Internal Revenue Bulletin 2007-27 (PDF rendition): IRS Notices

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
7-27
July 2, 2007
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
T.D. 9328, page 1.
Final regulations under section 475 of the Code concern an
elective safe harbor that permits dealers in securities and deal-
ers in commodities to elect to use the values of positions re-
ported on certain financial statements as the fair market values
of those positions. This safe harbor is intended to reduce the
compliance burden on taxpayers and to improve the adminis-
trability of the valuation requirement of section 475 for the IRS.
Notice 20
07–54, page 12.
This noti
ce provides guidance and transitional relief for the re-
turn prep
arer penalty provisions under section 6694 of the
Code.
Notice 2007–55, page 13.
This notice alerts taxpayers and their representatives that the
IRS intends to challenge claims under the relevant current statu-
tory and regulatory provisions that certain distributions, de-
scribed in the notice, from a real estate investment trust (REIT)
or other qualified investment entity (QIE) to foreign govern-
ments are not subject to section 897(h)(1) of the Code or are
exempt from taxation under section 892. The notice also an-
nounces that Treasury and the IRS intend to issue regulations
that will clarify the correct interpretation of these provisions,
and will apply to distributions occurring on or after June 13,
2007.
Notice 2007–56, page 15.
This notice changes the address to submit by mail applications
for allocation of the available volume cap for clean renewable
energy bonds (CREBs) under section 54 of the Code. Notice
2007–26 modified.
Rev. Proc. 2007–42, page 15.
Specifications are set forth for the private printing of paper
and laser-printed substitutes for the January 2007 revision of
Form 941,Employer’s QUARTERLY Federal Tax Return,and
January 2006 Schedule B (Form 941),Report of Tax Liability
for Semiweekly Schedule Depositors. This procedure will be
reproduced as the next revision of Publication 4436,General
Rules and Specifications for Substitute Form 941 and Schedule
B (Form 941). Rev. Proc. 2006–25 superseded.
Rev. Proc. 2007–43, page 26.
Specifications are set forth for the private printing of paper and
laser-printed substitutes for tax year 2007 Form W-2,Wage
and Tax Statement,andFormW-3,Transmittal of Wage and
Tax Statements. This procedure will be reproduced as the next
revision of Publication 1141,General Rules and Specifications
for Substitute Forms W-2 and W-3. Rev. Proc. 2006–55 su-
perseded.
ESTATE TAX
Notice 2007–54, page 12.
This notice provides guidance and transitional relief for the re-
turn preparer penalty provisions under section 6694 of the
Code.
GIFT TAX
Notice 2007–54, page 12.
This notice provides guidance and transitional relief for the re-
turn preparer penalty provisions under section 6694 of the
Code.
(Continued on the next page)
Fi
nding Lists begin on page ii.

EMPLOYMENT TAX
Notice 2007–54, page 12.
This notice provides guidance and transitional relief for the re-
turn preparer penalty provisions under section 6694 of the
Code.
Rev. Proc. 200
7–42, page 15.
Specificatio
ns are set forth for the private printing of paper
and laser-pri
nted substitutes for the January 2007 revision of
Form 941,Empl
oyer’s QUARTERLY Federal Tax Return,and
January 2006 S
chedule B (Form 941),Report of Tax Liability
for Semiweekl
y Schedule Depositors.Thisprocedurewillbe
reproduced a
s the next revision of Publication 4436,General
Rules and Spe
cifications for Substitute Form 941 and Schedule
B (Form 941).
Rev. Proc. 2006–25 superseded.
Rev. Proc. 2007–43, page 26.
Specifications are set forth for the private printing of paper and
laser-printed substitutes for tax year 2007 Form W-2,Wage
and Tax Statement,andFormW-3,Transmittal of Wage and
Tax Statements. This procedure will be reproduced as the next
revision of Publication 1141,General Rules and Specifications
for Substitute Forms W-2 and W-3. Rev. Proc. 2006–55 su-
perseded.
EXCISE TAX
Notice 200
7–54, page 12.
This notic
e provides guidance and transitional relief for the re-
turn prepa
rer penalty provisions under section 6694 of the
Code.
ADMINISTRATIVE
Notice 2007–54, page 12.
This notice provides guidance and transitional relief for the re-
turn preparer penalty provisions under section 6694 of the
Code.
Notice 20
07–56, page 15.
This noti
ce changes the address to submit by mail applications
for alloc
ation of the available volume cap for clean renewable
energy bo
nds (CREBs) under section 54 of the Code. Notice
2007–26
modified.
July 2, 20072007–27 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
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contents are compiled semiannually into Cumulative Bulletins,
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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
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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
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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
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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.
2007–27 I.R.B.July 2, 2007

July 2, 20072007–27 I.R.B.

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 54.—Credit to
Holders of Clean Renewable
Energy Bonds
What is the new address to submitby mailapplica-
tions for allocations of clean renewable energy bond
volume cap to finance qualified clean renewable en-
ergy projects? See Notice 2007-56, page 15.
Section 475.—Mark to
Market Accounting Method
for Dealers in Securities
26 CFR 1.475(a)–4: Safe harbor for valuation under
section 475.
T.D. 9328
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Safe Harbor for Valuation
Under Section 475
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document sets forth an
elective safe harbor that permits dealers in
securities and dealers in commodities to
elect to use the values of positions reported
on certain financial statements as the fair
market values of those positions for pur-
poses of section 475 of the Internal Rev-
enue Code (Code). This safe harbor is in-
tended to reduce the compliance burden on
taxpayers and to improve the administra-
bility of the valuation requirement of sec-
tion 475 for the IRS.
DATES:Effective Date:These regulations
are effective on June 12, 2007.
Applicability Dates:Section
1.475(a)–4, concerning a safe harbor to
use applicable financial statement values
for purposes of section 475, applies to
taxable years ending on or after June 12,
2007.
FOR FURTHER INFORMATION
CONTACT: Marsha A. Sabin or
John W. Rogers III (202) 622–3950 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545–1945. Comments on the
accuracy of the estimated burden and sug-
gestions for reducing the burden should
be sent to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
SE:W:CAR:MP:T:T:SP, Washington, D.C.
20224.
The collection of information in these
regulations is in §1.475(a)–4(f)(1) and
§1.475(a)–4(k). This information is re-
quired by the IRS to avoid any uncertainty
about whether a taxpayer has made an
election and to verify compliance with
section 475 and the safe harbor method of
accounting described in §1.475(a)–4(d).
This information will be used to facilitate
examination of returns and to determine
whether the amount of tax has been cal-
culated correctly. The collection of the
information is required to properly deter-
mine the amount of income or deduction
to be taken into account. The taxpayers
providing this information are sophisti-
cated dealers in securities or commodities.
Estimated total annual recordkeeping
burden: 49,232 hours.
Estimated average annual burden per
recordkeeper: 4–6 hours.
Estimated number of recordkeepers:
12,308.
Estimated frequency of recordkeeping:
Annually.
An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless it displays
a valid control number.
Books and records relating to the col-
lection of information must be retained as
long as their contents might become ma-
terial in the administration of any internal
revenue law. Generally, tax returns and tax
return information are confidential, as re-
quired by 26 U.S.C. § 6103.
Background
This document contains amendments to
26 CFR Part 1 under section 475 of the In-
ternal Revenue Code (Code). Section 475
was added to the Code by section 13223(a)
of the Omnibus Budget Reconciliation Act
of 1993 (Public Law 103–66, 107 Stat.
312). Section 475(a) generally provides
that the securities held by dealers in secu-
rities must be valued as of the last busi-
ness day of the year at fair market value.
Section 475(e) allowsdealers in commodi-
ties to elect similar treatment for their com-
modities. Under section 475(f), if a per-
son is engaged in a trade or business as
a trader in securities or a trader in com-
modities, the person may elect for the sec-
tion 475 mark-to-market regime to apply
to their trade or business.
Section 475(g) directs the Secretary
to prescribe regulations that may be nec-
essary or appropriate to carry out the
purposes of section 475. The legisla-
tive history of section 475 indicates that,
under this authority, the Secretary may
issue regulations to permit the use of
valuation methodologies that reduce the
administrative burden of compliance on
the taxpayer but clearly reflect income for
Federal income tax purposes. On May 5,
2003, the Treasury Department and the
IRS published in theFederal Register
an advance notice of proposed rulemak-
ing (Safe Harbor for Satisfying Certain
Statutory Requirements for Valuation un-
der Section 475 for Certain Securities
and Commodities) (REG–100420–03) [68
FR 23632] (the ANPRM); Announce-
ment 2003–35, 2003–1 C.B. 956 (see
§601.601(d)(2)). The ANPRM solicited
comments on whether a safe harbor ap-
proach using values reported on an ap-
plicable financial statement for certain
securities may be used for purposes of
section 475. On May 24, 2005, the Trea-
sury Department and the IRS published in
theFederal Registera notice of proposed
rulemaking (Safe Harbor for Valuation
under Section 475) (REG–100420–03,
2005–1 C.B. 1236 [70 FR 29663]) (the
2007–27 I.R.B.1July 2, 2007

NPRM). The NPRM set forth a possible
safe harbor for valuing these securities and
asked for comments on various aspects of
the safe harbor. A public hearing was held
on September 15, 2005. The IRS received
written and electronic comments respond-
ing to the NPRM. After consideration of
all comments, the proposed regulations
are adopted as amended by this Treasury
decision. The amendments are discussed
in this preamble.
Explanation of Provisions and
Summary of Contents
Overview
Section 475(a) requires dealers in se-
curities to mark their securities to market.
Section 475(e) allows dealers in commodi-
ties to elect similar treatment for their com-
modities. If the security or commodity is
inventory, it must be included in inventory
at its fair market value. If it is not inven-
tory and is held at the end of the taxable
year, gain or loss is recognized as if the se-
curity or commodity had been sold for its
fair market value on the last business day
of the taxable year.
Although the term “fair market value”
has a long-standing and well-established
meaning within the tax law, it is some-
times difficult to determine the fair market
value of certain securities and commodi-
ties. This has impeded the efficient ad-
ministration of the mark-to-market system
under section 475. Consequently, with a
view to improving the administrability of
the valuation requirements of section 475,
the Treasury Department and the IRS is-
sued the NPRM, which set forth a safe har-
bor for valuing securities and commodities
under section 475.
These final regulations adopt the ap-
proach of the NPRM with the modifica-
tions discussed in this preamble.
Underlying Principles of the Safe Harbor
The safe harbor generally permits eli-
gible taxpayers to elect to have the values
that are reported for eligible positions on
certain financial statements treated as the
fair market values of those eligible posi-
tions for purposes of section 475, if cer-
tain conditions are met. The safe har-
bor is based upon the principle that if the
mark-to-market method used for financial
reporting is sufficiently consistent with the
mark-to-market method required by sec-
tion 475, then the values used for finan-
cial reporting should be acceptable val-
ues for purposes of section 475. To en-
sure minimal divergence from fair market
value under tax principles, these regula-
tions impose certain restrictions on the fi-
nancial accounting methods and financial
statements that are eligible for the safe har-
bor and also require certain adjustments to
the values of the eligible positions on those
financial statements that may be used un-
der the safe harbor.
The safe harbor and its various require-
ments and limitations are based upon the
business model for derivatives dealers that
was described in comments received in
response to the ANPRM and the NPRM.
According to these comments, dealers
seek to capture and profit from bid-ask
spreads in the marketplace by entering
into balanced portfolios for their deriva-
tives, that is, positions that offset each
other, either individually or in the aggre-
gate. Although dealers may have some
open positions, they seek to have balanced
portfolios with a majority of positions
offsetting each other. Those offsetting po-
sitions generally remain on dealers’ books
over the terms of the positions.
The spread between bid and ask values
contains the dealer’s profit, which com-
pensates the dealer for all risks and ex-
penses. The creation of a balanced portfo-
lio may be seen as giving rise to a synthetic
annuity, with a value that is largely im-
mune from market-related changes in the
values of the component positions. At the
time the dealer has entered into the off-
setting positions and created the synthetic
annuity, all steps required to earn the in-
come from the synthetic annuity have been
completed. Recognizing the present value
of the income attributable to the bid-ask
spread is appropriate in the taxable year
the synthetic annuity is created. For a
matched book of eligible positions, such
as a dealer’s portfolio of interest rate swap
contracts, use of bid or ask values approx-
imates realizationaccounting and fails to
recognize in income the present value of
the synthetic annuity in the taxable year
that the synthetic annuity is created. The
final regulations are to be applied in a
manner consistent with the premise that
the present value of the synthetic annuity
should be recognized in income not later
than the taxable year in which the synthetic
annuity is created.
Commentators described a different
business model for securities that are not
derivatives, commonly known as physi-
cals. Under this model, dealers plan on
rapid turnover of the physicals that are
traded on qualified boards or exchanges or
on liquid over-the-counter markets. Ex-
cept for those acquired at the end of the
taxable year, the acquisition and disposi-
tion of a physical occurs within a single
taxable year, so that the effect of capturing
a bid-ask spread also occurs entirely within
that year. Consequently, for securities
traded on a qualified board or exchange,
as defined under section 1256(g)(7), there
is little difference between the results of re-
alization and mark-to-market accounting,
and little opportunity for manipulation.
Eligible Taxpayers
The NPRM provided that traders could
elect to use the safe harbor. In both the
ANPRMandtheNPRM,theTreasury
Department and IRS asked for comments
addressing whether traders in securities
and commodities should be able to elect
the safe harbor and whether the business
model for traders differs from the busi-
ness model for dealers. The commentators
that recommended that the safe harbor
apply to traders did so without providing
information about the business model for
traders and without suggesting how the
limitations set forth in the NPRM would
apply to traders. Without a full under-
standing of the business model for traders,
the Treasury Department and the IRS have
determined that it would be unwise to
include traders in the safe harbor at this
time. Accordingly, the final regulations
provide that the safe harbor is available
only to taxpayers who are dealers in se-
curities under section 475(a) or who are
dealers in commodities and are subject to
the election described in section 475(e)(1).
Eligible Positions
Because financial markets and prod-
ucts evolve rapidly, listing the securities
and commodities in the regulations would
make the regulations less flexible and
dynamic in the future. To ensure that
the safe harbor will be adaptable and ad-
ministrable in a changing environment,
the Commissioner willissue concurrently
July 2, 200722007–27 I.R.B.

with these final regulations a revenue pro-
cedure (Rev. Proc. 2007–41, 2007–26
I.R.B. 1492) that will list the types of se-
curities and commodities that are subject
to the safe harbor. This revenue procedure
may be updated as necessary.
It is important to note, however, that the
valuation methodology under the safe har-
bor applies only for positions that, taking
into account any elections and identifica-
tions that are in effect, are required to be
marked to market undersection 475. That
is, the safe harbor only addresses valua-
tion and does not expand or contract the
scope or application of section 475. For
example, if a security is not marked to mar-
ket under section 475 because it has been
properly identified as held for investment,
then it may not be marked to market for
Federal income tax purposes even though
the safe harbor election is in effect and the
security is properly marked to market on
the financial statement in accordance with
U.S. Generally Accepted Accounting Prin-
ciples (U.S. GAAP). Similarly, if a secu-
rity is not marked to market on the ap-
plicable financial statement because, for
example, it is a hedge for financial state-
ment purposes but section 475(a) applies
because the security is not a hedging trans-
action for tax purposes, then the security
must nevertheless be marked to market un-
der section 475.
Eligible Method
The NPRM set forth four core require-
ments that a financial accounting method
must satisfy in order to be eligible for the
safe harbor. First, the method must mark
eligible positions to market through valu-
ations made as of the last business day of
each taxable year. Second, it must recog-
nize into income on the income statement
any gain or loss from marking eligible po-
sitions to market. Third, it must recognize
into income on the income statement any
gain or loss on disposition of an eligible
position as if a year-end mark occurred im-
mediately before the disposition. Fourth, it
must arrive at fair value in accordance with
U.S. GAAP.
In addition to these core requirements,
the NPRM imposed certain limitations to
ensure minimal divergence from fair mar-
ket value. Under the first limitation, the
financial accounting method must not re-
sult in values at or near the bid or ask val-
ues, even if the use of bid or ask values is
permissible under U.S. GAAP. This limi-
tation applies to all eligible positions ex-
cept those that are traded on a qualified
board or exchange, as defined in section
1256(g)(7). This limitation ensures that a
sufficient portion of the synthetic annuity
captured by a dealer is reported in the cor-
rect accounting period of that dealer.
Under the second limitation in the
NPRM, if a method of valuation is based
on the present value of projected cash
flows from an eligible position or po-
sitions, that method must not take into
account any income or expense attrib-
utable to a period or time on or before
the valuation date. This limitation ensures
that items of income or expense will not be
accounted for twice, first through current
recognition and then again in the mark.
Under the third limitation in the NPRM,
no cost or risk may be accounted for more
than once, either directly or indirectly. For
example, a financial accounting method
may allow a special adjustment for credit
risk. If, however, a method computes the
present value of projected cash flows us-
ing a discount rate that takes credit risk into
account and the method employs a special
adjustment that takes some or all of the
credit risk into account, then the method
does not satisfy this limitation. This limi-
tation ensures that items of income or ex-
pense will not be accounted for twice.
Most of the comments received on the
NPRM focused on the core requirements
and limitations for eligible methods. As
explained in this preamble, the final regu-
lations address thosecomments, rejecting
some suggestions and modifying the reg-
ulations in response to others. The major-
ity of the comments focused on (1) requir-
ing changes in value to be reported on the
income statement, (2) limiting the use of
bid and ask values, and (3) excepting cer-
tain types of physical securities from the
bid-ask limitation.
Income Statement Requirement —
§1.475(a)–4(d)(2)(ii)
Some commentators suggested that
eligible taxpayers be allowed to report
changes in value on either the balance
sheet or the income statement, because
both are rigorously reviewed. They also
expressed concern that, because certain
items of other comprehensive income gen-
erally appear on the balance sheet and not
on the income statement, the methodology
used by many taxpayers for financial re-
porting would fail to be an eligible method
and, therefore, would not satisfy the safe
harbor.
When changes in value appear on the
income statement, they also appear in re-
tained earnings and in earnings-per-share.
This creates a tension between the benefits
of higher earnings for financial reporting
and the benefit of lower income for tax re-
porting. This tension helps to ensure the
reliability of values for tax purposes, a fun-
damental concept underlying the safe har-
bor. Balance sheet items, such as other
comprehensive income, do not have the
same tension. Therefore, the final regula-
tions retain the income statement require-
ment of the NPRM.
Bid-Ask Limitation
Some commentators suggested that the
bid-ask limitation be eliminated to make
it easier for taxpayers to qualify for the
safe harbor. These commentators indi-
cated that dealers generally do not retain
records of individual positions’ bid-ask
spreads for any meaningful period of time,
and it would be burdensome to monitor
the spreads of those positions for which
records do exist.
The safe harbor set forth in the NPRM
does not add to taxpayers’ existing record-
keeping burden. Without the safe har-
bor, other sections of the Code would re-
quire taxpayers to keep records to prove
the values of individual positions or to
keep records of spreads if taxpayers ac-
count for their income and loss based on
those spreads. The safe harbor simply al-
lows taxpayers to use those same records
to prepare both the applicable financial
statement and their tax return. Accord-
ingly, the bid-ask limitation has been re-
tained in the final regulations.
Additionally, according to some com-
mentators, the requirement in the NPRM
that values should be nearer to the mid-
market value than to the bid or ask value
could be interpreted in two ways. First,
it could be a requirement that, if not met
for a particular position, would disqualify
an entire financial accounting method as
an eligible method. Second, it could be a
safe harbor that, if not met for a particular
position, would not disqualify the method
2007–27 I.R.B.3July 2, 2007

