Internal Revenue Bulletin 1998-50 (PDF rendition): IRS Revenue Procedures

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.

INCOME TAX
T.D. 8790, page 4.
Final regulations under section 6662 of the Code relate to
the accuracy-related penalty.
EMPLOYEE PLANS
Rev. Proc. 98–59, page 8.
Roth IRAs; prototypes.This procedure describes the
method for obtaining approval of prototype Roth IRAs (in-
cluding dual-purpose IRAs) by a prototype sponsor. It also
provides guidance on transitional relief for users of Roth
IRAs that have not been approved by the Service.
EXEMPT ORGANIZATIONS
Announcement 98–111, page 21.
A list is given of organizations now classified as private foun-
dations.
EMPLOYMENT TAX
Page 4.
Railroad retirement; rate determination; quarterly.The
Railroad Retirement Board has determined that the rate of
tax imposed by section 3221 of the Code shall be 35 cents
per work-hour for the quarter beginning October 1, 1998.
ADMINISTRATIVE
REG–105170–97, page 10.
Proposed regulations under section 41 of the Code relate to
the computation of the credit for increasing research activi-
ties and the definition of qualified research.
Announcement 98–109, page 20.
T.D. 8785, 1998–42 I.R.B. 5, under section 861 of the
Code relating to the tax treatment of certain transactions in-
volving the transfer of computer programs, is corrected.
Announcement 98–110, page 21.
T.D. 8784, 1998–42 I.R.B. 4, under section 274 of the
Code relating to the use of mileage allowances to substanti-
ate automobile business expenses, is corrected.
Internal Revenue
bbuulllleettiinn
Bulletin No. 1998–50
December 14, 1998
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.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page 24.
IRB 1998-50 12/9/98 3:47 PM Page 1

The IRS Mission
Provide America’s taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
2
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to adminis-
ter the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provi-
sions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.
At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protect-
ing the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesi-
tate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.
Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, howev-
er, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.
IRB 1998-50 12/9/98 3:47 PM Page 2

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents of a permanent nature are consoli-
dated semiannually into Cumulative Bulletins, which are sold
on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
lished rulings and procedures, the effect of subsequent leg-
islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation 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 Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
and the disbarment and suspension list included in this part,
none of these announcements are consolidated in the Cumu-
lative Bulletins.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis
and are published in the first Bulletin of the succeeding semi-
annual period, respectively.
3
Introduction
The contents of this publication are not copyrighted and may be reprinted freely. Acitation 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.
IRB 1998-50 12/9/98 3:47 PM Page 3

Section 3221.—Rate of Tax
Determination of Quarterly Rate
of Excise Tax for Railroad
Retirement Supplemental
Annuity Program
In accordance with directions in Sec-
tion 3221(c) of the Railroad Retirement
Tax Act (26 U.S.C. 3221(c)), the Railroad
Retirement Board has determined that the
excise tax imposed by such Section
3221(c) on every employer, with respect
to having individuals in his employ, for
each work-hour for which compensation
is paid by such employer for services ren-
dered to him during the quarter beginning
October 1, 1998, shall be at the rate of 35
cents.
In accordance with directions in Sec-
tion 15(a) of the Railroad Retirement Act
of 1974, the Railroad Retirement Board
has determined that for the quarter begin-
ning October 1, 1998, 28.6 percent of the
taxes collected under Sections 3211(b)
and 3221(c) of the Railroad Retirement
Tax Act shall be credited to the Railroad
Retirement Account and 71.4 percent of
the taxes collected under such Sections
3211(b) and 3221(c) plus 100 percent of
the taxes collected under Section 3221(d)
of the Railroad Retirement Tax Act shall
be credited to the Railroad Retirement
Supplemental Account.
Dated August 24, 1998.
By the Authority of the Board
Beatrice Ezerski,
Secretary to the Board.
(Filed by the Office of the Federal Register on
August 31, 1998, 8:45 a.m., and published in the
issue of the Federal Register for September 1, 1998,
63 F.R. 46494)
Section 6662.—Imposition of
Accuracy-Related Penalty
26 CFR 1.6662–2: Accuracy-related penalty.
T.D. 8790
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Definition of Reasonable Basis
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the accuracy-
related penalty. These amendments are
necessary to define reasonable basis and
to make conforming changes to existing
regulations. These regulations affect any
taxpayer that files a tax return.
DATES: Effective date.These regulations
are effective December 2, 1998.
Applicability date.For dates of applic-
ability, see §§1.6662–2(d) and 1.6664–
1(b)(2).
FOR FURTHER INFORMATION CON-
TACT: Beverly A. Baughman, 202-622-
4940 (not a toll-free number).
SUPPLEMENTARYINFORMATION:
Background
On September 1, 1995, the IRS issued
final regulations [T.D. 8617 (60 F.R.
45661 [1995–2 C.B. 274])], relating to the
accuracy-related penalty under chapter 1
of the Internal Revenue Code. Those reg-
ulations provided guidance concerning the
reasonable basis standard for purposes of
(1) the negligence penalty under section
6662(b)(1), and (2) the disclosure excep-
tion to the penalties for disregarding rules
or regulations under section 6662(b)(1)
and the substantial understatement of in-
come tax under section 6662(b)(2). In the
preamble to the final regulations, the IRS
and Treasury Department requested com-
ments and suggestions on providing fur-
ther guidance on the reasonable basis stan-
dard. On November 12, 1996, proposed
regulations [IA–42–95 (1996–49 I.R.B.
21) (see §601.601(d)(2)(ii)(b) of this
chapter)] defining reasonable basis and
making conforming changes to the final
regulations relating to the accuracy-related
penalty were published in the
Federal
Register(61 F.R. 58020).
Written comments responding to the
notice of proposed rulemaking were re-
ceived. Apublic hearing was held on
February 25, 1997. After consideration
of all the comments, the proposed regula-
tions under section 6662 relating to the
definition of reasonable basis for pur-
poses of the accuracy-related penalty are
adopted as revised by this Treasury
decision.
In addition, on August 5, 1997, the Tax-
payer Relief Act (TRA) of 1997, Pub. L.
105–34 (111 Stat. 788), was enacted. The
Act added a restriction regarding whether
or not a corporation has a reasonable basis
for its tax treatment of an item for pur-
poses of reducing the amount of the sub-
stantial understatement penalty. This re-
striction has been incorporated into the
final regulations.
Explanation of Provisions and Summary
of Comments
These final regulations provide that a
return position will have a reasonable
basis for purposes of the accuracy-related
penalties if it is reasonably based on one
or more certain authorities. Also, if the
return position does not satisfy the rea-
sonable basis standard, a reasonable cause
and good faith exception may still apply.
One commentator suggested that the
substantial authority standard in §1.6662–
4(d)(3)(ii) of existing regulations and the
reasonable basis standard in §1.6662–
3(b)(3) of the proposed regulations be ex-
panded to include as authority a well-
reasoned construction of the applicable
regulatory provisions in addition to the
statutory provisions. The substantial au-
thority standard in §1.6662–4(d)(3)(ii)
has not been expanded to reflect this com-
ment. However, the definition of reason-
able basis in §1.6662–3(b)(3) has been
clarified to include an explicit cross-refer-
ence to the nature of the analysis discus-
sion in §1.6662–4(d)(3)(ii) of the substan-
tial authority regulations.
Several commentators suggested that
the final regulations explain where the
reasonable basis standard ranks in the hi-
erarchy of return position standards. This
suggestion was not adopted. The final
regulations do not rank the standards for-
mally because such a comparison would
change the focus of the reasonable basis
regulations from the taxpayer’s obligation
to determine his or her tax liability in ac-
cordance with the internal revenue laws to
December 14, 199841998–50 I.R.B.
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
IRB 1998-50 12/9/98 3:47 PM Page 4

