20044112004-6 I.R.B.

chined into smaller, thinner blades. X engages in a
systematic trial and error process of analyzing various
blade designs and materials to determine whether the
new shredding blade must be constructed of a differ-
ent material from that of its existing shredding blade
and, if so, what material will best meet X’s functional
requirements.
(ii)Conclusion. X’s activities to modify its cur-
rent production line by developing the new shredding
blade meet the requirements of qualified research as
set forth in paragraph (a)(2) of this section. Sub-
stantially all of X’s activities constitute elements of
a process of experimentation because X evaluated al-
ternatives to achieve a result where the method of
achieving that result, and the appropriate design of
that result, were uncertain as of the beginning of the
taxpayer’s research activities. X identified uncertain-
ties related to the development of a business compo-
nent, and identified alternatives intended to eliminate
these uncertainties. Furthermore, X’s process of eval-
uating identified alternatives was technological in na-
ture, and was undertaken to eliminate the uncertain-
ties.
Example 4.(i)Facts. X is in the business of de-
signing, developing and manufacturing automobiles.
In response to government-mandated fuel economy
requirements, X seeks to update its current model
vehicle and undertakes to improve aerodynamics by
lowering the hood of its current model vehicle. X de-
termines, however, that lowering the hood changes
the air flow under the hood, which changes the rate at
which air enters the engine through the air intake sys-
tem, and which reduces the functionality of the cool-
ing system. X’s engineers are uncertain how to de-
sign a lower hood to obtain the increased fuel econ-
omy, while maintaining the necessary air flow un-
der the hood. X designs, models, simulates, tests,
refines, and re-tests several alternative designs for
the hood and associated proposed modifications to
both the air intake system and cooling system. This
process enables X to eliminate the uncertainties re-
lated to the integrated design of the hood, air intake
system, and cooling system, and such activities con-
stitute eighty-five percent of X’s total activities to up-
date its current model vehicle. X then engages in
additional activities that do not involve a process of
evaluating alternatives in order to eliminate uncer-
tainties. The additional activities constitute only fif-
teen percent of X’s total activities to update its current
model vehicle.
(ii)Conclusion. In general, if eighty percent or
more of a taxpayer’s research activities measured on
a cost or other consistently applied reasonable basis
constitute elements of a process of experimentation
for a qualified purpose under section 41(d)(3)(A)
and paragraph (a)(5)(ii) of this section, then the
substantially all requirement of section 41(d)(1)(C)
and paragraph (a)(2)(iii) of this section is satisfied.
Substantially all of X’s activities constitute elements
of a process of experimentation because X evaluated
alternatives to achieve a result where the method of
achieving that result, and the appropriate design of
that result, were uncertain as of the beginning of X’s
research activities. X identified uncertainties related
to the improvement of a business component and
identified alternatives intended to eliminate these
uncertainties. Furthermore, X’s process of evaluat-
ing the identified alternatives was technological in
nature and was undertaken to eliminate the uncer-
tainties. Because substantially all (in this example,
eighty-five percent) of X’s activities to update its cur-
rent model vehicle constitute elements of a process of
experimentation for a qualified purpose described in
section 41(d)(3)(A), all of X’s activities to update its
current model vehicle meet the requirements of qual-
ifiedresearchassetforthinparagraph(a)(2)ofthis
section, provided that X’s remaining activities (in
this example, fifteen percent of X’s total activities)
satisfy the requirements of section 41(d)(1)(A) and
are not otherwise excluded under section 41(d)(4).
(b)* * *
(2)Shrinking-back rule. The require-
ments of section 41(d) and paragraph (a)
of this section are to be applied first at
the level of the discrete business compo-
nent, that is, the product, process, com-
puter software, technique, formula, or in-
vention to be held for sale, lease, or li-
cense,orusedbythetaxpayerinatradeor
business of the taxpayer. If these require-
ments are not met at that level, then they
apply at the most significant subset of el-
ements of the product, process, computer
software, technique, formula, or invention
to be held for sale, lease, or license. This
shrinking back of the product is to con-
tinue until either a subset of elements of
the product that satisfies the requirements
is reached, or the most basic element of the
product is reached and such element fails
to satisfy the test. This shrinking-back rule
is applied only if a taxpayer does not sat-
isfy the requirements of section 41(d)(1)
and paragraph (a)(2) of this section with
respect to the overall business component.
The shrinking-back rule is not itself ap-
plied as a reason to exclude research ac-
tivities from credit eligibility.
(3)Illustration. The following example
illustrates the application of this paragraph
(b):
Example. X, a motorcycle engine builder, devel-
ops a new carburetor for use in a motorcycle engine.
X also modifies an existing engine design for use with
the new carburetor. Under the shrinking-back rule,
the requirements of section 41(d)(1) and paragraph
(a) of this section are applied first to the engine. If the
modifications to the engine when viewed as a whole,
including the development of the new carburetor, do
not satisfy the requirements of section 41(d)(1) and
paragraph (a) of this section, those requirements are
applied to the next most significant subset of elements
of the business component. Assuming that the next
most significant subset of elements of the engine is
the carburetor, the research activities in developing
the new carburetor may constitute qualified research
within the meaning of section 41(d)(1) and paragraph
(a)ofthissection.
(c) * * *
(2) * * *
(iv)Clinical testing. Clinical testing of
a pharmaceutical product prior to its com-
mercial production in the United States is
not treated as occurring after the begin-
ning of commercial production even if the
product is commercially available in other
countries. Additional clinical testing of
a pharmaceutical product after a product
has been approved for a specific therapeu-
tic use by the Food and Drug Administra-
tion and is ready for commercial produc-
tion and sale is not treated as occurring af-
ter the beginning of commercial produc-
tion if such clinical testing is undertaken
to establish new functional uses, character-
istics, indications, combinations, dosages,
or delivery forms for the product. A func-
tional use, characteristic, indication, com-
bination, dosage, or delivery form shall
be considered new only if such functional
use, characteristic,indication, combina-
tion, dosage, or delivery form must be ap-
proved by the Food and Drug Administra-
tion.
*****
(4)Duplication of existing business
component. Activities relating to repro-
ducing an existing business component (in
whole or in part) from a physical exam-
ination of the business component itself
or from plans, blueprints, detailed specifi-
cations, or publicly available information
about the business component are not
qualified research. This exclusion does
not apply merely because the taxpayer ex-
amines an existing business component in
the course of developing its own business
component.
*****
(6)Internal use software for taxable
years beginning on or after December 31,
1985.[Reserved].
(7) * * *
(ii)Apportionment of in-house research
expenses. In-house research expenses
paid or incurred for qualified services
performed both in the United States, the
Commonwealth of Puerto Rico and other
possessions of the United States and out-
side the United States, the Commonwealth
of Puerto Rico and other possessions of
the United States must be apportioned be-
tween the services performed in the United
States, the Commonwealth of Puerto Rico
and other possessions of the United States
and the services performed outside the
United States, the Commonwealth of
2004-6 I.R.B.412February 9, 2004

Puerto Rico and other possessions of
the United States. Only those in-house
research expenses apportioned to the ser-
vices performed within the United States,
the Commonwealth of Puerto Rico and
other possessions of the United States are
eligible to be treated as qualified research
expenses, unless the in-house research ex-
penses are wages and the 80 percent rule
of §1.41–2(d)(2) applies.
*****
(10)Illustrations. The following exam-
ples illustrate provisions contained in para-
graphs (c)(1) through (9) (excepting para-
graphs (c)(6) of this section) of this sec-
tion. No inference should be drawn from
these examples concerning the application
of section 41(d)(1) and paragraph (a) of
this section to these facts. The examples
are as follows:
Example 1.(i)Facts. X, a tire manufacturer, de-
velops a new material to use in its tires. X conducts
research to determine the changes that will be neces-
sary for X to modify its existing manufacturing pro-
cesses to manufacture the new tire. X determines that
the new tire material retains heat for a longer period of
time than the materials X currently uses for tires, and,
as a result, the new tire material adheres to the man-
ufacturing equipment during tread cooling. X eval-
uates several alternatives for processing the treads at
cooler temperatures to address this problem, includ-
ing a new type of belt for its manufacturing equip-
ment to be used in tread cooling. Such a belt is not
commercially available. Because X is uncertain of
the belt design, X develops and conducts sophisti-
cated engineering tests on several alternative designs
for a new type of belt to be used in tread cooling until
X successfully achieves a design that meets X’s re-
quirements. X then manufactures a set of belts for its
production equipment, installs the belts, and tests the
belts to make sure they were manufactured correctly.
(ii)Conclusion. X’s research with respect to the
design of the new belts to be used in its manufacturing
of the new tire may be qualified research under sec-
tion 41(d)(1) and paragraph (a) of this section. How-
ever, X’s expenses to implement the new belts, in-
cluding the costs to manufacture, install, and test the
belts were incurred after the belts met the taxpayer’s
functional and economic requirements and are ex-
cluded as research after commercial production un-
der section 41(d)(4)(A) and paragraph (c)(2) of this
section.
Example 2.(i)Facts. For several years, X has
manufactured and sold a particular kind of widget. X
initiates a new research project to develop a new or
improved widget.
(ii)Conclusion. X’s activities to develop a new
or improved widget are not excluded from the defini-
tion of qualified research under section 41(d)(4)(A)
and paragraph (c)(2) of this section. X’s activities re-
lating to the development of a new or improved wid-
get constitute a new research project to develop a new
business component. X’s research activities relating
to the development of the new or improved widget, a
new business component, are not considered to be ac-
tivities conducted after the beginning of commercial
production under section 41(d)(4)(A) and paragraph
(c)(2) of this section.
Example 3.(i)Facts. X, a computer software de-
velopment firm, owns all substantial rights in a gen-
eral ledger accounting software core program that X
markets and licenses to customers. X incurs expen-
ditures in adapting the core software program to the
requirements of C, one of X’s customers.
(ii)Conclusion. Because X’s activities represent
activities to adapt an existing software program to a
particular customer’s requirement or need, X’s activ-
ities are excluded from the definition of qualified re-
search under section 41(d)(4)(B) and paragraph (c)(3)
of this section.
Example 4.(i)Facts.Thefactsarethesameas
inExample 3, except that C pays X to adapt the core
software program to C’s requirements.
(ii)Conclusion. Because X’s activities are ex-
cluded from the definition of qualified research un-
der section 41(d)(4)(B) and paragraph (c)(3) of this
section, C’s payments to X are not for qualified re-
search and are not considered to be contract research
expenses under section 41(b)(3)(A).
Example 5.(i)Facts. The facts are the same as in
Example 3, except that C’s own employees adapt the
core software program to C’s requirements.
(ii)Conclusion. Because C’s employees’ activ-
ities to adapt the core software program to C’s re-
quirements are excluded from the definition of qual-
ified research under section 41(d)(4)(B) and para-
graph (c)(3) of this section, the wages C paid to its
employees do not constitute in-house research ex-
penses under section 41(b)(2)(A).
Example 6.(i)Facts. X manufacturers and sells
rail cars. Because rail cars have numerous specifi-
cations related to performance, reliability and qual-
ity, rail car designs are subject to extensive, complex
testing in the scientific or laboratory sense. B orders
passenger rail cars from X. B’s rail car requirements
differ from those of X’s other existing customers only
in that B wants fewer seats in its passenger cars and
a higher quality seating material and carpet that are
commercially available. X manufactures rail cars
meeting B’s requirements.
(ii)Conclusion. X’s activities to manufacture
rail cars for B are excluded from the definition of
qualified research. The rail car sold to B was not
a new business component, but merely an adapta-
tion of an existing business component that did not
require a process of experimentation. Thus, X’s
activities to manufacture rail cars for B are excluded
from the definition of qualified research under sec-
tion 41(d)(4)(B) and paragraph (c)(3) of this section
because X’s activities represent activities to adapt
an existing business component to a particular cus-
tomer’s requirement or need.
Example 7.(i)Facts. X, a manufacturer, un-
dertakes to create a manufacturing process for a new
valve design. X determines that it requires a special-
ized type of robotic equipment to use in the manufac-
turing process for its new valves. Such robotic equip-
ment is not commercially available, and X, therefore,
purchases the existing robotic equipment for the pur-
pose of modifying it to meet its needs. X’s engineers
identify uncertainty that is technological in nature
concerning how to modify the existing robotic equip-
ment to meet its needs. X’s engineers develop sev-
eral alternative designs, and conduct experiments us-
ing modeling and simulation in modifying the robotic
equipment and conduct extensive scientific and lab-
oratory testing of design alternatives. As a result of
this process, X’s engineers develop a design for the
robotic equipment that meets X’s needs. X constructs
and installs the modified robotic equipment on its
manufacturing process.
(ii)Conclusion. X’s research activities to de-
termine how to modify X’s robotic equipment for
its manufacturing process are not excluded from
the definition of qualified research under section
41(d)(4)(B) and paragraph (c)(3) of this section,
provided that X’s research activities satisfy the re-
quirements of section 41(d)(1).
Example 8.(i)Facts. An existing gasoline ad-
ditive is manufactured by Y using three ingredients,
A, B, and C. X seeks to develop and manufacture its
own gasoline additive that appears and functions in
a manner similar to Y’s additive. To develop its own
additive, X first inspects the composition of Y’s addi-
tive, and uses knowledge gained from the inspection
to reproduce A and B in the laboratory. Any differ-
ences between ingredients A and B that are used in
Y’s additive and those reproduced by X are insignif-
icant and are not material to the viability, effective-
ness, or cost of A and B. X desires to use with A and
B an ingredient that has a materially lower cost than
ingredient C. Accordingly, X engages in a process of
experimentation to develop, analyze and test poten-
tial alternative formulations of the additive.
(ii)Conclusion. X’s activities in analyzing and
reproducing ingredients A and B involve duplication
of existing business components and are excluded
from the definition of qualified research under section
41(d)(4)(C) and paragraph (c)(4) of this section. X’s
experimentation activities to develop potential alter-
native formulations of the additive do not involve du-
plication of an existing business component and are
not excluded from the definition of qualified research
under section 41(d)(4)(C) and paragraph (c)(4) of this
section.
Example 9.(i)Facts. X,amanufacturingcor-
poration, undertakes to restructure its manufacturing
organization. X organizes a team to design an organi-
zational structure that will improve X’s business op-
erations. The team includes X’s employees as well
as outside management consultants. The team stud-
ies current operations, interviews X’s employees, and
studies the structure of other manufacturing facilities
to determine appropriate modifications to X’s current
business operations. The team develops a recommen-
dation of proposed modifications which it presents
to X’s management. X’s management approves the
team’s recommendation and begins to implement the
proposed modifications.
(ii)Conclusion. X’s activities in developing and
implementing the new management structure are ex-
cluded from the definition of qualified research un-
der section 41(d)(4)(D) and paragraph (c)(5) of this
section. Qualified research does not include activi-
ties relating to management functions or techniques
including management organization plans and man-
agement-based changes in production processes.
Example 10.(i)Facts. X, an insurance company,
develops a new life insurance product. In the course
of developing the product, X engages in research with
respect to the effect of pricing and tax consequences
on demand for the product, the expected volatility of
February 9, 20044132004-6 I.R.B.

interest rates, and the expected mortality rates (based
on published data and prior insurance claims).
(ii)Conclusion. X’s activities related to the new
product represent researchin the social sciences (in-
cluding economics and business management) and
are thus excluded from the definition of qualified
research under section 41(d)(4)(G) and paragraph
(c)(8) of this section.
(d)Recordkeeping for the research
credit. A taxpayer claiming a credit un-
der section 41 must retain records in
sufficiently usable form and detail to sub-
stantiate that the expenditures claimed are
eligible for the credit. For the rules gov-
erning record retention, see §1.6001–1. To
facilitate compliance and administration,
the IRS and taxpayers may agree to guide-
lines for the keeping of specific records
for purposes of substantiating research
credits.
(e)Effective dates. Thissectionisap-
plicable for taxable years ending on or af-
ter December 31, 2003.
PART 602—OMB CONTROL
NUMBERS UNDER THE PAPERWORK
REDUCTION ACT
Par. 4. The authority citation for part
602 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 5. In §602.101, paragraph (b) is
amended by removing the entry from the
table for §1.41–4(d).
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 18, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on December 31,
2003, 8:45 a.m., and published in the issue of the Federal
Register for January 2, 2004, 69 F.R. 22)
Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 280G.—Golden
Parachute Payments
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2004. See Rev.
Rul. 2004-9, page 428.
Section 382.—Limitation
on Net Operating Loss
Carryforwards and Certain
Built-In Losses Following
Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of February 2004. See Rev.
Rul. 2004-9, page 428.
Section 40
9.—Qualifi-
cations for Tax Credit
Employee Stock Own-
ership Plans
26 CFR 1.409(p)–1T: Prohibited allocation of secu-
rities in an S corporation.
(Also, §§ 1361, 4975, 4979A, 6011, 6111, and
6112; §§ 54.4975–11, 1.6011–4, 301.6111–2, and
301.6112–1.)
Employee stock ownership plans;
S corporations; listed transactions.A
finding of synthetic equity owned by a
disqualified person in a nonallocation year
of an ESOP, as those terms are defined in
section 409(p) of the Code and regulations
section 1.409(p)–1T, takes place in three
distinct situations. In addition, the trans-
actions described in this ruling, as well
as substantially similar transactions, are
designated as “listed transactions.”
Rev. Rul. 2004–4
ISSUES
In the three situations described below,
(1) are the individuals disqualified per-
sons within the meaning of § 409(p)(4) of
the Internal Revenue Code (the Code), (2)
does the related employee stock ownership
plan (ESOP) have a nonallocation year
within the meaning of § 409(p)(3), and
(3) are any disqualified persons treated as
owning synthetic equity within the mean-
ing of § 409(p)(5)?
FACTS
Situation 1
Before 2003, Individuals A and B own,
either directly or indirectly, in whole or in
part, a domestic professional services cor-
poration. In addition, before 2003, indi-
viduals C, D, and E each owns, either di-
rectly or indirectly, in whole or in part, his
or her own domestic professional services
corporation. A, B, C, D, and E (Taxpayers)
are employees of their respective domes-
tic professional services corporations (Ser-
vice Recipient Corporations).
In 2003, a new corporation (S Corp) is
formed, and elects to be treated as a sub-
chapter S corporation. S Corp forms a
subsidiary corporation for each Taxpayer
(QSubs A through E), and files a qualified
subchapter S subsidiary (QSub) election
for each subsidiary. S Corp contributes
cash in exchange for 100 percent of the is-
sued and outstanding stock of each QSub.
Each Taxpayer is designated as an officer
and investment manager for Taxpayer’s re-
spective QSub. In addition, each QSub
grants its respective Taxpayer a nonqual-
ified stock option to acquire substantially
all or a majority of the shares of the QSub.
AtthesametimethatSCorpisformed,
it establishes a plan (ESOP) which is de-
signed to be an employee stock ownership
plan (within the meaning of § 4975(e)(7))
and which holds 100 percent of the stock of
S Corp. All the employees of S Corp and
the QSubs participate in the ESOP, with the
exception of Taxpayers A through E.
Taxpayers A through E and their sup-
port staff terminate their existing employ-
ment relationship with their respective Ser-
vice Recipient Corporations and become
employees of the respective QSub. The
customers of Taxpayers A through E stop
doing business with the Service Recipi-
ent Corporations and begin doing business
with the respective QSub of Taxpayers A
through E.
Taxpayers A through E receive salary
payments from their respective QSub, in
an amount substantially less than the in-
come to S Corp generated by the busi-
ness activities of that Taxpayer after de-
duction for expenses. S Corp treats the
subsidiaries as valid QSubs, and treats the
income generated by each QSub each year,
and earnings thereon, as earned by S Corp.
The payments to the Taxpayers for cur-
rent salary are deducted by S Corp as an
ordinary and necessary business expense.
However, since S Corp is wholly owned
by an ESOP holding S corporation stock, S
Corp’s net earnings arenot taxed currently.
2004-6 I.R.B.414February 9, 2004