but would require the taxpayer to prove
that the method consistently produces val-
ues nearer to mid-market than to bid or ask.
The final regulations make it clear that this
provision is a safe harbor and that a method
that may occasionally produce a value that
is not nearer to mid-market than to bid or
ask will not preclude use of the safe harbor.
The Treasury Department and the IRS
also received suggestions from commenta-
tors seeking expansion of the exceptions to
the bid-ask limitations. Some commenta-
tors noted that the exception for exchange-
traded positions in the NPRM was too nar-
row because it did not cover those equi-
ties and debt securities, such as Treasury
obligations, that are traded in very liquid,
over-the-counter markets and have easily
determinable values. These commentators
suggested that, rather than limit the excep-
tion to positions on qualified boards or ex-
changes as defined in section 1256(g)(7),
the regulations should include within the
exception all positions for which there is
an established financial market within the
meaning of §1.1092(d)–1(b).
The exception for positions that are
traded on a qualified board or exchange de-
scribed in section 1256(g)(7) was included
in the NPRM to except those positions
with spreads so small that applying the
bid-ask limitation would have little effect
on the determination of fair market value.
Because section 1092 is an anti-abuse pro-
vision that Congress intended to be broad
in scope, the definition of established fi-
nancial market in §1.1092(d)–1(b) reflects
a corresponding breadth. Thus, expan-
sion of the exception for exchange-traded
positions by referenceto §1.1092(d)–1(b)
might inappropriately except too many po-
sitions from the general bid-ask limitation.
For example, many derivative contracts
for which dealers lock in spreads are po-
sitions for which there is an established
financial market. See §1.1092(d)–1(b),
(c). Consequently, the reference to section
1256(g)(7) has been retained.
Some of the comments about the bid-
ask exception were prompted by the view
that debt instruments should be excepted
from the bid-ask limitation for some of
the same reasons as positions traded on a
1256(g)(7) board or exchange.
The Treasury Department and the IRS,
however, decline at this time to adopt the
suggestion that debt instruments be gener-
ally excepted from the bid-ask limitation.
The Treasury Department and the IRS
recognize that dealers’ business model
for debt instruments generally is to turn
over debt securities very rapidly and that
dealers have a strong economic incentive
to do so because holding debt securities
consumes balance sheet resources and
poses risk management issues. Never-
theless, based on comments received, the
Treasury Department and the IRS do not
possess sufficient information to conclude
that spreads in the over-the-counter debt
markets arede minimis. Additionally, debt
instruments may be used to lock in spreads
with respect to open positions in other in-
struments, such as derivatives. Therefore,
excepting over-the-counter debt instru-
ments from the bid-ask limitation may be
contrary to the tenets of the dealer business
model for derivatives. Moreover, except-
ing debt instruments from the bid-ask
limitation might introduce a tax-motivated
distortion into the marketplace, as taxpay-
ers may decide to lock in spreads with
tax-advantaged instruments rather than
with instruments that are selected on the
basis of their non-tax economic attributes.
The Commissioner may, however, desig-
nate additional positions as being exempt
from the bid-ask limitation.
Understanding the need for a limitation
on the use of bid and ask values, one com-
mentator suggested an open position ex-
ception to the bid-ask limitation. Under
this alternative, offsetting positions in the
balanced portion of a portfolio would not
be valued at or near the bid or ask val-
ues. Open positions, however, would not
be subject to this limitation. Instead, they
could be valued at any value between and
including the bid and ask values. Accord-
ing to this commentator, the bid-ask limi-
tation ensures that the present value of the
income attributable to the bid-ask spread
is recognized in the taxable year the syn-
thetic annuity is created. Open positions, it
was noted, do not create a synthetic annu-
ity so the bid-ask limitation need not apply
to them.
The Treasury Department and the IRS
decline to adopt the rule suggested by
this commentator. Under a mark-to-mar-
ket system, when a dealer enters into an
open position with a customer, that dealer
has captured the spread inherent in that
customer position, even if the customer
position is not offset by another position.
Although it can be argued that a dealer
may be forced to pay a spread to obtain
a position offsetting the open customer
position, to assume a dealer would do so
across the board would be to ascribe cus-
tomer status (which is paying spreads) to
the dealer, a result inconsistent with the
dealer business model (which is charg-
ing spreads). Additionally, in the event
a dealer actually pays a spread to offset
the open customer position, the disadvan-
tageous terms of the offsetting position
will be reflected in the mark-to-market
valuation of that position. Administrabil-
ity is also a concern. Before accepting
the suggestion that a dealer should recog-
nize no mark-to-market income from any
open position until the position is offset
by one or more other positions, the Trea-
sury Department and the IRS would need
more information regarding the manner
in which to verify the process for deter-
mining the proper amounts of adjustments
taxpayers will use to achieve this result.
Eligible Methods, Eligible Positions and
the Safe Harbor Election
The final regulations modify the NPRM
by providing that the election to use the
safe harbor is made by filing a statement
with the taxpayer’s return declaring that
the taxpayer makes the safe harbor election
for all eligible positions for which it has an
eligible method. An example elaborating
on this concept has been added to the final
regulations.
Applicable Financial Statements
Not all financial statements qualify un-
der the safe harbor. Consequently, these
regulations set forth a system that enables
a taxpayer to determine which one of its
financial statements, if any, may be used
when applying the safe harbor. The fi-
nal regulations adopt the provisions of the
NPRM on applicable financial statements.
Some commentators expressed concern
that U.S. branches of foreign banks would
notbeeligibletousethesafeharborbe-
cause they do not prepare financial state-
ments in accordance with U.S. GAAP. The
comments suggested that many of these
branches prepare their financial statements
in accordance with rules that are substan-
tially similar to U.S. GAAP and, therefore,
should be permitted to use those non-U.S.
GAAP financial statements for purposes of
the safe harbor. The commentators also
July 2, 200742007–27 I.R.B.

suggested that call reports submitted to
U.S. bank regulators by foreign banks have
sufficientindiciaof reliability to merit use
in the safe harbor, even though changes
over time in the values in those reports may
not be directly reflected in income state-
ments prepared according to U.S. GAAP.
As noted in this preamble, the safe
harbor is based on the concept that, with
appropriate limitations, mark-to-market
values used on certain financial statements
can be sufficiently consistent with fair
market values under section 475. The IRS
and Treasury Department have concluded
that the requirements and limitations of
the safe harbor ensure sufficient consis-
tency when applied to financial statements
prepared according to U.S. GAAP. This
conclusion is less clear when the re-
quirements and limitations are applied to
financial statements prepared under other
accounting regimes. Consequently, the
final regulations retain the requirement
that applicable financial statements be
prepared in accordance with U.S. GAAP.
The final regulations retain the require-
ment in the NPRM that, to be an eligible
method, a financial statement method of
accounting must cause changes in value to
be recognized into income on the income
statement.
Nevertheless, making it practical for
foreign banks to use the safe harbor for
their U.S. branches could be valuable not
only to the foreign banks but also to the
IRS in its administration and application
of section 475. Therefore, the IRS and
Treasury Department are interested in ex-
panding the scope of these regulations so
that they may apply in the future to foreign
banks. Answers to the following questions
would facilitate efforts to achieve that ex-
pansion. First, should the safe harbor re-
quire that the values reported in the call re-
port of the foreign bank be the same values
that are reported in the income statement
filed in the foreign bank’s home coun-
try? If so, should the foreign bank, to-
gether with its certified independent regis-
tered public accountant, file with the U.S.
tax return, subject to penalties of perjury, a
statement to that effect?
Second, should the valuation standards
used in the foreign bank’s home country
be identical to the valuation standards un-
der U.S. GAAP, and if not identical, in
what ways may they differ? If so, should
the foreign bank, together with its certified
independent registered public accountant,
file a statement with the U.S. tax return,
subject to penalties of perjury, describing
the differences, if any, between the foreign
country valuation standards and those un-
der U.S. GAAP? Further, should the for-
eign valuation standards be fully consis-
tent with, and should the foreign country
have formally adopted, International Fi-
nancial Reporting Standards as published
by the International Accounting Standards
Board?
Third, should the income statement
filed by the foreign bank be filed with the
foreign bank’s home country bank regu-
lator (as distinct from a market regulator
like the SEC)?
Fourth, for purposes of these questions,
should the term “home country” mean the
country in which the foreign bank is char-
tered or incorporated?
Record Retention and Production
The safe harbor will be administrable
only if the IRS can readily verify that the
financial statements at issue are taxpayers’
applicable financial statements, that the ac-
counting methods used are eligible meth-
ods, and that the values used on the ap-
plicable financial statements are also used
on the Federal income tax return. Conse-
quently, recordkeeping and record produc-
tion are critical to the effective administra-
tion of the safe harbor.
These final regulations retain the provi-
sions of the NPRM regarding record reten-
tion and production. They provide specific
requirements for the types of records that
must be maintained and provided, to en-
able ready verification. In general, elect-
ing taxpayers must clearly show: (1) that
the same value used for financial reporting
was used on the Federal income tax return;
(2) that no eligible position subject to sec-
tion 475 is excluded from the application
of the safe harbor; and (3) that only eligi-
ble positions subject to section 475 are car-
ried over to the Federal income tax return
under the safe harbor.
Commentators expressed concern that
the language of the NPRM requiring all
schedules, exhibits, computer programs,
and other information used to produce val-
ues was too broad, making it difficult to
know what materials must be retained and
produced. They also expressed concern
that a requirement to keep computer pro-
grams and information used in producing
values not only would require taxpayers
to keep information about models that are
changed frequently but also would encour-
age IRS employees to examine valuation
models not just for compliance with the
definition of “eligible method” but also for
examining the accuracy of the underlying
valuations.
The final regulations retain the record
retention and production requirements set
forth in the NPRM. Other sections of the
Code already require taxpayers to maintain
records sufficient to support the accuracy
of items reported on their Federal tax re-
turns. Except for a possible increase in the
retentionperiodinsomeinstances,there-
fore, the final regulations create no addi-
tional burden. To avoid confusion or un-
due burden, the final regulations permit a
taxpayer to enter into an agreement with
the IRS specifying which records must be
maintained, how they must be maintained,
and for how long they must be maintained.
These agreements may include terms cov-
ering the maintenance of computer pro-
grams and information used in producing
values.
The maintenance and production re-
quirements of the regulations preclude
undue delay in producing records. One
commentator suggested that the 30-day
deadline provided too little time to pro-
duce records. During the development of
these regulations, the IRS conducted a test
program to determine not only whether
values could be traced from financial
statements to the taxreturn but also how
long it would take for taxpayers to produce
the necessary records.This test program
demonstrated that 30 days was generally
a sufficient period of time. For specific
cases, the Commissioner may excuse fail-
ures to provide records within 30 days
if the taxpayer shows reasonable cause
for the failure and has made a good faith
effort to comply. As noted above, the
taxpayer may also enter into an agreement
with the Commissioner that sets forth a
different time period. Accordingly, the
final regulations retain the general 30-day
requirement.
Special Analyses
It has been determined that this Trea-
sury decision is not asignificant regula-
tory action as defined in Executive Order
2007–27 I.R.B.5July 2, 2007

12866. Therefore, a regulatory assessment
is not required. It has also 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. It is
hereby certified that the collection of infor-
mation in these regulations will not have a
significant economic impact on a substan-
tial number of small entities. This certifi-
cation is based upon the expectation that
the safe harbor will be used primarily by
dealers in securities that are financial in-
stitutions with a sophisticated understand-
ing of the capital markets. Because section
475 is elective for dealers in commodi-
ties, some small businesses could qualify
for the safe harbor if they make two vol-
untary elections: (1) an election to mark
to market commodities under section 475
and (2) an election to apply the safe har-
bor. Because both elections are voluntary,
it is unlikely any small business taxpayer
who thinks the reporting and recordkeep-
ing requirements are too burdensome will
make these elections. Furthermore, the to-
tal average estimated burden per taxpayer
is small, as reported earlier in the pream-
ble. This is because most of the record-
keeping requirements do not require tax-
payers to generate new records, but instead
require records used for financial reporting
purposes to be kept for tax reporting pur-
poses. For all of these reasons, a Regula-
tory Flexibility Analysis under the Regula-
tory Flexibility Act (5 U.S.C. chapter 6) is
not required. Pursuant to section 7805(f)
of the Code, the notice of rulemaking pre-
ceding this regulation was submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
their impact on small business.
Drafting Information
The principal authors of these reg-
ulations are Marsha A. Sabin and
John W. Rogers III, Office of the Asso-
ciate Chief Counsel (Financial Institutions
and Products). However, other personnel
from 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 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 ***
Section 1.475(a)–4 also issued under
26 U.S.C. 475(g). * * *
Par. 2. Section 1.475–0 is amended by:
1. Revising the introductory text.
2. Adding entries to the table for
§1.475(a)–4.
3.Redesignating the entry for
§1.475(e)–1 as §1.475(g)–1.
The revision and addition reads as fol-
lows:
§1.475–0 Table of contents.
This section lists the major captions in
§§1.475(a)–3, 1.475(a)–4, 1.475(b)–1,
1.475(b)–2, 1.475(b)–4, 1.475(c)–1,
1.475(c)–2, 1.475(d)–1 and 1.475(g)–1.
*****
§1.475(a)–4 Safe harbor for valuation
under section 475.
(a) Overview.
(1) Purpose.
(2) Dealer business model.
(3) Summary of paragraphs.
(b) Safe harbor.
(1) General rule.
(2) Example. Use of eligible and non-
eligible methods.
(3) Scope of the safe harbor.
(c) Eligible taxpayer.
(d) Eligible method.
(1) Sufficient consistency.
(2) General requirements.
(i) Frequency.
(ii) Recognition at the mark.
(iii) Recognition on disposition.
(iv) Fair value standard.
(3) Limitations.
(i) Bid-ask method.
(A) General Rule.
(B) Safe harbor.
(ii) Valuations based on present values
of projected cash flows.
(iii) Accounting for costs and risks.
(4) Examples.
(e) Compliance with other rules.
(f) Election.
(1) Making the election.
(2) Duration of the election.
(3) Revocation.
(i) By the taxpayer.
(ii) By the Commissioner.
(4) Re-election.
(g) Eligible positions.
(h) Applicable financial statement.
(1) Definition.
(2) Primary financial statement.
(i) Statement required to be filed with
Securities and Exchange Commission
(SEC).
(ii) Statement filed with a Federal
agency other than the IRS.
(iii) Certified audited financial state-
ment.
(3) Example. Primary financial state-
ment.
(4) Financial statements of equal prior-
ity.
(5) Consolidated groups.
(6) Supplement or amendment to a fi-
nancial statement.
(7) Certified audited financial state-
ment.
(i) [Reserved.]
(j) Significant business use.
(1) In general.
(2) Financial statement value.
(3) Management of a business as a
dealer.
(4) Significant use.
(k) Retention and production of
records.
(1) In general.
(2) Specific requirements.
(i) Reconciliation.
(A) In general.
(B) Values on books and records with
supporting schedules.
(C) Consolidation schedules.
(ii) Instructions provided by the Com-
missioner.
(3) Time for producing records.
(4) Retention period for records.
(5) Agreements with the Commis-
sioner.
(l) [Reserved.]
(m) Use of different values.
*****
§1.475(g)–1 Effective dates.
Par. 3. Section 1.475(a)–4 is added to
read as follows:
§1.475(a)–4 Valuation safe harbor.
(a)Overview—(1)Purpose. This sec-
tion sets forth a safe harbor that, under cer-
tain circumstances, permits taxpayers to
July 2, 200762007–27 I.R.B.