the probability of the return position pre-
vailing in litigation.
Several commentators supported the
exclusion of a numerical qualification of
the reasonable basis standard in the pro-
posed regulations because they believed
that such a qualification would encourage
arbitrary and mechanical application of
the standards and create bad precedent
outside the scope of the reasonable basis
standard. The final regulations do not in-
clude a numerical qualification.
One commentator requested that the
final regulations refer specifically to Rev.
Rul. 59–60 (1959–1 C.B. 237) (see
§601.601(d)(2)(ii)(b) of this chapter),
which provides guidance regarding the
valuation of stock of closely held corpora-
tions for estate and gift tax purposes. The
final regulations do not adopt this sugges-
tion. It is not necessary to include a refer-
ence to a specific revenue ruling because
§1.6662–4(d)(3)(iii) of the existing regu-
lations already lists revenue rulings as an
acceptable type of authority.
One commentator requested that the
final regulations clarify the effect of the
Omnibus Budget Reconciliation Act of
1993, Pub. L. 103–66 (107 Stat. 312), and
the reasonable cause and good faith ex-
ception under section 6664 on a taxpayer’s
access to prepayment litigation in Tax
Court. The final regulations do not adopt
this suggestion. It is not necessary to clar-
ify that a taxpayer has access to prepay-
ment litigation in Tax Court because under
section 6665 the Tax Court has jurisdic-
tion to redetermine additions to tax in the
same manner as the underlying tax.
Pursuant to the Taxpayer Relief Act of
1997, Pub. L. 105–34 (111 Stat. 788),
§1.6662–4(e)(3) has been added to the
final regulations. That section provides
that for purposes of reducing the amount
of the substantial understatement penalty
by making an adequate disclosure, a cor-
poration will not be treated as having a
reasonable basis for its tax treatment of an
item attributable to a multi-party financ-
ing transaction entered into after August
5, 1997, if the treatment does not clearly
reflect the income of the corporation.
The Chief Counsel for Advocacy of the
Small Business Administration requested
that the preamble to the regulations ex-
plain why the IRS has concluded that this
regulation is not subject to the Regulatory
Flexibility Act (5 U.S.C. chapter 6). The
Chief Counsel for Advocacy submits that
the regulations tighten the definition of
reasonable basis and, thus, impose a de
facto recordkeeping requirement because
they may require small businesses to keep
and maintain records (such as the docu-
ments referred to in §1.6662–4(d)(3)(iii))
to support tax reporting decisions.
After carefully considering these com-
ments, the IRS and Treasury have con-
cluded that this regulation is not subject to
the Regulatory Flexibility Act, 5 U.S.C.
§ 603 (1994). That section requires a reg-
ulatory flexibility analysis for an interpre-
tative rule involving the internal revenue
laws only to the extent the interpretative
rule imposes a collection of information
requirement on small entities. Acollec-
tion of information requirement is defined
in 5 U.S.C. § 601(7) (1994) to mean the
obtaining, causing to be obtained, solicit-
ing, or requiring the disclosure to third
parties or the public, of facts or opinions
by or for an agency, regardless of form or
format, calling for either (i) answers to
identical questions posed to, or identical
reporting or recordkeeping requirements
imposed on, ten or more persons, other
than agencies, instrumentalities, or em-
ployees of the United States, or (ii) an-
swers to questions posed to agencies, in-
strumentalities, or employees of the
United States that are to be used for gen-
eral statistical purposes.
Furthermore, the phrase, recordkeeping
requirement, is defined in 5 U.S.C.
601(8) (1994) as a requirement imposed
by an agency on persons to maintain spec-
ified records. Ever since this term was
first used in the Paperwork Reduction Act
of 1980 (44 U.S.C. chapter 35), the IRS
and Treasury have consistently inter-
preted the phrase as applying only when
Treasury regulations directly require per-
sons to maintain specified records. We
believe this interpretation is consistent
with the explicit statutory language as
well as Congressional intent to apply the
law only to situations in which govern-
ment agencies require persons to maintain
particular records.
Thus, we believe the final regulations
do not impose a recordkeeping require-
ment or other collection of information
requirement, as defined in 5 U.S.C.
§§ 601(7), (8) (1994). The regulations do
not impose on taxpayers additional re-
quirements to either report information to
the IRS or to keep specified records. Be-
cause the regulations do not contain a re-
porting requirement or other collection of
information requirement, the provisions
of the Regulatory Flexibility Act do not
apply.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations.
Pursuant to section 7805(f) of the Inter-
nal Revenue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Chief Counsel for
Advocacy of the Small Business Admin-
istration for comment on the impact of the
proposed regulations on small business.
The Chief Counsel for Advocacy submit-
ted comments on these regulations, which
are discussed above.
Drafting Information
The principal author of these regula-
tions is Beverly A. Baughman, Office of
the Assistant Chief Counsel (Income Tax
& Accounting). However, other person-
nel from the IRS and Treasury Depart-
ment participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.6662–0 is amended
by:
1. Adding the entry for §1.6662–
2(d)(4).
2. Removing the entries for §1.6662–
3(b)(3)(i) and (ii).
3. Adding the entry for §1.6662–
4(e)(3).
4. Revising the entry for §1.6662–7(d).
5. Removing the entries for §1.6662–
7(d)(1) and (2).
1998–50 I.R.B.5December 14, 1998
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The revision and additions read as fol-
lows:
§1.6662–0 Table of contents.
* * * * *
§1.6662–2 Accuracy-related penalty.
* * * * *
(d) * * *
(4) Special rule for reasonable basis.
* * * * *
§1.6662–4 Substantial understatement of
income tax.
* * * * *
(e) * * *
(3) Restriction for corporations.
* * * * *
§1.6662–7 Omnibus Budget
Reconciliation Act of 1993 changes to the
accuracy-related penalty.
* * * * *
(d) Reasonable basis.
Par 3. Section 1.6662–2 is amended
by:
1. Revising the second sentence in
paragraph (d)(1).
2. Revising the first sentence in para-
graph (d)(2).
3. Adding paragraph (d)(4).
The addition and revisions read as fol-
lows:
§1.6662–2 Accuracy-related penalty.
* * * * *
(d) * * * (1) * * * Except as provided in
the preceding sentence and in paragraphs
(d)(2), (3), and (4) of this section,
§§1.6662–1 through 1.6662–5 apply to
returns the due date of which (determined
without regard to extensions of time for
filing) is after December 31, 1989, but be-
fore January 1, 1994. * * *
(2) Returns due after December 31,
1993. Except as provided in paragraphs
(d)(3) and (4) of this section and the last
sentence of this paragraph (d)(2), the pro-
visions of §§1.6662–1 through 1.6662–4
and §1.6662–7 (as revised to reflect the
changes made to the accuracy-related
penalty by the Omnibus Budget Reconcil-
iation Act of 1993) and of §1.6662–5
apply to returns the due date of which (de-
termined without regard to extensions of
time for filing) is after December 31,
1993. * * *
* * * * *
(4) Special rules for reasonable basis.
Section 1.6662–3(b)(3) applies to returns
filed on or after December 2, 1998.
Par. 4. Section §1.6662–3 is amended
by:
1. Revising the third sentence in para-
graph (b)(1) introductory text.
2. Revising paragraph (b)(3).
The revisions read as follows:
§1.6662–3 Negligence or disregard of
rules or regulations.
* * * * *
(b)* * * (1) * * * Areturn position that
has a reasonable basis as defined in para-
graph (b)(3) of this section is not attribut-
able to negligence. * * *
* * * * *
(3) Reasonable basis.Reasonable
basis is a relatively high standard of tax
reporting, that is, significantly higher than
not frivolous or not patently improper.
The reasonable basis standard is not satis-
fied by a return position that is merely ar-
guable or that is merely a colorable claim.
If a return position is reasonably based on
one or more of the authorities set forth in
§1.6662-4(d)(3)(iii) (taking into account
the relevance and persuasiveness of the
authorities, and subsequent develop-
ments), the return position will generally
satisfy the reasonable basis standard even
though it may not satisfy the substantial
authority standard as defined in §1.6662–
4(d)(2). (See §1.6662–4(d)(3)(ii) for
rules with respect to relevance, persua-
siveness, subsequent developments, and
use of a well-reasoned construction of an
applicable statutory provision for pur-
poses of the substantial understatement
penalty.) In addition, the reasonable
cause and good faith exception in
§1.6664–4 may provide relief from the
penalty for negligence or disregard of
rules or regulations, even if a return posi-
tion does not satisfy the reasonable basis
standard.
* * * * *
Par. 5. Section 1.6662–4 is amended
by:
1. Revising the second sentence in
paragraph (d)(2).
2. Adding paragraph (e)(3).
The addition and revision reads as fol-
lows:
§1.6662–4 Substantial understatement of
income tax.
* * * * *
(d) * * * (1) * * *
(2) * * * The substantial authority stan-
dard is less stringent than the more likely
than not standard (the standard that is met
when there is a greater than 50-percent
likelihood of the position being upheld),
but more stringent than the reasonable
basis standard as defined in §1.6662-
3(b)(3). * * *
* * * * *
(e) * * * (1) * * *
(3) Restriction for corporations.For
purposes of paragraph (e)(2)(i) of this
section, a corporation will not be treated
as having a reasonable basis for its tax
treatment of an item attributable to a
multi-party financing transaction entered
into after August 5, 1997, if the treatment
does not clearly reflect the income of the
corporation.
* * * * *
Par. 6. In §1.6662–7, paragraph (d) is
revised to read as follows:
§1.6662–7 Omnibus Budget
Reconciliation Act of 1993 changes to the
accuracy-related penalty.
* * * * *
(d) Reasonable basis.For purposes of
§§1.6662–3(c) and 1.6662–4(e) and (f)
(relating to methods of making adequate
disclosure), the provisions of §1.6662–
3(b)(3) apply in determining whether a re-
turn position has a reasonable basis.
Par. 7. Section 1.6664–0 is amended
by:
1. Revising the entry for §1.6664–
4(c)(2).
2. Removing the entries for §§1.6664–
4(c)(1)(iii), (c)(2)(i), and (c)(2)(ii).
3. Adding the entry for §1.6664–
4(g)(3).
The revision and addition reads as fol-
lows:
December 14, 199861998–50 I.R.B.
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§1.6664-0 Table of contents.
* * * * *
§1.6664–4 Reasonable cause and good
faith exception to section 6662 penalties.
* * * * *
(c) * * *
(2) Advice defined.
* * * * *
(g) * * *
(3) Special rules.
* * * * *
Par. 8. In §1.6664–4, paragraph (g) is
revised to read as follows:
§1.6664-4 Reasonable cause and good
faith exception to section 6662 penalties.
* * * * *
(g) Valuation misstatements of charita-
ble deduction property—(1) In general.
There may be reasonable cause and good
faith with respect to a portion of an under-
payment that is attributable to a substan-
tial (or gross) valuation misstatement of
charitable deduction property (as defined
in paragraph (g)(2) of this section) only
if—
(i) The claimed value of the property
was based on a qualified appraisal (as de-
fined in paragraph (g)(2) of this section)
by a qualified appraiser (as defined in
paragraph (g)(2) of this section); and
(ii) In addition to obtaining a qualified
appraisal, the taxpayer made a good faith
investigation of the value of the con-
tributed property.
(2) Definitions.For purposes of this
paragraph (g):
Charitable deduction propertymeans
any property (other than money or pub-
licly traded securities, as defined in
§1.170A–13(c)(7)(xi)) contributed by the
taxpayer in a contribution for which a de-
duction was claimed under section 170.
Qualified appraisalmeans a qualified
appraisal as defined in §1.170A–13(c)(3).
Qualified appraisermeans a qualified
appraiser as defined in §1.170A–13(c)(5).
(3) Special rules.The rules of this
paragraph (g) apply regardless of whether
§1.170A–13 permits a taxpayer to claim a
charitable contribution deduction for the
property without obtaining a qualified ap-
praisal. The rules of this paragraph (g)
apply in addition to the generally applica-
ble rules concerning reasonable cause and
good faith.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
Approved November 17, 1998.
Donald C. Lubick,
Acting Assistant Secretary of
the Treasury.
(Filed by the Office of the Federal Register on
December 1, 1998, 8:45 a.m., and published in the
issue of the Federal Register for December 2, 1998,
63 F.R. 66433)
1998–50 I.R.B.7December 14, 1998
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December 14, 199881998–50 I.R.B.
26 CFR 601.201: Rulings and determination
letters.
Rev. Proc. 98–59
SECTION 1. PURPOSE
This revenue procedure (1) provides
guidance on obtaining opinion letters to
drafters of Roth IRAs and (2) provides
transitional relief for users of Roth IRAs
that have not been approved by the Inter-
nal Revenue Service.
SECTION 2. BACKGROUND AND
GENERALINFORMATION
.01 Internal Revenue Code § 408A,
added by § 302 of the Taxpayer Relief Act
of 1997, Pub. L. 105–34, permits the es-
tablishment of a new type of individual
retirement arrangement, a Roth IRA, that
taxpayers can use, beginning in 1998, to
save money for their retirement or their
beneficiaries. Except as otherwise pro-
vided in § 408Aand the regulations there-
under, a Roth IRAis treated the same as a
traditional IRA.
.02 Subsections (a) and (b) of § 408 set
forth general requirements for individual
retirement accounts and individual retire-
ment annuities, respectively.
.03 Section 408(c) provides that a trust
established by an employer or an associa-
tion of employees for the benefit of em-
ployees or members, respectively, is
treated as an IRAif there is a separate ac-
counting for each employee or member
and the trust otherwise satisfies the re-
quirements of § 408(a) (a “section 408(c)
IRA”).
.04 In 1997, the Service issued two
model forms, Form 5305–R and Form
5305–RAthat may be used to establish a
Roth IRAas a trust account or a custodial
account, respectively. In 1998, the Service
issued Form 5305–RB, a model endorse-
ment that can be used to establish a Roth
individual retirement annuity. Model
forms issued by the Service contain pre-
approved language that, if followed, will
satisfy the applicable statutory require-
ments. Model forms should not be sub-
mitted to the Service, even if additional
provisions are added to Article IX of the
forms, provided that the additional provi-
sions comply with the instructions for Ar-
ticle IX. (But see section 3.05 of this rev-
enue procedure regarding automatic ap-
proval of Roth IRAdocuments that con-
tain language identical to a model form.)
.05 Announcement 97–122, 1997–50
I.R.B. 63 (December 15, 1997), which
was issued at the same time as Forms
5305–R and 5305–RA, announced the is-
suance of these forms and provided in-
terim guidance on Roth IRAs.
.06 On September 3, 1998, proposed
Income Tax Regulations under § 408A
were published in the Federal Register
(63 F.R. 46937).
.07 Notice 98–49, 1998–38 I.R.B. 5
(September 21, 1998), provides guidance
on Service-approved Roth IRAdocu-
ments and IRAreporting requirements.
.08 Notice 98–50, 1998–44 I.R.B. 10
(November 2, 1998), provides guidance
on reconverting amounts from a tradi-
tional IRAto a Roth IRA.
.09 Rev. Proc. 87–50, 1987–2 C.B.
647, provides the procedures for a spon-
soring organization or a mass submitter (a
“prototype sponsor”) to apply to the Ser-
vice for an opinion letter on whether a
prototype traditional IRAmeets the re-
quirements of § 408(a) or (b). Rev. Proc.
87–50 also contains procedures for em-
ployers and employee associations to
apply for a ruling on a section 408(c)
IRA.
.10 Rev. Proc. 98–8, 1998–1 I.R.B.
225 (January 5, 1998), provides guidance
to taxpayers for complying with the user-
fee program as it pertains to matters under
the jurisdiction of the Assistant Commis-
sioner (Employee Plans and Exempt Or-
ganizations).
SECTION 3. OPINION LETTERS
FOR ROTH IRAS
.01 Prototype program.Aprototype
sponsor may apply to the Service for an
opinion letter for a Roth IRAsubmitted
pursuant to this section 3. The same pro-
cedures and user fees apply to a submis-
sion for an opinion letter for a Roth IRA
as those that apply for a traditional IRA,
with the exceptions described in sections
3.02 and 3.03 below. (See Rev. Procs.
87–50 and 98–8.)
.02 Procedural requirements.An ap-
plication for approval of a prototype Roth
IRAmust be submitted using Form 5306,
Application for Approval of a Prototype
Individual Retirement Arrangement, with
the words “Roth IRA” written in the
upper margin of the form. The applica-
tion must be accompanied by a user fee in
the same amount as set by Rev. Proc. 98-8
for a traditional IRA.
.03 Dual-purpose prototype docu-
ments. Aprototype document can only
be used as one type of IRA(traditional,
SIMPLE, or Roth). However, a prototype
document may be designed for use as ei-
ther a traditional IRAor a Roth IRApro-
vided the conditions in (1) and (2) below
are satisfied:
(1) The document is designed so
that, upon execution, the owner must ex-
plicitly and unambiguously indicate
whether the IRAis to be a Roth IRAor a
traditional IRA, and it is clear that desig-
nation as one type precludes its use as the
other type.
(2) Contributions to a Roth IRAare
maintained in a separate trust, custodial
account or annuity from contributions to a
traditional IRA.
Application for approval of such a
dual-purpose prototype document must be
submitted using Form 5306, with the
words “Dual-purpose IRA” written in the
upper margin of the form. Except in the
case of a sponsoring organization’s word-
for-word identical adoption of a mass
submitter’s prototype dual-purpose IRA,
the application must be accompanied by a
user fee in the amount of 200 percent of
the applicable fee set by Rev. Proc. 98-8
for a prototype IRA.
.04 Section 408(c) IRAprogram.An
employer or employee association may
apply to the Service for an opinion letter
for a section 408(c) IRAthat is a Roth
IRAusing the same procedures in sec-
tions 3.01 and 3.02 above that apply for a
prototype Roth IRA.
.05 Model form language.The Service
will not issue an opinion letter on a docu-
ment which terms are word-for-word
identical to the operative provisions of
one of the model forms described in sec-
tion 2.04 of this revenue procedure (other
than any provisions which may be added
as Article IX to the form). Such a docu-
ment is deemed to meet the statutory re-
quirements for a Roth IRA. However, the
Part III. Administrative, Procedural, and Miscellaneous
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1998–50 I.R.B.9December 14, 1998
document should indicate which model
form it is identical to and the revision date
of the form.
.06 Sample language.Sample lan-
guage (also known as Listing of Required
Modifications, or LRMs) that the Service
finds acceptable for Roth IRAs may be
obtained by writing to the Service at: In-
ternal Revenue Service, 1111 Constitution
Avenue NW, Attention OP:E:EP, Room
6550, Washington, D.C. 20224. “LRM
Request” should be clearly printed on the
envelope. Alternatively, a request for an
LRM may be faxed to Nancy Arrington at
(202) 622-6199.
SECTION 4. TRANSITIONAL
RELIEF
.01 Prototype IRAs.An individual
who establishes a trust, custodial account
or annuity contract as a Roth IRAafter
December 31, 1997, and before the ap-
plicable date in section 4.01(3) below
using a document that has not been ap-
proved by the Service for use as a Roth
IRAis deemed to have used a document
that has been approved by the Service for
this use provided the conditions in sec-
tions 4.01(1) through 4.01(4) below are
satisfied:
(1) The individual used a document
provided by a prototype sponsor and the
document, or associated written material,
clearly designated the trust, custodial ac-
count or annuity as a Roth IRAat the time
of establishment.
(2) On or before June 30, 1999, the
prototype sponsor applies to the Service
for an opinion letter on the document de-
scribed in section 4.01(1) above using the
procedures described in section 3 of this
revenue procedure.
(3) The individual adopts the ap-
proved document within 120 days after
the later of: (a) the date the Service issues
a favorable opinion letter on the docu-
ment to the prototype sponsor and (b) if
the prototype sponsor seeks approval of
the document from one or more state in-
surance departments not later than 90
days after the Service issues a favorable
opinion letter on the document, the date
the document is approved by all such state
insurance departments. If, as a result of
amendments to the document required by
a state insurance department, the proto-
type sponsor applies to the Service for an
opinion letter on the amended document
within 90 days after it is approved by such
state insurance department, the date in (a)
in the preceding sentence is the date the
Service issues a favorable opinion letter
on the amended document.
(4) For the period beginning with
the establishment of the Roth IRAand
ending on the date the Service-approved
document is adopted, the individual and
the trustee, custodian or issuer comply in
operation with § 408A.
.02 Section 408(c) IRAs.An employer
or employee association that establishes a
trust or custodial account under § 408(c)
for use as a Roth IRAafter December 31,
1997, and before June 30, 1999, using a
document that has not been approved by
the Service for use as a Roth IRAis
deemed to have used a document that has
been approved by the Service for this use
provided the conditions in sections
4.02(1) through 4.02(4) below are satis-
fied.
(1) The employer or employee asso-
ciation used a document that clearly des-
ignated the trust or custodial account as a
Roth IRAat the time of establishment.
(2) On or before June 30, 1999, the
employer or employee association applies
to the Service for an opinion letter on the
document described in section 4.02(1)
above using the procedures described in
section 3 of this revenue procedure.
(3) The employer or employee asso-
ciation adopts the approved document
within 30 days after the date the Service
issues a favorable opinion letter on the
document to the employer or employee
association.
(4) For the period beginning with
the establishment of the Roth IRAand
ending on the date the Service-approved
document is adopted, the employer or em-
ployee association, the employee for
whose benefit the Roth IRAis estab-
lished, and the trustee or custodian com-
ply in operation with § 408A.
SECTION 5. EFFECTON OTHER
DOCUMENTS
Section 6.06 of Rev. Proc. 98–8 is
modified by sections 3.02 and 3.03 of this
revenue procedure, and section 6.02 of
Rev. Proc. 87–50 is modified by section 3
of this revenue procedure.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective on
November 30, 1998.
DRAFTING INFORMATION
The principal author of this revenue
procedure is Roger Kuehnle of the Em-
ployee Plans Division. For further infor-
mation regarding this revenue procedure,
please contact the Employee Plans Divi-
sion’s taxpayer assistance telephone ser-
vice at (202) 622-6074/75 (not toll-free
numbers) between 1:30 and 3:30 p.m.,
Eastern Time, Monday through Thursday.
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December 14, 1998101998–50 I.R.B.
Notice of Proposed Rulemaking
Credit for Increasing Research
Activities
REG–105170–97
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing.
SUMMARY: This document contains
proposed regulations relating to the com-
putation of the credit under section 41(c)
and the definition of qualified research
under section 41(d). The proposed regu-
lations reflect changes to section 41 made
by the Tax Reform Act of 1986, the Rev-
enue Reconciliation Act of 1989, the
Small Business Job Protection Act of
1996, and the Taxpayer Relief Act of
1997. The proposed regulations also pro-
vide certain technical amendments to the
regulations.
DATES: Written comments must be re-
ceived no later than March 2, 1999.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–105170–97),
room 5228, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–105170–97),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically via
the Internet by selecting the “Tax Regs”
option of the IRS Home Page, or by sub-
mitting comments directly to the IRS In-
ternet site at: http://www.irs.ustreas.gov/
prod/tax_regs/comments.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Lisa J. Shuman or Leslie H. Finlow
at (202)622-3120 (not a toll-free number);
concerning submission of comments, the
hearing, and/or to be placed on the build-
ing access list to attend the hearing, La
Nita Van Dyke at (202)622-7190 (not a
toll-free number).
SUPPLEMENTARYINFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in ac-
cordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)). Com-
ments on the collection of information
should be sent to the Office of Manage-
ment and Budget,Attn: Desk Officer for
the Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503, with copies to
the Internal Revenue Service,Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224. Comments on
the collection of information should be re-
ceived by March 2, 1999. Comments are
specifically requested concerning:
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the IRS, in-
cluding whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information (see below);
How the quality, utility, and clarity of
the information to be collected may be en-
hanced;
How the burden of complying with the
proposed collection of information may
be minimized, including through the ap-
plication of automated collection tech-
niques or other forms of information tech-
nology; and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide informa-
tion.
The collection of information in this
proposed regulation is in §§1.41–4(a) and
1.41–8(b). The information is required by
the IRS to ensure that taxpayers have en-
gaged in qualified research and to ensure
the proper computation of the credit for
increasing research activities under sec-
tion 41. Section 1.41–4(a) defines a
process of experimentation, as required
for credit eligibility, to include the record-
ing of the results of the experiments. This
requirement imposes no additional
recordkeeping burden, because taxpayers
engaging in a bona fide process of experi-
mentation already record the results in
any event (see discussion under Explana-
tion of Provisions, 3. Documentation,in
this preamble). The information required
by §1.41–8 will be used to determine if
the taxpayer has elected or revoked the
election to use the alternative incremental
credit allowed under section 41(c)(4).
The collection of information is manda-
tory. The likely respondents are busi-
nesses or other for-profit institutions and
organizations. Responses to this collec-
tion of information are required to elect to
use and to revoke the election to use the
alternative incremental credit computa-
tion allowed under section 41(c)(4).
The reporting burden contained in
§1.41–8(b)(2) (relating to the election of
the alternative incremental credit) is re-
flected in the burden of Form 6765.
Estimated total annual reporting burden
under §1.41–8(b)(3) (relating to the revo-
cation of the election to use the alternative
incremental credit): 250 hours.
Estimated average annual burden hours
per respondent: 50 hours.
Estimated number of respondents: 5.
Estimated frequency of responses: On
occasion.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
The research credit provisions origi-
nally appeared in section 44F of the Inter-
nal Revenue Code of 1954 (the 1954
Code), as added to the 1954 Code by sec-
tion 221 of the Economic Recovery Tax
Act of 1981. Section 471(c) of the Tax
Reform Act of 1984 redesignated section
44F as section 30. Section 231 of the Tax
Reform Act of 1986 (the 1986 Act) redes-
ignated section 30 as section 41 and sub-
stantially modified the research credit
Part IV. Items of General Interest
IRB 1998-50 12/9/98 3:47 PM Page 10

