Internal Revenue Bulletin 2004-7 (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.

Bulletin No. 200
4-7
February 17, 200
4
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
INCOME TAX
Rev. Rul. 2004–3, page 486.
Service partnerships.This ruling provides guidance con-
cerning the application of the U.S.-Germany income tax treaty
to a nonresident partner in a service partnership that conducts
activities in the United States. It makes clear that a nonresi-
dent partner is subject to U.S. income tax on his share of in-
come from the partnership to the extent that such income is
attributable to the partnership’s activities in the United States,
without regard to whether the partner performs services in the
United States. This ruling also applies to other U.S. income tax
treaties that have the same or similar provisions as those in the
U.S.-Germany treaty.
T.D. 910
7, page 447.
Final reg
ulations under section 263(a) of the Code provide rules
for appl
ying section 263(a) to amounts paid to acquire or cre-
ate inta
ngibles. These regulations also provide rules for apply-
ing sect
ion 263(a) to amounts paid to facilitate the acquisition
of a trad
e or business, a change in the capital structure of
abusin
ess entity, and certain other transactions. In addition,
these r
egulations provide safe harbor amortization under sec-
tion 16
7(a) for certain intangibles and explain the manner in
which t
axpayers may deduct debt issuance costs.
Notice 2004–5, page 489.
Pursuant to the authority granted under section 772(a)(11) of
the Code, the Secretary has determined that it is appropriate
for a partner of an electing large partnership to take into ac-
count separately the partner’s distributive share of the partner-
ship’s dividends received that are qualified dividend income as
defined in section 1(h)(11)(B). This requirement is effective for
dividends received by a partnership after December 31, 2002.
EMPLOYEE PLANS
Rev. Rul. 2004–10, page 484.
Significant detriment; defined contribution plan; al-
location of expenses.This ruling describes the applica-
tion of the significant detriment rule in regulations section
1.411(a)–11(c)(2)(i) in relationship to the Department of
Labor’s Field Assistance Bulletin 2003–3 pertaining to the
allocation of expenses in a defined contribution plan.
Rev. Rul.
2004–11, page 480.
Coverage;
special rules; request for comments.This
ruling de
scribes the application of the special coverage rule
for acqui
sitions and dispositions in section 410(b)(6)(C) of the
Code in a s
ituation involving a defined benefit plan and a profit-
sharing p
lan that includes a qualified cash or deferred arrange-
ment unde
r section 401(k)(2). In addition, the ruling holds that
asignif
icantchangeinaplanorinthecoverageofaplanduring
the tran
sition period under section 410(b)(6)(C)(ii) curtails the
period e
ffective as of the date of the change and does not make
the plan
retroactively ineligible to apply section 410(b)(6)(C). Fi-
nally,
the ruling also asks for comments as to other situations
that ma
y arise under section 410(b)(6)(C).
Rev. Rul. 2004–12, page 478.
Plan qualification; rollovers.This ruling describes a situa-
tion where an eligible retirement plan separately accounts for
amounts attributable to rollover contributions to the plan. As
a result, distributions of those amounts are not subject to the
restrictions on permissible timing that apply, under the applica-
ble requirements of the Code, to distributions of other amounts
from the plan.
(Continued on the next page)
Announcements of Disbarments and Suspensions begin on page 499.
Fi
nding Lists begin on page ii.

Rev. Rul. 2004–13, page 485.
Top-heavy status; special rules.This ruling describes four
situations where a non-governmental profit-sharing plan con-
tains a cash or deferred arrangement described in section
401(k) of the Code that provides for safe harbor matching con-
tributions. In the first situation, the ruling holds that the require-
ments of section 416(g)(4)(H) are met for that year. In the other
situations, the ruling holds that the contributions do not meet
the requirements of section 416(g)(4)(H).
Rev. Proc. 2004–14, page 489.
This document provides procedures under which a corpora-
tion’s S status will not be terminated by a direct rollover of stock
from its employee stock ownership plan (ESOP) to a partici-
pant’s individual retirement account (IRA). Rev. Proc. 2003–23
modified and superseded.
Rev. Proc. 2004–15, page 490.
Minimum funding standards; waivers.This procedure sets
forth guidelines for requesting waivers of the minimum funding
standards with respect to defined benefit and defined contri-
bution plans subject to section 412 of the Code. Rev. Procs.
2004–4, 2004–5, 2004–6 modified. Rev. Proc. 94–41 su-
perseded.
TAX CONVENTIONS
Rev. Rul. 2004–3, page 486.
Service partnerships.This ruling provides guidance con-
cerning the application of the U.S.-Germany income tax treaty
to a nonresident partner in a service partnership that conducts
activities in the United States. It makes clear that a nonresi-
dent partner is subject to U.S. income tax on his share of in-
come from the partnership to the extent that such income is
attributable to the partnership’s activities in the United States,
without regard to whether the partner performs services in the
United States. This ruling also applies to other U.S. income tax
treaties that have the same or similar provisions as those in the
U.S.-Germany treaty.
ADMINISTRATIVE
Rev. Proc. 2004–14, page 489.
This document provides procedures under which a corpora-
tion’s S status will not be terminated by a direct rollover of stock
from its employee stock ownership plan (ESOP) to a partici-
pant’s individual retirement account (IRA). Rev. Proc. 2003–23
modified and superseded.
Announcement 2004–10, page 501.
This document contains corrections to final and temporary reg-
ulations (T.D. 9048, 2003–1 C.B. 644) under section 1502 of
theCodethatredeterminethebasisofstockofasubsidiary
member of a consolidated group immediately prior to certain
transfers of such stock and certain deconsolidations of a sub-
sidiary member and also suspend certain losses recognized
on the disposition of stock of a subsidiary member.
February 17, 20042004-7 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping
them understand and meet their tax responsibilities and by
applying the tax law with integrity and fairness to all.
Introduction
The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly and may be obtained from the
Superintendent of Documents on a subscription basis. Bul-
letin contents are consolidated semiannually into Cumulative
Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned
against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B, Leg-
islation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury’s Office of the Assistant Sec-
retary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.*
The c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
* Beginning with Internal Revenue Bulletin 2003–43, we are publishing the index at the end of the month, rather than at the beginning.
2004-7 I.R.B.February 17, 2004

Part I. Rulings and Decisions Under the Internal Revenue Code
of 1986
Section 263.—Capital
Expenditures
26 CFR 1.263(a)–1: Capital expenditures; in gen-
eral.
T.D. 9107
DEPARTMENT OF
THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Guidance Regarding
Deduction and Capitalization
of Expenditures
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations that explain how sec-
tion 263(a) of the Internal Revenue Code
(Code) applies to amounts paid to acquire
or create intangibles. This document also
contains final regulations under section
167 of the Code that provide safe harbor
amortization for certain intangibles, and
final regulations under section 446 of the
Code that explain the manner in which
taxpayers may deduct debt issuance costs.
DATES:Ef
fective Date: These regulations
are effe
ctive December 31, 2003.
Applicab
ility Date: For dates of
applica
bility of the final regulations,
see §§1.
167(a)–3(b)(4), 1.263(a)–4(o),
1.263(a
)–5(m), and 1.446–5(d).
FOR FURTHER INFORMATION
CONTACT: Andrew J. Keyso, (202)
622–4800 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
Thecollectionofinformationinthisfi-
nal rule has been reviewed and, pending re-
ceipt and evaluation of public comments,
approved by the Office of Management
and Budget (OMB) under 44 U.S.C. 3507
and assigned control number 1545–1870.
The collection of information in this
regulation is in §1.263(a)–5(f). This in-
formationisrequiredtoverifytheproper
allocation of certain amounts paid in the
process of investigating or otherwise pur-
suing certain transactions involving the ac-
quisition of a trade or business. The col-
lection of information is voluntary and is
required to obtain a benefit. The likely
recordkeepers are business entities.
Comments on the collection of infor-
mation should be sent to theOffice of
Management and Budget,Attn: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC 20503, with
copies to theInternal Revenue Service,
Attn: IRS Reports Clearance Officer,
SE:W:CAR:MP:T:T:SP, Washington, DC
20224. Comments on the collection of
information should be received by March
5, 2004. Comments are specifically re-
quested concerning:
Whether the collection of information
is necessary for the proper performance
of the functions of the Internal Revenue
Service, including whether the information
will have practical utility;
The accuracy of the estimated burden
associated with the collection of informa-
tion (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
collection of information may be mini-
mized, including through the application
of automated collection techniques or
other forms of information technology;
and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of service to provide information.
Estimated total annual recordkeeping
burden: 3,000 hours.
Estimated average annual burden hours
per recordkeeper: 1 hour.
Estimated number of recordkeepers:
3,000.
An agency may not conduct or sponsor,
and a person is not required to respond to, a
collection of information unless it displays
a valid control number assigned by the Of-
fice of Management and Budget.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by 26 U.S.C. 6103.
Background
On January 24, 2002, the IRS and
Treasury Department published an ad-
vance notice of proposed rulemaking in
theFederal Register(REG–125638–01,
published in the Bulletin as Announce-
ment 2002–9, 2002–1 C.B. 536 [67 FR
3461]) announcing an intention to pro-
vide guidance on the extent to which
section 263(a) of the Internal Revenue
Code (Code) requires taxpayers to cap-
italize amounts paid to acquire, create,
or enhance intangible assets. A notice
of proposed rulemaking was published in
theFederal Register(REG–125638–01,
2003–1 C.B. 373 [67 FR 77701]) on
December 19, 2002, proposing regula-
tions under section 263(a) (relating to the
capitalization requirement), section 167
(relating to safe harbor amortization) and
section 446 (relating to the allocation of
debt issuance costs). A public hearing
was held on April 22, 2003. In addition,
written comments responding to the notice
of proposed rulemaking were received.
After consideration of all of the public
comments, the proposed regulations are
adopted as revised by this Treasury deci-
sion. The revisions are discussed below.
Explanation of Provisions
I.Format of the Final Regulations
The final regulations modify the format
of the proposed regulations. The final reg-
ulations retain in §1.263(a)–4 the rules re-
quiring capitalization of amounts paid to
acquire or create intangibles and amounts
paid to facilitate the acquisition or creation
of intangibles. However, the rules requir-
ing capitalization of amounts paid to facil-
itate an acquisition of a trade or business, a
change in the capital structure of a business
entity, and certain other transactions are
contained in a new §1.263(a)–5. Dividing
2004-7 I.R.B.447February 17, 2004

the rules into two sections enabled the IRS
and Treasury Department to apply some
of the simplifying conventions in the pro-
posed regulations to certain acquisitions
of tangible assets in §1.263(a)–5, while
limiting the application of §1.263(a)–4 to
costs of acquiring and creating intangibles.
The format of the final regulations con-
tained in §§1.446–5 and 1.167(a)–3 is es-
sentially unchanged from the format of the
proposed version of these regulations.
II.Explanation and Summary of
Comments Concerning §1.263(a)–4
A.General principle of capitalization
The final regulations identify cate-
gories of intangibles for which capital-
ization is required. As in the proposed
regulations, the final regulations provide
that an amount paid to acquire or create
an intangible not otherwise required to
be capitalized by the regulations is not
required to be capitalized on the ground
that it produces significant future benefits
for the taxpayer, unless the IRS pub-
lishes guidance requiring capitalization
of the expenditure. If the IRS publishes
guidance requiringcapitalization of an
expenditure that produces future benefits
for the taxpayer, such guidance will apply
prospectively. While most commentators
support this approach, some commenta-
tors expressed concernsthat this approach,
particularly the prospective nature of fu-
ture guidance, will permit taxpayers to
deduct expenditures that should properly
be capitalized. The IRS and Treasury
Department continue to believe that the
capitalization principles in the regulations
strike an appropriate balance between the
capitalization provisions of the Code and
the ability of taxpayers and IRS personnel
to administer the law, and are a reasonable
means of enforcing the requirements of
section 263(a).
The final regulations change the gen-
eral principle of capitalization in three
respects from the proposed regulations.
First, §1.263(a)–4 of the final regulations
does not include the rule requiring cap-
italization of amounts paid to facilitate
a “restructuring or reorganization of a
business entity or a transaction involv-
ing the acquisition of capital, including a
stock issuance, borrowing, or recapitaliza-
tion.” As noted above, the rules requiring
taxpayers to capitalize amounts paid to
facilitate these typesof transactions are
now contained in §1.263(a)–5.
Second, the final regulations elimi-
nate the word “enhance” from portions
of the general principle. Commentators
expressed concerns that the use of the term
“enhance” would require capitalization in
unintended circumstances. For example, if
a taxpayer acquires goodwill as part of the
acquisition of a trade or business, future
expenditures to maintain the reputation
of the trade or business arguably could
constitute amounts paid to “enhance” the
acquired goodwill. The final regulations
remove the word “enhance” in favor of
more specifically identifying the types of
enhancement for which capitalization is
appropriate. For example, the final reg-
ulations modify the proposed regulations
to provide that a taxpayer must capitalize
an amount paid to “upgrade” its rights
under a membership or a right granted by
a government agency.
Third, the final regulations eliminate
the use of, and the definition of, the term
“intangible asset” that was contained in the
proposed regulations. This change was
made in an effort to aid readability. The fi-
nal regulations simply identify categories
of “intangibles” for which amounts are re-
quired to be capitalized.
The final regulations clarify that noth-
ing in §1.263(a)–4 changes the treatment
of an amount that is specifically provided
for under any other provision of the Code
(otherthansection162(a)or212)orreg-
ulations thereunder. Thus, where another
section of the Code (or regulations un-
der that section) prescribes a specific treat-
ment of an amount, the provisions of that
section apply and not the rules contained
in these final regulations. For example,
where the treatment of an insurance com-
pany’s policy acquisition expenses is pre-
scribed by sections 848 and 197(f)(5) of
the Code, those sections apply and not
these final regulations. Similarly, capital-
ization is not required under the final regu-
lations for expenditures that are deductible
under section 174.
The general definition of a separate and
distinct intangible asset in paragraph (b)(3)
of the final regulations is unchanged from
the proposed regulations, except to clarify
that a separate and distinct intangible asset
must be intrinsicallycapable of being sold,
transferred, or pledged (ignoring any re-
strictions imposed on assignability) sepa-
rate and apart from a trade or business. The
final regulations also clarify that a fund is
treated as a separate and distinct intangible
asset of the taxpayer if amounts in the fund
may revert to the taxpayer.
In addition, the application of the sep-
arate and distinct intangible asset defini-
tion to specific intangibles has been further
limited in the final regulations. The final
regulations provide that an amount paid
to create a package design, computer soft-
ware or an income stream from the perfor-
mance of services under a contract is not
treated as an amount that creates a separate
and distinct intangible asset. For a further
discussion of issues pertaining to computer
software, see the discussion in Part II.H.
of this Preamble titled “Computer software
issues.” In addition, examples are added
to paragraph (l) of the final regulations to
clarify that product launch costs and stock-
lifting costs do not create a separate and
distinct intangible asset.
B.Clear reflection of income
Commentators questioned how the reg-
ulations interact with the clear reflection of
income requirement of section 446(b) and
whether the IRS would argue that an ex-
penditure that is not required to be capi-
talized by the regulations should nonethe-
less be capitalized on the ground that de-
duction of the expenditure does not clearly
reflect income under section 446. If an
amount paid to acquire or create an intan-
gible is not required to be capitalized by
another provision of the Code or regula-
tions thereunder or by the final regulations
or in subsequent published guidance, the
IRS will not argue that the clear reflection
of income requirement of section 446(b)
and the regulations thereunder necessitates
capitalization.
C.Intangibles acquired from another
The final regulations retain the require-
ment of the proposed regulations that a tax-
payer must capitalize amounts paid to an-
other party to acquire any intangible from
that party in a purchase or similar transac-
tion. Like the proposed regulations, the fi-
nal regulations provide a nonexclusive list
of intangibles for which capitalization is
required. To further clarify that the list
is illustrative, the final regulations modify
the introductory language to specifically
February 17, 20044482004-7 I.R.B.

state that the list contains “examples” of
intangibles within the scope of paragraph
(c).
D.Created intangibles
1. In General
The final regulations retain the eight
categories of created intangibles contained
in the proposed regulations. As discussed
above, the final regulations eliminate the
term “enhance” from the general princi-
ple. Instead, as described below, several
of the categories of created intangibles are
revised to more specifically identify the
types of enhancements for which capital-
ization is required.
A commentator noted that the approach
adopted in the regulations of defining cat-
egories of intangibles may be subject to
abuse if taxpayers seek to deduct expen-
ditures based on immaterial distinctions
between those expenditures and expendi-
tures included in the listed categories. To
address this concern, the final regulations
contain a rule providing that the determi-
nation of whether an amount is paid to cre-
ate an intangible identified in the final reg-
ulations is made based on all of the facts
and circumstances, disregarding distinc-
tions between the labels used in the reg-
ulations to describe the intangible and the
labels used by the taxpayer and other par-
ties to describe the transaction. The IRS
and Treasury Department intend to con-
strue broadly the categories of intangibles
identified in the regulations in response
to any narrow technical arguments that an
intangible created by the taxpayer is not
literally described inthe categories. For
example, a taxpayer that obtains what is,
in substance, a membership in an organ-
ization cannot avoidcapitalization under
paragraph (d)(4) of the final regulations by
arguing that the right is titled an “admis-
sion” or that the right explicitly provides
the taxpayer a “participation right” but not
a membership.
2. Financial Interests
The final regulations require taxpayers
to capitalize an amount paid to another
party to create, originate, enter into, re-
new or renegotiate with that party certain
financial interests. The final regulations
retain the categories of financial interests
contained in the proposed regulations, with
minor modifications.
The final regulations eliminate the rule
contained in paragraph (d)(2)(ii) of the
proposed regulations providing that cap-
italization is not required for an amount
paid to create or originate an option or
forward contract if the amount is alloca-
ble to property required to be provided or
acquired by the taxpayer prior to the end
of the taxable year in which the amount is
paid. This rule was unnecessary and was
incorrectly read by some commentators to
suggest that taxpayers could immediately
deduct amounts paid to create or originate
an option or forward contract. The final
regulations clarify the treatment of these
amounts.
3. Prepaid Expenses
The final regulations retain the rule con-
tained in the proposed regulations. The
reference to “benefits to be received in the
future” has been deleted to avoid any im-
plication of a “significant future benefits”
test. No comments were received suggest-
ing changes to the rule.
4. Certain Memberships and Privileges
The final regulations retain the rule
contained in the proposed regulations, but
clarify that capitalization also is required
if a taxpayer renegotiates or upgrades a
membership or privilege. The final regula-
tions also modify an example contained in
the proposed regulations that does not ad-
dress the implications of section 274(a)(3)
and unintentionally implies that an amount
paid to obtain membership in a social club
is required to be capitalized under the reg-
ulations. The revised example addresses
an amount paid to obtain a membership in
a trade association.
5. Certain Rights Obtained From a
Governmental Agency
The final regulations retain the rule
contained in the proposed regulations, but
clarify that capitalization also is required
if a taxpayer renegotiates or upgrades its
rights. For example, a holder of a business
license that pays an amount to upgrade its
license, enabling it to sell additional types
of products or services, must capitalize
that amount.
Several commentators questioned
whether an amount paid to a government
agency to obtain a patent from that agency
is required to be capitalized under this
rule if section 174 applies to the amount.
As previously discussed, the regulations
do not affect the treatment of an expendi-
ture under other provisions of the Code.
Accordingly, an amount paid to a govern-
ment agency to obtain a patent from that
agency is not required to be capitalized
under the final regulations if the amount is
deductible under section 174.
6. Certain Contract Rights
The final regulations retain the rules
contained in the proposed regulations re-
garding capitalization of amounts paid to
enter into certain agreements. In addition,
the final regulations clarify that taxpayers
must capitalize amounts paid to another
party to create, originate, enter into, renew,
or renegotiate with that party an agreement
not to acquire additional ownership inter-
ests in the taxpayer (i.e., a standstill agree-
ment). The IRS and Treasury Department
believe that the benefits obtained by the
taxpayer from a standstill agreement are
similar to the benefits that result from other
agreements identified in the rule and that
capitalization is therefore appropriate. The
rule does not apply to a standstill agree-
ment governed by another provision of the
Code, such as section 162(k). An exam-
ple has been added to the final regulations
to illustrate the application of this rule.
The final regulations also clarify that a tax-
payer must capitalize costs that facilitate
the creation of an annuity, endowment con-
tract or insurance contract that does not
have or provide for cash value (e.g.,acom-
prehensive liability policy or a property
and casualty policy) if the taxpayer is the
covered party under the contract.
The final regulations add three rules to
address public comments that capitaliza-
tion is not appropriate if the taxpayer has
only a hope or expectation that a customer
or supplier will begin or continue a busi-
ness relationship with the taxpayer. First,
the final regulations provide that amounts
paid with the mere hope or expectation of
developing or maintaining a business re-
lationship are not required to be capital-
ized, provided the amount is not contingent
on the origination, renewal or renegotia-
tion of an agreement. The IRS and Trea-
2004-7 I.R.B.449February 17, 2004

sury Department believe that amounts that
are contingent on the origination, renewal
or renegotiation of an agreement are prop-
erly capitalized as amounts paid to origi-
nate, renew or renegotiate the agreement.
Second, the final regulations provide that
an agreement does not provide a “right” to
provide services if the agreement merely
provides that the taxpayer will stand ready
to provide services if requested, but places
no obligation on another party to request or
pay for the taxpayer’s services. Third, the
final regulations provide that an agreement
that may be terminated at will by the other
party (or parties) to the agreement prior to
the expiration of the period prescribed by
the “12-month rule” does not constitute an
agreement providing the taxpayer the right
to use property or provide (or receive) ser-
vices. However, where the other party (or
parties) to the agreement is economically
compelled not to terminate the agreement
prior to the expiration of the period pre-
scribed by the “12-month rule” in the reg-
ulations, then the agreement is not consid-
ered to be an agreement that may be termi-
nated at will. Several examples are added
to the final regulations to illustrate the ap-
plication of these rules.
The final regulations also clarify the
meaning of “renegotiate.” Under the fi-
nal regulations, a taxpayer is treated as
renegotiating an agreement if the terms
of the agreement are modified. In addi-
tion, a taxpayer is treated as renegotiating
an agreement if the taxpayer enters into
a new agreement with the same party (or
substantially the same parties) to a termi-
nated agreement, the taxpayer could not
cancel the terminated agreement without
the agreement of the other party (or par-
ties), and the other party (or parties) would
not have agreed to the cancellation unless
the taxpayer entered into the new agree-
ment. SeeU.S. Bancorp v. Commissioner,
111 T.C. 231 (1998).
The final regulations retain the $5,000
de minimisrule contained in the proposed
regulations. In addition, the final regula-
tions provide that, if an amount is paid in
the form of property, the property is val-
ued at its fair market value at the time
of the payment for purposes of determin-
ing whether thede minimisrule applies.
The final regulations also retain the pool-
ingmethodforde minimiscosts of creat-
ing similar agreements. See Part II.G. of
this Preamble titled “Safe harbor pooling
methods” for a further explanation of rules
pertaining to pooling.
7. Certain Contract Terminations
The final regulations retain the rule
contained in the proposed regulations.
No comments were received suggesting
changes to the rule. The final regula-
tions, however, clarify that the contract
termination provisions do not apply to
amounts paid to terminate a transaction
subject to §1.263(a)–5. See Part III of this
Preamble (“Explanation and Summary of
Comments Concerning §1.263(a)–5”) for
a discussion of the treatment of amounts
paid to terminate a transaction described
in §1.263(a)–5.
8. Benefits Arising From the Provision,
Production, or Improvement of Real
Property
The final regulations retain the rule
contained in the proposed regulations, but
clarify that the exceptions to the rule apply
only to the extent the taxpayer receives
fair market value consideration for the real
property.
9. Defense or Perfection of Title to
Intangible Property
The final regulations retain the rule
contained in the proposed regulations.
No comments were received suggesting
changes to the rule. The final regulations
clarify that amounts paidtoanotherparty
to terminate an agreement permitting that
party to purchase the taxpayer’s intangi-
blepropertyortoterminateatransaction
described in §1.263(a)–5 are not treated
as amounts paid to defend or perfect title.
See Part III of this Preamble (“Explanation
and Summary of Comments Concerning
§1.263(a)–5”) for a discussion of the
treatment of amounts paid to terminate a
transaction described in §1.263(a)–5.
E.Transaction costs
1. In General
The final regulations require taxpayers
to capitalize amounts that facilitate the
acquisition or creation of an intangible.
The proposed regulations provide that an
amount facilitates a transaction if it is
paid “in the process of pursuing the trans-
action.” Some commentators questioned
whether amounts paid to investigate a
transaction constitute amounts paid in the
process of pursuing the transaction. The
IRS and Treasury Department believe that
it is inappropriate to distinguish amounts
paid to investigate the acquisition or cre-
ation of an intangible from other amounts
paid in the process of acquiring or creating
an intangible. To clarify that investiga-
tory costs are within the scope of the rule,
the final regulations provide that amounts
facilitate a transaction if they are paid in
the process of “investigating or otherwise
pursuing the transaction.” In addition, the
final regulations clarify that an amount
paid to determine the value or price of an
intangible is an amount paid in the process
of investigating or otherwise pursuing the
transaction.
The proposed regulations provide that,
in determining whether an amount is paid
to facilitate a transaction, the fact that the
amount would (or would not) have been
paid “but for” the transaction is “not rel-
evant.” The IRS and Treasury Department
believe that the fact that the amount would
or would not have been paid “but for” the
transaction is a relevant factor, but not the
only factor, to be considered. Accordingly,
the final regulations revise this rule to pro-
vide that the fact that the amount would (or
would not) have been paid “but for” the
transaction is a relevant but not a “deter-
minative” factor.
The final regulations eliminate the rule
in the proposed regulations that treats
amounts paid to terminate (or facilitate
the termination of) an existing agreement
as facilitating another transaction that is
expressly conditioned on the termination
of the agreement. The IRS and Treasury
Department decided that well advised tax-
payers could easily avoid the rule by using
general representations, while uninformed
taxpayers inadvertently could be caught
by the rule. The IRS and the Treasury
Department considered replacing the “ex-
pressly conditioned” rule with a “mutually
exclusive” rule similar to the one con-
tained in §1.263(a)–5 (see Part III of this
Preamble). A mutually exclusive rule was
not adopted in §1.263(a)–4 because such a
rule could have been interpreted as requir-
ing capitalization of contract termination
costs that historically have been deductible
(for example, an amount paid to terminate
a burdensome supply contract if the tax-
payer enters into a new supply contract
February 17, 20044502004-7 I.R.B.

(for which capitalization is required under
the regulations) with another party if the
taxpayer could not contract with both par-
ties). A mutually exclusive rule also was
not adopted in the final regulations be-
cause it would have been administratively
difficult to apply such a rule in the context
of ordinary business transactions. Instead,
§1.263(a)–4 of the final regulations pro-
vides that an amount paid to terminate (or
facilitate the termination of) an existing
agreement does not facilitate the acquisi-
tion or creation of another agreement.
Commentators expressed concern that
the rules in the proposed regulations re-
quiring taxpayers to capitalize amounts
paid in the process of pursuing certain
agreements could be interpreted very
broadly to require taxpayers to capitalize
amounts that should be treated as de-
ductible costs of sustaining or expanding
the taxpayer’s business. To address this
concern, the final regulations add a rule
providing that an amount is treated as not
paid in the process of investigating or oth-
erwise pursuing the creation of a contract
right if the amount relates to activities per-
formed before the earlier of the date the
taxpayer begins preparing its bid for the
contract or the date the taxpayer begins
discussing or negotiating the contract with
another party to the contract. An example
is provided in the final regulations illus-
trating the application of the rule.
2. Simplifying Conventions
The final regulations retain the simpli-
fying conventions applicable to employee
compensation, overhead, andde minimis
costs, with several modifications.
For example, the final regulations
treat as employee compensation certain
amounts paid to persons who may not be
employees of the taxpayer under section
3401(c). Specifically, the final regulations
provide that a guaranteed payment to a
partner in a partnership is treated as em-
ployee compensation. In addition, annual
compensation paid to a director of a cor-
poration is treated as employee compen-
sation. The final regulations also provide
that, in the case of an affiliated group of
corporations filing a consolidated federal
income tax return, a payment by one mem-
ber of the group to a second member of
the group for services performed by an
employee of the second member is treated
as employee compensation if the services
are performed at a time during which both
members are affiliated. Other than this
rule for entities joining in a consolidated
return, the final regulations do not treat
employees of one entity as employees of
a related entity. The limited exception is
made for entities joining in a consolidated
return because these entities are appro-
priately viewed as a single taxpayer for
purposes of the employee compensation
simplifying convention. The IRS and
Treasury Department believe that when
other related entities provide services to
each other, they generally will maintain
records of the time charged and will not be
subject to undue recordkeeping burdens as
a result of section 263(a).
Several commentators suggested that
the simplifying convention for employee
compensation should apply to amounts
paid to independent contractors who are
not hired specifically to facilitate a capital
transaction. For example, many compa-
nies hire outside contractors to provide
administrative and secretarial services,
and these contractors work on a variety
of transactions, only some of which may
be capital. The final regulations extend
the employee compensation simplifying
convention to amounts paid to outside
contractors for secretarial, clerical, and
similar administrative services.
The final regulations retain the $5,000
de minimisthreshold contained in the pro-
posed regulations. Some commentators
suggested that the threshold be a higher
amount, or at least be indexed for inflation.
The final regulations do not adopt these
suggestions, but provide that the IRS may
prescribe a higher threshold amount in fu-
ture published guidance. The final regula-
tions also provide that, for purposes of de-
termining whether a transaction cost paid
in the form of property isde minimis,the
property is valued atits fair market value
at the time of the payment. The final reg-
ulations also retain the pooling method for
de minimistransaction costs. See Part II.G.
of this Preamble titled “Safe harbor pool-
ing methods” for a further explanation of
the rules relating to pooling.
The final regulations permit taxpayers
to elect to capitalize employee compen-
sation, overhead, orde minimiscosts.
Several commentators noted that taxpay-
ers may capitalize such costs for financial
accounting purposes, and it may be dif-
ficult to segregate these costs for federal
income tax purposes. The final regulations
permit taxpayers to make this capitaliza-
tion election with regard to any or all of
the three categories of costs covered by the
simplifying conventions (i.e.,employee
compensation, overhead, orde minimis
costs).
F.12-month rule
The regulations retain the 12-month
rule contained in the proposed regulations.
Under the 12-month rule, a taxpayer is
not required to capitalize amounts paid to
create (or facilitate the creation of) certain
rights or benefits with a brief duration.
Some commentators suggested that the
first prong of the measuring period should
be deleted, resulting in a rule that con-
siders only whether the benefit extends
beyond the end of the taxable year fol-
lowing the year in which the payment is
made. The final regulations do not adopt
this suggestion. The IRS and Treasury
continue to believe that the rule contained
in the proposed regulations is sufficient to
ease the recordkeeping burden for trans-
actions of relatively brief duration.
The final regulations clarify that if
a taxpayer is permitted to terminate an
agreement described in this rule after a
notice period, in determining whether the
“12 month rule” applies, amounts paid to
terminate the agreement before the end of
the notice period create a benefit for the
taxpayer that lasts for the amount of time
by which the notice period is shortened.
The final regulations permit taxpayers
to elect not to apply the 12-month rule to
categories of similar transactions. The IRS
and Treasury Department recognize that
some taxpayers may capitalize amounts
for financial accounting purposes that
would not be required to be capitalized
for federal income tax purposes due to
the 12-month rule. In some cases, it may
be difficult for taxpayers to identify and
calculate these amounts for purposes of
applying the 12-month rule. For this rea-
son, the final regulations permit taxpayers
to elect to capitalize these amounts not-
withstanding that the 12-month rule would
not require capitalization.
G.Safe harbor pooling methods
The final regulations adopt, with slight
modifications, the pooling methods con-
2004-7 I.R.B.451February 17, 2004

tained in the proposed regulations forde
minimiscosts and the 12-month rule. The
pooling rules in the final regulations are
very general. However, the IRS may pub-
lish guidance in the Internal Revenue Bul-
letin prescribing additional rules for apply-
ing the pooling methods to particular in-
dustries or to specific types of transactions.
The final regulations provide that a
taxpayer may utilize the pooling methods
only if the taxpayer reasonably expects
to engage in at least 25 similar transac-
tions during the taxable year. The final
regulations require a minimum number
of similar transactions to prevent inap-
propriate skewing of the average cost or
average benefit period. Although pooling
reduces the burden on taxpayers of having
to separately analyze each transaction, this
burden is not as significant when there
are only a small number of transactions to
consider.
The final regulations do not require the
same pools to be used under the pooling
method as are required for depreciation
purposes under section 167. However, tax-
payers should draw no inferences that a
pool permitted under the regulations con-
stitutes an acceptablepool for depreciation
purposes under section 167.
A commentator suggested that the fi-
nal regulations permit taxpayers to esti-
mate the costs (or renewal expectancy) of
items included in a pool based on a sam-
ple of items included in the pool. The fi-
nal regulations do not adopt this sugges-
tion. The IRS and Treasury Department
believe that it is inappropriate to apply the
pooling rules by looking at a sample of
items included in the pool. In estimating
the renewal expectancy of items in a pool,
however, taxpayers are permitted to con-
sider their historic experience with similar
items.
The final regulations clarify that a
pooling method authorized by the regula-
tions constitutes a method of accounting.
Accordingly, a taxpayer that adopts (or
changes to) a pooling method authorized
by the regulations must use the method for
the year of adoption (or year of change)
and for all subsequent taxable years dur-
ing which the taxpayer qualifies to use
the method, unless a change to another
method is required by the Commissioner,
or unless permission to change to another
method is granted by the Commissioner.
The final regulations also add a rule
that is intended to prevent abuse of the
de minimisrules through pooling of sim-
ilar agreements. The IRS and Treasury
Department are concerned that one or
more large-dollar transactions may qual-
ify under thede minimisrule if averaged
with numerous small-dollar transactions.
To discourage this potential abuse, the
regulations prohibit the inclusion of an
agreement in the pool if the amount paid
to obtain the agreement is reasonably
expected to differ significantly from the
average amount attributable to other agree-
ments properly included in the pool. The
final regulations add an example illustrat-
ing the application of this rule.
H.Computer software issues
Based on public comments, the IRS and
Treasury Department decided that issues
relating to the development and imple-
mentation of computer software are more
appropriately addressed in separate guid-
ance, and not in these final regulations.
While these final regulations require a
taxpayer to capitalize an amount paid to
another party to acquire computer software
from that party in a purchase or similar
transaction (see §1.263(a)–4(c)), nothing
in these regulations is intended to affect the
determination of whether computer soft-
ware is acquired from another party in a
purchase or similar transaction, or whether
computer software is developed or other-
wise self-created (including amounts paid
to implement Enterprise Resource Plan-
ning (ERP) software). While the proposed
regulations identify ERP implementation
costsasanissuetobeaddressedinthe
final regulations, the IRS and Treasury
Department believe that rules regarding
the treatment of such costs are more ap-
propriately addressed in separate guidance
dedicated exclusively to computer soft-
ware issues. Until separate guidance is
issued, taxpayers may continue to rely
on Revenue Procedure 2000–50, 2000–2
C.B. 601.
III.Explanation and Summary of
Comments Concerning §1.263(a)–5
A.In general
Section 1.263(a)–5 contains rules re-
quiring taxpayers to capitalize amounts
paid to facilitate the acquisition of a trade
or business, a change in the capital struc-
ture of a business entity, and certain other
transactions. The types of transactions
covered by §1.263(a)–5 are more clearly
identified than in paragraph (b)(1)(iii)
of the proposed regulations. Section
1.263(a)–5 applies to acquisitions of an
ownership interest in an entity conducting
a trade or business only if, immediately
after the acquisition, the taxpayer and the
entity are related within the meaning of
section 267(b) or 707(b). Other acquisi-
tions of an ownership interest in an entity
are governed by the rules contained in
§1.263(a)–4, and not the rules contained
in §1.263(a)–5.
Similar to the §1.263(a)–4 final regula-
tions, the §1.263(a)–5regulations clarify
that an amount facilitates a transaction if
it is paid in the process of “investigating
or otherwise pursuing the transaction” and
that an amount paid to determine the value
or price of a transaction is an amount paid
in the process of investigating or otherwise
pursuing that transaction. In addition, the
fact that an amount would (or would not)
have been paid “but for” the transaction is
a relevant, but not determinative, factor in
evaluating whether an amount is paid to fa-
cilitate a transaction.
B.Acquisition of assets constituting a
trade or business
As explained in the preamble to the
proposed regulations, the proposed regu-
lations (and the simplifying conventions
in the proposed regulations) apply only to
amounts paid to acquire (or facilitate the
acquisition of) intangibles acquired as part
of a trade or business and do not apply
to amounts paid to acquire (or facilitate
the acquisition of) tangible assets acquired
as part of a trade or business. The pre-
amble to the proposed regulations further
notes that the IRS and Treasury Depart-
ment were considering the application of
the rules in the proposed regulations to tan-
gible assets acquired as part of a trade or
business in order to provide a single ad-
ministrable standard in these transactions.
To avoid the application of one set of rules
to intangible assets acquired in the acqui-
sition of a trade or business and a differ-
ent set of rules to the tangible assets ac-
quired in the acquisition, the final regula-
tions under §1.263(a)–5 provide a single
set of rules for amounts paid to facilitate an
February 17, 20044522004-7 I.R.B.