elect to use the values of positions reported
on certain financial statements as the fair
market values of those positions for pur-
poses of section 475. This safe harbor is
based on the principle that, if a mark-to-
market method used for financial report-
ing is sufficiently consistent with the re-
quirements of section 475 and if the finan-
cial statement employing that method has
certainindiciaof reliability, then the val-
ues used on that financial statement may
be used for purposes of section 475. If
other provisions of the Internal Revenue
Code or regulations require adjustments to
fair market value, use of the safe harbor
does not eliminate the need for those ad-
justments. See paragraph (e) of this sec-
tion.
(2)Dealer business model.Thesafe
harbor is based on the business model for
a derivatives dealer. Under this model, the
dealer seeks to capture and profit from bid-
ask spreads in the marketplace by entering
into substantially offsetting positions with
customers that will remain on the deriva-
tives dealer’s books over their terms. Be-
cause the positions in the aggregate tend to
offset each other, the dealer has achieved
a predictable net cash flow (for example,
a synthetic annuity) that reflects the cap-
tured bid-ask spread. This net cash flow
is generally impervious to market fluctua-
tions in the values on which the component
derivatives are based. Section 475 requires
current recognition of the present value of
the net cash flow attributable to the capture
of these spreads.
(3)Summary of paragraphs. Paragraph
(b) of this section sets forth the safe harbor.
Todeterminewhomayusethesafehar-
bor, paragraph (c) of this section defines
the term “eligible taxpayer.” Paragraph (d)
of this section sets forth the basic require-
ments for determining whether the method
used for financial reporting is sufficiently
consistent with the requirements of sec-
tion 475. Paragraph (e) of this section de-
scribes adjustments to the financial state-
ment values that may be required for pur-
poses of applying this safe harbor. Para-
graph (f) of this section describes the pro-
cedure for making the safe harbor elec-
tion and the conditions under which the
election may be revoked. Paragraph (g)
of this section provides that the Commis-
sioner will issue a revenue procedure that
lists the types of securities and commodi-
ties that are eligible positions for purposes
of the safe harbor. Using rules for de-
termining priorities among financial state-
ments, paragraph (h) of this section defines
the term “applicable financial statement”
and so describes the financial statement,
if any, whose values may be used in the
safe harbor. In some cases, as required
by paragraph (j) of this section, the safe
harbor is available only if the taxpayer’s
operations make significant business use
of financial statement values. Paragraph
(k) of this section sets forth requirements
for record retention and record production.
Paragraph (m) of this section provides that
the Commissioner may use fair market val-
ues that clearly reflect income, but which
differ from values used on the applicable
financial statement, if an electing taxpayer
fails to comply with the recordkeeping and
record production requirements of para-
graph (k) of this section.
(b)Safe harbor—(1)General rule.
Subject to any adjustment required by
paragraph (e) of this section, if an eligi-
ble taxpayer uses an eligible method for
the valuation of an eligible position on
its applicable financial statement and the
eligible taxpayer is subject to the election
described in paragraph (f) of this section,
the value that the eligible taxpayer assigns
to that eligible position on its applicable
financial statement is the fair market value
of the eligible position for purposes of
section 475 and must be used for purposes
of section 475, even if that value is not
the fair market value of the position for
any other purpose of the internal revenue
laws. Notwithstanding the rule set forth
in this paragraph, the Commissioner may,
in certain circumstances, use fair market
values that clearly reflect income but dif-
fer from the values used on the applicable
financial statement. See paragraph (m) of
this section.
(2)Example.Use of eligible and non-eligible
methods. X uses eligible methods on its applicable
financial statement for some, but not all, securities
and commodities that are eligible positions. When X
elects into the safe harbor, the election applies to all
eligible positions for which X has an eligible method.
Therefore, once the election is in effect, the financial
statement values for eligible positions for which X
has an eligible method are the fair market values of
those eligible positions for purposes of section 475.
Since X, however, does not have an eligible method
for all eligible positions, those eligible positions for
which X does not have an eligible method remain
subject to the fair market value requirements of sec-
tion 475 as set out in case law and otherwise.
(3)Scope of the safe harbor.Thesafe
harbormaybeusedonlytodetermineval-
ues for eligible positions that are properly
marked to market under section 475. It
does not determine whether any positions
may or may not be subject to mark-to-mar-
ket accounting under section 475.
(c)Eligible taxpayer. An eligible tax-
payer is —
(1) A dealer in securities, as defined in
section 475(c)(1); or
(2) A dealer in commodities, as defined
in section 475(e), that is subject to an elec-
tion under section 475(e).
(d)Eligible method—(1)Sufficient
consistency. An eligible method is a
mark-to-market method that is sufficiently
consistent with the requirements of a
mark-to-market method under section
475. To be sufficiently consistent with the
requirements of a mark-to-market method
under section 475, the eligible method
must satisfy all of the requirements of
paragraph (d)(2) and paragraph (d)(3) of
this section.
(2)General requirements.The
method—
(i)Frequency. Must require a valuation
of the eligible position no less frequently
than annually, including a valuation as of
the last business day of the taxable year;
(ii)Recognition at the mark. Must rec-
ognize into income on the income state-
ment for each taxable year mark-to-mar-
ket gain or loss based upon the valuation or
valuations described in paragraph (d)(2)(i)
of this section;
(iii)Recognition on disposition.Must
require, on disposition of the eligible po-
sition, recognition into income (on the in-
come statement for the taxable year of dis-
position) as if a year-end mark occurred
immediately before such disposition; and
(iv)Fair value standard. Must require
use of a valuation standard that arrives at
fair value in accordance with U.S. Gen-
erally Accepted Accounting Principles
(U.S. GAAP).
(3)Limitations—(i)Bid-ask
method—(A)General rule.Except
for eligible positions that are traded on a
qualified board or exchange, as defined in
section 1256(g)(7), or eligible positions
that the Commissioner designates in a
revenue procedure or other published
guidance, the valuation standard used
must not, other than on ade minimis
portion of a taxpayer’s positions, permit
2007–27 I.R.B.7July 2, 2007

values at or near the bid or ask value.
Consequently, the valuation method
described in §1.471–4(a)(1) fails to satisfy
this paragraph (d)(3)(i)(A).
(B)Safe harbor. The restriction in para-
graph (d)(3)(i)(A) of this section is satis-
fied if the method consistently produces
values that are closer to the mid-market
values than they are to the bid or ask val-
ues.
(ii)Valuations based on present values
of projected cash flows. If the method of
valuation consists of projecting cash flows
from an eligible position or positions and
determining the present value of those cash
flows, the method must not take into ac-
count any cash flows attributable to a pe-
riod or time on or before the valuation date.
In addition, adjustment of the gain or loss
recognized on the mark may be required
with respect to payments that will be made
after the valuation date to the extent that
portions of the payments have been rec-
ognized for tax purposes before the valu-
ation and appropriate adjustment has not
been made for purposes of determining fi-
nancial statement value.
(iii)Accounting for costs and risks.Val-
uations may account for appropriate costs
and risks, but no cost or risk may be ac-
counted for more than once, either directly
or indirectly. Further, no valuation adjust-
ment for any cost or risk may be made for
purposes of this safe harbor if that valu-
ation adjustment is not also permitted by,
and taken for, U.S. GAAP purposes on the
taxpayer’s applicable financial statement.
If appropriate, the costs and risks that may
be accounted for include, but are not lim-
ited to, credit risk (appropriately adjusted
for any credit enhancement), future admin-
istrative costs, and model risk. An adjust-
ment for credit risk is implicit in comput-
ing the present value of cash flows using a
discount rate greater than a risk-free rate.
Accordingly, a determination of whether
any further downward adjustment to value
for credit risk is warranted, or whether an
upward adjustment is required, must take
that implicit adjustment into consideration.
(4)Examples. The following examples
illustrate this paragraph (d):
Example 1. (i) X, a calendar year taxpayer, is
a dealer in securities within the meaning of section
475(c)(1). X generally maintains a balanced port-
folio of interest rate swaps and other interest rate
derivatives, capturing bid-ask spreads and keeping
its market exposure within desired limits (using, if
necessary, additional derivatives for this purpose).
X uses a mark-to-market method on a statement that
it is required to file with the United States Securi-
ties and Exchange Commission (SEC) and that sat-
isfies paragraph (d)(2) of this section with respect to
both the contracts with customers and the additional
derivatives. When determining the amount of any
gain or loss realized on a sale, exchange, or termi-
nation of a position, X makes a proper adjustment
for amounts taken into account respecting payments
or receipts. All of X’s counterparties on the deriva-
tives have credit ratings of AA/aa, according to stan-
dard credit ratings obtained from private credit rating
agencies.
(ii) Under X’s valuation method, as of each val-
uation date, X determines a mid-market probability
distribution of future cash flows under the derivatives
and computes the present values of these cash flows.
In computing these present values, X uses an indus-
try standard yield curve that is appropriate for obli-
gations by persons with credit ratings of AA/aa. In
addition, based on information that includes its own
knowledge about the counterparties, X adjusts some
of these present values either upward or downward
to reflect X’s reasonable judgment about the extent
to which the true credit status of each counterparty’s
obligation, taking credit enhancements into account,
differs from AA/aa.
(iii) X’s methodology does not violate the re-
quirement in paragraph (d)(3)(iii) of this section
that the same cost or risk not be taken into account,
directly or indirectly, more than once.
Example 2. (i) The facts are the same as inExam-
ple 1, except that X uses a AAA/aaa rate to discount
the payments to be received under the derivatives.
Based on information that includes its own knowl-
edge about the counterparties, X adjusts these present
values to reflect X’s reasonable judgment about the
extent to which the true credit status of each coun-
terparty’s obligation, taking credit enhancements into
account, differs from a AAA/aaa obligation.
(ii) X’s methodology does not violate the require-
ment in paragraph (d)(3)(iii) of this section that the
same cost or risk not be taken into account, directly
or indirectly, more than once.
Example 3. (i)ThefactsarethesameasinEx-
ample 1, except that, after computing present values
using the discount rates that are appropriate for oblig-
ors with credit ratings of AA/aa, and based on infor-
mation that includes X’s own knowledge about the
counterparties, X adjusts some of these present values
either upward or downward to reflect X’s reasonable
judgment about the extent to which the true credit
status of each counterparty’s obligation, taking credit
enhancements into account, differs from AAA/aaa.
(ii) X’s methodology violates the requirement in
paragraph (d)(3)(iii) of this section that the same cost
or risk not be taken into account, directly or indirectly,
more than once. By using a AA/aa discount rate,
X’s method takes into account the difference between
risk-free obligations and AA/aa obligations. This dif-
ference includes the difference between a rating of
AAA/aaa and one of AA/aa. By adjusting values for
the difference between a rating of AAA/aaa and one
of AA/aa, X takes into account risks that it had al-
ready accounted for through the discount rates that it
used. The same result would occur if X judged some
of its counterparties’ obligations to be of AAA/aaa
quality but X failed to adjust the values of those obli-
gations to reflect the difference between a rating of
AAA/aaa and one of AA/aa.
Example 4. (i) The facts are the same as inExam-
ple 1, except that X determines the mid-market value
for each derivative and thensubtracts the correspond-
ing part of the bid-ask spread.
(ii) X’s methodology violates the rule in para-
graph (d)(3)(i) of this section that forbids valuing po-
sitions at or near the bid or ask value.
Example 5. (i) The facts are the same as inExam-
ple 1, and, in addition, X’s adjustments for all risks
and costs, including credit risk, future administrative
costs and model risk, may occasionally cause the ad-
justed value of an eligible position to be at or near the
bid value or ask value.
(ii) X’s methodology does not violate the rule
in paragraph (d)(3)(i)(A) of this section that forbids
valuing eligible positions at or near the bid or ask
value.
(e)Compliance with other rules.
Notwithstanding any other provisions
of this section, the fair market values for
purposes of the safe harbor must be con-
sistent with section 482, or rules that adopt
section 482 principles, when applicable.
For example, if a notional principal con-
tract is subject to section 482 or section
482 principles, the values of future cash
flows taken into account in determining
the value of the contract for purposes of
section 475 must be consistent with sec-
tion 482.
(f)Election—(1)Making the election.
Unless the Commissioner prescribes oth-
erwise, an eligible taxpayer elects under
this section by filing with the Commis-
sioner a statement declaring that the tax-
payer makes the safe harbor election in
this section for all eligible positions for
which it has an eligible method. In addi-
tion to any other information that the Com-
missioner may require, the statement must
describe the taxpayer’s applicable finan-
cial statement for the first taxable year for
which the election is effective and must
state that the taxpayer agrees to provide
upon the request of the Commissioner all
information, records,and schedules in the
manner required by paragraph (k) of this
section. The statement must be attached
to a timely filed Federal income tax return
(including extensions) for the taxable year
for which the election is first effective.
(2)Duration of the election.Once
made, the election continues in effect for
all subsequent taxable years unless re-
voked.
(3)Revocation—(i)By the taxpayer.
An eligible taxpayer that is subject to an
election under this section may revoke
July 2, 200782007–27 I.R.B.

the election only with the consent of the
Commissioner.
(ii)By the Commissioner.TheCom-
missioner, after consideration of the rele-
vant facts and circumstances, may revoke
an election under this section, effective be-
ginning with the first open year for which
the election is effective or with any subse-
quent year, if—
(A) The taxpayer fails to comply with
paragraph (k) of this section (concerning
record retention and production) and the
taxpayer does not show reasonable cause
for this failure;
(B) The taxpayer ceases to have an ap-
plicable financial statement or ceases to
use an eligible method; or
(C) For any other reason, no more than a
de minimisnumber of eligible positions, or
no more than ade minimisfraction of the
taxpayer’s eligible positions, are covered
by the safe harbor in paragraph (b) of this
section.
(4)Re-election. If an election is re-
voked, either by the Commissioner or by
the taxpayer, the taxpayer (or any succes-
sor in interest of the taxpayer) may not
make the election without the consent of
the Commissioner for any taxable year that
begins before the date that is six years af-
ter the first day of the earliest taxable year
affected by the revocation.
(g)Eligible positions. For any taxpayer,
an eligible position is any security or com-
modity that the Commissioner in a rev-
enue procedure or other published guid-
ance designates as an eligible position with
respect to that taxpayer for purposes of this
safe harbor.
(h)Applicable financial statement—(1)
Definition. An eligible taxpayer’s applica-
ble financial statement for a taxable year
is the taxpayer’s primary financial state-
ment for that year if that primary finan-
cial statement is described in paragraph
(h)(2)(i) of this section (concerning state-
ments required to be filed with the SEC)
or if that primary financial statement both
meets the requirements of paragraph (j) of
this section (concerning significant busi-
ness use) and is described in either para-
graph (h)(2)(ii) or (iii) of this section. Oth-
erwise, or if the taxpayer does not have
a primary financial statement for the tax-
able year, the taxpayer does not have an
applicable financial statement for the tax-
able year.
(2)Primary financial statement.For
any taxable year, an eligible taxpayer’s pri-
mary financial statement is the financial
statement, if any, described in one or more
of paragraphs (h)(2)(i), (ii), and (iii) of
this section. If more than one financial
statement of the taxpayer for the year is
so described, the primary financial state-
ment is the one first described in para-
graphs (h)(2)(i), (ii), and (iii) of this sec-
tion. A taxpayer has only one primary fi-
nancial statement for any taxable year.
(i)Statement required to be filed with
the Securities and Exchange Commission
(SEC). A financial statement that is pre-
pared in accordance with U.S. GAAP and
that is required to be filed with the SEC,
such as the 10-K or the Annual Statement
to Shareholders.
(ii)Statement filed with a Federal
agency other than the Internal Revenue
Service. A financial statement that is
prepared in accordance with U.S. GAAP
and that is required to be provided to the
Federal government or any of its agencies
other than the Internal Revenue Service
(IRS).
(iii)Certified audited financial state-
ment. A certified audited financial state-
ment that is prepared in accordance with
U.S. GAAP; that is given to creditors for
purposes of making lending decisions,
given to equity holders for purposes of
evaluating their investment in the eligible
taxpayer, or provided for other substantial
non-tax purposes; and that the taxpayer
reasonably anticipates will be directly re-
lied on for the purposes for which it was
given or provided.
(3)Example.Primary financial statement.Xpre-
pares financial statement FS1, which is required to
be filed with a Federal government agency other than
the SEC or the IRS. FS1 is thus described in para-
graph (h)(2)(ii) of this section. X also prepares fi-
nancial statement FS2, which is a certified audited fi-
nancial statement that is given to creditors and that X
reasonably anticipates will be relied on for purposes
of making lending decisions. FS2 is thus described
in paragraph (h)(2)(iii) of this section. Because FS1,
which is described in paragraph (h)(2)(ii) of this sec-
tion, is described before FS2, which is described in
paragraph (h)(2)(iii) of this section, FS1 is X’s pri-
mary financial statement.
(4)Financial statements of equal pri-
ority. If the rules of paragraph (h)(2) of
this section cause two or more financial
statements to be of equal priority, then the
statement that resultsin the highest aggre-
gate valuation of eligible positions being
marked to market under section 475 is the
primary financial statement.
(5)Consolidated groups. If the tax-
payer is a member of an affiliated group
that files a consolidated return, the pri-
mary financial statement of the taxpayer
is the primary financial statement, if any,
of the common parent (within the meaning
of section 1504(a)(1)) of the consolidated
group.
(6)Supplement or amendment to a fi-
nancial statement. A financial statement
includes any supplement or amendment to
the financial statement.
(7)Certified audited financial state-
ment. For purposes of this paragraph (h),
a financial statement is a certified audited
financial statement if it is certified by
an independent certified public accoun-
tant from a Registered Public Accounting
firm, as defined in section 2(a)(12) of the
Sarbanes-Oxley Act of 2002, Public Law
107–204, 116 Stat. 746 (July 30, 2002),
15 U.S.C. §7201(a)(12), and rules promul-
gated under that Act, and is—
(i) Certified to be fairly presented (a
“clean” opinion);
(ii) Certified to be fairly presented sub-
ject to a concern about a contingency, other
than a contingency relating to the value of
eligible positions (a qualified “subject to”
opinion); or
(iii) Certified to be fairly presented
except for a method of accounting with
which the Certified Public Accountant dis-
agrees and which is not a method used to
determine the value of an eligible position
held by the eligible taxpayer (a qualified
“except for” opinion).
(i) [Reserved].
(j)Significant business use—(1)In gen-
eral. A financial statement is described in
this paragraph (j) if—
(i) The financial statement contains val-
ues for eligible positions;
(ii) The eligible taxpayer makes signif-
icant use of financial statement values in
most of the significant management func-
tions of its business; and
(iii) That use is related to the manage-
ment of all or substantially all of the eligi-
ble taxpayer’s business.
(2)Financial statement value.Forpur-
poses of this paragraph (j), the termfinan-
cial statement valuemeans—
(i) A value that is taken from the finan-
cial statement; or
2007–27 I.R.B.9July 2, 2007