provisions. The amendments made to
section 41 by the 1986 Act primarily re-
late to the definition of qualified research
in section 41(d) and the computation of
basic researchpayments under section
41(e). The Revenue Reconciliation Act of
1989 (the 1989 Act), the Revenue Recon-
ciliation Act of 1993 (the 1993 Act), the
Small Business Job Protection Act of
1996 (the 1996 Act), and the Taxpayer
Relief Act of 1997 (the 1997 Act) also
amended the research credit provisions.
These amendments primarily relate to the
trade or business requirement in section
41(b) and the computation of the credit
under sections 41(c) and 41(f).
On May 17, 1989, the IRS published in
the Federal Register(54 F.R. 21203)
final regulations under section 41. The
1989 final regulations generally do not re-
flect the amendments to section 41 made
by the 1986 Act, the 1989 Act, the 1993
Act, the 1996 Act, and the 1997 Act. The
amendments proposed by this document
contain rules relating primarily to the
amendments to section 41(d) made by the
1986 Act. The amendments proposed by
this document also contain some rules re-
lating to amendments to section 41 made
by the 1989 Act, the 1996 Act, and the
1997 Act.
On January 2, 1997, the IRS published
in the Federal Register(62 F.R. 81) pro-
posed regulations (the 1997 proposed reg-
ulations) under section 41 describing
when computer software that is developed
by (or for the benefit of) a taxpayer pri-
marily for the taxpayer’s internal use can
qualify for the credit for increasing re-
search activities. The 1997 proposed reg-
ulations reflect a change to section 41
made by the 1986 Act. The proposed reg-
ulations set forth in this notice of pro-
posed rulemaking complement but other-
wise do not affect the 1997 proposed
regulations.
The Tax and Trade Relief Extension
Act of 1998 extended the research credit
from June 30, 1998 through June 30,
1999. In the Conference Report, H.R.
Rep. No. 105–825, at 1547–49 (1998), the
conferees address the scope of the term
qualified research,comment on an aspect
of the process of experimentation require-
ment, and note a lack of clarity in the in-
terpretation of the distinction between in-
ternal-use software and other software.
These proposed regulations reflect the
views expressed by the conferees, as well
as prior legislative history, regarding the
term qualified researchand the process of
experimentation. The IRS and Treasury
request comments on the distinction be-
tween internal-use software and other
software.
Explanation of Provisions
1. Qualified Research
Congress enacted the research credit to
encourage business firms to perform the
research necessary to increase the innova-
tive qualities and efficiency of the U.S.
economy. H.R. Rep. No. 99-426, at 177
(1985); S. Rep. No. 99–313, at 694
(1986). In extending the research credit
in the 1986 Act, Congress expressed con-
cern that, in practice, taxpayers had ap-
plied the existing definition of qualified
researchtoo broadly and some taxpayers
had claimed the credit for virtually any
expense relating to product development.
H.R. Rep. No. 99–426, at 178; S. Rep.
No. 99–313, at 694–95. Many taxpayers
claiming the credit were not in industries
that involved high technology or its appli-
cation in developing technologically new
and improved products or methods of pro-
duction. H.R. Rep. No. 99–426, at 178;
S. Rep. No. 99–313, at 695.
To address these concerns, Congress
narrowed the scope of the research credit
by providing in the Internal Revenue
Code (Code) an express definition of the
term qualified research.In determining
eligibility for the research credit, section
41(d) requires that qualified research ac-
tivities satisfy a multi-part test. First, the
taxpayer’s expenditures must be eligible
to be treated as expenses under section
174. See §1.174–2(a)(1) (defining re-
search and experimental expenditures).
Second, the expenditures must relate to
research undertaken for the purpose of
discovering information that is both tech-
nological in nature and the application of
which is intended to be useful in develop-
ing a new or improved business compo-
nent of the taxpayer. The proposed regu-
lations provide that research is undertaken
for the purpose of discovering informa-
tion that is technological in nature only if
the research activities are undertaken to
obtain knowledge that exceeds, expands,
or refines the common knowledge of
skilled professionals in the particular field
of technology or science and the process
of experimentation utilized fundamentally
relies on principles of physical or biologi-
cal sciences, engineering, or computer
science. Consistent with the requirement
that the research activities be undertaken
to obtain knowledge that exceeds, ex-
pands, or refines the common knowledge
of skilled professionals in the particular
field of technology or science, the credit
may be available where the technological
advance sought by the taxpayer is evolu-
tionary, and, in certain circumstances,
where the taxpayer is not the first to
achieve the same advance. Moreover, the
credit is available regardless of whether
the taxpayer succeeds or fails in achieving
the desired advance.
Third, section 41(d) requires that sub-
stantially all of the activities of the re-
search constitute elements of a process of
experimentationthat relates to a new or
improved function, performance, reliabil-
ity or quality. As noted in the previous
paragraph, the process of experimentation
utilized must fundamentally rely on prin-
ciples of physical or biological sciences,
engineering, or computer science.
In developing a process of experimen-
tation rule applicable to all scientific dis-
ciplines, IRS personnel met with person-
nel from the National Science Foundation
and the National Institute of Standards
and Technology. The proposed regulation
explains that a process of experimentation
is a process involving the evaluation of
more than one alternative designed to
achieve a result where the means of
achieving that result are uncertain at the
outset. This requires that the taxpayer (i)
develop one or more hypotheses designed
to achieve the intended result; (ii) design
a scientific experiment (that, where ap-
propriate to the particular field of re-
search, is intended to be replicable with
an established experimental control) to
test and analyze those hypotheses
(through, for example, modeling, simula-
tion, or a systematic trial and error
methodology); (iii) conduct the experi-
ment and record the results; and (iv) re-
fine or discard the hypotheses as part of a
sequential design process to develop or
improve the business component.
The proposed regulation does not re-
quire that the results of the experiments
be recorded in any specific manner. The
results of the experiments should be
1998–50 I.R.B.11December 14, 1998
IRB 1998-50 12/9/98 3:47 PM Page 11