Amounts of income to S Corp generated
by the business activities of each Taxpayer
(net of expenses) but not paid to Taxpayers
within 2
1
/2months after the end of the year
accumulate in each Taxpayer’s respective
QSub, for example, in a brokerage account
in each subsidiary, over which the respec-
tive Taxpayer has investment control as the
investment manager of the subsidiary. A
through E can access the amounts accumu-
latedintheirrespectiveQSubbyexercis-
ing their option to purchase shares in the
QSub. If each Taxpayer’s option to pur-
chase shares of QSub stock were synthetic
equity of S Corp (determined in accor-
dance with § 1.409(p)–1T(f)(4)(ii)), then
each Taxpayer would own at least 10 per-
cent of the sum of the outstanding shares
of S Corp plus the synthetic equity shares
of S Corp.
Situation 2
The facts are the same as inSituation 1,
except that instead of 5 individuals, there
are 11 individuals (Taxpayers A through
K) each of whom is an employee of a
Service Recipient Corporation owned ei-
ther directly or indirectly, in whole or in
part, by that Taxpayer. As inSituation 1,
amounts of income to S Corp generated
by the business activities of each Taxpayer
(net of expenses) but not paid to the Tax-
payer accumulate in each Taxpayer’s re-
spective QSub, andeach Taxpayer has the
right to acquire stock in that Taxpayer’s
QSub under the same terms as described in
Situation 1. If each Taxpayer’s option to
purchase shares of QSub stock were syn-
thetic equity of S Corp, then each Taxpayer
would own less than 10 percent of the sum
of the outstanding shares of S Corp plus the
synthetic equity shares of S Corp.
Situation 3
Before 2003, Corporation M is an S
corporation with 200 employees, wholly
owned by an ESOP that was established
after March 14, 2001, in which substan-
tially all of its employees participate. Be-
fore 2003, Individual A (Taxpayer) oper-
ated a professional services corporation as
a separate business. In 2003, Corporation
M forms a QSub for A by contributing cash
in exchange for 100 percent of the issued
and outstanding stock of the QSub. As in
Situation 1, A and A’s support staff ter-
minate their existing employment relation-
ship with A’s Service Recipient Corpora-
tion and become employees of the QSub;
A’s customers become customers of the
QSub; amounts of income to S Corp gen-
erated by the business activities of A (net
of expenses) but not paid to A accumulate
in A’s QSub; and A has the right to acquire
stock in the QSub under the same terms as
described inSituation 1. A does not par-
ticipate in the Corporation M ESOP. If A’s
option to purchase shares of the QSub were
synthetic equity of S Corp, then A would
own less than 10 percent of the total of the
outstanding shares of S Corp plus the syn-
thetic equity shares of S Corp.
LAW
Section 4975(e)(7) provides that an
ESOP is a defined contribution plan that
is designed to invest primarily in qual-
ifying employer securities and that is
either a stock bonus plan which is qual-
ified, or a stock bonus plan and money
purchase pension plan both of which are
qualified, under § 401(a). A plan is not
treated as an ESOP under the Code unless
it meets the following requirements, to
the extent applicable: § 409(h) (relating
to participants’ right to receive employer
securities; put options); § 409(o) (relat-
ing to participants’ distribution rights and
payment requirements); § 409(n) (relating
to securities received in transactions to
which § 1042 applies); § 409(p) (relating
to prohibited allocations of securities in
an S corporation); § 664(g) (relating to
qualified gratuitous transfers of qualified
employer securities); and § 409(e) (re-
lating to participants’ voting rights if the
employer has a registration-type class of
securities). As authorized by § 4975(e)(7),
additional requirements are imposed under
§ 54.4975–11 of the Excise Tax Regula-
tions.
Section 1361(b)(1)(B) provides that an
S corporation may not have as a share-
holder a person that is not an estate, a trust
describedin§1361(c)(2),anorganization
described in § 1361(c)(6), or an individual.
In 1996, § 1361(c)(6) was amended to per-
mit a qualified plan under § 401(a) to be
a shareholder in an S corporation. Section
1316(a) of the Small Business Job Protec-
tion Act of 1996 (SBJPA) (110 Stat. 1755)
(1996).
Section 1361(b)(3)(A) provides that,
for purposes of title 26 of the U.S. Code, a
corporation that is a qualified Subchapter
S subsidiary will not be treated as a sepa-
rate corporation and all assets, liabilities,
and items of income, deduction and credit
of the corporation are treated as assets,
liabilities, and such items (as the case may
be) of the S corporation.
Section 511(a)(1) imposes a tax on
the unrelated business taxable income
(as defined in § 512(a)) of organizations
described in § 511(a)(2), which include
plans that qualify under § 401(a). Section
512(e)(1) provides that if an organization
described in § 1361(c)(6) holds stock in an
S corporation, the interest is treated as an
interest in an unrelated trade or business
and, notwithstanding the organization’s
general tax-exempt status, all items of in-
come, loss, or deduction taken into account
under § 1366(a) and any gain or loss on
the disposition of the stock in the S corpo-
ration are taken into account in computing
the unrelated business taxable income of
the organization. In 1997, § 512(e) was
amended to provide that § 512(e) does not
apply to employer securities (within the
meaning of § 409(l)) held by an ESOP
described in § 4975(e)(7). Section 1523
of the Taxpayer Relief Act of 1997 (TRA
’97) (111 Stat. 788) (1997). Accordingly,
S corporation income allocable to stock
held by an ESOP is not subject to regular
income or unrelated business income tax.
Congress became aware that the tax
exemption for earnings on S corporation
stock held by an ESOP may lead to in-
appropriate tax deferral or avoidance in
some cases. In order to address these con-
cerns, Congress enacted § 409(p) as part
of the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA)
(115 Stat. 38) (2001). Section 409(p) is
effective for plan years beginning after
December 31, 2004. However, pursuant to
section 656(d)(2) of EGTRRA, § 409(p) of
the Code is effective for plan years ending
after March 14, 2001, for an ESOP that
is established after that date, or if the em-
ployer securities held by the plan consist
of stock in an S corporation that did not
have an S election in effect on that date.
Notice 2002–2, Q&A–15, 2002–1 C.B.
285, provides that an S corporation does
not have an election in effect on March 14,
2001, unless a valid election was actually
filed on or before that date and is effective
with respect to such corporation on or
before that date. Temporary and proposed
February 9, 20044152004-6 I.R.B.

regulations under § 409(p) were issued on
July 21, 2003 (T.D. 9081, 2003–35 I.R.B.
420; REG–129709–03, 2003–35 I.R.B.
506, September 2, 2003), effective gen-
erally for plan years ending after October
20, 2003.
Section 409(p) is intended to limit the
tax benefits of ESOPs maintained by S cor-
porations unless the ESOP provides mean-
ingful benefits to rank-and-file employees.
As explained in the legislative history:
The Committee continues to believe
that S corporations should be able to en-
courage employee ownership through
an ESOP. The Committee does not be-
lieve, however, that ESOPs should be
used by S corporation owners to obtain
inappropriate tax deferral or avoidance.
Specifically, the Committee believes
that the tax deferral opportunities pro-
vided by an S corporation ESOP should
be limited to those situations in which
there is broad-based employee cover-
age under the ESOP and the ESOP ben-
efits rank-and-file employees as well as
highly compensated employees and his-
torical owners.
H. R. Rep. No. 107–51, part 1, at 100
(2001).
Sections 409(p) and 4979A apply if
a nonallocation year occurs in an em-
ployee stock ownership plan, as defined
in § 4975(e)(7), that holds shares of stock
of an S corporation that are employer se-
curities as defined in § 409(l). Section
409(p)(1) requires that an ESOP holding
employer securities consisting of stock in
an S corporation must provide that no por-
tion of the assets of the plan attributable
to (or allocable in lieu of) such employer
securities may, during a nonallocation
year, accrue (or be allocated directly or
indirectly under any plan of the employer
meeting the requirements of § 401(a)) for
the benefit of any disqualified person, as
defined in § 409(p).
Under § 409(p)(3), (4), and (5), a “non-
allocation year” means a plan year of
an ESOP during which, at any time, the
ESOP holds any employer securities that
are shares of an S corporation and either:
1) disqualified persons own at least 50 per-
cent of the number of outstanding shares
of stock in the S corporation (including
deemed-owned ESOP shares), or 2) dis-
qualified persons own at least 50 percent
of the aggregate number of outstanding
shares of stock (including deemed-owned
ESOP shares) and synthetic equity in the S
corporation. For these purposes, the rules
of § 318(a) apply to determine ownership
of shares in the S corporation (includ-
ing deemed-owned ESOP shares) and
synthetic equity. However, § 318(a)(4)
(relating to options to acquire stock) is
disregarded and, in applying § 318(a)(1),
the members of an individual’s family
include members of the individual’s fam-
ily specified in § 409(p)(4)(D). In addi-
tion, an individual is treated as owning
deemed-owned ESOP shares of that indi-
vidual notwithstanding the employee trust
exception in § 318(a)(2)(B)(i).
As indicated by the legislative history
above, § 409(p) is intended to limit the tax
benefits of ESOPs maintained by S cor-
porations unless the ESOP provides broad
based coverage for, and meaningful bene-
fits to, rank-and-file employees. See H.R.
Rep. No. 107–51, part 1, at 100 (2001).
Accordingly, Congress added § 409(p)(7),
recognizing that the structure of § 409(p)
was not expected to be sufficient in all
cases to ensure broad-based coverage for,
and meaningful benefits to, rank-and-file
employees. Section 409(p)(7)(A) thus
authorizes the Secretary to prescribe such
regulations as may be necessary to carry
out the purposes of § 409(p). Section
409(p)(7)(B) provides that the Secretary
may, by regulation or other guidance of
general applicability, provide that a nonal-
location year occurs in any case in which
the principal purpose of the ownership
structure of an S corporation constitutes
an avoidance or evasion of § 409(p). The
legislative history to § 409(p) includes the
following with respect to exercise of this
authority:
For example, this might apply if more
than 10 independent businesses are
combined in an S corporation owned
by an ESOP in order to take advantage
of the income tax treatment of S corpo-
rationsownedbyanESOP.
H. R. Conf. Rep. No. 107–84, at 277
(2001).
Pursuant to § 409(p)(7)(B), § 1.409(p)–
1T(c)(3) of the Temporary Income Tax
Regulations provides that the Commis-
sioner, in revenue rulings, notices and
other guidance published in the Internal
Revenue Bulletin, may provide that a
nonallocation year occurs in any case in
which the principal purpose of the owner-
ship structure of an Scorporation consti-
tutes an avoidance or evasion of § 409(p).
For any year that is a nonallocation year,
taking into account the legislative his-
tory cited above, § 1.409(p)–1T(c)(3) also
provides that this exercise of authority
includes the authorityto treat any person
as a disqualified person.
Under § 409(p)(4), a disqualified per-
son is any person for whom: 1) the number
of such person’s deemed-owned ESOP
shares is at least 10 percent of the num-
ber of deemed-owned ESOP shares of the
S corporation; 2) the aggregate number
of such person’s deemed-owned ESOP
shares and synthetic equity shares is at
least 10 percent of the aggregate number
of deemed-owned ESOP and synthetic eq-
uity shares of the S corporation; 3) the ag-
gregate number of deemed-owned ESOP
shares of such person and of the mem-
bers of such person’s family is at least 20
percent of the number of deemed-owned
ESOP shares of the S corporation; or 4)
the aggregate number of deemed-owned
ESOP shares and synthetic equity shares
of such person and of the members of such
person’s family is at least 20 percent of
the aggregate number of deemed-owned
ESOP and synthetic equity shares of the S
corporation.
Section 409(p)(4)(C) defines “deemed-
owned ESOP shares” to mean, with respect
to any person: 1) any shares of stock in the
S corporation constituting employer secu-
rities that are allocated to such person’s ac-
count under the ESOP; and 2) such per-
son’s share of the stock in the S corpora-
tion that is held by the ESOP but is not
allocated to the account of any participant
or beneficiary (with such person’s share to
be determined in the same proportion as
the most recent stock allocation under the
ESOP).
Section 1.409(p)–1T(f)(1), interpreting
§ 409(p)(5), provides that the determina-
tion of whether someone is a disqualified
person and whether a plan year is a non-
allocation year is made without regard to
“synthetic equity” attributable to that per-
son and is also made separately taking into
account synthetic equity. For purposes of
§ 409(p) and § 1.409(p)–1T, synthetic eq-
uity is treated as owned by a person in the
same manner as stock is treated as owned
by a person, directly or under the rules of
§ 318(a)(2) and (3).
Section 409(p)(6)(C) defines “syn-
thetic equity” to include any stock op-
2004-6 I.R.B.416February 9, 2004

tion, warrant, restricted stock, deferred
issuance stock right, stock appreciation
right payable in stock, or similar interest
or right that gives the holder the right
to acquire or receive stock of the S cor-
poration in the future. Synthetic equity
also includes a right to a future payment
(payable in cash or any other form other
than stock of the S corporation) from an
S corporation that is based on the value
of the stock of the S corporation or ap-
preciationinsuchvalue,suchasastock
appreciation right with respect to stock of
an S corporation that is payable in cash or
a phantom stock unit with respect to stock
of an S corporation that is payable in cash.
Section 1.409(p)–1T(f)(2)(iv) provides
a rule treating nonqualified deferred com-
pensation as synthetic equity. Specifically,
that section of the temporary regulations
provides that synthetic equity also includes
any remuneration for services rendered to
the S corporation, or a related entity, to
which § 404(a)(5) applies (including re-
muneration for which a deduction would
be permitted under § 404(a)(5) if separate
accounts were maintained), any right to re-
ceive property (to which § 83 applies) in a
future year for the performance of services
to an S corporation, or related entity, and
anytransferofproperty(towhich§83ap-
plies) in connection with the performance
of services to an S corporation, or a related
entity, to the extent that the property is not
substantially vested within the meaning of
§ 1.83–3(i) of the Income Tax Regulations
by the end of the plan year in which trans-
ferred. Section 1.409(p)–1T(f)(2)(iv) also
provides that synthetic equity includes any
other remuneration for services rendered
to the S corporation, or a related entity, un-
der a plan, method or arrangement, defer-
ring the receipt of compensation to a date
that is after the 15th day of the 3d calen-
dar month after the end of entity’s taxable
year in which the related services are ren-
dered, other than a plan that is an eligi-
ble retirement plan within the meaning of
§ 402(c)(7)(B).
Pursuant to the authority in § 409(p)(7),
§ 1.409(p)–1T(f)(2)(iii)(A) provides that
synthetic equity also includes a right to
acquire stock or other similar interests
in a related entity if such interests in the
related entity are the only significant asset
of the S corporation and the S corpora-
tion is the only significant owner of the
related entity. Whether an asset is the
only significant asset of the S corporation
or the S corporation is the only signifi-
cant owner of the related entity depends
on the relevant facts and circumstances.
Section 1.409(p)–1T(f)(2)(iii)(A)(4) pro-
vides that a related entity means any
entity in which the S corporation holds
an interest and which is a partnership,
a trust, an eligible entity that is disre-
garded as an entity that is separate from its
owner under § 301.7701–3 of the Proce-
dure and Administration Regulations or a
Qualified Subchapter S Subsidiary under
§ 1361(b)(3).
Pursuant to the authority in § 409(p)(7),
§ 1.409(p)–1T(f)(2)(iii)(C) provides that
the Commissioner may, if necessary to
carry out the purposes of § 409(p), through
revenue rulings, notices, and other guid-
ance published in the Internal Revenue
Bulletin, provide that synthetic equity in-
cludes a right to acquire stock or other
similar interests in a related entity in cases
in which such interests in the related entity
are not the only significant asset of the
S corporation or the S corporation is not
the only significant owner of the related
entity.
Section 1.409(p)–1T(f)(4)(ii) provides
that, in the case of synthetic equity that is
determined by reference to shares of stock
(or other similar interests) in a related en-
tity, the person who is entitled to the syn-
thetic equity is treated as owning shares of
stock in the S corporation with the same
aggregate value as the number of shares
of stock (or similar interests) of the related
entity (with such value determined without
regard to any lapse restriction as defined at
§ 1.83–3(i)).
Section 4979A imposes a 50 percent ex-
cise tax in certain cases, including an allo-
cation of employer securities that is pro-
hibited by § 409(p), the ownership of any
synthetic equity by a disqualified person
during a nonallocation year, and the occur-
rence of the first nonallocation year of an
ESOP, as described in § 4979A(e)(2)(C).
Section 4979(A)(c)(1)(A) provides for this
excise tax to be paid by the employer spon-
soring the ESOP.
ANALYSIS
In each situation described above, the
ownership structure of the S corporation
is designed to allow one or more Taxpay-
ers, each operating a business for that Tax-
payer’s own benefit, to take advantage of
the tax-exempt status of the S corporation
that results from the ownership of its out-
standing stock by the ESOP. The owner-
ship structure thereby avoids current taxa-
tion of the profits of each Taxpayer’s sepa-
rate business, while each Taxpayer retains
the right to at least 50 percent of the busi-
ness through the right to acquire shares
in the QSub. Because the profits of each
business are being segregated and accumu-
lated in each Taxpayer’s QSub, the ESOP
is owner of the business only in form, not
in substance, to the extent that the Tax-
payer has a right to the profits by exercis-
ing the Taxpayer’s option to acquire the
shares of the QSub. Thus, the ESOP is
not providing benefits to rank-and-file em-
ployees that reflect its ownership share in
the S corporation.
InSituation 1, each Taxpayer is using
options on QSub stock to retain ownership
of his or her separate business, with the
profits of that business being segregated
from the profits of the businesses of the
other QSubs. In this way, the structure is
designed to divert the profits of each busi-
ness away from the ESOP. If each QSub
were an S corporation directly owned by
an ESOP, each Taxpayer’s right to acquire
shares of that corporation would be syn-
thetic equity pursuant to § 409(p)(6)(C).
Accordingly, the structure described in
Situation 1is similar to other forms of syn-
thetic equity, such as the right to acquire
stockinarelatedentitythatistheonlysig-
nificant asset of an S Corporation (owned
by an ESOP). Further, the economic ef-
fect is similar to nonqualified deferred
compensation for services rendered to the
QSub which is declared to be synthetic
equity in § 1.409(p)–1T(f)(2)(iv).
Consequently, the options granted
to each Taxpayer inSituation 1to ac-
quire shares in the QSub for that Tax-
payer’s business should be treated
as synthetic equity in S Corp. Ac-
cordingly, pursuant to the authority in
§ 1.409(p)–1T(f)(2)(iii)(C), the Commis-
sioner in this revenue ruling provides that
the options are synthetic equity. Because
these options are synthetic equity inSit-
uation 1, each Taxpayer is a 10 percent
owner of the number of deemed-owned
shares of S Corp, Taxpayers A through E
are thus disqualified persons, and, because
disqualified persons A through E own an
aggregate of at least 50 percent of the
February 9, 20044172004-6 I.R.B.

shares, 2003 is a nonallocation year for
the ESOP.
A group of individuals with the same
right to acquire the accumulated profits
of their businesses as described inSitu-
ation 1should not avoid the application
of § 409(p) merely because each individ-
ual’s right to acquire the accumulated prof-
its of that individual’s business does not
have a value equal to at least 10 percent of
the value of S Corp because more than 10
separate businesses are combined (as de-
scribed inSituation 2). In fact, Congress
anticipated the combining of more than 10
businesses as a means of avoiding the ap-
plication of § 409(p) and gave this own-
ership structure as an example of the type
of situation where exercise of the authority
granted in § 409(p)(7)(B) would be appro-
priate.
Further, an individual with the same
right to acquire the accumulated profits of
that individual’s business, similar to the
rights described inSituation 1, should not
avoid the application of § 409(p) merely
because the business is combined, as inSit-
uation 3, with the business of an S corpo-
ration owned by an ESOP that otherwise
fulfills Congressional intent by providing
broad-based coverage and benefits to rank-
and-file employees. The rank-and-file em-
ployees inSituation 3are not sharing in the
profits of the Taxpayer’s separate business
through the ESOP’s ownership share to the
extent that the profits of that business are
being accumulated for the benefit of that
Taxpayer. With respect to that Taxpayer’s
separate business, the ownership structure
of the S corporation is designed to avoid or
evade the application of § 409(p).
In all three situations, the accumulation
of profits for the benefit of a specific indi-
vidual is comparable to the operation of an
S corporation owned by an ESOP. More-
over, as inSituation 1,ifanyoneofthese
businesses were the only business activity
of S Corp, the option held by the taxpayers
would be synthetic equity which would re-
sult in a nonallocation year and each tax-
payer being a disqualified person if those
shares of synthetic equity were at least 50
percent of the shares of stock of S Corp
plus the total synthetic equity shares.
Accordingly, pursuant to the authority
of § 409(p)(7)(B) and § 1.409(p)–1T(c)(3),
the Commissioner provides in this revenue
ruling that a nonallocation year occurs and
the individual is a disqualified person in
any case in which (i) shares of an S corpo-
ration are employer securities held by an
ESOP, (ii) the profits of the S corporation
generated by the business activities of a
specific individual are accumulated and
held for the benefit of that individual in a
QSub or similar entity (such as a limited
liability company), (iii) these profits are
notpaidtotheindividual as compensation
within 2
1
/2months after the end of the year
in which earned, and (iv) the individual has
rights to acquire shares of stock (or similar
interests) of the QSub or similar entity
representing 50 percent or more of the fair
market value of the stock of such QSub or
similar entity. In addition, pursuant to the
authority in § 1.409(p)–1T(f)(2)(iii)(C),
the Commissioner in this revenue ruling
provides that such individual’s right to ac-
quire shares of stock (or similar interests)
of the QSub or similar entity is synthetic
equity. For purposes of this paragraph,
the rights of the individual are determined
after taking into account the attribution
rules of § 409(p).
As a result, inSituations 2 and 3,the
Taxpayer’s right to acquire the shares of
the QSub is syntheticequity, each indi-
vidual Taxpayer (A through K inSituation
2,andAinSituation 3) is a disqualified
person, and a nonallocation year occurs.
The respective Taxpayers inSituations 2
and 3are disqualified persons regardless
of whether, at any time, a particular Tax-
payer owns synthetic equity shares of S
Corp equal to at least 10 percent of the sum
of the outstanding shares of S Corp plus the
synthetic equity shares of S Corp.
The same conclusions would apply with
respect toSituations 1, 2, and 3even if the
support staff of the Taxpayers were to con-
tinue to be employed by their respective
Service Recipient Corporations, the Ser-
vice Recipient Corporations were to con-
tinue to provide substantially the same ser-
vices for their customers, any of the Tax-
payers or their support staff were to be em-
ployees of S Corp (instead of employees of
a QSub), or any of the Taxpayers were to
participate in the ESOP.
Treasury and the Service intend to re-
flect the guidance in this revenue ruling
in regulations under § 409(p), effective for
plan years ending after October 20, 2003.
It is expected that the regulations would
apply to similar transactions that have the
effect of reserving profits from an individ-
ual’s business activities to provide similar
tax benefits to the individual, either with
theuseofaQSuborthroughtheuseofan-
other method.
In appropriate cases, the Service may
challenge other tax benefits claimed by
any taxpayer involved in this type of busi-
ness structure. For example, in the appro-
priate case, the Service may take the po-
sition for income tax purposes that, even
though the Taxpayer purported to trans-
fer his or her business (including the em-
ployment of his or her support staff) to
the QSub, the Taxpayer never relinquished
ownership of his or her business and, there-
fore, the Taxpayer should still be taxed on
the profits. The Service might also take
the position that the subsidiary is not a
QSub. Alternatively, if the support staff
of the Taxpayers were to continue to be
employed by their respective Service Re-
cipient Corporations, and the Service Re-
cipient Corporations were to continue to
provide substantially the same services for
their customers, the Service might assert
that each Taxpayer continues to be em-
ployed by their respective Service Recip-
ient Corporation, with the related tax con-
sequences.
HOLDINGS
With respect toSituation 1, for purposes
of §§ 409(p) and 4979A, (1) A through E
are disqualified persons with respect to the
ESOP, (2) the ESOP has a nonallocation
year, and (3) the options to acquire stock
in QSubs A through E are synthetic equity
to which the § 4979A excise tax applies.
With respect toSituation 2, for purposes
of §§ 409(p) and 4979A, (1) A through K
are disqualified persons with respect to the
ESOP, (2) the ESOP has a nonallocation
year, and (3) A through K are each treated
as owning synthetic equity in the form of
each individual’s option to acquire shares
of the corresponding QSub.
With respect toSituation 3, for purposes
of §§ 409(p) and 4979A, (1) A is a disqual-
ified person with respect to the ESOP, (2)
the ESOP has a nonallocation year, and (3)
A is treated as owning synthetic equity in
the form of A’s option to acquire shares of
the corresponding QSub.
EFFECTIVEDATEAND
TRANSITION RULE
This revenue ruling applies for plan
years ending after October 20, 2003, but
2004-6 I.R.B.418February 9, 2004