acquisition of a trade or business, regard-
less of whether the transaction is structured
as an acquisition of the entity or as an ac-
quisition of assets (including tangible as-
sets) constituting a trade or business.
C.Special rules for certain costs
1. Borrowing Costs
The final regulations retain the rule in
the proposed regulations that an amount
paid to facilitate a borrowing does not fa-
cilitate another transaction (other than the
borrowing).
2. Costs of Asset Sales
The final regulations provide that an
amount paid to facilitate a sale of assets
does not facilitate a transaction other than
the sale, regardless of the circumstances
surrounding the sale. This modifies the
rule in the proposed regulations, which re-
quires capitalization of amounts paid to fa-
cilitate a sale of assets where the sale is re-
quired by law, regulatory mandate, or court
order and the sale itself facilitates another
capital transaction. Several commentators
argued that costs to dispose of assets are
properly viewed as costs to facilitate the
sale, and not costs to facilitate a subsequent
transaction. The IRS and Treasury Depart-
ment have adopted this suggestion and re-
vised the rule in the final regulations.
3. Mandatory Stock Distributions
The final regulations modify the rules
in the proposed regulations relating to gov-
ernment mandated divestitures of stock.
The proposed regulations provide that cap-
italization is not required for a distribu-
tion of stock by a taxpayer to its share-
holders if the divestiture is required by law,
regulatory mandate, or court order, except
in cases where the divestiture itself facil-
itates another capital transaction. The fi-
nal regulations eliminate the exception. In
addition, the final regulations clarify that
costs to organize an entity to receive the di-
vested properties or to facilitate the trans-
fer of certain divested properties to a dis-
tributed entity also are not required to be
capitalized under section 263(a). See sec-
tions 248 and 709. An example has been
added to the final regulations illustrating
this rule.
4. Bankruptcy Reorganization Costs
Commentators suggested that the final
regulations clarify that not all costs in-
curred in the process of pursuing a bank-
ruptcy reorganization under Chapter 11 of
the Bankruptcy Code must be capitalized.
The final regulationscontain a special rule
defining the scope of bankruptcy costs re-
quired to be capitalized. Under the rule,
costs of the debtor to institute or admin-
ister a Chapter 11 proceeding generally
are required to be capitalized. However,
costs to operate the debtor’s business dur-
ing a Chapter 11 proceeding (including the
types of costs described in Revenue Rul-
ing 77–204, 1977–1 C.B. 40) do not fa-
cilitate the bankruptcy and are treated in
the same manner as such costs would have
been treated had the bankruptcy proceed-
ing not been instituted. In addition, the
final regulations provide that capitaliza-
tion is not required for amounts paid by a
taxpayer to defend against the commence-
ment of an involuntary bankruptcy pro-
ceeding against the taxpayer.
Commentators specifically requested
that the final regulations address the treat-
ment of costs incurred in a Chapter 11
bankruptcy proceeding that is instituted in
order to manage and resolve tort claims
and distinguish these proceedings from
other bankruptcy cases. The final reg-
ulations do not distinguish between a
bankruptcy proceeding that is instituted to
resolve tort claims and other bankruptcy
proceedings. However, the final regula-
tions clarify that a specific amount paid
to formulate, analyze, contest or obtain
approval of the portion of a plan of reor-
ganization under Chapter 11 that resolves
the taxpayer’s tort liability is not required
to be capitalized if the amount would have
been treated as an ordinary and necessary
business expense under section 162 had
the bankruptcy proceeding not been insti-
tuted.
5. Stock Issuance Costs of Open-End
Regulated Investment Companies
The final regulations retain the rule that
amounts paid by an open-end regulated in-
vestment company to facilitate an issuance
of its stock are treated as amounts that
do not facilitate a capital transaction un-
less the amounts are paid during the initial
stockofferingperiod.
6. Integration Costs
The final regulations retain the rule in
the proposed regulations that an amount
paid to integrate the business operations
of the taxpayer with the business opera-
tions of another entity does not facilitate
a transaction described in §1.263(a)–5, re-
gardless of when the integration activities
occur.
7. Costs Associated with Terminated
Transactions
The final regulations clarify when costs
of terminating a transaction described in
§1.263(a)–5 (including break-up fees) are
treated as facilitating another transaction
described in §1.263(a)–5. Under the pro-
posed regulations, termination costs facil-
itate a subsequent transaction if the sub-
sequent transaction is “expressly condi-
tioned” on the termination. The final reg-
ulations do not contain an “expressly con-
ditioned” rule. Instead, an amount paid to
terminate (or facilitate the termination of)
an agreement to enter into a transaction de-
scribed in the regulations is treated as facil-
itating another transaction described in the
regulations only if the transactions are mu-
tually exclusive andthe agreement is ter-
minated to enable the taxpayer to engage
in the second transaction. In addition, an
amount paid to facilitate a transaction de-
scribed in the regulations is treated as fa-
cilitating a second transaction described in
the regulations only if the transactions are
mutually exclusive and the first transac-
tion is abandoned to enable the taxpayer to
engage in the second transaction. The fi-
nal regulations contain several examples to
demonstrate the application of these rules.
D.Simplifying conventions
In general, the simplifying conventions
applicable to transactions described in
§1.263(a)–5 are similar to the simplify-
ing conventions applicable to acquisitions
or creations of intangibles governed by
§1.263(a)–4. See Part II.E.2 of this Pre-
amble titled “Simplifying Conventions”
for an explanation of the simplifying con-
ventions applicable to the acquisition or
creation of an intangible governed by
§1.263(a)–4.
The simplifying convention for em-
ployee compensation treats amounts paid
to persons who are not employees as
2004-7 I.R.B.453February 17, 2004

employee compensation if the amounts
are paid for secretarial, clerical, or sim-
ilar administrative support services. In
the context of transactions described in
§1.263(a)–5, this rule does not apply to
services involving the preparation and dis-
tribution of proxy solicitations and other
documents seeking shareholder approval
of a transaction described in §1.263(a)–5.
The IRS and Treasury Department believe
that these inherently facilitative services,
whicharecommonlyperformedbyin-
dependent contractors, are appropriately
capitalized.
In addition, the final regulations pro-
vide that the term “de minimiscosts” does
not include commissions paid to facilitate
a transaction described in §1.263(a)–5.
This rule maintains consistency with the
rule in §1.263(a)–4(e)(4)(iii)(B), which
provides that thede minimisrule does not
apply to commissions paid to facilitate the
acquisition or creation of certain financial
interests.
E.Special rules for certain acquisitive
transactions
The final regulations contain a “bright
line date” rule and an “inherently facilita-
tive” rule intended to aid the determination
of amounts paid to facilitate certain acquis-
itive transactions. The final regulations
modify the bright line date rule provided in
the proposed regulations. Under the final
regulations, an amount (that is not an in-
herently facilitative amount) facilitates the
transaction only if the amount relates to
activities performed on or after the earlier
of (i) the date on which a letter of intent,
exclusivity agreement, or similar written
communication is executed by representa-
tives of the acquirer and the target or (ii)
the date on which the material terms of the
transaction are authorized or approved by
the taxpayer’s board of directors (or other
appropriate governing officials). Where
board approval is not required for a par-
ticular transaction, thebrightlinedatefor
the second prong of the test is the date
on which the acquirer and the target exe-
cute a binding writtencontract reflecting
the terms of the transaction.
Many comments were received con-
cerning the bright line dates. Some com-
mentators noted that any bright line date
is inappropriate and that the determination
should be based on all of the facts and
circumstances surrounding the transac-
tion. As discussed in the preamble to the
proposed regulations, the IRS and Trea-
sury Department continue to believe that
a bright line rule is necessary to eliminate
the subjectivity and controversy inherent
in this area. Further, the IRS and Treasury
Department believe that the bright line
rule is within the scope of the authority
of the IRS and Treasury Department to
prescribe rules necessary to enforce the
requirements of section 263(a), and that
the bright line rule, as modified in these
final regulations, serves as an appropriate
and objective standard for determining
the point in time at which amounts paid
in certain acquisitive transactions must be
capitalized.
Some commentators who agreed with
theuseofabrightlinedateruletoim-
prove administrability of section 263(a)
suggested that the bright line date should
be the date the taxpayer’s board of direc-
tors approves a transaction. The date of
the board of directors approval may, in
some cases, be the date determined under
the rule contained in the final regulations.
However, the IRS and Treasury Depart-
ment believe that an earlier date is more
appropriate where the parties have mutu-
ally agreed to pursue a transaction, not-
withstanding the fact that the parties are
not bound to complete the transaction. Ac-
cordingly, the rule requires capitalization if
the parties execute a letter of intent, exclu-
sivity agreement, or similar written com-
munication. The termsimilar written com-
municationin the rule is not intended to in-
clude a confidentiality agreement.
The board of directors approval date
contemplated by the rule is not the date the
board authorizes a committee (or manage-
ment) to explore the possibility of a trans-
action with another party. Additionally,
the board of directors approval date con-
templated by the rule is not intended to
be the date the board ratifies a shareholder
vote in favor of the transaction.
Some commentators suggested that the
final regulations clarify how the bright line
date rule applies to a target that puts itself
up for auction. These commentators noted
that, under the proposed regulations, sub-
mission of a bid by a bidder could trigger
thebrightlinedateforthetarget,evenif
the target has not made any decision re-
garding the bid. Under the final regula-
tions, submission of a bid by a bidder does
nottriggerthebrightlinedateforthetar-
get because the first part of the test requires
execution by both the acquirer and the tar-
get and the second part of the test is applied
independently by the acquirer and the tar-
get. The final regulations include an exam-
ple illustrating the application of the rule in
this case.
The final regulations specifically iden-
tify the types of transactions to which the
bright line date and inherently facilitative
rules apply. Some commentators sug-
gested that the final regulations extend the
rule to apply not only to acquisitive trans-
actions, but to spin-offs, stock offerings,
and acquisitions of individual assets that
do not constitute a trade or business. The
IRS and Treasury Department believe that
the bright line test is not suitable for these
transactions and that amounts paid in the
process of investigating or otherwise pur-
suing these transactions are appropriately
capitalized.
Regarding the inherently facilitative
rule contained in the proposed regula-
tions, several commentators suggested
that the rule be deleted or changed to a
rebuttable presumption that the identified
amounts are capital. The final regulations
do not adopt this suggestion. The IRS and
Treasury Department believe that the list
of inherently facilitative amounts prop-
erly identifies certain types of costs that
are capital regardless of when they are
incurred. In addition, a rebuttable pre-
sumption would not provide the certainty
sought by the regulations. However, the
final regulations modify the list of inher-
ently facilitative amounts to more clearly
identify the types of costs considered in-
herently facilitative. For example, the
proposed regulations treat “amounts paid
for activities performed in determining
the value of the target” as inherently fa-
cilitative costs. Commentators expressed
concerns that this language would require
taxpayers to capitalize all due diligence
costs. The final regulations tighten this
category to include amounts paid for “se-
curing an appraisal, formal written eval-
uation, or fairness opinion related to the
transaction.” General due diligence costs
are intended to be addressed by the bright
line test, not the inherently facilitative
rules.
Some commentators questioned
whether the regulations are intended to
affect the treatment of an expenditure un-
February 17, 20044542004-7 I.R.B.

der section 195. As a result of section
195(c)(1)(B), the regulations are relevant
in determining whether an expenditure
constitutes a start-up expenditure within
the meaning of section 195. An amount
cannot constitute a start-up expenditure
within the meaning of section 195(c)(1)(B)
if the amount is a capital expenditure un-
der section 263(a). Accordingly, amounts
required to be capitalized under the final
regulations do not constitute start-up ex-
penditures within the meaning of section
195(c)(1). Conversely, amounts that are
not required to be capitalized under the
final regulations may constitute start-up
expenditures within the meaning of section
195(c)(1) provided the other requirements
of that section are met.
F.Hostile takeover defense costs
The IRS and Treasury Department de-
cided that the rules in the proposed regula-
tions for amounts paid to defend against a
hostile takeover attempt are unnecessary.
The hostile transaction rule in the pro-
posed regulations does not permit taxpay-
ers to deduct costs that otherwise would
have been capitalized under the regula-
tions. For example, the hostile transaction
rule does not apply to any inherently fa-
cilitative costs or to costs that facilitate an-
other capital transaction (for example, a re-
capitalization or a proposed merger with a
white knight). Other amounts that a target
would pay in defending against a hostile
acquisition would notbe capitalized un-
der the final regulations either because the
costs would not be paid in investigating or
otherwise pursuing the transaction with the
hostile acquirer (for example, costs to seek
an injunction against the acquisition) or
would relate to activities performed before
the bright line dates (while the transaction
is hostile, the target will not execute any
agreements with the acquirer and the tar-
get’s board of directors will not authorize
the acquisition). Thus, the IRS and Trea-
sury Department believe the hostile trans-
action rule in the proposed regulations is
unnecessary and could cause needless con-
troversy over when a transaction changes
from hostile to friendly. Accordingly, the
final regulations do not contain any spe-
cial rules related to hostile acquisition at-
tempts. The final regulations contain an
example illustrating how the regulations
apply in the context of a hostile acquisition
attempt.
G.Documentation of success-based fees
Under the proposed regulations, a pay-
ment that is contingent on the success-
ful closing of an acquisition facilitates the
acquisition except to the extent that evi-
dence clearly demonstrates that some por-
tion of the payment is allocable to ac-
tivities that do not facilitate the acquisi-
tion. The final regulations retain the suc-
cess-based fee rule, but extend it to all
transactions to which §1.263(a)–5 applies,
instead of just acquisitive transactions. In
addition, the final regulations eliminate the
“clearly demonstrates” standard in favor
of a rule providing that success-based fees
facilitate a transaction except to the ex-
tent the taxpayer maintains sufficient doc-
umentation to establish that a portion of
the fee is allocable to activities that do not
facilitate the transaction. The regulations
require that this documentation consist of
more than a mere allocation between activ-
ities that facilitate the transaction and ac-
tivities that do not facilitate the transaction.
H.Treatment of capitalized costs
The final regulations provide that
amounts required to be capitalized by an
acquirer in a taxable acquisitive transac-
tion are added to the basis of the acquired
assets in an asset transaction or to the basis
of the acquired stock in a stock transac-
tion. Amounts required to be capitalized
by the target in an acquisition of its assets
in a taxable transaction are treated as a
reduction of the target’s amount realized
on the disposition of its assets.
The final regulations do not address
the treatment of amounts required to be
capitalized in certain other transactions
to which §1.263(a)–5 applies (for exam-
ple, amounts required to be capitalized
in tax-free transactions, costs of a target
in a taxable stock acquisition and stock
issuance costs). The IRS and Treasury De-
partment intend to issue separate guidance
to address the treatment of these amounts
and will consider at that time whether such
amounts should be eligible for the 15-year
safe harbor amortization period described
in §1.167(a)–3.
IV.Effective Dates and Changes in
Methods of Accounting
The final regulations under
§§1.263(a)–4 and 1.263(a)–5 apply
to amounts paid or incurred on or after
December 31, 2003. Except as provided
below regarding changes to a pooling
method authorized by these regulations,
a taxpayer seeking to change a method
of accounting to comply with the final
regulations must make the change on a
modified cut-off basis, taking into account
for purposes of section 481(a) only
amounts paid or incurred in taxable years
ending on or after January 24, 2002 (the
date of publication of the advance notice
of proposed rulemaking in theFederal
Register).
As explained in the preamble to the
proposed regulations, the IRS and Trea-
sury Department are concerned that an
unrestricted section 481(a) adjustment for
changes in methods of accounting made
to comply with these regulations would
create administrative burdens on taxpay-
ers and the IRS. In addition, many of the
simplification conventions in the final
regulations (including the 12-month rule
and the rules for employee compensation,
overhead andde minimiscosts) represent
a change in the position traditionally taken
by the IRS and the Treasury Department in
interpreting section 263(a). However, the
IRS and Treasury Department also want
to reduce the potential for inconsistent
treatment of conservative and aggressive
taxpayers. Allowing a section 481(a) ad-
justment for amounts paid or incurred in
taxable years ending on or after the date
of the advance notice of proposed rule-
making achieves the best balance of these
concerns.
For changes relating to the use of a
pooling method under §1.263(a)–4, tax-
payers must apply a cut-off method. Ap-
plying a cut-off method reduces the burden
on taxpayers of having to determine which
assets fit into a pool on a retroactive basis.
The preamble to the proposed regu-
lations provides that taxpayers may not
change a method of accounting in reliance
upon the rules contained in the proposed
regulations until the rules are published as
final regulations. Nonetheless, the IRS has
received numerous Forms 3115 from tax-
payers seeking the Commissioner’s con-
sent to change their method of accounting
2004-7 I.R.B.455February 17, 2004

for items addressed in the advance notice
of proposed rulemaking or in the pro-
posed regulations. The IRS suspended
processing of these requests pending pub-
lication of these final regulations. Upon
publication of the final regulations, the
IRS intends to process these requests in
a manner consistent with the rules con-
tained in the final regulations, including
the effective date rules and rules relating
to the computation of the section 481(a)
adjustment. For example, if the change is
requested for a taxable year ending prior
to the effective date of the final regulations
and concerns a method of accounting that
the Commissioner does not recognize as
permissible prior to the effective date of
the final regulations, the IRS intends to
reject the request. Similarly, if the change
is requested for a taxable year ending on or
after the effective date of the final regula-
tions and concerns a method of accounting
that is permissible under the final regula-
tions, the IRS intends to return the request
to the taxpayer (and refund the user fee)
and advise the taxpayer to utilize the au-
tomatic consent procedures as authorized
by the final regulations. Subsequent to
the publication of these final regulations,
the IRS may issue additional guidance for
utilizing the automatic consent procedures
as authorized by these regulations. Un-
less these regulations specifically identify
a treatment of amounts as a method of
accounting (for example, the safe harbor
pooling methods), nothing in these reg-
ulations is intended to address whether
the treatment of amounts to which these
regulations apply constitutes a method of
accounting.
V.Explanation of Amendments to
§1.167(a)–3
The final regulations essentially retain
the amendments to §1.167(a)–3 as con-
tained in the proposed regulations. The fi-
nal regulations provide that those amend-
ments are effective for intangible assets
created on or after the date the final reg-
ulations are published in theFederal Reg-
ister.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment
is not required. It also has been determined
that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does
not apply to these regulations. It is hereby
certified that the collection of information
requirement in these regulations will not
have a significant economic impact on a
substantial number of small entities. This
certification is based on the fact that the
regulations merely require a taxpayer to re-
tain records substantiating amounts paid in
the process of investigating or otherwise
pursuing certain transactions involving the
acquisition of a trade or business. There-
fore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f)
of the Code, the notice of proposed rule-
making preceding this regulation was sub-
mitted to the Chief Counsel for Advocacy
of the Small Business Administration for
comment on its impact on small business.
The Chief Counsel for Advocacy did not
submit any comments on the regulations.
Drafting Information
The principal author of these final reg-
ulations is Andrew J. Keyso of the Office
of Associate Chief Counsel (Income Tax
and Accounting). However, other person-
nel from the IRS and Treasury Department
participated in their development.
*****
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART I — INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.167(a)–3 is amended
by:
1. Designating the text of the section
as paragraph (a) and adding a heading to
newly designated paragraph (a).
2. Adding paragraph (b).
The additions read as follows:
§1.167(a)–3 Intangibles.
(a)In general.***
(b)Safe harbor amortization for certain
intangible assets—(1)Useful life.Solely
for purposes of determining the deprecia-
tion allowance referred to in paragraph (a)
of this section, a taxpayer may treat an in-
tangible asset as having a useful life equal
to 15 years unless —
(i) An amortization period or useful
life for the intangible asset is specifically
prescribed or prohibited by the Internal
Revenue Code, the regulations thereunder
(other than by this paragraph (b)), or other
published guidance in the Internal Rev-
enue Bulletin (see §601.601(d)(2) of this
chapter);
(ii) The intangible asset is described
in §1.263(a)–4(c) (relating to intangi-
bles acquired from another person) or
§1.263(a)–4(d)(2) (relating to created fi-
nancial interests);
(iii) The intangible asset has a useful
life the length of which can be estimated
with reasonable accuracy; or
(iv) The intangible asset is described
in §1.263(a)–4(d)(8)(relating to certain
benefits arising from the provision, pro-
duction, or improvement of real property),
in which case the taxpayer may treat the
intangible asset as having a useful life
equal to 25 years solely for purposes of
determining the depreciation allowance
referred to in paragraph (a) of this section.
(2)Applicability to acquisitions of a
trade or business, changes in the capital
structure of a business entity, and certain
other transactions. The safe harbor use-
ful life provided by paragraph (b)(1) of
thissectiondoesnotapplytoanamount
required to be capitalized by §1.263(a)–5
(relating to amounts paid to facilitate an
acquisition of a trade or business, a change
in the capital structure of a business entity,
and certain other transactions).
(3)Depreciation method. A taxpayer
that determines its depreciation allowance
for an intangible asset using the 15-year
useful life prescribed by paragraph (b)(1)
of this section (or the 25-year useful life
in the case of an intangible asset described
in §1.263(a)–4(d)(8)) must determine the
allowance by amortizing the basis of the
intangible asset (as determined under sec-
tion 167(c) and without regard to salvage
value) ratably over the useful life begin-
ning on the first day of the month in which
the intangible asset is placed in service by
the taxpayer. The intangible asset is not el-
igible for amortization in the month of dis-
position.
February 17, 20044562004-7 I.R.B.

(4)Effective date. This paragraph (b)
applies to intangible assets created on or
after December 31, 2003.
Par. 3. Section 1.263(a)–0 is added to
read as follows:
§1.263(a)–0 Table of contents.
This section lists captioned para-
graphs contained in §§1.263(a)–1 through
1.263(a)–5.
§1.263(a)–1 Capital expenditures; in
general.
§1.263(a)–2 Examples of capital
expenditures.
§1.263(a)–3Electiontodeductor
capitalize certain expenditures.
§1.263(a)–4 Amounts paid to acquire or
create intangibles.
(a) Overview.
(b) Capitalization with respect to intangi-
bles.
(1) In general.
(2) Published guidance.
(3) Separate and distinct intangible asset.
(i) Definition.
(ii) Creation or termination of contract
rights.
(iii) Amounts paid in performing services.
(iv) Creation of computer software.
(v) Creation of package design.
(4) Coordination with other provisions of
the Internal Revenue Code.
(i) In general.
(ii) Example.
(c) Acquired intangibles.
(1) In general.
(2) Readily available software.
(3) Intangibles acquired from an em-
ployee.
(4) Examples.
(d) Created intangibles.
(1) In general.
(2) Financial interests.
(i) In general.
(ii) Amounts paid to create, originate, enter
into, renew or renegotiate.
(iii) Renegotiate.
(iv) Coordination with other provisions of
this paragraph (d).
(v) Coordination with §1.263(a)–5.
(vi) Examples.
(3) Prepaid expenses.
(i) In general.
(ii) Examples.
(4) Certain memberships and privileges.
(i) In general.
(ii) Examples.
(5) Certain rights obtained from a govern-
ment agency.
(i) In general.
(ii) Examples.
(6) Certain contract rights.
(i) In general.
(ii) Amounts paid to create, originate, enter
into, renew or renegotiate.
(iii) Renegotiate.
(iv) Right.
(v)De minimisamounts.
(vi) Exception for lessee construction al-
lowances.
(vii) Examples.
(7) Certain contract terminations.
(i) In general.
(ii) Certain break-up fees.
(iii) Examples.
(8) Certain benefits arising from the pro-
vision, production, or improvement of real
property.
(i) In general.
(ii) Exclusions.
(iii) Real property.
(iv) Impact fees and dedicated improve-
ments.
(v) Examples.
(9) Defense or perfection of title to intan-
gible property.
(i) In general.
(ii) Certain break-up fees.
(iii) Example.
(e) Transaction costs.
(1) Scope of facilitate.
(i) In general.
(ii) Treatment of termination payments.
(iii) Special rule for contracts.
(iv) Borrowing costs.
(v) Special rule for stock redemption costs
of open-end regulated investment compa-
nies.
(2) Coordination with paragraph (d) of this
section.
(3) Transaction.
(4) Simplifying conventions.
(i) In general.
(ii) Employee compensation.
(iii)De minimiscosts.
(iv) Election to capitalize.
(5) Examples.
(f) 12-month rule.
(1) In general.
(2) Duration of benefit for contract termi-
nations.
(3) Inapplicability to created financial in-
terests and self-created amortizable sec-
tion 197 intangibles.
(4) Inapplicability to rights of indefinite
duration.
(5) Rights subject to renewal.
(i) In general.
(ii) Reasonable expectancy of renewal.
(iii) Safe harbor pooling method.
(6) Coordination with section 461.
(7) Election to capitalize.
(8) Examples.
(g) Treatment of capitalized costs.
(1) In general.
(2) Financial instruments.
(h) Special rules applicable to pooling.
(1) In general.
(2) Method of accounting.
(3) Adopting or changing to a pooling
method.
(4) Definition of pool.
(5) Consistency requirement.
(6) Additional guidance pertaining to pool-
ing.
(7) Example.
(i) [Reserved].
(j) Application to accrual method taxpay-
ers.
(k) Treatment of related parties and indi-
rect payments.
(l) Examples.
(m) Amortization.
(n) Intangible interests in land [Reserved].
(o) Effective date.
(p) Accounting method changes.
(1) In general.
(2) Scope limitations.
(3) Section 481(a) adjustment.
§1.263(a)–5 Amounts paid or incurred
to facilitate an acquisition of a trade or
business, a change in the capital structure
of a business entity, and certain other
transactions.
(a) General rule.
(b) Scope of facilitate.
(1) In general.
(2) Ordering rules.
(c) Special rules for certain costs.
(1) Borrowing costs.
(2) Costs of asset sales.
(3) Mandatory stock distributions.
(4) Bankruptcy reorganization costs.
(5) Stock issuance costs of open-end regu-
lated investment companies.
(6) Integration costs.
2004-7 I.R.B.457February 17, 2004

(7) Registrar and transfer agent fees for the
maintenance of capital stock records.
(8) Termination payments and amounts
paid to facilitate mutually exclusive trans-
actions.
(d) Simplifying conventions.
(1) In general.
(2) Employee compensation.
(i) In general.
(ii) Certain amounts treated as employee
compensation.
(3)De minimiscosts.
(i) In general.
(ii) Treatment of commissions.
(4) Election to capitalize.
(e) Certain acquisitive transactions.
(1) In general.
(2) Exception for inherently facilitative
amounts.
(3) Covered transactions.
(f) Documentation of success-based fees.
(g) Treatment of capitalized costs.
(1) Tax-free acquisitive transactions [Re-
served].
(2) Taxable acquisitive transactions.
(i) Acquirer.
(ii) Target.
(3) Stock issuance transactions [Re-
served].
(4) Borrowings.
(5) Treatment of capitalized amounts by
option writer.
(h) Application to accrual method taxpay-
ers.
(i) [Reserved].
(j) Coordination with other provisions of
the Internal Revenue Code.
(k) Treatment of indirect payments.
(l) Examples.
(m) Effective date.
(n) Accounting method changes.
(1) In general.
(2) Scope limitations.
(3) Section 481(a) adjustment.
Par. 4. Sections 1.263(a)–4 and
1.263(a)–5 are addedto read as follows:
§1.263(a)–4 Amounts paid to acquire or
create intangibles.
(a)Overview. This section provides
rules for applying section 263(a) to
amounts paid to acquire or create in-
tangibles. Except to the extent provided in
paragraph (d)(8) of this section, the rules
provided by this section do not apply to
amounts paid to acquire or create tangible
assets. Paragraph (b)ofthissectionpro-
vides a general principle of capitalization.
Paragraphs (c) and (d) of this section iden-
tify intangibles for which capitalization
is specifically required under the general
principle. Paragraph (e) of this section
provides rules for determining the extent
to which taxpayers must capitalize trans-
action costs. Paragraph (f) of this section
provides a 12-month rule intended to sim-
plify the application of the general princi-
ple to certain payments that create benefits
of a brief duration. Additional rules and
examples relating to these provisions are
provided in paragraphs (g) through (n) of
this section. The applicability date of the
rules in this section is provided in para-
graph (o) of this section. Paragraph (p) of
this section provides rules applicable to
changes in methods of accounting made to
comply with this section.
(b)Capitalization with respect to intan-
gibles—(1)In general. Except as other-
wise provided in this section, a taxpayer
must capitalize —
(i) An amount paid to acquire an intan-
gible (see paragraph (c) of this section);
(ii) An amount paid to create an intangi-
ble described in paragraph (d) of this sec-
tion;
(iii)Anamountpaidtocreateoren-
hance a separate and distinct intangible as-
set within the meaning of paragraph (b)(3)
of this section;
(iv) An amount paid to create or en-
hance a future benefit identified in pub-
lished guidance in theFederal Register
or in the Internal Revenue Bulletin (see
§601.601(d)(2)(ii) of this chapter) as an
intangible for which capitalization is re-
quired under this section; and
(v) An amount paid to facilitate (within
the meaning of paragraph (e)(1) of this sec-
tion) an acquisition or creation of an intan-
gible described in paragraph (b)(1)(i), (ii),
(iii)or(iv)ofthissection.
(2)Published guidance. Any published
guidance identifying a future benefit as an
intangible for which capitalization is re-
quired under paragraph (b)(1)(iv) of this
section applies only to amounts paid on or
after the date of publication of the guid-
ance.
(3)Separate and distinct intangible as-
set—(i)Definition.Thetermseparate
and distinct intangible assetmeans a prop-
erty interest of ascertainable and measur-
able value in money’s worth that is subject
to protection under applicable state, fed-
eral or foreign law and the possession and
control of which is intrinsically capable of
being sold, transferred or pledged (ignor-
ing any restrictions imposed on assignabil-
ity) separate and apart from a trade or busi-
ness. In addition, for purposes of this sec-
tion, a fund (or similar account) is treated
as a separate and distinct intangible asset
of the taxpayer if amounts in the fund (or
account) may revert to the taxpayer. The
determination of whether a payment cre-
ates a separate and distinct intangible as-
set is made based on all of the facts and
circumstances existing during the taxable
year in which the payment is made.
(ii)Creation or termination of contract
rights. Amounts paid to another party to
create, originate, enter into, renew or rene-
gotiate an agreement with that party that
produces rights or benefits for the taxpayer
(and amounts paid to facilitate the cre-
ation, origination, enhancement, renewal
or renegotiation of such an agreement) are
treated as amounts that do not create (or fa-
cilitate the creation of) a separate and dis-
tinct intangible asset within the meaning
of this paragraph (b)(3). Further, amounts
paid to another party to terminate (or fa-
cilitate the termination of) an agreement
with that party are treated as amounts that
do not create a separate and distinct in-
tangible asset within the meaning of this
paragraph (b)(3). See paragraphs (d)(2),
(d)(6), and (d)(7) of this section for rules
that specifically require capitalization of
amounts paid to create or terminate certain
agreements.
(iii)Amounts paid in performing ser-
vices. Amounts paid in performing ser-
vices under an agreement are treated as
amounts that do not create a separate and
distinct intangible asset within the mean-
ing of this paragraph (b)(3), regardless of
whether the amounts result in the creation
of an income stream under the agreement.
(iv)Creation of computer software.Ex-
cept as otherwise provided in the Internal
Revenue Code, the regulations thereunder,
or other published guidance in theFederal
Registeror in the Internal Revenue Bul-
letin (see §601.601(d)(2)(ii) of this chap-
ter), amounts paid to develop computer
software are treated as amounts that do not
create a separate and distinct intangible as-
set within the meaning of this paragraph
(b)(3).
(v)Creation of package design.
Amounts paid to develop a package de-
February 17, 20044582004-7 I.R.B.

sign are treated as amounts that do not
create a separate and distinct intangible
asset within the meaning of this paragraph
(b)(3). For purposes of this section, the
termpackage designmeans the specific
graphic arrangement or design of shapes,
colors, words, pictures, lettering, and other
elements on a given product package, or
the design of a container with respect to
its shape or function.
(4)Coordination with other provisions
of the Internal Revenue Code—(i)In gen-
eral. Nothing in this section changes the
treatment of an amount that is specifically
provided for under any other provision of
the Internal Revenue Code (other than sec-
tion 162(a) or 212) or the regulations there-
under.
(ii)Example. The following example
illustrates the rule of this paragraph (b)(4):
Example. On January 1, 2004, G enters into an
interest rate swap agreement with unrelated counter-
party H under which, for a term of five years, G
is obligated to make annual payments at 11% and
H is obligated to make annual payments at LIBOR
on a notional principal amount of $100 million. At
the time G and H enter into this swap agreement,
the rate for similar on-market swaps is LIBOR to
10%. To compensate for this difference, on January 1,
2004, H pays G a yield adjustment fee of $3,790,786.
This yield adjustment fee constitutes an amount paid
to create an intangible and would be capitalized un-
der paragraph (d)(2) of this section. However, be-
cause the yield adjustment fee is a nonperiodic pay-
ment on a notional principal contract as defined in
§1.446–3(c), the treatment of this fee is governed by
§1.446–3 and not this section.
(c)Acquired intangibles—(1)In gen-
eral. A taxpayer must capitalize amounts
paid to another party to acquire any intan-
gible from that party in a purchase or sim-
ilar transaction. Examples of intangibles
within the scope of this paragraph (c) in-
clude, but are not limited to, the following
(if acquired from another party in a pur-
chase or similar transaction):
(i) An ownership interest in a corpora-
tion, partnership, trust, estate, limited lia-
bility company, or other entity.
(ii) A debt instrument, deposit, stripped
bond, stripped coupon (including a servic-
ing right treated for federal income tax pur-
poses as a stripped coupon), regular inter-
est in a REMIC or FASIT, or any other in-
tangible treated as debt for federal income
tax purposes.
(iii) A financial instrument, such as —
(A) A notional principal contract;
(B) A foreign currency contract;
(C) A futures contract;
(D) A forward contract (including an
agreement under which the taxpayer has
the right and obligation to provide or to ac-
quire property (or to be compensated for
such property, regardless of whether the
taxpayer provides or acquires the prop-
erty));
(E) An option (including an agreement
under which the taxpayer has the right to
provide or to acquire property (or to be
compensated for such property, regardless
of whether the taxpayer provides or ac-
quires the property)); and
(F) Any other financial derivative.
(iv) An endowment contract, annuity
contract, or insurance contract.
(v) Non-functional currency.
(vi) A lease.
(vii) A patent or copyright.
(viii) A franchise, trademark or trade-
name (as defined in §1.197–2(b)(10)).
(ix) An assembled workforce (as de-
fined in §1.197–2(b)(3)).
(x) Goodwill (as defined in §1.197–
2(b)(1)) or going concern value (as defined
in §1.197–2(b)(2)).
(xi) A customer list.
(xii) A servicing right (for example,
a mortgage servicing right that is not
treated for federal income tax purposes as
a stripped coupon).
(xiii) A customer-based intangible
(as defined in §1.197–2(b)(6)) or sup-
plier-based intangible (as defined in
§1.197–2(b)(7)).
(xiv) Computer software.
(xv) An agreement providing either
party the right to use, possess or sell an in-
tangible described in paragraphs (c)(1)(i)
through (v) of this section.
(2)Readily available software.An
amount paid to obtain a nonexclusive li-
cense for software that is (or has been)
readily available to the general public on
similar terms and has not been substan-
tially modified (within the meaning of
§1.197–2(c)(4)) is treated for purposes
of this paragraph (c) as an amount paid
to another party to acquire an intangible
from that party in a purchase or similar
transaction.
(3)Intangibles acquired from an em-
ployee. Amounts paid to an employee to
acquire an intangible from that employee
are not required to be capitalized under
this section if the amounts are includible in
the employee’s income in connection with
the performance of services under section
61 or 83. For purposes of this section,
whether an individual is an employee is de-
termined in accordance with the rules con-
tained in section 3401(c) and the regula-
tions thereunder.
(4)Examples. The following examples
illustrate the rules of this paragraph (c):
Example 1.Debt instrument. X corporation, a
commercial bank, purchases a portfolio of existing
loans from Y corporation, another financial institu-
tion. X pays Y $2,000,000 in exchange for the portfo-
lio. The $2,000,000 paid to Y constitutes an amount
paid to acquire an intangible from Y and must be cap-
italized.
Example 2.Option. W corporation owns all of
the outstanding stock of X corporation. Y corporation
holds a call option entitling it to purchase from W all
of the outstanding stock of X at a certain price per
share. Z corporation acquires the call option from Y
in exchange for $5,000,000. The $5,000,000 paid to
Y constitutes an amount paid to acquire an intangible
from Y and must be capitalized.
Example 3.Ownership interest in a corporation.
Same asExample 2, but assume Z exercises its option
and purchases from W all of the outstanding stock of
X in exchange for $100,000,000. The $100,000,000
paid to W constitutes an amount paid to acquire an
intangible from W and must be capitalized.
Example 4.Customer list. N corporation, a re-
tailer, sells its products through its catalog and mail
order system. N purchases a customer list from R
corporation. N pays R $100,000 in exchange for the
customer list. The $100,000 paid to R constitutes an
amount paid to acquire an intangible from R and must
be capitalized.
Example 5.Goodwill. Z corporation pays W
corporation $10,000,000 to purchase all of the as-
sets of W in a transaction that constitutes an appli-
cable asset acquisition under section 1060(c). Of
the $10,000,000 consideration paid in the transac-
tion, $9,000,000 is allocable to tangible assets pur-
chased from W and $1,000,000 is allocable to good-
will. The $1,000,000 allocable to goodwill consti-
tutes an amount paid to W to acquire an intangible
from W and must be capitalized.
(d)Created intangibles—(1)In gen-
eral. Except as provided in paragraph (f)
of this section (relating to the 12-month
rule), a taxpayer must capitalize amounts
paid to create an intangible described in
this paragraph (d). The determination of
whether an amount is paid to create an in-
tangible described in this paragraph (d) is
to be made based on all of the facts and cir-
cumstances, disregarding distinctions be-
tween the labels used in this paragraph (d)
to describe the intangible and the labels
used by the taxpayer and other parties to
the transaction.
(2)Financial interests—(i)In gen-
eral. A taxpayer must capitalize amounts
paid to another party to create, originate,
enter into, renew or renegotiate with that
party any of the following financial inter-
2004-7 I.R.B.459February 17, 2004

ests, whether or not the interest is regularly
traded on an established market:
(A) An ownership interest in a corpora-
tion, partnership, trust, estate, limited lia-
bility company, or other entity.
(B) A debt instrument, deposit, stripped
bond, stripped coupon (including a servic-
ing right treated for federal income tax pur-
poses as a stripped coupon), regular inter-
est in a REMIC or FASIT, or any other in-
tangible treated as debt for federal income
tax purposes.
(C) A financial instrument, such as —
(1)Aletterofcredit;
(2) A credit card agreement;
(3) A notional principal contract;
(4) A foreign currency contract;
(5) A futures contract;
(6) A forward contract (including an
agreement under which the taxpayer has
the right and obligation to provide or to ac-
quire property (or to be compensated for
such property, regardless of whether the
taxpayer provides or acquires the prop-
erty));
(7) An option (including an agreement
under which the taxpayer has the right to
provide or to acquire property (or to be
compensated for such property, regardless
of whether the taxpayer provides or ac-
quires the property)); and
(8) Any other financial derivative.
(D) An endowment contract, annuity
contract, or insurance contract that has or
may have cash value.
(E) Non-functional currency.
(F) An agreement providing either party
the right to use, possess or sell a financial
interest described in this paragraph (d)(2).
(ii)Amounts paid to create, originate,
enter into, renew or renegotiate.An
amount paid to another party is not paid
to create, originate, enter into, renew or
renegotiate a financial interest with that
party if the payment is made with the
mere hope or expectation of developing or
maintaining a business relationship with
that party and is not contingent on the
origination, renewal or renegotiation of a
financial interest with that party.
(iii)Renegotiate. A taxpayer is treated
as renegotiating a financial interest if the
terms of the financial interest are modi-
fied. A taxpayer also is treated as renego-
tiating a financial interest if the taxpayer
enters into a new financial interest with the
same party (or substantially the same par-
ties) to a terminated financial interest, the
taxpayer could not cancel the terminated
financial interest without the consent of the
other party (or parties), and the other party
(or parties) would not have consented to
the cancellation unless the taxpayer en-
tered into the new financial interest. A
taxpayer is treated as unable to cancel a
financial interest without the consent of
the other party (or parties) if, under the
terms of the financial interest, the taxpayer
is subject to a termination penalty and the
other party (or parties) to the financial in-
terest modifies the terms of the penalty.
(iv)Coordination with other provisions
of this paragraph (d). An amount de-
scribedinthisparagraph (d)(2) that is also
described elsewhere in paragraph (d) of
this section is treated as described only in
this paragraph (d)(2).
(v)Coordination with §1.263(a)–5.See
§1.263(a)–5 for the treatment of borrowing
costs and the treatment of amounts paid by
an option writer.
(vi)Examples. The following examples
illustrate the rules of this paragraph (d)(2):
Example 1.Loan. X corporation, a commercial
bank, makes a loan to A in the principal amount of
$250,000. The $250,000 principal amount of the loan
paid to A constitutes an amount paid to another party
to create a debt instrument with that party under para-
graph (d)(2)(i)(B) of this section and must be capital-
ized.
Example 2.Option. W corporation owns all of
the outstanding stock of X corporation. Y corporation
pays W $1,000,000 in exchange for W’s grant of a
3-year call option to Y permitting Y to purchase all
of the outstanding stock of X at a certain price per
share. Y’s payment of $1,000,000 to W constitutes
an amount paid to another party to create an option
with that party under paragraph (d)(2)(i)(C)(7) of this
section and must be capitalized.
Example 3.Partnership interest. Z corporation
pays $10,000 to P, a partnership, in exchange for an
ownership interest in P. Z’s payment of $10,000 to P
constitutes an amount paid to another party to create
an ownership interest in a partnership with that party
under paragraph (d)(2)(i)(A) of this section and must
be capitalized.
Example 4.Take or pay contract. Q corpora-
tion, a producer of natural gas, pays $1,000,000 to
R during 2005 to induce R corporation to enter into a
5-year “take or pay” gas purchase contract. Under the
contract, R is liable to pay for a specified minimum
amount of gas, whether or not R takes such gas. Q’s
payment of $1,000,000 is an amount paid to another
party to induce that party to enter into an agreement
providing Q the right and obligation to provide prop-
erty or be compensated for such property (regardless
of whether the property is provided) under paragraph
(d)(2)(i)(C)(6) of this section and must be capitalized.
Example 5.Agreement to provide property.Pcor-
poration pays R corporation $1,000,000 in exchange
for R’s agreement to purchase 1,000 units of P’s prod-
uct at any time within the three succeeding calendar
years. The agreement describes P’s $1,000,000 as a
sales discount. P’s $1,000,000 payment is an amount
paid to induce R to enter into an agreement providing
P the right and obligation to provide property under
paragraph (d)(2)(i)(C)(6) of this section and must be
capitalized.
Example 6.Customer incentive payment.Scor-
poration, a computer manufacturer, seeks to develop
a business relationship with V corporation, a com-
puter retailer. As an incentive to encourage V to pur-
chase computers from S, S enters into an agreement
with V under which S agrees that, if V purchases
$20,000,000 of computers from S within 3 years from
the date of the agreement, S will pay V $2,000,000
on the date that V reaches the $20,000,000threshold.
V reaches the $20,000,000 threshold during the third
year of the agreement, and S pays V $2,000,000. S is
not required to capitalize its payment to V under this
paragraph (d)(2) because the payment does not pro-
vide S the right or obligation to provide property and
does not create a separate and distinct intangible as-
set for S within the meaning of paragraph (b)(3)(i) of
this section.
(3)Prepaid expenses—(i)In general.
A taxpayer must capitalize prepaid ex-
penses.
(ii)Examples. The following examples
illustrate the rules of this paragraph (d)(3):
Example 1.Prepaid insurance. N corporation, an
accrual method taxpayer, pays $10,000 to an insurer
to obtain three years of coverage under a property and
casualty insurance policy. The $10,000 is a prepaid
expense and must be capitalized under this paragraph
(d)(3). Paragraph (d)(2) of this section does not apply
to the payment because the policy has no cash value.
Example 2.Prepaid rent. X corporation, a cash
method taxpayer, enters into a 24-month lease of of-
fice space. At the time of the lease signing, X prepays
$240,000. No other amounts are due under the lease.
The $240,000 is a prepaid expense and must be capi-
talized under this paragraph (d)(3).
(4)Certain memberships and privi-
leges—(i)In general. A taxpayer must
capitalize amounts paid to an organization
to obtain, renew, renegotiate, or upgrade
a membership or privilege from that or-
ganization. A taxpayer is not required to
capitalize under this paragraph (d)(4) an
amount paid to obtain, renew, renegotiate
or upgrade certification of the taxpayer’s
products, services, or business processes.
(ii)Examples. The following examples
illustrate the rules of this paragraph (d)(4):
Example 1.Hospital privilege. B, a physician,
pays $10,000 to Y corporation to obtain lifetime staff
privileges at a hospital operated by Y. B must capital-
ize the $10,000 payment under this paragraph (d)(4).
Example 2.Initiation fee. X corporation pays a
$50,000 initiation fee to obtain membership in a trade
association. X must capitalize the $50,000 payment
under this paragraph (d)(4).
Example 3.Product rating. V corporation, an
automobile manufacturer, pays W corporation, a na-
tional quality ratings association, $100,000 to con-
duct a study and provide a rating of the quality and
safety of a line of V’s automobiles. V’s payment is
February 17, 20044602004-7 I.R.B.