recorded in a manner that is appropriate
for the particular field of science in which
the experiment is conducted and for the
type of experimentation involved. In
some fields, for example, experiments are
recorded in lab books. When developing
computer software, by contrast, the exper-
iments might be recorded in comment
lines contained in the source code.
In the 1986 Act, Congress also speci-
fied that expenditures incurred in certain
research, research-related, or non-re-
search activities are not eligible for the
credit. The excluded activities are: post-
production activities, adaptation, duplica-
tion, surveys and studies, research outside
the United States, research in the social
sciences, funded research, and research
related to certain internal-use computer
software.
Section 1.41–4 of this proposed regula-
tion contains rules that clarify the defini-
tion of the term qualified research and
other terms used in section 41(d). The
proposed regulation also provides rules
relating to activities for which the re-
search credit is not allowed.
2. Application of Tests
In the legislative history to the 1986
Act, Congress stated that if the require-
ments of section 41(d) are not met for an
entire product, the term business compo-
nentmeans the most significant set of ele-
ments of that product for which all the re-
quirements of section 41(d) are met. The
legislative history provides that this
“shrinking back” is to continue until ei-
ther a subset of elements of the product
that satisfies the requirements is reached,
or the most basic element of the product is
reached and such element fails to satisfy
the test.
Consistent with the legislative history,
§1.41–4(b) of the proposed regulation ex-
plains that the “shrinking-back” concept
is the method for applying the tests in sec-
tion 41(d) to a business component.
3. Documentation
Taxpayers must (a) record the results of
their scientific experiments (in a manner
that is appropriate for the particular field
of science in which the experiment is con-
ducted and for the type of experiment in-
volved) and (b) comply with the record-
keeping requirements of section 6001 and
the regulations thereunder. The require-
ment that taxpayers record the results of
their scientific experiments is not in-
tended to cause taxpayers to create
records that otherwise would not be cre-
ated. Rather, the recording of results is
inherent in a process of experimentation
to discover information that is technologi-
cal in nature. Limiting the availability of
the credit to taxpayers who record the re-
sults of their scientific experiments is not
intended to change taxpayer behavior, but
to identify taxpayers who engage in a
bona fide process of experimentation and
thus may be eligible for the credit.
4. Election of the Alternative Incremental
Credit
The notice of proposed rulemaking
provides rules for electing the alternative
incremental credit, which may be elected
under section 41(c)(4). Section 1.41-8 of
the proposed regulation provides that the
election is made on Form 6765, “Credit
for Increasing Research Activities,” and
that the completed form must be attached
to the taxpayer’s timely filed original re-
turn (including extensions) for the taxable
year to which the election applies.
Proposed Effective Date
In general, the regulations are proposed
to be effective for expenditures paid or in-
curred on or after the date final regula-
tions are published in the Federal Regis-
ter. The regulations addressing the base
amount are proposed to be effective for
taxable years beginning on or after the
date final regulations are published in the
Federal Register.The regulations pro-
viding for the election and revocation of
the alternative incremental credit are pro-
posed to be effective for taxable years
ending on or after the date final regula-
tions are published in the Federal Regis-
ter.No inference should be drawn from
the proposed effective date concerning
the application of section 41 to expendi-
tures paid or incurred or the computation
of the base amount before the proposed
effective date.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions. It is hereby certified that the collec-
tion of information contained in these reg-
ulations will not have a significant
economic impact on a substantial number
of small entities. Accordingly, a Regula-
tory Flexibility Analysis under the Regu-
latory Flexibility Act (5 U.S.C. chapter 6)
is not required. This certification is based
on the information that follows. The eco-
nomic impact of the collection of infor-
mation contained in these regulations on
any small entity would result from the en-
tity being required to (1) record the results
of experiments related to its qualified re-
search activities, (2) elect on Form 6765
to use the alternative incremental credit if
the entity desires to use that method, and
(3) obtain permission to revoke the alter-
native incremental credit election, if so
desired. Because taxpayers record results
in conducting their research activities in
any event (see discussion under Explana-
tion of Provisions,3. Documentation,in
this preamble), the economic impact of
the recordkeeping requirement in the reg-
ulation would not be significant. The
economic impact of electing the alterna-
tive incremental credit on Form 6765 also
would not be significant because the elec-
tion is made on the same form and is
based on the same information that is
used to claim the research credit. Pur-
suant to section 7805(f), this notice of
proposed rulemaking will be submitted to
the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written comments
(preferably a signed original and eight (8)
copies) that are submitted timely (in the
manner described in the ADDRESSES
portion of this preamble) to the IRS. Sub-
missions might include comments on the
definition of gross receipts, comments re-
garding the exclusion for post-production
activities, comments on whether and how
the definition of a process of experimenta-
tion should be refined to ensure that it is
appropriate for all scientific fields, and
comments on the interaction of the discov-
ery requirement and the duplication exclu-
sion and the effect of such interaction on
specific industries. Also, submissions
December 14, 1998121998–50 I.R.B.
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might include comments on clarifying the
distinction between internal-use software
(i.e., software described in section
41(d)(4)(E)) and other software. All com-
ments will be available for public inspec-
tion and copying.
Apublic hearing will be scheduled in
the Internal Revenue Building, 1111 Con-
stitution Avenue, NW, Washington, DC.
The IRS recognizes that persons outside
the Washington, DC area also may wish
to testify at the public hearing through
teleconferencing. Requests to include
teleconferencing sites must be received
by January 18, 1999. If the IRS receives
sufficient indications of interest to war-
rant teleconferencing to a particular city,
and if the IRS has teleconferencing facili-
ties available in that city on the date the
public hearing is to be scheduled, the IRS
will try to accommodate the requests.
The IRS will publish the time and date
of the public hearing and the locations of
any teleconferencing sites in an an-
nouncement in the Federal Register.The
announcement will include the date by
which persons that wish to present oral
comments at the hearing must submit re-
quests to speak, outlines of the topics to
be discussed, and the time to be devoted
to each topic.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal authors of these proposed
regulations are Lisa J. Shuman and Leslie
H. Finlow of the Office of the Assistant
Chief Counsel (Passthroughs and Special
Industries). However, personnel from
other offices of the IRS and the Treasury
Department participated in their develop-
ment.
*****
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows. (Note:
The proposed amendments complement
the proposed amendments published at 62
F.R. 83, January 2, 1997.)
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Revise the undesignated center-
heading immediately before §1.30–1 to
read as follows:
CREDITS ALLOWABLE UNDER
SECTION 30 THROUGH 44B
Par. 3. Remove the undesignated cen-
terheading immediately before §1.41–0.
Par. 4. Section 1.41–0 is revised to
read as follows:
§1.41–0 Table of contents.
This section lists the paragraphs con-
tained in §§1.41–0 through 1.41–8.
§1.41–0 Table of contents.
§1.41–1 Credit for increasing research
activities.
(a) Basic principles.
(b) Amount of credit.
(c) Introduction to regulations under
section 41.
§1.41–2 Qualified research expenses.
(a) Trade or business requirements.
(1) In general.
(2) New business.
(3) Research performed for others.
(i) Taxpayer not entitled to results.
(ii) Taxpayer entitled to results.
(4) Partnerships.
(i) In general.
(ii) Special rule for certain partnerships
and joint ventures.
(b) Supplies and personal property used
in the conduct of qualified research.
(1) In general.
(2) Certain utility charges.
(i) In general.
(ii) Extraordinary expenditures.
(3) Right to use personal property.
(4) Use of personal property in taxable
years beginning after December 31,
1985.
(c) Qualified services.
(1) Engaging in qualified research.
(2) Direct supervision.
(3) Direct support.
(d) Wages paid for qualified services.
(1) In general.
(2) “Substantially all.”
(e) Contract research expenses.
(1) In general.
(2) Performance of qualified research.
(3) “On behalf of.”
(4) Prepaid amounts.
(5) Examples.
§1.41–3 Base amount for taxable years
beginning on or after the date final
regulations are published in the Federal
Register.
(a) and (b) [Reserved]
(c) Definition of gross receipts.
(1) In general.
(2) Amounts excluded.
(3) Foreign corporations.
(d) Consistency requirement.
(1) In general.
(2) Illustrations.
§1.41–4 Qualified research for
expenditures paid or incurred on or after
the date final regulations are published in
the Federal Register.
(a) Qualified research.
(1) General rule.
(2) Requirements of section 41(d)(1).
(3) Discovering information.
(4) Technological in nature.
(5) Process of experimentation.
(6) Substantially all requirement.
(7) Use of computers and information
technology.
(8) Illustrations.
(b) Application of requirements for
qualified research.
(1) In general.
(2) Shrinking-back rule.
(3) Illustration.
(c) Excluded activities.
(1) In general.
(2) Research after commercial produc-
tion.
(i) In general.
(ii) Certain additional activities related
to the business component.
(iii) Activities related to production pro-
cess or technique.
(3) Adaptation of existing business com-
ponents.
(4) Duplication of existing business
component.
(5) Surveys, studies, research relating to
management functions, etc.
(6) Internal-use computer software.
(7) Activities outside the United States.
(i) In general.
(ii) Apportionment of in-house research
expenses.
(iii) Apportionment of contract research
expenses.
(8) Research in the social sciences, etc.
(9) Research funded by any grant, con-
tract, or otherwise.
(10) Illustrations.
1998–50 I.R.B.13December 14, 1998
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(d) Documentation.
§1.41–5 Basic research for taxable years
beginning after December 31, 1986.
[Reserved]
§1.41–6 Aggregation of expenditures.
(a) Controlled group of corporations;
trades or businesses under common
control.
(1) In general.
(2) Definition of trade or business.
(3) Determination of common control.
(4) Examples.
(b) Minimum base period research ex-
penses.
(c) Tax accounting periods used.
(1) In general.
(2) Special rule where timing of re-
search is manipulated.
(d) Membership during taxable year in
more than one group.
(e) Intra-group transactions.
(1) In general.
(2) In-house research expenses.
(3) Contract research expenses.
(4) Lease payments.
(5) Payment for supplies.
§1.41–7 Special rules.
(a) Allocations.
(1) Corporation making an election
under subchapter S.
(i) Pass-through for taxable years be-
ginning after December 31, 1982, in
the case of an S corporation.
(ii) Pass-through, for taxable years be-
ginning before January 1, 1983, in
the case of a subchapter S corpora-
tion.
(2) Pass-through in the case of an estate
or trust.
(3) Pass-through in the case of a partner-
ship.
(i) In general.
(ii) Certain expenditures by joint ven-
tures.
(4) Year in which taken into account.
(5) Credit allowed subject to limitation.
(b) Adjustments for certain acquisitions
and dispositions—Meaning of terms.
(c) Special rule for pass-through of
credit.
(d) Carryback and carryover of unused
credits.
§1.41–8 Special rules for taxable years
ending on or after the date final
regulations are published in the Federal
Register.
(a) Alternative incremental credit.
(b) Election.
(1) In general.
(2) Time and manner.
(3) Revocation.
Par. 5. Section 1.41–1 is revised to
read as follows:
§1.41–1 Credit for increasing research
activities.
(a) Basic principles.Section 41 pro-
vides a credit for increasing research activ-
ities. The credit is intended to encourage
business firms to perform the technologi-
cal research necessary to increase the inno-
vative qualities and efficiency of the U.S.
economy. The credit provides an incentive
for business firms to increase their expen-
ditures for research to obtain new knowl-
edge through a scientific process of experi-
mentation. Consequently, the credit is not
to be applied too broadly or in a manner
such that virtually any expense relating to
the development of a product is eligible for
the credit, even if some portion of the ex-
pense of developing the product does qual-
ify for the credit. Similarly, the credit is
not available for an expenditure merely be-
cause the expenditure may be treated as an
expense under section 174. On the other
hand, the credit may be available even
though the technological advance sought
by the taxpayer is evolutionary, and, in cer-
tain circumstances, even if another tax-
payer has previously achieved the same
advance. Moreover, the credit is available
regardless of whether the taxpayer suc-
ceeds or fails in achieving the desired ad-
vance. The credit is limited to eligible ex-
penditures paid or incurred for qualified
research, as defined in section 41(d) and
§1.41–4.
(b) Amount of credit.The amount of a
taxpayer’s credit is determined under sec-
tion 41(a). For taxable years beginning
after June 30, 1996, and at the election of
the taxpayer, the portion of the credit de-
termined under section 41(a)(1) may be
calculated using the alternative incremen-
tal credit set forth in section 41(c)(4).
(c) Introduction to regulations under
section 41.(1) Sections 1.41–2 through
1.41–8 and 1.41–3Athrough 1.41–5Aad-
dress only certain provisions of section
41. The following table identifies the
provisions of section 41 that are ad-
dressed, and lists each provision with the
section of the regulations in which it is
covered.
December 14, 1998141998–50 I.R.B.
Section of the regulationSection of the Internal Revenue Code
§1.41–241(b)
§1.41–341(c)
§1.41–441(d)
§1.41–541(e)
§1.41–641(f)
§1.41–741(f)
41(g)
§1.41–841(c)
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(2) Section 1.41–3Aalso addresses the
special rule in section 221(d)(2) of the
Economic Recovery Tax Act of 1981 re-
lating to taxable years overlapping the ef-
fective dates of section 41. Section 41
was formerly designated sections 30 and
44F. Sections 1.41–0 through 1.41–8 and
1.41–0Athrough 1.41–5Arefer to these
sections as section 41 for conformity pur-
poses. Whether section 41, former sec-
tion 30, or former section 44F applies to a
particular expenditure depends upon
when the expenditure was paid or in-
curred.
§1.41–2 [Amended]
Par. 6. Section 1.41–2 is amended as
follows:
1. The last sentence of paragraph
(a)(3)(i) is amended by removing the lan-
guage “§1.41–5(d)(2)” and adding
“§1.41–4A(d)(2)” in its place.
2. The last sentence of paragraph
(a)(3)(ii) is amended by removing the lan-
guage “§1.41–5(d)(3)” and adding
“§1.41–4A(d)(3)” in its place.
3. The last sentence of paragraph
(a)(4)(ii)(F) is amended by removing the
language “§1.41–9(a)(3)(ii)” and adding
“§1.41–7(a)(3)(ii)” in its place.
4. Paragraph (e)(1)(i) is amended by
removing the language “§1.41–5” and
adding “§1.41–4 or 1.41–4A, whichever
is applicable” in its place.
Par. 7. An undesignated centerheading
is added immediately following §1.44B–1
to read as follows:
RESEARCH CREDIT—FOR TAXABLE
YEARS BEGINNING BEFORE JANU-
ARY1, 1990
§1.41–3 [Redesignated as §1.41–3A]
Par. 8. Section 1.41–3 is redesignated
as §1.41–3Aand added under the new un-
designated centerheading “RESEARCH
CREDIT—FOR TAXABLE YEARS BE-
GINNING BEFORE JANUARY1,
1990.”
Par. 9. New §1.41-3 is added to read as
follows:
§1.41–3 Base amount for taxable years
beginning on or after the date final
regulations are published in the Federal
Register.
(a) and (b) [Reserved]
(c) Definition of gross receipts—(1) In
general.For purposes of section 41,
gross receipts means the total amount, as
determined under the taxpayer’s method
of accounting, derived by the taxpayer
from all its activities and from all sources
(e.g., revenues derived from the sale of
inventory before reduction for cost of
goods sold).
(2) Amounts excluded.For purposes of
this paragraph (c), gross receipts do not
include amounts representing—
(i) Returns or allowances;
(ii) Receipts from the sale or exchange
of capital assets, as defined in section
1221;
(iii) Repayments of loans or similar in-
struments (e.g., a repayment of the princi-
pal amount of a loan held by a commer-
cial lender);
(iv) Receipts from a sale or exchange
not in the ordinary course of business,
such as the sale of an entire trade or busi-
ness or the sale of property used in a trade
or business as defined under section
1221(2); and
(v) Amounts received with respect to
sales tax or other similar state and local
taxes if, under the applicable state or local
law, the tax is legally imposed on the pur-
chaser of the good or service, and the tax-
payer merely collects and remits the tax to
the taxing authority.
(3) Foreign corporations.For pur-
poses of section 41, in the case of a for-
eign corporation, gross receipts include
only gross receipts that are effectively
connected with the conduct of a trade or
business within the United States. See
section 864(c) and applicable regulations
thereunder for the definition of effectively
connected income.
(d) Consistency requirement—(1) In
general.In computing the credit for in-
creasing research activities for taxable
years beginning after December 31, 1989,
qualified research expenses and gross re-
ceipts taken into account in computing a
taxpayer’s fixed-base percentage and a
taxpayer’s base amount must be deter-
mined on a basis consistent with the defi-
nition of qualified research expenses and
gross receipts for the credit year, without
regard to the law in effect for the taxable
years taken into account in computing the
fixed-base percentage or the base amount.
This consistency requirement applies
even if the period for filing a claim for
credit or refund has expired for any tax-
able year taken into account in computing
the fixed-base percentage or the base
amount.
(2) Illustrations. The following exam-
ples illustrate the application of the con-
sistency rule of paragraph (d)(1) of this
section:
Example 1.(i) X, an accrual method taxpayer
using the calendar year as its taxable year, incurs
qualified research expenses in 1990. X wants to
compute its research credit under section 41 for the
tax year ending December 31, 1990. As part of the
computation, X must determine its fixed-base per-
centage, which depends in part on X’s qualified re-
search expenses incurred during the fixed-base pe-
riod, the taxable years beginning after December 31,
1983, and before January 1, 1989.
(ii) During the fixed-base period, X reported the
following amounts as qualified research expenses on
its Form 6765:
1984 . . . . . . . . . . . . . . . . . . .$ 100x
1985 . . . . . . . . . . . . . . . . . . . . .120x
1986 . . . . . . . . . . . . . . . . . . . . .150x
1987 . . . . . . . . . . . . . . . . . . . . .180x
1988 . . . . . . . . . . . . . . . . . . . . .170x
Total . . . . . . . . . . . . . . . . . . . .$ 720x
1998–50 I.R.B.15December 14, 1998
Section of the regulationSection of the Internal Revenue Code
§1.41–3A41(c) (taxable years beginning before January 1, 1990)
§1.41–4A41(d) (taxable years beginning before January 1, 1986)
§1.41–5A41(e) (taxable years beginning before January 1, 1987)
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(iii) For the taxable years ending December 31,
1984, and December 31, 1985, X based the amounts
reported as qualified research expenses on the defin-
ition of qualified research in effect for those taxable
years. The definition of qualified research changed
for taxable years beginning after December 31,
1985. If X used the definition of qualified research
applicable to its taxable year ending December 31,
1990, the credit year, its qualified research expenses
for the taxable years ending December 31, 1984, and
December 31, 1985, would be reduced to $ 80x and
$ 100x, respectively. Under the consistency rule in
section 41(c)(5) and paragraph (d)(1) of this section,
to compute the research credit for the tax year end-
ing December 31, 1990, X must reduce its qualified
research expenses for 1984 and 1985 to reflect the
change in the definition of qualified research for tax-
able years beginning after December 31, 1985.
Thus, X’s total qualified research expenses for the
fixed-base period (1984-1988) to be used in comput-
ing the fixed-base percentage is $ 80 + 100 + 150 +
180 + 170 = $ 680x.
Example 2. The facts are the same as in Example
1,except that, in computing its qualified research ex-
penses for the taxable year ending December 31,
1999, X claimed that a certain type of expenditure in-
curred in 1999 was a qualified research expense. X’s
claim reflected a change in X’s position, because X
had not previously claimed that similar expenditures
were qualified research expenses. The consistency
rule requires X to adjust its qualified research ex-
penses in computing the fixed-base percentage to in-
clude any similar expenditures not treated as quali-
fied research expenses during the fixed-base period,
regardless of whether the period for filing a claim for
credit or refund has expired for any year taken into
account in computing the fixed-base percentage.
Par. 10. Section 1.41–4 is revised to
read as follows:
§1.41–4 Qualified research for
expenditures paid or incurred on or after
the date final regulations are published in
the Federal Register.
(a) Qualified research—(1) General
rule.Research activities related to the de-
velopment or improvement of a business
component constitute qualified research
only if the research activities meet all of
the requirements of section 41(d)(1) and
this section, and are not otherwise ex-
cluded under section 41(d)(3)(B) or (4),
or this section.
(2) Requirements of section 41(d)(1).
Research constitutes qualified research
only if it is research—
(i) With respect to which expenditures
may be treated as expenses under section
174, see §1.174–2;
(ii) That is undertaken for the purpose
of discovering information that is techno-
logical in nature, and the application of
which is intended to be useful in the de-
velopment of a new or improved business
component of the taxpayer; and
(iii) Substantially all of the activities of
which constitute elements of a process of
experimentation that relates to a new or
improved function, performance, reliabil-
ity or quality.
(3) Discovering information. For pur-
poses of section 41(d) and this section,
the term discovering informationmeans
obtaining knowledge that exceeds, ex-
pands, or refines the common knowledge
of skilled professionals in a particular
field of technology or science.
(4) Technological in nature. For pur-
poses of section 41(d) and this section,
information is technological in nature if
the process of experimentation used to
discover such information fundamentally
relies on principles of physical or biolog-
ical sciences, engineering, or computer
science.
(5) Process of experimentation.For
purposes of section 41(d) and this section,
a process of experimentation is a process
to evaluate more than one alternative de-
signed to achieve a result where the
means of achieving that result are uncer-
tain at the outset. Aprocess of experi-
mentation in the physical or biological
sciences, engineering, or computer sci-
ence requires that the taxpayer—
(i) Develop one or more hypotheses de-
signed to achieve the intended result;
(ii) Design a scientific experiment
(that, where appropriate to the particular
field of research, is intended to be replica-
ble with an established experimental con-
trol) to test and analyze those hypotheses
(through, for example, modeling, simula-
tion, or a systematic trial and error
methodology);
(iii) Conduct the experiment and record
the results; and
(iv) Refine or discard the hypotheses as
part of a sequential design process to de-
velop or improve the business compo-
nent.
(6) Substantially all requirement.The
substantially all requirement of section
41(d)(1)(C) and paragraph (a)(2)(iii) of
this section is satisfied only if 80 percent
or more of the research activities, mea-
sured on a cost or other consistently ap-
plied reasonable basis, constitute ele-
ments of a process of experimentation for
a purpose described in section 41(d)(3).
The substantially all requirement is ap-
plied separately to each business compo-
nent.
(7) Use of computers and information
technology.The employment of comput-
ers or information technology, or the re-
liance on principles of computer science
or information technology to store, col-
lect, manipulate, translate, disseminate,
produce, distribute, or process data or in-
formation, and similar uses of computers
and information technology does not it-
self establish that qualified research has
been undertaken.
(8) Illustrations. The following exam-
ples illustrate the application of paragraph
(a) of this section:
Example 1.(i) Facts.X undertakes to develop
for sale a tool that would improve its suite of appli-
cation development products. The desired tool
would handle connectivity problems for software
application developers by providing data access via
a layer of software that is more effective than exist-
ing software at finding data in various locations and
forms within a network, translating it if need be, and
then delivering the result to whatever application or
user requested it. The means of developing such
versatile database access middleware are not in the
common knowledge of skilled professionals in the
relevant technological fields. In order to determine
whether it can successfully develop the desired tool,
X develops, tests, and discards or refines various al-
gorithms and protocols.
(ii) Conclusion.X’s activities to develop the
technology to build the new software development
tool may be qualified research within the meaning of
section 41(d)(1) and paragraph (a) of this section. In
developing the technology, X undertook to obtain
knowledge that exceeds, expands, or refines the
common knowledge of skilled professionals in the
relevant technological fields.
Example 2.(i) Facts. X acquired a new software
environment, including a new operating system and
a new database management system with related
tools. X undertook a project to redeploy its data pro-
cessing systems to the new software environment.
X anticipated that, relative to the old system, the
new system would significantly increase the time-
sharing capabilities of its computer system. The
project activities included redesign of databases and
user interfaces, and translation of code from one
programming language to another. In migrating to
the new software environment, X relied on tech-
niques and approaches that were within the common
knowledge of skilled professionals in the relevant
technological fields.
(ii) Conclusion.X’s activities to redeploy its data
processing systems to the new software environment
are not qualified research within the meaning of sec-
tion 41(d)(1) and paragraph (a) of this section. X
did not undertake to obtain knowledge that exceeds,
expands, or refines the common knowledge of
skilled professionals in the relevant technological
fields.
Example 3. (i) Facts.X operates a computer
system that does not recognize dates beginning in
December 14, 1998161998–50 I.R.B.
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the year 2000. In order to ensure that its computer
system will not malfunction in the year 2000, X in-
curs substantial costs having its employees manually
search its computer programs to find all date fields
used in the programs and replace all of the date
fields with year 2000 compliant date fields.
(ii) Conclusion. Because the activities of X’s
employees were not undertaken to obtain knowledge
that exceeds, expands, or refines the common
knowledge of skilled professionals in the relevant
technological fields and do not involve a process of
experimentation, the activities are not qualified re-
search within the meaning of section 41(d)(1) and
paragraph (a) of this section.
Example 4.(i) Facts.X is engaged in the busi-
ness of developing and manufacturing widgets. X
wants to manufacture an improved widget made out
of a material that X has not previously used. Al-
though X is uncertain how to use the material to
manufacture an improved widget, the viability and
means of using the material to manufacture such
widgets are within the common knowledge of
skilled professionals in the relevant technological
fields.
(ii) Conclusion.Even though X’s expenditures
for the activities to resolve the uncertainty in manu-
facturing the improved widget may be treated as ex-
penses for research activities under section 174 and
§1.174–2, X’s activities to resolve the uncertainty in
manufacturing the improved widget are not quali-
fied research within the meaning of section 41(d)
and paragraph (a) of this section. Although X’s ac-
tivities were intended to eliminate uncertainty, the
activities were not undertaken to obtain knowledge
that exceeds, expands, or refines the common
knowledge of skilled professionals in the relevant
technological fields.
Example 5. (i) Facts.X desires to build a bridge
that can sustain greater traffic flow without deterio-
ration than can existing bridges. The technology
used to build such a bridge is not in the common
knowledge of skilled professionals in the relevant
technological fields. X eventually abandons the pro-
ject after attempts to develop the technology prove
unsuccessful.
(ii) Conclusion.X’s activities to develop the
technology to build the bridge may be qualified re-
search within the meaning of section 41(d)(1) and
paragraph (a) of this section, regardless of the fact
that X did not actually succeed in developing that
technology. In seeking to develop the technology, X
undertook to obtain knowledge that exceeds, ex-
pands, or refines the common knowledge of skilled
professionals in the relevant technological fields.
Example 6.(i) Facts.The facts are the same as
in Example 5,except that Ysuccessfully builds a
bridge that can sustain the greater traffic flow.
Thereafter, Z seeks to build a bridge that can also
sustain such greater traffic flow. The technology
used by Yto build its bridge is a closely guarded se-
cret that is not known to Z and remains beyond the
common knowledge of skilled professionals in the
relevant technological fields.
(ii) Conclusion.Z’s activities to develop the
technology to build the bridge may be qualified re-
search within the meaning of section 41(d)(1) and
paragraph (a) of this section, even if it so happens
that the technology used by Z to build its bridge is
similar or identical to the technology used by Y. In
developing the technology, Z undertook to obtain
knowledge that exceeds, expands, or refines the
common knowledge of skilled professionals in the
relevant technological fields.
Example 7.(i) Facts.X and other manufacturing
companies have previously designed and manufac-
tured a particular kind of machine using Material S.
Material Tis less expensive than Material S. X
wishes to design a new machine that appears and
functions exactly the same as its existing machines,
but that is made of Material Tinstead of Material S.
The technology necessary to achieve this objective
is not within the common knowledge of skilled pro-
fessionals in the relevant technological fields.
(ii) Conclusion. X’s activities to design the new
machine using Material Tmay be qualified research
within the meaning of section 41(d)(1) and para-
graph (a) of this section. In seeking to design the
machine, X undertook to obtain knowledge that ex-
ceeds, expands, or refines the common knowledge
of skilled professionals in the relevant technological
fields.
Example 8.(i) Facts.X, a tire manufacturer,
seeks to build a tire that will not deteriorate as
rapidly under certain conditions of high speed and
temperature as do existing tires. The design of such
a tire is not within the common knowledge of skilled
professionals in the relevant technological fields. X
commences laboratory research on January 1. On
April 1, X determines in the laboratory that a certain
combination of materials and additives can with-
stand higher rotational speeds and temperatures than
the combination of materials and additives used in
existing tires. On the basis of this determination, X
undertakes further research activities to determine
how to design a tire using those materials and addi-
tives, and to determine whether such a tire functions
outside the laboratory as intended under various ac-
tual road conditions. By September 1, but not prior
to September 1, X’s research has progressed to the
point where, applying X’s knowledge to date, both
the viability and means of producing the desired tire
would be within the common knowledge of skilled
professionals in the relevant technological fields.
However, X continues to engage in certain research
activities related to the tire after September 1, and
until the first tire rolls off the assembly line on De-
cember 1.
(ii) Conclusion.Some or all of X’s research ac-
tivities until September 1 may be qualified research
within the meaning of section 41(d)(1) and para-
graph (a) of this section. In seeking to design the
tire, X undertook to obtain knowledge that exceeds,
expands, or refines the common knowledge of
skilled professionals in the relevant technological
fields. The activities conducted after September 1
are not qualified research within the meaning of sec-
tion 41(d)(1) and paragraph (a) of this section, be-
cause those activities were not undertaken to obtain
knowledge that exceeds, expands, or refines the
common knowledge of skilled professionals in the
relevant technological fields.
(b) Application of requirements for
qualified research—(1) In general.The
requirements for qualified research in sec-
tion 41(d)(1) and paragraph (a) of this
section, must be applied separately to
each business component, as defined in
section 41(d)(2)(B). In cases involving
development of both a product and a man-
ufacturing or other commercial produc-
tion process for the product, research ac-
tivities relating to development of the
process are not qualified research unless
the requirements of section 41(d) and this
section are met for the research activities
relating to the process without taking into
account the research activities relating to
development of the product. Similarly,
research activities relating to develop-
ment of the product are not qualified re-
search unless the requirements of section
41(d) and this section are met for the re-
search activities relating to the product
without taking into account the research
activities relating to development of the
manufacturing or other commercial pro-
duction process.
(2) Shrinking-back rule.The require-
ments of section 41(d) and paragraph (a)
of this section are to be applied first at the
level of the discrete business component
to be held for sale, lease or license, or
used by the taxpayer in a trade or business
of the taxpayer. If all aspects of the re-
quirements are not met at the first level,
the requirements are to be applied at the
next most significant subset of elements
of the business component. The shrink-
ing-back of the applicable business com-
ponent continues until a subset of ele-
ments of the business component satisfies
the requirements of section 41(d) and
paragraph (a) of this section (treating that
subset of elements as a business compo-
nent) or the most basic element fails to
satisfy the requirements.
(3) Illustration. The following exam-
ple illustrates the application of this para-
graph (b):
Example.X, a motorcycle engine builder, devel-
ops a new carburetor for use in a motorcycle engine.
X also modifies an existing engine design for use
with the new carburetor. Under the shrinking-back
rule, the requirements of section 41(d)(1) and para-
graph (a) of this section are applied first to the en-
gine. If the modifications to the engine when
viewed as a whole, including the development of the
new carburetor, do not satisfy the requirements of
section 41(d)(1) and paragraph (a) of this section,
those requirements are applied to the next most sig-
nificant subset of elements of the business compo-
nent. For purposes of this example, it is assumed
that the new carburetor is the next most significant
subset of elements of the business component. The
research activities in developing the new carburetor
may constitute qualified research within the mean-
ing of section 41(d)(1) and paragraph (a) of this sec-
tion.
1998–50 I.R.B.17December 14, 1998
IRB 1998-50 12/9/98 3:47 PM Page 17