(ii) A value that is produced by a
process that is in all respects identical to
the process that produces the values that
appear on the financial statement but that
is not taken from the statement because
either—
(A) The value was determined as of a
date for which the financial statement does
not value eligible positions; or
(B) The value is used in the manage-
ment of the business before the financial
statement has been prepared.
(3)Management functions of a busi-
ness. For purposes of this paragraph (j),
the termmanagement functions of a busi-
nessrefers to the financial and commer-
cial oversight of the business. Oversight
includes, but is not limited to, senior
management review of business-unit prof-
itability, market risk measurement or
management, credit risk measurement or
management, internal allocation of capital,
and compensation of personnel. Manage-
ment functions of a business do not include
either tax accounting or reporting the re-
sults of operations to persons other than
directors or employees.
(4)Significant use. If an eligible tax-
payer uses financial statement values
for some significant management func-
tions and uses values that are not financial
statement values for other significant man-
agement functions, then the determination
of whether the taxpayer has made signifi-
cant use of the financial statement values
is made on the basis of all the facts and
circumstances. This determination must
particularly take into account whether
the taxpayer’s reliance on the financial
statement values exposes the taxpayer to
material adverse economic consequences
if the values are incorrect.
(k)Retention and production of
records—(1)In general. In addition to
all records that section 6001 otherwise
requires to be retained, an eligible tax-
payer subject to the election provided by
this section must keep, and timely pro-
vide to the Commissioner upon request,
records and books of account that are
sufficient to establish that the financial
statement to which the income tax return
conforms is the taxpayer’s applicable fi-
nancial statement, that the method used on
that statement is an eligible method, and
that the values used for eligible positions
for purposes of section 475 are the values
used in the applicable financial statement.
This obligation extends to all records and
books that are required to be maintained
for any period for financial or regulatory
reporting purposes, even if these records
or books may not otherwise be specifically
covered by section 6001. All records and
books described in this paragraph (k) must
be maintained for the period described in
paragraph (k)(4) of this section, even if a
lesser period of retention applies for finan-
cial statement or regulatory purposes.
(2)Specific requirements—(i) Verifica-
tion andreconciliation. Unless the Com-
missioner otherwise provides—
(A)In general. An eligible taxpayer
must provide books and records to ver-
ify the appropriate use of the safe harbor
and reconciliation schedules between the
applicable financial statement for the tax-
able year and the Federal income tax re-
turn for that year. The required verifi-
cation materials and reconciliation sched-
ules include all supporting schedules, ex-
hibits, computer programs, and any other
information used in producing the values
and schedules, including the documenta-
tion of rules and procedures governing de-
termination of the values. The required
reconciliation schedules must also include
a detailed explanation of any adjustments
necessitated by the imperfect overlap be-
tween the eligible positions that the tax-
payer marks to market under section 475
and the eligible positions for which the ap-
plicable financial statement uses an eligi-
ble method. In the time and manner pro-
vided by the Commissioner, a corporate
taxpayer subject to this paragraph (k) must
reconcile the net income amount reported
on its applicable financial statement to the
amount reported on the applicable forms
and schedules on its Federal income tax re-
turn (such as the Schedule M–1, “Recon-
ciliation of Income (Loss) per Books With
Income per Return”; Schedule M–3, “Net
Income (Loss) Reconciliation for Corpora-
tions With Total Assets of $10 Million or
More”; and Form 1120F, “U.S. Income Tax
Return of a Foreign Corporation”). Eli-
gible taxpayers that are not otherwise re-
quired to file a Schedule M–1 or Schedule
M–3 must reconcile net income using sub-
stitute schedules similar to Schedule M–1
and Schedule M–3, and these substitute
schedules must be attached to the return.
(B)Values on books and records with
supporting schedules. The books and
records must state the value used for
each eligible position separately from the
value used for any other eligible position.
However, an eligible taxpayer may make
adjustments to values on a pooled basis,
if the taxpayer demonstrates that it can
compute gain or loss attributable to the
sale or other disposition of an individual
eligible position.
(C)Consolidation schedules.Anel-
igible taxpayer must provide a schedule
showing the consolidation and de-consoli-
dation that is used in preparing the appli-
cable financial statement, along with ex-
hibits and subordinate schedules. This
schedule must provide information that ad-
dresses the differences for consolidation
and de-consolidation between the applica-
ble financial statement and the Federal in-
come tax return.
(ii)Instructions provided by the Com-
missioner. The Commissioner may pro-
vide an alternative time or manner in
which an eligible taxpayer subject to this
paragraph (k) must establish that the same
values used for eligible positions on the
applicable financial statement are also the
values used for purposes of section 475 on
the Federal income tax return.
(3)Time for producing records.All
documents describedin this paragraph
(k) must be produced within 30 days of a
request by the Commissioner, unless the
Commissioner grants a written extension.
Generally, the Commissioner will exer-
cise his discretion to excuse a minor or
inadvertent failure to provide requested
documents if the taxpayer shows reason-
able cause for the failure, has made a good
faith effort to comply with the requirement
to produce records,and promptly reme-
dies the failure. For failures to maintain,
or timely produce, records, see para-
graph (f)(3)(ii) of this section (allowing
the Commissioner to revoke the election),
and see paragraph (m) of this section (al-
lowing the Commissioner, but not the
taxpayer, to use for eligible positions that
otherwise might be subject to the safe
harbor fair market values that clearly re-
flect income but that are different from
the values used on the applicable financial
statement).
(4)Retention period for records.All
materials required by this paragraph (k)
and section 6001 must be retained as long
as their contents may become material in
the administration of any internal revenue
law.
July 2, 2007102007–27 I.R.B.

(5)Agreements with the Commissioner.
The Commissioner and an eligible tax-
payer may enter into a written agreement
that establishes, for purposes of this para-
graph (k), which records must be main-
tained, how they must be maintained, and
for how long they must be maintained.
(l) [Reserved].
(m)Use of different values.If,withre-
spect to the records that relate to certain el-
igible positions for a taxable year, the tax-
payer fails to satisfy paragraph (k) of this
section (concerning record retention and
record production), then, for those eligible
positions for that year, the Commissioner
may use values that the Commissioner de-
termines to be fair market values that are
appropriate to clearly reflect income, even
if the values so determined are different
from the values reported for those posi-
tions on the applicable financial statement.
See also paragraph (f)(3)(ii) of this section
(concerning revocation of the election by
the Commissioner when a taxpayer does
not produce required records and fails to
demonstrate reasonable cause for the fail-
ure).
§1.475(e)–1 [Redesignated as
§1.475(g)–1]
Par. 4. Section 1.475(e)–1 is redesig-
nated as §1.475(g)–1.
Par. 5. Newly designated §1.475(g)–1
is amended by redesignating para-
graphs (d) through (j) as paragraphs (e)
through (k), respectively, and adding a
new paragraph (d) to read as follows:
§1.475(g)–1 Effective dates.
*****
(d) Section 1.475(a)–4 (concerning a
safe harbor to use applicable financial
statement values for purposes of sec-
tion 475) applies to taxable years ending
on or after June 12, 2007.
*****
PART602–OMBCONTROL
NUMBERS UNDER PAPERWORK
REDUCTION ACT
Par. 6. The authority citation for part
602 continues to read as follows:
Authority: 26 USC 7805
Par. 7. In §602.101, paragraph (b)
isamendedbyaddingtheentryfor
1.475(a)–4 to the table to read as fol-
lows:
§602.101 OMB Control numbers.
*****
(b) * * *
CFR part or section where
identified and described
Current OMB
control No.
*****
1.475(a)–4........................................................... 1545–1945
*****
Kevin M. Brown,
Deputy Commissioner for
Services and Enforcement.
Approved May 30, 2007.
Eric Solomon,
Assistant Secretary of
theTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on June 11, 2007,
8:45 a.m., and published in the issue of the Federal Register
for June 12, 2007, 72 F.R. 32172)
Section 482.—Allocation
of Income and Deductions
Among Taxpayers
Must the fair market values for purposes of the safe
harbor be consistent with section 482, if a taxpayer is
subject to section 482. See T.D. 9328, page 1.
Section 892.—Income of
Foreign Governments and of
International Organizations
A notice alerts taxpayers and their representatives
that the IRS intends to challenge claims under the rel-
evant current statutory and regulatory provisions that
certain distributions, described in the notice, from a
real estate investment trust (REIT) or other qualified
investment entity (QIE) to foreign governments are
not subject to section 897(h)(1) of the Internal Rev-
enue Code or are exempt from taxation under section
892 of the Code. The notice also announces that Trea-
sury and the IRS intend to issue regulations that will
clarify the correct interpretation of these provisions.
See Notice 2007-55, page 13.
Section 897.—Disposition
of Inv
estment in United
State
sRealProperty
Anoti
ce alerts taxpayers andtheir representatives
that t
he IRS intends to challenge claims under the rel-
evant current statutory and regulatory provisions that
certain distributions, described in the notice, from a
real estate investment trust (REIT) or other qualified
investment entity (QIE) to foreign governments are
not subject to section 897(h)(1) of the Internal Rev-
enue Code or are exempt from taxation under section
892 of the Code. The notice also announces that Trea-
suryandtheIRSintendtoissue regulations that will
clarify the correct interpretation of these provisions.
See Notice 2007-55, page 13.
Section 1256.—Section
1256 Contracts Marked
to Market
If a dealer has eligible positions that trade on a
qualified board or exchange, are they permitted to
report those positions’ values at or near the bid or ask
value. See T.D. 9328, page 1.
2007–27 I.R.B.11July 2, 2007

Part III. Administrative, Procedural, and Miscellaneous
Preparer Penalty Provisions
Under the Small Business and
Work Opportunity Act of 2007
Notice 2007–54
This notice provides guidance and
transitional relief for the return preparer
penalty provisions under section 6694 of
the Internal Revenue Code, as amended by
the Small Business and Work Opportunity
Act of 2007.
SCOPE
The transitional relief provided by this
notice will apply to all returns, amended
returns, and refund claims due on or be-
fore December 31, 2007 (determined with
regard to any extension of time for filing);
to 2007 estimated tax returns due on or be-
fore January 15, 2008; and to 2007 em-
ployment and excise tax returns due on or
before January 31, 2008.
BACKGROUND
The Small Business and Work Oppor-
tunity Act of 2007, Pub. L. No. 110–28,
121 Stat.
, (the Act) was enacted into
law on May 25, 2007. Section 8246 of
the Act amends several provisions of the
Code to extend the application of the in-
come tax return preparer penalties to all
tax return preparers, alter the standards of
conduct that must be met to avoid imposi-
tion of the penalties for preparing a return
which reflects an understatement of liabil-
ity, and increase applicable penalties. The
amendments are effective for tax returns
prepared after the date of the enactment,
May 25, 2007.
The amendments made by the Act raise
questions regarding activities represent-
ing preparation of a tax return, who is
a return preparer within the meaning of
section 7701(a)(36) (as amended), and
how the statute applies to signing and
non-signing preparers. In order to address
these questions, the Internal Revenue Ser-
vice and the Treasury Department are
considering whether regulations or other
published guidance are needed, includ-
ing but not limited to, amendments to
Treas. Reg. sections 301.7701–15 and
1.6694–0 through 1.6694–4. Because the
Act extends the types of returns subject
to the new provisions, changes are also
required to the relevant forms and pub-
lications. The Service must also alter
existing procedures in order to process
disclosures with certain forms and in elec-
tronic formats. Because the amendments
to section 6694 are effective immediately
for returns prepared after May 25, 2007,
the Service and the Treasury Department
believe that effective tax administration
requires transitional relief with respect to
the new standards of conduct under sec-
tion 6694(a).
PENALTY UNDER SECTION 6694
Prior to amendment by the Act, the
penalty under section 6694(a) applied if:
(1) any part of an understatement of li-
ability with respect to any return or claim
for refund is due to a position for which
there was not a realistic possibility of be-
ing sustained on its merits,
(2) any person who is an income tax
return preparer with respect to such return
or claim knew (or reasonably should have
known) of such position, and,
(3) such position was not disclosed as
provided in section 6662(d)(2)(B)(ii) or
was frivolous.
Prior to amendment by the Act, the
penalty under section 6694(b) applied if
any part of an understatement was due to:
(1) a willful attempt in any manner by
an income tax return preparer to understate
the liability for tax; or
(2) to any reckless or intentional disre-
gard of rules or regulations by an income
tax return preparer.
Section8246oftheActamendedsev-
eral provisions of the Code to extend the
scope of the income tax return preparer
penalties to preparers of all tax returns,
amended returns and claims for refund, in-
cluding estate and gift tax returns, genera-
tion-skipping transfer tax returns, employ-
ment tax returns, andexcise tax returns.
The Act amended section 6694(a) to pro-
vide that the penalty would apply if:
(A) the tax return preparer knew (or rea-
sonably should have known) of the posi-
tion,
(B) there was not a reasonable belief
that the position would more likely than
not be sustained on its merits, and
(C)(i) the position was not disclosed as
provided in section 6662(d)(2)(B)(ii), or
(ii) there was no reasonable basis for the
position.
Although the Act did not alter the stan-
dard of conduct under section 6694(b), it
increased the amount of the penalty and
made the penalty applicable to all tax re-
turn preparers.
Section 8246 of the Act amends the
standards of conduct under section 6694(a)
in two ways. First, for undisclosed po-
sitions, the Act replaces the realistic pos-
sibility standard with a requirement that
there be a reasonable belief that the tax
treatment of the position would more
likely than not be sustained on its mer-
its. Second, for disclosed positions, the
Act replaces the not-frivolous standard
with the requirement that there be a rea-
sonable basis for the tax treatment of the
position.
The Act also increased the first-tier sec-
tion 6694(a) penaltyfor understatements
from $250 to the greater of $1000 or 50%
of the income derived (or to be derived)
by the tax return preparer from the prepa-
ration of a return or claim with respect to
which the penalty was imposed. The Act
increased the second-tier section 6694(b)
penalty for willful or reckless conduct
from $1000 to the greater of $5,000 or
50% of the income derived (or to be de-
rived) by the tax return preparer.
Under both the prior and current law,
disclosure under section 6694(a) is ade-
quate if made on a Form 8275,Disclosure
Statement, or Form 8275–R,Regulation
Disclosure Statement, attached to the re-
turn, amended return, or refund claim, or
pursuant to the annual revenue procedure
authorized in Treasury Regulation sec-
tions 1.6694–2(c)(3) and 1.6662–4(f)(2).
In addition, under both the prior and cur-
rent law, the penalty under section 6694(a)
would not be imposed if it is shown that
there is reasonable cause for the under-
statement and the tax return preparer acted
in good faith.
July 2, 2007122007–27 I.R.B.