this revenue ruling (including the listing in
the Listed Transactions section below) is
not effective before March 15, 2004 if (i)
all interests in a QSub held by individuals
who would be disqualified persons under
this revenue ruling are distributed to those
individuals as compensation on or before
March 15, 2004, and (ii) no such individ-
ual has been a participant in the ESOP
at any time after October 20, 2003, and
before March 15, 2004. In addition, for
purposes of the excise tax under § 4979A,
an individual’s interest in a QSub that con-
stitutes synthetic equity under this revenue
ruling will be disregarded to the extent
such interest is distributed to the individ-
ual as compensation on or before March
15, 2004.
LISTED TRANSACTIONS
Arrangements that are the same as,
or substantially similar to, the fol-
lowing transaction are identified as
“listed transactions” for purposes of
§§ 1.6011–4(b)(2), 301.6111–2(b)(2) and
301.6112–1(b)(2) effective January 23,
2004, the date this document was released
to the public: Any transaction in which
(i) at least 50 percent of the outstanding
shares of an S corporation are employer
securities held by an ESOP, (ii) the profits
of the S corporation generated by the busi-
ness activities of a specific individual are
accumulated and held for the benefit of
that individual in a QSub or similar entity
(such as a limited liability company), (iii)
these profits are not paid to the individual
as compensation within 2
1
/2months after
the end of the year in which earned, and
(iv) the individual has rights to acquire
shares of stock (or similar interests) of
the QSub or similar entity representing 50
percent or more of the fair market value of
the stock of such QSub or similar entity.
For purposes of the preceding sentence,
the rights of an individual are determined
after taking into account the attribution
rules of § 409(p). These arrangements
are identified as “listed transactions” with
respect to the S corporation and each indi-
vidual who is a disqualified person under
this revenue ruling.
Independent of their classification as
“listed transactions,” transactions that are
the same as, or substantially similar to,
the transactions described in the preced-
ing paragraph may already be subject to
the disclosure requirements of § 6011
(§ 1.6011–4), the tax shelter registration
requirements of § 6111 (§§ 301.6111–1T,
301.6111–2), or the list maintenance re-
quirementsof§6112(§301.6112–1).
Persons required to register these tax
shelters under § 6111 who have failed to
do so may be subject to the penalty un-
der § 6707(a). Persons required to main-
tain lists of investors under § 6112 who
have failed to do so (or who fail to provide
such lists when requested by the IRS) may
be subject to the penalty under § 6708(a).
In addition, the IRS may impose penal-
ties on parties involved in this transac-
tion or substantially similar transactions,
including the accuracy-related penalty un-
der § 6662.
The Service and the Treasury recognize
that some taxpayers may have filed tax re-
turns taking the position that they were en-
titled to the purported tax benefits of the
type of transaction described in this rev-
enue ruling. These taxpayers should con-
sult with a tax advisor to ensure that their
transactions are disclosed properly and to
take appropriate corrective action.
DRAFTING INFORMATION
The principal authors of this revenue
ruling are Robert Gertner of the Employee
Plans, Tax Exempt and Government En-
tities Division and John Ricotta of the
Office of Division Counsel/Associate
Chief Counsel (Tax Exempt and Govern-
ment Entities). For further information,
Employee Plans’ taxpayer assistance tele-
phone service at 1–877–829–5500 (a
toll-free call) between the hours of 8:00
a.m. and 6:30 p.m. Eastern Time, Monday
through Friday or contact Mr. Gertner at
(202) 283–9888 (not a toll-free call).
Section 412.—Minimum
Funding Standards
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 446.—General Rule
for Methods of Accounting
26 CFR 1.446–1: General rule for methods of ac-
counting.
T.D. 9105
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Part 1
Changes in Computing
Depreciation
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regula-
tions.
SUMMARY: This document contains reg-
ulations relating to a change in comput-
ing depreciation or amortization as well as
a change from a nondepreciable or non-
amortizable asset to a depreciable or amor-
tizable asset (or vice versa). Specifically,
these regulations provide guidance to any
taxpayer that makes a change in depre-
ciation or amortization on whether such
change is a change in method of account-
ing under section 446(e) of the Internal
Revenue Code and on the application of
section 1016(a)(2) in determining whether
the change is a change in method of ac-
counting. The text of these temporary reg-
ulations also serves as the text of the pro-
posed regulations (REG–126459–03) set
forth in the notice of proposed rulemaking
on this subject in this issue of the Bulletin.
DATES:Effective Dates:Theseregula-
tions are effective January 2, 2004.
Applicability Dates: For dates of
applicability, see §§1.167(e)–1T(e),
1.446(e)–1T(e)(4), and 1.1016–3T(j).
FOR FURTHER INFORMATION
CONTACT: Sara Logan or Douglas Kim,
(202) 622–3110 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments to
26 CFR part 1 to provide regulations un-
der sections 167, 446(e), and 1016(a)(2)
of the Internal Revenue Code (Code).
February 9, 20044192004-6 I.R.B.

These regulations provide the changes in
depreciation or amortization that are, and
are not, a change in method of accounting
under §1.446–1(e). Additionally, these
regulations amend §1.167(e)–1 to pro-
vide that certain changes in depreciation
method for property for which depreci-
ation is determined only under section
167 are made without the consent of the
Commissioner of Internal Revenue, and
amend §1.1016–3 to provide that section
1016(a)(2) does not permanently affect a
taxpayer’s lifetime income for purposes
of determining whether a change in de-
preciation or amortization is a change in
method of accounting.
Explanation of Provisions
Background
Section 446 provides in general that
taxable income shall be computed under
the method of accounting on the basis of
which the taxpayer regularly computes
the taxpayer’s income in keeping the tax-
payer’s books. Section 446(e) provides
that, except as otherwise expressly pro-
vided in chapter 1 of the Code, a taxpayer
who changes the method of accounting
on the basis of which the taxpayer regu-
larly computes the taxpayer’s income in
keeping the taxpayer’sbooks shall, before
computing the taxpayer’s taxable income
under the new method, secure the consent
of the Secretary.
Section 1.446–1(e)(2)(ii)(a)providesin
pertinent part that a change in method of
accounting includes a change in the over-
all plan of accounting for gross income or
deductions or a change in the treatment
of any material item used in such overall
plan. A material item is any item that in-
volves the proper time for the inclusion of
the item in income or the taking of a de-
duction. However, §1.446–1(e)(2)(ii)(b)
provides in pertinent part that a change in
method of accounting does not include an
adjustment in the useful life of a deprecia-
ble asset. Although such adjustment may
involve the question of the proper time for
the taking of a deduction, such item is tra-
ditionally corrected by adjustments in the
current and future years.
Section 1.167(e)–1(a) provides that in
general, any change in the method of com-
puting the depreciation allowances with
respect to a particular account (other than
achangeinmethodpermittedorrequired
by reason of the operation of former sec-
tion 167(j)(2) and §1.167(j)–3(c)) is a
change in method of accounting, and such
a change will be permitted only with the
consent of the Commissioner, except that
certain changes to the straight line method
of depreciation will be permitted with-
out consent as provided in former section
167(e)(1), (2), and (3). Any request for a
change in method of depreciation shall be
made in accordance with section 446 and
the regulations under section 446.
In 1996, the IRS issued Rev. Proc.
96–31, 1996–1 C.B. 714, providing that a
change from not claiming the depreciation
or amortization allowable to claiming the
depreciation or amortization allowable is a
change in method of accounting for which
the consent of the Commissioner of Inter-
nal Revenue is required.
InKurzet v. Commissioner, 222 F.2d
830, 842–845 (10
th
Cir. 2000), the tax-
payer sought to change the classification
of property under section 168 from nonres-
idential real property to 15-year property
thereby resulting in a change in recovery
period from 31.5 years to 15 years. The
Tenth Circuit held that a change in recov-
ery period under section 168 is a change
in method of accounting under section
446(e). In reaching its holding, the Tenth
Circuit considered the taxpayer’s argu-
ment that a change in recovery period is
analogous to a change in useful life, but
concluded that the Commissioner’s in-
terpretation of §1.446–1(e)(2)(ii) in Rev.
Proc. 96–31 as requiring a taxpayer to
obtain permission for a change in recovery
period is not plainly erroneous or incon-
sistent with §1.446–1(e)(2)(ii).
InBrookshire Brothers Holding, Inc.
& Subsidiaries v. Commissioner, 320 F.3d
507 (5
th
Cir. 2003),aff’g. T.C. Memo.
2001–150,reh’g en banc denied,65Fed.
Appx. 511 (5
th
Cir. 2003), the Fifth Cir-
cuit held that a change in classification
of property under section 168 is not a
change in method of accounting under
section 446(e) because the change is the
functional equivalent of a change in use-
ful life thereby resulting in the change
falling under the useful life exception in
§1.446–1(e)(2)(ii)(b). The Eighth Cir-
cuit inO’Shaughnessy v. Commissioner,
332F.3d1125(8
th
Cir. 2003),rev’g in
part2002–1 U.S.T.C. (CCH) ¶50,235
(D. Minn. 2001), adopted the analysis
inBrookshireand held that a change in
classification of property under section
168 falls within the useful life exception
and, thus, does not constitute a change
in method of accounting under section
446(e).
Further, inGreen Forest Manufactur-
ingInc.v.Commissioner, T.C. Memo.
2003–75, the Tax Court extended its rea-
soning inBrookshire. The court held that
a change in computing depreciation from
the general depreciation system in section
168(a) to the alternative depreciation sys-
tem in section 168(g) is a change in classi-
fication that falls within the useful life ex-
ception and, therefore, is not a change in
method of accounting.
As a result of these decisions, there is
inconsistent treatment of taxpayers with
respect to whether a change in comput-
ing depreciation under section 168 is a
change in method of accounting under
section 446(e). These regulations clarify
the changes in depreciation or amortiza-
tion (depreciation) that are (and are not)
changes in method of accounting under
section 446(e).
Scope
The regulations provide the changes in
depreciation for property for which depre-
ciation is determined under section 167,
168, 197, 1400I, 1400L(b), or 1400L(c),
or former section 168, of the Code that
are (and are not) changes in method of
accounting under section 446(e). The
regulations also clarify that the rules in
§1.167(e)–1 with respect to a change in
the depreciation method made without
the consent of the Commissioner apply
only to property for which depreciation is
determined under section 167 (other than
under section 168, section 1400I, section
1400L, or former section 168).
Changes in Depreciation that are Changes
in Method of Accounting
In general, the regulations provide that
a change in the depreciation method, pe-
riod of recovery, or convention of a depre-
ciable or amortizable asset is a change in
method of accounting. This change may
be the result of, for example, a change in
the classification of property under section
168(e) or a change in computing deprecia-
tion from the general depreciation system
2004-6 I.R.B.420February 9, 2004

under section 168(a) to the alternative de-
preciation system of section 168(g). Fur-
ther, a change to or from claiming the ad-
ditional first year depreciation deduction
provided by section 168(k) or 1400L(b) is
a change in method of accounting under
certain circumstances.
The regulations clarify that the use-
ful life exception, which has been
moved from §1.446–1(e)(2)(ii)(b)to
§1.446–1T(e)(2)(ii)(d), applies only to
property for which the depreciation is de-
termined under section 167 (other than
under section 168, section 1400I, section
1400L, or former section 168). However,
a change to or from a useful life (or recov-
ery period or amortization period) that is
specifically assigned by the Code, the reg-
ulations under the Code, or other guidance
published in the Internal Revenue Bulletin
is a change in method of accounting.
The regulations also provide that a
change in salvage value to zero for a de-
preciable or amortizable asset for which
the salvage value is expressly treated as
zero by the Code, the regulations under
the Code, or other guidance published in
the Internal Revenue Bulletin, is treated
as a change in method of accounting. Any
other change in salvage value is not treated
as a change in method of accounting.
Further, the regulations provide that a
change in the accounting for depreciable
or amortizable assets from single asset
accounting to multiple asset accounting
(pooling), or vice versa, or from one type
of multiple asset accounting (pooling)
to a different type of multiple asset ac-
counting (pooling) is a change in method
of accounting. Also, for depreciable or
amortizable assets that are mass assets
accounted for in multiple asset accounts
or pools, a change in the method of iden-
tifying which assets have been disposed
is a change in method of accounting (for
example, from specific identification to a
first-in, first-out method).
Finally, the regulations provide that a
change in the treatment of an asset from
nondepreciable or nonamortizable (nonde-
preciable) to depreciable or amortizable
(depreciable), or vice versa, is a change
in method of accounting. For example,
a change in the treatment of an asset that
was used entirely in the taxpayer’s trade
or business and was never held for sale
from being treated as inventory to being
treated as depreciable property is a change
in method of accounting.
Exceptions
The regulations provide that a change in
computing depreciation allowances in the
taxable year in which the use of property
changes in the hands of the same taxpayer
is not a change in method of accounting.
The regulations also provide that the
making of a late depreciation election or
the revocation of a timely valid depreci-
ation election generally is not a change
in method of accounting. This rule also
applies to the making of a late election
or the revocation of a timely valid elec-
tion under section 13261(g)(2) or (3) of
the Revenue Reconciliation Act of 1993
(107 Stat. 312, 540) (relating to amorti-
zable section 197 intangibles). To make
a late depreciation election or to revoke a
timely valid depreciation election, a tax-
payer must submit a request for a private
letter ruling. Elections made under section
168(b)(2)(C), 168(b)(3)(D), or 168(g)(7)
are irrevocable.
Finally, the regulations provide that
any change in the placed-in-service date
of a depreciable or amortizable asset is not
treated as a change in method of account-
ing.
Item Being Changed
The regulations clarify that for purposes
of changes in depreciation, the item be-
ing changed is the depreciation treatment
of each individual depreciable or amorti-
zable asset. However, the item is the de-
preciation treatment of each vintage ac-
count with respect to depreciable assets
for which depreciation is determined under
§1.167(a)–11 (CLADR property). Further,
a change in computing depreciation under
section 167 (other than a change under sec-
tion 168, section 1400I, section 1400L, or
former section 168) is permitted only with
respect to all assets in a particular account
(as defined in §1.167(a)–7) or vintage ac-
count.
Special Rules
The regulations also provide rules
for the following: (1) a change from a
declining balance method under section
168(b)(1) or (2) to the straight line method;
(2) changes in certain depreciation meth-
ods under section 167 (other than under
section 168, section 1400I, section 1400L,
or former section 168); and (3) section
481 adjustments.
With respect to a change from the
200-percent or 150-percent declining bal-
ance method under section 168(b)(1) or
(2) to the straight line method, the regu-
lations provide that this change may be
made without the consent of the Commis-
sioner in the first taxable year in which the
depreciation allowance under the straight
line method is greater than the deprecia-
tion allowance under the declining balance
method.
With respect to changes in deprecia-
tion methods under section 167 (other than
under section 168, section 1400I, section
1400L, or former section 168), the regu-
lations provide cross-references to regula-
tions under section 167 that allow certain
depreciation method changes to be made
without the consent of the Commissioner.
With respect to section 481 adjust-
ments, the regulations also clarify that
except as otherwise expressly provided
by the Code, the regulations under the
Code, or other guidance published in the
Internal Revenue Bulletin, a change from
one permissible method of computing de-
preciation to another permissible method
of computing depreciation for a deprecia-
ble or amortizable asset is implemented
on either a cut-off method (as described
in section 2.06 of Rev. Proc. 97–27,
1997–1 C.B. 680, and in section 2.06 of
Rev. Proc. 2002–9, 2002–1 C.B. 327) or
a modified cut-off method (under which
the adjusted depreciable basis of the asset
as of the beginning of the year of change
is recovered using the new permissible
method of accounting). Because no items
are duplicated or omitted from income
when the cut-off method or the modified
cut-off method is used to effect the change
in method of accounting, no section 481
adjustment is required or permitted. How-
ever, a change froman impermissible
method of computing depreciation to a
permissible method of computing depre-
ciation results in a negative or positive
section 481 adjustment because the ad-
justed depreciable basis of the asset as
of the beginning of the year of change is
changed as a result of the change in com-
puting depreciation.Similarly, a change
in the treatment of an asset from nonde-
preciable to depreciable (or vice versa) or
February 9, 20044212004-6 I.R.B.

a change from expensing to depreciating
an asset (or vice versa) will also result in
a negative or positive section 481 adjust-
ment.
Application of the Allowed or Allowable
Rule to Changes in Method of Accounting
Section 1016(a)(2) provides that the ba-
sisofpropertyisadjustedinrespectof
any period since February 28, 1913, for
exhaustion, wear and tear, obsolescence,
amortization, and depletion, to the extent
of the amount allowed as deductions in
computing taxable income and resulting in
a reduction for any taxable year of the tax-
payer’s taxes, but not less than the amount
allowable.
Concurrently with the issuance of these
regulations, the IRS and Treasury Depart-
ment will issue a revenue procedure that
will allow a taxpayer to change the tax-
payer’s method of determining deprecia-
tion for a depreciable or amortizable as-
set after its disposition if the taxpayer did
not take into account any depreciation al-
lowance, or did take into account some de-
preciation but less than the depreciation al-
lowable, for the asset in computing taxable
income in the year of disposition or in prior
taxable years. Because the taxpayer is per-
mitted to claim the allowable depreciation
not taken into account for this asset, the
taxpayer’s lifetime income is not perma-
nently affected by the “allowed or allow-
able” rule under section 1016(a)(2). Ac-
cordingly, the regulations provide that sec-
tion 1016(a)(2) does not permanently af-
fect a taxpayer’s lifetime income for pur-
poses of determining whether a change in
depreciation is a change in method of ac-
counting under section 446(e) and the reg-
ulations under section 446(e).
The revenue procedure also will revise
the depreciation changes included in Rev.
Proc. 2002–9, 2002–1 C.B. 327, the au-
tomatic change in method of accounting
revenue procedure, to conform with these
regulations and will waive the application
of Rev. Rul. 90–38, 1990–1 C.B. 57, for
changes in depreciation made under Rev.
Proc. 97–27, 1997–1 C.B. 680, or Rev.
Proc. 2002–9.
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 assessment
is not required. It also has been deter-
mined that section 553(b) of the Admin-
istrative Procedure Act (5 U.S.C. chapter
5) does not apply to these regulations. For
the applicability of the Regulatory Flexi-
bility Act (5 U.S.C. chapter 6), refer to the
Special Analyses section of the preamble
to the cross-reference notice of proposed
rulemaking published in theFederal Reg-
ister. Pursuant to section 7805(f) of the
Code, these temporary regulations will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on its impact on small busi-
ness.
Drafting Information
The principal author of these regula-
tions is Sara Logan, Office of Associate
Chief Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 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. Section 1.167(e)–1 is amended
by:
1. Revising paragraph (a).
2. Adding new paragraph (e).
The addition and revision read as fol-
lows:
§1.167(e)–1 Change in method.
(a)In general. [Reserved]. For further
guidance, see §1.167(e)–1T(a).
*****
(e)Effective date. [Reserved]. For fur-
ther guidance, see the first two sentences
of §1.167(e)–1T(e).
Par. 3. Section 1.167(e)–1T is added to
read as follows:
§1.167(e)–1T Change in method
(temporary).
(a)In general. (1) Any change in the
method of computing the depreciation
allowances with respect to a particular
account (other than a change in method
permitted or required by reason of the
operation of former section 167(j)(2) and
§1.167(j)–3(c)) is a change in method
of accounting, and such a change will
be permitted only with the consent of the
Commissioner, except that certain changes
to the straight line method of depreciation
will be permitted without consent as pro-
vided in former section 167(e)(1), (2),
and (3). Except as provided in paragraphs
(c) and (d) of this section, a change in
method of computing depreciation will
be permitted only with respect to all the
assets contained in a particular account as
defined in §1.167(a)–7. Any change in the
percentage of the current straight line rate
under the declining balance method, for
example, from 200 percent of the straight
line rate to any other percent of the straight
line rate, or any change in the interest fac-
torusedinconnectionwithacompound
interest or sinking fund method, will con-
stitute a change in method of depreciation.
Any request for a change in method of
depreciation shall be made in accordance
with section 446(e) and the regulations un-
der section 446(e). For rules covering the
use of depreciation methods by acquiring
corporations in the case of certain corpo-
rate acquisitions, see section 381(c)(6) and
the regulations under section 381(c)(6).
(2) Paragraphs (b), (c), and (d) of this
section apply to property for which de-
preciation is determined under section
167 (other than under section 168, section
1400I, section 1400L, or under section
168 prior to its amendment by the Tax
Reform Act of 1986 (100 Stat. 2121)) of
the Internal Revenue Code.
(b) through (d) [Reserved]. For further
guidance, see §1.167(e)–1(b) through (d).
(e)Effective date. This section applies
on or after December 30, 2003. For the ap-
plicability of regulations before December
30, 2003, see §1.167(e)–1 in effect prior to
December 30, 2003 (§1.167(e)–1 as con-
tained in 26 CFR part 1 edition revised as
of April 1, 2003). The applicability of this
section expires on or before December 29,
2006.
Par. 4. Section 1.446–1 is amended by:
1. Revising paragraphs (e)(2)(ii)(a),
(e)(2)(ii)(b), and (e)(2)(iii).
2. Adding new paragraphs (e)(2)(ii)(d)
and (e)(4).
2004-6 I.R.B.422February 9, 2004