an amount paid to obtain a certification of V’s product
and is not required to be capitalized under this para-
graph (d)(4).
Example 4.Business process certification.Zcor-
poration, a manufacturer, seeks to obtain a certifica-
tion that its quality control standards meet a series of
international standards known as ISO 9000. Z pays
$50,000 to an independent registrar to obtain a cer-
tification from the registrar that Z’s quality manage-
ment system conforms to the ISO 9000 standard. Z’s
payment is an amount paid to obtain a certification of
Z’s business processes and is not required to be cap-
italized under this paragraph (d)(4).
(5)Certain rights obtained from a gov-
ernmental agency—(i)In general.A
taxpayer must capitalize amounts paid to
a governmental agency to obtain, renew,
renegotiate, or upgrade its rights under a
trademark, trade name,copyright, license,
permit, franchise, or other similar right
granted by that governmental agency.
(ii)Examples. The following examples
illustrate the rules of this paragraph (d)(5):
Example 1.Business license. X corporation pays
$15,000 to state Y to obtain a business license that
is valid indefinitely. Under this paragraph (d)(5), the
amountpaidtostateYisanamountpaidtoagovern-
ment agency for a right granted by that agency. Ac-
cordingly, X must capitalize the $15,000 payment.
Example 2.Bar admission. A, an individual, pays
$1,000 to an agency of state Z to obtain a license
to practice law in state Z that is valid indefinitely,
provided A adheres to the requirements governing the
practice of law in state Z. Under this paragraph (d)(5),
the amount paid to state Z is an amount paid to a
government agency for a right granted by that agency.
Accordingly, A must capitalize the $1,000 payment.
(6)Certain contract rights—(i)In gen-
eral. Except as otherwise provided in this
paragraph (d)(6), a taxpayer must capital-
ize amounts paid to another party to create,
originate, enter into, renew or renegotiate
with that party —
(A) An agreement providing the tax-
payer the right to use tangible or intangible
property or the right to be compensated for
the use of tangible or intangible property;
(B) An agreement providing the tax-
payer the right to provide or to receive ser-
vices (or the right to be compensated for
services regardless of whether the taxpayer
provides such services);
(C) A covenant not to compete or an
agreement having substantially the same
effect as a covenant not to compete (ex-
cept, in the case of an agreement that
requires the performance of services, to
the extent that the amount represents rea-
sonable compensation for services actually
rendered);
(D) An agreement not to acquire addi-
tional ownership interests in the taxpayer;
or
(E) An agreement providing the tax-
payer (as the covered party) with an annu-
ity, an endowment, or insurance coverage.
(ii)Amounts paid to create, originate,
enter into, renew or renegotiate.An
amount paid to another party is not paid
to create, originate, enter into, renew or
renegotiate an agreement with that party if
thepaymentismadewiththemerehope
or expectation of developing or maintain-
ing a business relationship with that party
and is not contingent on the origination,
renewal or renegotiation of an agreement
with that party.
(iii)Renegotiate. A taxpayer is treated
as renegotiating an agreement if the terms
of the agreement are modified. A tax-
payer also is treated as renegotiating an
agreement if the taxpayer enters into a new
agreement with the same party (or sub-
stantially the same parties) to a terminated
agreement, the taxpayer could not cancel
the terminated agreement without the con-
sent of the other party (or parties), and
the other party (or parties) would not have
consented to the cancellation unless the
taxpayer entered into the new agreement.
A taxpayer is treated as unable to cancel
an agreement without the consent of the
other party (or parties) if, under the terms
of the agreement, the taxpayer is subject to
a termination penalty and the other party
(or parties) to the agreement modifies the
terms of the penalty.
(iv)Right. An agreement does not pro-
vide the taxpayer a right to use property or
to provide or receive services if the agree-
ment may be terminated at will by the other
party (or parties) to the agreement before
the end of the period prescribed by para-
graph (f)(1) of this section. An agreement
is not terminable at will if the other party
(or parties) to the agreement is economi-
cally compelled not to terminate the agree-
ment until the end of the period prescribed
by paragraph (f)(1) of this section. All of
the facts and circumstances will be con-
sidered in determining whether the other
party (or parties) to an agreement is eco-
nomically compelled not to terminate the
agreement. An agreement also does not
provide the taxpayer the right to provide
services if the agreement merely provides
that the taxpayer will stand ready to pro-
vide services if requested, but places no
obligation on another person to request or
pay for the taxpayer’s services.
(v)De minimis amounts. A taxpayer is
not required to capitalize amounts paid to
another party (or parties) to create, origi-
nate, enter into, renew or renegotiate with
that party (or those parties) an agreement
described in paragraph (d)(6)(i) of this sec-
tion if the aggregate of all amounts paid
to that party (or those parties) with respect
to the agreement does not exceed $5,000.
If the aggregate of all amounts paid to
the other party (or parties) with respect to
that agreement exceeds $5,000, then all
amounts must be capitalized. For purposes
of this paragraph (d)(6), an amount paid
in the form of property is valued at its
fair market value at the time of the pay-
ment. In general, a taxpayer must deter-
mine whether the rules of this paragraph
(d)(6)(v) apply by accounting for the spe-
cific amounts paid with respect to each
agreement. However, a taxpayer that rea-
sonably expects to create, originate, enter
into, renew or renegotiate at least 25 simi-
lar agreements during the taxable year may
establish a pool of agreements for purposes
of determining the amounts paid with re-
spect to the agreements in the pool. Under
this pooling method, the amount paid with
respect to each agreement included in the
pool is equal to the average amount paid
with respect to all agreements included in
the pool. A taxpayer computes the average
amount paid with respect to all agreements
included in the pool by dividing the sum of
all amounts paid with respect to all agree-
ments included in the pool by the number
of agreements included in the pool. See
paragraph (h) of this section for additional
rules relating to pooling.
(vi)Exception for lessee construction
allowances. Paragraph (d)(6)(i) of this
section does not apply to amounts paid by
a lessor to a lessee as a construction al-
lowance to the extent the lessee expends
the amount for the tangible property that is
owned by the lessor for federal income tax
purposes (see, for example, section 110).
(vii)Examples. The following exam-
ples illustrate the rules of this paragraph
(d)(6):
Example 1.New lease agreement. V seeks to
lease commercial property in a prominent downtown
location of city R. V pays Z, the owner of the com-
mercial property, $50,000 in exchange for Z entering
into a 10-year lease with V. V’s payment is an amount
paid to another party to enter into an agreement pro-
viding V the right to use tangible property. Because
2004-7 I.R.B.461February 17, 2004

the $50,000 payment exceeds $5,000, no portion of
the amount paid to Z isde minimisfor purposes of
paragraph (d)(6)(v) of this section. Under paragraph
(d)(6)(i)(A) of this section, V must capitalize the en-
tire $50,000 payment.
Example 2.Modification of lease agreement.
Partnership Y leases a piece of equipment for use
in its business from Z corporation. When the lease
has a remaining term of 3 years, Y requests that Z
modify the existing lease by extending the remaining
term by 5 years. Y pays $50,000 to Z in exchange
for Z’s agreement to modify the existing lease. Y’s
payment of $50,000 is an amount paid to another
party to renegotiate an agreement providing Y the
right to use property. Because the $50,000 payment
exceeds $5,000, no portion of the amount paid to Z is
de minimisfor purposes of paragraph (d)(6)(v) of this
section. Under paragraph (d)(6)(i)(A) of this section,
Y must capitalize the entire $50,000 payment.
Example 3.Modification of lease agreement.In
2004, R enters into a 5-year, non-cancelable lease of a
mainframe computer for use in its business. R subse-
quently determines that the mainframe computer that
R is leasing is no longer adequate for its needs. In
2006, R and P corporation (the lessor) agree to ter-
minate the 2004 lease and to enter into a new 5-year
lease for a different and more powerful mainframe
computer. R pays P a $75,000 early termination fee.
P would not have agreed to terminate the 2004 lease
unless R agreed to enter into the 2006 lease. R’s pay-
ment of $75,000 is an amount paid to another party
to renegotiate an agreement providing R the right to
use property. Because the $75,000 payment exceeds
$5,000, no portion of the amount paid to P isde min-
imisfor purposes of paragraph (d)(6)(v) of this sec-
tion. Under paragraph (d)(6)(i)(A) of this section, R
must capitalize the entire $75,000 payment.
Example 4.Modification of lease agreement.
Same asExample 3, except the 2004 lease agreement
allows R to terminate the lease at any time subject to
a $75,000 early termination fee. Because R can ter-
minate the lease without P’s approval, R’s payment
of $75,000 is not an amount paid to another party
to renegotiate an agreement. Accordingly, R is not
required to capitalize the $75,000 payment under this
paragraph (d)(6).
Example 5.Modification of lease agreement.
Same asExample 4, except P agreed to reduce the
early termination fee to $60,000. Because R did not
pay an amount to renegotiate the early termination
fee, R’s payment of $60,000 is not an amount paid
to another party to renegotiate an agreement. Ac-
cordingly, R is not required to capitalize the $60,000
payment under this paragraph (d)(6).
Example 6.Covenant not to compete. R corpora-
tion enters into an agreement with A, an individual,
that prohibits A from competing with R for a period
of three years. To encourage A to enter into the agree-
ment, R agrees to pay A $100,000 upon the signing
of the agreement. R’s payment is an amount paid to
another party to enter into a covenant not to compete.
Because the $100,000 payment exceeds $5,000, no
portion of the amount paid to A isde minimisfor pur-
poses of paragraph (d)(6)(v) of this section. Under
paragraph (d)(6)(i)(C) of this section, R must capital-
ize the entire $100,000 payment.
Example 7.Standstill agreement. During 2004
through 2005, X corporation acquires a large minor-
ity interest in the stock of Z corporation. To ensure
that X does not take control of Z, Z pays X $5,000,000
for a standstill agreement under which X agrees not to
acquire any more stock in Z for a period of 10 years.
Z’s payment is an amount paid to another party to en-
ter into an agreement not to acquire additional owner-
ship interests in Z. Because the $5,000,000 payment
exceeds $5,000, no portion of the amount paid to X is
de minimisfor purposes of paragraph (d)(6)(v) of this
section. Under paragraph (d)(6)(i)(D) of this section,
Z must capitalize the entire $5,000,000 payment.
Example 8.Signing bonus. Employer B pays a
$25,000 signing bonus to employee C to induce C to
come to work for B. C can leave B’s employment at
any time to work for a competitor of B and is not re-
quired to repay the $25,000 bonus to B. Because C
is not economically compelled to continue his em-
ployment with B, B’s payment does not provide B
the right to receive services from C. Accordingly, B
is not required to capitalize the $25,000 payment.
Example 9.Renewal. In 2000, M corporation and
N corporation enter into a 5-year agreement that gives
M the right to manage N’s investment portfolio. In
2005, N has the option of renewing the agreement for
another three years. During 2004, M pays $10,000 to
send several employees of N to an investment semi-
nar. M pays the $10,000 to help develop and maintain
its business relationship with N with the expectation
that N will renew its agreement with M in 2005. Be-
cause M’s payment is not contingent on N agreeing to
renew the agreement, M’s payment is not an amount
paid to renew an agreement under paragraph (d)(6)(ii)
of this section and is not required to be capitalized.
Example 10.De minimis payments. X corpo-
ration is engaged in the business of providing wire-
less telecommunications services to customers. To
induce customer B to enter into a 3-year non-can-
celable telecommunications contract, X provides B
with a free wireless telephone. The fair market value
of the wireless telephone is $300 at the time it is pro-
vided to B. X’s provision of a wireless telephone to
B is an amount paid to B to induce B to enter into an
agreement providing X the right to provide services,
as described in paragraph (d)(6)(i)(B) of this section.
Because the amount of the inducement is $300, the
amount of the inducement isde minimisunder para-
graph (d)(6)(v) of this section. Accordingly, X is not
required to capitalize the amount of the inducement
provided to B.
(7)Certain contract terminations—
(i)In general. A taxpayer must capi-
talize amounts paid to another party to
terminate —
(A) A lease of real or tangible personal
property between the taxpayer (as lessor)
and that party (as lessee);
(B) An agreement that grants that party
the exclusive right to acquire or use the
taxpayer’s property or services or to con-
duct the taxpayer’s business (other than an
intangible described in paragraph (c)(1)(i)
through (iv) of this section or a financial
interest described in paragraph (d)(2) of
this section); or
(C) An agreement that prohibits the tax-
payer from competing with that party or
from acquiring property or services from
a competitor of that party.
(ii)Certain break-up fees. Paragraph
(d)(7)(i) of this section does not apply to
the termination of a transaction described
in §1.263(a)–5(a) (relating to an acqui-
sition of a trade or business, a change
in the capital structure of a business en-
tity, and certain other transactions). See
§1.263(a)–5(c)(8) for rules governing the
treatment of amounts paid to terminate a
transaction to which that section applies.
(iii)Examples. The following examples
illustrate the rules of this paragraph (d)(7):
Example 1.Termination of exclusive license
agreement. On July 1, 2005, N enters into a license
agreement with R corporation under which N grants
R the exclusive right to manufacture and distribute
goods using N’s design and trademarks for a period
of 10 years. On June 30, 2007, N pays R $5,000,000
in exchange for R’s agreement to terminate the ex-
clusive license agreement. N’s payment to terminate
its license agreement with R constitutes a payment to
terminate an exclusive license to use the taxpayer’s
property, as described in paragraph (d)(7)(i)(B) of
this section. Accordingly, N must capitalize its
$5,000,000 payment to R.
Example 2.Termination of exclusive distribution
agreement. On March 1, 2005, L, a manufacturer, en-
ters into an agreement with M granting M the right to
be the sole distributor of L’s products in state X for
10 years. On July 1, 2008, L pays M $50,000 in ex-
change for M’s agreement to terminate the distribu-
tion agreement. L’s payment to terminate its agree-
ment with M constitutes a payment to terminate an
exclusive right to acquire L’s property, as described in
paragraph (d)(7)(i)(B) of this section. Accordingly, L
must capitalize its $50,000 payment to M.
Example 3.Termination of covenant not to com-
pete. On February 1, 2005, Y corporation enters into
a covenant not to compete with Z corporation that
prohibits Y from competing with Z in city V for a
period of 5 years. On January 31, 2007, Y pays Z
$1,000,000 in exchange for Z’s agreement to termi-
nate the covenant not to compete. Y’s payment to ter-
minate the covenant not to compete with Z constitutes
a payment to terminate an agreement that prohibits
Y from competing with Z, as described in paragraph
(d)(7)(i)(C) of this section.Accordingly, Y must cap-
italize its $1,000,000 payment to Z.
Example 4.Termination of merger agreement.
N corporation and U corporation enter into an
agreement under which N agrees to merge into U.
Subsequently, N pays U $10,000,000 to terminate
the merger agreement. As provided in paragraph
(d)(7)(ii) of this section, N’s $10,000,000 payment
to terminate the merger agreement with U is not re-
quired to be capitalized under this paragraph (d)(7).
In addition, N’s $10,000,000 does not create a sep-
arate and distinct intangible asset for N within the
meaning of paragraph (b)(3)(i) of this section. (See
§1.263(a)–5 for additional rules regarding termina-
tion of merger agreements).
(8)Certain benefits arising from the
provision, production, or improvement of
real property—(i)In general. A taxpayer
February 17, 20044622004-7 I.R.B.

must capitalize amounts paid for real prop-
erty if the taxpayer transfers ownership of
the real property to another person (except
to the extent the real property is sold for
fair market value) and if the real property
can reasonably be expected to produce sig-
nificant economic benefits to the taxpayer
after the transfer. A taxpayer also must
capitalize amounts paid to produce or im-
prove real property owned by another (ex-
cept to the extent the taxpayer is selling
services at fair market value to produce or
improve the real property) if the real prop-
erty can reasonably be expected to produce
significant economic benefits for the tax-
payer.
(ii)Exclusions. A taxpayer is not re-
quired to capitalize an amount under para-
graph (d)(8)(i) of this section if the tax-
payer transfers real property or pays an
amount to produce or improve real prop-
erty owned by another in exchange for ser-
vices, the purchase or use of property, or
the creation of an intangible described in
paragraph (d) of this section (other than in
this paragraph (d)(8)). The preceding sen-
tence does not apply to the extent the tax-
payer does not receive fair market value
consideration for the real property that is
relinquished or for the amounts that are
paid by the taxpayer to produce or improve
real property owned by another.
(iii)Real property. For purposes of this
paragraph (d)(8), real property includes
property that is affixed to real property and
that will ordinarily remain affixed for an
indefinite period of time, such as roads,
bridges, tunnels, pavements, wharves and
docks, breakwaters and sea walls, eleva-
tors, power generation and transmission
facilities, and pollution control facilities.
(iv)Impact fees and dedicated improve-
ments. Paragraph (d)(8)(i) of this section
does not apply to amounts paid to satisfy
one-time charges imposed by a state or lo-
cal government against new development
(or expansion of existing development) to
finance specific offsite capital improve-
ments for general public use that are ne-
cessitated by the new or expanded devel-
opment. In addition, paragraph (d)(8)(i)
of this section does not apply to amounts
paid for real property or improvements
to real property constructed by the tax-
payer where the real property or improve-
ments benefit new development or expan-
sion of existing development, are imme-
diately transferred to a state or local gov-
ernment for dedication to the general pub-
lic use, and are maintained by the state or
local government. See section 263A and
the regulations thereunder for capitaliza-
tion rules that apply to amounts referred to
in this paragraph (d)(8)(iv).
(v)Examples. The following examples
illustrate the rules of this paragraph (d)(8):
Example 1.Amount paid to produce real property
owned by another. W corporation operates a quarry
on the east side of a river in city Z and a crusher on
the west side of the river. City Z’s existing bridges
are of insufficient capacity to be traveled by trucks in
transferring stone from W’s quarry to its crusher. As
a result, the efficiency of W’s operations is greatly
reduced. W contributes $1,000,000 to City Z to de-
fray in part the cost of constructing a publicly owned
bridge capable of accommodating W’s trucks. W’s
payment to city Z is an amount paid to produce or
improve real property (within the meaning of para-
graph (d)(8)(iii) of this section) that can reasonably
be expected to produce significant economic benefits
for W. Under paragraph (d)(8)(i) of this section, W
must capitalize the $1,000,000 paid to city Z.
Example 2.Transfer of real property to another.
K corporation, a shipping company, uses smaller ves-
sels to unload its ocean-going vessels at port X. There
is no natural harbor at port X, and during stormy
weather the transfer of freight between K’s ocean ves-
sels and port X is extremely difficult and sometimes
impossible, which can be very costly to K. Conse-
quently, K constructs a short breakwater at a cost of
$50,000. The short breakwater, however, is inade-
quate, so K persuades the port authority to build a
larger breakwater that will allow K to unload its ves-
sels at any time of the year and during all kinds of
weather. K contributes the short breakwater and pays
$200,000 to the port authority for use in building the
larger breakwater. Because the transfer of the small
breakwater and $200,000 is reasonably expected to
produce significant economic benefits for K, K must
capitalize both the adjusted basis of the small break-
water (determined at the time the small breakwater
is contributed) and the $200,000 payment under this
paragraph (d)(8).
Example 3.Dedicated improvements. X corpo-
ration is engaged in the development and sale of res-
idential real estate. In connection with a residential
real estate project under construction by X in city Z,
X is required by city Z to construct ingress and egress
roads to and from its project and immediately trans-
fer the roads to city Z for dedication to general public
use. The roads will be maintained by city Z. X pays its
subcontractor $100,000 to construct the ingress and
egress roads. X’s payment is a dedicated improve-
ment within the meaning of paragraph (d)(8)(iv) of
this section. Accordingly, X is not required to capital-
ize the $100,000 payment under this paragraph (d)(8).
See section 263A and the regulations thereunder for
capitalization rules that apply to amounts referred to
in paragraph (d)(8)(iv) of this section.
(9)Defense or perfection of title to in-
tangible property—(i)In general.Atax-
payer must capitalize amounts paid to an-
other party to defend or perfect title to in-
tangible property if that other party chal-
lenges the taxpayer’s title to the intangible
property.
(ii)Certain break-up fees. Paragraph
(d)(9)(i) of this section does not apply to
the termination of a transaction described
in §1.263(a)–5(a) (relating to an acqui-
sition of a trade or business, a change
in the capital structure of a business en-
tity, and certain other transactions). See
§1.263(a)–5 for rules governing the treat-
ment of amounts paid to terminate a trans-
action to which that section applies. Para-
graph (d)(9)(i) of this section also does not
applytoanamountpaidtoanotherparty
to terminate an agreement that grants that
party the right to purchase the taxpayer’s
intangible property.
(iii)Example. The following exam-
ple illustrates the rules of this paragraph
(d)(9):
Example.Defense of title. R corporation claims
to own an exclusive patent on a particular technol-
ogy. U corporation brings a lawsuit against R, claim-
ing that U is the true owner of the patent and that R
stole the technology from U. The sole issue in the suit
involves the validity of R’s patent. R chooses to settle
the suit by paying U $100,000 in exchange for U’s re-
lease of all future claim to the patent. R’s payment to
U is an amount paid to defend or perfect title to intan-
gible property under paragraph (d)(9) of this section
and must be capitalized.
(e)Transaction costs—(1)Scope of fa-
cilitate—(i)In general. Except as other-
wise provided in this section, an amount is
paid to facilitate the acquisition or creation
of an intangible (the transaction) if the
amount is paid in the process of investigat-
ing or otherwise pursuing the transaction.
Whether an amount is paid in the process
of investigating or otherwise pursuing the
transaction is determined based on all of
the facts and circumstances. In determin-
ing whether an amount is paid to facili-
tate a transaction, the fact that the amount
would (or would not) have been paid but
for the transaction is relevant, but is not
determinative. An amount paid to deter-
mine the value or price of an intangible is
an amount paid in the process of investi-
gating or otherwise pursuing the transac-
tion.
(ii)Treatment of termination payments.
An amount paid to terminate (or facilitate
the termination of) an existing agreement
does not facilitate the acquisition or cre-
ation of another agreement under this sec-
tion. See paragraph (d)(6)(iii) of this sec-
tion for the treatment of termination fees
2004-7 I.R.B.463February 17, 2004

paid to the other party (or parties) of a rene-
gotiated agreement.
(iii)Special rule for contracts.An
amount is treated as not paid in the process
of investigating or otherwise pursuing the
creation of an agreement described in
paragraph(d)(2)or(d)(6)ofthissectionif
the amount relates to activities performed
before the earlier of the date the taxpayer
begins preparing its bid for the agreement
or the date the taxpayer begins discussing
or negotiating the agreement with another
party to the agreement.
(iv)Borrowing costs. An amount paid
to facilitate a borrowing does not facilitate
an acquisition or creation of an intangible
described in paragraphs (b)(1)(i) through
(iv) of this section. See §§1.263(a)–5 and
1.446–5 for the treatment of an amount
paid to facilitate a borrowing.
(v)Special rule for stock redemp-
tion costs of open-end regulated invest-
ment companies. Anamountpaidbyan
open-end regulated investment company
(within the meaning of section 851) to fa-
cilitate a redemption of its stock is treated
as an amount that does not facilitate the
acquisition of an intangible under this sec-
tion.
(2)Coordination with paragraph (d) of
this section. In the case of an amount paid
to facilitate the creation of an intangible
described in paragraph (d) of this section,
the provisions of this paragraph (e) apply
regardless of whether a payment described
in paragraph (d) is made.
(3)Transaction. For purposes of this
section, the termtransactionmeans all of
the factual elements comprising an acqui-
sition or creation of an intangible and in-
cludes a series of steps carried out as part
of a single plan. Thus, a transaction can
involve more than one invoice and more
than one intangible. For example, a pur-
chase of intangibles under one purchase
agreement constitutes a single transaction,
notwithstanding the fact that the acquisi-
tion involves multiple intangibles and the
amounts paid to facilitate the acquisition
are capable of being allocated among the
various intangibles acquired.
(4)Simplifying conventions—(i)In
general. For purposes of this section, em-
ployee compensation (within the meaning
of paragraph (e)(4)(ii) of this section),
overhead, andde minimiscosts (within
the meaning of paragraph (e)(4)(iii) of this
section) are treated as amounts that do not
facilitate the acquisition or creation of an
intangible.
(ii)Employee compensation—(A)
In general.Thetermemployee compen-
sationmeans compensation (including
salary, bonuses and commissions) paid to
an employee of the taxpayer. For purposes
of this section, whether an individual is
an employee is determined in accordance
with the rules contained in section 3401(c)
and the regulations thereunder.
(B)Certain amounts treated as em-
ployee compensation. For purposes of
this section, a guaranteed payment to a
partner in a partnership is treated as em-
ployee compensation. For purposes of
this section, annual compensation paid to
a director of a corporation is treated as
employee compensation. For example, an
amount paid to a director of a corporation
for attendance at a regular meeting of the
board of directors (or committee thereof)
is treated as employee compensation for
purposes of this section. However, an
amount paid to a director for attendance
at a special meeting of the board of direc-
tors (or committee thereof) is not treated
as employee compensation. An amount
paid to a person that is not an employee
of the taxpayer (including the employer of
the individual who performs the services)
is treated as employee compensation for
purposes of this section only if the amount
is paid for secretarial, clerical, or similar
administrative support services. In the
case of an affiliated group of corporations
filing a consolidated federal income tax
return, a payment by one member of the
group to a second member of the group
for services performed by an employee of
the second member is treated as employee
compensation if the services provided by
theemployeeareprovidedatatimeduring
which both members are affiliated.
(iii)De minimis costs—(A)In gen-
eral. Except as provided in paragraph
(e)(4)(iii)(B) of this section, the termde
minimis costsmeans amounts (other than
employee compensation and overhead)
paid in the process of investigating or
otherwise pursuing a transaction if, in
the aggregate, the amounts do not exceed
$5,000 (or such greater amount as may
be set forth in published guidance). If the
amounts exceed $5,000 (or such greater
amount as may be set forth in published
guidance), none of the amounts arede
minimiscosts within the meaning of this
paragraph (e)(4)(iii)(A). For purposes of
this paragraph (e)(4)(iii), an amount paid
in the form of property is valued at its fair
market value at the time of the payment.
In determining the amount of transaction
costs paid in the process of investigat-
ing or otherwise pursuing a transaction, a
taxpayer generally must account for the
specific costs paid with respect to each
transaction. However, a taxpayer that
reasonably expects to enter into at least
25 similar transactions during the tax-
able year may establish a pool of similar
transactions for purposes of determining
the amount of transaction costs paid in
the process of investigating or otherwise
pursuing the transactions in the pool. Un-
der this pooling method, the amount of
transaction costs paid in the process of
investigating or otherwise pursuing each
transaction included in the pool is equal
to the average transaction costs paid in
the process of investigating or otherwise
pursuing all transactions included in the
pool. A taxpayer computes the average
transaction costs paid in the process of
investigating or otherwise pursuing all
transactions included in the pool by divid-
ing the sum of all transaction costs paid
in the process of investigating or other-
wise pursuing all transactions included
in the pool by the number of transactions
included in the pool.See paragraph (h) of
this section for additional rules relating to
pooling.
(B)Treatment of commissions.The
termde minimis costsdoes not include
commissions paid to facilitate the acqui-
sition of an intangible described in para-
graphs (c)(1)(i) through (v) of this section
or to facilitate the creation, origination, en-
trance into, renewal or renegotiation of an
intangible described in paragraph (d)(2)(i)
of this section.
(iv)Electiontocapitalize. A taxpayer
may elect to treat employee compensation,
overhead, orde minimiscosts paid in the
process of investigating or otherwise pur-
suing a transaction as amounts that facili-
tate the transaction. The election is made
separately for each transaction and applies
to employee compensation, overhead, or
de minimiscosts, or to any combination
thereof. For example, a taxpayer may elect
to treat overhead andde minimiscosts, but
not employee compensation, as amounts
that facilitate the transaction. A taxpayer
makes the election by treating the amounts
February 17, 20044642004-7 I.R.B.

to which the election applies as amounts
that facilitate the transaction in the tax-
payer’s timely filed original federal in-
come tax return (including extensions) for
the taxable year during which the amounts
are paid. In the case of an affiliated group
of corporations filing a consolidated re-
turn, the election is made separately with
respect to each member of the group, and
not with respect to the group as a whole. In
the case of an S corporation or partnership,
the election is made by the S corporation
or by the partnership, and not by the share-
holders or partners. An election made un-
der this paragraph (e)(4)(iv) is revocable
with respect to each taxable year for which
made only with the consent of the Com-
missioner.
(5)Examples. The following examples
illustrate the rules of this paragraph (e):
Example 1.Costs to facilitate. In December
2005, R corporation, a calendar year taxpayer, enters
into negotiations with X corporation to lease com-
mercial property from X for a period of 25 years. R
pays A, its outside legal counsel, $4,000 in Decem-
ber 2005 for services rendered by A during Decem-
ber in assisting with negotiations with X. In January
2006, R and X finalize the terms of the lease and ex-
ecute the lease agreement. R pays B, another of its
outside legal counsel, $2,000 in January 2006 for ser-
vices rendered by B during January in drafting the
lease agreement. The agreement between R and X is
an agreement providing R the right to use property,
as described in paragraph (d)(6)(i)(A) of this section.
R’s payments to its outside counsel are amounts paid
to facilitate the creation of the agreement. As pro-
vided in paragraph (e)(4)(iii)(A) of this section, R
must aggregate its transaction costs for purposes of
determining whether the transaction costs arede min-
imis. Because R’s aggregate transaction costs exceed
$5,000, R’s transaction costs are notde minimiscosts
within the meaning of paragraph (e)(4)(iii)(A) of this
section. Accordingly, R must capitalize the $4,000
paid to A and the $2,000 paid to B under paragraph
(b)(1)(v) of this section.
Example 2.Costs to facilitate. Partnership X
leases its manufacturing equipment from Y corpora-
tion under a 10-year lease. During 2005, when the
lease has a remaining term of 4 years, X enters into
a written agreement with Z corporation, a competitor
of Y, under which X agrees to lease its manufactur-
ing equipment from Z, subject to the condition that X
first successfully terminates its lease with Y. X pays
Y $50,000 in exchange for Y’s agreement to termi-
nate the equipment lease. Under paragraph (e)(1)(ii),
X’s $50,000 payment does not facilitate the creation
of the new lease with Z. In addition, X’s $50,000
payment does not terminate an agreement described
in paragraph (d)(7) of this section. Accordingly, X
is not required to capitalize the $50,000 termination
payment under this section.
Example 3.Costs to facilitate. W corporation en-
ters into a lease agreement with X corporation under
which W agrees to lease property to X for a period of
5 years. W pays its outside counsel $7,000 for legal
services rendered in drafting the lease agreement and
negotiating with X. The agreement between W and
X is an agreement providing W the right to be com-
pensated for the use of property, as described in para-
graph (d)(6)(i)(A) of this section. Under paragraph
(e)(1)(i) of this section, W’s payment to its outside
counsel is an amount paid to facilitate the creation of
that agreement. As provided by paragraph (e)(2) of
this section, W must capitalize its $7,000 payment to
outside counsel notwithstanding the fact that W made
no payment described in paragraph (d)(6)(i) of this
section.
Example 4.Costs to facilitate. U corporation,
which owns a majority of the common stock of T
corporation, votes its controlling interest in favor of
a perpetual extension of T’s charter. M, a minority
shareholder in T, votes against the extension. Un-
der applicable state law, U is required to purchase the
stock of T held by M. When U and M are unable to
agree on the value of M’s shares, U brings an action
in state court to appraise the value of M’s stock inter-
est. U pays attorney, accountant and appraisal fees of
$25,000 for services rendered in connection with the
negotiation and litigation with M. Because U’s attor-
ney, accountant and appraisal costs help establish the
purchase price of M’s stock, U’s $25,000 payment
facilitates the acquisition of stock. Accordingly, U
must capitalize the $25,000 payment under paragraph
(b)(1)(v) of this section.
Example 5.Costs to facilitate. For several years,
H corporation has provided services to J corporation
whenever requested by J. H wants to enter into a mul-
tiple-year contract with J that would give H the right
to provide services to J. On June 10, 2004, H starts
to prepare a bid to provide services to J and pays
a consultant $15,000 to research potential competi-
tors. On August 10, 2004, H raises the possibility of
a multi-year contract with J. On October 10, 2004,
H and J enter into a contract giving H the right to
provide services to J for five years. During 2004, H
pays $7,000 to travel to the city in which J’s offices
are located to continue providing services to J under
their prior arrangement and pays $6,000 for travel to
the city in which J’s offices are located to further de-
velop H’s business relationship with J (for example,
to introduce new employees, update J on current de-
velopments and take J’s executives to dinner). H also
pays $8,000 for travel costs to meet with J to discuss
and negotiate the contract. Because the contract gives
H the right to provide services to J, H must capital-
ize amounts paid to facilitate the creation of the con-
tract. The $7,000 of travel expenses paid to provide
services to J under their prior arrangement does not
facilitate the creation of the contract and is not re-
quired to be capitalized, regardless of when the travel
occurs. The $6,000 of travel expenses paid to fur-
ther develop H’s business relationship with J is paid
in the process of pursuing the contract (and therefore
must be capitalized) only to the extent the expenses
relate to travel on or after June 10, 2004 (the date H
begins to prepare a bid), and before October 11, 2004
(the date after H and J enter into the contract). The
$8,000 of travel expenses paid to meet with J to dis-
cuss and negotiate the contract is paid in the process
of pursuing the contact and must be capitalized. The
$15,000 of consultant fees is paid to investigate the
contract and also must be capitalized.
Example 6.Costs that do not facilitate.Xcor-
poration brings a legal action against Y corporation
to recover lost profits resulting from Y’s alleged in-
fringement of X’s copyright. Y does not challenge
X’s copyright, but argues that it did not infringe upon
X’s copyright. X pays its outside counsel $25,000 for
legal services rendered in pursuing the suit against Y.
Because X’s title to its copyright is not in question,
X’s action against Y does not involve X’s defense
or perfection of title to intangible property. Thus,
the amount paid to outside counsel does not facilitate
the creation of an intangible described in paragraph
(d)(9) of this section. Accordingly, X is not required
to capitalize its $25,000 payment under this section.
Example 7.De minimis rule. W corporation, a
commercial bank, acquires a portfolio containing 100
loans from Y corporation. As part of the acquisition,
W pays an independent appraiser a fee of $10,000 to
appraise the portfolio. The fee is an amount paid to
facilitate W’s acquisition of an intangible. The ac-
quisition of the loan portfolio is a single transaction
within the meaning of paragraph (e)(3) of this section.
Because the amount paid to facilitate the transaction
exceeds $5,000, the amount is notde minimisas de-
fined in paragraph (e)(4)(iii)(A) of this section. Ac-
cordingly, W must capitalize the $10,000 fee under
paragraph (b)(1)(v) of this section.
Example 8.Compensation and overhead.Pcor-
poration, a commercial bank, maintains a loan acqui-
sition department whose sole function is to acquire
loans from other financial institutions. As provided
in paragraph (e)(4)(i) of this section, P is not required
to capitalize any portion of the compensation paid to
the employees in its loan acquisition department or
any portion of its overhead allocable to the loan ac-
quisition department.
(f)12-month rule—(1)In general.Ex-
cept as otherwise provided in this para-
graph (f), a taxpayer is not required to cap-
italize under this section amounts paid to
create (or to facilitatethe creation of) any
right or benefit for the taxpayer that does
not extend beyond the earlier of —
(i) 12 months after the first date on
which the taxpayer realizes the right or
benefit; or
(ii) The end of the taxable year follow-
ing the taxable year in which the payment
is made.
(2)Duration of benefit for contract ter-
minations. For purposes of this paragraph
(f), amounts paid to terminate a contract
or other agreement described in paragraph
(d)(7)(i) of this section prior to its expira-
tion date (or amounts paid to facilitate such
termination) create a benefit for the tax-
payer that lasts for the unexpired term of
the agreement immediately before the date
of the termination. If the terms of a con-
tract or other agreement described in para-
graph (d)(7)(i) of this section permit the
taxpayer to terminate the contract or agree-
ment after a notice period, amounts paid
by the taxpayer to terminate the contract
or agreement before the end of the notice
2004-7 I.R.B.465February 17, 2004