TRANSITIONAL RELIEF
In order to provide sufficient time to ad-
dress issues pertaining to the implementa-
tion of the Act, the Service is providing
the following transitional relief: For in-
come tax returns, amended returns, and re-
fund claims, the standards set forth under
the previous law and current regulations
under section 6694 will be applied in de-
termining whether the Service will impose
a penalty under section 6694(a). Gener-
ally, in applying transitional relief for in-
come tax returns, amended returns or re-
fund claims, disclosure would be adequate
if made on a Form 8275,Disclosure State-
ment, or Form 8275–R,Regulation Dis-
closure Statement, attached to the return,
amended return, or refund claim, or pur-
suant to the annual revenue procedure au-
thorized in Treasury Regulation sections
1.6694–2(c)(3) and 1.6662–4(f)(2).
For all other returns, amended returns,
and claims for refund, including estate,
gift, and generation-skipping transfer tax
returns, employment tax returns, and ex-
cise tax returns, the reasonable basis stan-
dard set forth in the regulations issued un-
der section 6662, without regard to the
disclosure requirements contained therein,
will be applied in determining whether the
Service will impose a penalty under sec-
tion 6694(a).
This transitional relief will apply to
all returns, amended returns, and refund
claims due on or before December 31,
2007 (determined with regard to any
extension of time for filing); to 2007 esti-
mated tax returns due on or before January
15, 2008; and to 2007 employment and
excise tax returns due on or before January
31, 2008.
No transitional relief is available under
section 6694(b) as transitional relief is not
appropriate for return preparers who ex-
hibit willful or reckless conduct, regardless
of the type of return prepared.
EFFECTIVE DATE
This notice is effective as of May 25,
2007.
CONTACT INFORMATION
The principal author of this notice is
Michael E. Hara of the Office of Associate
Chief Counsel (Procedure and Adminis-
tration). For further information regard-
ing this notice, contact Mr. Hara at (202)
622–4910 (not a toll-free call).
Guidance to Clarify the
Treatment of Certain
Distributions Under Internal
Revenue Code Section
897(h)(1)
Notice 2007–55
PURPOSE
The Treasury Department (Treasury)
and Internal Revenue Service (IRS) are
aware of a type of transaction, described
below, in which a foreign government
inappropriately claims that certain dis-
tributions from a real estate investment
trust (REIT) or other qualified investment
entitytotheforeigngovernmentarenot
subject to section 897(h)(1) of the Inter-
nal Revenue Code (Code) or are exempt
from taxation under section 892 of the
Code. This notice alerts taxpayers and
their representatives that the IRS intends
to challenge such claims under the rel-
evant current statutory and regulatory
provisions. In addition, Treasury and the
IRS intend to issue regulations that will
clarify the correct interpretation of these
provisions. These regulations will apply
to distributions occurring on or after June
13, 2007.
TRANSACTIONS AT ISSUE
In a typical transaction, a foreign gov-
ernment purchases a non-controlling inter-
est in a privately held (and domestically
controlled) REIT, with a view to receiving
dividends from the REIT over the course
of the remaining life of the REIT (for ex-
ample, five to seven years). At the end of
the REIT’s life, the REIT typically sells
all or a portion of its assets and distributes
the sales proceeds (and any remaining as-
sets) to its shareholders in complete liqui-
dation. In some cases, the liquidation may
take place over more than one year.
Notwithstanding section 897(h)(1), the
foreign government (or withholding agent)
asserts that distributions from the REIT
(including distributions in liquidation) that
are attributable to gain from the sale or
exchange of a United States real prop-
erty interest (USRPI) described in section
897(c)(1)(A)(i) areexempt from taxation
(and withholding) under section 892. The
foreign government (or withholding agent)
may also assert that section 897(h)(1) does
not apply to liquidating distributions from
the REIT.
BACKGROUND
Section 892 addresses the taxation of
income of foreign governments. Section
892(a)(1) excludes from gross income
and exempts from U.S. federal income
tax certain categories of income earned
by foreign governments, including divi-
dends from and capital gains with respect
to investments in the United States in
stocks, bonds, or other domestic securi-
ties. Section 892(a)(2)(A) provides that
the exclusion under section 892(a)(1) does
not apply to income derived from the con-
duct of any commercial activity (whether
within or without the United States), in-
come received by a controlled commercial
entity or received (directly or indirectly)
from a controlled commercial entity, or in-
come derived from the disposition of any
interest in a controlled commercial entity.
In addition, income derived from sources
other than described in section 892(a)(1)
is not excluded from gross income and is
not exempt from tax under section 892.
See the flush language following Treas.
Reg. § 1.892–3T(a)(1)(iii). Under section
892(a)(3), a foreign government is treated
as a corporate resident of its country for
purposes of the Code.
Section 897 provides special rules for
the disposition of an investment in U.S.
real property. Section 897(a)(1) provides,
in part, that gain or loss of a nonresi-
dent alien individual or a foreign corpo-
ration from the disposition of a USRPI is
taken into account under section 871(b)(1)
or 882(a)(1) as if the nonresident alien
individual or foreign corporation, respec-
tively, were engaged in a trade or busi-
ness in the United States during the tax-
able year and as if such gain or loss were
effectively connected with such trade or
business. Section 897(c)(1)(A) defines a
USRPI to mean (i) an interest in real prop-
erty located in the United States or the Vir-
gin Islands and (ii) any interest (other than
solely as a creditor) in a domestic corpo-
ration that is a United States real prop-
erty holding corporation (USRPHC). As
defined in section 897(c)(2), a USRPHC
2007–27 I.R.B.13July 2, 2007

means any corporation if the fair market
value of its USRPIs equals or exceeds 50
percent of the total fair market value of its
USRPIs, its interests in real property lo-
cated outside the United States, and any
other assets which are used or held for use
in a trade or business.
Section 897(h)(1) provides that any dis-
tribution by a qualified investment entity
to a nonresident alien individual, foreign
corporation, or other qualified investment
entity shall, to the extent attributable to
gain from the sale or exchange by the
qualified investment entity of a USRPI, be
treated as gain recognized by such nonres-
ident alien individual, foreign corporation,
or other qualified investment entity from
the sale or exchange of a USRPI. Thus,
such distributions are taxable to such
nonresident alien individual or foreign
corporation under section 897(a)(1). For
purposes of section 897(h)(1), a qualified
investment entity means any REIT and
any regulated investment company (RIC)
described in section 897(h)(4)(A)(i)(II).
A foreign government is treated un-
der Treas. Reg. § 1.897–9T(e) as a
foreign person with respect to USRPIs.
Further, Treas. Reg. §§ 1.897–9T(e)
and 1.1445–10T(b) provide that a foreign
government is subject to taxation under
sections 897 and 1445 on the disposition
of a USRPI “except to the extent specifi-
cally otherwise provided in the regulations
issued under section 892.”
The regulations issued under section
892 do not specifically exempt foreign
governments from taxation under sections
897 and 1445. The flush language fol-
lowing Treas. Reg. § 1.892–3T(a)(1)(iii)
provides that:
Income derived from sources other
than described in this paragraph
[§ 1.892–3T(a)(1)] (such as income
earned from a U.S. real property inter-
est described in section 897(c)(1)(A)(i))
is not exempt from taxation under sec-
tion 892. Furthermore, any gain de-
rived from the disposition of a U.S.
real property interest defined in section
897(c)(1)(A)(i) shall in no event qual-
ify for exemption under section 892.
This language makes it clear that gain
from the disposition of a USRPI described
in section 897(c)(1)(A)(i) is not exempt
from taxation under section 892. Gain
derived by a foreign government from
the disposition of a USRPI defined in
section 897(c)(1)(A)(ii) (i.e., an interest
in a USRPHC), however, is exempt from
tax under Treas. Reg. § 1.892–3T if
the USRPHC does not constitute a con-
trolled commercial entity under section
892(a)(2)(B).See Example (1)of Treas.
Reg. § 1.892–3T(b).
TREATMENT OF DISTRIBUTIONS
UNDER SECTION 897(h)(1)
1. Distributions During the Life of the
REIT
Section 897(h)(1) treats any distribu-
tion by a qualified investment entity to
a foreign corporation as gain recognized
by the foreign corporation from the dis-
position of a USRPI to the extent that the
distribution is attributable to gains from
sales or exchanges by the qualified invest-
ment entity of USRPIs. As a result, to the
extent that such distributions are attribut-
able to gain recognized from sales or ex-
changes of a USRPI, the distributions are
subject to U.S. income taxation under sec-
tions 897(a)(1) and 882(a)(1) as effectively
connected income and to withholding un-
der section 1445(e). In addition, where ap-
plicable, such distributions are treated and
taxed as gain attributable to the alienation
of a USRPI under the capital gains articles
of U.S. income tax treaties.
Accordingly, the IRS will challenge
under current statutory and regulatory
provisions an assertion that section 892
exempts from taxation (and withhold-
ing) distributions froma qualified invest-
ment entity that are treated under section
897(h)(1) as gain recognized by a foreign
government shareholder from the sale or
exchange of a USRPI described in section
897(c)(1)(A)(i). In addition, Treasury and
the IRS will clarify in regulations that the
language in Treas. Reg. § 1.892–3T(a)(1)
denying exemption from taxation with
respect to a disposition of a USRPI de-
fined in section 897(c)(1)(A)(i) applies
also to distributions attributable to gain
from the sale or exchange of USRPIs to
which section 897(h)(1) applies. Thus, the
regulations will clarify that distributions
received by a foreign government from a
qualified investment entity that are attrib-
utable to gain from sales or exchanges by
the qualified investment entity of USRPIs
described in section 897(c)(1)(A)(i) are
not exempt from taxation under section
892. Instead, the regulations will clarify
that such distributions are subject to U.S.
income taxation under section 882(a)(1)
as effectively connected income pursuant
to section 897(a)(1) and to withholding
under section 1445(e). In addition, the
regulations will clarify that, where appli-
cable, such distributions are treated and
taxed as gain attributable to the alienation
of a USRPI under the capital gains articles
of U.S. income tax treaties.
2. Liquidating Distributions
Sections 897(h)(1) and 1445(e)(6) by
their terms apply to all distributions to
the extent attributable to gain from sales
or exchanges by the qualified investment
entity of a USRPI. Accordingly, the IRS
will challenge under current statutory and
regulatory provisions an assertion by any
foreign taxpayer that section 897(h)(1)
does not apply to distributions in com-
plete liquidation under sections 331 and
332. In addition, regulations will clarify
that the application of section 897(h)(1)
and withholding under section 1445(e) is
not limited to distributions by qualified
investment entities that are subject to sec-
tion 316. The regulations will clarify that
the term “distribution,” as used in sections
897(h)(1) and 1445(e)(6), includes any
distribution included under sections 301,
302, 331, and 332, where the distribution
is attributable, in whole or in part, to gain
from the sale or exchange of a USRPI
by a qualified investment entity or other
pass-through entity.
EFFECTIVE DATE
Regulations incorporating the guidance
in this notice will apply to distributions
occurring on or after June 13, 2007.
DRAFTING INFORMATION
The principal authors of this notice are
David A. Juster and Margaret A. Hogan of
the Office of the Associate Chief Counsel
(International). However, other personnel
from Treasury and the IRS participated in
its development. For further information
regarding section 892 issues in this notice,
contact Mr. Juster at (202) 622–3850 (not
a toll-free call). For further information
regarding section 897 issues in this notice,
July 2, 2007142007–27 I.R.B.

contact Ms. Hogan at (202) 622–3860 (not
a toll-free call).
Change of Address for
Submission of CREBs
Applications
Notice 2007–56
This notice changes the address for
submission by mail of applications for
allocations of the national clean renewable
energy bond (“CREB”) volume limitation
(“volume cap”) allocations under section
54 of the Internal Revenue Code (the
“Code”) and Notice 2007–26, 2007–14
I.R.B. 870 (April 2, 2007). Applicants
for CREB volume cap allocations submit-
ting applicationsby mailmust send their
applications to Internal Revenue Service
(IRS), Attention: Deb Beaulieu, 56 In-
verness Drive East MS 7222, Englewood,
CO 80112. This noticemodifiesNotice
2007–26, which provides guidance on
CREBs in connection with the allocation
process for the available volume cap au-
thorization under section 54.
Section 1303 of the Energy Tax Incen-
tives Act of 2005, Pub. L. No. 109–58,
119 Stat. 594 (2005) (the “2005 Act”),
addedsection54totheCode. Section
54 originally provided for a total national
volume cap of $800 million for CREBs
to finance eligible clean renewable energy
projects. Pursuant to the 2005 Act, during
2006 the Internal Revenue Service allo-
cated the $800 million volume cap to qual-
ified clean renewable energy projects.
Section 202 of the Tax Relief and
Health Care Act of 2006, Pub. L. No.
109–432, 120 Stat. 2922 (2006) (the
“2006 Act”), amended section 54, in part,
by increasing the total national volume
cap for CREBs from $800 million to $1.2
billion. Pursuant to the 2006 Act, Notice
2007–26 solicits applications of the avail-
able CREB volume cap as described in
section 6 of Notice 2007–26.
Section 3.d. of Notice 2007–26 pro-
vides that CREB applications must be sub-
mitted in one of the following ways: (1)
by hard copy in duplicate accompanied by
a copy of the application in electronic for-
mat on compact disc (“CD”) by mail to
the Internal Revenue Service (IRS), Atten-
tion SE:T:GE:TEB, 1111 Constitution Av-
enue, NW, PE – 5N3, Washington, D.C.
20224; (2) by hard copy in duplicate ac-
companied by a copy of the application in
electronic format on compact disc (“CD”)
by hand delivery Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to the Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue, NW,
PE – 5N3, Washington, D.C., attention
SE:T:GE:TEB; or (3) by electronic sub-
mission in PDF format of a copy of a
signed original document to the IRS to
Tina.F.Hill@irs.gov.
This notice changes the address to
which applicants may send applications
for CREB volume cap authorityby mail
only. Item (1) of section 3.d. of Notice
2007–26 is amended to read as follows:
“(1) by hard copy in duplicate accom-
panied by a copy of the application in
electronic format on compact disc (“CD”)
by mail to the Internal Revenue Service
(IRS), Attention: Deb Beaulieu, 56 In-
verness Drive East MS 7222, Englewood,
CO 80112;”.
This noticemodifiesNotice 2007–26.
This notice is effective immediately upon
release.
The principal authors of this notice
are Zoran Stojanovic and Timothy L. Jones
of the Office of Associate Chief Counsel
(Financial Institutions & Products). For
further information regarding this notice,
contact Tina Hill at (202) 283–9774 (not a
toll-free call).
Note.This revenue procedure will be reproduced as the next revision of IRS Publication 4436, General Rules and Specifications for
Substitute Form 941 and Schedule B (Form 941).
Rev. Proc. 2007–42
TABLE OF CONTENTS
SECTION 1 – PURPOSE
............................................................................................. 16
SECTION 2 – WHAT’S NEW......................................................................................... 16
SECTION 3 – GENERAL REQUIREMENTS FOR REPRODUCING IRS OFFICIAL FORM 941 AND
SCHEDULE B (FORM 941)
.............................................................................. 17
SECTION 4 – REPRODUCING FORM 941 AND SCHEDULE B (FORM 941) FOR SOFTWARE-GENERATED
PAPER FORMS
......................................................................................... 17
SECTION 5 – OMB REQUIREMENTS FOR SUBSTITUTE FORMS....................................................... 18
SECTION 6 – REPRODUCIBLE COPIES OF FORMS................................................................... 19
SECTION7–EFFECTONOTHERDOCUMENTS..................................................................... 19
SECTION 8 – EXHIBITS............................................................................................ 19
2007–27 I.R.B.15July 2, 2007

Section 1 – Purpose
.01The purpose of this publication is to provide general rules and specifications from the Internal Revenue Service (IRS) for paper
and computer-generated substitutes for theJanuary 2007 revision of Form 941, Employer’s QUARTERLY Federal Tax Return, and
for the January 2006 revision of Schedule B (Form 941), Report of Tax Liability for Semiweekly Schedule Depositors.
Note.Substitute territorial forms (941-PR, 941-SS, and Anexo B (Forma 941-PR)) should also conformto the specifications outlined
in this revenue procedure.
.02This publication provides measurementsand printing specifications for substitute Form 941 and Schedule B (Form 941). If
you need more in-depth information on who must complete the forms and how to complete them, see the Instructions for Form 941
and Publication 15 (Circular E), Employer’s Tax Guide, or visit the IRS website atw
ww.irs.gov.
.03Forms should not be submitted to the IRS for specific approval. If you are uncertain of any specification and want clarification,
do the following.
(1) Submit a letter citing the specification.
(2) State your understanding of the specification.
(3) Enclose an example (if appropriate) of how the formwould appear if produced using your understanding.
(4) Use the following address. Be sure to include your name, complete address, phone number, and, if applicable, your email
address with your correspondence.
Internal Revenue Service
Attn: Substitute Forms Program
SE:W:CAR:MP:T:T:SP, IR-6406
1111 Constitution Avenue, NW
Washington, DC 20224
Note.Allow at least 30 days for the IRS to respond.
.04However, software developers and form producers should send ablank copy of their substitute Form 941 and Schedule B (Form
941) in pdf format toD
orene.Beard@irs.gov. The purpose is not specifically for approval but to assist the IRS in preparing to scan
these forms. Submitters will only receive comments if a significant problem is discovered through this process. Submitters are not
expected to delay marketing their forms inorder to receive feedback. In no case should submitters include “live” taxpayer data.
.05The six-digit form ID (95xxxx) on Form 941 and Schedule B (Form 941) identifies the official substitute paper form. The
six-digit form ID (97xxxx) identifies substitute 6x10 grid Form 941 and Schedule B (Form 941). The six-digit form ID (99xxxx)
identifies the official IRS issued Form 941and Schedule B (Form 941). The last two digits of the code identify the calender year. For
example, the last two digits of ID code97107 identifies calender year 2007.
Section 2 – What’s New
.01There are new 6x10 grid layouts for the 2007 revisions of Form 941.
.02There are no changes to the January 2006 revision of Schedule B(Form 941), and therefore, this revision remains useable.
.03We added the year to the heading for the “Report for this Quarter” box in the upper right corner of page 1.
.04We added space between line 13 and the instructions below it.
.05We deleted the entry space for the third party designee’s telephone number in Part 4 on page 2. In addition, we moved the text
“Personal Identification Number” and the fill-in boxes for the number tothe left to line up under “Designee’s name.”
.06To increase visibility, we reformatted the signature section in Part 5 on page 2 to conform to the signature areas of new Form
944.
.07We made changes to the text of the instructions to the payment voucher, Form 941-V. We revised the first sentence of the third
paragraph in the section “Making Payments With Form 941.”
.08We changed the wording of the second line of text for line 12 from “Make checks payable to UnitedStates Treasury” to “Follow
the Instructions for Form 941-V, Payment Voucher.”
July 2, 2007162007–27 I.R.B.