The additions and revisions read as fol-
lows:
§1.446–1 General rule for methods of
accounting.
*****
(e) * * *
(2) * * *
(ii) (a) [Reserved]. For further guid-
ance, see §1.446–1T(e)(2)(ii)(a).
(b) [Reserved]. For further guidance,
see §1.446–1T(e)(2)(ii)(b).
*****
(d)Changes involving depreciable or
amortizable assets.[Reserved].Forfur-
ther guidance, see §1.446–1T(e)(2)(ii)(d).
(iii)Examples. [Reserved]. For further
guidance, see §1.446–1T(e)(2)(iii).
*****
(4)Effective date. [Reserved]. For fur-
ther guidance, see §1.446(e)–1T(e)(4)(i)
and (ii).
Par. 5. Section 1.446–1T is added to
read as follows:
§1.446–1T General rule for methods of
accounting (temporary).
(a) through (e)(2)(i) [Reserved]. For
further guidance, see §1.446–1(a) through
(e)(2)(i).
(e)(2)(ii)(a) A change in the method of
accounting includes a change in the over-
all plan of accounting for gross income or
deductions or a change in the treatment
ofanymaterialitemusedinsuchover-
all plan. Althougha method of account-
ing may exist under this definition with-
out the necessity of a pattern of consis-
tent treatment of an item, in most instances
a method of accounting is not established
for an item without such consistent treat-
ment. A material item is any item that in-
volves the proper time for the inclusion of
the item in income or the taking of a de-
duction. Changes in method of account-
ing include a change from the cash re-
ceipts and disbursement method to an ac-
crual method, or vice versa, a change in-
volving the method or basis used in the
valuation of inventories (see sections 471
and 472 and the regulations under sec-
tions 471 and 472), a change from the cash
or accrual method to a long-term contract
method, or vice versa (see §1.460–4), cer-
tain changes in computing depreciation or
amortization (see paragraph (e)(2)(ii)(d)of
this section), a change involving the adop-
tion, use or discontinuance of any other
specialized method of computing taxable
income, such as the crop method, and a
change where the Internal Revenue Code
and regulations under the Code specifi-
cally require that the consent of the Com-
missioner must be obtained before adopt-
ing such a change.
(b) A change in method of accounting
does not include correction of mathemati-
cal or posting errors, or errors in the com-
putation of tax liability (such as errors in
computation of the foreign tax credit, net
operating loss, percentage depletion, or in-
vestment credit). Also, a change in method
of accounting does not include adjustment
of any item of income or deduction that
does not involve the proper time for the in-
clusion of the item of income or the tak-
ing of a deduction. For example, correc-
tions of items that are deducted as inter-
est or salary, but that are in fact payments
of dividends, and of items that are de-
ducted as business expenses, but which are
in fact personal expenses, are not changes
in method of accounting. In addition, a
change in the method of accounting does
not include an adjustment with respect to
the addition to a reserve for bad debts. Al-
though such adjustment may involve the
question of the proper time for the tak-
ing of a deduction, such items are tradi-
tionally corrected by adjustment in the cur-
rent and future years. For the treatment
of the adjustment of the addition to a bad
debt reserve (for example, for banks un-
der section 585 of the Internal Revenue
Code), see the regulations under section
166 of the Internal Revenue Code. A
change in the method of accounting also
does not include a change in treatment re-
sulting from a change in underlying facts.
For further guidance on changes involv-
ing depreciable or amortizable assets, see
paragraph (e)(2)(ii)(d)ofthissectionand
§1.1016–3T(h).
(c) [Reserved]. For further guidance,
see §1.446–1(e)(2)(ii)(c).
(d)Changes involving depreciable
or amortizable assets—(1)Scope.This
paragraph (e)(2)(ii)(d) applies to property
subject to section 167, 168, 197, 1400I,
1400L(b), or 1400L(c), or to section 168
prior to its amendment by the Tax Reform
Act of 1986 (100 Stat. 2121) (former sec-
tion 168).
(2)Changes in depreciation or amorti-
zation that are a change in method of ac-
counting. Except as provided in paragraph
(e)(2)(ii)(d)(3) of this section, a change in
the treatment of an asset from nondepre-
ciable or nonamortizable to depreciable
or amortizable, or vice versa, is a change
in method of accounting. Additionally,
a correction to require depreciation or
amortization in lieu of a deduction for the
cost of depreciable or amortizable assets
that had been consistently treated as an
expense in the year of purchase, or vice
versa, is a change in method of accounting.
Further, except as provided in paragraph
(e)(2)(ii)(d)(3) of this section, the follow-
ing changes in computing depreciation or
amortization are a change in method of
accounting:
(i) A change in the depreciation or
amortization method, period of recovery,
or convention of a depreciable or amorti-
zable asset.
(ii) A change from not claiming to
claiming the additional first year deprecia-
tion deduction provided by section 168(k)
or 1400L(b) for, and the resulting change
to the amount otherwise allowable as a
depreciation deduction for the remain-
ing adjusted depreciable basis (or similar
basis) of, qualified property, 50-percent
bonus depreciation property, or qualified
New York Liberty Zone property, provided
the taxpayer did not make the election out
of the additional first year depreciation de-
duction (or did not make a deemed election
out of the additional first year depreciation
deduction; for further guidance, see Rev.
Proc. 2002–33, 2002–1 C.B. 963, Rev.
Proc. 2003–50, 2003–29 I.R.B. 119, and
§601.601(d)(2)(ii)(b)ofthischapter)for
the class of property in which the qualified
property, the 50-percent bonus deprecia-
tion property, or the qualified New York
Liberty Zone property is included.
(iii) A change from claiming the 30-per-
cent additional first year depreciation
deduction to claiming the 50-percent addi-
tional first year depreciation deduction for
50-percent bonus depreciation property
(provided the property is not included in
any class of property for which the tax-
payer elected the 30-percent, instead of
the 50-percent, additional first year de-
preciation deduction) or a change from
claiming the 50-percent additional first
year depreciation deduction to claiming
the 30-percent additional first year depre-
February 9, 20044232004-6 I.R.B.

ciation deduction for qualified property
(including propertythat is included in
a class of property for which the tax-
payer elected the 30-percent, instead of
the 50-percent, additional first year de-
preciation deduction) or qualified New
York Liberty Zone property, and the re-
sulting change to the amount otherwise
allowable as a depreciation deduction
for the property’s remaining adjusted de-
preciable basis (or similar basis). This
paragraph (e)(2)(ii)(d)(2)(iii)doesnotap-
ply if a taxpayer is making a late election
or revoking a timely valid election under
section 168(k) or 1400L(b) (see paragraph
(e)(2)(ii)(d)(3)(iii)ofthissection).
(iv) A change from claiming to not
claiming the additional first year depre-
ciation deduction for an asset that is not
qualified property, 50-percent bonus de-
preciation property, or qualified New York
Liberty Zone property, and the resulting
change to the amount otherwise allowable
as a depreciation deduction for the prop-
erty’s depreciable basis.
(v) A change in salvage value to zero
for a depreciable or amortizable asset
for which the salvage value is expressly
treated as zero by the Internal Revenue
Code (for example, section 168(b)(4)), the
regulations under the Code (for example,
§1.197–2(f)(1)(ii)), or other guidance pub-
lished in the Internal Revenue Bulletin.
(vi) A change in the accounting for de-
preciable or amortizable assets from a sin-
gle asset account to a multiple asset ac-
count (pooling), or vice versa, or from one
type of multiple asset account (pooling) to
a different type of multiple asset account
(pooling).
(vii) For depreciable or amortizable as-
sets that are mass assets accounted for in
multiple asset accounts or pools, a change
in the method of identifying which as-
sets have been disposed. For purposes
of this paragraph (e)(2)(ii)(d)(2)(vii), the
termmass assetsmeans a mass or group of
individual items of depreciable or amorti-
zable assets that are not necessarily homo-
geneous, each of which is minor in value
relative to the total value of the mass or
group, numerous in quantity, usually ac-
counted for only on a total dollar or quan-
tity basis, with respect to which separate
identification is impracticable, and placed
in service in the same taxable year.
(viii) Any other change in depreciation
or amortization as the Secretary may des-
ignate by publication in theFederal Regis-
teror in the Internal Revenue Bulletin (see
§601.601(d)(2) of this chapter).
(3)Changes in depreciation or amor-
tization that are not a change in method
of accounting—(i)Useful life.Anadjust-
ment in the useful life of a depreciable or
amortizable asset forwhich depreciation
is determined under section 167 (other
than under section 168, section 1400I, sec-
tion 1400L, or former section 168) is not
a change in method of accounting. This
adjustment in useful life is corrected by
adjustments in the taxable year in which
the conditions known to exist at the end
of that taxable year changed thereby re-
sultinginaredeterminationoftheuseful
life under §1.167(a)–1(b) (or if the period
of limitation for assessment under section
6501(a) has expired for that taxable year,
in the first succeeding taxable year open
under the period of limitation for assess-
ment), and in subsequent taxable years. In
other situations, the adjustment in useful
life may be corrected by adjustments in
the earliest taxable year open under the
period of limitation for assessment un-
der section 6501(a) or the earliest taxable
year under examination by the Internal
Revenue Service (IRS) but in no event
earlier than the placed-in-service year
of the asset, and in subsequent taxable
years. However, if a taxpayer initiates the
correction in useful life, in lieu of filing
amended federal tax returns (for example,
because the conditions known to exist at
the end of a prior taxable year changed
thereby resulting in a redetermination of
the useful life under §1.167(a)–1(b)), the
taxpayer may correct the adjustment in
useful life by adjustments in the current
and subsequent taxable years. This para-
graph (e)(2)(ii)(d)(3)(i) does not apply if
a taxpayer is changing to or from a useful
life (or recovery period or amortization
period) that is specifically assigned by
the Internal Revenue Code (for example,
section 167(f)(1), section 168(c), section
197), the regulations under the Code, or
other guidance published in the Internal
Revenue Bulletin and, therefore, such
change is a change in method of account-
ing (unless paragraph (e)(2)(ii)(d)(3)(v)of
this section applies).
(ii)Change in use. A change in com-
puting depreciation or amortization al-
lowances in the taxable year in which the
use of an asset changes in the hands of the
same taxpayer is not a change in method
of accounting.
(iii)Elections. Generally, the making
of a late depreciation or amortization elec-
tion or the revocation of a timely valid de-
preciation or amortization election is not
a change in method of accounting, except
as otherwise expressly provided by the In-
ternal Revenue Code, the regulations un-
der the Code, or other guidance published
in the Internal Revenue Bulletin. This
paragraph (e)(2)(ii)(d)(3)(iii) also applies
to making a late election or revoking a
timely valid election made under section
13261(g)(2) or (3) of the Revenue Recon-
ciliation Act of 1993 (107 Stat. 312, 540)
(relating to amortizable section 197 intan-
gibles). A taxpayer may request consent
to make a late election or revoke a timely
validelectionbysubmittingarequestfora
private letter ruling.
(iv)Salvage value. Except as provided
under paragraph (e)(2)(ii)(d)(2)(v)ofthis
section, a change in salvage value of a de-
preciable or amortizable asset is not treated
as a change in method of accounting.
(v)Placed-in-service date. Any change
in the placed-in-service date of a depre-
ciable or amortizable asset is not treated
as a change in method of accounting. The
change in placed-in-service date may be
corrected by adjustments in the earliest
taxable year open under the period of
limitation for assessment under section
6501(a) or the earliest taxable year under
examination by the IRS but in no event
earlier than the placed-in-service year of
the asset, and in subsequent taxable years.
However, if a taxpayer initiates the change
in placed-in-service date, in lieu of filing
amended federal tax returns, the taxpayer
may correct the placed-in-service date by
adjustments in the current and subsequent
taxable years.
(vi) Any other change in depreciation or
amortization as the Secretary may desig-
nate by publication in theFederal Regis-
teror in the Internal Revenue Bulletin (see
§601.601(d)(2) of this chapter).
(4)Item being changed. For purposes
of a change in depreciation or amortization
to which this paragraph (e)(2)(ii)(d)ap-
plies, the item being changed generally is
the depreciation treatment of each individ-
ual depreciable or amortizable asset. How-
ever, the item is the depreciation treatment
of each vintage account with respect to a
depreciable asset for which depreciation is
2004-6 I.R.B.424February 9, 2004

determined under §1.167(a)–11 (CLADR
property). Further, a change in comput-
ing depreciation or amortization under sec-
tion 167 (other than under section 168, sec-
tion 1400I, section 1400L, or former sec-
tion 168) is permitted only with respect to
all assets in a particular account (as defined
in §1.167(a)–7) or vintage account.
(5)Special rules. For purposes of a
change in depreciation or amortization
to which this paragraph (e)(2)(ii)(d)ap-
plies—
(i)Declining balance method to the
straight line method for MACRS property.
For tangible, depreciable property subject
to section 168 (MACRS property) that
is depreciated using the 200-percent or
150-percent declining balance method of
depreciation under section 168(b)(1) or
(2), a taxpayer may change without the
consent of the Commissioner from the
declining balance method of depreciation
to the straight line method of depreciation
in the first taxable year in which the use of
the straight line method with respect to the
adjusted depreciable basis of the MACRS
property as of the beginning of that year
will yield a depreciation allowance that
is greater than the depreciation allowance
yielded by the use of the declining balance
method. When the change is made, the
adjusted depreciable basis of the MACRS
property as of the beginning of the taxable
year is recovered through annual depre-
ciation allowancesover the remaining
recovery period (for further guidance, see
section 6.06 of Rev. Proc. 87–57, 1987–2
C.B. 687, and §601.601(d)(2)(ii)(b)ofthis
chapter).
(ii)Depreciation method changes
for section 167 property.Foradepre-
ciable or amortizable asset for which
depreciation is determined under sec-
tion 167 (other than under section 168,
section 1400I, section 1400L, or for-
mer section 168), see §1.167(e)–1T(b),
(c), and (d) for the changes in depre-
ciationmethodthatarepermittedtobe
made without the consent of the Com-
missioner. For CLADR property, see
§1.167(a)–11(c)(1)(iii) for the changes in
depreciation method for CLADR property
that are permitted to be made without the
consent of the Commissioner. Further,
see §1.167(a)–11(b)(4)(iii)(c) for how to
correct an incorrect classification or char-
acterization of CLADR property.
(iii)Section 481 adjustment. Except as
otherwise expressly provided by the Inter-
nal Revenue Code, the regulations under
the Code, or other guidance published in
the Internal Revenue Bulletin, no section
481 adjustment is required or permitted
for a change from one permissible method
of computing depreciation or amortization
to another permissible method of com-
puting depreciation or amortization for an
asset because this change is implemented
by either a cut-off method (for further
guidance, see section 2.06 of Rev. Proc.
97–27, 1997–1 C.B. 680, section 2.06 of
Rev. Proc. 2002–9, 2002–1 C.B. 327, and
§601.601(d)(2)(ii)(b)ofthischapter)ora
modified cut-off method (under which the
adjusted depreciable basis of the asset as of
the beginning of the year of change is re-
covered using the new permissible method
of accounting), as appropriate. However,
achangefromanimpermissiblemethodof
computing depreciation or amortization to
a permissible method of computing depre-
ciation or amortization for an asset results
in a section 481 adjustment. Similarly, a
change in the treatment of an asset from
nondepreciable or nonamortizable to de-
preciable or amortizable (or vice versa) or
a change in the treatment of an asset from
expensing to depreciating (or vice versa)
results in a section 481 adjustment.
(iii)Examples. The rules of this para-
graph (e) are illustrated by the following
examples:
Example 1. Although the sale of merchandise is
an income producing factor, and therefore inventories
are required, a taxpayer in the retail jewelry business
reports his income on the cash receipts and disburse-
ments method of accounting. A change from the cash
receipts and disbursements method of accounting to
the accrual method of accounting is a change in the
overall plan of accounting and thus is a change in
method of accounting.
Example 2. A taxpayer in the wholesale dry
goods business computes its income and expenses on
the accrual method of accounting and files its Fed-
eral income tax returns on such basis except for real
estate taxes which have been reported on the cash
receipts and disbursements method of accounting.
A change in the treatment of real estate taxes from
the cash receipts and disbursements method to the
accrual method is a change in method of accounting
because such change is a change in the treatment of a
material item within his overall accounting practice.
Example 3. A taxpayer in the wholesale dry
goods business computes its income and expenses on
the accrual method of accounting and files its Federal
income tax returns on such basis. Vacation pay has
been deducted in the year inwhich paid because the
taxpayer did not have a completely vested vacation
pay plan, and, therefore, the liability for payment did
not accrue until that year. Subsequently, the taxpayer
adopts a completely vested vacation pay plan that
changes its year for accruing the deduction from the
year in which payment is made to the year in which
the liability to make the payment now arises. The
change for the year of deduction of the vacation pay
plan is not a change in method of accounting but
results, instead, because the underlying facts (that is,
the type of vacation pay plan) have changed.
Example 4. From 1968 through 1970, a taxpayer
has fairly allocated indirect overhead costs to the
value of inventories on a fixed percentage of direct
costs. If the ratio of indirect overhead costs to direct
costs increases in 1971, a change in the underlying
facts has occurred. Accordingly,an increase in the
percentage in 1971 to fairly reflect the increase in
the relative level of indirect overhead costs is not a
change in method of accounting but is a change in
treatment resulting from a change in the underlying
facts.
Example 5. A taxpayer values inventories at cost.
A change in the basis for valuation of inventories
from cost to the lower of cost or market is a change in
an overall practice of valuing items in inventory. The
change, therefore, is a change in method of account-
ing for inventories.
Example 6. A taxpayer in the manufacturing busi-
ness has for many taxable years valued its inventories
at cost. However, cost has been improperly computed
since no overhead costs have been included in valu-
ing the inventories at cost. The failure to allocate an
appropriate portion of overhead to the value of inven-
tories is contrary to the requirement of the Internal
Revenue Code and the regulations under the Code. A
change requiring appropriate allocation of overhead
is a change in method of accounting because it in-
volves a change in the treatment of a material item
used in the overall practice of identifying or valuing
items in inventory.
Example 7. A taxpayer has for many taxable
years valued certain inventories by a method which
provides for deducting 20 percent of the cost of the
inventory items in determining the final inventory
valuation. The 20 percent adjustment is taken as a
“reserve for price changes.” Although this method is
not a proper method of valuing inventories under the
Internal Revenue Code or the regulations under the
Code, it involves the treatment of a material item used
in the overall practice of valuing inventory. A change
in such practice or procedure is a change of method
of accounting for inventories.
Example 8. A taxpayer has always used a base
stock system of accounting for inventories. Under
this system a constant price is applied to an assumed
constant normal quantity of goods in stock. The base
stock system is an overall plan of accounting for in-
ventories which is not recognized as a proper method
of accounting for inventories under the regulations.
A change in this practice is, nevertheless, a change of
method of accounting for inventories.
Example 9. In 2000, A1, a calendar year taxpayer
engaged in the trade or business of manufactur-
ing knitted goods, purchased and placed in service
a building and its components at a total cost of
$10,000,000 for use in its manufacturing operations.
A1 classified the $10,000,000 as nonresidential real
property under section 168(e). A1 did not make
any elections under section 168 on its 2000 Federal
tax return. As a result, on its 2000, 2001, and 2002
February 9, 20044252004-6 I.R.B.