period create a benefit for the taxpayer that
lasts for the amount of time by which the
notice period is shortened.
(3)Inapplicability to created financial
interests and self-created amortizable sec-
tion 197 intangibles. Paragraph (f)(1) of
this section does not apply to amounts paid
to create (or facilitate the creation of) an
intangible described in paragraph (d)(2) of
this section (relating to amounts paid to
create financial interests) or to amounts
paid to create (or facilitate the creation
of) an intangible that constitutes an amor-
tizable section 197 intangible within the
meaning of section 197(c).
(4)Inapplicability to rights of indefinite
duration. Paragraph (f)(1) of this section
does not apply to amounts paid to create
(or facilitate the creation of) an intangible
of indefinite duration. A right has an in-
definite duration if it has no period of du-
ration fixed by agreement or by law, or if
it is not based on a period of time, such as
a right attributable toan agreement to pro-
vide or receive a fixed amount of goods or
services. For example, a license granted
by a governmental agency that permits the
taxpayer to operate a business conveys a
right of indefinite duration if the license
may be revoked only upon the taxpayer’s
violation of the terms of the license.
(5)Rights subject to renewal—(i)In
general. For purposes of paragraph (f)(1)
of this section, the duration of a right in-
cludes any renewal period if all of the
facts and circumstances in existence dur-
ing the taxable year in which the right is
created indicate a reasonable expectancy
of renewal.
(ii)Reasonable expectancy of renewal.
The following factors are significant in de-
termining whether there exists a reason-
able expectancy of renewal:
(A)Renewal history. The fact that sim-
ilar rights are historically renewed is ev-
idence of a reasonable expectancy of re-
newal. On the other hand, the fact that sim-
ilar rights are rarely renewed is evidence
of a lack of a reasonable expectancy of re-
newal. Where the taxpayer has no experi-
ence with similar rights, or where the tax-
payer holds similar rights only occasion-
ally, this factor is less indicative of a rea-
sonable expectancy of renewal.
(B)Economics of the transaction.The
fact that renewal is necessary for the
taxpayer to earn back its investment in
the right is evidence of a reasonable ex-
pectancy of renewal. For example, if a
taxpayer pays $14,000 to enter into a re-
newable contract with an initial 9-month
term that is expected to generate income
to the taxpayer of $1,000 per month, the
fact that renewal is necessary for the tax-
payer to earn back its $14,000 payment
is evidence of a reasonable expectancy of
renewal.
(C)Likelihood of renewal by other
party. Evidence that indicates a likelihood
of renewal by the other party to a right,
such as a bargain renewal option or similar
arrangement, is evidence of a reasonable
expectancy of renewal. However, the
mere fact that the other party will have the
opportunity to renew on the same terms as
are available to others is not evidence of a
reasonable expectancy of renewal.
(D)Terms of renewal. The fact that
material terms of the right are subject to
renegotiation at the end of the initial term
is evidence of a lack of a reasonable ex-
pectancy of renewal. For example, if the
parties to an agreement must renegotiate
price or amount, the renegotiation require-
ment is evidence of a lack of a reasonable
expectancy of renewal.
(E)Terminations. The fact that similar
rights are typically terminated prior to re-
newal is evidence of a lack of a reasonably
expectancy of renewal.
(iii)Safe harbor pooling method.In
lieu of applying the reasonable expectancy
of renewal test described in paragraph
(f)(5)(ii) of this section to each separate
right created during a taxable year, a tax-
payer that reasonably expects to enter into
at least 25 similar rights during the taxable
year may establish a pool of similar rights
for which the initial term does not extend
beyond the period prescribed in paragraph
(f)(1) of this section and may elect to ap-
ply the reasonable expectancy of renewal
test to that pool. See paragraph (h) of
this section for additional rules relating
to pooling. The application of paragraph
(f)(1) of this section to each pool is deter-
minedinthefollowingmanner:
(A) All amounts (exceptde minimis
costs described in paragraph (d)(6)(v) of
this section) paid to create the rights in-
cluded in the pool and all amounts paid to
facilitate the creation of the rights included
in the pool are aggregated.
(B) If less than 20 percent of the rights
in the pool are reasonably expected to be
renewed beyond the period prescribed in
paragraph (f)(1) of this section, all rights
in the pool are treated as having a duration
that does not extend beyond the period pre-
scribed in paragraph (f)(1) of this section,
and the taxpayer is not required to capital-
ize under this section any portion of the
aggregate amount described in paragraph
(f)(5)(iii)(A) of this section.
(C) If more than 80 percent of the rights
in the pool are reasonably expected to be
renewed beyond the period prescribed in
paragraph (f)(1) of this section, all rights
in the pool are treated as having a duration
that extends beyond the period prescribed
in paragraph (f)(1) of this section, and the
taxpayer is required to capitalize under this
section the aggregate amount described in
paragraph (f)(5)(iii)(A) of this section.
(D) If 20 percent or more, but 80 per-
cent or less, of the rights in the pool are
reasonably expected to be renewed beyond
the period prescribed in paragraph (f)(1)
of this section, the aggregate amount de-
scribed in paragraph (f)(5)(iii)(A) of this
section is multiplied by the percentage of
the rights in the pool that are reasonably
expected to be renewed beyond the pe-
riod prescribed in paragraph (f)(1) of this
section and the taxpayer must capitalize
the resulting amount under this section by
treatingsuchamountascreatingasepa-
rate intangible. The amount determined
by multiplying the aggregate amount de-
scribed in paragraph (f)(5)(iii)(A) of this
section by the percentage of rights in the
pool that are not reasonably expected to be
renewed beyond the period prescribed in
paragraph (f)(1) of this section is not re-
quired to be capitalized under this section.
(6)Coordination with section 461.In
the case of a taxpayer using an accrual
method of accounting, the rules of this
paragraph (f) do not affect the determi-
nation of whether a liability is incurred
during the taxable year, including the de-
termination of whether economic perfor-
mance has occurred with respect to the li-
ability. See §1.461–4 for rules relating to
economic performance.
(7)Election to capitalize. A taxpayer
may elect not to apply the rule contained
in paragraph (f)(1) of this section. An
election made under this paragraph (f)(7)
applies to all similar transactions during
the taxable year to which paragraph (f)(1)
of this section would apply (but for the
election under this paragraph (f)(7)). For
example, a taxpayer may elect under this
February 17, 20044662004-7 I.R.B.

paragraph (f)(7) to capitalize its costs
of prepaying insurance contracts for 12
months, but may continue to apply the
rule in paragraph (f)(1) to its costs of
entering into non-renewable, 12-month
service contracts. A taxpayer makes the
election by treating the amounts as capital
expenditures in its timely filed original
federal income tax return (including ex-
tensions) for the taxable year during which
the amounts are paid. In the case of an
affiliated group of corporations filing a
consolidated return, the election is made
separately with respect to each member
of the group, and not with respect to the
group as a whole. In the case of an S
corporation or partnership, the election
is made by the S corporation or by the
partnership, and not by the shareholders
or partners. An election made under this
paragraph (f)(7) is revocable with respect
to each taxable year for which made only
with the consent of the Commissioner.
(8)Examples. Therulesofthispara-
graph (f) are illustrated by the following
examples, in which it is assumed (unless
otherwise stated) that the taxpayer is a cal-
endar year, accrual method taxpayer that
does not have a short taxable year in any
taxable year and has not made an election
under paragraph (f)(7) of this section:
Example 1.Prepaid expenses. On December 1,
2005, N corporation pays a $10,000 insurance pre-
mium to obtain a property insurance policy (with no
cash value) with a 1-year term that begins on Feb-
ruary 1, 2006. The amount paid by N is a prepaid
expense described in paragraph (d)(3) of this section
and not paragraph (d)(2) of this section. Because the
right or benefit attributable to the $10,000 payment
extends beyond the end of the taxable year following
the taxable year in which the payment is made, the
12-month rule provided by this paragraph (f) does not
apply. N must capitalize the $10,000 payment.
Example 2.Prepaid expenses. (i) Assume the
samefactsasinExample 1, except that the policy
has a term beginning on December 15, 2005. The
12-month rule of this paragraph (f) applies to the
$10,000 payment because the right or benefit attrib-
utable to the payment neither extends more than 12
months beyond December 15, 2005 (the first date the
benefit is realized by the taxpayer), nor beyond the
end of the taxable year following the taxable year in
which the payment is made. Accordingly, N is not
required to capitalize the $10,000 payment.
(ii) Alternatively, assume N capitalizes prepaid
expenses for financial accounting and reporting pur-
poses and elects under paragraph (f)(7) of this section
not to apply the 12-month rule contained in paragraph
(f)(1) of this section. N must capitalize the $10,000
payment for federal income tax purposes.
Example 3.Financial interests. On October 1,
2005, X corporation makes a 9-month loan to B in the
principal amount of $250,000. The principal amount
of the loan to B constitutes an amount paid to cre-
ate or originate a financial interest under paragraph
(d)(2)(i)(B) of this section. The 9-month term of the
loan does not extend beyond the period prescribed by
paragraph (f)(1) of this section. However, as pro-
vided by paragraph (f)(3) of this section, the rules
of this paragraph (f) do not apply to intangibles de-
scribed in paragraph (d)(2) of this section. Accord-
ingly, X must capitalize the $250,000 loan amount.
Example 4.Financial interests. X corporation
owns all of the outstanding stock of Z corpora-
tion. On December 1, 2005, Y corporation pays X
$1,000,000 in exchange for X’s grant of a 9-month
call option to Y permitting Y to purchase all of the
outstanding stock of Z. Y’s payment to X constitutes
an amount paid to create or originate an option with
X under paragraph (d)(2)(i)(C)(7)ofthissection.
The 9-month term of the option does not extend
beyond the period prescribed by paragraph (f)(1) of
this section. However, as provided by paragraph
(f)(3) of this section, the rules of this paragraph (f)
do not apply to intangibles described in paragraph
(d)(2) of this section. Accordingly, Y must capitalize
the $1,000,000 payment.
Example 5.License. (i) On July 1, 2005, R cor-
poration pays $10,000 to state X to obtain a license to
operate a business in state X for a period of 5 years.
The terms of the license require R to pay state X an
annual fee of $500 due on July 1, 2005, and each of
the succeeding four years. R pays the $500 fee on
July1asrequiredbythelicense.
(ii) R’s payment of $10,000 is an amount paid to
a governmental agency fora license granted by that
agency to which paragraph (d)(5) of this section ap-
plies. Because R’s payment creates rights or benefits
for R that extend beyond 12 months after the first date
on which R realizes the rights or benefits attributable
to the payment and beyond the end of 2006 (the tax-
able year following the taxable year in which the pay-
ment is made), the rules of this paragraph (f) do not
apply to R’s payment. Accordingly, R must capital-
ize the $10,000 payment.
(iii) R’s payment of each $500 annual fee is a
prepaid expense described in paragraph (d)(3) of this
section. R is not required to capitalize the $500 fee
in each taxable year. The rules of this paragraph (f)
apply to each such payment because each payment
provides a right or benefit to R that does not extend
beyond 12 months after the first date on which R real-
izes the rights or benefits attributable to the payment
and does not extend beyond the end of the taxable
year following the taxableyear in which the payment
is made.
Example 6.Lease. On December 1, 2005, W cor-
poration enters into a lease agreement with X corpo-
ration under which W agrees to lease property to X
for a period of 9 months, beginning on December 1,
2005. W pays its outside counsel $7,000 for legal
services rendered in drafting the lease agreement and
negotiating with X. The agreement between W and
X is an agreement providing W the right to be com-
pensated for the use of property, as described in para-
graph (d)(6)(i)(A) of this section. W’s $7,000 pay-
ment to its outside counsel is an amount paid to fa-
cilitate W’s creation of the lease as described in para-
graph (e)(1)(i) of this section. The 12-month rule of
this paragraph (f) applies to the $7,000 payment be-
cause the right or benefit that the $7,000 payment fa-
cilitates the creation of neither extends more than 12
months beyond December 1, 2005 (the first date the
benefit is realized by the taxpayer), nor beyond the
end of the taxable year following the taxable year in
which the payment is made. Accordingly, W is not
required to capitalize its payment to its outside coun-
sel.
Example 7.Certain contract terminations.Vcor-
poration owns real property that it has leased to A for
a period of 15 years. When the lease has a remaining
unexpired term of 5 years, V and A agree to termi-
nate the lease, enabling V to use the property in its
trade or business. V pays A $100,000 in exchange
for A’s agreement to terminate the lease. V’s payment
to A to terminate the lease is described in paragraph
(d)(7)(i)(A) of this section. Under paragraph (f)(2) of
this section, V’s payment creates a benefit for V with
a duration of 5 years, the remaining unexpired term
of the lease as of the date of the termination. Because
the benefit attributable to the expenditure extends be-
yond 12 months after the first date on which V real-
izes the rights or benefits attributable to the payment
and beyond the end of the taxable year following the
taxable year in which the payment is made, the rules
of this paragraph (f) do not apply to the payment. V
must capitalize the $100,000 payment.
Example 8.Certain contract terminations.As-
sume the same facts as inExample 7, except that the
lease is terminated when it has a remaining unexpired
term of 10 months. Under paragraph (f)(2) of this
section, V’s payment creates a benefit for V with a
duration of 10 months. The 12-month rule of this
paragraph (f) applies to the payment because the ben-
efit attributable to the payment neither extends more
than 12 months beyond the date of termination (the
first date the benefit is realized by V) nor beyond the
end of the taxable year following the taxable year in
which the payment is made. Accordingly, V is not
required to capitalize the $100,000 payment.
Example 9.Certain contract terminations.As-
sume the same facts as inExample 7,exceptthatei-
ther party can terminate the lease upon 12 months no-
tice. When the lease has a remaining unexpired term
of 5 years, V wants to terminate the lease, however,
V does not want to wait another 12 months. V pays
A $50,000 for the ability to terminate the lease with
one month’s notice. V’s payment to A to terminate
the lease is described in paragraph (d)(7)(i)(A) of this
section. Under paragraph (f)(2) of this section, V’s
payment creates a benefit for V with a duration of 11
months, the time by which the notice period is short-
ened. The 12-month rule of this paragraph (f) applies
to V’s $50,000 payment because the benefit attrib-
utable to the payment neither extends more than 12
months beyond the date of termination (the first date
the benefit is realized by V) nor beyond the end of the
taxable year following the taxable year in which the
payment is made. Accordingly, V is not required to
capitalize the $50,000 payment.
Example 10.Coordination with section 461.(i)U
corporation leases office space from W corporation at
a monthly rental rate of $2,000. On August 1, 2005, U
prepays its office rent expense for the first six months
of 2006 in the amount of $12,000. For purposes of
this example, it is assumed that the recurring item
exception provided by §1.461–5 does not apply and
that the lease between W and U is not a section 467
rental agreement as defined in section 467(d).
(ii) Under §1.461–4(d)(3), U’s prepayment of
rent is a payment for the use of property by U for
2004-7 I.R.B.467February 17, 2004

which economic performance occurs ratably over
the period of time U is entitled to use the property.
Accordingly, because economic performance with
respect to U’s prepayment of rent does not occur
until 2006, U’s prepaid rent is not incurred in 2005
and therefore is not properly taken into account
through capitalization, deduction, or otherwise in
2005. Thus, the rules of this paragraph (f) do not
apply to U’s prepayment of its rent.
(iii) Alternatively, assume that U uses the cash
method of accounting and the economic performance
rules in §1.461–4 therefore do not apply to U. The
12-month rule of this paragraph (f) applies to the
$12,000 payment because the rights or benefits at-
tributable to U’s prepayment of its rent do not extend
beyond December 31, 2006. Accordingly, U is not
required to capitalize its prepaid rent.
Example 11.Coordination with section 461.N
corporation pays R corporation, an advertising and
marketing firm, $40,000 on August 1, 2005, for ad-
vertising and marketing services to be provided to
N throughout calendar year 2006. For purposes of
this example, it is assumed that the recurring item ex-
ception provided by §1.461–5 does not apply. Under
§1.461–4(d)(2), N’s payment arises out of the provi-
sion of services to N by R for which economic perfor-
manceoccursastheservices are provided. Accord-
ingly, because economic performance with respect to
N’s prepaid advertising expense does not occur until
2006, N’s prepaid advertising expense is not incurred
in 2005 and therefore is not properly taken into ac-
count through capitalization, deduction, or otherwise
in 2005. Thus, the rules of this paragraph (f) do not
apply to N’s payment.
(g)Treatment of capitalized costs—(1)
In general. An amount required to be cap-
italized by this section is not currently de-
ductible under section 162. Instead, the
amount generally is added to the basis of
the intangible acquired or created. See sec-
tion 1012.
(2)Financial instruments. In the case
of a financial instrument described in para-
graph (c)(1)(iii) or (d)(2)(i)(C) of this sec-
tion, notwithstanding paragraph (g)(1) of
this section, if under other provisions of
law the amount required to be capitalized
is not required to be added to the basis of
the intangible acquired or created, then the
other provisions of law will govern the tax
treatment of the amount.
(h)Special rules applicable to pooling
—(1)In general. Except as otherwise pro-
vided, the rules of this paragraph (h) ap-
ply to the pooling methods described in
paragraph (d)(6)(v) of this section (relating
tode minimisrules applicable to certain
contract rights), paragraph (e)(4)(iii)(A) of
this section (relating tode minimisrules
applicable to transaction costs), and para-
graph (f)(5)(iii) of this section (relating to
the application of the 12-month rule to re-
newable rights).
(2)Method of accounting. A pool-
ing method authorized by this section con-
stitutes a method of accounting for pur-
poses of section 446. A taxpayer that
adopts or changes to a pooling method
authorized by this section must use the
method for the year of adoption and for
all subsequent taxable years during which
the taxpayer qualifies to use the pooling
method unless a change to another method
is required by the Commissioner in order
to clearly reflect income, or unless per-
mission to change to another method is
granted by the Commissioner as provided
in §1.446–1(e).
(3)Adopting or changing to a pooling
method. A taxpayer adopts (or changes to)
a pooling method authorized by this sec-
tion for any taxable year by establishing
one or more pools for the taxable year in
accordance with the rules governing the
particular pooling method and the rules
prescribed by this paragraph (h), and by
using the pooling method to compute its
taxable income for the year of adoption (or
change).
(4)Definition of pool. A taxpayer may
use any reasonable method of defining a
pool of similar transactions, agreements or
rights, including a method based on the
type of customer or the type of product or
service provided under a contract. How-
ever, a taxpayer that pools similar trans-
actions, agreements or rights must include
in the pool all similar transactions, agree-
ments or rights created during the taxable
year. For purposes of the pooling meth-
ods described in paragraph (d)(6)(v) of this
section (relating tode minimisrules appli-
cable to certain contract rights) and para-
graph (e)(4)(iii)(A) of this section (relat-
ing tode minimisrules applicable to trans-
action costs), an agreement (or a trans-
action) is treated as not similar to other
agreements (or transactions) included in
the pool if the amount at issue with re-
spect to that agreement (or transaction) is
reasonably expected to differ significantly
from the average amount at issue with re-
spect to the other agreements (or transac-
tions) properly included in the pool.
(5)Consistency requirement.Atax-
payer that uses the pooling method de-
scribed in paragraph (f)(5)(iii) of this sec-
tion for purposes of applying the 12-month
rule to a right or benefit —
(i) Must use the pooling methods de-
scribed in paragraph (d)(6)(v) of this sec-
tion (relating tode minimisrules appli-
cable to certain contract rights) and para-
graph (e)(4)(iii)(A) of this section (relating
tode minimisrules applicable to transac-
tion costs) for purposes of determining the
amount paid to create, or facilitate the cre-
ation of, the right or benefit; and
(ii) Must use the same pool for purposes
of paragraph (d)(6)(v) of this section and
paragraph (e)(4)(iii)(A) of this section as
is used for purposes of paragraph (f)(5)(iii)
of this section.
(6)Additional guidance pertaining to
pooling. The Internal Revenue Service
may publish guidance in the Internal Rev-
enue Bulletin (see §601.601(d)(2) of this
chapter) prescribing additional rules for
applying the pooling methods authorized
by this section to specific industries or to
specific types of transactions.
(7)Example. The following example
illustrates the rules of this paragraph (h):
Example.Pooling. (i) In the course of its busi-
ness, W corporation enters into 3-year non-cancelable
contracts that provide W the right to provide services
to its customers. W generally pays certain amounts in
the process of pursuing an agreement with a customer,
including amounts paid to credit reporting agencies to
verify the credit history of the potential customer and
commissions paid to the independent sales agent who
secures the agreement withthe customer. In the case
of agreements that W enters into with customers who
are individuals, the agreements contain substantially
similar terms and conditions and W typically pays
between $100 and $200 in the process of pursuing
each transaction. During 2005, W enters into agree-
ments with 300 individuals. Also during 2005, W
enters into an agreement with X corporation contain-
ing terms and conditions that are substantially simi-
lar to those contained in the agreements W enters into
with its customers who are individuals. W pays cer-
tain amounts in the process of pursuing the agreement
with X that W would not typically incur in the process
of pursuing an agreement with its customers who are
individuals. For example, W pays amounts to pre-
pare and submit a bid for the agreement with X and
amounts to travel to X’s headquarters to make a sales
presentation to X’s management. In the aggregate, W
pays $11,000 in the process of obtaining the agree-
ment with X.
(ii) The agreements between W and its customers
are agreements providing W the right to provide ser-
vices, as described in paragraph (d)(6)(i)(B) of this
section. Under paragraph (b)(1)(v) of this section,
W must capitalize transaction costs paid to facilitate
the creation of these agreements. Because W enters
into at least 25 similar transactions during 2005, W
may pool its transactions for purposes of determining
whether its transaction costs arede minimiswithin the
meaning of paragraph (e)(4)(iii)(A) of this section. W
adopts a pooling method by establishing one or more
pools of similar transactions and by using the pooling
method to compute its taxable income beginning in
its 2005 taxable year. If W adopts a pooling method,
W must include all similar transactions in the pool.
February 17, 20044682004-7 I.R.B.

Under paragraph (h)(4) of this section, the transac-
tion with X is not similar to the transactions W enters
into with its customers who are individuals. While
the agreement with X contains terms and conditions
that are substantially similar to those contained in the
agreements W enters into with its customers who are
individuals, the transaction costs paid in the process
of pursuing the agreement with X are reasonably ex-
pected to differ significantly from the average trans-
action costs attributable to transactions with its cus-
tomers who are individuals. Accordingly, W may not
include the transaction with X in the pool of transac-
tions with customers who are individuals.
(i) [Reserved].
(j)Application to accrual method tax-
payers. For purposes of this section,
the termsamount paidandpayment
mean, in the case of a taxpayer using
an accrual method of accounting, a li-
ability incurred (within the meaning of
§1.446–1(c)(1)(ii)). A liability may not
be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(k)Treatment of related parties and in-
direct payments. For purposes of this sec-
tion, references to a party other than the
taxpayer include persons related to that
party and persons acting for or on behalf of
that party (including persons to whom the
taxpayer becomes obligated as a result of
assuming a liability of that party). For this
purpose, persons are related only if their
relationship is described in section 267(b)
or 707(b) or they are engaged in trades or
businesses under common control within
the meaning of section 41(f)(1). Refer-
ences to an amount paid to or by a party
include an amount paid on behalf of that
party.
(l)Examples. The rules of this sec-
tion are illustrated by the following exam-
ples in which it is assumed that the In-
ternal Revenue Service has not published
guidance that requirescapitalization under
paragraph (b)(1)(iv) of this section (relat-
ing to amounts paid to create or enhance a
future benefit that is identified in published
guidance as an intangible for which capi-
talization is required):
Example 1.License granted by a governmental
unit. (i) X corporation pays $25,000 to state R to ob-
tain a license to sell alcoholic beverages in its restau-
rant. The license is valid indefinitely, provided X
complies with all applicable laws regarding the sale
of alcoholic beverages in state R. X pays its outside
counsel $4,000 for legal services rendered in prepar-
ing the license application and otherwise representing
X during the licensing process. In addition, X deter-
mines that $2,000 of salaries paid to its employees
is allocable to services rendered by the employees in
obtaining the license.
(ii) X’s payment of $25,000 is an amount paid to a
governmental unit to obtain a license granted by that
agency, as described in paragraph (d)(5)(i) of this sec-
tion. The right has an indefinite duration and consti-
tutes an amortizable section 197 intangible. Accord-
ingly, as provided in paragraph (f)(3) of this section,
the provisions of paragraph (f) of this section (relating
to the 12-month rule) do not apply to X’s payment. X
must capitalize its $25,000 payment to obtain the li-
cense from state R.
(iii) As provided in paragraph (e)(4) of this
section, X is not required to capitalize employee
compensation because such amounts are treated
as amounts that do not facilitate the acquisition or
creation of an intangible. Thus, X is not required
to capitalize the $2,000 of employee compensation
allocable to the transaction.
(iv) X’s payment of $4,000 to its outside coun-
sel is an amount paid to facilitate the creation of an
intangible, as described in paragraph (e)(1)(i) of this
section. Because X’s transaction costs do not exceed
$5,000, X’s transaction costs arede minimiswithin
the meaning of paragraph (e)(4)(iii)(A) of this sec-
tion. Accordingly, X is not required to capitalize the
$4,000 payment to its outside counsel under this sec-
tion.
Example 2.Franchise agreement. (i) R corpo-
ration is a franchisor of income tax return prepara-
tion outlets. V corporation negotiates with R to ob-
tain the right to operate an income tax return prepa-
ration outlet under a franchise from R. V pays an ini-
tial $100,000 franchise fee to R in exchange for the
franchise agreement. In addition, V pays its outside
counsel $4,000 to represent V during the negotiations
with R. V also pays $2,000 to an industry consultant
to advise V during the negotiations with R.
(ii) Under paragraph (d)(6)(i)(A) of this section,
V’s payment of $100,000 is an amount paid to another
party to enter into an agreement with that party pro-
viding V the right to use tangible or intangible prop-
erty. Accordingly, V must capitalize its $100,000
payment to R. The franchise agreement is a self-cre-
ated amortizable section 197 intangible within the
meaning of section 197(c).Accordingly, as provided
in paragraph (f)(3) of this section, the 12-month rule
contained in paragraph (f)(1) of this section does not
apply.
(iii) V’s payment of $4,000 to its outside coun-
sel and $2,000 to the industry consultant are amounts
paid to facilitate the creation of an intangible, as de-
scribed in paragraph (e)(1)(i) of this section. Because
V’s aggregate transaction costs exceed $5,000, V’s
transaction costs are notde minimiswithin the mean-
ing of paragraph (e)(4)(iii)(A) of this section. Ac-
cordingly, V must capitalize the $4,000 payment to
its outside counsel and the $2,000 payment to the in-
dustry consultant under this section into the basis of
the franchise, as provided in paragraph (g) of this sec-
tion.
Example 3.Covenant not to compete. (i) On De-
cember 1, 2005, N corporation, a calendar year tax-
payer, enters into a covenant not to compete with B,
a key employee that is leaving the employ of N. The
covenant not to compete is not entered into in con-
nection with the acquisition of an interest in a trade
or business. The covenant not to compete prohibits
B from competing with N for a period of 9 months,
beginning December 1,2005. N pays B $25,000 in
full consideration for B’s agreement not to compete.
In addition, N pays its outside counsel $6,000 to fa-
cilitate the creation of the covenant not to compete
with B. N does not have a short taxable year in 2005
or 2006.
(ii) Under paragraph (d)(6)(i)(C) of this section,
N’s payment of $25,000 is an amount paid to another
party to induce that party to enter into a covenant not
to compete with N. However, because the covenant
not to compete has a duration that does not extend
beyond 12 months after the first date on which N re-
alizes the rights attributable to its payment (i.e.,De-
cember 1, 2005) or beyond the end of the taxable year
following the taxable year in which payment is made,
the 12-month rule contained in paragraph (f)(1) of
this section applies. Accordingly, N is not required
to capitalize its $25,000 payment to B or its $6,000
payment to facilitate the creation of the covenant not
to compete.
Example 4.Demand-side management.(i)Xcor-
poration, a public utility engaged in generating and
distributing electrical energy, provides programs to
its customers to promote energy conservation and en-
ergy efficiency. These programs are aimed at reduc-
ing electrical costs to X’scustomers, building good-
will with X’s customers, and reducing X’s future op-
erating and capital costs. X provides these programs
without obligating any of its customers participat-
ing in the programs to purchase power from X in
the future. Under these programs, X pays a consul-
tant to help industrial customers design energy-effi-
cient manufacturing processes, to conduct “energy ef-
ficiency audits” that serve to identify for customers
inefficiencies in their energy usage patterns, and to
provide cash allowances to encourage residential cus-
tomers to replace existing appliances with more en-
ergy efficient appliances.
(ii) The amounts paid by X to the consultant are
not amounts to acquire or create an intangible under
paragraph (c) or (d) of this section or to facilitate such
an acquisition or creation. In addition, the amounts
do not create a separate and distinct intangible asset
within the meaning of paragraph (b)(3) of this sec-
tion. Accordingly, the amounts paid to the consultant
are not required to be capitalized under this section.
While the amounts may serve to reduce future oper-
ating and capital costs and create goodwill with cus-
tomers, these benefits, without more, are not intan-
gibles for which capitalization is required under this
section.
Example 5.Business process re-engineering.(i)
V corporation manufactures its products using a batch
production system. Under this system, V continu-
ously produces component parts of its various prod-
ucts and stockpiles these parts until they are needed
in V’s final assembly line. Finished goods are stock-
piled awaiting orders from customers. V discovers
that this process ties up significant amounts of V’s
capital in work-in-process and finished goods inven-
tories. V hires B, a consultant, to advise V on improv-
ing the efficiency of its manufacturing operations. B
recommends a complete re-engineering of V’s man-
ufacturing process to a process known as just-in-time
manufacturing. Just-in-time manufacturing involves
reconfiguring a manufacturing plant to a configura-
tion of “cells” where each team in a cell performs
the entire manufacturing process for a particular cus-
tomer order, thus reducing inventory stockpiles.
(ii) V incurred three categories of costs to con-
vert its manufacturing process to a just-in-time sys-
2004-7 I.R.B.469February 17, 2004

tem. First, V paid B, a consultant, $250,000 in profes-
sional fees to implement the conversion of V’s plant
to a just-in-time system. Second, V paid C, a contrac-
tor, $100,000 to relocate and reconfigure V’s manu-
facturing equipment from an assembly line layout to a
configuration of cells. Third, V paid D, a consultant,
$50,000 to train V’s employees in the just-in-time
manufacturing process.
(iii) The amounts paid by V to B, C, and D are
not amounts to acquire or create an intangible under
paragraph (c) or (d) of this section or to facilitate such
an acquisition or creation. In addition, the amounts
do not create a separate and distinct intangible asset
within the meaning of paragraph (b)(3) of this sec-
tion. Accordingly, the amounts paid to B, C, and D
are not required to be capitalized under this section.
While the amounts produce long term benefits to V in
the form of reduced inventory stockpiles, improved
product quality, and increased efficiency, these bene-
fits, without more, are not intangibles for which cap-
italization is required under this section.
Example 6.Defense of business reputation.(i)
X, an investment adviser, serves as the fund manager
of a money market investment fund. X, like its com-
petitors in the industry, strives to maintain a constant
net asset value for its money market fund of $1.00
per share. During 2005, in the course of managing
the fund assets, X incorrectly predicts the direction
of market interest rates, resulting in significant in-
vestment losses to the fund. Due to these significant
losses, X is faced with the prospect of reporting a
net asset value that is less than $1.00 per share. X
is not aware of any investment adviser in its industry
that has ever reported a net asset value for its money
market fund of less than $1.00 per share. X is con-
cerned that reporting a net asset value of less than
$1.00 per share will significantly harm its reputation
as an investment adviser, and could lead to litigation
by shareholders. X decides to contribute $2,000,000
to the fund in order to raise the net asset value of the
fund to $1.00 per share. This contribution is not a
loan to the fund and does not give X any ownership
interest in the fund.
(ii) The $2,000,000 contribution is not an amount
paid to acquire or create an intangible under para-
graph (c) or (d) of this section or to facilitate such
an acquisition or creation. In addition, the amount
does not create a separate and distinct intangible as-
set within the meaning of paragraph (b)(3) of this sec-
tion. Accordingly, the amount contributed to the fund
is not required to be capitalized under this section.
While the amount serves to protect the business rep-
utation of the taxpayer and may protect the taxpayer
from litigation by shareholders, these benefits, with-
out more, are not intangibles for which capitalization
is required under this section.
Example 7.Product launch costs. (i) R corpo-
ration, a manufacturer of pharmaceutical products, is
required by law to obtain regulatory approval before
selling its products. While awaiting regulatory ap-
proval on Product A, R pays to develop and imple-
ment a marketing strategy and an advertising cam-
paign to raise consumer awareness of the purported
need for Product A. R also pays to train health care
professionals and other distributors in the proper use
of Product A.
(ii) The amounts paid by R are not amounts paid
to acquire or create an intangible under paragraph (c)
or (d) of this section or to facilitate such an acquisi-
tion or creation. In addition, the amounts do not cre-
ate a separate and distinct intangible asset within the
meaning of paragraph (b)(3) of this section. Accord-
ingly, R is not required to capitalize these amounts
under this section. While the amounts may benefit R
by creating consumer demand for Product A and in-
creasing awareness of Product A among distributors,
these benefits, without more, are not intangibles for
which capitalization is required under this section.
Example 8.Stocklifting costs. (i) N corporation is
a wholesale distributor of Brand A aftermarket auto-
mobile replacement parts. In an effort to induce a re-
tail automobile parts supply store to stock only Brand
A parts, N offers to replace all of the store’s inven-
tory of other branded parts with Brand A parts, and
to credit the store for its cost of other branded parts.
The store is under no obligation to continue stocking
Brand A parts or to purchase a minimum volume of
Brand A parts from N in the future.
(ii) The amount paid by N as a credit to the store
for the cost of other branded parts is not an amount
paid to acquire or create an intangible under para-
graph (c) or (d) of this section or to facilitate such
an acquisition or creation. In addition, the amount
does not create a separate and distinct intangible as-
set within the meaning of paragraph (b)(3) of this sec-
tion. Accordingly, N is not required to capitalize the
amount under this section. While the amount may
create a hope or expectation by N that the store will
continue to stock Brand A parts, this benefit, without
more, is not an intangible for which capitalization is
required under this section.
(iii) Alternatively, assume that N agrees to credit
the store for its cost of other branded parts in ex-
change for the store’s agreement to purchase all of
its inventory requirements for such parts from N for
a period of at least 3 years. The amount paid by N as
a credit to the store for the cost of other branded parts
is an amount paid to induce the store to enter into an
agreement providing R the right to provide property.
Accordingly, R must capitalize its payment.
Example 9.Package design costs. (i) Z corpo-
ration manufactures and markets personal care prod-
ucts. Z pays $100,000 to a consultant to develop a
package design for Z’s newest product, Product A.
Z also pays a fee to a government agency to obtain
trademark and copyright protection on certain ele-
ments of the package design. Z pays its outside le-
gal counsel $10,000 for services rendered in prepar-
ing and filing the trademark and copyright applica-
tions and for other services rendered in securing the
trademark and copyright protection.
(ii) The $100,000 paid by Z to the consultant for
development of the package design is not an amount
paid to acquire or create an intangible under para-
graph (c) or (d) of this section or to facilitate such
an acquisition or creation. In addition, as provided
in paragraph (b)(3)(v) of this section, amounts paid
to develop a package design are treated as amounts
that do not create a separate and distinct intangible
asset. Accordingly, Z is not required to capitalize the
$100,000 payment under this section.
(iii) The amounts paid by Z to the government
agency to obtain trademark and copyright protection
are amounts paid to a government agency for a right
granted by that agency. Accordingly, Z must capital-
ize the payment. In addition, the $10,000 paid by Z
to its outside counsel is an amount paid to facilitate
the creation of the trademark and copyright. Because
the aggregate amounts paid to facilitate the transac-
tion exceed $5,000, the amounts are notde minimis
as defined in paragraph (e)(4)(iii)(A) of this section.
Accordingly, Z must capitalize the $10,000 payment
to its outside counsel under paragraph (b)(1)(v) of this
section.
(iv) Alternatively, assume that Z acquires an ex-
isting package design for Product A as part of an ac-
quisition of a trade or business that constitutes an ap-
plicable asset acquisition within the meaning of sec-
tion 1060(c). Assume further that $100,000 of the
consideration paid by N in the acquisition is properly
allocable to the package design for Product A. Under
paragraph (c)(1) of this section, Z must capitalize the
$100,000 payment.
Example 10.Contract to provide services.(i)Q
corporation, a financial planning firm, provides fi-
nancial advisory services on a fee-only basis. During
2005, Q and several other financial planning firms
submit separate bids to R corporation for a contract
to become one of three providers of financial advi-
sory services to R’s employees. Q pays $2,000 to
a printing company to develop and produce materi-
als for its sales presentation to R’s management. Q
also pays $6,000 to travel to R’s corporate headquar-
ters to make the sales presentation, and $20,000 of
salaries to its employees for services performed in
preparing the bid and making the presentation to R’s
management. Q’s bid is successful and Q enters into
an agreement with R in 2005 under which Q agrees
to provide financial advisory services to R’s employ-
ees, and R agrees to pay Q’s fee on behalf of each
employee who chooses to utilize such services. R en-
ters into similar agreements with two other financial
planning firms, and R’s employees may choose to use
the services of any one of the three firms. Based on
its past experience, Q reasonably expects to provide
services to at least 5 percent of R’s employees.
(ii) Q’s agreement with R is not an agreement pro-
viding Q the right to provide services, as described
in paragraph (d)(6)(i)(B) of this section. Under para-
graph (d)(6)(iv) the agreement places no obligation
on another person to request or pay for Q’s services.
Accordingly, Q is not required to capitalize any of the
amounts paid in the process of pursuing the agree-
ment with R.
Example 11.Mutual fund distributor.(i)Din-
curs costs to enter into a distribution agreement with
M, a mutual fund. The initial term of the distribu-
tion agreement is two years, and afterwards must be
approved annually by M. The distribution agreement
can be terminated by either party on 60 days notice.
Although distribution agreements are rarely termi-
nated in the mutual fund industry, M is not econom-
ically compelled to continue D’s distribution agree-
ment. Under the distribution agreement, D has the
exclusive right to sell shares of M and agrees to use
its best efforts to solicit orders for the sale of shares of
M. D sells shares in M directly to the general public as
well as through brokers. When an investor places an
order for M shares with a broker, D pays the broker a
commission for selling the shares to the investor. Un-
der the distribution agreement, D receives compensa-
tion from M in the form of 12b–1 fees (which equal
a percentage of M’s net asset value attributable to in-
vestors that have held their shares for up to 6 years)
and contingent deferred sales charges (which are paid
if the investor redeems the purchased shares within 6
years).
February 17, 20044702004-7 I.R.B.