(c) Excluded activities—(1) In general.
Qualified research does not include any
activity described in sections 41(d)(3)(B)
and (4), this paragraph (c), and paragraph
(e) of this section.
(2) Research after commercial produc-
tion—(i) In general.Activities conducted
after the beginning of commercial pro-
duction of a business component are not
qualified research. Activities are con-
ducted after the beginning of commercial
production of a business component if
such activities are conducted after the
component is developed to the point
where it is ready for commercial sale or
use, or meets the basic functional and
economic requirements of the taxpayer
for the component’s sale or use.
(ii) Certain additional activities related
to the business component.The follow-
ing activities are deemed to occur after
the beginning of commercial production
of a business component—
(A) Preproduction planning for a fin-
ished business component;
(B) Tooling-up for production;
(C) Trial production runs;
(D) Trouble shooting involving detect-
ing faults in production equipment or
processes;
(E) Accumulating data relating to pro-
duction processes; and
(F) Debugging or correcting flaws in a
business component.
(iii) Activities related to production
process or technique.In cases involving
development of both a product and a man-
ufacturing or other commercial produc-
tion process for the product, the exclusion
described in section 41(d)(4)(A) and para-
graphs (c)(2)(i) and (ii) of this section ap-
plies separately for the activities relating
to the development of the product and the
activities relating to the development of
the process. For example, even after a
product meets the taxpayer’s basic func-
tional and economic requirements, activi-
ties relating to the development of the
manufacturing process still may consti-
tute qualified research, provided that the
development of the process itself sepa-
rately satisfies the requirements of section
41(d) and this section, and the activities
are conducted before the process meets
the taxpayer’s basic functional and eco-
nomic requirements or is ready for com-
mercial use.
(3) Adaptation of existing business
components.Activities relating to adapt-
ing an existing business component to a
particular customer’s requirement or need
are not qualified research. This exclusion
does not apply merely because a business
component is intended for a specific cus-
tomer.
(4) Duplication of existing business
component.Activities relating to repro-
ducing an existing business component
(in whole or in part) from a physical ex-
amination of the business component it-
self or from plans, blueprints, detailed
specifications, or publicly available infor-
mation about the business component are
not qualified research. This exclusion
does not apply merely because the tax-
payer inspects an existing business com-
ponent in the course of developing its
own business component.
(5) Surveys, studies, research relating
to management functions, etc.Qualified
research does not include activities relat-
ing to—
(i) Efficiency surveys;
(ii) Management functions (except for
the direct supervision of qualified re-
search as defined in §1.41–2(c)(2)) or
techniques, including such items as
preparation of financial data and analysis,
development of employee training pro-
grams and management organization
plans, and management-based changes in
production processes (such as rearranging
work stations on an assembly line);
(iii) Market research, testing, or devel-
opment (including advertising or promo-
tions);
(iv) Routine data collections; or
(v) Routine or ordinary testing or in-
spections for quality control.
(6) Internal-use computer software.
[Reserved].
1
(7) Activities outside the United
States—(i) In general.Research con-
ducted outside the United States, as de-
fined in section 7701(a)(9), does not con-
stitute qualified research.
(ii) Apportionment of in-house research
expenses.In-house research expenses
paid or incurred for qualified services per-
formed both in the United States and out-
side the United States must be appor-
tioned between the services performed in
the United States and the services per-
formed outside the United States. Only
those in-house research expenses appor-
tioned to the services performed within
the United States are eligible to be treated
as qualified research expenses, unless the
in-house research expenses are wages
and the 80 percent rule of §1.41–2(d)(2)
applies.
(iii) Apportionment of contract re-
search expenses.If contract research is
performed partly in the United States and
partly outside the United States, only 65
percent (or 75 percent in the case of
amounts paid to qualified research con-
sortia) of the portion of the contract
amount that is attributable to the research
activity performed in the United States
may qualify as a contract research ex-
pense (even if 80 percent or more of the
contract amount is for research performed
in the United States).
(8) Research in the social sciences, etc.
Qualified research does not include re-
search in the social sciences (including
economics, business management, and
behavioral sciences), arts, or humanities.
(9) Research funded by any grant, con-
tract, or otherwise. Qualified research
does not include any research to the ex-
tent funded by any grant, contract, or oth-
erwise by another person (or governmen-
tal entity). To determine the extent to
which research is so funded, §1.41-4A(d)
applies.
(10) Illustrations.The following ex-
amples illustrate provisions contained in
paragraphs (c)(1) through (9) of this sec-
tion. No inference should be drawn from
these examples concerning the applica-
tion of section 41(d)(1) and paragraph (a)
of this section to these facts:
Example 1.(i) Facts. X, a pharmaceutical com-
pany, performs additional clinical tests on one of its
products after that product has been approved for a
specific therapeutic use by the FDAand is ready for
commercial production and sale. The clinical tests
study the drug’s long-term morbidity and mortality
profile, and are undertaken to develop information
to use in the marketing materials for the drug.
(ii) Conclusion.Because the additional tests are
performed after the drug is ready for commercial
sale, X’s activities in connection with the tests are
excluded from the definition of qualified research
under section 41(d)(4)(A) and paragraph (c)(2) of
this section.
December 14, 1998181998–50 I.R.B.
1
Section 1.41–4(e), proposed on January 2, 1997
(62 F.R. 83), including any revisions to that pro-
posed rule will be incorporated as this paragraph
(c)(6) in the final rule.
IRB 1998-50 12/9/98 3:47 PM Page 18