federal tax returns, A1 depreciated the $10,000,000
under the general depreciation system of section
168(a), using the straight line method of deprecia-
tion, a 39-year recovery period, and the mid-month
convention. In 2003, A1 completes a cost segrega-
tion study on the building and its components and
identifies items that cost a total of $1,500,000 as
section 1245 property. As a result, the $1,500,000
should have been classified in 2000 as 5-year prop-
erty under section 168(e) and depreciated on A1’s
2000, 2001, and 2002 Federal tax returns under the
general depreciation system, using the 200-percent
declining balance method of depreciation, a 5-year
recovery period, and the half-year convention. Pur-
suant to paragraph (e)(2)(ii)(d)(2)(i)ofthissection,
A1’s change to this depreciation method, recovery
period, and convention is a change in method of
accounting. This method change results in a section
481 adjustment. The useful life exception under
paragraph (e)(2)(ii)(d)(3)(i)ofthissectiondoesnot
apply because the assets are depreciated under sec-
tion 168.
Example 10. In 1996, B, a calendar year tax-
payer, purchased and placed in service new equip-
ment at a total cost of $1,000,000 for use in its plant
located outside the United States. The equipment is
15-year property under section 168(e) with a class life
of 20 years. The equipment is required to be depre-
ciated under the alternative depreciation system of
section 168(g). However, B incorrectly depreciated
the equipment under the general depreciation system
of section 168(a), using the 150-percent declining
balance method, a 15-year recovery period, and the
half-year convention. In 2003, the IRS examines B’s
2000 Federal income tax return and changes the de-
preciation of the equipment to the alternative depreci-
ation system, using the straight line method of depre-
ciation, a 20-year recoveryperiod, and the half-year
convention. Pursuant to paragraph (e)(2)(ii)(d)(2)(i)
of this section, this change in depreciation method
and recovery period made by the IRS is a change in
method of accounting. This method change results
in a section 481 adjustment. The useful life excep-
tion under paragraph (e)(2)(ii)(d)(3)(i) of this section
does not apply because the assets are depreciated un-
der section 168.
Example 11. In May 2001, C, a calendar year tax-
payer, purchased and placed in service equipment for
use in its trade or business. C never held this equip-
ment for sale. However, C incorrectly treated the
equipment as inventory on its 2001 and 2002 Federal
tax returns. In 2003, C realizes that the equipment
should have been treated as a depreciable asset. Pur-
suant to paragraph (e)(2)(ii)(d)(2)ofthissection,C’s
change in the treatment of the equipment from inven-
tory to a depreciable asset is a change in method of
accounting. This method change results in a section
481 adjustment.
Example 12. Since 2001, D, a calendar year
taxpayer, has used the distribution fee period method
to amortize distributor commissions and, under
that method, established pools to account for the
distributor commissions (for further guidance,
see Rev. Proc. 2000–38, 2000–2 C.B. 310, and
§601.601(d)(2)(ii)(b) of this chapter). A change in
the accounting of distributor commissions under
the distribution fee period method from pooling to
single asset accounting is a change in method of
accounting pursuant to paragraph (e)(2)(ii)(d)(2)(vi)
of this section. This method change results in no sec-
tion 481 adjustment because the change is from one
permissible method to another permissible method.
Example 13. Since 2000, E, a calendar year tax-
payer, has accounted for items of MACRS property
that are mass assets in pools. Each pool includes only
the mass assets that are placed in service by E in the
same taxable year. E is able to identify the cost ba-
sis of each asset in each pool. None of the pools are
general asset accounts under section 168(i)(4) and the
regulations under section 168(i)(4). E identified any
dispositions of these mass assets by specific identi-
fication. Because of changes in E’s recordkeeping
in 2003, it is impracticable for E to continue to iden-
tify disposed mass assets using specific identification.
As a result, E wants to change to a first-in, first-out
method under which the mass assets disposed of in
a taxable year are deemed to be from the pool with
the earliest placed-in-service year in existence as of
the beginning of the taxable year of each disposition.
Pursuant to paragraph (e)(2)(ii)(d)(2)(vii)ofthissec-
tion, this change is a change in method of account-
ing. This method change results in no section 481
adjustment because the change is from one permissi-
ble method to another permissible method.
Example 14. In August 2001, F, a calendar tax-
payer, purchased and placed in service a copier for
use in its trade or business. F incorrectly classified
the copier as 7-year property under section 168(e). F
made no elections under section 168 on its 2001 Fed-
eral tax return. As a result, on its 2001 and 2002 Fed-
eral tax returns, F depreciated the copier under the
general depreciation system of section 168(a), using
the 200-percent declining balance method of depre-
ciation, a 7-year recovery period, and the half-year
convention. In 2003, F realizes that the copier is
5-year property and should have been depreciated
on its 2001 and 2002 Federal tax returns under the
general depreciation system using a 5-year recovery
period rather than a 7-year recovery period. Pur-
suant to paragraph (e)(2)(ii)(d)(2)(i) of this section,
F’s change in recovery period from 7 to 5 years is a
change in method of accounting. This method change
results in a section 481 adjustment. The useful life ex-
ception under paragraph (e)(2)(ii)(d)(3)(i)ofthissec-
tion does not apply because the copier is depreciated
under section 168.
Example 15. In 1998, G, a calendar year taxpayer,
purchased and placed in service an intangible asset
that is not an amortizable section 197 intangible and
that is not described in section 167(f). G amortized
the cost of the intangible asset under section 167(a)
using the straight line method of depreciation and a
useful life of 13 years. In 2003, because of chang-
ing conditions, G changes the remaining useful life
of the intangible asset to 2 years. Pursuant to para-
graph (e)(2)(ii)(d)(3)(i) of this section, G’s change in
useful life is not a change in method of accounting
because the intangible asset is depreciated under sec-
tion 167 and G is not changing to or from a useful life
that is specifically assigned by the Internal Revenue
Code, the regulations under the Code, or other guid-
ance published in the Internal Revenue Bulletin.
Example 16. In July 2001, H, a calendar year tax-
payer, purchased and placedin service “off-the-shelf”
computer software and a new computer. The cost of
the new computer and computer software are sepa-
rately stated. H incorrectly included the cost of this
software as part of the cost of the computer, which
is 5-year property under section 168(e). On its 2001
Federal tax return, H elected to depreciate its 5-year
property placed in service in 2001 under the alterna-
tive depreciation system of section 168(g). The class
life for a computer is 5 years. As a result, because
H included the cost of the computer software as part
of the cost of the computer hardware, H depreciated
the cost of the software under the alternative depreci-
ation system, using the straight line method of depre-
ciation, a 5-year recoveryperiod, and the half-year
convention. In 2003, H realizes that the cost of the
software should have been amortized under section
167(f)(1), using the straight line method of depre-
ciation, a 36-month useful life, and a monthly con-
vention. H’s change from 5-years to 36-months is a
change in method of accounting because H is chang-
ing to a useful life that is specifically assigned by sec-
tion 167(f)(1). The change in convention from the
half-year to the monthly convention also is a change
in method of accounting. Both changes result in a
section 481 adjustment.
Example 17. On September 15, 2001, I2, a cal-
endar year taxpayer, purchased and placed in service
new equipment at a total cost of $500,000 for use in
its business. The equipment is 5-year property un-
der section 168(e) with a class life of 9 years and
is qualified property under section 168(k). I2 did
not place in service any other depreciable property in
2001. Section 168(g)(1)(A) through (D) do not ap-
ply to the equipment. I2 intended to elect the alter-
native depreciation system under section 168(g) for
5-year property placed in service in 2001. However,
I2 did not make the election. Instead, I2 deducted on
its 2001 Federal tax return the 30-percent additional
first year depreciation attributable to the equipment
and, on its 2001 and 2002 Federal tax returns, depre-
ciated the remaining adjusted depreciable basis of the
equipment under the general depreciation system un-
der 168(a), using the 200-percent declining balance
method, a 5-year recovery period, and the half-year
convention. In 2003, I2 realizes its failure to make the
alternative depreciation system election in 2001 and
files a Form 3115 to change its method of depreci-
ating the remaining adjusted depreciable basis of the
2001 equipment to the alternative depreciation sys-
tem. Because this equipment is not required to be de-
preciated under the alternative depreciation system,
I2 is attempting to make an election under section
168(g)(7). However, this election must be made in
the taxable year in which the equipment is placed in
service (2001) and, consequently, I2 is attempting to
make a late election under section 168(g)(7). Accord-
ingly, I2’s change to the alternative depreciation sys-
tem is not a change in accounting method pursuant to
paragraph (e)(2)(ii)(d)(3)(iii) of this section. Instead,
I2 must submit a request for a private letter ruling un-
der §301.9100–3 of this chapter, requesting an exten-
sion of time to make the alternative depreciation sys-
tem election on its 2001 Federal tax return.
(3) [Reserved]. For further guidance,
see §1.446–1(e)(3).
(4)Effective date—(i)In general.Ex-
cept as provided in paragraphs (e)(3)(iii)
and (e)(4)(ii) of this section, paragraph (e)
of this section applies on or after Decem-
ber 30, 2003. For the applicability of reg-
ulations before December 30, 2003, see
2004-6 I.R.B.426February 9, 2004

§1.446–1(e) in effect prior to December
30, 2003 (§1.446–1(e) as contained in 26
CFR part 1 edition revised as of April 1,
2003).
(ii)Changes involving depreciable or
amortizable assets. With respect to para-
graph (e)(2)(ii)(d) of this section, para-
graph (e)(2)(iii)Examples 9through17
of this section, the addition of the lan-
guage “certain changes in computing de-
preciation or amortization (see paragraph
(e)(2)(ii)(d) of this section)” to the last sen-
tence of paragraph (e)(2)(ii)(a)ofthissec-
tion, and the removal of all language re-
garding useful life and the sentence “On
the other hand, a correction to require de-
preciation in lieu of a deduction for the cost
of a class of depreciable assets which had
been consistently treated as an expense in
the year of purchase involves the question
of the proper timing of an item, and is to
be treated as a change in method of ac-
counting” from paragraph (e)(2)(ii)(b)of
this section—
(A) For any change in depreciation or
amortization that is a change in method of
accounting, this section applies to such a
change in method of accounting made for
taxable years ending on or after December
30, 2003; and
(B) For any change in depreciation or
amortization that is not a change in method
of accounting, this section applies to such
a change made for taxable years ending on
or after December 30, 2003.
(iii) The applicability of paragraph
(e) of this section expires on or before
December 29, 2006.
Par. 6. Section 1.1016–3 is amended
by:
1. Redesignating paragraph (h) as para-
graph (i).
2. Adding new paragraphs (h) and (j).
The additions read as follows:
§1.1016–3 Exhaustion, wear and tear,
obsolescence, amortization, and depletion
for periods since February 28, 1913.
*****
(h)Application to a change in method
of accounting. [Reserved]. For further
guidance, see §1.1016–3T(h).
*****
(j)Effective date. [Reserved]. For fur-
ther guidance, see §1.1016–3T(j)(1) and
(2).
Par. 7. Section 1.1016–3T is added to
read as follows:
§1.1016–3T Exhaustion, wear and tear,
obsolescence, amortization, and depletion
for periods since February 28, 1913
(temporary).
(a) through (g) [Reserved]. For further
guidance, see §1.1016–3(a) through (g).
(h)Application to a change in method of
accounting. For purposes of determining
whether a change in depreciation or amor-
tization for propertysubject to section 167,
168, 197, 1400I, 1400L(b), or 1400L(c),
or to section 168 prior to its amendment
by the Tax Reform Act of 1986 (100 Stat.
2121) (former section 168) is a change in
method of accounting under section 446(e)
and the regulations under section 446(e),
section 1016(a)(2) does not permanently
affect a taxpayer’s lifetime income.
(i) [Reserved]. For further guidance,
see §1.1016–3(i).
(j)Effective date—(1)In general.Ex-
cept as provided in paragraph (j)(2) of this
section, this section applies on or after De-
cember 30, 2003. For the applicability of
regulations before December 30, 2003, see
§1.1016–3 in effect prior to December 30,
2003 (§1.1016–3 as contained in 26 CFR
part 1 edition revised as of April 1, 2003).
(2)Depreciation or amortization
changes. Paragraph (h) of this section
applies to a change in depreciation or
amortization for property subject to sec-
tion 167, 168, 197, 1400I, 1400L(b), or
1400L(c), or former section 168 for tax-
able years ending on or after December
30, 2003.
(3) The applicability of this section ex-
pires on or before December 29, 2006.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 18, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury
(Tax Policy).
(Filed by the Office of the Federal Register on December 30,
2003, 8:45 a.m., and published in the issue of the Federal
Register for January 2, 2004, 69 F.R. 5)
Section 467.—Certain
Payments for the Use of
Property or Services
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 468.—Special
Rules for Mining and Solid
Waste Reclamation and
Closing Costs
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 482.—Allocation
of Income and Deductions
Among Taxpayers
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2004. See Rev.
Rul. 2004-9, page 428.
Section 483.—Interest on
Certain Deferred Payments
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 642.—Special
Rules for Credits and
Deductions
Federal short-term, mid-term, and long-term rates
are set forth for the month of February 2004. See Rev.
Rul. 2004-9, page 428.
Section 807.—Rules for
Certain Reserves
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 846.—Discounted
Unpaid Losses Defined
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
February 9, 20044272004-6 I.R.B.

Section 1274.—Determi-
nation of Issue Price in the
Case of Certain Debt Instru-
ments Issued for Property
(Also sections 42, 280G, 382, 412, 467, 468, 482,
483, 642, 807, 846, 1288, 7520, 7872.)
Federal rates; adjusted federal rates;
adjusted federal long-term rate and the
long-term exempt rate.For purposes of
sections 382, 642, 1274, 1288, and other
sections of the Code, tables set forth the
rates for February 2004.
Rev. Rul. 2004–9
This revenue ruling provides various
prescribed rates for federal income tax
purposes for February 2004 (the current
month). Table 1 contains the short-term,
mid-term, and long-term applicable fed-
eral rates (AFR) for the current month
for purposes of section 1274(d) of the
Internal Revenue Code. Table 2 contains
the short-term, mid-term, and long-term
adjusted applicable federal rates (adjusted
AFR) for the current month for purposes
of section 1288(b). Table 3 sets forth the
adjusted federal long-term rate and the
long-term tax-exempt rate described in
section 382(f). Table 4 contains the ap-
propriate percentages for determining the
low-income housing credit described in
section 42(b)(2) for buildings placed in
service during the current month. Finally,
Table 5 contains the federal rate for de-
termining the present value of annuity, an
interest for life or for a term of years, or
a remainder or a reversionary interest for
purposes of section 7520.
REV. RUL. 2004–9 TABLE 1
Applicable Federal Rates (AFR) for February 2004
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-Term
AFR1.62%1.61%1.61%1.60%
110% AFR1.78%1.77%1.77%1.76%
120% AFR1.94%1.93%1.93%1.92%
130% AFR2.10%2.09%2.08%2.08%
Mid-Term
AFR3.44%3.41%3.40%3.39%
110% AFR3.79%3.75%3.73%3.72%
120% AFR4.13%4.09%4.07%4.06%
130% AFR4.48%4.43%4.41%4.39%
150% AFR5.19%5.12%5.09%5.07%
175% AFR6.06%5.97%5.93%5.90%
Long-Term
AFR4.94%4.88%4.85%4.83%
110% AFR5.44%5.37%5.33%5.31%
120% AFR5.95%5.86%5.82%5.79%
130% AFR6.44%6.34%6.29%6.26%
REV. RUL. 2004–9 TABLE 2
Adjusted AFR for February 2004
Period for Compounding
AnnualSemiannualQuarterlyMonthly
Short-term adjusted
AFR
1.41%1.41%1.41%1.41%
Mid-term adjusted AFR2.64%2.62%2.61%2.61%
Long-term adjusted
AFR
4.31%4.26%4.24%4.22%
2004-6 I.R.B.428February 9, 2004

REV. RUL. 2004–9 TABLE 3
Rates Under Section 382 for February 2004
Adjusted federal long-term rate for the current month4.31%
Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted
federal long-term rates for the current month and the prior two months.)4.58%
REV. RUL. 2004–9 TABLE 4
Appropriate Percentages Under Section 42(b)(2) for February 2004
Appropriate percentage for the 70% present value low-income housing credit7.97%
Appropriate percentage for the 30% present value low-income housing credit3.42%
REV. RUL. 2004–9 TABLE 5
Rate Under Section 7520 for February 2004
Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years,
or a remainder or reversionary interest4.2%
Section 1288.—Treatment
of Original Issue Discounts
on Tax-Exempt Obligations
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 1361.—S Corpora-
tion Defined
26 CFR 1.1361–4: Effect on QSub election.
Whether an Employee Stock Ownership Plan may
be a shareholder in an S corporation. See Rev. Rul.
2004-4, page 414.
Section 4975.—Tax on
Prohibited Transactions
26 CFR 54.4975–11: “ESOP” requirements.
Whether, under each of the three situations de-
scribed therein, the Employee Stock Ownership Plan
of an S corporation has a nonallocation year within
the meaning of section 409(p)(3) of the Internal Rev-
enue Code. See Rev. Rul. 2004-4, page 414.
Section 4979A.—Tax
on Certain Prohibited
Allocations of Qualified
Securities
Whether transactions involving an S corporation
ESOP and the ownership by a disqualified person of
synthetic equity in a nonallocation year of the ESOP
give rise to the excise tax described in section 4979A.
See Rev. Rul. 2004-4, page 414.
Section 6011.—General
Requirement of Return,
S
tatement or List
26 CFR 1.6011–4: Requirement of statement disclos-
ing participation in certain transactions by taxpay-
ers.
Whether transactions involving an S corporation
ESOP and the ownership by a disqualified person of
synthetic equity in a nonallocation year of the ESOP
is a listed transaction. See Rev. Rul. 2004-4, page
414.
26 CFR 1.6011–4: Requirement of statement disclos-
ing participation in certain transactions by taxpay-
ers.
T.D. 9108
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
Confidential Transactions
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: These final regulations mod-
ify and clarify the rules relating to confi-
dential transactions under the Income Tax
Regulations, and make minor conforming
changes to the list maintenance rules under
the Procedure and Administration Regula-
tions. These regulations affect taxpayers
participating in reportable transactions and
persons responsible for maintaining and
furnishing lists of investors in reportable
transactions.
DATES:Effective Date:These regulations
are effective December 29, 2003.
Applicability Date:For dates of
applicability, see§1.6011–4(h) and
§301.6112–1.
FOR FURTHER INFORMATION
CONTACT: Tara P. Volungis or
Charlotte Chyr, 202–622–3070 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in these regulations have been
previously reviewed and approved by
the Office of Management and Budget
in accordance with the Paperwork Re-
duction Act of 1995 (44 U.S.C. 3507(d))
under control numbers 1545–1685 and
1545–1686.
February 9, 20044292004-6 I.R.B.

An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless the collec-
tion of information displays a valid OMB
control number assigned by the Office of
Management and Budget.
Books or records relating to a collection
of information must be retained as long
as their contents may 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
This document amends 26 CFR parts
1 and 301 by modifying and clarifying
the rules relating to the disclosure of re-
portable transactionsby certain taxpayers
on their Federal income tax returns under
section 6011 and by making conforming
changes to the rules under section 6112.
On October 17, 2002, the IRS is-
sued temporary and proposed regulations
modifying the rules under sections 6011,
6111, and 6112 (T.D. 9017, 2002–2 C.B.
815; REG–103735–00, REG–154117–02,
REG–154116–02,REG–154115–02,
REG–154429–02,REG–154423–02,
REG–154426–02,REG–110311–98,
2002–2 C.B. 832; T.D. 9018, 2002–2
C.B 823; REG–103736–00, 2002–2 C.B.
834) (the October 2002 regulations). The
October 2002 regulations were published
in theFederal Register(67 FR 64799, 67
FR 64840; 67 FR 64807, 67 FR 64842) on
October 22, 2002. On December 11, 2002,
and on January 7, 2003, the IRS and Trea-
sury Department held a public hearing on
these regulations. On February 28, 2003,
the IRS issued final regulations under sec-
tions 6011, 6111, and 6112 (T.D. 9046,
2003–1 C.B. 614) (the February 2003 reg-
ulations). The February 2003 regulations
were published in theFederal Register
(68 FR 10161) on March 4, 2003.
Since finalizing the disclosure regula-
tions, the IRS and Treasury Department
have received numerous comments con-
cerning the confidentiality filter. The
IRS and Treasury Department received
requests to exclude certain transactions
from the scope of the confidentiality fil-
ter, and requests to modify the language
of the regulation itself. After reviewing
these comments, the IRS and Treasury
Department have decided to narrow the
confidentiality filter under §1.6011–4(b)
(3).
Explanation of Provisions
Section 1.6011–4(b)(3) provides that
certain transactions are identified as con-
fidential transactions. Confidential trans-
actions are reportable transactions that
are subject to the disclosure rules under
§1.6011–4 and the list maintenance rules
under §301.6112–1. Currently, a confi-
dential transaction is a transaction that is
offered under conditions of confidential-
ity. The confidentiality filter generally
provides a presumption of non-confiden-
tiality if the taxpayer receives written
authorization to disclose the tax treatment
and tax structure of the transaction.
The IRS and Treasury Department
have concluded that the confidentiality
filter should be limited to situations in
which an advisor is paid a large fee and
imposes a limitation on disclosure that
protects the confidentiality of the advi-
sor’s tax strategies. The IRS and Treasury
Department believe that the confidential-
ity filter should not apply to transactions
in which confidentiality is imposed by
a party to the transaction acting in such
capacity. Accordingly, the confidentiality
filter has been narrowed to reflect this
policy. Further, the exceptions and pre-
sumption language have been removed
because the IRS and Treasury Department
have concluded that they no longer are
necessary under this narrower rule. Con-
forming changes have been made to the
rules under §301.6112–1.
The IRS and Treasury Department also
have made minor clarifying changes under
§1.6011–4. The regulations clarify that a
return includes amended returns for pur-
poses of determining when a disclosure
must be made. The IRS and Treasury De-
partment will continue to accept comments
and will make other changes as appropri-
ate.
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 assessment
is not required. It has been determined
pursuant to 5 U.S.C. 553(b)(B) that notice
and public procedure are unnecessary and
contrary to the public interest. These final
regulations substantially reduce taxpayer
compliance burdens by limiting the scope
of transactions subject to the disclosure re-
quirements of §1.6011–4. For the same
reason, pursuant to 5 U.S.C. 553(d)(1) and
(3) a delayed effective date for these fi-
nal regulations is not required. Because no
notice of proposed rulemaking is required,
the provisions of the Regulatory Flexibil-
ity Act (5 U.S.C. chapter 6) do not apply.
However, the IRS and Treasury Depart-
ment welcome comments on whether these
final regulations impose additional costs
and compliance burdens on small busi-
nesses. Any such comments should pro-
vide specific information concerning those
costs and burdens. In addition, the IRS and
Treasury Department will consider hold-
ing a public hearing concerning these regu-
lations if there is sufficient interest from af-
fected parties. Pursuant to section 7805(f)
of the Internal Revenue Code, these regu-
lations were submitted to the Chief Coun-
sel for Advocacy of the Small Business
Administration for comment on their im-
pact on small business.
Draftin
g Information
The principal authors of these regula-
tions are Tara P. Volungis and Charlotte
Chyr, Office of the Associate Chief Coun-
sel (Passthroughs and Special Industries).
However, other personnel from the IRS
and Treasury Department participated in
their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 301
are amended as follows:
PART 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. Section 1.6011–4 is amended as
follows:
1. Paragraph (b)(3) is revised.
2. Paragraph (e)(1) is amended by re-
moving the second sentence and replacing
it with two new sentences in its place.
3. Paragraphs (e)(2)(i) and (h) are re-
vised.
The revisions and additions read as fol-
lows:
2004-6 I.R.B.430February 9, 2004