(ii) The distribution agreement is not an agree-
ment providing D with the right to provide services,
as described in paragraph (d)(6)(i)(B) of this section,
because the distribution agreement can be termi-
nated by M at will upon 60 days notice and M is
not economically compelled to continue the distri-
bution agreement. Accordingly, D is not required
to capitalize the costs of creating (or facilitating the
creation of) the distribution agreement under para-
graphs (b)(1)(ii) or (v) of this section. In addition,
as provided in paragraph (b)(3)(ii) of this section,
amounts paid to create an agreement are treated as
amounts that do not create a separate and distinct
intangible asset. Accordingly, D also is not required
to capitalize the costs of creating (or facilitating the
creation of) the distribution agreement under para-
graph (b)(1)(iii) or (v) of this section.
(iii) Under paragraph (b)(3)(iii), the broker com-
missions paid by D in performing services under the
distribution agreement do not create (or facilitate the
creation of) a separate and distinct intangible asset.
In addition, the broker commissions do not create an
intangible described in paragraph (d) of this section.
Accordingly, D is not required to capitalize the bro-
ker commissions under this section.
(m)Amortization. For rules relating
to amortization of certain intangibles, see
§1.167(a)–3.
(n)Intangible interests in land.[Re-
served].
(o)Effective date. This section applies
to amounts paid or incurred on or after
December 31, 2003.
(p)Accounting method changes—(1)
In general. A taxpayer seeking to change
amethodofaccountingtocomplywith
this section must secure the consent of
the Commissioner in accordance with the
requirements of §1.446–1(e). For the tax-
payer’s first taxable year ending on or
after December 31, 2003, the taxpayer is
granted the consent of the Commissioner
to change its method of accounting to
comply with this section, provided the
taxpayer follows the administrative proce-
dures issued under §1.446–1(e)(3)(ii) for
obtaining the Commissioner’s automatic
consent to a change in accounting method
(for further guidance, for example, see
Rev. Proc. 2002–9, 2002–1 C.B. 327, and
§601.601(d)(2)(ii)(b) of this chapter).
(2)Scope limitations. Any limitations
on obtaining the automatic consent of the
Commissioner do not apply to a taxpayer
seeking to change to a method of account-
ingtocomplywiththissectionforitsfirst
taxable year ending on or after December
31, 2003.
(3)Section 481(a) adjustment.With
the exception of a change to a pooling
method authorized by this section, the
section 481(a) adjustment for a change in
method of accounting to comply with this
section for a taxpayer’s first taxable year
ending on or after December 31, 2003, is
determined by taking into account only
amounts paid or incurred in taxable years
ending on or after January 24, 2002. A
taxpayer seeking to change to a pooling
method authorized by this section on or
after the effective date of these regulations
must change to the method using a cut-off
method.
§1.263(a)–5 Amounts paid or incurred
to facilitate an acquisition of a trade or
business, a change in the capital structure
of a business entity, and certain other
transactions.
(a)General rule. A taxpayer must cap-
italize an amount paid to facilitate (within
the meaning of paragraph (b) of this sec-
tion) each of the following transactions,
without regard to whether the transaction
is comprised of a single step or a series of
steps carried out as part of a single plan and
without regard to whether gain or loss is
recognized in the transaction:
(1) An acquisition of assets that consti-
tute a trade or business (whether the tax-
payer is the acquirer in the acquisition or
the target of the acquisition).
(2) An acquisition by the taxpayer of an
ownership interest in a business entity if,
immediately after the acquisition, the tax-
payer and the business entity are related
within the meaning of section 267(b) or
707(b) (see §1.263(a)–4 for rules requiring
capitalization of amounts paid by the tax-
payer to acquire an ownership interest in a
business entity, or to facilitate the acquisi-
tion of an ownership interest in a business
entity, where the taxpayer and the business
entity are not related within the meaning of
section 267(b) or 707(b) immediately after
the acquisition).
(3) An acquisition of an ownership in-
terest in the taxpayer (other than an acqui-
sition by the taxpayer of an ownership in-
terest in the taxpayer, whether by redemp-
tion or otherwise).
(4) A restructuring, recapitalization, or
reorganization of the capital structure of a
business entity (including reorganizations
described in section 368 and distributions
of stock by the taxpayer as described in
section 355).
(5) A transfer described in section 351
or section 721 (whether the taxpayer is the
transferor or transferee).
(6) A formation or organization of a dis-
regarded entity.
(7) An acquisition of capital.
(8) A stock issuance.
(9) A borrowing. For purposes of this
section, a borrowing means any issuance
of debt, including an issuance of debt in
an acquisition of capital or in a recapital-
ization. A borrowing also includes debt
issued in a debt for debt exchange under
§1.1001–3.
(10) Writing an option.
(b)Scope of facilitate—(1)In gen-
eral. Except as otherwise provided in this
section, an amount is paid to facilitate a
transaction described in paragraph (a) of
this section if the amount is paid in the
process of investigating or otherwise pur-
suing the transaction. Whether an amount
is paid in the process of investigating
or otherwise pursuing the transaction is
determined based on all of the facts and
circumstances. In determining whether an
amount is paid to facilitate a transaction,
the fact that the amount would (or would
not) have been paid but for the transaction
is relevant, but is not determinative. An
amount paid to determine the value or
price of a transaction is an amount paid in
the process of investigating or otherwise
pursuing the transaction. An amount paid
to another party in exchange for tangible
or intangible property is not an amount
paid to facilitate the exchange. For exam-
ple, the purchase price paid to the target
of an asset acquisition in exchange for its
assets is not an amount paid to facilitate
the acquisition. Similarly, the purchase
pricepaidbyanacquirertothetarget’s
shareholders in exchange for their stock
in a stock acquisition is not an amount
paid to facilitate the acquisition of the
stock. See §1.263(a)–1, §1.263(a)–2, and
§ 1.263(a)–4 for rules requiring capitaliza-
tion of the purchase price paid to acquire
property.
(2)Ordering rules. An amount paid in
the process of investigating or otherwise
pursuing both a transaction described in
paragraph (a) of this section and an ac-
quisition or creation of an intangible de-
scribed in §1.263(a)–4 is subject to the
rules contained in this section, and not
to the rules contained in §1.263(a)–4. In
addition, an amount required to be cap-
2004-7 I.R.B.471February 17, 2004

italized by §1.263(a)–1, §1.263(a)–2, or
§1.263(a)–4 does not facilitate a transac-
tion described in paragraph (a) of this sec-
tion.
(c)Special rules for certain costs—(1)
Borrowing costs.Anamountpaidtofacili-
tate a borrowing does not facilitate another
transaction (other than the borrowing) de-
scribed in paragraph (a) of this section.
(2)Costs of asset sales.Anamountpaid
by a taxpayer to facilitate a sale of its as-
sets does not facilitate another transaction
(other than the sale) described in paragraph
(a) of this section. For example, where
a target corporation, in preparation for a
merger with an acquiring corporation, sells
assets that are not desired by the acquiring
corporation, amounts paid to facilitate the
sale of the unwanted assets are not required
to be capitalized as amounts paid to facili-
tate the merger.
(3)Mandatory stock distributions.An
amount paid in the process of investigat-
ing or otherwise pursuing a distribution
of stock by a taxpayer to its sharehold-
ers does not facilitate a transaction de-
scribed in paragraph (a) of this section if
the divestiture of the stock (or of proper-
tiestransferredtoanentitywhosestockis
distributed) is required by law, regulatory
mandate, or court order. A taxpayer is not
required to capitalize (under this section or
§1.263(a)–4) an amount paid to organize
(or facilitate the organization of) an entity
if the entity is organized solely to receive
properties that the taxpayer is required to
divest by law, regulatory mandate, or court
order and if the taxpayer distributes the
stock of the entity to its shareholders. A
taxpayer also is not required to capital-
ize (under this section or §1.263(a)–4) an
amount paid to transfer property to an en-
tity if the taxpayer is required to divest
itself of that property by law, regulatory
mandate, or court order and if the stock of
the recipient entity is distributed to the tax-
payer’s shareholders.
(4)Bankruptcy reorganization costs.
An amount paid to institute or adminis-
ter a proceeding under Chapter 11 of the
Bankruptcy Code by a taxpayer that is the
debtor under the proceeding constitutes an
amount paid to facilitate a reorganization
within the meaning of paragraph (a)(4) of
this section, regardless of the purpose for
which the proceeding is instituted. For
example, an amount paid to prepare and
file a petition under Chapter 11, to ob-
tain an extension of the exclusivity period
under Chapter 11, to formulate plans of
reorganization under Chapter 11, to an-
alyze plans of reorganization formulated
by another party in interest, or to contest
or obtain approval of a plan of reorga-
nization under Chapter 11 facilitates a
reorganization within the meaning of this
section. However, amounts specifically
paid to formulate, analyze, contest or ob-
tain approval of the portion of a plan of
reorganization under Chapter 11 that re-
solves tort liabilities of the taxpayer do
not facilitate a reorganization within the
meaning of paragraph (a)(4) of this section
if the amounts would have been treated as
ordinary and necessary business expenses
under section 162 had the bankruptcy pro-
ceeding not been instituted. In addition,
an amount paid by the taxpayer to defend
against the commencement of an invol-
untary bankruptcy proceeding against the
taxpayer does not facilitate a reorgani-
zation within the meaning of paragraph
(a)(4) of this section. An amount paid by
the debtor to operate its business during a
Chapter 11 bankruptcy proceeding is not
an amount paid to institute or administer
the bankruptcy proceeding and does not
facilitate a reorganization. Such amount
is treated in the same manner as it would
have been treated had the bankruptcy pro-
ceeding not been instituted.
(5)Stock issuance costs of open-end
regulated investment companies.Amounts
paid by an open-end regulated investment
company (within the meaning of section
851) to facilitate an issuance of its stock
are treated as amounts that do not facili-
tate a transaction described in paragraph
(a) of this section unless the amounts are
paid during the initial stock offering pe-
riod.
(6)Integration costs. An amount paid
to integrate the business operations of the
taxpayer with the business operations of
another does not facilitate a transaction de-
scribed in paragraph (a) of this section, re-
gardless of when the integration activities
occur.
(7)Registrar and transfer agent fees for
the maintenance of capital stock records.
An amount paid by a taxpayer to a reg-
istrar or transfer agent in connection with
the transfer of the taxpayer’s capital stock
does not facilitate a transaction described
in paragraph (a) of this section unless the
amount is paid with respect to a specific
transaction described in paragraph (a). For
example, a taxpayer is not required to capi-
talize periodic payments to a transfer agent
for maintaining records of the names and
addresses of shareholders who trade the
taxpayer’s shares on a national exchange.
By comparison, a taxpayer is required to
capitalize an amount paid to the transfer
agent for distributing proxy statements re-
questing shareholder approval of a transac-
tion described in paragraph (a) of this sec-
tion.
(8)Termination payments and amounts
paid to facilitate mutually exclusive trans-
actions. Anamountpaidtoterminate(or
facilitate the termination of) an agreement
to enter into a transaction described in
paragraph (a) of this section constitutes an
amount paid to facilitate a second transac-
tion described in paragraph (a) of this sec-
tion only if the transactions are mutually
exclusive. An amount paid to facilitate a
transaction described in paragraph (a) of
this section is treated as an amount paid
to facilitate a second transaction described
in paragraph (a) of this section only if the
transactions are mutually exclusive.
(d)Simplifying conventions—(1)In
general. For purposes of this section, em-
ployee compensation (within the meaning
of paragraph (d)(2) of this section), over-
head, andde minimiscosts (within the
meaning of paragraph (d)(3) of this sec-
tion) are treated as amounts that do not
facilitate a transaction described in para-
graph (a) of this section.
(2)Employee compensation—(i)In
general.Thetermemployee compen-
sationmeans compensation (including
salary, bonuses and commissions) paid to
an employee of the taxpayer. For purposes
of this section, whether an individual is
an employee is determined in accordance
with the rules contained in section 3401(c)
and the regulations thereunder.
(ii)Certain amounts treated as em-
ployee compensation. For purposes of
this section, a guaranteed payment to a
partner in a partnership is treated as em-
ployee compensation. For purposes of
this section, annual compensation paid to
a director of a corporation is treated as
employee compensation. For example, an
amount paid to a director of a corporation
for attendance at a regular meeting of the
board of directors (or committee thereof)
is treated as employee compensation for
purposes of this section. However, an
February 17, 20044722004-7 I.R.B.

amount paid to the director for attendance
at a special meeting of the board of direc-
tors (or committee thereof) is not treated
as employee compensation. An amount
paid to a person that is not an employee
of the taxpayer (including the employer of
the individual who performs the services)
is treated as employee compensation for
purposes of this section only if the amount
is paid for secretarial, clerical, or similar
administrative supportservices (other than
services involving the preparation and dis-
tribution of proxy solicitations and other
documents seeking shareholder approval
of a transaction described in paragraph (a)
of this section). In the case of an affiliated
group of corporations filing a consolidated
federal income tax return, a payment by
one member of the group to a second mem-
ber of the group for services performed
by an employee of the second member
is treated as employee compensation if
the services provided by the employee
are provided at a time during which both
members are affiliated.
(3)De minimis costs—(i)In general.
The termde minimis costsmeans amounts
(other than employee compensation and
overhead) paid in the process of investigat-
ing or otherwise pursuing a transaction de-
scribed in paragraph (a) of this section if, in
the aggregate, the amounts do not exceed
$5,000 (or such greater amount as may be
set forth in published guidance). If the
amounts exceed $5,000 (or such greater
amount as may be set forth in published
guidance), none of the amounts arede min-
imiscosts within the meaning of this para-
graph (d)(3). For purposes of this para-
graph (d)(3), an amount paid in the form of
property is valued at its fair market value
atthetimeofthepayment.
(ii)Treatment of commissions.The
termde minimis costsdoes not include
commissions paid to facilitate a trans-
action described in paragraph (a) of this
section.
(4)Election to capitalize. A taxpayer
may elect to treat employee compensa-
tion, overhead, orde minimiscosts paid in
the process of investigating or otherwise
pursuing a transaction described in para-
graph (a) of this section as amounts that
facilitate the transaction. The election is
made separately for each transaction and
applies to employee compensation, over-
head, orde minimiscosts, or to any com-
bination thereof. For example, a taxpayer
may elect to treat overhead andde min-
imiscosts, but not employee compensa-
tion, as amounts that facilitate the trans-
action. A taxpayer makes the election by
treating the amounts to which the elec-
tion applies as amounts that facilitate the
transaction in the taxpayer’s timely filed
original federal income tax return (includ-
ing extensions) for the taxable year during
which the amounts are paid. In the case
of an affiliated group of corporations filing
a consolidated return, the election is made
separately with respect to each member of
the group, and not with respect to the group
as a whole. In the case of an S corporation
or partnership, the election is made by the
S corporation or by the partnership, and not
by the shareholders or partners. An elec-
tion made under this paragraph (d)(4) is re-
vocable with respect to each taxable year
for which made only with the consent of
the Commissioner.
(e)Certain acquisitive transactions—
(1)In general. Except as provided in para-
graph (e)(2) of this section (relating to in-
herently facilitativeamounts), an amount
paid by the taxpayer in the process of in-
vestigating or otherwise pursuing a cov-
ered transaction (as described in paragraph
(e)(3) of this section) facilitates the trans-
action within the meaning of this section
only if the amount relates to activities per-
formed on or after the earlier of —
(i) The date on which a letter of intent,
exclusivity agreement, or similar written
communication (other than a confidential-
ity agreement) is executed by representa-
tives of the acquirer and the target; or
(ii) The date on which the material
terms of the transaction (as tentatively
agreed to by representatives of the acquirer
and the target) are authorized or approved
by the taxpayer’s board of directors (or
committee of the board of directors) or, in
the case of a taxpayer that is not a corpora-
tion, the date on which the material terms
of the transaction (as tentatively agreed
to by representatives of the acquirer and
the target) are authorized or approved by
the appropriate governing officials of the
taxpayer. In the case of a transaction that
does not require authorization or approval
of the taxpayer’s board of directors (or
appropriate governing officials in the case
of a taxpayer that is not a corporation)
the date determined under this paragraph
(e)(1)(ii) is the date on which the acquirer
and the target execute a binding written
contract reflecting the terms of the trans-
action.
(2)Exception for inherently facilitative
amounts. An amount paid in the process of
investigating or otherwise pursuing a cov-
ered transaction facilitates that transaction
if the amount is inherently facilitative, re-
gardless of whether the amount is paid for
activities performed prior to the date deter-
mined under paragraph (e)(1) of this sec-
tion. An amount is inherently facilitative
if the amount is paid for —
(i) Securing an appraisal, formal written
evaluation, or fairness opinion related to
the transaction;
(ii) Structuring the transaction, includ-
ing negotiating the structure of the transac-
tion and obtaining tax advice on the struc-
ture of the transaction (for example, ob-
taining tax advice on the application of
section 368);
(iii) Preparing and reviewing the doc-
uments that effectuate the transaction (for
example, a merger agreement or purchase
agreement);
(iv) Obtaining regulatory approval of
the transaction, including preparing and re-
viewing regulatory filings;
(v) Obtaining shareholder approval of
the transaction (for example, proxy costs,
solicitation costs, and costs to promote the
transaction to shareholders); or
(vi) Conveying property between the
parties to the transaction (for example,
transfer taxes and title registration costs).
(3)Covered transactions. For purposes
of this paragraph (e), the termcovered
transactionmeans the following transac-
tions:
(i) A taxable acquisition by the taxpayer
of assets that constitute a trade or business.
(ii) A taxable acquisition of an owner-
ship interest in a business entity (whether
the taxpayer is the acquirer in the acqui-
sition or the target of the acquisition) if,
immediately after the acquisition, the ac-
quirer and the target are related within the
meaning of section 267(b) or 707(b).
(iii) A reorganization described in sec-
tion 368(a)(1)(A), (B), or (C) or a reorga-
nization described in section 368(a)(1)(D)
in which stock or securities of the corpo-
ration to which the assets are transferred
are distributed in a transaction which qual-
ifies under section 354 or 356 (whether the
taxpayer is the acquirer or the target in the
reorganization).
2004-7 I.R.B.473February 17, 2004

(f)Documentation of success-based
fees— An amount paid that is contingent
on the successful closing of a transaction
described in paragraph (a) of this section is
an amount paid to facilitate the transaction
except to the extent the taxpayer maintains
sufficient documentation to establish that
a portion of the fee is allocable to activi-
ties that do not facilitate the transaction.
This documentation must be completed on
or before the due date of the taxpayer’s
timely filed original federal income tax
return (including extensions) for the tax-
able year during which the transaction
closes. For purposes of this paragraph (f),
documentation must consist of more than
merely an allocation between activities
that facilitate the transaction and activities
that do not facilitate the transaction, and
must consist of supporting records (for
example, time records, itemized invoices,
or other records) that identify —
(1) The various activities performed by
the service provider;
(2) The amount of the fee (or percentage
of time) that is allocable to each of the
various activities performed;
(3) Where the date the activity was
performed is relevant to understanding
whether the activity facilitated the transac-
tion, the amount of the fee (or percentage
of time) that is allocable to the perfor-
mance of that activity before and after the
relevant date; and
(4) The name, business address, and
business telephone number of the service
provider.
(g)Treatment of capitalized costs—
(1)Tax-free acquisitive transactions.[Re-
served].
(2)Taxable acquisitive transactions—
(i)Acquirer. In the case of an acquisi-
tion, merger, or consolidation that is not
described in section 368, an amount re-
quired to be capitalized under this section
by the acquirer is added to the basis of the
acquired assets (in the case of a transac-
tion that is treated as an acquisition of the
assets of the target for federal income tax
purposes) or the acquired stock (in the case
of a transaction that is treated as an acqui-
sition of the stock of the target for federal
income tax purposes).
(ii)Target—(A)Asset acquisition.In
the case of an acquisition, merger, or con-
solidation that is not described in section
368 and that is treated as an acquisition
of the assets of the target for federal in-
come tax purposes, an amount required to
be capitalized under this section by the tar-
get is treated as a reduction of the target’s
amount realized on the disposition of its
assets.
(B)Stock acquisition.[Reserved].
(3)Stock issuance transactions.[Re-
served].
(4)Borrowings. For the treatment of
amounts required to be capitalized under
this section with respect to a borrowing,
see §1.446–5.
(5)Treatment of capitalized amounts by
option writer. Anamountrequiredtobe
capitalized by an option writer under para-
graph (a)(10) of this section is not cur-
rently deductible under section 162 or 212.
Instead, the amount required to be capital-
ized generally reduces the total premium
received by the option writer. However,
other provisions of law may limit the re-
duction of the premium by the capital-
ized amount (for example, if the capital-
ized amount is never deductible by the op-
tion writer).
(h)Application to accrual method tax-
payers. For purposes of this section,
the termsamount paidandpayment
mean, in the case of a taxpayer using
an accrual method of accounting, a li-
ability incurred (within the meaning of
§1.446–1(c)(1)(ii)). A liability may not
be taken into account under this section
prior to the taxable year during which the
liability is incurred.
(i) [Reserved].
(j)Coordination with other provisions
of the Internal Revenue Code. Nothing in
this section changes the treatment of an
amount that is specifically provided for un-
der any other provision of the Internal Rev-
enue Code (other than section 162(a) or
212) or regulations thereunder.
(k)Treatment of indirect payments.For
purposes of this section, references to an
amount paid to or by a party include an
amount paid on behalf of that party.
(l)Examples. The following examples
illustrate the rules of this section:
Example 1.Costs to facilitate. Q corporation
pays its outside counsel $20,000 to assist Q in reg-
istering its stock with the Securities and Exchange
Commission. Q is not a regulated investment com-
pany within the meaning of section 851. Q’s pay-
ments to its outside counsel are amounts paid to facil-
itate the issuance of stock. Accordingly, Q must cap-
italize its $20,000 payment under paragraph (a)(8) of
this section (whether incurred before or after the is-
suance of the stock and whether or not the registration
is productive of equity capital).
Example 2.Costs to facilitate. Q corporation
seeks to acquire all of the outstanding stock of Y
corporation. To finance the acquisition, Q must is-
sue new debt. Q pays an investment banker $25,000
to market the debt to the public and pays its outside
counsel $10,000 to prepare the offering documents
for the debt. Q’s payment of $35,000 facilitates a
borrowing and must be capitalized under paragraph
(a)(9) of this section. As provided in paragraph (c)(1)
of this section, Q’s payment does not facilitate the
acquisition of Y, notwithstanding the fact that Q in-
curred the new debt to finance its acquisition of Y.
See §1.446–5 for the treatment of Q’s capitalized pay-
ment.
Example 3.Costs to facilitate.(i)Zagreesto
pay investment banker B $1,000,000 for B’s services
in evaluating four alternative transactions ($250,000
for each alternative): an initial public offering; a bor-
rowing of funds; an acquisition by Z of a competitor;
and an acquisition of Z by a competitor. Z eventually
decides to pursue a borrowing and abandons the other
options.
(ii) The $250,000 payment to evaluate the possi-
bility of a borrowing is an amount paid in the process
of investigating or otherwise pursuing a transaction
described in paragraph (a)(9) of this section. Accord-
ingly Z must capitalize that $250,000 payment to B.
See §1.446–5 for the treatment of Z’s capitalized pay-
ment.
(iii) The $250,000 payment to evaluate the pos-
sibility of an initial public offering is an amount paid
in the process of investigating or otherwise pursuing a
transaction described in paragraph (a)(8) of this sec-
tion. Accordingly, Z must capitalize that $250,000
payment to B under this section. Because the bor-
rowing and the initial public offering are not mutually
exclusive transactions, the $250,000 is not treated as
an amount paid to facilitate the borrowing. When Z
abandons the initial public offering, Z may recover
under section 165 the $250,000 paid to facilitate the
initial public offering.
(iv) The $500,000 paid by Z to evaluate the pos-
sibilities of an acquisition of Z by a competitor and
an acquisition of a competitor by Z are amounts paid
in the process of investigating or otherwise pursuing
transactions described in paragraphs (a) and (e)(3) of
this section. Accordingly, Z is only required to cap-
italize under this section the portion of the $500,000
payment that relates to inherently facilitative activi-
ties under paragraph (e)(2)ofthissectionortoac-
tivities performed on or after the date determined un-
der paragraph (e)(1) of this section. Because the bor-
rowing and the possible acquisitions are not mutually
exclusive transactions, no portion of the $500,000 is
treated as an amount paid to facilitate the borrowing.
When Z abandons the acquisition transactions, Z may
recover under section 165 any portion of the $500,000
that was paid to facilitate the acquisitions.
Example 4.Corporate acquisition. (i) On Febru-
ary 1, 2005, R corporation decides to investigate the
acquisition of three potential targets: T corporation,
U corporation, and V corporation. R’s consideration
of T, U, and V represents the consideration of three
distinct transactions, any or all of which R might con-
summate and has the financial ability to consummate.
On March 1, 2005, R enters into an exclusivity agree-
mentwithTandstopspursuingUandV.OnJuly1,
February 17, 20044742004-7 I.R.B.

2005, R acquires all of the stock of T in a transaction
described in section 368. R pays $1,000,000 to an in-
vestment banker and $50,000 to its outside counsel
to conduct due diligence on T, U, and V; determine
the value of T, U, and V; negotiate and structure the
transaction with T; draft the merger agreement; se-
cure shareholder approval; prepare SEC filings; and
obtain the necessary regulatory approvals.
(ii) Under paragraph (e)(1) of this section, the
amounts paid to conduct due diligence on T, U and
V prior to March 1, 2005 (the date of the exclusiv-
ity agreement), are not amounts paid to facilitate the
acquisition of the stock of T, U or V and are not re-
quired to be capitalized under this section. However,
the amounts paid to conduct due diligence on T on
and after March 1, 2005, are amounts paid to facili-
tate the acquisition of the stock of T and must be cap-
italized under paragraph (a)(2) of this section.
(iii) Under paragraph (e)(2) of this section, the
amounts paid to determine the value of T, negotiate
and structure the transaction with T, draft the merger
agreement, secure shareholder approval, prepare SEC
filings, and obtain necessary regulatory approvals are
inherently facilitative amounts paid to facilitate the
acquisition of the stock of T and must be capitalized,
regardless of whether those activities occur prior to,
on, or after March 1, 2005.
(iv) Under paragraph (e)(2) of this section, the
amounts paid to determine the value of U and V are
inherently facilitative amounts paid to facilitate the
acquisition of U or V and must be capitalized. Be-
cause the acquisition of U, V, and T are not mutually
exclusive transactions, the costs that facilitate the ac-
quisition of U and V do not facilitate the acquisition
of T. Accordingly, the amounts paid to determine the
value of U and V may be recovered under section 165
in the taxable year that R abandons the planned merg-
ers with U and V.
Example 5.Corporate acquisition; employee
bonus. Assume the same facts as inExample 4,
except R pays a bonus of $10,000 to one of its cor-
porate officers who negotiated the acquisition of T.
As provided by paragraph (d)(1) of this section, Y
is not required to capitalize any portion of the bonus
paid to the corporate officer.
Example 6.Corporate acquisition; integration
costs. Assume the same facts as inExample 4, except
that, before and after the acquisition is consummated,
R incurs costs to relocate personnel and equipment,
provide severance benefitsto terminated employees,
integrate records and information systems, prepare
new financial statements for the combined entity, and
reduce redundancies in the combined business oper-
ations. Under paragraph (c)(6) of this section, these
costs do not facilitate the acquisition of T. Accord-
ingly, R is not required to capitalize any of these costs
under this section.
Example 7.Corporate acquisition; compensa-
tion to target’s employees. Assume the same facts
as inExample 4, except that, prior to the acquisition,
certain employees of T held unexercised options is-
sued pursuant to T’s stock option plan. These op-
tions granted the employees the right to purchase T
stock at a fixed option price. The options did not have
a readily ascertainable value (within the meaning of
§1.83–7(b)), and thus no amount was included in the
employees’ income when the options were granted.
As a condition of the acquisition, T is required to ter-
minate its stock option plan. T therefore agrees to pay
its employees who hold unexercised stock options the
difference between the option price and the current
value of T’s stock in consideration of their agreement
to cancel their unexercised options. Under paragraph
(d)(1) of this section, T is not required to capitalize
the amounts paid to its employees. See section 83 for
the treatment of amounts received in cancellation of
stock options.
Example 8.Asset acquisition; employee compen-
sation. N corporation owns tangible and intangible
assets that constitute a trade or business. M corpora-
tion purchases all the assets of N in a taxable transac-
tion. Under paragraph (a)(1) of this section, M must
capitalize amounts paid to facilitate the acquisition of
the assets of N. Under paragraph (d)(1) of this sec-
tion, no portion of the salaries of M’s employees who
work on the acquisition are treated as facilitating the
transaction.
Example 9.Corporate acquisition; retainer.Y
corporation’s outside counsel charges Y $60,000 for
services rendered in facilitating the friendly acquisi-
tion of the stock of Y corporation by X corporation.
Y has an agreement with its outside counsel under
which Y pays an annual retainer of $50,000. Y’s
outside counsel has the right to offset amounts billed
for any legal services rendered against the annual re-
tainer. Pursuant to this agreement, Y’s outside coun-
sel offsets $50,000 of the legal fees from the acquisi-
tion against the retainer and bills Y for the balance of
$10,000. The $60,000 legal fee is an amount paid to
facilitate the acquisition of an ownership interest in
Y as described in paragraph (a)(3) of this section. Y
must capitalize the full amount of the $60,000 legal
fee.
Example 10.Corporate acquisition; antitrust de-
fense costs. On March 1, 2005, V corporation enters
into an agreement with X corporation to acquire all
of the outstanding stock of X. On April 1, 2005, fed-
eral and state regulators file suit against V to prevent
the acquisition of X on the ground that the acquisi-
tion violates antitrust laws. V enters into a consent
agreement with regulators on May 1, 2005, that al-
lows the acquisition to proceed, but requires V to hold
separate the business operations of X pending the out-
come of the antitrust suit and subjects V to possible
divestiture. V acquires title to all of the outstanding
stock of X on June 1, 2005. After June 1, 2005, the
regulators pursue antitrust litigation against V seek-
ing rescission of the acquisition. V pays $50,000 to
its outside counsel for services rendered after June 1,
2005, to defend against the antitrust litigation. V ulti-
mately prevails in the antitrust litigation. V’s costs to
defend the antitrust litigation are costs to facilitate its
acquisition of the stock of X under paragraph (a)(2)
of this section and must be capitalized. Although ti-
tle to the shares of X passed to V prior to the date
V incurred costs to defend the antitrust litigation, the
amounts paid by V are paid in the process of pursuing
the acquisition of the stock of X because the acquisi-
tion was not complete until the antitrust litigation was
ultimately resolved. V must capitalize the $50,000 in
legal fees.
Example 11.Corporate acquisition; defensive
measures. (i) On January 15, 2005, Y corporation,
a publicly traded corporation, becomes the target of
a hostile takeover attempt by Z corporation. In an
effort to defend against the takeover, Y pays legal
fees to seek an injunction against the takeover and
investment banking fees to locate a potential “white
knight” acquirer. Y also pays amounts to complete a
defensive recapitalization,and pays $50,000 to an in-
vestment banker for a fairness opinion regarding Z’s
initial offer. Y’s efforts to enjoin the takeover and
locate a white knight acquirer are unsuccessful, and
on March 15, 2005, Y’s board of directors decides to
abandon its defense against the takeover and nego-
tiate with Z in an effort to obtain the highest possi-
ble price for its shareholders. After Y abandons its
defense against the takeover, Y pays an investment
banker $1,000,000 for a second fairness opinion and
for services rendered in negotiating with Z.
(ii) The legal fees paid by Y to seek an injunc-
tion against the takeover are not amounts paid in the
process of investigating or otherwise pursuing the
transaction with Z. Accordingly, these legal fees are
not required to be capitalized under this section.
(iii) The investment banking fees paid to search
for a white knight acquirer do not facilitate an acqui-
sition of Y by a white knight because none of Y’s
costs with respect to a white knight were inherently
facilitative amounts and because Y did not reach the
date described in paragraph (e)(1) of this section with
respect to a white knight. Accordingly, these amounts
are not required to be capitalized under this section.
(iv) The amounts paid by Y to investigate and
complete the recapitalization must be capitalized un-
der paragraph (a)(4) of this section.
(v) The $50,000 paid to the investment bankers
for a fairness opinion during Y’s defense against the
takeover and the $1,000,000 paid to the investment
bankers after Y abandons its defense against the
takeover are inherently facilitative amounts with
respect to the transaction with Z and must be capital-
ized under paragraph (a)(3) of this section.
Example 12.Corporate acquisition; acquisition
by white knight. (i) Assume the same facts as inEx-
ample 11, except that Y’s investment bankers iden-
tify three potential white knight acquirers: U corpo-
ration, V corporation, and W corporation. Y pays its
investment bankers to conduct due diligence on the
three potential white knight acquirers. On March 15,
2005, Y’s board of directors approves a tentative ac-
quisition agreement underwhich W agrees to acquire
all of the stock of Y, and the investment bankers stop
due diligence on U and V. On June 15, 2005, W ac-
quires all of the stock of Y.
(ii) Under paragraph (e)(1) of this section, the
amounts paid to conduct due diligence on U, V, and
W prior to March 15, 2005 (the date of board of di-
rectors’ approval) are not amounts paid to facilitate
the acquisition of the stock of Y and are not required
to be capitalized under this section. However, the
amounts paid to conduct due diligence on W on and
after March 15, 2005, facilitate the acquisition of the
stock of Y and are required to be capitalized.
Example 13.Corporate acquisition; mutually ex-
clusive costs. (i) Assume the same facts as inExam-
ple 11, except that Y’s investment banker finds W, a
white knight. Y and W execute a letter of intent on
March 10, 2005. Under the terms of the letter of in-
tent, Y must pay W a $10,000,000 break-up fee if the
merger with W does not occur. On April 1, 2005, Z
significantly increases the amount of its offer, and Y
decides to accept Z’s offer instead of merging with W.
Y pays its investment banker $500,000 for inherently
facilitative costs with respect to the potential merger
with W. Y also pays its investment banker $2,000,000
for due diligence costs with respect to the potential
2004-7 I.R.B.475February 17, 2004

merger with W, $1,000,000 of which relates to ser-
vices performed on or after March 10, 2005.
(ii) Y’s $500,000 payment for inherently facilita-
tive costs and Y’s $1,000,000 payment for due dili-
gence activities performed on or after March 10, 2005
(the date the letter of intent with W is entered into),
facilitate the potential merger with W. Because Y
could not merge with both W and Z, under paragraph
(c)(8) of this section the $500,000 and $1,000,000
payments also facilitate the transaction between Y
and Z. Accordingly, Y must capitalize the $500,000
and $1,000,000 payments as amounts that facilitate
the transaction with Z.
(iii) Similarly, because Y could not merge with
both W and Z, under paragraph (c)(8) of this section
the $10,000,000 termination payment facilitates the
transaction between Y and Z. Accordingly, Y must
capitalize the $10,000,000 termination payment as an
amount that facilitates the transaction with Z.
Example 14.Break-up fee; transactions not
mutually exclusive. N corporation and U corporation
enter into an agreement under which U would acquire
all the stock or all the assets of N in exchange for U
stock. Under the terms of the agreement, if either
party terminates the agreement, the terminating party
must pay the other party $10,000,000. U decides to
terminate the agreement and pays N $10,000,000.
Shortly thereafter, U acquires all the stock of V
corporation, a competitor of N. U had the finan-
cial resources to have acquired both N and V. U’s
$10,000,000 payment does not facilitate U’s acquisi-
tion of V. Accordingly, U is not required to capitalize
the $10,000,000 payment under this section.
Example 15.Corporate reorganization; initial
public offering. Y corporation is a closely held cor-
poration. Y’s board of directors authorizes an initial
public offering of Y’s stock to fund future growth. Y
pays $5,000,000 in professional fees for investment
banking services related to the determination of the
offering price and legal services related to the devel-
opment of the offering prospectus and the registra-
tion and issuance of stock. The investment banking
and legal services are performed both before and after
board authorization. Under paragraph (a)(8) of this
section, the $5,000,000 is an amount paid to facilitate
a stock issuance.
Example 16.Auction. (i) N corporation seeks to
dispose of all of the stock of its wholly owned sub-
sidiary, P corporation, through an auction process and
requests that each bidder submit a non-binding pur-
chase offer in the form of a draft agreement. Q cor-
poration hires an investment banker to assist in the
preparation of Q’s bid to acquire P and to conduct a
due diligence investigation of P. On July 1, 2005, Q
submits its draft agreement. On August 1, 2005, N
informs Q that it has accepted Q’s offer, and presents
Q with a signed letter of intent to sell all of the stock
of P to Q. On August 5, 2005, Q’s board of directors
approves the terms of the transaction and authorizes
Q to execute the letter of intent. Q executes a binding
letter of intent with N on August 6, 2005.
(ii) Under paragraph (e)(1) of this section, the
amounts paid by Q to its investment banker that are
not inherently facilitative and that are paid for ac-
tivities performed prior to August 5, 2005 (the date
Q’s board of directors approves the transaction), are
not amounts paid to facilitate the acquisition of P.
Amounts paid by Q to its investment banker for ac-
tivities performed on or after August 5, 2005, and
amounts paid by Q to its investment banker that are
inherently facilitative amounts within the meaning of
paragraph (e)(2) of this section are required to be cap-
italized under this section.
Example 17.Stock distribution. Z corporation
distributes natural gas throughout state Y. The fed-
eral government brings an antitrust action against Z
seeking divestiture of certain of Z’s natural gas dis-
tribution assets. As a result of a court ordered divesti-
ture,Zandthefederalgovernment agree to a plan of
divestiture that requires Z to organize a subsidiary to
receive the divested assets and to distribute the stock
of the subsidiary to its shareholders. During 2005, Z
pays $300,000 to various independent contractors for
the following services: studying customer demand in
the area to be served by the divested assets, identify-
ing assets to be transferred to the subsidiary, organiz-
ing the subsidiary, structuring the transfer of assets
to the subsidiary to qualify as a tax-free transaction
to Z, and distributing the stock of the subsidiary to
the stockholders. Under paragraph (c)(3) of this sec-
tion, Z is not required to capitalize any portion of the
$300,000 payments.
Example 18.Bankruptcy reorganization.(i)X
corporation is the defendant in numerous lawsuits al-
leging tort liability based on X’s role in manufactur-
ing certain defective products. X files a petition for
reorganization under Chapter 11 of the Bankruptcy
Code in an effort to manage all of the lawsuits in a
single proceeding. X pays its outside counsel to pre-
pare the petition and plan of reorganization, to an-
alyze adequate protection under the plan, to attend
hearings before the Bankruptcy Court concerning the
plan, and to defend against motions by creditors and
tort claimants to strike the taxpayer’s plan.
(ii) X’s reorganization under Chapter 11 of the
Bankruptcy Code is a reorganization within the mean-
ing of paragraph (a)(4) ofthis section. Under para-
graph (c)(4) of this section, amounts paid by X to its
outside counsel to prepare, analyze or obtain approval
of the portion of X’s plan of reorganization that re-
solves X’s tort liability do not facilitate the reorga-
nization and are not required to be capitalized, pro-
vided that such amounts would have been treated as
ordinary and necessary business expenses under sec-
tion 162 had the bankruptcy proceeding not been in-
stituted. All other amounts paid by X to its outside
counsel for the services described above (including
all amounts paid to prepare the bankruptcy petition)
facilitate the reorganization and must be capitalized.
(m)Effective date. This section applies
to amounts paid or incurred on or after
December 31, 2003.
(n)Accounting method changes—(1)
In general. A taxpayer seeking to change
a method of accounting to comply with
this section must secure the consent of
the Commissioner in accordance with the
requirements of §1.446–1(e). For the tax-
payer’s first taxable year ending on or
after December 31, 2003, the taxpayer is
granted the consent of the Commissioner
to change its method of accounting to
comply with this section, provided the
taxpayer follows the administrative proce-
dures issued under §1.446–1(e)(3)(ii) for
obtaining the Commissioner’s automatic
consent to a change in accounting method
(for further guidance, for example, see
Rev. Proc. 2002–9, 2002–1 C.B. 327, and
§601.601(d)(2)(ii)(b) of this chapter).
(2)Scope limitations. Any limitations
on obtaining the automatic consent of the
Commissioner do not apply to a taxpayer
seeking to change to a method of account-
ing to comply with this section for its first
taxable year ending on or after December
31, 2003.
(3)Section 481(a) adjustment.The
section 481(a) adjustment for a change in
method of accounting to comply with this
section for a taxpayer’s first taxable year
ending on or after December 31, 2003, is
determined by taking into account only
amounts paid or incurred in taxable years
ending on or after January 24, 2002.
Par. 5. Section 1.446–5 is added to read
as follows:
§1.446–5 Debt issuance costs.
(a)In general. This section provides
rules for allocating debt issuance costs
over the term of the debt. For purposes of
this section, the termdebt issuance costs
means those transaction costs incurred
by an issuer of debt (that is, a borrower)
that are required to be capitalized under
§1.263(a)–5. If these costs are otherwise
deductible, they are deductible by the
issuer over the term of the debt as deter-
mined under paragraph (b) of this section.
(b)Method of allocating debt issuance
costs—(1)In general. Solely for purposes
of determining the amount of debt issuance
costs that may be deducted in any period,
these costs are treated as if they adjusted
the yield on the debt. To effect this, the is-
suer treats the costs as if they decreased the
issue price of the debt. See §1.1273–2 to
determine issue price. Thus, debt issuance
costs increase or create original issue dis-
count and decrease or eliminate bond is-
suance premium.
(2)Original issue discount.Anyre-
sulting original issue discount is taken into
account by the issuer under the rules in
§1.163–7, which generally require the use
of a constant yield method (as described in
§1.1272–1) to compute how much origi-
nal issue discount is deductible for a pe-
riod. However, see §1.163–7(b) for spe-
cial rules that apply if the total original is-
sue discount on the debt isde minimis.
February 17, 20044762004-7 I.R.B.