Example 2.(i) Facts.The facts are the same as
in Example 1, except that, while studying the long-
term morbidity and mortality profile of the drug
product, X discovers that the product may be useful
in treating a different medical condition. X begins
new clinical studies to establish the compound’s
new potential therapeutic use.
(ii) Conclusion.Because the new clinical studies
are performed to establish a new therapeutic use of
the drug product, the additional clinical studies per-
formed to establish the new therapeutic use are not
excluded from the definition of qualified research
under section 41(d)(4)(A) and paragraph (c)(2) of
this section.
Example 3.(i) Facts.X, a domestic corporation
that manufactures paper, develops and markets a
new type of paper containing a different chemical
composition than the paper generally available for
commercial sale. Prior to manufacturing the paper,
X conducts preproduction planning for the finished
paper product, tools up for production, conducts trial
production runs, engages in trouble shooting involv-
ing detecting problems in production equipment, ac-
cumulates production process data, and debugs the
product.
(ii) Conclusion.X’s activities of preproduction
planning, tooling up for production, trial production
runs, trouble shooting, accumulation of production
process data, and product debugging do not consti-
tute qualified research with respect to development
of the paper product because the activities are
deemed to occur after the beginning of commercial
production of the product. Whether any activities
engaged in by X to develop a process for manufac-
turing the paper constitute qualified research de-
pends on whether the development of the process it-
self separately satisfies the requirements of section
41(d) and this section, and whether the process
meets the taxpayer’s basic functional and economic
requirements or is ready for commercial use.
Example 4.(i) Facts. X, a computer software
development firm, owns all substantial rights in a
general ledger accounting software core program
that X markets and licenses to customers. After en-
tering into a contractual agreement with a customer,
X incurs expenditures in modifying the core soft-
ware program to adapt the program to the cus-
tomer’s requirement or need.
(ii) Conclusion.Because X’s activities represent
activities to modify an existing software program to
adapt the program to a particular customer’s require-
ment, X’s activities are excluded from the definition
of qualified research under section 41(d)(4)(B) and
paragraph (c)(3) of this section.
Example 5.(i) Facts.An existing gasoline addi-
tive is manufactured by Yusing three ingredients, A,
B, and C. X seeks to develop and manufacture its
own gasoline additive that appears and functions in
a manner similar to Y’s additive. To develop its own
additive, X first inspects the composition of Y’s ad-
ditive, and uses knowledge gained from the inspec-
tion to reproduce Aand B in the laboratory. Any dif-
ferences between ingredients Aand B that are used
in Y’s additive and those reproduced by X are in-
significant and are not material to the viability, ef-
fectiveness, or cost of Aand B. X desires to use
with Aand B an ingredient that has a materially
lower cost than ingredient C. Accordingly, X en-
gages in a process of experimentation to discover
potential alternative formulations of the additive
(i.e., the development and use of various ingredients
other than C to use with Aand B).
(ii) Conclusion.X’s activities in analyzing and
reproducing ingredients Aand B involve duplication
of existing business components and are excluded
from qualified research under section 41(d)(4)(C)
and paragraph (c)(4) of this section. X’s experimen-
tation activities to discover potential alternative for-
mulations of the additive do not involve duplication
of an existing business component and are not ex-
cluded from qualified research under section
41(d)(4)(C) and paragraph (c)(4) of this section.
Example 6. (i) Facts. X, an appliance manufac-
turer, rearranges employee work stations in its man-
ufacturing assembly line and develops a new em-
ployee training program to train employees for the
rearranged work stations.
(ii) Conclusion.X’s activities associated with re-
arranging the work stations and developing a new
employee training program represent activities re-
lated to management functions or techniques and are
excluded from qualified research under section
41(d)(4)(D) and paragraph (c)(5) of this section.
Example 7.(i) Facts. X, an insurance company,
develops a new life insurance product. In the course
of developing the product, X engages in research
with respect to the effect of pricing and tax conse-
quences on demand for the product, the expected
volatility of interest rates, and the expected mortality
rates (based on published data and prior insurance
claims).
(ii) Conclusion.X’s activities related to the new
product represent research in the social sciences, and
are thus excluded from qualified research under sec-
tion 41(d)(4)(G) and paragraph (c)(7) of this section.
(d) Documentation.See section 6001
and the regulations thereunder for the
recordkeeping requirements that must be
satisfied.
§1.41–5 [Redesignated as §1.41–4A,
and Amended]
Par. 11. Section 1.41–5 is redesignated
as §1.41–4A, and the last sentence of
paragraph (d)(1) is amended by removing
the language “§1.41–8(e)” and adding
“§1.41–6(e)” in its place.
§1.41–6 [Redesignated as §1.41–5 and
Amended]
Par. 12. Section 1.41–6 is redesignated
as §1.41–5 and the section heading is
amended by removing the language “De-
cember 31, 1985” and adding “December
31, 1986” in its place.
§1.41–7 [Redesignated as §1.41–5A,
and Amended]
Par. 13. Section 1.41–7 is redesignated
as §1.41–5A, and amended as follows:
1. The section heading is amended by
removing the language “January 1, 1986”
and adding “January 1, 1987” in its place.
2. Paragraph (e)(2) is amended by re-
moving the language “§1.41–5(c)” and
adding “1.41–4A(c)” in its place.
§1.41–8 [Redesignated as §1.41–6, and
Amended]
Par. 14. Section 1.41–8 is redesignated
as §1.41–6, and the last sentence of para-
graph (c) is amended by removing the
language “§1.41–3, except that §1.41–
3(c)(2)” and adding “§1.41–3A, except
that §1.41–3A(c)(2)” in its place.
§1.41–9 [Redesignated as §1.41–7]
Par. 15. Section 1.41–9 is redesignated
as §1.41–7.
Par. 16. New §1.41–8 is added to read
as follows:
§1.41–8 Special rules for taxable years
ending on or after the date final
regulations are published in the Federal
Register.
(a) Alternative incremental credit.At
the election of the taxpayer, the credit de-
termined under section 41(a)(1) equals
the amount determined under section
41(c)(4).
(b) Election—(1) In general.Atax-
payer may elect to apply the provisions of
the alternative incremental credit in sec-
tion 41(c)(4) for any taxable year of the
taxpayer beginning after June 30, 1996.
If a taxpayer makes an election under sec-
tion 41(c)(4), the election applies to the
taxable year for which made and all sub-
sequent taxable years.
(2) Time and manner of election.An
election under section 41(c)(4) is made by
completing the portion of Form 6765,
“Credit for Increasing Research Activi-
ties,” relating to the election of the alter-
native incremental credit, and attaching
the completed form to the taxpayer’s
timely filed original return (including ex-
tensions) for the taxable year to which the
election applies.
(3) Revocation. An election under this
section may not be revoked except with
the consent of the Commissioner. Atax-
payer must attach the Commissioner’s
consent to revoke an election under sec-
tion 41(c)(4) to the taxpayer’s timely filed
original return (including extensions) for
the taxable year of the revocation.
Par. 17. Section 1.41–0Ais added
under the new undesignated centerhead-
1998–50 I.R.B.19December 14, 1998
IRB 1998-50 12/9/98 3:47 PM Page 19