Section 3 – General Requirements for Reproducing IRS Official Form 941 and Schedule B
(Form 941)
.01Donotsubmit substitute Form 941 and Schedule B (Form 941) to the IRS for approval. Substitute Form 941 and Schedule B
(Form 941) thatcompletely conformto the specifications contained in this revenue procedure do not require prior approval from the
IRS.
.02Print the form on paper that is 8.5 inches wide by 11 inches deep.
.03Use white paper that meets generally-accepted weight, color,and quality standards (minimum 20 lb. white bond paper).
Note.Reclaimed fiber in any percentage is permitted provided that the requirements of this standard are met.
.04The IRS prefers printing Form 941 on both sides of a single sheet of paper, but it is acceptable to print on one side of each of
two separate sheets of paper.
.05Make substitute paper forms as identical to the official IRS-printed forms as possible.
.06Print using nonreflective black inks.
.07Use typefaces that are substantially identicalin size and shape to the official forms and use rules and shading that are substan-
tially identical to those on the official forms.
.08Print the six-digit form ID codes in the upper right-hand corner of each form using nonreflective black, carbon-based, 12-point
(minimum 10-point required) OCR-A font. Use the official paper over-the-counter IRS forms to develop your substitute paper forms.
Print “950107” on page 1 of Form 941, “950207” on page 2 of Form 941, and “950306” on Schedule B (Form 941) of substitute paper
forms. See Section 4 for form ID codes for software-generated forms.
Note.Maintain as much white space as possible around the form ID code. Do not allow character strings to print adjacent to the code.
.09Print the OMB number in the same location as on the official forms.
.10Print all entry boxes and checkboxes exactly as shown on the official forms.
.11Print your IRS-issued three-letter substitute form printer source code in the middle at the bottom of page 1 of Form 941.
Note.You can obtain a three-letter substitute form printer source code by requesting it by email at*
taxforms@irs.gov.(Theasterisk
must be included in the address.) Please enter “Substitute Forms” on the subject line.
.12Print “For Privacy Act and Paperwork Reduction Act Notice, see the back of the Payment Voucher” at the bottom of page 1 of
Form 941.
.13Print “For Paperwork Reduction Act Notice, see separate instructions” at the bottom of Schedule B (Form 941).
.14Do not print the form catalog number (“Cat. No.”) at the bottom of the forms or instructions.
.15Do not print the Government Printing Office (GPO) symbol at the bottom of the forms or instructions.
.16See Exhibits A and B in Section 8.
Section 4 – Reproducing Form 941 and ScheduleB (Form 941) for Software-Generated Paper
Forms
.01You may use the 6x10 grid exhibits (C and D) at the end of this document to develop a software version of Form 941 and
Schedule B (Form 941). Please follow the specifications exactly to develop the fields.
.02If you are developing software that is designed using the 6x10 grid in the exhibits, you may make the following modifications.
See Exhibits C and D in Section 8.
•Use “970107” for page 1 of Form 941, “970207” for page 2 of Form 941, and “970306” for Schedule B (Form 941) as the form
ID codes.
Note.Maintain as much white space as possible around the form ID code. Do not allow character strings to print adjacent to the
code.
•Place all boxes and entry spaces in the same field locations as indicated in the 6x10 grid exhibits.
•Use single lines for “Employer Identification Number” (EIN) and other entry areas in the entity section of page 1 of Form 941.
•You do not need to use reverse type as shown on the IRS official form.
•You do not need to pre-print decimal points in the data boxes. However, where the amounts are required, the amounts should be
printed with decimal points and place holders for cents.
2007–27 I.R.B.17July 2, 2007

•Use a single box for “state abbreviation” in line 14 of Form 941.
•Delete the pre-printed formatting in the “date” box for line 16 and in Parts 5 and 6 of Form 941.
•Delete the pre-printed formatting in the “Phone” box for Parts 5 and 6.
•Use a single box for “Personal Identification Number (PIN)” in Part 4 of Form 941.
•You may delete all shading when using the 6x10 grid format.
.03If producing both the form and the data or the form only, print your three-letter IRS-issued form printer source code in Row
63, Columns 49-51 on page 1 of Form 941. See Section 3.11.
.04If producing only the data on the form, print your four-digit software industry form code in Row 4, Columns 58-61 on page 1
of Form 941. See the National Association of Computerized Tax Processors (NACTP) website atw
ww.nactp.orgfor information on
these codes.
.05Print “For Privacy Act and Paperwork Reduction Act Notice,see the Payment Voucher” at the bottom of page 1 of Form 941.
.06Print “For Paperwork Reduction Act Notice, see separate instructions” at the bottom of Schedule B (Form 941).
.07Do not print the form catalog number (“Cat. No.”) at the bottom of the forms or instructions.
.08Do not print the Government Printing Office (GPO) symbol at the bottom of the forms or instructions.
.09To enable accurate scanning and processing, enter data on Form 941 and Schedule B (Form 941) as follows:
•Show name and EIN on all pages and attachments.
•Use 12-point (minimum 10-point) Courier font (if possible).
•Omit dollar signs,
but use commas to show amounts.
•Except for lines 1, 2, and 10, leave blank any data field with a va
lue of zero.
•Enter negative amounts with a minus sign. For example, report “-10.59” instead of “(10.59).”
Note.The IRS prefers that you use a minus sign for negative amounts instead of parentheses or some other means. However, if
your software only allows for parentheses in reporting negative amounts, you may use them.
Section 5 – OMB Requirements for Substitute Forms
.01The Paperwork Reduction Act (the Act) of 1995 (Public Law 104-13) requires the following.
•The Office of Management and Budget (OMB) approves all IRS tax forms that are subject to the Act.
•Each IRS form contains the OMB approval number, if assigned.(The official OMB numbers may be found on the official IRS
forms and are also shown on the forms in the exhibits.)
•Each IRS form (or its instructions) states:
(1) Why the IRS needs the information,
(2) How it will be used, and
(3) Whether or not the information is required to be furnished to the IRS.
.02This information must be provided to any users of official or substitute IRS forms or instructions.
.03The OMB requirements for substitute IRS forms are the following.
•Any substitute form or substitute statement to a recipient must show the OMB number as it appears on the official IRS form.
•For Form 941 and Schedule B (Form 941), the OMB number (1545-0029) must appear exactly as shown on the official IRS form.
•For Form 941 and Schedule B (Form 941), the OMB number must use one of the following formats.
(1) OMB No. 1545-0029 (preferred) or
(2) OMB # 1545-0029 (acceptable).
.04If no instructions are provided to users on your forms, you must furnish to them the exact text of the Privacy Act and Paperwork
Reduction Act Notice.
July 2, 2007182007–27 I.R.B.

Section 6 – Reproducible Copies of Forms
.01You can order official IRS forms and information copies of federal tax materials at local IRS offices or by calling the IRS
National Distribution Center at 1-800-829-3676. Otherways to get federal tax material include the following.
•TheIRSwebsiteatwww.irs.gov.
•The IRS’ CD (Publication 1796).
.02The IRS also offers an alternative to downloading electronic files and provides current and prior year access to tax forms and
instructions through its Federal Tax Forms CD. Order Publication 1796, IRS Federal Tax Products CD, by using the IRS website at
w
ww.irs.gov/cdordersor by calling 1-877-CDFORMS (1-877-233-6767).
Section 7 – Effect on Other Documents
.01Revenue Procedure 2006-25, 2006-21 I.R.B. 926 (reproduced as Publication 4436, Rev. 5-2006) is superseded.
Section 8 – Exhibits
.01Please follow the specifications indicatedin the following exhibits to produce substitute Form 941 and Schedule B (Form 941).
.02These forms are subject to review and possible change as required. Therefore, employers are cautioned against overstocking
supplies of privately-printed substitutes.
.03Donotsubmit substitute Form 941 and Schedule B (Form 941) to the IRS for approval. Substitute Form 941 and Schedule B
(Form 941) thatcompletely conformto the specifications contained in this revenue procedure may be privately printed without prior
approval from the IRS.
2007–27 I.R.B.19July 2, 2007

July 2, 2007202007–27 I.R.B.

2007–27 I.R.B.21July 2, 2007

July 2, 2007222007–27 I.R.B.

2007–27 I.R.B.23July 2, 2007

July 2, 2007242007–27 I.R.B.

2007–27 I.R.B.25July 2, 2007

Note.This revenue procedure will be reproduced as the next revision of IRS Publication 1141, General Rules and Specifications for
Substitute Forms W-2 and W-3.
26 CFR 601.602: Tax forms and instructions.
(Also Part I, Sections 6041, 6051, 6071, 6081, 6091; 1.6041–1, 1.6041–2, 31.6051–1, 31.6051–2, 31.6071(a)–1, 31.6081(a)–1, 31.6091–1.)
Rev. Proc. 2007–43
TABLE OF CONTENTS
Part A. General
SECTION 1. PURPOSE............................................................................................. 26
SECTION 2. WHAT’S NEW.......................................................................................... 27
SECTION 3. GENERAL RULES FOR PAPER FORMS W-2 AND W-3..................................................... 28
SECTION 4. GENERAL RULES FOR FILING FORMS W-2 (COPY A) ELECTRONICALLY................................. 29
Part B. Specifications for Substitute Forms W-2 and W-3
SECTION 1A. SPECIFICATIONS FOR RED-INKSUBSTITUTE FORM W-2 (COPY A) AND FORM W-3
FILED WITH THE SSA
.................................................................................. 30
SECTION 1B. SPECIFICATIONS FOR LASER-PRINTED SUBSTITUTE FORM W-2 (COPY A) AND FORM
W-3 FILED WITH THE SSA
.............................................................................. 31
SECTION 2. REQUIREMENTS FOR SUBSTITUTE FORMS FURNISHED TO EMPLOYEES (COPIES B, C,
AND 2 OF FORM W-2)
.................................................................................. 33
Part C. Additional Instructions
SECTION 1. ADDITIONAL INSTRUCTIONS FOR FORM PRINTERS.................................................... 35
SECTION 2. INSTRUCTIONS FOR EMPLOYERS...................................................................... 36
SECTION 3. OMB REQUIREMENTS FOR BOTH RED-INK AND LASER-PRINTED SUBSTIT
UTE FORMS
................... 36
SECTION 4. REPRODUCIBLE COPIES OF FORMS.................................................................... 37
SECTION 5. EFFECT ON OTHER DOCUMENTS...................................................................... 37
Part A. General
Section 1. Purpose
.01The purpose of this revenue procedure is to state the requirements of the Internal Revenue Service (IRS) and the Social Security
Administration (SSA) regarding the preparation and use of substitute forms for Form W-2, Wage and Tax Statement, and Form W-3,
Transmittal of Wage and Tax Statements, for wages paid during the 2007 calendar year.
.02For purposes of this revenue procedure, substitute Form W-2 (Copy A) and substitute Form W-3 are forms that are not printed
by the IRS. Copy A or any other copies of a substitute Form W-2or a substitute Form W-3 must conform to the specifications in
this revenue procedure to be acceptable to the IRS and the SSA. No IRS office is authorized to allow deviations from this revenue
procedure. Preparers should also refer to the separate 2007 Instructions for Forms W-2 and W-3 for details on how to complete
these forms. See Part C, Section 4, for information on obtaining the official IRS forms and instructions. See Part B, Section 2, for
requirements for the copies of substitute forms furnished to employees.
.03For purposes of this revenue procedure, the official, IRS-printed red dropout ink Forms W-2 (Copy A) and W-3 and their exact
substitutes are referred to as “red-ink.” TheSSA-approved, laser-printed, black-and-white Forms W-2 (Copy A) and W-3 are referred
to as “laser-printed.”
Any questions about the red-ink Form W-2 (Copy A) and Form W-3 and the substitute employee statements should be emailed to
*
taxforms@irs.gov(the asterisk must be included in the address). Please enter “Substitute Forms” on the subject line. Or send your
questions to:
July 2, 2007262007–27 I.R.B.

Internal Revenue Service
Attn: Substitute Forms Program
SE:W:CAR:MP:T:T:SP, IR 6406
1111 Constitution Ave., NW
Washington DC 20224
Any questions about the black-and-white laser-printed Form W-2 (Copy A) and Form W-3 should be emailed to
l
aser.forms@ssa.govor sent to:
Social Security Administration
Data Operations Center
Attn: Laser Forms Approval, Room 235
1150 E. Mountain Drive
Wilkes-Barre PA 18702-7997
Also, see Sections 3.05 and 3.06 of Part A.
Note.You should receive a response within 30 days from either the IRS or the SSA.
.04The IRS maintains a centralized call site at its Enterprise Computing Center — Martinsburg (ECC)to answer questions related
to information returns (Forms W-2, W-3, 1099 series, 1096, etc.). You can reach the call site at 304-263-8700 (not a toll-free number)
or 1-866-455-7438 (toll-free). The Telecommunication Device for the Deaf (TDD) number is 304-267-3367 (not a toll-free number).
The hours of operation are Monday through Friday from 8:30 a.m. to 4:30 p.m. Eastern time. IRS/ECC does not process Forms W-2
(Copy A). Forms W-2 (Copy A) prepared on paper and/or electronically must be filed with the SSA. IRS/ECC does, however, process
waiver requests (Form 8508, Request for Waiver From Filing Information Returns Electronically/Magnetically) and extension of time
to file requests (Form 8809, Application for Extension of Time To File Information Returns) for Forms W-2 (Copy A) and requests
for an extension of time to furnish the employee copies of FormW-2. See Publication 1220, Specifications for Filing Forms 1098,
1099, 5498, and W-2G Electronically or Magnetically, for information on waivers and extensions of time.
.05The following form instructions and publications provide more detailed filing procedures for certain information returns:
•2007 Instructions for Forms W-2 and W-3,
•Instructions for Forms W-2c and W-3c (Rev. January 2006), and
•Publication 1223, General Rules and Specifications for Substitute Forms W-2c and W-3c.
Section 2. What’s New
.01 Relocation of employee’s SSN on Form W-2.We moved the “Employee’s social security number” box on Form W-2 from
box d to box a. We moved the “Control number” box, optionally used by some employers to identify individual Forms W-2, from
box a to box d. We also relocated the form ID number (“22222”) and “Void” boxes to the top left corner of Form W-2. We made
these changes to protect the employee’s SSN from disclosure when employers furnish Forms W-2 to their employees using a window
envelope and to enhance processing efficiency.
.02 Relocation of form ID on Form W-3.For consistency with the revisions to Form W-2, we relocated the form ID number
(“33333”) to the top left corner of Form W-3.
.03 Form W-3PR.Form W-3PR is 7.3 inches wide and should beprintedon8.5by11-inchpaperusinga.5-inch top margin with
.6-inch left and right margins.
.04 Logos and advertising.The IRS has identified questionable Forms W-2 as a key indicator of potentially abusive and fraudulent
returns. Some questionable Forms W-2 may be confused with legitimate Forms W-2 that carry logos and advertisements. The IRS has
received questions concerning whether a logo or an identifying slogan for an employer or other preparer is acceptable on the substitute
employee statements. We were also asked whether an advertisement for tax preparation software or other marketing materials are
acceptable on, or attached to, the substitute employee statements. The IRS is continuing to solicit comments regarding these questions.
The IRS anticipates responding to these questions by revising the regulations concerning this issue after the comments have been
considered, and it will include requirements brought about by theregulations in a future update of this revenue procedure. Send your
comments to:
2007–27 I.R.B.27July 2, 2007

Internal Revenue Service
Attn: Substitute Forms Program
SE:W:CAR:MP:T:T:SP, IR 6406
1111 Constitution Ave., NW
Washington DC 20224
.05 Title change.SSA publication MMREF-1, Magnetic Media Reportingand Electronic Filing, has been changed to SSA publi-
cation EFW2, Specifications for Filing Forms W-2 Electronically.
.06 Editorial changes.We made editorial changes. Redundancies were eliminated as much as possible.
Section 3. General Rules for Paper F
orms W-2 and W-3
.01Employers not filing electronically must file paper FormsW-2(CopyA)alongwithFormW-3withtheSSAbyusingeither
the official IRS form or a substitute form that exactly meets thespecifications shown in Parts B and C of this revenue procedure.
Note.Substitute territorial forms (W-2AS, W-2GU, W-2VI) shouldalso conform to the specifications as outlined in this revenue
procedure. These forms require the form designation (“W-2AS,” “W-2GU,” “W-2VI”) on Copy A to be in black ink. If you are an
employer in the Commonwealth of the Northern Mariana Islands, you must contact the Division of Revenue and Taxation, Capitol
Hill, Saipan, MP, 96950, to get Form W-2CM and instructions for completing and filing the form.
Employers who file with the SSA electronically or on paper may design their own statements tofurnish to employees. These
employee statements designed by employers must comply with the requirements shown in Parts B and C.
.02Red-ink substitute forms that completely conform to the specifications contained in this revenue procedure may be privately
printed without prior approval from the IRS or the SSA. Only the black-and-white laser-printed forms need to be submitted to the
SSAforapproval(seeSection1BofPartB).
.03As in the past, Form W-2 (Copy A) and Form W-3 may be generated using a laser-printer by following all guidelines and
specifications (also see Section 1B of Part B). In general, regardless of the method of entering data, using black ink on Forms W-2
and W-3 provides better readability for processing by scanning equipment. Colorsother than black are not easily read by the scanner
and may result in delays or errors in the processing of Forms W-2 (Copy A) and W-3. The printing of the data should be centered
within the boxes. The size of the variable data must be printed in a font no smaller than 10-point.
Note.With the exception of the identifying number, the year, the form number for Form W-3, and the corner register marks, the
preprinted form layout for the red-ink Forms W-2 (Copy A) and W-3, must be in Flint J-6983 red OCR dropout ink or an exact match.
(See Section 1A.03 of Part B.)
.04Substitute forms filed with the SSA and substitute copies furnished to employees that do not conform to these specifications
are unacceptable. Forms W-2 (Copy A) and W-3 filed with the SSA that do not conform may be returned. In addition, penalties may
be assessed for not complying with the form specifications.
.05Substitute red-ink forms should not be submitted to either theIRS or the SSA for specific approval. If you are uncertain of any
specification and want clarification, do the following.
(1)Submit a letter or email citing the specification to the appropriate address in section 3.06.
(2)State your understanding of the specification.
(3)Enclose an example (if appropriate) of how the form would appear if produced using your understanding.
(4)Be sure to include your name, complete address, phone number, and if applicable, your email address with your correspon-
dence.
.06Any questions about the specifications, especially those for the red-ink Form W-2 (Copy A) and Form W-3, should be emailed
to*
taxforms@irs.gov(the asterisk must be included in the address). Please enter “Substitute Forms” on the subject line. Or send your
questions to:
Internal Revenue Service
Attn: Substitute Forms Program
SE:W:CAR:MP:T:T:SP, IR 6406
1111 Constitution Ave., NW
Washington DC 20224
July 2, 2007282007–27 I.R.B.