(3)Bond issuance premium.Anyre-
maining bond issuance premium is taken
into account by the issuer under the rules
of §1.163–13, which generally require the
use of a constant yield method for purposes
of allocating bond issuance premium to ac-
crual periods.
(c)Examples. The following examples
illustrate the rules of this section:
Example 1. (i) On January 1, 2004, X borrows
$10,000,000. The principal amount of the loan
($10,000,000) is repayable on December 31, 2008,
and payments of interest in the amount of $500,000
are due on December 31 of each year the loan is out-
standing. X incurs debt issuance costs of $130,000
to facilitate the borrowing.
(ii) Under §1.1273–2, the issue price of the loan
is $10,000,000. However, under paragraph (b) of
this section, X reduces the issue price of the loan by
the debt issuance costs of $130,000, resulting in an
issue price of $9,870,000. As a result, X treats the
loan as having original issue discount in the amount
of $130,000 (stated redemption price at maturity of
$10,000,000 minus the issue price of $9,870,000).
Because this amount of original issue discount is
more than thede minimisamount of original issue
discount for the loan determined under §1.1273–1(d)
($125,000 ($10,000,000 x .0025 x 5)), X must allo-
cate the original issue discount to each year based on
the constant yield method described in §1.1272–1(b).
See §1.163–7(a). Based on this method and a yield
of 5.30%, compounded annually, the original is-
sue discount is allocableto each year as follows:
$23,385 for 2004, $24,625 for 2005, $25,931 for
2006, $27,306 for 2007, and $28,753 for 2008.
Example 2. (i) Assume the same facts as inEx-
ample 1, except that X incurs debt issuance costs of
$120,000 rather than $130,000.
(ii) Under §1.1273–2, the issue price of the loan
is $10,000,000. However, under paragraph (b) of
this section, X reduces the issue price of the loan by
the debt issuance costs of $120,000, resulting in an
issue price of $9,880,000. As a result, X treats the
loan as having original issue discount in the amount
of $120,000 (stated redemption price at maturity of
$10,000,000 minus the issue price of $9,880,000).
Because this amount of original issue discount is
less than thede minimisamount of original issue
discount for the loan determined under §1.1273–1(d)
($125,000), X does not have to use the constant yield
method described in §1.1272–1(b) to allocate the
original issue discount to each year. Instead, under
§1.163–7(b)(2), X can choose to allocate the original
issue discount to each year on a straight-line basis
over the term of the loan or in proportion to the
stated interest payments ($24,000 each year). X also
could choose to deduct the original issue discount at
maturity of the loan. X makes its choice by reporting
the original issue discount in a manner consistent
with the method chosen on X’s timely filed federal
income tax return for 2004. If X wanted to use the
constant yield method, based on a yield of 5.279%,
compounded annually, the original issue discount is
allocable to each year as follows: $21,596 for 2004,
$22,736 for 2005, $23,937 for 2006, $25,200 for
2007, and $26,531 for 2008.
(d)Effective date. This section applies
to debt issuance costs paid or incurred for
debt instruments issued on or after Decem-
ber 31, 2003.
(e)Accounting method changes—(1)
Consent to change. An issuer required to
change its method of accounting for debt
issuance costs to comply with this section
must secure the consent of the Commis-
sioner in accordance with the requirements
of §1.446–1(e). Paragraph (e)(2) of this
section provides the Commissioner’s auto-
matic consent for certain changes.
(2)Automatic consent.TheCom-
missioner grants consent for an issuer to
change its method of accounting for debt
issuance costs incurred for debt instru-
ments issued on or after December 31,
2003. Because this change is made on
a cut-off basis, no items of income or
deduction are omitted or duplicated and,
therefore, no adjustment under section 481
is allowed. The consent granted by this
paragraph (e)(2) applies provided—
(i) The change is made to comply with
this section;
(ii) The change is made for the first tax-
able year for which the issuer must account
for debt issuance costs under this section;
and
(iii) The issuer attaches to its federal in-
come tax return for the taxable year con-
taining the change a statement that it has
changed its method of accounting under
this section.
PART 602—OMB CONTROL
NUMBERS UNDER THE PAPERWORK
REDUCTION ACT
Par. 6. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 7. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order for §1.263(a)–5 to read as follows:
§602.101 OMB Control numbers.
*****
(b) * * *
CFR part or section where
identified and described
Current OMB
control No.
*****
1.263(a)–5.................................................................................. 1545–1870
*****
Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.
Approved December 19, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
(Filed by the Office of the Federal Register on December 31,
2003, 8:45 a.m., and published in the issue of the Federal
Register for January 5, 2004, 69 F.R. 435)
Section 401.—Qualified
Pension, Profit-Sharing,
and
Stock Bonus Plans
26 C
FR 1.401(a)(4)–1: Nondiscrimination require-
men
ts of section 401(a)(4).
Whe
ther the application of section 410(b)(6)(C) of
the
Code to a defined benefit plan causes that de-
fin
ed benefit plan to fail the nondiscrimination re-
qui
rements of section 1.401(a)(4)–1(b)(2) of the In-
2004-7 I.R.B.477February 17, 2004

come Tax Regulations. See Rev. Rul. 2004-11, page
480.
26 CFR 1.401(a)(31)–1: Requirement to offer direct
rollover of eligible rollover distributions.
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
(Also, §§ 402, 403, 408, 457.)
Plan qualification; rollovers.This
ruling describes a situation where an eligi-
ble retirement plan separately accounts for
amounts attributable to rollover contribu-
tions to the plan. As a result, distributions
of those amounts are not subject to the re-
strictions on permissible timing that ap-
ply, under the applicable requirements of
the Code, to distributions of other amounts
from the plan.
Rev. Rul. 2004–12
ISSUE
If an eligible retirement plan sepa-
rately accounts for amounts attributable
to rollover contributions to the plan, are
distributions of those amounts subject to
the restrictions on permissible timing that
apply, under the applicable requirements
of the Internal Revenue Code, to distribu-
tions of other amounts from the plan?
LAW AND ANALYSIS
Portability
Prior to the enactment of the Economic
Growth and Tax Relief Reconciliation Act
of 2001 (“EGTRRA”), Pub. L. 107–16,
certain restrictions applied to rollovers by
individuals of funds accumulated in retire-
ment plans maintained by their employers
or in IRAs maintained by the individuals.
Sections 641 through 643 of EGTRRA
(as amended by § 411 of the Job Creation
and Worker Assistance Act of 2002, Pub.
L. 107–147) substantially increased the
rollover opportunities available to individ-
uals, by expanding both the types of plans
eligible to accept rollovers and the types
of funds that can be rolled over. Rules
applicable to rollovers (including the new
portability rules) are contained in the fol-
lowing sections of the Code:
(1) Section 402(c) provides that if any
amount paid from a qualified trust in an
eligible rollover distribution is transferred
to an eligible retirement plan in a rollover
that meets the requirements of that section,
the amount transferred is not includible in
gross income for the taxable year in which
paid. Similar rules apply to § 403(a) an-
nuity plans, § 403(b) tax-sheltered annu-
ities, IRAs and § 457 eligible governmen-
tal plans.
(2) Section 402(c)(2) provides that the
portion of an eligible rollover distribution
that would otherwise not be includible in
gross income cannot be rolled over un-
less such previously taxed amounts are
transferred either (i) in a direct trustee-to-
trustee transfer to a defined contribution
plan qualified under § 401(a) that agrees
to separately account for such amounts or
(ii) to an IRA.
(3) Section 401(a)(31) requires that
a qualified trust provide for the di-
rect trustee-to-trustee transfer (a “direct
rollover”) of eligible rollover distribu-
tions. In the case of previously taxed
amounts, the limitations described in the
preceding paragraph apply. Similar rules
apply to § 403(a) annuity plans, § 403(b)
tax-sheltered annuities and § 457 eligible
governmental plans. (See §§ 403(a)(5),
403(b)(10) and 457(d)(1)(C).)
(4) Section 408(d)(3)(A) provides that
previously taxed amounts distributed from
an IRA may only be rolled over to another
IRA.
(5) Section 402(c)(10) provides that
a § 457 eligible governmental plan may
not accept a rollover from another type
of eligible retirement plan unless it sepa-
rately accounts for suchrollover. Section
72(t)(9) provides that a distribution from
such separate account is subject to the
10-percent additional tax under § 72(t) as
if the distribution were from a plan de-
scribed in § 401(a).
(6) Section 402(f) requires that the re-
cipient of an eligible rollover distribution
be apprised of the fact that, if the distri-
bution is rolled over to an eligible retire-
ment plan, distributions from such eligible
retirement plan may be subject to restric-
tions and tax consequences that are differ-
ent from those applicable to distributions
from the plan making the eligible rollover
distribution. (See § 402(f)(1)(E).)
Distribution Rules Applicable to Rollovers
In many instances, the Code, or Income
Tax Regulations or other guidance issued
by the Service, provides explicitly for the
treatment of rollover contributions. For
example, the survivor annuity require-
ments of §§ 401(a)(11) and 417 apply to
all “benefits provided under a plan, in-
cluding benefits attributable to rollover
contributions” (§ 1.401(a)–20, Q&A–11).
Similarly, pursuant to § 411(a)(11)(D),
in determining whether an employee’s
accrued benefit exceeds $5,000 (and thus
may not be immediately distributed with-
out the consent of the employee), a plan
may provide that rollover contributions
(and attributable earnings) are disregarded.
In other instances, rollovers are implic-
itly included. For example, § 72(t) im-
poses a 10-percent additional tax on a tax-
payer who receives “any amount” from a
qualified retirement plan (within the mean-
ing of § 4974(c)) except as otherwise pro-
vided in § 72(t); the reference to “any
amount” and the lack of an exception for
amounts attributable to rollover contribu-
tions indicate that § 72(t) is applied with-
out regard to whether the amounts dis-
tributed are attributable to rollover contri-
butions.
The rules restricting the timing of dis-
tributions, other than those relating to
required minimum distributions under
§ 401(a)(9), generally apply to employer
contributions made to the plan or annu-
ity. For example, §§ 401(k)(2)(B) and
403(b)(11) prohibit the distribution of em-
ployer contributions that are elective de-
ferrals (within the meaning of § 402(g)(3))
prior to the occurrence of certain events.
Section 403(b)(7)(A)(ii) provides that
employer contributions to custodial ac-
counts treated as § 403(b) tax-sheltered
annuities may not be distributed prior to
the occurrence of certain events. Section
457(d)(1)(A) provides generally that an
eligible plan meets the distribution re-
quirements of § 457(d) if under the plan
amounts will not be made available to par-
ticipants or beneficiaries earlier than the
calendar year in which the participant at-
tains age 70
1
/2or when the participant has
a severance from employment. Similarly,
regulations under § 401 provide general
rules regarding the timing of distributions
of employer contributions to pension,
profit-sharing and stock bonus plans (see
February 17, 20044782004-7 I.R.B.

§ 1.401–1(b)(1)(i), (ii) and (iii)). Thus,
§ 1.401–1(b)(1)(i) provides that a pension
plan is a plan established and maintained
by an employer primarily to provide sys-
tematically for the payment of definitely
determinable benefits to employees over
a period of years, usually for life, after
retirement. The Service has interpreted
this to mean that employer contributions
to a pension plan may not be distributed
prior to retirement, death, disability or
other severance from employment, or ter-
mination of the plan.
Rev. Rul. 69–277, 1969–1 C.B. 116,
and Rev. Rul. 94–76, 1994–2 C.B. 46, ad-
dress distributions of other types of con-
tributions. Rev. Rul. 69–277 provides
that a pension plan may permit distribu-
tion to an employee of amounts attribut-
able to the employee’s after-tax contribu-
tions prior to the employee’s termination
of employment. Rev. Rul. 94–76 provides
that a profit-sharing plan may permit the
immediate distribution of amounts attrib-
utable to a rollover.
Based on the foregoing, eligible re-
tirement plans that separately account for
amounts attributable to rollover contri-
butions may permit the distribution of
amounts attributable to an individual’s
rollover, at any time, pursuant to the indi-
vidual’s request (with spousal consent, if
applicable to the plan).
In contrast to rollovers, Rev. Rul.
94–76 and Rev. Rul. 2002–42, 2002–2
C.B. 76, provide that, in the case of
a § 414(l) transfer between dissimilar
§ 401(a) plans (or a plan amendment
treated as such a transfer), the character-
istics of the transferor plan continue to
apply to the transferred assets held in the
transferee plan. Thus, when employees’
accounts in an employer’s money pur-
chase pension plan are transferred to the
employer’s profit-sharing plan, the trans-
ferred assets remain subject to the rules
applicable to distributions from a money
purchase pension plan: for example, they
may not be distributed prior to retirement,
death, disability or other severance from
employment, or termination of the plan,
even though other assets in the plan may
be distributed earlier.Similarly, pursuant
to § 401(a)(11)(B), a defined contribution
plan not otherwise subject to the survivor
annuity requirements of §§ 401(a)(11)
and 417 is subject to such requirements if
the plan is a transferee of a plan subject
to such requirements. However, if the
transferee plan separately accounts for the
transferred assets and any income thereon,
the survivor annuity requirements only
apply with respect to the transferred assets
(and income thereon).
In the case of § 403(b) tax-sheltered an-
nuities, Rev. Rul. 90–24, 1990–1 C.B.
97, provides that an amount directly trans-
ferred from an annuity subject to the early
distribution restrictions of § 403(b)(7) or
(11) to an annuity not otherwise subject to
such restrictions is not treated as a distri-
bution if the transferred amount continues
to be subject to the early distribution re-
strictions of § 403(b)(7) or (11), respec-
tively. In the case of plan-to-plan trans-
fers between § 457 eligible governmental
plans, § 1.457–10(b)(6) provides that an
amount transferred is subject to the dis-
tribution restrictions of the receiving plan
in the same manner as if the transferred
amount had originally been deferred under
the receiving plan if the participant is per-
forming services for the entity maintaining
the receiving plan.
HOLDING
If an eligible retirement plan sepa-
rately accounts for amounts attributable to
rollover contributionsto the plan, distri-
butions of those amounts are not subject
to the restrictions on permissible timing
that apply, under theapplicable require-
ments of the Internal Revenue Code, to
distributions of other amounts from the
plan. Accordingly, the plan may permit
the distribution of amounts attributable to
rollover contributions at any time pursuant
to an individual’s request.
Thus, for example, if the receiving plan
is a money purchase pension plan and the
plan separately accounts for amounts at-
tributable to rollover contributions, a plan
provision permitting the in-service distri-
bution of those amounts will not cause the
plan to fail to satisfy the requirements of
§ 1.401–1(b)(1)(i). Similarly, if the receiv-
ing plan is a § 457 eligible governmental
plan or a tax-sheltered annuity described
in § 403(b)(7) or (11), amounts attributable
to rollovers that are maintained in separate
accounts are permitted to be distributed
at any time even though distribution of
other amounts under the plan or contract is
restricted pursuant to § 457(d)(1)(A) and
§ 403(b)(7) or (11), respectively.
However, a distribution of amounts at-
tributable to a rollover contribution is sub-
ject to the survivor annuity requirements of
§§ 401(a)(11) and 417, the minimum dis-
tribution requirements of § 401(a)(9), and
the additional income tax on premature
distributions under § 72(t), as applicable to
the receiving plan. Thus, for example, if a
distribution from an IRA is rolled over into
a plan described in § 401(a), any distribu-
tion from the § 401(a) plan of amounts at-
tributable to the rollover would be subject
to the exceptions from the § 72(t) tax that
apply to § 401(a) plans and not the excep-
tions that apply to IRAs.
This holding does not apply to amounts
received by a plan as a result of a merger,
consolidation or transfer of plan assets un-
der § 414(l), nor to plan-to-plan transfers
otherwise permitted between § 403(b) tax-
sheltered annuities and between § 457 eli-
gible governmental plans.
DRAFTING INFORMATION
The principal author of this revenue rul-
ing is Roger Kuehnle of the Employee
Plans, Tax Exempt and Government Enti-
ties Division. For further information re-
garding this revenue ruling, please con-
tact Employee Plans’ taxpayer assistance
telephone service at 1–877–829–5500 (a
toll-free number), between the hours of
8:00 a.m. and 6:30 p.m. Eastern Time,
Monday through Friday. Mr. Kuehnle
may be reached at 202–283–9888 (not a
toll-free number).
Section 402.—Taxability of
Beneficiary of Employees’
Trust
Whether amounts are eligible for rollover distribu-
tions. See Rev. Rul. 2004-12, page 478.
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
Section 403.—Taxation of
Employee Annuities
Whether amounts attributable to rollovers that are
accounted for separately aresubject to the plan’s gen-
2004-7 I.R.B.479February 17, 2004

eral distribution requirements. See Rev. Rul. 2004-
12, page 478.
Section 408.—Individual
Retirement Accounts
Whether amounts attributable to rollovers that are
accounted for separately are subject to the IRA’s gen-
eral distribution requirements. See Rev. Rul. 2004-
12, page 478.
Section 409.—Qualifi-
cations for Tax Credit
Employee Stock Own-
ership Plans
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
Section 410.—Minimum
Participation Standards
26 CFR 1.410(b)–2: Minimum coverage require-
ments (after 1993).
(Also, § 401; § 1.401(a)(4)–1.)
Coverage; special rules; request for
comments.This ruling describes the ap-
plication of the special coverage rule for
acquisitions and dispositions in section
410(b)(6)(C) of the Code in a situation
involving a defined benefit plan and a
profit-sharing plan that includes a quali-
fied cash or deferred arrangement under
section 401(k)(2). In addition, the ruling
holds that a significant change in a plan or
in the coverage of a plan during the transi-
tion period under section 410(b)(6)(C)(ii)
curtails the period effective as of the date
of the change and does not make the plan
retroactively ineligible to apply section
410(b)(6)(C). Finally, the ruling also asks
for comments as to other situations that
may arise under section 410(b)(6)(C).
Rev. Rul. 2004–11
ISSUES
(1) Will the plans described below be
treated as satisfying the requirements of
§ 1.401(a)(4)–1(b)(2) of the Income Tax
Regulations, relating to nondiscriminatory
contributions or benefits, and the require-
ments of §§ 401(k) and 401(m) of the Inter-
nal Revenue Code, as well as the require-
ments of § 410(b), by reason of the special
rule in § 410(b)(6)(C) for certain acquisi-
tions or dispositions?
(2) Does a significant change in a plan’s
coverage during the transition period un-
der § 410(b)(6)(C)(ii) make a plan ineligi-
ble for the special rule in § 410(b)(6)(C),
or merely curtail the transition period dur-
ing which the special rule may be applied
to the plan?
FACTS
Subsidiary S, which is part of X, a
controlled group of corporations under
§ 414(b), sponsors a defined benefit pen-
sion plan and a profit-sharing plan for
its employees. Both plans are qualified
under § 401(a), and the plan year of each
plan is the calendar year. Only employ-
ees of S are eligible to participate in the
plans. The defined benefit plan would
satisfy a nondiscrimination safe harbor
under § 1.401(a)(4)–3(b) but for the fact
that the plan provides a subsidized early
retirement benefit that is not currently
available to substantially all employees.
For purposes of satisfying the nondis-
crimination requirements of § 401(a)(4),
the defined benefit plan is therefore re-
structured into two component plans, as
permitted by § 1.401(a)(4)–9(c), one com-
ponent consisting of all the accruals and
other benefits, rights, and features pro-
vided to those employees to whom the
subsidized early retirement benefit is cur-
rently available, and the other component
consisting of all the accruals and other
benefits, rights, and features provided to
those employees to whom the subsidized
early retirement benefit is not currently
available. Each of the component plans
separately satisfies a nondiscrimination
safe harbor under § 1.401(a)(4)–3(b) and
the other nondiscrimination requirements
of § 401(a)(4) and also separately satisfies
§ 410(b) by satisfying the ratio percentage
test of § 1.410(b)–2(b)(2). The profit-shar-
ingplanincludesonlyaqualifiedcash
or deferred arrangement, as defined in
§ 401(k)(2), and matching contributions
that are subject to the nondiscrimination
requirements of § 401(m).
On June 22, 2004, all of the stock
of S is sold to corporation Y. Immedi-
ately before the sale, the defined benefit
plan maintained by S satisfies the mini-
mum coverage requirements of § 410(b)
by satisfying the ratio percentage test of
§ 1.410(b)–2(b)(2), and the qualified cash
or deferred arrangement and the matching
contribution portion of the profit-sharing
plan each satisfy the ratio percentage test.
For this purpose, neither plan is aggre-
gated with any other plan, and X does
not apply the coverage requirements of
§ 410(b) on the basis of separate lines of
business under § 414(r). In addition, each
of the component plans under the defined
benefit plan satisfies the nondiscrimina-
tion requirements of § 401(a)(4) and the
ratio percentage test of § 1.410(b)–2(b)(2)
immediately before the sale.
S continues to maintain the profit-shar-
ing plan without change after the sale. S
also continues to maintain the defined ben-
efit plan, but amends the plan to signifi-
cantly change the benefit formula effective
April 1, 2005.
LAW
Under § 401(a)(3), a plan is not qual-
ified under section § 401(a) unless it
satisfies the minimum coverage require-
ments of § 410(b) and § 1.410(b)–2. In
order to satisfy § 410(b) and § 1.410(b)–2,
the group of employees benefiting under
a plan must not discriminate in favor of
highly compensated employees (within
the meaning of § 414(q)). In general, a
plan satisfies § 410(b) for a plan year if the
plan satisfies either the ratio percentage
test in § 1.410(b)–2(b)(2) or the average
benefit test in § 1.410(b)–2(b)(3) for the
plan year. A plan satisfies the ratio per-
centage test for a plan year if, for the plan
year, the plan benefits a percentage of
nonhighly compensated employees which
is at least 70 percent of the percentage
of highly compensated employees ben-
efiting under the plan. A plan satisfies
the average benefit test for a plan year
if, for the plan year, the plan satisfies
the nondiscriminatoryclassification test
in § 410(b)(2)(A)(i) and § 1.410(b)–4
and the average benefit percentage test in
§ 410(b)(2)(A)(ii) and § 1.410(b)–5. In
general, the average benefit percentage
test requires the determination of each
employee’s employee benefit percentage,
based on employer-provided contributions
or benefits, under all of the employer’s
qualified plans.
Section 410(b)(6)(C)provides a special
rule for applying the minimum coverage
February 17, 20044802004-7 I.R.B.

requirements in situations involving cer-
tain acquisitions or dispositions. Under
§ 410(b)(6)(C), if a person becomes, or
ceases to be, a member of a group de-
scribed in § 414(b), (c), (m), or (o), the
requirements of § 410(b) are treated as
having been met during the transition pe-
riod with respect to any plan covering em-
ployees of such person or any other mem-
ber of such group, provided two condi-
tions are met. First, the plan must have
satisfied the requirements of § 410(b) im-
mediately before each such change in the
members of a group. Second, the cover-
age under the plan must not significantly
change during the transition period (other
than by reason of the change in the mem-
bers of a group) or the plan must meet such
other requirements as the Secretary may
prescribe. The transition period is defined
in § 410(b)(6)(C)(ii) as the period begin-
ning on the date of the change in members
of a group and ending on the last day of
the first plan year beginning after the date
of such change.
For purposes of § 410(b)(6)(C), § 1.410
(b)–2(f) provides that the terms “acqui-
sition” and “disposition” refer to an as-
set or stock acquisition, merger, or other
similar transaction involving a change in
employer of the employees of a trade or
business. Section 1.410(b)–2(f) provides
that a plan may be treated as satisfying
§ 410(b) during the transition period fol-
lowing an acquisition or disposition if the
plan satisfies § 410(b) (without regard to
§ 410(b)(6)(C)) immediately before the ac-
quisition or disposition and there is no sig-
nificant change in the plan or in the cover-
age of the plan other than the acquisition
or disposition.
Section 1.410(b)–7 provides the def-
inition of plan that applies for purposes
of § 410(b). In general, each single plan
within the meaning of § 414(l) is a separate
plan for purposes of § 410(b), but certain
plans must be treated as comprising two
or more separate plans, each of which is
a single plan for purposes of § 410(b).
Under § 1.410(b)–7(c), the portion of a
plan that is a “section 401(k) plan” is
treated as a separate plan for purposes of
§ 410(b). (A “section 401(k) plan” is a
plan consisting solely of elective contribu-
tions described in §1.401(k)–1(g)(3) under
a qualified cash or deferred arrangement
described in § 1.401(k)–1(a)(4)(i).) Simi-
larly, the portion of a plan that is a “section
401(m) plan” is treated as a separate plan
for purposes of § 410(b). (A “section
401(m) plan” is a plan consisting solely
of employee contributions described in
§1.401(m)–1(f)(6) or matching contribu-
tions described in §1.401(m)–1(f)(12), or
both.) Thus, in the case of a plan that
includes elective contributions and em-
ployee or matching contributions, the plan
must be disaggregated. The portion of the
plan that is a section 401(k) plan and the
portion of the plan that is a section 401(m)
plan must separately satisfy § 410(b).
In general, for purposes of the ratio
percentage test and the nondiscriminatory
classification test, an employer may per-
missively aggregate two or more plans,
other than plans that are required to be
disaggregated. If the employer does so,
the aggregated plans are treated as a sin-
gle plan for purposes of §§ 410(b) and
401(a)(4).
Under § 401(a)(4), a plan is not qual-
ified under § 401(a) unless the contribu-
tions or benefits under the plan do not
discriminate in favor of highly compen-
sated employees (within the meaning
of § 414(q)). Sections 1.401(a)(4)–1
through 1.401(a)(4)–13 set forth the ex-
clusive rules for determining whether a
plan satisfies this requirement. Section
1.401(a)(4)–1(b)(2) requires that either
the contributions or the benefits under
the plan be nondiscriminatory in amount.
Section 1.401(a)(4)–3 contains the rules
for determining whether employer-de-
rived benefits under a defined benefit
plan are nondiscriminatory in amount.
Unless the plan satisfies a nondiscrimina-
tion safe harbor under § 1.401(a)(4)–3(b),
the plan must satisfy the general test for
nondiscrimination in amount of bene-
fits under § 1.401(a)(4)–3(c) for the plan
year. However, § 1.401(a)(4)–1(c)(4)(iii)
and § 1.401(a)(4)–9(c) allow a plan to be
treated as consisting of two or more com-
ponent plans for purposes of satisfying
§ 401(a)(4). If each component plan satis-
fies §§ 401(a)(4) and 410(b) as if it were
a separate plan, then the plan is treated as
satisfying § 401(a)(4). A component plan
consists of all the allocations or accruals
and other benefits, rights, and features pro-
vided under the plan to a selected group
of employees. Every employee must be
included in one and only one component
plan under a plan for a plan year. The
requirement that each component plan
satisfy § 410(b) is in addition to the re-
quirement that the plan satisfy § 410(b).
Section 1.401(a)(4)–1(c)(4)(iv) provides
that, except as otherwise specifically pro-
vided, references to satisfying § 410(b) in
the regulations under § 401(a)(4) mean sat-
isfying § 1.410(b)–2, taking into account
any special rules available in satisfying
that section (other than the permissive
aggregation rules of § 1.410(b)–7(d)).
Section 401(k)(1) provides that a
profit-sharing or stock bonus plan does
not fail to be qualified under § 401(a)
merely because the plan includes a qual-
ified cash or deferred arrangement. Sec-
tion 401(k)(3)(A)(i) provides that a cash
or deferred arrangement is not a qual-
ified cash or deferred arrangement un-
less those employees eligible to benefit
under the arrangement satisfy the pro-
visions of § 410(b)(1). (This require-
ment corresponds to the requirement in
§ 1.410(b)–7(c) that a section 401(k) plan
must separately satisfy § 410(b).) Section
401(k)(3)(A)(ii) provides that a cash or
deferred arrangement is not a qualified
cash or deferred arrangement unless the
arrangement satisfies the actual deferral
percentage (ADP) test described therein.
Section 401(m) provides special
nondiscrimination requirements for em-
ployee and matching contributions under
a qualified defined contribution plan. Sec-
tion 401(m)(1) provides that the amount
of employee and matching contributions
under a defined contribution plan satisfies
the requirements of § 401(a)(4) only if
the employee and matching contributions
under the plan satisfy the actual contribu-
tion percentage (ACP) test described in
§ 401(m)(2).
ANALYSIS
The sale of S to Y is an acquisi-
tion or disposition within the mean-
ing of § 1.410(b)–2(f), and the defined
benefit plan and each of the disag-
gregated portions ofthe profit-sharing
plan satisfy § 410(b) (without regard to
§ 410(b)(6)(C)) immediately before the
acquisition or disposition. The sale would
affect the data required to be taken into
account in applying the requirements of
§ 410(b) to the plans in the absence of the
special rule in § 410(b)(6)(C).
There is no significant change in the
section401(k)planorinthecoverageof
2004-7 I.R.B.481February 17, 2004

thesection401(k)plan(otherthantheac-
quisition or disposition) during the transi-
tion period under § 410(b)(6)(C)(ii). Like-
wise, there is no significant change in the
section 401(m) plan or in the coverage of
the section 401(m) plan. Therefore, the
special rule in § 410(b)(6)(C) may be ap-
plied to each of the disaggregated portions
of the profit-sharing plan for the transition
period starting on the date of sale of S to
Y (June 22, 2004) and continuing through
December 31, 2005 (that is, the last day
of the plan year beginning on January 1,
2005). Accordingly, under § 410(b)(6)(C),
the profit-sharing plan will be treated as
satisfying the requirements of § 410(b)
during the transition period.
The coverage requirement for a qual-
ified cash or deferred arrangement in
§ 401(k)(3)(A)(i) requires the group of
employees eligible to benefit under the
arrangement to satisfy § 410(b). There-
fore, the special rule for certain acqui-
sitions or dispositions in § 410(b)(6)(C)
and § 1.410(b)–2(f) may be applied for
purposes of satisfying that requirement.
Accordingly, the cash or deferred ar-
rangement in the profit-sharing plan will
be treated as satisfying the coverage re-
quirement in § 401(k)(3)(A)(i) during the
transition period.
On the other hand, the ADP test and
ACP test described in § 401(k)(3)(A)(ii)
and § 401(m)(2), respectively, do not re-
fer to § 410(b). Rather, these tests require
the comparison of the average of the ac-
tual deferral ratios and actual contribution
ratios of the group of eligible highly com-
pensated employees and the group of el-
igible nonhighly compensated employees
under the plan. Therefore, the special rule
for certain acquisitions or dispositions in
§ 410(b)(6)(C) and § 1.410(b)–2(f) does
not apply for purposes of satisfying the
ADP test or the ACP test and thus pro-
vides no relief from satisfying these tests
using the averages of the actual deferral ra-
tios and actual contribution ratios, respec-
tively, of the eligible employees under the
plan. Accordingly, the cash or deferred ar-
rangement and the matching contributions
under the profit-sharing plan must satisfy
the ADP test and the ACP test following
thesaleofStoYusingtheseratios.
The benefit formula in the defined ben-
efit plan does not satisfy a nondiscrimina-
tion safe harbor because the plan provides
a subsidized early retirement benefit that
is not currently available to substantially
all employees. However, for purposes of
satisfying § 401(a)(4), the plan is restruc-
tured, as permitted by § 1.401(a)(4)–9(c),
into two component plans each of which
separately satisfies a nondiscrimination
safe harbor. Section 1.401(a)(4)–9(c) re-
quires that each component plan separately
satisfy § 410(b) as well as § 401(a)(4).
Pursuant to § 1.401(a)(4)–1(c)(4)(iv), the
requirements of § 410(b) are to be applied
to the component plans taking into account
any special rules available in satisfying
§ 1.410(b)–2 (other than the permissive ag-
gregation rules of § 1.410(b)–7(d)). Thus,
for purposes of satisfying the requirements
of § 1.401(a)(4)–9(c), the special rule in
§ 410(b)(6)(C) and § 1.410(b)–2(f) may
be applied, provided (1) each component
plan separately satisfies §§ 401(a)(4) and
410(b) immediately before the acquisition
or disposition and (2) neither the plan nor
the coverage under the plan is significantly
changed during the transition period (other
than by reason of the change in the mem-
bers of a group) or the plan meets such
other requirements as the Secretary may
prescribe.
Each component plan under the de-
fined benefit plan separately satisfies
§§ 401(a)(4) and 410(b) immediately be-
fore the sale of S to Y, and there is no
significant change in the defined benefit
plan or in the coverage under the defined
benefit plan (other than the acquisition or
disposition) during the period following
the sale and prior to April 1, 2005.
The plan amendment significantly
changing the benefit formula in the de-
fined benefit plan, effective April 1, 2005,
is a significant change in the plan or in
the coverage of the plan (other than the
acquisition or disposition) for purposes of
§ 410(b)(6)(C) and § 1.410(b)–2(f). For
this purpose, a change in the plan means
a change in the benefits or in the benefit
levels under the plan.
The effect of § 410(b)(6)(C) is to pro-
vide time for a plan sponsor to consider
what coverage or other plan changes will
need to be made for the sponsor’s plans
to continue to satisfy the minimum cov-
erage requirements following an acquisi-
tion or disposition. Thus, the plan spon-
sorisrelievedfromhavingtoimmediately
amend its plans or otherwise effect cover-
age changes to comply with § 410(b). The
rule in § 410(b)(6)(C) is permissive, so that
plan sponsors may choose to satisfy the re-
quirements of § 410(b) after an acquisition
or disposition either with or without regard
to § 410(b)(6)(C). Furthermore, the transi-
tion period described in § 410(b)(6)(C)(ii)
is the maximum period allowed to a plan
sponsor before the sponsor must take into
account the change in the employer re-
sulting from the acquisition or disposition.
There is no requirement to apply the relief
in § 410(b)(6)(C) for the whole of the al-
lowable transition period. Thus, the effect
of a significant change in a plan or in the
coverage of a plan (other than the acqui-
sition or disposition) during the transition
period under § 410(b)(6)(C)(ii) is to curtail
the period effective as of the date of the
change and not to make the plan retroac-
tively ineligible to apply § 410(b)(6)(C).
Accordingly, under § 410(b)(6)(C), the de-
fined benefit plan will be treated as satis-
fying the requirements of § 410(b) and the
requirements of § 1.401(a)(4)–1(b)(2) dur-
ing the applicable transition period from
June 22, 2004, through March 31, 2005.
Starting April 1, 2005, the defined
benefit plan must satisfy the require-
ments of § 410(b) and the requirements
of § 1.401(a)(4)–1(b)(2) without regard
to the special rule in § 410(b)(6)(C). That
is, the plan must satisfy these require-
ments taking into account the employees
of Y. The profit-sharing plan must sat-
isfy the requirements of §§ 410(b) and
401(k)(3)(A)(i) taking into account the
employees of Y starting the first day of
the plan year beginning on January 1,
2006. The plan amendment significantly
changing the benefit formula in the de-
fined benefit plan does not curtail the
profit-sharing plan’s transition period un-
der § 410(b)(6)(C)(ii) because the plans
satisfy the requirements of § 410(b) inde-
pendently of each other.
HOLDINGS
ISSUE (1)
Under the facts setforth, the defined
benefit plan will be treated as satisfy-
ing the requirements of § 410(b) and the
requirements of § 1.401(a)(4)–1(b)(2) dur-
ing the applicable transition period from
June 22, 2004, through March 31, 2005.
The profit-sharing plan will be treated as
satisfying the minimum coverage require-
ments of § 410(b) by reason of the special
February 17, 20044822004-7 I.R.B.