§1.6011–4 Requirement of statement
disclosing participation in certain
transactions by taxpayers.
*****
(b)*****
(3)Confidential transactions—(i)In
general. A confidential transaction is a
transaction that is offered to a taxpayer
under conditions of confidentiality and for
which the taxpayer has paid an advisor a
minimum fee.
(ii)Conditions of confidentiality.A
transaction is considered to be offered to
a taxpayer under conditions of confiden-
tiality if the advisor who is paid the min-
imum fee places a limitation on disclosure
by the taxpayer of the tax treatment or tax
structure of the transaction and the limi-
tation on disclosure protects the confiden-
tiality of that advisor’s tax strategies. A
transaction is treatedas confidential even
if the conditions of confidentiality are not
legally binding on the taxpayer. A claim
that a transaction is proprietary or exclu-
sive is not treated as a limitation on dis-
closure if the advisor confirms to the tax-
payer that there is no limitation on disclo-
sure of the tax treatment or tax structure of
the transaction.
(iii)Minimum fee. For purposes of this
paragraph (b)(3), the minimum fee is:
(A) $250,000 for a transaction if the
taxpayer is a corporation.
(B) $50,000 for all other transactions
unless the taxpayer is a partnership or trust,
all of the owners or beneficiaries of which
are corporations (looking through any
partners or beneficiaries that are them-
selves partnerships or trusts), in which
case the minimum fee is $250,000.
(iv)Determination of minimum fee.For
purposes of this paragraph (b)(3), a mini-
mum fee includes all fees for a tax strategy
or for services for advice (whether or not
tax advice) or for the implementation of
a transaction. These fees include consid-
eration in whatever form paid, whether in
cash or in kind, for services to analyze the
transaction (whether or not related to the
tax consequences of the transaction), for
services to implement the transaction, for
services to document the transaction, and
for services to prepare tax returns to the ex-
tent that the fees exceed the fees customary
for return preparation. For purposes of this
paragraph (b)(3), a taxpayer also is treated
as paying fees to an advisor if the taxpayer
knows or should know that the amount it
pays will be paid indirectly to the advisor,
such as through a referral fee or fee-shar-
ing arrangement. A fee does not include
amounts paid to a person, including an ad-
visor, in that person’s capacity as a party
to the transaction. For example, a fee does
not include reasonable charges for the use
of capital or the sale or use of property.
(v)Related parties. For purposes of
this paragraph (b)(3), persons who bear a
relationship to each other as described in
section 267(b) or 707(b) will be treated as
thesameperson.
*****
(e) * * *
(1) * * * In addition, the disclosure
statement for a reportable transaction must
be attached to each amended return that
reflects a taxpayer’s participation in a re-
portable transaction. A copy of the disclo-
sure statement must be sent to OTSA at the
same time that any disclosure statement is
firstfiledbythetaxpayer.***
(2) * * *
(i)Listed transactions. If a transaction
becomes a listed transaction after the fil-
ing of a taxpayer’s tax return (including an
amended return) reflecting either tax con-
sequences or a tax strategy described in
the published guidance listing the transac-
tion (or a tax benefit derived from tax con-
sequences or a tax strategy described in
the published guidance listing the transac-
tion) and before the end of the period of
limitations for the final return (whether or
not already filed) reflecting the tax conse-
quences, tax strategy, or tax benefit, then a
disclosure statement must be filed as an at-
tachment to the taxpayer’s tax return next
filed after the date the transaction is listed
regardless of whether the taxpayer partici-
patedinthetransactioninthatyear.
*****
(h)Effective dates. This section applies
to Federal income tax returns filed after
February 28, 2000. However, paragraphs
(b)(3), (e)(1), and (e)(2)(i) of this section
applytotransactionsenteredintoonoraf-
ter December 29, 2003. All the rules in
this section may be relied upon for trans-
actions entered into on or after January 1,
2003, and before December 29, 2003. Oth-
erwise, the rules that apply with respect to
transactions entered into before December
29, 2003, are contained in §1.6011–4 in ef-
fect prior to December 29, 2003, (see 26
CFR part 1 revised as of April 1, 2003).
PART 301—PROCEDURE AND
ADMINISTRATION
Par. 3. The authority citation for part
301 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 4. In §301.6112–1, paragraph
(c)(3)(iii) is amended by revising the first
sentence, removing the words “for advice
or implementation” from the third sen-
tence, and adding two sentences after the
third sentence, to read as follows:
§301.6112–1 Requirement to prepare,
maintain, and furnish lists with respect to
potentially abusive tax shelters.
*****
(c) * * *
(3) * * *
(iii) * * * In determining whether the
minimum fee threshold is satisfied, all fees
for a tax strategy or for services for advice
(whether or not tax advice) or for the im-
plementation of a transaction that is a po-
tentially abusive tax shelter are taken into
account.***Afeedoesnotinclude
amounts paid to a person, including an ad-
visor, in that person’s capacity as a party
to the transaction. For example, a fee does
not include reasonable charges for the use
of capital or the sale or use of property.
***
*****
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 18, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on December 29,
2003, 8:45 a.m., and published in the issue of the Federal
Register for December 30, 2003, 68 F.R. 75128)
Section 6111.—Registra-
tion of Tax Shelters
26 CFR 301.6111–2: Confidential corporate tax
shelters.
Whether transactions involving an S corporation
ESOP and the ownership by a disqualified person of
synthetic equity in a nonallocation year of the ESOP
February 9, 20044312004-6 I.R.B.

is a listed transaction. See Rev. Rul. 2004-4, page
414.
Section 6112.—Organizers
and Sellers of Potentially
Abusive Tax Sh
elters Must
Keep Lists of
Investors
26 CFR 301.611
2–1: Requirement to prepare, main-
tain and furn
ish lists with respect to potentially abu-
sive tax shel
ters.
Whether a lis
t must be maintained identifying each
person who wa
s sold an interest in transactions in-
volving an S corporation ESOP and the ownership by
a disqualified person of synthetic equity in a nonallo-
cation year of the ESOP. See Rev. Rul. 2004-4, page
414.
Section 7520.—Valuation
Tables
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
Section 7872.—Treatment
of Loans With Below-Market
Interest Rates
The adjusted applicable federal short-term, mid-
term, and long-term rates are set forth for the month
of February 2004. See Rev. Rul. 2004-9, page 428.
2004-6 I.R.B.432February 9, 2004

Part III. Administrative, Procedural, and Miscellaneous
Electronic Delivery of Form
1099 and Form 5498 Payee
Statements
Notice 2004–10
I. Purpose and Scope
This notice provides guidance to spon-
sors or administrators of retirement plans
or qualified tuition programs (QTPs), em-
ployers of simplified employee pensions
(SEPs), or trustees, custodians, or issuers
of traditional Individual Retirement Ar-
rangements (IRAs), Roth IRAs, Coverdell
education savings accounts (CESAs), or
Archer Medical Savings Accounts (Archer
MSAs) regarding the electronic delivery
of payee statements to recipients. Specifi-
cally, this notice provides that a furnisher
of a Form 1099 or a Form 5498 relat-
ing to the reporting of contributions and
distributions of pensions, SEPs, tradi-
tional IRAs, Roth IRAs, QTPs, CESAs,
and Archer MSAs may deliver electroni-
cally the payee statementsrequiredtobe
furnished to recipients for 2003 and sub-
sequent years.
II. Background
Section 220(h) of the Internal Revenue
Code provides that the Secretary may re-
quire the trustee of an Archer MSA to
make such reports regarding the account
to the Secretary and to the account holder
with respect to contributions, distributions,
and such other matters as the Secretary de-
termines appropriate.The required reports
must be filed at the time and in the manner
and furnished to the individuals at the time
and in the manner prescribed by the Secre-
tary.
Section 408(i) provides that the trustee
of an IRA and the issuer of an endowment
contract described in § 408(b) or an indi-
vidual retirement annuity must make such
reports regarding theaccount, contract, or
annuity to the Secretary and to the indi-
viduals for whom the account, contract,
or annuity is, or is to be, maintained with
respect to contributions (and the years to
which they relate), distributions aggregat-
ing $10 or more in any calendar year, and
such other matters as the Secretary may re-
quire. These reports must be filed at the
time and in the manner the Secretary pre-
scribes and must be furnished to individu-
als not later than January 31 of the calendar
year following the calendar year to which
the reports relate and in the manner pre-
scribed by the Secretary.
Section 408(l) provides that an em-
ployer who makes contributions on behalf
of employees to a SEP must provide re-
ports with respect to such contributions as
the Secretary may require. The required
reports must be filed at the time and in the
manner and furnished to employees at the
time and in the manner prescribed by the
Secretary.
Section 529(d) provides that each offi-
cer or employee having control of a § 529
QTP must make such reports regarding the
program to the Secretary and to designated
beneficiaries with respect to contributions,
distributions, or such other matters as the
Secretary may require. The required re-
ports must be filed at the time and in the
manner and furnished to the individuals at
thetimeandinthemannerprescribedby
the Secretary.
Section 530(h) provides that the trustee
of a CESA must make reports regarding
the account to the Secretary and to the ben-
eficiary of the account with respect to con-
tributions, distributions, or such other mat-
ters as the Secretary may require. The re-
quired reports must be filed at the time and
in the manner and furnished to the indi-
viduals at the time and in the manner pre-
scribed by the Secretary.
Section 6047(d)(1) provides for the
Secretary by forms or regulations to re-
quire the plan sponsor or administrator
from which designated distributions may
be made and the issuer of a contract under
which designated distributions may be
made to make returns and reports regard-
ing the plan or contract to the Secretary
and to participants andbeneficiaries of the
plan or contract and such other persons
as the Secretary may by regulations pre-
scribe. Section 6047(d)(2) provides that
the reports must be in the form, be made
at such time, and contain such information
as the Secretary may prescribe by forms or
regulations. Under § 3405(e)(1), a desig-
nated distribution generally includes any
distribution or payment from or under a
§ 401 qualified plan, a § 403(b) tax-shel-
tered annuity, a § 457 governmental plan,
an IRA, and a commercial annuity.
Section 401 of the Job Creation and
Worker Assistance Act of 2002, Pub. L.
No. 107–147, 116 Stat. 21, 40 (2002), pro-
vides that any person required to furnish a
statement under any section of subpart B
of part III of subchapter A of chapter 61
of the Internal Revenue Code for any tax-
able year ending after the date of the enact-
ment of the Act, may electronically furnish
such statement (without regard to any first
class mailing requirement) to any recipient
who has consented to the electronic provi-
sion of the statement in a manner similar to
the one permitted under the regulations is-
sued under § 6051 of the Internal Revenue
Code or in such other manner as provided
by the Secretary. In accordance with this
provision, part H of the 2003 General In-
structions for Forms 1099, 1098, 5498, and
W–2G, under the heading “Electronic re-
cipient statements,” provides that if a fur-
nisher is required by sections 6041 through
6050T to furnish a written statement of an
informationreturntoarecipient, then the
furnisher may provide the payee statement
electronically instead of on paper if the re-
quirements specified in the instructions are
satisfied.
The Secretary also has the authority to
permit the electronic furnishing of Forms
1099 and 5498 payee statements relating
to pensions, SEPs, traditional IRAs, Roth
IRAs, QTPs, CESAs, and Archer MSAs.
However, the 2003 General Instructions
for Forms 1099, 1098, 5498, and W–2G do
not provide that payee statements for re-
porting contributions and distributions of
pensions, traditional IRAs, Roth IRAs, and
Archer MSAs may be furnished electroni-
cally.
III. Permitted Electronic Delivery of
Payee Statements
This notice provides that, until further
guidance is published, notwithstanding
part H of the 2003 General Instructions
for Forms 1099, 1098, 5498, and W–2G,
a sponsor or administrator of a retirement
plan or a QTP, an employer of a SEP, or
a trustee, custodian, or issuer of an IRA,
a Roth IRA, a CESA, or an Archer MSA
may furnish the required Form 1099 or
Form 5498 payee statements electroni-
February 9, 20044332004-6 I.R.B.

cally to recipients if the furnisher satisfies
the consent, format, posting, and noti-
fication requirements described in part
H of the 2003 General Instructions for
Forms 1099, 1098, 5498, and W–2G and
furnishes such payee statements by their
respective due dates.
This notice hereby modifies part H of
the 2003 General Instructions for Forms
1099, 1098, 5498, and W–2G by permit-
ting the electronic delivery of the Form
1099–R, Form 1099–MSA, Form 1099–Q,
Form 5498, Form 5498–ESA, and Form
5498–MSA payee statements by their re-
spective due dates.
IV. Effective Date
This notice is applicable with respect
to Form 1099–R, Form 1099–MSA, Form
1099–Q, Form 5498, Form 5498–ESA,
and Form 5498–MSA payee statements
required to be furnished to recipients for
2003 and subsequent years.
V. Effect on Other Documents
The document entitled 2003 General In-
structions for Forms 1099, 1098, 5498, and
W–2G is hereby modified.
Drafting Information
The principal author of this notice is
Pamela R. Kinard of the Office of the Di-
vision Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities).
However, other personnel from the IRS
and Treasury participated in its develop-
ment. For further information regarding
this notice, contact Pamela R. Kinard at
(202) 622–6060 (not a toll-free number).
Recordkeeping Agreement
Pilot Program Involving Credit
for Increasing Research
Activities
Notice 2004–11
SECTION 1. PURPOSE
This notice announces a pilot program
that will permit the Internal Revenue Ser-
vice (Service) and large and mid-size busi-
ness taxpayers to enter into research credit
recordkeeping agreements (RCRAs). If
a taxpayer complies with the terms of a
RCRA, then the Service will deem the tax-
payer to have satisfied the recordkeeping
requirements of section 6001 of the In-
ternal Revenue Code (Code) for purposes
of the credit for increasing research ac-
tivities under section 41 (research credit).
A RCRA does not relieve the taxpayer of
its section 6001 recordkeeping obligations
for purposes of any other provision of the
Code.
The purposes of the pilot program are
to develop and evaluate a procedure:
1. To resolve issues concerning the
type and amount of documents that a tax-
payer must maintain, retain, and produce
to satisfy the recordkeeping requirements
of section 6001 for the research credit; and
2. To reduce the costs, burdens, and de-
lays frequently encountered by taxpayers
and the Service in examinations involving
the research credit.
SECTION 2. DESCRIPTION OF THE
PILOT PROGRAM
The Large and Mid-Size Business Op-
erating Division (LMSB) will administer
the pilot program. The pilot program is
available to LMSB taxpayers who have
claimed the research credit on a timely
filed original Form 1120,“U.S. Corpora-
tion Income Tax Return,”series return if
the return is currently under examination.
LMSB anticipates that it may select five to
ten applicants for participation in the pilot
program.
LMSB intends to establish a team to
work with selected applicants to resolve
the type and amount of documents that
each of these taxpayers must maintain, re-
tain, and produce with respect to the tax-
able years covered by the RCRA to satisfy
the recordkeeping requirements of section
6001 for the researchcredit. Pilot program
participants may be asked to evaluate the
pilot program. The Service will evaluate
the program and it may be extended, with
modifications, on a permanent basis.
SECTION 3. DESCRIPTION OF A
RCRA
The Service and a taxpayer will enter
into a RCRA through a letter of under-
standing signed by the Industry Director.
The letter of understanding will specify the
type and amount of documents that the tax-
payer must maintain, retain, and produce
to be deemed to satisfy the recordkeeping
requirements of section 6001 for the re-
search credit.
A RCRA may cover up to three consec-
utive taxable years ending after the date of
the RCRA’s issuance. A RCRA will not
cover the following businesses or taxpay-
ers:
1. Any trade or business (or major por-
tion of any trade or business) acquired by
the taxpayer after the RCRA was issued;
2. Any corporation that joined the tax-
payer’s controlled group of corporations
after the RCRA was issued, see I.R.C.
§ 41(f)(1)(A); and
3. Any trade or business (whether
or not incorporated) that was not under
common control with the taxpayer on the
date the RCRA was issued, see I.R.C.
§ 41(f)(1)(B).
SECTION 4. REQUEST TO
PARTICIPATE IN THE RCRA PILOT
PROGRAM
.01Contentofrequest.
A taxpayer must submit a written re-
quest to participate in the pilot program to
the Team Manager assigned to the exam-
ination. Taxpayers should submit the re-
quest on or before May 10, 2004. The re-
quest to participate in the RCRA pilot pro-
gram must contain the following informa-
tion:
1. The names, addresses, telephone
numbers, and taxpayer identification num-
bers of all members of the taxpayer’s con-
trolled group of corporations and trades or
businesses under common control with the
taxpayer;
2. The name, title, address, and tele-
phone number of a contact person and a
properly executed Form 2848,“Power of
Attorney and Declaration of Representa-
tive,”if the information contact is an au-
thorized representative of the taxpayer;
3. The location of the person responsi-
ble for the taxpayer’s tax matters;
4. The location of the taxpayer’s re-
search credit records;
5. A discussion of the taxpayer’s
suitability for the pilot program and any
unique benefits that may result from a
RCRA with the taxpayer;
6. A statement that the taxpayer agrees
that interviews and the inspection of the
taxpayer’s books and records under the
RCRA procedures (seeSection 6): (1) do
2004-6 I.R.B.434February 9, 2004

not constitute an examination or an inspec-
tion of books of account for purposes of
section 7605(b) or any administrative pro-
visions adopted by the Service, and (2) will
not preclude or impede a later examination
of a return or inspection of records under
section 7602 or any administrative provi-
sions adopted by the Service for any tax-
able year.
7. A statement that the Service need not
comply with any applicable procedural re-
strictions (including providing notice un-
der section 7605(b)) before beginning an
examination or inspection under RCRA
procedures (seeSection 6); and
8. A statement that the taxpayer is will-
ing to participate in the pilot program and
to evaluate the pilot program.
.02Signature.
The taxpayer or the taxpayer’s autho-
rized representativemust sign the request
to participate in the RCRA pilot program.
The request must include a copy of Form
2848 if the request is signed by an autho-
rized representative.
.03No user fee.
The Service will not charge a user fee
for a RCRA request during the pilot pro-
gram.
SECTION 5. RECOMMENDATION
ANDSELECTIONPROCESSFOR
PARTICIPATION IN THE RCRA PILOT
PROGRAM
.01Team Manager’s role.
Team Managers will forward a copy of
the taxpayer’s written request to partici-
pate in the pilot program to:
1. The Industry Director for the LMSB
industry group with jurisdiction over the
taxpayer;
2. The Director, Pre-filing and Techni-
cal Guidance, for LMSB; and
3. The Director, Field Specialists, for
LMSB.
.02Recommendation process.
The Team Manager will recommend
whether LMSB should accept the taxpayer
to participate in the pilot program. The
Team Manager will consider the following
factors:
1. The taxpayer’s cooperation with the
Service in the past;
2. The resources needed for the Ser-
vice to evaluate the taxpayer’s records and
recordkeeping systems; and
3. The potential benefits of a RCRA.
.03Selection process.
The selection of a taxpayer for the pi-
lot program is subject to the approval of
the Industry Director and the concurrence
of the Director, Pre-filing and Technical
Guidance. In addition to the factors set
forth in Section 5.02, the following factors
will be considered in selecting taxpayers to
participate in the pilot program:
1. The potential to provide a cross-
section of industries; and
2. The probability of the parties com-
pleting a RCRA within a reasonable period
of time.
.04Communication with the taxpayer.
The Industry Director or Director,
Field Operations, will contact the taxpayer
within 14 days after receipt of the request
to discuss the taxpayer’s suitability for
the pilot program. LMSB will notify the
taxpayer in writing whether the taxpayer
has been selected to participate in the pilot
program. If LMSB does not select the tax-
payer, the taxpayer has no right to appeal
the decision.
SECTION 6. TERMS OF A RCRA
The LMSB team and the taxpayer will
negotiate the terms of the RCRA. The
LMSB team and the taxpayer will take
into account the taxpayer’s current record-
keeping systems, records created during
research activities, and records used to
track costs associated with research activ-
ities. A RCRA may require a taxpayer to
create and retain records that it does not
currently create and retain. The Service
will enter into a RCRA only if it deter-
mines that the records to be maintained,
retained, and produced under the RCRA
satisfy the requirements of section 6001
for the research credit.
SECTION 7. APPROVAL OF A RCRA
The terms of the RCRA negotiated by
the LMSB team and the taxpayer are sub-
ject to the approval of the Industry Direc-
tor and the concurrence of the Director,
Pre-filing and Technical Guidance, and the
Director, Field Specialists. If the Industry
Director approves the negotiated RCRA,
the Industry Director will sign a letter of
understanding evidencing the terms of the
RCRA.
SECTION 8. EFFECT OF A RCRA
The taxpayer must maintain, retain, and
produce records in accordance with the
terms and conditions in the RCRA. The
taxpayer’s compliance with the RCRA es-
tablishes only that the taxpayer has sat-
isfied the recordkeeping requirements of
section 6001 for the research credit and
does not establish that any amounts will be
treated as qualified research expenses for
purposes of section 41(b).
With respect to the taxable years cov-
ered by the RCRA, a RCRA does not
limit the Service’s ability to request
non-recorded information during exam-
inations through interviews and other
information gathering methods. In ad-
dition, the Service during examinations
may request non-recorded information,
through interviews and other information
gathering methods, as well as recorded
information not identified in the RCRA,
to verify the information contained in doc-
uments required under the RCRA if the
Service has reason to question the infor-
mation’s accuracyor reliability.
A taxpayer may terminate the RCRA
at any time. The Industry Director may
terminate the RCRA if the Service deter-
mines that the taxpayer has not complied
with the terms of the RCRA. The taxpayer
may not appeal an Industry Director’s de-
cision to terminate a RCRA.
SECTION 9. EFFECTIVE DATE
The pilot program is effective on Feb-
ruary 9, 2004.
SECTION 10. COMMENTS
The Service invites interested persons
to comment on the pilot program. Inter-
ested persons should send comments to:
Internal Revenue Service
Attn: Large and Mid-Size Business
Division LM:Q
Mint Building, 3rd Floor, M–3–148
1111 Constitution Avenue, NW
Washington, D.C. 20224
SECTION 11. PAPERWORK
REDUCTION ACT
The collection of information contained
in this notice has been reviewed and ap-
proved by the Office of Management and
Budget in accordance with the Paperwork
February 9, 20044352004-6 I.R.B.