Any questions about the black-and-white laser-printed Form W-2 (Copy A) and Form W-3 should be emailed to
l
aser.forms@ssa.govor sent to:
Social Security Administration
Data Operations Center
Attn: Laser Forms Approval, Room 235
1150 E. Mountain Drive
Wilkes-Barre PA 18702–7997
Note.You should receive a response within 30 days from either the IRS or the SSA.
.07Forms W-2 and W-3 are subject to annual review and possible change. Therefore, employers arecautioned against overstocking
supplies of privately-printed substitutes.
.08Separate instructions for Forms W-2 and W-3 are provided inthe 2007 Instructions for Forms W-2 and W-3. Form W-3 should
be used only to transmit paper Forms W-2 (Copy A). Form W-3 is a single sheet including only essential filing information. Be sure
to make a copy of your completed Form W-3 for your records. Copies of the current year official IRS Forms W-2 and W-3, and the
instructions for those forms, may be obtained from most IRS offices or by calling 1-800-829-3676. The IRS provides only cutsheet
sets of Forms W-2 and cutsheets of Form W-3. The instructions and information copies of the forms may also be found on the IRS
website atw
ww.irs.gov.
.09Because substitute Forms W-2 (Copy A) and W-3 are machine-imaged and scanned by the SSA, the forms must meet the same
specifications as the official IRS Forms W-2 and W-3 (as shown in the exhibits).
Section 4. General Rules for Filing Forms W-2 (Copy A) Electronically
.01Employers must file Forms W-2 (Copy A) with the SSA electronically if they file 250 or more calendar year 2007 Forms W-2
(Copy A) during a calendar year unless the IRS granted a waiver.For details, get the 2007 Instructions for Forms W-2 and W-3.
The SSA publication EFW2, Specifications for Filing Forms W-2 Electronically, contains specifications and procedures for electronic
filing of Form W-2 information with the SSA. Employers are cautioned to obtain the most recent revision of EFW2 (and supplements)
due to any subsequent changes in specifications and procedures.
.02You may obtain a copy of the EFW2 by:
•Accessing the SSA website at:
w
ww.socialsecurity.gov/employer/pub.htm,
•Writing to:
Social Security Administration
OCO, DES; Attn: Employer Reporting Services Center
300 North Greene Street
Baltimore MD 21290-0300
•Calling your local SSA Employer Services Liaison Officer (ESLO) (the ESLOs’ phone numbers are available at:
w
ww.socialsecurity.gov/employer/empcontacts.htm), or
•Calling the SSA’s Employer Reporting Services staff at 1-800-772-6270.
.03Electronic filers do not file a paper Form W-3. See the SSA publication EFW2 for guidance on transmitting Form W-2 (Copy
A) information to SSA electronically.
.04Employers with fewer than 250 Forms W-2 are encouraged to electronically file Forms W-2 (Copy A) with the SSA. Doing so
will enhance the timeliness and accuracy of forms processing.
.05Employers who do not comply with the electronic filing requirements for Form W-2 (Copy A) and who are not granted a waiver
by the IRS may be subject to penalties. Employers who file Form W-2 information with the SSA electronically must not send the
same data to the SSA on paper Forms W-2 (Copy A). Any duplicate reporting may subject filers to unnecessary contacts by the SSA
or the IRS.
2007–27 I.R.B.29July 2, 2007

Part B. Specifications for Substitute Forms W-2 and W-3
Section 1A. Specifications for Red-Ink Substitute Form W-2 (Copy A) and Form W-3 Filed
with the SSA
.01The official IRS-printed red dropout ink Form W-2 (Copy A) and W-3 and their exact substitutes are referred to as red-ink in
this revenue procedure. Employers may file substitute Forms W-2 (Copy A) and W-3 with the SSA. The substitute forms must be
exact replicas of the official IRS forms with respect to layoutand content because they will be read by scanner equipment.
.02Paper used for cutsheets and continuous-pinfed forms for substitute Form W-2 (Copy A) and Form W-3 that are to be filed with
the SSA must be white 100% bleached chemical wood, 18-20 pound paper only, optical characterrecognition (OCR) bond produced
in accordance with the following specifications:
•Acidity
:Phvalue,average,notlessthan..................................................
4.5
•Basisweight:17x22inch500cutsheets,pound..........................................18-20
•Metric equivalent—gm./sq. meter
(a tole
ranceof+5pct.isallowed) .......................................................
68-75
•Stiffness: Average, each direction, not less than—milligrams
Crossdirection........................................................................50
Machi
nedirection .....................................................................
80
•Tearing strength: Average, eachdirection, not less than—grams.............................40
•Opacity:Average,notlessthan—percent.................................................82
•Refle
ctivity:Average,notlessthan—percent .............................................
68
•Thickness:Average—inch..............................................................0.0038
Metricequivalent—mm................................................................0.097
(a to
lerance of +0.0005 inch (0.0127 mm) is allowed) Paper cannot vary more than 0.0004
inch
(0.0102 mm) from one edge to the other.
•Porosity:Average,notlessthan—seconds................................................10
•Finish (smoothness): Average, each side—seconds........................................20-55
(forinformationonly)theSheffieldequivalent—units......................................170-d200
•Di
rt: Average, each side, not to exceed—parts per million..................................
8
Note.Reclaimed fiber in any percentage is permitted, provided the requirements of this standard are met.
.03All printing of substitute Forms W-2 (Copy A) and W-3 must be in Flint red OCR dropout ink except as specified below. The
following must be printed in nonreflective black ink:
•Identifying number “22222” or “33333” at the top of the forms.
•Tax year at the bottom of the forms.
•The four (4) corner register marks on the forms.
•The form identification number (“W-3”) at the bottom of Form W-3.
•All the instructions below Form W-3 beginning with “Send this entire page....” line to the bottom of Form W-3.
.04The vertical and horizontal spacing for all federal payment and data boxes on Forms W-2 and W-3 must meet specifications.
On Form W-3 and Form W-2 (Copy A), all the perimeter rules must be 1-point (0.014-inch), while all other rules must be one-half
point (0.007-inch). Vertical rules must be parallel to the left edge of the form; horizontal rules parallel to the top edge.
.05The official red-ink Form W-3 and Form W-2 (Copy A) are 7.5inches wide. Employers filing Forms W-2 (Copy A) with the
SSA on paper must also file a Form W-3. Form W-3 must be the same width (7.5 inches) as the Form W-2. One Form W-3 is printed
July 2, 2007302007–27 I.R.B.

on a standard-size, 8.5 x 11-inch page. Two official Forms W-2 (Copy A) are contained on a single 8.5 x 11-inch page (exclusive of
any snap-stubs).
.06The top, left, and right margins for the Form W-2 (Copy A) and Form W-3 are .5 inches (
1
/2inch). All margins must be free of
printing except for the words “DO NOT STAPLE” on red-ink Form W-3. The space between the two Forms W-2 (Copy A) is 1.33
inches.
.07The identifying numbers are “22222” for Form W-2 (Copies A (and 1)) and “33333” for Form W-3. No printing should appear
anywhere near the identifying numbers.
Note.The identifying number must be printed in nonreflective black ink in OCR-A font of 10 characters per inch.
.08The depth of the individual scannable image on a page must be the same as that on the official IRS forms. The depth from the
top line to the bottom line of an individual Form W-2 (Copy A) must be 4.17 inches and the depth from the top line to the bottom line
of Form W-3 must be 4.67 inches. (See Exhibits A and B.)
.09Continuous-pinfed Forms W-2 (Copy A) must be separated into 11-inch deep pages. The pinfed strips must be removed when
Forms W-2 (Copy A) are filed with the SSA. The two Forms W-2 (CopyA) on the 11-inch page must not be separated (only the pages
are to be separated (burst)). The words “Do Not Cut, Fold, or Staple Forms on This Page” must be printed twice between the two
Forms W-2 (Copy A) in Flint red OCR dropout ink. Perforations are required on all other copies (Copies 1, B, C, 2, and D) to enable
the separation of individual forms.
.10Box 12 of Form W-2 (Copy A) contains four entry boxes – 12a, 12b, 12c, and 12d. Do not make more than one entry per box.
Enter your first code in box 12a (for example, enter Code D in box 12a, not 12d, if it is your first entry). If more than four items need
to be reported in box 12, use a second Form W-2 to report the additional items (see “Multiple forms” in the 2007 Instructions for
Forms W-2 and W-3). Do not report the same federal tax data to the SSA on more than one Form W-2 (Copy A). However, repeat
the identifying information (employee’s name, address, and SSN; employer’s name, address, and EIN) on each additional form.
.11The checkboxes in box 13 of Form W-2 (Copy A) must be .14 inches each; the space before the first checkbox is .20 inches;
the spacing on each remaining side of the 3 checkboxes is .36 inches (see Exhibit A). The checkboxes in box b of Form W-3 must
also be .14 inches (see Exhibit B for other dimensions in box b).
Note.More than 50% of an applicable checkboxmustbecoveredbyan“X.”
.12All substitute Forms W-2 (Copy A) and W-3 in the red-ink formatmust have the tax year, form number, and form title printed
on the bottom face of each form using type identical to that of the official IRS form. The red-ink substitute Form W-2 (Copy A) and
Form W-3 must have the form producer’s EIN entered directly to the left of “Department of the Treasury,” in red.
.13The words “For Privacy Act and Paperwork Reduction Act Notice, see back of Copy D.” must be printed in Flint red OCR
dropout ink in the same location as on the official Form W-2 (Copy A). The words “For Privacy Act and Paperwork Reduction Act
Notice, see back of Copy D of Form W-2.” must be printed at the bottom of the page of Form W-3 in black ink.
.14The Office of Management and Budget (OMB) Number must be printed on substitute Forms W-3 and W-2 (on each ply) in the
same location as on the official IRS forms.
.15All substitute Forms W-3 must include the instructions that are printed on the same sheet below the official IRS form.
.16The back of substitute Form W-2 (Copy A) and Form W-3 must be free of all printing.
.17All copies must be clearly legible. Hot wax and cold carbon spots are not permitted for Form W-2 (Copy A). Interleaved carbon
should be black and must be of good quality to assure legibility onall copies and to avoid smudging. Fading must be minimized to
assure legibility.
.18Chemical transfer paper is permitted for Form W-2 (Copy A) only if the following standards are met:
•Only chemically-backed paper is acceptable for Form W-2 (Copy A). Front and back chemically-treated paper cannot be processed
properly by scanning equipment.
•Chemically-transferred images must be black.
•Carbon-coated forms are not permitted.
.19The Government Printing Office (GPO) symbol and the CatalogNumber (Cat. No.) must be deleted from substitute Form W-2
(Copy A) and Form W-3.
Section 1B. Specifications for Laser-Printed Substitute Form W-2 (Copy A) and Form W-3
Filed with the SSA
.01The SSA-approved, laser-printed, black-and-white Forms W-2(Copy A) and W-3 are referred toas laser-printed. Specifica-
tions for the laser-printed (black-and-white) Forms W-2 (Copy A) and W-3 are similar to the red-ink forms (Part B, Section 1A) except
for the items that follow (see Exhibits E and F). Exhibits are samples only and must not be downloaded to meet tax obligations.
2007–27 I.R.B.31July 2, 2007

(1) Forms must be printed on 8.5 x 11-inch single-sheet paper only, not on continuous-feed using a laser printer. There must be
two Forms W-2 (Copy A) printed on a page. There must be no horizontal perforations between the two Forms W-2 (Copy A) on each
page.
(2) All forms and data must be printed in nonreflective black ink only.
(3) The data and forms must be programmed to p
rint simultaneously. Forms cannot be produced separately from wage data entries.
(4) The forms must not contain corner register marks.
(5) The forms must not contain any shaded areas including those boxes that are entirely shaded on the red-ink forms.
(6) Identifying numbers on both Form W-2 (“22222”) and Form W-3 (“33333”) must be preprinted in 14-point Arial bold font or
a close approximation.
(7) The form numbers (“W-2” and “W-3”) must be in 18-point Arial font or a close approximation. The tax year (“2007”) on
Forms W-2 (Copy A) and W-3 must be in 20-point Arial font or a close approximation.
(8) No part of the box titles or the data printed on the forms may touch any of the vertical or horizontal lines, nor should any of
the data intermingle with the box titles. The data should be centered in the boxes.
(9) Do not print any information in the margins of the laser-printed forms (for example, do not print “DO NOT STAPLE” in the
top margin of Form W-3).
(10) The word “Code” must not appear in box 12 on Form W-2 (Copy A).
(11) A 4-digit vendor code preceded by four zeros and a slash (for example, 0000/1234) must appear in 12-point Arial font, or
a close approximation, under the tax year in place of the Cat. No. on Form W-2 (Copy A) and in the bottom right corner of the
“For Official Use Only” box at the bottom of Form W-3. Do not display the form producer’s EIN to the left of “Department of the
Treasury.” The vendor code will be used to identify the form producer.
(12) Do not print Catalog Numbers (Cat. No.) on either Form W-2 (Copy A) or Form W-3.
(13) Do not print the checkboxes in:
•Box (b) of Form W-3. The “X” should be programmed to be printedand centered directly below theapplicable “Kind of Payer.”
•The “Void” box of Form W-2 (Copy A). The “X” should be programmed to be printed to the right of “Void” because of space
limitations.
•Box13ofFormW-2(CopyA).The“X”shouldbeprogrammedtobeprinted and centered directly below the applicable box title.
(14) Do not print dollar signs. If there are no money amounts being reported, the entire field should be left blank.
(15) The space between the two Forms W-2 (Copy A) is 1.33 inches.
.02You must submit samples of your laser-printed substitute forms to the SSA. Only laser-printed, black-and-white substitute
Forms W-2 (Copy A) and W-3 for tax year 2007 will be accepted for approval by the SSA. Questions regarding other forms (that is,
red-ink Forms W-2c, W-3c, 1099 series, 1096, etc.) must be directed to the IRS.
.03You will be required to send one set of blank and one set of dummy-data, laser-printed substitute Forms W-2 (Copy A) and
W-3 for approval. Sample data entries should be filled in to the maximum length for each box entry, preferably using numeric data
or alpha data, depending upon the type required to be entered. Include in your submission the name, telephone number, fax number,
and email address of a contact person who can answer questions regarding your sample forms.
.04To receive approval, you may first contact the SSA atl
aser.forms@ssa.govto obtain a template and further instructions in PDF
or Excel format. You may also send your 2007 sample, laser-printed substitute forms to:
Social Security Administration
Data Operations Center
Attn: Laser Forms Approval, Room 235
1150 E. Mountain Drive
Wilkes-Barre PA 18702-7997
July 2, 2007322007–27 I.R.B.