rule in § 410(b)(6)(C) during the plan’s
applicable transition period from the date
of the sale through December 31, 2005.
The cash or deferred arrangement will
also be treated as satisfying the coverage
requirement of § 401(k)(3)(A)(i) during
this transition period. However, the cash
or deferred arrangement and the match-
ing contributions under the profit-sharing
plan will not, by reason of the special
rule in § 410(b)(6)(C), be treated as sat-
isfying the ADP test or the ACP test in
§ 401(k)(3)(A)(ii) and § 401(m)(2), and,
therefore, the plan must satisfy these tests
for the plan years ending on December 31,
2004, and December 31, 2005.
ISSUE (2)
A significant change in a plan or in the
coverage of a plan curtails the transition
period under § 410(b)(6)(C)(ii), so that
§ 410(b)(6)(C) ceases to apply to the plan
as of the date of the change. The change
does not make the plan retroactively ineli-
gible to apply § 410(b)(6)(C).
REQUEST FOR COMMENTS
The facts in this revenue ruling de-
scribe only one of many situations that
may involve the application of the special
rule for acquisitions and dispositions in
§ 410(b)(6)(C). Different types of transac-
tions or different fact patterns may raise
questions other than those addressed in
this revenue ruling or may require differ-
ent analyses. The Service and the Treasury
are considering issuing additional guid-
ance regarding § 410(b)(6)(C) of a more
comprehensive nature and invite public
comments. Comments are invited on the
issues on which guidance is needed and on
the appropriate resolution of these issues.
Commentators are specifically asked to
comment on what the appropriate analy-
sis would be if the facts of the ruling were
changed as in the situations described be-
low. In commenting on these situations,
commentators are asked to address:
•the requirement in § 410(b)(6)(C)(i)(I)
(i.e., that the plan satisfy § 410(b) im-
mediately prior tothe acquisition or
disposition), and
•the requirement in § 410(b)(6)(C)(i)(II)
(i.e., that coverage under the plan not
be significantly changed during
the transition period),
including how each of these two require-
ments applies with respect to the seller,
the transferred employees, and the buyer
in each situation; and
•whether, without creating a potential
for abuse, there are appropriate cir-
cumstances where a plan that is re-
quired to calculate employee alloca-
tion or accrual rates or employee bene-
fit percentages to determine that the re-
quirements of § 401(a)(4) or § 410(b)
(e.g., the general test or the average
benefit percentage test) are satisfied
should be treated as satisfying those re-
quirements during the transition period
following a § 410(b)(6)(C) acquisition
or disposition.
In the following situations, assume that
the defined benefit plan sponsored by S
(Plan A) provides a benefit of one percent
of compensation per year of service and
that S does not sponsor a profit-sharing
plan. Otherwise, the facts are the same as
in the revenue ruling except as described
in each of the three situations.
Situation 1: Effect of Transaction if
Part of Seller’s Plan is Spun-off and is
Maintained by Buyer.Atthetimeofthe
sale of S to Y, Plan A covers other employ-
ees of group X as well as employees of S.
WhenSissoldtoY,PlanAissplitintotwo
plans, Plan A–1 which covers employees
of group X who are not employees of S,
and Plan A–2, which covers employees of
S. Plan A–2 is thus spun off as a separate
plan that is maintained by S after the sale
of S to Y.
a. Assume that, had the sale of S to Y
not occurred, Plan A–1 would not
satisfy § 410(b) without being aggre-
gated with Plan A–2 (or that Plan A–2
would not satisfy § 410(b) without
being aggregated with Plan A–1).
b. Assume that, after the spin-off, a sig-
nificant change is made to Plan A–2,
but the change is not made to Plan
A–1.
Commentators are also asked to con-
sider what the analysis would be if, when
S is sold to Y, there is no plan spin-off. As
a result, the employees of S do not benefit
under a plan after the sale.
Situation 2: Effect on Buyer’s Plan if
Seller’s Plan is Assumed by Buyer.Sis
a division of group X, rather than a sub-
sidiary, and the transaction is the sale of
all of the assets and liabilities of division
S to Y. In conjunction with the sale, all di-
vision S employees become employees of
Y. Y also maintains a defined benefit plan
(Plan B) that provides a benefit of two per-
cent of compensation for each year of ser-
vice. Plan A is assumed by Y, so that em-
ployees of S continue to accrue benefits
at the rate of one percent of compensation
per year of service. The other employees
ofYdonotparticipateinPlanA,andthe
employees of S do not participate in Plan
B. For purposes of analyzing the applica-
tion of § 410(b)(6)(C) to Plan B, consider
both the situation where the exclusion of
the employees of S from Plan B is the re-
sult of Plan B’s existing terms and the situ-
ation where the exclusion is the result of an
amendment to Plan B adopted at the time
ofthesaleofStoY.
Situation 3: Effect on Buyer’s Plan if
Seller’s Plan is Not Assumed by Buyer.
The transaction is the same as in Situation
2, the sale of the assets and liabilities of di-
vision S to Y and the transfer of division S
employees. However, Y does not assume
Plan A, and there are three alternative sce-
narios with respect to the coverage of em-
ployees of S under Plan B:
a. Plan B does not exclude the employ-
ees of S. As a result, the employees of
S immediately begin to accrue bene-
fits at the rate of two percent of com-
pensation per year of service under
Plan B.
b. Plan B excludes the employees of S.
As a result, the employees of S do not
benefit under a plan after the sale.
c. Plan B is amended at the time of the
sale of S to Y to provide a benefit
of one percent of compensation per
year of service to the employees of S,
while continuing to provide the two
percent benefit formula for the other
employees of Y.
The Service also welcomes comments
on other situations or other questions re-
lating to the application of § 410(b)(6)(C).
2004-7 I.R.B.483February 17, 2004

SUBMISSION OF COMMENTS
Comments should be submitted by
May 17, 2004, to CC:PA:LPD:RU (Rev.
Rul. 2004–11), Room 5203, Internal Rev-
enue Service, POB 7604 Ben Franklin
Station, Washington, D.C. 20044. Com-
ments may be hand delivered between
thehoursof8a.m. and5p.m.,Monday
through Friday to CC:PA:LPD:RU (Rev.
Rul. 2004–11), Courier’s Desk, Internal
Revenue Service, 1111 Constitution Ave.,
NW, Washington D.C. Alternatively, com-
ments may be submitted via the Internet at
Notice.Comments@irscounsel.treas.gov.
All comments will be available for public
inspection.
DRAFTING INFORMATION
The principal authors of this revenue
ruling are James Flannery of Employee
Plans, Tax Exempt and Government Enti-
ties Division, and R. Lisa Mojiri-Azad of
the Office of Division Counsel/Associate
Chief Counsel (Tax Exempt and Govern-
ment Entities). For further information re-
garding this revenue ruling, please contact
the Employee Plans’ taxpayer assistance
telephone service at 1–877–829–5500 be-
tween the hours of 8:00 a.m. and 6:30
p.m. Eastern time, Monday through Fri-
day (a toll-free number). Mr. Flannery
may be reached at 1–202–283–9888 (not
a toll-free call). Ms. Mojiri-Azad may
be reached at 1–202–622–6060 (also not a
toll-free call).
Section 411.—Minimum
Vesting Standards
26 CFR 1.411(a)–11: Restriction and valuation of
distributions.
Significant detriment; defined con-
tribution plan; allocation of expenses.
This ruling describes the application of the
significant detriment rule in regulations
section 1.411(a)–11(c)(2)(i) in relation-
ship to the Department of Labor’s Field
Assistance Bulletin 2003–3 pertaining to
the allocation of expenses in a defined
contribution plan.
Rev. Rul. 2004–10
ISSUE
Does a defined contribution plan un-
der which the accounts of former employ-
ees are charged apro ratashare of the
plan’s reasonable administrative expenses,
but the accounts of current employees are
not charged those expenses, fail to satisfy
the requirements of § 411(a)(11) of the In-
ternal Revenue Code?
FACTS
Employer X maintains Plan A, a quali-
fied defined contribution plan. Plan A pro-
vides that a participant who terminates em-
ployment will receive payment of his or
her vested account balance under the plan
commencing at normal retirement age or,
if later, at termination of employment (sub-
ject to § 401(a)(9), in the case of a 5 per-
cent owner). The plan permits a partici-
pant who terminates employment prior to
normal retirement age to elect at any time
after termination of employment to receive
an immediate distribution of the vested ac-
count balance.
Plan A provides that certain adminis-
trative expenses,e.g., investment man-
agement fees, are to be allocated to the
individual accounts of participants and
beneficiaries based upon the ratio of each
account balance to the total account bal-
ances of all participants and beneficiaries.
Plan A further provides that the share of
these expenses allocable to each partici-
pant’s and beneficiary’s account will be
paid from the plan and charged against
the account to the extent not paid by the
employer. Employer X pays the portion
of these expenses allocable to the accounts
of current employees, but not those of for-
mer employees or their beneficiaries. All
of the administrative expenses are proper
plan expenses, within the meaning of the
Employee Retirement Income Security
Act of 1974 (ERISA), and are reasonable
with respect to the services to which they
relate.
LAW AND ANALYSIS
Section 411(a)(11)(A) sets forth re-
quirements that must be satisfied with re-
spect to certain distributions in order for a
plan to be qualified under § 401(a). Under
§ 411(a)(11), if the present value of a par-
ticipant’s nonforfeitable benefit exceeds
$5,000, a plan meets the requirements
of § 411(a)(11) only if the plan provides
that the benefit may not be immediately
distributable without the consent of the
participant.
Section 1.411(a)–11(c)(2)(i) of the In-
come Tax Regulations provides that con-
sent to a distribution is not valid if, under
the plan, a significant detriment is imposed
on any participant who does not consent
to the distribution. That regulation further
provides that whether or not a significant
detriment is imposed is determined by the
Commissioner by examining the particular
facts and circumstances.
An allocation of administrative ex-
penses of a defined contribution plan to
the individual account of a participant who
does not consent to a distribution is not a
significant detriment within the meaning
of § 1.411(a)–11(c)(2)(i) if that allocation
is reasonable and otherwise satisfies the
requirements of Title I of ERISA, such as
apro rataallocation. Such an allocation
does not impose a detriment so signifi-
cant as to be inconsistent with the deferral
rights mandated by § 411(a)(11) because
analogous fees would be imposed in the
marketplace, either implicitly or explicitly,
for a comparable investment outside the
plan (e.g., fees charged by an investment
manager for an IRA investment). Accord-
ingly, whether or not such expenses are
charged to the accounts of current employ-
ees,chargingsuchexpensesonapro rata
basis to the accounts of former employees
is not a significant detriment, within the
meaning of § 1.411(a)–11(c)(2)(i), that is
imposed on a participant who does not
consent to a distribution.
On May 19, 2003, the Employee Bene-
fits Security Administration (the EBSA) of
the Department of Labor issued Field As-
sistance Bulletin (FAB) 2003–3 which sets
forth guidelines on the allocation of ad-
ministrative expenses among plan partic-
ipants in a defined contribution plan. As-
suming that the expenses at issue are both
proper expenses of the defined contribu-
tion plan and reasonable expenses with re-
spect to the services to which they relate,
FAB 2003–3 states that, for purposes of Ti-
tle I of ERISA, certain administrative ex-
penses may be allocated on apro ratabasis
and certain administrative expenses may
February 17, 20044842004-7 I.R.B.

properly be charged to an individual partic-
ipant rather than allocated among all plan
participants.
However, not every method of allo-
cating plan expenses is reasonable and a
method that is not reasonable could result
in a significant detriment. For example,
allocating the expenses of active employ-
eespro ratato all accounts, including the
accounts of both active and former em-
ployees, while allocating the expenses of
former employees only to their accounts
would not be reasonable since former em-
ployees would be bearing more than an
equitable portion of the plan’s expenses.
Accordingly, such an allocation of ex-
penses could be a significant detriment.
Taxpayers are also reminded that the
allocation of plan expenses must com-
ply with the nondiscrimination rules of
§ 401(a)(4). The method of allocating
plan expenses is a plan right or feature
described under § 1.401(a)(4)–4(e)(3)(i).
For example, if, in anticipation of the di-
vorce of a plan participant who is a highly
compensated employee, the plan’s method
of allocating expenses is changed so that
the expense of a determination of whether
an order constitutes a qualified domestic
relations order under § 414(p) ceases to
be allocated solely to the account of the
participant for whom the expense is in-
curred, but instead is allocatedpro rata
to all accounts, the timing of such change
may cause the plan to fail to satisfy the
requirements of § 1.401(a)(4)–1(b)(3) and
(4) with respect to the nondiscriminatory
availability of benefits, rights and fea-
tures and with respect to the timing of plan
amendments.
HOLDINGS
Plan A does not fail to satisfy the re-
quirements of § 411(a)(11) merely because
it charges reasonable plan administrative
expenses to the accounts of former em-
ployees and their beneficiaries on apro
ratabasis, but does not charge the accounts
of current employees. Plan A also would
not fail to comply with the requirements
of § 411(a)(11) merely because it charged
reasonable plan administrative expenses to
the accounts of former employees and their
beneficiaries, but not the accounts of cur-
rent employees, on another reasonable ba-
sis that complies with the requirements of
Title I of ERISA.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Michael Rubin of the Employee
Plans, Tax Exempt and Government En-
tities Division. For further information
regarding this revenue ruling, please con-
tact Employee Plans’ taxpayer assistance
telephone service at 1–877–829–5500
(a toll-free number) between the hours
of 8:00 a.m. and 6:30 p.m. Eastern
Time, Monday through Friday (a toll-free
call). Mr. Rubin may be reached at (202)
283–9888 (not a toll-free call).
Section 412.—Minimum
Funding Standards
Procedures with respect to applications for waivers
of the minimum funding standards under section
412(d) of the Code and section 303 of ERISA are set
forth. See Rev. Proc. 2004-15, page 490.
Section 416.—Special
Rules for Top-Heavy Plans
Top-heavy status; special rules.This
ruling describes four situations where a
non-governmental profit-sharing plan con-
tains a cash or deferred arrangement de-
scribed in section 401(k) of the Code that
provides for safe harbor matching contri-
butions. In the first situation, the rul-
ing holds that the requirements of section
416(g)(4)(H) are met for that year. In the
other situations, the ruling holds that the
contributions do not meet the requirements
of section 416(g)(4)(H).
Rev. Rul. 2004–13
ISSUE
In the situations described below,
which plans meet the requirements of
§ 416(g)(4)(H) of the Internal Revenue
Code for the 2004 plan year so that they
are not subject to the top-heavy rules in
§416?
FACTS
Situation 1.A nongovernmental
profit-sharing plan containing a cash or de-
ferred arrangement (“CODA”) described
in § 401(k) provides for safe harbor match-
ing contributions that are intended to sat-
isfy the requirements of § 401(k)(12)(B)
and otherwise satisfies the requirements
of § 401(k)(12). The plan also permits the
employer to make a nonelective contribu-
tion for any plan year at the employer’s
discretion. The nonelective contribution
is subject to 5-year vesting described in
§ 411(a)(2)(A) and is allocated to par-
ticipants’ accounts in the same ratio that
each participant’s compensation bears to
the compensation of all participants. The
plan is a calendar-year plan and covers
all employees of the employer (includ-
ing highly compensated employees as
defined in § 414(q)) who have 1 year of
service and are age 21 or older. Other than
elective contributions and the matching
contributions, no other contributions are
made to the plan for 2004 and there are no
forfeitures.
Situation 2. The facts are the same as
in Situation 1, except the employer makes
a discretionary nonelective contribution to
the plan for 2004.
Situation 3. The facts are the same as
in Situation 1, except forfeitures occur in
2004 due to the severance from employ-
ment of a participant who was not fully
vested in amounts attributable to discre-
tionary nonelective contributions made in
a prior year. Pursuant to the terms of the
plan, forfeitures are allocated to partici-
pants’ accounts for 2004 in the same man-
ner as nonelective contributions.
Situation 4. The facts are the same as in
Situation 1, except employees are permit-
ted to make elective contributions immedi-
ately upon commencement of employment
but are not eligible for matching contribu-
tions until they have completed 1 year of
service with the employer.
LAW AND ANALYSIS
Under § 416, a plan that is a top-heavy
plan (as defined in § 416(g)) for a plan
year must satisfy the vesting requirements
of § 416(b) and the minimum benefit re-
quirements of § 416(c) for such plan year.
Section 416 does not apply to any govern-
mental plan.
Section 416(g)(4)(H) provides that
the term “top-heavy plan” does not in-
clude a plan that consists solely of (1)
a CODA that meets the requirements of
§ 401(k)(12) and (2) matching contri-
butions that meet the requirements of
§ 401(m)(11). Section 416(g)(4)(H),
which is effective for years beginning af-
ter December 31, 2001, was added to the
2004-7 I.R.B.485February 17, 2004

Code by the Economic Growth and Tax
Relief Reconciliation Act of 2001, Pub.
L. 107–16.
The determination of whether a plan
is a top-heavy plan is made on a year-
by-year basis. Thus, a plan that satis-
fies § 416(g)(4)(H) for one plan year may
be subject to the top-heavy requirements
the next plan year if it does not satisfy
§ 416(g)(4)(H) for the next plan year.
Section 401(k)(12) and § 401(m)(11)
provide design-based safe harbor methods
for satisfying the actual deferral percent-
age (“ADP”) nondiscrimination test con-
tained in § 401(k)(3)(A)(ii) and the actual
contribution percentage (“ACP”) nondis-
crimination test contained in § 401(m)(2).
Section 401(k)(12) provides that a CODA
is treated as satisfying the ADP test if the
CODA meets certain contribution and no-
tice requirements. To satisfy the ADP test
safe harbor contribution requirement, an
employer must make either (1) a nonelec-
tive contribution equalto at least 3 percent
of each eligible nonhighly compensated
employee’s compensation (“safe harbor
nonelective contribution”) or (2) a match-
ing contribution that satisfies certain min-
imum amount and rate conditions (“safe
harbor matching contribution”). Matching
contributions do not satisfy § 401(k)(12)
or § 401(m)(11) if the rate of matching
contributions for a highly compensated
employee at any rate of elective contribu-
tions is greater than that for a nonhighly
compensated employee who is eligible
to make elective contributions. Also, a
plan does not meet the requirements of
§ 401(k)(12) if, under the terms of the
plan, a nonhighly compensated employee
is eligible to make elective contributions
but is not eligible to receive either a safe
harbor nonelective contribution or a safe
harbor matching contribution. Safe harbor
nonelective contributions and safe harbor
matching contributions must be nonfor-
feitable when contributed to the plan and
subject to withdrawal restrictions.
Section 401(m)(11) provides that a de-
fined contribution plan is treated as sat-
isfying the ACP test for matching contri-
butions if the plan meets the requirements
of § 401(k)(12) and in addition meets cer-
tain limitations on the amount and rate of
matching contributions available under the
plan.
In Situation 1, although the plan pro-
vides for discretionary nonelective con-
tributions, none are made for 2004 and
thus only contributions described in
§ 401(k)(12) or § 401(m)(11) are made
to the plan for that year.
In Situation 2, the employer makes a
discretionary nonelective contribution for
2004, a type of contribution that is not de-
scribed in § 401(k)(12) or § 401(m)(11).
In Situation 3, the allocation of forfei-
tures to participants’ accounts does not sat-
isfy the requirements for safe harbor non-
elective contributions under § 401(k)(12).
In Situation 4, under the plan, newly
hired nonhighly compensated employees
who make elective contributions will not
be eligible to receive any matching con-
tributions until they have completed 1
year of service. Since this will result in
a greater rate of matching contributions
for highly compensated employees than
for nonhighly compensated employees,
the matching contributions do not sat-
isfy the requirements of § 401(k)(12) (or
§ 401(m)(11)). Further, since all eligible
nonhighly compensated employees un-
der the plan do not receive safe harbor
nonelective contributions or safe harbor
matching contributions, the matching con-
tributions made under the plan do not
satisfy the requirements of § 401(k)(12).
However, certain plans that provide for
early participation may satisfy the re-
quirements of § 401(k)(12) with respect
to the portion of the plan that covers
employees who have completed the min-
imum age and service requirements of
§ 410(a)(1), while satisfying the ADP
test of § 401(k)(3)(A)(ii) for the eligi-
ble employees who have not completed
the minimum age and service require-
ments. Unless a plan (within the meaning
of § 414(l)) meets the requirements of
§ 416(g)(4)(H), no portion of the plan
will satisfy § 416(g)(4)(H). (See Notice
2000–3, 2000–1 C.B. 413, Q&A–10.)
HOLDINGS
In Situation 1, the plan meets the re-
quirements of § 416(g)(4)(H) and is there-
fore not subject to the top-heavy rules in
§ 416 for 2004 because no other contri-
butions are made to the plans other than
contributions described in § 401(k)(12) or
§ 401(m)(11). The plans in Situation 2,
Situation 3 and Situation 4 do not meet
the requirements of § 416(g)(4)(H) and are
therefore subject tothe top-heavy rules in
§ 416 for 2004.
DRAFTING INFORMATION
The principal author of this revenue rul-
ing is Roger Kuehnle of the Employee
Plans, Tax Exempt and Government Enti-
ties Division. For further information re-
garding this revenue ruling, please con-
tact Employee Plans’ taxpayer assistance
telephone service at 1–877–829–5500 (a
toll-free number), between the hours of
8:00 a.m. and 6:30 p.m. Eastern Time,
Monday through Friday. Mr. Kuehnle
may be reached at 1–202–283–9888 (not
a toll-free number).
Section 457.—Deferred
Compensation Plans
of State and Local
Governments and
Tax-Exempt Organizations
Whether amounts attributable to rollovers that are
accounted for separately are subject to the section 457
plan’s general distribution requirements. See Rev.
Rul. 2004-12, page 478.
Section 894.—Income
Affected by Treaty
26 CFR 1.894–1: Income affected by treaty.
Service partnerships.This ruling pro-
vides guidance concerning the application
of the U.S.-Germany income tax treaty to
a nonresident partner in a service partner-
ship that conducts activities in the United
States. It makes clear that a nonresident
partner is subject to U.S. income tax on
his share of income from the partnership to
the extent that such income is attributable
to the partnership’s activities in the United
States, without regard to whether the part-
ner performs services in the United States.
This ruling also applies to other U.S. in-
come tax treaties that have the same or
similar provisions as those in the U.S.-Ger-
many treaty.
Rev. Rul. 2004–3
ISSUE
Whether a nonresident partner in a ser-
vice partnership that has a fixed base in
the United States is subject to U.S. tax
on income attributable to that fixed base
February 17, 20044862004-7 I.R.B.

under Article 14, Independent Personal
Services, of the Convention Between the
United States of America and the Federal
Republic of Germany for the Avoidance
of Double Taxation and the Prevention of
Fiscal Evasion with Respect to Taxes on
Income and Capital and to Certain Other
Taxes, signed on August 29, 1989, as
amended by the Protocol signed on the
same date (the “Treaty”).
FACTS
P is a service partnership that is orga-
nized under the laws of Germany. P has
offices in Germany and the United States.
ItsU.S.officeisafixedbaseunderArti-
cle 14 of the Treaty. P is comprised of two
partners: A, a nonresident alien individual
who is a resident of Germany under Arti-
cle 4 of the Treaty, and B, a U.S. resident.
A performs services solely at P’s office in
Germany and B performs services solely
at P’s office in the United States. A and B
agree to divide the profits of the partner-
ship equally.
LAW AND ANALYSIS
Under section 701 of the Internal Rev-
enue Code (the “Code”), a partnership is
not subject to income tax; rather, the per-
sons carrying on the business of the part-
nership as partners are liable for income
tax in their separate or individual capaci-
ties. Code section 702 requires a partner
to determine its income tax by separately
taking into account itsdistributive share
of the partnership’s income. Under sec-
tion 702(b), the character of an item of in-
come, gain, loss, deduction, or credit is de-
termined as if such item were realized di-
rectly from the source from which it was
realized by the partnership, or incurred in
the same manner as incurred by the part-
nership. Under Code section 704, a part-
ner’s distributive share generally is deter-
mined by the partnership agreement unless
an allocation under the agreement does not
have substantial economic effect.
Under section 875(1) of the Code, a
nonresident alien individual who is a part-
ner in a partnership that is engaged in a
U.S. trade or business is himself consid-
ered to be so engaged. Section 871(b)(1)
of the Code provides that a nonresident
alien individual is taxable under Code sec-
tions 1 or 55 on his taxable income that is
effectively connected with the conduct of
a U.S. trade or business.
Section 894(a)(1) states that the provi-
sions of the Code shall be applied to any
taxpayer with due regard to any U.S. treaty
obligation that applies to such taxpayer.
InDonroy, Ltd. v. United States, 301 F.2d
200 (9
th
Cir. 1962), the court held that the
U.S. permanent establishment of a partner-
ship was attributable to a foreign person
that was a limited partner under the 1942
U.S.-Canada income tax treaty. InUnger
v. Commissioner, 936 F.2d 1316,1319
(D.C. Cir. 1991), the court followed the
holding inDonroy,notingthatitstoodfor
the proposition that the office or perma-
nent establishment of a partnership is, as
a matter of law, the office of each of the
partners—whether general or limited.See
also Johnston v. Commissioner,24T.C.
920 (1955) (holding that a partnership’s
permanent establishment is deemed to
be a permanent establishment of its part-
ners); Rev. Rul. 90–80, 1990–2 C.B. 170
(same).
Article 14 of the Treaty provides:
1. Income derived by an individual who
is a resident of a Contracting State
from the performance of personal
services in an independent capacity
shall be taxable only in that State,
unless such services are performed in
the other Contracting State and the
income is attributable to a fixed base
regularly available to the individual
in that other State for the purpose of
performing his activities.
2. The term “personal services in an
independent capacity” includes but
is not limited to independent scien-
tific, literary, artistic, educational,
or teaching activities as well as the
independent activities of physicians,
lawyers, engineers, economists, ar-
chitects, dentists, and accountants.
Applying Article 14 in the partner-
ship context requires a determination of
whether an individual partner in a service
partnership who derives income attrib-
utable to the fixed base of the service
partnership in the other Contracting State
is taxable on that income even though
the partner does not perform any services
in the other Contracting State. Consis-
tent with section 875 and the case law
discussed above, the fixed base of a part-
nership is attributed to its partners for
purposes of applying Article 14 of the
Treaty. Accordingly, A is treated as hav-
ing a fixed base regularly available to
him in the United States. A is subject to
U.S. net income taxation on his allocable
shareofincomefromPtotheextentthat
such income is attributable to the fixed
base in the United States without regard to
whether A performs services in the United
States.
HOLDING
A is treated as having a fixed base reg-
ularly available to him in the United States
and is subject to U.S. net income taxation
on his allocable share of income from P
to the extent that such income is attribut-
able to P’s fixed base in the United States,
without regard to whether A performs ser-
vices in the United States. This holding
also is applicable in interpreting other U.S.
income tax treaties that contain provisions
that are the same or similar to Article 14 of
the Treaty.
DRAFTING INFORMATION
The principal author of this revenue rul-
ing is Nina Chowdhry of the Office of As-
sociate Chief Counsel (International). For
further information regarding this revenue
ruling, contact Nina Chowdhry at (202)
622–3880 (not a toll-free call).
Section 1361.—S
Corporation Defined
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
Section 1362.—Election;
Revocation; Termination
26 CFR 1.1362–1: Election to be an S Corporation.
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
2004-7 I.R.B.487February 17, 2004

Section 1366.—Pass-Thru
of Items to Shareholders
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
Section 4975.—Tax on
Prohibited Transactions
26 CFR 54.4975–7(b)(10): Put option.
If the requirements of this revenue procedure are
satisfied, the Service will accept the position that a
corporation’s S election is not affected when an ESOP
distributes stock of that corporation to a participant’s
IRA in a direct rollover. See Rev. Proc. 2004-14,
page 489.
February 17, 20044882004-7 I.R.B.

Part III. Administrative, Procedural, and Miscellaneous
Dividends as a Separately
Stated Item
Notice 2004–5
Section 772(a)(11) of the Internal Rev-
enue Code provides that, in determining
the income tax of a partner of an electing
large partnership (ELP), the partner shall
take into account separately the partner’s
distributive share of partnership items
(inadditiontothoselistedin§772(a)(1)
through (10)) to the extent that the Secre-
tary determines that the separate treatment
of these items is appropriate.
Pursuant to this authority, the Secretary
has determined that it is appropriate for a
partner of an ELP to take into account sep-
arately the partner’s distributive share of
the partnership’s dividends received that
are qualified dividend income (QDI) as de-
fined in § 1(h)(11)(B). This requirement to
separately account for QDI takes into ac-
count the changes in the taxation of QDI
under § 302 of the Jobs and Growth Tax
Relief Reconciliation Act of 2003, Pub. L.
No. 108–27, 117 Stat. 752. This require-
ment is effective for dividends received by
a partnership after December 31, 2002.
The principal author of this notice
is Bradford R. Poston of the Office of
Associate Chief Counsel (Passthroughs
and Special Industries). For further in-
formation regarding this notice, contact
Bradford R. Poston at (202) 622–3060
(not a toll-free call).
26 CFR 1.1362–2: Termination of election.
(Also Part I, §§ 401, 402, 409, 1361, 1362, 1366,
4975; 1.401(a)(31)–1; 1.1362–1; 54.4975–7(b)(10).)
Rev. Proc. 2004–14
SECTION 1. PURPOSE
The Treasury Department and the Inter-
nal Revenue Service have determined that
it is consistent with the purposes of, and
policies underlying,employee stock own-
ership plans (ESOPs) to enable an ESOP
to direct certain rollovers of distributions
of S corporation stock to an individual re-
tirement plan (IRA) in accordance with a
distributee’s election without terminating
the corporation’s S election. Accordingly,
if the requirements of this revenue proce-
dure are satisfied, the Service will accept
the position that a corporation’s S election
is not affected when an ESOP distributes
stock of that corporation to a participant’s
IRA in a direct rollover.
Rev. Proc. 2003–23, 2003–1 C.B. 599,
provides that the Service will accept the
position that an S corporation’s election is
not affected as a result of an ESOP’s dis-
tribution of S corporation stock in a direct
rollover to an IRA if the terms of the ESOP
require that the S corporation repurchase
its stock immediately upon the ESOP’s
distribution of the stock to the IRA, the S
corporation actually repurchases the stock,
and the other requirements of that revenue
procedure are satisfied. This revenue pro-
cedure modifies Rev. Proc. 2003–23 by
providing that the Service also will ac-
cept the position that an S corporation’s
election is not affected as a result of an
ESOP’s distribution of S corporation stock
in a direct rollover to an IRA if the terms
of the ESOP require that the S corpora-
tion repurchase its stock immediately upon
the ESOP’s distribution of the stock to the
IRA, the ESOP is permitted to assume the
rights and obligations of the S corporation
to repurchase the S corporation stock im-
mediately upon the ESOP’s distribution of
the stock to an IRA, the ESOP repurchases
the stock, and the other terms of this rev-
enue procedure are satisfied.
SECTION 2. BACKGROUND
In 1996,Congress amended
§ 1361(b)(1)(B) of the Internal Rev-
enue Code to make ESOPs (as defined
in § 4975(e)(7)), along with other plans
qualified under § 401(a), eligible S
corporation shareholders. A fundamental
purposeofanESOP,includinganESOP
that holds stock in an S corporation, is to
provide participants with equity owner-
ship in the employer corporation through
participation in the ESOP, including
distributions of employer securities to
participants.SeeS. Rep. 94–938 at 180,
1976–3C.B.218(statingthatanESOP“is
a technique of corporate finance designed
to build beneficial equity ownership of
shares in the employer corporation in its
employees”).
Section 409(h) generally requires that
an ESOP provide for distributions in the
form of employer securities. An ESOP
meets the requirements of § 409(h)(1)(A)
and (B) if a participant who is entitled to
a distribution has the right to demand that
the participant’s benefits be distributed in
the form of employer securities and, if the
employer securities are not readily trade-
able on an established securities market,
has a right to require that the employer re-
purchase the securities under a fair valua-
tion formula. This right is commonly re-
ferred to as a “put option.” The put op-
tion must permit a participant to put the se-
curity to the employer in accordance with
§ 409(h) and § 54.4975–7(b)(10) of the Ex-
cise Tax Regulations. However, under no
circumstances may the put option bind the
ESOP. The put option may grant the ESOP
an option to assume the rights and obliga-
tions of the employer to repurchase the se-
curities at the time that the put option is
exercised.
Section 409(h)(2)(B) provides that an
ESOP maintained by an S corporation is
permitted to provide for distributions only
in cash or for distributions of employer
securities subject to a repurchase require-
ment which meets the requirements of
§ 409(h)(1)(B).
Under § 401(a)(31) and A–1 of
§ 1.401(a)(31)–1 of the Income Tax Reg-
ulations, a qualified plan, including an
ESOP, is required to permit the distribu-
tee of any eligible rollover distribution
(as defined in § 402(c)(4)) to have the
distribution paid in a direct rollover (as
defined in A–3 of § 1.401(a)(31)–1) to
an eligible retirement plan (as defined
in § 402(c)(8)(B)) specified by the dis-
tributee. Therefore, an ESOP that holds
S corporation stock and permits distribu-
tions in the form of employer securities
is required to permit participants to elect
to have any distribution of S corporation
stock that is an eligible rollover distri-
bution be paid in a direct rollover to an
eligible retirement plan specified by the
distributee,includinganIRA.AnIRA
trustee or custodian, however, is not a per-
missible S corporation shareholder.See
§§ 1361(b) and 1361(c)(6).
2004-7 I.R.B.489February 17, 2004

Under § 409(h)(2)(B), an ESOP that
provides for distributions in the form of se-
curitiesofanemployerthatisanScor-
poration is permitted to provide that the S
corporation stock included in the distribu-
tion is subject to a repurchase requirement.
Thus, an ESOP is permitted to provide that
any stock in an S corporation that is dis-
tributed is subject to immediate repurchase
by the S corporation upon a direct rollover
of the stock from the ESOP to an IRA.
SECTION 3. SCOPE
This revenue procedure sets forth cer-
tain requirements related to an ESOP’s dis-
tribution of S corporation stock to a partic-
ipant where the participant elects to have
the S corporation stock distributed to an
IRA in a direct rollover. If these require-
ments are satisfied, the Service will accept
the position that the distribution does not
affect the S corporation’s election to be
taxed as an S corporation.
SECTION 4. APPLICATION
The Service will accept the position that
an S corporation’s election is not affected
as a result of an ESOP’s distribution of
S corporation stock where the participant
directs that such stock be distributed to an
IRA in a direct rollover, provided that:
.01 The terms of the ESOP require that
the S corporation repurchase the stock im-
mediately upon the ESOP’s distribution of
the stock to an IRA;
.02 Either, pursuant to the terms of the
ESOP, the S corporation actually repur-
chases the S corporation stock contempo-
raneouslywith,andeffectiveonthesame
day as, the distribution, or, pursuant to the
terms of the ESOP, the ESOP is permitted
to assume the rights and obligations of the
S corporation to repurchase the S corpora-
tion stock immediately upon the ESOP’s
distributionofthestocktoanIRAandthe
ESOP actually repurchases the S corpo-
ration stock contemporaneously with, and
effective on the same day as, the distribu-
tion; and
.03 No income (including tax-exempt
income), loss, deduction, or credit attribut-
able to the distributed S corporation stock
under § 1366 is allocated to the partici-
pant’s IRA.
SECTION 5. EFFECT ON OTHER
REVENUE PROCEDURES
Rev. Proc. 2003–23 is modified and
superseded.
SECTION 6. DRAFTING
INFORMATION
The principal authors of this rev-
enue procedure are Audrey W. Ellis of
the Office of Associate Chief Counsel
(Passthroughs and Special Industries),
John Ricotta of the Office of Division
Counsel/Associate Chief Counsel (Tax
Exempt and Government Entities) and
Robert Gertner of the Employee Plans,
Tax Exempt and Government Entities Di-
vision. For further information regarding
the S corporation aspects of the revenue
procedure, contact Ms. Ellis at (202)
622–3060 (not a toll-free call). For further
information regarding the employee plans
aspects of the revenue procedure, contact
the Employee Plans’ taxpayer assistance
telephone service at 1–877–829–5500 (a
toll-free call) between the hours of 8:00
a.m. and 6:30 p.m. Eastern Time, Monday
through Friday or contact Mr. Gertner at
(202) 283–9888 (not a toll-free call).
26 CFR 601.201: Rulings and determination letters.
(Also Part I, § 412.)
Rev. Proc. 2004–15
SECTION 1. PURPOSE
The purpose of this revenue procedure
is to outline the procedures of the Inter-
nal Revenue Service with respect to appli-
cations for waivers of the minimum fund-
ing standard under either § 412(d) of the
Internal Revenue Code or section 303 of
the Employee Retirement Income Security
Act of 1974 (ERISA), Pub. L. 93–406,
1974–3 C.B. 1, 41.
SECTION 2. REQUESTS FOR
WAIVERS OF THE MINIMUM
FUNDING STANDARD FOR
DEFINED BENEFIT PLANS
.01 Submission.—Requests for waivers
of the minimum funding standard for de-
fined benefit plans must be submitted to:
Employee Plans
Internal Revenue Service
Commissioner, TE/GE
Attention: SE:T:EP:RA
P.O. Box 27063
McPherson Station
Washington, D.C. 20038
The user fee required by Rev. Proc.
2004–8, 2004–1 I.R.B. 240, or its succes-
sors, must be sent with such requests.
.02 Necessary Procedural Docu-
ments.—A request will not be considered
unless it complies with (1) through (5)
below.
(1) The request must be signed by the
taxpayer maintaining the plan (hereinafter
referred to as “applicant”) or an authorized
representative of the applicant who either
must be identified in (a), (b), or (c) of
subsection 9.02(11) of Rev. Proc. 2004–4,
2004–1 I.R.B. 125, or must be an en-
rolled actuary within the meaning of
§ 7701(a)(35) of the Code. Where an au-
thorized representative signs the request or
will appear before the Service in connec-
tion with the request, a Form 2848,Power
of Attorney and Declaration of Represen-
tative, must be submitted with the request.
For multiemployer plans, the request must
be made by the Board of Trustees (which
shall be deemed to be the applicant) or by
an authorized representative of the Board
of Trustees. An individual is not an au-
thorized representative of the applicant
merely on account of being the adminis-
trator or trustee of the plan.
(2) The request also must contain a
declaration in the following form: “Un-
der the penalties of perjury, I declare that I
have examined this request, including ac-
companying documents, and to the best of
my knowledge and belief, the facts pre-
sented in support of the request are true,
correct, and complete.” This declaration
must be signed by the applicant (e.g.,an
authorized officer of a corporation). The
signature of an individual with a power of
attorney will not suffice for the declara-
tion. See section 9.02(13) of Rev. Proc.
2004–4,supra,p.142.
(3) Because a request for a waiver con-
stitutes a request for a ruling, compliance
with § 6110 of the Code is also required.
Section 601.201 of the Statement of Pro-
cedural Rules sets forth the requirements
February 17, 20044902004-7 I.R.B.