Reduction Act (44 U.S.C. 3507) under
control number 1545–1859.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
OMB control number.
The collection of information in this no-
tice is in Section 4. This information is
required to submit a request to participate
in the RCRA Pilot Program. This infor-
mation will be used to enable the Service
to determine whether the applicant is suit-
able for participation in the RCRA Pilot
Program. The collection of information is
voluntary to obtain a benefit. The likely re-
spondents are businesses or other for profit
institutions.
The estimated total annual reporting
burden is 1,170 hours.
The estimated annual burden per re-
spondent varies from 5 hours to 126 hours,
depending on individual circumstances,
with an estimated average of 18 hours.
The estimated number of respondents is
65.
The estimated annual frequency of re-
sponses is on occasion.
Books or records relating to a collection
of information must be retained as long
as their contents may 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.
SECTION 12. CONTACT
INFORMATION
The principal author of this notice is
Michael Hara of the Office of Associate
Chief Counsel (Procedure and Administra-
tion), Administrative Provisions and Judi-
cial Practice Division. Mr. Hara may be
contacted at (202) 622–4910 (not a toll-
free number).
For information regarding the RCRA
Pilot Program, contact Hugh Whitledge,
Engineer Technical Advisor, of the LMSB
Pre-filing and Technical Guidance Office
at (972) 308–7115 (not a toll-free number).
Taxpayers interested in participating in the
pilot program, or with questions about the
pilot program, may also contact the Team
Manager assigned to the examination of
the taxpayer before submitting a request to
participate in the pilot program.
2004-6 I.R.B.436February 9, 2004

Part IV. Items of General Interest
Notice of Proposed
Rulemaking; Notice of
Proposed Rulemaking
by Cross-Reference to
Temporary Regulations and
Notice of Public Hearing
Changes in Computing
Depreciation
REG–126459–03
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking;
Notice of proposed rulemaking by cross-
reference to temporary regulations and no-
tice of public hearing.
SUMMARY: In this issue of the Bulletin,
the IRS is issuing temporary regulations
(T.D. 9105) under sections 446(e) and
1016(a)(2) of the Internal Revenue Code
relating to a change in computing depreci-
ation or amortization as well as a change
from a nondepreciable or nonamortiz-
able asset to a depreciable or amortizable
asset (or vice versa). The text of those
temporary regulations also serves as the
text of these proposed regulations. This
document also provides notice of a public
hearing on these proposed regulations.
DATES: Written or electronic comments
must be received by April 1, 2004. Out-
lines of topics to be discussed at the public
hearing scheduled for April 7, 2004, at 10
a.m. must be received by March 17, 2004.
ADDRESSES: Send submissions to
CC:PA:LPD:PR (REG–126459–03), room
5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washing-
ton, DC 20044. Alternatively, submis-
sions may be hand-delivered Monday
through Friday between the hours of 8
a.m. and 4 p.m. to CC:PA:LPD:PR
(REG–126459–03), Courier's Desk, Inter-
nal Revenue Service, 1111 Constitution
Avenue, NW, Washington, DC, or sent
electronically, via the IRS Internet site at:
http://www.irs.gov/regs.
FOR FURTHER INFORMATION
CONTACT: Concerning the proposed
regulations, Sara Logan or Douglas Kim,
(202) 622–3110; concerning submissions
of comments, the hearing, and/or to be
placed on the building access list to attend
the hearing, Sonya Cruse, (202) 622–4693
(not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Temporary regulations (T.D. 9105) in
this issue of the Bulletin amend 26 CFR
part 1 relating to sections 167, 446, and
1016 of the Internal Revenue Code (Code).
The temporary regulations provide guid-
ance under section 446(e) on whether a
change in computing depreciation or amor-
tization as well as a change from a non-
depreciable or nonamortizable asset to a
depreciable or amortizable asset (or vice
versa) is a change in method of accounting
that requires the consent of the Commis-
sioner.
The text of those temporary regulations
also serves as the text of these proposed
regulations. The preamble to the tempo-
rary regulations explains the temporary
regulations and these proposed regula-
tions.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866. Therefore, a regulatory as-
sessment is not required. It also has been
determined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. chap-
ter 5) does not apply to these regulations
and, because these regulations do not im-
pose on small entities a collection of infor-
mation requirement, the Regulatory Flex-
ibility Act (5 U.S.C. chapter 6) does not
apply. Therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to sec-
tion 7805(f) of the Internal Revenue Code,
this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on its impact on small busi-
ness.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments
(a signed original and eight (8) copies)
or electronic comments that are submitted
timely to the IRS. The IRS and Treasury
Department specifically request comments
on the clarity of the proposed rules and
how they can be made easier to understand.
All comments will be available for public
inspection and copying.
A public hearing has been scheduled
for April 7, 2004, beginning at 10:00 a.m.
in the Auditorium, 7th Floor, Internal Rev-
enue Building, 1111 Constitution Avenue,
NW, Washington, DC. Due to building
security procedures, visitors must enter
at the Constitution Avenue entrance. In
addition, all visitors must present photo
identification to enter the building. Be-
cause of access restrictions, visitors will
not be admitted beyond the immediate
entrance area more than 30 minutes before
the hearing starts. For information about
having your name placed on the build-
ing access list to attend the hearing, see
theFOR FURTHER INFORMATION
CONTACTsection of this preamble.
The rules of 26 CFR 601.601(a)(3) ap-
ply to the hearing. Persons who wish to
present oral comments at the hearing must
submit an outline of the topics to be dis-
cussed and the time to be devoted to each
topic (signed original and eight (8) copies)
by March 17, 2004. A period of 10 minutes
will be allotted to each person for making
comments. An agenda showing the sched-
uling of the speakers will be prepared af-
ter the deadline for receiving outlines has
passed. Copies of the agenda will be avail-
able free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Sara Logan, Office of Associate
Chief Counsel (Passthroughs and Special
Industries). However, other personnel
from the IRS and Treasury Department
participated in their development.
*****
February 9, 20044372004-6 I.R.B.

Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 reads as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.167(e)–1 is amended
by revising paragraphs (a) and (e) to read
as follows:
§1.167(e)–1 Change in method.
(a) [The text of the proposed amend-
ment to §1.167(e)–1(a) is the same as the
text of §1.167(e)–1T(a) published else-
where in this issue of the Bulletin].
*****
(e)Effective date. This section applies
on or after December 30, 2003. For the ap-
plicability of regulations before December
30, 2003, see §1.167(e)–1 in effect prior to
December 30, 2003 (§1.167(e)–1 as con-
tained in 26 CFR part 1 edition revised as
of April 1, 2003).
Par. 3. Section 1.446–1 is amended
by revising paragraphs (e)(2)(ii)(a),
(e)(2)(ii)(b), (e)(2)(ii)(d), (e)(2)(iii), and
(e)(4) to read as follows:
§1.446–1 General rule for methods of
accounting.
*****
(e) * * *
(2) * * *
(ii)(a)and(b) [The text of the pro-
posed amendment to §1.446–1(e)(2)(ii)(a)
and (b) is the same as the text of
§1.446–1T(e)(2)(ii)(a)and(b)published
elsewhere in this issue of the Bulletin].
*****
(d) [The text of this paragraph
(e)(2)(ii)(d) is the same as the text of
§1.446–1T(e)(2)(ii)(d) published else-
where in this issue of the Bulletin].
(iii) [The text of the proposed amend-
ment to §1.446–1(e)(2)(iii) is the same as
the text of §1.446–1T(e)(2)(iii) published
elsewhere in this issue of the Bulletin].
*****
(4)Effective date—(i)In general.Ex-
cept as provided in paragraphs (e)(3)(iii)
and (e)(4)(ii) of this section, paragraph (e)
of this section applies on or after Decem-
ber 30, 2003. For the applicability of reg-
ulations before December 30, 2003, see
§1.446–1(e) in effect prior to December
30, 2003 (§1.446–1(e) as contained in 26
CFR part 1 edition revised as of April 1,
2003).
(ii)Changes involving depreciable or
amortizable assets. With respect to para-
graph (e)(2)(ii)(d)ofthissection,para-
graph (e)(2)(iii)Examples 9through17
of this section, the addition of the lan-
guage “certain changes in computing de-
preciation or amortization (see paragraph
(e)(2)(ii)(d) of this section)” to the last sen-
tence of paragraph (e)(2)(ii)(a)ofthissec-
tion, and the removal of all language re-
gardingusefullifeandthesentence“On
the other hand, a correction to require de-
preciation in lieu of a deduction for the cost
of a class of depreciable assets which had
been consistently treated as an expense in
the year of purchase involves the question
of the proper timing of an item, and is to
be treated as a change in method of ac-
counting” from paragraph (e)(2)(ii)(b)of
this section—
(A) For any change in depreciation or
amortization that is a change in method of
accounting, this section applies to such a
change in method of accounting made for
taxable years ending on or after December
30, 2003; and
(B) For any change in depreciation or
amortization that is not a change in method
of accounting, this section applies to such
a change made for taxable years ending on
or after December 30, 2003.
Par. 4. Section 1.1016–3 is amended
by revising paragraphs (h) and (j) to read
as follows:
§1.1016–3 Exhaustion, wear and tear,
obsolescence, amortization, and depletion
for periods since February 28, 1913.
*****
(h) [The text of the proposed amend-
ment to §1.1016–3(h) is the same as the
text of §1.1016–3T(h) published else-
where in this issue of the Bulletin].
*****
(j)Effective date—(1)In general.Ex-
cept as provided in paragraph (j)(2) of this
section, this section applies on or after De-
cember 30, 2003. For the applicability of
regulations before December 30, 2003, see
§1.1016–3 in effect prior to December 30,
2003 (§1.1016–3 as contained in 26 CFR
part 1 edition revised as of April 1, 2003).
(2)Depreciation or amortization
changes. Paragraph (h) of this section
applies to a change in depreciation or
amortization for property subject to sec-
tion 167, 168, 197, 1400I, 1400L(b), or
1400L(c), or former section 168 for tax-
able years ending on or after December
30, 2003.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on December 30,
2003, 8:45 a.m., and published in the issue of the Federal
Register for January 2, 2004, 69 F.R. 42)
2004-6 I.R.B.438February 9, 2004

Announcement of Disciplinary Actions Involving
Attorneys, Certified Public Accountants, Enrolled Agents,
and Enrolled Actuaries — Suspensions, Censures,
Disbarments, and Resignations
Announcement 2004-6
Under Title 31, Code of Federal Regu-
lations, Part 10, attorneys, certified public
accountants, enrolled agents, and enrolled
actuaries may not accept assistance from,
or assist, any person who is under disbar-
ment or suspension from practice before
the Internal Revenue Service if the assis-
tance relates to a matter constituting prac-
tice before the Internal Revenue Service
and may not knowingly aid or abet another
person to practice before the Internal Rev-
enue Service during a period of suspen-
sion, disbarment, or ineligibility of such
other person.
To enable attorneys, certified public
accountants, enrolled agents, and enrolled
actuaries to identify persons to whom
these restrictions apply, the Director, Of-
fice of Professional Responsibility will
announce in the Internal Revenue Bulletin
their names, their city and state, their pro-
fessional designation, the effective date
of disciplinary action, and the period of
suspension. This announcement will ap-
pear in the weekly Bulletin at the earliest
practicable date after such action and will
continue to appear in the weekly Bulletins
for five successive weeks.
Disbarments From Practice Before the Internal Revenue
Service After Notice and an Opportunity for a Proceeding
Under Title 31, Code of Federal Regu-
lations, Part 10, after notice and an oppor-
tunity for a proceeding before an adminis-
trative law judge, the following individu-
als have been disbarred from practice be-
fore the Internal Revenue Service:
NameAddressDesignationEffective Date
Baxley II, MiltonGainesville, FLCPAOctober 24, 2003
Consent Suspensions From Practice Before the Internal
Revenue Service
Under Title 31, Co
de of Federal Regu-
lations, Part 10,
an attorney, certified pub-
lic accountant, e
nrolled agent, or enrolled
actuary, in order
to avoid institution or con-
clusion of a proc
eeding for his or her dis-
barment or suspe
nsion from practice be-
fore the Interna
l Revenue Service, may of-
fer his or her con
sent to suspension from
such practice. Th
eDirector,OfficeofPro-
fessional Respon
sibility, in his discretion,
may suspend an att
orney, certified public
accountant, enro
lled agent or enrolled ac-
tuary in accorda
nce with the consent of-
fered.
The following in
dividuals have been
placed under con
sent suspension from
practice before t
he Internal Revenue Ser-
vice:
NameAddressDesignationDate of Suspen
sion
Nietupski, John E.Springfield, MAEnrolled AgentIndefinite
from
October 15, 2005
Roberts, Dennis C.Oklahoma City, OKAttorneyIndefinite
from
October 27, 2003
February 9, 20044392004-6 I.R.B.

NameAddressDesignationDate of Suspension
Waldo-Grant, Barbara A.Grand Rapids, MIEnrolled AgentIndefinite
from
November 1, 2003
Naylor, Dale C.El Cajon, CAEnrolled AgentIndefinite
from
November 12, 2003
Schlude, Richard M.Wilkes Barre, PAEnrolled AgentIndefinite
from
November 19, 2003
Stern, Samuel L.Robbinsdale, MNAttorneyIndefinite
from
November 19, 2003
Robles, MichaelDallas, TXCPAIndefinite
from
December 1, 2003
Young Jr., Donald A.Redondo Beach, CAEnrolled AgentDecember 1, 2003
to
August 31, 2004
Hitchcock, William C.Irvine, CAEnrolled AgentIndefinite
from
December 30, 2003
Willms, Bryant E.Lee Summit, MOEnrolled AgentJanuary 1, 2004
to
December 31, 2004
Expedited Suspensions From Practice Before the Internal
Revenue Service
Under Title 31, Code of Federal Regu-
lations, Part 10, the Director, Office of Pro-
fessional Responsibility, is authorized to
immediately suspend from practice before
the Internal RevenueService any practi-
tioner who, within five years from the date
the expedited proceeding is instituted (1)
has had a license to practice as an attor-
ney, certified public accountant, or actuary
suspended or revoked for cause or (2) has
been convicted of certain crimes.
The following individuals have been
placed under suspension from practice be-
fore the Internal Revenue Service by virtue
of the expedited proceeding provisions:
NameAddressDesignationDate of Suspension
Greene, MarvinChicago, ILCPAIndefinite
from
October 21, 2003
Bolusky, Eric B.Perkins, OKAttorneyIndefinite
from
October 21, 2003
Crutchfield Jr., ErnestLatty, OHEnrolled AgentIndefinite
from
October 21, 2003
2004-6 I.R.B.440February 9, 2004

NameAddressDesignationDate of Suspension
Covey, CharlesGladstone, MOCPAIndefinite
from
October 23, 2003
Prosperi, Arnold P.Jupiter Island, FLAttorneyIndefinite
from
November 24, 2003
Lucas, ChristopherOverlandPark, KSAttorneyIndefinite
from
November 24, 2003
Ramsey, Henry A.Burnet, TXCPAIndefinite
from
December 15, 2003
Resignations of Enrolled Agents
Under Title 31, Code of Federal Regu-
lations, Part 10, an enrolled agent, in or-
der to avoid the institution or conclusion
of a proceeding for his or her disbarment
or suspension from practice before the In-
ternal Revenue Service, may offer his or
her resignation as an enrolled agent. The
Director, Office of Professional Responsi-
bility, in his discretion, may accept the of-
fered resignation.
The Director, Office of Professional
Responsibility, has accepted offers of res-
ignation as an enrolled agent from the
following individuals:
NameAddressDate of Resignation
Pettyplace, Edward F.Sacramento, CAJanuary 30, 2004
Correction of User Fee in
Appendix A of Rev. Proc.
2004–1
Announcement 2004–8
Section (3)(b)(ii) of Appendix A of
Rev. Proc. 2004–1, 2004–1 I.R.B. 1, 62
(January 5, 2004) incorrectly provides that
the user fee is $1,500 for a letter ruling re-
quest involving an extension of time to file
Form 3115,“Application for Change in
Accounting Method,”under § 301.9100–3.
The correct user fee is $1,200, not $1,500.
For further information regarding this
announcement, contact George Bowden at
(202) 622–3400 (not a toll-free call).
C
redit for Increasing Research
A
ctivities
A
nnouncement 2004–9
A
GENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Advance notice of proposed
rulemaking.
SUMMARY: This document invites
comments from the public regarding
certain rules and standards relating
to internal-use software under section
41(d)(4)(E) of the Internal Revenue Code
(REG–153656–03). All materials submit-
ted will be available for public inspection
and copying. This document also ad-
dresses the effective date for final rules
relating to internal-use software.
DATES: Comments are requested on or
before March 2, 2004.
ADDRESSES: Send written comments
to: Internal Revenue Service, Attn:
CC:PA:LPD:PR [REG–153656–03], room
5203, POB 7604, Ben Franklin Station,
Washington, DC 20044. In the alternative,
taxpayers may submit comments in writ-
ing, by hand delivery to CC:PA:LPD:PR
[REG–153656–03], Courier’s Desk, In-
ternal Revenue Service, 1111 Constitution
Ave., NW, Washington, DC, or elec-
tronically, via the IRS Internet site at:
www.irs.gov/regs.
FOR FURTHER INFORMATION
CONTACT: Nicole R. Cimino at (202)
622–3120 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Introduction
On December 31, 2003, the Treasury
Department and the IRS issued final reg-
ulations (T.D. 9104, 2004–6 I.R.B. 406)
for the credit for increasing research ac-
tivities under section 41 (research credit).
February 9, 20044412004-6 I.R.B.

T.D. 9104 provides rules relating to the
definition ofqualified researchunder
section 41(d) but does not finalize rules
relating to internal-use software under
section 41(d)(4)(E). This advance notice
of proposed rulemaking (ANPRM) in-
vites comments from the public regarding
the proposed regulations issued in 2001
relating to internal-use software under
section 41(d)(4)(E). Although the Trea-
sury Department and the IRS welcome
comments on all aspects of those proposed
regulations, the Treasury Department and
the IRS specifically request comments
concerning the definition of internal-use
software. In addition, the Treasury De-
partment and the IRS request comments on
whether final rules relating to internal-use
software should have retroactive effect.
Background
Section 41(d)(4)(E) provides that, ex-
cept to the extent provided by regulations,
research with respect to computer software
which is developed by (or for the bene-
fit of) the taxpayer primarily for internal
use by the taxpayer (internal-use software)
is excluded from the definition of quali-
fied research under section 41(d). (Soft-
ware that is developed for use in an activity
which constitutes qualified research and
software that is developed for use in a pro-
duction process with respect to which the
general credit eligibility requirements are
satisfied are not excluded as internal-use
software under the provisions of section
41(d)(4)(E).) The statutory exclusion for
internal-use software and the regulatory
exceptions to this exclusion have been the
subject of a series of proposed and final
regulations.
Legislative History
The legislative history to the Tax Re-
form Act of 1986, Public Law 99–514 (100
Stat. 2085) (1986 Act), states that “the
costs of developing software are not eli-
gibleforthecreditwherethesoftwareis
used internally, for example, in general
and administrative functions (such as pay-
roll, bookkeeping, or personnel manage-
ment) or in providing noncomputer ser-
vices (such as accounting, consulting, or
banking services) except to the extent per-
mitted by Treasury regulations.” See H.R.
Conf. Rep. No. 841, at II–73 (1986 leg-
islative history). The 1986 legislative his-
tory further states that Congress intended
that regulations would make the costs of
new or improved internal-use software eli-
gible for the credit only if the research sat-
isfies, in addition to the general require-
ments for credit eligibility, an additional,
three-part high threshold of innovation test
(i.e., that the software was innovative, that
the software development involved signif-
icant economic risk, and that the software
was not commercially available for use by
the taxpayer).
Congress has extended the research
credit a number of times since the 1986
Act but has not made any changes to the
statutory definition of qualified research
or to the statutory exclusion for inter-
nal-use software in section 41(d)(4)(E).
When Congress extended the research
credit in the Tax Relief Extension Act
of 1999, Public Law 106–170 (113 Stat.
1860) (1999 Act), however, the legislative
history stated the following with respect
to internal-use software:
The conferees further note the rapid
pace of technological advance, espe-
cially in service-related industries, and
urge the Secretary to consider carefully
the comments he has and may receive in
promulgating regulations in connection
with what constitutes “internal use”
with regard to software expenditures.
The conferees also wish to observe
that software research, that otherwise
satisfies the requirements of section
41, which is undertaken to support the
provision of a service, should not be
deemed “internal use” solely because
the business component involves the
provision of a service.
H.R. Conf. Rep. No. 106–478, at 132
(1999).
1997 Proposed Regulations
On January 2, 1997, the Treasury De-
partment and the IRS published proposed
regulations (REG–209494–90, 1997–1
C.B. 723 [62 FR 81]) in theFederal Reg-
isterunder section 41 relating to inter-
nal-use software (1997 proposed regula-
tions). In relevant part, the 1997 proposed
regulations stated:
Research with respect to computer
software that is developed by (or for
the benefit of) the taxpayer primarily
for the taxpayer’s internal use is eligi-
ble for the research credit only if the
software satisfies the requirements of
paragraph (e)(2) of this section. Gener-
ally, research with respect to computer
software is not eligible for the research
credit where software is used internally,
for example, in general and administra-
tive functions (such as payroll, book-
keeping, or personnel management)
or in providing noncomputer services
(such as accounting, consulting, or
banking services).
Prop. §1.41–4(e)(1) (1997).
The 1997 proposed regulations con-
tained an exception to the internal-use
software rules for certain software devel-
oped by the taxpayer as a part of a new
or improved package of computer soft-
ware and hardware developed together as
a single product. Such software would
not be subject to the high threshold of
innovation requirements for internal-use
software under the 1997 proposed regu-
lations. The 1997 proposed regulations,
however, did not contain a specific defini-
tion of internal-use software. Instead, the
1997 proposed regulations provided that
the determination of whether software was
internal-use software would depend on the
facts and circumstances of each case:
All relevant facts and circumstances are
to be considered in determining if com-
puter software is developed primarily
for the taxpayer’s internal use. If com-
puter software is developed primarily
for the taxpayer’s internal use, the re-
quirements of this paragraph (e) apply
even though the taxpayer intends to,
or subsequently does, sell, lease, or li-
cense the computer software.
Prop. §1.41–4(e)(4) (1997).
2001 Final Regulations (T.D. 8930)
On January 3, 2001, the Treasury De-
partment and the IRS published in theFed-
eral Registerfinal regulations (T.D. 8930,
2001–1 C.B. 433 [66 FR 280]) relating,
in relevant part, to the definition of inter-
nal-use software for purposes of section
41(d)(4)(E). With respect to the general
definition of internal-use software, T.D.
8930 provided:
Software is developed primarily for the
taxpayer’s internal use if the software
is to be used internally, for example, in
general administrative functions of the
taxpayer (such as payroll, bookkeeping,
2004-6 I.R.B.442February 9, 2004