ing “RESEARCH CREDIT—FOR TAX-
ABLE YEARS BEGINNING BEFORE
JANUARY1, 1990” to read as follows:
§1.41–0ATable of contents.
This section lists the paragraphs con-
tained in §§1.41–0A, 1.41–3A, 1.41–4A
and 1.41–5A.
§1.41–0ATable of contents.
§1.41–3ABase period research
expenses.
(a) Number of years in base period.
(b) New taxpayers.
(c) Definition of base period research
expenses.
(d) Special rules for short taxable years.
(1) Short determination year.
(2) Short base period year.
(3) Years overlapping the effective dates
of section 41 (section 44F).
(i) Determination years.
(ii) Base period years.
(4) Number of months in a short taxable
year.
(e) Examples.
§1.41–4AQualified research for taxable
years beginning before January 1, 1986.
(a) General rule.
(b) Activities outside the United States.
(1) In-house research.
(2) Contract research.
(c) Social sciences or humanities.
(d) Research funded by any grant, con-
tract, or otherwise.
(1) In general.
(2) Research in which taxpayer retains
no rights.
(3) Research in which the taxpayer re-
tains substantial rights.
(i) In general.
(ii) Pro rata allocation.
(iii) Project-by-project determination.
(4) Independent research and develop-
ment under the Federal Acquisition
Regulations System and similar pro-
visions.
(5) Funding determinable only in subse-
quent taxable year.
(6) Examples.
§1.41–5ABasic research for taxable
years beginning before January 1, 1987.
(a) In general.
(b) Trade or business requirement.
(c) Prepaid amounts.
(1) In general.
(2) Transfers of property.
(d) Written research agreement.
(1) In general.
(2) Agreement between a corporation
and a qualified organization after
June 30, 1983.
(i) In general.
(ii) Transfers of property.
(3) Agreement between a qualified fund
and a qualified educational organi-
zation after June 30, 1983.
(e) Exclusions.
(1) Research conducted outside the
United States.
(2) Research in the social sciences or
humanities.
(f) Procedure for making an election to
be treated as a qualified fund.
§1.218–0 [Removed]
Par. 18. Section 1.218–0 is removed.
§1.482–7 [Amended]
Par. 19. In §1.482–7, the sixth sentence
of paragraph (h)(1) is amended by remov-
ing the language “§1.41–8(e)” and adding
“§1.41–6(e)” in its place.
Michael P. Dolan,
Deputy Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on
December 1, 1998, 8:45 a.m., and published in the
issue of the Federal Register for December 2, 1998,
63 F.R. 66503)
Classification of Certain
Transactions Involving Computer
Programs; Correction
Announcement 98–109
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to final regulations.
SUMMARY: This document contains a
correction to Treasury Decision 8785
(1998–42 I.R.B. 5), which was published
in the Federal Registeron Friday, Octo-
ber 2, 1998 (63 F.R. 52971) relating to the
tax treatment of certain transactions in-
volving the transfer of computer pro-
grams.
DATES: This correction is effective Oc-
tober 2, 1998.
FOR FURTHER INFORMATION CON-
TACT: Anne Shelburne, (202) 874-1305
(not a toll-free number).
SUPPLEMENTARYINFORMATION:
Background
The final regulations that are the sub-
ject of this correction are under section
861 of the Internal Revenue Code.
Need for Correction
As published, T.D. 8785 contains errors
which may prove to be misleading and are
in need of clarification.
Correction of Publication
Accordingly, the publication of the
final regulations (T.D. 8785), which were
the subject of F.R. Doc. 98–26475, is cor-
rected as follows:
1. On page 52971, column 1, in the
preamble under the caption heading
“FOR FURTHER INFORMATION
CONTACT”, line 1, the language “Anne
Shelburne, (202) 622-3880 (not a” is cor-
rected to read “Anne Shelburne, (202)
874-1305 (not a”.
2. On page 52975, column 3, in the
preamble under the paragraph heading
“8. Services and Know-How”,second
paragraph, lines 21 through 25, the lan-
guage “secret protection. Know-how is
considered a property interest under ap-
plicable law, and only if the know-how is
specifically contracted for between the
parties. These additional” is corrected to
read “secret protection. These addi-
tional”.
§1.861–18 [Corrected]
3. On page 52982, column 1, §1.861–
18(i)(4) Example 1,line three from the
bottom of the paragraph, the language “A
is not required to change from its accrual”
is corrected to read “Ais not required to
change from its”.
4. On page 52982, column 2, §1.861–
18(i)(4) Example 2,line five from the bot-
tom of the paragraph, the language “Ais
not required to change from its accrual” is
corrected to read “Ais not required to
change from its”.
December 14, 1998201998–50 I.R.B.
IRB 1998-50 12/9/98 3:47 PM Page 20

Cynthia E. Grigsby,
Chief, Regulations Unit,
Assistant Chief Counsel (Corporate).
Substantiation of Business
Expenses—Use of Mileage
Allowances to Substantiate
Automobile Expenses;
Correction
Announcement 98–110
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to temporary regu-
lations.
SUMMARY: This document contains a
correction to Treasury Decision 8784
(1998–42 I.R.B. 4), which was published
in the Federal Registeron Thursday, Oc-
tober 1, 1998 (63 F.R. 52600) relating to
the use of mileage allowances to substan-
tiate automobile business expenses.
DATES: This correction is effective Oc-
tober 1, 1998.
FOR FURTHER INFORMATION CON-
TACT: Donna Crisalli, (202) 622-4920
(not a toll-free number).
SUPPLEMENTARYINFORMATION:
Background
The temporary regulations that are the
subject of this correction are under sec-
tion 274 of the Internal Revenue Code.
Need for Correction
As published, T.D. 8784 contains an
error which may prove to be misleading
and is in need of clarification.
Correction of Publication
Accordingly, the publication of the
temporary regulations (T.D. 8784), which
were the subject of F.R. Doc. 98–26226,
is corrected as follows:
§1.274(d)–1T[Corrected]
On page 52601, column 1, §1.274(d)–
1T(a)(1) and (2), the last line of the para-
graph, the language “guidance, see
§1.274(d)–1(a)(1).” is corrected to read
“guidance, see §1.274(d)–1(a)(1) and
(2).”.
Cynthia E. Grigsby,
Chief, Regulations Unit,
Assistant Chief Counsel (Corporate).
Foundations Status of Certain
Organizations
Announcement 98–111
The following organizations have
failed to establish or have been unable to
maintain their status as public charities or
as operating foundations. Accordingly,
grantors and contributors may not, after
this date, rely on previous rulings or des-
ignations in the Cumulative List of Orga-
nizations (Publication 78), or on the pre-
sumption arising from the filing of notices
under section 508(b) of the Code. This
listing does notindicate that the organiza-
tions have lost their status as organiza-
tions described in section 501(c)(3), eligi-
ble to receive deductible contributions.
Former Public Charities.The following
organizations (which have been treated as
organizations that are not private founda-
tions described in section 509(a) of the
Code) are now classified as private foun-
dations:
G & H Visual and Performing Arts
Educational Center, St. Louis, MO
GRECOM, Richmond, VA
Gainesville Area Aids Project Inc.,
Gainesville, FL
Gainesville Chess Club Inc., Gainesville,
FL
Gainesville Pride Arts Inc., Gainesville,
FL
Galen Enterprises Inc., Suffolk, VA
Galena Park Police Auxiliary Association
Inc., Galena Park, TX
Galion Area Betterment Commission
Inc., Galion, OH
Gallegos Lane Residents Association,
Santa Fe, NM
Galveston County Employers for Quality
Health Care, Texas City, TX
Gamma Lambda Educational Foundation
Inc., Carmel, IN
Gang Alternatives Partnership Inc.,
Sparks, NV
Gardnermontachusett Childrens Museum
Inc., Gardner, MA
Garrison Childrens Education Fund,
Garrison, NY
Gay and Lesbian Community Center of
Greater Cincinnati Inc., Cincinnati, OH
Gaza American Economic Development
Foundation, Columbus, OH
Geared for Life Inc., Birmingham, MI
Geary Foundation Inc., Geary, OK
Generations Adult Day Care Inc.,
St. Louis, MO
Genesee Region Home Care Association
Inc., Rochester, NY
Genesis Center, Manteca, CA
Genesis Housing Corporation, Baltimore,
MD
Genesis Rehabilitation Inc., Pittsburgh,
PA
George Aiken Ministries Inc.,
Okeechobee, FL
Georgia Equine Rescue League Ltd.,
Jersey, GA
Georgia Somali Community Inc., Stone
Mountain, GA
Gerald M. Bowers Study Club in
Periodontology, Inc., Westminster, MD
Gerald Walker Memorial Scholarship
Foundation Inc., Garland, TX
Gift of Life Inc., Landover Hills, MD
Ginger Thomas Broadcasting Corp.,
St. Thomas, VI
Girls and Boys Against Gangs,
San Francisco, CA
Gita in Thought and Action, Palos
Heights, IL
Give Them a Second Chance Inc.,
Plantation, FL
Glendale Educational Opportunity Inc.,
Glendale, CO
Global Community Inc., New York, NY
Global Concern Inc., Lenexa, KS
Global Ministry Resources, Portland, OR
Global Reconstruction Organization for
Kids, Spokane, WA
Global Share, Prescott, AZ
Global Support Connection Inc., New
York, NY
Global Youth Resources Organization
Inc., Burnsville, MN
Globallove Inc., a Colorado Non-Profit
Corporation, Denver, CO
Globe-Link Productions Inc., Miami, FL
Glorias Teensy Weensy Learning Center,
Ferriday, LA
Gloucester Pride Stride Committee Inc.,
Gloucester, MA
God is Moving Inc., Houston, TX
Gods Christian Missionary Service Inc.,
Rochester, NY
Gods Way for Today Inc., Denver, CO
1998–50 I.R.B.21December 14, 1998
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Golden Child Care, Stafford, TX
Golf for Childrens Charities Inc.,
Newtown, PA
Good News Gospel Missions Inc., Port
St. Lucie, FL
Good Ole Boys, Cincinnati, OH
Good Samaritan Housing Inc., Balm, FL
Good Samaritan Medical Clinic Inc.,
Roswell, GA
Goodnow Library Foundation Inc.,
Boston, MA
Gospel Evangelistic Ministries,
St. Joseph, MO
Gospel Extended Ministries, Broken
Arrow, OK
Gospel of Deliverance Christian Group
Home, Sonora, CA
Gospel Wings International Inc.,
Okanogan, WA
Government and Community Together
for Legal Lives Inc., Brooklyn, NY
Grace Restoration Ministries Inc.,
Thomasville, GA
Grand Ledge Swim Club Inc., Eagle, MI
Grand Ledge Wrestling Club Inc.,
Lansing, MI
Grand Prairie Rape Crisis Coalition,
Grand Prairie, TX
Granite State All-State Shoot Out,
Manchester, NH
Grant Day Care Corp., Overland Park,
KS
Grant School Community Foundation,
San Diego, CA
Grants Pass Childrens Center, Grants
Pass, OR
Grassroots Tennis of New Haven Inc.,
New Haven, CT
Grateful Daycare Team Parenting and
Learning Center, Pickens, MS
Gray Foundation, Santa Rosa, CA
Grayson County Fair Association,
Sherman, TX
Great Commission Comunications of
North Iowa Inc., Mason City, IA
Great Plains Football League Inc.,
Wichita, KS
Great Pond Mountain Conservation
Trust, Orland, ME
Great River Road Arts Coalition
Corporation, Prescott, WI
Great Things Incorporated Foundation,
St. Louis, MO
Greater Brimingham Fair Housing Center
Inc., Brimingham, AL
Greater Boston Athletic Association Inc.,
Quincy, MA
Greater Cincinnati Earth Angel Cruise
Foundation, Cincinnati, OH
Greater Detroit Islamic Alliance,
Southfield, MI
Greater Loup Valley Activities Inc., Ord,
NE
Greater Provo Open, Provo, UT
Greater Resources and Aids Awareness
Community, Kansas City, MO
Greater Rochester Christian Gathering
Inc., Rochester, NY
Greater San Diego Chamber of
Commerce Foundation, San Diego, CA
Greater Shelby County Ministerial
Coalition Inc., Shelbyville, KY
Greater Shreveport Human Relations
Commission, Shreveport, LA
Greater Tulsa Luis Palau Crusades Inc.,
Tulsa, OK
Greater Wauzeka Enterprise Association
Incorporated, Wauzeka, WI
Green Bay Swim Club Inc., Green Bay,
WI
Green Futures Inc., Assonet, MA
Green Hill K-9 Search & Rescue Inc.,
Enosburg Falls, VT
Greene & Beyond Inc., South Bend, IN
Greene Youth Athletic Assn. Inc., Greene,
ME
Greenville Area Alliance for the Mentally
Ill, Greenville, AL
Gretna Community Youth Association
Inc., Gretna, NE
Greyhound Rescue Society Inc., Sugar
Loaf, NY
Grid Ink CANonprofit Corporation,
Pittsburgh, PA
Groton Mystic Falcons Youth Football
League Inc., Groton, CT
If an organization listed above submits
information that warrants the renewal of
its classification as a public charity or as a
private operating foundation, the Internal
Revenue Service will issue a ruling or de-
termination letter with the revised classi-
fication as to foundation status. Grantors
and contributors may thereafter rely upon
such ruling or determination letter as pro-
vided in section 1.509(a)–7 of the Income
Tax Regulations. It is not the practice of
the Service to announce such revised clas-
sification of foundation status in the Inter-
nal Revenue Bulletin.
December 14, 1998221998–50 I.R.B.
IRB 1998-50 12/9/98 3:47 PM Page 22