applicable to requests for rulings and de-
termination letters which are subject to
§ 6110. Section 601.210(e) furnishes spe-
cific instructions to applicants. The appli-
cant must also pay the user fee required by
Rev. Proc. 2004–8 or its successors.
The applicant must provide with the re-
quest either a statement of proposed dele-
tions and the statutory basis for each
proposed deletion, or a statement that no
information other than names, addresses,
and taxpayer identifying numbers need be
deleted.
(4) The applicant must provide a copy
of a written notification that an applica-
tion for a waiver of the minimum funding
standard under § 412(d) of the Code has
been submitted to the Service. The origi-
nal of the written notification must bear a
signature by an appropriate officer of the
applicant and must be in substantially the
form set forth in the Model Notice found
in the Appendix A to this revenue proce-
dure. The Service does not require the ap-
plicant to furnish any information in addi-
tion to that required by the Model Notice in
the Appendix A to plan participants, ben-
eficiaries, alternate payees, or employee
organizations as part of the waiver appli-
cation process, but additional information
may, of course, be provided by the appli-
cant pursuant to the collective bargaining
process or otherwise.
The application must state that such notice
was hand delivered or mailed to the last
known address of each employee organiza-
tion, participant, beneficiary, and alternate
payee (within the meaning of § 414(p)(8)
of the Code) within 14 days prior to the
date of the application. If the applicant
makes a reasonable effort to carry out the
provisions of this paragraph, failure of an
employee organization, participant, bene-
ficiary, or alternate payee to receive the
notice will not cause the applicant to fail
the notice requirement. However, merely
posting the notice on a bulletin board is not
sufficient to satisfy this requirement.
.03 Necessary Waiver Informa-
tion.—The applicant must furnish ap-
propriate evidence that the employer and
all other entities included within the con-
trolled group of which the employer is a
member are unable to satisfy the minimum
funding standard for a plan year without
temporary substantial business hardship
and that application of the standard would
be adverse to the interest of plan partic-
ipants in the aggregate. In the case of a
multiemployer plan, the applicant must
furnish appropriate evidence that 10 per-
cent or more of the number of employers
contributing to or under the plan are unable
to satisfy the minimum funding standard
for a plan year without substantial busi-
ness hardship and that application of the
standard would be adverse to the interest
of plan participants in the aggregate. What
constitutes appropriate evidence will de-
pend on the facts and circumstances of
each case. A response must be furnished
for each of the subsections (1) through (7)
below. In certain cases some of the mate-
rial described in subsections (1) through
(7) may be inapplicable, unavailable, in-
appropriate or burdensome to furnish. In
such cases, the applicant should furnish
a statement indicating why the material
for a particular subsection is inapplicable,
unavailable, inappropriate or burdensome.
(1) General facts concerning the em-
ployer.
A brief statement should be submitted
concerning: (a) the history of the em-
ployer and its primary business; (b) the
ownership of the employer and any re-
cent or contemplated changes (such as
acquisitions, mergers, discontinuances of
operations) which might have a bearing
on the employer’s organization or finan-
cial condition; (c) whether the employer
is aggregated with any other entity for
purposes of §§ 414(b), (c), (m) or (o) of
the Code; and (d) whether the plan is also
maintained by employers described in (c)
above or any other employers.
(2) The financial condition of the em-
ployer.
The annual financial report of the em-
ployer and each of the other entities
included within the controlled group of
which the employer is a member for each
of the two fiscal years that commenced
prior to any plan year for which a waiver is
requested and the annual financial report
for each fiscal year that commenced with
or within each plan year for which a waiver
is requested must be submitted. This sub-
mission must include at least the balance
sheet, profit and loss statement, cash flow
statement, and notes to the financial state-
ment. Recent interim financial reports
for each of the controlled group mem-
bers, if available, should also be submitted
along with an interim financial report
covering the corresponding period for the
previous year. If the employer submits
financial reports to the Securities and Ex-
change Commission, these reports should
be submitted for the same periods as the
annual financial reports. Preferably, the
financial report should include certified
financial statements. If certified financial
statements have not been prepared, an
uncertified report is acceptable. If nei-
ther certified nor uncertified reports are
available, copies of the company’s federal
income tax returns, including all of the
supporting schedules, must be submitted.
(See also paragraph 5.)
(3) Executive compensation arrange-
ments (not required for multiemployer
plans)
For each person who is an officer (within
the meaning of Q&A T–13 of § 1.416–1
of the Income Tax Regulations) or direc-
tor of the applicant or any entity aggre-
gated with the applicant for purposes of
§§ 414(b), (c), (m), or (o) of the Code
(“aggregated entities”), provide a detailed
statement concerning all amounts that the
applicant or any aggregated entity has paid
or will pay to or for the benefit of such
person during the plan year for which the
request is made and the immediately pre-
ceding 24 months. For this purpose, if the
number of employees (including part-time
employees) of the applicant and all aggre-
gated entities as of the first day of the plan
year for which the request is made is: (a)
not more than 30, no more than three per-
sons shall be treated as officers; (b) more
than 30 but not more than 100, no more
than 10% of such employees (rounded to
the next integer) shall be treated as offi-
cers; or (c) more than 100, no more than
10 of such employees shall be treated as
officers. In each case, this limited num-
ber of officers shall be comprised of those
officers to whom or for whose benefit the
applicant and all aggregated entities have
paid or will pay the largest such amounts
during such period. In addition, provide
information concerning amounts paid or
to be paid during such period to or for
2004-7 I.R.B.491February 17, 2004

the benefit of up to five additional persons
who are former officers or directors of the
applicant or any aggregated entity or who
are aggregated with any such former offi-
cer or director for purposes of §§ 414(b),
(c), (m) or (o) of the Code and who would
be included in such limited number of offi-
cers if they were officers of the applicant.
The statement should include, among other
payments, amounts paid with respect to:
(a) salary; (b) non–qualified deferred com-
pensation; (c) fringe benefits, perquisites,
and other personal benefits; (d) bonuses
and incentive compensation, including
amounts deferred from previous periods;
(e) money or other property set aside in
any trust, escrow, insurance policy, or
other similar funding vehicle during the
years in question for the benefit of any
such person, whether or not included in
such person’s income; (f) grants of stock
options, restricted stock, or other equity
compensation; (g) money or other property
paid by reason of the exercise of any stock
option or stock appreciation right or pur-
suant to any phantom stock plan or agree-
ment; (h) money or other property paid
pursuant to any other long-term incentive
plan; (i) loans to or for the benefit of such
persons and any loan repayments during
such period; (j) money or other property
paid in connection with any change in
control or termination of employment or
service and (k) any other compensation
to or for the benefit of such persons that
has affected or will affect the cash flow
of the applicant or any aggregated entity
for such period. Applicants may omit in-
formation regarding any plan that satisfies
the qualification requirements of § 401(a)
of the Code and any other pension, profit
sharing, employee stock ownership, em-
ployee stock purchase, group life, health,
hospitalization, medical reimbursement,
fitness or wellness, employee relocation,
severance, or similar plan that does not
discriminate in scope, terms, or operation
in favor of officers or directors of the ap-
plicant and that is available generally to
all salaried employees.
(4) Nature and extent of the business
hardship. An explanation of the nature
and extent of the business hardship should
include the following.
(a) A discussion of the underlying
reasons which have led to the current situ-
ation (such as declining sales, unexpected
losses, labor disputes, etc.).
(b) A statement concerning the
prospects for recovery, including reasons
whysuchrecoveryislikely.
(c) A statement describing the ac-
tions taken or planned to effect recovery.
(d) A statement as to when and to
what extent it is anticipated that required
contributions to the plan can reasonably be
expected to resume.
(e) Financial projections and col-
lateral information for certain employers
(not required for multiemployer plans)
If the sum of the outstanding balances of
any amortization bases established under
§ 412(b)(2)(C) of the Code for waivers
granted to the plan for any prior plan
years (calculated as of the first day of the
plan year for which a new waiver is be-
ing requested) when added to the amount
for which a waiver is currently being re-
quested, equals or exceeds $1,000,000,
items (4)(b) & (c) should be supported
by financial projections, for not less than
the next five years, for each trade or busi-
ness of the plan sponsor, along with any
supporting text and schedules. These
projections should include revenues, ex-
penses, and cash flow statements, along
with all major strategic and economic
assumptionsusedinderivingthem. The
cash flow projectionsshould include cap-
ital expenditures, forecasted contributions
to the pension plan(s), long-term debt
repayments, and any mandatory debt re-
payments. Any projections based on a sig-
nificant strategic or financial turnaround
should fully explain this turnaround. Also,
a brief description should be included
of what collateral, if required, would be
available to secure any waived contribu-
tions.
The Service may request additional in-
formation, including items listed in
§ 412(d)(2) of the Code.
(5) Facts concerningthe pension plan.
For each pension plan for which a waiver
is requested, the following information
should be supplied.
(a) The name of the plan, the
plan’s identification number, and file
folder number (if any).
(b) The date the plan was adopted.
(c) The effective date of the plan.
(d) The classes of employees cov-
ered. If the only participants are owners
of the employer or relatives of owners, so
state.
(e) The number of employees
covered.
(f) A copy of the current plan doc-
ument and the most recent summary plan
description.
(g) A brief description of all plan
amendments adopted during the year for
which the waiver is requested and the pre-
vious four years which affect plan costs,
including the approximate effect of each
amendment on such costs.
(h) The most recent actuarial re-
port plus any available actuarial re
ports for
the preceding two plan years. Also,
if not
shown in that report, the present va
lue of
accrued benefits, present value of
vested
benefits, and fair market value of a
ssets
(excluding contributions not yet p
aid).
(i) How the plan is funded (i.e.,
trust fund, individual insurance policies,
etc.).
(j) A list of the contributions
actually paid in each month, from the
twenty–fourth month prior to the begin-
ning of the plan year for which the waiver
is requested through the date of the request
and the plan year to which the contribu-
tions were applied, with the employee
contributions and the employer contribu-
tions listed separately.
(k) The plan year for which the
waiver is requested (e.g., 1/1/03–12/31/03).
(l) The approximate contribution
required to meet the minimum funding
standard and the approximate amount re-
quested to be waived. For defined benefit
plans, this amount should be determined
by the plan’s enrolled actuary.
February 17, 20044922004-7 I.R.B.

(m) A copy of the most recently
completedAnnual Return/Report of Em-
ployee Benefit Plan(Form 5500 series, as
applicable) and in the case of a defined
benefit plan, a copy of the corresponding
Actuarial Information schedule (Schedule
B of Form 5500).
(n) Whether the plan is subject to
Title IV of ERISA.
(o) A copy of each ruling letter
that waived the minimum funding stan-
dard during the last 15 plan years, a state-
ment of the amount waived for each plan
year, and a statement of the outstanding
balance of the amortization base for each
waived funding deficiency. The outstand-
ing balance of the amortization base for
each waiver is to be calculated as of the
first day of the plan year for which a waiver
is being requested.
(6) Other pension, profit–sharing, or
stock bonus plans. If the employer main-
tains more than one plan, an outline of the
essential facts for each such plan should be
submitted. This should include:
(a) A brief description of the plan,
including the name of the plan and its plan
year.
(b) The number of employees
covered.
(c) The classes of employees cov-
ered.
(d) The approximate annual con-
tribution required.
(e) The amount of contributions
that have been made, or are intended to be
made, for any plan year of such other plan
commencing in, or ending in, the plan year
for which the waiver is requested.
(f) A statement as to whether a
waiver request is contemplated for the
plan.
(7) Other information.
(a) Describe the nature of any
matters pertaining to the plan which are
currently pending or are intended to be
submitted to the Service, Department of
Labor or the Pension Benefit Guaranty
Corporation.
(b) Furnish details of any existing
arbitration, litigation, or court procedure
which involves the plan.
(c) Also state which Area Office
maintains files concerning the plan.
(8) Although it is not required, a digest
of certain information from the financial
statements described in this section will fa-
cilitate the processing of a waiver request.
For example, a digest could show for the
applicable years:
(a) current assets;
(b) inventory included in current
assets;
(c) fixed assets;
(d) other assets;
(e) total assets;
(f) current liabilities;
(g) long–term liabilities;
(h) other liabilities;
(i) total liabilities;
(j) working capital;
(k) equity;
(l) sales;
(m) cost of sales;
(n) gross profit;
(o) other income and expense;
(p) net profit before taxes;
(q) income taxes;
(r) net profit after taxes; and
(s) for plans for which waivers are
requested, pension costs expensed in deter-
mining (p).
.04 Additional Copy of Information Re-
quired.—The applicant must furnish two
copies of the necessary waiver information
described in section 2.03, if the sum of the
outstanding balancesof any amortization
bases established under § 412(b)(2)(C) of
the Code for waivers granted to the plan
for any prior plan years (calculated as of
the first day of the plan year for which
a new waiver is being requested) when
added to the amount for which a waiver
is currently being requested, equals or ex-
ceeds $1,000,000.
.05 Checklist.—A checklist has been
provided in Appendix B for the conve-
nience of the taxpayer submitting the re-
quest. In certain cases some of the mate-
rial described above may be inappropriate
or burdensome to furnish. In such cases,
the request for approval should include a
statement indicating why such material is
not being furnished.
SECTION 3. REQUEST FOR
WAIVERS FOR DEFINED
CONTRIBUTION PENSION PLANS
.01 Background Information.—Section
3 of Rev. Rul. 78–223, 1978–1 C.B.
125, requires that a defined contribution
pension plan contain certain provisions in
order for a waiver to be granted. If the
applicant does not want to draft individ-
ually designed provisions to satisfy the
requirements of section 3 of Rev. Rul.
78–223, the Service will provide sample
plan amendment language that complies
with such requirements. See subsection
.02. However, a provision that satisfies
section 3 of Rev. Rul. 78–223 does not
necessarily satisfy the requirements of
§ 401(a) of the Code. In order to provide
maximum flexibility in obtaining a waiver
for a defined contribution pension plan,
three alternative procedures are provided
in subsections .02, .03, and .04, in which
a single request may cover either a waiver
ruling only or a waiver ruling and a de-
termination letter as to the status under
§ 401(a) of the Code.
.02 Waiver Ruling Only/Without Sub-
mission of Plan Amendment.—Under this
procedure, requests for waivers must be
submitted to:
Employee Plans
Internal Revenue Service
Commissioner, TE/GE
Attention: SE:T:EP:RA
P.O. Box 27063
McPherson Station
Washington, D.C. 20038
The applicant must satisfy the require-
ments of section 2 of this revenue proce-
dure except those applicable only to de-
fined benefit plans,e.g.section 2.03(5)(h).
2004-7 I.R.B.493February 17, 2004

Any waiver ruling granted under this pro-
cedure will be accompanied by a plan
amendment supplied by the Service which
will, if adopted, satisfy section 3 of Rev.
Rul. 78–223. The waiver will be condi-
tioned upon the plan being amended by
adoption of that amendment, within a rea-
sonable period of time, and will contain
a caveat stating that the ruling is not a
ruling as to the effect the plan provision
may have on the qualified status of the
plan. Upon receipt of that amendment,
the applicant may (within 60 days of date
of the letter) request reconsideration of
this waiver condition if the amendment
is inappropriate. Reconsideration may be
requested by submitting a letter from the
applicant (or authorized representative) to
the above address.
.03 Waiver Ruling Only/With Submis-
sion of Plan Amendment.—Under this
procedure, requests for waivers must be
submitted to:
Employee Plans
Internal Revenue Service
Commissioner, TE/GE
Attention: SE:T:EP:RA
P.O. Box 27063
McPherson Station
Washington, D.C. 20038
The applicant must satisfy the require-
ments of section 2 of this revenue proce-
dure, except those applicable only to de-
fined benefit plans,e.g.section 2.03(5)(h),
and must include the plan provisions nec-
essary to satisfy section 3 of Rev. Rul.
78–223. All waivers issued pursuant to
this subsection will contain a caveat indi-
cating that the ruling is not a ruling as to
the effect any plan provision, submitted
pursuant to the previous sentence, may
have on the qualified status of the plan.
.04 Waiver Ruling and Determination
Letter Request.—Under this procedure
both the request for a waiver ruling and
the request for a determination letter on
the effect of any amendment necessary
to satisfy section 3 of Rev. Rul. 78–223
must be submitted by the applicant to the
Office of the Commissioner, Tax Exempt
and Government Entities Division where
it will be treated as if it had been submitted
as a request for technical advice from the
Determinations Manager.
(1) The request that is submitted to the
Office of the Commissioner, Tax Exempt
and Government Entities Division must in-
clude the following:
(a) The combined request must
satisfy all the procedural requirements
described in section 3.03 of this revenue
procedure;
(b) The submission must include
a completed Form 5300 and all necessary
documents, plan amendments, and infor-
mation required by the Form 5300 and by
this revenue procedure for approval of the
plan amendments;
(c) The request must indicate
which Area Office has audit jurisdiction
over the return; and
(d) The user fee for both the
waiver request and the determination letter
request must be contained in the submis-
sion to the Office of the Commissioner,
Tax Exempt and Government Entities Di-
vision.
(2) The procedures for notice and
comment by interested parties, which are
contained in sections 17, 18, and 19, of
Rev. Proc. 2004–6, 2004–1 I.R.B. 197,
oritssuccessors,aswellasthenoticeand
comment procedures provided in section
2.02 of this revenue procedure must be
satisfied. Comments are to be forwarded
to the Determinations Office that is con-
sidering the determination letter request
for the plan amendments.
(3) The waiver request will be handled
bytheOfficeoftheCommissioner,Tax
Exempt and Government Entities Division
as follows:
(a) The waiver request and sup-
porting documents will be forwarded to the
Actuarial Group, SE:T:EP:RA:T:A, which
will treat the request as a technical ad-
vice on the qualification issue with respect
to the plan provisions necessary to satisfy
section 3 of Rev. Rul. 78–223.
(b) The appropriate Determina-
tions Office will be notified of the request.
In order not to delay the processing of the
request, all materials relating to the deter-
mination letter request will be sent by the
Office of the Commissioner, Tax Exempt
and Government Entities Division to the
Determinations Manager for considera-
tion while the technical advice request is
completed.
(c) The Office of the Commis-
sioner, Tax Exempt and Government Enti-
ties Division will consider both issues. If
a waiver is to be granted and if the Office
of the Commissioner, Tax Exempt and
Government Entities Division believes
that qualification of the plan is not ad-
versely affected by the plan amendment,
a technical advice memorandum will be
issued to the Determinations Manager.
The Determinations Manager must decide
within 10 working days from the date of
the technical advice memorandum either
to furnish the applicant with the technical
advice memorandum and with a favor-
able advance determination letter, or to
ask for reconsideration of the technical
advice memorandum. This request must
be in writing. An initial written notice of
intent to make this request may be sub-
mitted within 10 working days of the date
of the technical advice memorandum and
followed by a written request within 30
working days from the date of such writ-
ten notice. If the Determinations Manager
does not ask for reconsideration of the
technical advice memorandum within 10
working days, the Actuarial Group will
issue the waiver ruling. This ruling will
not contain the caveat described in section
3.02.
SECTION 4. DEADLINE FOR
REQUESTING A WAIVER
All waiver requests (for plans other than
multiemployer plans) must be submitted
no later than the 15th day of the 3rd month
following the close of the plan year for
which the waiver is requested. The Ser-
vice cannot extend this statutory deadline.
A request for a waiver with respect to a
multiemployer plan generally must be sub-
mitted no later than the close of the plan
year following the plan year for which the
waiver is requested.
In seeking a waiver with respect to a
plan year which has not yet ended, the ap-
plicant may have difficulty in furnishing
sufficient current evidence in support of
the request. For this reason it is gener-
ally advised that a request not be submit-
ted earlier than 180 days prior to the end
February 17, 20044942004-7 I.R.B.

of the plan year for which the waiver is re-
quested.
SECTION 5. GENERAL
Employers who have difficulty in fur-
nishing the information specified in this
Revenue Procedure may call the Em-
ployee Plans Customer Assistance Service
at 1–877–829–5500 (a toll–free number),
or write for guidance at the following ad-
dress:
Internal Revenue Service
Commissioner, TE/GE
Attention: SE:T:EP:RA:T:A
1111 Constitution Avenue, N.W.
Washington, D.C. 20224
Additional information sent after the ini-
tial request should be sent to the Actuarial
Group. In appropriate instances, prelim-
inaryconferencesmaybeaffordedinad-
dition to conferencesavailable under Rev.
Proc. 2004–4, 2004–1 I.R.B. 125.
SECTION 6. BANKRUPTCY
PETITIONS
If the applicant or a significant num-
berofcontrolledgroupmembersfilea
bankruptcy petition after the request for a
waiver of the minimum funding standard
is submitted to the Service, the applicant
must provide to the Service an update to
the information required to be submitted in
section 2 of this revenue procedure, espe-
cially the financial information in section
2.03(4).
SECTION 7. EFFECTIVE DATE
This revenue procedure is effective for
all ruling requests received after February
17, 2004, the date of its publication in the
Internal Revenue Bulletin.
SECTION 8. EFFECT ON OTHER
REVENUE PROCEDURES
Rev. Proc. 2004–4 is modified to the
extent that this revenue procedure provides
special procedures for issuing rulings with
respect to requests for waivers of the min-
imum funding standard.
Rev. Proc. 2004–5 is modified to the
extent that this revenue procedure provides
special procedures for furnishing technical
advice to Determinations managers when
both a request for a waiver of the minimum
funding standard and a request for a deter-
mination letter have been submitted for a
defined contribution plan.
Rev. Proc. 2004–6 is modified to the
extent that this revenue procedure provides
special proceduresto follow in issuing a
determination letter for a defined contribu-
tion plan if a waiver of the minimum fund-
ing standard has been requested.
Rev. Proc. 94–41, 1994–1 C.B. 711, is
superseded
SECTION 9. PAPERWORK
REDUCTION ACT
The collection of information con-
tained in this revenue procedure has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act (44
U.S.C. § 3507) under control number
1545–1873.
An agency may not conduct or sponsor,
and a person is not required to respond
to, a collection of information unless the
collection of information displays a valid
control number.
The collection of information in this
revenue procedure is in sections 2 and 3.
This information is required to evaluate
and process the request for a change in
funding method. The collection of infor-
mation is required to obtain approval for
a change in funding method. The likely
respondents are businesses or other for-
profit institutions, nonprofit institutions,
and small businesses and organizations.
The estimated total annual reporting
burden is 4,730 hours.
The estimated annual burden per re-
spondent varies from 75 to 100 hours,
depending on individual circumstances,
with an estimated average burden of 86
hours. The estimated number of respon-
dents and/or recordkeepers is 55.
The estimated annual frequency of re-
sponses is one.
Books or records relating to a collection
of information must be retained as long
as their contents may become material in
the administration of any internal revenue
law. Generally, tax returns and tax return
information are confidential, as required
by 26 U.S.C. § 6103.
DRAFTING INFORMATION
The principal author of this revenue
procedure is John C. Heil of the Employee
Plans, Tax Exempt and Government En-
tities Division. For further information
regarding how this revenue procedure ap-
plies to employee plans matters, contact
the Employee Plans Customer Assistance
Service at 1–877–829–5500 (a toll-free
call). Mr. Heil’s telephone number is
(202) 283–9694 (not a toll-free call).
2004-7 I.R.B.495February 17, 2004

APPENDIX A
MODEL NOTICE OF FUNDING WAIVER APPLICATION
TO EMPLOYEE ORGANIZATIONS (UNIONS),
PARTICIPANTS, BENEFICIARIES, AND ALTERNATE PAYEES
This notice is to inform you that an application for a waiver of the minimum funding standard under § 412(d) of the Internal
Revenue Code (Code) and section 303 of the Employee Retirement Income Security Act of 1974 (ERISA) has been submitted by
[INSERT PLAN SPONSOR'S NAME] to the Internal Revenue Service (Service) for the [INSERT PLAN NAME] for the plan
year beginning [INSERT DATE].
Under § 412(f)(4)(B) of the Code and section 303(e)(2) of ERISA,the Service will consider any relevant information submitted
concerning this application for a waiver of the minimum funding standard. You may send this information to the following address:
Director, Employee Plans
Internal Revenue Service
Attention: SE:T:EP:RA:T:A
1111 Constitution Avenue, N.W.
Washington, D.C. 20224
Any such information should be submitted as soon as possibleafter you have received this notice. Due to the disclosure
restrictions of § 6103 of the Code, the Service can not provide any information with respect to the waiver request itself.
In accordance with section 104 of ERISA and § 2520.104b–10 of the Department of Labor Regulations (29 C.F.R. Part 2520),
annual financial reports for this plan, which include employer contributions made to the plan and the accumulated funding
deficiency for the plan for any plan year, are available for inspection at the Department of Labor in Washington, D.C. Copies of
such reports may be obtained upon request and upon payment of copying costs from the following address:
Public Disclosure Room
Room N–5507
Employee Benefits Security Administration
U.S. Department of Labor
200 Constitution Avenue, N.W.
Washington, D.C. 20210
As required by section 104(b)(2) of ERISA, copies of the latest annual plan report are available for inspection at the principal
office of the plan administrator, who is located at [INSERT ADDRESS]. Copies of the annual report may be obtained upon
request and upon payment of a copying charge of [INSERT CHARGE] by writing to the plan administrator at the above address.
The following information is provided pursuant to § 412(f)(4)(A) of the Code and section 303(e)(1) of ERISA:
Present Value of Vested Benefits $
Present Value of Benefits, calculated as though the plan terminated $
Fair Market Value of Plan Assets $
The above present values were calculated using an interest rate of [INSERT INTEREST RATE].
[SIGNATURE OF APPROPRIATE OFFICER OF THE PLAN SPONSOR]
[INSERT NAME]
[INSERT TITLE]
February 17, 20044962004-7 I.R.B.

APPENDIX B
WAIVER OF MINIMUM FUNDING STANDARD REQUEST CHECKLIST
IS YOUR SUBMISSION COMPLETE?
INSTRUCTIONS
The Service will be able to respond more quickly to your waiverof minimum funding standard request if it is carefully prepared
and complete. To ensure your request is in order, use this checklist. Answer each question in the checklist by inserting Y for yes,
N for no, or N/A for not applicable, as appropriate, in the blank next to the item.Sign and date the checklist (as taxpayer or
authorized representative) andplace it on top of your request.
You must submit a completed copy of this checklist with your request. If a completed checklist is not submitted with your request,
substantive consideration of your submission will be deferred until a completed checklist is received.
1. If you want to designate an authorized representative, have you included a properly executed Form 2848
(Power of Attorney and Declaration of Representative)?
2. Have you satisfied all the requirements of Rev. Proc. 2003–4 or its successors(especially concerning
signatures and penalties of perjury statement)? (See section 2.02(1) & (2))
3. Have you included statement of proposed deletions? (See §2.02(3))
4. Have you included the user fee required under Rev. Proc. 2003–8 or its successors? (See section 2.01 &
2.02(3))
5. Have you included a copy of the written notification that an application for a waiver has been submitted
and a statement that such notice was delivered to each employee organization, participant, beneficiary and
alternate payee? (See section 2.02(4) and Appendix A)
6. Have you included the general facts concerning the employer? (See section 2.03(1))
7. Have you included a description of the employer’s financial condition? (See section 2.03(2)).
8. If the plan is not a multiemployer plan, have you included a description of the employer’s executive
compensation arrangements? (See section 2.03(3))
9. Have you included an explanation of the nature and extent of the business hardship, including financial
projections if the waiver requestexceeds $1,000,000 and the plan is not a multiemployer plan? (See sec-
tion 2.03(4))
10. Have you included information concerning the pension plan? (See section 2.03(5))
11. Have you included information concerning other pension, profit-sharing, or stock bonus plans of the
employer? (See section 2.03(6))
12. Have you included information concerning other matters pertaining to the plan? (See section 2.03(7))
2004-7 I.R.B.497February 17, 2004

13. Have you provided a digest of financial information? (See section 2.03(8))
14. Have you provided 2 copies of the necessary waiver information described in section 2.03 if the waiver
request exceeds $1,000,000? (See section 2.04)
15. If the waiver request pertains to a defined contribution pension plan, have you provided a copy of the
plan amendment or determination letter request, if applicable? (See section 3.01–3.04)
16. Have you submitted the request for a waiver no later than the 15
th
day of the 3
rd
month following
the close of the plan year if the plan is not a multiemployer plan, or no later than the close of the plan year
following the plan year for which the waiver is requested if the plan is a multiemployer plan? (See section 4)
SignatureDate
Title or Authority
Typed or printed name of person signing checklist
February 17, 20044982004-7 I.R.B.

Part IV. Items of General Interest
Announcement of Disciplinary Actions Involving
Attorneys, Certified Public Accountants, Enrolled Agents,
and Enrolled Actuaries — Suspensions, Censures,
Disbarments, and Resignations
Announcement 2004-6
Under Title 31, Code of Federal Regu-
lations, Part 10, attorneys, certified public
accountants, enrolled agents, and enrolled
actuaries may not accept assistance from,
or assist, any person who is under disbar-
ment or suspension from practice before
the Internal Revenue Service if the assis-
tance relates to a matter constituting prac-
tice before the Internal Revenue Service
and may not knowingly aid or abet another
person to practice before the Internal Rev-
enue Service during a period of suspen-
sion, disbarment, or ineligibility of such
other person.
To enable attorneys, certified public
accountants, enrolled agents, and enrolled
actuaries to identify persons to whom
these restrictions apply, the Director, Of-
fice of Professional Responsibility will
announce in the Internal Revenue Bulletin
their names, their city and state, their pro-
fessional designation, the effective date
of disciplinary action, and the period of
suspension. This announcement will ap-
pear in the weekly Bulletin at the earliest
practicable date after such action and will
continue to appear in the weekly Bulletins
for five successive weeks.
Disbarments From Practice Before the Internal Revenue
Service After Notice and an Opportunity for a Proceeding
Under Title 31, Code of Federal Regu-
lations, Part 10, after notice and an oppor-
tunity for a proceeding before an adminis-
trative law judge, the following individu-
als have been disbarred from practice be-
fore the Internal Revenue Service:
NameAddressDesignationEffective Date
Baxley II, MiltonGainesville, FLCPAOctober 24, 2003
Consent Suspensions From Practice Before the Internal
Revenue Service
Under Title 31, Code of Federal Regu-
lations, Part 10, an attorney, certified pub-
lic accountant, enrolled agent, or enrolled
actuary, in order to avoid institution or con-
clusion of a proceeding for his or her dis-
barment or suspension from practice be-
fore the Internal Revenue Service, may of-
fer his or her consent to suspension from
such practice. The Director, Office of Pro-
fessional Responsibility, in his discretion,
may suspend an attorney, certified public
accountant, enrolled agent or enrolled ac-
tuary in accordance with the consent of-
fered.
The following individuals have been
placed under consent suspension from
practice before the Internal Revenue Ser-
vice:
NameAddressDesignationDate of Suspension
Nietupski, John E.Springfield, MAEnrolled AgentIndefinite
from
October 15, 2005
Roberts, Dennis C.Oklahoma City, OKAttorneyIndefinite
from
October 27, 2003
2004-7 I.R.B.499February 17, 2004

NameAddressDesignationDate of Suspension
Waldo-Grant, Barbara A.Grand Rapids, MIEnrolled AgentIndefinite
from
November 1, 2003
Naylor, Dale C.El Cajon, CAEnrolled AgentIndefinite
from
November 12, 2003
Schlude, Richard M.Wilkes Barre, PAEnrolled AgentIndefinite
from
November 19, 2003
Stern, Samuel L.Robbinsdale, MNAttorneyIndefinite
from
November 19, 2003
Robles, MichaelDallas, TXCPAIndefinite
from
December 1, 2003
Young Jr., Donald A.Redondo Beach, CAEnrolled AgentDecember 1, 2003
to
August 31, 2004
Hitchcock, William C.Irvine, CAEnrolled AgentIndefinite
from
December 30, 2003
Willms, Bryant E.Lee Summit, MOEnrolled AgentJanuary 1, 2004
to
December 31, 2004
Expedited Suspensions From Practice Before the Internal
Revenue Service
Under Title 31, Code of Federal Regu-
lations, Part 10, the Director, Office of Pro-
fessional Responsibility, is authorized to
immediately suspend from practice before
the Internal RevenueService any practi-
tioner who, within five years from the date
the expedited proceeding is instituted (1)
has had a license to practice as an attor-
ney, certified public accountant, or actuary
suspended or revoked for cause or (2) has
been convicted of certain crimes.
The following individuals have been
placed under suspension from practice be-
fore the Internal Revenue Service by virtue
of the expedited proceeding provisions:
NameAddressDesignationDate of Suspension
Greene, MarvinChicago, ILCPAIndefinite
from
October 21, 2003
Bolusky, Eric B.Perkins, OKAttorneyIndefinite
from
October 21, 2003
Crutchfield Jr., ErnestLatty, OHEnrolled AgentIndefinite
from
October 21, 2003
February 17, 20045002004-7 I.R.B.

NameAddressDesignationDate of Suspension
Covey, CharlesGladstone, MOCPAIndefinite
from
October 23, 2003
Prosperi, Arnold P.Jupiter Island, FLAttorneyIndefinite
from
November 24, 2003
Lucas, ChristopherOverlandPark, KSAttorneyIndefinite
from
November 24, 2003
Ramsey, Henry A.Burnet, TXCPAIndefinite
from
December 15, 2003
Resignations of Enrolled Agents
Under Title 31, Code of Federal Regu-
lations, Part 10, an enrolled agent, in or-
der to avoid the institution or conclusion
of a proceeding for his or her disbarment
or suspension from practice before the In-
ternal Revenue Service, may offer his or
her resignation as an enrolled agent. The
Director, Office of Professional Responsi-
bility, in his discretion, may accept the of-
fered resignation.
The Director, Office of Professional
Responsibility, has accepted offers of res-
ignation as an enrolled agent from the
following individuals:
NameAddressDate of Resignation
Pettyplace, Edward F.Sacramento, CAJanuary 30, 2004
Guidance Under Section
1502; Suspension of Losses
on Certain Stock Dispositions;
Correction
Announcement 2004–10
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to final and tempo-
rary regulations.
SUMMARY: This document corrects fi-
nal and temporary regulations (T.D. 9048,
2003–1 C.B. 644 [68 FR 12287]) pub-
lished in theFederalRegister on March
14, 2003. The final and temporary reg-
ulations redetermine the basis of stock
of a subsidiary member of a consoli-
dated group immediately prior to certain
transfers of such stock and certain decon-
solidations of a subsidiary member and
also suspend certain losses recognized on
the disposition of stock of a subsidiary
member.
DATES: This document is effective on
March 14, 2003.
FOR FURTHER INFORMATION
CONTACT: Aimee K. Meacham, (202)
622–7530 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The final and temporary regulations
(T.D. 9048) that are the subject of these
corrections are under section 1502 of the
Internal Revenue Code.
Need for Correction
As published, the final and temporary
regulations (T.D. 9048) contain errors
that may prove to be misleading and are
in need of clarification. In particular,
this document supplies text clarifying
§ 1.1502–35T(c)((5)(i).
Correction of Publication
Accordingly, the publication of the final
and temporary regulations (T.D. 9048) that
were the subject of FR. Doc. 03–6119, is
corrected as follows:
2004-7 I.R.B.501February 17, 2004

§ 1.1502–35T [Corrected]
1.On page 12294, column 1,
§ 1.1502–35T(c)(5)(i), line 8 from the
bottom of the paragraph, the language
“subsidiary (or any successor) is not a”
is corrected to read “subsidiary (and any
successor) is not a”.
La Nita Van Dyke,
Acting Chief, Publications
and Regulations Branch,
Legal Processing Division,
Associate Chief Counsel (Procedure
and Administration).
(Filed by the Office of the Federal Register on January 12,
2004, 8:45 a.m., and published in the issue of the Federal
Register for January 13, 2004, 69 F.R. 1918)
February 17, 20045022004-7 I.R.B.

Definition of Terms
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
fact situation set forth therein. Thus, if
an earlier ruling held that a principle ap-
plied to A, and the new ruling holds that the
same principle also applies to B, the earlier
ruling is amplified. (Compare withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies to both A
and B, the prior ruling is modified because
it corrects a published position. (Compare
withamplifiedandclarified, above).
Obsoleteddescribes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is self
contained. In this case, the previously pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names in
subsequent rulings. After the original rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis used in rare situations
to show that the previous published rul-
ings will not be applied pending some
future action such as the issuance of new
or amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
DC—Dummy Corporation.
DE—Donee.
Del. Order
—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
2004-7 I.R.B.iFebruary 17, 2004

Numerical Finding List
1
Bulletins 2004–1 through 2004–7
Announcements:
2004-1, 2004-1 I.R.B.254
2004-2, 2004-3 I.R.B.322
2004-3, 2004-2 I.R.B.294
2004-4, 2004-4 I.R.B.357
2004-5, 2004-4 I.R.B.362
2004-6, 2004-3 I.R.B.322
2004-7, 2004-4 I.R.B.365
2004-8, 2004-6 I.R.B.441
2004-9, 2004-6 I.R.B.441
2004-10, 2004-7 I.R.B.501
Notices:
2004-1, 2004-2 I.R.B.268
2004-2, 2004-2 I.R.B.269
2004-3, 2004-5 I.R.B.391
2004-4, 2004-2 I.R.B.273
2004-5, 2004-7 I.R.B.489
2004-6, 2004-3 I.R.B.308
2004-7, 2004-3 I.R.B.310
2004-8, 2004-4 I.R.B.333
2004-9, 2004-4 I.R.B.334
2004-10, 2004-6 I.R.B.433
2004-11, 2004-6 I.R.B.434
Proposed Regulations:
REG-116664-01, 2004-3 I.R.B.319
REG-122379-02, 2004-5 I.R.B.392
REG-139845-02, 2004-5 I.R.B.397
REG-126459-03, 2004-6 I.R.B.437
REG-156232-03, 2004-5 I.R.B.399
Revenue Procedures:
2004-1, 2004-1 I.R.B.1
2004-2, 2004-1 I.R.B.83
2004-3, 2004-1 I.R.B.114
2004-4, 2004-1 I.R.B.125
2004-5, 2004-1 I.R.B.167
2004-6, 2004-1 I.R.B.197
2004-7, 2004-1 I.R.B.237
2004-8, 2004-1 I.R.B.240
2004-9, 2004-2 I.R.B.275
2004-10, 2004-2 I.R.B.288
2004-11, 2004-3 I.R.B.311
2004-13, 2004-4 I.R.B.335
2004-14, 2004-7 I.R.B.489
2004-15, 2004-7 I.R.B.490
Revenue Rulings:
2004-1, 2004-4 I.R.B.325
2004-2, 2004-2 I.R.B.265
2004-3, 2004-7 I.R.B.486
Revenue Rulings— Continued:
2004-4, 2004-6 I.R.B.414
2004-5, 2004-3 I.R.B.295
2004-6, 2004-4 I.R.B.328
2004-7, 2004-4 I.R.B.327
2004-9, 2004-6 I.R.B.428
2004-10, 2004-7 I.R.B.484
2004-11, 2004-7 I.R.B.480
2004-12, 2004-7 I.R.B.478
2004-13, 2004-7 I.R.B.485
Tax Conventions:
2004-3, 2004-7 I.R.B.486
Treasury Decisions:
9099, 2004-2 I.R.B.255
9100, 2004-3 I.R.B.297
9101, 2004-5 I.R.B.376
9102, 2004-5 I.R.B.366
9103, 2004-3 I.R.B.306
9104, 2004-6 I.R.B.406
9105, 2004-6 I.R.B.419
9106, 2004-5 I.R.B.384
9107, 2004-7 I.R.B.447
9108, 2004-6 I.R.B.429
1
A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2003–27 through 2003–52 is in Internal Revenue Bulletin
2003–52, dated December 29, 2003.
February 17, 2004ii2004-7 I.R.B.

Findings List of Current Actions on
Previously Published Items
1
Bulletins 2004–1 through 2004–7
Proposed Regulations:
REG-115037-00
Corrected by
Ann. 2004-7, 2004-4 I.R.B.365
REG-143321-02
Withdrawn by
REG-156232-03, 2004-5 I.R.B.399
REG-146893-02
Corrected by
Ann. 2004-7, 2004-4 I.R.B.365
Revenue Procedures:
94-41
Superseded by
Rev. Proc. 2004-15, 2004-7 I.R.B.490
2000-38
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2000-50
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2002-9
Modified by
Rev. Proc. 2004-11, 2004-3 I.R.B.311
2002-71
Superseded by
Rev. Proc. 2004-13, 2004-4 I.R.B.335
2003-1
Superseded by
Rev. Proc. 2004-1, 2004-1 I.R.B.1
2003-2
Superseded by
Rev. Proc. 2004-2, 2004-1 I.R.B.83
2003-3
As amplified by Rev. Proc. 2003-14, and as
modified by Rev. Proc. 2003-48 superseded by
Rev. Proc. 2004-3, 2004-1 I.R.B.114
2003-4
Superseded by
Rev. Proc. 2004-4, 2004-1 I.R.B.125
2003-5
Superseded by
Rev. Proc. 2004-5, 2004-1 I.R.B.167
2003-6
Superseded by
Rev. Proc. 2004-6, 2004-1 I.R.B.197
Revenue Procedures— Continued:
2003-7
Superseded by
Rev. Proc. 2004-7, 2004-1 I.R.B.237
2003-8
Superseded by
Rev. Proc. 2004-8, 2004-1 I.R.B.240
2003-23
Modified and superseded by
Rev. Proc. 2004-14, 2004-7 I.R.B.489
2004-1
Corrected by
Ann. 2004-8, 2004-6 I.R.B.441
2004-4
Modified by
Rev. Proc. 2004-15, 2004-7 I.R.B.490
2004-5
Modified by
Rev. Proc. 2004-15, 2004-7 I.R.B.490
2004-6
Modified by
Rev. Proc. 2004-15, 2004-7 I.R.B.490
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2003–27 through 2003–52 is in Internal Revenue Bulletin 2003–52, dated December 29,
2003.
2004-7 I.R.B.iiiFebruary 17, 2004
*U.S. G.P.O.: 2004—304–774/60122