Send your sample forms via private mail carrier or certified mail in order to verify their receipt. You can expect approval (or
disapproval) by the SSA within 30 days of receipt of your sample forms.
.05The 4-digit vendor code preceded by four zeros and a slash (0000/) must be preprinted on the sample, laser-printed substitute
forms. Forms not containing a vendor code will be rejected and will not be submitted for testing or approval. If you do not have a
vendor code, you may contact the National Association of Computerized Tax Processors via email atp
resident@nactp.org.
.06 If you use forms produced by a vendor and have questions concerning approval,do not send the forms to the SSA for
approval. Instead, you may contact the software vendor to obtain a copy of SSA’s dated approval notice supplied to that vendor.
Section 2. Requirements for Substitute Forms Furnished to Employees (Copies B, C, and
2ofFormW-2)
Note.Printers are cautioned that therules in Part B, Section 2 (this section), apply only to employee copies of Form W-2 (Copies
B, C, and 2).Paper filers who send Forms W-2 (Copy A) to the SSA must follow the requirements in Part B, Sections 1A and/or 1B
above.
.01All employers (including those who file electronically) must furnish employees with at least two copies of Form W-2 (three or
more for employees required to file a state, city, or local income tax return). The following rules are guidelines for preparing employee
copies.
The dimensions of these copies (Copies B, C, and 2), but not Copy A, may differ from the dimensions of the official IRS form to
allow space for reporting additional information, including additional entries such as withholding for health insurance, union dues,
bonds, or charity in box 14. The limitation of a maximum of four items in box 12 of Form W-2 applies only to Copy A, which is filed
with the SSA.
Note.Payee statements (Copies B, C, and 2 of Form W-2) may be furnished electronically if employees give their consent (as de-
scribed in Treasury Regulations Section 31.6051–1(j)). Seealso Publication 15-A, Employer’s Supplemental Tax Guide.
.02The minimum dimensions for employee copies only (not Copy A) of Form W-2 should be 2.67 inches deep by 4.25 inches
wide. The maximum dimensions should be no more than 6.5 inches deep by no more than 8.5 inches wide.
Note.The maximum and minimum size specifications are for tax year 2007 only and may change in future years.
.03Either horizontal or vertical format is permitted (see Exhibit D).
.04The paper for all copies must be white and printed in black ink. The substitute Copy B, which employees are instructed to
attach to their federal income tax returns, should be at least 9-pound paper (basis 17 x 22-500). Other copies furnished to employees
should also be at least 9-pound paper (basis 17 x 22-500).
.05Employee copies of Form W-2 (Copies B, C, and 2), including those that are printed on a single sheet of paper, must be easily
separated. Providing perforations between the individual copies satisfies this requirement, but using scissors to separate Copies B, C,
and 2 does not.
Note.The perforation requirement in this section does not apply to printouts of copies of Forms W-2 that are furnished electronically to
employees (as described in Treasury Regulations Section 31.6051–1(j)). However, these employeesshould be cautioned to carefully
separate the copies of Form W-2. See Publication 15-A, Employer’s Supplemental Tax Guide, for information on electronically
furnishing Forms W-2 to employees.
.06Interleaved carbon and chemical transferpaper employee copies must be clearly legible. Hot wax and cold-carbon spots are
not permitted for employee copies. All copies must be able to bephotocopied. Interleaved carbonshouldbeblackandmustbeof
good quality to assure legibility on all copies and to avoid smudging. Fading must be minimized to assure legibility.
.07The electronic tax logo on the IRS official employee copies is not required on any of the substitute form copies. To avoid
confusion and questions by employees, employers are encouraged to delete the identifying number (“22222”) and the word “Void”
and its associated checkbox from the employee copies of Form W-2.
.08All substitute employee copies must contain boxes, box numbers, and box titles that match the official IRS Form W-2. Boxes
that do not apply can be deleted. However, certain core boxes must be included. The placement, numbering, and size of this informa-
tion is specified as follows:
•The items and box numbers that constitute the core data are:
Box 1 — Wages, tips, other compensation,
Box 2 — Federal income tax withheld,
2007–27 I.R.B.33July 2, 2007

Box 3 — Social security wages,
Box 4 — Social security tax withheld,
Box 5 — Medicare wages and tips, and
Box 6 — Medicare tax withheld.
The core boxes must be printed in the exact order shown on the official IRS form.
•The core data boxes (1 through 6) must be placed in the upper right of the form. Substitut
e vertical-format copies may have the
core data across the top of the form (see Exhibit D). In no instance, will boxes or othe
r information be permitted to the right of
thecoredata.
•The form title, number, or copy designation (B, C, or 2) may be at the top of the form. Also, a reversed or blocked-out area to
accommodate a postal permit number or other postalconsiderations is allowed in the upper-right.
•Boxes 1 through 6 must each be a minimum of 1
1
/8inches wide x
1
/4inch deep.
•Other required boxes are:
a) Employee’s social security number,
b) Employer identification number (EIN),
c) Employer’s name, address, and ZIP code,
e) Employee’s name, and
f) Employee’s address and ZIP code.
Identifying items must be present on the form and be in boxes similar to those on the official IRS form. However, they may be
placed in any location other than the top or upper right. You do not need to use the lettering system (a-c, e-f) used on the official IRS
form. The employer identification number (EIN) may be included with the employer’s name and address and not in a separate box.
Note.Box d (“Control number”) is not required.
.09All copies of Form W-2 furnished to employees must clearly showthe form number, the form title, and the tax year prominently
displayed together in one area of the form. The title of Form W-2 is“Wage and Tax Statement.” It is recommended (but not required)
that this be located on the bottom left of substitute Forms W-2. Thereference to the “Department of the Treasury — Internal Revenue
Service” must be on all copies of substitute Forms W-2 furnishedto employees. It is recommended (but not required) that this be
located on the bottom right of Form W-2.
.10If the substitute employee copies are labeled, the forms must contain the applicable description:
•“Co
py B, To Be Filed With Employee’s FEDERAL Tax Return.”
•“Copy C, For EMPLOYEE’S RECORDS.”
•“Copy 2, To Be Filed With Employee’s State, City, or Local Income Tax Return.”
It is recommended (but not required) that these be located on the lower left of Form W-2. If the substitute employee copies are not
labeled as to the disposition of the copies, then written notification using similar wordingmust be provided to each employee.
.11The tax year (2007) must be clearly printed on all copies of substitute Form W-2. It is recommended (but not required) that
this information be in the middle at the bottom of the Form W-2. The use of 24-pt. OCR-A font is recommended (but not required).
.12Boxes1,2,and9(ifapplicable)onCopyBmustbeoutlinedinbold 2-point rule or highlighted in some manner to distinguish
them. If “Allocated tips” are being reported, it is recommended (but not required) that box 8 also be outlined. If reported, “Social
security tips” (box 7) must be shown separately from “Social security wages” (box 3).
Note.Boxes 8 and 9 may be omitted if not applicable.
.13If employers are required to withhold and report state or local income tax, the applicable boxes are also considered core infor-
mation and must be placed at the bottom of the form. State information is included in:
•Box 15 (State, Employer’s state ID number)
July 2, 2007342007–27 I.R.B.

•Box 16 (State wages, tips, etc.)
•Box17(Stateincometax)
Local information is included in:
•Box 18 (Local wages, tips, etc.)
•Box 19 (Local income tax)
•Box 20 (Locality name)
.14Boxes 7 through 14 may be omitted from substitute employee copies unless the employer must report any of that information to
the employee. For example, if an employee did not have “Social security tips” (box 7), the form could be printed without that box. But
if an employer provided dependent care benefits, the amount must be reported separately, shown in box 10, and labeled “Dependent
care benefits.”
.15Employers may enter more than four codes in box 12 of substitute Copies B, C, and 2 (and 1 and D) of Form W-2, but each
entry must use Codes A-BB (see the 2007 Instructions for Forms W-2 and W-3).
.16If an employer has employees in any of the three categories in box 13, all checkbox headings must be shown and the proper
checkmark made, when applicable.
.17Employers may use box 14 for any other information that they wish to give to their employees. Each item must be labeled.
(See the instructions for box 14 in the 2007 Instructions for Forms W-2 and W-3.)
.18The front of Copy C of a substitute Form W-2 must contain the note “This information is being furnished to the Internal Revenue
Service. If you are required to file a tax return, a negligence penalty or other sanction may be imposed on you if this income is taxable
and you fail to report it.”
.19Instructions similar to those contained on the back of Copies B, C, and 2 of the official IRS Form W-2 must be provided to
each employee. An employer may modify or delete instructions thatdo not apply to its employees. (For example, remove Railroad
Retirement Tier 1 and Tier 2 compensation information for nonrailroad employees orinformation about dependent care benefits that
the employer does not provide.)
.20Employers must notify their employees who have no income tax withheld that theymay be able to claim a tax refund because
of the earned income credit (EIC). They will meet this notification requirement if they furnish a substitute Form W-2 with the EIC
notice on the back of Copy B, IRS Notice 797, Possible FederalTax Refund Due to the Earned Income Credit (EIC), or on their
own statement containing the same wording. They may also change the font on Copies B, C, and 2 so that the EIC notification and
Form W-2 instructions fit differently. For more information about notification requirements, see Notice 1015, Have You Told Your
Employees About the Earned Income Credit (EIC)?
Note.An employer does not have to notify any employee who claimed exemption from withholding on Form W-4, Employee’s
Withholding Allowance Certificate, for the calendar year.
Part C. Additional Instructions
Section 1. Additional Instructions for Form Printers
.01If electronic media is not used for filing with the SSA, the substitute copies of Forms W-2 (either red-ink or laser-printed)
should be assembled in the same order as the official IRS Forms W-2. Copy A should be first, followedsequentiallybyperforated
sets (Copies 1, B, C, 2, and D).
.02The substitute form to be filed by the employer with the SSA must carry the designation “Copy A.”
Note.Electronic filers do not submit either red-ink or laser-printed paper Form W-2 (Copy A) or Form W-3 to the SSA.
.03Substitute forms (red-ink or laser-printed) do not require a copy to be retained by employers (Copy D of Form W-2). However,
employers must be prepared to verify or duplicate the information if it is requested by the IRS or the SSA. Paper filers who do not
keep a Form W-2 (Copy D) should be able to generate a facsimile of Form W-2 (Copy A) in case of loss.
.04Except for copies in the official assembly, no additional copies that may be prepared by employers should be placed ahead of
Form W-2 (Copy C) “For EMPLOYEE’S RECORDS.”
.05You must provide instructions similar to those contained on the back of Copies B,C, and 2 of the official IRS Form W-2 to each
employee. You may print them on the back of the substitute Copies B, C, and 2 or provide them to employees on a separate statement.
You do not need to use the back of Copy 2. If you do not use Copy 2, you may include all the information, which is on the back of
the official Copies B, C, and 2, on the back of your substitute Copies B and C only. As an example, you may use the “Note” on the
back of the official Copy C as the dividing point between the text for your substitute Copies B and C. Do not print these instructions
on the back of Copy 1. Any Forms W-2 (Copy A) and W-3 that are filed with the SSA must have no printing on the reverse side.
2007–27 I.R.B.35July 2, 2007

Section 2. Instructions for Employers
.01Only originals of Form W-2 (Copy A) and Form W-3 may be filedwith the SSA. Carbon copies and photocopies are unaccept-
able.
.02Employers should type or machine-print data entries on the non-laser-generated forms wheneverpossible. Ensure good quality
by using a high-quality type face, inserting data in the middle of blocks that are well separated from other printing and guidelines, and
taking any other measures that willguarantee clear, sharp images. Black ink must be used with no script type, inverted font, italics or
dual-case alpha characters.
Note.12-point Courier font is preferred by the SSA.
.03Form W-2 (Copy A) requires decimal entries for wage data. Dollar signs should not be printed with money amounts on the
Forms W-2 (Copy A) and W-3.
.04The employer must provide a machine-scannable Form W-2 (Copy A). The employer must also provide employee copies
(Copies B, C, and 2) that are legible and able to be photocopied (by the employee). Do not print any data in the top margin of the
payee copies of the forms.
.05Any printing in box d (Control number) on Form W-2 or box a on Form W-3 may not touch any vertical or horizontal lines
and should be centered in the box.
.06The filer’s employer identification number (EIN) must be entered in box b of Form W-2 and box e of Form W-3. The EIN
entered on Form(s) W-2 (box b) and Form W-3 (box e) must be the same as on Forms 941, 943, 944, CT-1, Schedule H (Form 1040),
or any other corresponding forms filed withthe IRS. Be sure to use EIN format (00-0000000) rather than SSN format (000-00-0000).
.07The employer’s name, address, and EIN may be preprinted.
.08If available, employers should use the official IRS-preprinted Form W-3 that they received with Publication 393 or Publication
2184 when filing red-ink Forms W-2 (Copy A) with the SSA.
Section 3. OMB Requirements for Both Red-Ink and Laser-Printed Substitute Forms
.01The Paperwork Reduction Act (the Act) of 1995 (Public Law 104-13) requires the following:
•The Office of Management and Budget (OMB) approves all IRS tax forms that are subject to the Act.
•Each IRS form contains (in or near the upper right corner) the OMB approval number, if assigned. (The official OMB numbers
may be found on the official IRS printed forms and are also shown on the forms in Exhibits A, B, C, E, and F.)
•Each IRS form (or its instructions) states:
(1) Why the IRS needs the information,
(2) How it will be used, and
(3) Whether or not the information is required to be furnished to the IRS.
.02This information must be provided to any users of official or substitute IRS forms or instructions.
.03The OMB requirements for substitute IRS Form W-2 (Copy A) and Form W-3 are the following.
•Any substitute form or substitute statement to a recipient must show the OMB number as it appears on the official IRS form.
•The OMB number (1545-0008) must appear exactly as shown on the official IRS form.
•For any copy of Form W-2 other than Copy A, the OMB number must use one of the following formats:
(1) OMB No. 1545-0008 (preferred) or
(2) OMB # 1545-0008 (acceptable).
.04Any substitute Form W-2 (Copy A only) must state “For Privacy Act and Paperwork Reduction Act Notice, see back of Copy
D.” Any substitute Form W-3 must state “For Privacy Act and Paperwork Reduction Act Notice, see back of Copy D of Form W-2.”
If no instructions are provided to users of your forms, you must furnish them with the exact text of the Privacy Act and Paperwork
Reduction Act Notice.
July 2, 2007362007–27 I.R.B.

Section 4. Reproducible Copies of Forms
.01You can obtain official IRS forms and information copies of federal tax materials at local IRS offices or by calling the IRS
Distribution Center at 1-800-829-3676. Other ways to get federal tax material include the following.
•TheIRSwebsiteatwww.irs.gov.
•The IRS’ CD (Publication 1796).
Only contact the IRS, not the SSA, for IRS forms.
Note.Many IRS forms are provided on the IRS website and on the Federal Tax Forms CD. But copies of Form W-2 (Copy A) and
Form W-3 cannot be used for filing with the IRS or SSA when obtained by these methods because the forms do not meet the specific
printing specifications as described in this publication. Copies ofForms W-2 and W-3 obtained from these sources are for information
purposes only.
.02The IRS also offers an alternative to downloading electronic files and provides current and prior-year access to tax forms and
instructions through its FederalTax Forms CD. The CD will be available for the upcoming filing season. Order Publication 1796, IRS
Federal Tax Products CD, by using the IRS website atw
ww.irs.gov/cdordersor by calling 1-877-CDFORMS (1-877-233-6767).
Section5.EffectonOtherDocuments
.01Revenue Procedure 2006-55, 2006-52 I.R.B. 1151, dated December 26, 2006 (reprinted as Publication 1141, Revised 12-2006),
is superseded.
ListofExhibits
Exhibit A — Form W-2 (Copy A) (Red-Ink)
Exhibit B — Form W-3 (Red-Ink)
Exhibit C — Form W-2 (Copy B)
Exhibit D — Form W-2 (Alternative Employee Copies) (Illustrating Horizontal and Vertical Formats)
Exhibit E — Form W-2 (Copy A) (Laser-Printed)
Exhibit F — Form W-3 (Laser-Printed)
2007–27 I.R.B.37July 2, 2007

July 2, 2007382007–27 I.R.B.

2007–27 I.R.B.39July 2, 2007

July 2, 2007402007–27 I.R.B.

2007–27 I.R.B.41July 2, 2007

July 2, 2007422007–27 I.R.B.

2007–27 I.R.B.43July 2, 2007

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.
July 2, 2007i2007–27 I.R.B.

Numerical Finding List
1
Bulletin 2007–27
Notices:
2007-54, 2007-27 I.R.B.12
2007-55, 2007-27 I.R.B.13
2007-56, 2007-27 I.R.B.15
Revenue Procedures:
2007-42, 2007-27 I.R.B.15
2007-43, 2007-27 I.R.B.26
Treasury Decisions:
9328, 2007-27 I.R.B.1
1
A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., publishedin Internal Revenue Bulletins 2007–1 through 2007–26 is in Internal Revenue Bulletin
2007–26, dated June 25, 2007.
2007–27 I.R.B.iiJuly 2, 2007

Finding List of Current Actions on
Previously Published Items
1
Bulletin 2007–27
Notices:
2007-26
Modified by
Notice 2007-56, 2007-27 I.R.B.15
Revenue Procedures:
2006-25
Superseded by
Rev. Proc. 2007-42, 2007-27 I.R.B.15
2006-55
Superseded by
Rev. Proc. 2007-43, 2007-27 I.R.B.26
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2007–1 through 2007–26 is in Internal Revenue Bulletin 2007–26, dated June 25, 2007.
July 2, 2007iii2007–27 I.R.B.

INTERNAL REVENUE BULLETIN
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