1998–50 I.R.B.23December 14, 1998
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to Abut not
to B, and the new ruling holds that it ap-
plies to both Aand B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. Aruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms
IRB 1998-50 12/9/98 3:47 PM Page 23

December 14, 1998241998–50 I.R.B.
Numerical Finding List
1
Bulletins 1998–29 through 49
Announcements:
98–62, 1998–29 I.R.B. 13
98–68, 1998–29 I.R.B. 14
98–69, 1998–30 I.R.B. 16
98–70, 1998–30 I.R.B. 17
98–71, 1998–30 I.R.B. 17
98–72, 1998–31 I.R.B.14
98–73, 1998–31 I.R.B.14
98–74, 1998–31 I.R.B.15
98–75, 1998–31 I.R.B.15
98–76, 1998–32 I.R.B.64
98–77, 1998–34 I.R.B.30
98–78, 1998–34 I.R.B.30
98–79, 1998–34 I.R.B.31
98–80, 1998–34 I.R.B.32
98–81, 1998–36 I.R.B.35
98–82, 1998–35 I.R.B. 17
98–83, 1998–36 I.R.B. 36
98–84, 1998–38 I.R.B.30
98–85, 1998–38 I.R.B.30
98–86, 1998–38 I.R.B.31
98–87, 1998–40 I.R.B.11
98–88, 1998–41 I.R.B. 14
98–89, 1998–40 I.R.B.11
98–90, 1998–42 I.R.B.22
98–91, 1998–40 I.R.B.12
98–92, 1998–41 I.R.B.15
98–93, 1998–43 I.R.B.10
98–94, 1998–43 I.R.B.32
98–95, 1998–44 I.R.B.13
98–96, 1998–44 I.R.B.18
98–97, 1998–44 I.R.B.18
98–98, 1998–44 I.R.B.18
98–99, 1998–46 I.R.B.34
98–100, 1998–46 I.R.B.42
98–101, 1998–45 I.R.B.27
98–102, 1998–45 I.R.B.28
98–103, 1998–47 I.R.B.12
98–104, 1998–47 I.R.B. 13
98–105, 1998–49 I.R.B.21
98–106, 1998–48 I.R.B.10
98–107, 1998–48 I.R.B.10
98–108, 1998–48 I.R.B.12
Court Decisions:
2063, 1998–49 I.R.B. 6
2064, 1998–37 I.R.B. 4
2065, 1998–39 I.R.B.7
Notices:
98–36, 1998–29 I.R.B. 8
98–37, 1998–30 I.R.B.13
98–38, 1998–34 I.R.B.7
98–39, 1998–33 I.R.B.11
98–40, 1998–35 I.R.B. 7
98–41, 1998–33 I.R.B.12
98–42, 1998–33 I.R.B.12
98–43, 1998–33 I.R.B.13
98–44, 1998–34 I.R.B.7
98–45, 1998–35 I.R.B.7
98–46, 1998–36 I.R.B. 21
98–47, 1998–37 I.R.B. 8
98–48, 1998–39 I.R.B.17
98–49, 1998–38 I.R.B.5
Notices—Continued
98–50, 1998–44 I.R.B.10
98–51, 1998–44 I.R.B. 11
98–52, 1998–46 I.R.B. 16
98–53, 1998–46 I.R.B. 24
98–54, 1998–46 I.R.B. 25
98–55, 1998–46 I.R.B. 26
98–56, 1998–47 I.R.B.9
98–57, 1998–47 I.R.B.9
98–58, 1998–49 I.R.B. 13
98–59, 1998–49 I.R.B.16
98–60, 1998–49 I.R.B.16
Railroad Retirement Quarterly Rate:
1998–31 I.R.B. 7
Proposed Regulations:
REG–209446–82, 1998–36 I.R.B. 24
REG–209060–86, 1998–39 I.R.B. 18
REG–209769–95, 1998–41 I.R.B.8
REG–209813–96, 1998–35 I.R.B. 9
REG–246256–96, 1998–34 I.R.B.9
REG–104641–97, 1998–29 I.R.B. 9
REG–104565–97, 1998–39 I.R.B.21
REG–106177–97, 1998–37 I.R.B.33
REG–109708–97, 1998–45 I.R.B.29
REG–115446–97, 1998–36 I.R.B. 23
REG–116608–97, 1998–29 I.R.B. 12
REG–118926–97, 1998–39 I.R.B.23
REG–118966–97, 1998–39 I.R.B.29
REG–119227–97, 1998–30 I.R.B. 13
REG–122488–97, 1998–42 I.R.B. 19
REG–101363–98, 1998–40 I.R.B.10
REG–102023–98, 1998–48 I.R.B. 6
REG–106221–98, 1998–41 I.R.B.10
REG–110332–98, 1998–33 I.R.B.18
REG–110403–98, 1998–29 I.R.B.11
REG–115393–98, 1998–39 I.R.B.34
Revenue Procedures:
98–40, 1998–32 I.R.B. 6
98–41, 1998–32 I.R.B. 7
98–42, 1998–28 I.R.B. 9
98–43, 1998–29 I.R.B. 8
98–44, 1998–32 I.R.B. 11
98–45, 1998–34 I.R.B.8
98–46, 1998–36 I.R.B. 21
98–47, 1998–37 I.R.B. 8
98–48, 1998–38 I.R.B.7
98–49, 1998–37 I.R.B. 9
98–50, 1998–38 I.R.B.8
98–51, 1998–38 I.R.B.20
98–52, 1998–37 I.R.B. 12
98–53, 1998–40 I.R.B.9
98–54, 1998–43 I.R.B.7
98–55, 1998–46 I.R.B.27
98–56, 1998–46 I.R.B.33
98–57, 1998–48 I.R.B.5
98–58, 1998–49 I.R.B.19
Revenue Rulings:
98–34, 1998–31 I.R.B. 12
98–35, 1998–30 I.R.B. 4
98–36, 1998–31 I.R.B.6
98–37, 1998–32 I.R.B.5
98–38, 1998–32 I.R.B.4
Revenue Rulings—Continued
98–39, 1998–33 I.R.B.4
98–40, 1998–33 I.R.B.4
98–41, 1998–35 I.R.B.6
98–42, 1998–35 I.R.B. 5
98–43, 1998–36 I.R.B. 9
98–44, 1998–37 I.R.B.4
98–45, 1998–38 I.R.B.4
98–46, 1998–39 I.R.B. 10
98–47, 1998–39 I.R.B. 4
98–48, 1998–39 I.R.B. 6
98–49, 1998–40 I.R.B.4
98–50, 1998–40 I.R.B.7
98–51, 1998–43 I.R.B.4
98–52, 1998–45 I.R.B.4
98–53, 1998–46 I.R.B.12
98–54, 1998–46 I.R.B.14
98–55, 1998–47 I.R.B. 5
98–56, 1998–47 I.R.B.5
98–57, 1998–49 I.R.B.4
Tax Conventions:
1998–43 I.R.B. 6
Treasury Decisions:
8771, 1998–29 I.R.B. 6
8772, 1998–31 I.R.B. 8
8773, 1998–29 I.R.B. 4
8774, 1998–30 I.R.B. 5
8775, 1998–31 I.R.B.4
8776, 1998–33 I.R.B.6
8777, 1998–34 I.R.B.4
8778, 1998–36 I.R.B. 4
8779, 1998–36 I.R.B. 11
8780, 1998–39 I.R.B.14
8781, 1998–40 I.R.B. 4
8782, 1998–41 I.R.B.5
8783, 1998–41 I.R.B.4
8784, 1998–42 I.R.B.4
8785, 1998–42 I.R.B.5
8786, 1998–44 I.R.B. 4
8787, 1998–46 I.R.B. 5
8788, 1998–45 I.R.B.6
1
Acumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1998–1 through 1998–28
will be found in Internal Revenue Bulletin 1998–29,
dated July 20, 1998.
IRB 1998-50 12/9/98 3:47 PM Page 24

1998–50 I.R.B.25December 14, 1998
Finding List of Current Action on
Previously Published Items
1
Bulletins 1998–29 through 49
*Denotes entry since last publication
Notices:
87–13
Modified by
98–49, 1998–38 I.R.B. 5
87–16
Modified by
98–49, 1998–38 I.R.B. 5
Revenue Procedures:
83–58
Obsoleted by
98–37, 1998–32 I.R.B. 5
88–17
Clarified, modified, and superseded by
98–54, 1998–43 I.R.B. 7
94–23
Amplified and superseded by
98–55, 1998–46 I.R.B. 27
97–40
Amplified and superseded by
98–55, 1998–46 I.R.B. 27
97–60
Superseded by
98–50, 1998–38 I.R.B. 8
97–61
Superseded by
98–51, 1998–38 I.R.B. 20
98–14
Modified by
98–53, 1998–40 I.R.B. 9
Revenue Rulings:
57–271
Obsoleted by
98–37, 1998–32 I.R.B. 5
67–301
Modified by
98–41, 1998–35 I.R.B. 6
70–225
Obsoleted by
98–44, 1998–37 I.R.B. 4
71–277
Obsoleted by
98–37, 1998–32 I.R.B. 5
71–434
Obsoleted by
98–37, 1998–32 I.R.B. 5
71–574
Obsoleted by
98–37, 1998–32 I.R.B. 5
72–75
Obsoleted by
98–37, 1998–32 I.R.B. 5
72–120
Obsoleted by
98–37, 1998–32 I.R.B. 5
Revenue Rulings—Continued
72–121
Obsoleted by
98–37, 1998–32 I.R.B. 5
72–122
Obsoleted by
98–37, 1998–32 I.R.B. 5
74–77
Obsoleted by
98–37, 1998–32 I.R.B. 5
75–19
Obsoleted by
98–37, 1998–32 I.R.B. 5
76–562
Obsoleted by
98–37, 1998–32 I.R.B. 5
77–214
Obsoleted by
98–37, 1998–32 I.R.B. 5
79–106
Obsoleted by
98–37, 1998–32 I.R.B. 5
83–113
Obsoleted by
98–37, 1998–32 I.R.B. 5
85–143
Obsoleted by
98–37, 1998–32 I.R.B. 5
88–8
Obsoleted by
98–37, 1998–32 I.R.B. 5
88–76
Obsoleted by
98–37, 1998–32 I.R.B. 5
88–79
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–4
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–5
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–6
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–30
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–38
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–49
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–50
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–53
Obsoleted by
98–37, 1998–32 I.R.B. 5
Revenue Rulings—Continued
93–81
Obsoleted by
98–37, 1998–32 I.R.B. 5
3–91
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–92
Obsoleted by
98–37, 1998–32 I.R.B. 5
93–93
Obsoleted by
98–37, 1998–32 I.R.B. 5
94–5
Obsoleted by
98–37, 1998–32 I.R.B. 5
94–6
Obsoleted by
98–37, 1998–32 I.R.B. 5
94–30
Obsoleted by
98–37, 1998–32 I.R.B. 5
94–51
Obsoleted by
98–37, 1998–32 I.R.B. 5
94–79
Obsoleted by
98–37, 1998–32 I.R.B. 5
95–2
Obsoleted by
98–37, 1998–32 I.R.B. 5
95–9
Obsoleted by
98–37, 1998–32 I.R.B. 5
97–37
Obsoleted by
98–39, 1998–33 I.R.B. 4
1
Acumulative finding list for previously published
items mentioned in Internal Revenue Bulletins
1998–1 through 1998–28 will be found in Internal
Revenue Bulletin 1998–29, dated July 20, 1998.
IRB 1998-50 12/9/98 3:47 PM Page 25

December 14, 1998261998–50 I.R.B.
Notes
IRB 1998-50 12/9/98 3:47 PM Page 26

IRB 1998-50 12/9/98 3:47 PM Page 27

INTERNAL REVENUE BULLETIN
The Introduction on page 3 describes the purpose and content of this publication. The weekly Internal Revenue Bulletin is sold
on a yearly subscription basis by the Superintendent of Documents. Current subscribers are notified by the Superintendent of
Documents when their subscriptions must be renewed.
CUMULATIVE BULLETINS
The contents of this weekly Bulletin are consolidated semiannually into a permanent, indexed, Cumulative Bulletin. These are
sold on a single copy basis and are not included as part of the subscription to the Internal Revenue Bulletin. Subscribers to the week-
ly Bulletin are notified when copies of the Cumulative Bulletin are available. Certain issues of Cumulative Bulletins are out of print
and are not available. Persons desiring available Cumulative Bulletins, which are listed on the reverse, may purchase them from the
Superintendent of Documents.
HOW TO ORDER
Check the publications and/or subscription(s) desired on the reverse, complete the order blank, enclose the proper remittance,
detach entire page, and mail to the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402. Please
allow two to six weeks, plus mailing time, for delivery.
WE WELCOME COMMENTS ABOUT THE
INTERNAL REVENUE BULLETIN
If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can e-mail us your suggestions or comments through the IRS Internet Home Page
(www.irs.ustreas.gov) or write to the IRS Bulletin Unit, T:FP:F:CD, Room 5560, 1111 Constitution Avenue NW, Washington, DC
20224. You can also leave a recorded message 24 hours a day, 7 days a week at 1–800–829–9043.
IRB 1998-50 12/9/98 3:47 PM Page 28