or personnel management) or in pro-
viding noncomputer services (such as
accounting, consulting, or banking ser-
vices). If computer software is devel-
oped primarily for the taxpayer’s inter-
nal use, the requirements of this para-
graph (c)(6) apply even though the tax-
payer intends to, or subsequently does,
sell, lease, or license the computer soft-
ware.
§1.41–4(c)(6)(iv). T.D. 8930, therefore,
did not provide a specific definition of
internal-use software but instead identi-
fied two general categories of software as
examples of internal-use software: soft-
ware “used internally” and software used
“in providing noncomputer services.” T.D.
8930 eliminated the general facts and cir-
cumstances standard contained in the 1997
proposed regulations.
The preamble to T.D. 8930 addressed
the requests made by some commentators
that the definition of internal-use software
exclude software used to deliver a service
to customers and software that includes an
interface with customers or the public. The
preamble stated that after careful analy-
sis of the legislative history, the Treasury
Department and the IRS had concluded
that such broad exclusions would be in-
consistent with the statutory mandate, be-
cause the exclusion would extend to some
software that Congress clearly intended to
treat as internal-use software. The pream-
ble, however, continued by highlighting
changes that had been made in T.D. 8930 to
take into account the commentators’ con-
cerns as well as the legislative history to
the 1999 Act.
First, T.D. 8930 provided that the high
threshold of innovation test applicable to
internal-use software does not apply to
software used to provide computer ser-
vices (defined in T.D. 8930 generally as a
service offered by a taxpayer to customers
who conduct business with the taxpayer
primarily for the use of the taxpayer’s
computer or software technology). In
contrast, software used to provide a non-
computer service (defined in T.D. 8930
generally as a service other than a com-
puter service, even if such other service is
enabled, supported, or facilitated by com-
puter or software technology) would be
subject to the high threshold of innovation
test under T.D. 8930.
Second, T.D. 8930 contained a new ex-
ception to the high threshold of innova-
tion test for internal-use software for soft-
ware used to provide a noncomputer ser-
vice if the software, among other things,
contained features or improvements not
yet offered by a taxpayer’s competitors. In
describing this exception, the preamble to
T.D. 8930 stated:
This exercise of regulatory authority [to
create the exception for certain soft-
ware used to provide non-computer ser-
vices] is based on a determination that
the development of software containing
features or improvements that are not
available from a taxpayer’s competitors
and that provide a demonstrable com-
petitive advantage is more likely to in-
crease the innovative qualities and ef-
ficiency of the U.S. economy (by gen-
erating knowledge that can be used by
other service providers) than is the de-
velopment of software used to provide
noncomputer services containing fea-
tures or improvements that are already
offered by others. IRS and Treasury be-
lieve that drawing such a line is an ap-
propriate way to administer the credit
with a view to identifying and facilitat-
ing the credit availability for software
with the greatest potential for benefit-
ing the U.S. economy, an important ra-
tionale for the research credit.
In response to taxpayer concerns,
on January 31, 2001, the Treasury De-
partment and the IRS published Notice
2001–19, 2001–1 C.B. 784, announcing
that the Treasury Department and the IRS
would review T.D. 8930 and reconsider
comments previously submitted in con-
nection with the finalization of T.D. 8930.
2001 Proposed Regulations
On December 26, 2001, the Treasury
Department and the IRS published in the
Federal Registera notice of proposed
rulemaking (REG–112991–01, 2002–1
C.B. 404 [66 FR 66362]) reflecting their
review of T.D. 8930 (2001 proposed reg-
ulations). The 2001 proposed regula-
tions revised the definition of internal-use
software as compared to the definitions
contained in the 1997 proposed regula-
tions and T.D. 8930. The definition in the
2001 proposed regulations was based on
a presumption that turns on whether the
software is developed to be commercially
sold, leased, licensed, or otherwise mar-
keted for separately stated consideration:
Unless computer software is devel-
oped to be commercially sold, leased,
licensed, or otherwise marketed, for
separately stated consideration to un-
related third parties, computer software
is presumed developed by (or for the
benefit of) the taxpayer primarily for
the taxpayer’s internal use. For exam-
ple, the computer software may serve
general and administrative functions of
the taxpayer, or may be used in pro-
viding a noncomputer service. General
and administrative functions include,
but are not limited to, functions such as
payroll, bookkeeping, financial man-
agement, financial reporting, personnel
management, sales and marketing,
fixed asset accounting, inventory man-
agement and cost accounting. Com-
puter software that is developed to be
commercially sold, leased, licensed,
or otherwise marketed, for separately
stated consideration to unrelated third
parties is not developed primarily for
the taxpayer’s internal use. The re-
quirements of this paragraph (c)(6)
apply to computer software that is de-
veloped primarily for the taxpayer’s
internal use even though the taxpayer
subsequently sells, leases, licenses, or
otherwise markets the computer soft-
ware for separately stated consideration
to unrelated third parties.
Prop. §1.41–4(c)(6)(iv) (2001) (emphasis
added).
As explained in the preamble to the
2001 proposed regulations, this “sepa-
rately stated consideration” standard re-
flected the Treasury Department and the
IRS’ determination that software that is
sold, leased, licensed, or otherwise mar-
keted, for separately stated consideration
to unrelated third parties is software that is
intended to be used primarily by the cus-
tomers of the taxpayer, whereas software
that does not satisfy this requirement is
software that is intended to be used pri-
marily by the taxpayer for its internal use
or in connection with a noncomputer ser-
vice provided by the taxpayer. The 2001
proposed regulations modified the hard-
ware-software exception and continued to
provide that software used to provide com-
puter services was not required to satisfy
the additional qualification requirements
imposed on internal-use software. The
new proposed regulations, however, elim-
inated the specialrule in T.D. 8930 for
February 9, 20044432004-6 I.R.B.

certain software used to provide noncom-
puter services. The preamble to the 2001
proposed regulations explained that “[d]ue
to other revisions contained in these pro-
posed regulations, Treasury and the IRS
believe that the computer software tar-
geted by this rule generally would be
credit eligible without this rule.”
The preamble to the 2001 proposed
regulations also addressed the continued
concerns expressed by some commen-
tators that the definition of internal-use
software should not include software used
to deliver a service to customers and
software that includes an interface with
customers or the public. In addition to re-
peating the Treasury Department and IRS’
concern that such exclusions may conflict
with Congress’ intent regarding software
used in the provision of noncomputer ser-
vices, the preamble stated that an exclu-
sion for software that includes an interface
with customers or the public would en-
tail substantial administrative difficulties
and “may inappropriately permit certain
categories of costs (e.g., certain web site
development costs) to constitute qualified
research expenses without having to sat-
isfy the high threshold of innovation test.”
Discussion
Prior regulatory guidance generally
reflects three approaches to the definition
of internal-use software. First, the 1997
proposed regulations closely mirrored
the language contained in the legislative
history but did not provide a specific def-
inition of internal-use. Instead, the 1997
proposed regulations used the “general
and administrative functions” and “non-
computer services” language from the
legislative historyas examples of inter-
nal-use software and provided that the
determination of whether particular soft-
ware was internal-use software required
an evaluation of “all relevant facts and
circumstances.”
T. D. 8930 then attempted to provide
greater specificity regarding the defini-
tion of internal-use software. Although
T.D. 8930 eliminated the facts and cir-
cumstances test in the 1997 proposed
regulations, T.D. 8930 continued to pro-
vide a general definition of internal-use
software that incorporated the legislative
history’s examples of general and admin-
istrative functions and non-computer ser-
vices. Additionally, T.D. 8930 provided
that software used by the taxpayer to pro-
vide “computer services” was not subject
to the high threshold of innovation test
applicable to internal-use software, and
provided definitions ofcomputer services
andnoncomputer services. The exception
for computer services software, however,
required a determination of the primary
reason why a taxpayer’s customers con-
duct business with the taxpayer. T.D.
8930 also applied this exception to certain
software used to provide “noncomputer
services” provided that the software sat-
isfied additional requirements intended to
identify software containing new features
or improvements that provide a competi-
tive advantage to the taxpayer.
Finally, the 2001 proposed regulations
prescribed a bright-line, separately-stated
consideration rule for determining which
software is treated as internal-use soft-
ware for purposes of the research credit.
(The 2001 proposed regulations retained
the exception for software used to pro-
vide computer services, but removed the
special rule for noncomputer services.
Additionally, the 2001 proposed regula-
tions expanded upon the list of general and
administrative functions contained in the
legislative history and expanded the ex-
ception for integrated software-hardware
products.) The purpose of this rule was to
provide a clear definition of internal-use
software that could be readily applied by
taxpayers and more readily administered
by the IRS.
Numerous comments were received in
response to the 1997 proposed regulations,
T.D. 8930 and Notice 2001–19, and the
2001 proposed regulations regarding the
provisions relating to internal-use soft-
ware. Although commentators addressed
virtually all aspects of the internal-use
software provisions in the various itera-
tions of regulations, most of the comments
focused on the definition of internal-use
software. As previously stated, many
commentators believed that the definition
of internal-use software should exclude
any software used to deliver a service to
customers and any software that includes
an interface with customers or the pub-
lic. Some commentators suggested, as an
alternative, that the statutory production
process exception be extended to software
used in connection with the provision of
services.
With respect to the definition of in-
ternal-use software in the 2001 proposed
regulations, commentators stated that
the separately-statedconsideration test
was a poor indication of when computer
software was developed “primarily for
internal use by the taxpayer” and directly
conflicted with the legislative history to
the 1999 Act. In support of a narrower
definition of internal-use software, these
commentators pointed to technological
advancements and changes to the role of
computer software in business activities
since the exclusion for internal-use soft-
ware was enacted in 1986, including the
increased development of computer soft-
ware by taxpayers, the increased use of
computer software in all aspects of busi-
ness activity, and the role of computer
software (often integrated across a busi-
ness) in providing goods and services in
addition to the internal operations of a
business. Commentators further argued
that the definition should be based on the
underlying functionality of the software
(i.e., whether the software, in light of the
facts and circumstances, is used to deliver
services or goods to a taxpayer’s cus-
tomers). Commentators urged that a func-
tionality rule is preferable to a bright-line
rule (such as the separately-stated con-
sideration rule in T.D. 8930) even though
a bright-line rule provided a clearer rule
for identifying internal-use software for
purposes of the research credit.
The Treasury Department and the IRS
are continuing to consider the concerns
raised by commentators in response to
the definition of internal-use software
contained in the 2001 proposed regu-
lations, including the concern that the
separately-stated consideration test is
over-inclusive. Nevertheless, the Trea-
sury Department and the IRS are con-
cerned that the alternatives, including
expanded or modified exceptions, pro-
posed by commentators generally would
make the definition of internal-use soft-
ware more complex without providing
additional clarity. Several commentators
suggested similar definitions that would
exclude software that, for example, is
“integral and essential” to the provision
of services with integral defined as soft-
ware that directly “enables, supports, or
facilitates” a service. Some commentators
suggested a definition that would exclude
software that is “primarily used” by cus-
2004-6 I.R.B.444February 9, 2004

tomers, suppliers, or other third parties.
Other commentators suggested a defini-
tion that would limit internal-use software
to software that is developed primarily for
use in general and administrative func-
tions that enable, facilitate, or support
the taxpayer’s conduct of the taxpayer’s
trade or business, but would exclude cer-
tain customer interface software. These
suggestions would introduce many terms
(includingenable,support,facilitate,pri-
marily) that, due to their subjective nature,
the Treasury Department and the IRS be-
lieve would be prone to controversy and
could not be readily applied by taxpayers
or administered by the IRS. Another com-
mentator suggested limiting the definition
of internal-use software to software used
to perform a specifically enumerated list
of general and administrative functions.
Some commentators, however, have noted
that the often highlyintegrated nature
of software development today makes
it difficult, if not impossible, to divide
software development projects into sepa-
rate components, and thus a list approach
may not be administrable. Finally, as part
of their review of these comments, the
Treasury Department and the IRS also re-
viewed the possibility of using definitions
of internal-use software contained in prior
guidance.
In light of the statute, the legislative his-
tory, the history of the regulations regard-
ing internal-use software, and the com-
ments received, the Treasury Department
and the IRS have decided not to finalize in
T.D. 9104 the provisions in the 2001 pro-
posed regulations relating to internal-use
software. Instead, the Treasury Depart-
ment and the IRS are issuing this ANPRM
to solicit further comments regarding the
definition of internal-use software as well
as other provisions affecting the qualifi-
cation of internal-use software for the re-
search credit. The Treasury Department
and the IRS are mindful that Congress
specifically intended that computer soft-
ware “developed by (or for the benefit of)
the taxpayer primarily for internal use by
the taxpayer” be subject to additional re-
quirements before the software could qual-
ify for the research credit. At the same
time, the Treasury Department and the IRS
recognize that there have been changes in
computer software, and its role in busi-
ness activity, since the mid-1980s. In light
of these changes, the Treasury Department
and the IRS are concerned about the diffi-
culty of effecting Congressional intent be-
hind the exclusion for internal-use soft-
ware with respect to computer software be-
ing developed today. Despite Congress’
broad grant of regulatory authority in sec-
tion 41(d)(4)(E), the Treasury Department
and the IRS believe that this authority may
not be broad enough to resolve those diffi-
culties.
Accordingly, the Treasury Department
and the IRS request comments regarding
a definition of internal-use software that
appropriately reflects the statute and leg-
islative history, can be readily applied by
taxpayersandreadilyadministeredbythe
IRS, and is flexible enough to provide con-
tinuing application into the future. In sub-
mitting comments, commentators are in-
vited to address any of the definitions in-
cluded in prior guidance as well as other
definitions that have been proposed to the
Treasury Department and the IRS by com-
mentators.
In addressing these alternatives, com-
mentators also are invited to discuss how
software development efforts that en-
compass both internal-use software and
non-internal use software should be ad-
dressed under any particular definition.
The Treasury Department and the IRS are
concerned that the tendency toward the
integration of software across many func-
tions of a taxpayer’s business activities
may make it difficult for both taxpayers
and the IRS to separate internal-use soft-
ware from non-internal use software (or
software not subject to additional qualifi-
cation requirements) under any particular
definition of internal-use software. In
addition, the Treasury Department and
the IRS are concerned that a definition
of internal-use software that relies upon
the “primary” or “principal” use of that
software would be difficult to apply and
administer. The Treasury Department
and the IRS’ continuing goal is that any
final rule must provide clear, objective
guidance on what software is treated as
internal-use software for purposes of the
research credit.
Effective Dates
On December 31, 2003, the Treasury
Department and the IRS issued final reg-
ulations (T.D. 9104) relating to the defi-
nition of qualified research under section
41(d). The final regulations apply to tax-
able years ending on or after December 31,
2003. The final regulations do not con-
tain final rules for research with respect
to computer software “which is developed
by (or for the benefit of) the taxpayer pri-
marily for internal use by the taxpayer” for
purposes of section 41(d)(4)(E) (i.e.,inter-
nal-use software).
The Treasury Department and the IRS
have announced in prior guidance, includ-
ing Notice 87–12, 1987–1 C.B. 432, and
more recently in the 2001 proposed regu-
lations, that final regulations relating to in-
ternal-use software generally will be effec-
tive for taxable years beginning after De-
cember 31, 1985. In light of the length of
time that has passed since 1986, as well as
the developments with respect to computer
software discussed in this ANPRM, the
Treasury Department and the IRS request
comments on whether final regulations re-
lating to internal-use software should have
any retroactive effect.
With respect to internal-use software
for taxable years beginning after Decem-
ber 31, 1985, and until further guidance
is published in theFederal Register,tax-
payers may continue to rely upon all of the
provisions relating to internal-use software
in the 2001 proposed regulations (66 FR
66362). Alternatively, taxpayers may con-
tinue to rely upon all of the provisions re-
lating to internal-use software in T.D. 8930
(66 FR 280). For example, taxpayers rely-
ing upon the internal-use software rules of
T.D. 8930 must also apply the “discovery
test” as set forth in T.D. 8930.
Request for Public Comment
The Treasury Department and the IRS
invite interested persons to submit com-
ments (in the manner described in the
ADDRESSES caption) on issues arising
under the provisions for internal-use soft-
ware. The Treasury Department and the
IRS invite comments that address any of
the definitions included in prior guidance
as well as other definitions that have been
proposed to the Treasury Department and
the IRS by commentators. Specifically,
the Treasury Department and the IRS in-
vite comments that provide a definition of
internal-use software that—
1. Appropriately reflects the statute and
legislative history;
February 9, 20044452004-6 I.R.B.

2. Can be readily applied by taxpayers
and readily administered by the IRS; and
3. Is flexible enough to provide contin-
uing application in the future.
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on December 31,
2003, 8:45 a.m., and published in the issue of the Federal
Register for January 2, 2004, 69 F.R. 43)
2004-6 I.R.B.446February 9, 2004

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 ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
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 published position. (Compare
withamplifiedandclarified, 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 rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published 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 pub-
lished ruling is first modified and then, as
modified, is superseded.
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 rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations
to show that the previous published rul-
ings 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 fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
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—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
February 9, 2004i2004-6 I.R.B.

Numerical Finding List
1
Bulletins 2004–1 through 2004–6
Announcements:
2004-1, 2004-1 I.R.B.254
2004-2, 2004-3 I.R.B.322
2004-3, 2004-2 I.R.B.294
2004-4, 2004-4 I.R.B.357
2004-5, 2004-4 I.R.B.362
2004-6, 2004-3 I.R.B.322
2004-7, 2004-4 I.R.B.365
2004-8, 2004-6 I.R.B.441
2004-9, 2004-6 I.R.B.441
Notices:
2004-1, 2004-2 I.R.B.268
2004-2, 2004-2 I.R.B.269
2004-3, 2004-5 I.R.B.391
2004-4, 2004-2 I.R.B.273
2004-6, 2004-3 I.R.B.308
2004-7, 2004-3 I.R.B.310
2004-8, 2004-4 I.R.B.333
2004-9, 2004-4 I.R.B.334
2004-10, 2004-6 I.R.B.433
2004-11, 2004-6 I.R.B.434
Proposed Regulations:
REG-116664-01, 2004-3 I.R.B.319
REG-122379-02, 2004-5 I.R.B.392
REG-139845-02, 2004-5 I.R.B.397
REG-126459-03, 2004-6 I.R.B.437
REG-156232-03, 2004-5 I.R.B.399
Revenue Procedures:
2004-1, 2004-1 I.R.B.1
2004-2, 2004-1 I.R.B.83
2004-3, 2004-1 I.R.B.114
2004-4, 2004-1 I.R.B.125
2004-5, 2004-1 I.R.B.167
2004-6, 2004-1 I.R.B.197
2004-7, 2004-1 I.R.B.237
2004-8, 2004-1 I.R.B.240
2004-9, 2004-2 I.R.B.275
2004-10, 2004-2 I.R.B.288
2004-11, 2004-3 I.R.B.311
2004-13, 2004-4 I.R.B.335
Revenue Rulings:
2004-1, 2004-4 I.R.B.325
2004-2, 2004-2 I.R.B.265
2004-4, 2004-6 I.R.B.414
2004-5, 2004-3 I.R.B.295
2004-6, 2004-4 I.R.B.328
2004-7, 2004-4 I.R.B.327
2004-9, 2004-6 I.R.B.428
Treasury Decisions:
9099, 2004-2 I.R.B.255
9100, 2004-3 I.R.B.297
9101, 2004-5 I.R.B.376
9102, 2004-5 I.R.B.366
9103, 2004-3 I.R.B.306
9104, 2004-6 I.R.B.406
9105, 2004-6 I.R.B.419
9106, 2004-5 I.R.B.384
9108, 2004-6 I.R.B.429
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2003–27 through 2003–52 is in Internal Revenue Bulletin
2003–52, dated December 29, 2003.
2004-6 I.R.B.iiFebruary 9, 2004

Findings List of Current Actions on
Previously Published Items
1
Bulletins 2004–1 through 2004–6
Proposed Regulations:
REG-115037-00
Corrected by
Ann. 2004-7, 2004-4 I.R.B.365
REG-143321-02
Withdrawn by
REG-156232-03, 2004-5 I.R.B.399
REG-146893-02
Corrected by
Ann. 2004-7, 2004-4 I.R.B.365
Revenue Procedures:
2000-38
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2000-50
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2002-9
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2002-71
Superseded by
Rev. Proc. 2004-13, 2004-4 I.R.B.335
2003-1
Superseded by
Rev. Proc. 2004-1, 2004-1 I.R.B.1
2003-2
Superseded by
Rev. Proc. 2004-2, 2004-1 I.R.B.83
2003-3
As amplified by Rev. Proc. 2003-14, and as
modified by Rev. Proc. 2003-48 superseded by
Rev. Proc. 2004-3, 2004-1 I.R.B.114
2003-4
Superseded by
Rev. Proc. 2004-4, 2004-1 I.R.B.125
2003-5
Superseded by
Rev. Proc. 2004-5, 2004-1 I.R.B.167
2003-6
Superseded by
Rev. Proc. 2004-6, 2004-1 I.R.B.197
2003-7
Superseded by
Rev. Proc. 2004-7, 2004-1 I.R.B.237
Revenue Procedures— Continued:
2003-8
Superseded by
Rev. Proc. 2004-8, 2004-1 I.R.B.240
2004-1
Corrected by
Ann. 2004-8, 2004-6 I.R.B.441
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2003–27 through 2003–52 is in Internal Revenue Bulletin 2003–52, dated December 29,
2003.
February 9, 2004iii2004-6 I.R.B.
*U.S. Government Printing Office: 2004—304–774/60121